Potomac bathing beach
Ilargi: The good folks at Clusterstock produce another great graph today, but fail a little in the interpretation. Which I think is required, because the data are startling if you look closely.
American Cars Aren't American Anymore
The government won't let the Detroit car companies die because they're part of our history, and it's a matter of national pride. But we do have successful car manufacturing in this country. As this chart shows, we're nearly at the point where transplant (Toyota, Honda, Nissan, etc.) American production is surpassing the domestic production of the Detroit Three. They may be called transplants, but they employ American workers, pay US taxes and have plenty of American shareholders. They're American in everything but the history.
Ilargi: Here's what I see in this graph:
- It puts total US vehicle production at 5 million in 2009, from 12 million into 2002! But then, out of the blue, it predicts a rise to 6 million in 2010.
I think not, and I see nothing that points in that direction. It's empty data without better explaining. Green shoots, but not perennials.
- In 2002, the Detroit Big 3 produced 80% of 12 million cars, or 9.6 million vehicles.
- In 2009, they will build just over 50% of a total production of 5 million cars, or roughly 2.6 million vehicles.
That is a plunge of about 73% in 7 years (No wonder they’re going bankrupt!)
In other words, a simple 2+2 says that GM needs to close 75% of its plants and lay off 3 out of every 4 workers.
- And: these numbers measure production, not sales, which could well be -much- worse.
- And also: the "transplant" foreign producers build as many cars now as they did in 2000, so (bit of crude math) ALL losses are American.
- And: annual sales projections are now below 10 million vehicles, so only half of cars sold are actually made in America.
I read headlines today saying that US car sales were down less than expected, around 30%. A "less than expected" drop in sales? It's time to wonder how much further can they fall before you get the Detroit Big 0.
It's also time to start realizing that many of the numbers that are "better than expected", and lead to the market surge and the green shoots talk, are so only because all the fat has been cut off the bone. There's a myriad of categories we see everyday where nothing can be shaved off anymore before for example businesses will simply have to close, since you can run a store with a few less hands, but not with none. The first cuts are always far easier than the subsequent ones, and we risk forgetting that simple principle.
US pending home sales surge; mixed news for autos
Pending sales of previously owned U.S. homes shot up by 6.7 percent in April, the biggest monthly gain in 7-1/2 years, according to a report on Tuesday that buttressed views the U.S. recession was easing. And separate reports showing that U.S. auto sales fell by about 30 percent in May from last year provided another glimmer of optimism, with sales looking likely to beat analysts' modest expectations for the battered sector.
The National Association of Realtors said its Pending Home Sales Index, based on new sales contracts, rose to 90.3 in April from 84.6 in March. It was the third straight monthly increase and the largest jump since October 2001. The gain took the index 3.2 percent above its year-ago level, compared with economists' expectations for a rise of just 0.5 percent. "It's a very positive and encouraging number. It plays into the 'green shoots,' economy stabilization story," said William Hornbarger, senior fixed income strategist at Wachovia Securities in St. Louis.
The blue-chip Dow Jones industrial average rose for the fourth straight day on the housing news, with the Dow Jones home builder index gaining 2.7 percent. The dollar, a safe-haven currency that tends to fall when investors move into riskier assets, slid against the euro to a fresh low for the year on confidence that the worst of the recession was over. Prices for U.S. government bonds edged higher on bargain hunting.
While sales of existing homes have increased in recent months, nearly half involve properties that have gone through foreclosure or which have been sold for a loss -- evidence of the sector's underlying weaknesses. Tuesday's autos data showed that industry-wide sales for the month were on track to top 10 million units on the annualized basis tracked by analysts -- a better result than most economists had expected.
BOND YIELDS MENACE HOUSING A measure of housing affordability by the National Association of Realtors, based on home prices, mortgage rates and income, has reached record territory, with 30-year mortgage rates hovering near record lows with an abundance of homes on the market. But waning investor appetite for U.S. government debt that has pushed yields on the 10-year Treasury note sharply higher last week also threatens to drive up mortgage costs. Mortgage rates tend to move in tandem with yields on benchmark bonds.
Yields on the 10-year note reached as high as 3.75 percent last week, the highest level since mid-November. "Since (the Realtors') data was recorded, mortgage rates have started to move back up. That is something to be wary of going forward," said Lawrence Glazer, managing partner at Mayflower Advisors in Boston. The Federal Reserve has promised to invest $1.75 trillion to help push down borrowing costs.
The deep downturn in the U.S. housing market touched off a global credit crisis that sent economies worldwide tumbling into recession. Now, signs are emerging that the global economy is beginning to heal. An Ipsos/Reuters poll of 23,000 people in 23 countries found global consumer confidence was stabilizing after falling for 18 months, another hopeful sign for the world economy. Lawrence Yun, senior economist at the Realtors' trade group, credited improved home affordability and a new government program that provides an $8,000 tax credit for first-time homebuyers for the surge in U.S. buying activity.
Foreclosures: No End in Sight
A continuing steep drop in home prices combined with rising unemployment is powering a new wave of foreclosures. Unfortunately, there’s little evidence, so far, that the Obama administration’s anti-foreclosure plan will be able to stop it. The plan offers up to $75 billion in incentives to lenders to reduce loan payments for troubled borrowers. Since it went into effect in March, some 100,000 homeowners have been offered a modification, according to the Treasury Department, though a tally is not yet available on how many offers have been accepted.
That’s a slow start given the administration’s goal of preventing up to four million foreclosures. It is even more worrisome when one considers the size of the problem and the speed at which it is spreading. The Mortgage Bankers Association reported last week that in the first three months of the year, about 5.4 million mortgages were delinquent or in some stage of foreclosure. Not all of those families will lose their homes. Some will find the money to catch up on their payments. Others will qualify for loan modifications that allow them to hang on. But as borrowers become more hard pressed, lenders — whose participation in the Obama plan is largely voluntary — may not be able or willing to keep up with the spiraling demand for relief.
One of the biggest problems is that the plan focuses almost entirely on lowering monthly payments. But overly onerous payments are only part of the problem. For 15.4 million “underwater” borrowers — those who owe more on their mortgages than their homes are worth — a lack of home equity puts them at risk of default, even if their monthly payments have been reduced. They have no cushion to fall back on in the event of a setback, like job loss or illness.
This page has long argued that a robust anti-foreclosure plan should directly address the plight of underwater homeowners by reducing the loans’ principal balance. That would restore some equity to borrowers — and give them a further incentive to hold on to their homes — in addition to lowering monthly payments. The mortgage industry has resisted this approach, and the Obama plan does not emphasize it.
With joblessness rising, lower monthly payments could quickly become unaffordable for many Americans. In a recent report, researchers at the Federal Reserve Bank of Boston argued that unemployment is driving foreclosures and to make a difference, anti-foreclosure policy should focus on helping unemployed homeowners. The report suggests a temporary program of loans or grants to help them pay their mortgages while they look for another job.
The government will also have to make far more aggressive efforts to create jobs. The federal stimulus plan will preserve and generate a few million jobs, but that will barely make a dent — in the overall economic crisis or the foreclosure disaster. Since the recession began in December 2007, nearly six million jobs have been lost, and millions more are bound to go missing before this downturn is over. President Obama needs to put more effort and political capital into promoting the middle-class agenda that he outlined during the campaign, including a push for new jobs in new industries, expanded union membership and a fairer distribution of profits among shareholders, executives and employees.
There will be no recovery until there is a halt in the relentless rise in foreclosures. Foreclosures threaten millions of families with financial ruin. By driving prices down, they sap the wealth of all homeowners. They exacerbate bank losses, putting pressure on the still fragile financial system. Lower monthly payments are a balm, but they are no substitute for home equity. And until more Americans can find a good job and a steady paycheck, the number of foreclosures will continue to rise.
Commercial Real Estate — the Economy's Anvil
Commercial real estate may soon bulldoze the green shoots. A coming wave of defaults on loans to developers of condominiums, office buildings and malls could do significant damage to the already deflating economy. That was the overwhelming concern expressed at a public hearing of the Congressional Oversight Panel (COP) on Thursday that focused on corporate and commercial real estate lending. The COP was set up last fall as part of legislation that gave the Treasury Department permission to spend $700 billion to rescue the nation's ailing financial system.
The panel, which is headed by Harvard Law professor Elizabeth Warren, has no legislative or official regulatory powers. It is supposed to monitor the Treasury's spending and report back to Congress as to whether it is being effective in boosting lending and shoring up the financial sector. Thursday's hearing was one of a number of public forums the COP is hosting on different segments of the lending market. Warren is often criticized for being too critical of banks and their lending practices. But at the hearing on commercial real estate, Warren focused on how big a problem future loan defaults will be and what should be done about them.
She got an earful. Richard Parkus, an analyst at Deutsche Bank, said he thought two-thirds of all commercial real estate loans due in the next few years — hundreds of billions of dollars' worth — could go bust. Jeffrey DeBoer, president of trade group the Real Estate Roundtable, fretted that problems in the lending business could cost the nation thousands more construction and real estate jobs. Next up, Congressman Jerrold Nadler of New York expressed worry that the country was headed for a lost decade of economic stagnation.
There were not many solutions offered. Nadler said he thought the government should create new banks, which, unencumbered by souring loans, would boost lending. Nadler said he thought private investors would be interested in helping fund the new banks. A number of the panelists thought the government's TALF and PPIP programs meant to boost lending were helpful but not the answer. Parkus said he thought extending the terms of commercial loans set to default would only delay the problem and make it worse. As more and more bad loans pile up, he predicted, it will become progressively harder for any of them to get refinanced.
What is clear from the hearing is that commercial real estate could turn out to be a much bigger problem for banks and the economy than the Treasury Department, the Federal Reserve and other bank regulators seem to believe. "The question is, What percentage of commercial real estate loans will have trouble refinancing?" Parkus said at the COP hearing. "It is likely to be a big problem." How big? In the government's recent bank stress test, examiners predicted that commercial real estate loan losses for the 19 largest banks in the nation would be far less than the value of home loans that go unpaid in the next two years — $53 billion vs. $185 billion.
But Warren said she thought the two-year horizon of the government stress test may have understated the size of the banks' commercial real estate problem. The government assumed different default rates for each of the 19 banks for commercial real estate and other types of loans. Warren said the government had not given much information as to what determined the default rate used for each bank; she plans to release a report on the stress test in early June.
Parkus concurred that the stress tests probably went too light on potential losses. He expects that a little over $1 trillion in commercial real estate loans will be up for refinancing in the next four years. Because of falling real estate prices and lower rental incomes, he said, as many as two-thirds of those loans may not be eligible for refinancing and could end in default.
Kevin Pearson, executive vice president of M&T Bank, said he thinks banks will be able to avoid many of those loan losses through loan modifications or "through blocking and tackling," as he put it. Parkus, though, said that outlook was too positive. He countered that banks will have a very tough time refinancing the poor loans they made at the height of the credit bubble. "There are very large losses embedded in the system," he said.
Global Crisis 'Inevitable' Unless U.S. Starts Saving
Another global financial crisis triggered by a loss of confidence in the dollar may be inevitable unless the U.S. saves more, said Yu Yongding, a former Chinese central bank adviser. It’s “very natural” for the world to be concerned about the U.S. government’s spending and planned record fiscal deficit, Yu said in e-mailed comments yesterday relating to a visit to Beijing by U.S. Treasury Secretary Timothy Geithner. The Obama administration aims to reduce the fiscal deficit to “roughly” 3 percent of gross domestic product from a projected 12.9 percent this year, Geithner reaffirmed today.
The treasury secretary added that China’s investments in U.S. financial assets are very safe, and that the Obama administration is committed to a strong dollar. It may be helpful if “Geithner can show us some arithmetic,” said Yu. “We need to know how the U.S. government can achieve this objective.” The deficit is projected to reach $1.75 trillion in the year ending Sept. 30 from last year’s $455 billion shortfall, according to the Congressional Budget Office. The U.S. needs a higher savings rate and a smaller deficit on the current account, which is the broadest measure of trade, or “another financial crisis triggered by a dollar crisis could be inevitable,” the Chinese academic said.
The U.S. current account deficit fell to $673.3 billion or 4.74 percent of GDP last year from $731.2 billion, or 4.91 percent of GDP, the year earlier. China is the biggest foreign holder of U.S. Treasuries with $768 billion as of March. Premier Wen Jiabao called in March for the U.S. “to guarantee the safety of China’s assets.” Central bank Governor Zhou Xiaochuan has proposed a new global currency to reduce reliance on the dollar. Yu said U.S. tax revenue is not likely to increase in the short term because of low economic growth, inflexible expenditures and the cost of “fighting two wars.”
China wants to know how the U.S. will withdraw excess liquidity from its financial system “in a timely fashion so as to avoid inflation” when its economy recovers, said Yu, now a senior researcher at the government-backed Chinese Academy of Social Sciences. He questioned whether there would be enough demand to meet U.S. debt issuance this year. Referring to the Federal Reserve “as the world’s biggest junk investor,” and to Chairman Ben S. Bernanke as “helicopter Ben,” Yu said the Fed has dropped “tons of money from the sky since the subprime crisis.” “The balance sheet of the Federal Reserve not only has expanded like mad but is also ridden with ‘rubbish’ assets,” he said.
Western economies poised to account for less than 50% of world GDP in 2009
Western world economies will account for less than 50pc of global gross domestic product (GDP) this year, six years earlier than expected, a think-tank has warned. The Centre for Economics and Business Research (CEBR) is forecasting that because of the downturn and China's economic resilience, the combined contribution from the US, Canada and Europe to world GDP will be 49.4pc in 2009, down from 52pc in 2008. CEBR said prior to the financial crisis Western world GDP was not expected to fall below 50pc until 2015. The West's contribution to global GDP has been steadily falling since 2004, when it was about 60pc, but the recession has accelerated that process, CEBR said.
"The recession has brought forward the time when the non-Western economies produce more than half of world GDP, for the first time since the middle of the 19th century. We had expected this to happen, but not quite so soon. The West will have to start to get to grips with the fact that we are no longer dominant and cannot expect to have things our own way," said Douglas McWilliams, CEBR's chief executive. The think-tank predicts the West will account for just 45pc of the world economy by 2012, and expects global GDP to fall by 1.4pc this year, the first decline since 1946.
The global economy will start to grow again in the second half of 2009 but will moderate in 2010 as governments embark on "fiscal retrenchment," according to the CEBR. China will overtake Japan in 2009 to become the world's second largest economy in dollar terms, it said. "One of the factors causing the shift in shares of world GDP is the fact that the Chinese economy has bounced back rapidly," said Jörg Radeke, economist at CEBR. "This will have knock on effects on oil and commodity prices and is one reason why we are forecasting a price of oil of $80 a barrel in 2012," he added.
Oil Demand Falling Fast In Japan
Japan may be forced to shut more than a fifth of its refining capacity, at least 1 million barrels per day, in the next five years as oil demand falls faster than expected, the head of the country's top refiner said on Tuesday. Nippon Oil Corp President Shinji Nishio also told the Reuters Energy Summit that the company, after its planned merger with Nippon Mining, might shut in 200,000 bpd more capacity than originally planned by 2015, underscoring the rapid demand erosion in the world's No. 3 consumer. "I think we are likely to see an even faster decline than the government's projection," he said in Tokyo.
Japan's trade ministry projects oil sales will fall by an average annual 3.5 percent to 168.2 million kl (2.9 million bpd) in the year from April 2013, from a total 3.46 million bpd last year. It has the capacity to refine 4.8 million bpd. "Unless we cut the capacity by (1 million bpd), the nation's production will not be at an optimum level," he said. "When you think about the future beyond (2013), we will have to cut even further." Major Japanese refiners have slashed refinery production sharply in response to weakening demand, but relatively few have thus far mothballed capacity, despite a downturn in global profit margins that is likely to curtail hopes of shifting to exports.
Total oil sales in the year ended March 31 slumped 8 percent, the sixth straight year of decline, as the global economic crisis has slowed industrial activity, adding to already waning demand caused by an aging population, a shift toward smaller, fuel-efficient cars and drive to embrace greener energy sources. Nippon Oil will merge with smaller Nippon Mining Holdings next year, and plan to cut their capacity by about a fifth, or 400,000 bpd, by the end of March 2012.
"Considering that demand is declining at a faster speed than we had thought, 400,000 bpd may be not enough, and we have a scope for an additional need to cut around 200,000 bpd" by the end of March 2015, he said.
Nishio also said that the combined plant in Mizushima -- with four crude distillation units totalling 455,200 bpd -- was on a shortlist for closure, but declined to give more specifics amid growing speculation about which plants might be shuttered.
Nippon Oil shut its smallest 60,000 bpd Toyama refinery earlier this year, and has earmarked its 115,000 bpd Osaka refinery for conversion to an export-only plant through a venture with state-owned China National Petroleum Corp (CNPC). Nishio said Nippon Oil expected soon to finalise the Chinese venture that would give CNPC nearly half of the Osaka refinery, although he declined to give more details. The deal had been delayed to June or later from the initially planned April as global demand and profit margins slumped.
Japanese fall out of love with luxury
Japan’s trend-chasing office workers and ladies who lunch are giving up Louis Vuitton handbags and Chanel jackets for Zara dresses and Gap jeans, making what was a favourite market for luxury manufacturers into one of their biggest headaches. The downturn is forcing customers in Japan to scale back purchases of luxury goods, accelerating a long-term shift in consumer attitudes, according to a report by McKinsey, the consultants. “This is not a blip. This is a long-term shift in the market,” said Brian Salsberg, the author of a McKinsey report on the Japanese luxury goods market, the world’s second largest.
Sales of imported luxury goods suffered a 10 per cent drop last year to Y1,064bn ($11.1bn), according to a study published on Tuesday by Yano Research, a Japanese market research group. Yano Research forecast that the market would shrink further this year, falling below Y1,000bn to nearly half the peak of Y1,897bn in 1996 and then shrinking to levels last seen 20 years ago before it entered its era of strong growth. LVMH, the group with brands ranging from Moët to Louis Vuitton, reported an 18 per cent drop in sales in Japan in yen terms in the first quarter.
While luxury sales throughout the world are being hit by the recession, Mr Salsberg said that the implications of the latest slump for Japan were likely to be more serious and long-lasting. Japan became the world’s “only mass luxury market” in the 1980s and early 1990s, when Japanese consumers saw ownership of a Louis Vuitton bag or Hermes scarf as a middle-class rite of passage. But the growing confidence of shoppers in mixing and matching cheap and expensive products, coupled with competition from a growing array of luxury services such as spas and expensive restaurants, have robbed the brands of their hold on such spending.
Mr Salsberg said the brand makers, which created “a luxury bubble” with “a ridiculous number of store build-outs”, bore some blame for their predicament. He warned that they risked repeating the mistake in China.
China was the “growth story” for luxury but if makers flooded the market with stores as in Japan and people were able to buy such goods on every street corner, “the industry is going to destroy itself” there, he said.
10 reasons Terminators destroy 'Twitter-brains'
In the next "Terminator" sequel, Skynet will "send back" a new, more dangerous "Terminator," not another titanium killing machine but "Twitter Code." And after that, the "Tweet Code" will further limit communications between humanoids, from 140 words to 17 syllables, the length of a Zen koan but without the wisdom.Two more Skynet weapons further controlling us, destroying our humanity.
Why Twitter, why Tweet? Because both reflect a disturbing trend, the rapidly decreasing attention span and intelligence of the human brain. It's no match for Wall Street's version of the "Terminator's" Skynet that is rapidly expanding it's dominance over the public.
Seriously, Wall Street's Skynet has access to massive data bases on the behavior patterns of all humanoids: Transactions on securities, credit cards, loans, taxes, telephone calls, internet, and soon, all medical records, plus a financial innovation arsenal of quant algorithms and the K-Street network of 42,000 lobbyists gives Wall Street Skynet control of government, and absolute control of investors and our so-called democracy.
Folks, this is too real to make up. Less than a year ago, Wall Street banks were insolvent, near bankruptcy. Then in a swift "disaster capitalism" maneuver by Henry Paulson, Wall Street's Trojan Horse in Washington, they raided our Treasury and the Fed, while our clueless reps in Congress stood by.Eight short months later, Wall Street's back in "business as usual" with bigger salaries and bonuses, while taxpayers hold the bag for over $5 trillion in new debts, a record $546,668 per household reports USA Today.
Wall Street Skynet and its arsenal of Terminators
Forget the metaphor; Wall Street is the real Skynet. And the Twitter/Tweet Codes are just a few of their many nanobots -- financial-innovation Terminators -- infiltrating the investor's brain, dulling our long-term reasoning powers, replacing them with new short-term irrational neurotoxins that will block their capacity to detect the broader strategies of the Wall Street Skynet Conspiracy.
That coupled with a memory purge is preventing us from assembling the "Resistance," a rebellion against Wall Street's version of Skynet.Wall Street is hypnotizing Main Street investors: That way we forget the past, embrace the illusions and are easier to manipulate. In a trance state, we'll be unable to resist them.If you don't believe me, here are the 10 nanobots anaesthetizing your brain.
They are inspired by one of America's greatest business writers, Stanley Bing, author of a few books in my library: "Crazy Bosses;" "Rome, Inc.;" "Sun Tzu Was a Sissy;" "100 Bullshit Jobs;" and "What Would Machiavelli Do? The End Justifies the Meanness."Bing writes a Fortune column. His latest, "Lessons We'll Forget," tells me that Wall Street Skynet is operational: "The moment the human animal is comfortable again, it immediately begins the important task of forgetting everything painful that has happened to it.
"The past two years were painful, like the Great Depression, yet the investor's attention span has become so short, we're forgetting the pain, even cheering Wall Street.So here's Bing's intriguing message, adapted for investors who are Terminator fans. Your memory will be purged now as you read about Wall Street Skynet's strategy. And that purge is setting up Great Depression 2, Wall Street's third crash of this century:
1. You'll forget ... that economists misled us, and will again
Bing says "economics is a bunch of bushwa" -- that's nonsense, BS, hype: "Economists are obviously not only behind the curve ... they are in many cases the cause of it." The memory purge is in progress. We see it in the recent upsurge in the "Consumer Sentiment Index," an resurgence of exuberance that says the masses are ready to be misled again.
2. You'll forget ... new crooks are plotting to steal your money
Our brains are designed to deny and suppress bad experiences. Bing says: "Next time this all happens, people will once again be surprised that the guy who ran the exchange [Madoff was Nasdaq chairman] is the person who also managed the Ponzi scheme." And you've already forgotten that megacrook, former Treasury Secretary Hank Paulson. His Ponzi scheme was 15 times bigger than Bernie's, and Congress didn't indict him.
3. You'll forget ... that regulators are also political hacks in disguise
Bing words: "The law is an ass ... Virtually all of the regulators and legislators who were supposed to be monitoring the finance industry were certainly lawyers, as were the lawmakers who were asleep at the switch." The truth is the SEC, CFTC, all staff lawyers and their lobbyists are just more "politicians" gaming the law for their personal gain. Once the bull's back and you're making a few bucks (on paper), you'll forget all this.
4. You'll forget ... bankers are stupid, and will make stupid loans
Whether it's Rome, the Dutch Tulip Bulb Bubble, the Panic of 1837, or the dot-com insanity, "every panic in history has been precipitated by the same stupid sequence of events." Cash-rich bankers back too many greedy speculators, overextend, run out of cash. Banks go broke. Markets crash. Why do they never learn? Because bankers have a gene that makes them not only greedy but "stupid," says Bing. And "as soon as nobody is looking they'll do so again." Worse, bankers "forget" even faster than investors do.
5. You'll forget ... that America's run by a powerful wealthy elite
About eight million billionaires and millionaires run America. This small minority own and control about 90% of America's total wealth: "They're not smarter. They're not happier. They just know how the game is played and, for the most part, what to do to stay there. Sometimes everybody forgets that the whole thing is designed to keep the powerful in power and the rich in their McMansions." The other 300 million have no real power because America is not a democracy: "We'll forget that, of course, as soon as the markets simmer down."
6. You'll forget ... that the news is just another Wall Street 'Terminator'
Fewer newspapers, fewer reporters and "more blogspit" means "everything will only get worse" with the news, says Bing. "At the height of our troubles, the food chain [still] goes from security analyst and quote monkey straight to the wires and blogs and directly to you. And you read it and think whatever occupies your brain pan for the most recent five minutes." Then five minutes later, another relentless data dump of Wall Street's mind-numbing propaganda is crammed into our overloaded brains. We either forget, or go mad.
7. You'll forget ... your anger, and you'll let them get away with it
The subtitle of Bing's "What Would Machiavelli Do" -- The End Justifies the Meanness -- reflects the viciousness in today's public dialogue: Anger drives people to rebel, to join a revolution, the resistance, take responsibility, fight back. Instead, we'll wimp out, forget.
8. You'll forget ... nothing lasts forever (except Wall Street's hype)
Nothing? Remember the 2004 election when Reaganomics was hot? When Rove talked of a "permanent GOP majority?" Later when Bush had "a lot of political capital and planned to spend it?" When the Dow roared above 14,000? Obama's riding high now. Beware, Bing says: Nothing lasts, "not good times and not bad times either." Nothing.
9. You'll forget ... what's really important as soon as the bull roars
There more to life than stocks, the economy, your career and a retirement portfolio. And no matter what, Bing says, you'll eat breakfast today. Just don't forget it tastes better with loved ones. They will always help you forget everything else, if you haven't already.
10. You'll forget ... you can fight back, but the will is gone
Bing ends gently: "We just forgot all this stuff. Stuff? What stuff?" ... fade to black.As investors forget the pain of the past couple years, our silence alone will crush the Main Street Resistance. At the peak of the dot-com insanity, on March 20, 2000, I posted a column: "Next Crash, sorry, you'll never hear it coming." Investors were deaf: Then again on March 24, 2004 we warned a second time. Same title. But Wall Street was deaf, let their disaster fester, adding fuel for the catastrophic credit meltdown in 2007.Warning: A third disaster is festering. The worst is yet to come.
Yale's Robert Shiller says: "We recently lived through two epidemics of excessive financial optimism. I believe we are close to a third episode, only this one will spread irrational pessimism and distrust -- not exuberance. If that happens, our economic problems will become much worse than they need to be, and our social problems will multiply."Bing's "Lessons We'll Forget," is a perfect explanation of the coming third episode. And we have no will to fight back. The Great Depression 2 coming in 2011 is our destiny because 95 million investors are forgetting the lessons of prior "episodes" ... and will do nothing.
Now relax and listen to this soft peaceful hypnotic voice: "Yes, relax as I count backwards from 10 to 1. When we reach 1 you will wake up refreshed, optimistic. You will forget all the bad warnings from Bing, Shiller and Farrell about past and future disasters. Just stay in the eternally blissful 'Now.' Once awake, you will only remember this one fact: 'Wall Street is a trusted friend'... you won't forget that now ... will you?"
Schwarzenegger Warns of Deadline to Plug California Budget Hole
California Gov. Arnold Schwarzenegger and the state's chief accountant Tuesday warned lawmakers that they have until June 15 to close the state's crippling budget deficit. If they miss the deadline, the state will run out of cash by the end of July, said state Controller John Chiang. That means Californians could see a repeat of this past winter, when officials delayed payments to welfare recipients, private contractors and local governments to keep the state solvent amid a budget impasse. "California's day of reckoning is here," Mr. Schwarzenegger said in an unusual address before a joint legislative session. "We have no time to waste."
The state faces a $24 billion deficit in a $92 billion general-fund budget, a result of plummeting tax revenue during a recession. This new shortfall is in addition to the $42 billion gap that lawmakers closed in February through steep cuts and new taxes.Lawmakers must pass a balanced budget by June 15 for the state to obtain its annual loans from Wall Street. To make its payments, California must borrow money almost every summer because it pays out most of its funds in the first half of the fiscal year, from July to December, and receives most of its revenue in the second half.
Mr. Chiang said in an interview that such loans take about a month to acquire. He said banks would be unwilling to lend to a state government that doesn't have a balanced budget, especially during an economic crisis. "If you or I went to the bank," he said, "without a plan to pay them back and asked for a loan, the bank would laugh at you." If lawmakers get locked into a budget impasse like the 15-week stalemate Sacramento faced last winter, and if the state can't obtain loans, Mr. Chiang said, he would have to delay payments to keep the state solvent.
Assembly Speaker Karen Bass told reporters that the legislature would likely need the rest of the month to close the entire deficit, but that lawmakers by June 15 could pass a partial solution that would allow the state to borrow the needed funds. In his address Tuesday, Mr. Schwarzenegger acknowledged the severity of his budget proposals. He has proposed major cuts to education, health care and prisons, and has called for shutting down the vast majority of state parks and eliminating popular health-care programs. "I've heard the demonstrations outside," said the Republican governor, referring to the waves of protesters who have visited the Capitol in recent days. "It is an awful feeling, but we have no choice."
Advocates for low-income Californians say they are stunned that the governor has proposed cutting welfare at so many levels. They point to the impact of the governor's proposals on people such as Carmen Ballina, a 29-year-old single mother in San Diego. Ms. Ballina receives $750 a month from the state to help take care of her two sons. If the governor's cuts become a reality, she would lose that stipend as well as specialized child care for her sons, who both have disabilities. "If these get cut, I'm going to have to figure how to get food for my children," Ms. Ballina said.
California Leads Nation to Bond Default Abyss
There is an old joke that a borrower dies if everyone stops believing in him. A look at the history of financial crises suggests there is a kernel of truth in this. That’s why the California budget crisis may well lead to a second financial calamity that would be far worse than anything experienced over the past 18 months. California is, of course, facing a debacle. Voters rejected a series of ballot initiatives designed to restore some sense of sanity to the state’s budget. As a result, California is more than $21 billion in the hole.
Governor Arnold Schwarzenegger is struggling to find enough spending reductions to close the gap, but investors are skeptical. According to Fitch Ratings, which in March downgraded California’s general obligation bond rating, California has the worst rating of any state. Even amid economic calamity, the people of California are relatively wealthy, and the state’s economy is an impressive engine. If California were a country, it would have the eighth- largest economy on Earth. Given those advantages, the notion that California might default on its government debt might seem farfetched. After all, the reasoning goes, they can always raise taxes to pay off debt. Even a gridlocked legislature might act if California gets too close to the edge.
The problem with that line of thinking is that California’s politicians might get little notice that desperate times are at hand. For some borrowers, the first sign of problem is their inability to make an interest payment. For others -- and here lies the nightmare scenario -- the problem first becomes visible when all the lenders disappear. Imagine, for example, that California returns to credit markets in the coming months simply to roll over some of its expiring debt. Maybe the state borrowed money from China for two years back in 2007 and now has to borrow again to give the Chinese their money back. What happens if, seeing the catastrophic budget situation, lenders decide to shun California altogether?
If that happens, California would have to default on its obligation to give the Chinese their money back. It might do so by extending the terms of the existing debt, but that would be, nonetheless, a default, and a run on California debt surely could ensue. Once a panic occurs, similar assets tend to be swept up in the wave. Bad news spreads. Witness the run that occurred during the Asian financial crisis of the late 1990s. So if the unofficial eighth-largest economy fails on its debt, might the debt for the largest economy go with it?
A look at President Barack Obama’s budget suggests that the U.S. government’s fiscal situation is in worse shape than California’s. The deficit relative to gross domestic product for the entire U.S. this year is 12.9 percent, according to White House estimates released last month. If California had the same deficit relative to its GDP, it would be short about $230 billion -- 10 times the size of its current shortfall. What’s worse, the Obama administration’s attitude toward economic policy comes right out of the California playbook.
Notwithstanding White House claims that the federal deficit will drop to 8.5 percent of GDP next year, there is little cause to believe that the U.S. faces a brighter future than California. That shouldn’t come as a surprise. The Democrats have controlled the California legislature for most of the past four decades. In spite of protestations by the occasional powerless Republican governor, the Democrats adopted economic policies that define left-wing nirvana.
Roughly 40 percent of California’s income-tax revenue comes from the much-harped-upon top 1 percent of earners. Thanks in part to the “millionaire tax” approved by voters in 2004, California’s income-tax rate has reached 10.55 percent on the highest earnings -- second only to Obama’s native Hawaii, which taxes some income at 11 percent. High tax rates on individuals, of course, hit many small businesses hard. If you wonder why the California economy is going so much worse than most of the country, this is a good place to start.
California has to answer for its treatment of corporations as well, socking them with an income-tax rate that is just shy of 9 percent. Since the U.S. federal rate is so high relative to our trading partners, corporations that operate in California face a combined local and federal tax rate higher than that of any other country. (Japan is a distant second.) In case you wondered, California’s sales tax is high, too. Most places in California, the combined city and state sales tax rate is more than 8 percent. California is in crisis because state spending is so high that even those hefty taxes aren’t enough to balance the budget.
Except for the sales tax, the Obama administration’s plan is to copy California’s policies. Obama has proposed a massive tax increase on U.S. corporations by curbing the deferral of taxes on corporate income earned abroad. He also has advocated higher marginal tax rates on the rich, by letting George W. Bush’s tax cuts expire. Even with those tax hikes, Obama projects that deficits are here to stay because, like California’s Democrats, Washington’s can’t resist increasing government spending. It is easy to see how investors might stop believing in California. If they do, it would be rational for the U.S. to be next.
Administration: Highway fund to go broke in August
The Obama administration is warning lawmakers that the trust fund that pays for highway construction will go broke in August unless Congress approves an infusion of as much as $7 billion. Sen. Barbara Boxer, chairman of the Senate Environment and Public Works Committee, said at a hearing Tuesday that the administration has told senators the Federal Highway Trust Fund will need an estimated $5 billion to $7 billion to keep current construction projects going.
The California Democrat said another $8 billion to $10 billion will be needed to keep the fund solvent through the year ending Sept. 30, 2010. Transportation Department spokeswoman Jill Zuckman confirmed those figures. "The administration is working closely with Congress to solve this difficult problem and ensure that states have the resources they need to maintain our roads and highways," Zuckman said. A decline in driving that began in late 2007 has reduced federal gas tax revenue, the primary source of trust fund dollars. The trust fund is separate from the $48 billion in transportation projects included in the economic recovery law enacted by Congress and signed by President Barack Obama earlier this year.
Congress approved an emergency transfer of $8 billion in general treasury dollars last fall to make up a projected shortfall — the first time in the program's history that had happened. The fund dates back to creation of the federal interstate highway program in 1956. Sen. George Voinovich, R-Ohio, said it's clear that Congress must raise the federal gas tax, which is now 18.4 cents per gallon. "I know that doesn't go down so well with some folks," but it's "the reality of the situation," Voinovich said at the hearing, which was on Obama's nomination of former Arizona highways director Victor Mendez to head the Federal Highway Administration. "That will be one of my highest priorities, to get on that very quickly," Mendez said of the trust fund.
The law that authorizes federal highway programs is due to expire at the end of September, but the issue hasn't been on Congress' front burner. There is a consensus among transportation experts and lawmakers that there will have to be some form of a tax increase — always unpopular, but especially so in a recession — to make up for the lower gas tax revenues and to address a backlog of crumbling and congested highways, bridges and public transit systems.
Two congressionally mandated commissions have called for an immediate increase in the gas tax. The first commission, which issued its report in early 2008, recommended a 40-cent per gallon hike. The second panel, which issued its report earlier this year, recommended the tax be increased 10 cents per gallon for gas and 15 cents per gallon for diesel, and that both be indexed to inflation. The two panels also said fuel taxes are not a sustainable source of revenue over the long term as drivers shift to more fuel efficient vehicles. Both panels recommended Congress find a new revenue source to pay for highway and transit programs.
Their top recommendation was to tax motorists based on how many miles they drive. That would require equipping cars and trucks with devices that use GPS technology to record not only how many miles the vehicle was driven, but whether the driving occurred on interstate highways or secondary roads and whether it was during peak travel periods. The device would calculate the amount of tax owed and the bill could be downloaded. A mileage-based tax system would take about 10 years to implement.
The FDIC Is Going Broke
The banking crisis is supposedly over, but outside of the big firms, the number of FDIC problem-institutions has continued to grow. Also, as you can see, the FDIC is now careening towards broke. At the end of March, it had just $13 billion in assets, or .27% of the total accounts it insures. With more bank failures on the way -- they're announced every Friday -- it's time for an FDIC bailout.
General Motors offloads Hummer to Chinese
A Chinese heavy machinery manufacturer is the bidder for General Motors' Hummer brand. Sichuan Tengzhong Heavy Industrial Machinery, a privately-owned Chinese company, is finalising the deal, which is expected to raise between $150 million and $250 million for the bust American carmaker. If successful, it will mark the first time a US car company has had a Chinese owner. Sichuan Tengzhong, which is owned by a group of private equity investors, is one of China's biggest industrial machinery groups, manufacturing road construction equipment and trucks.
The company is likely to agree to keep manufacturing Hummers in the US at least until 2012, saving about 3,000 US jobs at GM's former factories and dealerships. GM refused to reveal the identity of the buyer earlier today or the price achieved for the business, however, it said that it expected the sale to close by the end of the third quarter. It also disclosed that the buyer planned to "aggressively fund future Hummer product programmes". Under the terms of the deal, GM will continue to make Hummers and provide business services for Tengzhong for an undefined transition period, including an agreement that one assembly plant would continue to assemble vehicles to the end of next year at least.
The demand for the gas-guzzling, expensive Hummer has waned in recent years. GM sold 27,485 of the vehicles in the US last year, down 51 per cent on 2007. More recent models have been marketed to off-road enthusiasts rather than drivers. Troy Clarke, the president of GM North America, said: "I’m confident that Hummer will thrive globally under its new ownership. And for GM, this sale continues to accelerate the reinvention of GM into a leaner, more focused, and more cost-competitive automaker." The sale of Hummer follows a strategic review of the company's brands. It is also aiming to offload Saturn and Saab. Its Pontiac brand will be phased out.
GM said that 16 parties have registered interest in purchasing its Saturn brand and three are looking at Sweden's Saab. The restructured GM, which hopes to emerge from bankruptcy protection by the start of August, plans to concentrate on Chevrolet, Cadillac, Buick and GMC brands. Ray Young, chief financial officer of GM, said that there were 16 potential bidders looking at Saturn. He also said that talks with the Swedish Government over a bridge loan for Saab were progressing, while a buyer was located.
A Swedish court last Friday gave GM until August 20 to find a buyer for Saab, which is based in Trolhattan in Sweden and has been in bankruptcy protection since February 20. Having filed for bankruptcy, GM wants to sell its assets to a Government-funded company that will emerge from Chapter 11 as a new version of GM. Judge Robert Gerber, who is hearing GM's bankruptcy case in the US Bankruptcy Court in the Southern District of Manhattan, set the hearing for GM's asset sale for June 30. He also gave the company immediate access to $15 billion in financing from the Government. The Government has promised $30.1 billion to get GM through the restructuring process.
Taking Taxpayers on the Government Motors Ride
To: U.S. Taxpayer Aggressive Growth Fund shareholders (Class A)
From: Investor Relations, Obama Family of Funds
Re: New Investment in Government Motors
We are eager to tell you about the Obama Family of Funds' latest investment: a plan to take a majority stake in the country's largest automaker. As an American taxpayer, you need take no action and automatically will become a shareholder in the former General Motors Corp. or, as it can now accurately be called, Government Motors. We believe this investment nicely broadens the portfolio of your fund, which had been overweighted in financial services and underweighted in the automotive sector.
For those who may have missed it, your fund manager, Barack Obama, announced the latest investment yesterday from Government Motors' new world headquarters on Pennsylvania Avenue and 16th Street NW in downtown Washington. "Our government will be making a significant additional investment of about $30 billion in GM, an investment that will entitle American taxpayers to ownership of about 60 percent of the new GM," he reported.
While this is a high-risk investment, Obama and his deputy fund managers believe the steps they have taken to protect your capital and maximize your return will allow the U.S. Taxpayer Aggressive Growth Fund to continue to lead other taxpayer funds in the distressed-asset sector, including the Chávez Funds of Venezuela, the Chinese Large Cap Fund and the Putin Investment Advisers funds.
In his announcement, fund manager Obama first reviewed his successful investment in Chrysler. After a month in bankruptcy proceedings, he said, "a new, stronger Chrysler is poised to complete its alliance with Fiat." Other investment professionals, he explained, did not realize how high a return the Chrysler investment could produce. "Many experts said that quick surgical bankruptcy was impossible. They were wrong," Obama said. "Others predicted that Chrysler's decision to enter bankruptcy would lead to an immediate collapse in consumer confidence that would send car sales over a cliff. They were wrong as well. In fact, Chrysler sold more cars in May than it did in April."
The fund manager then explained how he and other investment professionals advised GM on its new business plan. "Working with my Auto Task Force, GM and its stakeholders have produced a viable, achievable plan that will give this iconic American company a chance to rise again," he said. "It's a plan tailored to the realities of today's auto market, a plan that positions GM to move toward profitability even if it takes longer than expected for our economy to fully recover."
In short, Obama said, "what we have, then, is a credible plan that is full of promise." At the Obama Family of Funds, we believe that our passionate pursuit of investment perfection will return GM to profitability and will once again prove to our clients that the Obama Funds are engineered like no other taxpayer investment fund in the world.
As a busy portfolio manager, Obama explained that he will delegate considerable autonomy to his handpicked executive team. "What I have no interest in doing is running GM," he said. Of course, the Obama Funds would not object if Government Motors, after phasing out the Pontiac, Saturn, Saab and Hummer brands, later chose to launch new products called the Obama, the Geithner, the Bernanke or the Biden. But such matters are secondary to our primary investment goal of near-term asset appreciation. "In short, our goal is to get GM back on its feet, take a hands-off approach and get out quickly," Obama said.
The change of ownership will probably make GM a different kind of car company, so your fund manager took steps to reassure Government Motors' prospective customers. "GM will emerge from its bankruptcy quickly and as a stronger and more competitive company," he forecast, "and I want to remind everyone that if you are considering buying a GM car during this period of restructuring, your warranties will be safe and government-backed."
He also served notice that, in order to maximize shareholder returns, his management team will be expecting further labor concessions. Obama told Government Motors employees that they should accept "a sacrifice you may not have chose to make, but a sacrifice you were nevertheless called to make so that your children and all of our children can grow up in an America that still makes things." Fund manager Obama said his new business plan will be "the beginning of a new GM, a new GM that can produce the high-quality, safe and fuel-efficient cars of tomorrow," and he predicted that his new investment vehicle will "out-compete automakers around the world."
"And when that happens," he said, "we can truly say that what is good for General Motors and all who work there is good for the United States of America." We hope that you, as a Class A shareholder in the U.S. Taxpayer Aggressive Growth Fund, share our belief that our stake in Government Motors will turn out to be the ultimate investing experience.
GM rescue fraught with political risks for Obama
President Barack Obama says he has no interest in running General Motors Corp. We're about to find out if that's true. He has carved a unique task for himself: balancing his role as leader of the free (market) world with that of "reluctant" shareholder-in-chief of an iconic Detroit automaker. As such, he is promising to take a hands-off approach to managing day-to-day operations while still protecting what will be a $50-billion taxpayer investment.
At the same time, the government will be the virtual owner of one of the biggest lobbying outfits in Washington -- GM spent about $14 million on its interests in 2008 -- and play a direct role in putting directors on the company's board, if not in other major decisions. The White House may not choose which plants close or which dealers survive a massive restructuring -- Obama spokesman Robert Gibbs joked Monday that staff wouldn't be "picking out Chevy Malibus colors for next year" -- but the president will have to explain to tens of thousands of people who lose their jobs why the sacrifice he has ordered for GM is best for them and the nation.
At the same time, he'll need to keep Congress on the sidelines so as to not upset the balance between competing interests.
"The last thing a politician wants to do is say, 'That's not my business,' even when that's the correct answer," said James Gattuso, senior research fellow in regulator policy at the Heritage Institute, a conservative think tank in Washington. "To the extent he stands up" to political pressures, Obama's "going to lose political capital," Gattuso said. The president already was being criticized by conservative pundits for pushing a deal they say favors the UAW -- which contributed heavily to his campaign -- over bondholders who accepted pennies on the dollar for additional equity in the new GM.
The biggest questions Monday focused on the extent of the administration's role in running GM and its effect. Thomas Donohue, president and chief executive officer of the U.S. Chamber of Commerce, said he was concerned the White House could "put politics and special interests above sound business strategy." Obama set out to allay those concerns: The board -- not the government -- would call the shots "in all but the most fundamental decisions." "What we are not doing -- what I have no interest in doing -- is running GM," he said. "Our goal is to get GM on its feet, take a hands off approach, and get out quickly."
But political pressure already is mounting, with Democrats and Republicans in Congress clamoring for changes that would protect American plants and their workers, not to mention politically powerful dealers who would lose their franchises. Two Michigan House Democrats provide examples. John Dingell of Dearborn, dean of the House, issued a news release complaining about the closing of a transmission plant in Ypsilanti. And freshman Gary Peters of Bloomfield Hills expressed his disappointment that the Orion plant could be idled.
Sen. Bob Corker, a Tennessee Republican who called for union and bondholder concessions in an unsuccessful attempt to broker a deal to help Detroit's automakers last year, learned the Spring Hill plant in his state would at the least be idled. Delaware's Sen. Tom Carper, a Democrat who fought to save the Wilmington assembly plant, learned the plant would be closed. "I'm more than disappointed," he said, "I'm despondent." But by closing a plant in the home state of Vice President Joe Biden, GM -- and Obama's team -- may have sent with it a message that politics wasn't part of the discussion. It could be important with three plants -- those in Orion Township north of Pontiac, Spring Hill and Janesville, Wis. -- in the running for a small-car assembly plant.
Whether there's fallout for Obama in some key states for him -- Michigan, Ohio and across the industrial Midwest -- as GM sheds about a third of its jobs will depend on retraining efforts, new job creation and how well Obama can sell that he may have saved thousands more jobs and the industry as a whole. "I think there's resentment," Sen. Carl Levin, a Michigan Democrat, said of auto workers losing their jobs while financial firms receive government loans and weren't held to the same standard. "I think that's understandable. But I don't think that translates to fallout." "The most important thing," added David Cole, at Ann Arbor's Center for Automotive Research, "is not to cover yourself politically. It's to do the right thing to save the industry.
GM Bankruptcy: What It Means for Asian Rivals
Strong carmakers like Japan's Big Three and Hyundai may benefit in the short run, but they may face tough competition from GM and Chrysler after bankruptcy. As confirmation finally arrived that General Motors (GM) would, as widely expected, file for bankruptcy, the market reaction in Asia was anything but gloomy. In Japan, home of Toyota, Honda, and Nissan, the Nikkei 225 stock index continued its recent recovery on June 1, closing up 1.6%. All of the Japan Big Three rose. In Korea, home of Hyundai, the benchmark Kospi index rose 1.4%. "Anything that clears up some of the uncertainty is a positive," says Andrew Phillips, an analyst at KBC Securities in Tokyo, explaining the market response in Asia. Whether GM's woes will favor Asian automakers in the longer term, though, is much harder to gauge.
Sure, in the U.S. market the likes of Toyota and Hyundai, with new models and relatively healthy finances, are well positioned to benefit as GM follows Chrysler into the bankruptcy courts. In Hyundai's case, that's already happening. The Korean automaker and its small-car arm, Kia, increased U.S. market share to a record 7.5% in the first quarter of this year, up from 5.1% at the end of 2008. Toyota, like its archrival Honda, is hoping new hybrids, starting with the launch of the new Prius this month, will pep up battered sales in the U.S. But GM's problems also throw up plenty of risks as the U.S market, still the world's largest, enters an unprecedented period of reorganization. Analysts say that bankruptcy at two of the Detroit Three will have Asian auto executives worrying about everything from the financial health of suppliers to the wider impact on the economy and fears over a backlash against import brands.
Further into the future, there will be additional concerns that a leaner, more competitive GM underpinned by a stronger lineup of cars may prove a more formidable rival than its ailing predecessor. "Longer-term, GM's portfolio of smaller and more fuel-efficient cars will only strengthen competition in the segment where our forte lies," says Oles Gadacz, a spokesman for Hyundai in Seoul. In the coming weeks the biggest priority for the Asian automakers will be minimizing the impact on suppliers shared with GM. As the likelihood of GM entering bankruptcy increased, Asian rivals took steps to protect themselves from disruptions in their supply chains.
Honda, for instance, has increased inventories of some parts and added additional suppliers for others. Nissan chief Carlos Ghosn said on May 12 that it will consider financial assistance for suppliers on a case-by-case basis. Yet only now, with GM and Chrysler in bankruptcy, will it become clear if steps the Asian automakers have taken are sufficient. The size of the risk shouldn't be underestimated: Toyota, for instance, says about 60% of the 500 suppliers it uses in North America also have business with the Detroit Three. Sales operations also will be under scrutiny. Market watchers point out that the closure of hundreds of GM and Chrysler dealerships will hurt Asian automakers, which share many dealers with U.S. rivals. "If GM dealers fail or close down, Japanese automakers will also be negatively impacted," says Alberto Lapuz, managing director of J.D. Power's (MHP) Tokyo operations.
And attempts to capitalize on Detroit's woes must be undertaken more carefully than ever. For years, Japanese automakers in particular have built up goodwill among the car-buying public by transferring production and car development to the U.S. Advertising, meanwhile, is used to highlight how "American" their operations are. At such a delicate time, they will be wary of anything that comes across as taking advantage of rivals' difficulties. In other markets outside the U.S., opportunities to benefit from GM's troubles may be limited. In Europe, for all GM's problems, its deal to sell its Opel arm to Magna International is unlikely to provide immediate growth opportunities for Asian carmakers. And in Asia, too, things might not look much different from today.
In the important China market, for instance, GM executives insist little will change. And some analysts agree. Michael Dunne, managing director of China operations at J.D. Power in Shanghai, points out that if bankruptcy sees GM divided into "good" and "bad" portions, with the good assets safeguarded and the bad cast aside, GM's China business will be stacked into the good category. In the short term, that should mean business as usual. "The China market is of huge importance to the strategic future of the company—the bankruptcy won't leave GM flat on its back in China at all," he says. In Korea, where GM subsidiary GM Daewoo has severe financial problems, the Korean Development Bank is likely to provide fresh credit as the picture at GM becomes clearer.
How things will look in the U.S. once GM and Chrysler emerge from bankruptcy is even less clear. KBC Securities' Phillips says that a reduction in GM's production capacity could create sales opportunities for rivals when the U.S. market begins to grow again. After all, if GM cuts capacity to 2.5 million vehicles, for example, in a 15-million-a-year U.S. car market, its maximum market share would be 17%; that's roughly equal to Toyota's share today. More important, he reckons a new, leaner GM shorn of excess capacity won't need to spend as heavily on incentives. After trimming capacity, "a government-run company might not be so focused on volume," he says. That, Phillips argues, could aid profitability at GM and rival automakers.
Others, though, see tougher times ahead in the U.S. for GM's import brand rivals. Yasuhiro Matsumoto, a credit analyst at Shinsei Securities in Tokyo, argues that, while reorganization may offer greater sales opportunities in the U.S. for Asian automakers, increased competition may mean lower margins. Japanese carmakers, he says, will have plenty to lose since postbankruptcy Chrysler and GM will be more efficient, stronger rivals. Moreover, a smaller GM will enable other Asian automakers to enter the market and fill the vacuum. "The U.S. market used to be very profitable for Japanese automakers, but the good old days might not come back for Japanese or American automakers," he says.
Chinese banks avoiding investment in western lenders
Chinese banks are shunning investments in western banks because they have doubts about their financial health, the chairman of China Construction Bank (CCB), the world's second biggest bank, told the Financial Times. Guo Shuqing said Chinese banks were also being put off by a lack of growth potential in developed markets. "It's very difficult at the moment because there are still so many uncertainties," Guo told the newspaper in an interview. "We are not very interested on expanding our business in developed countries because the market is limited and growth potential is not there because of overbanking," he said.
The FT said CCB had been interested in investing in Standard Chartered, according to people familiar with the situation, but said Guo denied the bank would now consider such a move. He also told the newspaper that Bank of America had assured him that it wanted to remain CCB's second-largest shareholder, after the Chinese government. Battered western banks, BofA, Royal Bank of Scotland and UBS have sold stakes in big Chinese banks in recent months in order to raise capital. Last week Shaolin Xiao, head of China Construction Bank (London), told Reuters in an interview the bank planned to ramp up its international presence.
China rules out dollar challenge
A leading Chinese financial official yesterday rejected suggestions the US dollar could be replaced quickly as the global reserve currency as Tim Geithner, the US Treasury secretary, arrived in China on his first official visit. "In the short term I don't think we can find another currency to replace the US dollar," said Guo Shuqing, chairman of China Construction Bank and former head of the country's foreign exchange administrator. "The US dollar is the main currency because their economy is number one in terms of competitiveness, in terms of innovation."
In an interview with the Financial Times, Mr Guo also raised doubts about a proposal from Zhou Xiaochuan, China's central bank governor, to replace the dollar with a "super-sovereign reserve currency" based on special drawing rights issued by the International Monetary Fund. "We've had SDRs for many years but everybody knows they don't work so well," said Mr Guo. "People worry about US dollars very much because of the imbalances in the current account but that has been the case for many years - they have had a deficit in the current account since the very beginning of the 1970s."
The bulk of China's total international investment position is held in US dollar assets and only 6 per cent is in the form of direct investment. Fears that US moves to tackle the recession could undermine the value of the dollar have led to calls from senior Chinese officials, including Mr Zhou, for more conservative fiscal policy and suggestions that the dollar be replaced as the world's reserve currency. On his arrival in Beijing, Mr Geithner called for China to make its currency more flexible in return for fiscal reforms on the part of the US. In remarks to an audience at Peking University that set the tone for two days of talks with Chinese leaders, Mr Geithner reiterated the pledge by Barack Obama, the president, to lower the US fiscal deficit to about 3 per cent of gross domestic product once the economy was on a stable recovery path.
But Mr Geithner also named a long list of tasks the Chinese government had to address to make its contribution to a more balanced global economy. These included expanding its social safety net, spending more on education and encouraging changes in industry structure through market mechanisms. China has in the past protested when the US put it under pressure to allow its currency to appreciate. The US dollar fell to its lowest since mid-December yesterday against a basket of currencies and against the euro.
Dollar Declines as Nations Mull Reserve Currency Alternatives
The dollar weakened beyond $1.43 against the euro for the first time in 2009 on bets record U.S. borrowing will undermine the greenback, prompting nations to consider alternatives to the world’s main reserve currency. The euro gained for a fourth day versus the dollar as the Russian government said emerging-market leaders may discuss the idea of a supranational currency. The pound rose to the highest level since October and the Canadian dollar traded near an eight-month high on speculation signs of a recovery in U.S. and U.K. housing will spur higher-yield demand.
“There’s been a lot of talk out of Russia about a new global currency, and that’s contributing toward this latest bout of dollar weakness,” said Henrik Gullberg, a currency strategist in London at Deutsche Bank AG, the world’s largest currency trader. “These latest comments are just adding to the general dollar weakness we’ve seen recently.” The dollar slid 1.1 percent to $1.4317 per euro at 4:21 p.m. in New York, from $1.4159 yesterday. It touched $1.4331, the weakest level since Dec. 29. The dollar depreciated 1.1 percent to 95.54 yen, from 96.59. The euro traded at 136.77 yen, compared with 136.78. Sterling rose as much as 0.9 percent to $1.6596, the highest level since Oct. 30, while the Canadian dollar advanced 1.2 percent to C$1.0806, near the strongest level since Oct. 3.
Pending sales of existing homes in the U.S. climbed 6.7 percent in April, the National Association of Realtors said today. The median forecast of 32 economists surveyed by Bloomberg News was for a 0.5 percent gain. Banks in the U.K. granted 43,201 home loans that month, the highest level in a year, the Bank of England said. Russian President Dmitry Medvedev may discuss his proposal to create a new world currency when he meets counterparts from Brazil, India and China this month, Natalya Timakova, a spokeswoman for the president, told reporters by phone today. Russia’s proposals for the Group of 20 meeting in London in April included studying a supranational currency.
“We need some kind of universal means of payment, which could create the basis of a future international financial system,” Medvedev said in a June 1 interview with CNBC. “Naturally, because of the crisis in the American economy, attitude to the dollar has also changed.” Regional reserve currencies are an “unavoidable” part of “regionalizing” the global financial system, Deputy Finance Minister Dmitry Pankin said in Moscow today. The Dollar Index, which ICE uses to track the currency’s performance against the euro, yen, pound, Canadian dollar, Swedish krona and Swiss franc, fell as much as 1 percent to 78.33, the lowest level since Dec. 18.
“The market is looking for the opportunity to sell the U.S. dollar,” said Jack Spitz, a managing director for foreign exchange at National Bank of Canada in Toronto. “It took decades for the euro to be established. I can only imagine how long it would take for the BRIC countries to put together a currency.” There’s no replacement currency for the dollar in the short term, Guo Shuqing, former head of China’s foreign-exchange administrator, said in an interview with the Financial Times for an article published yesterday. The Dollar Index reached 89.62 on March 4, the highest level since 2006, as the global recession spurred investors to take refuge in Treasuries notes and bills.
Demand for the record amount of debt the U.S. is selling will remain sufficient, Treasury Secretary Timothy Geithner said in an interview today with state media outlets in China. The Chinese have a “very sophisticated understanding” of why the U.S. government is running up deficits, said Geithner in Beijing, pledging to rein in borrowing later. The U.S. will “do everything that is necessary” to preserve confidence in the nation’s financial markets, he said. The dollar also declined on speculation “smaller” central banks started today’s selling of the greenback, said Sebastien Galy, a currency strategist at BNP Paribas SA in New York.
“If people believe that there is official pressure behind it, then obviously it puts pressure on euro-dollar on the upside,” Galy said. “Small central banks have an incentive in doing something because if they’re the first movers, they will not suffer by far as much as the big ones.” Galy predicted the euro may reach $1.4360 today, a peak last reached in December. The euro fell earlier versus the yen as Europe’s jobless rate rose in April to the highest level in almost 10 years. Unemployment in the 16-member euro region increased to 9.2 percent from 8.9 percent in March, the European Union statistics office in Luxembourg said today.
The European Central Bank will keep its benchmark rate unchanged at 1 percent on June 4, according to the median forecast of 54 economists surveyed by Bloomberg News. The ECB said last month it would buy 60 billion euros ($86 billion) of covered bonds. The euro’s rally against the dollar may be entering its “last stage,” and investors would likely benefit from selling the euro against the greenback, according to UBS AG, the world’s second-biggest foreign-exchange trader. Europe’s currency is poised to weaken toward $1.30, analysts led by Mansoor Mohi-uddin, Zurich-based chief currency strategist at UBS, wrote in a note to clients yesterday. The analysts reiterated forecasts for the euro to trade at $1.40 in one month’s time and then drop. “We remain positive on the U.S. dollar and think that the greenback is likely in its final stage of weakness,” the analysts wrote. “Equity and bond flows have the potential to surprise and could lend support to the dollar.”
Toxic assets 'bridge too far'
The Federal Reserve should not be involved in financing toxic assets that date from the bubble era, Charles Plosser, president of the Philadelphia Fed, has told the Financial Times. “I think it is a bridge too far,” said Mr Plosser, arguing that such proposed Fed loans would expose the US central bank to credit risk and tie up a sizeable chunk of its balance sheet in long- term assets that would be hard to price and liquidate. The Fed agreed to consider providing investors with loans to buy these assets – including bubble-era subprime securities – as part of a wider effort to clean up bank balance sheets involving the Treasury and the Federal Deposit Insurance Corporation.
His comments challenge Fed chairman Ben Bernanke’s view that the Fed can help to restart trading in these assets without unduly limiting its balance sheet flexibility or taking on too much credit risk, once haircuts on loans and Treasury risk capital are taken into account. Mr Plosser is an independent-minded member of the Federal Open Market Committee but his doubts about the so-called “legacy assets” programme are shared by many others. “I have reservations about the Fed intervening in private credit markets as a matter of principle. I think it confuses monetary and fiscal policy,” Mr Plosser said.
He said interventions in private credit markets involved picking winners, would be difficult to unwind, risked compromising the Fed’s independence and could delay the market’s self-healing. By contrast, Mr Plosser is less concerned than some of his colleagues about buying government debt. “I do not think that buying Treasuries is more inflationary than buying mortgage-backed securities,” he said, while operating in the Treasury market carried fewer costs. He said the Fed needed to focus on the medium to longer term rather than the short term, and ensure it was in a position to raise rates when it needed to in order to prevent excessive inflation.
Mr Plosser cares about the overall size of the Fed balance sheet but he said facilities involving short-term loans should be allowed to fluctuate, at least in the short term, based on market demand without the Fed feeling the need to offset them to maintain a target balance sheet size. “We still have $500bn to $600bn to go in planned asset purchases, so I am not too worried,” he said. Mr Plosser is much less confident than the Fed leadership that a large projected gap between demand and supply will offer strong protection against post-crisis inflation. He said this was the mistake made in the 1970s.
Real-time estimates of spare capacity were unreliable, he said. “We have had a tremendous shock to the financial sector and to the housing sector. It could lower the level of potential output even if it does not change the potential growth rate very much.” The fact that half the market seemed to fear excess inflation and the other half deflation suggested inflation expectations might not be as well anchored as the Fed would like, said Mr Plosser. He said the Fed had to continuously reinforce its credibility by showing it would do what was needed to keep inflation on target.
Treasury Toxic Asset Program Rife With Conflicts Of Interest
The hiring of private firms to provide "independent" advice to both the Treasury Department and the Federal Reserve raises concerns about potential conflicts of interest, according to a letter written by the Project on Governmental Oversight (POGO) and delivered to key members of Congress. It seems that some of those firms will be highly familiar with the assets in question. According to POGO's letter, the Federal Reserve Board has contracted with four firms to manage its $1.25 trillion program that purchases mortgage-backed securities.
One of those firms also works with the New York Fed to manage three companies it set up to absorb toxic assets, known as Maiden Lane, Maiden Lane II and Maiden Lane III. The four firms are Pacific Investment Management Co. (PIMCO), BlackRock, Inc., Goldman Sachs Asset Management, and Wellington Management Company, LLP. In addition, the Treasury Department is expected to approve five private firms to manage what it is calling its "Legacy Securities Program." PIMCO and BlackRock are also on that list. Legacy appears to be the new term for "toxic."
"It's perfectly understandable that the government is relying on the expertise of these private fund managers to assist with the complex tasks of asset management and valuation," wrote Danielle Brian, director of the independent nonprofit, which investigates government misconduct. "POGO is concerned, however, about the conflicts of interest that could arise if these fund managers are also investing in the same types of assets for their private clients." A spokeswoman for the Treasury Department declined to comment. POGO's letter cited a Bloomberg story from early March that highlighted potential conflicts of interest that could arise with this sort of arrangement.
"Citing two people with knowledge of the arrangement, Bloomberg News recently reported that PIMCO had been advising the federal government on the value of $118 billion in assets --including securities backed by residential and commercial loans -- that were guaranteed in the bailout of Bank of America Corp. But PIMCO had also been investing in these same types of mortgage-backed securities for a wide range of private clients," the letter notes. As of March 31, according to PIMCO's own disclosures, it was holding nearly a billion dollars in its mortgage-backed securities fund.
Leverage creeps back on to the radar
by Gillian Tett
Investors and policymakers have been scouring the financial landscape looking for green shoots. One hint of these can be found in an elegant building in London’s Knightsbridge district, which houses the CQS funds. A few months ago, hedge funds such as CQS, one of Europe’s largest credit funds, were finding it almost impossible to get leverage, or loans from banks to trade. The shock of the Lehman Brothers collapse left banks frantically hoarding any cash they had. Now CQS says the climate is easing – a touch.
“At the peak of the euphoria you would get 20 times leverage. It was mad,” says Michael Hintze, a former Goldman Sachs trader who co-founded CQS a decade ago. “Then it all disappeared. You could hardly get any leverage at all last autumn. [But] now we can get three times leverage on many assets. Not all – you cannot get leverage on most asset backed securities [such as mortgage bonds] or many Asian assets. There is still a lot of unwinding to go. But it is improving. It started to improve in late March and into early April.” Mr Hintze is keen to stress that this modest shift is not remotely similar to patterns seen in the boom.
During the peak of the bubble, average leverage across the empire of funds that CQS runs was around five times. These days it is nearer one-and-a-half times, echoing a dramatic shrinkage across the industry (see chart). That is forcing many credit funds to rethink their strategies. Though CQS was one of the first credit funds to appear in London, in the first seven years of this decade a plethora of other funds sprouted up around the Knightsbridge area. In the boom, many of these earned returns by applying high levels of leverage to highly rated assets.
While asset prices were rising and leverage was cheap, the strategy produced results, not least because investors were generally willing to buy products on the basis of credit ratings alone. But once asset prices plunged and the credibility of ratings was shattered, investor money deserted these funds. Numerous credit funds have closed, leaving Mayfair “feeling like a bombsite”, one banker says. CQS has not avoided pain. At the peak of the bubble, its assets under management reached $9.5bn. Now they are about $6.3bn, due to falling asset values and redemptions.
Some of its stable of funds have performed badly. A vehicle that specialises in convertible bonds declined 32 per cent last year. A fund that invests in oil rigs had to be restructured. That has been embarrassing for Mr Hintze, who has had a relatively high profile in London, partly because he is a big donor to the Conservative party. “What has happened with the rig fund is very, very disappointing,” says Mr Hintze, who is a “significant stakeholder” in the rig fund himself. “It gives you the idea of the dangers of leverage. We thought we were being very prudent.
There were some prime brokers offering in excess of 10 times leverage on these types of [rig] assets. “But thank God the fund didn’t leverage up more.” Yet the fact that CQS has retained an impressive $6bn of assets under management as other funds have closed is something of an achievement. Mr Hintze says that some of the investors who filed redemption notices to CQS are starting to cancel them as the climate improves. Away from the highly visible oil rig embarrassment, other parts of CQS are enjoying strong results. A CQS fund that invests in ABS, such as mortgage bonds, posted returns of 73 per cent last year, and 12 per cent so far this year. The convertible bond fund has returned 11 per cent this year and the main CQS multi-strategy fund is up 14 per cent.
There are signs that the carnage in the credit world is starting to produce benefits for the survivors. For one thing, there is less competition to buy assets, since so many other investment groups have imploded. “The [bank] prop desks are really just a shadow of their former selves. The fact that they are no longer so active, that they don’t have money, has really helped us,” Mr Hintze says. He adds that “post Lehman, the prices of many asset classes have fallen to levels where little leverage is required to make attractive returns”, meaning profits can be earned even with low levels of debt. That is pulling new competitors into the credit world, such as long-only funds, which were absent during the boom.
But it is also prompting groups such as CQS to reposition themselves to cope with the lower leverage world. Notably, instead of trying to earn returns by using cheap debt, the new mantra at CQS, as elsewhere, is to exploit traditional credit research skills. “There are a lot of opportunities in the asset backed securities market now, in the credit world, particularly if you take a more granular, fundamentals-based approach,” says Mr Hintze. He says that CQS has “invested in that fundamental credit research. You ask questions like ‘What is in that portfolio? What is happening to real estate prices in downtown LA?’” He adds: “It’s really back to basics now. I am working harder than ever before.”
SEC Examines Actions by Staffers
The inspector general of the Securities and Exchange Commission is investigating allegations that enforcement staff engaged in misconduct in connection with the insider trading case filed last fall against Mark Cuban. The inspector general opened his investigation after receiving a complaint from lawyers representing Mr. Cuban, according to a semiannual report from the inspector general to Congress released Monday. The report didn't name Mr. Cuban specifically, but a person familiar with the matter confirmed the case involves Mr. Cuban, the owner of the Dallas Mavericks.
The report also details other investigations under way, ranging from an audit of the agency's oversight of credit-rating agencies to a probe of whether enforcement attorneys improperly disclosed information about investigations in certain cases. "We appreciate the role of inspectors general in highlighting areas that may need improvement," said an SEC spokesman. "In fact, we have concurred with most of the recommendations stemming from the completed audits cited in the semiannual report and are implementing them as appropriate." The inspector general, David Kotz, has released a series of reports that have shaken the agency.
One of his recent probes detailed questionable trading by two SEC enforcement lawyers and prompted the agency to tighten restrictions on securities trading by employees. He is expected to release a report this summer on the agency's handling of the Bernard Madoff case. Thursday, Mr. Cuban filed a lawsuit in federal court in Washington against the SEC, alleging it didn't properly respond to his Freedom of Information Act requests seeking documents on SEC investigations that involved Mr. Cuban and his businesses. The SEC sued Mr. Cuban in November, alleging he dumped his 6% stake in Mamma.com after learning from the company's chief executive of its plans for a share offering. Share offerings often result in declines in stock prices. The SEC alleges Mr. Cuban sold to avoid losses. Mr. Cuban denies trading on inside information.
Mr. Kotz, the inspector general, is also investigating emails Jeffrey Norris, an SEC enforcement attorney in Fort Worth, Texas, exchanged with Mr. Cuban. The emails were about Mr. Cuban's involvement in a potential movie that suggested the government was involved in the 9/11 terrorist attacks. The SEC disciplined Mr. Norris, who it said wasn't involved in the investigation of Mr. Cuban. According to Mr. Kotz's report to Congress, he is also conducting an audit of the SEC's oversight of credit-rating firms both before Congress gave the agency explicit oversight authority in September 2006 and after the law went into effect.
Eurozone jobless rate hits 10-year high
Eurozone unemployment has leapt to the highest for a decade, highlighting how the continent’s deep recession is taking an increasingly severe toll on the labour market. The seasonally-adjusted jobless rate in the 16-country region rose from 8.9 per cent in March to 9.2 per cent in April, according to Eurostat, the European Union’s statistical office. The latest figure was the highest since September 1999. In April last year, the unemployment rate was 7.3 per cent. Recent forward-looking economic indicators have suggested that the pace of economic decline in the eurozone has slowed markedly since the beginning of the year. But latest unemployment data suggested that the rate at which jobs are being shed has not lost any intensity.
The impact of lengthening jobless queues on demand in coming months is a main reason why economists expect the eurzone’s economic recovery to remain weak for a protracted. “The eurozone recession may be past its peak, but for the labour market the worst is yet to come,” said Martin van Vliet at ING in Brussels. Details of the latest unemployment report show Spain continued to suffer the most, with an unemployment rate of 18.1 per cent in April – up from 10 per cent a year before. However national statistics from Madrid showed an improvement in the number of jobless in May with the figure falling for the the first time in 14 months, as an €8bn job creation plan took effect.
The rise in unemployment in Germany – the eurozone’s biggest economy – has been more modest with the rate reaching 7.7 per cent in April, up from 7.4 per cent a year before. German companies have shown a strong preference for hoarding labour, helped by government financial support, in the hope of an early economic rebound. German policymakers fear, however, that the much larger-scale job cutting is inevitable in coming months. European policymakers will also be alarmed by the rise in youth unemployment. In April, some 18.5 per cent of the labour forced aged under 25 were without a job – up from 14.7 per cent a year before.
Europe must take control of banking stress tests
After months of financial gloom, summer has brought some relief. However, there is now a danger that policymakers and market participants are lulled into a false sense of security, which would be likely to lead to another negative feedback loop. To prevent such an outcome, quick and resolute action is needed. In particular, Europe must complete the job of putting the financial system on firmer ground. If one looks at earlier episodes of large-scale macro-financial distress, a number of key lessons emerge. Japan’s experience in the past two decades, in particular, make clear that a banking system populated by zombie banks is a major threat to recovery; banking systems remain dysfunctional until losses are fully recognised and disclosed; and procrastination increases the ultimate cost to the taxpayer.
Sweden’s experience shows the benefits of expediting the clean-up. A dysfunctional banking system would represent a particular challenge for Europe, whose economies are much more dependent on banks than is that of the US. Big worries about the state of Europe’s banks remain, as current information is unsatisfactory and published accounts are not trusted. Recent International Monetary Fund estimates of potential future writedowns and recapitalisation needs have added to these concerns, as they suggest that the European Union trails the US in the recapitalisation process. Though European officials dispute the IMF figures, they have yet to produce alternatives.
In the US, stress tests have been used as an imperfect but effective tool to increase the public’s knowledge of the balance sheets of the major banks, and to identify further areas where action is needed. While the process of producing and disseminating results has proven challenging and subject to numerous caveats, what has been achieved represents an improvement over the previous situation. In contrast, Europe’s approach to stress testing has been half-hearted at best. The European supervisors argue that assessment would and should be carried out at a national level, under an EU umbrella. However, tests would be only loosely harmonised by adopting similar macroeconomic assumptions.
Furthermore, results would not be available before September, and publication (of aggregate results, not bank-by-bank data) would be at the discretion of national authorities. This compromise is intended to preserve each supervisor’s remit, and fit the variety of their institutional status. But this comes at a high price as regards the value of the results. There is no guarantee that the test will ensure that results are consistent across countries and across banking institutions. As long as national supervisors have discretion, identical assets are unlikely to be valued the same way in all countries. Each supervisor will be tempted to pretend its banks are in good shape. As a result, the planned procedure will not elicit the degree of confidence that European economies urgently need.
We cannot wait another four months to discover that we do not yet know the true state of Europe’s banking system. Instead, a systematic European approach is needed. The respective tests should be based on common macro scenarios, common valuation rules and common stress assumptions. They should be done for all the largest European banks simultaneously and the results should be published for each bank. And there should be centralised oversight of the tests, and aggregation of results. Admittedly, our proposal raises difficulties.
As the US experience has shown, genuine stress tests require that governments stand ready to say without delay how they intend to deal with insolvent institutions – including, in Europe, those with large cross-border operations. But it is worth noting that proper stress tests would not require any formal transfer of supervisory authority from national to European level. Rather, it could be carried out by a temporary task force responsible for ensuring consistency. Since the cost of procrastination is high, turf wars should not be allowed to block a potentially major step towards recovery. We urge European governments to act now.
This article is co-written by Peter Bofinger, Christian de Boissieu, Daniel Cohen, Wolfgang Franz, Christoph Schmidt and Wolfgang Wiegard. The writers belong either to the French Council of Economic Analysis or to the German Council of Economic Experts.
Reset Chart from Credit Suisse has a Major Error
Versions of the Credit Suisse reset graph above have been featured in the Financial Times, used by the International Monetary Fund, and are a staple of web sites like these that are dedicated to the housing bubble. It’s fairly shocking then to see what appears to be a major error in their calculations.
Last week (here and here) I noted that something didn’t make sense about Wells Fargo’s estimates that only one third of one percent of their Option-ARM loans would recast before 2012. Reader’s comments and an email from CalcualtedRisk helped me to get my head around what was going on. In fact, Wells Fargo’s numbers are technically correct.
First for some background, when Wells Fargo purchased Wachovia it acquired about $120 billion of Option-ARM loans originated by a Northern California company called Golden West. These Option-ARMs, or “Pick-A-Payment” loans, allowed borrowers to literally pick their monthly payment from four options: 1) a payment that would pay off the loan in 15 years, 2) a payment that would pay off the loan in 30 years, 3) a payment that only covered the interest, and 4) a minimum payment that was less than the interest only payment.
The last option allowed for “deferred interest” or “negative amortization”. In essence, since not all the interest due was being paid by the borrower, the principal balance on the loan would grow each month. This was an extremely popular choice for borrowers at the peak of the real estate bubble, as Golden West noted in their 2005 year-end filing with the SEC:In 2005, the initial monthly payment selected on almost all new loans was lower than the amount of interest due on the loans.
For obvious reasons this has been of particular concern. If the amount one owes on a loan goes up while the value of the home is decreasing, there is a heightened risk the borrower might walk away from the home leaving the bank to deal with the loss.
As the housing market has continued to deteriorate, the question on everyone’s mind is when will borrowers have to face the reality that they can't make a minimum payment forever? The Credit Suisse chart has been a guidepost for that reality check.
But interest rate resets don't pose much a problem for those with Option-ARMs when rates are low. They can continue making a minimum payment that only adjusts upwards by 7.5% once a year. The real "payment shock" comes went the loan is recast (i.e. becomes fully amortizing over the remaining term of the loan). This occurs after a contractual time limit (normally 5 or 10 years) or, if due to negative amortization, the loan value increases to 110-125% of the original principal of the loan.
For this reason Credit Suisse used the recast date in their chart above for Option-ARMs as stated by Mathew Padilla of the Orange County Register:Credit Suisse, an analyst told me, used resets in the chart for all loans except option adjustable-rate mortgages, when borrowers can choose a minimum payment that may be less than interest owed (option ARMs are in yellow on the chart… see how they are rising!). For option ARMs it used recasts, which can happen either when the loan amount expands to a maximum allowed — often 115% or 125% of original principal — or a set period, such as five years.
If you’re paying close attention here you’ll notice that something doesn’t add up. Wells Fargo, who holds more Option-ARMs on its books than any other institution, states in their last 10-Q filing:Based on assumptions of a flat rate environment, if all eligible customers elect the minimum payment option 100% of the time and no balances prepay, we would expect the following balance of loans to recast based on reaching the principal cap: $4 million in the remaining three quarters of 2009, $9 million in 2010, $11 million in 2011 and $32 million in 2012... In addition, we would expect the following balance of ARM loans having a payment change based on the contractual terms of the loan to recast: $20 million in the remaining three quarters of 2009, $51 million in 2010, $70 million in 2011 and $128 million in 2012.
In short, Wells expects $56 million in Option ARMs to recast due to the loan balance reaching 125% of the value of the original loan and another $269 million to recast based on the terms of the loan. Given that we’re talking about a portfolio of over $100 BILLION of these loans, this means ESSENTIALLY NO LOANS WILL RECAST due to the negative amortization limits or contractual terms before 2012.
Both assumptions seemed suspect, yet, they are in fact true. Looking at page 55 of the Golden West 10-K from 2005 we read:...most of our loans are scheduled to have a payment change without respect to any annual limit in order to reamortize the loan over its remaining life at the end of the tenth year or when the loan balance reaches 125% of the original amount. We term this reamortization a “recast.” Historically, most loans in our portfolio have paid off before the loan’s payment is recast.
History doesn’t look like it will be a good guide going forward but this at least clearly spells out what we are facing. If recasts don’t happen contractually for 10 years this means that the $49 billion of Golden West Option ARMs originated in 2004 will recast in 2014, and the $51 billion originated in 2005 will recast in 2015.
But take a look at the chart. Credit Suisse shows NOT A SINGLE OPTION-ARM RECAST IN 2014 (nor any in 2013 or the first three months of 2015).
Maybe Credit Suisse moved the recasts up based on the loans hitting their 125% balance caps as they state in their footnote? But again, the numbers don’t add up to what Wells states in their last 10-Q: virtually no recasts due to "reaching the principal cap" before 2012.
They also don’t add up if you model this out in excel with some actual numbers. Take a look at the table below:
(Click for Larger Image)
Here we look at a hypothetical $500,000 Option-ARM mortgage originated by Golden West in January 2004 that now sits on Wells Fargo’s books. In order for the loan to recast before 2014 it needs to have enough negative amortization to hit the 125% limit. Wells Fargo assumes a "flat rate" environment in their calculations, but I assumed that today the CODI index (used for a majority of Golden West loans) plus margin jumps to 7% from its current level of 4.875%. At the end of the year I assume it jumps another 100 basis points to 8% and stays there until 2014.
Even with the assumption of higher rates the loan never hits its 125% cap. The loan currently has accrued about $40,000 of negative amortization. By 2014 it would accrue another $45,000, making the final balance $585,388 (115% of the original loan). In order to get the loan to hit the 125% cap by 2012 the accrual rate would need to jump today to 10% and say there for the next 3 years.*
In short, the Credit Suisse chart above looks to be incorrect. Contractually, these recasts won’t happen until 2014 and given the generous 125% cap it is unlikely negative amortization makes these loans hit that limit unless we have a major spike in interest rates. As mind boggling as it may seem, recasts for Wells Fargo’s giant Option-ARM portfolio won’t take place for another 5 years.
Of course, none of this is to say that Wells Fargo is out of the woods. They are essentially stashing away on their balance sheet tens of billions of neg-am loans that will recast into 20-year fixed rate mortgages in 2014 and 2015. Talk about a payment shock. (Although, it is important to note that the minimum payment automatically increases by 7.5% a year. If rates were to stay low this could mean that borrowers would eventually start paying more than their interest only payment and paying down their loans. My guess though is that these automatic increases will get people walking away from their homes before the recast date. Who wants to pay $3000 a month on a home that's underwater? Any way you look at it, it’s a mess.)
Also worrisome is that we’ve heard from readers that WaMu/JP Morgan is notifying Option-ARM borrowers that they are extending their minimum payments out another 5 years. Are they pushing off recasts into 2014/15 as well?
The bottom line something doens't add up when Wells Fargo predicts virtually no Option-ARM recasts before 2012, while Credit Suisse predicts no recasts after 2012. While I would guess Wells Fargo is underestimating recasts assuming a flat rate environment, the bulk of recasts do look like they will be pushed out to 2014/2015. Surely, some of these recasts need to be reflected in the Credit Suisse chart. I’ll leave it to others what this means for the housing market, but what is clear is this needs more attention.
Republican Senators neuter Federal Reserve Transparency bill
It's time to pick sides While the world watches Susan Boyle lose the top prize and cowers in the wake of the dreaded swine flu, the world financial crisis deepens and worsens. The American people are slowly waking up to fiscal realities as our iconic car dealerships and banking establishments flounder in an ocean of red ink. Everywhere we turn something else blows up, and we can't seem to find a bottom to the stock market.
Prices seem inflated much beyond what government measurements are reporting. As you are reading this, our entire financial system is being restructured. Now is the time for the American people to wake up and check their premises. We have a golden opportunity now that has not existed for 100 years since the inception of our Federal Reserve System. We can at last open up the books with HR 1207 to audit the monetary base. This would be extremely enlightening as to the depth of the financial crisis the country is in.
If American governmental organizations have agreements with foreign central banks relating to the US Dollar, then we need to know that. It's impossible for investors and savers in the middle class to have critical information to plan for their futures. A certain level of secrecy for a private business that manufactures rare toys would be one thing in regards to privacy. A government organization that controls the printing presses and therefore the amount of bread and meat on American plates in a recession must be subject to an audit.
Prominent investment gurus such as Jim Rogers and Peter Schiff have recommended us shuttering the doors of the bank. The American people would do well to listen to those opinions outside of the mainstream that have been accurately predicting what is happening in our financial system. HR 1207, the bill to Audit the Fed, now has 179 co-sponsors. Currently the leadership of the two parties has not addressed this legislation until recently.
A Senate audit bill that is unrelated to HR 1207 titled "HC-45" was introduced to audit the Fed and was promptly amended to limit the scope. It appears now that a so-called limited government Republican by the name of Richard Shelby did the watering down of the bill. Apparently he has written into the margins of the bill in pencil "with respect to a single and specific partnership or corporation." That means that the scope of the GAO's audit has been severely limited. This modified version of the amendment does not give GAO authority to look at all of the additional taxpayer risk.
Why the secrecy congressmen? Senator Charles Grassley conceded to the amendments, and has therefore shown his stripes as willing to compromise the financial security of the United States citizenry for his own political gain. Voters would do well to remember Senator Grassley and Shelby as people who do not support oversight or transparency into the monetary system of the United States. These Senators have abdicated their responsibility to the people and should immediately step down.
Claims for Federal Reserve Bank independence from politics are political distortions. The regional private banks appoint the governors of the Fed, and therefore have a private interest in the policy set forth. The President appoints the head of the Fed, so therefore it must be accountable to the people.The American people are not stupid, and during these times of financial crisis when all Americans are forced to report every penny they come in contact with their entire lives, the Federal Reserve must submit to the same scrutiny.
It's time to audit the fed, and for people from all parties and all ideological backgrounds who support openness and sunshine into government policy to support the audit. This isn't a libertarian issue; even the principled left supports these actions. Everyone who is on the other side of the fence on this issue only has something to hide.
Auto Companies and Interest Rate Derivatives
A couple of weeks ago in this space in an article titled, Theater of the Absurd: a view from the inside, a case was made that Interest Rate Derivatives, not credit derivatives, are the ‘root cause’ for the macro economic problems our global financial system is currently facing.
The gist of the piece explained how interest rate swaps [IRS], specifically, have been utilized by agents of the Federal Reserve [primarily J.P. Morgan and Goldman Sachs] to “neuter usury.” Because IRS greater than 3 years duration typically have U.S. government bond transactions embedded in them – the cancerous growth of outstanding notional amounts of these instruments [beginning mid 1990s time frame], absent end-user demand – effectively gave these players [the Fed in drag] control of the ‘long end’ of the interest rate curve, beyond the historic, accepted and generally understood purview of the Fed – namely, the short term Fed Funds [overnight] rate.
Prior to the proliferation and explosive growth of interest rate swaps, values at the long end of the interest rate curve were determined by a breed of investor / trader known as the “bond vigilantes” who regularly enforced corrective and sometimes bitter discipline on the bond markets when naturally spend-thrift governments incurred too much debt. The IRS edifice that was created was so overwhelming – and created so much artificial demand for government bonds - it “steamrollered” the bond vigilantes into extinction.
The explosive growth of outstanding interest rate derivatives notionals was concurrent with increasingly substantive changes to inflation reporting, which has been so meticulously documented by John Williams of Shadow Stats fame, which provided the intellectual ‘cover’ / excuse necessary to explain the wholesale, fraudulent, gross mis-pricing of capital which followed.
In response to the article Theater of the Absurd, I received a great deal of correspondence from folks seeking further commentary and explanation as to exactly how this mis-pricing of capital has impacted things in the real world.
So here’s a snippet of how this mis-pricing of capital has contributed to our current situation:
The Auto Companies' Problems are Not Really of Their Own Making
I’ve written about this before but it bears repeating. Today, General Motors filed for bankruptcy protection. Their demise has been widely followed for years with a great deal of commentary regarding their sinking fortunes centered on ‘legacy costs’ or spiraling expenses being borne by their pension plan.
Some Background On Pensions
Auto workers' pension plans were, for the most part, devised and modeled by actuaries 50 - 60 years ago. The framers of these plans were smart. They well understood the math, or rather, the demographics of their work forces. They knew and were able to model and plan how much capital would need to be set aside over the years to meet their future obligations. Implicitly in their models, these actuaries used "assumptions" on expected rates of future return; namely, that fixed income investments would return a minimum of the real inflation rate + 250 [or so basis points].
It should also be understood that pensions - broadly - fall into two broad categories:
Defined Benefit Plans - In a defined benefit pension plan, an employer commits to paying its employee a specific benefit for life beginning at his or her retirement. This type of pension plan was more common pre 1980s.
Defined Contribution Plan - In a defined contribution pension plan, the amount of the contributions are set in advance. The amount of the eventual retirement income is not set in advance. A member's retirement income will depend on several factors, including the total amount accumulated in his or her account:
Foreign auto makers’ pension plans are almost exclusively Defined Contribution Plans. Most North American pensions today [since 1980] are also Defined Contribution Plans.
Understanding how changes in inflation reporting have adversely impacted the auto company's pension plans is KEY to understanding why the auto companies are in the financial straight-jackets they now find themselves.
Auto companies labor contracts stipulate that pensions are of the Defined Benefit variety. Additionally, labor contracts with the car companies have traditionally required the car companies to keep their pensions "fully funded" meaning that any shortfall in pension performance required the subject company to "top up" the fund out of operating revenue.
So, as health care costs escalated in the real world at the real world inflation rate, PENSION ASSETS [or the fixed income portion thereof] were only earning a FALSE rate based on corrupted or "rigged" interest rates.
To get your head around how debilitating this was:
In recent years General Motors has had pension assets under management of roughly 100 billion. Their asset mix is roughly considered to be along traditional lines of 55% - 65% invested in equities and 35% - 45% invested in bonds [fixed income]. Using the mid-point on the fixed income allocation, this means, by extension, that GM's pension assets have roughly 40 billion invested in bonds [fixed income] or equivalents.
Now, if interest rates are 800 - 1000 basis points lower than modeled expectations - this amounts to a 2 – 5 billion per year shortfall in pension asset return from that which was modeled! This cancerous shortfall has been funded year-in-and-year-out by the auto companies and has had a disastrous material impact on their financial positions. These funds were not available to be reinvested back into operations to improve the product.
The situation described above is a logical outcome which confirms and reinforces the work of John Williams. This is an outcome that has afflicted virtually all legacy defined benefit pensions - **with the exception of the defense-related industries** - from the steel industry to the airlines. They've all shared, more or less, the same fate arising from benefit costs being bourn in the real world versus income being derived by falsified fixed income benchmarks.
The Danger of the Military-Industrial Complex – The National Security Thing
**Of course, the beloved defense industry has always been “unaffected” by this debilitating drain on their resources because their defined benefit pensions have clauses that allow them to pass on any deficiencies that arise in their plans through increased costs of goods provided. That’s the real reason why their financial positions remain relatively healthier and it also explains why stealth bombers are 3 billion bucks a copy.
An Easily Understandable Explanation of Derivative Markets
Heidi is the proprietor of a bar in Detroit. She realizes that virtually all of her customers are unemployed alcoholics and, as such, can no longer afford to patronize her bar. To solve this problem, she comes up with new marketing plan that allows her customers to drink now, but pay later.
She keeps track of the drinks consumed on a ledger (thereby granting the customers loans). Word gets around about Heidi's "drink now, pay later" marketing strategy and, as a result, increasing numbers of customers flood into Heidi's bar. Soon she has the largest sales volume for any bar in Detroit.
By providing her customers' freedom from immediate payment demands, Heidi gets no resistance when, at regular intervals, she substantially increases her prices for wine and beer, the most consumed beverages. Consequently, Heidi's gross sales volume increases massively.
A young and dynamic vice-president at the local bank recognizes that these customer debts constitute valuable future assets and increases Heidi's borrowing limit. He sees no reason for any undue concern, since he has the debts of the unemployed alcoholics as collateral.
At the bank's corporate headquarters, expert traders transform these customer loans into DRINKBONDS, ALKIBONDS and PUKEBONDS. These securities are then bundled and traded on international security markets.
Naive investors don't really understand that the securities being sold to them as AAA secured bonds are really the debts of unemployed alcoholics. Nevertheless, the bond prices continuously climb, and the securities soon become the hottest-selling items for some of the nation's leading brokerage houses.
One day, even though the bond prices are still climbing, a risk manager at the original local bank decides that the time has come to demand payment on the debts incurred by the drinkers at Heidi's bar. He so informs Heidi. Heidi then demands payment from her alcoholic patrons, but being unemployed alcoholics they cannot pay back their drinking debts. Since Heidi cannot fulfill her loan obligations she is forced into bankruptcy. The bar closes and the eleven employees lose their jobs.
Overnight, DRINKBONDS, ALKIBONDS and PUKEBONDS drop in price by 90%. The collapsed bond asset value destroys the banks liquidity and prevents it from issuing new loans, thus freezing credit and economic activity in the community. The suppliers of Heidi's bar had granted her generous payment extensions and had invested their firms' pension funds in the various BOND securities. They find they are now faced with having to write off her bad debt and with losing over 90% of the presumed value of the bonds.
Her wine supplier also claims bankruptcy, closing the doors on a family business that had endured for three generations, her beer supplier is taken over by a competitor, who immediately closes the local plant and lays off 150 workers.
Fortunately though, the bank, the brokerage houses and their respective executives are saved and bailed out by a multi-billion dollar no-strings attached cash infusion from the Government. The funds required for this bailout are obtained by new taxes levied on employed, middle-class, non-drinkers. Now, do you understand?
The Newspaper Industry's Horrifying First Quarter In 12 Frightening Stats
Newspaper ad sales during the first quarter shrank 28.3%, or $2.6 billion, from where they were during the same quarter a year ago, according to a new slew of statistics from the Newspaper Association of America. More bruising stats from the report:
• Print ad sales declined 29.7% to $5.9 billion
• Online sales down 13.4% to $696.3 million
• Classifieds down 42.3% to $1.5 billion
• Ad sales collapse 16.6% to $37.8 billion in 2008. The worst decline ever.
• 2009 revenues will likely come in lower than $30 billion, less than they did in 1987
• Employment advertising shrank 67.4% to $205.4 million
• Real Estate down 45.6% to $336.9 million
• Auto down 43.4% to $332.8 million
• National campaigns down 25.9% to $1.1 billion
• Retail down 23.7% to $3.3 billion
• "Other" down 16.5% to $587.7 million
GM Insolvency 'Proves America's Global Power is Waning'
The insolvency of General Motors shows America's weakening industrial clout and poses major risks not just for the economy but for Barack Obama, write German media commentators. If the planned restructuring of the automaker fails, his economic policy will lie in ruins, they say. General Motors, once the world's largest automaker and a rock-solid icon of America's industrial might for much of its 100-year history, filed for insolvency on Monday and will receive an additional $30 billion in taxpayer funds in a restructuring that will turn it into a slimmed-down, mostly government-owned company.
President Barack Obama has said he is confident GM can emerge quickly from bankruptcy and has pledged a "hands-off" approach, saying the government has been thrust into a reluctant position as controlling shareholder. The carmaker is expected to shed more than 35,000 jobs, leaving fewer than 200,000 in its revamp. Obama wants GM to emerge from court protection in as little as 60 to 90 days. German media commentators say GM's insolvency marks further proof of American's waning economic influence in the world, and they express concern that Obama's administration, despite its assurances that it won't interfere in GM's business, will distort competition by running the firm according to political rather than market principles.
Business daily Handelsblatt writes:
"America's economy is losing power and influence in the world. It's a creeping process and only becomes visible on days like yesterday: General Motors, a warhorse among the world's industrial companies, significantly bigger than the failed and scandal-ridden Enron and WorldCom, has filed for bankruptcy protection. A fat chapter has been added to the book on America's de-industrialization. This process, which began with the relocation of textile production to Asia and then pushed steel producers, tire plants and many other industries out of the country, has plunged the country's political leaders into increasing despair.
How else can one interpret the gigantic rescue operation for GM that will end in the nationalization of the biggest auto company in a country that has always hailed itself as the paragon of capitalism? One has to say in defense of the Obama government that it was caught between a rock and a hard place. Unlike in Opel's case, a collapse of its parent company, which is seven times larger, would have triggered an economic and social earthquake. Obama decided to prevent it. He is holding on to an industry in which America hasn't been able to spearhead innovations for years. One is inclined to wish him good luck in this risky endeavour."
Business daily Financial Times Deutschland writes:
"The restructuring of the group will turn into a political drama. That creates considerable risks for the entire US economy, but also for international competitors operating in the American auto market. The restructuring of GM will be extremely expensive for the American taxpayer, $50 billion could disappear into a black hole. But in the long run, the fact that it will be impossible to run this company in line with market principles will weigh far more heavily than the financial burden.
It's already clear that job cuts and plant closures will soon be discussed in a similar way as the closure of military bases: regional politics will be at least as important as productivity figures. It's to be feared that the government's new-found role as one of the biggest auto producers will make it lose interest in free and open competition. Suggestions that US manufacturers should build small, fuel-efficient cars in America rather than importing them don't bode well. It's absurd if the government gets involved in product development. There's long been a consensus in Washington that America needs more fuel-efficient cars. But no one has dared to take the simplest and most market-consistent step of raising fuel taxes."
Center-left Süddeutsche Zeitung writes:
"If Obama fails in his attempt to save America's automobile industry, his economic policy will lie in ruins. But politicians make poor business managers and the economic crisis hasn't altered this fundamental truth. This isn't because elected politicians aren't as competent as private sector managers, but because they have other interests. This has to be so -- politicians are committed to the common good and have to organize electoral majorities to achieve their goals. In the nationalized General Motors, serious conflicts of interest are unavoidable.
Obama is right to want to force the auto industry to become more fuel-efficient. But the few models with which General Motors has been earning money happen to be gas-guzzling pick-up trucks and sports-utility vehicles. How does the state as shareholder tackle this? Or jobs: politicians have already prevented GM from shifting jobs to China. That's good for the workers, but bad for GM. Business success and political goals are often in conflict with each other."
Conservative Frankfurter Allgemeine Zeitung writes:
"The insolvency of General Motors is a historic moment for America. June 1 also marks the day on which Barack Obama rewrote the rules of American capitalism. It's an alarming development. The government's insistence that it's a reluctant shareholder which will play a largely passive role in General Motors doesn't seem very credible. That's already clear from the list of principles it has compiled for its handling of future stakes in private companies. The government says it will give companies leeway but at the same time cited a number of cases in which it would intervene in corporate management.
In fact Barack Obama has shown in the case of General Motors and Chrysler that he's prepared to play a very active role. He dictated very unattractive debt reduction terms for creditors and then labelled them as speculators. Who is going to lend a government-owned company money in the future if they're treated like that? Also, General Motors recently bowed to pressure from the government and withdrew plans to import small vehicles from China after the trade union protested against it. General Motors mustn't become a pawn of American political forces. Barack Obama's actions so far don't inspire much hope."
GM's "Death Star" Jeopardizes Illinois Town
Ralph Nader said a General Motors bankruptcy would launch "a conclusive Death Star to tens of thousands of jobs, thousands of small businesses and adverse effects to hundreds of communities around the country." The Death Star, a moon-sized superweapon from the Star Wars movies, could destroy an entire planet in a single attack. The Death Star created by GM's bankruptcy filing on Monday probably can't blow up an entire planet, but it might be able to do some damage to a small town in Illinois.
In May, GM notified Rust Chevrolet in Cissna Park, Ill. that the dealership's contract with GM would not be renewed at the end of 2010. Rust Chevrolet was one of 1,100 dealerships axed by GM in May -- a number that nearly doubled with Monday's bankruptcy filing. The delayed closings are GM's attempt to give its dealerships a soft landing. Cissna Park's mayor says that if Rust Chevrolet goes bust, it could have a devastating impact on the area. "If we keep our school, our grocery store, and our car dealership, we'll be OK," said Mayor Rick Baier, in an interview with the Huffington Post. "And we're losing one of those things."
Baier said car sales account for about half of the town's approximately $100,000 in sales tax revenue, and a fifth of its roughly $250,000 in total annual revenue. If the dealership closes and is unable to reopen as a used car dealership or body shop, the town would have to raise rates, fees and income taxes just to keep the necessary services -- like its schools -- up and running. And it would have to delay less urgent projects, like repairs to streets and wastewater treatment systems. "It's just gonna be a major hit for Cissna Park," he said. "Apparently GM doesn't account for any type of loyalty."
Rust Chevrolet has been operated continuously by the same family, in the same location for almost a century. "We've been affiliated with Chevrolet for over 94 years. My grandfather started right here," said the dealership's co-owner, Karen Rust Walder. In a good year, the dealership sells 100 units. And 2008 was a very good year, causing Rust Walder to wonder, why her dealership? "Maybe we didn't have the numbers that GM wanted to see, but I've paid all my bills with them and I owe them nothing," she said. "It's not like we were a financial drain for them. I don't know why this would be a good business decision at all."
Bill Visnic, a senior editor for Edmunds AutoObserver, told the Huffington Post that GM supports dealers through its marketing programs, parts, and inventories, and that those costs factor into a calculation to close a dealership. The broad formula, Visnic said, "is 'How much do we as a car maker think it costs to support you versus how many car sales do you make every year?'" Visnic said that even after GM sheds 2,100 dealers, which will leave it with 4,100, it may still have too many. But he says that in its rush to go into and out of bankruptcy as quickly as possible, GM may be cutting carelessly.
"I can almost guarantee you there are some dealers by sheer dollars and cents who've been wronged," he said. "Some dealers that have been cut are reasonably viable and making a contribution to overall profitability of the company ... but they don't have the time to pick through them." GM has not published a list of closing dealerships. The Huffington Post, with readers' help, has been working to compile an inventory. John McEleney, chairman of the National Automobile Dealers Association, said that GM has too many dealers for its market share. While McEleney praised GM for giving dealerships until late 2010 to wind down -- providing a much softer landing than the three weeks Chrysler gave some 800 of its dealerships -- he said GM's "Death Star" blast is too large.
"They're taking advantage of an opportunity that they can reject these (dealership) contracts out of hand," McEleney said. "We think they went too deep." Rust Chevrolet is the only car dealership in Cissna Park, which Baier (who also works as a fireman and editor of the local paper) describes as a quiet town with little crime, excellent schools, and one grocery store. "It's just a nice quiet place to raise your family. And there are a lot of older retired people, they've lived here all their lives. They don't want to leave Cissna Park. They want to die here," he said. "The community, they want to rally around Rust Chevrolet. They want to fight GM but we don't know how do it."
Cissna Park may not have Luke Skywalker and an army of Ewoks, but it does have a congressman. On Monday, Illinois Rep. Tim Johnson (R), who represents the area, wrote a letter on the town's behalf asking GM to reconsider its decision to abandon Rust Chevrolet. In the letter, provided by Johnson's office to the Huffington Post, Johnson noted that Cissna Park relies on the dealership for half of its sales tax revenue. And he wrote that he didn't see what GM stood to gain from closing it.
"In the larger picture of General Motors, I cannot imagine that closing a dealership of this size makes a significant difference in the sustainability of the corporation," Johnson wrote. "The effect on Cissna Park of such a decision, however, would be devastating. Please consider the scale of these decisions and the century of loyalty of Rust Chevrolet and Cissna Park as you work through these difficult times."
GM's Saga of Decline and Denial
The beginning of the end for General Motors Corp. as an independent company was marked by a denial. Rick Wagoner, then GM's chief executive, stepped up to a podium in a Dallas hotel July 10 to address an audience of Texas business leaders, and outlined his view: The struggling car maker might have to sell its Hummer brand, but the rest of the company was safe. And as for Wall Street speculation of a bankruptcy filing, no way. Reports speculating about bankruptcy, he said, "don't help anything and are completely inaccurate."
But over the course of the next 10 months, nothing could stem the company's slide. Mr. Wagoner was eventually forced out. By Monday morning the bankruptcy papers had been filed and the U.S. government was poised to own a majority stake in the company. It was quite a drop. Once, General Motors was Microsoft and Apple and Toyota all rolled into one. GM set the standard of how a company should be run, how utilitarian products could be made cool and how they should be sold. It helped win a world war, drive American prosperity and reinvigorate business-school curricula.
"Nobody else could cover the whole range of the marketplace like GM, not Ford, not Chrysler," said Gerald Meyers, a former chief executive of American Motors Corp. and now a professor of business management at the University of Michigan. In the end, though, GM was a victim of its own success -- its path to bankruptcy paved with the very management, marketing and labor practices that made it the world's largest and most profitable company for much of the 20th century. Strategies that had once been deemed innovative "became a millstone on the whole company," said Mr. Meyers.
Founded in 1908 by William C. "Billy" Durant, a high-school dropout who had risen to president of the Buick Motor Co., GM was initially set up as a holding company to acquire other auto makers. It soon took over Oldsmobile, Cadillac and Oakland, which would later change its name to Pontiac, and eventually Chevrolet. Under the leadership of Alfred P. Sloan, a Massachusetts Institute of Technology-trained engineer who ran the company in the 1920s, the company pioneered a strategy for organizing its various divisions in a way that would fuel its growth for decades.
The idea was to use the brands to offer a "a car for every purse and purpose," as Mr. Sloan described it. Chevrolet made affordable cars. Pontiac and Oldsmobile were progressively more upscale. Buick was a true premium brand and Cadillac the pinnacle of luxury. Together they formed a "ladder of success," allowing customers to move up as their station in life improved, without having to leave the GM family. In 1932, a focused GM moved past its older rival, Ford Motor Co., to become the world's largest car maker -- a title it would hold for 77 years. By the late 1950s, GM alone had 50% of the U.S. auto market. GM wasn't just immensely profitable. It was cool, too.
The company's hot models, such as the Corvette and Camaro, had the same cachet as the iPhone curries among today's younger generations, and inspired pop songs like "GTO" and "409." As the Beach Boys crooned: "She's real fine, my 409." For a time, GM dominated so much of the American auto market that the government questioned whether it should use antitrust laws to break up the company -- the same kinds of issues that plagued Microsoft Corp. In the 1970s, trouble started. Japanese auto makers were gaining market share with well-made small cars, helped by two spikes in oil prices.
GM's strategy of offering a multiplicity of brands started to fray. To cut costs, GM began stocking its makes with nearly identical cars. That blurred the differences between brands and made it hard for consumers to tell a Chevy from a Pontiac or a Buick. To confront the rising threat from foreign auto makers, GM in 1985 created an entirely new brand, Saturn, at a cost of several billion dollars. It was set up as a separate car company whose mission was to win back customers who had defected to foreign makes.
By the mid-1990s, GM had added two more brands -- Saab, a niche auto maker based in Sweden, and Hummer, maker of hulking military vehicles. With so many nameplates to manage, and rising competition from the likes of Toyota and Honda Motor Co., GM struggled to develop enough new models for all of its brands. While spending heavily on new models to pump up Oldsmobile, GM let Saturn languish, and its sales shriveled. In 2000, Rick Wagoner was named CEO. He took the reins intending to reinvent the company. In one of his first moves, he decided it was futile to keep Oldsmobile. It proved costly, as GM had to compensate dealers who lost Olds franchises. Analysts estimated the tab at $2 billion.
To preserve GM's market share, Mr. Wagoner set out to revive Saturn and GM's other smaller brands. As part of that mission, he hired Robert Lutz, a former Chrysler CEO and renowned car guru, to develop a new generation of cars. Billions of dollars were allocated to the cause. The smaller brands -- Buick, Pontiac, Saturn -- would get first dibs ahead of GM's biggest and strongest brand, Chevrolet. A string of flashy new models conceived under Mr. Lutz showed up in the weaker brands. Pontiac and Saturn each got a roadster, the Buick LaCrosse, Pontiac G6 and Saturn Aura midsize sedans arrived while Chevrolet had to wait for a new Malibu. At the beginning of 2005, GM's business began unraveling. Years of heavy sales incentives had gutted its profit margins, and the company warned a significant loss was likely that year.
By March, there were signs that some people inside GM might be having doubts about the brand strategy. At a conference of financial analysts in New York, Mr. Lutz described Buick and Pontiac as "damaged brands" that had suffered as a result of too little investment in new models. GM ended up reporting a loss of $8.65 billion for 2005. In 2006, Mr. Wagoner faced off in a boardroom battle with billionaire Kirk Kerkorian and his adviser, Jerome B. York, who had publicly called on GM to eliminate some brands and for a time had a seat on GM's board. Mr. Wagoner eventually prevailed, and by the end of 2006 Mr. Kerkorian sold his stake and Mr. York left the board.
GM's smaller brands, meanwhile, weren't gaining enough critical mass to generate returns. Between 2003 and 2007, Saturn, Saab and Hummer together averaged annual pretax losses of $1.1 billion a year. In February 2008, at a gathering of auto dealers in San Francisco, Mr. Wagoner said that any specific talk about killing brands was "not a thoughtful discussion." The GM board wasn't so sure. By the spring, with gas prices soaring to $4 a gallon, sales of GM's Hummer SUVs were in free fall. The board was also concerned about the shadow Hummer cast on GM's image among consumers, people familiar with the matter said. Toyota was increasingly seen as the auto industry's technology leader because of its Prius hybrid. Hummer made GM seem like the gas-guzzler company.
In early June Mr. Wagoner announced GM was considering a sale of the brand. Around that time, Mr. Lutz sat down for lunch with Mr. Wagoner. Spiking gas prices and the global meltdown of mortgage-backed securities were creating visions of empty dealerships loaded with unsold inventory. Over sandwiches in the Ren Center, as GM's headquarters is known, Mr. Lutz told his boss, "Rick, I don't like the way this smells. My gut tells me the economy is set up for a real collapse."
Years of massive losses had left GM ill-prepared for a major economic shock. At the time it had about $21 billion in cash, but it was burning a billion or more each month. On Wall Street, speculation about GM's fate intensified. Merrill Lynch issued a report in early July headlined, "GM Bankruptcy Not Impossible." The cost-cutting effort remained incomplete as the Fourth of July approached. Just before the holiday, GM's top 20 or so executives gathered at Mr. Wagoner's estate in Birmingham, Mich., for a barbecue. It was an annual event for the CEO and meant as a social gathering where no formal business was to be discussed. Even though GM's fortunes were worsening, the usual rules held, people familiar with the matter said.
About a week later, a decision against cutting brands had been made. Although Hummer was under review for a possible sale, "We don't have to eliminate any more brands," Mr. Wagoner said to a group of Texas businesspeople. Wall Street wasn't convinced. Later that day, GM stock closed at $9.69, it's lowest point in 54 years. About two weeks later, GM reported a $15.5 billion loss for the second quarter and a plan to slash $10 billion in expenses and borrow several billion more. Ominously the company only said it had enough cash to last until the end of the year.
A possible deal with Chrysler LLC seemed like it might achieve the savings GM needed. In early August, Frederick "Fritz" Henderson met to discuss potential synergies. After the collapse of Lehman Bros. in September, auto sales plunged further. GM's talks with Chrysler were in full swing. The two companies estimated they could save up to $37.8 billion over a six-year period. When news of the talks leaked out, many in the industry were confounded. GM already had too many brands, the thinking went. What would it do with Chrysler, Dodge and Jeep if it merged with Chrysler?
By November, however, the GM board was growing increasingly concerned about the auto maker's deteriorating finances, and the talks with Chrysler were halted. Just before Thanksgiving, Mr. Wagoner and the CEOs of Chrysler and Ford asked Congress for billions of dollars in loans. The GM CEO told Congress a bankruptcy filing was unthinkable. Customers wouldn't buy from a bankrupt auto maker and the company would collapse, he said. The reaction was harsh. Lawmakers slammed the CEOs for flying corporate jets to Washington, grilled them on how exactly they'd use taxpayer money, and pushed them to cut their own salaries to $1 a year.
On the first day of December, they returned for a second appeal, this time with more detailed turnaround plans. Mr. Wagoner acknowledged GM would run out of money by the end of the year. But he also continued to assert that bankruptcy could not be an option. On one point he had changed his view. As part of GM's turnaround plan, the company would cut some of its brands. Saab, like Hummer, would be sold, Pontiac's model line would be trimmed to one or two cars. GM would look into options for Saturn.
Five days before Christmas the Bush Treasury Department provided bailout loans to GM and Chrysler and told them to come back in February with tougher turnaround plans. When the plans arrived on Feb. 17, the Obama Treasury Department was getting its auto task force into place. Over the next few weeks, the task-force members ramped up on the auto industry and studied GM's turnaround strategy. The more it learned, however, the more concerned members became about GM's future profits and market share, people familiar with the matter said.
On March 27, GM officials traveled to Washington to discuss the matter. In a one-on-one meeting, Steven Rattner, the Wall Street financier who is heading the task force, told Mr. Wagoner GM's latest turnaround plan "doesn't cut it," and informed Mr. Wagoner the government wanted him to resign, a person familiar with the matter said.
Mr. Henderson, the COO, was named the new CEO, and readily acknowledged bankruptcy was probable. Over the next several weeks, task-force members pushed GM to go "faster and deeper" in its restructuring -- and to look at shedding more brands. Eventually, Mr. Henderson agreed to close down Pontiac all together, but dug in his heels to keep Buick and GMC. On Monday GM filed papers for Chapter 11 in New York.
From Ordering Steak and Lobster, to Serving It
Carlos Araya used to order lobster, filet mignon and $200 bottles of red wine at the Palm Restaurant in midtown Manhattan. Now, he seats customers at its Tribeca branch. Mr. Araya, 38 years old, lost his job in 2007 as a crude oil trader on the New York Mercantile Exchange. After visiting dozens of headhunters with no luck, he applied in August 2008 to be a host at the Palm to support his wife, two young daughters and mortgage payments. His salary has plunged from $200,000 to $25,000.
If the financial crisis was the flood, then the Arayas are one of the families standing in the stagnant waters left behind. Some former Wall Street employees, highly trained and accustomed to comfortable salaries, are having trouble translating their specialized skills to other fields that pay well, and instead find themselves forced to accept low-wage work. Now, Mr. Araya is on the brink of losing it all and is doubtful that he will ever return to Wall Street.
And he isn't alone. Nearly 25,000 jobs have been lost in New York City's financial sector since August 2007, according to the New York State Department of Labor. The finance industry in New York is expected to lose 56,800 jobs from the end of 2007 to the beginning of 2012, according to projections from the Independent Budget Office, a publicly funded information agency. John Carbonaro was let go as a floor clerk by Bank of America in January 2009, and despite his job-hunting efforts, remains a "Mr. Mom." Joe Morrone, a laid-off trading clerk from Prudential, has been unemployed for two years and struggles to support his daughters and grandson.
He has had stints as a deli worker, a doorman and a bouncer. "I used to have three cars," Mr. Morrone says. "Now I share one." The result is an unlikely stream of erstwhile Wall Street pros need help. "I've got 'em all -- Lehman, AIG, Citi," says Bob Townley, head of Manhattan Youth in Tribeca, an organization that gave the Arayas financial assistance to pay for childcare while they are working. "I can hear it in a parent's voice when there's trouble. Others are too proud to ask for help."
Many of these parents once made donations to Mr. Townley's program. Now they are asking for aid to pay for their kids. Mr. Araya's daughters, ages 6 and 7, are in an after-school program at Mr. Townley's center.
Nowadays, during Mr. Araya's late nights at the Palm, reminders of his old life crop up when former colleagues come in. Some are encouraging and offer hugs. Others sneer, he says. "The way they look at you, you know they're thinking negatively," he says. Some are laid-off like him, and ask if the restaurant is hiring.
As a host, Mr. Araya wears a suit and tie. He's on his feet most of the day, either escorting guests to tables or manning the podium at the front, answering phone calls, managing reservations on the computer and fielding orders from wait staff and managers. Although he's thankful for the work at the Palm, paydays can be bittersweet. "At the end of the week, I get my paycheck," he says, "and I think, 'I used to make this much in a day.' " Mr. Araya's wife, Dennise, has gone back to work as an administrative assistant for a construction company and leaves home at 6 a.m. Mr. Araya often works until one or two in the morning and on weekends, leaving little time for the family to be together. He calls his daughters every night during his break at the restaurant on his cellphone to say good night.
Mr. Araya now is the one who gets his children ready for school. He's learned to tie pony tails, inadvertently shrunk sweaters in the wash and knows which grocery store has the best price on milk. The Arayas stopped dining out, pulled their daughters out of ballet and tumbling classes, and dropped cable television -- even though the flat screen he bought when they first moved in still sits in the living room. Last month, for the first time, the Arayas didn't make a mortgage payment. Their savings are almost depleted. The mortgage, taxes and fees for the family's condo cost $6,200. Combined, he and Denise bring in $4,000 a month. Three months ago, he and his wife applied to restructure their mortgage. The bank told them it is still processing the request. They fear foreclosure and bankruptcy.
Recently, their oldest daughter asked Mr. Araya if the family would have to move. He told her he didn't know. She countered: "How much money do we need?" "The way she looked at me," Mr. Araya says, "I could tell she was counting the money in her piggy bank." He went into the bathroom and cried. After a few minutes, he dried his eyes and walked back into the living room. Mr. Araya, the son of a cab driver, grew up in a working-class neighborhood in nearby Queens. Like thousands of New Yorkers, he used a Wall Street job to vault into a comfortable lifestyle that included his apartment -- bought for $960,000 four years ago -- in Manhattan's Battery Park City neighborhood and family vacations to Cabo San Lucas, Disneyland and Las Vegas.
The Arayas purchased the condo in 2005 with a 20% down payment and a pre-construction price. The proximity of the two-bedroom, two-bathroom apartment to the trading pit allowed Mr. Araya to spend more time with his family and less time commuting. Ms. Araya diligently managed the family budget with Excel charts to ensure that they had no credit card debt, good credit histories even an emergency fund saved over five years that is now depleted. Mr. Araya says he would be lucky to find a buyer and break even on the apartment now.
Mr. Araya dropped out of college in 1992 to work in the pits, where he quickly advanced from runner to trader. He shifted between large firms like J.P. Morgan Chase & Co. and smaller shops like Aren Brokerage Service, the firm that eventually laid him off. A wrestler in high school, Mr. Araya was known for elbowing his way through the loud commodities pits. Nights were late; mornings began at 4:30 am, fueled by coffee. "You'd clock in and just try to kill each other till the bell rang," Mr. Araya says.
He had a knack for the Merc job. He could gauge from the roar of traders' voices how the market was faring. He gained loyal clients, and was confident enough to engage in profane shouting matches with them on the phone. Mr. Araya still has dreams about the hand signals traders use to indicate orders. His trading jacket hangs in his closet. Every day lately, he spends two hours online, trolling job Web sites like Monster.com and e-mailing former colleagues. The leads have dried up, since some of them are laid off themselves. He's contacted headhunters, been on a dozen interviews in the last year and a half, but nothing has come of them. "It was a hard reality at first," he says. "I used to see unemployed people and think they were lazy, that it was all on them. Now it's happened to me."
Dealing gold in the Dominican Republic
Forget warnings from the IMF, the OECD and George Soros. You know your currency is well and truly down the swanny when even drug dealers are refusing payment in it. In a report entitled US Gold, Going, or Completely Gone? Rob Kirby, forensic analyst at Kirby Analytics, says almost 3,000 metric tonnes of gold compounds were exported from the US in 2008." Paul Mylchreest, of the Thunder Road Report, notes that a "very suspicious" 174 tonnes of gold compounds were exported to the Dominican Republican – "that well known hub of the world gold trade".
"Maybe these gold compounds really are used in gold paint and that artist who normally puts colourful tarpaulins around islands and buildings has painted the whole of the Dominican Republic gold," Mylchreest ponders. "I'll go and check Google Earth." But, he reckons the transformation of the Dominican Republic into a key staging post in the cocaine trade between South America and the US, is a far more likely. "Wouldn't it be interesting if drug smugglers have seen the writing on the wall for the paper dollar and will now only accept payment in gold bullion?"