Women are trained as engine mechanics in thorough Douglas training methods at Douglas Aircraft Company, Long Beach, California. Skipping ahead to 2009, and the end of an era:
Today Kodak announced that, after 74 colorful years, it will stop making Kodachrome film
Ilargi: “The smartest players in the US stock market – the top insiders who run public companies – are not betting their own money on an economic recovery,” said Charles Biderman, chief executive of TrimTabs.
When you think it through, Biderman says all that needs to be said today. Executives at a large number of companies are selling their shares, while in public, in many cases, they keep touting the great situation their company is in. Crazily enough, it's legal.
The financial markets go down, so does oil, all perfectly predictable. Just as predictable is that it won't all keep going down. Not this time around. Not yet. We’ll have to wait till fall.
But that's just the markets. Ordinary people's lives will keep on going down; no force in the world can stop that deafening wave anymore. The number of people who fall through the grooves and keep right on sinking grows fast, as stats on welfare recipients make abundantly clear.
Some numbers take some time to sink in. The default rate on OptionARM mortgages is at 35%, and resets have hardly started yet. Which means millions more foreclosures are locked in already between today and 2014.
Another nice stat: ”the number of U.S. households paying more than half their incomes for housing jumped from 13.8 million in 2001 to 17.9 million in 2007”. Where would it be now? 25 million households? 35 million?
$930 billion is owed on US credit cards, or $3100 for every single American citizen. Just on credit cards. Remember that Meredith Whitney predicted $2.5 trillion will vanish in plastic credit lines.
People's spending power goes down at lightning speed, and down with it goes GDP. Overall, the picture becomes that the old are losing their homes, and the young will never have a job that allows them to buy a home. Whatever you imagine the future will be, it won't be like today at all, that much is certain.
The mortally wounded banks that play healthy with the help of the government will get to do so even more if Obama's regulatory reforms plans are accepted. But it's just the most expensive exercise in futility the world has ever known. Not that that comes as a surprise to you anymore, I’m sure. The losses will keep on piling on, and they will come from all sides. Credit cards defaults, commercial real estate, which is plunging at a 30-50% clip as we speak, and has much further downward to go, speculative corporate bonds that are closing in on a 10% default rate,
The World Bank, meanwhile, wants the rich world to cough up $1 trillion to help the poor in other countries. Don't worry, they don't really believe it either. The rich world will have more than enough poor of its own to take care of. Please don't you believe that it will.
And don't believe that there will be a recovery any time soon. Make your decisions based on the assumption that there'll be no recovery for at least a generation. That will save you a lot of hardship.
Makes you think all the world's a sunny day, doesn't it?
When I think back
On all the crap I learned in high school
It's a wonder
I can think at all
And though my lack of education
Hasn't hurt me none
I can read the writing on the wall
You give us those nice bright colors
You give us the greens of summers
Makes you think all the world's a sunny day, oh yeah!
I got a Nikon camera
I love to take a photograph
So Mama, don't take my Kodachrome away
If you took all the girls I knew
When I was single
And brought them all together for one night
I know they'd never match
My sweet imagination
And everything looks worse in black and white
You give us those nice bright colors
You give us the greens of summers
Makes you think all the world's a sunny day, oh yeah!
I got a Nikon camera
I love to take a photograph
So Mama, don't take my Kodachrome away
The chief executives at 10 large banks were all smiles last week as they repaid a total of $68 billion of Troubled Asset Relief Program money -- but some on Wall Street feel they rushed too quickly to get the government off their backs. Economists and analysts are predicting a slow economic recovery and rising unemployment will create a massive credit meltdown over the next couple of years that could whack banks with defaults that are twice the size of the TARP repayment.
Defaults linked to the $930 billion owed on US credit cards, along with the faltering commercial real estate market and the $2 trillion speculative corporate-debt sector are all heading higher, they said. "The banks have been through the market losses -- now its time for them to go through the credit losses," said Diane Vazza, head of global fixed income research at Standard & Poor's. Despite the banks' increased capital ratios, the credit losses predicted by the S&P executives could lead them back for more federal assistance.
David Wyss, S&P's chief economist said banks should brace for a plastic meltdown as credit-card losses track the unemployment figures almost exactly. "Credit-card losses, on average, are equal to the unemployment rate plus about 5 percent," he said, noting his estimates that the nationwide jobless rate could rise as high as 12.5 percent by 2011. "If one more thing goes wrong, say oil goes over $100 a barrel, or the banks have to deal with another big hit like the commercial real-estate market dropping substantially, unemployment could continue to rise through 2011," Wyss said.
Tania Azarchs, who covers the financial sector for S&P, agrees that the banks are facing a bleak future: "Regardless of how they are feeling now, and how the economy recovers, there are a lot more losses to come that the banks will have to realize," she said. Speculative-grade corporate bonds are already defaulting at a rate of 8.25 percent this year, way ahead of last year's 3.4 percent. Azarchs forecasts, meanwhile, that the default rate will hit 14 percent by the end of the first quarter next year.
The final big hit the banks will have to take is set to come from the commercial real-estate market. Prices for commercial buildings are down by between 30 percent and 50 percent, according to real-estate research specialist Reis Inc. -- while the number of transactions in the pipeline in the first quarter of the year were 89 percent lower than the market peak at the end of 2007. Banks rushed to repay their TARP debt, in large part to get themselves out from under pay restrictions. "They wanted to get out of TARP to prove they are strong enough to stand alone," Azarchs said, "They were in a crisis of confidence. But now they are facing many new crises."
Ilargi: Nice chart at Clusterstock, but as you can see in my financials list, today's losses change the picture a little.
Wall Street after the stress tests
Three Banks Suspend Their TARP Dividends
At least three small, cash-strapped banks have stopped paying the U.S. government dividends that they owe because they got $315.4 million in capital infusions under the Troubled Asset Relief Program. Pacific Capital Bancorp, a Santa Barbara, Calif., lender that got $180.6 million from the Treasury Department in November, has since posted net losses of $49.7 million. Pacific Capital said Monday that it suspended dividend payments on its common and preferred stock as part of a wider effort to save about $8 million per quarter. A bank spokeswoman confirmed that the U.S.'s preferred shares are included in the dividend freeze.
Seacoast Banking Corp. of Florida, of Stuart, Fla., and Midwest Banc Holdings Inc., of Melrose Park, Ill., have also halted their TARP-related dividends, citing the banking industry's turmoil and a desire to fortify their balance sheets. Treasury spokeswoman Meg Reilly said Monday that "a number of banks" that got taxpayer-funded capital under TARP are no longer paying dividends to the government. "Treasury respects the contractual rights of [TARP recipients] to make decisions about dividend distributions, and that banks are best positioned to decide how to manage their own capital base."
The moves are a sign of the deepening misery for large swaths of the U.S. banking industry, suffering under bad loans and the recession even as large firms such as J.P. Morgan Chase & Co. and Goldman Sachs Group Inc. rebound from the crisis, including by repaying their TARP funds last week. "Here the government has given the banks money at great terms, but the fact that they can't keep up with it is worrisome," said Michael Shemi, an investor at New York hedge-fund firm Christofferson, Robb & Co. "It tells you of the deep problems of community and regional banks."
Since last October, TARP's Capital Purchase Program has pumped about $200 billion into more than 600 banks across the U.S. The government got preferred shares that generally churn out annual 5% dividends for the first five years, followed by 9% a year until the capital is repaid. The dividends, which are supposed to be paid each quarter, were established to ensure taxpayer funds were being put to good use and weren't handouts.
So far, the Treasury Department has collected about $4.5 billion in dividends from TARP recipients. Pacific Capital, Seacoast and Midwest, which got their TARP money in December, were set to pay the government a total of $16 million a year in dividends. None of the banks mentioned TARP in news releases announcing suspension of the payments, but representatives confirmed Monday that the dividends had been stopped at least temporarily.
Gerard Cassidy, a banking analyst at RBC Capital Markets, said he was surprised that some TARP recipients "already are in such difficult financial situation" that they are no longer making dividend payments. "It goes to show you that the due diligence performed by the Treasury was not sufficient." Some lawmakers and banking-industry officials have criticized what they view as a lack of transparency and consistency in Treasury's decisions about which banks received aid. Ms. Reilly, the Treasury spokeswoman, said the injections "helped to stabilize the financial system."
Under a provision in the TARP contracts between banks and the U.S. government, a bank usually can defer dividend payments for as long as six quarters, though it eventually will have to cover the entire amount. In a smaller number of contracts in which the Treasury got so-called noncumulative preferred stock, the bank can skip dividend payments without penalty. But if the bank misses six quarterly payments in a row, the Treasury Department can appoint two directors to the bank's board.
George Leis, Pacific Capital's chief executive, said in a statement Monday that hoarding the bank's cash "will improve our flexibility to consider other actions that may need to be taken in order to achieve our targeted capital ratios." The bank, which is wrestling with a spike in loan defaults, plans to resume dividend payments when doing so "would be consistent with our overall financial performance and capital requirements," Mr. Leis said. The decision to halt the dividends appears to stem partly from federal pressure. In April, the bank entered into a memorandum of understanding with regulators that requires it to boost its capital levels by June 30.
Ilargi: No kidding!
White House: 10 percent unemployment within months
The White House says double-digit unemployment is coming sooner than previously acknowledged. White House spokesman Robert Gibbs says the president expects the nation will reach 10 percent unemployment within the next few months.
In an interview with Bloomberg last week, President Barack Obama said he expected the nation to reach 10 percent unemployment sometime this year. The current unemployment rate reached a 25-year high of 9.4 percent in May. While many analysts expect the recession to end by late summer, they warn that unemployment will stay high into next year.
Pessimistic executives cash out of shares
Growing pessimism about the prospects for a global economic recovery sent stock and commodity prices tumbling on Monday while new data showed that leading US corporate executives were cashing out of their share holdings at a rapid pace. US government bond yields followed equity prices lower, confounding analysts who had expected that Treasury rates would rise this week as the federal government auctioned off a record $104bn of debt.Analysts said the market mood was captured by a World Bank report that said the global economy would contract 2.9 per cent this year, compared with a previous estimate of a 1.7 per cent fall.
A White House spokesman said later in the day that the US unemployment rate was likely to rise to 10 per cent in the next couple of months. The downbeat commentary reinforced the view that investors should be more worried about the impact of economic weakness on corporate profits than the possibility of higher inflation and interest rates. “We have had a great run in equities, emerging market currencies, credit and other risky assets, now people are struggling to justify lofty valuations,” said Alan Ruskin, strategist at RBS Securities. He added: “The ‘green shoots’ argument for the economy was very tentative to start with.”
Executives in charge of the largest US companies sent a signal of their concerns by selling far more shares than they bought this month, according to data based on Securities and Exchange Commission filings.
Share sales by so-called company insiders are outstripping purchases so far this month by more than 22 times. TrimTabs, the investment research company, said insiders of S&P 500 listed companies have unloaded $2.6bn in shares in June, compared with $120m in purchases.
“The smartest players in the US stock market – the top insiders who run public companies – are not betting their own money on an economic recovery,” said Charles Biderman, chief executive of TrimTabs.
The S&P 500 index fell 3.06 per cent to 893.04 – its first close below 900 this month. Analysts noted that the index closed below its 50-day and 200-day moving averages. “This is evidence that the rally since March has been a correction and not necessarily the start of a meaningful multi-year rally,” said Jack Ablin, chief investment officer at Harris Private Bank. The yield on the 10-year Treasury fell 10 basis points to 3.68 per cent. Crude oil prices fell $2.62, or 3.77 per cent, to $66.93 a barrel. Earlier, the FTSE Eurofirst 300 index slid 2.6 per cent while London’s FTSE 100 index fell 2.3 per cent. Emerging market equities also fell sharply, with Russia leading the retreat.
Insiders Exit Shares at the Fastest Pace in Two Years
Executives at U.S. companies are taking advantage of the biggest stock-market rally in 71 years to sell their shares at the fastest pace since credit markets started to seize up two years ago. Insiders of Standard & Poor’s 500 Index companies were net sellers for 14 straight weeks as the gauge rose 36 percent, data compiled by InsiderScore.com show. Amgen Inc. Chairman and Chief Executive Officer Kevin Sharer and five other officials sold $8.2 million of stock. Christopher Donahue, the CEO of Federated Investors Inc., and his brother, Chief Financial Officer Thomas Donahue, offered the most in three years.
Sales by CEOs, directors and senior officers have accelerated to the highest level since June 2007, two months before credit markets froze, as the S&P 500 rebounded from its 12-year low in March. The increase is making investors more skittish because executives presumably have the best information about their companies’ prospects. "If insiders are selling into the rally, that shows they don’t expect their business to be able to support current stock- price levels," said Joseph Keating, the chief investment officer of Raleigh, North Carolina-based RBC Bank, the unit of Royal Bank of Canada that oversees $33 billion in client assets. "They’re taking advantage of this bounce and selling into it."
The S&P 500 slid 2.6 percent to 921.23 last week, the first weekly decline since May 15, as investors speculated the three- month jump in share prices already reflected a recovery in the economy and profits. Stocks dropped as the Federal Reserve reported that industrial production fell in May and S&P cut credit ratings on 18 U.S. banks, saying lenders will face "less favorable" conditions. The S&P 500 slid 2.2 percent at 11:06 a.m. in New York after the Washington-based World Bank said the global recession this year will be deeper than it predicted in March.
Insiders increased their disposals as S&P 500 companies traded at 15.5 times profit on June 2, the highest multiple to earnings in eight months, Bloomberg data show. Equities climbed as the U.S. government and the Fed pledged $12.8 trillion to rescue financial markets during the first global recession since World War II. Executives at 252 companies in the S&P 500 unloaded shares since March 10, with total net sales reaching $1.2 billion, according to data compiled by Princeton, New Jersey-based InsiderScore, which tracks stocks. Companies with net sellers outnumbered those with buyers by almost 9-to-1 last week, versus a ratio of about 1-to-1 in the first week of the rally.
"They’re looking to take some money off the table because they think the rally will come to an end," said Ben Silverman, the Seattle-based research director at InsiderScore. "It’s the most bearish we’ve seen insiders, on a whole, in two years." The last time there were more U.S. corporations with executives reducing their holdings than adding to them was during the week ended June 19, 2007, the data show. The next month, two Bear Stearns Cos. hedge funds filed for bankruptcy protection as securities linked to subprime mortgages fell apart, helping trigger almost $1.5 trillion in losses and writedowns at the world’s biggest financial companies and the 57 percent drop in the S&P 500 from Oct. 9, 2007, to March 9, 2009.
Insider selling during the height of the dotcom bubble in the first quarter of 2000 climbed to a record $41.7 billion on a net basis, according to data compiled by Bethesda, Maryland- based Washington Service. The sales coincided with the end of the S&P 500’s bull market and preceded a 2 1/2 year slump that erased half the value of U.S. equities. Bill Latimer, the director of research at O’Shaughnessy Asset Management, says insider transactions aren’t an accurate barometer of stock performance because executives often reduce their stakes for reasons that have little to do with a company’s prospects.
"When you’re dealing with an individual’s buying or selling, you’re clouding the picture with what their specific financial situation may be," said Latimer, whose Stamford, Connecticut-based firm oversees about $4.5 billion. During January 2008, executives at New York Stock Exchange- listed companies bought more shares than they sold for the first time since 1995, Washington Service data show. The S&P 500 slumped 40 percent in the next 12 months. Citigroup Inc. CEO Vikram Pandit purchased 750,000 on Nov. 13, paying an average of about $9.25 apiece, the New York-based bank said in a U.S. Securities and Exchange Commission filing. Citigroup closed last week at $3.17.
U.S. laws require executives and directors to disclose stock purchases or disposals within two business days to the SEC. Sharer, the chairman at Thousand Oaks, California-based Amgen since January 2001, disposed of $1.76 million worth in the world’s largest biotechnology company on May 12, an SEC filing showed. The sale of 36,411 shares trimmed his unrestricted stake by 13 percent and came three weeks after the company reported first-quarter earnings that trailed analysts’ estimates. Between May 22 and June 9, five Amgen officers, including George Morrow, the executive vice president for global commercial operations, and Roger Perlmutter, the executive vice president for research and development, sold a combined $6.4 million.
"From time to time, and within appropriate trading windows, Amgen executives exercise their right to sell shares for tax planning, to prevent stock option expiries and other purposes," spokesman David Polk wrote in an e-mailed response to questions. Federated’s Christopher and Thomas Donahue together sold about 65,000 for $1.68 million on June 4 and June 5 through a family trust, according to SEC filings. The transactions were the biggest outright sales for each since December 2005 and followed a 52 percent rally this year that recouped more than a third of 2008’s stock losses.
The executives began selling two days after the third- biggest U.S. manager of money-market funds, which was founded by their father, John Donahue, in 1955, reached an almost eight- month high compared with reported profits. Federated said in a statement on June 8 that the officers sold as part of a "longer-term" diversification strategy. Ed Costello, a spokesman, said the Pittsburgh-based company had no comment beyond the news release.
"If these folks don’t have confidence in the company and don’t feel that it’s an attractive value, then why as a shareholder would I think it’s a good value?" said Jason Cooper, who helps manage $3 billion at 1st Source Investment Advisors in South Bend, Indiana. Seven directors at CME Group Inc., the world’s largest futures exchange, disposed of almost $3 million since May. John Pietrzak sold for the first time since becoming a director of the Chicago-based company in July 2007, according to data compiled by InsiderScore. Board member Joseph Niciforo cut his stake by 28 percent. "It’s our policy to never comment on any executive sale of shares," said Allan Schoenberg, a CME spokesman.
Nine insiders at TiVo Inc., the maker of digital video recorders, sold $10.6 million between June 3 and June 11, after the Alviso, California-based company jumped to a five-year high. That was the most by value over a one-month period in more than five years, InsiderScore data show. A 53 percent jump in TiVo’s stock on June 3 initiated trading plans of some insiders such as CFO Anna Brunelle, who cut her holdings by 17 percent, according to regulatory filings to the SEC compiled by InsiderScore.
The so-called 10b5-1 programs allow executives to cash out a portion of their holdings when stocks reach predetermined prices. Brunelle also sold through her plan from exercising options with average expiration dates about seven years away, InsiderScore data show. Geoffrey Yang, a TiVo director since 1997, cut his stake by 8.4 percent, raising $1.5 million. The sale was the first by Yang in almost two years. Chief Technical Officer James Barton reaped an 89 percent profit from selling $2.8 million that he received from exercising stock options that were due to expire in four years, according to InsiderScore.
Electronic Arts Inc. Chairman Lawrence Probst and two other executives sold a combined $1.2 million worth since May 28, after the world’s second-largest video-game publisher jumped 49 percent from an almost nine-year low. Probst, who joined the Redwood City, California-based company in 1984 and was CEO between 1991 and 2007, trimmed his holdings by 25,000 shares on May 28, SEC filings show. Frank Gibeau, president of the EA games division, slashed his stake by 66 percent after unloading about $538,300 worth the same day, the filings show.
The sales came three weeks after Electronic Arts, which makes "Madden NFL," the world’s most- popular sports video game, reported a narrower fiscal fourth- quarter loss than analysts estimated. Jeff Brown, a spokesman for Electronic Arts, didn’t immediately return a telephone call seeking comment. "It does make you wonder if the market rebound is running out of steam," said Scott Leiberton, the managing director for the equities division of Principal Global Investors, which oversees $189 billion in Des Moines, Iowa. "If you see broad- based selling among the management team or large holders, that’s generally not a good sign because presumably who knows that business better than they do?"
World Bank warns of deeper global contraction
The World Bank predicted Monday that the global economy will shrink 2.9% this year, a deeper fall than the 1.7% contraction it predicted in March. It also warned that international capital to developing nations will continue to slow, with flows projected to fall to $363 billion in 2009 from their peak of $1.2 trillion in 2007. Developing countries will grow by 1.2% in 2009, the bank said, down from 5.9% in 2008 and 8.1% in 2007. Excluding China and India, gross domestic product in developing countries is expected to contract 1.6%.
The world has entered an era of slower growth that will require tighter and more effective oversight of the financial system, the bank said in a statement. In March, the bank said the slowdown represents "nothing less than an emergency" for economic and social development in low-income countries. Last November, the bank said the global economy would probably grow 0.9% in 2009 and 3% in 2010.
World Bank Warns On Emerging Countries’ GDP
Developing countries' net private capital inflows fell 41% last year and will be cut nearly in half this year, the World Bank said in a report that offers little hope that the countries will provide the spark for the global economic engine. Meanwhile, European Central Bank Gov. Jean-Claude Trichet said Sunday that the ECB expects the global economy to moderate its slide over the remainder of the year and resume climbing in 2010.
The World Bank estimated in its annual development-finance review that gross domestic product in developing countries will grow just 1.2% this year, well off the 8.1% pace in 2007 and the 5.9% gain in 2008. The report, issued at a conference in Seoul, projects a 2.9% contraction in global GDP this year, as rich countries contract by 4.5%. "The crisis of the past two years is having dramatic effects on capital flows to developing countries, and the world appears to be entering an era of lower growth," World Bank Chief Economist Justin Lin said.
The report said net flows of private capital to developing countries fell to $707 billion in 2008 from $1.2 trillion in 2007, and it projects they will fall an additional 48% this year to $363 billion. "Net private capital flows will be insufficient to meet the external financing needs of many of these [developing] countries, and in view of the intense fiscal pressures triggered by the crisis, the prospects for large increases in aid flows are dim," the report said.
"The bulk of new commitments by international financial institutions will go to middle-income countries in 2009, and workers' remittances to low-income countries are projected to decline by 5%. Such sobering facts reinforce the importance of broad international agreement to mobilize the necessary resources to achieve" United Nations' goals for alleviating world poverty. On a regional basis, the report offered the following outlook for developing countries:
- East Asia and the Pacific: China's fiscal-stimulus efforts should spur a recovery in the region, starting later this year, with regional GDP rising 6.6% in 2010 and 7.8% in 2011.
- Europe and Central Asia: GDP is projected to fall 4.7% in 2009, and grow by just 1.6% in 2010.
- Latin America and the Caribbean: Regional GDP is seen falling by 2.3% this year, then growing about 2% in 2010.
- Middle East and North Africa: While less directly affected by the global credit crunch, growth in the region is expected to be cut roughly in half this year, to 2.1%, before accelerating to 3.8% in 2010 and 4.6% in 2011.
- South Asia: GDP is expected to grow by 4.6% this year, followed by 7% next year and 7.8% in 2011.
- Sub-Saharan Africa: Sharp declines in remittances and export prices will take a heavy toll on a region that was growing at a 5.7% annual rate in the past three years, with growth slowing to 1% in 2009 and 3.7% in 2010.
In Paris, Mr. Trichet said in an interview with French radio station Europe 1 that the Iran conflict means "there is clearly an additional risk for the international economy," but that Iran isn't the only area of instability in the world. That is all the more reason to proceed quickly with the program put together by the Group of 20 countries in April to deal with the global economic crisis and regulatory reform, he said.
He repeated that the ECB expects the global economy to recover next year. "We expect a slowing in the decline of activity," Mr. Trichet said. "The first quarter was very bad; the following quarters will be less bad, until the end of the year when one can expect pretty much stability in terms of activity," he added. "We should record a resumption of positive activity over the course of next year." But Mr. Trichet cautioned that governments must gradually address their bloated budget deficits as the economic recovery gathers pace next year.
World Bank calls on west to help relieve trillion dollar drain on world's poor
The world's poorest countries will see $1tn (£600bn) drain from their economies this year according to the first detailed analysis of how the global recession is hitting developing nations.
Figures published today by the World Bank show the financial crisis taking a heavy toll, with the flow of money into the developing world halving this year after heavy losses in 2008. Despite recent talk of economic green shoots in Britain and the US, the lack of international capital means many poor countries will stay in recession for longer as companies and governments are starved of investment.
The World Bank is calling for greater international policy co-ordination and tighter regulation of the global financial system in response. Releasing its authoritative annual Global Development Finance report, the Washington-based institution singles out Africa, central and eastern Europe and Latin America as regions suffering most from the global recession even while rich nations are starting to talk about recovery.
It reveals that net private capital inflows to poor countries tumbled to $707bn in 2008 from a peak of $1.2 trillion in 2007. And it forecasts that the inflows will halve again this year to just $363bn. There is also little chance of overseas aid payments by rich countries taking up the slack left by the drop in private capital flows. The G8 nations, especially France and Italy, were criticised this month for reneging on their promises of increased aid to poor countries.
"To prevent a second wave of instability, policies have to focus rapidly on financial sector reform and support for the poorest countries," said Hans Timmer, director of the World Bank's prospects group.
Developing countries are expected to grow by only 1.2% this year after 6% growth in 2008 and 8% in 2007. But if China and India are excluded, gross domestic product (GDP) in the remaining developing countries is projected to fall 1.6%, causing continued job losses and throwing more people into poverty.
Overall, global GDP is likely to shrink by 2.9% this year and world trade flows by 10%. Europe and central Asia will see a contraction of nearly 5%, recovering to 1.6% in 2010. Sub-Saharan Africa will suffer a drop in growth to just above 1%, sharply down from an average of 5.7% in recent years, hit by falls in remittances from overseas workers and a plunge in foreign direct investment. Thailand has so far suffered the worst, with its GDP plunging by over a fifth in the final quarter of 2008.
"We have to understand that this is a crisis unlike any other," says Mansoor Dailami, lead author of the report. Meanwhile, poverty campaigners today criticise Gordon Brown for refusing to send a cabinet minister to the UN summit on the economic crisis in New York this week while personally attending the "outdated and elitist" G8 meeting in Italy next month. Nick Dearden, from the Jubilee Debt Campaign, said: "If we're ever going to see a more just economy, the prime minister and other western leaders need to start listening to the majority of the world." Ruth Tanner, from War on Want, added: "Brown is determined to see off calls for regulation and continue on the path of free-market fundamentalism at all costs.
The UK government has made no secret of its efforts to rubbish the UN process. Alarmingly, it now looks like the government is also going out of its way to undermine the involvement of developing countries as well." The Department for International Development said Britain was doing all it could to limit the effects of the recession on poor countries and pointed to the London G20 summit in April which agreed to make available $1.1tn to help the world economy through the crisis, including $50bn specifically for low-income countries.
Numbers On Welfare See Sharp Increase
Welfare rolls, which were slow to rise and actually fell in many states early in the recession, now are climbing across the country for the first time since President Bill Clinton signed legislation pledging "to end welfare as we know it" more than a decade ago. Twenty-three of the 30 largest states, which account for more than 88% of the nation's total population, see welfare caseloads above year-ago levels, according to a survey conducted by The Wall Street Journal and the National Conference of State Legislatures. As more people run out of unemployment compensation, many are turning to welfare as a stopgap.
The biggest increases are in states with some of the worst jobless rates. Oregon's count was up 27% in May from a year earlier; South Carolina's climbed 23% and California's 10% between March 2009 and March 2008. A few big states that had seen declining welfare caseloads just a few months ago now are seeing increases: New York is up 1.2%, Illinois 3% and Wisconsin 3.9%. Welfare rolls in a few big states, Michigan and New Jersey among them, still are declining. The recent rise in welfare families across the country is a sign that the welfare system is expanding at a time of added need, assuaging fears of some critics of Mr. Clinton's welfare overhaul who said the truly needy would be turned away.
"To me it's good news," says Ron Haskins of the Brookings Institution, who helped draft the 1996 welfare-overhaul law as a Republican congressional staff member. "This is exactly what should happen." Welfare cases peaked at above five million in 1995 and declined sharply after the 1996 law put time limits on benefits and emphasized moving recipients from welfare to work. The time limits vary by state, but the federally mandated maximum is five years with some exceptions; after that, benefits end.
The cash-assistance program, called Temporary Assistance for Needy Families (TANF), was created by the 1996 law and replaced previous welfare and jobs-training programs. Funded partly by the federal government and partly by the states, it primarily assists women who have children and no job, or a very low-paying one. The number of families on welfare had been falling steadily and, nine months into the recession, stood at 1.6 million in September 2008, the most recent date for which national tallies are available.
"This is the first real test," said Liz Schott, a welfare analyst at the Center on Budget and Policy Priorities, a liberal Washington think tank. "We always said, how is it going to perform? How is TANF going to perform in an economic downturn?" One clue, she says, can be found in a different measure. Although the TANF program seems to be accommodating increased need, it is doing so at a slower rate than another government initiative: the food-stamp program. The number of food-stamp recipients has risen in every state and was 19% higher in March than a year ago, a much bigger increase than the number of welfare cases.
Food-stamp eligibility is significantly easier than the criteria for receiving welfare, so food-stamp assistance tends to rise first. The food-stamp program covers a much larger pool of people who have trouble making ends meet but make more money than the allowable limits under TANF. In general, a family of four must have a monthly income of less than $2,297 to qualify for food stamps. Welfare, on the other hand, is designed as a last resort. The average monthly welfare benefit in 2006, which reflects the most current data collected by the government, was $372.
Antoinette Tatum has been receiving food stamps since September when she and her 4-year-old daughter moved to Kensington, Md. When her car transmission failed, Ms. Tatum couldn't commute to her job in Baltimore, about 45 minutes away by car, so she quit. Unable to find a full-time job, Ms. Tatum did temporary work but found that the more she earned, the fewer government benefits she received; ultimately she couldn't make ends meet. "The government, they help the extremes. But people in between have the hardest time," said Ms. Tatum, 28. "You don't make enough money to get by but you make too much to get help." She turned to welfare, and expects to begin getting checks at the end of this month. She is considering staying on welfare and going to college instead of seeking another low-wage job.
The recession is straining many state welfare programs. State budget woes often mean more cases without more employees. And the demand for cash assistance is squeezing funds for job-training programs targeted both at the unemployed with little work experience and unemployed professionals with extensive work experience. In South Carolina, for example, the vast majority of welfare funding is being directed to the cash-assistance program, leaving little to actually help people find jobs and get off welfare. "When we really are talking about how to put people back to work or get them retrained, with the budget problems our state is having, I really worry," says Sue Berkowitz, the director of the South Carolina Appleseed Legal Justice Center, which advocates for low-income people.
The federal government's fiscal stimulus includes $5 billion for states where more families receive welfare or spending increases on employment subsidies or short-term emergency assistance. That provision sparked concerns from the Heritage Foundation and other conservative groups that President Barack Obama was undoing the provisions of the 1996 law intended to encourage states to get people off welfare and onto payrolls. So far, only California and Ohio have received stimulus grants, but 38 other states and territories said they plan to apply, said Jeffrey Kelley, spokesman for the Department of Health and Human Services' Administration for Children and Families.
The lag in the increase in welfare cases during the worst recession in a generation is curious to some some scholars. "In many respects, the mystery that had been operating until now had been how can there be such a rapid increase in unemployment and long-term unemployment and not show up in the welfare [system]?" says Mark H. Greenberg, director of Georgetown University's Center on Poverty, Inequality and Public Policy. The extension of unemployment benefits by Congress -- for as long as 59 weeks in some states -- may be one reason.
"To some extent unemployment [compensation] is doing what we hoped it would do, which is being the first safety net for unemployed workers," says Don Winstead, the deputy secretary of Florida's Department of Children and Families. Without those extensions, he added, the number of families on welfare in Florida would have risen even more than it has: up 14% in June versus a year ago. Another cause of the delay may be that welfare is targeted at women and children, and this recession has been hardest on men. The lag in the increase in welfare cases may simply show that it took longer for the recession to hurt women than men, says Mr. Haskins of the Brookings Institution.
Despite the deep recession, a few big states still have declining welfare rolls. In Michigan, for example, welfare caseloads were down 4.8% in April from a year ago even though the number of residents receiving food stamps was up 13% in March to more than 1.4 million people. Some advocacy groups for the poor complain that strict front-end requirements -- which force welfare recipients to look for work in a state with a 14% unemployment rate before even meeting with a caseworker -- deter many from seeking help.
A further explanation is that income limits for welfare eligibility are set so low, and haven't been adjusted for so long, that having a low-wage part-time job can disqualify an applicant. In New Jersey, a family of three earning more than $636 a month is ineligible. "These are the people who really will fall through the cracks because they're not eligible for any help," says Donna Gapas, who oversees the welfare program in Hunterdon County, N.J.
Housing Eludes Recovery as Job Losses, Foreclosures Climb
Unemployment and consumer debt are putting home ownership beyond the reach of would-be buyers even as U.S. home prices reset to 2003 levels, according to a report today by Harvard University’s Joint Center for Housing Studies. "Clear signs of a recovery have yet to emerge, and job losses and the steady stream of foreclosures are keeping many markets under pressure," researchers for the Cambridge, Massachusetts-based center wrote. "Sales of both new and existing homes continued to struggle to find a bottom."
Tight residential real estate markets and low mortgage rates fueled a five-year property boom as the number of U.S. households paying more than half their incomes for housing jumped from 13.8 million in 2001 to 17.9 million in 2007, the researchers said. The federal government is now trying to stabilize the market by offering incentives for lenders to modify the terms of delinquent mortgages and the Federal Reserve has pledged to buy as much as $1.25 trillion in mortgage-backed securities to free up funding for new home loans.
When recovery comes, immigrants and children born to the post-World War II baby-boom generation will lead it, the Harvard researchers said. So-called "echo boomers will help keep demand strong for the next 10 years and beyond" as they turn 25-44 years old, according to the report. "Even under the low immigration assumptions, minorities will fuel 73 percent of household growth in 2010-20, with Hispanics leading the way at 36 percent," researchers found.
Minority households have been hit harder by the recession and the housing slump than whites, according to the report. The unemployment rate for black residents in April was 15 percent compared with 8 percent for whites, the report said. In low-income minority neighborhoods, the median foreclosure rate was 8.4 percent compared with 6.3 percent in low-income white neighborhoods from January 2007 through June 2008.
Even as falling prices have made homes more affordable, roadblocks to buying remain, including the difficulty of getting a mortgage as lenders require bigger down payments and higher incomes to qualify for a mortgage, the report said. "The home buying market will continue to struggle until the foreclosure crisis comes to an end," the report said. "Although new federal efforts may prevent millions of families from losing their homes, mounting job losses will likely keep foreclosures at elevated levels."
Cuts Are Here to Stay, Companies Say
Many companies that have cut jobs, pay and benefits during the recession may not be quick to restore them. According to a new survey, 52% of companies expect to employ fewer people in three to five years than they did before the recession began. The survey of 179 companies was conducted this month by consulting firm Watson Wyatt Worldwide Inc. Among employers who have cut salaries, 55% expect to restore the cuts in the next year. But 20% expect the cuts to be permanent.
Of employers who have increased employee contributions to health-care premiums, 46% don't plan to reverse the increases. Of all survey respondents, 73% said they expect employees to shoulder more of the cost of health care than before the recession began. Nearly half of the employers who have cut their contributions to retirement plans expect to reinstate them in the next year. The remainder plan to restore the contributions after that, expect the cut to be permanent, or aren't sure. "We're not going to go back to the status quo," says Laurie Bienstock, national director of Watson Wyatt's strategic-rewards practice.
The survey offered a few hints of good news. About a quarter of respondents said they believe their companies' results had already "bottomed out," compared with 13% in a similar survey in April. Most companies that have frozen salaries or hiring said they plan to lift those freezes over the next 12 months. Roughly one-third said they are still planning layoffs, but that was down from 46% in April. The survey comes amid other signs that the rate at which employers are cutting jobs may be slowing.
The U.S. shed 345,000 nonfarm jobs in May, about half the average monthly decline for the prior six months, according to the Bureau of Labor Statistics. A May survey of 2,100 employers world-wide by consulting firm Mercer found that 58% plan to cut jobs in the remainder of 2009, compared with 66% who laid off workers in the prior six months. Mercer says 5% plan to cut more than one-tenth of their employees in 2009, down from 13% who cut that deep in the six months before the survey.
by Martin D. Weiss
Washington and Wall Street seem to be treating California as if it were a sideshow in the financial circus of these turbulent times.
California is home to the largest manufacturing belt in the United States and to Silicon Valley, the nation’s largest high-tech center.
California is America’s most populous state with 38 million people. Its GDP of $1.8 trillion is the largest in the U.S. Its economy is bigger than those of Russia, Brazil, Canada, or India.
And it’s collapsing.
Major California counties are ground zero in the continuing mortgage meltdown:
Los Angeles County with 5.32 percent of mortgages 90 days past due … Monterrey County, 8.02 percent … Imperial, 8.13 … San Bernadino, 8.66 … Madeira, 9.21 … San Joaquin, 9.53 … Riverside, 10.2 … Merced, 10.57 … and more!
California’s inventory of foreclosed homes is skyrocketing. Home prices are plunging. And the impact of surging unemployment is just beginning to show up in the data …
Worst Unemployment in 64 Years
The state’s unemployment rate has surged to 11.5 percent, the worst since World War II.
Last month, California lost 68,900 jobs. And since July 2007, it has lost 859,000 jobs, including 739,500 just in the past 12 months.
Even if the economy recovers, an unlikely scenario in my view, economists agree that California will continue to be slammed by layoffs, at least through the end of this year and probably well into 2010.
And even assuming a national recovery, UCLA’s Anderson Forecast projects an average unemployment rate of 12.1 percent from this fall through next spring.
What about without a national recovery? California’s jobless could go beyond 15 percent.
Worse, if you include part-time workers seeking full-time work plus workers who have given up looking entirely, it could reach 25 percent, exceeding the worst national unemployment levels of the Great Depression.
“Our wallet is empty.
Our bank is closed. And
our credit is dried up.”
These are not the words of a Dr. Doom in New York or a forlorn banker in Georgia. They represent the confession of Governor Arnold Schwarzenegger before a rare joint session of the California legislature … and with no exaggeration!
The state faces a stunning $24.3 billion budget deficit, even assuming no significant deterioration in the economy from this point onward. And the state has lost virtually all hope of President Obama declaring, “California is too big to fail.”
California State Treasurer Bill Lockyer tried to make that argument to Washington, and did so with great vigor. But he was rejected. After the long line-up of failed companies with hat in hand in recent months — on the steps of Congress or the White House lawn — some folks in government finally appear to have learned how to just say “no.”
“You’re on your own,” is the message from the president to the governor. “Beyond your share of the stimulus package, that’s it! No more!”
Result: The inevitability of massive state cutbacks, including large numbers of state jobs getting axed — all while the California jobless rate is already 11.5 percent.
How many state jobs are in jeopardy? Right now, Schwarzenegger is proposing laying off 5,000 state employees, as well as slashing education and social welfare programs. But the Anderson Forecast projects that Schwarzenegger’s budget cuts will eventually result in 64,000 job cuts from state government plus countless private-sector and local government jobs.
Massive Downgrades Coming
California’s credit rating is already the lowest among all U.S. states.
But with Moody’s, S&P, and Fitch still greatly influenced by massive conflicts of interest, it’s not nearly low enough.
And sure enough, on Friday, Moody’s tacitly admitted as much, announcing that it may have to cut California’s rating by several notches in one fell swoop!
Standard & Poor’s put California on watch for a possible downgrade a few days earlier. Fitch did the same May 29.
The big problem: Once downgraded, California’s rating is likely to fall below the minimal level legally required for most money market funds, forcing these funds to dump California paper posthaste.
Moody’s wrote:“If the Legislature does not take action quickly, the state’s cash situation will deteriorate to the point where the controller will have to delay most non-priority payments in July. … Lack of action could result in a multi-notch downgrade.”
But lack of action is precisely what Sacramento is now becoming most famous for. In fact, in their latest scuffle, Democrats proposed a budget that would raise $2 billion from cigarette taxes and oil companies. But the governor promptly vetoed the plan. So now Sacramento is in a new, escalating battle over the deficit just weeks before the state is expected to run out of cash to meet payroll and other bills.
State officials continue to insist that a state default is unthinkable … much like GM executives said their bankruptcy could never happen.
In my view, there is a very HIGH probability that California will default.
It’s obvious its debt merits a junk bond rating from every Wall Street rating agency.
And it’s equally obvious that the ratings agencies are artificially inflating the rating, stalling downgrades, and grossly understating the risk to investors.
1. If you wait for Moody’s or S&P to act, it could be too late. Even if you can’t get what you might consider a good price, sell all California paper now!
2. Seriously consider dumping all tax-exempt bonds. I know the income is better than equivalent Treasuries. But if California defaults, it could set off a chain reaction of bond price plunges and defaults throughout the municipal bond market.
3. Don’t underestimate the impact California’s depression is having — and will continue to have — on the rest of the U.S. economy. At $1.8 trillion, the state’s GDP is so large, any further deterioration could wipe out every so-called “green shoot” in the national economy seen to date.
4. Stay safe, with a big portion of your nest egg in cash, tucked away in short-term Treasury bills … and with a very modest portion in gold, as an insurance policy against a dollar decline.
Ilargi: It's no secret I don't always see eye to eye with Mish on everything, to put to diplomatically. Still, his insight in the deflation issue is very welcome in the face of the oceans of misunderstanding flowing freely out there.
The Big Inflationist Scare
Inquiring minds are reading Pushing on a String by Gary North.
Gary always writes an interesting column. Indeed, there is too much to excerpt that I suggest reading it. Gary has many of his facts correct, yet still manages to come to the wrong conclusion.CONCLUSIONYes, the bankers are terrified, not just in the US but globally.
The Federal Reserve can re-ignite monetary inflation at any time by charging banks a fee to keep excess reserves with the FED.
Anyone who predicts an inevitable price deflation does not understand that the present scenario is the product of legitimately terrified bankers and the Federal Reserve's Board of Governors. At any time, the FED can get all of the banks' money lent. But the FED knows that this will double the money supply within weeks. This will create mass price inflation.
This is the central fact in the inflation vs. deflation debate. Until the deflationists answer it with a unified voice, they will remain, as their predecessors remained, people with neither a theoretical nor a practical case for their position.
So, the FED waits. Meanwhile, the Federal government's share of the economy rises relentlessly because of the deficits. This is not going to change in the next few years.
We are seeing Keynesianism's last stand. When it fails, the FED will force the banks to lend. Then we will see mass inflation.
Mass deflation? Forget about it.
However, Gary's hypothesis "the Federal Reserve can re-ignite monetary inflation at any time by charging banks a fee to keep excess reserves with the FED", is just that, a hypothesis, and I believe a very poor one at that.
Bernanke's idea to pay interest on reserves will slowly recapitalize banks over time. This is why he desperately wanted to do so. To suggest he is about to charge interest on deposits is silly.
The key fact now is there are not enough credit worthy customers for banks to want to lend, or for that matter willing borrowers looking to expand debt. Thus, if banks had to pay interest on reserves, rather than causing mass inflation, the Fed would cause mass panic.
Indeed, the likely result would be banks scrambling for dollars to repay the Fed as opposed to a mad dash to lend dollars.
Clearly the Fed understands this. Thus, it's not the Fed who is screaming about the banks' unwillingness to lend; it's Congress. Moreover, banks won't lend because most of them know the score as well, regardless of what lies they tell the public about being well capitalized. This is why "reserves" are accumulating in the first place.
Of course those "excess reserves" are a mirage; they don't really exist. Banks need those reserves because of the massive wave of credit card defaults and foreclosures yet to hit the books. Every uptick in unemployment exacerbates credit card losses, foreclosures, losses on home equity loans, etc, something that Gary North ignores.
So charging interest on reserves would not bring about inflation, it would cause a systemic deflationary crash if Bernanke was foolish enough to attempt it.
No Unified Voice
Gary writes "Until the deflationists answer it with a unified voice, they will remain, as their predecessors remained, people with neither a theoretical nor a practical case for their position."
There is no such thing as a "unified deflationist voice". Of course there is no such thing as a "unified inflationist voice" either.
No Inflationist Voice
Most inflationists, Gary North included (but certainly not all), look at the situation through the eyes of money supply in conjunction with the Fed's so-called ability to cause inflation at will. However, if the Fed could cause inflation at will, it would have done it long ago. Note: Congress can create inflation at will by giving everyone $1 million, but the Fed cannot do such a thing, nor would they even if they could, because it would destroy banks.
The Fed does not really give a damn about consumers; all it cares about is banks. That is why bailout money went to lending institutions not individuals. However, individuals are still loaded up in debt with no way to pay it back given the collapse in jobs. Still others are able to pay back loans but instead are walking away.
Anyone ignoring the complete collapse of credit or assuming as Gary does in the above article, is making a second huge mistake. Indeed, the Flow of Funds Report Offers Hard Evidence of Deflation.
Other inflationists look at consumers prices, some look at commodity prices, still others look at the price of gold as a measure of inflation. Of those watching money supply, some concentrate on Base Money supply as Gary North does, others M2, M3, MZM, or even Austrian Money Supply as a measure of inflation. Interestingly, there are even two different versions of Austrian Money supply with a pretty big difference between the two versions.
Every one of them is wrong.
We have a credit based economy and anyone watching money supply and not watching credit is simply wrong. This is a statement of fact, not idle conjecture. Only those watching and expecting the collapse in credit and understanding the role of gold got things correct. This is a very small group of people.
No Deflationist Voice
Just as there is no unified inflationist voice, there is no unified deflationist voice. Some, like Prechter were 30 years early. Prechter finally got his deflation. However, he did not get the collapase in gold back to $250 as he called for years. Prechter simply does not understand gold is money, and what that means during deflationary times.
Certainly most in mass media treat deflation as if it can be measured by a drop in consumer prices. Gary North plays ping pong with inflationists and deflationists stating what they believe as if they all believed the same thing, yet interestingly he decries the lack of a "unified voice". Here is one interesting section:Why anyone worries about price deflation is a mystery to me. With the power of money creation through the purchase of assets, there is no theoretical limit to how high prices can rise. Because people associate rising prices of whatever they sell or own as a sign of prosperity, there is always support for fiat money.Actually, no one should be worried about a drop in prices because deflation is a natural state of affairs on account of rising productivity over time.
The deflationist says, "the banks can create credit, but people may decide not to borrow." This is true. But why wouldn't they borrow?
More importantly Gary makes a huge leap of faith, overstating the Fed's ability to cause inflation, and concludes "Why wouldn't they borrow?" The answer should be obvious.
Why Consumers Won't Borrow
Cash strapped boomers headed into retirement are finding they do not have enough money on which to retire. They are traveling less, spending less, and have too much of their assets tied up in illiquid real estate investments. Moreover, banks will not lend because there are too few qualified borrowers.
Peak Credit is in. The Effect of Household Deleveraging on Housing, Consumption and the Stock Market is massive.
Moreover, please note that the Fed cannot control sentiment of either borrowers or lenders. The Fed can merely encourage.
Personal Savings Rate Rising
click on chart for sharper image
The savings rate is rising, as expected. And in case inflationists have not noticed, lending standards have tightened dramatically.
Pending regulation is massive and will likely restrict credit in aggregate. Everyone wants to prevent a recurrence of the last bubble. There is no need. The housing bubble will not be reblown for decades.
There is virtually no evidence consumers want to borrow. Likewise, there is virtually no evidence, none, that banks are about to go on a lending spree. Moreover, there is no evidence the Fed is attempting to force banks to lend. And finally, there is no evidence the Fed is considering charging banks a fee to keep excess reserves with the FED, or that if they did, that it would accomplish anything other than a deflationary collapse.
Fears of massive inflation are at this point ridiculous.
Don't believe the hyperinflation hype - dare to make cuts
London asset managers 36 South are launching a "hyperinflation fund" for those convinced that money-printing by central banks around the world must lead to Weimar or Zimbabwe soon enough. Flush from last year's 234pc rise in their Black Swan Fund, they are betting that quantitative easing and war-time deficits have sown the seeds of inflation reaching "10pc, 15pc, 20pc, or more". They capture the mood of the times, but are they right? We know that the Fed's balance sheet has exploded (to $2.07 trillion), but that is only half the story.
Data from the St Louis Fed shows that the "monetary multiplier" has collapsed from a decade-average of 1.6 to the depths of 0.893. The "velocity" of money has slowed to a crawl. Professor David Beckworth from Texas State University said the Fed's efforts to boost the money supply are barely keeping pace with the deflation shock. Stimulus is not gaining traction. The credit system is broken. Where will the inflation impulse come from given that capacity use is at a post-war low of 68pc in the US, and nearer 60pc worldwide? The immediate threat is wage deflation.
Tim Congdon – a hard-money Friedmanite from International Monetary Research – says the Fed is still not easing enough, perhaps because it is spooked by so much criticism or faces a mutiny by its own hawks. "If Ben Bernanke and his officials are listening to this sort of stuff and taking it seriously, they are making the same mistake as the Fed in the early 1930s," he said. The US "output gap" is near 7pc. That is a powerful lid on inflation. The sin has been to let M2 money growth wither since January, to let bank lending contract at a 5pc annual rate, and to let 10-year bond yields rise to nearly 4pc. The Fed pays lip service to the Friedman-Schwartz theory of the Depression, but has not digested the lesson.
Mr Congdon's prescription is what Britain did in 1931 and 1992: monetary stimulus à l'outrance (today: bond purchases), offset by spending cuts. This mix – easy money/tight fiscal – would halt debt deflation without ruining the public finances of the US, Britain, and Europe in the way that Keynesian schemes ruined Japan. "The markets would rocket," he said. Personally, I backed the Brown fiscal package last autumn, but only to buy time when Western banks seized up, and to pressure G20 surplus states to play their part. That phase has passed. Today's danger is creditor revulsion as governments worldwide raise $6 trillion in debt this year. The solution is remarkably simple. Stop borrowing and step up the Friedman monetary blitz to stop loan collapse. Does any nation have the nerve to do it?
Is the Bull Run Pulling Up Lame?
The stock market is stumbling. After a powerful rally that pushed the Dow Jones Industrial Average ahead by more than 30% in three months through last week, stocks are clearly having trouble extending their gains. Many analysts see a pullback ahead, and they are debating whether it will be just a temporary annoyance or something bigger and more painful. Indicators of market health, including trading volume, buying demand and trading by companies and corporate insiders, are beginning to flash yellow or red. People also are beginning to question whether the economic fundamentals are strong enough to justify continued gains.
The Dow finished Friday at 8539.73, down 3% for the week. It is at the same levels now as in early May. The Standard & Poor's 500-stock index, which a week ago was up as much as 40% from its March low, ended Friday was at 921.23, still 36% above the low. "This 40% rally isn't based on a 40% increase in fundamentals," says Michael Farr, president of Washington, D.C., money-management firm Farr, Miller & Washington. "The economy is still declining. Credit isn't coming back. Unemployment is rising and we are seeing a much less robust consumer. I think the market at some point is going to give back a large portion of these gains."
Mr. Farr and others say it is impossible to know whether the market already has topped out, or will edge higher before giving up the ghost. But even many bullish investors see a downturn ahead. Stocks have surged since early March in part because government stimulus spending has found its way into financial markets and because some investors have moved money out of cash and into stocks. Other investors may emerge from the sidelines. China Investment Corp., the giant sovereign-wealth fund, is considering potential U.S. investments. Its chairman, Lou Jiwei, has expressed concern that the fund is in danger of missing opportunities as the market rallies, according to people who work with the fund.
While those forces could keep pushing stocks higher for a while, some investors and analysts see signs that the rally's underpinnings already are weakening. Stocks seem a lot less cheap than before their big gains, and investors are no longer impressed when the economic news is simply less bad than before, says Linda Duessel, market strategist at Federated Investors in Pittsburgh. She thinks improving corporate-profit reports will help push stocks significantly higher in the summer and fall. But, first, "history would suggest we would get a 5% to 10% correction somewhere," she says.
That's the optimistic view. Pessimists think the damage could be greater, and the real pessimists worry that stocks could fall to new lows by autumn. They say stocks just aren't behaving as they have at the start of past bull markets. Consider trading volume. Average daily volume for all New York Stock Exchange stocks hit a record of 7.21 billion shares in March, as the rally began and heavy buying sent stocks sharply higher. That slipped to 6.42 billion in April, and so far this month, it is running at 5.14 billion, putting it well below the 2009 average of 6.15 billion a day.
"A new bull market is one when investors are prepared to commit larger and larger amounts of new money to equities," says Paul Desmond, president of Lowry Research in North Palm Beach, Fla. "What we have seen here is a very consistent drop in total volume going back to early April." Mr. Desmond says his data, going back to the 1930s, don't show any new bull market with such a weak volume trend, which leads him to believe that this rally won't become a lasting bull market.
Other data reinforce that concern. The number of stocks joining in the gains has begun to shrink, which doesn't typically happen this soon in a real bull market. And Mr. Desmond's measure of stock demand, based on the amount of trading volume and price change occurring on stock gains, indicates that demand has been fading, another negative signal. "Investors are risking smaller and smaller amounts of capital and that is a bad sign," Mr. Desmond says.
Phil Roth of New York brokerage firm Miller Tabak shares many of these concerns, and has other worries as well. New stock issuance hit a record in May, he notes, which has created a lake of supply just as demand is softening. Senior corporate officers, who had been buying for their accounts earlier this year, have become net sellers. Neither trend supports the market. Mr. Roth says indexes still might gain some ground before topping out, and he wouldn't be surprised to see the Dow hit 9000. But once it starts to fall, he fears, it could sink below the March closing low of 6547.05.
People who recently took money from cash and bought stocks won't want to reverse course unless they get a shock, he says. If they do get a shock, perhaps an indication that the economy's troubles are more lasting than people had hoped, that could produce new selling and new lows. "At some point, investors will be saying, where is the good news?" he says. Mr. Roth also tracks corporate-bond yields, because falling bond yields make bonds less desirable and can help stocks. While Treasury bond yields overall have been rising this year, the difference, or spread, between corporate yields and Treasurys has been shrinking. The spread between yields of double-A corporate bonds and Treasury bonds has averaged 1.45 percentage points over the past 30 years, Mr. Roth says. At its worst during the credit crunch last year it was 3.81 points.
Recently, it has fallen to 2.78 points, better but still not half way back to average. That means corporate bonds remain more attractive than normal and are competing with stocks for investor money, especially when investors are nervous. Given the big recent stock gains, investors seem to be waiting for either a fall in price or a considerable brightening in the economic outlook before they put a lot more money into the market. "We could see a little bit more upside and then some very frustrating, choppy trading in the summer, setting up for a traditional October low," warns John Schlitz, chief technical strategist at Instinet in New York.
Fed plans repo markets revamp
The US Federal Reserve is considering dramatic changes to the giant repurchase – or repo – markets where banks around the world raise overnight dollar loans. The plans include creating a utility to replace the Wall Street banks that handle transactions, people familiar with the matter say. The Fed’s deliberations are partly motivated by concerns that the structure of the US overnight repurchase market may have exacerbated the financial turmoil that accompanied the failure of Lehman Brothers in September last year. Fed officials plan to meet next month with market participants to discuss reforms.
People familiar with the Fed’s thinking say it is looking into the creation of a mechanism to replace the clearing banks – the biggest of which are JPMorgan Chase and Bank of New York Mellon – that serve as intermediaries between borrowers and lenders. "The Fed is raising questions about whether the system really protects the interests of all participants," says one person familiar with the Fed’s thinking. In the repo markets, borrowers, such as banks, pledge collateral in return for overnight loans from lenders, such as money market funds.
The clearing banks stand between the parties, providing services such as valuing the collateral and advancing cash during the hours when trades are being made and unwound. Fed officials fear this arrangement puts the clearing banks in a difficult position in a crisis. As the value of the securities falls, clearing banks have an obligation to demand more collateral to avoid losses. But in doing so, they could destabilise a rival. "The clearing banks fear the positions of the investment banks are so large that a default would be difficult for them to manage," the person familiar with the Fed’s thinking said.
"[Everyone] is thinking about how to remove conflicts of interest of the clearing banks and the investment banks so that the investment banks aren’t vulnerable to a sudden restriction of credit." The system’s complications were evident during Lehman’s collapse. JPMorgan, one of Lehman’s biggest trading partners, acted as its clearing bank in the repo market and – along with BoNY Mellon – served as the clearing bank for the New York Federal Reserve’s credit facility for securities companies.
Lawyers for the Lehman estate and for creditors have raised questions about whether JPMorgan acted too aggressively in seizing and marking down Lehman’s collateral. Hedge funds have bought Lehman debt on the theory that the estate can claw back some of that collateral in court. Citing confidentiality concerns, JPMorgan declined to comment. The Fed hopes to have a new repo system in place by October, when its credit facility for securities companies is to close.
AIG Trading Partners Put Collateral Squeeze on Insurer Before U.S. Bailout
Goldman Sachs Group Inc. and Societe Generale SA extracted about $11.4 billion from American International Group Inc. before the insurer’s collapse as the firms demanded to hold cash against losses on mortgage-linked securities, according to regulatory filings. Goldman Sachs got $5.9 billion and Societe Generale received $5.5 billion of about $18.5 billion in collateral paid by AIG in the 15 months before the September bailout. The payments helped settle AIG’s obligations on $62.1 billion of credit-default swaps that the Federal Reserve later removed from the New York-based insurer as part of the rescue.
"When counterparties see trouble coming, they’ll do everything they can to get their money back, even if it means the death of the other firm," said William Cohan, a former JPMorgan Chase & Co. investment banker and author of "House of Cards," about the financial crisis. President Barack Obama proposed an overhaul in regulations last week to prevent the failure of systemically important institutions such as AIG, which needed a $182.5 billion government rescue to stave off bankruptcy.
Banks that bought swaps as protection against losses on mortgage-linked assets demanded cash collateral as the market value of the securities plunged last year, overwhelming AIG’s ability to pay. "It was precisely that drain of liquidity to Goldman and SocGen that put AIG in a position of illiquidity and ultimately threw them into the government’s arms," said Charles Calomiris, a finance professor at Columbia Business School in New York.
AIG disclosed a complete list last month of payments made to settle the $62.1 billion in derivatives. The figures for the period before the bailout were calculated by subtracting post- rescue payments disclosed in March from the sum of more than 150 transactions outlined in May. Including collateral from before and after the rescue and payments made by Maiden Lane III, a vehicle created by the Fed to retire the swaps, Goldman Sachs received about $14 billion from AIG, Societe Generale got $16.5 billion, and Deutsche Bank AG received $8.5 billion. More than a dozen more banks got a total of about $23.1 billion.
Michael DuVally, a spokesman for New York-based Goldman Sachs, the most profitable securities firm before converting to a bank last year, declined to comment. Stephanie Carson-Parker of Societe Generale, France’s second-largest bank, also declined to comment, as did AIG’s Christina Pretto and Deutsche Bank’s Ted Meyer. Goldman Sachs was more aggressive than other firms in seeking collateral from AIG because the bank’s models showed a greater decline in the value of securities that had been insured, said two people with knowledge of the matter, who declined to be identified because the contracts were private.
"Goldman is to be congratulated for seeing the problem ahead of others and protecting itself from the impending failure of AIG," said William Poole, former president of the St. Louis Fed, in an interview last week. "It’s not the responsibility of any private firm to determine what the public interest is -- that’s why we have a government." Goldman Sachs bought protection on about $20 billion in assets from AIG, meaning the company was counting on $10 billion from the insurer after the underlying holdings lost about half their value, Goldman Sachs Chief Financial Officer David Viniar said in a March conference call.
The firm had "no direct exposure" to AIG because it held about $7.5 billion in collateral and hedged its remaining $2.5 billion risk to the firm’s potential failure, Viniar said. The $7.5 billion tally includes trades unrelated to Maiden Lane. "All we did was call for the collateral that was due to us under the contracts," Viniar said on March 20. Arriving at a value for the swaps was "challenging" because of the dearth of pricing information for securities that seldom traded, increasing the possibility of disputes with counterparties about how much collateral was owed, AIG said in a November filing.
Joseph Cassano, who ran the AIG swaps unit until March 2008, told investors at a December 2007 conference that AIG rejected some banks’ demands for collateral. The Department of Justice is probing whether Cassano, 54, misled investors and auditors about the contracts, a person familiar with the inquiry said in April. "We have, from time to time, gotten collateral calls from people," Cassano said on Dec. 5, 2007. "Then we say to them, ‘Well, we don’t agree with your numbers.’ And they go, ‘Oh.’ And they go away."
Credit-default swaps allow investors to buy protection against a possible default. The contracts pay the holder face value for the underlying securities or the cash equivalent should a borrower fail to repay debt.
Banks received the full face value to retire the Maiden Lane III holdings by being allowed to keep $35 billion in collateral and getting $27.1 billion in payments to retire the contracts. "Our government effectively made a cash infusion through AIG and this Maiden Lane vehicle to Goldman and the other banks," said Haag Sherman, who helps oversee $7.5 billion as chief investment officer of Houston-based Salient Partners.
Goldman Sachs and JPMorgan were involved in a failed effort on the morning of Sept. 15 last year to save AIG with a $75 billion private credit line, AIG said in the November filing. Later that day, the insurer’s credit rating was downgraded, triggering a fresh round of collateral calls and forcing the federal rescue.
The insurer said in November that Maiden Lane III would be funded by as much as $30 billion from the New York Fed, with AIG contributing up to $5 billion. A separate facility, with as much as $22.5 billion from the New York Fed, was established to wind down the insurer’s securities-lending program. In addition to the $52.5 billion for the two vehicles, the government committed to invest as much as $70 billion in the company and provided a $60 billion credit line.
A Triple-A Punt
If world-class lobbying could win a Stanley Cup, the credit-ratings caucus would be skating a victory lap this week. The Obama plan for financial re-regulation leaves unscathed this favored class of businesses whose fingerprints are all over the credit meltdown. The government-anointed judges of risk at Standard & Poor's, Moody's and Fitch inflicted upon investors the AAA-rated subprime mortgage-backed security. They also inflicted upon the world's nest eggs the even more opaque AAA-rated collateralized debt obligation (CDO).
Without the ratings agency seal of approval -- required by SEC, Federal Reserve and state regulation for many institutional investors -- it would have been nearly impossible to market the structured financial products at the heart of the crisis. Yet Team Obama suggests only that regulators reduce the agencies' favored role "wherever possible." It's a revealing phrase, implying that there are situations when it's appropriate to rely on ratings from the big three instead of actually analyzing a potential investment. Can anyone name one? Probably not, which makes one wonder how the ratings-agency lobby could be so effective.
The truth is that the strongest defenders of this flawed system are mutual funds, state pension administrators and the federal regulators now managing the various bailout programs. Digging into the underlying assets in a pool of mortgages or judging the credit risk in a collection of auto loans is hard work. But putting taxpayer or investor money in something labeled "triple-A" is easy. Everyone is covered if the government's favorite credit raters have signed off.
The Obama plan also calls for regulators to "minimize" the ability of banks to use highly-rated securities to reduce their capital requirements when they have not actually reduced their risks. Minimize, not eliminate? Does the Treasury believe that some baseline level of fakery is acceptable in bank financial statements? To review, a critical ingredient in the meltdown was the Basel banking standards pushed by the Federal Reserve. Among other problems, Basel allowed Wall Street firms to claim that highly-rated mortgage-backed securities on their books were almost as good as cash as a capital standard.
The Obama plan does make plenty of vague suggestions, similar to those proposed by the rating agencies themselves, to improve oversight of the ratings process and better manage conflicts of interest. The Obama Treasury has even adopted the favorite public relations strategy of the ratings agency lobby: Blame the victim. "Market discipline broke down as investors relied excessively on credit rating agencies," says this week's Treasury reform white paper. After regulators spent decades explicitly demanding that banks and mutual funds hold securities rated by the big rating agencies, regulators now have the nerve to blame investors for paying attention to the ratings.
Even the Fed, which until recently would accept as collateral only securities that had been rated by S&P, Moody's or Fitch, has lately acknowledged the flaws in this approach. The New York Fed has anointed two more firms, DBRS and Realpoint, to judge the default risk of commercial mortgage-backed securities eligible for the Term Asset-Backed Securities Loan Facility (TALF). Since the passage of a 2006 law intended to promote competition, the SEC has also approved new firms to rate securities that money market funds and brokerages are required to hold.
But inviting more firms to become members of this exclusive club isn't the answer. As long as government requires investors to pay for a service, and then selects which businesses may provide it, it's unlikely investors will get their money's worth. History says it's more likely that investors who use the agencies' "investment-grade" ratings as a guide will be exposed to severe losses -- ask people who went long on Enron and WorldCom.
It's time to let markets decide how to judge creditworthiness.
One lesson of the crisis is that the unregulated credit default swap (CDS) market provided a more accurate measurement of the risk of financial firms than the government's chosen ratings system. Apparently even the largest provider of these government-required ratings, S&P, has taken this lesson to heart. The company recently introduced a new "Market Derived Signals" model that incorporates the prices of CDS contracts "to create a measure that facilitates the interpretation of market information." This looks like a signal that even the prime beneficiaries of a government policy believe that the policy failed. So why won't the Obama Administration embrace real reform?
Bankers’ pay soars in attempt to halt exodus
Wall Street names that have been among the most buffeted in recent months – Merrill Lynch, UBS and Citigroup – are hiking pay for their top investment bankers in an attempt to stop an exodus of talent.
Rivals report that poaching the best people from troubled banks has become far trickier. "Since the middle of May it has got far more difficult to get the people we want," said one senior banker. Between late 2008 and May, expansionist banks such as Barclays Capital, Credit Suisse and Deutsche Bank had plundered hundreds of senior bankers from those groups that were laid low by the financial crisis, in particular Merrill and UBS.
"I would say UBS and Merrill have each lost 25 per cent of their best people," said Patrick Field, chairman of London-based financial headhunter Hanover Search. In spite of the troubled environment, market rates for bankers have been running close to the boom-time highs of two years ago. "In some cases we’ve been paying up to 80 per cent of 2007," admitted one senior executive at an expanding bank. But the environment changed four or five weeks ago, bankers say.
Partly driven by a need to hold on to good staff – and partly to offset the threat of bonus taxes or caps in the US – UBS, Merrill and Morgan Stanley have all increased their basic pay substantially. Citi now plans to do the same. According to insiders and rivals, market salary rates for managing directors have jumped from about $250,000 (€180,000) only a few months ago, to closer to $400,000. As well as base salary hikes, banks are once more offering guaranteed bonuses to staff approached with lucrative offers by rivals. Bank of America, for example, has seen off attempts to poach top Merrill bankers by matching or bettering offers.
Regulators will be concerned – increasing basic pay and guaranteeing bonuses run directly counter to their efforts to push banks towards pay that better reflects long-term performance. There have also been small signs of the trampled banks scoring coups of their own. Last week UBS hired a new strategy chief, Vesna Nevistic, from Goldman Sachs while last month it took on Rajeev Misra, formerly of Deutsche Bank, as global head of credit.
Obama defends Fed as overseer on systemic risk
President Barack Obama in an interview aired on Monday defended his administration's plan to give the Federal Reserve new powers to oversee systemic risks in the economy. Obama, in an interview shown on the CBS Early Show, said the administration wants an overseer that "is accountable and clear when it comes to these large systemic firms that could potentially bring down the entire financial system. The Fed has the expertise and the credibility I think to do it." Asked whether lapses by the Fed contributed to last year's crisis, Obama said, "It wasn't the Fed where regulations broke down here."
Kool-Aid Drinkers Survive Financial Overhaul
President Barack Obama doesn’t need to just overhaul financial regulation. He needs to exorcise the ghost of Alan Greenspan. For far too long, regulators weren’t willing to regulate, inspired by the view of the former Federal Reserve chairman that too much oversight is a greater threat to markets than too little. That turned out to be a bigger cause of the credit crisis than the particular structure of the agencies overseeing the financial system.
Donald Kohn, the Fed’s vice chairman, summed up the prevailing regulatory attitude in 2005, saying, "The actions of private parties to protect themselves -- what chairman Greenspan has called private regulation -- are generally quite effective," while government regulation risks undermining "financial stability itself." Unless Obama can change that mindset, which is entrenched in many of the institutions overseeing banks and markets, the details of his 88-page reform plan won’t matter much. And while there appears to be a newfound appreciation for government oversight, we can’t be certain yet about the intentions of those shaping the Obama plan. Some of them, after all, were one-time advocates of Greenspan’s views, or at least failed to challenge them.
Treasury Secretary Timothy Geithner, one of the architects of the Obama overhaul, was a big promoter of the kind of so- called financial innovation that ultimately helped bring about the crisis. During a speech in early 2007, Geithner argued that innovative products such as credit default swaps and collateralized debt obligations "should help make markets both more efficient and more resilient." And Geithner, at least back then, echoed Greenspan’s belief that regulators shouldn’t try to stop bubbles from forming. In the same speech, the then-chief executive of the Federal Reserve Bank of New York also said, "We cannot identify the likely sources of future stress to the system and act preemptively to diffuse them."
Geithner wasn’t alone in espousing Greenspan’s hands-off approach. His co-pilot on the new Obama plan, National Economic Council Director Lawrence Summers, held similar views. Summers aligned with Greenspan to kill off attempts to regulate derivatives markets when he worked in Bill Clinton’s administration. That deprived regulators of influence over a key and fast-growing market, an area in which risks to financial institutions would fester.
In unveiling his regulatory plan Wednesday, Obama noted that there is always tension between those who favor the market’s "invisible hand" and those who favor "the guiding hand of government." He rightly added that such tension isn’t always a bad thing. Yet in recent years, the invisible hand ruled. Under Greenspan’s laissez-faire approach, markets would police themselves and risk would be spread far and wide. The theory was that losses would be more easily absorbed if a broad base of investors, rather than a few banks, held risk.
Even as cracks began to gape in the financial system in early 2007, Geithner continued to hew to this view. While acknowledging in his speech at the time that problems with subprime mortgages may signal a gathering storm, he said that credit-market innovations should help ease any pain: "If risk is spread more broadly, shocks should be absorbed with less trauma." It didn’t work out that way. Rather than dispersing risk, many of the policies espoused during the Greenspan era simply caused risks to regroup out of investors’ and regulators’ sight.
This meant that investors couldn’t know who was holding what types of assets, which ultimately led them to stop trading with one another. Credit markets began to freeze. Greenspan and his followers also trumpeted financial engineering, hailing the creation of exotic securities that would supposedly help to disperse risk. In the end, much of the innovation -- like structured investment vehicles or CDOs -- proved ephemeral. Even those who weren’t Greenspan disciples, such as Fed Chairman Ben Bernanke, failed to challenge the prevailing orthodoxy. Bernanke has been reluctant to abandon the financial- innovation theme promoted by his predecessor.
In a speech this April, Bernanke acknowledged that financial innovation is currently "perceived as the problem." That said, the Fed chairman rose to its defense, saying that, "Innovation, at its best, has been and will continue to be a tool for making our financial system more efficient and more inclusive." Given that so many regulators and political leaders sipped from the Greenspan Kool-Aid cup, it will take time to see if the financial crisis has sobered them up. If not, Obama can play with regulatory organizational charts all he wants, and it won’t make much difference.
Financial Reform: Don't Abandon It to Regulators
Since the beginning of the financial crisis, the government has become the nation's biggest mortgage lender, guaranteed nearly $3 trillion in money-market assets, restructured two car companies, taken equity stakes in almost 600 banks and lent more than $300 billion to the life-insurance industry as well as a variety of other companies. The government is now also responsible for "compensation practices" in many of those companies.
Last week the president unveiled his plan for financial regulatory reform with a profusion of promises. But the Obama plan ignores the source of the problems and instead picks some wrong solutions, mostly in the form of enhanced regulatory oversight. The plan makes bailouts a permanent modus operandi. Tax-payer funds will now be available to any financial holding company, including insurance and consumer finance companies.
Meanwhile, the plan does not deal with the rating agencies. They aided and abetted the financial collapse by providing AAA ratings to questionable securities that were used to drive us into this mess. And the Obama plan does not offer a mechanism to track leverage, which is the most dangerous and crucial factor in this crisis. Instead, the same regulators who missed the signs of the current crisis will receive added powers to prevent the next one. But regulators pored over CitiGroup's books for decades and failed to detect its excessive leverage and sloppy credit standards, or prevent its demise. Why would they now do a better job for AIG?
Nor does the plan seriously address the government-sponsored mortgage companies, Freddie Mac and Fannie Mae. They were the single largest source of funding for the subprime market, with a 40% market share at the peak. Those two companies alone amassed hundreds of billions in losses and were at the heart of the storm engulfing our economy. They also had hundreds of dedicated regulators specializing in their mortgage business, but to no avail.
More disclosure is not an adequate solution because a big part of the problem was the Federal government's determination to extend the benefits of home ownership to low income families. The Federal Housing Administration, in pushing unsustainable mortgages to people who put up almost no equity, led to loose lending and the dangerous abundance of capital that broke our financial system. And while the President mentioned compensation as a key cause of the crisis, his plan makes no reference to how he plans to change it.
As for hedge funds, I believe regulation and oversight will be beneficial for the hedge fund industry. My firm, Wellcap Partners, first registered with the SEC in 2005. But despite all the talk these last few years about the risks of "secretive, unregulated" hedge funds, they did not create systemic risks. While thousands of hedge funds lost hundreds of billions of dollars last year, and many have shut down, it was the big regulated entities such as commercial and investment banks that brought the house down.
This is because prime brokers, without any impetus from any regulator, simply wouldn't let hedge funds lever up excessively. Also, in contrast to banks who are focused on short term deals and do not have their own capital at risk, in most funds the managers have a meaningful slice of their net worth in the fund. That guarantees a different mindset.
Increased regulation and oversight of financial institutions, in itself not a bad idea, cannot be done in a manner that reduces their discipline and self reliance. We cannot create more institutions that are "too big to fail". Those institutions will enjoy lower funding costs, which in turn will allow them to gain market share and become even more insulated, powerful and dangerous. More importantly, our financial system cannot be trusted again to regulators or the Federal Reserve Bank, in the futile hope that they are able to save us. This is a task well above their pay grade.
We're All Sick Of 'Green Shoots'
Whoa. CNBC Europe is some kinda spin-free bizarro world where the anchors aren't obligated to see the world through green-shoot colored glassses. At the 2:45 mark in this clip with Nouriel Roubini, the anchor thanks Dr. Doom for using the phrase "yellow weeds", saying he's totally sick of green shoots. Roubini explains that the v-shaped recovery isn't happening, and that the rally thus far has been based on relief that the system didn't collapse, but that the fundamentalss don't support a further rally.
Ilargi: Roubini first predicts a bout of deflation, and then veers off into a murky 2010 with asset inflation and later price inflation. I’d say he can just about see the tip of his nose, but that's it before he starts confusing himself.
Current default rate on option ARMs 35% or higher
Call it son of subprime. Experts warn that a new wave of mortgage foreclosures may be coming soon and could rival the default rates for subprime mortgages and slow efforts to find bottom in a prolonged national housing slump. The mortgages in question are $230 billion of option adjustable-rate mortgages, creative lending products that flourished at the height of the housing boom. In an option ARM, a borrower can opt to pay less than his or her monthly balance due, and the difference is tacked onto the outstanding loan balance.
Many experts had expected an explosion of defaults in the springtime on these roughly 564,000 outstanding mortgages. However, interest rates dropped to historic lows, and that delayed the detonation of what many housing analysts still see as a ticking time bomb. "They're probably going to default at a rate that makes subprime look like a walk in the park," warned Rick Sharga, senior vice president for RealtyTrac, a foreclosure research firm in Irvine, Calif.
Option ARMs have triggers that reset to a new interest rate based on either a set timeframe or when debt exceeds some cap above the loan's value. The spring drop in interest rates allowed many borrowers to escape a day of reckoning because the lower rates prevented a triggering of that cap. That just postponed the problem, however, because most option ARMs have five-year automatic trigger dates. These loans were most prevalent in states such as California, Florida and Nevada, where home prices have sunk so far that many homeowners are underwater: They owe more than their homes are worth.
The bulk of outstanding option ARMs — a product no longer available to homebuyers — were issued between 2004 and 2007. Monthly payments on these mortgages are due to reset to a higher lending rate between 2009 and 2012. "They're going to have a loan they cannot afford on a house that's probably way underwater and not have a lot of good options on how to avoid foreclosure proceedings," Sharga said. While a smaller number than subprime mortgages, option ARMs grew from 3 percent of all mortgages bundled and sold to investors in 2004 to 14 percent by 2007.
They pose risks for the broader U.S. economy because they threaten to add inventory to a depressed housing market and could hasten the blistering pace of foreclosure filings — more than 1 million from March to May alone. "We can't rebuild housing values when there's a serious risk that another set of mortgages is collapsing," said Elizabeth Warren, a Harvard University law professor who heads a government panel overseeing the spending of Wall Street bailout money.
The Mortgage Bankers Association, representing mortgage lenders, takes a more optimistic view. "Relative to what the industry was looking at a year and a half ago . . . the recast is not going to be the problem people thought it was going to be," said Michael Fratantoni, the vice president of research for the MBA. If the subprime crisis hit like a heart attack, the option ARM problem is more like a worsening chronic illness.
In a prescient cover story on Sept. 11, 2006, Business Week magazine labeled option ARMs "nightmare mortgages" and warned that it "might be the riskiest and most complicated home loan product ever created." Subprime mortgages caught the nation by surprise because of their short two-year resets to higher interest rates. Option ARMs reset over a longer horizon and thus are a slowly unfolding nightmare. "This one, everyone knows it's worsening. Everyone sees it worsening," said Sandipan Deb, a credit analyst in New York with Barclays Capital, a global investment firm. This long lead time gives lenders and borrowers time to seek alternatives, MBA's Fratantoni said.
Analysts put the current default rate on option ARMs at 35 percent or higher. Most were sold into a secondary market, where they were pooled with other mortgages and sold to investors as bonds or securities. The number of these loans is quantifiable, but banks aren't required to disclose how many such loans they wrote. It's unclear how many option ARMs remain on banks' books and weren't sold to investors.
Barclays Capital estimates that at least 37.5 percent of option ARMs originated in 2005 remain outstanding, as well as 63 percent of those originated in 2006 and 82 percent that originated in 2007. Deb and fellow Barclays analysts forecast a 38 percent loss rate for pools of option ARMs originated in 2006 and 48 percent losses for those issued in 2007. Since option ARMs were most popular in states with the largest home price declines, many borrowers owe 30 percent or 40 percent more than their homes' current values. That puts many of the Obama administration's mortgage relief programs out of reach for them, since these programs aid borrowers by lowering interest rates.
"The problem with these option ARM borrowers is they are already paying a low rate," Deb said, adding that a better solution would involve forgiving part of the loan balance, something that most lenders have been unwilling to do. The Obama administration, however, has offered financial incentives to lenders that are willing to accept a short sale or deed-in-lieu transfers. Both of these options involve a bank taking back an underwater mortgage, freeing the owner from further payment and allowing for a speedy resale of the property, avoiding foreclosure proceedings. "These are the kinds of properties that are right out of central casting for those types of procedures," said Sharga, of RealtyTrac.
The Retirement Dilemma: Keep Working?
Americans nearing retirement have too much debt and nowhere near the savings they need to live comfortably for 20-odd years. As the first cohort of the baby boom generation this year hits 63—which is the average age of retirement in the U.S.—the big question is: Are they financially ready to retire? That question is only going to gain urgency in the next several years as more and more boomers jump into the pool of retired Americans. Unfortunately, statistics suggest that retirement isn't going to be nearly as comfortable as most boomers had hoped.
Declining wealth, brought about by lower stock prices and falling home values, has hurt older households substantially. Americans lost 18% of their net worth last year, and the decline has disproportionately hit households of those nearing retirement. But even before the asset bubble burst, Americans looked ill-prepared for retirement. A year later the situation is no better. The Center for Retirement Research (CRR) at Boston College estimates that 43% of Americans are "at risk," meaning they would be unable to maintain their current standard of living in retirement. The good news: Most Americans seem to understand their situation. Only 19% of the population says they are prepared when they really aren't, according to a CRR survey.
The bad news is that they don't seem to be doing much about it, whether through saving, paying off debt, or taking advantage of preretirement investment opportunities available to them. Simply put, many Americans are not financially prepared to stop working because of a variety of issues. Many households have no real retirement plan, period. The average American family has not saved enough to retire and maintain the standard of living they've enjoyed in previous years. Moreover, at a time when they should be free of burdens such as mortgages, many pre-retirement households still have a high level of debt when they should be planning for reduced earnings.
Watching their retirement savings dwindle or fretting about looming layoffs, workers now have far less confidence that they'll have sufficient funds for their golden years than they did in 2007, according to the Retirement Confidence Survey done in April 2009 by the Employee Benefits Re?search Institute and Matthew Greenwald & Associates. Historically, most Americans have relied on government programs to fund their retirement, but they're also losing confidence in this option, according to the survey. With good reason: The financial vulnerability of those set to retire soon is matched by increasing cracks in that foundation. New projections for federal entitlements such as Social Security and Medicare indicate that both will run out of money sooner than expected—well within the lifetimes of most boomers.
It's probably too late to do much for the first wave of boomer retirees—they're already too close to retirement. Even most younger Americans will have to rethink their retirement strategies because no magic cure exists. The solution may lie in a combination of actions such as raising the age to collect full Social Security benefits and Medicare to be more in line with longer life spans, working beyond retirement, and aggressively cutting debt. Alicia Munnell and Steven Sass put a likely answer to this problem right in the title of their recent book, Working Longer: The Solution to the Retirement Income Challenge, (Brookings Institution, Washington, D.C., 2008). Two years ago the average American expected to retire at age 63. Now it's 65, according to the Retirement Confidence Survey.
But it's unclear if all workers will actually work that long, since the same survey also showed that 47% of retirees stopped working "earlier than planned." For quite some time, Americans have not had enough savings to finance retirement, but a look at total financial assets shows the situation has worsened. At the end of 2007 the median household in the 55-to-64 age group had total financial assets of only $72,400 according to the 2007 Survey of Consumer Finances (SCF), which the Federal Reserve does every three years. Based on the performance of financial markets over the last year, that number is probably now down to $55,000.
The SCF gives little reason for optimism. Even in the pre-retirement age group (ages 55-64), only 58.4% of families saved any money last year, just slightly above the national 56.5% ratio. Median net worth was $253,700 for this cohort, but most of that is tied up in the family home, which declined in value this year and in any case is not a very liquid asset. These households are richer than the national median of $120,300, but they're not rich enough to live in comfort for 20 years of expected retirement. While measures of wealth show pre-retirees are better off than younger Americans, disparities among different subgroups have risen.
The average level of wealth is much higher than the median, at $935,800 for the 55-to-64 group and $556,300 for the nation. The top wealth owners are in relatively good shape, but most of the population isn't rich or even adequately financed. Wealth is concentrated in the top 10% of households, which had a net worth averaging $4 million in 2007. Net worth is much less evenly distributed than income. The ratio of the income of the 95th percentile to the median, a standard measure of inequality, is 4.4. The equivalent wealth ratio is 15.7.
Of course, part of the reason for the inequality is that wealth tends to increase over time. Older households have more money than younger households because they have had time to accumulate wealth and pay down mortgage and other debt. While households in the 55-to-64 bracket have only 115% of median income, they have 199% of median net worth. The ratio of their net worth to the national median has gone up in recent years. In 1998 it was only 178%. In our view, the growth of defined-contribution accounts, such as IRAs and 401(k)s, probably explains most of the increase.
At the other extreme, the high percentage of families without any pension or retirement savings is a concern. This percentage has declined over the period for which the Fed has been doing the SCF surveys, but currently 42.3% of all households have no pension or other retirement savings, such as a 401(k) or IRA. For those who have coverage, 55.8% have a defined-benefit plan (37% of the total number of households), while 65.8% have a defined-contribution account (21.6% have both). The median value of these accounts was $45,000, but it was $98,000 for households in the 55-to-64 age bracket. (The median is only for the 57.7% of the population having such accounts.)
Not everyone with access to such a plan makes use of it. In 2007 only 83.8% of family heads with access to a defined-contribution account participated (down slightly from 84.1% in 2004). Participation is tied closely to income and was much lower for eligible households in the bottom two quintiles (45.7% and 71.9%), while 91.3% of those eligible in the top quintile participated. Of course, even $98,000 is too little for retirement. The rule of thumb is that a new retiree (age: mid-60s) can afford to take out only 4% of the asset balance each year to support consumption—and $4,000 a year doesn't go very far in today's world.
A big problem is that pre-retiree households are increasingly saddled with debt at a time in people's lives when they should be reducing their living costs. The old rule was that all debts should be paid by retirement. Financial institutions designed a 30-year mortgage, in part, to be paid off by age 65. But the 2007 SCF found that 81.8% of households in the 55-to-64 age bracket and 65.5% of those in the 65-to-74 age bracket still had outstanding debt. The older you are, the more likely you are to own a home. This is important in retirement, since owning your own home can provide liquidity through a reverse mortgage or sale (especially if you move to an assisted-care facility) and will generally cut your cost of living, particularly if you have paid off the mortgage. Unfortunately, many haven't. For households in the 55-to-64 bracket, 55.3% have mortgages, compared with a national ratio of 48.7%.
Homeownership rates also continue to increase with age even after retirement. Those in the 65-to-74 bracket have an 81.3% homeownership rate, and for those 75 and up, 85.2%. The median mortgage in the 55-to-64 age bracket is $85,000, compared with a median home value of $219,700. Retirees' debt loads also differ from those of working households. As might be expected, retirees are less likely to have debt, with only 52.3% having any and only 27% with a mortgage on their primary residence (vs. 48.7% overall). The median debt for retired households is $20,000, well below the national median of $67,300. Retirees have median net worth of $161,300, vs. $120,300 overall.
40 or 50 graduates chasing every job in the market
If Toby Irving had his way, he'd be one of the people working hard to overcome the recession. Instead, he's another statistic of it. The 21-year-old LSE graduate is desperate to find work in the City, but feels like he is banging his head against a brick wall. Living at home with his parents in London, Toby spends his time trying to find employment as a trainee economic consultant, but to no avail. "It's frustrating. What I find especially annoying is that in previous years it seemed like City jobs were being thrown around. Now you have to be at the extreme top to even get an interview."
With three As at A-level and a CV jam-packed with work experience and internships, Toby wasn't expecting the milk round to turn so sour. The struggle facing graduates trying to break into the job market is well-documented, but what has been less well discussed is the long-term affect on business. A report by the European Association for People Management (EAPM) and the Boston Consulting Group warns of a human resources time-bomb as the "baby boomers" near retirement age, and cuts in graduate recruitment slow the stream of new blood to a trickle.
Stephanie Bird, a board member of EAPM and director of HR capacity at the Chartered Institute for Personnel Development, says: "It's short-term gain, in exchange for long-term pain. "We've seen in the past, and we're seeing now, how companies will over-recruit when times are good, and then shut the tap off when things get more difficult. "The attitude is we'll think about it when we get there. Then you'll find yourself relying on other people for strategy and becoming dependent on them; it becomes a case of buying people, not building them."
Nick Tout, director of Hays recruitment's accountancy and finance department, says: "Most commercial organisations have significantly lower hiring levels and many have stopped graduate recruitment completely – they will be the first to suffer when there is an upturn. "The investment in training and upskilling candidates that will then be required may negate any short term cost-cutting that is being achieving by not recruiting graduates." Martin Birchall, managing director of High Fliers, which specialises in graduate recruitment research, admits that the situation is "bleak". "We have a massive, massive oversupply of graduates," he says. "The graduate population has doubled – but the number of graduate jobs certainly hasn't. There are now 40 or 50 graduates chasing every job in the market."
High Fliers report that investment banks have slashed their recruitment by almost half, while high street banks and other financial organisations have also decreased their graduate intake. "Last year when we interviewed 15,000 final-year students from the class of 2008, investment banking was the second most popular destination. This year, it only just made it into the top 10 in terms of the number of students applying. And teaching is the top destination for the first time. "So I think students have recognised that they need to go for the areas which perhaps are recruiting, and have better job security, rather than chasing high salaries," he says.
Interestingly, Britain's two largest graduate recruiters – PricewaterhouseCoopers and Deloitte – are maintaining their recruitment at the same level as last year. Both companies are taking on 1,000 graduate trainees, and argue that reports of a drop in graduate vacancies have been overplayed. Sonja Stockton, head of recruitment at PWC, said: "The market has certainly shifted. We've taken some of the best talent from investment banks. And we've also still got vacancies in the regions. Sarah Shillingford, graduate recruitment partner at Deloitte, agrees that applicants need to be flexible about where they work. "My concern is that some graduates think the degree of difficulty is far worse than it is, so that is putting people off trying," she says. "People think that jobs have been filled up, when they haven't at all."
Ms Shillingford adds that the current squeeze on graduate recruitment across the financial sector may mean ripe pickings for those who do manage to break in. "I don't want people to think I'm saying it is easy – but there are a lot of people who perhaps think things are worse than they are." Stephanie Bird of the Chartered Institute for Personnel Development says: "Not all organisations would be able to continue recruiting, as Deloitte and PWC have done."
Russia Stocks Fall 20% in World’s First Bear Market Since March
Russia’s Micex Index tumbled more than 20 percent from its 2009 peak, becoming the world’s first benchmark equity index to enter a bear market since global stocks began rallying in March. The index of ruble-denominated shares slid 7.8 percent to 937.98, bringing its decline since June 1 to 22 percent. The 30- company gauge posted the steepest drop worldwide today and has led a slide from New York to Mumbai this month on concern the global recession will persist longer than investors estimated.
The Micex, which rallied as much as 135 percent since October, reversed direction after reaching the most expensive level relative to profit estimates since January 2007, according to Bloomberg data. Russia’s economy may shrink 7.5 percent this year as industrial output slumps, unemployment rises and investors pull capital from the world’s largest energy exporter, the World Bank said today. The lender also forecast a 2.9 percent contraction in the global economy.
"The market needs to pause because it has been going up too much," said Nicholas Field, who helps manage about $11 billion in emerging-market stocks at Schroders Plc in London, including Russian equities. "Nothing goes in a straight line." The MSCI All-Country World Index has dropped 6 percent from its 2009 high, paring its gain from a six-year low on March 9 to 38 percent. The Russian economy shrank an annual 9.8 percent in the first quarter, the most in 15 years, as companies struggled to raise funds and falling incomes crimped consumer demand. Industrial output shrank a record annual 17.1 percent in May.
"Some of Russia’s main industrial production data was disappointing and is a reminder that the real economy is going to be impacted quite severely this year," said Michael Wang, an emerging-markets strategist at Morgan Stanley in London. "There is not going to be a quick V-shaped recovery in Russia." Earnings for Russian companies may tumble 61 percent in 2009 before rebounding 12 percent next year, according to forecasts from Citigroup Inc. in New York. That compares with a 24 percent decline this year for developing nations as a whole, and a 23 percent increase in 2010, the brokerage’s data showed.
After Russia, Croatian stocks are the closest to a bear- market decline since the global equity rally began. The Balkan nation’s Crobex Index is down 15 percent from its 2009 high. A bear market is defined as a decline of 20 percent or more. Brazil’s Bovespa Index has dropped 8.7 percent from its peak this year, while India’s Bombay Stock Exchange Composite Index slid 7.4 percent. The Shanghai Composite Index closed today at its highest level since July 28. The Russian market’s "extreme" rally since October makes a 20 percent decline less meaningful than for markets that didn’t rise as much, said Lombard Odier & Cie.’s Curtis Butler.
"It seems a bit absurd at this point to be using the phrase ‘bear market,’" Butler, chief investment officer of emerging-market equities at Lombard, said in a phone interview. The decline is a "healthy development that will allow investors who have booked significant profits to offload shares to those who have not participated," he said. Investors fled Russia last year, taking capital outflows to a record $132.7 billion, as Urals crude, the country’s main export blend, declined as much as 77 percent from a July peak.
A five-day war with Georgia in August increased speculation that overseas companies would reduce investments, after the conflict was condemned by the U.S. Russian corporations slashed output and cut staff after the collapse of New York investment bank Lehman Brothers Holdings Inc. froze credit markets worldwide and the global economy slipped into its first recession since World War II. The Micex tumbled as much as 73 percent last year.
The Russian market’s rally from its four-year low on Oct. 24 to its peak this month was the steepest among stock benchmarks in the world’s 70 biggest markets. Investors returned as oil more than doubled and the nation’s currency, the ruble, recovered from a 19 percent slide against the dollar last year. Urals crude has dropped 4.8 percent from its high this year, while the ruble has weakened 2.3 percent against the dollar since June 1.
Russia Recession Sends 'Damaging Waves' Through CIS
Russia’s economy is shrinking more than expected, sending "damaging waves" throughout the former Soviet Union, the World Bank said. Collapsing industrial production, rising unemployment and capital flight will reduce Russia’s gross domestic product by 7.5 percent this year and restrain "intraregional trade flows and transfers," the World Bank said in a report posted on its Web site today. The Washington-based bank’s last Russian forecast, in March, was for the economy to shrink 4.5 percent. Klaus Rohland, the bank’s chief representative in Russia, said in an interview last month that he agreed with the International Monetary Fund’s projection for a contraction of 6 percent.
"Remittances to the broader CIS region are expected to decline for the first time in a decade, by 25 percent," the World Bank said. The CIS, or Commonwealth of Independent States, is an alliance of former Soviet republics. The economy of the world’s biggest energy exporter shrank an annual 9.8 percent in the first quarter, the most in 15 years, as companies struggled to raise funds and falling incomes crimped consumer demand. Industrial production shrank a record annual 17.1 percent in May.
Funds sent to the Commonwealth of Independent States amounted to $3.17 billion in the fourth quarter, a decrease of $1.1 billion compared with the previous three month period, Russia’s central bank said in a statement on its Web site on March 11. Remittances to the CIS accounted for 92 percent of the total sent abroad from Russia last year. Prime Minister Vladimir Putin on June 19 said Russian unemployment fell for the first time in 10 months in May while retail sales dropped the most in almost a decade. "Despite a series of positive signals, conditions in the economy remain difficult," Putin said. "Most industries are gradually adapting to the new economic realities."
Retail sales fell the most in almost a decade in May, sliding an annual 5.6 percent, the fourth consecutive decline and the biggest since September 1999. The average monthly wage decreased an annual 3.3 percent in May, while real disposable incomes dropped 1.3 percent. "The prolonged credit crunch, untamed recession in the euro area, and sharp contraction in Russia will continue to put pressure on current accounts in a number of countries," the World Bank said today.
CIS countries have more than $283 billion of short-term debt coming due this year and only Russia has the funds to pay creditors, due to its current-account surplus and foreign currency reserves, the largest after China and Japan, the World Bank said. "The small oil-importing countries in the CIS will be the most affected owing to their close economic ties with Russia," the lender said. "GDP is expected to fall by 6 percent in Armenia, by 3.3 percent in Belarus, and by 3 in Moldova."
Europe cannot ignore its financial trilemma
The supervision of cross-border financial institutions has long been organised on the basis of "he who pays the piper calls the tune", as Charles Goodhart, the economist, puts it. In other words, since public money is at stake when bailing out insolvent banks, supervisory responsibilities are inextricably linked with fiscal policy. This has been the main rationale for supervisory powers remaining at national level, where taxation powers lie, even within the European single market. The developments of the past decade, including the current crisis, have to some extent called into question the validity of this reasoning.
First, financial integration, in particular within Europe, has made such progress that a bank’s failure has repercussions not only for the taxpayers of the country where the bank is incorporated but also for those in other countries. This applies not only to banks with cross-border activities but also to those with mainly national operations that have a high exposure to the banks of other countries, in particular through the money market. Bank insolvencies can be highly contagious and spread throughout the single financial system.
Second, the European Union’s push to harmonise financial regulation – via the Lamfalussy framework designed to ensure national watchdogs co-ordinate new regulations – has not achieved its objective, namely a level playing field. To give an example, the latest capital requirement directive includes more than 150 exemptions, allowing for discretion in how the directive is transposed into national legislation. Convergence between supervisory practices has also been insufficient.
Third, while in principle there is a single European financial market, in practice national institutions and financial centres compete. Such competition puts pressure on national authorities to interpret regulations and implement supervision in such a way as to give an advantage to their financial system. This in turn encourages a "lighter" supervisory touch, in order to reduce the burden on domestic banks and make the national financial centre more attractive. In this context, the stability of Europe’s financial market is likely to depend on the weakest link in the chain.
These developments point to a clash between three objectives: financial integration, financial stability and national supervisory autonomy. The three cannot be achieved simultaneously and the recent crisis is a confirmation of the risks involved. This "trilemma" was recognised in Lord Turner’s recent review of financial regulation: "Sounder arrangements require either increased national powers, implying a less open single market, or a greater degree of European integration."
Continuing to enhance co-operation between national authorities within the single market is necessary but has proved not to be sufficient. For supervisory powers to remain at the national level within an integrated European market, a common set of regulations and agreed practices – a so-called single rulebook – is required. Also needed is a framework to resolve differences of views between national authorities, especially concerning cross-border institutions.
This might have fiscal implications for the national authorities. But the recent crisis has shown that it is an illusion to think that national taxpayers can be protected simply by maintaining supervision at the national level. Ultimately taxpayers might also have to support – and in the recent crisis have already supported – the domestic parts of insolvent institutions which are supervised by foreign authorities. This burden-sharing is more likely to be acceptable to countries if it is the result of an agreed and binding common framework, rather than a unilateral decision by one national supervisory authority.
The alternative is to retreat from the freedoms of the single market. This is ultimately a choice for the member states. Many EU countries evidently do not wish to move back to a less open internal market and may not even be able to do so, because of the single currency that binds them together irrevocably. Others, however, remain reluctant to strengthen supervisory powers at the European level. Last week’s meeting of the leaders of European states decided not to decide on this issue. Let’s hope that we won’t have to wait for the next crisis for a clear choice to be made.
ECB chief Trichet says governments have reached borrowing limit
European Central Bank president Jean-Claude Trichet warned today that governments that have borrowed billions to fight the economic crisis had no room for more debt and would have to start bringing down budget deficits. Trichet said the large injection of funds in an effort to stimulate European economies had been the right response, but said there was a need to get public finances back under control as soon as possible. "There is a moment where you can't spend any more and you can't accumulate any more debt. I think we are at that moment," Trichet told Europe 1 radio.
"We are in exceptional circumstances," he said, adding that financial markets and consumers had to be convinced that budgets would return to normal. The ECB has slashed interest rates to shore up a battered economy, though a rate of 1% is higher than in the United States or Britain and was cut more slowly. Although the eurozone was not at the core of the freezing up of financial markets in the autumn of 2007, its banks held vast amounts of toxic assets and countries such as Germany, which was heavily dependent on exports, have plunged into recession as world trade collapsed.
But Trichet said there was now wide agreement that the bloc's economy would be showing clear signs of recovery by 2010 if the appropriate action was taken. "In that hypothesis, we will have growth coming back again and so we have to begin the operation that consists of moving progressively towards balance," he said, referring to budget deficits. Trichet said the unprecedented actions taken by central banks had restored confidence to money markets that were almost crippled by the shock of the Lehman Brothers collapse last year. "As far as risk, risk premiums on money markets, the functioning of the money markets is concerned, we have returned to a situation I would qualify as 'pre-Lehmans'," he said.
Trichet also repeated calls for an overhaul of the rules underpinning the global economy. He said the global crisis had revealed the fragility of the financial system, which had encouraged short-term decisions and reinforced cyclical swings and he said it should be strengthened "in an extremely significant manner". "We would not be forgiven for starting again with the same degree of fragility."
He welcomed the recent steps agreed by European Union leaders to tighten financial supervision. "Some might say we should go much faster but I think one has to be realistic and practical."
Trichet said that as head of the ECB he would be able to lead a new European Systemic Risk Board that would monitor risks to stability but he declined to comment on whether he would actually chair the body. Britain and national banking and insurance regulators in the EU oppose the ECB chairing the new board.
City of London warns EU rules are a threat to UK economy
The City of London has warned that new European regulations could ride roughshod over the interests of the UK, where the financial services sector employs more than 1m people and generates billions of pounds in income. In an outspoken attack on the accord signed last week to create an EU regulator, the City of London Corporation said the Brussels legislation posed a dangerous risk to the success of the economy. Stuart Fraser, chairman of the Corporation's policy & resources committee, said: "We have lost the broader argument about ceding control of UK rules to the EU, though we are happy that some concessions have been made." "We now still have a situation where binding arbitration dictated by Brussels could overrule the UK's Financial Services Authority."
Last week's summit in Brussels saw 27 European leaders sign a draft agreement that would see three European Supervisory Authorities set up to oversee banking, insurance and securities. Though these bodies do not have the power to force financial consequences, such as a banking bail-out, they do have recourse to binding arbitration – which means the City watchdog may yet have to cow tow to their edicts if there is a conflict with another national regulator. Mr Fraser said: "We will have to see what exactly is meant by these general terms and how the power is used."
Mr Fraser also added his voice to fears that planned European regulations could lead to an exodus of hedge funds from the UK. The EU Alternative Investment Directive, issued last month, has met with heavy criticism from hedge funds which claim parts of its, including debt restrictions and that only European domiciled firms would be able to market to EU investors, would be unworkable. It has sparked a battle with the UK's multi-billion pound hedge fund community which has warned it might have to move overseas, to New York or Geneva aunless the proposals are watered down.
Mr Fraser said the European Council was absolutely right to decide more time needed to discuss the proposed legislation. "Europe does not like private equity or hedge funds and seems hell bent on driving these industries out of Europe. Here in the UK we see their role as vital and with 85pc of hedge funds operating out of London, if the legislation is not radically changed, the cost to the British economy will be huge." The UK hedge fund industry's response is being co-ordinated by trade body the Alternative Management Association and a number of prominent hedge funds have set up a steering committee. Man Group, Marshall Wace and Lansdowne Partners are on the committee. Meanwhile, AIMA has welcomed a report from the International Organization of Securities Commissions proposing new global regulations for hedge funds including large hedge funds reporting information to their national regulators concerned with systemic risk.
ECB set for record ‘stimulus by stealth’
The European Central Bank is on track to deliver a record-breaking "stimulus by stealth" to the eurozone economy on Tuesday, as the first-ever offer of unlimited one-year funds could see demand running into several hundred billion euros. The size of the ECB’s emergency liquidity-boosting operation, which was announced last month, is expected to be bolstered dramatically by the belief in financial markets that eurozone official interest rates will not fall – and the opportunity to borrow on such favourable conditions will not be repeated.
Analysts said demand was likely to exceed the previous record €348.6bn ($483bn), injected in a single ECB operation in December 2007. "This could be a big final easing – by stealth," said Erik Nielsen, European economist at Goldman Sachs. "If I were a bank I would be gathering up all the furniture to use as collateral to take part."
When the financial market crisis first erupted in mid-2007, the ECB led the way among the world’s central banks in pumping in extra liquidity to ease tensions. After the collapse of Lehman Brothers last year it expanded its armoury substantially by agreeing to match in full demand for liquidity for periods of up to six months. Although such steps have attracted less attention, ECB policymakers argue that the effects on the recession-hit eurozone economy have been similar to "quantitative" or "credit" easing measures unveiled by the Bank of England and US Federal Reserve.
May’s decision to offer funds for one-year – which in Tuesday’s offer will be available at the ECB’s main interest rate of just 1 per cent, the lowest ever – marked a further escalation of the ECB’s offensive. Unlike previous operations, however, banks are not expected to hold back in the expectation that interest rates will subsequently fall. Creating an additional incentive, the ECB has reserved the right in future one-year operations to charge an interest rate above its main policy rate.
Strengthening the case against further ECB interest rate cuts, Germany’s Ifo "business climate" index on Monday added to evidence that the eurozone’s largest economy is stabilising. It rose for a third consecutive month, from 84.3 in May to 85.9 this month – the highest since November. However, the rise was due to companies taking a more favourable view about the outlook for the next six months. Businesses’ assessment of current conditions deteriorated even further – dropping in June to the lowest since the survey began in 1991.
Meanwhile, Ewald Nowotny, Austria’s central bank governor and an ECB policymaker, said he saw ECB interest rates remaining unchanged until at least 2010. "If the economy is developing in the way that we expect, I do not see a perspective for this year and we will need to look again next year," he told Bloomberg in an interview. Analysts said Tuesday’s ECB move would depress market rates for short-term funding, from maturities ranging from overnight to a year, as the increased liquidity in the financial system in effect loosened monetary policy in Europe. Don Smith, economist at interdealer broker Icap, said: "A lot of banks will see this as a good rate to lock in funding for a year."
Berlin weaves a deficit hair-shirt for us all
by Wolfgang Münchau
A decision was taken recently in Berlin to introduce a balanced-budget law in the German constitution. It was a hugely important decision. It may not have received due attention outside Germany given the flood of other economic and financial news. From 2016, it will be illegal for the federal government to run a deficit of more than 0.35 per cent of gross domestic product. From 2020, the federal states will not be allowed to run any deficit at all. Unlike Europe’s stability and growth pact, which was first circumvented, later softened and then ignored, this unilateral constitutional law will stick.
I would expect that for the next 20 or 30 years, deficit reduction will be the first, second and third priority of German economic policy. Anchoring the stability law at the level of the national constitution is an extreme measure – like locking the door, and throwing the keys away. It can only ever be undone with a two-thirds majority – and even a future Grand Coalition may not be able to deliver this as both of the large parties are in a process of secular decline. It means that future fiscal policy will be in the hands of the justices of Germany’s Constitutional Court.
The new law replaces a much softer constitutional clause – a golden investment rule that said deficits can only be used to finance investments. It was not a satisfactory rule, but at least it allowed structural deficits in principle. The new law not only sets draconian deficit ceilings, it also provides a detailed numerical toolkit to implement the rules over the economic cycle. I can foresee two outcomes. First, Germany might end up in a procyclical downward spiral of debt reduction and low growth. In that case, the constitutionally prescribed pursuit of a balanced budget would require ever greater budgetary cuts to compensate for a loss of tax revenues.
To meet the interim deficit reduction goals, the new government will have to start cutting the structural deficits by 2011 at the latest. There is clear danger that the budget consolidation timetable might conflict with the need for further economic stimulus, should the economic crisis take another turn for the worse. There is still economic uncertainty. Bankruptcies are rising, and the German banks are just about to tighten their credit standards again. I simply cannot see how Germany can produce robust growth in such an environment, not even in 2011. If that scenario prevails – as I believe it will – the new constitutional law will produce a pro-cyclical fiscal policy with immediate effect.
One could also construct a virtuous cycle – the second outcome. If Germany were to return to a pre-crisis level of growth in 2011, and all is well after that, the consolidation phase would then start in a cyclical upturn. Either of those scenarios, even the positive one, is going to be hugely damaging to the eurozone. In the first case, the German economy would become a structural basket case, and would drag down the rest of Europe for a generation. In the second case, economic and political tensions inside the eurozone are going to become unbearable.
Over the past 25 years, France has more or less followed Germany’s lead at every turn, but I suspect this may be a turn too far. Deficit reduction has not been, nor will it be, a priority for Nicolas Sarkozy, the French president. On the contrary: he has listened to bad advice from French economists who told him that budget deficits are irrelevant, and that he should focus only on structural reforms. Budget deficits and debt levels matter in a monetary union. But a zero level of debt is neither necessary nor desirable.
I am a little surprised not to hear howls of protests from France and other European countries. Germany has not consulted its European partners in a systematic way. While the Maastricht treaty says countries should treat economic policy as a matter of common concern, this was an example of policy unilateralism at its most extreme. What is the rationale for such a decision? It cannot be economic, for there is no rule in economics to suggest that zero is the correct level of debt, which is what a balanced budget would effectively imply in the very long run. The optimal debt-to-GDP ratio might be lower for Germany than for some other countries, but it surely is not zero.
While the balanced budget law is economically illiterate, it is also universally popular. Average Germans do not primarily regard debt in terms of its economic meaning, but as a moral issue. Der Spiegel, the German news magazine, had an intriguing report last week on the country’s young generation. One of the protagonists in its story was a young woman who had borrowed a little money to set up her own company. The company turned out to be a success, and she had began to repay the loan. And yet she said she had not felt proud of having taken on debt. This general level of debt-aversion is bizarre.
Many ordinary Germans regard debt as morally objectionable, even if it is put to proper use. They see the financial crisis primarily as a moral crisis of Anglo-Saxon capitalism. The balanced budget constitutional law is therefore not about economics. It is a moral crusade, and it is the last thing, Germany, the eurozone and the world need right now.
Iceland at risk of a 'junk' credit rating
Iceland is concerned that its credit rating could soon be downgraded to "junk" status – meaning there is a high risk of the country defaulting on its sovereign debt. Finance minister Steingrimur Sigfusson acknowledged that the ratings agencies, including Fitch, Moody's and Standard & Poor's, are reviewing their classifications. "We're obviously concerned, and people in the finance ministry and central bank are meeting with rating companies, not only Fitch, and discussing these things," Mr Sigfusson said. "Certain steps are being taken to monitor the situation that will have an effect on the eventual outcome of the rating."
Iceland's credit rating is already in a vulnerable position after its three biggest banks and currency collapsed late last year. The International Monetary Fund was forced to put together an emergency loan package of $10bn (£6bn) to avoid a default. Fitch and Standard & Poor's already rate Iceland's debt as BBB- – one grade above junk. Moody's ranks it as Baa1, three notches above non-investment grade. The government is currently struggling to pass hefty budget cuts through parliament, as Johanna Sigurdardottir, the new prime minister, is under pressure to deal with a deficit of 170bn ISK (£800m) by 2013.
There has also been widespread anger among Icelandic MPs about the terms of its agreement with the UK to repay a £3.3bn loan at a costly interest rate of 5pc. The British Treasury stepped in to compensate customers of the collapsed Icelandic bank, Icesave, but the tiny Nordic nation has agreed to pay back every depositor up to €22,000 (£18,500).
Lithuania’s Economy Will Contract 16% This Year, IMF Says
Lithuania’s economy will contract 16 percent this year as the Baltic state suffers the twin blows of shrinking export markets and depleted access to credit, the International Monetary Fund said. "The road ahead will be challenging, requiring continued steps to safeguard fiscal and financial sustainability," Catriona Purfield, head of the Washington-based fund’s mission to Lithuania, said at a press conference in Vilnius today.
The Baltic states of Latvia, Lithuania and Estonia are suffering the European Union’s severest recessions, and also enduring the steepest economic decline of all developing regions, the World Bank said today. Still, that hasn’t prompted Lithuania to follow neighboring Latvia and seek a bailout, the IMF confirmed today. Lithuania’s economy will shrink 3.4 percent in 2010, according to the fund. The government targets bringing the budget deficit to within 3 percent of gross domestic product in two years to help Lithuania adopt the euro, Prime Minister Andrius Kubilius said at the same press conference today.
"A further budget consolidation equivalent to more than 7 percent of GDP is needed within the next two years," Kubilius said. "That’s challenging but achievable." He targets euro adoption by 2012. The budget gap will be between 6 percent and 7 percent of GDP this year, Kubilius said in a June 18 interview. Lithuania plans to push through its second round of budget cuts since the beginning of the year, with the first parliamentary debate on the revisions due tomorrow. The measures include an increase in value-added tax by 2 percentage points to 21 percent, reduced social benefits and 9.5 percent wage cuts.
"The package tomorrow represents a very important down payment on the structural reform that needs to be done over the medium term," Purfield said. The country has already cut budget spending by 7 percent of GDP this year, a move the IMF said described as a "sizable fiscal adjustment" and a "skillful management of economic policies." Lithuania’s currency board arrangement is "a credible path toward euro adoption but it will need to be supported by strong policy efforts," such as long-term fiscal adjustments, additional buffers in the financial system and wage and structural reforms, according to the IMF.
All three Baltic states peg their currencies to the euro as part of the exchange rate mechanism. Lithuania’s economy may contract 18.2 percent this year, the finance ministry said last week. Baltic neighbor Latvia obtained a 7.5 billion euro ($10.5 billion) loan from a group led by the International Monetary Fund and the European Commission in December.
World Bank Says Latvia, Bulgaria Short-Term Debt Tops Reserves
Latvia, Belarus and Bulgaria lack enough international reserves to cover debts coming due this year and may have to tap "official sources" for more capital or cut spending, the World Bank said. Latvia’s short-term debt amounted to 250 percent of its $3.9 billion lati reserves, Belarus’s debt was 290 percent of its reserves and Bulgaria’s short-term debt was about 100 percent of its $16 billion reserves in February, the Washington- based lender said in a report today.
The global financial crisis is pinching eastern Europe’s access to credit, forcing countries including Latvia, Belarus and Hungary to accept international aid from the International Monetary Fund, the World Bank and other donors. Bulgaria has yet to seek assistance, though there is "a high liquidity risk" in the region that may hurt banking systems, the World Bank said. As of February, "Belarus, Bulgaria and Latvia held insufficient international reserves to cover debt coming due in 2009," the World Bank said in the report. "For those countries that lack large foreign-currency reserves, the gap will have to be bridged either through capital flows from official sources or through internal adjustment."
The region’s large external financing requirements in 2009 include more than $283 billion in short-term debt coming due, the World Bank said. Russia is the only country in the region with high short-term debt level that could foot the bill from reserves or its current-account surplus if external finance was not available. The financing gaps in the region could be as high as $102 billion, or 3.7 percent of GDP in 2009, the report said. With the sharp fall-off in capital flows, tight capital markets, and large borrowing requirements, the gap will have to be bridged.
Bulgaria and Latvia are among the most vulnerable in the region because they have fixed exchange rates in systems that limit their central banks’ ability to adjust monetary policy. Bulgaria’s total short-term debt of 13 billion euros ($18,000) is private, according to central bank data. Bulgaria so far appears able to handle the coming-due short-term debts, which amount to about 36 percent of gross foreign debt, said Elisabeth Andreew, an economist at Nordea Bank in Copenhagen.
"I don’t see an immediate threat to the currency board in Bulgaria," Andreew said. The debt "is almost fully covered by reserves, so the country seems to have room to maneuver as regards its external debt burden, at least for now." Still, the biggest threat to Bulgaria’s currency board is a possible devaluation in the Baltic countries, Andreew said. Since Latvia is set to receive the next payment on its international loan, it may avoid devaluation, she said.
Kazakhstan, the Former Yugoslav Republic of Macedonia, Moldova, Poland, Romania, and Bulgaria had short-term debt levels above 50 percent of their reserves, the report said. "So far, rollover of short-term debt has not proved to be the problem initially feared, in part because of moral suasion exercised by domestic and international authorities on lending banks," the report said.
The predominance of foreign-owned banks in central and eastern Europe, mostly with headquarters in Austria, Greece, Italy, and Sweden, could expose countries in the region to a sharp reduction in access to foreign capital if parent banks in high-income countries are forced to scale back lending in the region as they seek to bolster their own balance sheets, the report said. "In countries with more rigid exchange rate and/or monetary policy response, the adjustment will have to take place through a sharp contraction in imports and, thus, in domestic demand," the global lender said.
Denmark Delivers 12% With Mortgage Bonds as World Channels Angst of Hamlet
To be in bonds or not to be in bonds is the question for investors worldwide amid ever-widening budget deficits that may lead to resurgent inflation. Except in Denmark, where the debt market’s Hamlets are nowhere to be found. Denmark’s mortgage-bond market, the largest behind the U.S. and Germany, returned 12.3 percent since prices fell to a 15- month low in October, according to Danske Bank A/S, the nation’s largest bank. The Danish benchmark three-year note gained 7.8 percent in the past eight months, compared with 4.3 percent for a similar U.S. security and 4 percent for a German note.
The nation’s mortgage-bond market will grow 6.5 percent this year to $410 billion, according to Nordea Bank AB, as homeowners take out new loans or refinance old ones following central bank interest-rate cuts that outpaced those in the U.S. and Europe in the past year. The bonds, described by George Soros in October as the "the best-performing in Europe," haven’t suffered a default since they were introduced after the great fire of Copenhagen in 1795.
"The fundamentals in the Danish mortgage market are incredibly sound," said Jacob Skinhoj, the Copenhagen-based chief analyst at Nordea, Scandinavia’s biggest bank. "That will keep performance high for the rest of the year." Scandinavia’s smallest economy has a jobless rate of 3.3 percent, compared with 9.2 percent in the euro-area and 9.4 percent in the U.S. Danish house prices fell 11.6 percent in the year ended March, compared with 16.9 percent for the U.S., according to the Knight Frank Global House Price Index.
The yield on the benchmark Realkredit Danmark three-year note fell 277 basis points, or 2.77 percentage points, since Oct. 27 as the bonds gained, versus declines of 189 basis points for comparable U.S. notes and 127 points for German bonds. The three-year Danish note’s yield fell to 3.05 percent on June 19, from 3.19 percent a week earlier, according to Danske Bank. Bonds rallied as Denmark’s Nationalbanken cut its benchmark repurchase rate eight times, to 1.55 percent from 5.5 percent in November. The Federal Reserve lowered its target rate for overnight bank loans once, to a range of zero to 0.25 percent from 1 percent, in the same period. The European Central Bank reduced the main refinancing rate six times, to 1 percent from 3.75 percent in October.
The securities also rose after the government, the Financial Supervisory Authority and the Danish Insurance Association decided in October to let pension funds, which hold about 25 percent of outstanding mortgage debt, change the way they calculate future obligations. That eased concern that the funds would sell mortgage bonds. Denmark’s mortgage market has exceeded the country’s $325 billion gross domestic product since 2006 and the government bond market, which totals $88 billion, according to the central bank. Mortgage securities outperformed government bonds since mid-March after lagging behind for the first time in almost three years.
Mortgage lenders can’t take customer deposits, so they raise money by selling bonds backed by every home loan. Lenders also must balance loans with bonds that carry similar terms. Unlike in the U.S. and Germany, they must also retain the risk that borrowers will default by continuing to provide such functions as collecting interest payments. The market should be a "model" for all others, Soros, the billionaire founder of Soros Fund Management LLC, which oversees about $21 billion, wrote in a Wall Street Journal editorial in October. Michael Vachon, a spokesman for Soros in New York, didn’t answer an e-mailed request for comment last week.
The bonds are rallying as investors fret over rising budget deficits and the threat of inflation as governments and central banks try to pull out of the first global recession since World War II. Government bonds worldwide have lost 1.68 percent this year, after reinvested interest, compared with a gain of 8.9 percent in all of 2008, according to Merrill Lynch & Co.’s Global Sovereign Broad Market Plus Index. The securities haven’t had a losing year since falling 0.64 percent in 1999.
Denmark’s budget deficit will likely represent 1.3 percent of GDP this year, according to the government. That compares with 12.2 percent in the U.S. and 5 percent in the 16-nation euro area, according to the median estimates of economists surveyed by Bloomberg. Refinancing is bolstering the market and driving demand for lower-yielding flexible-rate mortgages, which reset each year, according to Nordea’s Skinhoj. Adjustable-rate loans rose to 33 percent of the market, from 20 percent a year ago, according to Nordea.
Danish lenders are likely to have to sell $100 billion of notes backed by adjustable-rate mortgages at their annual auction in December, which may weigh on prices in the second half of the year, according to Danske Bank. The sales, in which buyers such as pension funds bid for the bonds and lenders set the rate for the loans for the following year, totaled $68 billion last year. The market has "a false sense of security from last year’s auction, which went fine in the end," Jens Peter Soerensen, the Copenhagen-based chief analyst at Danske Bank, wrote in a May 27 report. "The problem is this auction will be 1.5 times as big and the financial crisis probably won’t be gone by December."
Denmark, with 5.5 million people, hasn’t escaped the economic slowdown. GDP will shrink 3.5 percent this year, before growing 1 percent in 2010, Frankfurt-based Deutsche Bank AG, Germany’s biggest bank, said in a June 19 report. That compares with a 3.1 percent contraction in the U.S. and a 4.3 percent slide in the euro-area. The country more than doubled the amount of funds used to cover bad loans since March as part of the country’s bank rescue package passed in October. Financial Stability, the name of the Copenhagen-based entity managing the government-backed plan, has lost 3.5 billion kroner ($660 million), compared with 1.525 billion kroner at the end of March, it said last week.
The rescue package is funded by banks and lenders have contributed 35 billion kroner, with the state pledging to cover losses exceeding that amount. Financial Stability has bailed out five of Denmark’s 140 banks.
"We’re not finished with the banking crisis," said Harald Eggerstedt, a credit strategist at RIA Capital Markets, an Edinburgh, Scotland-based securities broker. The Nationalbanken will lower its key lending rate to 1.25 percent by the end of the year, while the Fed and ECB leave theirs on hold, according to Nordea.
While the housing market shows "no signs of improvement," property values will be supported by "solid growth in disposable incomes for people in employment and a low interest rate, especially at the short end of the curve," the Copenhagen-based bank said in a June 11 statement. Denmark’s 14 largest banks are "relatively robust" and will be able to withstand the recession with funds obtainable from the government’s second bank package, the central bank said June 4. Danske Bank, Sydbank A/S and Jyske Bank A/S, the country’s three biggest banks, have all applied for funds.
The world is swimming in oil
Oil tankers are anchored off the Dutch coast, unable to deliver their cargo to the port of Rotterdam because its oil facilities are filled to capacity, but also because it is more profitable. Last Friday, a total of eight supertankers - very large crude carriers (VLCC) – had anchored off the Dutch coast, half of them fully loaded. Each of them can carry up to 2 million barrels of crude oil, enough to fill up 6 million small cars.
These supertankers could reach the port of Rotterdam, Europe's biggest oil refining and trade centre, in less than an hour. But they don't. There just isn't enough room, says Jeroen Kortsmit, commercial manager at Royal Dirkzwager, a maritime advisory company. "The port of Rotterdam is filled to capacity." Rotterdam is being flooded with crude oil, which has become superfluous because of the economic slowdown. The port can normally hold up to 12.8 million cubic metres of crude oil. That's 80 million barrels, or enough to supply all 27 member states of the European Union for five days. Now the Rotterdam port is full and companies active in oil shortage, like Vopak, Oiltanking and Eurotank, are doing good business these days.
It is the same in other world ports. The global on-shore supply of crude oil reached 2.75 billion barrels in the first quarter of 2009, 180 million barrels more than a year earlier, according to the International Energy Agency (IEA) in Paris. That's only half a million barrels shy of the 1998 record at the time of the Asian crisis. The IEA says an additional 100 to 115 million barrels were stored at sea at the end of April. "We counted 28 tankers off the Dutch coast last Friday," says Kortsmit, "and only a quarter of them were empty." Floating oil storage is now back at the March level of 85 million barrels, but that's still the total global oil production for one day.
Capacity problems at the ports are not the only reason why so many oil tankers are bobbing aimlessly off the coasts. A number of them have thrown anchor there deliberately. Their cargo belongs to traders who have bought surplus oil at low prices, and are waiting for the right time to bring it on the market. There has always been a certain amount of floating oil storage, but never in such quantities. The reason is that for a number of months oil has been cheaper on the spot market than on the futures market.
"It is what we call a contango," says Pieter Kulsen, who has been working in the oil trade for thirty years. Traders buy cheap oil on the spot market and later sell it for much more on the futures market. The price difference is more than enough to pay for the cost of floating storage, especially since the tariffs on land are higher because of the capacity problems. Lots of people are taking advantage of this situation. "It's no use naming names," says Kulsen, "it is a widespread phenomenon in the oil business."
Meanwhile, oil prices are on the rise again. When the "contango" becomes smaller - because the spot price rises faster than the futures price - the profits will gradually decrease until there is nothing more to be gained. "At that point huge quantities of oil will become available on the market, which in turn will affect the price of oil," says Kulsen. It could take up to six months until the floating storage has trickled back into the market. Once the economy picks up again, sailing - instead of speculating - will once again become the main activity for oil tankers. Gradually, the idle oil tankers in the North Sea should disappear as well.
Study Shows Expense of Finding Oil, Nat. Gas Soared in 2008
The U.S. oil and gas industry's costs of finding resources rose 35 percent last year amid the wild rise and fall in commodity prices, an Ernst & Young study released Thursday showed. The three-year average cost per barrel of oil equivalent, excluding acquisitions of proved reserves, was $27.22. But in 2008 that spiked to $51.96. "This validates that finding oil and gas reserves is very, very expensive," said Marcela Donadio, oil and gas sector leader for the Americas. She noted that cost also demonstrates why some companies have delayed final investment decisions on costly expansions or new projects, such as those in Canada's oil sands or deep-water exploration.
The study examined U.S. exploration and production results for 40 companies from 2004 through last year. The companies, which include oil majors as well as large and small to midsize independents, collectively hold 70 percent of U.S. oil reserves and 61 percent of U.S. natural gas reserves. Overall costs, including acquisitions, rose 35 percent last year to $132.1 billion, the study said.
But oil reserves fell 7 percent to 15 billion barrels, largely because regulatory reporting rules required companies to book reserves that can be produced economically at the closing price on the last trading day of the year. Last year that price was $44.60 a barrel -- far below the year-end 2007 price of $95. The same rule forced reductions of 6.7 trillion cubic feet of booked natural gas reserves as well. Even with those write-downs, gas reserves rose 4 percent overall amid the boom in shale production last year.
However, starting at the end of 2009, companies can book reserves based on average annual price rather than a one-day snapshot. In 2008, that average was about $99 a barrel. So as prices recover alongside the economy, reserves that were written off can be restored to companies' books as they become economical to produce again, said Charles Swanson, managing partner of Ernst & Young's Houston office. "It certainly was a year to remember," he said.
Confidential Memo Reveals US Plan to Provoke an Invasion of Iraq
A confidential record of a meeting between President Bush and Tony Blair before the invasion of Iraq, outlining their intention to go to war without a second United Nations resolution, will be an explosive issue for the official inquiry into the UK's role in toppling Saddam Hussein. The memo, written on 31 January 2003, almost two months before the invasion and seen by the Observer, confirms that as the two men became increasingly aware UN inspectors would fail to find weapons of mass destruction (WMD) they had to contemplate alternative scenarios that might trigger a second resolution legitimising military action.
Bush told Blair the US had drawn up a provocative plan "to fly U2 reconnaissance aircraft painted in UN colours over Iraq with fighter cover". Bush said that if Saddam fired at the planes this would put the Iraqi leader in breach of UN resolutions. The president expressed hopes that an Iraqi defector would be "brought out" to give a public presentation on Saddam's WMD or that someone might assassinate the Iraqi leader. However, Bush confirmed even without a second resolution, the US was prepared for military action. The memo said Blair told Bush he was "solidly with the president".
The five-page document, written by Blair's foreign policy adviser, Sir David Manning, and copied to Sir Jeremy Greenstock, the UK ambassador to the UN, Jonathan Powell, Blair's chief of staff, the chief of the defence staff, Admiral Lord Boyce, and the UK's ambassador to Washington, Sir Christopher Meyer, outlines how Bush told Blair he had decided on a start date for the war. Paraphrasing Bush's comments at the meeting, Manning, noted: "The start date for the military campaign was now pencilled in for 10 March. This was when the bombing would begin."
Last night an expert on international law who is familar with the memo's contents said it provided vital evidence into the two men's frames of mind as they considered the invasion and its aftermath and must be presented to the Chilcott inquiry established by Gordon Brown to examine the causes, conduct and consequences of the Iraq war. Philippe Sands, QC, a professor of law at University College London who is expected to give evidence to the inquiry, said confidential material such as the memo was of national importance, making it vital that the inquiry is not held in private, as Brown originally envisioned.
In today's Observer, Sands writes: "Documents like this raise issues of national embarrassment, not national security. The restoration of public confidence requires this new inquiry to be transparent. Contentious matters should not be kept out of the public domain, even in the run-up to an election." The memo notes there had been a shift in the two men's thinking on Iraq by late January 2003 and that preparing for war was now their priority. "Our diplomatic strategy had to be arranged around the military planning," Manning writes. This was despite the fact Blair that had yet to receive advice on the legality of the war from the Attorney General, Lord Goldsmith, which did not arrive until 7 March 2003 - 13 days before the bombing campaign started.
In his article today, Sands says the memo raises questions about the selection of the chair of the inquiry. Sir John Chilcott sat on the 2004 Butler inquiry, which examined the reliability of intelligence in the run-up to the Iraq war, and would have been privy to the document's contents - and the doubts about WMD running to the highest levels of the US and UK governments. Many senior legal experts have expressed dismay that Chilcott has been selected to chair the inquiry as he is considered to be close to the security services after his time spent as a civil servant in Northern Ireland.
Brown had believed that allowing the Chilcott inquiry to hold private hearings would allow witnesses to be candid. But after bereaved families and antiwar campaigners expressed outrage, the prime minister wrote to Chilcott to say that if the panel can show witnesses and national security issues will not be compromised by public hearings, he will change his stance. Lord Guthrie, a former chief of the defence staff under Blair, described the memo as "quite shocking". He said that it underscored why the Chilcott inquiry must be seen to be a robust investigation: "It's important that the inquiry is not a whitewash as these inquiries often are."
This year, the Dutch government launched its own inquiry into its support for the war. Significantly, the inquiry will see all the intelligence shared with the Dutch intelligence services by MI5 and MI6. The inquiry intends to publish its report in November - suggesting that confidential information about the role played by the UK and the US could become public before Chilcott's inquiry reports next year.