Three models from Washington's spring fashion show snapped at Arlington Beach
Ilargi: We can now safely conclude that the Obama administration's mortgage relief plans are huge failures. The $787 billion stimulus plan is not getting anywhere: only $50 billion has been spent so far. The first phase (an FDIC-led test run) of the notorious PPiP toxic asset bailout plan was today declared dead by the FDIC.
There can be no doubt that we're looking at a dismal record thus far, it's an unbelievable mess (and the same crew that hatched those eggs will soon bring you bank reforms). Dismal, that is, if we focus on concrete measures and their results. When it comes to "faith, hope and charity", it's a different story. Today had an exceptional drop -except for the last bit, which showed the sort of meteor rise we're now accustomed to-, but overall, the Obama Bull still rules the day.
How come, I hear you ask, if all those programs fail so miserably? Another great graph at Clusterstock at least partially answers your question:
The Trash Rally
Skeptical bears have dismissed the nearly 3-month old rally as just a lot of short-covering and piling into beaten down trash, like financials. With this chart, you can see what they mean. Since the lows in early March, the S&P 500 is up less than 50%, but the NASDAQ OMX Government Relief index -- a basket of companies that have taken government support in one way or another has more than doubled. Interestingly, the financial heavy index has slipped a bit since early may. Major banks, which were once the most volatile stocks, have become a snooze.
Ilargi: The one financial plan that hasn't failed (and you're right, it's not exactly ONE plan, it's a cookbook full of alphabet soup recipes), is that one that concerns not help for citizens but bailouts for banks. Yes, do think about that. As the graph shows, bailed-out firms (re: banks, financials) have outperformed the S&P to such an extent that one might be forgiven for thinking they account for about ALL of the upward swing in the S&P 500. Chris Whalen at The Institutional Risk Analyst sums up the bailout programs like this:
- Government subsidized TARP capital injections,
- Below-market loans via repurchase transactions with the Federal Reserve Banks,
- Below-market funding via FDIC guarantees on debt, and
- Subsidies for Bear, Stearns, AIG and other credit default swap ("CDS") counterparties of the large banks.
The idea advocated by the big banks now is that they will pay back TARP, just one of the taxpayer funded highways to heaven. And then be free to pay their executives hundreds of millions a year once again. In my kind of reality, no bank should be allowed to pay back TARP without at the very least also paying back the taxpayer for what has been received through AIG and Bear Stearns. If that does not happen, it will per saldo be the taxpayer bending over for those silly salaries and bonuses. And wasn't that a bit of an issue recently?
All this ties in directly with all the billions in stock the banks have sold in the past few weeks. It hurts me to see reported that many of these "investments" come from institutional investors such as market funds (and pension funds, of course), the funds little people's money is in. The fund managers apparently haven't learned a thing, and neither have many of the little people. The financials were reportedly “underrepresented" in their portfolios. And the recession is now proclaimed to be over, a depression was completely avoided, and you have a government assuring its people that a 3.5% growth rate will magically appear later this year. In other words, buy bank stock, never mind that none of their real problems have even been addressed, let alone solved.
And that of course is what kills the PPiP. That and the continuing conspiracy to keep the true values of the bank's assets hidden away from daylight. PPiP fails because A) Washington can't figure out a way to satisfy both the outside world and the banks with what it offers for toxic paper, and B) banks have much less reason to sell at realistic prices now large investors have stepped back in.
Meanwhile: That toxic paper is still worth the same -nothing minus 1-. Foreclosures are raging ever stronger across the land. Job losses keep on adding up at around 600.000 a month for now, and they will inevitably rise with foreclosure numbers.
I’ll tell you what will happen come fall 2009. Wall Street banks will again be forced to report behemoth losses (something they know today). Their share prices will crater. Mutual and pension funds will find they lose billions more on the shares they're buying today. The government will come up with more rescue plans, partially using the argument that past rescue funds need to be rescued. They'll tell us that the TARP funds have been paid back to a large extent, so why not do it again? We got our money back, right? And that's when we will remember we got back only a part of the money. And it will be too late.
PS: Want another blatant example of how news is concocted and contortioned in the media? Look no further:
"Macroeconomic Advisers was founded in 1982 as Laurence H. Meyer & Associates, Ltd. by Laurence Meyer, Joel Prakken and Chris Varvares. Laurence Meyer left the firm in June of 1996 to assume a seat on the Federal Reserve's Board of Governors. Macroeconomic Advisers (MA) is a privately owned corporation that specializes in macroeconomic forecasting and policy analysis."
These undoubtedly high-paid "experts" today predict US companies will shed 1 million more jobs in 2009. At the same time, ADP says 532.000 jobs were cut in May, an estimate set to be revised upward by about 10%. The US has been losing around 600.000 jobs monthly so far this year, which would mean additional losses of between 4 and 4.5 million jobs. Which means MA's estimate would be off by 300-350%. Am I the only one getting so utterly sick of this? These are apparently the circles from which members of the Federal Reserve's Board of Governors are recruited. And I refuse to any longer believe these folk are just terribly stupid; they mislead on purpose, get paid millions to do it, and they control the place.
PS2: Look for giant upcoming pink slip floods at state and municipal levels. They’re all broke. Cailfornia is a warning sign. Arnie is slashing like he's still in the movies, and his'll be the pattern to follow.
PS3: The Wall Street Journal exposes yet more Congressmen today as stoogies for sale. Remember Rep. Kanjorski and his honesty from a few weeks ago? He's the second best client at the financial handout counter. Yes, this whole thing is rotten to the core.
PS4: I'm honored to see that Sean Brodrick, one of Martin Weiss' close confidants at Money and Markets, puts TAE among his 7 Favorite Blogs in the Universe.
ADP Estimates U.S. Companies Cut Payrolls by 532,000
Companies in the U.S. cut an estimated 532,000 workers from payrolls in May as the labor market showed little sign of improving even as the recession abated, a private report showed today. The drop in the ADP Employer Services gauge was higher than economists forecast. April’s reading was revised to show a reduction of 545,000 workers, up from a previous estimate of 491,000. Companies from General Motors Corp. and Chrysler LLC to American Express Co. continue to cut jobs to control costs even as the economy shows signs of stabilizing. Mounting unemployment will restrain consumer spending, muting any recovery.
"We really haven’t seen much evidence that things are turning around on the labor front," Mark Vitner, a senior economist at Wachovia Corp. in Charlotte, North Carolina, said before the report. Economists forecast the ADP report would show a decline of 525,000 jobs, according to the median of 28 estimates in a Bloomberg News survey. Projections ranged from decreases of 425,000 to 580,000. A government report on June 5 may show payrolls at companies and government agencies shrank by 520,000 in May and unemployment rose to a 25-year high of 9.2 percent, according to a Bloomberg survey of economists.
Job-cut announcements last month showed the smallest increase in more than a year, Chicago-based placement firm Challenger, Gray & Christmas Inc. also said today. Planned firings rose to 111,182, up 7.4 percent from May 2008. The rise was the smallest since firings last dropped in February 2008. Today’s ADP report showed a reduction of 267,000 workers in goods-producing industries including manufacturers and construction companies. Employment in manufacturing dropped by 149,000. Service providers cut 265,000 workers.
Companies employing more than 499 workers shrank their workforces by 100,000 jobs. Medium-sized businesses, with 50 to 499 employees, cut 223,000 jobs and small companies decreased payrolls by 209,000. "Despite some recent indications that economic activity is stabilizing, employment, which usually trails overall economic activity, is likely to decline for at least several more months," Joel Prakken, chairman of Macroeconomic Advisers, said in a statement. The ADP report is based on data from 500,000 businesses. ADP began keeping records in January 2001 and started publishing its numbers in 2006.
US firms may cut another million jobs in 2009-Macroeconomic Advisers
U.S. companies may reduce another million or so jobs for the remainder of 2009, even if the economy emerges from recession later this year, Joel Prakken, chairman of Macroeconomic Advisers said on Wednesday. The U.S. jobless rate will likely peak in a range of 9.5 percent to 10.0 percent in 2010. This compares with 8.9 percent in April -- the highest since September 1983, Prakken said in a conference call with reporters.
Earlier, the ADP National Employment Report, which was jointly created by Prakken's economic research firm and ADP Employer Services, showed the U.S. private sector shed 532,000 jobs in May, greater than analysts' forecasts. The ADP data are used by some traders as a predictor of the government's closely watched monthly payroll figure. "There is no way this is good news," Prakken said of the latest data. May's job losses were "widespread" and heavy in the manufacturing and services industries, he said.
Since the U.S. recession began in December 2007, 5.7 million jobs have disappeared, according to the government. The median forecast among economists polled by Reuters for the government's payroll figure is a decline of 520,000 in May, compared with a 539,000 drop in April. The Labor Department will release its May employment report at 8:30 a.m. (1230 GMT) on Friday.
The report comes in the wake of a major shakeup in the U.S. auto sector earlier this week. General Motors filed for bankruptcy, while Chrysler said it will sell most of its assets to Italian carmaker Fiat. Job losses at two of the "Big Three" carmakers will be "large regional negatives" in U.S. states such as Michigan where GM and Chrysler plants and parts producers are located, Prakken said. But these auto layoffs, which have been widely expected, will not have a "dominant effect" on the national employment picture, he said.
U.S. business bankruptcies rise 40 percent in May
U.S. business bankruptcy filings jumped 40 percent in May from a year ago as the sluggish U.S. economy pushed more businesses into the red, a bankruptcy data provider said on Tuesday.There were 7,514 commercial bankruptcy filings for the month, compared with just 5,354 during the same month a year ago, according to Automated Access to Court Electronic Records (AACER), a database of U.S. bankruptcy statistics used by attorneys and lenders.
In just two years, the number of businesses filing for bankruptcy in May has more doubled. Last month brought the bankruptcies of yellow pages telephone directory publisher RH Donnelley Corp, auto parts maker Visteon Corp and apparel retailer Anchor Blue Retail Group Inc. Per day, 376 companies sought protection from creditors in bankruptcy court. "The average filing amount per day is actually the highest since the bankruptcy law changed in October of 2005," said Mike Bickford, president of AACER.
The figures do not include Chrysler, which filed for bankruptcy in April or General Motors, which filed on June 1. U.S. bankruptcy laws changed in 2005. AACER's count of commercial cases includes bankruptcy filings from companies, as well as individuals who say they are running a business. There are many more bankruptcy filings to come, Bickford said. "I would see continued filings throughout 2009 and well into 2010," he said, citing data trends.
U.S. MBA Mortgage Applications Index Fell 16 Percent Last Week
Mortgage applications in the U.S. dropped last week as the biggest jump in mortgage rates in seven months pushed down refinancing. The Mortgage Bankers Association’s index of applications to purchase a home or refinance a loan fell 16 percent to 658.7 in the week ended May 29, from 786 the week before. The group’s refinancing gauge plunged 24 percent, while the purchase measure increased 4.3 percent.
An improving economic outlook in recent weeks has pushed up borrowing costs and caused homeowners to shy away from refinancing. At the same time, prices are still declining and borrowing costs are below year-earlier levels, making housing more affordable to some prospective buyers and helping to stabilize the market. "This increase in rates would hit refinancing given they seem to be quite responsive to mortgage rates," Abiel Reinhart, an economist at JPMorgan Chase & Co. in New York, said before the report. "Home sales look to be relatively stable. They’ve already reached a trough earlier in the year, but they haven’t picked up just yet."
The mortgage bankers’ refinancing gauge decreased to 2,953.6, the lowest level since February, from 3,890.4 the previous week. The purchase index rose to 267.7, a two-month high, from 256.6.
The share of applicants seeking to refinance loans fell to 62.4 percent of total applications from 69.3 percent. The average rate on a 30-year fixed-rate loan rose to 5.25 percent, the highest level since January, from 4.81 percent the prior week. The increase was the biggest since October. The rate reached 4.61 percent in late March, the lowest level since the mortgage bankers group began records in 1990.
At the current 30-year rate, monthly borrowing costs for each $100,000 of a loan would be about $552. That is about $59 less than the same week a year earlier, when the rate was 6.17 percent. The average rate on a 15-year fixed mortgage rose to 4.80 percent from 4.44 percent the prior week. The rate on a one-year adjustable mortgage increased to 6.61 percent from 6.55 percent. The Washington-based Mortgage Bankers Association’s loan survey, compiled every week, covers about half of all U.S. retail residential mortgage originations.
A report from the National Association of Realtors yesterday showed the number of Americans signing contracts to buy previously owned homes climbed 6.7 percent in April, the biggest gain in more than seven years. The Realtors group said gains in pending sales have been larger than actual home resales in recent months because distressed properties are taking longer to close since they require lender approval. Also, some of the pending contracts fall through before a transaction is completed, chief economist Lawrence Yun said yesterday.
"Business could be a whole lot better," James Gillespie, chief executive officer of Coldwell Banker Real Estate LLC said in an interview yesterday. While first-time buyers are taking advantage of foreclosure-driven price decreases, the market for those trying to sell one home and buy a bigger property is still weak, he said. Coldwell Banker is lobbying Congress for a $15,000 tax credit for all homebuyers, rather than the $8,000 credit provided to first-time purchasers by the Obama administration’s stimulus plan.
States' Budget Woes Are Poised to Worsen
State budgets look bad now, but they are set to get worse. The bulk of funds from the federal government's stimulus package will be allocated by 2011, but tax collections aren't likely to be enough to take their place -- even if the economy is recovering. The drop in tax revenue is set to be deeper and last longer as collections have become more sensitive to business cycles in recent years. At the same time, states face growing health-care costs and the need to replenish pension programs funded by decimated investments.
And some of the stimulus funds expand programs that will require state money to sustain them after the federal largesse runs out. "There are so many issues that go way beyond the current downturn," said Scott Pattison, executive director of the National Association of State Budget Officers. "This is an awful time for states fiscally, but they're even more worried about 2011, 2012, 2013, 2014." Already, acrimony is building as states grapple with budget problems. In Illinois, lawmakers failed to pass a budget Sunday after rejecting the tax increases that Gov. Pat Quinn, a Democrat, said were needed to close an $11.6 billion spending gap.
The Texas Legislature adjourned Monday in disarray, without approving funding needed to keep the state's transportation and insurance agencies running. In Arizona, Gov. Jan Brewer, a Republican, on Monday released a controversial budget proposal that would temporarily raise the sales tax and partly revive a state property tax. And in California, Republican Gov. Arnold Schwarzenegger warned Tuesday that lawmakers have until June 15 to close the state's budget deficit, or California will be unable to borrow the cash it needs to pay its bills after July. With most governors busy stanching the current budget bleeding, only a few have taken steps to head off future problems.
Tennessee Gov. Phil Bredesen, a Democrat, in March laid out a four-year plan to balance the budget without using rainy-day funds. In Oregon, Democratic Gov. Ted Kulongoski has called for a "reset" of state government, arguing that voters must reconsider 1990s ballot measures that shifted school funding from property taxes to income taxes and that imposed mandatory minimum prison sentences. Gov. Schwarzenegger is proposing lasting cuts to health care and prisons.
Altogether, states face aggregate budget shortfalls of at least $230 billion from fiscal 2009 through fiscal 2011, said Mr. Pattison. For most states, that covers the period from July 1, 2008, to June 30, 2011. That aggregate figure is nearly double the roughly $130 billion in federal stimulus funds that states can use flexibly over three years. (About $120 billion in further stimulus funding comes with stricter requirements, and sometimes new, costly mandates.) When today's federal assistance peters out, a number of state budget officers don't expect new tax revenue to replace it. As the recession grinds on, states are posting significant declines in revenue from their three major sources: sales, personal-income and corporate taxes.
About a quarter of states saw their economies contract last year, the Commerce Department said Tuesday. Alaska's gross domestic product -- the total value of all the goods and services it produced -- slipped the most in 2008, falling an inflation-adjusted 2% from the previous year largely because of declining oil output. The Great Lakes states of Michigan, Ohio and Indiana posted some of the steepest GDP drops, as the woes of Detroit's auto makers hurt manufacturers throughout the region.
North Dakota's GDP gain of 7.3% topped the nation. Its largely agricultural economy has been well shielded from the housing bust, financial crisis and manufacturing decline that have weighed on the overall U.S. economy. Still, in general most forecasters see a very slow recovery, which suggests a commensurately slow upturn in state revenues. Federal Reserve officials, for instance, see unemployment, at 8.9% at last report, averaging between 9% and 9.5% next year and remaining elevated through 2011; some private forecasters are more pessimistic.
State tax collections could take five years or more from when the recession began in December 2007 to recover to prerecession levels, says Donald J. Boyd, senior fellow at the Nelson A. Rockefeller Institute of Government at the State University of New York. In addition, revenues appear to have grown more sensitive to the business cycle in the past decade, in part because capital-gains taxes have become a bigger component of tax bases, according to new research by Federal Reserve Bank of Chicago economists Leslie McGranahan and Richard Mattoon. That could prolong the effect of the downturn and, by increasing volatility, make it harder for states to plan budgets.
The best outcome they can imagine, some state officials say, is that the stimulus funding allows them to make spending cuts gradually: for example, by relying more on attrition and less on layoffs to cut payrolls. (Unlike the federal government, states generally are required to balance their budgets.) That's sparking tough choices. In April, Tennessee's sales tax revenue was 9.9% below the previous year, and total tax revenue for the month was nearly $200 million less than the state's forecast. The state expects general-fund tax revenue to rise about 4.4% in the fiscal year beginning July 1, 2010, from a year earlier. But that entire increase is expected to be eaten up by inflation in education costs, increased Medicaid enrollment, and funding a pension plan whose nominal value has dropped from $32 billion to $25 billion.
So the state is looking to make long-lasting spending cuts. It plans to eliminate 1,373 jobs. Some economic-development projects are potentially on the chopping block. "This is not simply trimming around the edges," said the state's top budget officer, Dave Goetz. "This is entire programs." States also can raise taxes and fees, of course, but if residents continue to hold down their spending, that thriftiness will limit additional sales-tax revenue. Massachusetts state Treasurer Timothy P. Cahill, a Democrat who is considering a run for governor next year, has been critical of discussions in the Legislature to raise the sales-tax rate. "This is such a consumer-based recession that I think you'd be compounding the problem by increasing a tax on consumer spending," he said.
European Spending, Exports Decline Most in 14 Years
European consumer spending and exports contracted the most in at least 14 years in the first quarter and investment slumped as the worst global recession in more than six decades prompted companies to cut output and jobs. Gross domestic product shrank 2.5 percent from the fourth quarter, matching an initial estimate and the most since the data were first compiled in 1995, the European Union’s statistics office in Luxembourg said.
Household consumption contracted 0.5 percent while exports dropped 8.1 percent and imports fell 7.2 percent, all the most since the series began in 1995. Investment spending declined 4.2 percent after a 4.3 percent contraction in previous quarter that was also the sharpest since 1995. Even with evidence building that the worst of the economic crisis may be over, euro-area unemployment has risen to a 10-year high as payrolls start to reflect the severity of the recession with companies from ThyssenKrupp AG to Air France-KLM Group firing workers.
European Central Bank President Jean-Claude Trichet, who said on May 7 that he saw "tentative signs" of stabilization in the economy, will unveil the bank’s latest economic forecasts tomorrow and details on its next policy steps. "The declines in exports and investment are mind-bogglingly large," Kenneth Wattret, chief euro-region economist at BNP Paribas in London, said today. "The economy is in dire straits so the pressure is still there on the ECB to do more unconventional things."
Today’s report showed that from a year earlier, the euro- area economy shrank 4.8 percent in the first quarter, compared with a 1.7 percent contraction in the previous three months. The statistics office had initially put the annual contraction at 4.6 percent. The running down of inventories contributed 1 percentage point to the contraction in the quarter, the report showed. "In a way it’s a good sign because it means that inventory unwinding, at least in part, has run its course," said Daniele Antonucci, European economist at Capital Economics in London.
Amid global concerns about deflation, euro-area producer prices fell 4.6 percent in April from a year earlier, the most since the data were first compiled in 1981, a separate report showed today. With the euro-area economy expected to shrink 4 percent this year and 0.1 percent in 2010, according to EU forecasts, the ECB tomorrow will give details of its strategy to haul the region out of the recession. The financial crisis, which started with the collapse of the U.S. property market in 2007, has triggered more than $1.48 trillion of writedowns and credit losses at financial companies and sent the global economy into its first recession since World War II, according to data compiled by Bloomberg.
The ECB will probably hold its main interest rate at a record low of 1 percent tomorrow, according to economists surveyed by Bloomberg News, as it sets out the mechanisms for buying 60 billion euros ($86 billion) of covered bonds, low-risk securities backed by mortgages and public sector loans. ECB council member Ewald Nowotny said in a letter to Austrian hoteliers last week that the bank could expand the asset-purchase program beyond that, buying bonds or commercial paper.
The global economy will shrink 1.3 percent this year before expanding 1.9 percent in 2010, according to forecasts by the International Monetary Fund. Still, European economic confidence rose for a second month in May and a report today showed the manufacturing and service industries contracted more slowly in May. Investors have also grown more optimistic as the MSCI World Index is trading around seven-month highs. In the U.K., the euro region’s largest trading partner, consumer confidence increased in May to the highest level in six months as shoppers became more hopeful that the economy will emerge from the recession, Nationwide Building Society said today.
China Sees 'Grim' Job Market, Deeper Impact From Global Crisis
China’s government said unemployment is worsening, a quick rebound in trade is becoming less likely, and the nation is yet to feel the full effects of a global slump. The foundations for an economic recovery aren’t solid, the State Council said in a statement on a government Web site today. Trade faces "unprecedented difficulties," Vice Commerce Minister Zhong Shan said separately. Falling exports dragged China’s economic growth to the slowest pace in almost a decade in the first quarter as the government rolled out a 4 trillion yuan ($586 billion) stimulus package. The Shanghai Composite Index has climbed 52 percent this year as investors bet that Premier Wen Jiabao can engineer a recovery in the world’s third-biggest economy.
"Rising unemployment, if not properly addressed, could be a time-bomb in China’s economy," said Tao Dong, Hong Kong-based chief Asia economist at Credit Suisse Group AG. Still, airing problems may signal that the government is confident that it’s in control of the situation, Tao said. China will announce more measures to help labor-intensive industries, the State Council said, describing the job market as "grim," with registered unemployment climbing and new jobs shrinking compared with a year earlier. The registered urban jobless rate was 4.3 percent at the end of March, a figure that doesn’t account for unemployed migrant workers.
Exports and imports are set to decline in the first half and the outlook for the rest of the year is not optimistic, Zhong said in a statement about export credit insurance posted on the commerce ministry’s Web site. He didn’t specify why a speedy recovery in trade is becoming less likely. The World Trade Organization in March predicted a 9 percent drop in global commerce this year. China, the world’s second-biggest exporter, has cut export taxes, boosted credit and insurance for overseas sales and pledged to keep its currency stable as manufacturers weather the collapse in global demand. Overseas sales plunged 22.6 percent in April from a year earlier, the sixth straight monthly decline.
Zhong’s comments contrast with signs that the outlook for shipments is improving. An index of export orders increased to 50.1 in May, the first expansion in 11 months, a government backed manufacturing index showed. "China’s exports may start to grow as early as January after the major economies such as the U.S. and Japan gradually recover later this year," said Xing Ziqiang, a Beijing-based economist at China International Capital Corp. Falling exports are the biggest challenge for China’s economy, the State Council said on May 27.
German PM Merkel mauls central banks
Unconventional monetary policies being pursued by the world’s main central banks could aggravate rather than ease the economic crisis, Angela Merkel, Germany’s chancellor, suggested on Tuesday.
Her surprisingly strong attack on the US Federal Reserve, the Bank of England and the European Central Bank was remarkable coming from a leader who had so far scrupulously adhered to her country’s tradition of never commenting on monetary policy.
"What other central banks have been doing must be reversed. I am very sceptical about the extent of the Fed’s actions and the way the Bank of England has carved its own little line in Europe," she told a conference in Berlin. "Even the European Central Bank has somewhat bowed to international pressure with its purchase of covered bonds." She added: "We must return to independent and sensible monetary policies, otherwise we will be back to where we are now in 10 years’ time."
Ms Merkel’s decision to ignore one of the cardinal rules of German politics – an unwritten ban on commenting on monetary policy out of respect for central bank independence – suggested Berlin is far more concerned about the ECB’s approach than has so far been apparent. Meanwhile, Berlin is anxious that central banks will struggle to re-absorb the vast amount of liquidity they are pouring into the markets and fears the long-term inflationary potential of hyper-loose monetary policies.
The ECB’s efforts have been focused on pumping unlimited liquidity into the eurozone banking system for increasingly long periods. But last month, it followed the US Federal Reserve and Bank of England in announcing an an asset purchase programme to help a return to more normal market conditions. The ECB announced it had agreed in principle to buy €60bn in "covered bonds", which are issued by banks and backed by public-sector loans or mortgages. The purchases were only agreed after extensive discussions within the 22-strong ECB governing council.
According to one version of May’s meeting, the council had discussed a €125bn asset purchase programme that would also have included other private sector assets, but only the purchase of covered bonds was agreed. Axel Weber, ECB council member and president of Germany’s Bundesbank, has been among those who expressed scepticism about direct intervention in financial markets. In a Financial Times interview in April he expressed "a clear preference for continuing to focus our attention on the bank financing channel".
He has also been among the most pro-active council members in warning that the monetary stimulus will have to be reduced once the economic situation improves. Details of the covered bond purchase scheme will be unveiled by the ECB after its meeting on Thursday. One likely solution is that the package will be split according to eurozone countries’ capital shares in the ECB, which would result in Germany accounting for about 25 per cent of the €60bn programme. The ECB is widely expected to leave its main interest rate unchanged at 1 per cent, its lowest ever.
Bernanke Urges Deficit Reduction
U.S. Federal Reserve Chairman Ben Bernanke on Wednesday urged lawmakers to commit to reducing the nearly $2 trillion budget deficit, warning that the government can't borrow "indefinitely" to meet the growing demand on its resources. Mr. Bernanke also reiterated that the pace of economic contraction appears to be slowing, setting the stage for a return to growth later this year. "Unless we demonstrate a strong commitment to fiscal sustainability in the longer run, we will have neither financial stability nor healthy economic growth," Mr. Bernanke said in prepared testimony to the House Budget Committee.
The White House estimates that the budget deficit will reach around $1.8 trillion this year and fall to about $900 billion by 2011. That, Mr. Bernanke said, will push the debt-to-GDP ratio from 40% before the financial crisis began to 70% by 2011, which would be the highest since after World War II. "Certainly, our economy and financial markets face extraordinary near-term challenges, and strong and timely actions to respond to those challenges are necessary and appropriate," Mr. Bernanke told the House panel. However, the retirement of the Baby Boom generation will place even more of a burden on entitlement programs like Social Security and Medicare, and "we will not be able to continue borrowing indefinitely to meet those demands," he said.
Mr. Bernanke suggested that fiscal concerns may already be having an effect in the markets. Yields on longer-term Treasury securities and fixed-rate mortgages have risen, he noted. "These increases appear to reflect concerns about large federal deficits but also other causes, including greater optimism about the economic outlook, a reversal of flight-to-quality flows, and technical factors related to the hedging of mortgage holdings," he said. Mr. Bernanke adhered closely to the Fed's cautiously upbeat outlook for the economy.
Consumer spending, he said, has been flat since the start of the year and sentiment has improved. Housing, he said, "has also shown some signs of bottoming" and lean inventories should eventually spur production. Still, he cautioned that even when an upturn begins, growth will remain below its long-run potential "for a while." "Sizable" job losses, he said, should continue for "the next few months," pushing the unemployment rate higher. The government releases May payroll figures Friday. Economists expect another payroll decline of over 500,000, raising the jobless rate past 9%.
Against that backdrop of widening economic slack, inflation should fall over the next year compared to 2008, Mr. Bernanke said, though an improving economy and stable inflation expectations "should limit further declines in inflation." Meanwhile, Mr. Bernanke said the ability of banks to raise new capital "suggests that investors are gaining greater confidence in the banking system." But while financial conditions have improved since the start of the year, they remain under stress and continue to act as a brake on the economy, he said.
Ilargi: The following article addresses a prepared text for a speech to be held tomorrow.
Greenspan: The-Too-Big-To-Fail Phenomenon Could Cripple Economy
The former chair of the Federal Reserve, Alan Greenspan, argued on Thursday that the government has lost credibility on economic matters and is largely to blame for allowing the nation's biggest banks to become "too big to fail." Speaking at the American Enterprise Institute, the man once known as "the Maestro" offered a sharp critique of policies that have essentially guaranteed the liabilities of major financial and housing market institutions. Looking to the future, he warns, the government has effectively created a "highly disturbing" market paradigm where similar institutions would operate under the belief that they, too, have a safety net.
"Of all the regulatory challenges that have emerged out of this crisis," Greenspan said, "I view the [Too Big To Fail] problem and the TBTF precedents, now fresh in everyone's mind, as the most threatening to market efficiency and our economic future." In an expansive address about the current economic and regulatory landscape, Greenspan argued that there is little the government can do now to rectify this error, other than pass a constitutional amendment to prevent future bailouts. Short of that, he said, the government has "lost very considerable credibility."
"The market says, 'we don't believe you. [You] gave a credit to Fannie and Freddie on the expectation that in the event of a crisis they would be bailed out,'" Greenspan said. "Having lost that credibility with respect to Fannie and Freddie I don't think you could pass that legislation today, which would essentially say that the government can not bail out financial institutions." "I wish there were [easy solution to this]," he added. "There are some questions which do not have easy answer and that is why I am so terribly disturbed by this whole too-big-to-fail issue, because if it continues to function it will disable our financial system."
But if Greenspan considered the bailout of large financial institutions a problematic economic development, he was also troubled by the process by which these institutions got to this point. As Chairman of the Fed, he said he would testify at the Capitol that Fannie and Freddie were not "too big to fail" only to watch Congress treat them as such. In a October 1999 speech before the American Bankers Association, Greenspan said that he warned that the nation "face[d] the reality that the megabanks being formed by growth and consolidation are increasingly complex entities that create the potential for unusually large systemic risks in the national and international economy should they fail.''
That said, Greenspan's tenure at the Fed remains defined by some of the very features that are now considered, at least in part, behind the current crisis. He was a cheerleader for the market even as it grew structurally less secure. And while he may have warned that Fannie and Freddie were at risk, Greenspan championed stripping down the broader regulatory structures of the financial system. Indeed the economy that he helped create over the course of several decades became personified, in large part, by the growth of the unwieldy and unstable institutions that he currently laments.
For example, in that same October 1999 speech, Greenspan argued against a "one-size-fits-all approach to regulation" of the banking industry, saying that he preferred a "program that is the least intrusive, most market based, and most consistent with current and future sound risk-management practices possible." On Thursday, meanwhile, he continued to air and even elaborated upon that long-standing skepticism, saying that a return to more regulation would hamper America's economic recovery.
"To compete successfully in the global marketplace requires that the domestic market itself be highly competitive," he said in his prepared remarks. "Heavy regulation and a thwarting of 'creative destruction' undermine that capability." Later, in his question-and-answer session, Greenspan claimed that even if a new regulative system were put in place, it would be inherently reactive and unreliable in deterring future crises.
U.S. to unveil regulatory reform plan June 17
The Obama administration plans to unveil on June 17 its sweeping plan to overhaul financial regulation, according to a source familiar with thinking at the U.S. Treasury Department. The proposal will serve as a framework for lawmakers as they embark on the thorny task of restructuring how banks, hedge funds, derivatives, and other financial firms and securities are policed. Treasury Secretary Timothy Geithner will testify on June 18 before the House Financial Services Committee on the proposal, the source said, speaking anonymously because the administration has not formally announced the dates.
Administration officials and lawmakers have said they are aiming to have broad legislation passed by the end of the year. The two groups have been meeting over the past few weeks to hash out an outline of the proposal, which will likely put the Federal Reserve in charge of monitoring systemic risk and will give the Federal Deposit Insurance Corp new powers to unwind large, troubled financial institutions. The exact structure of the plan has been fluid, with Federal Reserve Chairman Ben Bernanke telling a congressional committee on Wednesday that "the exact structure of the arrangements, I think, remains to be discussed" when asked about the Fed's future role.
A particularly difficult problem is how to rationalize the four bank regulators -- an issue fraught with turf battles both among the agencies and congressional committees. The Treasury source, and another source familiar with the Treasury's thinking, said the administration will not propose to merge the bank regulation responsibilities into one super bank regulator. Rather, it will likely propose to merge the Office of Thrift Supervision, which mostly regulates mortgage lenders, and the Office of the Comptroller of the Currency (OCC), which regulates many of the nation's largest banks.
The OCC would be the on-site inspector of a broader array of banks, ending on-site visits from the Fed and the FDIC. The Fed as systemic risk regulator, and the FDIC, as guardian of the deposit insurance fund, would have to rely on OCC data. "There's no reason why we need three agencies conducting separate, duplicative on-site exams," the source said. The Fed could also lose some of its consumer protection responsibilities, which would move to a new agency that would supervise financial products, such as credit cards, mortgage-related products and insurance.
But the Fed could gain supervisory powers over broker dealers (currently a securities regulator function), hedge funds, private equity and derivatives, in the central bank's new capacity as systemic risk regulator. The new consumer protection entity would not include investor protection - which currently falls under the Securities and Exchange Commission's purview, one of the sources said. The investor protection and market integrity role would likely be housed in an agency that would be produced from a merger of the SEC and Commodity Futures Trading Commission, sources have said.
The new investor protection agency would oversee all investment products. An advisory committee would then back up the Fed in monitoring systemic risk across all financial products and institutions. This would be similar to the President's Working Group on Financial Markets, which is chaired by the Treasury secretary and composed of the chairmen of agencies like the SEC, the Fed and the CFTC.
Banks' Telethon Is Nearly Over
Financial Giants Raise $85 Billion-Plus in a Month, More Than Needed
Banks are having an easy time dialing for dollars. J.P. Morgan Chase & Co., Morgan Stanley, American Express Co. and regional bank KeyCorp said Tuesday they sold a combined $8.7 billion in common stock. That pushed the total value of shares sold by the 19 financial firms that were stress-tested by the government to at least $65 billion since the results were announced May 7. Nonguaranteed debt sales and the conversion of preferred shares to common stock have generated roughly another $20 billion, for a total of $85 billion or more, giving most of the banks considerably more capital than U.S. regulators have required them to amass as they ride out the recession. Money is pouring in so fast that surprised bankers can hardly believe it, especially since most investors didn't want to go near financial stocks just three months ago, even though they were nearly 40% cheaper.
"It's easy to raise capital now," one executive at a bank that recently raised capital through a public stock offering said Tuesday. Investors are "happy to gobble it up." Some investors who participated in recent bank-stock sales said the logic is simple: The likelihood that the economy will veer off a cliff is dwindling, and many banks look cheap on a price-to-earnings basis. "The Armageddon trade is off the table," said David Tepper, president of Appaloosa Management LP, a Short Hills, N.J., hedge-fund firm that owns shares of Bank of America Corp., SunTrust Banks Inc. and Fifth Third Bancorp. Based on likely earnings in 2011 and 2012, the banking industry "may be the cheapest sector in the market," he added.
Appaloosa participated in a common-stock offering and preferred-share swap by Bank of America, according to a person familiar with the situation. The Charlotte, N.C., bank said Tuesday it has raised nearly $33 billion and "now believes it will comfortably exceed" the $33.9 billion it was told to raise by the Federal Reserve. Mutual funds and other large institutional investors have been aggressive buyers in some of the stock offerings, according to people involved in the deals. Because lots of those investors had previously shunned bank stocks, they lagged behind the overall market when bank stocks rallied starting in March. This month's frenzy of deals was a chance to increase exposure to the industry at a slight discount to the market price.
Despite the enthusiasm, industry experts and even some investment bankers who arranged stock offerings and encouraged their clients to move quickly to drum up capital are worried about a potential letdown. Since March 9, a Keefe, Bruyette & Woods Inc. index of large-bank stocks has soared 87%, compared with the Dow Jones Industrial Average's 34% rebound. "I'm an optimist by nature, but it's perplexing because there are still problems out there," said William Mutterperl, a lawyer at Reed Smith LLP in New York and a former vice chairman at PNC Financial Services Group Inc. "No one has suggested foreclosures are going down, and I don't think anyone is saying loan quality is getting any better."
Analysts at Moody's Investors Service warned Tuesday that U.S. banks with debt that is rated by the Moody's Corp. unit face about $470 billion in losses through next year. If the economy continues to suffer, those losses could swell to $640 billion, and Moody's would likely accelerate its bank-debt downgrades. "In such a scenario, absent continuation, and likely deepening, of U.S. government capital and liquidity support programs for the banking industry, numerous banks would be insolvent," the Moody's analysts wrote. One executive at a New York bank said investors seem to be embracing any tidbit of good news, while ignoring red flags about banks' ill health. He compared the industry with an intensive-care patient who has stabilized but remains critical. "A bucket of cold water will be thrown in people's faces," the executive said.
By one measurement, investors are more enthusiastic about the industry's future than bank executives are. At the 15 stress-tested banks that have raised capital by selling stock to the public, no senior executives have recently reported buying shares themselves, according to Jonathan Moreland, director of research at InsiderInsights.com. The New York firm tracks stock-buying and selling patterns among corporate executives. In January and February, for example, Bank of America Chief Executive Kenneth Lewis and J.P. Morgan Chairman and CEO James Dimon were big buyers of their company's shares. Bank of America shares are up 263% from their March low, while J.P. Morgan has jumped 118%.
"I would have expected to have seen many more insiders continue bullish purchase activity over the past two months," Mr. Moreland said. "The fact that they haven't feeds into my fears that this is just a bear-market rally." Robert Stickler, a Bank of America spokesman, declined to comment on why Mr. Lewis hasn't bought more shares during the stock's rally. The CEO has a paper profit of more than $2 million on the 400,000 shares he bought earlier this year. "He has made a nice investment," Mr. Stickler said. Another possible warning sign: British bank stocks fell Monday after Sheik Mansour Bin Zayed Al Nahyan, a member of Abu Dhabi's royal family and the chairman of Abu Dhabi's International Petroleum Investment Co., decided to sell part of a large stake in Barclays PLC.
Barclays's share price has risen fivefold since January. Sheik Mansour will reap a £1.5 billion ($2.5 billion) profit on the sale. Buyers in Morgan Stanley's $2.3 billion stock offering Tuesday were led by China Investment Corp., which got 44.7 million shares for $1.2 billion, bringing its overall stake in the Wall Street firm to about 9.9%. It was the Chinese sovereign-wealth fund's first major public investment in a Western bank since the global financial crisis began worsening early last year. Mitsubishi UFJ Financial Group also agreed to purchase 16 million Morgan Stanley shares, bringing its stake to about 20%.
The General Motors bailout only delays an inevitable crash
There is no justification for pumping so much money into the car industry, argues Tracy Corrigan. So far, the US taxpayer has ploughed more than $50 billion into General Motors, the 100-year-old car manufacturer which filed for bankruptcy yesterday. GM, Americans joke, now stands for Government Motors, since the state owns 60 per cent of it. There is a new American dream: that a slimmed-down GM will emerge from bankruptcy to prosper in the private sector. But it is not at all clear that huge amounts of government money should be injected to bring about this result.
The US bankruptcy system is usually rather good at allowing companies to restructure and relaunch themselves, so why drag in the taxpayer? The most appealing argument for doing so – that it will save jobs – is also among the weakest. First of all, GM will shed at least 20,000 more workers anyway. Yet even that may not be enough – it is doubtful that demand, particularly for GM's inefficiently-produced cars, will ever bounce back to previous levels. In which case additional government funding will be needed to avoid further redundancies. In other words, the latest infusion of cash will not save jobs at GM and its suppliers; it will only delay the fall of the axe for some workers.
That is not nothing – particularly since the delay will also help diffuse the broader economic impact of GM's blowout – but it is not enough to justify intervention on this scale. As Robert Reich, the former US labour secretary, has argued, if the only practical purpose is to slow the decline of GM to allow workers, suppliers, dealers and communities to adjust to its eventual demise, then the funds would be better spent helping the Midwest economy diversify away from cars. A slightly stronger case for hitting up the taxpayer is that the private-sector financing that would speed a leaner GM through the restructuring process is hard to come by, given the state of the US economy and its car industry.
However, this presupposes that a viable – and reasonably sizeable – business will come out at the other end. If private money, which seems to be flooding into other distressed assets, isn't available to make this bet, there may well be a good reason. Lastly, and most ludicrously of all, there is the "well, we bailed out the banks" claim on the public purse. The argument goes like this: we helped the banks, which we hate, so we should jump at the chance to assist the car industry, which actually makes things. But governments didn't bail out the banks to be nice to them. It just seemed like a better option than a systemic banking collapse, which would have disabled every sector of the economy.
Car manufacturers and their suppliers represent a significant but relatively small part of the global economy. Their success or failure has no bearing on, for example, the healthcare industry, book publishing or, well, banking. As it happens, banking remains a profitable business (those banks which aren't still writing off ill-judged loans are actually making money). Global car production, on the other hand, is currently twice as great as demand, and GM is not best placed to survive the inevitable cull. In 1953, Charlie Wilson, the president of GM, which at the time made more than half the cars sold in the US every year, famously told a Senate hearing that what was good for GM was good for America and vice versa.
Even if he was right then, Americans understand that this is no longer the case. A Rasmussen poll found 67 per cent of them oppose the bailout plan; even when presented with the choice between a bailout and letting GM go out of business, 56 per cent prefer no General Motors at all to Government Motors. The case for government intervention is even weaker in the UK, where only the vestiges of a car industry survive. Here, the Government should limit itself to highlighting the relative efficiency of British production, and – barring some short-term lending – keep its hands off taxpayers' cash.
Cheney: Bush passed buck on GM
Former Vice President Dick Cheney says that former President George W. Bush did not want to be the one who "pulled the plug" on General Motors and instead decided to pass on the issue to President Barack Obama. "I thought that, eventually, the right outcome was going to be bankruptcy," Cheney said of the company during the second part of interview with Fox News’ Greta Van Susteren that aired Tuesday night.
"[GM] had to go through such a dramatic restructuring to have any chance of survival that they had to be able to renegotiate labor contracts and so forth," he said. "And the president decided that he did not want to be the one who pulled the plug just before he left office." Cheney said that rather than acting on GM, the Bush administration "put together a package that tided GM over until the new administration had a chance to look at it."
The former vice president stated that the choice was made in order to aid the Obama administration, thinking that forcing GM to restructure late in the Bush term would have dumped on Obama the "first crises the new administration would have to deal with." "These are big issues and [Bush] wouldn't be there through the process of managing it, but in effect, would have sort of pulled the plug on GM," Cheney said, adding that he and Bush wanted to allow Obama’s team to "decide what they wanted to do."
Government Motors will still lobby government
UPDATE: Wednesday morning, 14 hours after this piece was posted online, a General Motors spokesman informed the Examiner that GM was canceling all of its contracts with outside lobbying firms. The company will maintain its in-house lobbying shop however. I will add further updates here throughout the day.
General Motors will continue its multimillion-dollar lobbying operation in Washington, even after the federal government takes ownership of it. The automaker may even maintain its high-dollar lobbying contracts with some of the wealthiest and most influential K Street firms. "We believe we have an obligation to remain engaged at the federal and state levels," General Motors stated in an e-mail after President Barack Obama announced his plan for the federal takeover of the carmaker, "and to have our voice heard in the policymaking process."
As a result, some of the jobs that the White House will save with this unprecedented nationalization could be on K Street in downtown D.C., rather than in Detroit. GM spent $13.1 million on lobbying in 2008. In the first quarter of this year, while surviving on federal bailout money, the company’s lobbying tab was $2.8 million. Washington’s most powerful lobbying firms are among the 14 firms the company employed as of the last filings. None of the firms would comment on whether it would continue to work for GM. An assistant to leading Republican strategist and lobbyist Charlie Black of BKSH & Associates said "Charlie doesn’t know" what effect GM’s bankruptcy will have on the firm’s contract with the automaker.
Assuming GM continues its current lobbying effort, many of K Street’s most storied lobbyists, such as Black, would in effect be working for taxpayer money. One such government contractor would be Stuart Eizenstat at the top-tier firm Covington & Burling, who served in the administrations and on the campaigns of every Democratic president from Lyndon B. Johnson to Bill Clinton. GM hired him and his firm 10 days after Obama’s election. Ken Duberstein, Ronald Reagan’s former White House chief of staff, is also on GM retainer, as is former Sen. Don Nickles, R-Okla., who served as the majority whip in the upper chamber.
In addition to hiring these outside firms, General Motors operates its own in-house lobbying shop in a pricey office at 101 Constitution Ave. NW, across the street from the Capitol grounds. Under Obama’s plan, taxpayers would in effect cover 60.8 percent of the cost of this operation. The lobbying office referred inquiries to GM’s press office, which replied with two e-mails. One e-mail outlined its "obligation to remain engaged" and to participate in the policymaking process, citing health care, cap-and-trade, and foreign trade. When asked specifically whether GM would continue to retain outside lobbyists, a GM spokesman wrote back, "As with all aspects of our business, GM sometimes will use consultants with strong expertise on certain issues. The list of these consultants is public. The use of these consultants is constantly under review."
By press time, the White House did not respond to two phone messages and an e-mail inquiring whether the president intended to restrict GM lobbying or spending on lobbying while the government owned the company. The awkwardness of GM, in effect, lobbying its owner, is one of the many conundrums created by the business-government partnerships initiated by President George W. Bush last fall.
If Obama were to place lobbying restrictions on GM — limiting GM employees’ and consultants’ contacts with government officials — that would amount to restricting communication between the company’s management and its shareholders.
A related question: Will all discussions between administration officials and GM management continue to count as "lobbying contacts" covered under federal law? Elliot Berke, a government ethics lawyer in Washington, told me, "Nobody really knows what any of this means." Insurance giant AIG suspended its entire lobbying practice once the government bought a majority stake in it, terminating all contracts by Oct. 1.
In the first three months of this year, GM lobbied on issues including its own bailout, the stimulus, climate change, transportation funding, air bag laws, fuel-efficiency requirements, prescription drugs, health care reform, cellulosic ethanol, hydrogen-powered cars, fuel cells and Mexican trucks, among others. GM is a member of the U.S. Climate Action Partnership, a coalition that lobbies Washington for cap-and-trade restrictions on greenhouse gas emissions, as is Chrysler, a USCAP spokesman confirmed Tuesday afternoon. AIG, on the other hand, withdrew from the coalition upon its bailout. Trying to be a business and a de facto government agency simultaneously won’t be easy, and the problem of lobbying shows why.
FDIC to Delay PPIP Test Sale of Distressed Loans
The U.S. plan to rid toxic loans from banks’ balance sheets has been put on hold as lenders raise capital, a person familiar with the matter said today, suggesting less demand from banks to use the program. The Federal Deposit Insurance Corp., which planned a trial sale in June using as much as $100 billion from the Troubled Asset Relief Program, hasn’t shelved the program, said the person, who declined to be identified because the decision isn’t public. Treasury Secretary Timothy Geithner, in Beijing, today said interest in such U.S. programs may be waning as market confidence improves.
"Banks are able to solve their problems in other ways and there is less pressure for them to use the PPIP as a solution," said John Douglas, a former FDIC general counsel and now a partner at Paul, Hastings, Janofsky & Walker LLP. "There’s very little appetite for this on the bank side." The Obama administration unveiled the two-part Public- Private Investment Partnership on March 23 in its effort to shore up the financial system by removing illiquid assets. Since the announcement, U.S. banks including 19 lenders subjected to stress tests have raised more than $73 billion, data compiled by Bloomberg show.
FDIC Chairman Sheila Bair last week said lenders might hesitate to sell assets or buy loans because of "discomfort" that lawmakers might add transparency requirements after the program started. She cited a mortgage bill signed May 20 by President Barack Obama that increased scrutiny of managers of the public-private investment funds and added rules for expanded disclosure of the debt sales. "I wouldn’t comment beyond the remarks Chairman Bair made last week," said FDIC spokesman Andrew Gray. "There are issues that we are looking at." Geithner said in Beijing he still plans to work with regulators to set up programs to help lenders sell assets such as mortgage-backed securities.
Promised Help Is Elusive for Some Homeowners
She had seen the advertisements for the new government program offering relief. She had heard President Obama promise that help was on the way for homeowners like her, people who had lost jobs and could no longer make their mortgage payments. But when Eileen Ulery called her mortgage company — Countrywide, now part of Bank of America — the bank did not offer to alter her mortgage. Rather, the bank tried to sell her a new loan with a slightly lower monthly payment while asking her to pay $13,000 toward the principal and a fresh $5,000 in fees.
Her problem was that she did not yet present a big enough problem to merit aid. Yes, she was teetering toward delinquency. She was among millions of homeowners rapidly sliding toward danger for whom the Obama administration had devised an aid program — some already in foreclosure proceedings, others headed that way as they ran out of means to make their payments. But unlike those in imminent peril of losing their homes, Ms. Ulery had never missed a payment. "I don’t know who this bailout is helping," she said. "We’ve given these banks all this money and they’re not doing what they say they’re doing. Something’s not working right. They keep saying they’re doing all this, but we don’t see it down here at this level."
More than three months after the Obama administration outlined a new program aimed at rescuing millions of distressed homeowners by compensating banks that modify mortgages, Ms. Ulery’s experience illustrates the mixture of confusion, frustration and limited assistance that now reigns. Through many months of wrangling over the fate of the financial system, with hundreds of billions of taxpayer dollars dispensed on bailouts, distressed homeowners have waited for their own rescue amid talk that it was finally on the way. Modifications of so-called subprime and Alt-A mortgages — those made to people with tarnished credit — actually fell by 11 percent in May from April, according to research by Alan M. White at Valparaiso University School of Law.
A Treasury spokeswoman, Jenni Engebretsen, confirmed that homeowners like Ms. Ulery — current on their mortgages yet grappling with a hardship like unemployment — were eligible for loan modifications under the program. She said mortgage servicers had offered to modify more than 100,000 loans since the department announced the program. But how many loans have been modified? Ms. Engebretsen declined to say, noting that the Treasury was working with mortgage companies to "fine-tune reporting systems."
A spokesman for Bank of America Home Loans, Rick Simon, confirmed that the bank offered Ms. Ulery refinancing and not loan modification. The bank is now focusing on modifications only for those borrowers "who are already in severe threat of foreclosure," he said. "We’re still putting the systems in place to handle people who are current on their loans," Mr. Simon said, declining to say how many loans Bank of America had modified. "It’s still very, very early in the program." Ms. Ulery, 63, is the face of the latest wave of troubled American homeowners, a surge of people in financial danger not because of reckless gambling on real estate, but because of lost income.
Far from being one of those who used easy-money loans to speculate on homes proliferating across the desert soil of greater Phoenix, she has lived in the same modest, stucco-sided condo in suburban Mesa for a dozen years. She bought the two-bedroom home in 1997 for $77,500. For two decades, she worked as an executive assistant at nearby Arizona State University, bringing home more than $1,000 every other week — enough to pay the bills.
Round-faced, wry and given to staccato bursts of laughter, Ms. Ulery regularly visits yard sales, seeking out plates and patchwork quilts for her collections. She takes pleasure in her two grandchildren and her beagle. She enjoys an occasional glass of wine, favoring a $6 merlot that comes in a screw-top bottle. "I’m not an extravagant-type person," she said. "I see these big houses all around, and they’re beautiful, but I’m comfortable in my little condo."
Like tens of millions of other American homeowners, she added to her mortgage balance as the value of her condo swelled, at one point exceeding $200,000. She refinanced to pay off some credit cards and settle into a 30-year, fixed-rate loan. Later, she took out a home equity line of credit to buy a new Hyundai. She refinanced again in 2007, borrowing $20,000, mostly for a new roof. Over the years, her monthly payment swelled from about $600 to more than $1,000. With planning and self-control — she tracks her monthly expenses on a color-coded spreadsheet — she always came up with the money. "I’ve never been late," she said.
But the equation broke down last year, when she lost her job in university budget cuts. Ms. Ulery received six months of severance. She arranged a monthly $1,500 Social Security check. But when the severance ran out in October, her mortgage finally exceeded her limited means. With so many people out of work, and with her doctor counseling rest for a stress-related illness, she did not pursue another paycheck, negotiating to have her university pension begin earlier. She has been leaning on credit cards.
Across the country, millions of homeowners in similar straits have been sliding into delinquency. Some owe more than their houses are worth. Ms. Ulery is among that unhappy cohort — her house is worth about $122,000, and she owes $143,000 — but walking away is not for her. "In my family, we don’t do that," she said. "You pay your bills. And I wanted my home." In March, she heard about the Obama administration program. The Countrywide Web site directed her to a government site, makinghomeaffordable.gov, she said. There, she took a test to determine her eligibility for a loan modification.
Was her home her primary residence? Check. Was she having trouble paying her mortgage? Check again, and so on until the screen told her that she might qualify. In April, she called the bank. The representative said the bank was not doing modifications for people like her, she recalled. He shifted the conversation: if she handed over $18,000, he could lower her payment to $967 from $1,046. Her interest rate would actually increase slightly, with the drop largely because she was putting down more money.
"I just laughed," Ms. Ulery said. "It was a really good deal for them." To which she poses her own question: What sort of deal is it for the American taxpayer? As she sees it, the same banks that generated the mortgage crisis are now getting public money to fix it, while doing little more than seeking new fees. "I don’t think the government gets it," she said. "These are the same people you couldn’t trust before."
US Banks, Money Managers Make Derivatives Pitch
A group of large banks and money managers made commitments to improve disclosures and reduce systemic risk in the derivatives markets over the next few months, as the threat of legislation looms.
In an eight-page letter to William Dudley, president of the Federal Reserve Bank of New York, market participants mapped out a timeline to record all their over-the-counter derivative trades in central repositories and expand access to credit-default-swap clearinghouses to clients of banks.
The group also pledged to come up with a mechanism to resolve disputes over derivative valuations and level the playing field between dealers and investment firms. They were some of the most explicit commitments yet from an industry accused of exacerbating the recent financial crisis, and that is now trying to get its house in order to pre-empt new laws that could change the market's structure. Last month, the Treasury proposed giving the Securities and Exchange Commission and the Commodity Futures Trading Commission authority to mandate centralized clearing of certain derivatives and force trading of standardized contracts onto exchanges or electronic platforms.
The industry letter accompanied an official acknowledgment from the New York Fed and was posted on the central bank's Web site Tuesday. "We will continue to demand further improvements until our objectives are achieved," said Mr. Dudley in a statement responding to the letter. Copies of the letter were sent to 11 regulatory bodies, including the Office of the Comptroller of the Currency, the SEC and the U.K. Financial Services Authority.
The signatories comprised about two dozen of the derivatives market's most prominent participants, including large dealer banks such as J.P. Morgan Chase & Co. and Deutsche Bank AG and money managers AllianceBernstein, Citadel Investment Group and BlueMountain Capital Management. Key among the goals was a commitment to register all credit-derivatives trades in either a central clearinghouse or a trade warehouse by July 17.
Geithner's China Pitch
Timothy Geithner gets all the easy assignments. This week the Treasury Secretary has been traveling to China to assure America's leading creditor that it should keep buying American T-bills because, well, because . . . let's hope his private chats were more persuasive than his public argument. The world's most important bond salesman told a Peking University audience Monday that "in the United States, we are putting in place the foundations for restoring fiscal sustainability." News reports said the audience tittered at that one, and no wonder. The Chinese are well aware of the great American fiscal and monetary blowout, with the 2009 federal budget deficit set to reach 13% of GDP, if we catch a break or two.
Mr. Geithner portrayed this as a virtuous case of policy necessity to end the recession, after which the U.S. is determined to swear off the sauce and quickly get back to a deficit of "roughly 3% of GDP." Promising that with a straight face is called taking one for the Obama team. The Chinese must have been especially startled to hear Mr. Geithner add that the U.S. plans to "put in place comprehensive health-care reform that will bring down the growth in health-care costs, costs that are the principal driver of our long-run fiscal deficit." So by adding another few trillion dollars in new health entitlements, the U.S. will "bring down" the cost of health care. The Chinese will have to consult their Washington embassy on that fiscal puzzler.
Mr. Geithner dutifully tried to look past the current downturn to explain how the two countries can achieve "more balanced, sustained growth of the global economy, once this recovery is firmly established." This is code for pushing "balanced trade" as an elixir for economic prosperity. Treasury Secretaries aplenty have tried this formula without success, but no matter. The logic goes something like this: Once the financial system stabilizes, all will be well if China can get its consumers to spend more and the U.S. can save more. Trade deficits will disappear and the world will live happily ever after.
There's at least one hitch: The U.S.-China trade imbalance didn't cause the current financial crisis. To the extent that "global imbalances" played a role, the original sinner was the Fed, which flooded the world with dollars that stirred global (and especially U.S.) demand for credit and goods. As a country with a low domestic propensity to consume, China ramped up its export machine to meet that demand. As it piled up dollar reserves, China didn't invest them at home but sent them back to the U.S. to purchase T-bills and Fannie Mae mortgage-backed securities. Voila -- the housing bubble. The policy point is that the "imbalances" resulted more from reckless monetary policy than from spendthrift American consumers or Chinese exchange-rate policy.
Mr. Geithner is right that the Chinese should invest more at home and Americans should save more. We suspect the latter will happen naturally as U.S. consumers respond to the recent recent credit meltdown. Or at least they might if the great U.S. fiscal and monetary reflation now underway doesn't eventually lead to inflation that makes it foolish for Americans to save. And speaking of inflation risks -- that is, danger of a debased dollar and dollar assets -- Mr. Geithner didn't help by advising China Monday to allow "greater exchange-rate flexibility." Exchange rates are relative prices, so what Mr. Geithner really means is that he wants the yuan to appreciate vis-a-vis the dollar.
This is a sop to Members of Congress and trade lobbyists in Washington who think the U.S. can depreciate its way back to economic health. It's also a signal to the Chinese that the U.S. may secretly want the dollar to decline, which is one reason that, despite the global recession, the prices of oil and other goods that are denominated in dollars have been rising again. The Chinese are reportedly investing in commodities in part as a hedge against a falling dollar. This may also explain why Treasury bond yields have recently been rising at the long end, as the world's investors demand a higher return as a hedge against future inflation risk.
Mr. Geithner is certainly right that China needs to adjust its export-dependent growth model, which has struggled amid the decline of global demand.
He urged China to stimulate consumption by introducing better pensions and health care and upgrading its financial services to allow capital to flow from people who have it to people who need it. But in fact, China's version of "stimulus" has been arguably more responsible than America's, with more of it going to public works projects than simply to transfer payments for short-term consumption. The U.S. and Chinese economies are inexorably linked, and so Mr. Geithner was wise to tone down his policy demands. He'll find the U.S. has more credibility if it proves to the world it has no intention of inflating away its rising debt burden.
Detroit’s Woes Wound an Army of Suppliers
For nine years, the Strong brothers, Mark and Tim, made tools in their machine shop to maintain the giant presses that stamped steel sheets into fenders and hoods at a nearby General Motors factory in Lansing, Mich. Aircraft parts were a sideline, but when auto work dried up last November, the brothers managed to get more orders from that side of the business to keep them afloat. They have been shaping wing spars for the A10 Thunderbolt, used to provide ground support in combat.
"The wars in Afghanistan and Iraq helped us a lot," Mark Strong said. Wing spars, however, are hardly a substitute for the tools that G.M. seemed to always need from the Strongs for its assembly lines. The $632,000 in sales the brothers rang up in 2008 has shrunk to less than $95,000 so far this year. The seven-employee staff in their machine shop in Mason, Mich., is down to just three, and the Strongs hope the wing spars will somehow carry them over until G.M. once again sends business their way.
The brothers are among the tens of thousands of suppliers whose fortunes are directly tied, for better or worse, to the automakers. And now, with new-car sales touching low levels not seen in decades, and with G.M. and Chrysler forced to shut plants as they struggle through bankruptcy, their prospects seem grim. "Most of these supplier companies are family-owned," said Daniel Luria, research director of the Michigan Manufacturing Research Center in Ann Arbor. "And in a period when the families can’t sell, the decision is to preserve the companies as future streams of revenue for the next generation."
Auto suppliers, which employ more workers than the car companies themselves, have cut way back, almost hibernating, as they lay off employees earning $10 to $22 an hour, or cut back their hours. Some, like the Strongs, are trying to diversify, but such efforts have not noticeably offset the lost automotive business. "We are estimating that 500 suppliers out of 4,000 could go out of business between now and the end of the year," said Neil DeKoker, chief executive of the Original Equipment Suppliers Association. Billings just to the three Detroit automakers from the nation’s auto suppliers have fallen to $7 billion a month, on average, from $16 billion in January, he said.
The Whitlam Label Company, in Centerline, Mich., has tried to diversify. It makes a wide variety of labels and bar codes that are pasted on car parts and on finished vehicles, including the stickers on radiator covers warning people to keep their hands away from the fan. The company has expanded into food and beverage packaging. But its revenue is still down, running at an annual rate of $14 million this year, well below the $20 million of 2008. Its work force dropped to 100 from 130 (10 of them are children and grandchildren of the late George Shaieb Sr., a Syrian immigrant who bought the company in 1973).
Whitlam is faring better than others in the downturn because it is still shipping labels to Chrysler and G.M., including price labels taped on the windows of thousands of unsold vehicles. "We are trying to get more automotive by selling more aggressively to Toyota and Honda and the other foreign transplants," said Richard Shaieb, Whitlam’s president and one of George Shaieb’s sons. That market represents fewer opportunities for companies like Mr. Shaieb’s. After all, the percentage of parts made in the United States for foreign brands assembled here is less than the domestic content of vehicles made by G.M., Chrysler and Ford, according to Mr. Luria.
But that is not the concern of George Buhaj today. The company Mr. Buhaj heads as president — Avon Broach, a machining operation in Rochester Hills, Mich. — designs and makes broach tools, which are used by the three Detroit automakers and also other suppliers to cut and shape transmission gears and other complex parts. After layoffs in March, his payroll is down to 16 from 25. "Business just fell right off because of the Chrysler bankruptcy and the potential for one at G.M.," he said.
In April, Mr. Buhaj, who is 49 and bought out other Avon owners in 1993, cut back the work day by several hours. He said he was planning another layoff in the next couple of weeks, dropping at least two more people. A year ago, struggling for orders, he started searching for customers in other industries. "I have identified wind energy and medical," he said. "I’m not yet making parts for these but I’m trying."
Pioneer Forge, near Toledo, Ohio, would also like to diversify, said Michael Regal. He manages the factory, which forges tie rods and other steering links for trucks, including pickup trucks assembled by Ford and Chrysler. The company has not made a profit for two months, Mr. Regal said, and the work force is down to 51, from 100 a year ago. Revenues have plunged to less than $10 million, at an annual rate, from more than $15 million in 2007, just prior to the start of the recession.
Mr. Regal says he sees no other choice but to try to sell more steering mechanism forgings to foreign auto companies that assemble vehicles in the United States. He would like to diversify away from auto supply, but the economics work against Pioneer and many others in the industry. "You have to set up your operation to handle the mass volumes that the automotive industry sends at you, and you become a captive of the parts that you make," he said. "If you want to venture out into some other business, you have to have a lot of capital to do that, and when things take a turn for the worse, the capital is not there."
Obama Stimulus Slow to Trickle Into 'Real Economy'
California public-works official Bob Beaumont says the $2.1 million he may get from President Barack Obama’s stimulus plan "isn’t going to make a lot of difference" in a county with $40 million in "shovel-ready" projects. "It seems like the federal stimulus is trickling down very slowly," says Beaumont, chief assistant director of public works for Marin County, north of San Francisco. "My feeling is it’s not finding its way into the economy as quickly as it should." The $787 billion package Congress passed in February is having less impact than economists expected in pulling the U.S. out of the worst recession in at least 50 years. About $111 billion in planned infrastructure spending is arriving so slowly that recovery in the final six months of 2009 may be weak.
"Most of the stimulus still hasn’t yet reached the real economy," says Robert Solow, professor emeritus at the Massachusetts Institute of Technology in Cambridge, who won the 1987 Nobel Prize for economics. "It will help us a lot in the second half of the year. But given the collapse in consumer spending, business investment and state and local government spending, I think it’s premature to be getting optimistic." In Marin County, which ranked fifth in the nation in per- capita personal income in 2007, Beaumont says he expects to hear this week about final approval for the $2.1 million from Washington for road improvements. "It has been a difficult process," he says. "The paperwork to get the money is voluminous and time-consuming."
Jim Ryan, chief executive officer of W.W. Grainger Inc., a Lake Forest, Illinois-based distributor of building-maintenance supplies, isn’t being carried away by the stimulus either. "We haven’t seen it yet," he said in a May 20 interview. "We won’t start seeing some of that money till late this year, early next year." Jared Bernstein, chief economist for the office of Vice President Joe Biden, which is overseeing the program’s implementation, defends the pace so far, saying the administration wants to make sure money isn’t wasted. "We’re hitting the right balance between speed and oversight," he says, adding that spending will "ramp up" in the next three months. "The timing is good."
Still, the amount that has reached the economy under the Obama plan so far is small, even by the administration’s own reckoning. About $50 billion has been paid out, not enough to revive a $14 trillion economy. Some $112 billion more has been committed. Workers surprised economists by saving rather than spending the first dollops of cash they received in their paychecks under the plan, as retail sales fell short of forecasts in April. States, meanwhile, have been slow to take advantage of the emergency aid contained in the first phase of the stimulus, particularly the increased help for those out of work. The spending in stage two, including outlays for infrastructure and budget assistance for the states, probably will have greater impact because it will go right into the economy, rather than being set aside in savings.
"This is the moment of truth for the stimulus," says Mark Zandi, chief economist at Moody’s Economy.com in West Chester Pennsylvania. "We’ve got to see it working soon." Nigel Gault, chief U.S. economist at IHS Global Insight in Lexington, Massachusetts, sees the economy eking out a 0.2 percent annualized advance in the third quarter, thanks to the Obama plan. Without the program, Gault says there would be a 2.4 percent contraction. He forecasts growth of 0.7 percent in the fourth quarter, well below the 3.5 percent seen by the administration in its budget outlook. The economy contracted at a 5.7 percent pace in the first quarter, capping its worst six- month performance in five decades. Public construction spending declined 0.6 percent in April after rising 1 percent in March, the Commerce Department reported yesterday.
Construction and engineering company stocks have soared in anticipation of increased revenue from stepped-up government projects. A Standard & Poor’s index of 11 construction and engineering companies is up 56 percent since the beginning of March, compared with 35 percent for the S&P 500. Irving, Texas-based Fluor Corp., the largest publicly traded U.S. engineering firm, is up 66 percent, and San Francisco engineering company URS Corp. has gained 80 percent. Jim Owens, chief executive officer of Peoria, Illinois- based Caterpillar Inc., said his dealers are seeing some benefit. "People are starting to bid work again," Owens, whose company is the world’s largest maker of bulldozers and earth- moving equipment, said on NBC’s "Meet the Press" program May 31. "It’ll have a positive impact and I think we’ll start to see that kick in through the summer and into the fall."
The continuing travails of the states may blunt some of the impact of the federal spending. Under the program, states have to submit requests to Washington for the roughly $144 billion set aside to help them balance their budgets. So far, 20 have been approved. Jon Shure, deputy director of the state fiscal project at the Center on Budget and Policy Priorities in Washington, says the funds will probably help states close about 30 percent to 40 percent of their budget shortfalls over the next two years. The remainder will have to come from spending cuts and tax increases, which will act as a drag on the economy, he says.
California used at least $7.9 billion of federal funds to help narrow a $42 billion budget gap in April, according to Jean Ross, executive director of the California Budget Project, a Sacramento-based policy-research group. A collapse of revenue since then has helped open an additional $24 billion hole. To close that, Republican California Governor Arnold Schwarzenegger has proposed more than $16 billion in savings, including cuts in state worker pay and aid to the elderly and to schools. Schwarzenegger, appearing before the California legislature today, urged quick action to eliminate the deficit, saying "if we don’t act, the state will simply run out of money and go insolvent."
Politics has blocked the arrival of stimulus money in some states, with several Republican governors refusing funding on principle. Louisiana Governor Bobby Jindal turned down $98 million to expand unemployment benefits, arguing that taking the funds will lead to higher taxes down the road. Even states that are more open to the federal government’s largesse have been slow off the mark. That’s partly because they’ve had to alter unemployment-compensation programs to bring them in line with new federal requirements, such as having to include part-time workers. New York Governor David Paterson, a Democrat, just signed legislation extending unemployment benefits an extra 13 weeks on May 20, allowing the state to tap $645 million in stimulus funds.
The kick to consumer spending from the package has also proven smaller than economists expected. Retail sales fell for the second straight month in April, dropping 0.4 percent. Economists surveyed by Bloomberg had been expecting sales to remain steady, in part because the tax cuts in the stimulus plan began to show up in April paychecks via reduced withholding. If consumer spending remains weak through the third quarter, "that would postpone the recovery into next year," says Allen Sinai, chief economist at Decision Economics in New York.
Fed Said to Toughen Terms for Banks to Repay TARP
Federal Reserve officials surprised bankers in the past week by demanding they raise specific amounts of new capital before repaying taxpayer funds, applying a more stringent assessment than the stress tests in May. JPMorgan Chase & Co. and American Express Co. were told they need to boost common equity, less than four weeks after being informed they had enough to withstand a deeper economic slump. Morgan Stanley was directed to raise more funds after already selling stock to cover its stress-test shortfall. One firm was told June 1, people with direct knowledge said. The central bank’s further scrutiny signals concern at the political and economic dangers of having a bank boomerang back to government aid once it leaves the program.
"The Fed doesn’t want to be criticized for allowing people to repay this and then having the banks say we just don’t have the capital to make loans now," said Lawrence Kaplan, a former attorney at the Office of Thrift Supervision who now works at law firm Paul, Hastings, Janofsky & Walker LLP in Washington. "It’s an exercise to make sure that no one is going to get criticized for allowing these redemptions." The Fed’s demands also partly reflect the biggest three- month rally in U.S. financial shares in at least two decades, which has made it easier for banks to raise the funds. The central bank said in a June 1 statement that the biggest 19 lenders "must successfully demonstrate access to public equity markets" before repaying TARP money.
Goldman Sachs Group Inc. hasn’t been required to seek any more funds since the firm raised $5.75 billion by selling shares in April, according to a person familiar with the matter. The firm sold $1.91 billion of stock in Industrial & Commercial Bank of China Ltd. this week, of which about half is owned by funds managed by Goldman Sachs. That sale was unrelated to any capital raising requirements, the person said. JPMorgan Chase & Co. Chief Financial Officer Michael Cavanagh told analysts on a conference call June 1 that the New York-based bank was informed by regulators it needed to raise $5 billion in common equity. JPMorgan announced it would sell that amount.
"We believe we’ve met all the terms to get out of TARP," JPMorgan Chairman Jamie Dimon said on the conference call. "If we don’t get out of TARP, we’d be very surprised. We don’t think we should be surprised." Fed approvals for an "initial set" of TARP repayments by banks among the 19 largest institutions are scheduled to be announced next week. "Both the banks and the government would like to have the institutions operate on their own," said former Fed Governor Randall Kroszner, who is now an economics professor at the University of Chicago’s Booth School of Business. "It is very important that the stability of those institutions not be questioned during the recovery."
Morgan Stanley, JPMorgan and American Express raised at least $7.7 billion this week as they learned of the new hurdles to leave the TARP. Morgan Stanley was judged in last month’s stress tests to need an additional capital buffer of $1.8 billion. The New York- based bank then raised $4.6 billion in common equity, only to be told this week it needed $2.2 billion more to repay TARP. "It doesn’t make a lot of sense if they’ve raised well in excess of the initial capital requirement to then be told you need a little bit more," said David Killian, a portfolio manager at Sterling Asset Management LLC in King of Prussia, Pennsylvania, who manages $500 million including stock in Morgan Stanley, JPMorgan and Goldman Sachs. "It’s government."
The 19 largest U.S. banks have more than $200 billion of preferred equity shares owned by the Treasury. The TARP program became a stigma for banks after the government set compensation limits and began criticizing the expenses of companies receiving aid. JPMorgan’s Dimon poked fun at the program June 1, reading a mock letter to Treasury Secretary Timothy Geithner. "Dear Timmy, we are happy to be able to pay back the $25 billion you lent us," Dimon said at the 31st Annual NYU International Hospitality Industry Investment Conference. "We hope you enjoyed the experience as much as we did." Capital One Financial Corp., the McLean, Virginia-based bank that specializes in credit cards, doesn’t need its TARP money "going forward," Chief Financial Officer Gary Perlin said today at an investor conference. He added that while TARP has bolstered the banking system, the lender has enough liquidity and government capital is "high-cost."
Capital One, which took $3.6 billion in TARP funds, was told by regulators it didn’t need to raise more capital based on the results of last month’s stress tests. Banks’ funding costs have declined and their reliance on the Fed’s liquidity programs has diminished as confidence in the financial system improves. The London interbank offered rate, or Libor, for three-month dollar loans stood at 0.65 percent yesterday, down from 1 percent May 1, according to the British Bankers’ Association. The Fed’s May 7 analysis showed that banks could lose $599.2 billion over two years in a "more adverse" scenario. That projection was based on an unemployment rate averaging 10.3 percent in 2010, with a 0.5 percent economic expansion -- less than the 1.9 percent median estimate in a Bloomberg News survey.
One risk is that the loss estimates the Fed used on specific products, such as credit-card loans and commercial real-estate loans, is even higher for some firms. If banks repay TARP funds next week, "politically, the administration can claim a victory," said Dino Kos, managing director at Portales Partners LLC and a former New York Fed executive vice president. "They can claim TARP is working, we’re getting our money back and making a profit. But there are more shoes to drop in commercial and industrial loans, leveraged loans, and real estate."
Court to Hear Challenge to Chrysler, Fiat Pact
A federal court late Tuesday agreed to hear an appeal related to the bankruptcy of Chrysler LLC, potentially extending the auto maker's stay in Chapter 11 reorganization by at least several days. The Second U.S. Circuit Court of Appeals in New York said it would hear an appeal by a group of Indiana pension funds challenging the sale of most of Chrysler's assets to the company's proposed partner, Fiat SpA of Italy. Oral arguments in the appeal will begin Friday, according to the court's order. Chrysler had hoped to potentially exit bankruptcy as soon as this week.
The circuit court's acceptance of the appeal is a small victory for Chrysler, however. Any appeals normally go first to a lower, district court. Going directly to the circuit court allows them to skip a step and speed up the process if the company prevails. The deal must close by June 15 or Fiat can potentially walk away from the deal, Chrysler has said. Neither Chrysler nor an attorney for the Indiana funds could be reached for comment. The sale to Fiat was approved early Monday by U.S. Bankruptcy Judge Arthur Gonzalez in Manhattan.
He found the sale order should be heard by the Second U.S. Circuit Court of Appeals, saying that skipping the district-court level "is appropriate because this case involves a matter of public importance, and an immediate appeal may materially advance the progress of this case." The pension funds hold about $42 million of Chrysler's $6.9 billion in secured debt. Secured debt is backed by the borrower's assets and normally puts the lender at the front of the line for repayment.
The Indiana pension funds -- the Indiana State Teachers Retirement Fund, the Indiana State Pension Trust and the Indiana Major Moves Construction Fund -- have argued the sale of Chrysler is unconstitutional, saying the plan upends the rights of senior lenders to be paid off before junior creditors. The Indiana funds also contend that the U.S. Treasury Department doesn't have the authority to lend bankruptcy financing under the Troubled Asset Relief Program because Chrysler isn't a financial company.
Under Chrysler's plan, Fiat would initially own 20% of the new company, though it would have the option of increasing its stake to as much as 51%. The United Auto Workers union would initially get a 55% stake, while the U.S. and Canada, which are lending Chrysler $4.9 billion during the bankruptcy, would own 8% and 2%, respectively. Senior lenders owed $6.9 billion would receive $2 billion, giving them a recovery of about 29 cents on the dollar.
The Indiana funds say that, under Chrysler's plan, creditors with less seniority, namely the UAW, would see a better recovery. The UAW's health-care trust has an unsecured claim against Chrysler for about $10.5 billion. In addition to the equity stake in Chrysler that the trust would receive, it would also get a $4.5 billion note. The Indiana funds bought the Chrysler debt at 43 cents on the dollar in July 2008. Most other secured lenders have agreed to the restructuring plan Chrysler has proposed in bankruptcy court that will pay them 29 cents on the dollar for their debt.
Northwestern Mutual Makes First Gold Buy in 152 Years
Northwestern Mutual Life Insurance Co., the third-largest U.S. life insurer by 2008 sales, has bought gold for the first time the company’s 152-year history to hedge against further asset declines. "Gold just seems to make sense; it’s a store of value," Chief Executive Officer Edward Zore said in an interview following his comments at a conference hosted by Standard & Poor’s in Brooklyn. "In the Depression, gold did very, very well."
Northwestern Mutual has accumulated about $400 million in gold, and Zore said the price could double or even rise fivefold if the economy continues to weaken. Gold gained 10 percent last month, the most since November. The commodity has more than tripled since 2000, rising for eight straight years. Gold futures for August delivery slipped $4.80 to $975.50 at 4:03 p.m. in New York. "The downside risk is limited, but the upside is large," Zore said. "We have stocks in our portfolio that lost 95 percent." Gold "is not going down to $90." Policyholder-owned Northwestern Mutual, based in Milwaukee, ranks third by 2008 life insurance premiums according to data from the National Association of Insurance Commissioners. The data excludes annuities.
It's a funny old game: where is the dream team of economists to tackle the slump?
Let's play Fantasy Economics. It's a simple game based on Fantasy Football, where fans select a dream squad from the Premier League and win points if their players score, create or save goals. In Fantasy Football, you want a solid goalkeeper, a playmaker, a couple of strikers likely to bag 15-20 goals a season each. So, here's the challenge. This, by common consent, is the most challenging global economic environment there has been since the second world war. Now is the time for big-picture economists to put in a performance on the big stage. Who among those plying their trade in the world of macro-economics would you want on your team?
Putting a team together of economists no longer with us is a breeze. A team of dead economists drawn from all strands of the discipline might include Adam Smith, David Ricardo, Thomas Malthus, Karl Marx, Alfred Marshall, John Maynard Keynes, Friedrich Hayek, Richard Kahn, Joseph Schumpeter, Hyman Minsky and Herman Daly. Whether these classical economists, Keynesians, free marketeers and greens would gel is open to question, but on paper it looks a formidable line-up. Indeed, those on the bench would also be formidable: some would argue that William "Bill" Phillips or Milton Friedman deserve a place. I'd be tempted to find room for Karl Polanyi, even though he was an economic historian rather than an economist.
Still, you get the picture. There is a wealth of talent to pick from; so much, in fact, that it would be relatively easy for free marketeers, Keynesians, greens and Marxists to choose their own team. Keynes, for example, might be the creative midfield playmaker in a team including Joan Robinson, Kahn, James Meade, Phillips, Nicky Kaldor, John Hicks, James Tobin, Michael Kalecki, Tommy Balogh and Polanyi (if eligible).
Picking a modern 11 of comparable quality is a lot tougher. Indeed, trying the game out at a Cambridge college a couple of weeks back, the consensus among the economists there was that there has not been a Keynesian economist since Minsky who would make the cut.
At the heart of Minsky's work was the notion that deregulated financial markets have an in-built tendency to produce wild boom-bust cycles, and that periods of stability carry within them the seeds of an eventual bubble. "A fundamental characteristic of our economy," Minsky wrote, "is that the financial system swings between robustness and fragility, and these swings are an integral part of the process that generates business cycles." Unsurprisingly perhaps, there has been a revival in interest in Minsky's work over the past two years, and much debate about whether the moment when the boom of the mid-years of this decade turned to financial crisis was a "Minsky moment".
Interestingly, Minsky delivered his warning in 1974, just as Keynesian economics was going out of fashion during the stagflation that followed the first post-war oil shock. Among living economists, the Cambridge academics thought only Joseph Stiglitz and Paul Krugman would be vying for a place. The demise of ?Keynesian economics in the land of its birth was underlined by the rueful acceptance that there is no longer a living British economist who would get into the squad.
In truth, though, the same might be said of a team captained by Hayek or Schumpeter. Neither believed that conventional economics was much good at describing the way the world actually works; Schumpeter, in particular, was scathing about the validity of perfect competition, the basis for almost all economics teaching. But candidates for an all-star team of free-market macro-economists are also thin on the ground. The success of ?Freakonomics and similar books tell their own story: until the crisis broke in 2007, it was assumed that the big picture was largely sorted and economists needed to concentrate on micro-economics, where much good work has been done, incidentally.
As a profession, economics not only has nothing to say about what caused the world to come to the brink of financial collapse last autumn, but also a supreme lack of interest in it. If, for example, you scroll down the list of papers scheduled for publication by the Review of Economic Studies, one of the prestigious UK journals, there is not the slightest sense that the world of general equilibrium and real business cycle models has been turned upside down in the past two years. There is, on the other hand a paper on "Generalised non-parametric deconvolution with an application to earnings dynamics", which includes the insight that "Monte Carlo simulations show good finite-sample performance, less so if distributions are skewed or "leptokurtic". Got that? And that's just the abstract. The full article is even more fun – if you get your kicks from fantasy economics divorced from reality.
The big divide in economics is not between Keynesians and Hayekians, but between those who are interested in looking at the world as it is and those who are interested in how it would be if it conformed to the dictates of their mathematical models. The insights that Smith, Marx and Keynes brought to economics came not from differential calculus but from an attempt to understand what was happening during the early stages of the Industrial Revolution, the expansion of the mid-19th century and the Great Slump. To those who believe in it, general equilibrium theory is a beautiful expression of the world assuming that the price mechanism works to align demand with supply and that human beings are rational economic agents. There is no room for the idea – supported by Minsky and Schumpeter – that instability is inherent to the economy, and might be good for it.
Experiments have shown just how limited the modern approach can be. Try this one for size: you are given £100 and told to share it with a stranger. If the stranger accepts your offer you get the money, but if he rejects it neither of you get a penny. How would you divide the cash? An economist's answer is that you offer the stranger £1 and keep £99 for yourself. That way you are both better off but you maximise your benefit. But this is not what tends to happen, since it offends people's sense of fairness. Many people share the money equally. There are economists out there battling against the mainstream. Andrew Oswald, Amartya Sen, Robert Frank – you can take your pick of those who have insights into the way we live now. Paul Ormerod has written a series of books describing how general equilibrium theory has driven economics down a blind alley.
But it should be of concern that mainstream economics is disappearing up its own fundament, with the determination to see economics as a hard science crowding out a more nuanced and relevant approach. In the 1930s, Keynes was more interested in casino economics than he was in Monte Carlo simulations, but there is no Keynes, Schumpeter or Hayek out there with answers to our predicament.
Perhaps Henry Ford got it wrong: it's ?economics that's bunk, not history.
Congress Helped Banks Defang Key Rule
Not long after the bottom fell out of the market for mortgage securities last fall, a group of financial firms took aim at an accounting rule that forced them to report billions of dollars of losses on those assets. Marshalling a multimillion-dollar lobbying campaign, these firms persuaded key members of Congress to pressure the accounting industry to change the rule in April. The payoff is likely to be fatter bottom lines in the second quarter.
The accounting issue lies at the heart of the financial crisis: Are the hardest-to-value securities worth no more than what the market is willing to pay, or did the market grow too dysfunctional to properly set values?
The rule change angered some investor advocates. "This is political interference on a major issue, and it raises questions about whether accounting standards going forward will have the quality and integrity that the market needs," says Patrick Finnegan, director of financial-reporting policy for CFA Institute Centre for Financial Market Integrity, an investor trade group. Backers of the change say it was necessary because existing accounting rules never contemplated the kind of market turmoil that unfolded last year.
The rules had required banks, securities firms and insurers to use market prices to help assign values to mortgage securities and other assets that don't trade on exchanges -- to "mark to market." But when markets went haywire last fall, financial firms complained that the rules forced them to slash the value of many assets based on fire-sale prices. That contributed to big losses that depleted their capital and left several of the nation's largest firms on the brink of failure. Earlier this year, financial-services organizations put their lobbyists on the case. Thirty-one financial firms and trade groups formed a coalition and spent $27.6 million in the first quarter lobbying Washington about the rule and other issues, according to a Wall Street Journal analysis of public filings. They also directed campaign contributions totaling $286,000 to legislators on a key committee, many of whom pushed for the rule change, the filings indicate.
Rep. Paul Kanjorski, a Pennsylvania Democrat who heads the House Financial Services subcommittee that pressed for the accounting change, received $18,500 from coalition members in the first quarter, the second-highest total among committee members, according to Federal Election Commission records. Over the past two years, Mr. Kanjorski received $704,000 in contributions from banking and insurance firms, the third-highest total among members of Congress, according to the FEC and the Center for Responsive Politics. A spokeswoman says Rep. Kanjorski believes the accounting industry's rule-making body, the Financial Accounting Standards Board, or FASB, made the right move since neither mark-to-market critics nor advocates are "entirely pleased with the outcome." She says campaign contributions didn't factor into the congressman's thinking.
During a March 12 hearing before the House subcommittee, FASB came under intense pressure from committee members. "If the regulators and standard setters do not act now to improve the standards, then the Congress will have no other option than to act itself," Rep. Kanjorski said in his opening remarks. "We want you to act," Rep. Kanjorski told Robert Herz, FASB's chief. Mr. Herz waffled about how quickly the standards board could act. Rep. Kanjorski leaned over the dais. "You do understand the message that we're sending?" he said. "Yes," Mr. Herz replied. "I absolutely do, sir."
FASB made speedy revisions to its rules. In an interview, Mr. Herz said FASB merely accelerated the matter on its agenda, and tried to be responsive to input from investors and financial-services firms. The change helped turn around investor sentiment on banks. Financial firms had the option of reflecting the accounting change in their first-quarter results; they will be required to do so in the second quarter. Wells Fargo & Co. said the change increased its capital by $4.4 billion in the first quarter. Citigroup Inc. said the change added $413 million to first-quarter earnings. The Federal Home Loan Bank of Boston said the shift boosted its first-quarter earnings by $349 million. Robert Willens, a tax and accounting analyst, estimates that the changes will increase bank earnings in the second quarter by an average of 7%.
The American Bankers Association, a trade group, acknowledges that it exerted pressure to change the rules. The ABA was the biggest donor to the campaign funds of committee members in the weeks before the hearing. It gave a total of $74,500 to 33 members of the committee in the first quarter, according to the Journal analysis of public filings. An ABA spokesman says that is its normal level of support for lawmakers, and that the initiative was part of a broader effort to change accounting rules. "We worked that hearing," says ABA President Edward Yingling. "We told people that the hearing should be used to talk about the big problems with 'mark to market,' and you had 20 straight members of Congress, one after another, turn to FASB and say, 'Fix it.'"
The banking industry's victory stands in contrast to at least one defeat it has been dealt in recent weeks, on new credit-card legislation. Mark-to-market accounting has been around for decades. Many banks were content with the rules when the markets were going up. But the rules became a big problem in late 2007. As markets turned down, FASB clarified the rules and established how certain financial instruments, including mortgage securities, should be valued. The guidelines said valuations should reflect "observable" input such as market prices whenever possible. They required banks to disclose extensive information about assets they were unable to value based on market prices.
Financial firms last year reported losses or write-downs totaling roughly $175 billion, according to Michael Mayo, an analyst at the CLSA unit of Credit Agricole SA. The lobbying plan began taking shape last year. Stock and bond markets were tanking. Lehman Brothers Holdings Inc. collapsed in September. Some markets seized up, including those for mortgage securities. Investors worried that some banks and other financial firms might not survive if they didn't begin posting profits in 2009. Conrad Hewitt, then the Securities and Exchange Commission's chief accountant, says financial-services representatives, including the ABA's, called his office repeatedly. He says he met with executives of Citigroup and Wells Fargo, among others.
Last year, Mr. Hewitt recalls, he challenged ABA lobbyist Donna Fisher and a Wells Fargo executive on their valuation complaints. "If you say you're required to value the securities at 50 cents," he recalls asking, "and you believe that the securities are really worth 80 or 90 cents, do you have a lot of buyers because of this unusually low valuation?" The two responded that there were no buyers, according to Mr. Hewitt. "Then maybe the securities should be valued at less than 50 cents," Mr. Hewitt says he responded. Ms. Fisher declined to comment, as did Wells Fargo. Mr. Hewitt now is a consultant to financial firms.
The lobbying picked up early this year. Lawmakers were growing more concerned about the problems spreading. Federal regulators were forced to guarantee billions of dollars in uninsured deposits at credit unions, which are member-owned cooperative banks. The Federal Home Loan Banks -- cooperatives owned by more than 8,000 commercial banks, thrifts, credit unions and insurers -- took billions of dollars in write-downs on their mortgage securities. Mr. Yingling, the ABA president, says his organization assigned at least four of its roughly dozen Washington lobbyists to meet with members of the House Financial Services Committee.
"Their instructions for the early part of this year were to talk to as many people about 'mark to market' as they can," he says.
In late January, Mr. Yingling says, he met with Rep. Ed Perlmutter, a Colorado Democrat. Mr. Perlmutter said he was "very concerned" about the mark-to-market accounting issue. The ABA sent campaign contributions, ranging from $500 to $5,000, to the 33 committee members. The ABA's political action committee, Mr. Yingling notes, was focusing on dozens of issues in addition to mark-to-market accounting. Rep. Perlmutter received $2,500 from the ABA, according to public filings. He says he believed the accounting rules were causing "a drastic loss in capital that never should have occurred." He says the ABA money "had no influence" on his thinking.
Rep. Frank Lucas, an Oklahoma Republican, also received $2,500 from the ABA, the filings indicate. He says the contributions didn't sway his thinking and that the rules were making it difficult for even healthy banks to weather the downturn. On Feb. 18, FASB said it didn't expect to complete its examination of mark-to-market standards until the end of June. Banks, credit unions, Federal Home Loan Banks and insurance company trade associations launched in late February what they called the "Fair Value Coalition." Its goal was to change the accounting rules. The coalition itself raised no funds, leaving it to its members to make political contributions.
On March 5, Reps. Perlmutter and Lucas introduced legislation to broaden oversight of FASB, putting it under the purview of not only the SEC, but also the Federal Reserve Board, Treasury Department, Federal Deposit Insurance Corp. and the Public Company Accounting Oversight Board. Four days later, the Fair Value Coalition wrote to Rep. Barney Frank, the Massachusetts Democrat who heads the House Financial Services Committee, and to Rep. Spencer Bachus, an Alabama Republican who was an early advocate of changing the rules. The letter, signed by 31 institutions and trade groups, called on Congress to use the hearings to address the "unacceptable" pace of FASB and to "correct the unintended consequences" of mark-to-market accounting.
In an interview, Rep. Frank, who got $8,500 from coalition members in late March, said a "wide range of people concerned about the economy, not just banks, were pushing for this." Rep. Kanjorski scheduled a hearing on the issue for March 12. Bank lobbyists jammed a congressional hearing room. In his opening remarks, Rep. Kanjorski threatened that Congress would get involved if FASB didn't act. Rep. Perlmutter said mark-to-market accounting was "exaggerating and multiplying" the economic slump. "We have been dithering while this patient's been sick," he said. Rep. Gary Ackerman (D., N.Y.) and Rep. Kanjorski pushed Mr. Herz to agree to a speedier timetable. They repeatedly cited Rep. Perlmutter's legislation to broaden oversight of FASB.
"It will be done in three weeks. Can and will," Rep. Ackerman instructed Mr. Herz. "Yes," Mr. Herz replied. "Can and will," Rep. Ackerman repeated. Rep. Ackerman declined to comment through a spokesman.
A FASB director, Lawrence Smith, said at the time that FASB had little choice but to act. "We can't ignore what's going on around us," he said. On April 2, FASB introduced the changes that lawmakers sought. In a draft proposal, FASB changed its rules to say that financial firms could "presume" markets were dysfunctional unless there was ample evidence otherwise. Then they could use internal models to set values, rather than market prices. Their models are not fully disclosed to investors.
But many investor groups opposed the changes. In the final proposal, FASB deleted the word "presume." It was a modest setback for the industry: Financial firms couldn't use internal pricing models to value assets unless a series of conditions existed indicating that markets were dysfunctional. Still, many saw the new rules as a watering down of standards. That triggered a backlash within FASB. At a meeting of a FASB advisory group in New York on April 28, three of its members threatened to resign in protest, concerned that FASB had jeopardized its credibility.
Lynn Turner, the SEC's former chief accountant and a former FASB member, was one of them. He says he doesn't think the banking industry will be satisfied until mark-to-market accounting is dismantled completely. "Despite efforts by FASB to give ground to the banks, enough is never enough," he says. Now, the Fair Value Coalition is gearing up to take on mark-to-market accounting again. On April 27, a member of the House subcommittee sent a letter to Rep. Frank calling for another hearing to revisit the issue. A FASB spokesman says the group is continuing to look at the issue.
click to see who's who
Bank pays staff to take five years off
Employees of BBVA, Spain's second biggest bank, are being offered 30 per cent of their usual salary in return for staying away from work for between three and five years. Anyone signing up to the scheme is guaranteed a job when their extended leave comes to an end. They will also have their health care costs covered for the length of their sabbatical. The offer is targeted at long-term employees of the company who have "personal or professional projects" they wish to undertake during their time off. Juan Ignacio Apoita, BBVA's head of human resources, told the Financial Times: "We're looking at offering alternatives to people. It's obvious as well that it has an impact on costs."
Other options open to the bank's 30,000 Spanish employees include a shorter working week on reduced pay, or time off arrangements to allow staff to look after relatives or go back in to education. Although Spanish banks have escaped the worst of the global downturn because of tight regulation, they have found it difficult to impose redundancies because staff are entitled to large payoffs under domestic labour laws. In Britain, manufacturing workers at firms including Jaguar Land Rover have agreed to accept four-day-weeks and temporary factory shutdowns in an attempt to minimise job cuts and keep their employers afloat.
'Catch 22' Wage Deflation Threatens Debt-Laden Spain as Unemployment Soars
Spanish workers are finding that the cure for a decade-long borrowing binge may just make things worse.As Spain sinks deeper into recession and the jobless rate heads for 20 percent, the highest in Europe, employers are telling workers to accept wage cuts if they want to stay competitive. That’s making it harder for households to tackle a debt load built up during the country’s economic boom and equivalent to 18,000 euros ($25,700) per person.
"There’s a Catch-22 problem for Spain," said Dominic Bryant, an economist at BNP Paribas SA in London, referring to the 1961 novel by Joseph Heller that highlights a no-win situation faced by a World War II pilot trying to avoid duty. "The solution for the competitiveness problem makes their debt problem worse. By squeezing wages you weaken the domestic economy further." Annual growth of almost 4 percent over a decade turned Spain into an engine of Europe’s economy, boosting pay and prices as a building boom encouraged households to rack up 800 billion euros in debt. More than a year into a housing slump that helped spark the worst recession in six decades, the challenge is to trim labor costs and pay back loans without hobbling the country’s route to recovery.
For Patricio Zuniga, a 40 year-old builder in Madrid, that’s looking difficult after a 50 percent wage cut since the peak of the boom in 2007. "We only just make it to the end of the month and we’ve already run through our savings," said Zuniga, whose mortgage burden is now 80 percent of his family’s income. "They say: ‘If you like it you can take it and if not, well, that’s it.’" BNP’s Bryant doesn’t expect domestic demand to grow until the second half of 2011.
At 70 percent of gross domestic product last year, Spain’s mortgage and consumer credit burden is the largest of the euro region’s major economies and compares with 45 percent for the bloc as a whole, European Central Bank data shows. Spain is also one of the countries threatened most by deflation. Consumer prices fell annually in March for the first time since 1952 and dropped 0.8 percent in May. The rate for the bloc as a whole was zero.
"Deflation raises the size of your debt," said Gayle Allard, vice rector at Madrid’s Instituto de Empresa business school. "It’s hard to think of a worse combination of factors than you’ve got here." While influential unions are still managing to win pay raises, that may change as unemployment surges. Companies’ wages grew 3.5 percent in March on the year. In the same month, workers at Seat, a unit of Volkswagen AG, agreed to a salary freeze to convince management to manufacture its Q3 vehicle in Spain.
ArcelorMittal, the world’s largest steelmaker, will temporarily lay off 11,964 workers in Spain until the end of the year, the MCA-UGT union said today. "When the downturn starts to affect those represented by the unions, that’s when they tend to become more sensitive to what’s going on in the economy," said Gregorio Izquierdo, head of research at Madrid’s Institute of Economic Studies. Temporary workers are already seeing pay cuts. At 29 percent, Spain had twice as much temporary employment as the average in the 27-member European Union last year and the highest in the bloc, according to the EU’s statistics office.
For many workers, lower wages are wiping out the benefits of the ECB’s interest-rate cuts since the economic crisis intensified last year. "You can imagine how worried I am," said Pedro Sanchez Abellan, 30, in Madrid. He took a 25 percent salary reduction this year in a temporary job installing security systems, to earn 900 euros per month, making it harder to pay off a 3,000- euro loan. Spain’s slump has seen a series of companies including property developer Martinsa-Fadesa SA shed workers as they seek protection from creditors.
Shares have dropped. Second-largest lender Banco Bilbao Vizcaya Argentaria SA and third-largest builder Fomento de Construcciones & Contratas SA have both fallen more than 40 percent since the end of 2007. Spain’s services industry contracted more sharply in May than the previous month, as an index based on a survey of purchasing managers by Markit Economics fell to 39.1 from 42.3 in April. Falling wages would squeeze public finances. With the European Commission forecasting a deficit at 9 percent of GDP this year, investors are charging more to hold Spanish debt. The extra interest demanded over German bunds is more than triple what it was last year.
"If there’s negative wage growth, that implies income tax receipts are going to be falling, and so other things being equal it becomes more costly to repay its existing debt," said Ben May, an economist at Capital Economics in London. One of Spain’s most pressing problems is that it has become less competitive since the euro was created in 1999, with Commerzbank AG estimating based on labor costs that it has become 10 percent more expensive relative to the rest of the currency bloc.
"The only way for Spain to recover the lost competitiveness of the last 10 years will be for a sustained drop in prices and wages," said Luis Garicano, a professor at the London School of Economics. That means debt burdens will keep rising for workers such as Zuniga, the builder. His 1,680-euro monthly mortgage payment eats up most of the combined 2,000 euros he and his wife earn. "The mortgage is only three years old, we’ve got 30 years left to go," he said.
Kroes hits at 'obsolete' German banking system
Neelie Kroes, the European Union’s competition commissioner, has made her strongest and most explicit call to date for restructuring the German banking system. In an interview with a German newspaper published on Wednesday, Ms Kroes said that she believed that Germany’s "three-pillar" system of commercial banks, co-operative banks and savings banks was obsolete. "It does not at all encompass the role that Germany plays and should play. Europe urgently needs a Germany that is in good form again," she said. Asked what measures Germany should take, Ms Kroes replied that it should "concentrate on market structures".
Taxpayers, whose money has been used to help bail out banks during the financial crisis, would not be content with the status quo, she suggested. The commissioner’s latest remarks follow repeated comments and speeches over recent weeks in which she has stressed the general need for ailing banks which have received large amount of government aid to restructure. Last month, for example, she said that many banks would have to redefine their business models. "For many that will mean a greater focus on retail banking," she said, adding that they might also be obliged to cut back cross-border operations and focus on domestic markets.
This view is controversial: some critics, including Axel Weber, head of Germany’s Bundesbank, have argued that such changes will frustrate the goal of a pan-European banking market. In a more specifically German context, Ms Kroes has also previously called for a "profound restructuring" of the country’s regionally-owned banks, known as the Landesbanken. Problems were evident there well before the financial crisis and in May, the European Commission finally approved a restructuring plan for WestLB which will see the bank halve its asset base and change its ownership structure. It is also looking into aid given to BayernLB.
"These particular cases… illustrate the need for a profound restructuring in the sector… Potentially this will contribute to a consolidation among the Landesbanken," Ms Kroes said at the time. In her latest interview with the Süddeutsche Zeitung paper, Ms Kroes described the German banking system as "completely different" to that in France, Italy or the UK. She acknowledged that her views and decisions had frequently been questioned by Peer Steinbrueck, Germany’s finance minister but said: "We work toughly, but openly together. And constructively. Germany are no weaklings. Neither are we. But you know, I don’t like having to deal with softies."
Fight Erupts in Berlin over State Aid for Private Firms
Even as Chancellor Angela Merkel's government continues to pat itself on the back for saving Opel from bankruptcy, economic experts are slamming the deal as a departure from the market economy. The fight is emerging as a major issue in the run-up to September's federal election. Germany's Social Democrats have been in overdrive lately. In addition to presenting themselves as the saviors of struggling private sector giants, they've also been trying to anchor their savior status in a campaign platform ahead of September's general election. According to the financial daily Handelsblatt, the center-left party wants to establish clear guidelines for when the state can help a private company.
State money, the party's draft platform reads, can only be used when the company's business plan is "sustainable" and "future oriented." Or, the party could add, when it becomes politically convenient to do so. That, at least, seems to have been the rationale behind Foreign Minister (and SPD candidate for the Chancellery) Frank-Walter Steinmeier's February promise to Opel workers that he would do all he could to save the company. The party repeated the strategy over the weekend, with an eye toward propping up the wobbly department store chain Karstadt and its parent company Arcandor. "We want to show that we don't just save industrial jobs, but also in the service sector and jobs for women," party head Franz Müntefering told the paper Tagesspiegel am Sonntag.
But with critique against state aid for private companies now mounting in Germany, the SPD may soon be forced to change its tune. "I am growing concerned that we are taking giant strides away from elementary principles of the market economy and I don't know if it can be reversed after the general elections," Justus Haucap, head of Germany's Monopolies Commission, wrote in a contribution for Handelsblatt. Haucaup was seconded by Wolfgang Franz, a member of the German Council of Economic Experts, which advises Berlin on economic questions. "Following the state measures for Opel, the danger of a flood of further state interventions is very large, especially given the approaching campaign," Franz told the newspaper. Addressing Arcandor's difficulties, he said: "The Karstadt problems have absolutely nothing to do with the current recession.
They began well before that." Further accusations of political meddling came from Martin Kannegiesser, head of Gesamtmetall, a union representing the metalworking and electrical industry. "It seems that the economy is becoming politicized," he said in the Tuesday edition of the Berliner Zeitung. "The Opel solution is a sin resulting from political opportunism." The salvo from leading economics experts echoes a bitter battle currently being waged within Chancellor Angela Merkel's governing coalition. Despite having managed to come up with a plan to save the German carmaker Opel from following its parent company General Motors into bankruptcy, not everyone in the Berlin cabinet is pleased with the deal.
Indeed, Economics Minister Karl-Theodor von Guttenberg -- a member of the Christian Social Union, which is the Bavarian sister party to Merkel's Christian Democratic Union -- argued until the very last minute in favor of initiating bankruptcy proceedings for Opel. Reports in the German press indicate that he only backed down after Merkel made her position clear. The government ultimately agreed to making €1.5 billion ($2.12 billion) in bridge financing available to Opel, while opting to accept an offer by the Canadian auto parts company Magna in conjunction with the Russian bank Sberbank to take a controlling stake. Now, Guttenberg finds himself as the favorite target of attacks from the SPD.
Deputy SPD floor leader Joachim Poss accused Guttenberg on Tuesday of "idiotic blathering about insolvency" and said "once the government weighs the risks, an economics minister has to either support the solution decided upon, or reject it and draw the appropriate consequences." Some have interpreted Poss' statement as an invitation for Guttenberg to resign. Chancellor candidate Steinmeier also blasted Guttenberg on Tuesday saying "I expect him, as economics minister, to ensure that the further process runs without difficulties." Finance Minister Peer Steinbrück, likewise a member of the SPD, said that he was "somewhat annoyed" by Guttenberg.
The dispute only promises to get worse in the coming weeks. Arcandor, which owns the nation-wide department store chain Karstadt in addition to the travel industry giant Thomas Cook, has requested loan guarantees worth €650 million ($920 million) in addition to a €200 million loan from the state-owned development bank KfW. In theory, the money is there for the taking. Back in February, the German government approved a €40 billion fund for ailing companies as part of the country's second economic stimulus package. But the fund was established to help those firms that were economically healthy prior to the financial crisis. The cut-off date is July 2008. Both Opel and Arcandor began their slides well before that date, a fact which has turned both companies into a political issue.
Indeed, even as Guttenberg appeared to sacrifice cabinet discipline for ideology during the Opel debate, he may ultimately emerge as the one participant who strove to protect German taxpayer money from political expedience. On Tuesday, he told the daily Passauer Neue Presse that "the pledges of help that were given (by Steinmeier to Opel) definitely undermined the company's negotiating position." Guttenberg is equally skeptical of efforts to save Arcandor, though he has ordered a committee to take a close look at the possibility. And the SPD? Hans Eichel, a senior SPD politician and former finance minister under Chancellor Gerhard Schröder, warned against a competition among politicians when it comes to saving German firms. "The resources limit the number of lifelines," he said.
GM, GMAC Bank Join the Zombie Dance Party
As we told subscribers to the IRA Advisory Service last week, in Q1 2009 Citigroup (NYSE:C) and other large banks evidenced improvements in ROE, Efficiency and Exposure thanks to the generous subsidies being provided by the US government from several sources:
1) Government subsidized TARP capital injections,
2) Below-market loans via repurchase transactions with the Federal Reserve Banks,
3) Below-market funding via FDIC guarantees on debt, and
4) Subsidies for Bear, Stearns, AIG and other credit default swap ("CDS") counterparties of the large banks.
Subscribers to the consumer or professional versions of the IRA Bank Monitor may view the Q1 2009 profiles for all US banks. We'll be talking more about zombie banks later this week in an interview with Professor Ed Kane of Boston College. As we discussed with Dr. Kane and also with our friend Josh Rosner last week, without the bailouts of Bear, AIG and the work-around of many other CDS counterparties, the capital of JPMorganChase (NYSE:JPM) would have evaporated several times over as CDS contracts were triggered. But given that the big news today is the bankruptcy of General Motors (NYSE:GM), we thought it would be useful to take a look at GMAC and its FDIC-insured bank unit, GMAC Bank, now known as "Ally."
Most of the readers of The IRA are aware that GMAC, the financing arm of GM, is insolvent. At the behest of President Barrack Obama and the Democratic leadership in the Congress, the US Treasury and the Federal Reserve Board have taken extraordinary and, we believe, illegal actions to keep GMAC afloat.
The reason is simple: without GMAC, GM cannot finance car sales and has little chance of emerging from bankruptcy. And without GM and its parts suppliers, the Democrats will begin to lose millions of voters in heartland rust belt states where the legacy automakers are located as workers migrate south looking for jobs. For the Democrats, slowing the liquidation of the UAW beyond the 2012 general election is "job one."
So let's examine Ally, f/k/a GMAC Bank (FDIC Cert# 57803). As of Q1 2009, Ally was rated "F" by the IRA Bank Monitor, due to severe degradation in ROE. The Stress Index score for Ally was 21.2 driven by a score of 100 for the ROE subindex. Like the larger zombie banks, the other Stress Index factors for GMAC Bank/Ally for loan defaults, capital, lending capacity and efficiency are all currently below the industry averages (and indeed, below the 1995 benchmark levels of stress). But these "improved" measures are, in our view, a mirage created by the fact of government subsidies.
Without the billions of dollars in public funds already injected into GMAC Bank/Ally's parent, the bank arguably would already be in the hands of the FDIC. More, when you examine the profile for GMAC Bank/Ally on The IRA Bank Monitor (the legal name had not been changed at the end of Q1, so search for "GMAC"), here are some of the factors that jump out and bite you in the face:
** First, Ally has non-performing loans equal to almost 6% of loans and leases. Subtract those from the bank level TCE and you get closer to the cash reality of Ally's capital base, which puts it into the regulatory category of "undercapitalized."
** Second, while Ally's deposit base appears to be stable, due in large part to the above-market rates being offered in TV and print media across the country, one quarter of the bank's assets are funded off the FHLBs -- well above the regulatory limit of 15% established by regulators as "unsafe and unsound." The percentage has come down from 30% several quarter back, but is still too high. In The IRA Bank Monitor, banks with > 15% FHLB advances trigger a moral hazard flag.
** Third, the moral hazard of GMAC Bank is clearly illustrated by the fact that the bank has apparently decided to double down at the derivative roulette table. As of Q1 2009, OBS derivatives positions reported by the $30 billion asset GMAC Bank/Ally to the FDIC jumped from $13.3 billion at the end of Q4 2008 to over $40 billion as of Q1 2009. This dramatic increase in OBS derivatives positions NOT FOR TRADE suggests that GMAC is trying to hit a home run and thereby salvage their position.
But the real issue to us is why is this marginal lenders being allowed to compete with solvent, well-run banking institutions? The answer obviously is the same politics behind the GM bailout. Give the recent decision by the FDIC to limit the interest rates offered on deposits by institutions that are less than well capitalized, we wonder: When is the OTS and the FDIC going to restrict the full-page advertisements by GMAC Bank/Ally that were running in newspapers around the US offering rates that are nearly 1.5% above the rates offered by sound institutions?
As in the case of Ford Motor (NYSE:F) competing with the two auto GSEs, Chrysler and GM, well-managed banks in the US now have to compete with an irrational, GSE bank in the form of GMAC Bank/Ally whose only apparent objective is to raise enough cash today to survive until the next bailout from the US Treasury. If you believe the statements by the Obama Administration that $30 billion will be the limit of US government assistance to GM, then you should feel less than confident in keeping your money in GMAC Bank/Ally.
Iceland turns from the devil to the deep blue sea
In the bright, white late afternoon sunshine, crates of bloody haddock and cod are being piled up in harbour at Grindavik, a fishing town near Reykjavik. With the banking fairytale over, Iceland is once again relying on the sea for its prosperity. "We didn't send the Icelandic ship down but now they are counting on us," says Birgir Hermannsson, first mate on the Duddi Gisla, as he unloads the day's catch. The broken nation is regrouping around its traditional fishing industry, which accounted for more than a third of Icelandic exports last year.
But it is not just the icy waters of the northern Atlantic and falling fish prices (down 40% in some markets) the crew of the Duddi Gisla is worried about. The spring election ushered in a coalition government threatening not only to change the decades-old way the country manages its fishing rights but also seek a mandate to join the European Union. Hermannsson admits to being concerned: "The price of cod has gone down. Fishermen are scared joining the EU means the fishing grounds will be controlled from Brussels."
Ceding control of its fishing rights will be hard for a small but proud island nation to accept but it should also worry all fish eaters. The common fisheries policy has not set a good example, with recent European commission figures stating that nearly 90% of Europe's species are being pulled out of the water at unsustainable rates. Britain's biggest fish supplier, Iceland is widely respected for a sustainable approach that has resulted in an abundant supply of haddock and cod. Fishing companies own a percentage of the total catch, a figure set each year by scientists.
It is one of just a handful of countries that meets the sustainability criteria Waitrose uses when buying the fish for its stores. The retailer stopped sourcing cod and haddock from the North Sea in 1999 because of concerns over future stocks. Waitrose fish buyer Quentin Clark says the collapse in fish stocks is a disaster of the same order as climate change: "It's a no-brainer that we should be supporting sustainable fishing in countries like Iceland where quotas are set on a biological rather than political basis."
Like Iceland's homeowners, its fishing companies are also heavily in debt after investing in the now collapsed domestic banking sector. Insiders describe how company executives were seduced on glamorous junkets, being flown by private jet to La Scala in Milan or Old Trafford, depending on the passion of choice. But those days are long gone. The industry's debt is estimated to be 400-500bn kronur (£2-2.25bn). Fridrik Arngrímsson, managing director of the Federation of Icelandic Fishing Vessel Owners, says many companies have already been hit by weak demand from important markets such as northern Spain, where recession has suppressed the appetite for salt cod.
"The price of our products has fallen," says Arngrímsson, who says the combination of debt and quota cuts next year could cause some companies to collapse. "Many companies bought quota for a high price – in some cases too high a price. There was a bubble there also." The government has made waves by suggesting reforms that range from tinkering to taking all the fishing rights back and letting companies rent quota from the state. Critics argue the under?lying agenda is job creation – the official unemployment rate is 9% with more job losses expected as the hobbled banking sector shrinks further.
Minister of fisheries and agriculture Jón Bjarnason won't be drawn on why reform is necessary but says: "You have to look at man-made systems and decide whether they are suitable or could be done better. The fisheries and agriculture have always been very important for Iceland but these resources were put to the back when everybody thought they could make money selling shares. We have to look at how we can secure jobs as well as make sure we use the resource in a sustainable way. "Do you think we will establish the banks in the same way? No. We need to create jobs and use our resource to establish our society again."
Former prime minister Thorsteinn Pálsson, who was fisheries minister when the current system was introduced, says the changes proposed are "dangerous. We can't afford to run our fisheries on the basis of social welfare. It is impossible to create jobs in an industry that is based on a limited resource. Those who say we can increase employment by allowing people to buy vessels and go to sea are wrong: it will lead to over-fishing and a bad economy. "We have to manage our fisheries on an economically sound basis so we can create growth and invest in other sectors. That is the only way forward for Iceland."
Unlike Bjarnason, whose Left Green party is opposed to EU membership, Pálsson is a fan: "Most of the opposition to EU membership is based on a view of the fish industry because they are afraid of the new environment and that is understandable. We have to secure the interests of the Icelandic fisheries in the membership negotiations and I believe we can. I think that other member countries will understand how important the fisheries are for Iceland especially after the collapse of the bank system."
The mood music from Brussels has been positive lately with Joe Borg, European commissioner for fisheries and maritime affairs, seeking Icelandic input in his review of the common fisheries policy, which he has admitted has been a failure. But the domestic storm over how Iceland manages its fisheries is not expected to go away this year amid predictions that the country's GDP will shrink by up to 10%. So after a disastrous five-year love affair with high finance, fish is once again the island's currency: the big ?question is whether Iceland can have its fish and eat it.
Rising government bond rates prove policy works
by Martin Wolf
Is the US (and a number of other high-income countries) on the road to fiscal Armageddon? Are recent jumps in government bond rates proof that investors are worried about fiscal prospects? My answers to these questions are: No and No. This does not mean there is no reason for worry. It is rather that there are powerful arguments against fiscal retrenchment right now and strong reasons for welcoming recent moves in the bond markets. Last week, the Financial Times carried two columns arguing that the US fiscal path was unsustainable, one by Stanford University’s John Taylor and the other by the Harvard historian Niall Ferguson. The latter, in turn, was a comment on a debate with, among others, the New York Times columnist and Nobel laureate Paul Krugman at the end of April. On one point all serious analysts agree: public debt cannot rise, relative to gross domestic product, without limit. To embark on fiscal stimulus in the short run, one must be credible in the long run.
So what is the disagreement? Prof Ferguson made three propositions: first, the recent rise in US government bond rates shows that the bond market is "quailing" before the government’s huge issuance; second, huge fiscal deficits are both unnecessary and counterproductive; and, finally, there is reason to fear an inflationary outcome. These are widely held views. Are they right? The first point is, on the evidence, wrong. The jump in bond rates is a desirable normalisation after a panic. Investors rushed into the dollar and government bonds. Now they are rushing out again. Welcome to the giddy world of financial markets. At the end of December 2008, US 10-year Treasury yields fell to the frighteningly low level of 2.1 per cent from close to 4 per cent in October (see chart).
Partly as a result of this fall and partly because of a surprising rise in the yield on inflation-protected bonds (Tips), implied expected inflation reached a low of close to zero. The deflation scare had become all too real. What has happened is a sudden return to normality: after some turmoil, the yield on conventional US government bonds closed at 3.5 per cent last week, while the yield on Tips fell to 1.9 per cent. So expected inflation went to a level in keeping with Federal Reserve objectives, at close to 1.6 per cent. Much the same has happened in the UK, with a rise in expected inflation from a low of 1.3 per cent in March to 2.3 per cent. Fear of deflationary meltdown has gone. Hurrah!
It is true that spreads between conventional US bonds and bonds issued by Germany and the UK have narrowed (see chart). But US yields were extraordinarily depressed during the panic. Normality returns. If inflation expectations are not worth worrying about, so far, what about the other concern caused by huge bond issuance: crowding out of private borrowers? This would show itself in rising real interest rates. Again, the evidence is overwhelmingly to the contrary. The most recent yield on Tips is below 2 per cent, while that on UK index-linked securities is close to 1 per cent. Meanwhile, as confidence has grown, spreads between corporate bonds and Treasuries have fallen (see chart).
One can also use estimates of expected inflation derived from government bonds to estimate real rates of interest on corporate bonds. These have also fallen sharply (see chart). While riskier bonds are yielding more than they were two years ago, they are yielding far less than in late 2008. This, too, is very good news indeed. Now turn to the fiscal policy. The argument advanced by opponents is either that fiscal policy is always unnecessary and ineffective or, as Prof Ferguson suggests, redundant, because this is not a "Great Depression". Monetarists argue fiscal policy is always unnecessary, since monetary expansion does the trick. Economists who believe in "Ricardian equivalence" – after the early-19th-century economist David Ricardo – argue fiscal policy is ineffective, because households will offset any government dis-saving with their own higher savings.
Economists disagree fiercely on these points. My approach is "Keynesian": in extreme moments, the excess of desired savings over investment soars. Again, monetary policy, while important, becomes less effective when interest rates are zero. It is then wise to wear both monetary belt and fiscal braces. A deep recession proves there is a huge rise in excess desired savings at full employment, as Prof Krugman argues. At present, therefore, fiscal deficits are not crowding the private sector out. They are crowding it in, instead, by supporting demand, which sustains jobs and profits. Prof Ferguson argues that fiscal expansion was unnecessary because this is only a mild recession. The question, however, is why it is only a mild recession, since precursors of a depression were surely present.
The answer, in part, is the aggressive monetary policies of central banks and the rescue of the financial system. But is that all? What would have happened if governments had decided to cut spending and raise taxes? One might disagree on how much deliberate fiscal loosening was needed. But one of the most important reasons this is not the Great Depression is that we have learnt a lesson from experience then, and in Japan in the 1990s: do not tighten fiscal policy too soon. Moreover, historically well-run economies are certainly able to support higher levels of public indebtedness very comfortably.
This, then, brings us to the last concern: the fear of inflation. This is essentially the question of how to exit from current extreme policies. People need to believe that the extraordinarily aggressive monetary and fiscal policies of today will be reversed. If they do not believe this, there could well be a big upsurge in inflationary expectations long before the world economy has recovered. If that were to happen, policymakers would be caught in a painful squeeze and the world might indeed end up in 1970s-style stagflation. The exceptional policies used to deal with extreme circumstances are working. Now, as a result, policymakers are walking a tightrope: on one side are premature withdrawal and a return to deep recession; on the other side are soaring inflationary expectations and stagflation. It is irresponsible to insist either on immediate tightening or on persistently loose policies. Both the US and the UK now risk the latter. But their critics risk making an equal and opposite mistake. The answer is both clear and tricky: choose sharp tightening, but not yet.
UK, Ireland Resist Push for More Financial Regulation
The European Union is split over how best to apply the lessons of the global downturn to the regulation of financial markets. Countries like Germany want tighter controls on risky deals and exotic securities, but the UK, Ireland and parts of Eastern Europe are fighting for free markets. Peer Steinbrück's face always darkens when he is asked how much more taxpayers' money he will need to bail out the banks. "I don't know," says the German finance minister. "I won't know until after the fact."
And when he is asked how he feels, late in the evening after a cabinet meeting in Berlin or a meeting of European Union finance ministers in Brussels, Steinbrück sometimes grumbles in response: "Lousy!" Europe's finance ministers are not in an enviable position these days. Washington is constantly putting pressure on them to inject additional billions into the economy. Meanwhile Brussels threatens to take them to court for incurring too much government debt. And in times of so much uncertainty, they are also expected to provide answers to the big questions on everyone's mind: How can we jump-start the economy without completely destroying government budgets? Can banks be relieved of their toxic assets without unloading all the risk onto the shoulders of taxpayers?
In addition, the 27 EU finance ministers have been given a special task to complete for their respective leaders. At their last meeting in March, the heads of state and government of the EU countries charged the European Commission in Brussels and their finance ministers with investigating new regulatory options. At their next summit in June, "the European Council will take first decisions (sic) to strengthen EU financial sector regulation and supervision," as it is phrased in Brussels bureaucratese. The G-20 summit of the world's leading heads of state and government also vowed to proceed in the same direction. But what happens to the summit visions when attempts are made to put the lofty ideas into practice?
There has admittedly been some progress. The European Commission has made some preliminary proposals and the parliament has passed a law under which the amount that one bank can lend to another will be limited in future to 25 percent of the bank's own capital. And banks will be required to retain at least 5 percent of any high-risk securities that they sell. But that was the extent of it, at least for the time being. Moreover, it is highly unlikely that further concrete measures will follow the politicians' bold announcements.
There is a crack running straight through the EU, says Werner Langen, a member of the European Parliament for Germany's conservative Christian Democratic Union. Sources close to the EU's finance ministers have expressed similar sentiments, saying that the traditional, continental core of Europe is once more facing off against the British, the Irish and some of the organization's new Eastern European members. London and Dublin, in particular, are blocking anything that could create problems in their respective financial industries. This is understandable, given the fact that Great Britain and Ireland have very few other future-proof industrial sectors. But this path is immensely dangerous for Europe.
"We have absolutely no risk management today," says David Wright, deputy director general of the European Commission. According to Wright, there were no warning signals before the financial meltdown because "the necessary mechanisms simply do not exist." Wright believes that it is high time for change. Almost everyone agrees, at least in theory. Even Britain's Prime Minister Gordon Brown had come out clearly in favor of "a strong step in the direction of regulation" at the meeting of EU leaders, a satisfied Chancellor Angela Merkel said after the March summit. "Complex products like banking derivatives which were supposed to disperse risk around the world have instead spread contagion," Brown said in a speech at the European Parliament in Strasbourg in March, where he called for the creation of "global standards" to respond to "global problems."
But in expressing these sentiments, Brown apparently neglected to inform his own ministers, undersecretaries and officials of his change of course. They continue to block the creation of substantial regulations for financial institutions at the negotiations in Brussels. All the same, the majority of EU members seem determined to reestablish, as far as possible, political control over markets that have become widely deregulated. Specifically, they want:
- stricter equity capital regulations for banks, the goal being to prevent excessively risky transactions;
- a registration requirement for large hedge funds which would also cover their debt-financed leveraged transactions;
- guidelines for salaries and bonus payments in the financial industry, which would be tied to long-term corporate results;
- a licensing requirement for rating agencies, which would no longer be allowed to provide consulting services to the same customers they rate;
- Europe-wide control of financial market players and common regulatory requirements.
For some, these proposals are much too far-reaching, while for others they do not go far enough. Poul Nyrup Rasmussen, president of the Party of European Socialists, is critical of the Commission's draft law and describes it as having "more holes than a Swiss cheese." Martin Schulz, chairman of the Socialist group in the European Parliament, wants to see a "greater unbundling" of executive compensation and bank profits. A simple "recommendation" on the regulation of executive compensation is worthless, says Christian Democratic European Parliament member Klaus-Heiner Lehne. What is needed, according to Lehne, is a real law or -- in EU jargon -- guideline. A similar recommendation, says Lehne, has been in place since 2004, but "only one member state has observed it." Christine Lagarde, France's conservative finance minister, also believes that the proposals are "not enough," and she even sees dangerous gaps. For instance, she says, Brussels wants to allow investment funds which are certified in other regions of the world to be sold in the EU without further examination. Lagarde fears that such funds could prove to be a "Trojan horse" for intruders from tax havens and would "open the door to funds from the Cayman Islands."
The British, in particular, take a completely different view of things. On Feb. 22, during a preparatory meeting in Berlin ahead of the G-20 summit, the British negotiator warned his counterparts against excessively extensive regulatory plans. "We should be careful that we do not create problems for the future," he said. The defenders of Britain's investment funds are indeed making sure that the gentlemen in London's City will not be asked to endure too much regulation. They threaten that if regulation becomes too strict, they will move to other markets in Asia or the United States. Meanwhile the British press has been drumming up support for the industry. Even Stuart Fraser, the head of the Policy and Resources Committee of the City of London, warns that tighter EU regulation "would drive the whole industry overseas." Antonio Borges, chairman of the Hedge Fund Standards Board, told the Daily Telegraph that the proposed regulations are "a blatant attack on the UK and US financial systems by Continental countries that neither have a tradition of alternative investments nor a proper understanding of them."
Such views are applauded in Europe's new east, where many politicians identify ideologically with the British-Irish position, even though they have no banking centers of their own to protect. Some believe that unregulated growth is more useful in economic terms than the German-style security-focused model. Many of them came of age in communist planned economies and later studied the free market approach at US universities. The resistance coming from both the west and the east has already produced results. For one, a powerful European regulatory authority is unlikely to emerge in the future; regulation will remain in the hands of national authorities. The only remaining bone of contention will probably be the extent to which national regulators should cooperate with each other, and under which rules they should assess risk and, if necessary, intervene in the market.
Germany's central bank, the Bundesbank, also supported London's rejection of the idea of an EU-wide authority -- partly in an effort to protect its own turf. "Only the leaders themselves" can now ensure that the June summit will yield more than just "insubstantial chapter headings," says one of the summit's Brussels organizers, noting that French President Nicolas Sarkozy would secretly like to present himself as a "great regulator." German Chancellor Angela Merkel, in the midst of an election campaign, will hardly be willing to stand on the sidelines, says the Brussels official, and Gordon Brown has gone too far in his rhetoric to be able to block everything. Many experts doubt whether all of this will be enough to make sure the right lessons for the future are drawn from the crisis.
"We have no understanding at all of the macroeconomic effect of microeconomic processes in these markets," says Carsten Pillath, the general director of the General Secretariat of the Council of the European Union. "A market regulator needs tried-and-tested models in order to evaluate what is happening there. But such models don't exist." Before coming to the EU, Pillath worked in the Finance Ministry and Chancellery in Berlin. The lessons learned from past debacles "did not make us immune to the current crisis," he says. And the next crisis, which will presumably take a completely different course again? "We will enter that," he says, "with the same lack of knowledge."
Fiscal options for the UK: sovereign insolvency, inflation or serious fiscal pain
by Willem Buiter
Standard and Poor’s on Thursday, May 21 2009, issued the following statement: "Standard and Poor’s has revised the outlook on the United Kingdom to negative from stable. — The AAA’ long-term and A-1+’ short-term sovereign credit ratings were affirmed. — The outlook revision is based on our view that, even factoring in further fiscal tightening, the U.K.’s net general government debt burden may approach 100% of GDP and remain near that level in the medium term. " Is this good news for the UK or bad news? Both the UK’s long-term sovereign credit rating (reflecting the probability of sovereign default in the medium and long term) and its short-term sovereign credit rating (reflecting the probability of sovereign default during the next year) remain at the highest possible levels, AAA and A-1+ respectively. However, the negative outlook is bad, even if it is not bad news. Based on past behaviour, there is a one-in-three chance of a sovereign moving from a negative outlook to a one-notch downgrade.
The fact that one of the three leading credit agencies is publicly hinting at less than complete confidence in the solvency of the British sovereign is not in and of itself terribly significant any longer. Following their incompetent and deeply conflicted performance in rating structured products, the credibility of the rating agencies is badly impaired even in those domains - sovereign debt and the debt of large corporates - where they have not made complete asses of themselves. Even though the credibility and reputation of the rating agencies is in tatters, the fact that they have not yet been written out of the regulations and rule books governing the investment behaviour of many institutional investors means that a downgrade would still affect market demand for UK sovereign debt. This will probably raise the funding cost of the UK sovereign somewhat.
But even without the input from the rating agencies, it would have been clear that the UK is about to exit its AAA status. It shares this fate with most of the other G7 countries. In two or three years, Canada may be the only G7 country left to have an AAA rating. France could conceivably join Canada. There is nothing too shocking about this. Not that long ago, Japan’s sovereign rating was on a par with Botswana’s (I thought that was rather unfair on Botswana). I will expand on the case of the UK in what follows, saving a more detailed consideration of the US fiscal predicament (which is much worse than that of the UK) for a future post. Sovereign debt is serviced out of future primary (non-interest) general government budget surpluses.
More interestingly, non-monetary sovereign debt held outside the central bank is serviced out of the future primary budget surpluses of the consolidated general government and central bank and out of the future revenues from new base money creation (seigniorage) by the central bank. I’ll refer to the non-monetary debt of the consolidated general government and central bank as state debt. Think of the state as the consolidated UK Treasury and Bank of England in the UK and as the consolidated US Federal Treasury and the Fed in the US. State and local debt and budget deficits in the US either are a side show or are taken over by the Federal government if push comes to shove (watch California externalise its state debt during the coming months). UK state debt is expected to rise from just over 50 percent of annual GDP today to over 100 percent of GDP in four or five years time. With deficits of 12 percent of GDP or higher very likely during the next couple of years, there needs to be a decent recovery by the end of the 2010 for the debt burden not to rise even faster.
Net interest payments on the public debt (currently a low 1.83 percent of GDP - an average effective interest rate of 3.6 percent) will double even if interest rates remain at their extremely low current levels, something I consider unlikely. During the decade preceding the crisis, tax revenues were flattered increasingly by the unsustainable housing boom and the profit and income explosion in the financial sector. Such easy revenue pickings are unlikely to be forthcoming in the future, even if the economy recovers as hoped by all and expected by a few. It is likely that the path of potential output in the UK will turn out to be lower because of the crisis. The UK Treasury estimates that a combination of a permanently higher cost of capital and a reduction in the effective supply of labour (due to lower net immigration and hysteresis’ effects from higher unemployment) will knock five percent off the level of the path of potential output.
Let’s assume that (non-monetary) state debt-to-GDP ratio in the UK doubles over the next 4 or 5 years and that the path of potential output is five percentage point below its old level, even if the growth rate of potential output is not permanently affected. What will the higher debt-to-GDP ratio do to the average effective interest rate paid on the public debt? Obviously it will rise. The real rate of return required on the public debt will rise because sovereign default risk is higher when the debt to GDP ratio is 100 percent than when it is 50 percent. There is also a risk of higher inflation if the government decides that rather than defaulting outright and formally on its debt, it prefers to reduce the real value of its nominal debt through higher inflation. An unanticipated increase in inflation will permit a de-facto amortisation of the debt in real terms, even if we allow for the effect of inflation expectations on nominal interest rates for newly issued debt.
The longer the maturity of the outstanding fixed-rate nominal debt, the more effective an unexpected increase in inflation is in reducing the real value of the public (and private) debt. Let’s assume, conservatively, that a doubling of the debt-to-GDP ratio from 50 to 100 percent raises the required real rate of interest by one percentage point. The permanent primary surplus (as a share of GDP), p, the permanent seigniorage (as a share of GDP), s, the state debt (as a share of GDP), b, the long-term real interest rate, r, and the long-term growth rate of real GDP, g) can be used to write the solvency constraint of the state as follows:
p + s = (r - g)b (1)
Permanent means roughly ‘long-run future average’. UK long-term real sovereign interest rates (20 years maturity or over yields on index-linked debt) are around one percent today. The long-run growth rate of real GDP is probably somewhere between 2.25 percent and 2.50 percent per annum. Bingo! The UK government lives in Ponzi land: with the growth rate of GDP (roughly the growth rate of the tax base) higher than the interest rate on the public debt forever, the government can always service its outstanding debt by issuing more debt. Primary surpluses, or monetary financing are never required. Bernie Madoff, come home, all is forgiven. Sure, in the current recession, GDP growth is negative so the current real interest rate on the public debt rt exceeds the current growth rate of real GDP, gt but solvency is not about cyclical relations between growth rates, interest rates, primary surpluses and seigniorage revenues, but about their long-term secular values. As long as r < g , any value of the public debt-to-GDP ratio is consistent with non-inflationary state solvency. Therefore, to worry about the solvency of the UK sovereign, or about the inflationary implications of current and prospective budget deficits, you have to believe that the current values of the real yields recorded on long-dated index-linked government debt understate the like actual future real rates the government will have to pay, and/or that the growth rate of real GDP will be lower in the future than it has been in the past couple of decades.
I believe that ex-ante global risk-free long-term real interest rates are likely to rise in the next few years and are likely to stay at their new higher levels, of around three percent per annum for the foreseeable future. I base this on my belief that the ex-ante global saving glut is likely to be over soon, as China, the other BRICS and the GCC states boost domestic demand and reduce their private and public saving rates, without a fully offsetting increase in the planned savings of the advanced industrial countries. Real GDP growth is also likely to be lower than the rate recorded in the past decade, if only because much of the increase in the value added of the UK financial sector over the past decade was illusory. Assume long-run real GDP growth declines slightly to 2.25 percent per annum. We are now out of Madovia and in the land of fiscal scarcity. With r = 0.03, g = 0.025 and b = 1.00, the UK state has to generate a permanent primary surplus plus seigniorage equal to at least 0.75 percent of GDP for the state to remain solvent.
If market nerves put a default risk premium of 100 basis points on top of the risk-free rate, the required permanent primary surplus plus seigniorage becomes 1.75 percent of GDP. This may not seem like much of a challenge, until you compare it with the current and near-future primary surpluses the government is likely to run. Non-inflationary seigniorage, under conditions of normal time preference is tiny in the UK, not more than 0.25 percent of GDP - often much less. The stock of coin ad currency is barely 4 percent of annual GDP. Bank reserves with the Bank of England have recently shot up to about £71 billion (around 5 percent of annual GDP), but since most reserves pay interest, no significant interest is earned on them. Let’s be optimistic, and argue that the UK state has to run a permanent primary surplus of 1.5 percent of GDP.
As the government deficit explodes over the next few years, the actual primary surplus is likely to be primary deficit of around 8 or 9 percent of GDP. As the economy recovers, tax receipts will rise and cyclical public expenditure will decline, but the rest of the public expenditure programme (health, education, pensions) will keep on rising in real terms and as a share of GDP. It is easily conceivable that when the output gap is closed again, in 4 or 5 years time, there will still be a primary deficit of five or six percent of GDP. That means that a permanent reduction in the primary deficit will be is required of between 6.5 and 7.5 percent of GDP. Such a permanent fiscal correction (tax increase or cut in public spending) is politically difficult. In the US, it would be impossible, given the paralysed state of its political institutions. The UK, with its elected dictatorship (effectively unicameral, first-past-the post system, no independent domestic judiciary capable of constraining the executive, no other formal checks and balances), may be able to impose the savage spending cuts or thumping tax increases that will be required to restore solvency without inflating the public debt away.
But the risk that the UK will choose the inflationary route is non-zero. These odds have increases because of the reluctance of the authorities to issue additional index-linked debt. The only credible commitment a government can make that it will not try to inflate its debt away in the future, is to issue only index-linked debt and indeed to retire all nominally denominated debt and replace it with index-linked debt. Neither the British nor the US authorities show any sign of doing so. In fact the opposite is the case. This reluctance to issue index-linked debt is consistent with a policy of keeping the inflation option open. Clearly, aggressive inflationary monetisation of the public debt, or a refusal to let the central bank reverse the monetisation that has already taken place, when the economy recovers, the output gap closes and liquidity preference comes down from its current extraordinary levels, are inconsistent with central bank independence. In the US, this would present no serious problem.
The Fed is the least independent of the leading central banks. I believe Bernanke takes price stability seriously and would resign rather than accept responsibility for a high inflation strategy forced on the Fed by the Treasury. With Larry Summers waiting in the wings to be the next Chairman of the Fed, however, the solvency-through-inflation route would be wide open. For the UK, the choice of the solvency-through-inflation option would require that the Treasury invokes its reserve powers, granted in the Bank of England Act 1998 and retained since then. This permits the Treasury to take back from the Monetary Policy Committee of the Bank of England, the power to set interest rates and conduct monetary policy generally. Should that happen, the inflationary consequences would be immediate - through a collapse of Sterling. I consider this outcome unlikely, but not impossible - and more likely that a ‘tail event’.
China Won’t Buy Oil for Stockpile on Storage Capacity
China, the world’s second-biggest energy consumer, won’t buy more oil for stockpiling until additional storage tanks are built, a government official said. Until the second phase of the country’s emergency oil reserves is constructed, there will be no additional purchases for stockpiling, Zeng Yachuan, deputy director-general of the policies and laws department at the National Energy Administration, told reporters at the Zhenhai facility in the coastal province of Zhejiang today.
The government started filling four storage bases on the eastern coast last year to hold the equivalent of 30 days of oil imports. Under a second phase, China plans to build underground caverns and storage tanks in inland regions. Representatives of domestic and foreign media visited the Zhenhai and Zhoushan bases today on a tour organized by the Energy Administration. Zhoushan has filled its tanks fully, Tang Zhibin, deputy general manager of the facility, told reporters. The base has 50 tanks, each with a capacity of 100,000 cubic meters.
Construction of the second phase will commence "soon," Zhang Guobao, director of the National Energy Administration, said in Beijing on June 1. The second phase of the stockpiles may be built in Zhoushan in Zhejiang province, Tang said today. Sinochem Corp., China’s largest chemicals trader, is building a commercial stockpile of crude oil and fuels in Zhoushan, next to the government’s emergency oil-storage base, Tang said. The capacity of the commercial stockpile will expand to 2 million cubic meters by the end of next year from more than 1 million cubic meters now, he said.
China is aiming to take advantage of weakened oil prices amid the global recession to build stockpiles, the National Development and Reform Commission, the top economic planner, said in March. The four storage bases under the first phase of stockpiling can hold a total of 16.4 million cubic meters of oil, including the 3.2 million cubic meters at Huangdao and 3 million cubic meters at Dalian, materials in an exhibition room at the Zhoushan base show. The "ultimate" goal is to build emergency crude-oil reserves that can meet 90 to 100 days of domestic demand, Zhang was quoted as saying by China National Petroleum Corp. in a company newsletter in April.
The Zhenhai base consists of 52 tanks, each capable of holding 100,000 cubic meters of oil, Zhenhai National Oil Reserve Co. said in a note handed out to reporters today. Markers showed that not all the tanks at Zhenhai, the largest of the four coastal bases, were full, as seen by reporters from the top of a 10-story lookout tower at 11:00 a.m. local time today. About half of the tanks are full, said Zhao Boxin, an official at the security department at Zhenhai.
China will expand purchases of important resources while commodity prices are low, Premier Wen Jiabao said in March. The cost of importing crude for stockpiling was $58 a barrel in 2008, well below the average price of oil last year, the National Energy Administration said in a statement on June 1. Crude oil in New York has slumped 53 percent from a record $147.27 a barrel in July last year as the global recession curbed energy use. China imported 178.9 million metric tons, or 1.3 billion barrels, of crude oil last year, adding to 189.7 million tons of domestic production, government data show
Kuwaiti Lawmaker Demands Publication Of Oil Reserves Size
A Kuwaiti lawmaker Monday demanded the oil minister provides the exact size of the OPEC member's crude reserves following doubts over the official figure of 100 billion barrels. In a question to Oil Minister Sheikh Ahmad Abdullah al-Sabah, liberal lawmaker Saleh al-Mulla demanded the volume of recoverable reserves in each Kuwaiti field, including offshore fields and those shared with Saudi Arabia.
Lawmakers in earlier parliaments posed similar questions after industry newsletter Petroleum Intelligence Weekly said in January 2006 that Kuwait's oil reserves stood at 48 billion barrels, based on internal records.
Two years ago, then oil minister Mohammad al-Olaim insisted Kuwaiti oil reserves were 100 billion barrels but lawmakers still doubted the figure. He gave no details about the size of proven reserves.
The PIW report also said Kuwait's fully proven reserves amounted to only 24.2 billion barrels. At the time, Kuwaiti oil officials said the report was inaccurate and it failed to take into account undeveloped reservoirs. Kuwait's 100 billion barrels form the world's fifth largest deposits after those of Saudi Arabia, Iran, Iraq and the United Arab Emirates. Kuwait, whose officially stated oil reserves constitute about 10% of global crude reserves, is pumping around 2.2 million barrels a day and oil income contributes more than 95% of public revenues.
Analysis Finds Elevated Risk From Soot Particles in the Air
A new appraisal of existing studies documenting the links between tiny soot particles and premature death from cardiovascular ailments shows that mortality rates among people exposed to the particles are twice as high as previously thought. Dan Greenbaum, the president of the nonprofit Health Effects Institute, which is releasing the analysis on Wednesday, said that the areas covered in the study included 116 American cities, with the highest levels of soot particles found in areas including the eastern suburbs of Los Angeles and the Central Valley of California; Birmingham, Ala.; Atlanta; the Ohio River Valley; and Pittsburgh.
The review found that the risk of having a condition that is a precursor to deadly heart attacks for people living in soot-laden areas goes up by 24 percent rather than 12 percent, as particle concentrations increase. A variety of sources produce fine particles, and they include diesel engines, automobile tires, coal-fired power plants and oil refineries. Comparing exposure within the New York and the Los Angeles metropolitan areas, the study found that the risks were evenly distributed in the vicinity of New York while some areas around Los Angeles, including neighborhoods near the Ports of Los Angeles and Long Beach, had elevated health risks.
The extended epidemiological analysis, which draws on data gathered from 350,000 people over 18 years, and an additional 150,000 people in more recent years, was conducted for the Health Effects Institute by scientists at the University of Ottawa. The institute was created by the Environmental Protection Agency and the industries that it regulates with the goal of obtaining unbiased studies.
The link between fine particles, the diameter of which is smaller than a 30th of a human hair, and cardiopulmonary disease has been established for two decades, and the E.P.A. has regulated such emissions since 1997. In 2006, despite mounting evidence that the particles were deadlier than first thought, the agency declined to lower chronic exposure limits. The United States Court of Appeals for the District of Columbia Circuit declared that decision inadequate, and the Obama administration is now considering what level is appropriate.
Sean's 7 Favorite Blogs in the Universe
I agree with Jesse. The banks want to pay back their TARP funds as quickly as possible so they will be released from scrutiny on their bonuses. Personally, I’m thinking we should threaten the bankers’ bonuses every damned day until they stop acting like termites (destroying everything from the inside out).
Jesse is one of my seven favorite bloggers in the universe. Here’s the list …
Jesse’s Cafe Americain Great commentary and charts.
The Big Picture. Top-notch analysis from Wall Street players.
Econbrowser. Kinda wonkish, but in a good way.
Naked Capitalism. Great links, great analysis, and I usually end up sending the “antidote du jour” to my daughter every day.
Theoildrum. They’re not only aware of Peak Oil, they’re proposing smart solutions.
The Automatic Earth. Good news roundup and great commentary.
Calculated Risk. Far and away the best economics blog on the web.
I could easily expand this list to 10 or 12 or 20, but too many and it dilutes the recommendation