Bathing pool in the Casino of the Hotel Alcazar, St. Augustine, Florida
Ilargi: Well, something must be going on when both the Wall Street Journal and Business Week start seriously questioning the very numbers on new home sales that earlier in the day had the entire American press (including, incidentally, the same Wall Street Journal) and investor community in a exuberant party mood. At the very least it makes one wonder what will happen to the next set of data the happy-talking heads try to cheerlead into a recovery, a recession's end and the salvation of their favorite country and/or planet.
While there is no doubt that the present questions in part originate with similar queries voiced by many parties in the digital community, the sad fact remains that to date a few lines in the Journal, no matter how little or late, carry more weight than a hundred or more stories pointing out the exact same distortion of what are a mere few pretty simple periodically released numbers.
What has been happening in the case of the public manipulation of home sales data is no different from the way jobless numbers are dealt with, or unemployment claims, or just about any statistical data you can think of. They are all bent in such a fashion that a picture emerges that is anywhere from less bad to much sunnier than objective analysis would warrant. Realtors do it with housing numbers, the government with unemployment figures, and the press, until now, has been only too glad to play along.
I'm sure no-one's volunteering yet to hold their breath on this one, but it would be a great service to everyone, except for those interested in distorted stats for reasons of money or power, if the Wall Street Journal has set a precedence today that many of its peers will follow, if only because they fear being exposed for reporting "false" information. Meanwhile, whatever the Journal decides, and I think for example there's another jobless claims report due on Thursday, the pressure on the media to quit feeding their readers and viewers irrelevant "news" in order to make them think things are better than they truly are, is kept increasingly alive by an increasing flow of analysis available online that will one day, unless they change their tune, make the mainstream media themselves irrelevant.
Perhaps that's what's behind the Journal's decision today. Not, mind you, that it matters all that much anymore. Plenty people by now understand that while new home sales may have gone up by an X percentage in one particular month, with an X+1 error margin to boot, what really counts in the change over the same period last year. And if that turns out to indicate a 23.1% loss, the same plenty people can figure out what the real picture is. Home sales and jobs, like so many things in life, are seasonal.
And I know that I tip one toe over the line by accusing the media of providing "false" information in these cases. Don't worry, my toe didn't slip, it's right where I want it..
Information can be classified as "false" when it is intentionally provided outside of, or without, its proper context, if and when that context can or must be presumed to be known by whoever provides said information. Which in turn allows me to perfectly gracefully close with a quote from Mark Hanson which Barry Ritholtz posted earlier at The Big Picture. Right there's all the context you’ll ever need. Here's hoping the Wall Street Journal, and all the rest of the media, get the message it sends before it makes them look ridiculous and be irrelevant.
And I didn't even yet get around to talking about the estimated $240 trillion in derivatives exposure for the Big 5 US banks that Fitch suggests.
Here's that context:
National new home sales, on a monthly basis, don’t even add up to half of the total foreclosure activity in California alone in a single month.
US Home Sales Numbers Fail Inspection
Many investors celebrated Monday after June's "surge" in U.S. new-home sales. Alas, it was largely wishful thinking. True, the Census Bureau reported sales up 11% from May. That's a big number, at first glance justifying Monday's 4.5% leap in the Dow Jones U.S. Home Construction Index. But it fails a close inspection.
First, home sales quite often jump in June, the height of the spring selling season. When trying to gauge the strength of home sales, then, it makes more sense to compare them to the same month a year ago. That comparison is less kind -- sales were down 21.3% from June of 2008. Seasonally unadjusted data show a total of 36,000 new homes were sold last month, the lowest June total since 1982, notes Richard Moody, chief economist at Forward Capital.
And the Census Bureau warns against assuming too much precision in these numbers, which are based on a sample survey. Accounting for a 13.2% margin of error -- at a 90% confidence level, suggesting the actual error could be higher -- new-home sales enjoyed somewhere between a 24.2% gain or a 2.2% decline from May. New-home inventories are falling, an encouraging development. But inventories are still higher than their historical norm, and there remains an avalanche of distressed sales.
Little wonder, then, that June's "surging" sales were driven by heavy discounting. The median new-home price -- not seasonally adjusted -- fell 12% in June from a year ago to $206,200, the lowest June sales price since 2003. And it was down 5.8% month on month. To paraphrase Pyrrhus, if sales keep soaring like this, then homebuilders will be utterly undone.
New Home Sales Fall 21.3%
Get ready for another round of bad reporting:
The $8,000 Fed tax credit (1st time buyers) and a $10,000 California tax credit (new homes only) likely helped out in NHS this month. Falling prices are also contributing to sales activity of the sector, which represents about 15% of the overall housing market.
Here is the official New Home Sales:
Sales of new one-family houses in June 2009 were at a seasonally adjusted annual rate of 384,000, according to estimates released jointly today by the U.S. Census Bureau and the Department of Housing and Urban Development. This is 11.0 percent (±13.2%)* above the revised May rate of 346,000, but is 21.3 percent (±11.4%) below the June 2008 estimate of 488,000.
Thus, we in fact know that Sales fell from last year. They were down 21.3%, a number greater than the margin of error.
The monthly data, on the other hand, is not statistically significant. Therefore we DO NOT KNOW what the change was from last month, as the margin of error is greater than the reported data point.
If New Home Sales are so strong, then can anyone explain why prices are still plummeting? Median home prices dropped 12% year-over-year, and 5.8% from the prior month.
Chart via Calculated Risk
Five Firms Hold 80% of Derivatives Risk, Fitch Report Finds
First-quarter financials mark the first time comprehensive derivatives disclosure was mandated for all U.S. companies.
Members of Congress probing threats to the global financial system — especially the threat of concentration of risk — will have a lot to ponder in newly mandated disclosures highlighted by a Fitch Ratings report issued last week. While derivatives use among U.S. companies is widespread, an "overwhelming majority of the exposure is concentrated among financial institutions," according to the rating agency's review of first-quarter financials.
Concentrated, in fact, among a mere handful of financial-services giants. About 80% of the derivative assets and liabilities carried on the balance sheets of 100 companies reviewed by Fitch were held by five banks: JP Morgan Chase, Bank of America, Goldman Sachs, Citigroup, and Morgan Stanley. Those five banks also account for more than 96% of the companies' exposure to credit derivatives. About 52% of the companies reviewed disclosed there were credit-risk-related contingent features in their derivative positions. Such features require a company to post collateral or settle outstanding derivative liabilities if there's a downgrade of the company's credit rating.
The Fitch analysts also found that just 22 companies disclosed the use of equity derivatives. Just six nonfinancial firms — IBM, General Motors, Verizon, Comcast, Textron, and PG&E — reported exposure to share-based derivatives. For the report, the rating agency reviewed first-quarter 2009 filings of the companies, which come from a range of industries and represent almost $6.4 trillion in aggregate outstanding debt. The companies also recorded a total notional amount of derivative positions of more than $296 trillion.
Unlike the financial firms, which both use derivatives and issue them for profit, nonfinancial companies seem mostly to use derivatives just to hedge specific risks, according to Fitch. While "derivatives trading by utilities and energy companies appear to be very limited," for instance, "most of the companies reviewed in both industries report the use of derivatives for hedging commodity risks," the report found. The first-quarter 2009 financial reports marked the first time comprehensive derivatives disclosure was mandated for all U.S. companies.
"The need for better disclosure on derivatives has been obvious since the implementation of Statement of Financial Accounting Standards 133, Accounting for Derivative Instruments and Hedging Activities," according to the Fitch report. But comprehensive disclosure of derivatives wasn't part of U.S. generally accepted accounting principles for most companies until March, when the Financial Accounting Standards Board implemented SFAS 161, Disclosures about Derivative Instruments and Hedging Activities.
The latter standard is an attempt to simplify hedge accounting, perhaps the most notorious example of the complexity of U.S. financial reporting. More than 800 pages of rulemaking and guidance were needed to make sense of SFAS 133. For its part, SFAS requires companies to improve their disclosures about how they account for and use derivatives, and how derivatives affect their balance sheets, income statements, and cash-flow statement. "The new derivative disclosures are a welcome addition for analysts and investors, and they bring much-needed transparency to financial reporting," says Olu Sonola, a Fitch Ratings director. "The disclosures reveal plenty, but careful analysis and additional scrutiny must be applied."
In particular, users of financial statements need added information about the sensitivity of companies' derivative valuations to major assumptions, according to the ratings agency. Since risk analysts often base their derivative valuations on quantitative models, changes in significant valuation assumptions are particularly important, says Fitch. The firm's analysts reported that perhaps "the most surprising information coming from our review of energy companies" was that Exxon Mobil — the biggest U.S. energy company — had no derivative exposure at the end of the first quarter. Instead, the company appears to rely on what's called natural hedges — countervailing trends within the corporation itself — to manage potential risks.
The report cited Exxon's 2008 10-K: "The corporation's size, strong capital structure, geographic diversity and the complementary nature of the upstream, downstream and chemical businesses reduce the corporation's enterprise-wide risk from changes in interest rates, currency rates and commodity prices. As a result, the corporation makes limited use of derivative instruments to mitigate the impact of such changes. The corporation does not engage in speculative derivative activities or derivative trading activities nor does it use derivatives with leveraged features."
Lost Value of Equities in U.S. State and Local Government Pension Plans: Now $1 Trillion
In the U.S., the pension plans of state and local governments have a large portion of their assets in equities. Due to this high exposure to equities, the plans suffered severe losses as the markets fell hard until March this year.
The average asset allocation of the typical U.S. Define Benefit (DB) plan has 60% in equities, 30% in fixed income and 10% in other assets.
“Public pension plans of U.S. State and local authorities also suffered severe losses due to high equity exposure and substantial leverage. The financial crisis has reduced the value of equities in State and local authorities’ DB plans by about US$1 trillion. These changes will become evident over time because State and local authority plans smooth both gains and losses by averaging the market value of assets over a five year period. However, they will be large as public plans in the United States have on average 60 percent of assets in equities. In addition, they leveraged themselves to fund liabilities. In general, state and local plans had an average funding ratio of 87 percent in 2007 which, by October 2008 would have declined to 65 percent if assets were valued at market values (Munnell et al. (2008) (the impact of smoothing is shown in Figure 13). In the optimistic scenario that assets level return to the 2007 values, funding ratios are projected to increase to 75 percent in 2013. Under the pessimistic scenario that asset values remain at the level of end 2008, funding ratios are expected to further decrease to 59 percent. In both scenarios, liabilities are assumed to grow at 5.7 percent per year.”
click to enlarge
Source: 'How the Financial Crisis Affects Pensions and Insurance and Why the Impacts Matter' by Gregorio Impavido and Ian Tower, IMF Working Paper.
To download the full paper in pdf format, click Pension-Plan-Impact-Crisis.
Option ARM Defaults Shrink Recast Wave, Barclays Says
The wave of "option" adjustable- rate mortgages recasting to higher payments, projected by some economists to represent a looming source of foreclosures that will hurt housing markets over the next few years, will be smaller than "feared" because many borrowers will default before their bills change, Barclays Capital analysts said. Option ARMs offer initial minimum payments that fall below the interest borrowers owe, creating growing balances and potential spikes in monthly bills. Payment resets occur after five years or when the debt grows to a preset amount, typically 110 percent to 120 percent of the original principal.
About 40 percent of borrowers with option ARMs are already delinquent, and "many" of the others will start missing payments before their obligations change, the Barclays mortgage- bond analysts wrote in a July 24 report. Recasts of securitized option ARMs will peak at about $6 billion a month in mid-2011 and include "volumes lower than feared" overall, they said. "The additional risk really will only be for borrowers who manage to stay current over the next couple of years and might default due to a payment shock," the New York-based analysts including Sandeep Bordia and Jasraj Vaidya wrote.
Whitney Tilson’s hedge fund, T2 Partners LLC, in a presentation dated July 3 said option ARM recasts may peak in the second half of 2011 at more than $16 billion a month, citing Credit Suisse Group data. While the lower number from Barclays analysts suggests an earlier end to the foreclosures contributing to record home-price declines, investors and some analysts including at Barclays and JPMorgan Chase & Co. have said the U.S. government’s effort to have more bad mortgages reworked will delay some defaults.
The Barclays analysts, who wrote that about 88 percent of option ARMs packaged into securities in 2007 will eventually default, said that after a rally in prices they no longer suggest owning related bonds, "a trade we have been recommending for months." Typical prices for the most-senior option ARM bonds from 2007 have jumped about 40 percent from March lows to 46 cents on the dollar, according to their report. JPMorgan analysts in New York including John Sim and Chris Flanagan wrote in a July 24 report that prices for so-called super-senior securities may reach the "mid-to-high 50" cents on the dollar.
The bonds "still represent one of the last double-digit yielding assets (for even bad scenarios) in the resi mortgage space," Jesse Litvak, a mortgage-bond trader for Jefferies & Co. in New York, wrote in an e-mail. "One of the biggest risks" will be the size of losses per foreclosure, he said. Lower short-term interest rates are benefiting option ARM borrowers in two ways, the Barclays analysts added.
They have lessened balance growth, allowing more recasts to happen only after five years. They also have reduced payment increases to a projected 30 percent to 35 percent for loans recasting over the next year and an estimated 50 percent to 80 percent for later recasts, compared with a more than doubling of payments under calculations last year, their report said. More than $750 billion of option ARMs were originated between 2004 and 2008 as borrowers used their low initial payments to afford higher-priced homes, according to newsletter Inside Mortgage Finance. Outstanding U.S. home loans totaled $10.5 trillion on March 31, according to Federal Reserve data.
Derivatives bill to clamp down on speculation
Congress will consider steps to curb speculation in the $39 trillion credit default swaps market and could prohibit investors from speculating on a borrower's credit quality, according to a U.S. House of Representatives Committee document obtained by Reuters. Congress and the Obama administration have been pushing for oversight of the market since insurer American International Group Inc's near-collapse because of its exposure to credit default swaps. The swaps are used to insure against debt defaults and speculate on a borrower's credit quality.
The House Agriculture and Financial Services committees will consider two options to curb speculation including a ban on so-called naked credit default swaps -- swaps for which a trader or investor does not hold the underlying asset being insured, such as a bond. The other option would require derivative dealers and investment advisers that manage in excess of $100 million to report their short interests in credit default swap contracts to the appropriate regulator, according to the document.
The derivatives bill is part of a broad overhaul of U.S. financial regulation sought by the White House and Democratic lawmakers in the House and Senate. The House is expected to begin debating this week a separate measure that would give shareholders the right to cast nonbinding votes on executive compensation at publicly traded companies. Policymakers have been broadly pushing for oversight of the $450 trillion over-the-counter derivatives market, which includes the credit swaps. The bill would give regulators authority to set position limits on dealers in credit default swaps, or CDS. It would also shift oversight of ICE Trust Clearinghouse from the Federal Reserve to the Securities and Exchange Commission, the document said.
The bill also addresses the role of clearinghouses, which act as intermediaries that assess risk from transactions, assign capital or margin requirements, and assure payment if one party defaults. The Obama administration wants more over-the-counter derivatives -- which are not traded on exchanges -- to be cleared by clearinghouses. The draft bill takes a stronger line, saying derivatives must be traded on an exchange and cleared by approved clearinghouses unless regulators decide to exempt them.
Waivers could include illiquid derivatives, those that are customized, and those in which a so-called end user of derivatives does not qualify as a "major market participant," the document said. The draft bill from Barney Frank's House Financial Services Committee is similar to a description by Agriculture Committee chairman Collin Peterson of an upcoming omnibus reform bill. "They had come to agreement on the bulk of what Frank would propose," a House Agriculture Committee spokesman said about the discussions between Peterson and Frank.
The Agriculture Committee passed a bill last winter that would, if enacted into law, require clearing of OTC derivatives in most cases and would allow regulators to temporarily suspend trading in naked CDS. The bill also would require futures regulators to set position limits on agricultural and energy contracts and require foreign exchanges to adopt reporting and disclosure rules that mirror U.S. standards. Under the draft bill, a new federal council would help resolve long-standing differences between futures and securities regulators, the Commodity Futures Trading Commission and the SEC.
The CFTC polices futures markets and the SEC oversees stock markets. The two bodies have long clashed over which has the right to approve new financial products, delaying approvals. The new council would determine which agency had authority over the new products within 180 days and resolve jurisdictional disputes between the SEC and the CFTC within the same time frame. The White House is expected to release its proposed legislative language for derivatives as early as Thursday, according to a source familiar with the administration's planning.
Ilargi: Very good from a Daily Kos reader. Please read.
The End of the Beginning of the Collapse
This morning, I started my day with a coffee cup and DailyKos, intrigued by the internicene conflict between the estimable bonddad (who has informed me countless times), and bobswern (who has also informed me countless times), each of whom posted diaries disagreeing with each other (Bonddad, bobswern) about whether we are seeing "the bottom" of the recession, and whether a gloomy or merely less-gloomy future awaits us). Their analysis was fascinating; less fascinating was the implicit and explicit sniping between adherents (and authors) to the different philosophies and assumptions of the others. But in both analyses, there was something seriously lacking.
Both presume that "the economy" is something human-created, and independent of world-scale limits. Both presume that the realities of the current mess (and implicitly, the likelihoods of the next five years) have a relationship to the past's realities, either by their use of graphs, or their use of employment rates. What I've been learning over the last couple of years, as one of the two ApocaDocs gathering and bequipping stories about five likely collapse scenarios (climate chaos, species collapse, biology breach, infectious disease, peak resources -- oh, and recovery too) is that nothing is happening as expected.
Scientists and specialists within all these topical arenas are saying "more than we thought," "faster than expected," "alarming," "unanticipated," "recently realized," "worse than we thought." The great migrations themselves are becoming extinct, from salmon to elk to butterflies to tuna. Bats in the Northeast are suffering catastrophically from white-nose syndrome, at die-off rates of 90%. Pollinators are suffering dramatically. Top-of-the-food-chain predators everywhere are collapsing. All marine mammals have high levels of PCBs, and flame retardants, and a broad array of other human-made toxins coursing through their bodies.
The waste-processed effluent from our cities contains the prozac and viagra and hormone replacement runoff, that we flush down the toilet, which makes fish hermaphroditic. That water mixes with the pesticide, herbicide, and fertilizer runoff from our factory farms -- creating a dead zone the size of New Jersey at the base of the Mississippi, joining other dead zones around the world. In between California and Hawaii there is a gumbo of plastic gyring in the Pacific that's at least the size of Texas. Plastic does not biodegrade, but breaks down into particles that fish consume.
And most estimates indicate we have already overfished between 85 and 90% of the raw biomass out of the ocean in the last century, and every day, we continue to hoover up four times more ocean biomass than is reborn. "Peak ocean" happened a long time ago, but our ever-more-efficient factory fishing has let us ignore it for a time. Coal power belches heavy metals and incredibly massive amounts of extra carbon dioxide into the atmosphere. Global warming is not a theory, it is a given.
CO2 does something much worse. While we bicker with global-warming deniers, the ocean is getting more acidic. Excess CO2 plus ocean produces carbonic acid. Ocean acidification is a clear and present danger. A slight rise in acidity dramatically affects calcium-carbonate-based lifeforms, like most plankton, shellfish, and coral, the cornerstones of the ocean biosphere. They are unable to form calcium carbonate shells, exoskeletons, or other structures. We're also reaching, in the very near-term, limits on oil, fresh water (as reported magnificently yesterday in the diary "Water Bankruptcy"), topsoil, lithium, phosphorus, and plenty more. Worst of all, nearly everything (and more) on the above list is happening "faster than expected."
Now: almost any of the above could radically disrupt the economy (and should). Sometime soon, fish prices will skyrocket as overfishing's legacy creates radical scarcity. Sometime soon, the impact and risk of ocean acidification will be recognized by society, and radical steps will need to be taken to prevent our rich, biodiverse ocean from becoming an acidic, jellyfish- and algae-filled cesspool, in our lifetimes. Sometime soon (and the next five years are likely to be exceedingly warm) we will see a serious drought in a major food-producing belt. Sometime soon we will see explosions of unintended consequences: unexpected blooms of dead zones, collapses of shellfish and coral, and the complex ecosystems they support.
Each of these would have dramatic economic consequences. If even 1/4 of what I describe above is the emergency I think it is, then there's what might be called "a disruptive economic force." The present is not what the past was; the near future is by no means what the recent present was. We have reached a tremendously complex, tremendously traumatic point in human history. Economists try to predict the future. Few economists have grappled with the limits we are confronting.
What bonddad and bobswarn both did is useful, in that they are mirroring the mindset of many traders, analysts, pundits, and economists. I think there's plenty of evidence that that entire community is based on a failed model: a failed economic model, a failed environmental model, a failed energy model, a failed sustainable-lifestyle model. It seems to me we are likely to be entering the era of "converging emergencies."
It's the problem of, say, the 90% deathrate in bats in the Northeast, causing a rise in crop pests, causing a drastic rise in pesticide use, causing a general decline in pollinators and other beneficial species, while also causing reproductive problems in freshwater fish downstream. It's the problem of, say, topsoil depletion and aquifer pollution in the Midwest, compounded by climate-chaos drought and a monoculture of soy and corn, causing increasing use of fertilizer, causing the depletion and rapid rise in prices of phosphorus, while also causing the farm runoff to create algal blooms in rivers and lakes and outlets.
It's the problem of, say, rising oceans drastically devaluing private and commercial property that is 20 feet "above (the former) sea level," including city infrastucture, homes, and businesses, while the costs of energy are rising, ports are having to reconfigure, and shipping costs treble, as we confront the costs of CO2 realistically. I could go on. Converging emergencies will be the realities of the next three to ten years, and oddly, most economists, traders, policy-makers, and the rest, have only the haziest of notions that things might be "off."
"Gloomy" or "Not-so-gloomy" seems to me rather silly. A radical economic and societal restructuring will happen in the next five to ten years. I have no idea how it will affect our 401ks, or our TIAA-CREFs, or our cost-to-goods ratio. The selling price of houses may depend on their south-facing land, and proximity to small farms. The valuation of a stock may depend on its relationship to emergency response. The employment numbers may depend on what FEMA requires. The next three to ten years (presuming that it becomes ever more clear to the financial markets just how bad things are) will be wacky, and not at all like the previous three to ten years.
In the end, my fascination with the bonddad/bobswern discussion is similar to that of my fascination with, say, photovoltaic cell technology development. It may make a difference to me, personally, and for an industry, and might impact the converging emergencies.... but until it becomes a key part of society's proactive response to the converging emergencies, then it's just an interesting datapoint to my personal investment strategy.
"The Economy" is, as we are seeing, far more like an ecosystem than like a predictable, plottable system. The "financial system" is based on a prediction of a stable future -- and I'm pretty sure that stability is not in our future. So what happens to the financial system when the past is utterly no predictor of future performance, and all bets are off?
The End of the End of the Recession
Zero Hedge, in collaboration with David Rosenberg, Chief Economist & Strategist, Gluskin Sheff + Associates, Inc., is pleased to release the attached analysis "The End Of The End Of The Recession." It is our hope that this piece will provide some badly-needed perspective on "the recession is over" debate, a topic that has become as one-sided as it is wrong-headed. Our purposes is to promote rational, informed discourse on the subject and to this end we enthusiastically solicit reader feedback. Our presentation is licensed "creative commons: attribution" and we hope that our readers will feel free to forward it on or excerpt from it freely, provided attribution is preserved.
The End of the End of the Recession
It's PRIME TIME: Stage 2 of the U.S. Collapse
To listen to our political leaders, the mainstream media and financial bubblevision t.v. programs, you would think that the financial crisis has stabilized and the housing market is bottoming. But if you un-spin the data fed to us by the Government and the media, the facts show that the financial system is on the precipice of another very large crisis. As the housing market collapse spreads into the prime-rated mortgage sector, a veritable avalanche of foreclosed middle to high-end homes will flood the market, triggering a much larger credit and economic crisis than what was experienced during the past 18 months.
The onset of the financial crisis in this country last year was largely precipitated by the inevitable bursting of the housing and mortgage bubble. In what was an unregulated multi-trillion dollar Ponzi scheme, the price of houses rose to unsustainably insane valuation levels, fueled by the reckless and tragic use of no-holds-barred mortgage financing. This "Stage 1" of the financial collapse was triggered by an escalation in defaults and foreclosures primarily in the subprime and Alt-A mortgage sectors.
The associated collateral damage from this reverberated into the implosion $100's of billions of off-balance-sheet assets and derivatives, many of which were fraudulently rated by the rating agencies and recklessly pumped into investors by Wall Street. This took the Dow from 14,000 to 6,440 and was addressed by the Government/Fed with as much as $24 trillion in direct monetary injections and financial guarantees. During this Stage 1 we saw the Government takeover of Fannie Mae, Freddie Mac, the de facto Government takeover of AIG, the collapse of Bear Stearns, Lehman, Merrill Lynch, Countrywide, Washington Mutual, Wachovia; the U.S. auto industry, among many any other corporate failures and smaller regional bank collapses (64 smaller bank failures this year as of 7/24/09).
Stage 2 of the financial collapse of the U.S. is being triggered by the accelerating rates of default/foreclosure in the prime-rated mortgage market, as well as the collapse of commercial real estate. I am going to focus on the residential mortgage component, as it is three times as large as the commercial real estate mortgage market. Whereas the subprime and Alt-A mortgage markets are roughly $1.5 trillion combined, the prime-rate mortgage market is in excess of $10 trillion, depending on your source of data. For purposes of my analysis, I am using data presented by Mark Hanson of Field Check Group in his "7-19 Mortgage Default Crisis - Brutal Past Two-Months" article posted here (any housing/foreclosure data I use comes from this article):
I have been asserting that the housing collapse would not end until prices fall enough to balance out the supply/demand equation. This includes the inventory of new and existing homes for sale, the inventory of foreclosed homes either on the market or being held by banks but not listed for sale AND the inventory of rental units. Data released this past week show that the rental unit vacancy rate surged to an all-time high. This will put downward pressure on rental rates, of which I am already seeing evidence in Denver. As rental rates decline, it becomes relatively more attractive to rent rather than to own, putting more downward pressure on the price buyers will be willing to pay to buy a home vs. rent.
The biggest problem, however, facing the housing market, is the impending surge in bank foreclosure inventory, fueled by the rapid increase in defaults and foreclosures in the $10 trillion prime mortgage sector of the market. Delinquencies surged in May and foreclosure inventories hit new highs. The May foreclosure rate hit 2.79% of all mortgages. This foreclosure rate increased from April to May by 6.2% and surged from May 2008 by 88.3%. Further troubling is the 5% spike in the rate of delinquencies from April to May. This compares to the April to May average increase in delinquencies over the past four years of 1.1%. The increase in delinquencies from May 2008 to May 2009 spiked up by 50%.
What's most troubling about this data is that the main source of these horrific foreclosure/default numbers is the rapid increase in defaults in Prime-rated mortgages over the last six months. Once a mortgage defaults, it typically takes 12 to 18 months for the property to be foreclosed and either listed for sale for held in suspense by banks hoping for a miracle in the condition of the housing market.
The default/foreclosure statistics for Prime mortgages are starting to follow the same statistical path experienced in the subprime and Alt-A markets. Currently, over 12% of all subprime mortgages and 8% of all Alt-A mortgages have been foreclosed. Let's assume that the total foreclosure rate for the prime mortgage market eventually hits 5%. I believe this is a conservative estimate given what has already occurred in subprime and Alt-A, the surging rate of delinquencies in the prime sector and the rapidly escalating rate of unemployment, which directly correlates to mortgage defaults.
Assuming 5% means that $500 billion in prime mortgages will be foreclosed. This equates to the entire size of the subprime mortgage market. Imagine the damage this is going to cause to the entire financial system in this country. And my guesstimate may well be way too low (it is not too high, I can assure you of that). To put this in perspective, Stage 1 of the financial collapse primarily affected the middle to lower income demographics who purchased a home using subprime and Alt-A financing. A lot of these properties are being purchased and turned into rentals, fueling the rental inventories.
In what will be a much larger and more severe Stage 2, accelerating defaults in the prime mortgage sector will cause foreclosures to balloon in the upper-middle (think of overbuilt suburban McMansion developments or overvalued renovation homes in trendy urban areas) and high income neighborhoods. Anecdotally, as I drive through all the trendy renovated urban enclaves around Denver, I see "for sale" and "for rent" signs popping up like uncontrolled weeds as homeowners attempt to avoid foreclosure by selling or renting. It's one thing for an investor to scoop up several low-priced homes and rent them out, hoping for future price recovery. But how will the housing market ever absorb a massive increase in larger, overvalued homes which would never have been built in the first place if a housing bubble never occurred?
As this prime mortgage-financed foreclosure inventory balloons, it is going to drive prices down to levels thought unimaginable. As the value of the collateral for the mortgages declines, banks and investors who own the associated mortgage and mortgage-related paper will suffer massive hits to the value of their assets. Even worse, we will see another round of derivative-related bank and insurance company implosions, some of which will vaporize into thin air the way Bear Stearns and Lehman did, and Countrywide, Wash Mutual, Wachovia and Merrill should have, were it not for the taxpayer financed bailouts of these firms. This Stage of the financial collapse will likely bring down several large State and corporate pension plans as well.
And finally, how will the Federal Reserve and Treasury deal with this impending financial explosion? If it took $24 trillion of direct and indirect financial support and monetary printing in order to "stabilize" the shock of Stage 1, how much money-printing will it take in order to hold the system together as Stage 2 materializes and engulfs our system with multiple financial disasters? It can be argued that the collapse of CIT is the first sign of Stage 2 hitting. It will be interesting to see which other financial firms hit the wall. We know that Bank of America - which sits on Countrywide and Merrill Lynch's subprime mess, Wells Fargo - which sits perched on Wachovia's $122 billion of explosive Pay-Option ARM paper, and GE Capital - a giant-sized CIT - are prime candidates to be vaporized by their nuclear balance sheets.
To conclude, based on the spin-free data presented above, a bottom to the housing market is nowhere in sight. In fact, I would argue that housing prices have at least another 30-40% to fall from where they are now. This is a guesstimate based on all of the above evidence. I don't know what general level of valuation will mark the end of the housing market freefall. I do know that all the so-called experts (like Ben Bernanke et. al.) who said less than 18 months ago that the financial crisis would be contained to the subprime mortgage market and would top out at $200 billion were tragically wrong in their assessment. I also know that I am on record saying prices will revert to 1981 levels and that this crisis would end up costing $5-10 trillion. Looks like the jury is out on home prices and I was way too low on the dollar cost. I also know that, not only are we nowhere near a bottom, but that the worst is yet to occur.
10 Lawmakers Say Goldman Is Gambling With Taxpayer Money
Dear Chairman Bernanke:
In the fall, Goldman Sachs secured access to government funding by converting from an investment bank into an ordinary bank. Despite this shift, the CFO of the company, David Viniar, said last week that the company is continuing to operate as if it were still a high-risk investment bank: "Our model really never changed," he noted in a quote to Bloomberg. "We've said very consistently that our business model remained the same."
This statement seems accurate. Earlier this year, the Federal Reserve granted a temporary exemption to Goldman Sachs from standard bank holding company Market Risk Rules, allowing the company to continue operating as if it were an investment bank. The company and its employees have taken full advantage of its new government subsidies, and the retained ability to bet big. In its most recent quarter, Goldman Sachs earned high profits of $2.7 billion on revenues of $13.76 billion, with 78 percent of this revenue derived from high-risk trading and principal investments. It paid out much of this revenue in compensation, setting aside a record $772,858 for each employee at an annualized rate. The company's own measurement of risk, its Value-at-Risk model, recently showed potential trading losses at $245 million a day, up from $184 million last May.
Despite its exemption from bank holding company regulations, Goldman Sachs has access to taxpayer subsidies, including FDIC-backed bonds, TARP money (since repaid), counterparty payments funneled through AIG, and an implicit backstop from the taxpayer that allowed a public equity offering in a queasy market. The only difference between Goldman Sachs today and Goldman Sachs last year is that today, the company is officially gambling with government money. This is the very definition of "heads we win, tails the taxpayers lose."
It is worth noting that there sometimes might be good reasons to grant temporary regulatory exemptions, considering that companies cannot instantly change their business model. Still, given Goldman Sachs's last quarter results and public statements that it is not changing its business model, we are worried that the company is using its regulatory freedom to evade capital requirements and take outsized risks with taxpayers on the hook for losses. With this in mind, our questions are as follows:
- In the letter granting a regulatory exemption to Goldman Sachs, you stated that the SEC-approved VaR models it is now using are sufficiently conservative for the transition period to bank holding company. Please justify this statement.
- If Goldman Sachs were required to adhere to standard Market Risk Rules imposed by the Federal Reserve on ordinary bank holding companies, how would its capital requirements differ from the current regulatory regime?
- What is the difference in exposure to the taxpayer between these two regulatory regimes?
- What is the difference in total risk to the portfolio between these two regulatory regimes?
- Goldman Sachs stated that "As of June 26, 2009, total capital was $254.05 billion, consisting of $62.81 billion in total shareholders' equity (common shareholders' equity of $55.86 billion and preferred stock of $6.96 billion) and $191.24 billion in unsecured long-term borrowings." As a percentage of capital, that's a lot of long-term unsecured debt. Is any of this coming from the Government? In this last quarter, how much capital has Goldman Sachs received from the Federal Reserve and other government facilities such as FDIC-guaranteed debt, either directly or indirectly?
- Many risk-management experts, most notably best-selling author Nassim Taleb, note that VaR models can dramatically understate risk. What is your overall view of Taleb's argument, and of the utility of Value-at-Risk models as regulatory tools?
As we work through legislative conversations regarding systemic risk, these questions are taking on increased significance. We appreciate your time and the efforts you are making to explain the actions of the Federal Reserve to Congress, and to taxpayers.
Alan Grayson (D-Fla.)
Brad Miller (D-N.C.)
Dan Lipinski (D-Ill.)
Elijah Cummings (D-Md.)
Ron Paul (R-Texas)
Tom Perriello (D-Va.)
Maxine Waters (D-Calif.)
Jackie Speier (D-Calif.)
Maurice Hinchey (D-N.Y.)
Walter Jones (R-N.C.)
Real Yields Highest Since 1994 Aid Record Debt Sales
The highest inflation-adjusted yields in 15 years are helping provide the Treasury with record demand at auctions as the U.S. prepares to sell $115 billion of notes this week. Treasuries are the cheapest relative to inflation since 1994 after consumer prices fell 1.4 percent in June from a year earlier. The real yield, or the difference between rates on government securities and inflation, for 10-year notes was 5.10 percent today, compared with an average of 2.74 percent over the past 20 years.
The gap helps explain why investors are buying bonds after losing 4.8 percent this year, the steepest decline on record, according to Merrill Lynch & Co. indexes that date back to 1978. While Treasury will probably sell an unprecedented $2 trillion of debt this year, Federal Reserve Chairman Ben S. Bernanke said last week that limited inflation pressures will allow policy makers to keep interest rates near zero. "Concerns surrounding rising Treasury supply to fund the various U.S. stimulus programs are overblown," strategists led by Brad Henis in New York at Citigroup Inc., one of the Fed’s 17 primary dealers required to bid at the auctions, wrote in a July 23 research report.
The government is selling $6 billion of 20-year Treasury Inflation Protected Securities, $42 billion of 2-year notes, $39 billion due in 5 years, and $28 billion of 7-year notes through July 30. It’s only the second time that three so-called coupon issues and TIPS will be sold in a single week since the regular sales began in 1976. The previous record was $104 billion in 2-, 5-, and 7-year debt the week of June 22. Bernanke’s testimony on the economy and monetary policy before Congress last week helped ease concern that efforts by the central bank and the administration of President Barack Obama to end the worst recession in half a century will spark faster inflation.
Treasuries rallied as Bernanke spoke, with the yield on the benchmark 3.125 percent note due May 2019 declining 12 basis points, or 0.12 percentage point, to 3.48 percent on July 21. Bonds fell today, with the yield on the 10-year note rising four basis points to 3.70 percent by 8:30 a.m. in New York, according to BGCantor Market Data. Citigroup recommends buying 10-year notes when yields approach 4 percent and selling them when they move closer to 3.25 percent. Rates on benchmark 10-year notes fell 33 basis points from this year’s high of 4 percent on June 11. Bernanke "helped to restore confidence in the market about exit strategies," said Brian Weinstein, who runs the $9 billion TIPS fund in New York at BlackRock Inc., the largest publicly traded U.S. money manager. "The risk of inflation is longer term."
While the economy is showing "tentative signs of stabilization," the central bank intends to maintain a "highly accommodative" monetary policy for "an extended period," Bernanke said in semi-annual testimony before the House Financial Services Committee. Consumer prices have stabilized, after surging in the year earlier period on rising food and energy costs, as demand cooled following the collapse of global credit markets. Crude oil declined 54 percent to $68.48 a barrel on the New York Mercantile Exchange, from the record high of $147.27 set on July 11, 2008. The 1.4 percent drop in consumer prices last month was the biggest since January 1950.
The U.S. more than doubled bond and note offerings to $963 billion in the first half of 2009 in an effort to end the recession and finance a budget deficit that the Congressional Budget Office projects will reach $1.85 trillion this year. It may sell another $1.1 trillion in the second half, according to London-based Barclays Plc, another primary dealer. Including bills, the Treasury has raised $1.046 trillion in new cash this year, according to government data.
"There’ve been very valid concerns about whether the market would be able to take down that kind of supply consistently," said Christopher Sullivan, who oversees $1.5 billion as chief investment officer at United Nations Federal Credit Union in New York. "Given the demand seen at many of the auctions, that fear has been a little bit misplaced." At the six sales of two-year notes this year, investors offered an average $2.81 of every $1 of debt sold, compared with $2.34 during the same period last year. For five-year notes, the so-called bid-to-cover ratio has risen to $2.22 in six sales, up from $2.07 last year.
This week’s auctions will raise a record $96 billion in new cash, up from the previous record of $85 billion during the week of June 22, according to Louis Crandall, chief economist at Wrightson ICAP LLC, a Jersey City, New Jersey-based research firm that specializes in government finance. Treasuries rallied that week by the most since the period ended March 20, as the yield on the 10-year note tumbled 24.5 basis points to 3.54 percent. Citigroup expects that demand to continue as sales in other parts of the bond market decline. While the firm forecasts Treasury supply in fiscal 2010 to be $389 billion higher each quarter than the average from 2003 through 2008, it also sees sales from issuers such as government agencies and companies to be $326 billion lower per quarter.
Demand from international investors has increased along with the sales. The government relies on foreign buyers to finance the budget deficit and almost 50 percent of the $6.6 trillion in marketable Treasuries are held outside the country, up from 35 percent in 2000, U.S. figures show. Indirect bidders, a class of investors that includes central banks, purchased 67.2 percent of the record $27 billion in seven-year notes sold on June 25, or double the amount of bids at the previous sale in May, according to the Treasury.
The ratio was the highest since 2004 on the sale of $37 billion in five-year notes the day before, while the $40 billion in two-year notes auctioned on June 23 attracted the highest percentage of indirect bids for that maturity in at least six years. "U.S. short-term to middle-term securities are attractive because the market is pricing in a rate hike," said Masataka Horii, one of four managers for the $47 billion Kokusai Global Sovereign Open fund in Tokyo. "But I think the U.S. will keep its zero-rate policy."
International buyers increased their Treasury holdings by 7 percent through May to $3.29 trillion, while China, the biggest lender to the U.S., raised its holdings to $801.5 billion. Two-year notes are the only U.S. coupon securities to earn money for investors this year because of speculation the Fed won’t raise its target rate for overnight loans between banks from a range of zero to 0.25 percent.
The notes have returned 0.33 percent, including reinvested interest, according to Merrill Lynch indexes. Five-year notes lost 2.86 percent and 10-year securities are down 9.92 percent. "What Bernanke said is positive for the bond market," said Michael Cheah, who manages $2 billion in bonds at SunAmerica Asset Management in Jersey City, New Jersey. "Demand should be good because bond investors should take away from Bernanke being very specific that the Federal Reserve is committed to keeping short-term interest rates low."
I'll be Britain's hate figure, says top Tory Philip Hammond
Prepare for rapid post-election budget and deep spending cuts
David Cameron may be forced to stage a rapid post-election budget to calm the markets and prevent a drop in Britain's credit rating in the first days of a Tory government, Philip Hammond, the shadow Treasury chief secretary, warns in a Guardian interview today. Anticipating an era of deep short-term cuts in public spending, Hammond urges voters to give the Conservatives a big majority so a new government can act boldly to cut the public debt, warning that the public finances are in such a state "the worst outcome for Britain would be an unclear political result at the election".
Hammond, destined to be the man to rein in public spending if the Tories gain power, also concedes he is "likely to become a great figure to pin up on the dartboard, and throw darts at. I am sure there will be short-term pain and brickbats." But he argues: "It is absolutely not the case that people in the public services are dreading this, or saying 'oh my God, what is going to happen?' " He claims civil servants are preparing to make cuts without waiting for instructions from on high. "There is a sense of liberation that we are going to empower public sector professionals to undertake the reform."
Setting out Tory ideas, Hammond discloses there will have to be a budget either soon after a spring election, or in the autumn, so the Conservatives can start to rein in public spending next year. He warns that Britain's credit-worthiness could be downgraded, pushing the economy into crisis. Such a move, which has been threatened by the international credit rating agency Standard and Poor's, would make it much more expensive to pay back the national debt, which this week reached a record £799bn.
He said: "We have got this Damocles' sword of Standard and Poor's hanging over us, with the commitment they have made to review Britain's credit rating in the summer of 2010 after the general election. Everybody in Britain has a vital interest in ensuring that the triple A credit rating agency is maintained." "It is absolutely essential that we send a signal to the markets that we have a credible plan to resolve the fiscal crisis and the debt crisis over a sensible period time," he says.
He warns that it would be dangerous to assume the government could do whatever it likes without getting a market reaction. Implying that the Tories will regard it as necessary to hold an emergency budget, he says: "I think the markets will expect to see early action because we have made it clear that we will start the process in 2010 whereas Labour has said it won't start the process until 2011-12. Early action adds credibility." Hammond was speaking as the latest economic figures publishedtoday showed worse than expected second quarter growth figures, with a fall of 0.8%, worse than the consensus forecast of a 0.3% fall.
His remarks come after analysis for the Guardian, carried out by the Institute for Fiscal Studies, showed that Britain would face spending cuts of more than 16% to key public services if Labour and the Tories live up to their pledge of protecting schools, hospitals and defence. He said one of the first tasks of an incoming Treasury team, in examining when to hold the special budget will be the reaction of the markets, and whether the economy is "going to get anywhere near" the government's forecast of 3.5 % growth in 2011.
Hammond also discloses that the Conservatives may try to speed up the Labour timetable to reduce the deficit, and intends to place most of the burden for that deficit reduction on spending cuts, because the current level of projected debt in relation to GDP – about 56% – is unsustainable. He also says he is worried that there are not enough civil servants in Whitehall with experience of cutting services. "There are a lot of civil servants in key posts who have never had to deal with the spending restraint … likely to be required now," he says.
He also rejects growing right wing calls to drop David Cameron's pledge that the NHS budget will be protected from cuts and rise at least in line with inflation. He admits that he had come to the issue of ring-fencing the NHS budget as a sceptic on the basis that a lot of money had gone in and productivity had fallen. But he said:"The pressure of demography is so inexorable that the NHS is going to struggle to deliver the kind of service people expect even with modest real terms increases in budgets."
Iceland's krona proves the magic wand as Europe ails
Iceland's krona is working its magic cure. Well-heeled Japanese tourists – once a rarity – can be seen these days sampling halibut at Reykjavik's Siggi Hall, or buying Gymur jackets at the 66°North store on Bankastraeti. The krona has fallen by half against the euro since the `New Viking' trio of Landsbanki, Glitnir, and Kaupthing strayed out of their depth and brought down Iceland's financial system. Nothing is cheap, but prices have come within reach. Reykjavik's cafés are packed with euro-youth, at last able to afford a taste of all-night dancing at this Arctic Ibiza.
Out in Iceland's Eastern fjords, Alcoa has raised aluminium production to record levels – and metal matters as much as fish for exports. "The smelters are running full speed," said the new-broom finance minister, Steingrimur Sigfusson. So is Mr Sigfusson himself. Last week he launched three new banks on the ruins of the old. Normality is returning. "We are going to get through this better than feared. We're feeling real activity in the economy, and much of this comes from a favourable exchange rate," said Mr Sigfusson.
Iceland's great lurch towards casino capitalism over the last decade has a cultural logic. "We are a fishing culture: when the herring is there, we take it," said Andri Snaer Magnason, author of `Dreamland: A Self-Help Manual for a Frightened Nation'. There was no easier catch on offer than the Greenspan bubble and the global "carry trade". How could fishermen resist? In one sense it was a terrifying shock for the 310,000 inhabitants of this Norse-Celtic outpost of lava rock to see their currency, banks, and global image crash in a single week last autumn. Yet nothing has really changed.
"Everything still feels normal. The services of the state are intact. The swimming pool is open. You can still have a decent heart attack in Iceland," said Mr Magnason. "Friends who lost jobs in banking have already found new work, and you could say the krona has worked as a buffer for us. We all went down together, and that has led to healthier recession without mass unemployment." The jobless rate has risen to 9.1pc. This is below the eurozone average of 9.5pc, and is stabilising much earlier.
Those who point to Iceland as a scarecrow exhibit of what happens to a small country caught in a financial storm without the shield of euro membership have the matter backwards, as will become ever clearer over the next two years. The OECD expects Iceland's economy to shrink 7pc this year. This is much better than Ireland at minus 9.8pc, and recovery will come sooner. So next time you hear the Sacra Congregatio of the euro faith incant yet again that EMU saved Ireland from a terrible fate, know that they deceive only themselves.
You take your punishment early with devaluation, as Britain did on leaving Gold in 1931, or ending the D-mark torture in 1992, or now. You look a sorry sight at first, but sweet vindication comes later. It is those caught in a deflation trap with fixed exchange rates that face slow asphyxiation, and deeper social damage. Youth unemployment is already 34pc in Spain, 28pc in Latvia, 25pc in Italy, 24pc in Greece, and rising.
At Iceland's central bank – mercifully, no longer listed beside al Qaeda as a terrorist body by UK authorities – Governor Svein Harald Oygard says currency therapy is working as it should. "If you lean back and look you can see that fall of the krona accentuated the shock at first, but it is also now working as a turbocharger for recovery. "We've seen a strong hit on wealth and asset values, but the story for real economy is very different."
Devaluation is always double-edged. Some 13pc of households in Iceland hold mortgages in euros, Swiss francs, or God forbid, yen. Their debt levels doubled overnight.
Some 70pc of corporate loans are in foreign currencies. Exporters are hedged. Those that earn in krona are not, and a "large number" are now in dire straits. The Governor is a Norwegian who cut his teeth in the Oslo banking crisis of the early 1990s. He was brought in as a troubleshooter after the last crew was literally banged out of the Sedlabanki by the Saucepan Revolution in February. With justifiable pride, he showed me the latest trade figures. Iceland has defied the global shipping crash to eke out an 11pc rise in exports over the last year. Even China has seen a fall of 21pc.
Iceland will be back in surplus by next year, from a peak deficit of 25pc of GDP. You could say the same about Latvia, which has stuck to its euro peg under orders from Brussels. But there is a big difference. Latvia is balancing its books by crushing demand. Exports are down 28pc, but imports are down even more. The result of this Stone Age policy is economic contraction of 18pc this year, and 4pc in 2010 (state data). Icelanders have taken a hit, of course. Unions have accepted 'real' wage cuts of 10pc. Health care and welfare is being cut 5pc, education 7pc, and the rest 10pc. This is comparable to what is happening in Ireland, but again there is a difference. Dublin faces a Sysphean task as collapsing tax revenues force ever deeper austerity: Reykjavik is over the worst.
It baffles me why rating agencies still talk of downgrading Iceland's debt to junk. The country should emerge with public debt of 80pc to 100pc of GDP – much like Britain. Yet Iceland also has the world's best-funded pension system at 120pc of GDP. It is the two together that counts. In their angst, Icelanders look wistfully at the apparent safe port of EU membership. The Althingi has voted to start entry talks. But the storm will have blown over well before an EU referendum is held in two or three years. By then the delayed cluster bomb of Europe's unemployment will have detonated. Try selling EU protection then.
Why you should still avoid banks
Chancellor Alistair Darling is trying to put the frighteners on banking bosses today. "You lot just aren’t lending enough," he’ll say at today’s meeting at the Treasury. "You know how we gave you all that taxpayers’ money to bail you out? Well, now we want you to lend it back to the taxpayers." A bank boss with a modicum of back bone might put up his hand at this point, and say: "But wasn’t it unquestioning, reckless lending, done without consideration of the risks involved, which got us into this mess in the first place?"
But instead they’ll probably make various reassuring noises, then run back to their boardrooms, and continue to hoard money. Why? Because bankers might be self-interested, but they’re not stupid. They know that there’s a whole lot more pain coming down the line. And the taxpayer may not feel flush enough to bail them out next time.
The sub-prime crisis and the housing crisis have all been raked over and kicked around in the media for years now. But these aren’t the only problems threatening banks’ balance sheets – not by a long chalk. As this morning’s Financial Times flags up, credit card debt is the next big issue to face banks around the world – notably the British banking sector. This is already a big problem in the States. The International Monetary Fund reckons that of the $1,914bn in outstanding US consumer debt, 14% will go bad. For Europe, meanwhile, the IMF reckons that 7% of the outstanding $2,647bn in consumer debt will go bad.
And in Europe, Britain’s the country that’ll bear the brunt of that pain. The British owe far more as a proportion of income (currently at a record high of more than 170%, compared to just over 100% in the early 1990s recession) than any other European nation. And in fact, despite their reputation as consumption machines, the Americans can’t hold a candle to us either. Their personal debt ‘only’ clocks in at around 140% of income.
In the US, credit card default is already at record highs and rising. Losses on credit cards, at 10.8%, are already higher than the current unemployment rate of 9.5%. That’s highly unusual – as the FT points out, "credit card loss rates have in the past closely tracked unemployment, topping the jobless rate on just a handful of occasions". So this puts the US in uncharted territory, as far as how high defaults could end up going. And the worry is that we’ll face something similar over here.
Enjoying this article? Sign up for our free daily email, Money Morning, to receive intelligent investment advice every weekday. On top of that, there’s the little question of securitisation. That’s right – it wasn’t just packages of mortgages that were sliced and diced and sold onto investors and banks across the world. Our credit cards got chopped and spliced into little morsels of prime and not-so-prime debt as well.
In other words, as the FT puts it, "if this highly leveraged recession does lead to record levels of credit defaults, it will not just be the banks that suffer." In Britain, analysts reckon about a third of credit card debt was securitised, while in the US, it was two thirds. So pension funds and insurers who bought said debt, will feel the pain as well. The threat from growing credit card debt – not to mention the ongoing danger from souring mortgages and commercial property loans – is just another reason why we’re still avoiding the banking sector, and most financials on a more general basis.
There are just too many unknowns out there that could easily derail any recovery. Having the government so heavily involved in the sector is also a problem. If banks are forced to lend, or to cut interest rates against their better judgement, then it’ll be even harder for them to claw their way back to health.
Loans by U.S. Banks Shrink Amid Lingering Economic Fears
Lending continues to slow as bankers and borrowers refrain from taking risks, in a bearish sign for the economy. The total amount of loans held by 15 large U.S. banks shrank by 2.8% in the second quarter, and more than half of the loan volume in April and May came from refinancing mortgages and renewing credit to businesses, not new loans, an analysis by The Wall Street Journal shows. The numbers underscore two related trends weighing on the economy. Financial institutions are clamping down on lending to conserve capital as a cushion against mounting loan losses. And loan demand is falling as companies shelve expansion plans and consumers trim spending to ride out the recession.
That combination is making it harder for the U.S. economy to rebound, and some analysts predict that loan portfolios won't start growing until the second half of 2010. "I think it is good for banks if we continue to be prudent as an industry and not reach to get loan growth by reducing our underwriting," Richard Davis, chief executive of U.S. Bancorp, said last week. The Minneapolis regional bank's overall loan portfolio declined 1.2% to $182 billion from March to June, despite issuing $16 billion of mortgages. Most of the mortgages came from refinancing existing loans.
The loan figures reviewed by the Journal include giants such as J.P. Morgan Chase & Co., Bank of America Corp. and Citigroup Inc., as well as regional banks such as Fifth Third Bancorp, based in Cincinnati, and Regions Financial Corp., of Birmingham, Ala. The 15 banks hold 47% of federally insured deposits and got $182.5 billion in taxpayer-funded capital infusions through the Troubled Asset Relief Program. As of June 30, the banks had $4.2 trillion of loans on their balance sheets, down from $4.3 trillion as of March 31.
Loan portfolios shrank at 13 of the big banks, with the steepest decline at Comerica Inc., Dallas, where the loan total was down 4.3% to $46.6 billion in the latest quarter. Just $1.6 billion of the $10.2 billion in credit extended by Comerica in the second quarter came from new commitments. A bank spokesman said many borrowers "are being cautious." Bank of America, Charlotte, N.C., reported its loan portfolio slipped 3.6% to $942.2 billion in the second quarter. A spokesman for the largest U.S. bank by assets said the decrease reflects higher loan losses and lower loan demand as borrowers pay off outstanding debts. "There were fewer opportunities to make high-quality loans because of the recession," he added.
Some borrowers complain banks aren't trying hard enough to expand credit. Ernie Cambo, a principal with Miami real-estate developer CPF Investment Group, had to halt work earlier this year on a 2.5-million-square-foot project called Ave Aviation and Commerce Center because he couldn't line up financing beyond the initial phases. Now he isn't certain he will be able to find bank financing for a planned $4 million building for a South Florida auto auctioneer, despite having a signed lease. "You will find no more frustrated borrower than me right now," said Mr. Cambo, 39 years old. "I am growing in this downturn, and I can't get any incremental debt."
The slow pace of lending has created political heat for the Obama administration. On Friday, Rep. Spencer Bachus (R., Ala.) pressed Treasury Secretary Timothy Geithner to "tell me why we didn't really see that multiplier effect" from banks funneling their TARP money into lots of loans. "I think you did," Mr. Geithner responded. Each dollar of taxpayer-funded capital gave banks $8 to $12 of lending capacity, and the initial $200 billion infusion by the Bush administration prevented a decline of more than $1 trillion in the overall loan supply, the Treasury secretary said.
Supporters of the bank bailout concede that lending has dipped, but note that the program wasn't meant to expand loan volume, but rather to prevent a collapse -- and has succeeded on that score. Richard Neiman, a member of the committee formed by Congress to assess the effectiveness of TARP, said in an interview that "you need to be cautious in reading too much into these numbers." Congress intended to "stabilize the financial markets," he added, and there "is no specific reference to increasing lending" in the rescue-program legislation that was signed into law last year.
The 15 banks reported about $803 billion in loan volume in the second quarter, up 12.7% from the first quarter. But nearly 60% of the increase in April and May came from refinancing mortgages and renewing business loans, according to data Treasury collected from the banks. In contrast, new home purchases accounted for just 23% of all mortgage loans. May is the latest month for which the government's figures are available. At BB&T Corp., of Winston-Salem, N.C., a surge in mortgage refinancing fueled the regional bank's increase of 0.1% in the size of its overall loan portfolio, which hit $100.3 billion as of June 30. Mortgage lending "is really booming," CEO Kelly King said, but loan growth slowed in May and June, "especially in the commercial area."
Banking analysts said the fact that less than half of loan volume is coming from new loans shows how far the economy still has to go to dig out of the recession. "You are looking for net new loans in the marketplace to be a signal of true change, and we have not seen that yet," said Christopher Marinac, research director at FIG Partners in Atlanta. "You've got to have fewer people paying down loans...and you've got to get banks to loosen underwriting standards," said RBC Capital Markets analyst Gerard Cassidy. "That is when you will see loan balances in the U.S. banking system expand from where they are today. When that happens, you will see the economy really start to blossom."
On a year-over-year basis, total loans held by the 15 big banks rose 17% from $3.6 trillion in 2008's second quarter. The increase was skewed by the impact of acquisitions that included J.P. Morgan's takeover of the banking operations of Washington Mutual Inc. and Wachovia Corp.'s purchase by Wells Fargo & Co. Excluding purchases, loan portfolios shrank by about 10% as of June 30 from a year earlier. The figures are a strong but imperfect indicator of loan activity. For example, loans sold to other institutions aren't counted on a bank's balance sheet at the end of the quarter. Since the financial crisis erupted, though, sales of loans have withered.
Credit card crisis to grip Britain, IMF warns
Britain’s credit card debt crisis will get significantly worse in the coming months with a wave of consumer payment defaults, the International Monetary Fund has warned. The organisation expects £1.5bn of consumer debt across Europe will not be repaid, much of it in Britain which has the highest number of credit card borrowers on the continent. Analysts say failure to pay credit card bills is likely to increase as unemployment rises and the number of personal insolvencies, which reached 29,774 in the first quarter of the year, continues to rise.
The IMF said the crisis would echo the problems already felt in the United States, where it expects 14 per cent of the country’s £1.16bn credit card debt to go unpaid this year, the Financial Times reported. The newspaper said National Debtline, the UK charity, had received 41,000 calls in May about loans, credit cards and mortgage arrears – double the number it received in the same month last year. In the United States, credit card defaults have been rising for months as a sharp rise in unemployment takes its toll on overstretched consumers. Barclays, Britain’s biggest credit card lender, said in May that overdue payments or defaults had risen in the first three months of this year.
Europe braced for rising credit card defaults
Lenders in Europe bracing themselves for a rising wave of consumer debt defaults as the credit card crisis that has caused billions of dollars in losses among US banks spreads across the Atlantic. The International Monetary Fund estimates that of US consumer debt totalling $1,914bn, about 14 per cent will turn sour. It expects that 7 per cent of the $2,467bn of consumer debt in Europe will be lost, with much of that falling in the UK, the continent’s biggest nation of credit card borrowers.
National Debtline of the UK said that the number of calls it had received from UK consumers worried about loans, credit cards and mortgage arrears had reached 41,000 in May – double the 20,000 calls it had received in May 2008. It added that the number of calls showed no sign of abating. In the US, credit card defaults have been rising for months as a spike in unemployment and the most severe economic downturn since the Great Depression took their toll on overstretched consumers.
Banks such as Citigroup, Bank of America, JPMorgan Chase and Wells Fargo and credit card issuers such as American Express have suffered billions of dollars in losses in their credit card portfolios and have warned of more to come. The rate of US credit card losses has overtaken the rate of unemployment in recent months – a highly unusual occurrence that makes it more difficult for card issuers to forecast future losses. In the UK, the latest credit card indices from Moody’s, the ratings agency, show that annualised charge-off rates have risen from 6.4 per cent of loans in May 2008 to 9.37 per cent in May 2009. In the US, that rate is above 10 per cent.
Analysts expect further defaults as UK unemployment rises and personal insolvencies, which reached 29,774 in the first quarter of the year, continue to increase. The falling UK housing market and more stringent lending requirements by banks has also meant that indebted consumers can now no longer rely on withdrawing equity from their homes to pay off other debts such as credit cards or unsecured loans. Jonathan Pierce, analyst at Credit Suisse, said in a recent note that UK credit card securitisation had suffered "a very sharp rise in arrears to a level well beyond the previous peak seen in 2006".
UK banks, which begin reporting their first-half results next week, have already warned that they faced a sharp increase in credit card debts, although this is relatively small in the context of writedowns in other areas such as commercial lending. Barclays, the UK’s biggest credit card lender with 11.7m UK customers through Barclaycard, said in May that UK credit card delinquencies had increased in the first quarter of the year, reflecting adverse economic conditions and rising unemployment.
As a result it had been reducing credit limits and tightening approval rates for new credit cards which were running at less than 50 per cent in March. Lloyds Banking Group also said in May it had seen impairments rise in both secured and unsecured lending. Lloyds will have to absorb any future losses on credit cards itself as it has not been able to include credit card loans among the £260bn of toxic assets it has insured with the UK government.
With UK trends tending to trail the US by six months, analysts will be in particular watching the reporting season closely for any signs that default rates on UK securitised credit card debt is rising. The severity of the financial crisis coupled with rising unemployment on both sides of the Atlantic have stoked fears of a substantially higher default rate in the coming months.
How the cards are cut
Mick Longfellow is teetering on the edge of financial chaos. A dedicated teacher married to an equally hard-working nurse, living in a modest house in Newcastle in the north-east of England, the pair spent the past decade treating themselves to gadgets, gizmos and home upgrades. They put in new windows. They bought the biggest television and sound system their living room could accommodate. They changed their cars every year or two. With two children to spoil as well, they were living on credit – lots of it. There were store cards, car loans, personal loans and credit cards.
Now, amid the recession, those lenders want their money back. "The bank just closed down our overdraft. That was the killer blow," says Mr Longfellow. But with the family’s debts running to £30,000 ($49,200, €34,600), far more than their annual disposable income, repayment is going to take a very long time. It is a sad blow for the Longfellows. But multiply one family’s debts by the millions of people across the world who are in an even worse state, losing jobs and homes, and the scale of the problem is clear. Estimates from the International Monetary Fund say that of US consumer debt totalling $1,914bn (£1,166bn, €1,346bn), 14 per cent will turn bad. For Europe, it expects 7 per cent of the $2,467bn of consumer debt will be lost, with much of that falling in the UK, the continent’s biggest nation of borrowers.
In the US, the carnage is well under way. For nearly two years, banks ranging from giants such as Citigroup to small community lenders have been bleeding as the economic downturn caused "maxed out" consumers to fall behind on their repayments of credit cards, automotive loans, student loans and other once-plentiful forms of credit.
In recent months, what started as a debacle has turned into a nightmare. As unemployment continued to rise and house prices kept falling, the rate of defaults has surpassed historic norms, rendering many of the computer models used by US banks to predict losses useless. In this phase of the crisis, lenders are flying blind. "We are asking boards of financial institutions to sit down, think about plausible nightmare scenarios and then take measures to deal with them," says Peter Niculescu, a former executive at Fannie Mae, the US mortgage institution, who is now a partner at Capital Market Risk Advisors, a financial consultancy.
America’s story makes a frightening read for banks on the other side of the Atlantic. The question now is what happens next in Europe, particularly in the UK, the continent’s biggest consumer lending market, where concrete signs of mass stress have so far been less obvious. "In the UK, particularly, we haven’t seen a lot of discussion about [consumer debt default]," says Nathan Powell, head of financial sector research at RiskMetrics, a credit data group. "There has been a focus on banks’ capital, liquidity and their mortgage exposure."
With much of the world in recession, the banking industry has been girding itself for some time against the threat – in recessions banks expect to make losses on loans. But some experts worry whether banks active in Europe, many of which have been rejuvenated by a quick bounce-back in their investment banking operations in the first half of the year, are yet taking sufficient account of the damage that their consumer loan books could yet wreak on profits.
"Proponents of a V-shaped [economic] recovery are underestimating how much rising unemployment and an unstable structure of indebtedness can lengthen and deepen this recession," says Sandy Chen, banks analyst at Panmure Gordon in London. Historic norms suggest that unsecured consumer loans default at a rate of less than 5 per cent in periods of recession. Although for credit cards the rate is higher, at 7 to 9 per cent, companies charge heftier interest rates to offset the increased risk of default.
But this is no ordinary recession – and no one can agree how bad it is going to get. Some economists argue that the worst may already be over but many believe in a "double-dip" downturn, with another fall-off in demand likely to come later this year. Whether or not that happens, the effects of the first dip are still filtering through to the real world. Unemployment is still rising – and fast – on both sides of the Atlantic. More than 9 per cent of working-age Americans are now without work, nearly double the year-ago figure, and the UK unemployment tally is at 7.6 per cent. There are widespread expectations that both numbers could soon exceed 10 per cent – and joblessness, unsurprisingly, is the biggest driver of consumer loan default.
The real unknown, however, is to what extent a recession already on a par with the 1930s will be turned into something even worse by record levels of consumer debt. British consumers’ leverage – how much they owe as a proportion of income – has been rising fast for a decade and for the past nine months has been running at a record high of more than 170 per cent – far bigger than anywhere else in Europe. In the US, the percentages have been rising too, and are hovering around the 140 per cent mark. In the last recession, of the early 1990s, UK leverage was barely more than 100 per cent and in the US it was less than 90 per cent. "The severity of this crisis has taken everyone by surprise," says Mr Powell at RiskMetrics. "Delinquencies and charge-offs [the percentage of outstanding loans that is unlikely to be recouped] are deteriorating at a faster rate than anyone expected a year ago."
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Industry executives in Europe are beginning to sound like their US counterparts in raising the alarm about spiralling losses on unsecured consumer debt as one of their biggest areas of concern. "We think the market in general is far too optimistic about the outlook for unsecured consumer debt defaults," says Antonio Horta-Osorio, chief executive of Abbey, the UK business of Spain’s Santander. "We have been actively reducing our exposure to consumer lending, so that it is now half the size it was three years ago."
The US experience is showing the way. "It started in subprime mortgages, then it moved to prime mortgages, then to car financing," says Mark Greene, chief executive of Fico, the US credit checking group. "Now it’s moving to credit cards." Over the past 18 months, US banks and card issuers have been coping with the fallout of millions of overleveraged consumers defaulting on an increasing portion of their unsecured debt. Loss rates on credit cards have almost tripled since January 2007 as soaring unemployment, housing woes and the stock market’s troubles prompted an ever-increasing number of borrowers to stop paying their balances.
Perhaps more worryingly, the long-held relationship between credit card loss rates and unemployment is breaking down. Credit card loss rates have in the past closely tracked unemployment, topping the jobless rate on just a handful of occasions, and only once by any significant margin. That was in 2005 as a flood of borrowers entered bankruptcy and wrote off their credit card debt before the passage of a law that made it harder to file for bankruptcy. But in this recession, job redundancies have been compounded by other sources of distress to push credit card losses higher. Losses on US credit cards as measured by Moody’s credit card index were at a record of close to 10.8 per cent in June, ahead of the nation’s 9.5 per cent unemployment rate.
As the recession has deepened, meanwhile, bankruptcy filings are once more approaching 2005 levels, fuelling the credit card meltdown. For some banks, losses on credit cards have been severe for months. Credit card loans originated by Washington Mutual, the troubled bank bought by JPMorgan Chase last September, are defaulting at a staggering rate of 24 per cent. Bank of America’s June charge-offs were close to 14 per cent and delinquencies – loans that have not been paid – were 1.9 per cent, exceeding the totals for Citigroup, JPMorgan, American Express, Capital One and Discover. If average charge-off rates reach 18 to 20 per cent, credit card losses for US issuers could exceed $82bn, the Federal Reserve said in May after stress tests on 19 large lenders.
Such losses are proving to be a problem even in cases where the banks thought they had offlaid the risk. Banks such as Citigroup, JPMorgan Chase and Bank of America have had to come to the rescue of the off-balance-sheet vehicles that help them to fund credit card loans, as these vehicles have been weakened by consumer defaults. In Britain, banks argue that they have been more prudent than peers elsewhere, owing to the scare of mass defaults four years ago after the law was changed to make personal bankruptcy via Individual Voluntary Arrangements far easier. That prompted the biggest lenders – Barclays, Lloyds, Royal Bank of Scotland, HBOS (now part of Lloyds) and HSBC – to toughen their criteria for lending: they lent less, and only to people with decent credit records.
But what the banks do not point out is how many of them then let their standards slip at a crucial time. Just ahead of the financial crisis, in 2007, the big five banks (now the big four) started an aggressive expansion of their lending. Barclays is typical – after tempering its consumer lending in 2006, for example, it expanded it from less than £38bn to more than £53bn over the next two years. That kind of expansion at Lloyds and RBS has compounded those groups’ balance sheet woes. When the UK banks start reporting their six-monthly results early next month, they will give some idea of how bad those bad debts are turning out to be. They are already planning for default rates at the top end of historic levels.
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One of the best insights into the likely patterns in consumer debt defaults comes from the niche world of credit card securitisations – where the performance data of a second-hand package of a bank’s credit card "receivables", or credit repayments, are published monthly. The so-called Master Trusts of US credit card debt show default rates running at 9 to 18 per cent, up by 50 to 100 per cent over the past year, with most of the rise coming since the start of 2009. With UK trends tending to trail the US by six months, analysts are now watching closely for signs that British securitisations, with default rates running at a relatively stable 7 to 14 per cent, start rising.
The focus on the securitisation data is a stark reminder, too, that it if this highly leveraged recession does lead to record levels of credit defaults, it will not just be the banks that suffer. Analysts estimate that in the UK close to one-third – and in the US about two-thirds – of consumer debt has historically been securitised. If those packages of debt turn bad – or even worse than they had already been reckoned to be – that would hit the investors that are holding them hard.
Some of those investors will be investment banks – compounding the impact of the core lending losses to which their commercial banking rivals (or sister operations) are already exposed. In other cases, the pain will be even more broadly felt, says Huw van Steenis, analyst at Morgan Stanley. "I think the bigger holders now of securitisations are insurance companies and pension funds." For families such as the Longfellows, with retirement looming in the next decade, that threatens to be the real sting in the tail.
Credit card lenders have been backed into a legal as well as financial corner as a result of the economic crisis, writes Saskia Scholtes. Banks’ profligacy during the consumer lending boom, combined with the scale of the subsequent collapse, ignited popular anger and this year spurred the passage of strict new regulations for the US industry.
Lenders hoping to raise their defences against record high default rates and growing unemployment would normally raise interest rates for the riskiest credit card borrowers. But by next February, credit card lending laws mean this will be much harder to do. Banks such as Citigroup, Bank of America and JPMorgan Chase and monoline credit card lenders including American Express have therefore tried to pre-empt the new rules by raising rates now.
Citigroup, for example, has sharply increased interest rates on up to 15m US credit card accounts in recent months, largely on cards it co-brands with retailers such as Sears. Such private label credit cards have historically had some of the highest default rates. Banks say such moves are necessary to cushion losses but they acknowledge that it could push some borrowers over the edge. In the long term, banks say the restrictions will reduce credit availability and raise the cost of credit for all borrowers. "If we can’t raise rates for the guy that overspends and always pays late, then we have to charge everyone more to make up for the risk – that means higher rates for the guy that always pays his bill on time too," says one disgruntled credit card banker.
Jamie Dimon, JPMorgan Chase’s chief executive, this month hit out at the new rules, saying they will cost the bank’s card unit up to $700m (£426m, €492m) next year. While JPMorgan supported most of the reforms introduced by the US government in the wake of the crisis, he said, some of the "fast and furious" regulatory activity had gone "a little bit too far". Nevertheless, for some consumer activists, the rules restricting arbitrary and excessive credit card fees have done little to quell complaints among consumers that they are being gouged by credit card issuers.
Protesters descended on Wall Street last week as part of a multi-city campaign to bring back anti-usury laws. They are calling for a national interest rate cap of 10 per cent for credit cards and other types of consumer loans. Similar actions took place in Washington, Boston, Chicago and London. The groups that organised the event, dubbed "10 per cent is enough", have also sent letters demanding meetings with the chief executives of Wells Fargo, Citigroup, Bank of America, Capital One, Discover and JPMorgan Chase.
SEC rule on 'naked' short-selling now permanent
Federal regulators on Monday made permanent an emergency rule aimed at reducing abusive short-selling, put in at the height of last fall's market turmoil. The Securities and Exchange Commission announced that it took the action on the rule targeting so-called "naked" short-selling, which was due to expire Friday. Short-sellers bet against a stock. They generally borrow a company's shares, sell them, and then buy them when the stock falls and return them to the lender -- pocketing the difference in price.
"Naked" short-selling occurs when sellers don't even borrow the shares before selling them, and then look to cover positions sometime after the sale. The SEC rule includes a requirement that brokers must promptly buy or borrow securities to deliver on a short sale. At the same time, the SEC has been considering several new approaches to reining in rushes of regular short-selling that also can cause dramatic plunges in stock prices.
Investors and lawmakers have been clamoring for the SEC to put new brakes on trading moves they say worsened the market's downturn starting last fall. SEC Chairman Mary Schapiro has said she is making the issue a priority.
The five SEC commissioners voted in April to put forward for public comment five alternative short-selling plans. One option is restoring a Depression-era rule that prohibits short sellers from making their trades until a stock ticks at least one penny above its previous trading price. The goal of the so-called uptick rule is to prevent selling sprees that feed upon themselves -- actions that battered the stocks of banks and other companies over the last year. Another approach would ban short-selling for the rest of the trading session in a stock that declines by 10 percent or more.
In addition to making the "naked" short-selling rule permanent, the SEC and its staff are working with major stock exchanges to make data on short-sale transactions and volumes publicly available through the exchanges' Web sites, the SEC announcement said. It will result in "a substantial increase" over the amount of information currently required, the agency said. "Today's actions demonstrate the (SEC's) determination to address short-selling abuses while at the same time increasing public disclosure of short-selling activities that affect our markets," Schapiro said in a statement.
U.S. Pay Czar to Rework Contracts Deemed High
The U.S. pay czar, now preparing to vet the compensation at businesses receiving major federal aid, will push to renegotiate contracts that he views as excessive or seek other ways to reduce overall outlays, said people familiar with the matter. The role of the government in setting pay is reaching a pivotal moment. Seven banks and industrial companies that received significant bailouts must submit proposals for their compensation packages by Aug. 13.: Treasury Department official Kenneth Feinberg, who has authority to oversee pay for the 100 highest-paid employees at those companies, has been meeting regularly with the seven firms to help them fix a level and structure of compensation that the government deems proper, say industry and U.S. officials.
With public anger high over the rich pay packages awarded to some financial executives, Mr. Feinberg must walk a fine line between curbing pay at companies benefiting from taxpayer funds while not squeezing compensation so hard that it hurts the ability of companies to lure talent. None of the firms have yet submitted their proposed pay packages. GMAC has proposed to Mr. Feinberg that it be able to pay its top people a mix of 20% cash and 80% stock, according to a person familiar with the situation.
Dealing with contracts is arguably among the trickiest issues facing Mr. Feinberg and the firms he oversees. Companies are legally allowed to enter into guaranteed pay arrangements. But there is little appetite among lawmakers for giving large payouts to employees at firms receiving taxpayer-funded bailouts. A furor erupted earlier this year after the Obama administration allowed AIG, which has received several government lifelines, to pay bonuses that the firm said it was contractually obligated to make.
Mr. Feinberg can't rip up legal contracts. But he is expected to push firms and employees to renegotiate payments he deems too high, said people familiar with the Treasury's plans. If that can't be done, they said, Mr. Feinberg is expected to factor the amount of a contract into an employee's overall pay and use that calculation to bring down total compensation. For instance, if an employee were legally guaranteed a $1 million bonus for 2009, Mr. Feinberg might subtract that amount from the employee's 2009 base salary, or cut the employee's future pay to compensate for that amount.
One of the first tests facing him Mr. Feinberg is what to do if Citigroup seeks to honor its profit-sharing contract with a top energy trader, Andrew J. Hall, that could pay out as much as $100 million for 2009. Mr. Hall, head of Citigroup's energy-trading unit, Phibro LLC, and Citi are in talks about a possible divestment of Phibro, as previously reported. If that deal happens, the question of Mr. Hall's pay might be moot. It is unclear how Mr. Feinberg would rule on Mr. Hall's case. Citigroup hasn't yet submitted his or any other employee's compensation package for review. If Mr. Feinberg deems Mr. Hall's pay excessive, he would likely try to get Citigroup to lower the amount. If that isn't possible, Mr. Feinberg might apply that $100 million towards Mr. Hall's future earnings.
"Companies will need to convince Mr. Feinberg that they have struck the right balance to discourage excessive risk-taking and reward performance for their top executives," said Andrew Williams, a Treasury Department spokesman. A Citigroup spokeswoman said: "Citi continues to examine ways to ensure its employee-compensation practices are competitive in this very challenging market environment." A spokesman for GM said the company "has every intention of complying" with the government's executive-pay guidelines. A GMAC spokeswoman said, "Attracting and retaining key talent is critical toward continuing our efforts to transform the company and restore profitability."
A spokeswoman for Chrysler Financial said, "We continue to work with Special Master, Kenneth R. Feinberg, on corporate executive compensation, to seek advice and input with regard to our compensation plans." A GMAC spokeswoman said, "Attracting and retaining key talent is critical toward continuing our efforts to transform the company and restore profitability." A representatives of Bank of America had no comment. A Chrysler spokesman wasn't able to provide immediate comment.
Mr. Feinberg holds enormous power over the subset of firms he oversees under the bailout, formally known as the Troubled Asset Relief Program. He must approve or reject compensation for the most highly paid employees and oversee the structure of each firm's compensation. Among the things he will examine is whether a firm's compensation rewards risk, is comparable to that of peers and is tied to long-term performance. His decisions aren't subject to appeal, and he is operating largely independent of the Treasury Department. Mr. Feinberg, an attorney, isn't receiving government compensation for his work.
Legal experts said Mr. Feinberg's power, combined with the opprobrium a firm may suffer if it is perceived as making excessive payouts, could give the government leverage. "Mr. Feinberg can certainly put all types of informal pressure on firms to get them to renegotiate," said John Olson, a partner with Gibson, Dunn & Crutcher LLP, in Washington, D.C. Even before Mr. Feinberg was appointed, the government pushed AIG to reduce some of its planned bonus payments. A spokeswoman for AIG declined to comment.
Several firms receiving TARP funds have been using compensation contracts to attract employees. With so much uncertainty surrounding TARP, financial firms say they need to promise certain levels of pay to attract top talent and prevent skilled workers from going to work at non-TARP firms. Many firms, such as Goldman Sachs and J.P. Morgan Chase & Co., have returned TARP funds, freeing them from government restrictions. TARP puts restrictions on how recipients can compensate employees. Bonuses must be capped at no more than one-third of total compensation and payable only in restricted stock. Employment contracts signed before Feb. 11, 2009, are exempt.
Citi 'milestone' as Washington takes 34% stake
The US government is poised to take a 34 per cent stake in Citigroup, increasing both its exposure to and influence over the troubled financial group following yesterday's completion of a long-awaited $58bn share offering. The move is a milestone in a financial crisis that has forced the US authorities to come to the rescue of some of the largest institutions in the country. Citi has been a repeated recipient of government aid and is the only large surviving bank to have had to cede a shareholding to the government.
Citi announced last night that virtually all of the non-government holders of preferred shares had agreed to convert them into common stock, a move that will pave the way for the government to complete the exchange of its $25bn of preferred shares in the next few days. The outcome was expected as Citi had made it financially unpalatable for preferred shareholders to refuse to convert their stakes into common shares. The offer - part of Citi's latest bail-out - is aimed at giving the bank enough capital to rebuild its fortunes and absorb further losses caused by the financial crisis.
The government has indicated that, in spite of becoming Citi's single largest shareholder, it would take a hands-off approach and not take up any board seats. Nevertheless, Citi has been under close regulatory scrutiny and is operating under tighter controls than most other banks. The US government, which has injected $45bn into Citi since the beginning of the crisis, still has warrants that give it the right to buy a further $20bn of shares in the bank.
Vikram Pandit, Citi's chief executive, said in a statement that the completion of the exchange was a "milestone" that would give the bank new "financial strength". After the offering, Citi will have $100bn in tangible common equity - a measure of the strength of its balance sheet. But the conversion of $58bn of preferred shares held by sovereign wealth funds, institutional investors and the government, would force Citi to issue billions of new common shares. That, in turn, will dilute the value of the shares held by existing shareholders and depress the value of its earnings per share - the metric used by analysts to measure a company's profitability.
Citi has revamped its board partly in response to pressure from the Federal Deposit Insurance Corporation, one of its regulators. The bank has appointed eight new members to its board, including three last week.
Citi swings axe to restructure Italian business
Citigroup is looking to sell – or failing that, to close – its private banking business in Italy and is to reduce its presence in the country by about half. The move, part of the US banking group’s global restructuring programme, is expected to see the number of people employed in Italy fall from 1,000 to about 500 by the end of this year, with most of the job losses coming in its Italian consumer finance business. That unit, which has 65 branches round the country, is being closed.
Citigroup’s scaling down in Italy represents a dramatic shift in policy for the bank, which expanded rapidly round the world in the past decade. But it is consistent with its strategy of shrinking its balance sheet and divesting itself of non-core assets as it tries to revive its fortunes after suffering billions of dollars of losses during the global financial crisis. Citigroup has held talks with Banco Santander of Spain, among others, about selling its Italian private business, which has assets of about €2bn ($2.8bn) under management and is considered too small to be competitive. If the bank cannot find a buyer, it is expected to close the unit.
Once the restructuring has been completed, Citigroup’s business in Italy will be concentrated on corporate and investment banking and global transaction services. Two years ago it sold its retail banking unit to Credem, an Italian bank. Citigroup has also sold its Milan headquarters, in a sale and leaseback deal. Sergio Ascolani, Citigroup’s head of banking in Italy, told the Financial Times: "It’s absolutely rational, with current markets, to exit from businesses that are marginal and invest in areas where Citi is globally strong."
He added: "We’re not exiting Italy, just rationalising here." Citigroup is one of the chief casualties of the global financial crisis and is under intense pressure to restructure and shrink after using hundreds of billions of US taxpayer dollars to prop itself up. It is expected to finalise the sale of a 34 per cent stake to the US government as part of its latest bail-out.
In January, Citigroup placed $650bn-worth of non-core assets and businesses into a separate division with a view to selling them or winding them down. The new unit, called Citi Holdings, includes the bank’s US consumer finance operations, about half of its credit card business and most of the toxic mortgage-backed securities that caused most of Citi’s losses. On Friday, Citi created a special board committee to oversee Citi Holdings and monitor the disposal of its assets.
Bernanke's protests on too-big-to-fail ring hollow
Like any politician, it seems Federal Reserve Chairman Ben Bernanke is prone to saying one thing when he's on the hustings and doing another thing when he's back inside the Washington Beltway. A case in point is the issue of too-big-to-fail banks roaming the American economy. Bernanke was asked about this issue more than any other during his town hall meeting on Sunday night with citizens of Kansas City.
The Fed chairman went to Kansas City to assure the average Americans that the economy was on the mend and the central bank was on top of the situation. But going through decades of endless debate and little action over the too-big-to-fail question didn't fit with that strategy. "The problem we have is that in a financial crisis if you let the big firms collapse in a disorderly way, they'll bring down the whole system," Bernanke told the meeting. "When the elephant falls down, all the grass gets crushed as well," Bernanke added. He said he had to "hold his nose" to rescue such institutions during this crisis. As a result, Bernanke said it was his "top priority" to fix the issue of too-big-to-fail.
But Burt Ely, an expert on banking regulation, does not see that sense of urgency from the central bank or the White House. The Obama administration's reform of Wall Street regulation, which is backed by Bernanke on almost all points, basically sidesteps the issue of too-big-to-fail, argues Ely. The plan would put extra requirements on the capital and activities of firms found to be too-big-to-fail. It would also put in place a new resolution program between bailout and bankruptcy where the government can come in and seize the firm and unwind it in an orderly way.
The Fed's top expert on the subject, Gary Stern, the president of the Minneapolis Federal Reserve Bank, said he was disappointed in the approach taken by Treasury, calling it "status quo plus." "The Treasury proposal fails to come to grips with too-big-to-fail and therefore leaves the financial system considerably more vulnerable than it needs to be to future bouts of instability," Stern said in a speech earlier this month. "There is little reason to think that these steps will, individually or collectively, succeed in reining in too-big-to-fail effectively over time because they do not change the incentives which create the problem. In fact, there is nothing in the Treasury proposal designed to put creditors of large, systemically important financial institutions at risk of loss," Stern said.
Stern wants the government to insist that it will not bail out uninsured creditors of the biggest firms. This will make risk more expensive. In turn, banks won't be able to take on excessive amounts. Ely said the Fed and other banking regulators have flubbed the issue for decades and major questions remain in the wake of Bernanke's handling of the recent crisis. "It was all ad hoc, and precedents have now been set," Ely said. Experts still debate why the government let Lehman Brothers fail after a buyer was found for Bear Stearns.
Even in the aftermath of the crisis, regulators are still reluctant to identify which firms are too-big-to-fail, Ely said. "How far does it extend -- to firms like GE Capital and insurance companies? Does it include domestic operations of foreign banks?" Ely asked. Ely advocates a solution where big financial firms are required to find a series of voluntary guarantors who would agree to provide - for a fee -- unlimited equity should a firm exhaust its supply. Ely said he was never able to make any headway with his argument until the recent crisis hit. "People are coming toward me," Ely said. "We're not going to get rid of these big financial institutions. We're stuck with these big monsters," Ely said.
'Cash-For-Clunkers' Plan Attracts 16,000 Auto Dealers
Almost 16,000 U.S. auto dealers have applied to participate in the "cash-for-clunkers" vehicle trade-in program, or about 80 percent of the nation’s new- vehicle retailers, Transportation Secretary Ray LaHood said. The government is trying to help jump-start slumping auto sales through the program, giving consumers new-vehicle credits of as much as $4,500 for turning in older cars. "We’re very excited about the tremendous interest in this program," LaHood said today at a news conference to outline the program. "We think it’s going to turn into a good news story for many communities that have been hit hard by the recession."
Sales of cars and light trucks in 2008 fell to 13.2 million, after averaging more than 16 million a year during this decade, and General Motors Co. and Chrysler Group LLC are working to restore demand after emerging from bankruptcy. There were about 19,000 U.S. dealers at the end of June, according to the National Automobile Dealers Association. The Transportation Department has processed 15,893 dealer applications, LaHood said. The law took effect on July 1, and the U.S. published rules for the program July 24. LaHood said his agency has received 45,000 phone calls from people asking about the program.
President Barack Obama signed the clunkers program into law June 24 after Congress approved it the previous week as part of legislation to finance the Iraq and Afghanistan wars. The $1 billion in federal subsidies may spark 250,000 new car sales, U.S. lawmakers have said. They’re betting the clunkers effort will help spur purchases by consumers who weren’t otherwise in the market for a new car. John Bailey, 26, said he traded in a car two days ago for a new Chevrolet Cobalt. Bailey, of Manassas, Virginia, said he wouldn’t have traded in his 1994 Oldsmobile had it not been for the cash-for-clunkers plan.
"It’s a great incentive for consumers," said Bailey, who works in the shipping and receiving department of a semiconductor manufacturer. Cash for clunkers will end Nov. 1 or when the $1 billion in subsidies expire, whichever occurs first. Congress must decide later this year whether to approve legislation extending it into 2010.
"With the tremendous public interest leading up to today, we anticipate that the $1 billion in funding for the cash for clunkers program will go quickly," John McEleney, chairman of the McLean, Virginia-based National Automobile Dealers Association, said in a statement today. Representatives Sander Levin of Michigan and Betty Sutton of Ohio, both Democrats, said at the press conference that they may try to extend the program if the initial allotment is exhausted swiftly.
China's Power at Issue in High-Level U.S. Talks
Climate change, protectionism fears, and questions about how China navigates its rise as a global economic power will dominate the agenda on Monday, July 27, when the Obama Administration resumes a senior-level U.S.-China economic dialogue initiated in the Bush Administration. But few experts expect any serious progress on the main issues separating the two economic giants.
Led by Secretary of State Hillary Clinton and Treasury Secretary Timothy Geithner, the U.S. will continue to press China during the two-day meetings to turn its economy away from a reliance on exports and more toward domestic consumption. Washington will push Beijing for a joint approach to climate change and to allow its currency to appreciate. On the Chinese side, Vice Premier Wang Qishan will push again for assurances that the U.S. is making a priority of curbing inflation in order to safeguard the value of Beijing's $1.5 trillion in U.S.-denominated reserves. Co-heading the Chinese delegation will be State Councilor Dai Bingguo.
In a briefing with reporters, senior Obama Administration officials suggested that they are not expecting a breakthrough at the Strategic & Economic Dialogue, or SED. Yet experts say the process of the two countries simply meeting, talking, and agreeing—even if vaguely on a senior level—is a value in itself in terms of smoothing frictions. "The SED is all about warm and fuzzy feelings and verbal assurances that China won't switch out of dollars, which they can't do anyway [on a significant scale], and assurances that the U.S. and China will do everything they can to fight protectionism," said Michael Pettis, a professor of finance at Peking University.
The summit comes two months after Geithner traveled to Beijing and adopted a low-key tone with the Chinese compared with the blunter style of George W. Bush Treasury Secretary Hank Paulson. Paulson initiated the dialogue in 2005, but the Obama Administration is seeking to give China more of a stake in the outcome of broad global issues by adding Clinton, along with political issues such as North Korea, Iran, terrorism, and nuclear proliferation. The shift to a joint economic-political agenda accompanies a diplomatically far more assertive China during the financial crisis, which has fixed attention on Beijing's enormous new role in the global economy.
One subtext of the talks is a U.S. attempt to synchronize economic recovery policies and a conclusion in Washington that the U.S. economy has permanently shifted—and that China's economy must change with it. The Administration specifically wants Beijing to temper its reliance on U.S. consumption for China's economic growth. There has been a fundamental change in the U.S. economy, said a senior Obama Administration official in the briefing with reporters: "Household savings is up, and we are not going back to the way it was in 2006 and 2007. They need to prepare for a new U.S. and global economy."
As they have in previous discussions, the Chinese have signaled that they are worried about the inflationary impact of enormous U.S. budget deficits. "I believe the Chinese delegation, especially Vice Premier Wang Qishan, will explicitly raise the hope that the U.S. should make responsible economic policies, including financial and monetary policies, to maintain stability of the dollar and safeguard the safety of China's assets," said Zhu Guangyao, China's assistant finance minister, in a Beijing news conference last week. Zhu said: "China hopes the dialogue could further the negotiation of a bilateral agreement on investment protection, which is still under way."
Accusations of trade protectionism will be a key subject of the talks as well. The Chinese are seeking assurances that its companies won't be blocked as they pursue investments abroad. Last week the Chinese made explicit what has been apparent for some time: Beijing intends to use its enormous reserves of cash to buy up foreign commercial assets. The Chinese call this policy "going out" and say they plan to accelerate it. "We should hasten the implementation of our going out strategy and combine the utilization of foreign exchange reserves with the going out of our enterprises," said Chinese Premier Wen Jiabao.
A senior Obama Administration official said the U.S. side will make clear that Washington is open to Chinese investment. But, illustrating that jobs and foreign investment are sensitive U.S. domestic political issues, the official repeated at least twice that while Washington welcomes Chinese investment, national security is nonnegotiable. Recently, the U.S. and the much of the rest of the world have sought trade redress by China more aggressively than they did in previous years.
According to a study released on July 23 by Brandeis University economics professor Chad Bown, China was the most frequent target of new World Trade Organization investigations in the second quarter of this year. It was named in 19 of 23 new investigations of products, the report said. In the same period, Chinese exporters were a target in every one of 17 WTO anti-dumping punishments regarding products. "I believe China especially is quite worried about rising protectionism against its exporters—not only from the U.S. but from the entire WTO membership," Bown said.
Threat of Unemployment
Are markets taking too rosy a view of unemployment? Unemployment is usually seen as a lagging rather than leading economic indicator: In the last two U.S. downturns, firms continued shedding jobs for months after the recession was officially over. Typically, companies only start hiring in earnest once a recovery is clearly under way. But this time, unemployment may play a bigger role in determining the timing and shape of recovery.
True, the markets are currently betting the old orthodoxy still holds sway. Unemployment has climbed quickly. The U.S. rate hit 9.5% in June, higher than any point since 1983, and up from 5.6% a year earlier, one of the steepest annual rises on record. In the euro zone, May's 9.5% unemployment rate was the highest in 10 years. The Organization for Economic Cooperation and Development forecasts rates of 10% in the U.S. and more than 12% in the euro zone in 2010. But that has not stopped equity markets from rallying strongly, amid growing hopes of a recovery this year.
That's partly because job losses and other cost cuts have provided a cushion for corporate profits: 82% of the S&P 500 companies to report so far have beaten second-quarter earnings expectations. The snag is that only 50% have beaten sales targets, as Deutsche Bank points out. For the moment, earnings are only being held up by costs shrinking faster than revenue. For a true recovery, sales need to start growing too. Rising unemployment may make that harder to achieve.
First, the flipside of improved corporate profits is real financial and consumer pain. U.S. credit card bad debt, for example, is rising faster than unemployment. Annualized write-offs of securitized credit card debt hit a record 10.8% in June, according to Moody's. The agency expects that to rise to 12% to 13% in mid-2010. In Europe, Fitch's U.K. credit card charge-off index hit a record high of 9% in April. Historically, investors have assumed that a one percentage point increase in unemployment will lead to a one percentage point increase in bad credit card debt. But the pace of job losses and levels of debt means nobody is confident previous correlations will hold. Similarly, rising unemployment could also hit house prices again, causing further turmoil for mortgage-backed securities.
Meanwhile, high unemployment is also likely to weigh on consumer sentiment. Nearly 60% of U.S. consumers expect high unemployment to persist over the next several years, the University of Michigan reported Friday. That could shape behavior: Federal Reserve Chairman Ben Bernanke warned last week that unemployment could weigh on consumer spending. Continued pressure on sales could be a further impetus for companies to cut costs and jobs, leading to more losses on consumer debt.
The danger of a lost generation
For the first time in three generations, Americans across the nation are facing the threat of long-term unemployment. Already more than one in four jobless Americans have now been out of work for more than six months, the highest level since records began in 1948. For both individuals and national economies, long-term joblessness has proved to be extremely corrosive. Skills atrophy after extended periods of enforced indolence. Then, when an economy recovers, these workers are no longer in a position to fill new jobs.
As a result the potential maximum speed at which the economy can grow declines, and the workers themselves come to be seen as "damaged goods." Those unlucky enough to be graduating in 2009 may find that their salaries never match those of similarly qualified peers who finished in 2006. To his great credit, President Obama has been quick to spot the danger. Under the administration’s stimulus package, the unemployed can now claim benefits well beyond the standard six months. In some badly afflicted states, insurance will last up to a year and a half.
The government is also offering $4 billion in funds to retrain workers. Tax breaks in the package aim to make it more affordable for young people to sit out the recession in school. Another $12 billion for community colleges has the same goal. Yet even this heroic effort may be too little, too late for many Americans. The closest analogy to America’s current unemployment crisis is probably Japan. Here too was a nation accustomed to minimal long-term joblessness. In Japan the lost decade produced a lost generation.
Faced with a "hiring ice age," graduates settled for lower status or temporary jobs. By the time companies were in the mood to hire again in bulk around 2007, they chose fresh graduates. Many of Japan’s thirtysomethings never caught up. A multitude of academic papers suggest that an early bout of long-term unemployment can have an even more pernicious result. According to a recent study by Tom Mroz at Clemson University, a six-month spell of unemployment at the age of 22 tended to reduce wages the following year by eight percent.
More worryingly, almost 10 years later these workers were still paid about three percent less than their peers, even controlling for education, region and personal characteristics. Other studies have shown an even more powerful hit, with wages still about 10 percent lower five years after the initial period of joblessness. "Youth unemployment creates permanent scars rather than temporary blemishes," says Dartmouth Professor David Blanchflower. An unfortunately timed demographic bulge means that there will be an unusually large number finishing school over coming years. For more experienced workers, there is a risk of permanent displacement from the labor force. This risk is especially great for workers in financial services — an industry that is unlikely to grow back to its peak size any time soon.
This is a problem that few nations have ever had much success in combating. Even before the latest economic crisis struck, half of the jobless in Germany and Italy had been out of work for more than 12 months. Japan, too, has had trouble bringing its long-term jobless rate down. "Getting a job during the crisis in most countries is becoming an even more daunting challenge," said Stefano Scarpetta, head of employment at the Organization for Economic Cooperation and Development.
The United States may have better luck thanks to the flexibility of its labor market. Still, Obama has been right to focus heavily on training. Even if the skills learned in community colleges prove to be useless, avoiding a damaging period of inactivity may offer value for money for taxpayers in the long run. For many, the best way to avoid being damaged by a weak job market will be to stay out of it.
Eastern Europe Faces Threat of More Defaults
Eastern European economies face a rise in nonperforming loans and corporate defaults severe enough to destabilize their already shaky banking systems, the European Bank for Reconstruction and Development warned Friday. EBRD President Thomas Mirow warned former communist bloc countries of a possible second wave of financial crisis, according to the text of his speech in Vienna marking the 20th anniversary of the fall of the Iron Curtain.
The warning came as Latvia, a prominent casualty of the region's financial turmoil, stepped up efforts to deliver reforms requested by the International Monetary Fund. Latvian Prime Minister Vladis Dombrovskis said Friday he has told his cabinet to look for $1 billion in cuts to next year's budget. That is a reduction of 10.7% from 2009 spending, according to Ieva Aile, communications head at the prime minister's office. Nonperforming loans are rising across the EBRD countries and have doubled in the past year in Turkey, Romania, Ukraine and Albania, according to the EBRD. Recent data from national central banks show commercial banks in Romania are no longer collecting interest on more than 8% of the loans they've extended, and the figure is nearing 5% in Turkey, where credit cards are already defaulting at a double-digit pace.
"The immediate challenges we face are a severe rise in nonperforming loans and possible corporate defaults, resulting in rising unemployment, knock-on effects on other companies and on bank balance sheets," said Mr. Mirow. Many of the once fast-growing ex-communist economies lately have been hit by collapsing demand and vanishing foreign investment flows, leaving large foreign-currency debts and current-account deficits. Already, many have turned to the IMF in the crisis, which so far has toppled governments in Latvia, Hungary and Bulgaria.
To prevent a recurrence, Mr. Mirow said Eastern European countries need to restructure private debt, reduce foreign-exchange exposure and adequately capitalize banks. He cautioned that, although the region's economies have stabilized in recent months, the impact of the "unprecedented market crisis" still poses major risks. "This is a severe challenge which we must not underestimate, neither economically nor politically, and we must not allow a sense of complacency to take hold," he said. In Latvia, Mr. Dombrovskis' directive comes just a month after the Riga government agreed to cut spending for this year by the same amount to keep international aid flowing in.
When more grain equals fewer nutrients
Since the Green Revolution of the 1960s, the world has produced a lot more grain—but there may be a lot less in it, a unique experiment in the United Kingdom has revealed. Recent analysis of 160 years of crop samples from Rothamsted Research Station near London discovered that levels of essential micronutrients remained consistent in wheat grain from 1844 to the late 1960s, but then began a decline that continues to this day.
The nutrient decline began when traditional long-straw wheat varieties where phased out in favour of higher-yielding semi-dwarf varieties. As wheat plants have grown smaller since the 1960s, grain nutrient density has continued to decrease. Compared to the old long-straw varieties, Rothamsted’s modern dwarf wheat grain carries on average 20-30 per cent less zinc, iron, copper and magnesium. For zinc, a critical human nutrient, the decline is even more pronounced if the most recent five years of data are compared, with average nutrient levels in wheat harvested from 1844-1967.
The Rothamsted work supports a United States Department of Agriculture study, published in 2006, that compared nutrient levels in hard red winter wheat varieties grown from 1873 to 2000. The US Department of Agriculture (USDA) researchers found that compared to 130 years ago, modern varieties deliver 36 per cent less selenium, 34 per cent less zinc and 28 per cent less iron in their grain. Nutrient decline in food is a driving force behind the organic farming sector, on the assumption that high-tech agricultural methods have depleted the mineral levels in soils and thus made less available for plants to take up.
But at Rothamsted, it seems that soil is not the issue. The research project used the soil and grain archives of the research station’s 166-year-old Broadbalk experiment, the longest-running agricultural experiment in the world. The Broadbalk wheat plots were established in 1843, and were laid out to compare the relative performance of wheat fertilised with inorganic fertilisers, farmyard manure, and wheat given no treatment at all. Nutrient declines in grain have occurred across all these treatments to a similar degree—but mineral levels in the soil have either remained stable or increased.
Concentrations of zinc in the treated Broadbalk soils have increased 40-60 per cent since 1860, and yet zinc densities in grain have declined more than any other measured nutrient. "We can’t put it down to soil impoverishment, so my guess is that the nutrient decline is related to plant physiology," said Rothamsted researcher Professor Steve McGrath. That presents three possible areas for further research. One is that in selecting for dwarf plant genes, breeders have inadvertently dwarfed root mass and made the plant less capable of foraging for nutrients.
Another possibility arises if micronutrients are relocated from vegetative material into growing grain. "If the vegetative mass is smaller, it may mean there is less ability to translocate micronutrients into the grain," Prof. McGrath said. "The third possibility is dilution. The grain is bigger, the grain yield is larger than old varieties; is it just that less mobile micronutrients are just not catching up with grain production so you get a dilution effect?"
That answer isn’t likely to emerge anytime soon. Prof. McGrath said there has been little apparent interest in the finding, and making a case for further research in a restricted funding environment is a long and complicated process with no guarantee of success. However, he understands that micronutrient deficiency, zinc and iron in particular, are implicated in health problems across the developed and developing worlds alike.
"People are suffering growth, health and effects on mental development from lack of zinc and iron," he said. Dr Carole Hungerford, author of the Australian medical nutrition textbook "Good Health in the 21st Century", wrote that zinc is an essential nutrient for fertility, bone and joint health and immunity. It is also essential for the structural integrity of the DNA molecule, which has led some researchers to speculate that zinc deficiency may contribute to cancer.