Girls outside movie house in Amite City, Louisiana
Ilargi: No, we're not getting into today’s home prices data. Well, maybe just to say that Business Week made it two days in a row with a happy note in the morning and a more realistic one in the afternoon. I guess that way they can claim to always be right. No, prices didn't rise, says BW. In fact, they went down. Just not by a lot:
.... seasonally adjusted prices fell just 0.16% from the previous month.
That's still real different from all other headlines, including their own morning line. But let's leave that stuff alone.
Today's best story for me comes from Elizabeth MacDonald at FOX, who spells out how there are hundreds of billions of dollars being drawn, quartered, drowned and smothered to death at General Electric, all of which the US taxpayer, who else, will have to cough up. The insane ways in which its "banking unit" GE Capital, an insane sort of company to begin with, was contorted in order to make sure its sticky hands and wide open beak were best positioned to gobble up public funds, is a sight to behold.
Everybody talks about Gold in Sacks these days, but GE is just as much a cornerstone in America's taxpayer subsidized corporations. Not that they're not just very happy to play under the radar for now. Count them in for a few hundred billion in losses, easily. They'll be announced when you're not counting. And be honest, who is these days?
I’ll leave you with a series of direct quotes, and don't worry, you won’t be the only one whose eyes hurt after reading through them.
• GE Capital was launched in 1932 to help finance its parent’s industrial operations.
• GE chief executive Jeffrey Immelt now sits on the Obama administration’s economic advisory board.
• Earnings at GE Capital plummeted 80% in the second quarter, triggering a 47% plunge in GE’s overall profits.
• GE now says GE Capital faces $34.4 billion in pretax losses and impairments over the next two years....
• Some $270 billion has been torched, immolated out of GE’s market capitalization since 2008....
• GE’s shares hit a 17-year low earlier this year.
• GE let its finance unit dangerously bulk up on all sorts of bad assets during the bubble years, including commercial real estate, $230 billion or so (GE is one of the world’s largest commercial lenders), as well as $183 billion in consumer finance assets (including private label credit cards), and all sort of other assets coming from distressed markets such as the UK and Eastern Europe...
• GE first shocked Wall Street in April 2008 when it missed its earnings estimates by a country mile, with the finance unit’s losses in tow. Ever since, GE has been racing to pare down GE Capital’s $635.5 billion balance sheet to $400 billion. GE chief executive Immelt has also been steadily jawboning lower the company’s profit targets, and vows to cut GE Capital’s profit share of the parent’s earnings down to 30% from 55% in 2007. The market itself is helping Immelt keep to that promise.
• GE Capital has about $81 billion in long-term debt maturing by the end of 2009, and of that, $43 billion came due June 30.
• Last fall [..] GE and its coterie of lawyers descended on Washington to get banking regulators to let GE and its sick finance unit in the door in the taxpayer bailout programs. GE did so by delivering a tortured reading of a 1991 law enacted after the S&L crisis.
The law had to do with stopping “systemic risk” and although GE does not own a bank, it instead owns two small thrifts. Though the thrifts represent just 3% of its overall assets, GE rammed itself through this giant loophole hooked wider by its lawyers.
• ... GE won access to the FDIC debt guarantee program, nearly 40%, it’s estimated, of which represent backstops for GE Capital. GE gets to insure a maximum $126 billion of its debt through this program–already GE is the single biggest corporate user of this FDIC debt insurance.
• If companies can’t take this ocean of water onto their balance sheets when this FDIC insurance expires 2012, then the FDIC, meaning, the US taxpayer must. Already, the FDIC has insured an estimated $340 billion in this program....
• GE also accesses the Federal Reserve’s commercial paper backstop, a maximum $98 billion there ...
• And its footnote disclosures show it may access the Fed’s TALF program, whereby it gets government help for its securitizations of tens of billions of dollars worth of all sorts of assets on its balance sheet, with another $55 billion or so now sitting warehoused in Enron-style off balance sheet vehicles.
• However, GE Capital is not subject to the Fed’s stress tests, nor is it subject to the Fed’s rules for limiting risk, nor is it subject to government limits on executive compensation.
• A look at its balance sheet should also trigger serious concern. GE has $572.8 billion in liabilities and $635.5 billion in assets teetering atop a razor-thin $32.9 billion in tangible common equity....
• To some analysts on Wall Street, GE Capital appears levered up like any run of the mill, overextended hedge fund.
• And here’s one of its most glaring, fire-engine red flags: GE Capital also has $203.2 billion borrowings coming due in the next four years, about two-thirds of the company’s total debt.
Tiny Home-Price Drop is Best News Yet
You won't find it in the July 28 press release from Standard & Poor's, or in most news reports, for that matter. But the most encouraging statistic from the Standard & Poor's Case-Shiller 20-City Composite Home Price Index report released on July 28 is that in May, seasonally adjusted prices fell just 0.16% from the previous month.
That minuscule monthly change works out to an annual rate of decline of a little under 2%. That's a huge improvement considering that from last September through March, the index was falling at an annual rate of more than 20%. S&P's press release, and most news reports, focused on the unadjusted prices, comparing them with a year earlier and noting that the rate of decline had slowed.
Even some longtime bears were impressed by the data. Economist David Rosenberg of Gluskin Sheff & Associates in Toronto wrote, "now this is a green shoot!"
To be sure, this is not definitive evidence that the housing bust is over. Prices, and sales volumes, could still take another tumble. For one thing, the $8,000 federal tax credit for first-time homebuyers expires in November. More important, the number of home foreclosures is continuing to mount, adding supply to the market at the same time that sales of new and existing homes remove supply. As long as the unemployment rate is around double digits, there will be downward pressure on the housing market.
You have to dig a little bit for the seasonally adjusted data, by the way. It's here on the S&P Web site. (S&P, like BusinessWeek, is owned by The McGraw-Hill Companies.)
The raw, unadjusted index actually showed a price increase from April to May, but that's not the right number to focus on because prices typically rise from April to May—a fact that The Wall Street Journal's Web site missed in its article headlined "Home Prices Post Monthly Increase."
"Recession's Over, Recovery Underway": What's Missing in Action
by Charles Hugh Smith
The mainstream media is gleefully hyping "the recession is over, the recovery is underway." Nice, except for everything that's missing in action.
"The recession is over, the recovery is underway." Exactly what will be driving this fabulous "recovery"? Let's check in on the usual forces which have powered previous recoveries:
1. Autos/vehicles: missing in action (MIA). Annual sales have plummeted from 17 million vehicles a year to about 9 million a year, and the U.S. probably contains about 30 million surplus/lightly used vehicles ( a number snagged from economist David Rosenberg's latest report). Modern vehicles can easily last 15-20 year, so the "need" to replace vehicles is rather low. Actual "necessary" replacement might require as few as 5 million vehiclesa year.
With unemployment at 16%, assets down by $10 trillion and the FIRE economy (finance, real estate and insurance) in disarray, where does anyone think the consumer borrowing firepower will come from to finance an extra 8 million vehicles a year?
2. Housing/real estate: missing in action (MIA). Let's see: new home sales down from 1.4 million a year to 350,000 a year and the headlines are screaming "recovery in housing" even as house prices are down 50% from the bubble peak andstill declining. The Case-Shiller index just came in at a year-over-year decline of 17% and the market is cheering because it's a few tenths of a percent "better than expected."
The U.S. has 18.7 million vacant homes and even if you bulldoze a couple million in shrinking rust-belt cities we still have 16.7 million vacant dwellings, plus thousands more foolishly being constructed every year.
Furniture sales and auctions of old furniture are in the ditch; ditto draperies, carpeting, hardwood flooring, etc. etc., much of which is still manufactured in the U.S. No wonder the manufacturing sector is still contracting as well.
The bubble in commercial real estate has yet to pop but the needle is currently being inserted into the balloon. Too many malls, too many strip malls, too many office towers, too many CRE buildings everywhere.
3. FIRE economy: missing in action (MIA). Finance, real estate and insurance were the boomtown industries in the housing bubble. They're diminished and will never come back; the consumer must save now to avoid a retirement in a cardboard box, flipping houses for profits is history and people are paying off debt, not churning new loans.
4. Healthcare: missing in action (MIA). Everybody and their brother has been touting healthcare as the "growth industry" but since it already consumes 17% of the entire U.S. GDP, there's very little oxygen left. The ever-expanding entitlements of Medicare and Medicaid are actually being trimmed, and those 15 million people who have lost their jobs and/or benefits can't go to the doctor and have their insurance carrier billed $10,000 any more. Healthcare has peaked and a growing shareof the government's revenues will be going to pay interest on the ballooning national debt, not expanding healthcare. Any other view is fantasy; the interest on the debt is already $400 billion a year and interest rates haven't even started rising.
5. Education: missing in action (MIA).This is the other highly touted "always expanding" jobs factory. Tell that to the thousands of teachers, janitors, and administrators being laid off as local government tax revenues crater. And people are finally waking up to the unfortunate fact that private diploma mills are not actually offering much of an edge in the real world; in fact, neither are pricey private universities.
When it comes time to create your own job, nobody cares about your diploma--they only want value and results. The current crop of graduates may be in some sort of elevated state of denial--i.e. believing the job drought will end next year--but the old ploy ofgoing back to graduate school to wait out the recession may not work unless you're getting a graduate degree in stem cell research or network security. In any event, education is no longer the "guaranteed job factory" because funding for all local government functions is being slashed.
6. Local government: missing in action (MIA). The same can be said for government itself, which continued to add tens of thousands of jobs even as the recession began slashing and burning the private sector economy. The reductions in local government headcount have yet to really kick in, as Federal stimulus funding is staving off cuts that would have resulted from plummeting tax revenues. All the stimulus has done is push the job cuts in state, county and city governments forward into 2010.
All three of these sectors--government, education and healthcare--expanded dramatically because tax revenues skyrocketed as a result of the bubble. For example, look at this chart of the total assessed value of Florida real estate 1990 to 2005: it tripled. Now think of all those luscious property taxes which gushed into local government coffers:
All those expecting unlimited growth in government, education and healthcare seem to forget that all these expanded as a result of the bubble in tax revenues derived from the bubble in credit, stock and bond markets and real estate.
7. Small business: missing in action (MIA).Small businesses are the real job engine of the economy, but unfortunately very few small businesses are expanding and anxious to hire more employees. The vast majority are still trying to stave off insolvency and are looking to cut more hours and staff positions. There simply is no alternative as the State (all levels of government) increases the tax load on small business even as they claim to "care about small business." True, in one way: they care the way parasites care about not killing the host outright but merely bleeding it to the point of near-death.
Unfortunately, the parasites misjudged and their host is expiring.
8. Domestic manufacturing: missing in action (MIA). While the manufacturing sector is still formidable in many areas, as we all know much has been shipped overseas for the basic, classic capitalist reason that the move increased profits stupendously. Now, however, a "recovery" or "export boom" in manufacturing cannot pull the entire economy any longer because the manufacturing sector has shrunk to such a small percentage of the overall economy.
9. Structural reform: missing in action (MIA).Instead of cleaning out the embezzlement, fraud, gaming, leverage, exploitation, obfuscation, etc. at the heart of the U.S. financial sector, the guilty have been rewarded with gargantuan bailouts and the innocent (taxpayers) punished. The public pension systems which boosted retirement benefits in the bubble years are heading for insolvency but rather than reform them the unions and political lackeys are shoving this reality under the rug lest various interest groups get angered.
Healthcare, a.k.a. sick-care, is in desperate need of deep structural reform but instead we are treated to a Kafka-esque nightmare charade in which another trillion dollars will be squandered "to save money later." The special interests have this "industry" in a chokehold and will only release their grip when the poor old system expires, as it most certainly will, and soon.
10. Strong dollar: missing in action (MIA). If the dollar loses half its current exchange value (as measured by the DXY Dollar Index) as many expect then the cost of all imports such as oil magically double. Thus we could see $130/barrel oil even as the price in gold or other currencies didn't move at all or actually became cheaper.
11. Collateral/borrowing power: missing in action (MIA). You've probably seen this chart or one like it recently:
With $10 trillion of assets down the drain and the entire economy maxed out on credit, where do economists expect new credit growth to come from? Martians with good credit landing and hurrying into Bank of America for loans?
12. Leadership: missing in action (MIA). We have few leaders in any sector, public or private; we have panderers to various special interests and voting blocs, similar to any run-of-the-mill Third World kleptocracy. To my knowledge only Ron Paul speaks to fundamental issues such as getting rid of the Federal Reserve and the failure of the entire Keynsian "intervention/manipulation of free markets to save them"project. Few speak to the end-state of all government dependent on credit bubbles for its growth and policy: insolvency.
Bashing Goldman Sachs Is Simply a Game for Fools
by Michael Lewis
From the moment I left Yale and started working for Goldman Sachs, I’ve felt uneasy interacting with those who don’t. It’s not that I think less of Goldman outsiders than I did while I remained among you. It’s just that I feel your envy, and know that nothing I can do or say will ever persuade you that I am no more than human. Thus, like many of my colleagues, I have adopted a strategy of never leaving Goldman Sachs, apart from a few brief, spasmodic attempts to make what you outsiders call “love” or “the beast with two backs.” Goldman recognizes how important it is for its people to replicate themselves. We bill no performance fees for the service.
Today, the sheer volume of irresponsible media commentary has forced us to reconsider our public-relations strategy. With every uptick in our share price it’s grown clearer that we who are inside Goldman Sachs must open a dialogue with you who are not. Not for our benefit, but for yours. America stands at a crossroads, and Goldman Sachs now owns both of them. In choosing which road to take, ordinary Americans must not be distracted by unproductive resentment toward the toll-takers. To that end we at Goldman Sachs would like to dispel several false and insidious rumors.
Rumor No. 1: “Goldman Sachs controls the U.S. government.”
Every time we hear the phrase “the United States of Goldman Sachs” we shake our heads in wonder. Every ninth-grader knows that the U.S. government consists of three branches. Goldman owns just one of these outright; the second we simply rent, and the third we have no interest in at all. (Note there isn’t a single former Goldman employee on the Supreme Court.) What small interest we maintain in the U.S. government is, we feel, in the public interest. Our current financial crisis has its roots in a single easily identifiable source: the envy others felt toward Goldman Sachs.
The bozos at Merrill Lynch, the dimwits at Citigroup, the nimrods at Lehman Brothers, the louts at Bear Stearns, even that momentarily useful lunatic Joe Cassano at AIG -- all of these people took risks that no non-Goldman person should ever take, in a pathetic attempt to replicate Goldman’s financial returns. For too long we have allowed others to emulate us. Now we are working productively with Treasury Secretary Tim Geithner and the Congress to ensure that we alone are allowed to take the sort of risks that might destroy the financial system.
Rumor No. 2: “When the U.S. government bailed out AIG, and paid off its gambling debts, it saved not AIG but Goldman Sachs.”
The charge isn’t merely insulting but ignorant. Less responsible journalists continue to bring up the $12.9 billion we received from AIG, as if that was some kind of big deal to us. But as our CFO David Viniar explained back in March, we were hedged. Our profits from AIG “rounded to zero.” People who don’t work at Goldman Sachs, of course, find this implausible: How could $12.9 billion round to zero? Easy, but you just need to understand the mathematics.
Let’s assume AIG transferred $12,880,560,250.34 of taxpayer money to Goldman Sachs. A Goldman outsider, asked to round this number, might call it $12,880,560,250.00. That’s not how we look at it; at Goldman we always round to the nearest $50 billion, so anything less than $25 billion rounds to zero. Think of it that way and you can see that $12,880,560,250.34 isn’t even close to not rounding to zero.
Rumor No. 3: “As the U.S. government will eat the losses if Goldman Sachs goes bust, Goldman Sachs shouldn’t be allowed to keep making these massive financial bets. At the very least the $11.4 billion Goldman Sachs already has set aside for employees in 2009 -- $386,429 a head, just for the first six months -- is unfair, as the U.S. taxpayer has borne so much of the risk of the wagers that generated the profits.”
Really, we don’t know where to begin with this one. It is wrong-headed in so many different ways! Let’s begin with the idea that the taxpayer is running a bigger risk than we are. The billions he stands to lose are trivial; after all, they round to zero. The real risk, when you think about it even for a minute, is the risk we take ourselves: that Goldman will cease to exist and we will cease to be Goldman employees. To flirt with such tragedy we obviously need to be paid.
Rumor No. 4: “Goldman employees all look alike.”
Several recent newspaper photos have revealed that a surprising number of Goldman Sachs workers are white, male and bald. That non-Goldman people glance at such photos and think “Holy crap, they even look alike!” just shows how deeply anti- Goldman bigotry runs in American life. We at Goldman represent unique clusters of DNA; if we bear some faint surface resemblance to one another, and to creatures from the 24th century, it is only because our superior powers of reasoning lead us to hold in our minds exactly the same thoughts, at exactly the same time.
A shared disinterest in growing hair, for instance, isn’t a coincidence of nature but an expression of healthy like- mindedness. “The world is a pool table,” our naked-headed CEO likes to tell us. “And all the people in it are either stripes or solids. You alone are the cue balls.”
Rumor No. 5: Goldman Sachs is “a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money.”
Those words are of course taken from a recent issue of Rolling Stone magazine and they are transparently false. For starters, the vampire squid doesn’t feed on human flesh. Ergo, no vampire squid would ever wrap itself around the face of humanity, except by accident. And nothing that happens at Goldman Sachs -- nothing that Goldman Sachs thinks, nothing that Goldman Sachs feels, nothing that Goldman Sachs does --ever happens by accident.
The Shadow Banking Pyramid
by Max Keiser
The current spate of fraud on Wall St., and specifically the front-running and market manipulation scams being committed by Wall St. banks on the floor of the NYSE and other market making venues, is finally getting some coverage This would be good news if it weren't meaningless.
Some background: I first started reporting on the rigged markets scandal in the U.S. and the U.K. five years ago in the pages of The Ecologist magazine in the U.K. I predicted that the unraveling of FannieMae and FreddieMac was all but certain due to obvious accounting fraud. I was one of many pointing out the blindingly obvious, but this information was kept out of view from the main stream America for fear it would frighten the sheep into cutting back on their leveraged speculation and consumption; using their homes like ATM machines.
In an economy dictated to by the unholy triangle of GE, CNBC, and Wall St., weapons, propaganda and lottery tickets, delusions (and fiat currencies) must be preserved. Talking about crooks on Wall St. has been a staple while co-hosting my radio show in London with Stacy Herbert on ResonanceFM 104.4, "The Truth About Markets." Week after week we forensically describe the workings of Wall St. frauds -- drawing on my experience as a former Wall St. trader and inventor of patented financial engineering technologies used on Wall St. today -- to explain how the scams are done in full view of the SEC and CFTC.
ResonanceFM is a musicians cooperative listened to primarily by bong smoking squatters in Shordditch who, by virtue of the fact that mainstream American and British media chose not to cover these crimes left open a niche for us to cover, have become preternaturally knowledgeable about fraudulent Collaterized Debt Obligations, Special Purpose Entity Accounts and High Frequency Trading Arbitrage. Many of these pot heads thank me today because many of them put their meager savings into gold bullion as we have been suggesting since 2002 -- which shot up 40% against the British Pound last year.
In 2006 I started making documentaries for Al Jazeera English. Death of the Dollar, Rigged Markets and Money Geyser explained, respectively, the structural weakness of the dollar, the structural weakness of the New York Stock Exchange, and the structural weakness of the global currency grid and in particular the currency and economy of Iceland. A year later, the Icelandic krona and the economy evaporated in a cloud of currency 'carry trade' ice and dust exactly as we predicted it would. In 2007 the sup-prime scandal and the controlled demolition of Bear Stearns and Lehman Brothers got under way thanks to the Washington-Wall St. revolving door that gave us the Goldman Sachs-Oval Office axis of insider trading, the S&L crash, the 1987 crash, the Long Term Capital Management (LTCM) crash, the crash of Drexal Burnham, Enron, WorldCom and the dot-com crash.
America has become the most corrupt empire in history and since the debts that caused each of these catastrophes was never paid off, but simply put off the balance sheet and traded in what Prime Minister Gordon Brown calls the 'Shadow Banking System' or to be more precise the Shadow Banking Pyramid, Americans can expect to live in the shadow of debt in perpetuity. America's debts are bigger than the entire GDP of the world, so unless the whole world decides to bail out America by gifting America 100 percent of their wages and profits for a year or more America can forget about ever digging its way out of the debt tomb.
In 2008 I produced and presented a series for BBC World News, The Oracle. For ten weeks I hammered away reporting on the rot that was threatening to take down America; the duplicitous spewings of Hank Paulson, Ben Bernanke, and Tim Geithner, as well as the parasitical machinations of the Fed, but I wasn't surprised when Congress appeased financial terrorists on Wall St. and coughed up 700 billion dollars in ransom at the end of last year to ensure payment of Goldman Sachs' bonus pool for 2008 and 2009.
This is why I do not believe that the main stream media's belated reporting on Wall St. scandals is meaningful. It's too late. Like the New York Times sitting on the Bush wire tap story until after the election of 2004, the story of banking buccaneers and vipers in the New York Times reads more like a requiem than a news story. The Egyptians had the great pyramids in the Valley of the Kings we have the great pyramids of debt created in the canyons of Wall St. These are now permanent features on the American and British financial landscape that have effectively turned Americans and Brits into debt slaves.
Wall Street on Speed
The New York Times recently reported that the latest scheme--or scam--on Wall Street is something called High Frequency Trading. Very sophisticated financial firms, such as Goldman Sachs, are tipped off by the New York Stock Exchange's own computers to pending buy and sell orders. Armed with ultra sophisticated computer algorithms, the insiders anticipate the direction of the market based on what they learn about supply and demand for a given security. They can make an extra penny here and an extra penny there at the expense of us suckers, adding up to billions.
"Nearly everyone on Wall Street is wondering how hedge funds and large banks like Goldman Sachs are making so much money so soon after the financial system nearly collapsed," wrote the Times' Charles Duhigg in a front page piece that was the talk of New York and Washington. "High-frequency trading is one answer." As debates in the blogosphere in the last couple of days have made clear, there are a couple of possibilities of what is at work here. One is that Goldman and others are literally using privileged information to make trades ahead of markets, in which case they are committing a felony.
Specifically, the abuse is known as "front-running," or trading ahead of customers, and it is an explicitly illegal form of market manipulation. Front running is epidemic on Wall Street--the whole point of an investment bank trading for its own account is to take advantage of its specialized knowledge of markets--and the SEC or the Justice Department shuts down front-running when it becomes too blatant to ignore. The other possibility is that the Goldmans of the world have found themselves a nice loophole. Tapping into the Stock Exchange's own computers and other sources of trading activity is something that anyone in theory could do, but only a few privileged insiders have the sophistication to exploit what they find. Often orders are placed, only to be cancelled. Their purpose is to figure out what the market is willing to pay, and then get in ahead of it.
But suppose that High Frequency Trading doesn't violate any law. It still is the essence of what's wrong with the recent metastasis of money markets into private game preserves for insider-traders. Consider for a moment some first principles. The legitimate and efficient function of financial markets is to connect investors to entrepreneurs, and depositors to borrowers. There is no legitimate reason whatever for this to be done by the millisecond. At bottom, the process is pretty simple. The intermediary--the bank, savings institution, or investment bank makes its fees for making a judgment about risk and reward. How likely is the loan to be paid back? How high an interest rate should it charge? How should a new issue of securities be priced? The investor decides whether to indulge a taste for risk or for prudence.
But the hyperactive trading markets and creations of recent decades such as credit default swaps and high speed trading algorithms add nothing to the efficiency of financial markets. They add only two things--risk to the system, and the opportunity for insiders to reap windfall profits. Therefore, whether or not Goldman's lawyers have figured out how it can engage in High Frequency Trading and stay within the law, there is a strong case that this entire brand of financial engineering should be prohibited. The whole game should be slowed down. Bona fide investors should get in line under the rule of first come, first served. Anything else should be considered illegal market manipulation. No dummy transactions. There is absolutely no gain to economic efficiency from having prices of securities change in milliseconds, and much gain to the opportunities for manipulation.
The need to restrain traders from exploiting their privileged knowledge is an old fight. During the New Deal, for example, many reformers proposed that floor specialists for investment bankers and brokerage houses simply be prohibited from trading for their own accounts. They should be there simply to execute buy and sell orders for customers. Otherwise, the conflict of interest would be overwhelming--and this was before computers. These reformers were overruled, but insider trading was explicitly prohibited (and good luck catching it.)
Now, as then, it is a mark of Wall Street's stranglehold on politics that the most sensible of remedies seem impossibly radical. One very good way to damp down the dictatorship of the traders, and raise some needed revenue along the way, would be through a punitively high transactions tax on very short term trades. Genuine investors should get favored fax treatment. Pure traders should be taxed, and very short term manipulation taxed into oblivion. If the financial crisis has proven anything, it is that capital markets have become an insiders' game in which trading profits crowd out the legitimate business of investment. The whole business-models of the most lucrative firms on Wall Street are a menace to the rest of the economy. Until the Obama administration recognizes this most basic abuse and shuts it down, it will be more enabler than reformer.
GE Capital Needs More Funds
by Elizabeth MacDonald
For the second time this year, GE has laid bare GE Capital’s books to assuage Wall Street’s concerns about the finance unit’s stability, and the results are of deep concern.
While the company works hard to calm investor nerves at yet another Wall Street meeting, there are a number of danger zones on GE Capital’s balance sheet that GE is scrambling to fix.
GE has been the worst performer in the Dow Jones Industrial Average this year, due to its finance unit’s serious problems. The industrial conglomerate now says it may need to inject $2 billion to $7 billion into GE Capital in 2011 to bolster its finances.
GE Stuns Wall Street–Again
Last week, GE shocked Wall Street once again with a nasty second quarter profit report. Earnings at GE Capital plummeted 80% in the second quarter, triggering a 47% plunge in GE’s overall profits. GE now says GE Capital faces $34.4 billion in pretax losses and impairments over the next two years under the worst case scenarios under the government’s stress tests.
If GE spins off GE Capital (which it vows it won’t), without the benefit of a deep-pocketed industrial parent and the extraordinary generosity of the US taxpayer, there are deep concerns that GE Capital might go under, analysts on Wall Street fear.
GE’s Non-bank Bank
Which is why GE has successfully pressured the government to let it use all sorts of taxpayer bailout programs, even though GE Capital is ostensibly not a bank, and is instead a charter member of the shadow banking system, where it sells bank products unregulated by the government.
If it were a bank, GE Capital would be the seventh largest in the country in terms of assets, just behind Morgan Stanley. A member of the Dow since 1896, GE Capital was launched in 1932 to help finance its parent’s industrial operations. GE chief executive Jeffrey Immelt now sits on the Obama administration’s economic advisory board.
While the US government has helped GE, it has refused to come to the help of GE Capital’s competitor CIT Group, leaving this small business finance company to scramble to get private funding to shore up its severely damaged balance sheet.
Earlier this year, the Obama administration said it would seek to do away with a notably weak bank regulator, the Office of Thrift Supervision, which also fell down on the job overseeing the troubled insurer AIG (AIG owns thrifts as well, putting it in the OTS’s purview). That raises the question whether GE Capital might be subject to more intense reviews by another government body–the Federal Reserve, since GE Capital uses Fed bailout programs.
Administration Growing Uneasy
The thinking behind the abolishment of the OTS was, the Administration was growing increasingly uneasy with non-banks like GE using a backdoor into taxpayer bailout programs since companies have purchased what are called ‘industrial loan companies,’ usually based in Utah, which do loan and credit card processing as well as other backroom banking operations. The Administration, the thinking is, instead wanted to force these companies to either focus on commerce or banking, but not both, triggering speculation GE would have to spin off GE Capital.
Immelt Sticks to His Guns
GE chief executive Immelt has said GE has no intention of doing that, and today the company is sticking to that party line.
“GE is and will remain committed to GE Capital, and we like our strategy,” Immelt has already said in a memo to staffers. The company again has reiterated that GE Capital would be profitable this year, with an estimated $5 billion in earnings, down from $7.1 billion last year and half the $10.3 billion it posted in 2007.
Some $270 billion has been torched, immolated out of GE’s market capitalization since 2008, and GE’s shares hit a 17-year low earlier this year.
Short-term Obsession = Long-Term Problems
Obsessed with short-term profit goals, GE let its finance unit dangerously bulk up on all sorts of bad assets during the bubble years, including commercial real estate, $230 billion or so (GE is one of the world’s largest commercial lenders), as well as $183 billion in consumer finance assets (including private label credit cards), and all sort of other assets coming from distressed markets such as the UK and Eastern Europe, assets which now sit like anvils on GE Capital’s balance sheet.
GE Struggles to Downsize GE Capital
GE first shocked Wall Street in April 2008 when it missed its earnings estimates by a country mile, with the finance unit’s losses in tow. Ever since, GE has been racing to pare down GE Capital’s $635.5 billion balance sheet to $400 billion. GE chief executive Immelt has also been steadily jawboning lower the company’s profit targets, and vows to cut GE Capital’s profit share of the parent’s earnings down to 30% from 55% in 2007.
The market itself is helping Immelt keep to that promise.
GE Capital Not Earning Its Keep
GE Capital earns its keep by exploiting the spread between the cost of debt it issues and the loans and finance contracts it writes, making it highly vulnerable to a credit market meltdown.
In other words, GE Capital relies on short-term borrowings for its funding needs, so when the credit markets collapsed last fall, GE was staring into the abyss. GE Capital has about $81 billion in long-term debt maturing by the end of 2009, and of that, $43 billion came due June 30.
How GE Maneuvered–Fast
Last fall, after AIG, Lehman Bros., Wachovia and Washington Mutual collapsed, after Freddie Mac and Fannie Mae were taken into government conservatorship, GE and its coterie of lawyers descended on Washington to get banking regulators to let GE and its sick finance unit in the door in the taxpayer bailout programs. GE did so by delivering a tortured reading of a 1991 law enacted after the S&L crisis.
The law had to do with stopping “systemic risk” and although GE does not own a bank, it instead owns two small thrifts. Though the thrifts represent just 3% of its overall assets, GE rammed itself through this giant loophole hooked wider by its lawyers.
Things got even worse earlier this year when GE lost its coveted Triple-A rating, which lets it borrow dirt cheap in the credit markets. It also slashed its dividend for the first time since 1938, a dividend tantamount to an annuity, analysts have noted. GE then raced to use taxpayer bailout programs.
GE’s Government Loopholes
So GE won access to the FDIC debt guarantee program, nearly 40%, it’s estimated, of which represent backstops for GE Capital. GE gets to insure a maximum $126 billion of its debt through this program–already GE is the single biggest corporate user of this FDIC debt insurance. The program lets GE borrow dirt-cheap in the credit markets to fund its operations. GE vows it will soon exit this program.
If companies can’t take this ocean of water onto their balance sheets when this FDIC insurance expires 2012, then the FDIC, meaning, the US taxpayer must. Already, the FDIC has insured an estimated $340 billion in this program, which it plans to end by October.
GE also accesses the Federal Reserve’s commercial paper backstop, a maximum $98 billion there. And its footnote disclosures show it may access the Fed’s TALF program, whereby it gets government help for its securitizations of tens of billions of dollars worth of all sorts of assets on its balance sheet, with another $55 billion or so now sitting warehoused in Enron-style off balance sheet vehicles.
However, GE Capital is not subject to the Fed’s stress tests, nor is it subject to the Fed’s rules for limiting risk, nor is it subject to government limits on executive compensation.
Ugly Profit Forecast
And while it says it will be profitable this year, GE Capital though has stress tested its balance sheet, and the results were ugly. As noted, it said it faces $34.4 billion in pretax losses and impairments over the next two years, using the worst case scenarios in the government’s stress tests.
GE Capital’s Perilous Balance Sheet
A look at its balance sheet should also trigger serious concern. GE has $572.8 billion in liabilities and $635.5 billion in assets teetering atop a razor-thin $32.9 billion in tangible common equity, its net worth on a hard assets basis, after you strip out ephemera like goodwill (the payment made above book value in acquisitions) or intangibles, like, say, the value of the brains of its spreadsheet jockeys.
To some analysts on Wall Street, GE Capital appears levered up like any run of the mill, overextended hedge fund.
Paying the Piper
And here’s one of its most glaring, fire-engine red flags: GE Capital also has $203.2 billion borrowings coming due in the next four years, about two-thirds of the company’s total debt.
Can GE refinance that debt without the taxpayers’ help?
Politicians Accused of Meddling in Bank Rules
Accounting rules did not cause the financial crisis, and they still allow banks to overstate the value of their assets, an international group composed of current and former regulators and corporate officials said in a report to be released Tuesday. The report, from the Financial Crisis Advisory Group, also deplored successful efforts by politicians to force changes in accounting rules and said that accounting standards should be kept separate from regulatory standards, contrary to the desire of large banks.
“The message to political bodies of ‘Don’t threaten, Don’t coerce’ flies in the face of some of what has been coming from the European Commission and from members of Congress,” said Harvey Goldschmid, a co-chairman of the group and a former member of the Securities and Exchange Commission. The report itself, written by a group that included Tommaso Padoa-Schioppa, a former Italian finance minister; Lucas Papademos, a vice president for the European Central Bank, and Michel Prada, a former head of the French stock market regulator, used considerably more diplomatic language.
“We have become increasingly concerned about the excessive pressure placed on the two boards to make rapid, piecemeal, uncoordinated and prescribed changes to standards, outside of their normal due process procedures,” the group wrote in its report, which was commissioned by the Financial Accounting Standards Board of the United States and the International Accounting Standards Board. “While it is appropriate for public authorities to voice their concerns and give input to standard setters, in doing so they should not seek to prescribe specific standard-setting outcomes,” the report added.
Earlier this year both boards, under pressure from banks and politicians, made rapid changes to allow banks more leeway in valuing assets and thus reduce the losses they would otherwise have to report. The group, whose other co-chairman is Hans Hoogervorst, the chairman of the Netherlands Authority for the Financial Markets, said that despite arguments that the financial crisis was worsened by forcing banks to write down their assets to market value, the overall effect had been the opposite.
Pointing to rules that delayed the write-down of bad loans and allowed banks to hide risks off their balance sheets, the group said the net impact of accounting rules “has probably been to understate the losses that were embedded in the system.” Banking regulators have been looking for ways to make the regulatory system less “pro-cyclical,” perhaps by allowing banks to postpone recognition of profits in good times so that losses would not be as large in bad times.
The group cautioned that there could be conflicts between the aim of accounting rule makers to accurately reflect a company’s financial position and the goals of banking regulators. “For example,” the group wrote, “transparency may not always be the best way to prevent a run on the bank.” When those differences arise, it said, it may make sense for regulators to measure bank capital differently than accounting rules would call for, but “the effects of those differences should be disclosed in a manner that does not compromise the transparency and integrity of financial reporting.”
Despite the apparent conflict with both bankers and bank regulators, the Financial Crisis Advisory Group included a number of people with experience in those fields. Among them were Gerry Corrigan, a former president of the Federal Reserve Bank of New York and now an official with Goldman Sachs; Nobuo Inaba, a former executive director of the Bank of Japan; Gene Ludwig, a former comptroller of the currency; and Klaus-Peter Müller, the chairman of the supervisory board of Commerzbank in Germany. The group also warned against changing rules in ways that would make it easier for banks to manage earnings.
At the center of the arguments are fundamental differences in the purpose of financial statements. In one comment letter submitted to the Financial Crisis Advisory Group, the French Banking Federation argued that only assets that banks intend to trade should have to be shown at fair value, with most others valued at the original cost unless the bank had determined that losses were likely. Using market value for such assets, the bankers said, has unreasonably damaged bank capital levels.
“In the current financial crisis, financial statements could be hardly used as a tool to evaluate the economic performance of entities from a financial stability perspective as they have more reflected the collapse of financial markets,” the bankers wrote. A competing view was voiced by Edward Trott, a former member of FASB and former partner in KPMG, a large accounting firm, who said that the banks imposed different standards on their customers than they wished to have imposed on them.
“The area for bank regulators to be involved with accounting standards setting is to help identify the financial information the banks need from others to make appropriate lending and investing decisions,” Mr. Trott wrote. “In my experience, banks want current fair value information about assets that serve as collateral for loans. They do not want information about what assets cost two or three years ago.”
China warns banks over asset bubbles
Chinese regulators on Monday ordered banks to ensure unprecedented volumes of new loans are channelled into the real economy and not diverted into equity or real estate markets where officials say fresh asset bubbles are forming. The new policy requires banks to monitor how their loans are spent and comes amid warnings that banks ignored basic lending standards in the first half of this year as they rushed to extend Rmb7,370bn in new loans, more than twice the amount lent in the same period a year earlier.
Beijing’s concerns are echoed in other countries across the region, most notably South Korea, where the government says it is taking steps to cool a real estate bubble, and Vietnam, where the government has ordered state banks to cap new lending to head off inflation. The situation in much of Asia is very different from most Western economies, where governments have flooded the financial system with liquidity to encourage unwilling banks to lend more. In China, regulators are now concerned that too much money is being lent by the state-controlled banks and the country’s tentative economic rebound could come at the cost of a stable financial system.
In statements published last week, Wu Xiaoling, who recently retired as deputy governor of the central bank, warned new lending this year would probably reach as high as Rmb12,000bn, a staggering increase of 40 per cent of the entire stock of outstanding loans in just one year. She called this sort of growth excessive and said it would lead to bubbles in the property and stock markets. The flood of new lending also has implications for the quality of bank loans and the country’s overall growth.
“China's economic recovery is being constructed on the back of a savaged banking system,” said Derek Scissors, a research fellow at the Heritage Foundation in Washington. “Tens of billions – and perhaps hundreds of billions – of dollars of loans will not be repaid.” He points out that in recent years total loan growth of around 15 per cent has supported gross domestic product growth of higher than 10 per cent but in the first half of this year total loan growth of around 33 per cent supported GDP expansion of only 7 per cent.
“China's economic policies have shifted from being unsustainable over the very long term to being unsustainable for any more than one year,” Mr Scissors said. China’s benchmark stock index has already more than doubled from the low it reached last November and property prices have also rebounded strongly with state media reporting long queues and scuffles at sales promotions for some new real estate projects.
Ms Wu hinted Beijing may soon raise the amount of money banks must hold on deposit with the central bank, marking a change of policy from last year when it aggressively slashed the reserve requirement ratio and interest rates. The central bank has also ordered 10 banks, including Bank of China, to buy Rmb100bn worth of central bank notes with a maturity of one year and a return of just 1.5 per cent, according to Chinese media reports. This move is interpreted as a warning to banks that have been the most active lenders that they should now start to rein in their excessive behaviour.
Worries about rapid credit growth have spread beyond China, write Tim Johnson in Bangkok and Christian Oliver in Seoul. Prakriti Sofat, a regional economist with HSBC in Singapore, has calculated outstanding loans in Vietnam have risen 17 per cent this year. Credit has been boosted a government move to subsidise 4 percentage points of interest on corporate loans to help sustain jobs. The ready availability of relatively cheap credit has coincided with a revival in the fortunes of the stock market, which is up more than 90 per cent from its low in February.
The central bank recently instructed banks to limit credit growth this year to 25 per cent. South Korean regulators have had their eyes on surging mortgage activity and property prices. Mortgage lending is running at the highest levels in two and half years. Bank lending to Korean households rose Won4,000bn last month, compared to Won2,800bn in May. To restrain mortgage growth, homebuyers are now limited to borrowing half the purchase price, down from 60 per cent. “We have seen some specific areas of Seoul where there appears to be some speculative activity so we are taking pre-emptive action,” said Rhee Chang-yong, vice chairman of Korea’s financial services commission.
Bank of China to Continue Lending Expansion Unless Government Clamps Down
Bank of China Ltd., which doled out the most loans among Chinese banks in the first half, plans to keep expanding credit unless the government clamps down on the nation’s record lending boom.
The nation’s third-largest bank will maintain its original target of generating about 10 percent of China’s new loans in 2009, Beijing-based spokesman Wang Zhaowen said by telephone yesterday. Bank of China may “fine tune” its strategy in line with any government policy changes, he said.
Bank of China advanced a record 902 billion yuan ($132 billion) of loans in the first half, leading a credit explosion that drove stocks and property prices higher and helped spur an economic recovery. The lending spree, encouraged by the government, has fanned concerns that asset bubbles will form and bad loans will rise, and the bank regulator yesterday called on lenders to control the flow of credit. “Banks are willing to sacrifice their long-term health for short-term gains in profit, and more importantly, to please the government,” said Wen Chunling, a Beijing-based analyst at Fitch Ratings. “A significant part of the loans extended in the first half may become non-performing over the next five to 10 years.”
Capital adequacy ratios at China’s banks have dropped as a result of a surge in lending in the first half of the year, the central bank said in a report on its Web site today. “The rapid decline in capital adequacy ratios and strengthened risk management may constrain the banking industry’s ability to sustain rapid growth in credit,” it said. The China Banking Regulatory Commission has indicated in past weeks it’s concerned about excessive credit creation. Yesterday, the watchdog told banks to ensure loans intended for investment in fixed assets go to projects that support the real economy. That push is colliding with the government’s attempts to ensure an economic recovery.
Premier Wen Jiabao last week pledged to maintain a “moderately loose” monetary policy, suggesting the government is more concerned with keeping the economy growing than with preventing a rebound in bad debts. “Banks have every incentive to dole out more loans,” said Yang Qingli, a Beijing-based analyst at BOCOM International Ltd. “When the government is driving in the fast lane, you can’t just stop immediately.” New loans in the nation may surge to a record 11 trillion yuan this year as the government is still concerned about “a possible second dip in the recovery path,” BNP Paribas SA said last week. China’s economic growth accelerated to 7.9 percent in the second quarter.
“We will continue to expand lending and other business to implement the government’s fiscal and monetary policy and help economic growth,” Bank of China’s Wang said. “The key strategy won’t change.” The bank, 67.5 percent government-owned, accounted for 12.2 percent of new loans in China in the first half. Non-performing loans at China’s 17 biggest lenders, almost all of which are state-controlled, fell by 43 billion yuan from the start of the year to 444 billion yuan as of June 30. Foreign lenders, which hold less than 3 percent of China’s banking assets, reported an 11 percent increase in soured debts in the period, according to the banking regulator.
Chinese banks extended a record 7.37 trillion yuan of new loans in the first half, triple the amount offered in the same period a year earlier and 47 percent more than the government’s full-year target, after lending restrictions were eased in November to stem an economic slowdown. “I would say Chinese banks failed the test in dealing with this economic crisis,” said Wen of Fitch Ratings.
Standard & Poor’s said July 10 that credit risks are “mounting” at domestic banks and asset quality is likely to deteriorate this year and in 2010. The weakening of asset quality remains “manageable,” the ratings company said. Bank of China will continue to lend to 10 key industries with government policy support, including steel, shipbuilding and automobile, Wang said. About 30 percent of its loans went to those industries in the first half.
China May Press Geithner on Dollar, Economy in Washington Talks
The dollar may be the focus of Chinese-U.S. talks starting in Washington today as China presses the Obama administration on how it will tame the fiscal deficit and protect the U.S. currency’s value, Morgan Stanley said. Treasury Secretary Timothy Geithner and Secretary of State Hillary Clinton will host two days of meetings spanning topics from the economic crisis to North Korea. The Strategic and Economic Dialogue is the Obama administration’s first with China.
“If the key issue in the past was the renminbi’s exchange rate, now it’s the U.S. dollar,” said Wang Qing, an economist at Morgan Stanley in Hong Kong. The yuan is a denomination of the renminbi. “What China cares about the most is the stability of the dollar and the stability of U.S. policy.” The global slump has highlighted the common interests of the economies, ranked first and third largest in the world, as Vice Premier Wang Qishan seeks to preserve the value of the world’s biggest Treasury holdings and the U.S. pushes China to rely more on domestic demand and not exports for growth.
“Raising personal incomes and strengthening the social safety net to address the reasons why Chinese feel compelled to save so much would provide a powerful boost to Chinese domestic demand and global growth,” Geithner and Clinton wrote in a joint article published in today’s Wall Street Journal. The talks this week will move beyond economic matters for the first time.
Few global problems “can be solved without the U.S. and China together,” Geithner and Clinton wrote. “The strength of the global economy, the health of the global environment, the stability of fragile states and the solution to nonproliferation challenges turn in large measure on cooperation between the U.S. and China.” The two sides will probably discuss ways to revive the dormant six-party negotiations aimed at persuading North Korea to give up its nuclear program, a U.S. official said last week.
“From the provocative actions of North Korea, to stability in Afghanistan and Pakistan, to the economic possibilities in Africa, the U.S. and China must work together to reach solutions to these urgent challenges,” Geithner and Clinton wrote. China’s exchange-rate policy will be discussed, an Obama administration official said at a press briefing last week. The U.S. wants a more flexible yuan, though Geithner has avoided a showdown on the issue, declining to repeat comments he made in written remarks to lawmakers after his Senate confirmation hearing in January that China was “manipulating” its currency.
“This was a most unfortunate thing to say publicly,” said Donald Straszheim, managing principal of Straszheim Global Advisors in Los Angeles. “They think the playing field is basically tilted by China managing its currency.”
Both nations are pumping cash into their economies to revive growth in the face of the worst financial crisis since the Great Depression. Though Premier Wen Jiabao said in March he was worried about the safety of the nation’s U.S. assets, China bought $38 billion of U.S. notes and bonds in May, taking its holdings to $801.5 billion. The U.S. deficit may reach a record $1.85 trillion for the fiscal year ending Sept. 30, almost four times the previous fiscal year’s $455 billion shortfall, according to the Congressional Budget Office.
Federal Reserve Chairman Ben S. Bernanke will brief Chinese officials about how the U.S. plans to keep inflation in check over the next few years, people advised of the plan said this month. In June, Geithner told China that the U.S. wants to shrink its budget gap as soon as an economic recovery takes hold. “Both nations must avoid the temptation to close off our respective markets to trade and investment,” Geithner and Clinton wrote. “Both must work hard to create new opportunities for our workers and our firms to compete equally, so that the people of each country see the benefit from the rapidly expanding U.S.-China economic relationship.”
Housing Recovery: Sell Now Or Your Capital Will Be Trapped
by Charles Hugh Smith
As news reports of housing's "recovery" fill the mainstream media, the devastating effects of rising interest rates are never mentioned: every house with equity becomes a capital trap.
Here's the "housing is recovering" story graphically depicted:
Anecdotally, breathless stories of the return of multiple bids are filtering into a Mainstream Media anxious to report "proof" of a "recovery in housing."
Just for context, let's take a quick look at the Case-Shiller Index:
This translates into a 50% decline in bubblicious areas of the nation: Dr. Housing Bubble: Calif. Housing drops 50% from peak.
As noted in the above article, fully 58% of all California home sales are foreclosure resales. In other words, "the bottom is in, now is the time to snap up bargains."
Not so fast. Let's focus on the key feature of buying a house as opposed to, say, a TV: very, very few people buy a house with cash. The vast majority of real estate purchases are financed with mortgages--debt.
And credit is lent at a rate of interest. As a result, the relationship between interest rates and the value of real estate is a see-saw. Buyers can only afford X per month in mortgage payments. If interest rates double, they can only afford to buy a house at a much lower valuation. Here are graphic depictions of the relationship:
In other words, when interest rates double, house prices will drop in half, regardless of any other conditions.The newly risk-averse lenders will only originate mortgages which amount to roughly a third of the borrower/buyer's monthly income, and so this is the metric which controls the price of housing.
The price can be set to whatever level the seller desires, but it will eventually settle to the price the buyers can actually afford.
So why am I suggesting interest rates could double from 4.5% to 9% in the near future? Please consider this chart of total U.S. debt, 1929-2008:
The above debt expansion might remind you of the curveset to the right: exponential (and thus unsustainable).
We've all read about the $2 trillion Federal deficit for this fiscal year; but let's not forget that corporations, local governments and agencies and real estate buyers also want to borrow money. Bottom line: the demand for surplus capital far exceeds the supply of surplus capital globally.
Every other government on the planet (yes, even the Chinese government) is also anxious to borrow huge sums of money from someone to fund their exploding deficit spending. Courtesy of frequent contributor U. Doran, here is a report from Sprott Asset Management on how dependent the U.S. ison non-U.S. capital: The Solution...Is the Problem.
The excellent John Mauldin recently issued a report on how governments want to borrow $5 trillion but there is no more than $3 trillion available to borrow: Buddy, Can You Spare $5 Trillion?
This is the classic "unstoppable force hitting the immovable object"--oh, but wait: interest rates are set by the market and are thus quite movable.Consider this chart of the 10-year U.S. Treasury bill yield:
Note that the rise from 2003 lows was aborted by a global "flight to safety" and a massive intervention in the capital markets by the Federal Reserve and U.S. Treasury which caused interest rates to plummet to unprecedented lows.
But longer term, this cycle of declining interest rates is already extremely long in tooth at 28 years and counting. the average interest rates cycle has historically measured about 20 years in length, suggesting this cycle is due for a turn and the start of a 20+-year cycle of rising interest rates:
But wait: it gets worse. Surplus money looking for a home is drying up even as the demand for surplus capital skyrockets. This vicious circle can bedisplayed thusly:
The net result is interest rates will have to rise--and soon. While it is impossible to predict exact dates, simple laws of supply and demand dictate that rates will soon rise and will rise steeply as the shortfall between what governments want to borrow and what's available to borrow becomes visible (not to mention private demand for capital).
As interest rates rise, then the Capital Trap shuts on all equity locked in real estate.I covered this subject last year: The Housing Capital Trap Snaps Shut(May 28, 2008)
The mechanism can best be illustrated with an example. Let's say a homeowner who bought long ago has a $100,000 mortgage on a home which was once worth $450,00 at the bubble peak. Now the property has sunk to a value of $250,000. The owner still has $150,000 in equity: quite a substantial sum.
But if interest rates double, then the house would have to fall roughly in half to be affordable to buyers. Equity would shrink to a mere $25,000. Or alternatively, if the owner insisted the "true value" was still $250,000 based on other metrics, then the capital is trapped as the house cannot be sold in the marketplace.
Thus it can be argued that to the degree a house is an investment and the basis of household wealth, the owner would be wise to sell the house now in this brief "housing recovery" while rates are still low, pocket the $150,000 equity (For simplicity's sake, I leave out commissions, property taxes, etc.) and rent an equivalent home.
As interest rates rise, that equity will begin earning a decent return in a simple savings account.
I know this concept--that savings will accrue more wealth than equity in a house--is so alien as to be absurd. We have been conditioned by the past three decades of explosive rises in real estate valuations and declining interest rates to believe "real estate always rises" and cash is essentially trash. But the 28-year long orgy of ever-lower rates is ending, and may end abruptly, and soon, as the U.S. Treasury seeks not just to borrow trillions more but also roll over expiring bonds.
The key concept here is that a house is only worth what someone can afford to pay for it. Thus we must be wary of divining "the bottom" based on metrics which don't take rising interest rates into account.
Why can't the Fed just print the $2 trillion the government wants to borrow? Wouldn't that solve the problem? In theory, perhaps, but in practice, when the Fed did exactly that, announcing it was printing $300 billion to buy Treasuries, the bond market reacted violently by pushing rates up dramatically.
Printing trillons of dollars is seen as inflationary by the bond market, and if inflation is being ramped up to 4%, why buy a bond that pays 2%? To keep buying bonds which are guaranteed to lose money is simply unwise. The net result is the Fed cannot just print $3 trillion (don't forget all the bonds which have to be rolled over) and buy Treasuries--the bond market would instantly demand much higher rates to compensate for the additional risks of inflation.
Real estate industry cheerleaders counter by sayinghousing "always rises in inflationary eras." By that theyrefer to the 70s, when real estate shot up alongside rising inflation. But what they forget is that housing was rising from extreme levels of affordability, and that the Baby Boom was entering its prime homebuying decade in the 70s.
Now we have 18.7 million vacant homes, a high level of unaffordability and rising interest rates.
There are many psychological reasons to own property: the sense of security, that you can do what you want with the home and yard, and so on. These are very real and valuable. But as an investment, rising interest rates will trap whatever capital is sunk in the house. To the degree a house is not just shelter and psychological security but an investment, that matters.
Ilargi: I've long said that I sort of expect perhaps some country somewhere to blow open the derivatives bubble. But Italy, of all places?
JPMorgan, UBS, Deutsche Bank May Face Indictment in Milan Derivatives Case
The Italian prosecutor probing alleged fraud on derivatives contracts with the City of Milan will seek indictments against four banks after completing his investigation, two people familiar with the case said. Milan Prosecutor Alfredo Robledo will seek fraud charges against UBS AG, Deutsche Bank AG, JPMorgan Chase & Co. and Depfa Bank Plc, said the people, who asked not to be identified because the decision hasn’t been publicly announced. Robledo also is requesting that 14 individuals stand trial on fraud charges, one of the people said.
Robledo is trying to prove that the London units of the banks made about 101 million euros ($143 million) in so-called illicit profits by arranging contracts that adjusted payments on Milan’s 1.7 billion euros of bonds. The four banks defrauded Milan by misleading the borrower on the economic advantage of the financing and hid their commissions on the derivatives, Robledo has alleged. “We are confident that the strength of our legal position will ultimately be demonstrated through the judicial process,” JPMorgan said in an e-mailed statement today. “The JPMorgan employees involved in the transactions acted with the highest degree of professionalism and entirely appropriately.”
Zurich-based UBS, Frankfurt-based Deutsche Bank and Depfa Bank got back 164 million euros of assets seized by the authorities after prosecutors accepted a cash guarantee, three people familiar with the case said July 1. The banks deposited a total of 56 million euros in exchange for the assets that were seized on April 27, said the people. JPMorgan, which wasn’t part of that agreement, reached an accord in the past week to reduce the 92.3 million euros of its assets seized to 44.9 million euros, one of the people said. The City of Milan is separately suing the four banks after it lost money on derivatives it bought from the lenders in 2005.
Loss provisions spook Deutsche investors
Deutsche Bank on Tuesday confirmed the rebound in its investment banking operations, but increased its provisions substantially in the second quarter in a sign of the difficult economic climate that is set to delay the banking sector’s return to full health. Germany’s largest bank reported net income of €1.1bn ($1.57bn) in the second quarter, driven by investment banking in what Josef Ackermann, chief executive, said in a statement were “satisfactory” results.
The results exceeded a consensus estimate by analysts of about €1bn but were slightly below those of the first quarter. Shares in Deutsche Bank were 11 per cent lower at €46.28 in afternoon Frankfurt trading. Provisions against credit losses rose to €1bn, double the amount in the preceding three months and about the same as Deutsche Bank ’s total provisions during 2008. The sum included €433m related to two counterparties – unnamed by the bank – as well as a rise of more than 50 per cent in provisions against lending to private and business clients, driven in particular by the continued deterioration of lending in Spain.
In total Deutsche Bank took €1.4bn in one-off charges during the quarter. The bank declined any firm forecasts for 2009, with Mr Ackermann saying the outlook for would be strongly influenced by progress in the global economy. “We have witnessed stabilisation of the world’s banking industry and financial markets. Increased liquidity and lower volatility in financial markets are both supportive for our business,” he said. Revenues of €7.9bn were higher than in the first quarter but net interest income was significantly below analysts’ estimates
Deutsche Bank ’s core investment banking business more than doubled its revenues compared with the second quarter of 2008, with the bank pointing to “one of the best quarters ever” for interest rate trading. Foreign exchange trading and money markets were at a slightly lower level than in the first quarter, but revenues from equity sales and trading were the highest in 18 months. Investment banking produced pre-tax income of €828m compared with a €311m loss in the same quarter last year.
However, profits in Deutsche Bank’s other three banking divisions fell compared with a year ago. Wealth management remained troubled, with a 36 per cent fall in revenues and a pre-tax loss of €85m. The bank took a €110m charge on property held by Rreef, its alternative asset management business. Pre-tax profits in private and business banking fell from €328m a year ago to €55m, partly reflecting €150m in redundancy costs.
Reflecting Deutsche Bank’s attempts to shrink its balance sheet and reduce leverage, total assets fell by about 18 per cent to €1,730bn during the quarter, the lowest level since the financial crisis began in 2007. Using an alternative calculation under US accounting rules, Deutsche said it had cut its balance sheet by 31 per cent during the past 12 months. The bank’s tier one capital ratio rose to 11 per cent – its highest level since the crisis began – while the core tier one ratio, excluding so-called “hybrid” capital, was 7.8 per cent compared with 7.1 per cent at the end of March.
Investing rules for the End of Civilization
In his 2008 bestseller, "Wealth, War and Wisdom," hedge fund manager Barton Biggs warns that investors must "assume the possibility of a breakdown of the civilized infrastructure." And to prepare for a breakdown of civilization, "your safe haven must be self-sufficient and capable of growing some kind of food ... It should be well-stocked with seed, fertilizer, canned food, wine, medicine, clothes, etc." Bloomberg Markets suggested that by "etc." he meant guns, as Biggs added "a few rounds over the approaching brigands' heads would probably be a compelling persuader that there are easier farms to pillage."
That warning's not from a hippie radical. Biggs was a respected Wall Street guru at Morgan Stanley for 30 years. As the chief global strategist Institutional Investor magazine put him on its "All-America Research Team" 10 times. Smart Money said: "Biggs is without question the premier prognosticator on the international scene and a mover of markets from Argentina to Hong Kong." Biggs is advising America's wealthy elite. But what about Main Street Americans? Investors often ask me where to invest today, even Bogleheads and investors committed to the Lazy Portfolio strategy. They see the Goldman Conspiracy manipulating this rally. That worries many.
What do you believe? What value do you give to "the future." First, answer these three questions: What's your investment strategy if you know you might die on Dec. 21, 2012, or possibly this year after getting a negative diagnosis from an oncologist or maybe not till 2050 when the United Nations says global population will be 50% higher (from 6 billion now to 9 billion), while demand for energy, oil, gas and coal doubles and the global supply of those commodities remains relatively constant.
Disaster films, terminal illnesses, 2050 and 'The End'
Behavioral economists have answers. But your gut's also good at predicting. So here's what you'll likely do:
- You'll go see the new disaster film, "2012" about the end of the Mayan calendar. After all, it's by the same director who "destroyed" the earth in "The Day After Tomorrow," "Independence Day" and "Godzilla." No new investment strategies, but a must-see film, a great catharsis and distraction.
- If you had a terminal illness, the future is here, now. There's no tomorrow. You're concerned about protecting loved ones and future generations with what you have, and enjoying time with them.
- But how to invest for the "End of Civilization" coming around 2050? The next 40 years will be confusing: Accelerating struggles between aging populations and disenchanted youth, soaring commodity prices, global warming, peak oil, food shortages, famine, blackouts, rationing, civil disorder, increasing crime, worldwide jihads, riots, anarchy and other dark scenarios of a tomorrow with "warfare defining human life."
Yes, that's how doomsayers label the worst-case scenario. It also must be what Ultra-Conservative-Guru Biggs worries about in his darker moments. So back to the question: What will Main Street investors do? Here again, even with the planet's survival threatened, they'll go watch "2012," be entertained, experience a catharsis, feel relieved, and afterwards, have dinner, slip back into denial. And later, they'll vote against anything that offers solutions to future problems, especially if it raises taxes.
Why? Very simple: Our "Brains Aren't Wired to Fear the Future," writes New York Times columnist Nicholas Kristof. We're wired to respond to crises, while pushing off the real big problems (health care, Social Security, etc.) That's basic behavioral economics: Over tens of thousands of years, evolution has programmed our brains so that collectively we will behave counter-productive with the future, making an "End of Civilization" scenario inevitable, a foregone conclusion, a self-fulfilling prophecy. Why? Because our brains are handicapped, we are literally incapable of acting soon enough to solve the problem.
Six simple rules
But there must be a very small percentage of you out there with a desire to make your remaining days on Earth as pleasant as possible for you and your loved ones. So here are "Six New Rules till the End of Civilization 2050." If they don't scare you, hopefully they'll amuse you. Or better yet, wake you up, maybe get you into action ... before it's too late ... before your grandkids are fighting over what little is left:
1. Greed is really good
Yes, if you are going to follow the same advice as the rich, you and your family always come first. Grab more than your share, many times what's fair. No remorse, because 2050 is coming sooner than you think. Create a protective wall of money and resources that will make whatever time's left as comfortable as possible.
2. Invest in Goldman Sachs and its Wall Street co-conspirators
Seriously, these guys are the poster boys for the word "greed." The Goldman Gang, Goldman Conspiracy, whatever you call them, these guys just took control of Washington and the Treasury; their rapid recovery is proof that "greed is great." Do what they do. Amass as much capital and goods as possible, ignoring the rest of us, then cruise to the finish line.
3. Frugality, stockpiling, hoarding
"The Millionaire Next Door" says it's very simple: "Frugal Frugal Frugal! ... Millionaires live well below their means ... Being frugal is the cornerstone of wealth-building." That way you can stash away lots more for later when the going gets rough, when others attack to get what you've stockpiled.
4. Return to your roots
Remember Biggs' advice about subsistence farming. Survival instincts and personal ingenuity will be your best investment. Your family could be without electricity, water, gasoline in the final days, so keep "well-stocked with seed, fertilizer, canned food, wine, medicine, clothes, etc. Think Swiss Family Robinson."
5. Global warfare, plus ammo and guns
Five years ago Fortune did report on the "Pentagon's Weather Nightmare." Yes, the military warned of "the mother of all national security issues" as "the planet's carrying capacity shrinks, an ancient pattern reemerges: the eruption of desperate all-out wars over food, water, and energy supplies." So invest in the defense industries America needs as the rest of the world reacts more to our greed.
6. Accept death
Back in 1973, my first year at Morgan Stanley, I read Ernest Becker's brilliant Pulitzer Prize winner, "The Denial of Death." Today his message is even more powerful: Yes we will all die, tomorrow. But to enjoy the days left, you must accept death today ... accept even now as behavioral economists warn us that our brains are our own worst enemy, as well as the planet's, for we are on a self-destruct path of no return.
Parable at the Pearly Gates
Too macabre for you? So you don't miss the satire, here is a final message, in the spirit of Milton Berle's classic movie, "Always Leave Them Laughing." It's from USA Today, told by that great comedian Carol Leifer:"Mother Teresa died and went to heaven. God greeted her at the Pearly Gates. 'Be thou hungry, Mother Teresa?' asked God. 'I could eat,' Mother Teresa replied. So God opened a can of tuna and reached for a chunk of rye bread, and they began to share it. While eating this humble meal, Mother Teresa looked down into hell and saw the inhabitants devouring huge steaks, lobsters and pastries. Curious but deeply trusting, she remained quiet.
"The next day God again invited her to join him for a meal. Again, it was tuna and rye bread. Once again, Mother Teresa could see the denizens of hell enjoying lamb, turkey and delicious desserts. Still she said nothing. "The following day, mealtime arrived and another can of tuna was opened. She couldn't contain herself any longer. Meekly, she asked, 'God, I am grateful to be in heaven with you. But here in heaven all I get to eat is tuna and a piece of rye bread, and in the Other Place, they eat like emperors and kings! I just don't understand it.' God sighed. 'Let's be honest, Teresa,' he said. 'For just two people, it doesn't pay to cook.'"
So, cheer up, maybe the "End of Civilization" won't be all that bad, even for Wall Street, if you take Barton Biggs advice and stock up on something other than tuna and crackers.
The Great Recession: A Downturn Sized Up
What makes the current recession so bad? Other downturns have been more painful by some measures, but none since World War II has delivered so many severe blows to the economy at the same time.
Already it is the longest. The nonprofit National Bureau of Economic Research, which determines when the U.S. economy slips into recession, says the downturn began in December 2007, 19 months ago. That makes it longer than the wrenching, 16-month recessions of 1973-75 and 1981-82.
The unemployment rate is approaching the peak seen in the 1981-82 recession and the scope of job losses is the worst since the 1948-49 recession. The decline in gross domestic product is the deepest since the 1957-58 downturn, and Americans haven't seen so much of their wealth evaporate since the Great Depression. The NBER defines a recession as "a significant decline in economic activity spread across the economy, lasting more than a few months." Among the gauges the organization watches are GDP and employment, as well as income, sales and industrial output. Even if the current recession is, as many economists believe, at or near its end, it looks worse than its postwar predecessors.
With a dwindling number of people who remember the Great Depression, the 1981-82 recession is many Americans' high-water mark for economic pain. To tame the era's rampant inflation, the Federal Reserve pushed short-term interest rates above 20%, slamming the brakes on the economy. Millions lost their jobs, lifting the jobless rate to 10.8%. Last month, the unemployment rate hit 9.5%. But most economists forecast it will keep climbing even after the recession ends because businesses will remain cautious about hiring. Making matters worse, the economy needs to add some 100,000 jobs a month to keep pace with population growth.
While the unemployment rate isn't yet as high as in the early 1980s, the job losses associated with this recession already have been deeper because the downturn started with a lower unemployment rate than in the 1981-82 slump. Last month, there were 6.7 million fewer Americans working than in December 2007, when employment peaked -- a 4.7% decline, compared with 3.1% in 1981-82. "In terms of employment, we're now way past 1982 and we're just about to cross the worst postwar recession, which was 1948," says Stanford University economist Bob Hall, who heads the NBER's recession-dating group.
In 1948, the demand that built up during World War II rationing programs had been sated. Companies, left holding more inventory than they could sell, throttled back production and laid off workers. The recession that began that year pushed payrolls down by 5.2%. Jobs recovered quickly, however, after the excess inventory was cleared away. In contrast, the past two recessions, in 1990-91 and in 2001, saw payrolls decline long after the economy began recovering. That lagging drop is a shift in the way jobs respond to downturns that economists worry will continue.
Recent downturns have also been less abrupt, in part because the manufacturing sector, which responds to trouble by slashing production, is no longer as large a part of the economy. The declines in GDP -- the value of all goods and services produced -- associated with the 1990-91 and 2001 recessions were slight. That makes this recession's decline in GDP striking. Through the first quarter, GDP was down 3.1% from the peak it reached last year. The only post-World War II recession more severe was in 1958, when the U.S. was a manufacturing powerhouse. After consumer spending cooled in response to Fed rate increases, manufacturers ratcheted back, sending GDP down 3.7%. But the Fed cut rates, and the economy recovered quickly, making the downturn one of the briefest ever.
"A normal postwar recession ends when the Fed thinks it's done enough to fight inflation," says Brad DeLong, an economic historian at the University of California, Berkeley. But this downturn was set off by a housing and credit collapse, making Fed rate cuts less effective in spurring growth. Economists believe Friday's GDP report will show the economy contracted again in the second quarter and that, in combination with downward government data revisions, could make this recession's GDP drop even larger than 1958's.
The good news: This recession's drop in household income hasn't been nearly as severe as one of its predecessors. That is partly because many states have extended unemployment benefits. It also is because workers haven't seen their earning power eaten up by rising prices. That wasn't the case in the recession that stretched from 1973 to 1975, when food and energy costs jumped. Adjusting for inflation, U.S. household income fell 5.3% during that period. In the current recession, it has fallen by 3%.
But this recession has eaten away at Americans' wealth like never before. Falling home prices have decreased the equity the U.S. households have in their homes -- that is, the value of their homes minus what they owe on them -- by $5.1 trillion, a 41% drop. They also have lost trillions of dollars in the stock market. No other episode of wealth destruction since the 1930s comes close. As households work to rebuild the stores of wealth they lost, they spend less. Although spending has recovered a bit, it is still an inflation-adjusted 1.9% below its peak 2008 levels.
Only two other downturns have had comparable spending drops. In the 1953-54 recession, when Congress added to the Fed's inflation-fighting efforts by extending an unpopular tax on corporate profits, spending fell by as much as 3.3%. That drop was matched in 1980, after President Jimmy Carter, in an attempt to rein in inflation, persuaded the Fed to introduce stringent controls on the use of credit. Reversing those policies, and getting spending moving again, was relatively easy. But reversing the drop in wealth isn't. That means that tepid consumer spending could be a drag on the economy for years to come.
Study Finds Underwater Borrowers Drowned Themselves with Refinancings
Why are so many homeowners underwater on their mortgages? In crafting programs to prevent foreclosures, policymakers have assumed that the primary reason homeowners owe more on their home than it is worth is that they bought at the top of the market. In other words, they’ve lost equity primarily through forces beyond their control. A new study challenges this premise and finds that excessive borrowing may have played as great a role.
Michael LaCour-Little, a finance professor at California State University at Fullerton, looked at 4,000 foreclosures in Southern California from 2006-08. He found that, at least in Southern California, borrowers who defaulted on their mortgages didn’t purchase their homes at the top of the market. Instead, the average acquisition was made in 2002 and many homes lost to foreclosure were bought in the 1990s. More than half of all borrowers who lost their homes had already refinanced at least once, and four out of five had a second mortgage.
The original loan-to-value ratio for these borrowers stood at a reasonable 84%, but second and third liens left homeowners with a combined loan-to-value ratio of about 150% by the time of the foreclosure sale date. Borrowers, meanwhile, took out around $2 billion in equity from their homes, or nearly eight times the $262 million that they put into their homes. Lenders lost around four times as much as borrowers, seeing $1 billion in losses. “[W]hile house price declines were important in explaining the incidence of negative equity, its magnitude was more strongly influenced by increased debt usage,” writes Mr. LaCour-Little. “Hence, borrower behavior, rather than housing market forces, is the predominant factor affecting outcomes.”
If other housing markets across the country offer similar findings, then the study argues that current “policies aimed at protecting homeowners from foreclosure are misguided” because lenders, and not borrowers, have born the lion’s share of economic losses. Borrowers that bought homes without ever putting any or little equity in their homes could have seen huge returns on investment simply by extracting cash through refinancing. “Why such borrowers should enjoy any special government benefits such as waiver of the income taxation on debt forgiveness or subsidized loan modifications to reduce their borrowing costs is at best unclear,” the authors write.
Global Insight: Localisation back in fashion
by Gillian Tett
In some offices in the US Treasury, there are framed posters that exhort the country's population to buy American government bonds as part of their patriotic duty. The images date back to the 1940s when the US government was worried about how to plug the yawning funding gap created by the second world war. The patriotic theme may become relevant today. In recent years, western governments have celebrated the fact that capital markets are becoming globally integrated, and taken pride in the idea that investors all over the world have flitted between markets and currencies with ease, purchasing all manner of assets, including government bonds.
But in the coming years, western governments are set to issue a tsunami of government debt. The Organisation for Economic Co-operation and Development, for example, calculates that gross sovereign issuance from the OECD region could be almost $12,000bn (€8,445bn, £7,300bn) this year – a 30 per cent jump from two years ago. Most government officials assume they will need to sell a large chunk of this to non-residents. In the UK and US, for example, about 50 per cent of all government bond buyers are non-domestic, with heavy purchases made by Asian investors in recent years. But some officials are starting to wonder whether they should take more active steps to persuade domestic investors to purchase government bonds, too. Is it time, the whisper goes, to launch a quasi-patriotic debt-buying campaign?
Recent Japanese history shows why patriotism can sometimes matter. In the late 1990s, Japan's national debt burden spiralled dramatically when the country suffered its own banking crisis. That triggered alarm among some international investors, prompting them to sell their Japanese government bonds (JGBs). However, overall JGB prices have not tumbled in recent years, even as debt rose. A key distinguishing characteristic of Japan's bond market is that 95 per cent of the JGB market is held by domestic investors, such as quasi-state institutions or large investment funds with ties to the government. These groups have continued to purchase JGBs, partly due to subtle patriotic bias – but also because they have few other ideas about what to do with the money.
Other western debt management offices do not enjoy this scale of domestic support. But some are starting to feel grateful for a mild version of a "home bias" pattern. In Sweden, for example, government officials say one reason government bond yields have remained unexpectedly low over the past year is that local pension funds have to buy bonds in their local currency, to match assets with liabilities. That – crucially – ensures they buy krona bonds, since Sweden is not in the euro.
The UK also benefits to a small degree from that pattern, since UK pension funds need to hold long-term sterling assets. Moreover, in recent weeks, British regulators have told domestic banks they must hold a large chunk of liquid assets in the future – and quietly signalled to the banks that they expect most of these to be gilts. Officially, this stance is intended to ensure banks match their liabilities and assets. But it marks a stark contrast to the policy of recent years, when regulators seemed indifferent to the currency of bank assets. And it has drawn criticism from the Institute for International Finance: last week the Washington-based think-tank issued a report deploring the slide towards financial fragmentation, citing the UK's measures on bank liquidity as one lamentable policy.
Some countries have gone further and taken an explicitly patriotic line. In Spain, for example, the local social security system reserve fund is permitted to have up to 55 per cent of the nominal value of its holdings in German, French or Dutch bonds. But last year the fund switched to buying just Spanish debt. Elena Salgado, finance minister, says that is partly because Spanish debt offers better yields – but also because "Spanish public opinion" would oppose the idea of buying anything other than domestic debt at present.
Thus far, such moves are rare. Officials in places such as the US and UK vehemently reject the suggestion they might dictate what asset managers should buy. They also stress that quantitative easing programmes, in which central banks have been purchasing government bonds in recent months, will be temporary. Nevertheless, the higher that financial stresses become, the greater the risk that governments will start hunting for new ways to protect themselves. After several decades in which globalisation was the financial mantra, localisation is coming back into fashion. The consequences of that could yet prove unpredictable – not just for investors, but governments, too. The IIF is right to be uneasy.
Who Stole My Cheese? IMF looting of US gold reserves, Fed’s illegal manipulation of gold market
by Tracy R Twyman
The following is taken from my forthcoming book, Ex Nihilo.
When the International Monetary Fund was created at the Bretton Woods international conference in 1944, the member nations were asked to chip in a certain quota of money, related to the assessed size of that nation’s economy. This contribution was to be made 75% in that nation’s own currency, and 25% in gold, or in “currency redeemable in gold”—in other words, the dollar. This is how the US dollar became the “reserve currency of the world,” held in great volume by the central banks of the other participating countries. We agreed to redeem these dollars for gold for the other central banks upon demand, at the fixed price of $35 per ounce.
This became quite a problem over the years. The problem was that in order for the system to actually work, the US would need t very strictly control the value of its currency. This would meant that America couldn’t go printing money willy-nilly whenever they needed to pay for more social programs, or for military adventures. But of course, that was exactly what the US Congress proceeded to do over the next three decades. By 1971, the dollar had inflated considerably, and foreign central banks had looted the US gold reserves, so the Federal Reserve were only enough to cover 22% of the dollars in existence. West Germany and Switzerland pulled out of the Bretton-Woods system, and the demand for gold payment from other central banks increased even more, because those banks could then turn around and sell this gold on the open market at tremendous profit. The US dollar was standing on a precipice.
This was what motivated President Nixon to make a unilateral decision, without consulting the IMF, to close the “gold window” and stop redeeming dollars in gold. This was the final nail in the coffin of the Bretton Woods system, and unhinged the value of the dollar from gold completely. The international banking elite was enraged. Nonetheless, while it did not stop inflation, it did slow down the looting of Fort Knox and put the dollar on life support for a few more decades.
But “life support” is exactly what has been required ever since then. Because the US still does redeem dollars for gold for foreign central banks, via the IMF’s own currency, SDRs (Special Drawing Rights). Since 1975, gold has again been a legally traded commodity in the United States. And while the price of gold has fluctuated considerably, it has since then always been much higher than $35 an ounce. Presently the market value of an ounce of gold is inching towards $1000 an ounce. Yet the US is still redeeming SDRs for a mere $42.50 per ounce of gold so that they can be sold to large bullion banks and dumped onto the open market (a process technically called “dishoarding”). Our gold reserves are still being looted by the banksters.
But they are doing this for a specific reason. They need to dump gold on the market at below market value to keep the price of gold artificially suppressed, or else the fiat currencies of the world would collapse, and businessmen would begin to insist on doing business only in real money: gold and silver coin. To hide what they are doing, IMF-controlled central banks are allowed to report their gold certificates (paper that represents the gold that they have “leased out” or dishoarded) in the same column on their balance sheets where the gold reserves themselves are reported. So nobody actually knows how much gold is in reserve anymore. The last independent audit of Fort Knox happened in 1955. One was attempted during the Reagan administration, but the Federal Reserve thumbed its nose at the President, and the audit was never completed.
The evidence of dishoarding being used to suppress the price of gold (and thus prop up the fiat currencies) is overwhelming. In fact, Alan Greenspan actually admitted it in front of Congress on July 24, 1998 when he said: “Central banks stand ready to lease gold in increasing quantities should the price rise.” An international organization called the Gold Anti-Trust Association (GATA) has been formed, consisting of gold investors who resent their market being manipulated secretly and illegally by banks with the collusion of government. They even took out a full-page ad in the Wall Street Journal in recent years informing investors of what was going on. Strangely the ad, and all other public pronouncements from the group, have been ignored by the financial press so far.
There is no easy way out for central banks
by Wolfgang Münchau
Ben Bernanke was elegant, concise, and yet he missed the point. Last week, in his testimony to congress, the chairman of the Federal Reserve presented his “exit strategy” – a toolkit of policies to prevent an increase in inflation once the economy starts to recover. The policies are the best modern central banking has to offer. But simply possessing such tools does not make an exit strategy. For that, Mr Bernanke would, at the very least, need to define the circumstances that would trigger the use of such tools. I doubt very much that either Mr Bernanke, or his counterparts in Europe, are in a position to provide a credible definition at this point.
Before 2007, independent central banks would have had no problem presenting credible exit strategies. They would have pointed to their inflation target, and how they would use their medium-term inflation forecast or some other analytical framework to ensure that the price level would remain on a stable trajectory. The financial markets would have mostly agreed with the central bank’s decision on interest rates, give or take a quarter point.
That is simply not the case any longer. There are two big problems that need to be considered. One is the commercial banking system. This is more of an issue for the Europeans than the Americans, given the European governments’ inability to resolve the difficulty of continued bad debts. If the European Central Bank, for example, decided to exit tomorrow by raising interest rates, the likely consequence would be a banking meltdown. A credible monetary exit strategy, in Europe at least, would read like a suicide note.
The other problem, which is more troublesome for the US than the eurozone, is fiscal policy. As James Hamilton, professor of economics at the University of California, San Diego, pointed out in a recent analysis*, the direction of US debt, combined with the intermingling of monetary and fiscal policy, is inconsistent with the goal of long-term price stability. It is important to remember that this debate is about the future. Nobody in their right mind would want to implement an exit strategy any time soon despite sightings of mythical green shoots. At this point, the threat of a W-shaped recession is higher than that of an overheating recovery. But eventually this crisis will end, and it is then that the exit strategy becomes relevant.
We are not talking about exiting this year and probably not even next year, but perhaps sometime in 2011. If you take into account the lags through which monetary policy works, you could easily see how the Obama administration might get nervous in terms of the electoral timetable. Given the intermingling of monetary and fiscal policy, a rise in the Fed’s funds rate and the use of the exit tools described by Mr Bernanke would constitute a significant and simultaneous fiscal and monetary tightening.
Mr Hamilton makes another point, namely that US policy is premised on a belief that it can fund any government deficits without any damage to the currency. That belief was justified in the past, but there are doubts whether this is still true now. Should there ever be a funding crisis, it is not clear how the Fed could easily raise interest rates under such circumstances without causing a political and economic bloodbath. The intermingling of fiscal and monetary policy is the result of the central banks’ policies. Take, for example, the ECB’s recent extraordinary €442bn ($630bn, £380bn) injection of one-year liquidity at an interest rate of 1 per cent. This is a win-win game for the banks, especially since they were able to post collateral consisting of less than perfect securities, to put it mildly – those with a rating of BBB- or higher.
This repo auction was at least as much a fiscal as a monetary policy operation. It is part of an unpleasant strategy that consists of avoiding the political drawbacks of using taxpayers’ money to recapitalise banks, while abusing the central banking system by forcing it to undertake a quasi-fiscal rescue operation. The broad idea is to help the banks rebuild their depleted capital through helping them to notch up a few years of large risk-free profits. It would take a very long time to resolve a banking crisis that way, but eventually it would succeed, at a crippling cost to the economy.
As central banks take on these additional roles, their core function is bound to change. I cannot see how either the Fed or the ECB can pursue pure price stability policies under these circumstances. Such policies would be so damaging that no one in their right mind would want to advocate them.
That is why it is impossible to formulate ex-ante exit strategies in the current situation. The problem is not that central bankers are blind to the risks. The ones I know in Europe and the US are all inflation-averse and would not voluntarily advocate an extended period of price instability. Of course, they differ in their analytical frameworks and their views of how the channels of monetary policy work. But they would not readily adopt policies that they know would lead to excessive inflation later on. The point is that they may have no choice.
U.S. Effort to Modify Mortgages Falters
An Obama administration effort to reduce home foreclosures by lowering the mortgage payments of struggling borrowers before they fall behind is failing to help as many people as expected. Among the problems: Some homeowners are being told they must be behind on their payments to receive help, which runs counter to the aim of the program. In other cases, delays are so long that borrowers who are current on their payments when they ask for a loan modification are delinquent by the time they receive one. There is also confusion about who qualifies.
Administration officials have summoned executives of 25 mortgage-servicing companies to Washington on Tuesday to discuss efforts to help borrowers, both delinquent and at risk. Among the items on the table: what steps the companies should take to increase and speed up modifications. "We've made good progress," said Assistant Treasury Secretary Michael Barr. "But in our judgment, servicer performance is insufficient" and varies "quite significantly." Helping at-risk borrowers "is one of the items I think we can do better on."
The Obama administration in February laid out its foreclosure-prevention plan to much fanfare. One part of the program provides financial incentives for mortgage-servicing companies to reduce loan payments to affordable levels, not just for people already in trouble but also for those who are at risk of falling behind because of a change in their circumstances. So far, more than 200,000 borrowers who are delinquent or at risk of default have received trial modifications -- the first step. Administration officials said the modification program could eventually help three million to four million people.
Lisa Sitkin, a staff attorney with Housing and Economic Rights Advocates in Oakland, Calif., said she was pleased when help for at-risk borrowers was announced. "It's disturbing to see that it is several months later and it's still not up and running at any scale that is meaningful," she said. Mortgage-servicing companies said they were fully committed to the administration's plan. Bank of America Corp. is only this month beginning to implement the Obama plan for all at-risk borrowers, a company spokeswoman said. Bank of America has been putting such borrowers on a plan that allows them to make a partial mortgage payment for several months and then be considered for a loan modification.
Wells Fargo & Co. didn't begin offering some at-risk borrowers loan modifications under the Obama plan until early June. One issue was that mortgage companies were waiting for final federal guidelines on key issues such as how to determine whether a loan modification is preferable to a foreclosure, said Mary Coffin, head of loan servicing for Wells Fargo Home Mortgage. "We do realize that the last 90 days have been frustrating," she said. In June, nearly 40% of borrowers seeking a loan modification with Wells weren't yet delinquent, up from nearly 10% at the end of 2008.
Some borrowers say they are being told to stop making loan payments and seek a modification later. Alisha Gorder of Bridgeport, Conn., was referred to Auriton Solutions, a federally approved housing counselor, after she called a mortgage industry hotline because she wasn't getting anywhere with her mortgage company. Ms. Gorder has been struggling to make ends meet because sales have slid at her children's boutique and her husband, Christoph, who runs disaster-relief programs for the nonprofit AmeriCares, had to take a 21% cut in compensation.
"Stop paying on the mortgage since you don't have the resources to cover all your expenses," an Auriton employee said in a letter to Ms. Gorder in mid-July. The letter advised Ms. Gorder to focus on basic living expenses and to follow up with the lender after she had increased her income. Ms. Gorder said she was stunned. "To be told I should do something to put my family in this risky position doesn't make sense," she said. "I had a lot of faith in the system. For me, it's really shocking and jarring to see that the system doesn't work."
Auriton President Tiff Worley called the letter "poorly worded." But he added that the letter "correctly recognizes that this person has an upside-down budget situation and is still shorting things to her family every month." Employees at mortgage-servicing companies often tell borrowers they can't be helped if they are current on their loans, said Michael van Zalingen, director of homeownership services for the nonprofit Neighborhood Housing Services of Chicago. Other borrowers complained of long waits for help. Suzanne DeNick of New Jersey said J.P. Morgan Chase & Co. told her it would take four to six weeks for her modification request to be assigned to an analyst and another 90 to 120 days before she received a decision. The company also asked her to resend her application, further delaying the process.
July was the "last month we have savings to pay our mortgage," she said. A J.P. Morgan spokeswoman acknowledged "that the process took more than our typical time frame," but added that "it took some time for us to receive a completed and signed paperwork package from the borrower." Once paperwork is complete, it typically takes 30 to 60 days to determine whether a modification is possible, she said.
Meanwhile, there's plenty of confusion about just who is eligible for help. "Given widespread public mis-expectations, a significant percentage of borrowers seeking Home Affordable modifications under the imminent-default provisions will not qualify," said a Bank of America spokeswoman. Mortgage companies say that to be considered at risk of imminent default, borrowers must typically have liquid reserves that amount to less than three months of mortgage-related payments and, after figuring in expenses, a few hundred dollars or less left at the end of each month.
Corporate insiders are selling; more bearish than at any time in nearly two years
Corporate insiders have recently been selling their companies' shares at a greater pace than at any time since the top of the bull market in the fall of 2007. Does that mean you should immediately start lightening your equity exposure? It depends on whom you ask. But, first, the data.
Corporate insiders are a company's officers, directors and largest shareholders. They are required to report to the SEC whenever they buy or sell shares of their companies, and various research firms collect and analyze those transactions. One is the Vickers Weekly Insider Report, published by Argus Research. In their latest issue, received Monday afternoon, Vickers reported that the ratio of insider selling to insider buying last week was 4.16-to-1, the highest the ratio has been since October 2007. I don't need to remind you that the 2002-2007 bull market topped out that month.
To be sure, the weekly insider data can be volatile, especially during periods like the summer, in which the overall volume of insider transactions can be quite light. That is one of the reasons why Vickers also calculates an eight-week average of the insider sell-to-buy ratio, and it currently stands at 2.69-to-1. That's the highest that this eight-week ratio has been since November 2007. To put the insiders' recent selling into context, consider that in late April, the last time I devoted a column to the behavior of insiders (and when the rally that began on March 9 was still only six weeks old), the comparable eight-week sell-to-buy ratio was just 0.72-to-1.
Why, given this, shouldn't we be running, not walking, to the exits? May be you should, of course. But, in deciding whether to do so, there are several other factors to consider. The first reason to be at least a little bit skeptical of insiders' current pessimism is that they, on balance, failed to anticipate the 2007-2009 bear market. On the contrary, as I reported on numerous occasions during that bear market, they were largely bullish throughout. The average recommended equity exposure of Vickers' two model portfolios, for example, was around 90% from late 2007 through the early part of this year.
What makes insiders more worth listening to now than then? It's a fair enough question, of course. What those who are inclined to follow the insiders can say by way of response is that insiders, over the years, have been more right than wrong -- even though by no means infallible. Another reason not to immediately go to cash in response to insiders' increased recent predisposition to sell their companies' stock: They are often early.
In fact, Investors Intelligence, a newsletter edited by John Gray and Michael Burke, bases one of its market timing indicators on how the insiders were behaving 12 months previously. A similar point was made earlier this week by Jonathan Moreland, editor of the Insider Insights newsletter. While acknowledging that recent insider behavior "seems totally inconsistent with this rally continuing unabated," Moreland went on to argue that "it may take weeks or even months for insiders to be proven right. Money can be made in the meantime." The bottom line? Insiders are not always right. And even when they are right, they often are early. Even so, it's difficult to sugar-coat the recent increase in the pace of their selling.
By Jim Kunstler
By now, everyone in that fraction of the world that pays attention to something other than American Idol and their platter of TGI Friday's loaded potato skins knows that Goldman Sachs has been caught at another racket in the stock market: front-running trades. What a clever gambit, done with the help of the markets themselves - the Nasdaq in particular - in which information on trades is held back a fraction of a second from public view, while the data is shoveled to the computers of privileged subscribers who can execute zillions of programmed micro-trades before the rest of the herd makes a move.
This allows them to vacuum up hundreds of millions of dollars by doing absolutely nothing of value. The old-fashioned method used by brokers was called "churning," in which stocks were bought and sold incessantly (by phone) from the portfolios of inattentive clients merely to generate commissions. In any sensible society - i.e. a society with an instinct for self-preservation - it would be against the law and the people doing it would be sent to prison.
I'm not a lawyer, but I've got to think that the actions at the Nasdaq end - shoveling the data to the privileged subscribers a fraction of a second early - is patently illegal in the first place, since the whole purpose of an exchange is to create a fair trading space. Where both parties are concerned, it should amount to a plain vanilla criminal conspiracy to commit stock trading fraud. Maybe the larger question is: since when did we become a society lacking the instinct for self-preservation - that is, a society bent on suicide? Or maybe the question is better put to Goldman Sachs's CEO Lloyd Blankfein.
Since this racket was made public, there has been chatter all over the Web about how angry the American public is about Wall Street in general, and increasingly about Goldman Sachs in particular. Nobody has summed it up better than Rolling Stone's Matt Taibbi, calling the company "...a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money." And Taibbi's fierce article about Goldman Sachs came out weeks before this latest outrage.
As we turn the corner toward autumn, President Obama looks increasingly like a dupe, a tool, or a co-conspirator of Goldman Sachs. If he doesn't instruct the Justice Department to commence investigations of the company, and if he doesn't dissociate himself from their alumni hanging around the White House, the Treasury Department, and elsewhere in the government, he's going to become the object of an awful public wrath. Obama has no other choice at this point except to clean house - to fire Larry Summers, Robert Rubin, Tim Geithner, and all other former Goldman Sachs employees in positions of power and influence around him.
Actually, it's not necessary for the whole general public to be fed up with this situation. According to the Pareto 80-20 rule, it only takes one-fifth of the public to set social actions in motion, and only one-fifth of that one-fifth to do the heavy lifting. I think we've reached that point. The sentiment is now overwhelmingly tipped against Goldman Sachs (and Wall Street generally) and the only questions are whether the President of the US ends up lumped in with them, and whether we'll see orderly prosecutions or disorderly persecutions. At this point, it even begins to look as though Mr. Obama is taking cover behind the health care reform debate to avoid answering for his government's association with Goldman Sachs.
The trouble is, if the thoughtful and trustworthy members of the "Pareto 20 percent" don't stir themselves into action over Goldman's behavior, then sooner or later the thoughtless and reckless will take over. Bill Moyers hosted a fascinating report on his most recent podcast about the savagery of right-wing broadcasting and how it had led, in one instance, to the murder of a doctor who performed abortions. What bothers me is that, sooner or later, the conduct of Goldman Sachs will lead the growing ranks of the unemployed, foreclosed, disentitled, and hopeless into the hands of a savage right wing seeking mindless vengeance, for instance, against "the Jews," (as represented by Goldman Sachs), or brown-skinned people (as embodied by a vilified president).
Readers of this blog know I'm allergic to conspiracy theories. But surveying the scene out there, it is hard to not conclude that Goldman Sachs has become the "front-runner" of a criminal syndicate defrauding US taxpayers. This isn't the first time in American history that business veered into extremely antisocial behavior on the grand scale. The last quarter of the 19th century was just as bad, with frauds, swindles, sociopathic trusts, and predatory corporations preying on people trying desperately to make an honest living. Then, one summer day in 1901, a factory drone named Leon Czolgosz stepped up to President William McKinley in a reception line at the Buffalo World's Fair and plugged him twice in the abdomen. (Czolgosz liked to think of himself as an "anarchist," a then-fashionable ideology among the simmering powerless.)
Eight days later, McKinley expired and Teddy Roosevelt became president - to the extreme chagrin of the Republican business establishment - "... now that damned cowboy is in the White House!" cried Republican national leader Mark Hanna of Ohio. He was correct to be nervous. TR turned the corporate world upside down with reform, from dismantling monopolies to establishing the cabinet departments of Commerce and Labor, to bringing the new food industry under regulation. This naturally leads me to wonder if or when Barack Obama will have his TR Moment, when he stands up to the large malign forces operating arrantly in the daily life of this nation. I get volumes of email complaining about Mr. Obama. The writers behind them seem, on the whole, crankish, cynical to an extreme, and not very trustworthy observers of the scene. But I begin to sympathize with them.
In the meantime, the US economy gives the illusion of recovery - but to what? Back to a "consumer" credit card shopping orgy? Another house-buying fiesta? I don't think so. Households are drowning in debt. They're using their credit cards, if they still can, to buy staple foods. Those are the lucky ones who still have lines of credit left. Soon, many of these families won't even amount to households because they won't have a house. There is absolutely no way we are going back to that particular bubble economy.
The only bubble left is the government debt bubble, now leading to such extravagant excess that it can only end up wrecking the government, and perhaps American society with it. In the meantime, how much remaining wealth is Goldman Sachs and its cohorts vacuuming off the floor? Also meanwhile, oil is heading back to the $70 range (with the dollar shedding basis points). That's the oil price range where the economy begins to get wrecked all over again - that is, whatever remains of the economy. That's the price range where airlines go back to the intensive care unit and citizens have to max out their credit cards to buy gasoline. We're moving toward a very hard landing and very soon.
Wells Fargo Buys Mortgage Bonds as Defaults Rise
Wells Fargo & Co., the bank that boosted its U.S. property-related holdings by acquiring rival Wachovia Corp., is adding to those investments with purchases of mortgage-backed bonds, even as Federal Reserve Chairman Ben S. Bernanke warns of another wave of defaults. The bank reported its portfolio of real-estate securities, excluding those backed by the U.S. government, rose 6.6 percent last quarter to $41.2 billion. San Francisco-based Wells Fargo has been buying commercial-mortgage bonds because the debt has been available at “good” prices, said Tim Sloan, an executive vice president.
“We believe that there are good opportunities in investing in those securities,” Sloan said in a telephone interview on July 23. “There are good opportunities across the board today if you get the right people who can underwrite credit and can look into the deals and make sure you really understand what you’re investing in.” Wells Fargo is betting it can pick up discount-priced assets amid the recession that began in December 2007. It runs the risk of getting caught in a new round of defaults as more commercial mortgages turn sour. Properties valued at more than $108 billion are now in default, foreclosure or bankruptcy, almost double the figure at the start of the year, Real Capital Analytics Inc. said earlier this month.
Banks are buying mortgage-backed securities to put increased deposits to work as tighter lending standards and lower demand limit new loans. Holdings of residential- and commercial-mortgage bonds not backed by the U.S. government at the 25 largest American banks have climbed 4.9 percent this year, to $159.9 billion on July 15, according to Fed data released July 24. The banks are ranked by assets. The Fed figures include price changes; the Wells Fargo portfolio number reflects average balances. Banks buying mortgage-backed debt, which caused much of the $1.5 trillion of writedowns and credit losses at the world’s largest financial companies since 2007, can be looked at “two ways,” said Thomas Atteberry at First Pacific Advisors LLC in Los Angeles.
“One is: Your past history tells me you don’t know how to assess this risk that well,” he said in an interview. “The other is: Well, you’re bright people, you won’t make that same mistake again. Personally, I’m not convinced of the latter.” Atteberry was Morningstar Inc.’s fixed-income manager of the year in 2008, sharing the award with colleague Robert Rodriguez.
A goal of Treasury Secretary Timothy Geithner’s $40 billion Public-Private Investment Program, under which private investors partner with taxpayers in funds buying these securities, is to remove impaired debt from banks’ balance sheets to free them for new lending. When announced in March, the PPIP was billed as targeting purchases of $1 trillion of loans and securities. Wells Fargo, which received $25 billion of capital under the U.S. Troubled Asset Relief Program, owned an average of $138.1 billion of commercial-mortgage and construction loans last quarter, more than double the year-earlier level after its Jan. 2 purchase of Charlotte, North Carolina-based Wachovia.
Experience with the debt will help in the bank’s securities investing, according to Sloan, head of commercial, real estate and specialized financial services group in Wells Fargo’s wholesale banking division. “You’ve got to take apart the deal,” he said in the interview. “We’re the largest commercial real estate lender in the country. We think we’ve got a terrific team of people.” U.S. commercial-property prices fell 7.6 percent in May from a month earlier, according to Moody’s Investors Service, bringing the total decline to 35 percent since the market’s peak.
Bernanke told lawmakers July 22 that a potential wave of defaults in the $3.5 trillion commercial-mortgage market as borrowers find it difficult to refinance may present a “difficult” challenge to the economy. Mortgage-bond prices have rallied from record lows as the government unveiled programs to boost values and amid signs the recession may be easing, though much of the debt still trades at discounts unprecedented before 2008. Fixed-rate commercial- mortgage bonds rated AAA have returned an average of 15.1 percent this year, after prices fell more than 21.8 percent last year, according to Merrill Lynch & Co. index data. Those securities ended last week valued at about 87.6 cents on the dollar, compared with a low of 94 cents in the decade through 2007, according to the data.
Large bank holdings of “non-agency” mortgage securities have increased as refinancing and defaults reduced the size of the residential-bond market, which shrank 4.5 percent in the first quarter, Fed data show. Wells Fargo’s portfolio of all debt securities rose 11.6 percent last quarter from the first quarter to an average balance of $180 billion, while average holdings of loans declined 2.5 percent to $833.9 billion, according to the statement.
Here comes August, the cruellest month of all
The tills are ringing on the high street. Estate agents have a spring in their step. Bonuses are back in the City, and the stockmarket is up 1,000 points from its low. Beyond Britain's shores, there are signs of recovery in Chinese manufacturing and Japanese exports, and even some tentative hopes that the US property market has reached rock bottom. Almost two years to the day after the world was plunged into the deepest financial and economic crisis since the Great Depression, it finally seems safe for bankers, politicians and business leaders to head for the beach without having to keep their BlackBerrys switched on.
Even some of Wall Street's super-bears, such as the economist Nouriel Roubini, are beginning to suspect that the worst may be over. In Britain, Friday's news that GDP declined at a worse-than-expected 0.8% in the second quarter may have tempered expectations of a rapid return to business as usual; but with interest rates on both sides of the Atlantic at record lows and taxpayers' cash pouring into the economy, many experts are still tentatively predicting a modest recovery, starting this autumn. History suggests, however, that severing links with the office and dozing off in the sun could be a bad mistake. As far as economics is concerned, TS Eliot was wrong: it is August, not April, that is the cruellest month.
For Northern Rock boss Adam Applegarth, it was 9 August 2007 when, as he put it, "the world changed," and a seemingly arcane statement from BNP Paribas that it was struggling to value its mortgage-backed assets, triggered a seizure in the international financial markets from which they are yet to recover. Since then, the global economy has lurched through a series of six-monthly cycles: from the run on the Rock in September 2007, to its eventual nationalisation in February 2008, followed by the fire sale of Bear Stearns. And from then to the collapse of Lehman Brothers on 15 September last year - the pivotal moment in the entire crisis.
In the spring of 2008, as the fallout from Bear Stearns died down, investors comforted themselves that the worst was over, and economists clung to the notion of "decoupling," which suggested that fast-growing countries such as China and India would be untouched by the financial rout. In fact, during August the fuse was already burning down towards the near-death moment for the entire global financial system that followed Lehman's bankruptcy. Steve Barrow, head of G10 strategy at Standard Bank, says, "if you look at what happened this time last year, we had the start of the collapse in the oil price and the dollar. That really got going after Lehman Brothers fell, but the signs were already there before."
Some in the City will remember the Russian debt default of August 1998, while those with even longer memories will recall Saddam Hussein's invasion of Kuwait, in August 1990, which sent oil prices rocketing. As August 2009 gets under way, while the optimists are basking in sunshine, bears can find economic clouds everywhere, from a fresh crash in the housing market in the world's biggest economy to a mass debt default by African governments. "There are still huge vulnerabilities," says Russell Jones, global strategist at RBC Capital Markets in London. "There are issues of capitalisation in the banking sector; there are issues of public sector debt sustainability, not least here in the UK; and you've got the threat of central banks and governments wanting to take away the support to economies too soon."
The first concern is that the optimism in financial markets is premature. Just as they failed to foresee the deepest recession in a generation and chose to "keep dancing", as Citigroup boss Chuck Prince put it at the time, investors may now be clinging too enthusiastically to the hope that recession will be swiftly followed by recovery. Upbeat financial results from a series of US companies, including processor-maker Intel and investment bank Goldman Sachs, have helped drive up stock prices; but Graham Turner of GFC Economics says many firms have only chalked up profits by taking an axe to their costs.
That may be good for each company individually, but if wages right across the economy are depressed by pay freezes and reductions in hours, the hoped-for return of consumer spending is unlikely to materialise - the problem of shortage of demand first identified by John Maynard Keynes during the 1930s. "The stockmarket interprets slashing labour costs very positively. But we are now in a situation where the Fed can't do anything more, so if firms keep cutting wages, we will run into the very thing that Keynes always said we should avoid," Turner says.
American firms are still shedding staff aggressively - latest figures showed there were 554,000 new claims for unemployment benefit last week. How rapidly the job-cutting comes to an end could make the difference between a nascent recovery and a "double dip". Retail sales have already begun to fall back, despite President Obama's $800bn stimulus package. Barrow at Standard Bank agrees that rosy corporate earnings statements mask deeper problems. "This is all about cost-cutting and shedding labour, rather than economic growth improving," he says. Look more closely at many of the data being trumpeted as signs of recovery and they only appear positive because they are a marginal improvement on the three vertigo-inducing months with which the year began.
Jones of RBC points to the shaky finances in some US states as another source of summer panic. California is already paying its bills with IOUs, and Florida and New York are both in trouble. If a state defaulted, it could shock complacent markets into a renewed sell-off. Washington would be likely to step in with a bailout - but even if it did, it would simply underline the scale of debts to which the federal government could potentially be exposed. "I think the markets are aware of it; but the event itself, if there was a formal situation of default, would certainly create a bit of a spasm," Jones says.
Where some market gurus see the return of the good times, others see the next bubble inflating. Just as former Federal Reserve chairman Alan Greenspan "cured" the recession that followed dotcom mania by creating a fresh bubble in the US housing market, so some analysts fret that the emergency action taken by policymakers over the past year is building up big problems for the future. One such fear concerns the world's biggest emerging economy, China, where an explanation for the country's short and shallow downturn is that the communist rulers have presided over the sort of debt explosion witnessed in Britain and the US over the past 15 years. In the past six months, bank lending has increased by 25% of GDP - a staggering increase in so short a period.
Jones says: "The government just panicked, loosened monetary policy dramatically and told the banking sector to lend. They've solved the problem by inflating a big speculative bubble, which is obviously a source of instability." Other economists, such as Stephen Lewis at Monument Securities, are concerned that the current fad among policymakers for quantitative easing threatens a bubble in the bond market that will dwarf those seen in internet stocks or real estate over the past decade.
Quantitative easing is supposed to work by driving down long-term interest rates, which affect the cost of borrowing for homeowners and businesses. The risk of artificially depressing "yields" (the interest rate that bonds pay) means that central banks have to know how and when to remove the stimulus. US Federal Reserve chairman Ben Bernanke and the Bank of England's Mervyn King were not born the last time QE was deployed in the 1930s, and they will need to show delicacy if they are to get the timing right. The fact that the Bank of England delayed cutting interest rates for six months in 2008 even though the UK was already in recession does not inspire universal confidence.
Then there is the "Sarajevo effect" - the propensity for a problem in a seemingly unimportant corner of the globe to spread chaos, named after the Balkan city in which Archduke Franz Ferdinand was assassinated in June 1914 - an event that, by that, by August, had led to the outbreak of the first world war.
The travails of Iceland and its stricken banks during this crisis have already shown how a small economy can trigger widespread distress and panic through the financial system, and emerging markets - especially in eastern Europe - remain a source of potential vulnerability. Latvia is currently at odds with the International Monetary Fund over the terms of a loan to stabilise its shaky currency, and there were fears last week that a breakdown in talks could see the rescue programme collapse altogether, with knock-on effects across the rest of eastern Europe.
The northern Mediterranean has been Europe's soft underbelly during the crisis. Spain has had a housing boom-bust to match that in the US or the UK; Italy's manufacturing sector has been wrecked by falling demand and a chronic lack of competitiveness; and Greece's economic problems have led to rioting. But it is Turkey - candidate for EU membership and suffering a ferocious contraction - that is giving the greatest cause for concern. Emerging markets have been given a respite by the pick-up in global financial conditions since the spring, but the situation remains precarious. Barrow at Standard Bank says: "The Turkish lira has got very strong indeed; there's a risk that the markets have been a little bit too sanguine."
As if there weren't enough ticking time-bombs scattered around the world economy, policymakers are anxiously watching the spread of swine flu around the world. With confidence among families and firms still fragile as a result of the prolonged financial turmoil, the heavy human costs of the disease could be accompanied by a financial toll as sick employees take time off work, and even the healthy avoid hitting the high street for fear of contagion.
In the UK, where plans for emergency school closures are under consideration for the autumn, and thousands of workers are already staying at home rather than risk spreading infection, experts at consultancy Oxford Economics have calculated that if the disease were to become widespread, a six-month outbreak could prolong the recession by up to two years, and cost up to £60bn. Worldwide, the IMF has warned that a pandemic could have "notable effects".
Of course, just because the glass half-empty approach has repeatedly paid off over the past two years, it doesn't mean the pessimists are right in 2009. But even if none of these dire scenarios comes to pass, and summer turns to autumn without yet another outbreak of panic, some anxious market-watchers say we will only be storing up more trouble for the future. Turner of GFC Economics says he's bored with being a bear, but nevertheless, "if we did get through to September without anything coming out, that would make me even more worried that 2010 is going to be a really bad year".
What, me worry? The experts' fears
Roger Bootle, economic adviser to Deloitte & Touche
"There's got to be a possibility of more significant bank losses, or losses in other parts of the financial sector: insurers for example. There's also a possibility that over the summer the market is going to look at the indebtedness of certain countries and say, 'hang on, this is quite worrying'. "One non-economic thing I'm quite worried about is swine flu. There are occasions where these factors interact with a difficult situation, and significantly worsen the outlook. I would have thought that was a serious risk - for example, you could get widespread factory shutdowns."
Lord Oakeshott, Liberal Democrat treasury spokesman
"I hope it won't be another summer like 1931 when the government fell apart and the pound was devalued. Our economy will slide faster in 2009 than 78 years ago. The best bond salesman ever would struggle to sell a billion pounds worth of gilts every day. Britain has to do that with a prime minister clinging to power by gnawed fingertips and a chancellor he tried to sack. My fear is that world markets will stop giving Britain the benefit of the doubt, the pound will have to fall, interest rates will have to rise or we won't be able to go on borrowing."
Howard Archer, chief UK economist at Global Insight
"At the moment I'm most worried that swine flu could start having a bigger impact on the economy. The economy is fragile anyway. If swine flu is as bad as people are saying it could be a significant factor weighing down on recovery prospects. It could seriously hit confidence and could start to hit things like retail sales if people are worried about going to big shopping centres. "It could also hit small factories' output. If even a few people are off with swine flu it could affect production."
Jon Moulton, founder, Alchemy Partners
"An iceberg is definitely awaiting a victim - one day. I worry that the UK cannot persuade the next buyers to buy its gilts except at an elevated interest rate. And then woe follows."
U.S. to provide $1 billion to hire cops
The federal government will give $1 billion in grants to law enforcement agencies in every state to pay for the hiring and rehiring of law enforcement officers, Vice President Joe Biden and Attorney General Eric Holder announced Tuesday. The money comes from the stimulus bill -- the American Recovery and Reinvestment Act of 2009 -- the officials said. The law is designed to help pull the U.S. out of its recession by providing and saving jobs, and helping those most affected by the downturn in the economy. Beneficiaries can include state, local and tribal governments.
The Department of Justice received more than 7,200 applications for more than 39,000 officer positions, representing a total of $8.3 billion in requested funding. "The tremendous demand for these grants is indicative of both the tough times our states, cities and tribes are facing, and the unyielding commitment by law enforcement to making our communities safer," said Attorney General Eric Holder in a statement. Biden spoke of the bravery of police officers who never know when they might be shot, even on a simple call. With rows of police officers standing behind him, he pointed out the hazards and uncertainty of police work.
"It's just astounding to me how much we take for granted what you do, and thankfully how much you take for granted what you do," said Biden. "We ask you to go out to defend us, and you're entitled to be equipped to defend us," he added. The Recovery Act includes $4 billion in Department of Justice grant funding to local law enforcement. Some of this money was distributed to states previously to help crime victims, women who are targets of violence, Internet crimes against children and other needs.
The current round of grants will be awarded to 1,046 law enforcement agencies in all 50 states, and will provide 100 percent of the approved salary and benefits for 4,699 officers for three years. Police departments that receive the money must retain the grant-funded positions for a fourth year. The grants will be administered by the U.S. Department of Justice's Office of Community Oriented Policing Services (COPS). Funding decisions were based on reported crimes for the previous calendar year, community policing activities, budget changes, and poverty, unemployment, and foreclosure rates in the area.
"These officers will go to the places where they are needed the most," Holder said. Philadelphia Police Commissioner Charles Ramsey, who attended the news conference, said five police officers were killed in the line of duty in his city between May 3, 2008, and February 13, 2009. "So violence is very much a concern here in Philadelphia," he said. "There is far too much violence taking place every day on the streets of our city."
Pennsylvania plans to create or save 93 law enforcement positions statewide by awarding more than $20 million to 19 law enforcement agencies. The Philadelphia Police Department will be able to create and or preserve 50 jobs, according to the statement explaining the grants. Pennsylvania is one of the hardest-hit states in terms of economic decline, officials said. More than 19 percent of the families in Philadelphia live in poverty, and the unemployment rate jumped from 6.4 percent in 2008 to 8.8 percent in 2009.
Obese Americans Spend Far More on Health Care
Obese Americans spend about 42 percent more on health care than normal-weight Americans, according to a new study based on 2006 figures. Medical spending on obesity-related conditions is estimated to have reached $147 billion a year in 2008, according to the new study, published online on Monday in the journal Health Affairs. That figure represents almost 10 percent of all medical spending, the study found.
Obese Americans spend about $1,429 more on health care each year than the roughly $3,400 spent by normal-weight Americans. Most of the excess spending is for prescription drugs needed to manage obesity-related conditions, said Eric A. Finkelstein, one of the study's authors and the director of the public health economics program at the Research Triangle Institute, a nonprofit research organization. The results were presented on Monday at the first Weight of the Nation conference, which was held in Washington by officials at the Centers for Disease Control and Prevention.
"Obesity, and with it diabetes, are the only major health problems that are getting worse in this country, and they're getting worse rapidly," Dr. Thomas R. Frieden, director of the C.D.C., said. The average American consumes 250 more calories per day than just two decades ago, Dr. Frieden noted, and the rising obesity rate is the single greatest contributor to a national epidemic of diabetes.
Whistleblower tells of America's hidden nightmare for its sick poor
Wendell Potter can remember exactly when he took the first steps on his journey to becoming a whistleblower and turning against one of the most powerful industries in America. It was July 2007 and Potter, a senior executive at giant US healthcare firm Cigna, was visiting relatives in the poverty-ridden mountain districts of northeast Tennessee. He saw an advert in a local paper for a touring free medical clinic at a fairground just across the state border in Wise County, Virginia.
Potter, who had worked at Cigna for 15 years, decided to check it out. What he saw appalled him. Hundreds of desperate people, most without any medical insurance, descended on the clinic from out of the hills. People queued in long lines to have the most basic medical procedures carried out free of charge. Some had driven more than 200 miles from Georgia. Many were treated in the open air. Potter took pictures of patients lying on trolleys on rain-soaked pavements.
For Potter it was a dreadful realisation that healthcare in America had failed millions of poor, sick people and that he, and the industry he worked for, did not care about the human cost of their relentless search for profits. "It was over-powering. It was just more than I could possibly have imagined could be happening in America," he told the Observer Potter resigned shortly afterwards. Last month he testified in Congress, becoming one of the few industry executives to admit that what its critics say is true: healthcare insurance firms push up costs, buy politicians and refuse to pay out when many patients actually get sick.
In chilling words he told a Senate committee: "I worked as a senior executive at health insurance companies and I saw how they confuse their customers and dump the sick: all so they can satisfy their Wall Street investors." Potter's claims are at the centre of the biggest political crisis of Barack Obama's young presidency. Obama, faced with 47 million Americans without health insurance, has put reforming the system at the top of his agenda. If he succeeds, he will have pushed through one of the greatest changes to domestic policy of any president.
If he fails, his presidency could be broken before it is even a year old. Last week, in a sign of how high the stakes are, he addressed the nation in a live TV news conference. It is the sort of event usually reserved for a moment of deep national crisis, such as a terrorist attack. But Obama wanted to talk about healthcare. "This is about every family, every business and every taxpayer who continues to shoulder the burden of a problem that Washington has failed to solve for decades," he told the nation.
Obama's plans are now mired and the opponents of reform are winning. The Republican attack machine has cranked into gear, labelling reform as "socialist" and warning ordinary Americans that government bureaucrats, not doctors, will choose their medicines. The bill's opponents say the huge cost can only be paid by massive tax increases on ordinary Americans and that others will have their current healthcare plans taken away. Many centrist Democratic congressmen, wary of their conservative voters, are wavering. The legislation has failed to meet Obama's August deadline and is now delayed until after the summer recess. Many fear that this loss of momentum could kill it altogether.
To Potter that is no surprise. He has seen all this before. In his long years with Cigna he rose to be the company's top PR executive. He had an eagle-eye view of the industry's tactics of scuppering political efforts to get it to reform. "This is a very wealthy industry and they use PR very effectively. They manipulate public opinion and the news media and they have built up these relationships with all these politicians through campaign contributions," Potter said.
Potter was witness to the campaign against Michael Moore's healthcare documentary Sicko. The industry slammed the film as one-sided and politically motivated. Secret documents leaked from the American Health Insurance Plans, the industry's lobby group, detailed the plan to paint Moore as a fringe radical. Potter now says the film "hit the nail on the head". "The Michael Moore movie that I saw was full of truth," he admits.
Potter was also working for Cigna when it became embroiled in the case of Nataline Sarkisyan, whose family went public after Cigna refused to pay for a liver transplant that it considered "experimental" and therefore not covered by their policy. Cigna reversed this decision only hours before the Californian teenager died. "I wish I could have done more in that case," Potter said. Such sentiments are rare in an industry that has given America a healthcare system that can be cripplingly expensive for patients, but that does not produce a healthier population.
The industry is often accused of wriggling out of claims. Firms comb medical records for any technicality that will allow them to refuse to pay. In one recently publicised example, a retired nurse from Texas discovered she had breast cancer. Yet her policy was cancelled because her insurers found she had previously had treatment for acne, which the dermatologist had mistakenly noted as pre-cancerous. They decreed she had misinformed them about her medical history and her double mastectomy was cancelled just three days before the operation.
Last month three healthcare executives were grilled about such "rescinding" tactics by a congressional subcommittee. When asked if they would abandon them except in cases of deliberately proven fraud, each executive replied simply: "No." To Potter that attitude has a sad logic. The healthcare industry generates enormous profits and its top executives have a lavish corporate lifestyle that he once shared. Treating patients for their expensive conditions is bad for business as it reduces the bottom line. Kicking out patients who pursue claims makes perfect economic sense. "It is a system that is rigged against the policyholder," Potter said. The congressional probe found that just three firms had rescinded more than 20,000 policyholders between 2003 and 2007, saving hundreds of millions. "That's a lot of money that will now go towards their profits," Potter said.
A lot of that money also goes into contributions to politicians of both parties - $372m in the past nine years - and in lobbying groups to run TV ads slamming Obama's plans. Many of these ads deploy naked scare tactics. One report said that the industry was spending $1.4m a day on its campaign. In the face of that, it is perhaps no wonder that the Senate has delayed its vote, dealing a massive blow to Obama. "I have seen how the opponents of healthcare reform go to work... they are trying to delay action. They know that if they keep the process going for months, and turn it into a big mess, then the political impetus behind it will lessen," Potter said.
Potter, who now works at the Centre for Media and Democracy in Wisconsin, says the industry is afraid of Obama's reforms and that is why it is fighting so hard. It wants to deal him the same blow as it did Bill Clinton when it scuppered his attempt at reform in the 1990s. Potter admits that he is worried the industry might win again. "I have seen their tactics work. I have been a part of it," he said. He knows he has no chance of ever working again for a major firm. "I am a whistleblower and corporate America does not tend to like that," he said. But there is one thing Potter is not sorry about: leaving the healthcare industry and speaking out. "I have absolutely no regrets. I am doing the right thing," he said.
Comprehensive healthcare reform in the US has been an ambition of many presidents since the early part of the 20th century. None has succeeded in creating a system that gives all Americans the right to coverage. Barack Obama, below, is desperate to avoid the same fate.
British pensioners among the poorest in Europe
The over 65’s in Britain are worse off than their counterparts in Romania, Poland and France, Commission says
Britain's pensioners have the fourth highest level of poverty in Europe, according to figures published today by the European Commission. The over 65’s in Britain are, on average, worse off than their counterparts in Romania, Poland and France. The research, which compared relative poverty in the 27 member states, showed nearly one in three UK over-65s were at risk of poverty - the same proportion as in Lithuania (30 per cent). Only pensioners in Cyprus (51 per cent), Latvia (33 per cent), and Estonia (33 per cent) came out worse. The EU average was 19 per cent.
The figures came ahead of the work and pension committee's review of government efforts to tackle pensioner poverty, which is due to be published on Thursday. Michelle Mitchell, charity director for Age Concern and Help the Aged, said the report demonstrated that many older people were being left behind. "In a country where the richest have incomes five times higher than the poorest, older people are disproportionately bearing the burden of this inequality," she said. Steve Webb, the Liberal Democrat Shadow Work and Pensions Secretary, blamed the Labour Party for failing to address poverty in old age. He said: “The basic state pension is simply too little to live on for the millions of pensioners who have no other income.
Labour’s complex and undignified system of means-tested benefits has meant that many pensioners do not even claim the extra help that they are entitled to. “We need a more generous, universal pension based on citizenship that would give pensioners a sense of dignity and a stable income in retirement.” The EU study found pensioners in the Czech Republic were least likely to be living in poverty, with 5per cent below the threshold of an income of 60per cent of the national median.
World will warm faster than predicted in next five years, study warns
The world faces record-breaking temperatures as the sun's activity increases, leading the planet to heat up significantly faster than scientists had predicted for the next five years, according to a study.
The hottest year on record was 1998, and the relatively cool years since have led to some global warming sceptics claiming that temperatures have levelled off or started to decline. But new research firmly rejects that argument.
The research, to be published in Geophysical Research Letters, was carried out by Judith Lean, of the US Naval Research Laboratory, and David Rind, of Nasa's Goddard Institute for Space Studies.
The work is the first to assess the combined impact on global temperature of four factors: human influences such as CO2 and aerosol emissions; heating from the sun; volcanic activity and the El Niño southern oscillation, the phenomenon by which the Pacific Ocean flips between warmer and cooler states every few years.
The analysis shows the relative stability in global temperatures in the last seven years is explained primarily by the decline in incoming sunlight associated with the downward phase of the 11-year solar cycle, together with a lack of strong El Niño events. These trends have masked the warming caused by CO2 and other greenhouse gases.
As solar activity picks up again in the coming years, the research suggests, temperatures will shoot up at 150% of the rate predicted by the UN's Intergovernmental Panel on Climate Change. Lean and Rind's research also sheds light on the extreme average temperature in 1998. The paper confirms that the temperature spike that year was caused primarily by a very strong El Niño episode. A future episode could be expected to create a spike of equivalent magnitude on top of an even higher baseline, thus shattering the 1998 record.
The study comes within days of announcements from climatologists that the world is entering a new El Niño warm spell. This suggests that temperature rises in the next year could be even more marked than Lean and Rind's paper suggests. A particularly hot autumn and winter could add to the pressure on policy makers to reach a meaningful deal at December's climate-change negotiations in Copenhagen.
Bob Henson, of the National Centre for Atmospheric Research in Colorado, said: "To claim that global temperatures have cooled since 1998 and therefore that man-made climate change isn't happening is a bit like saying spring has gone away when you have a mild week after a scorching Easter." Temperature highs and lows
Hottest year of the millennium
Caused by a major El Niño event. The climate phenomenon results from warming of the tropical Pacific and causes heatwaves, droughts and flooding around the world. The 1998 event caused 16% of the world's coral reefs to die.
Most sunspots in a year since 1778
The sun's activity waxes and wanes on an 11-year cycle. The late 1950s saw a peak in activity and were relatively warm years for the period.
Coldest year of the millennium
Ash from the huge eruption the previous year of a Peruvian volcano called Huaynaputina blocked out the sun. The volcanic winter caused Russia's worst famine, with a third of the population dying, and disrupted agriculture from China to France.
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