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Ilargi: And so the meisters keep spinning the tale.
On Sunday, June 28, I wrote that David Axelrod's denial that it was a present consideration, in his Sunday morning TV interview with George Stephanopoulos, was the first sign that the public is being prepped for a second Obama stimulus plan. Matt Taibbi calls this the non-denial denial; I called it the other side of the "When did you stop beating your wife" questioning tactic. Same difference.
Last Sunday, July 5, VP Joe Biden changed the tune by just that little notch, saying the administration misread the economy, and when Stephanopoulos asked "So, no second stimulus?", replied: "No, I didn't say that," [..] "I think it's premature to make that judgment". That pushed the door open one more inch. But note: both men, on Obama's staff, issue a denial, which keeps their hands clean, while they do very much introduce the idea of the second stimulus. No coincidences anywhere to be found.
Today, two new developments.
First, in the next non-coincident, Laura Tyson, an adviser without an official White House post, is shoved on stage to be the first to deliver the real message. She says:
"The U.S. should consider drafting a second stimulus package focusing on infrastructure projects because the $787 billion approved in February was "a bit too small".
Tyson can't be held responsible, since she doesn't officially speak for the White House. But the word is out, and from a source close enough to Obama for him to refer back to, should that prove convenient at a later stage. Careful planning all along.
Second, the president did two interviews in Russia, and Biden's line that the administration "misread the economy" came up in both. Obama tried to somewhat cordially soften the words a bit, telling (MS)NBC's Chuck Todd that the administration "had incomplete information", and ABC's Jake Tapper that:
".... when we passed he stimulus, we hadn’t gotten the full report of the first quarter contractions in the economy that turned out to be way worse than anybody had anticipated."
Which is again, just like Biden's blatant one on Sunday, and it does pain me to say it about Obama, a lie. There is no way the White House had no access to all those people who have been saying since long before Obama was even elected that things would be way worse then the ever-optimistic green shoots crowd "anticipated". If the Obama "experts" were not aware of all the things that had been written to that effect, they don't belong where they are. It's not like Roubini, just to name one prominent economist, was that easy to miss 6 months ago. This goes back to a classic line about politicians coming up with excuses like these: they are either not telling the truth or they are incompetent, and whichever of the two is true, they need to be kicked out on the street.
But it got even stranger. Obama also said (which is hard to rhyme with that "we didn't know" claim) that they wouldn't have done anything different anyway. He delivers it all so smoothly, you really have to pay attention, or it escapes you.
Still, that is anutterly absurd thing to say. It translates as: "No matter how bad the economy was going to be, and how many of my voters would have been how deep in the doghouse, we wouldn't have cared one bit; we wouldn't have changed a thing." Now we're in territory that I find difficult to comprehend. Why didn't he say they would have indeed acted differently?
Again, his delivery and popularity still smooth over just about anything, but that doesn't make it any less puzzling. Unless, of course, it's the prelude to the imminent announcement of that second stimulus program. Perhaps it was in the cards all along. That would explain the "we wouldn't have changes a thing" line. I'm pretty sure that they've wagered on dlauching Stimulus 2.0 in October -or September at the earliest-, and perhaps this is their way of being the first to blink in the face of the numbers. That second program, mind you, would be by far the biggest battle the team has ever faced, and all they really have to go for them is Obama's popularity, plus their PR and spin skills and their media control. Which they may need to overcome the resistance on Capitol Hill.
In the same vein, but possibly even more disconcerting, is that while both Obama interviews, as I said, bring up Joe Biden's quote "We misread the economy", neither of the two interviewers asks the president whether there will be a second stimulus plan. That would, however, of course have been the most obvious question on the planet, apart maybe from Obama's view of Michael Jackson.
If it had been just one interview, I'd think the reporter could have had an off-day, and forgot, or maybe had his attention diverted elsewhere. But both reporters not asking the one most obvious question? I don't buy it. I immediately thought of Helen Thomas' complaint to White House Press Secretary Richard Gibbs last week, saying she'd never seen an administration that tried to exert such control over the press. Just like George Stephanopoulos didn't ask the obvious "hard" questions of either Axelrod or Biden, the ABC and MSNBC guys didn't either. That leads to one possible conclusion: the whole thing is carefully scripted. The press is utilized to convey the image of the administration that it prefers.
I've said it many times now: this is not an economic crisis, it's an all-out political one. And still, nobody seems to realize that. Or if they do, they're awfully quiet.
Then again, there may be some among us who feel relieved that at least part of the Obama economic team's plans seems to work. Not the $787 billion one for the citizens, we need a second round of that failure, but one of the alphabet multitude soup meant for the banks.
Meredith Whitney today said that she expects government assisted mortgage loan modifications to take such a flight soon (because lenders' liability is no more) that she sees herself forced to readjust her numbers for the big banks, Upward. They stand to make such juicy profits from the modifications that they may actually look healthy for another quarter. Never mind that the re-default rate on these modifications is ridiculously high. 22-46% according to Whitney, but I've seen far higher numbers here and there. Which is inevitable, obviously, with plummeting home prices.
The modifications, then, typically only serve to drag home owners deeper into their debt abyss, while the lenders make nice off the modifying fees, which are provided by the taxpayer. How much? Whitney's preliminary estimate: $18 billion. Come to think of it, it's just about idal: with that default rate, they can do another round of the same next year, with to a large extent the exact same people. What is this, some sort of circus, or an off-Broadway play, where all the world's a stage? Sometimes I think the only people lucky enough to get a chance to wake up are the ones who get their TV's taken away by the repo man. Maybe that's what we should call Obama: the repo man. When he's finished, you won't have much left.
Peace, Michael. Thank you.
Obama Responds To Biden On Economy: "We Had Incomplete Information"
In a pair of separate interviews, President Obama defended his administration's response to the economic crisis in the wake of Vice President Joe Biden's remark Sunday that "we misread how bad the economy was." "I would actually -- rather than say misread, we had incomplete information," President Obama told NBC News' Chuck Todd. "What we always knew was that a) this recession was gonna be deep, and b) it was gonna last for a while." Watch [at the 2:00 minute mark]:
"There's nothing that we would have done differently," Obama added in an interview with ABC News. "We needed a stimulus and we needed a substantial stimulus." In response to critics -- including retired Gen. Colin Powel and Warren Buffet -- who have publicly worried about the deficit, Obama said there were "legitimate concerns. In the midterm and long term we're going to have to get control of that."
"The question that some have argued is, 'Okay, what next?' Maybe you stop the freefall but you still have close to 10% unemployment,'" the president said. "And you know, this is something that we wrestle with constantly ... [W]e inherited a big deficit, and it is at a certain point potentially counterproductive if we're spending more money than we're having to borrow."
An Interview with President Obama
The day after he heralded a successful preliminary nuclear disarmament treaty with Russian President Dmitry Medvedev, President Obama today told ABC News in an interview that his approach to foreign affairs was already bearing modest fruit in efforts to disarm Iran and North Korea.
"In North Korea what we saw was a very strong unanimity around a very strong sanctions regime that I think it’s fair to say that even two or three years ago might not have been imposed by either Russia or China," the president said. "They might have blocked it in the Security Council. We’ve already seen a ship of North Korea’s turned back because of international effort to implement the sanctions and I think that is a positive step forward."
Mr. Obama said that Iran’s "governing elites… are going through a struggle that has been mirrored painfully and powerfully on the streets." He said that "the fact that we have both said we are willing to work with Iran -- at the same time as we have been very clear about our grave deep concerns with respect to not just the violence, not just the detentions that have taken place -- has created a space where the international community can potentially join and pressure Iran more effectively than they have in the past."
Video opens in new window
"Ultimately we’re going to have to see whether a country like Russia, for example, is willing to work with us to apply pressure on Iran to take a path toward international respectability as opposed to the path they’re on. That’s not something we’re going to know the results of for several more months as we continue to do the hard diplomatic work of putting this coalition together to tell Iran: ‘Make the better choice.'"
ABC News interviewed the president Tuesday afternoon at the exhibition center Gostiny Dvor, where he’d just finished speaking at the commencement address for the New Economic School.
Asked if the North Korean and Iranian nuclear proliferation challenges mean the United States needs Russia’s help more than Russia needs the United States, President Obama was non-committal.
"Russia, I think understands that their long term prosperity is still tied to the world economy and to the world community," he said, arguing that "on a whole host of international issues they recognize that a partnership with the United States will strengthen them and their interests, so I think there’s the opportunity for mutual benefit here."
He said of his new diplomatic efforts with Russia that the "tone" has been "reset" but now "comes the hard work of actually seeing this produce improvements in our security situation and the world security situation."
On Michael Jackson’s Funeral: 'At Some Point People Will Start Focusing Again on Things Like Nuclear Weapons'
Having joked that he’d have to discuss Michael Jackson in order to get media coverage of the U.S.-Russian summit, the president said he wasn’t at all irritated by the media attention to the funeral of the King of Pop.
"You know, this is part of American culture," the president said. "Michael Jackson, like Elvis, like Sinatra, when somebody whose captivated the imagination of the country for that long passes away, people pay attention. And I assume at some point people will start focusing again on things like nuclear weapons."
The last time President Obama was in Russia was in 2005 when then-Sen. Obama was part of a congressional delegation visiting future nuclear weapons sites.
At the time, the president recalled, "you had already started to see the Russian public concerned less with democracy and human rights than they were in consumption and a growing economy."
Mr. Obama said that "there was a renewed confidence that in some ways had pushed those other issues out to the side."
But in conversations with President Medvedev on this trip, President Obama says he’s convinced that "there is a growing recognition that if they want to diversity their economy, continuing to develop the entrepreneurs of the sort that I just spoke to at this graduation, that issues like rule of law, transparency, democracy are going to continue to be important."
Mr. Obama predicted that after what he called Russia’s "wild swings" since the 1990s, "you’re starting to see Russia balance out. And I think that they want to pursue economic growth but I think that they recognize that some of the nagging issues around civil society still have to be fixed."
'There’s Nothing That We Would Have Done Differently' on the Economy
Turning to domestic issues, the president said that when Vice President Joe Biden recently told ABC News’ George Stephanopoulos that the White House "misread" the economy when planning the stimulus package in January, the president said that "what Vice President Biden was referring to was simply the fact that when we passed he stimulus, we hadn’t gotten the full report of the first quarter contractions in the economy that turned out to be way worse than anybody had anticipated."
But the president denied that his economic prescription was wrong because the diagnosis was incomplete.
"There’s nothing that we would have done differently," he said. "We needed a stimulus and we needed a substantial stimulus."
Even with an economic assessment that was, in retrospect, overly optimistic, the president said his team knew "there was an economic tsunami coming at us, and we still knew that we were going to need a substantial stimulus," one that would include "tax cuts which you can get out really fast" and "money to states so they’re not laying off teachers and firefighters, and police officers at such a rapid pace."
Infrastructure projects were always going to take "six months to eight months to get that money actually into the ground because that’s the nature of big infrastructure projects," he said.
In Singapore over night, White House economic adviser Laura D'Andrea Tyson said that "we should be planning on a contingency basis for a second round of stimulus." Would the president support a second stimulus package, as some congressional Democrats have proposed?
"The question that some have argued is, ‘Okay, what next?’ Maybe you stop the freefall but you still have close to 10% unemployment,’" the president said. "And you know, this is something that we wrestle with constantly."
The challenge, the president said, is "that we inherited a big deficit, and it is at a certain point potentially counterproductive if we’re spending more money than we’re having to borrow."
The president said supporters such as Gen. Colin Powell (Ret.) and billionaire investor Warren Buffet, who have said they’re worried about the massive deficits the Obama administration is creating, have "legitimate concerns. In the midterm and long term we’re going to have to get control of that."
Working on short term stimulus "is one that where we’re pressing the gas, pressing the brakes, trying to get it right," he said.
The issues the president is dealing with here may be serious, but First Lady Michelle Obama and First Tweens Sasha and Malia accompanied their father to Moscow.
Calling his daughters "great travelers," the president said that "Sasha was walking down one of the halls of the Kremlin yesterday. She had her trench coat on, had her pockets in her trench coat."
The president joked that he and his wife "called her Agent 99, she just looked like she knew where she was going. I thought she was going to pull out her shoe phone."
Obama Adviser Says U.S. Should Mull Second Stimulus
The U.S. should consider drafting a second stimulus package focusing on infrastructure projects because the $787 billion approved in February was "a bit too small," said Laura Tyson, an outside adviser to President Barack Obama. The current plan "will have a positive effect, but the real economy is a sicker patient," Tyson said in a speech in Singapore today. The package will have a more pronounced impact in the third and fourth quarters, she added, stressing that she was speaking for herself and not the administration.
Tyson’s comments contrast with remarks made two days ago by Vice President Joe Biden and fellow Obama adviser Austan Goolsbee, who said it was premature to discuss crafting another stimulus because the current measures have yet to fully take effect. The government is facing criticism that the first package was rolled out too slowly and failed to stop unemployment from soaring to the highest in almost 26 years. Obama said last month that a second package isn’t needed yet, though he expects the jobless rate will exceed 10 percent this year. When Obama signed the first stimulus bill in February, his chief economic advisers forecast it would help hold the rate below 8 percent.
Unemployment increased to 9.5 percent in June, the highest since August 1983. The world’s largest economy has lost about 6.5 million jobs since December 2007. "The economy is worse than we forecast on which the stimulus program was based," Tyson, who is a member of Obama’s Economic Recovery Advisory board, told the Nomura Equity Forum. "We probably have already 2.5 million more job losses than anticipated." Republicans, including House Minority Leader John Boehner of Ohio, seized on the latest labor numbers to attack the Obama administration’s handling of the economy.
Even Democrats have bemoaned the pace of the package’s implementation. House Majority Leader Steny Hoyer, a Maryland Democrat, said on "Fox News Sunday" June 5 that congressional Democrats are "disappointed" stimulus funds weren’t distributed faster. "The money is just really starting to come out in more significant amounts now," Tyson said. "The stimulus is performing close to expectations but not in timing."
Tyson, 62, later told reporters that the U.S. can afford to pay for a second package, even as the fiscal deficit soars. She said the budget shortfall is "likely to be worse" than the equivalent of 12 percent of gross domestic product that the administration forecast for 2009 and the 8 percent to 9 percent it projected for next year.
The professor at the University of California’s Walter A. Haas School of Business downplayed worries from China and other countries with dollar reserves that the U.S. will let inflation soar as the deficit expands. "The concern is that the U.S. will have to inflate away its debt. I do not think that is a valid concern," she said. "The Federal Reserve is not going to let the U.S. government inflate away its debt." The U.S. needs to communicate its determination to reduce the annual shortfall once the economy recovers, she said.
While unemployment is worsening, other data have shown the economy is improving. U.S. manufacturing shrank last month at the slowest rate since August, according to the Institute for Supply Management’s factory index, and a measure of pending home sales advanced in May for a fourth month. Tyson said the U.S. should shift away from its dependence on consumption to grow, and promote expansion through investment and exports. The dollar will need to weaken in the longer term to promote export-led growth, she said.
Whitney's New Take On Modified Loans
Star analyst Meredith Whitney expects the number of mortgage modifications to become exponentially higher, which is good news for the banking sector. But she hasn't always felt this way. Over the past two years, Whitney, who recently opened the Meredith Whitney Advisory Group, has been relatively dismissive of the idea, "primarily due to the fact that few were taking place as the servicer historically bore substantial liability risk to alter the terms of a contract, and a large number of the modified loans ultimately re-defaulted anyway."
However, in late-May, through the Helping Families Save Their Homes Act of 2009, Whitney pointed out that services are now free of any legal liability from altering a mortgage contract. Meanwhile, the Treasury Department has allocated $18 billion to encourage services to modify loans. "We believe we are on the onset of changes impacting the mortgage market that could meaningfully influence earnings of the banks over the near to medium term," Whitney argued in a recent report.
She said that accelerations in loan modifications will materially change how loss reserves are measured, which will result in lower loss provisioning and higher earnings over the near term. The newfound flexibility is great news for the industry, which faces continued declines in home prices and rising unemployment. As Whitney noted, the U.S. government increased allocated incentives to mortgage companies by a fifth to modify home mortgages, while total incentives to servicers now stand at $18 billion and could climb higher.
"This is not the only incentive to banks," Whitney said. Modifications "cure" past dues and shift delinquent loans to current loans. As banks' loss provisions are based upon past due or delinquent loans, Whitney reasons that loss provisions will decline as modifications rise.
"The clear risk here is timing as current recidivism rates range 22-46% on modified loans. Banks may take advantage of a timing arbitrage, which could benefit near-term earnings," Whitney said. Earlier this year, Whitney projected financial losses though 2010, arguing firms including American Express, HSBC, Morgan Stanley and Goldman Sachs failed to reserve against real estate and mortgage losses.
Beyond the impact of the loans, Whitney expects the second quarter will result in continued growth in tangible capital. As such, Whitney raised her estimates on the banking sector, increasing her tangible book values for most of the banks she follows. "As we continue to believe the bank sector faces numerous challenges, we are most comfortable with stock valuations close to tangible book per share levels," Whitney said. Pointing to Bank of America, JPMorgan Chase, Wells Fargo and Citigroup, she expects future increases in tangible book value, except for Citigroup.
Don't Count on Consumers
The U.S. economy needs a shove. But where will it come from? Credit won't cut it. Consumer delinquencies hit a record in the first quarter, the American Bankers Association said Tuesday. Household debt as a proportion of disposable income peaked at 133% in the fourth quarter of 2007, when the current recession began. As of the first quarter of this year, the ratio had eased to 128%. In previous postwar recessions, it tended to hold steady. In the last downturn, it actually increased by 6 percentage points.
This time, the credit bubble left the ratio too high to begin with, so even with the Federal Funds target rate around zero, people have little appetite to borrow and consume their way to recovery. In May, the Federal Reserve Bank of San Francisco modeled a deleveraging of U.S. households, with the ratio falling back to 100% over a decade. The resulting drag was 0.75 percentage points off consumption growth every year.
The reason for rising delinquencies, and the reluctance to borrow more, is growing unemployment and, as a falling work week demonstrates, underemployment.
Joseph Lavorgna, Deutsche Bank's chief U.S. economist, points to a pattern of increasingly "jobless" recoveries starting in the 1980s. Furthermore, he says, the last upswing, which ended officially in December 2007, was weighted disproportionately to the construction and financial sectors. Jobs lost there won't return soon.
Restrained incomes and higher saving promise a grinding recovery with the threat of deflation and a lackluster outlook for the country's banks and cyclical industries. The wild card is whether authorities push aggressively for a politically more palatable but ultimately dangerous alternative: Inflating those debts away.
Remember The 40-Hour Work Week?
Last week it was revealed that the average work week of non-farm workers had dropped to an all-time low of 33 hours. It's a worrying sign that even with all the lahyoffs, employers aren't making their existing employees work more. So what happened to the 40-hour work week? Turns out, that's a long, distant memory.
US consumer delinquencies hit new highs
Soaring unemployment has pushed credit card and home-equity delinquencies to record levels as US consumers struggle with the loss of income, household wealth and sputtering investments, the American Bankers Association said on Tuesday. Delinquencies on all consumer loans rose to 3.23 per cent of all accounts in the first three months of the year, bringing them to the highest level since 1980. ABA defines a delinquency as an account that is more than 30 days past due.
"The number one driver of delinquencies is job loss," James Chessen, ABA’s chief economist said. "When people lose their jobs, they can’t pay their bills. Such consumers are leaning more heavily on their credit cards and the equity in their homes. In the first quarter bank card delinquencies have jumped to 4.75 per cent of all accounts from 4.52 per cent in the previous quarter. Delays are also leading to swollen balances. On delinquent credit card accounts, overdue balances now account for a record 6.6 per cent of all outstanding bank card debt, leading credit card companies to try to recoup losses by raising interest rates and minimum payments.
In June, Citigroup sharply increased interest rates on up to 15m US credit card accounts just months before curbs on such rises come into effect. And JPMorgan Chase said that, from August, some of its customers would see their minimum required payments rise from 2 per cent to 5 per cent of their unpaid monthly balances. The stricken US housing market, which has seen home values plunge by as much as 30 per cent from the 2006 peak, has also pushed home-equity loan delinquencies higher. According to ABA, late payments on home-equity loans are up to 3.52 per cent of all accounts and delinquencies on home-equity lines of credit hit 1.89 per cent. Both are fresh record highs.
"Even if home prices stop falling later this year, unemployment will keep home equity delinquencies high for some time," Mr Chessen said. Last week the labour department said that the US economy shed another 467,000 jobs in June, bringing the unemployment rate to a 26-year high of 9.5 per cent. Most economists predict the jobless rate to reach 10 per cent this year, before retreating by the end of 2010.
Home-Equity Delinquencies in U.S. Set Record as Economy Ravages Borrowers
Late payments on home-equity loans rose to a record in the first quarter as 18 straight months of job losses and a slumping economy left more borrowers unable to pay their debts, the American Bankers Association reported. Delinquencies on home-equity loans climbed to 3.52 percent of all accounts from 3.03 percent in the fourth quarter, and late payments on home-equity lines of credit climbed to a record 1.89 percent, the group reported today. An index of eight types of loans rose for a fourth straight quarter, to 3.23 percent from 3.22 percent in October through December, the group said.
"The number one driver of delinquencies is job losses, which we’ve seen build and build," James Chessen, the group’s chief economist, said in a telephone interview. "Delinquencies won’t come down without a dramatic improvement in the economy and businesses will have to start hiring again." The U.S. economy lost an average 691,000 jobs a month in the quarter, and more than 6.5 million positions have been shed since the recession began in December 2007.
The economy this year will shrink the most since 1946, according to a Bloomberg survey of 61 economists last month. President Barack Obama predicted last month unemployment will reach 10 percent this year. The rate was at a 26-year high of 9.5 percent in June. Delinquent bank-card accounts jumped to a record 6.60 percent of outstanding card debt in the first quarter from 5.52 percent in the previous period, a signal unemployed borrowers are relying on cards as falling prices erode the equity in their homes. More borrowers are using cards to meet daily expenses after losing their jobs, the ABA said.
U.S. banks issued 9.8 million credit cards from January through April, a 38 percent decline from the year-earlier period, according to data compiled by Equifax Inc., a credit bureau, quoted today in USA Today. The average limit on a new card fell 3 percent to $4,594, Equifax reported. "There is less equity to draw on and certainly financial institutions have been scaling back the available lines of credit," Chessen said. Banks boosted reserves for losses on delinquent loans and have adopted more cautious underwriting policies, he said.
The ABA’s survey tracks data from 300 banks, monitoring late payments on eight types of closed-end loans that are used as a benchmark for typical consumer delinquencies. The composite index rose to the highest level since the group began collecting data in October 1974. Loans are considered delinquent when a late payment is 30 days or more overdue.
Of the closed-end accounts, delinquencies rose on five: home-equity loans, direct auto loans, recreational vehicle, mobile home and personal loans, the group said. Auto loans are 45 percent of all consumer closed-end loans, the ABA said. Rates for indirect auto loans, made through third parties such as a dealer, fell to 3.42 percent from 3.53 percent in the fourth quarter. Property improvement and marine loan rates also declined.
U.S. Home Prices to Fall Through 2011's First Quarter
Home prices may fall in more than half of the largest U.S. cities through the first quarter of 2011 as unemployment and foreclosures rise, mortgage insurer PMI Group Inc. said. Thirty of the 50 biggest metropolitan areas have at least a 75 percent chance of lower prices through March 31, 2011, Walnut Creek, California-based PMI said in a report today. The decline is likely to spread to "all regions of the nation" from California, Florida, Nevada and Arizona, the states most affected by the housing slump, PMI said.
"The housing market has been hit by a demand shock of high unemployment and a supply shock of distressed foreclosure sales," LaVaughn Henry, senior economist at PMI, the fourth- largest U.S. mortgage insurer, said in an interview. Unemployment rose to 9.5 percent in June, bringing the total number of jobs lost to 6.5 million since December 2007, the Labor Department said July 2. Foreclosure filings may hit a record 1.8 million in the first half of the year as more jobless homeowners default on their loans, real estate data service RealtyTrac Inc. said last month.
Home prices in 20 major U.S. metropolitan areas dropped 18.1 percent in April from a year earlier, following an 18.7 decrease in March, according to the S&P/Case-Shiller index. Prices are forecast to fall 41.7 percent from their peak, Deutsche Bank AG analysts led by Karen Weaver wrote in a June 15 report. "Affordability is no longer the driving issue in the housing market and we believe prices still have a ways to fall in many areas before home prices reach their trough," the Deutsche Bank analysts wrote.
The 15 areas with the highest probability of lower prices in 2011 each have a 99 percent chance, PMI said. They include Miami, Fort Lauderdale, West Palm Beach, Orlando, Tampa and Jacksonville in Florida; Riverside, Los Angeles, Santa Ana, Sacramento and San Diego in California; Las Vegas; Phoenix; Providence, Rhode Island; and Detroit. Edison and Newark, in New Jersey, have a 97 percent and 96 percent chance, respectively. Nassau, New York, has a 92 percent chance. New York City showed an 88 percent chance of lower prices, according to PMI.
"The New York area has gone from a moderate level to an elevated level because of the big hit from the financial crisis," Henry said. Washington showed a 92 percent chance of lower prices; Portland, Oregon, and Baltimore each have 90 percent; Atlanta has 81 percent; Boston has an 80 percent chance; San Jose, California has 78 percent; and Minneapolis has a 75 percent chance, PMI said.
The probability of lower prices is 66 percent in the San Francisco area; 58 percent in Warren, Michigan; 46 percent in Seattle; 45 percent in Milwaukee; 41 percent in Cambridge, Massachusetts; 36 percent in Chicago; and 30 percent in Philadelphia, according to PMI.
The areas with the least chance of lower prices, each with less than a 6 percent probability, include Cleveland; Pittsburgh; Columbus, Ohio; San Antonio; Houston; Dallas, and Fort Worth, Texas, according to PMI. The insurer compiles its "market risk" index from income, interest-rate, home-price and affordability data going back to the early 1980s.
Loan servicers prefer big losses to loan forgiveness
A study of 3.5 million mortgages nationwide found that in June loan servicers held 32,000 foreclosure sales, with an average loss of 64.7% of the original loan balance. Alan White, an assistant professor at the Valparaiso University law school in Indiana, looked at subprime and alt-A mortgages written from 2005 to 2007, sold as securities to investors, and now serviced by five of the biggest servicers, including Bank of America, Chase, and Litton Loan Servicing. Gretchen Morgenson of the New York Times reported on his study, which was based on data collected by Wells Fargo, which is overseeing the loan trusts.
Losses averaged 56.1 percent of the original loan balance in November, and in February, 63.3 percent. Things are clearly getting worse for investors in mortgage securities. Morgenson calls the foreclosure sales "liquidation sales" and I can only assume she means properties sold at auction. That fits with what I observed at a trustee’s sale I visited recently in Santa Ana: Lenders or loan servicers offered an average 61% discount against balance due on first mortgages on seven properties, and they sold for an average 56% discount after investors bid up the prices a little.
The study also found that modifications decreased in May and June compared to February, while foreclosures increased. But the study is only looking at a slice of the market — one can’t assume loan mods are dropping across the entire industry. The Office of the Comptroller of the Currency, which tracks more home loans including prime, said in the first quarter loan mods increased 55% vs. the final three months of 2008. Still, the professor takes a grim view of government efforts to help people avoid foreclosure. "I was hoping we would see some impact in June of the government’s program," Mr. White said. "Is ‘Home Affordable’ working? My short answer is no."
White also found that servicers rarely "forgave" any principal, interest or fees owed. Instead, servicers preferred to foreclose and suffer huge losses. "That is not rational behavior," the professor said. Maybe, but lenders fear forgiving a lot of debt will encourage more people to default. And principal reductions mean recognizing a loss without gaining control of the collateral — in other words, running the risk a borrower will redefault and the ultimate loss be even greater if home prices continue to decline.
As Earnings Loom, Wall Street Starts to Worry
Stocks declined on Tuesday as investors questioned whether corporate earnings would justify the gains that Wall Street posted over the last three months. Energy stocks led the broader markets lower as shares of consumer-focused companies, industrial producers and utilities also fell. With few major economic figures scheduled to be released this week, many investors are focusing on corporate profits and losses.
"We’re a little concerned," said Nicholas Bohnsack, sector strategist at Strategas Research Partners. "The economy has moved toward less-bad territory, but it’s struggling to move into good, or a recovery mode." Before 2 p.m., the Dow Jones industrial average was down 75 points or 1 percent while the broader Standard & Poor’s 500-stock index slipped about 0.9 percent, though both rebounded somewhat from their earlier lows. The technology-focused Nasdaq fell about 1.2 percent. Markets in Asia closed slightly lower, and fell in late trading in Europe.
Underscoring concerns about an economic recovery, the American Bankers Association said that delinquency rates on home equity loans, auto loans and others rose slightly in the first three months of the year as people lost their jobs and fell behind on their debts. In all, 3.23 percent of loans were 30 days behind or more through the end of March, up from 3.22 percent a quarter earlier, the group reported. Investors are also expected to keep an eye on the G-8 summit meeting this week to see what the world leaders are thinking about the economy.
As earnings stagnate and consumers put more of their disposable income into savings — 6.9 percent, according to recent government figures — analysts are concerned that corporate revenue will flat-line or keep falling. And many corporations will only be able to beat earnings expectations by cutting jobs and other costs, which could worsen the already weak job market. "To the extent that they can continue to cut jobs, companies may do O.K. relative to expectations," Mr. Bohnsack said. "If they can’t, they’ll miss."
The year’s first round of earnings announcements this spring buoyed investor hopes with reports of smaller losses at many companies and some sizable profits at banks like Citigroup and Wells Fargo, which suffered huge losses during much of 2008. Many large banks report their earnings next week. But now, with stocks up more than 30 percent since their bear-market lows, some analysts are concerned that investors’ hopes have outpaced the corporate world’s power to generate cash in a deep recession. The aluminum maker Alcoa, which is expected to post another loss, will kick off the second-quarter earnings season on Wednesday.
Earnings for all companies in the S.&P. 500 are expected to fall 35.5 percent from a year earlier, according to figures from Thomson Reuters, with many of the declines concentrated in the materials, energy and financial sectors — three areas of the stock market that performed strongly in the second quarter. Shares of the lumber producer, Weyerhaeuser, were down 3.2 percent Tuesday after the company said it would cut its dividend to 5 cents a share from 25 cents a share in order to save money.
As stocks fell, investors concerned about dim prospects for a quick recovery put money into Treasury markets, pushing the yield on government debt lower. The yield on the benchmark 10-year note fell slightly, to 3.51 percent. Crude oil futures fell $1.32 cents to $62.73 a barrel, another drop for volatile oil prices. After racing past $70 a barrel, prices have fallen back to their lowest levels since late May amid expectations that supplies are expected to grow.
Glut of $4.5 Trillion Will Haunt Obama’s Dollar
It’s not a job Barack Obama signed up for, but it’s his nonetheless: Bond salesman-in-chief. Such is the lot of a U.S. president overseeing an historic increase in debt issuance. Cartoonists are busily churning out depictions of Obama, who partly nationalized automakers, standing on a car lot hawking Detroit’s clunkers. It’s time to begin picturing Obama shilling bonds few may soon want. His best customers? Asians, of course. Asia already holds about $4.5 trillion of currency reserves, most of them denominated in U.S. dollars. It’s a product of Asia’s "savings glut," of which the cash-strapped U.S. remains a major beneficiary. That is, if Asians don’t pull the plug.
The trouble is that the U.S. seems to be taking Asia’s money for granted. That’s a grave mistake for a White House that needs to offload record amounts of debt to fund a $787 billion stimulus package -- not to mention spending plans yet to be announced. Assuming Asia’s perpetual devotion is a mistake. It’s no coincidence that China is pushing for a new international currency at a time when it wants to diversify its almost $2 trillion of reserves. Such mutterings from Venezuela are one thing. They’re quite another coming from the biggest foreign holder of Treasuries, with about $764 billion.
"It would be important for the U.S. not to take its position for granted," World Bank President Robert Zoellick said last week. "My guess is what you will see over time, just as the euro has developed over time, you may have some other currencies develop as an alternative." Not that the yuan is ready for prime time. Besides, say analysts like Marc Chandler of Brown Brothers Harriman & Co. in New York, China’s desire for the yuan to become a global invoicing currency doesn’t outweigh its need to maintain control and help exporters. Ultimately, China’s ambitions are hemmed in by the realities of a currency that still isn’t convertible.
China speaks out of both sides of its mouth on the issue. One day, a top official says China wants an alternative to the dollar. The next, someone like Vice Foreign Minister He Yafei tells reporters that "we hope that as the main reserve currency the U.S. dollar will be stable" and that he’s "not aware" of China pushing to put the subject on the agenda of the Group of Eight’s agenda this week. The other BRICs nations -- the acronym refers to Brazil, Russia, India and China -- all have made noises about the dollar’s stability. Some more than others, of course, yet their concerns have been well reported.
Replacing the dollar as a long-term goal is fine. Doing it while the global financial system the dollar anchors is in tatters is ill-advised. Not surprisingly, folks in Washington are worried about a sudden move against the currency. It hardly seems a coincidence that while Managing Director Dominique Strauss-Kahn has called China’s yuan "substantially undervalued," the International Monetary Fund has toned down criticism over the disconnect from economic fundamentals. The softer rhetoric removes a sticking point between China and the IMF, as Asia’s second-largest economy seeks a larger role at the lender and the fund tries to increase China’s contributions.
Could the quid pro quo be that China avoid pulling the rug out from under the dollar? It’s possible. Still, Obama and Treasury Secretary Timothy Geithner shouldn’t assume Asia’s continued support. Not with the Federal Reserve holding interest rates near zero and untold waves of fresh debt flowing into uncertain markets. Rumblings about the U.S. losing its triple AAA credit rating have further raised the stakes.
Granted, Asia deserves some of the blame here. Over the past decade, the region was the site of a currency-reserve arms race. While the clear winner in this game of monetary one- upmanship is China, economies like Taiwan and South Korea are holding more dollars than they would like. It’s become the world’s biggest Ponzi scheme, really. The dollar isn’t crashing because those invested in it are propping it up and adding to their holdings. After all, the magnitude of Asia’s foreign-exchange holdings means it can’t dump the dollar without shooting its economies in the foot.
Asia should indeed be plotting how to reduce its dollar holdings. Those trillions of dollars would be better used in Asia to pay for better roads, bridges, airports and power grids and improved education and health care. Until then, the U.S. needs to reassure Asians they won’t suffer massive losses on their dollar holdings. It can start by circulating a credible exit strategy from today’s massive stimulus efforts.
The White House also needs to convince Asia that devaluing the dollar at some point to boost U.S. exports isn’t on the table. Obama and Geithner should plan to increase financial diplomacy efforts, traveling to Asia often. Asia has a $4.5 trillion dollar decision to make, and it’s up to the U.S. to help the region make the right one. Taking Asia’s money for granted would be a disastrous way to go.
Economic recovery faces serious hurdles
As the U.S. economy rounds the midyear turn, most economists believe that growth will resume as early as the current quarter. They are trying not to let you see that they are saying this with their fingers crossed. Several months ago, it looked as though the economy was in the process of bottoming out. A number of statistics had begun to point up, not the least of which was the stock market, considered by many to be a venerable leading indicator.
From the middle of March until the middle of June, stocks went on a tear, rising more than 30% -- the biggest jump in such a short period of time since the 1930s. It is an open question why stocks rose as much as they did -- especially since they have gone nowhere over the past few weeks. Some believe that stocks fell too far, while others think the market was anticipating a turn in corporate profits as early as the third quarter.
Whatever the case, it should be pointed out that even with this big run-up, stocks, as measured by the Dow Jones Industrial Average, are still below their levels at the turn of this year -- much less a year ago, when the Dow was just below 12,000, and 21 months ago, when the Dow peaked at 14,165. This has a direct bearing on the economic outlook and whether the market's expectations will come to fruition. Stocks at today's levels represent a tremendous loss in investors' net worth. This alone has been enough to put the kibosh on consumer spending, which represents 70% of the gross domestic product.
Another depressant holding back the urge to splurge is the drop in residential real-estate values. For many, a home is their biggest asset, and lower prices alone are enough to cause people to pull in their horns. Add in their inability to pull money out in the form of a home-equity loan, and the prospects for spending gains become even dimmer. To add insult to injury, the price of oil and gasoline has been on the rise since the beginning of this year. Although well below levels a year ago, when prices peaked at more than $4.00 a gallon nationwide, gasoline still costs about 60% more today than it did six months ago, making it difficult for many households to buy other goods and services.
Spending is also being constrained by a decision on the part of many households to rebuild their depleted bank accounts. The savings rate has gone from zero to a 15-year high of nearly 6% -- and they are earning very little on their savings, due to today's record low interest rates. On top of this, falling employment and rising unemployment are also exerting a drag on consumer spending. And if the past two recoveries are any guide, it could take a year or more after the economy turns before employers will resume hiring.
As for Washington's stimulus package, very little has hit the economy so far -- as I first pointed out in my column of May 26 and reiterated last week. Indeed, when you factor in cutbacks at the state and local level, you could almost say that fiscal policy has actually tightened over the past year. Even the turnaround in business productivity is nothing to cheer about. What good is it to be more efficient if you don't have many customers coming through the door?
Hybrid Securities Doomed Six Banks
The six family-controlled Illinois banks that collapsed on Thursday were doomed by massive holdings of trust preferred securities, Wall Street instruments that came into vogue during the industry's boom but are now battering a growing number of small banks. In 2005, the failed banks and two others owned by the Campbell family of Illinois started snapping up trust preferred securities, which are a hybrid between debt and equity, in an attempt to fuel earnings growth. Demand was sluggish for loans in the small Midwestern towns where the family's banks were based.
When the credit crisis hit, the values of the securities and pools into which they were packaged rapidly lost value, partly because some banks stopped paying dividends on the securities. Under accounting rules, the banks were required to write down the securities to market value. That forced the banks to absorb big losses, winnowing their capital cushions. The six failed banks, some of which were founded in the Civil War era, had about $1.38 billion in combined assets.
While the Federal Deposit Insurance Corp. found buyers for the banks' branches and some of their loans, the failures are expected to cost the agency's strapped insurance fund roughly $267 million. A total of 52 federally insured banks and savings institutions have gone bust this year. The Campbell family still controls three banks that remain in business. Two are based in Illinois and also have been battered by investments in trust preferred securities. A third bank, in Scottsdale, Ariz., steered clear of the securities because it had plenty of growth opportunities through lending. It is now suffering from a wave of souring loans to finance commercial real-estate projects.
Lyle Campbell, the 73-year-old patriarch of the family's banking business, said in an interview on Monday that he is scrambling to raise as much as $25 million from private investors to bolster capital at his three surviving banks. "The appetite is not large," he said. One of the three banks, First National Bank of Gilman, Ill., which was founded in 1869 and has about $44 million in assets, last week reached a preliminary deal to sell itself to an unidentified Illinois bank. "We weren't as bad as those that went down, but we needed capital," said Dale R. Warmbir, who is First National's president and has run the bank since 1977.
That was three years before Mr. Campbell and a partner bought a controlling stake. "It's a relief that it's over, but we're all angry that it had to happen," Mr. Warmbir added. Mr. Campbell, who oversaw the failed banks with his three sons, instructed executives at institutions owned by the family to buy trust preferred securities. In a process similar to the securitization of subprime mortgages, Wall Street brokerage firms bought the securities from individual banks and packaged them into collateralized-debt obligations. The firms then sold slices of the CDOs to investors, marketing them as lucrative but low risk. Many of the buyers were small and regional banks.
Mr. Campbell, who also races planes and helicopters and collects antique Lincoln Continental cars, said the CDOs were rated as investment grade and included securities issued by hundreds of U.S. banks. "They were so widely dispersed that we thought they'd be safe," he said. Regulators didn't object to his investments at the time, he added. As of March 31, 2007, the six failed banks were holding about $439 million of securities in their available-for-sale portfolios, according to a review of regulatory filings by The Wall Street Journal. That included trust preferred shares and other securities.
Mr. Campbell said he spent much of the past year urging the FDIC, Office of the Comptroller of the Currency and the Illinois Department of Financial and Professional Regulation to not force the banks to take painful write-downs. "We lost that argument," he said. As of March 31, 2009, the six banks' available-for-sale portfolios had declined by 33% to about $296 million. As a result of the write-downs, capital ratios at the six banks fell below the levels required by regulators. Mr. Campbell and his sons spent months unsuccessfully trying to drum up outside capital.
An FDIC spokesman said it was the Illinois regulators' decision to close the banks. Susan Hofer, a spokeswoman for the Illinois banking regulators, said: "We don't tell banks how to run their businesses, but if their investments go south or their business model stops working, it is our job to act decisively to protect their customers from undue risk."
Muni bonds feel US states’ fiscal stress
California’s high-profile budget crisis and the fiscal woes of states throughout the US are taking their toll on the public finance markets, sending borrowing costs higher for states, cities, counties and other municipal issuers. The Golden State and its gaping $26bn deficit have caught the headlines, but a handful of other states have also failed to agree on balanced budgets, even after federal stimulus. Even the states that have passed budgets have been forced to make dramatic cuts such as closing schools and laying off staff to compensate for plunging tax receipts.
"This is the first time in 20 or 25 years that we have seen a recession affect the entire nation simultaneously," says Robert Kurtter, a managing director in the public finance group at Moody’s Investors Service. "Most have been regional or sectoral in nature, such as manufacturing recession in the Midwest or the tech bust in California." States, cities and other entities raise money in the $2,700bn municipal market for projects and services benefiting the public good. Interest income on the bonds is exempt from some US taxes.
Yields on California’s long-term muni bonds are hovering at 6.10-6.20 per cent, up from about 5.50 per cent a few months ago and a full percentage point more than most other states. However, they are off recent highs as opportunistic buyers have moved in. But the uncertainty surrounding the California situation and the publicity that it has received is weighing on the overall market.
Even yields for top-rated, or triple A muni bonds, have increased slightly to 5.16 per cent from 5 per cent in the past few months. Matt Fabian, managing director at Municipal Market Advisors, a research company specialising in muni bonds, says yields should be lower, given a popular federal stimulus plan that subsidises state and other issuers to sell taxable munis, in effect drawing supply out of the tax-exempt muni market. "People are worried about committing capital to munis right now in the face of potential credit problems and ratings downgrades resulting from the state budget issues," he says.
By law, most US states have to enact balanced budgets. Otherwise, the financial workings of the government can go into a virtual shutdown, as has been the case in California. The state last week began issuing IOUs for payments including welfare checks and vendor bills. Arnold Schwarzenegger, state governor, has asked banks to accept the IOUs. Even in the absence of a budget, most states have measures in place to prioritise debt service or ensure that it continues for general obligation bonds.
GOs are backed by the full credit of the state. In California, for instance, the only payments that the state makes ahead of the bonds are funds for education, such as paying school teachers. Pennsylvania, another state without a balanced budget, has a state constitutional requirement that it maintain debt services on its GOs. This system so far has helped to insulate the muni bond market, even as states faced cumulative budget gaps of about $120bn heading into June 30, which is the fiscal year-end for 46 of the 50.
But Fitch Ratings on Monday cut the credit ratings of California bonds to triple B, several notches below any other state citing its "severe fiscal crisis." Ratings agencies are not considering sweeping credit downgrades for states based on late budgets alone, but persistent fiscal stress may pressure credit quality. "We don’t see late budgets by themselves causing downgrades, but the fiscal pressures faced by states across the country due to the weak economy could result in some downgrades," Mr Kurtter said.
He also says that local entities such as counties and school districts will come under pressure after states reduced allotted spending to them to plug gaps. Budget gaps could again open as the economic downturn continues. "The muni credit cycle is not over yet," says Gary Pollack, head of fixed-income research and trading in the private wealth management group at Deutsche Bank. "There is a risk that the second time around it is harder to close a budget after you have already made your cuts and received bail-out money from the federal government."
Ilargi: Ha ha. As I said yesterday, Goldman may yet come to regret calling the police on this one.
Goldman: Stolen Code Can Be Used To Manipulate Markets
Shut up Goldman Sachs! You're playing right into the hands of all your enemies and everyone who believes you know how to manipulate the stock market:Bloomberg: At a court appearance July 4 in Manhattan, Assistant U.S. Attorney Joseph Facciponti told a federal judge that Aleynikov’s alleged theft poses a risk to U.S. markets. Aleynikov transferred the code, which is worth millions of dollars, to a computer server in Germany, and others may have had access to it, Facciponti said, adding that New York-based Goldman Sachs may be harmed if the software is disseminated.
"The bank has raised the possibility that there is a danger that somebody who knew how to use this program could use it to manipulate markets in unfair ways," Facciponti said, according to a recording of the hearing made public yesterday. "The copy in Germany is still out there, and we at this time do not know who else has access to it."
And by "somebody who knew how to use this program" do they mean themselves?
Reservations about the dollar
Speculation is high that currency issues will be discussed at the Group of Eight leaders’ meeting in L’Aquila this week. China has called for reform of the global reserve system and creation of a new international reserve currency based on special drawing rights (SDRs). Although the Chinese deputy foreign minister suggested on Sunday that China expected the dollar to be the world’s main reserve currency for “many years to come”, action speaks louder than words: China said this month that companies taking part in a trial that uses the renminbi to settle trade will be eligible for export tax rebates.
It was only a question of time before the desirability of the dollar as the dominant global reserve currency would be questioned. Over the past decade, the US has failed to fulfil its basic obligation as the issuer of the global reserve currency: maintaining the dollar’s value. After peaking in 2002, the dollar in trade-weighted terms has depreciated almost ever since. Although the financial crisis has given the dollar a lift owing to its haven status, the consensus is that this rebound will be short-lived. The US’s aggressive policy response to the crisis – an extraordinary loosening of fiscal policy and large-scale asset purchases by the Federal Reserve – is raising serious concerns about the US’s long-term inflation outlook.
Its recent record on inflation has not been reassuring. Consumer price inflation averaged 2.7 per cent, versus 2.1 per cent in the eurozone and 1.8 per cent in the UK, over the past decade. This disparity may stem from differences in institutional frameworks. The past 20 years have witnessed the adoption of inflation targeting by central banks of most developed and many developing economies. In contrast, US monetary policy is guided by the Fed’s dual mandate of price stability and full employment. Whether the greater policy flexibility at the disposal of the Fed is in the best interest of the US is still unproven, but it is easy to see why it does not bolster confidence in the dollar, especially at a time when some of the structural disinflationary forces of the past decade may be in retreat.
New global economic trends are changing the costs and benefits of having a reserve currency. In coming years, all countries may have to fight over a shrinking global savings pool as baby boomers retire. This will increase the desire to enjoy the “exorbitant privilege” accruing to the issuer of the global reserve currency. But joining the club is not free. Reserve currency issuers may need to supply large quantities of their currencies, with the concomitant risk of running potentially large current account deficits. They will also surrender a loss of competitiveness to the US by allowing a significant appreciation of their currencies against the dollar.
The euro has established itself as a credible alternative. But the willingness of eurozone governments to run up large current account deficits should not be taken for granted and the scope for the already overvalued euro to appreciate further against the dollar is limited. With China likely to become the world’s largest exporter over the next few years, the renminbi is in a strong position to challenge the dollar’s reserve currency status. However, China would need to remove capital controls for the renminbi to become a true reserve currency and a freely floating renminbi would weaken the Chinese government’s control over its economy.
The SDR is unlikely to be a practical alternative to the dollar. In theory, countries can purchase liabilities issued by the International Monetary Fund that are linked to the SDR (of which the dollar has a 44 per cent weighting) as a way to reduce their exposure to the dollar. Indeed, both China and Russia have expressed interest in buying such IMF bonds. However, the problem is that these bonds can be traded only between central banks, so they cannot compete with the liquidity offered by traditional reserve assets such as government bonds. If the objective is to diversify out of dollars, reserve managers can achieve it more efficiently by directly increasing their holdings of euro, yen and sterling (the other currencies to which the SDR is linked). China has suggested the renminbi be included in the SDR. While this may help other nations gain exposure to the renminbi, China may need to accept a further increase in its own exposure to the dollar.
Notwithstanding the problems with the current global reserve system, there are at present no obvious alternatives to the dollar. That said, US fiscal profligacy will push the dollar risk premium higher over time. In other words, the US’s ability to obtain cheap external funding for financing its twin deficits is likely to be curtailed. In the near term, the global economy remains too fragile to absorb the shock of a large and disorderly decline of the dollar. In that respect, the chances for co-ordinated intervention among developed economies to support the dollar are higher now than any time in the past 10 years.
Completion of SIV asset disposal near
Almost all the $400bn of assets held in structured investment vehicles have now been disposed of, two years on from their starring role in the early days of the financial crisis. SIVs were early victims of the crisis when their style of financing illiquid long-term assets with short-term borrowing fell victim to the 2007 market crunch. The attraction to investors had been the profits generated by the difference between cheap short-term funding and the income from higher-yielding but illiquid long-term holdings, including subprime mortgages.
Once these benefits disappeared in the market convulsions, banks and other other SIV sponsors scrambled to rescue the vehicles. Analysts at Fitch Ratings calculate that 95 per cent of the assets held in SIVs at the July 2007 peak have now been disposed of as the vehicles have been wound down – with much pain to investors, but without the wild market dislocation many feared. Glenn Moore, of Fitch’s European structured credit team, said: "Although substantial, the asset disposals have been relatively orderly over the past two years. As the oversupply of assets from the SIV sector is removed, this is one less factor weighing on structured finance valuations."
Of the 29 SIVs, five have been restructured, 13 were consolidated onto the sponsoring bank’s balance sheets and seven defaulted on payments of their senior borrowings. Fitch estimates just four have unwound themselves, at least one of which did so without losses to senior investors. SIVs that were consolidated or restructured accounted for two thirds of total SIV assets while the defaulting SIVs were worth 32 per cent. The three SIVs that successfully unwound themselves accounted for about 2 per cent of assets in the vehicles.
Investors are still struggling to recover their holdings in SIVs and in many cases have gone to court to push for a more equal sharing of whatever is left over. This may not be much; Ernst & Young, the receiver of Sigma Finance which ceased operations in October last year, only managed to raise $306m for assets with a face value of $2bn.
Debt Burden Quickens Power Shift as G-8 Loses Clout
The world’s most affluent nations will take decades to work off the biggest buildup in debt since World War II. The political costs may be permanent, laid bare at this week’s Group of Eight summit of leading industrial powers. Bank bailouts and recession-fighting measures will explode the debt of the advanced economies to at least 114 percent of gross domestic product in 2014, more than triple the 35 percent of the main emerging economies including China, the International Monetary Fund forecasts.
The run-up in debt has hastened a power shift that is sapping the industrial world’s authority to impose its economic doctrine, currency arrangements or greenhouse-gas reduction strategies. Even some G-8 officials acknowledge that the group has lost its grip amid the global recession they spawned. The eight-nation forum that starts tomorrow in L’Aquila, Italy is "a lot less relevant given its makeup and given developments in the world," French Finance Minister Christine Lagarde said July 5. "Big players, like emerging economies, India, China or Mexico, are invited, but they’re given only a jump seat outside of the main summit."
The industrial world is beset by the harshest economic conditions in a lifetime: a projected U.S. budget deficit of 13.6 percent of GDP in 2009, unmatched since World War II; an annualized 14.2 percent contraction in Japanese GDP in the first quarter, also the worst since the war; in the first three months of 2009, German exports had their steepest quarterly decline since 1970 when the data were first compiled.
Reflecting the relative fortunes of the G-8 and emerging markets, developing nations’ share of worldwide stock-market capitalization has climbed to a record 24 percent from 15 percent at the start of 2007 as investors piled into the fastest-growing economies. "Despite a global economic contraction and some uncertainties over growth in domestic demand, China’s economic recovery will continue," Zhang Jianhua, head of the central bank’s research bureau, said in this month’s China Finance magazine.
While the surge in borrowing has prompted calls for alternatives to the dollar as a reserve currency, emerging- markets policy makers aren’t near consensus on a plausible option. Chinese Deputy Foreign Minister He Yafei said July 2 the dollar will reign supreme for "many years to come." Staunching the recession, combating climate change, promoting trade and dealing with Iran top the agenda of the G-8, a grouping of 880 million people with combined GDP of $32 trillion that includes the U.S., Japan, Germany, Britain, France, Italy, Canada and Russia.
Divisions persist over dialing back stimulus measures -- Germany says now is the time to begin curbing deficits -- and the scope of financial oversight. Britain opposes more intrusive market oversight proposed by the European Union. "Different countries are pulling in different directions and that is, I think, quite troubling," said Niall Ferguson, a history professor at Harvard University in Cambridge, Massachusetts. The uncoordinated response is "one of the classic symptoms of a global crisis."
While the eight deliberate, leaders of five developing economies -- China, India, Brazil, Mexico and South Africa -- hold a parallel summit nearby before the G-8 meeting. Led by China, the emerging economies don’t share the "somber fiscal outlook" of the affluent world, the IMF says. The IMF says the debt won’t be repaid as quickly as after World War II, which ended with debt topping 250 percent of GDP in the U.K., 200 percent in Japan and 100 percent in the U.S. In wartime, governments exercised "comprehensive control" over the economy and citizens felt a "moral duty" to buy war bonds, the IMF said in a June 9 report.
Rich nations’ debt constituted 78 percent of GDP in 2006, the year before the financial crisis took hold, while emerging- markets debt has dipped from 38 percent, the IMF says. The industrial world’s borrowing spree "decreases its ability to maneuver," said Paul Hofheinz, president of the Lisbon Council, a Brussels research group. Underscoring the need for a broader global consensus, leaders of the Group of 20 nations have met twice in response to the global financial crisis since the G-8 gathered in Japan last year and plan a third summit in Pittsburgh on Sept. 24-25.
Lesser-developed countries upstaged the 2008 G-8. Arguing that emissions cuts would stunt the economic growth that is lifting millions out of poverty, they forced through a joint statement entitling countries to tackle global warming according to their "respective capabilities." The climate clash will be rerun in L’Aquila, as the countdown starts to a United Nations summit in December to hammer out a replacement to the Kyoto Protocol.
Russia plays a dual role, straddling the G-8 and acting in concert with developing economies. In a sign of the shifting world order, Russia last month hosted the first-ever summit of the BRIC economies -- Brazil, Russia, India, China -- financiers of $1.1 trillion in U.S. Treasury debt as of April. How much U.S. debt to keep remains in dispute. Russian President Dmitry Medvedev and Indian economic adviser Suresh Tendulkar have questioned the dollar’s dominance of the world’s $6.5 trillion in currency reserves.
The BRIC get-together failed to endorse a Russian call for diversification from the dollar, showing it is easier to denounce the U.S.-led world order than come up with a viable alternative. "The credibility of the Anglo-Saxon model is under threat," Mohamed El-Erian, chief executive officer of Pacific Investment Management Co., said in a Web commentary last month. "Yet there are no ready substitutes that are able and willing to step in."
U.S. Considers Curbs on Speculative Trading of Oil
Reacting to swings in oil prices in recent months, federal regulators announced on Tuesday that they were considering trading restrictions on hedge funds and other "speculative" traders in markets for oil, natural gas and other energy products. In a big departure from the hands-off approach to market regulation of the last two decades, the chairman of the Commodity Futures Trading Commission, Gary Gensler, said
The agency also announced that it would pull back part of the veil on the oil and gas markets, publishing more detailed information about the aggregate activity of hedge funds and traders who arbitrage between domestic and foreign energy prices. "My firm belief is that we must aggressively use all existing authorities to ensure market integrity," Mr. Gensler said in a written statement. Mr. Gensler announced that his agency will hold several hearings in July and August, the first of which will examine whether to impose federal "speculative limits" on futures contracts for energy products.
Oil prices have swung wildly in the last year, hitting about $145 a barrel last summer, then plunging to $33 in December before rising to about $70. Much of that gyration stemmed from chaos in the global financial system, as banks and much of Wall Street came perilously close to collapse last September and the global economy fell into the most severe recession in decades. But a growing number of critics have blamed some of the extreme volatility on the role of purely financial investors — those who are simply betting on the direction of energy prices, as opposed to those who actually use such products, like airlines.
The Commodity Futures Trading Commission, an independent regulatory agency that regulates the trading of futures contracts for commodities ranging from wheat and corn to oil, precious metals and currencies, has for years followed a deregulatory path that rarely interfered with the burgeoning markets they regulated. Federal officials said "speculative" traders were primarily those that the agency defines as "non-commercial," which are essentially financial investors who are not users or producers of the commodities and are primarily interested in betting on the direction of prices. "Commercial users," by contrast, include farmers, airlines and oil companies that want to hedge against the risk of rapid price changes.
Non-commercial traders accounted for almost a fifth of the activity in several major oil and gas products for the week that ended June 30, according to data compiled by the commodities agency. Mr. Gensler, who was nominated by President Obama and took over the agency earlier this year, made it clear that he is pushing toward tighter regulation on several fronts. His efforts mirror actions taken by the Justice Department to strengthen antitrust enforcement and by financial regulators to police banks and investment firms much more closely.
Mr. Gensler noted that his agency already imposes volume limits on speculative trading in agricultural products like wheat and corn. But in the case of energy products, the agency allows the futures exchanges — primarily the New York Mercantile Exchange — to set limits. A future is a contract to buy or to sell a particular volume of a commodity by a particular date. Futures contracts were originally created to help farmers shield themselves from price volatility between the time they planted their crops and the time of harvest. But futures are now used to hedge price swings in everything from oil and gas to electricity, Treasury bonds and foreign currencies.
In the case of energy products, Mr. Gensler said, the exchanges were not required to set or enforce position limits aimed at preventing "excessive speculation." The contrast between approaches taken for agricultural and energy commodities, he said, "deserves thoughtful review." Mr. Gensler added that the agency would be reviewing the manner in which traders receive exemptions from trading limits by claiming the need to carry out "bona fide hedging transactions."
Europe's IPO Values Drop 95%
Europe's market for initial public offerings in the second quarter saw IPO proceeds drop 95% from a year earlier to €456 million ($637.4 million), and the market looks unlikely to recover until the second quarter of next year, a study showed Tuesday. Based on its quarterly review of IPO activity in Europe, business-advisory firm PricewaterhouseCoopers LLP said that IPOs "continued to suffer from the global loss of confidence in the capital markets." It said investors were also pressured to put their money into listed companies that resorted to secondary offerings and rights issues to strengthen their balance sheets amid the global financial crisis.
"Europe's IPO markets remain shut to all intents and purposes, with a continued low level of activity in what is traditionally a busy quarter for listings," said Tom Troubridge, head of PwC's Capital Markets Group. PwC said the second quarter saw €456 million raised by 28 new listings. This was an improvement from the €9 million raised by 18 companies in the first quarter but "still lagged way behind" the €9.17 billion raised from 133 new listings in the second quarter last year.
"While there is no indication at the moment of the IPO markets re-opening in the sense of a spate of new listings, there are some early signs of companies thinking about preparing for listing," Mr. Troubridge said. "Given the fact that it typically takes six months to prepare for an IPO, we are sticking to our forecast that the IPO markets will not return until the second quarter of 2010," he added. Mr. Troubridge said that "when the markets do re-open, the initial listings are likely to be largely domestic companies, with little cross-border activity expected until the end of next year or beyond."
The four largest IPOs of the quarter accounted for 88% of the total money raised. The largest IPO was that of Max Property Group PLC, hosted by London's AIM market and raising €226 million. The second largest was Lubelski Wegiel Bogdanka SA, a Polish coal-mining company, which raised €116 million on the Warsaw Stock Exchange. London led in terms of IPO value, raising €258 million from three IPOs, compared with €6.3 billion from 46 IPOs in the same quarter last year. The Warsaw Stock Exchange was the largest market by volume with seven IPOs raising €126 million, but was a significant fall from the second quarter of last year when €1.89 billion was raised from 37 IPOs.
Treasury to delay bank overhaul
The centrepiece of the Government's plan to overhaul financial regulation has been delayed, perhaps until after the election, it has emerged. The long-awaited White Paper on financial regulation, due to be published on Wednesday, will offer no firm proposals on how authorities will control banks' balance sheets to avoid future crises. Although it will indicate that the Government needs so-called macro-prudential tools to control the financial system, it will present topics for discussion rather than hard-and-fast new laws.
It means that it is now highly unlikely to formulate a concrete policy over how these tools will work or who – the Bank of England or Financial Services Authority – will wield them until after the election, expected next June. The decision stemmed from the high degree of complexity surrounding the quest to devise a new "second tool" for economic policy to go alongside interest rates. However, some are likely to suspect that the fact that the Conservatives would, if elected, be likely to overhaul the system of financial regulation significantly, also played a part. News that the Treasury will not rush into legislation is likely to reassure the City, where banks and financial practitioners have warned repeatedly about the danger of knee-jerk regulation. However, it will spark criticism over the time the Government has taken to hand down new powers in the wake of the collapse of the banking system.
The Bank of England's financial stability director Andy Haldane said recently that there remain many "unanswered questions" about how macro-prudential regulation would work, adding that the questions "will shape the intellectual and public policy debate over the next several decades, just as the Great Depression shaped the macroeconomic policy debate from the 1940s to the early 1970s." Simon Morris, partner at law firm CMS Cameron McKenna, said: "Perhaps the Government thinks by asking enough people, someone will eventually come up with the right answer. You can legislate on macro-prudential tools about as effectively as you can against rainfall."
However, the White Paper will also outline other new financial regulation powers which can be imposed within the coming months – including the Turner Review's proposals on the amount of liquidity and capital banks must set aside – alongside those that are still under discussion. The latter will include both macro-prudential regulation and new laws to ensure that in the future banks do not become too big to fail. Insiders refer to this latter section as a "Green Paper" and admit it will take "some, perhaps many, months" before it is fleshed out into legislation. Among the new laws to be included in the White Paper will be rules on the amount of capital and liquidity banks must set aside in the future.
The paper will say that those banks which are taking greater risks and which are awarding their employees more excessive bonuses will have higher capital and liquidity requirements, effectively limiting their profitability. The Government will also introduce new laws giving the FSA powers to gather extra information off hedge funds. However, it will stop short of setting a cap on the amounts banks can pay out in bonuses, instead stipulating that the FSA considers remuneration policies when setting institutions' capital and liquidity requirements, insisting that in future bonuses must be tied to profits rather than revenues, and stretched out over time.
UK Chancellor Darling to instruct British banks to plan for their own demise
Chancellor of the Exchequer Alistair Darling will call on British banks to plan for their own demise by drawing up plans to unwind their businesses in case they fail, a person familiar with the plan said. The demand is part of a Treasury proposal for legislation tightening regulation of financial services. Darling will make a statement to Parliament about the measures tomorrow at 12:30 p.m. London time.
The rules are aimed at preventing a repeat of turmoil in financial markets that forced Britain to rescue Royal Bank of Scotland Group Plc and Lloyds Banking Group Plc last year. Prime Minister Gordon Brown’s government is coordinating the overhaul with President Barack Obama’s administration in the U.S. "What we have now is not sufficient and having a resolution mechanism in place would make a tremendous difference," said Viral Acharya, professor of finance at Stern School of Business in New York. "Governments now have to make sure they can wind down banks in a smooth manner." Darling will redraw British rules to force bondholders to share losses with equity owners during bankruptcy and take steps to disclose trades of complex derivatives, the person said.
The Treasury is adopting all the recommendations made in March by Financial Services Authority Chairman Adair Turner, who called for a "revolution" in the way the industry is governed. He suggested banks hold more capital and hedge funds to be more open with regulators. He wants mortgage loans not to exceed the value of the property they are secured against. Parliament will start work on drafting laws to implement Darling’s plan after its summer recess ends in October. The Treasury will issue a draft of proposed legislation tomorrow.
The chancellor also is planning to ask banks to protect deposit-taking operations from more risky trading businesses, requiring instructions including HSBC Holdings Plc and Barclays Plc to ring-fence investment banking units, people familiar with the plan said on June 24. Treasury Minister Paul Myners on June 18 said the U.K. will also force institutions trading complex derivatives to hold more capital, mirroring U.S. plans to curb risk in the $560 trillion market blamed for deepening the global recession.
Those proposals already have attracted criticism. The British Bankers’ Association has said the plan to reorganize units to lower risk may lead some lenders to relocate abroad. At a less-developed stage will be proposals to beef up the role of the FSA and the Bank of England, which will be given new authority to police banks and assess risks to the stability of the economy from asset-price bubbles. Tomorrow’s plan also won’t tackle the issue of executive pay, identified by Darling and Brown as sources of instability in financial markets.
Instead Darling will wait until later this month for a report on the issue by David Walker, a senior adviser at Morgan Stanley, before recommending steps. The worst financial crisis since World War II has forced the British government to extend more than 40 billion pounds ($65 billion) of aid to banks and take on at least 1.4 trillion pounds of liabilities, more than the value of the economy. While plans exist at national, regional and global levels for greater oversight, there is disagreement on who will do it and what tools they will use.
The government is seeking to find ways of coping with institutions deemed "too big to fail," something Bank of England Governor Mervyn King said last month needed to be addressed to limit risks to taxpayers. He suggested that banks should be required to write "a will" describing how administrators could unwind their assets. "Making a will should be as much a part of good housekeeping for banks as it is for the rest of us," King said on June 17. "And it would be sensible for the various authorities to work across national boundaries to identify detailed plans for how each large cross-border financial institution could be wound down."
As part of the effort, the government wants all investors financing banks -- whether through companies, equity or bonds -- to share in any losses when an institution is rescued. Shareholders suffered the biggest losses when the government took control of Lloyds and RBS, and the Treasury wants greater discipline elsewhere in markets. The person said British plans will be go no further than those outlined in the U.S. by Obama. British officials are pushing for a common approach with American and European regulators that would centralize the settlement of derivative trades through a web of clearinghouses.
UK slams EU hedge fund rules
A draft European Union law that would subject hedge funds to new regulatory controls needs “major surgery” before Britain can support it, Lord Myners, a UK Treasury minister, said on Tuesday. The financial services minister, in a fiercely critical speech, hit out at European countries seeking to “make political capital” from advocating a clampdown on the hedge fund industry, calling their actions “woefully short-sighted” and “bordering on a weak form of protectionism”.
“It is perhaps easy for other European countries to make political capital out of demanding intrusive regulation of an industry of which they have little or no direct experience,” he said. The EU directive, a response to public anger at the excessive risk-taking that led to the credit crisis, would require many hedge funds and private equity firms to register with regulators and disclose more about themselves and their investments. They would also have to meet increased minimum capital requirements and limits on borrowing, which have triggered threats from some big UK hedge funds to move overseas unless the plan is rewritten.
Lord Myners, speaking to the Alternative Investment Management Association, pledged to fight the proposed legislation. “The UK is reaching out bilaterally to leverage natural alliances and win over others,” he said. “Officials will lobby in more than a dozen key capitals over the summer. I myself will be engaging directly with my opposite numbers in key member states.” The minister added that there was now widespread acceptance among leading European regulators, including Jacques de Larosière, chairman of the strategic committee of the French treasury, and the EU internal markets commissioner Charlie McCreevy, that hedge funds and private equity funds had not been central to the financial crisis.
Three-quarters of Europe’s hedge fund-managed assets, worth around $300bn, are managed out of London. The City of London is also hoping to win support from the US administration to head off the new regulations from Brussels. Delegates from the City of London Corporation, a standard bearer for UK financial services, visited Washington last month to warn of the threat to British and US companies from the directive. Lord Myners said: “Our aim is a framework which allows efficient, well run and well regulated fund managers to compete for business without restriction across the EU and to make the EU a base from which to compete in global markets. The draft directive needs major surgery before this can be delivered.”
Berlin Making Hollow Threats to Banks Over Credit Crunch
German politicians say the banks have had the carrot -- billions of dollars in financial aid. But they're now threatening banks with the stick in the form of new legislation unless they start lending more cash to companies. But media commentators aren't taking the threats too seriously quite yet. At the end of last week Germany's own plan for "bad banks" was approved. This will see the toxic assets of German banks dealt with in special government-backed bad banks.
But over the weekend several prominent German politicians -- including Finance Minister Peer Steinbrück and Economics Minister Karl-Theodor zu Guttenberg -- voiced their concerns about where all those billion were actually going and asked why the credit crunch was not abating. Bankers were accused of using the extra funds inconsiderately -- investing in federal bonds or stashing the cash in high interest accounts -- and not extending more credit to German industry. Analysts say that there is concern that German lending, which has remained relatively steady, could slow down in the second half of the year, choking off any hope of a recovery from Germany's worst recession since the 1930s.
Guttenberg of the conservative Christian Social Union (CSU) described this as "unacceptable" and Steinbruck of the Social Democrats (SPD), traditionally Guttenberg's opponent in free market matters, agreed. Steinbrück threatened tough measures if banks refuse to extend more credit to firms crying out for cash. Meanwhile Volker Kauder, the parliamentary floor leader of the conservative Christian Democrats, said that "in the first instance, the banks must use this cheap money to finance the German economy -- rather than themselves."
Foreign Minister Frank-Walter Steinmeier (SPD) also weighed in with a bit of intimidation. "If in the next few weeks we don't see the banks prepared to fulfill their duties as service providers to the German economy, then we will have to consider taking further steps." Despite the fact that these opinions were coming from both the political right and left, most local commentators were rather dismissive, saying the situation was far more complex than politicians were making it out to be and that such comments had more to do with electioneering -- Germany's general elections are in September -- than sound economic theory or any actual, existing legislation.
The Financial Times Deutschland says that the argument politicians are expounding is way too simplistic and that rather than dictating how banks do business, they should get into the lending business themselves:
"To tell the banks off like this smacks of electioneering. It also helps distract attention from the government's own economic strategies. And for the German businesses weathering the worst economic crisis in 60 years, it doesn't help a bit. The most recent data indicates that every day it's getting more difficult for businesses to obtain credit from their banks. But this is normal in a recession.
Negative outlooks and falling orders affect one's credit rating and therefore the preparedness of one's bank to lend money. That effect is bolstered by equity ratio guidelines, as outlined by the Basel II banking accord, which states how much capital banks should put aside in order to deal with running issues like debt defaulters. The banks that are looking more closely at creditors and choosing to park their funds in the central bank are actually acting rationally. Whereas making German banks the whipping boy for the credit crunch is not rational.
Banks that give out credit willy nilly now, just because they have been asked to by politicians, will be first on the list for financial aid next year. And you can just imagine what the politicians are going to say then. If they are so worried then Steinbrück and co … should decide -- elections ahead of them, summer holidays behind them -- to extend credit all by themselves either through their own KfW development bank or through the auspices of the European Central Bank."
Business daily Handelsblatt writes that the political grandstanding is unsettling and potentially an indicator of deeper problems with the state's willingness to play financial savior to all and sundry:
"Not once during this financial emergency has the government come up with any direct intervention. Carsten Schneider, the SPD parliamentary group's chief budget expert, demanded answers on this - but his was a voice lost in the desert. And he was criticized from all sides, including by his party colleague Steinbrück. So it seems that even a year after the collapse of Lehman Brothers bank, any kind of government intervention is still viewed suspiciously, a remnant of the GDR.
They could create them but right now Steinbrück and Guttenberg are threatening the bankers with weapons they don't actually have. It's like holding a water pistol to someone's head. And it's also about making it look as though they are taking the banks to task - that impression will come in handy should the credit crunch get even worse. When you're running an election campaign, it's important to make an impact. But it's not exactly building confidence. The government has given the impression that they are going to leap in whenever there isn't enough money. But with this sort of thing, they're indicating that their budget is already over extended."
Center-right Frankfurter Allgemeine Zeitung says that politicians are too quick to forget lessons learned at the beginning of the economic downturn. "All the talk is of banks getting money for nothing and not giving anything back. But that is just not true. In the first few months of this year German banks extended just as much credit as they did last year. There's a credit crunch, this is the result of a recession, and the outcome of that is more creditors defaulting on loans. There's a tidal wave of debt swamping the credit market. And the instrument once used to regulate this -- the securities market -- is dead because of the financial crisis. However, caught up in the national anger at banks, such basic facts don't really seem to count. At the beginning of this crisis we all saw what happens when credit is given out irresponsibly. There's a lesson to be learned from all this: credit comes at a price."
Left-wing daily Die Tageszeitung says that any money that does come to the banks from the state should come with conditions --particularly if the bankers won't behave appropriately. "What can the bankers possibly want next? Millions of euros worth of aid has been given them. And what do they do with it all? They save it up in the European Central Bank, buy federal bonds or consider moving their money to where the interest rates are highest. No wonder then that trade associations and labor unions are getting upset with them.
And now the politicians are angry too. How can they persuade the banks to behave? Well, that's the wrong question. It's not about persuasion. It's about ensuring that credit facilities are available to businesses -- this will protect employees and keep jobs safe. The bankers were only too happy to take the carrot. But now, the only option is the stick. Any money that comes from political institutions must come with conditions. As in, you're only getting this aid if the volume of credit rises. The system won't break down if one or two banks go under. It will if the economy is cut off from credit."
East European countries win time on deficits
Five central and eastern European countries were on Tuesday given more time to reduce their budget deficits, in a sign that the European Union for now considers the fight against recession a higher priority than fiscal consolidation. EU finance ministers set Hungary, Lithuania and Romania a target date of 2011 for cutting their deficits to below 3 per cent of gross domestic product. Latvia and Poland were set a target date of 2012. Policymakers in the EU’s 27 countries have expressed concern in recent months about the bloc’s soaring budget deficits, and have spoken of the need to convince financial markets that governments will return as soon as possible to fiscal discipline.
The EU’s total budget deficit is expected to rise to 7.3 per cent of GDP next year from 6 per cent this year, 2.3 per cent in 2008 and 0.8 per cent in 2007, according to European Commission forecasts. However, at a regular monthly meeting in Brussels, finance ministers made clear their view that it would be premature to force the pace of deficit reduction at a time when most countries are struggling to overcome their worst recession in decades. “We haven’t reached the time yet at which the exit strategy could be applied. We’re still in the middle of the crisis,” said Jean-Claude Juncker, Luxembourg’s prime minister, who chairs the eurogroup of finance ministers from the 16-nation eurozone. Poland, the largest of the five ex-communist countries under consideration, received relatively lenient treatment from its EU partners on the grounds that it is likely to experience a recession this year as well as fast-rising unemployment.
Finance ministers called on Poland to make fiscal adjustments of at least 1.25 per cent of GDP a year, starting from next year, in order to bring its deficit below 3 per cent in 2012. Poland’s deficit was 3.9 per cent in 2008 and is at risk of rising this year above the 4.6 per cent originally planned by the government, economists said. The finance ministers also took special account of Hungary’s economic difficulties, recognising that it was no longer realistic to expect the government to follow an October 2006 recommendation to cut its deficit this year to 3.2 per cent.
Instead, they accepted Hungary’s revised deficit targets of 3.9 per cent this year, 3.8 per cent in 2010 and 2.8 per cent in 2011. Hungary, which received a €20bn international assistance package last October, including a €6.5bn EU loan, has been a repeat deficit offender for more than a decade. From 1997 to 2006, Hungary’s fiscal deficit was about 6.6 per cent of GDP, a full four percentage points higher than the average for the EU’s new member-states, according to calculations by economists at Deutsche Bank.
UK freezing of Landsbanki assets 'as damaging to Iceland as Treaty of Versailles'
The bitter state of relations between Iceland and Britain over the collapse of Icesave has emerged in official documents warning the UK that it was inflicting damage equal to the Treaty of Versailles. A diplomatic row erupted between the two nations after Landsbanki, the parent bank of Icesave, failed last October affecting 300,000 British savers. But private correspondence reveals that relations were even frostier than publicly disclosed after the Treasury froze the assets of Landsbanki as security in case Iceland refused to compensate British savers.
A letter from Ingibjorg Solrun Gisladottir, Iceland's then foreign minister, addressed to the UK several weeks after the crash highlights the disastrous impact on the Icelandic economy. "Total possible liabilities, if pushed to their maximum, could impose on Iceland reparations on a similar economic scale to the Treaty of Versailles," the letter dated October 23 said. Another major objection was the Anti-Terrorism, Crime and Security Act used by the Treasury to freeze the assets, putting Iceland on a list of suspect organisations. "It makes no sense to see an Icelandic company listed next to the Al-Qaeda and the Taleban on the Treasury website," she wrote. Two further letters from Arni Mathieson, the then finance minister, to Alistair Darling in December and January received no answer from the Treasury.
A senior Treasury adviser, Clive Maxwell, finally sent a 12-page response in mid February explaining the UK's refusal to lift the legislation while the terms of compensation were still under dispute. Mr Maxwell accused Iceland's plans for compensation of being opaque and contradictory. He also said too many of Landsbanki's assets had been put into a new bank for domestic customers. This left creditors of the old bank – such as UK charities and councils – with fewer assets to cover their claims. The UK lifted the freezing order last month, after it agreed to give Iceland a £1.3bn loan at 5.5pc interest rates to pay Icesave savers 20,887 euros (£18,000) each.
Iceland's special investigator says company offices are searched in criminal probe
The offices of two companies were searched Tuesday in a criminal investigation related to the collapse of the nation's banking system, Iceland's Special Prosecutor said. The Special Prosecutor's office said investigators searched nine locations, including seven houses, associated with the investment firms Milestone and Sjova. Milestone gained a controlling interest in Sjova in 2005. "The investigation focuses on a suspicion of alleged breaches of corporate law, laws on insurance companies and in some cases the penal code ...," the prosecutor said in a brief statement which gave no details of any suspected wrongdoing.
"This involves great sums of money and the investigation touches on a great number of people and many incidents," the statement added. National broadcaster RUV said searches were made at the homes of Karl Wernersson and Steingrimur Wernersson, the brothers who formerly owned Milestone, and the home of Thor Sigfusson, former chief executive of Sjova. The Special Prosecutor's office did not confirm that report.
"All of my actions can stand broad daylight," Sigfusson was quoted as saying on Visir, a news Web site. Sigfusson said he was unaware of any illegal activity. Special Prosecutor Olafur Hauksson, who took office on Feb. 1, has been charged with investigating suspected crimes related to the collapse of Icelandic banks last year. Milestone grew out of a pharmaceutical business which leveraged its rising share price to acquire a two-thirds stake in Sjova in 2005, and full control a year later.
Milestone also became the largest shareholder in Glitnir bank in January 2006, with a 21.6 percent stake, but subsequently reduced its holdings. Glitnir bank, Iceland's third largest bank, went into receivership on Oct. 8 as the bubble burst in the nation's bloated banking sector. Sjova had been sold to Milestone's Swedish subsidiary, Moderna Finance AB, in 2008. Sjova has since been returned to the ownership of the parent company, which disposed of its Swedish assets.
Sjova has undergone reorganization as a new company with its investment business separated from insurance. "Sjova's insurance business is sound and well run. Following the restructuring, the company's balance sheet will be strong and the insurance operations solid," the Glitnir Resolution Committee said in a statement on May 27.
Exclusive Interview: Journalist Matt Taibbi
I usually read like a freshman fraternity pledge shot-gunning a beer. But when I read Matt Taibbi I enjoy his work like Dorothy J. Gaiter savors a vintage wine. Although Matt blushes at grandiose comparisons, he is possibly the most talented writer to stuff Rolling Stone since Hunter S. Thompson. At the very least, the pen-slinging sensation has accidentally unseated Michael Lewis as the King Writer of Wall Street. Not in a coup d’etat sort of way. More like the way Lebron James has taken a seat next to Kobe Bryant.
When I first received an email titled "MUST READ" from a buddy at a top hedge fund, I was a bit surprised the attachment was a scanned article from Rolling Stone. However, the street cred was obvious as Matt’s articles started piling up in my inbox and on excellent financial blogs across the globe. When I overcame my skepticism and read a few sentences, I had that excited feeling a young person gets when they first read Hunter S., Jonathan Swift, or Joseph Heller. I knew I was witnessing the next star writer shine a light on the financial crisis like no major media outlet would dare. In my opinion, anyone who can make finance interesting and easy to understand while explaining how we all got ripped off deserves a Pulitzer Prize.
Like a 16-year old female Jonas Brothers fan on Xanax, I tried to remain professional while having an intellectual conversation with one of the hottest journalists of the day. I think you will find Matt as interesting as his writing.
Damien Hoffman: Matt, when did you realize writing was your passion and you could make a living as a writer?
Matt: Wow. Those are two very different things. I’ve wanted to be a writer as long as I can remember — maybe the age of 11 or 12. I was never really good at anything else. So, whether or not I could make a living as a writer, writing was my best shot [laughing]. I never tried to do anything else seriously. I’ve been working at writing for a long time. I didn’t actually start making a living writing until about four or five years ago [laughing].
Damien: Did you choose to study writing in college?
Matt: Yeah, I was an English major — which is basically preparation for unemployment.
Matt: I don’t think people can study to become a better writer. It’s mostly intrinsic. You have to read a lot and write a lot. I started that process at about 18-years old. I tried to imitate most of my favorite writers, and my writing worked out from there.
Damien: At that age, what stuff were you writing and what writers were you learning from?
Matt: I was always into the humorists and comics. I loved the Russian writers — which is one of the reasons I ended up spending a lot of time in Russia. For a long time, my favorite author was Nikolai Gogol. I also liked the English short story writer Saki [Hector Hugh Munro] who was mean and nasty. I was into Mark Twain, Jonathan Swift, Joseph Heller. Then there are a bunch of Russians who most people are not familiar with.
Damien: Did you read them in Russia?
Matt: In my junior year of college I went overseas to Russia. I sort of never came back. I stayed from 1990 until 2002. During that time I ran my own newspaper.
Damien: Most people don’t know you played basketball. How did you fit in the hoops?
Matt: I played for the Red Army baseball team in Russia, then basketball in Mongolia. In 1996 I was working as a reporter in Moscow for a newspaper called the Moscow Times. After work everyday I would go out to Moscow State University and play basketball on the street. One day I met a kid from Mongolia who told me about a basketball league in Mongolia called the MBA [laughing] — the Mongolian Basketball Association. I thought it was the coolest thing. So, I went into work the next morning, quit my job, got on the Trans-Siberian Railway, went to Mongolia to tryout for the team, and ended up playing for a season. I probably would have stayed longer, but I got very ill and had to leave the country. But it was a terrific experience.
Damien: I consider you one of the most interesting writers at Rolling Stone since Hunter S. [Thompson]. Did he have any influence on you as a writer?
Matt: Absolutely. When I was growing up I loved Fear and Loathing in Las Vegas. I didn’t read Hunter as early as some of the other writers. I was a little older. So I hadn’t read him in time to copy his style. I probably would have if I read him in time. He is a fantastic writer. Fear and Loathing in Las Vegas is one of the best books ever written.
I love Hunter’s approach to his work. What he does is a lot different than what I do. He was a lot more ambitious and his writing was more like great fiction — very three-dimensional, he was a character in his stories, and his pieces were very alive. On the other hand, what I do is much more traditional op-ed writing or typical reporting. I try to imitate a few things Hunter did, but not on the same level at all. Hunter was definitely great.
Damien: What was the path from your first scrappy paychecks for writing something to ultimately getting some book deals and a job at Rolling Stone?
Matt: At first I had my own newspaper in Russia called The Exile. I was the co-editor of that paper for about six or seven years. It was a well-known publication in Russia. We were notorious for our practical jokes and reporting. In fact, in around 1998 Rolling Stone did a story on us. As a result, when I moved back to the States in 2002, I got a call from my current boss Will Dana who offered me the opportunity to cover the presidential campaign in 2004. I’ve been working for them almost full-time ever since.
Damien: Most people think working at Rolling Stone would be like living the movie Almost Famous. Is that accurate?
Matt: [Laughing] Obviously the atmosphere at the magazine is different than it was back in the rock and roll heyday — the late 60’s and early 70’s. I was most surprised
by how professional Rolling Stone is. Most people would expect Rolling Stone to be a party hearty atmosphere, doing bong hits in the hallways and that kind of stuff. But actually, the fact-checking to get an article in print is five times more rigorous than any publication I’ve ever worked for. When I first started working at Rolling Stone, I didn’t like it at first compared to the indie journalism world I came from. But it’s turned out to be a good thing and given me newfound respect for this organization. It’s also helped me grow a lot as a writer.
Damien: In the 60‘s and 70‘s, politics and rock music were inseparable. So, Rolling Stone was a perfect vehicle for educating the masses. Your political and financial reporting is top of the line. Do you feel like it’s reaching your target audience?
Matt: One thing that’s both a plus and minus working in American journalism these days is the mainstream press — which should be covering politics and finance — are doing such a terrible job, it opens great opportunities for smaller news organizations that wouldn’t have had them previously. The only reason Rolling Stone can even think about having an important voice in financial reporting is a result of the traditional financial reporters blowing the stories for the past five or six years or so.
One of the things I love about Rolling Stone is their desire to cover more than rock music and gossip. They don’t have a complex about stepping into the middle of something like the Wall Street story or politics. I think that’s very cool. Most media organizations would not want to step outside their typical purview to go after stories as complicated as the recent financial crisis. Most media organizations also tend to avoid taking on targets that have a history of litigating against people who write about them.
Damien: So did editors nail you with covering Wall Street, or was it an extension of your political coverage?
Matt: After the election story started to wrap-up last year, the financial crisis became an organic topic to cover. I think there was a lot of recognition across the journalism world that the politics story was the finance story. The story had evolved. If you wanted to cover politics, you had to do the financial stuff because people need to know about it to inform political decisions. So, they assigned it to me, but I wanted to do it anyway. For a long time I felt guilty about not knowing enough about finance. It was the perfect time to take the plunge. I was nervous about the move at first, but it all worked out.
Damien: It’s definitely worked out because your articles have become a cult phenomenon on Wall Street. I’ve seen an interview during which you said finance is not your favorite, so I have a theory you’ve accidentally unseated Michael Lewis as the King Writer of Wall Street.
Matt: I don’t know about that. For one thing, Lewis understands finance a lot better than I do.
Damien: That may be true. But since the 80’s Lewis has been the King Writer of Wall Street after he wrote Liar’s Poker. Now, all of a sudden, your works are getting passed around and blogged about like a full blown blitzkrieg. How have you experienced the reaction to your articles?
Matt: It’s been really cool. Unlike almost any other sector of society, Wall Street is a place where people are reluctant to issue very strongly worded statements in public because they are worried about how powerful companies will react. The financial press is captive to a lot of these companies like Goldman Sachs or Morgan Stanley. A lot of the hedge fund managers I talk with have many complaints, but they are afraid to speak because they don’t want an unfavorable response from the big players on Wall Street. So, the only people who can really complain are complete outsiders.
Obviously, the Financial Times or Wall Street Journal is not going to take the chance of alienating an important company like Goldman Sachs. The same phenomenon exists in politics where the NBC or FOX news is not going to completely alienate the White House because they need access to the White House. So, in order for some of this reporting to get done, we need someone totally outside the financial and political world. It’s been cool to play that role.
Damien: Has your collection of works and popularity led to a new book?
Matt: I’m working on a book now that will talk about this financial stuff. It’s very satisfying for me personally because it’s a new world to learn about plus I provide a service to readers by taking something that’s complicated and explaining it in terms they can understand. I plan on coming back to finance over and over again because it’s been a lot of fun and personally rewarding.
Damien: Since you are an outsider who can speak freely about companies in the financial space, do you think Goldman Sachs is the first transnational entity that’s truly more powerful than every government on the face of the Earth?
Matt: It’s hard to say. It seems more like comparing apples and oranges. On the other hand, it’s hard to imagine any company more influential than Goldman Sachs. They have an enormous reach and scope. They were an appropriate target to choose from this world. Although in some of their responses [to my articles] they complained they were not doing anything else other’s weren’t doing, it would be absurd to pick another bank as an example of the over-reaching power of Wall Street. I don’t know if they’re more powerful than other governments, but they are as powerful as a company can be.
Damien: The last word I wrote after I finished reading "The Great American Bubble Machine" was ‘Leviathan’. Since you’ve done some great research covering Wall Street and Washington, do you know of policy tools we can use to dismember what you affectionately called the "great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money"?
Matt: I interviewed a government regulator for my previous piece ["The Big Takeover"] who said state regulators already have enormous power. The state banking commissions or insurance agencies, SEC, or the Office of Thrift Supervision can simply write a letter to these banks and say, "You won’t exist tomorrow unless you …" or, "You’re not going to get government funding unless you do this."
So, they already have enough power to correct all the problems people are worried about. The problem is getting the appropriate people to staff those bureaucracies. If enough people put pressure on members of Congress and the President to appoint the appropriate people, then we should solve most of these issues. I’m not sure what new policy initiatives would be needed. I just think we need new people.
Damien: Do you believe the citizenry can put enough pressure on our legislators, or are we the sheeple who are too confused, ignorant, or entertained to affect change?
Matt: The real problem is people aren’t organized enough to make it worth the while of politicians to pay attention to ordinary people. The disadvantage the average Joe has against Goldman Sachs is Goldman can concentrate its campaign contributions in its favor. The typical politician is not going to upset or alienate the five most powerful investment banks because he knows realistically he will jeopardize 30% or 35% of his next election cycle’s contributions. On the other side, there isn’t a way for the average person to organize and deny these politicians the money they need to get reelected. So, until we solve the campaign contribution problem, we won’t have the legislative tool to rebalance the power.
Damien: That’s just in one country. A lot of these powerful companies are transnational. So what do you think of when you see both the US and China flags flying over the door of Goldman Sachs’s office at 85 Broad Street in Manhattan?
Matt: They’ve found a way to masterfully play against the disorganization of the world’s governments. For example, last year they only paid $14 million in taxes because they knew exactly where to shift their revenues. Most of their revenues took place in countries with extremely low tax rates. So long as the international financial regulations are chaotic and disorganized, companies like Goldman are always going to have an advantage because they will place their exchanges in the most unregulated environments. The greatest example is the commodities exchange. They were able to use a loophole to put an oil commodities exchange in the US while keeping a window abroad so customers could avoid US regulations. Goldman and other powerful companies are experts at finding loopholes where regulators are not as organized as they are. We have to figure out a way to address this problem.
Damien: So are we living in a Catch-22 where we have to choose between the Goldman Leviathan sucking the world’s wealth from loopholes or the omniscient eye at the top of the governmental pyramid which becomes the one crown reigning over us all?
Matt: It’s pick your poison. But before we can even worry about the international government question, we have to start at home with our own country. We have to start by protecting the citizens of our country. Even in the United States, Goldman is allowed to get away with things they shouldn’t be allowed to get away with. If we can tighten up and enforce the rules here, we will be much better off before even looking at the international issue.
Damien: Most powerful institutions such as the Federal Reserve and Vatican dismiss most criticisms as “fringe conspiracy theory.” Why should the average citizen not dismiss your claims against Goldman as fringe conspiracies about bankers or Jews?
Matt: That was the tactical criticism I got from Goldman who said to the media, "Next thing you know he’s going to blame us for the Kennedy assassination and say we faked the moon landing." But if you pay attention to all the criticisms they are leveling, it’s what we call in this business a "non-denial denial." When people respond by calling names and changing the subject, it means they don’t have any issue with the factual allegations in the article. So, in response to being called a conspiracy theorist, the fact is they are resorting to the rhetorical non-denial denial shows they don’t have any real basis to criticize the facts in the article. The article speaks for itself and the fact they don’t have substantive issues with the piece is highly revealing. In fact, before the article went to print I was extremely nervous we had gotten something wrong and Goldman would come out with a whole list of things they’d say we made mistakes about. But the fact that they didn’t come up with a single thing greatly emboldens me to think we got it right.
Damien: Another indie media outlet Zero Hedge is receiving the same rhetorical response from Goldman about alleged front running claims. What are your thoughts about indie journalists such as Zero Hedge who are covering the financial crisis? Are there any other journalists who you think are doing an extraordinary job covering finance or politics?
Matt: In the oil and commodities space I think Mike Masters is doing a great job. His website is accidentalhuntbrothers.com. Zero Hedge is an amazing story because it’s a small independent blogger. Just by virtue of the fact they were right, they forced Goldman Sachs to respond to them. They’ve made themselves major players in Wall Street journalism.
This gets back to what we discussed before. A small time blogger would never be able to become such an influential news source if it weren’t for the fact that the Wall Street Journal and Financial Times consistently not doing the job they are supposed to be doing. The stuff with Goldman, AIG, or Merrill Lynch isn’t hidden or hard to see — it’s right out in the open. Anybody who knows anything about this stuff should have been screaming about it ages ago. It’s pathetic that the real reporting has been left to a music magazine and some independent bloggers.
Damien: Do you think the mainstream media will ever get in the weeds and report the gritty information?
Matt: Not in real time. They get around to it eventually. But far after the fact. At some point there’s always a magical moment in time when the tide turns and the major media will criticize a powerful person or organization. It’s a form of herd behavior. There’s a theory that if there’s 50 deer in a herd, the instant 26 decide to run away, they all run away. But until that moment, they all stand still. The same goes for journalism. Everybody backed Bush in the Iraqi War and through the 2004 election, then all of a sudden everyone realized he was wrong about almost everything and the entire press turned on him. I think that’s going to happen with this Wall Street story too. For a while, there will be a reluctance to go after the key players. But once the floodgates open, the mainstream press will take up the slack and do the job they’re supposed to be doing.
Damien: So the press protection in the First Amendment to the Constitution is a delayed protection held up by issues of access?
Matt: Yeah. Also, news organizations are hierarchical too. Journalists don’t get promoted because they’re risk takers or rabble-rousers. They tend to get promoted for the opposite qualities. So the people who tend to be the elite political and financial reporters have an instinct to protect the status quo. It’s not in their nature to go after Goldman Sachs, the White House, or whoever.
Damien: So from your outsider vantage point, where are you going to shine your pen light next?
Matt: They have me on the healthcare thing now. So I will be off the financial story for a while.
Damien: Well, Matt, best of luck with that. I look forward to reading your next article. Thanks for taking the time to chat with me amidst the Goldman storm.
Matt: Thank you, Damien. I enjoyed it. I’d be happy to talk with you anytime.
How Citi Blew Itself Up By Cleverly Avoiding AIG
While nearly every other Wall Street firm had AIG's Financial Products group in Wilton, Connecticut on speed dial, Citigroup reportedly avoided doing business with them. Instead of off-loading risk onto the insurance giant by taking out credit default swap contracts, Citigroup prefered to keep one-hundred percent of the risk themselves, an AIG trader tells Michael Lewis in Vanity Fair. Lewis has a long article in this month's Vanity Fair that describes how AIG FP blew up. It's finally online and makes for an entertaining read. In case you are pressed for time, here's the short version: they sold lots of credit default swaps on subprime mortgage backed paper while no one internally had a clue what was going on.
But almost in passsing he mentions a conversation he had with a trader that reveals that Citi was different than every other firm on the street. It avoided doing business with AIG FP. While AIG was ramping up its credit default swap business from a single half-billion dollar deal each month to 20, Citi never got in on the game. "We were doing every single deal with every single Wall Street firm, except Citigroup," the trader tells Lewis. "Citigroup decided it liked the risk and kept it on their books. We took all the rest."
In a sense, this is not ground-breaking news. When AIG released its list of counter-parties to credit default swaps and securities lending transactions, CIti wasn't on the list. There were fifteen others, including Goldman Sachs, Wachovia, Bank of America and Merrill Lynch. But no Citi. At the time, however, no one seems to have noticed. (Incidentally, now that we're thinking in terms of the presence of absence, why weren't Morgan Stanley and Wells Fargo on the list?)
So why was Citi hungrier for risk than other firms? Why wasn't it a buyer of credit default swaps from AIG? Our best guess is that Citi believed it had discovered a cheaper alternative to credit default swaps--the structured investment vehicles. You remember those right? The SIVs were off-balance sheet entities that owned long term debt and were funded with short-term debt. Citi managed at least seven of them holding a total of $100 billion worth of assets at their height. When these began to meltdown, the government attempted to organize a bailout ominously called the M-LEC (and nicknamed by bloggers as "The Entity") that faltered because other Wall Street banks saw it as a gift to Citi.
It's very possible that instead of buying credit default swaps on its mortgage backed securities, Citi was just selling them to the SIVs it managed. Since these were off-balance sheet, Citi wouldn't have faced the capital requirement constraints that often prompted other banks to buy credit default swaps. Citi could lend and securitize, then sell off any extra inventory into its own SIVs, freeing up the capital it got from the SIV to make more loans. Lather, rinse, repeat.
If we're right about this, the SIVs provided Citi with credit protection the same way AIG did for the rest of Wall Street. Except, of course, that when the government made AIG's counter-parties whole, Citi found it had come up short. When the SIVs collapsed, it wound up having to fund their bailout itself. The enormously expensive SIV bailout helped contribute to the pitiful financial condition that has made Citi more or less a ward of the federal government.
The Man Who Crashed the World
by Michael Lewis
Almost a year after A.I.G.’s collapse, despite a tidal wave of outrage, there still has been no clear explanation of what toppled the insurance giant. The author decides to ask the people involved—the silent, shell-shocked traders of the A.I.G. Financial Products unit—and finds that the story may have a villain, whose reign of terror over 400 employees brought the company, the U.S. economy, and the global financial system to their knees.
Six months ago, I received an odd phone call from a man named Jake DeSantis at A.I.G. Financial Products—the infamous unit of the doomed insurance company, staffed by expensively educated, highly paid traders, whose financial ineptitude is widely suspected of costing the U.S. taxpayer $182.5 billion and counting. At the time A.I.G. F.P.’s losses were reported, it became known that a handful of traders in this curious unit had sold trillions of dollars of credit-default swaps (essentially unregulated insurance policies) on piles of U.S. subprime mortgages, but its employees hadn’t yet become the leading examples of Wall Street greed.
And so this was before Jake DeSantis and his colleagues found themselves suburban-Connecticut outcasts, before their first death threats, before the House of Representatives passed a bill because of them (taxing 90 percent of their large bonuses), before New York attorney general Andrew Cuomo announced he was going after their paychecks, and before Iowa senator Charles Grassley said that A.I.G.’s leaders should follow the Japanese example and "either do one of two things, resign or go commit suicide."
DeSantis turned out to be a friend of a friend. He’d called because he didn’t know anyone else "in the media." As a type he was instantly recognizable: a "quant," a numbers guy who was allowed to take financial risks because of his superior math skills, but who had no taste for company politics or public exposure. He’d grown up in the Midwest, the son of schoolteachers, and discovered Wall Street as a scholarship student at M.I.T. The previous seven years he’d spent running A.I.G. F.P.’s profitable stock-market-related trades. He wasn’t looking for me to write about him or about A.I.G. F.P.
He just wanted to know why the public perception of what had happened inside his unit, and the larger company, was so different from the private perception of the people inside it, who actually knew what had happened. The idea that the employees of A.I.G. F.P. had conspired to maximize their short-term gains at the company’s longer-term expense, for instance. He and the other traders had been required to defer about half of their pay for years, and intertwine their long-term interests with their firm’s.
The people who lost the most when A.I.G. F.P. went down were the employees of A.I.G. F.P.: DeSantis himself had just watched more than half of what he’d made over the previous nine years vanish. The incentive system at A.I.G. F.P., created in the mid-1990s, wasn’t the short-term-oriented racket that helped doom the Wall Street investment bank as we knew it. It was the very system that U.S. Treasury secretary Timothy Geithner, among others, had proposed as a solution to the problem of Wall Street pay.
Even more oddly, the public explanation of A.I.G.’s failure focused on the credit-default swaps sold by traders at A.I.G. F.P., when A.I.G.’s problems were clearly broader. There was the mortgage-insurance unit in North Carolina, United Guaranty, that had taken on all sorts of silly risks in the past two years, lost several billion dollars, and replaced their C.E.O. There were the fund managers at A.I.G., the parent company, who had blown nearly $50 billion on trades in subprime mortgages—that is, they had lost more than A.I.G. F.P., whose losses stood around $45 billion. And there was a pattern: all of this stuff had happened since 2005, after an accounting scandal forced C.E.O. Maurice "Hank" Greenberg to resign.
Greenberg, who had headed A.I.G. since 1968, was a bullying, omnipotent ruler—one of those bosses who did not so much build a company as tailor it to his character and render it incapable of being run by anyone else. After he was forced out, Greenberg said, "The new management wanted to prove that they could continue to grow without former management" and so turned a blind eye to all sorts of risks. So how come most of the senior management at A.I.G. was left in place by the U.S. Treasury after the bailout? Why were officials, both public and private, so intent on leading others to believe all the losses at A.I.G. had been caused by a few dozen traders in this fringe unit in London and Connecticut?
I had no idea, was busy doing other things, and had no special interest in Jake DeSantis’s predicament. I listened politely, made my excuses—and went back to whatever it was I’d been doing. But then, on March 19, the new C.E.O. of A.I.G., Edward Liddy, went to Washington to testify. The story broke—or, rather, rebroke, as it had been reported two weeks earlier, without stirring much notice—that A.I.G. F.P. had just shelled out $450 million in bonuses to the 400 employees of A.I.G. F.P., including to Jake DeSantis. It must have been an otherwise slow news day because all hell broke loose, in a way it hadn’t before and hasn’t since in this financial crisis. The perception was that the very same people who had made these insane, greed-driven decisions that might cost the U.S. taxpayer $182.5 billion were still paying themselves big bucks! An exchange between C.E.O. Liddy and Florida congressman Alan Grayson captured the spirit of that moment:
grayson: Mr. Liddy, you said before that there’s 20 or 25 people who were involved in the credit default business. What are their names, please?
liddy: I don’t have their names at my disposal, sir. grayson: Well, I’m sure you remember a few of the names. I mean, they did cause your company to crash.
liddy: You know, I’ve been at the company, as you know, for six months. I don’t know all the people that were in AIG F.P., and many of them are gone.
grayson: Well, there or gone, it doesn’t really matter. I want to know who they are. Names, please.…
liddy: If it’s possible to provide you the names, we will. We will cooperate with you.
grayson: That’s good, but I want to know the names that you know right now.
liddy: I don’t know them, sir.
grayson: Not a single one. You’re talking about a group, a small group of people who caused your company to lose $100 billion, as you sit here today, you can’t give me one single name.
liddy: The single name I would give you is Joseph Cassano, who ran …
grayson: That’s a good start. You already gave that name. Give me another name.
liddy: I just don’t know them. I do not know those names. I don’t have them all at my command.
grayson: Well, how can you propose to solve the problems of the company that you’re now running if you don’t know the names of the people who caused that problem? … I would expect you’d at least know more than one name. How about two names? Give us one more name.
liddy: I’m just not going to do that, sir, because that will provide—that’ll be the—that could be a list of people that we could do—individuals who want to do damage to them could do that. It’s just not …
grayson: Well, listen, these same people could now be working right now today at Citibank. Is it more important to protect them, the ones who caused the $100 billion loss, or protect us? Which is more important to you right now?
For a brief moment you had a glimpse of how harshly financial people might be treated if Wall Street ever lost its political influence. Just days before, Larry Summers had gone on the morning talk shows to explain that a contract is a contract and the government couldn’t just go in and void it and take back A.I.G.’s paychecks, but that "every legal step possible to limit those bonuses is being taken by Secretary Geithner and by the Federal Reserve System." Then Obama himself went out of his way to denounce the greed at A.I.G. F.P. and say he was looking for a way to get the bonus money back—and even that failed to slake the public anger. "On A.I.G.," a journalist asked Obama at a press conference, "why did you wait—why did you wait days to come out and express that outrage? It seems like the action is coming out of New York and the attorney general’s office. It took you days to come public with Secretary Geithner and say, Look, we’re outraged. Why did it take so long?"
"It took us a couple of days because I like to know what I’m talking about before I speak," Obama said testily. "All right?"
It’s unlikely that he actually did know what he was talking about, except in the broadest outlines. Nor, for that matter, did the people who had engineered the bailout. How could they? At no point did anyone from the U.S. Treasury or the U.S. Congress, or any of the various New York State authorities that had gotten involved, call them up, much less visit A.I.G. F.P.—as, say, someone might who was genuinely curious to know what, exactly, had happened there. Not even A.I.G. C.E.O. Ed Liddy had bothered to make the drive from Manhattan to Wilton, Connecticut, where many of the offending trades had been done, and most of the offending bonuses were being paid, to ask questions of the people still on the scene—people who could have told him a great deal about what had happened and why.
Everyone seemed to be operating on whatever they read in the newspapers—and the people inside A.I.G. F.P., who had the best view of the action, did not appear to be talking to reporters. Depending on which account you read, you thought they had lost $40 billion, or $100 billion, or $152 billion. They had done this by selling credit-default swaps on subprime-mortgage bonds—which is to say they had insured Goldman Sachs, Deutsche Bank, Merrill Lynch, and the rest against Americans with weak credit histories defaulting on their mortgages. But why? Apparently, because they were greedy: the premiums they took in from the insurance allowed them to pay themselves big bonuses, which they’d grown so accustomed to that they now were reduced to stealing from the U.S. taxpayer. And that, it seemed, was that.
The day after Liddy’s testimony, I got another call from Jake DeSantis. (I was still the only person "in the media" with whom he felt any connection.) He was upset. He’d turned down offers of more money from other people. He’d stayed only because the company had begged him to help clean up the mess: the bonus he was paid was the result of profits he had generated by selling off his trades in global equities—profits which almost surely would have been losses had he not hung around. He’d had nothing to do with the trades that lost money; the handful of people who’d known about them, when they happened, were long gone, and even they had been guided by a certain understandable logic. Now A.I.G.’s new leader, who had accepted these bonuses and run them by both the Treasury and the Federal Reserve, flies down to Washington and tells the world that he found the bonuses "distasteful."
"You go to church and you go to soccer practice and people look at you funny," said DeSantis. "This is changing people’s views on who I am as a person." He’d decided to resign, write a letter to Liddy, and, as he put it, "release it to the media." It sounded like the sort of thing that might work on a TV show. "What does that mean: ‘Release it to the media’?" I asked. That, he said, was why he’d called me: he thought I knew how. Having no clue, I put him in touch with the editor of the New York Times op-ed page, who published Jake DeSantis’s letter of resignation on March 25 at the top of his page under the headline: dear a.i.g., i quit! In it Jake repeated what he’d told me, offered a bit of his life story, and confessed the size of his after-tax bonus ($742,006.40). He also explained that he had for a year spent up to 14 hours a day helping to dismantle the company and that he and the others who had nothing to do with the losses had agreed to do so based on the promise their contracts would be honored.
It’s never easy to prove that a piece of writing causes anything, but Jake’s letter was an instant sensation. Bits of it were reprinted in major publications around the world. Within a few days it was the most sent, most blogged, and most read item on the Times’s Web site, and remained so for the entire month. Three point nine million browsers clicked on it and read it, and the tone of the public discussion changed. New York attorney general Andrew Cuomo stopped saying he intended to hound the millions paid to the people who worked at A.I.G. F.P., and started saying he was more interested in the $12.9 billion A.I.G. had paid out to Goldman Sachs, and others, to cover the massive bets against U.S. subprime mortgages that they had made with A.I.G.
The House tax bill stalled in the Senate. I didn’t really know Jake DeSantis, but I thought, That was just incredibly brave. He stepped out alone in front of the mob and compelled it to disband, at least for the moment. But I never heard back from him. After a few days of not being able to open a newspaper or go to a Web site without seeing some reference to Jake DeSantis and his letter, I phoned him. "Oh hey," he said cheerily. "They published my letter."
No shit, Jake. "Has it worked out O.K.?" I asked. "Oh yeah," he said, "but I had to move my family out of our house."
He had woken up the morning his piece ran to find media trucks jamming the end of his driveway. He took his family out back through the woods—"We live in the middle of nowhere"—and secreted them at a friend’s house. "I’ve been going back and standing on the porch down the road and pretending to be a gawking neighbor," he said, "but they’re all still there blocking the end of the driveway. They’re waiting for me to come back, I guess." His voice mail, he said, was also jammed. "All these media people keep calling," he said. "Like who?" I asked. "We don’t watch TV, so I don’t know who they are," he said. I pressed him. "Well, there’s one guy who has been calling a bunch. Matt Lauer. I don’t know who he’s with." The only caller he could completely identify was Katie Couric:
"She called our mayor personally and tried to butter her up to get her to tell her where I am," he said. (A Couric producer says, "Katie placed a brief call to the mayor, expressed interest in the interview, and nothing further happened.") He suspected, probably rightly, that the media wanted him to play the role of the greedy Wall Street trader who had stolen millions and now claimed to feel misunderstood. "O.K.," he said. "I can do this and probably not make an ass of myself. But I can do nothing and not make an ass of myself. I’ll stick with that." With that, A.I.G. F.P. went dark again, which, I now realized, was a shame. DeSantis had established, sort of, what the people in his unit didn’t do. He’d left unexplained what exactly they did do.
Here is an amazing fact: nearly a year after perhaps the most sensational corporate collapse in the history of finance, a collapse that, without the intervention of the government, would have led to the bankruptcy of every major American financial institution, plus a lot of foreign ones, too, A.I.G.’s losses and the trades that led to them still haven’t been properly explained. How did they happen? Unlike, say, Bernie Madoff’s pyramid scheme, they don’t seem to have been raw theft. They may have been an outrageous departure from financial norms, but, if so, why hasn’t anyone in the place been charged with a crime?
How did an insurance company become so entangled in the sophisticated end of Wall Street and wind up the fool at the poker table? How could the U.S. government simply hand over $54 billion in taxpayer dollars to Goldman Sachs and Merrill Lynch and all the rest to make good on the subprime insurance A.I.G. F.P. had sold to them—especially after Goldman Sachs was coming out and saying that it had hedged itself by betting against A.I.G.? Since I had him on the phone I asked Jake DeSantis for what Congressman Grayson had asked Edward Liddy: names.
He obligingly introduced me to his colleagues in London and Connecticut, and they walked me through what had happened—all of them speaking to someone from the outside for the first time. All, for obvious reasons, were terrified of seeing their names in print, and asked not to be mentioned by name. That was fine by me, as their names are not what’s interesting. What’s interesting is their point of view on the event closest to the center of the financial crisis. For while they disagreed on this and that, they all were fairly certain that if it hadn’t been for A.I.G. F.P. the subprime-mortgage machine might never have been built, and the financial crisis might never have happened.
A.I.G. F.P. was created back in 1987 by refugees from Drexel Burnham, led by a trader named Howard Sosin, who claimed to have a better model to trade and value interest-rate swaps. Nineteen-eighties financial innovation had all sorts of consequences, but one of them was a boom in the number of deals between big financial firms that required them to take each other’s credit risks. Interest-rate swaps—in which a party swaps a stream of income from a floating rate of interest for one from a fixed rate of interest—was one such innovation.
Once upon a time Chrysler issued a bond through Morgan Stanley, and the only people who wound up with credit risk were the investors who had bought the Chrysler bond. Now Chrysler might sell its bonds and simultaneously enter into a 10-year interest-rate-swap transaction with Morgan Stanley—and just like that Chrysler and Morgan Stanley were exposed to each other. If Chrysler went bankrupt, its bondholders obviously lost; depending on the nature of the swap and the movement of interest rates, Morgan Stanley might lose, too. If Morgan Stanley went bust, Chrysler along with anyone else who had done interest-rate swaps with Morgan Stanley stood to suffer. Financial risk had been created, out of thin air, and it begged to be either honestly accounted for or disguised.
Enter Sosin, with his supposedly new and improved interest-rate-swap model (even though Drexel Burnham was not at the time a market leader in interest-rate swaps). There was a natural role for a blue-chip corporation with the highest credit rating to stand in the middle of swaps and long-term options and the other risk-spawning innovations. The traits required of this corporation were that it not be a bank—and thus subject to bank regulation and the need to reserve capital against the risky assets—and that it be willing and able to bury exotic risks on its balance sheet. There was no real reason that company had to be A.I.G.; it could have been any AAA-rated entity with a huge balance sheet. Berkshire Hathaway, for instance, or General Electric. A.I.G. just got there first.
In a financial system that was rapidly generating complicated risks, A.I.G. F.P. became a huge swallower of those risks. In the early days it must have seemed as if it was being paid to insure against events extremely unlikely to occur—how likely was it that all sorts of companies and banks all over the globe would go bust at the same time? Its success bred imitators: Zurich Re F.P., Swiss Re F.P., Credit Suisse F.P., Gen Re F.P. All of these places were central to what happened in the last two decades; without them the new risks being created would have had no place to hide, but would have remained in full view of bank regulators. All of these places have been washed away by the general nausea now felt in the presence of complicated financial risks, but there was a moment when their existence seemed cartographically necessary to the financial world. And A.I.G. F.P. was the model for them all.
The division’s first 15 years were consistently, amazingly profitable—there wasn’t the first hint that it might be running risks that would cause it to lose money, much less cripple its giant parent. Its traders were able to claim that they were "hedged," and even if the term was misleading, they never sold exactly the same thing as the thing they had bought—there was always some slight difference. The risks it ran were probably trivial in relation to its capital, because the risks that the financial system wanted to lay off on it were, in fact, not terribly risky. One indication of this is that, even in the middle of the calamity, the 95 percent of A.I.G. F.P. that had nothing to do with subprime-mortgage bonds continued to generate profits. By 2001, A.I.G. F.P. could be counted on to generate $300 million a year, or 15 percent of A.I.G.’s profits.
Meanwhile, the people who worked at A.I.G. F.P. got rich. Exactly how rich is hard to say, but there are plenty of hints. One is that a company lawyer—a mere lawyer!—took home a $25 million bonus at the end of one year. Another is that in 2005, when Howard Sosin and his wife divorced, she received more than $40 million of an estate valued at $168 million—and Sosin had left A.I.G. in 1993, receiving $182 million from the company! He had been replaced that year as C.E.O. by a gentler soul named Tom Savage, who had allowed Hank Greenberg to take some of the sugar out of F.P., but even then the small band of traders had, arguably, a sweeter deal than any money managers in the world. The typical hedge fund kept 20 percent of profits; the traders at A.I.G. F.P. kept 30 to 35 percent.
The typical hedge fund or private-equity fund has to schlep around and raise money all the time, and post collateral with big Wall Street firms for all the trades they do. The traders at A.I.G. F.P. had essentially unlimited capital on tap from the parent company, along with the AAA rating, rent-free. For the people who worked there, A.I.G. F.P. was a financial miracle. They were required to leave 50 percent of their bonuses in the company, but they were happy to do so; many of them, viewing it as the best way to grow their own savings, invested far more than the minimum back in the company. When it collapsed, the employees lost more than $500 million of their own money.
How and why their miracle became a catastrophe, A.I.G. F.P.’s traders say, is a complicated story, but it begins simply: with a change in the way decisions were made, brought about by a change in its leadership. At the end of 2001 its second C.E.O., Tom Savage, retired, and his former deputy, Joe Cassano, was elevated. Savage is a trained mathematician who understood the models used by A.I.G. traders to price the risk they were running—and thus ensure that they were fairly paid for it. He enjoyed debates about both the models and the merits of A.I.G. F.P.’s various trades. Cassano knew a lot less math and had much less interest in debate.
It’s impossible to deliver the full flavor of a man’s character without talking to him, and relying instead upon a bunch of people who remain afraid of seeing their names in print. That Joe Cassano is the son of a police officer and was a political-science major at Brooklyn College seems, in retrospect, far less relevant than that he’d spent most of his career, both at Drexel and A.I.G. F.P., in the back office, doing operations. Across A.I.G. F.P. the view of the boss was remarkably consistent: a guy with a crude feel for financial risk but a real talent for bullying people who doubted him. "A.I.G. F.P. became a dictatorship," says one London trader. "Joe would bully people around. He’d humiliate them and then try to make it up to them by giving them huge amounts of money."
"One day he got me on the phone and was pissed off about a trade that had lost money," says a Connecticut trader. "He said, ‘When you lose money it’s my fucking money. Say it.’ I said, ‘What?’ ‘Say "Joe, it’s your fucking money!"’ So I said, ‘It’s your fucking money, Joe.’" "The culture changed," says a third. "The fear level was so high that when we had these morning meetings you presented what you did not to upset him. And if you were critical of the organization, all hell would break loose." Says a fourth, "Joe always said, ‘This is my company. You work for my company.’ He’d see you with a bottle of water. He’d come over and say, ‘That’s my water.’ Lunch was free, but Joe always made you feel he had bought it." And a fifth: "Under Joe the debate and discussion that was common under Tom [Savage] ceased. I would say what I’m saying to you. But with Joe over my shoulder as the audience." A sixth: "The way you dealt with Joe was to start everything by saying, ‘You’re right, Joe.’"
According to traders, Cassano was one of those people whose insecurities manifested themselves in a need for obedience and total control. "One day he came in and saw that someone had left the weights on the Smith machine, in the gym," says a source in Connecticut. "He was literally walking around looking for people who looked buff, trying to find the guy who did it. He was screaming, ‘Who left the fucking weight on the fucking Smith machine? Who left the fucking weight on the fucking Smith machine?’" If that rings a bell it may be because you read The Caine Mutiny and recall Captain Queeg scouring the ship to find out who had stolen the strawberries. Even by the standards of Wall Street villains, whose character flaws wind up being exaggerated to fit the crime, Cassano was a cartoon despot.
Oddly, he was as likely to direct his anger at profitable traders as at unprofitable ones—and what caused him to become angry was the faintest whiff of insurrection. Even more oddly, his anger had no obvious effect on the recipient’s paycheck; a trader might find himself routinely abused by his boss and yet delighted by his year-end bonus, determined by that same boss. Every one of the people I spoke with admitted that the reason they hadn’t taken a swing at Joe Cassano, before walking out the door, was that the money was simply too good. A man who valued loyalty and obedience above all other traits had not any tools to command them except money.
Money worked, but only up to a point. If you were going to be on the other side of a trade from Goldman Sachs, you had better know what, exactly, Goldman Sachs was up to. A.I.G. F.P. could attract extremely bright people, whose success depended on precision of both calculation and judgment. It was now run, roughly, by a man who didn’t fully understand all the calculations and whose judgment was clouded by his insecurity. The few people willing to question that judgment wound up quitting the firm. Left behind were people who more or less accommodated Cassano. "If someone is a complete asshole," one of them puts it to me, "you seek his approval in a way you don’t if he’s a nice guy."
All of which raises an obvious question: Who put a man like Joe Cassano in charge of such an enterprise as A.I.G. F.P.? The simple answer is Hank Greenberg, the C.E.O. of A.I.G.; the more complicated one is A.I.G. F.P.’s board, consisting of many smart people, including Harvard economist Martin Feldstein. "Tom Savage proposed Joe to replace him," says Greenberg, "and we had no reason to think he wasn’t able to do the job."
A.I.G. F.P.’s employees for their part suspect that the only reason Greenberg promoted Cassano was that he saw in him a pale imitation of his own tyrannical self and felt he could control him. "So long as Greenberg was there, it worked," says one trader, "because he watched everything Joe did. After the Nikkei collapsed [in the 1990s], a trader in Japan lost 20 million. Greenberg personally flew to Tokyo and took him into a room and grilled him until he was satisfied." In March 2005, however, Eliot Spitzer forced Greenberg to resign. And, as one trader puts it, "the new guys running A.I.G. had no idea." They thought the money machine ran on its own, and Cassano did nothing to discourage the view. By 2005, A.I.G. F.P. was indeed, in effect, his company.
But even here the story’s messier than its broad outlines. For a start, the guy who had the most invested in A.I.G. F.P. was Joe Cassano. Cassano had been paid $38 million in 2007, but left $36.75 million of that inside the firm. His financial interest in A.I.G. F.P. struck those who worked for him as secondary to his psychological investment: the firm was, by all accounts, Cassano’s sole source of self-worth, its success his lone status symbol. He wore crappy clothes, drove a crappy car, and spent all of his time at the office. He had made huge piles of money ($280 million!), but so far as anyone could tell he didn’t spend any of it. "Joe wasn’t a trader and now he wasn’t a risktaker, in his personal life," says one of the traders. "With the money he didn’t have in the company he bought Treasury bonds."
He had no children, no obvious social ambition; his status concerns seemed limited to his place in the global financial order. He entertained a notion of himself as the street-smart guy who had triumphed over his social betters—which of course implied that he wasn’t quite sure that he had. "Joe had Goldman envy," one trader tells me—which was strange, as Cassano’s brother and sister both worked for Goldman Sachs. "His whole life was F.P.," another trader says. "Without F.P. he had nothing." That was another reason, in addition to fear, that the highly educated, highly intelligent people who worked for Joe Cassano were slow to question whatever he was doing: he was the last person, they assumed, who would blow the place up.
The more subtle change inside A.I.G. F.P. occurred not long after Cassano assumed control. In 1998, A.I.G. F.P. had entered the new market for credit-default swaps: it sold insurance to banks against the risk of defaults by huge numbers of investment-grade public corporations. As Gillian Tett tells it in her new book, Fool’s Gold, bankers at J. P. Morgan, having invented credit-default swaps, went looking for an AAA-rated company to assume the bulk of the risk associated with them, and discovered A.I.G. The relationship began innocently enough, by Wall Street standards. The risk in these early deals was indeed small: it was unlikely that large numbers of investment-grade companies in different countries and different industries would default on their debt at the same time. (Even now A.I.G. F.P.’s $450 billion portfolio of corporate credit-default swaps, which dwarfs the $75 billion portfolio of subprime-mortgage credit-default swaps, has avoided losses.) But it made explicit what until then had only been implicit: A.I.G. F.P. was the most receptive dumping ground for new risks created by big Wall Street firms.
And in the early 2000s, the big Wall Street firms performed this fantastic bait and switch in two stages. Stage One was to apply technology that had been dreamed up to re-distribute corporate credit risk to consumer credit risk. The banks that used A.I.G. F.P. to insure piles of loans to IBM and G.E. now came to it to insure much messier piles that included credit-card debt, student loans, auto loans, prime mortgages, and just about anything else that generated a cash flow. "The problem," as one trader puts it, "is that something else came along that we thought was the same thing as what we’d been doing." Because there were many different sorts of loans, to different sorts of people, the logic applied to corporate credit seemed to apply to this new pile of debt: it was sufficiently diverse that it was unlikely to all go bad at once. But then, these piles, at least at first, contained almost no subprime-mortgage loans.
Toward the end of 2004, that changed dramatically—but just how dramatically A.I.G. F.P. was extremely slow to realize. In the run-up to the financial crisis there were several moments when an intelligent, disinterested observer might have realized that the system was behaving strangely. Maybe the most obvious of these was the effects of U.S. monetary policy on borrowing and lending. The combination of the dot-com bust and the 9/11 attacks had led Alan Greenspan to pump money into the system, and to lower interest rates. In June 2004 the Fed began to contract the money supply, and interest rates rose. In a normal economy, when interest rates rise, consumer borrowing falls—and in the normal end of the U.S. economy that happened: from June 2004 to June 2005 prime-mortgage lending fell by half. But in that same period subprime lending doubled—and then doubled again. In 2003 there had been a few tens of billions of dollars of subprime-mortgage loans.
From June 2004 until June 2007, Wall Street underwrote $1.6 trillion of new subprime-mortgage loans and another $1.2 trillion of so-called Alt-A loans—loans which for some reason or another can be dicey, usually because the lender did not require the borrower to supply him with the information typically required before making a loan. The subprime sector of the financial economy clearly was responding to different signals than the others—and the result was booming demand for housing and a continued rise in house prices. Perhaps the biggest reason for this was that the Wall Street firms packaging the loans into bonds had found someone to insure against what turned out to be the rather high risk that they’d go bad: Joe Cassano.
A.I.G. F.P. was already insuring these big, diversified, AAA-rated piles of consumer loans; to get it to insure subprime mortgages was only a matter of pouring more and more of the things into the amorphous, unexamined piles. They went from being 2 percent subprime mortgages to being 95 percent subprime mortgages. And yet no one at A.I.G. said anything about it—not C.E.O. Martin Sullivan, not Joe Cassano, not Al Frost, the guy in A.I.G. F.P.’s Connecticut office in charge of selling his firm’s credit-default-swap services to the big Wall Street firms. The deals, by all accounts, were simply rubber-stamped by Cassano and then again by A.I.G. brass—and, on the theory that this was just more of the same, no one paid them special attention. It’s hard to know what Joe Cassano thought and when he thought it, but the traders inside A.I.G. F.P. are certain that neither Cassano nor the four or five people overseen directly by him, who worked in the unit that made the trades, realized how completely these piles of consumer loans had become, almost exclusively, composed of subprime mortgages.
Gene Park worked in the Connecticut office and sat close enough to the credit-default-swap traders to have a general idea of what they were up to. In mid-2005 he’d read a front-page story in The Wall Street Journal about the mortgage lender New Century. He noted how high its dividend was and thought he might like to buy some of its stock for himself. As he dug into New Century, however, Park saw that it owned all these subprime mortgages—and he could see from its own statements that the quality of the loans was frightening. Just after that he got a phone call from a penniless, jobless old college friend who had been offered a package of loans to buy a house he couldn’t afford. At the same time, Park saw Al Frost announcing new credit-default-swap deals at an alarming rate. A year before, Frost might have had one half-billion-dollar deal each month; now he was doing 20, all on piles of consumer loans.
"We were doing every single deal with every single Wall Street firm, except Citigroup," says one trader. "Citigroup decided it liked the risk and kept it on their books. We took all the rest." When traders asked Frost why Wall Street was suddenly so eager to do business with A.I.G., says a trader, "he would explain that they liked us because we could act quickly." Park put two and two together and guessed that the nature of these piles of consumer loans insured by A.I.G. F.P. was changing, that they contained a lot more subprime mortgages than anyone knew, and that if U.S. homeowners began to default in sharply greater numbers A.I.G. didn’t have anywhere near the capital required to cover the losses. He told Andy Forster, Cassano’s right-hand man in London, who brought this up at a meeting, but Cassano dismissed the concerns as overblown.
Oddly, this dramatic increase in the amount of risk A.I.G. F.P. was assuming came at exactly the moment when it lost the reason for its existence. The day after Hank Greenberg was forced to resign, in March 2005, the credit-rating agencies downgraded A.I.G. from AAA to AA. The AAA rating was the competitive advantage; without it, the natural course of action would have been to close or dramatically shrink A.I.G. F.P.’s business. Instead, Cassano grew it.
Toward the end of 2005, Cassano promoted Al Frost, then went looking for someone to replace him as the ambassador to Wall Street’s subprime-mortgage-bond desks. As a smart quant who understood abstruse securities, Gene Park was a likely candidate. That’s when Park decided to examine more closely the loans that A.I.G. F.P. had insured. He suspected Joe Cassano didn’t understand what he had done, but even so Park was shocked by the magnitude of the misunderstanding: these piles of consumer loans were now 95 percent U.S. subprime mortgages. Park then conducted a little survey, asking the people around A.I.G. F.P. most directly involved in insuring them how much subprime was in them.
He asked Gary Gorton, a Yale professor who had helped build the model Cassano used to price the credit-default swaps. Gorton guessed that the piles were no more than 10 percent subprime. He asked a risk analyst in London, who guessed 20 percent. He asked Al Frost, who had no clue, but then, his job was to sell, not to trade. "None of them knew," says one trader. Which sounds, in retrospect, incredible. But an entire financial system was premised on their not knowing—and paying them for their talent! By the time Joe Cassano invited Gene Park to London for the meeting in which he would be "promoted" to the job of creating even more of these ticking time bombs, Park knew he wanted no part of it. He announced that, if he was made to take the job, he’d quit. (Had he taken it he would now be a magazine cover.)
This, naturally, infuriated Joe Cassano, who, says one trader, thought Park was being lazy, dreaming up reasons not to do the deals that would require work. Confronted with the new development—his company was insuring not consumer credit generally but subprime mortgages—Cassano didn’t blink. He simply claimed that the fact was irrelevant: for the bonds to default, U.S. house prices had to fall, and Cassano didn’t believe house prices could ever fall everywhere in the country at once. After all, Moody’s and S&P still rated this stuff AAA!
Still, Cassano agreed to meet with all the big Wall Street firms and discuss the logic of their deals—to investigate how a bunch of shaky loans could be transformed into AAA-rated bonds. Together with Park and a few others, Cassano set out on a series of meetings with Morgan Stanley, Goldman Sachs, and the rest—all of whom argued how unlikely it was for housing prices to fall all at once. "They all said the same thing," says one of the traders present. "They’d go back to historical real-estate prices over 60 years and say they had never fallen all at once." (The lone exception, he said, was Goldman Sachs. Two months after their meeting with the investment bank, one of the A.I.G. F.P. traders bumped into the Goldman guy who had defended the bonds, who said, Between you and me, you’re right.
These things are going to blow up.) The A.I.G. F.P. executives present were shocked by how little actual thought or analysis seemed to underpin the subprime-mortgage machine: it was simply a bet that U.S. home prices would never fall. Once he understood this, Joe Cassano actually changed his mind. He agreed with Gene Park: A.I.G. F.P. shouldn’t insure any more of these deals. And at the time it didn’t really seem like all that big of an issue. A.I.G. F.P. was generating around $2 billion year in profits. At the peak, the entire credit-default-swap business contributed only $180 million of that. He was upset, it seemed, mainly that he had been successfully contradicted.
What no one realized was that it was too late. A.I.G. F.P.’s willingness to assume the vast majority of the risk of all the subprime-mortgage bonds created in 2004 and 2005 had created a machine that depended for its fuel on subprime-mortgage loans. "I’m convinced that our input into the system led to a substantial portion of the increase in housing prices in the U.S. We facilitated a trillion dollars in mortgages," says one trader. "Just us." Every firm on Wall Street was making fantastic sums of money from this machine, but for the machine to keep running the Wall Street firms needed someone to take the risk. When Gene Park informed them that A.I.G. F.P. would no longer do so—Hello, my name is Gene Park and I’m closing down your business—he became the most hated man on Wall Street.
The big Wall Street firms solved the problem by taking the risk themselves. The hundreds of billions of dollars in subprime losses suffered by Merrill Lynch, Morgan Stanley, Lehman Brothers, Bear Stearns, and the others were hundreds of billions in losses that might otherwise have been suffered by A.I.G. F.P. Unwilling to take the risk of subprime-mortgage bonds in 2004 and 2005, the Wall Street firms swallowed the risk in 2006 and 2007. Lending standards had fallen, property values had risen, and the more recent loans were thus far riskier than the earlier ones, but still they gobbled them up—for if they didn’t, the machine would have ceased to function. The people inside the big Wall Street firms who ran the machine had made so much money for their firms that they were now, in effect, in charge. And they had no interest in anything but keeping it running. A.I.G. F.P. wasn’t an aberration; what happened at A.I.G. F.P. could have happened anywhere on Wall Street … and did.
As recently as August 2007, A.I.G. F.P. traders were feeling almost smug: all these loans made in 2006 and 2007 were going bad, but the relatively more responsible 2005 vintage that they had insured didn’t look as if it would suffer any credit losses. They were, they thought, the smart guys at the poker table. Joe Cassano even went on an investor conference call and said, famously, "It is hard for us, without being flippant, to even see a scenario within any kind of realm of reason that would see us losing $1 on any of those transactions."
What no one realized is that Joe Cassano, in exchange for the privilege of selling credit-default swaps on subprime-mortgage bonds to Goldman Sachs and Merrill Lynch and all the rest, had agreed to change the traditional terms of trade between A.I.G. and Wall Street. In the beginning, A.I.G. F.P. had required its counter-parties simply to accept its AAA credit: it refused to post collateral. But in the case of the subprime-mortgage credit-default swaps, Cassano had agreed to several triggers, including A.I.G.’s losing its AAA credit rating, that would require the firm to post collateral. If the value of the underlying bonds fell, it would fork over cash, so that, for instance, Goldman Sachs would not need to be exposed for more than a day to A.I.G.
Worse still, Goldman Sachs assigned the price to the underlying bonds—and thus could effectively demand as much collateral as it wanted. In the summer of 2007, the value of everything fell, but subprime fell fastest of all. The subsequent race by big Wall Street banks to obtain billions in collateral from A.I.G. was an upmarket version of a run on the bank. Goldman Sachs was the first to the door, with shockingly low prices for subprime-mortgage bonds—prices that Cassano wanted to dispute in court, but was prevented by A.I.G. from doing so when he was fired. A.I.G. couldn’t afford to pay Goldman off in March 2008, but that was O.K. The U.S. Treasury, led by the former head of Goldman Sachs, Hank Paulson, agreed to make good on A.I.G.’s gambling debts. One hundred cents on the dollar.
A pair of ancient maples shade Joe Cassano’s London home. It’s a tasteful, almost inconspicuous place on a square, one of the best in London, just around the corner from Harrods. Only the living-room drapes are left open, to let in the spring light. Four black porcelain elephants decorate the windowsill. Behind them a shadow moves through the room. Cassano resigned from A.I.G. F.P. early last year, but he didn’t simply leave. He continued to turn up at his desk and spend the day staring at his Bloomberg TV. The traders thought it strange; only later did they learn that A.I.G. was still paying him $1 million a month to consult. As far as anyone could tell, he had nothing to do. And then one day he simply stopped showing up.
From time to time they spotted him cycling past their Mayfair office. Every now and again some British newspaper snapped a picture of him exiting his house with his racing bike. Apart from that he had as good as vanished. His absence is as frustrating as it is expected—the people best positioned to explain this financial disaster have all similarly vanished from view. It would be nice if Joe Cassano came out of hiding and tried to explain what he did and why, but there is little chance of that.
The people still left inside A.I.G. F.P. like to list just how many things had to go wrong for their business to implode. Any one of a number of things might have sufficed to avert their catastrophe: our political leaders might have decided against the Wall Street argument not to regulate credit-default swaps; the ratings agencies might have resisted the Wall Street argument to rate subprime bonds AAA; Wall Street banks, in 2006 and 2007, might have declined to replace A.I.G. F.P. in the role of subprime risktaker of last resort; and on and on. Their list is mostly a catalogue of large, impersonal forces. But impersonal forces require people to conspire with them. Joe Cassano was the perfect man for these times—as responsible for a series of disastrous trades as a person in a big company can be. He discouraged the dissent of subordinates who understood them better than he did. He acted with the approval of A.I.G., but he also must have known that A.I.G. wasn’t able to evaluate his trades.
Once he was persuaded to stop insuring subprime-mortgage bonds, the logical course of action was to reverse the deals he had already done. In 2006 he might have found a way to do this, if he had been willing to accept the costs involved, but he wasn’t. Had he been, the machine he helped to create would have kept running—by then it had a life of its own—and the losses would have simply wound up more concentrated inside the big banks. But he’d have saved his company. No one would be blaming Jake DeSantis for blowing up the world.
And yet the A.I.G. F.P. traders left behind, much as they despise him personally, refuse to believe Cassano was engaged in any kind of fraud. The problem is that they knew him. And they believe that his crime was not mere legal fraudulence but the deeper kind: a need for subservience in others and an unwillingness to acknowledge his own weaknesses. "When he said that he could not envision losses, that we wouldn’t lose a dime, I am positive that he believed that," says one of the traders. The problem with Joe Cassano wasn’t that he knew he was wrong. It was that it was too important to him that he be right. More than anything, Joe Cassano wanted to be one of Wall Street’s big shots. He wound up being its perfect customer.