B-24 bomber assembly hall, location unspecified
Ilargi: I've written before about the US health care issue(s), and I'm hesitant to spend (too) much additional time and space on it. The reason is that just about right from the start is has been clear that the "dialogue", if you can even call it that, has been rigged and bought a long time ago.
A Reuters article from this weekend, Angry Americans disrupt town-hall healthcare talks, describes a concerted campaign to disrupt Democrat town hall meetings on health care reform and operates at the following level:
[..] speakers asked about "martial law" and "forced vaccinations" and when the topic turned to illegal immigrants in the Bible Belt town, someone shouted: "Bus them home."
How obvious would you like it? The level of misinformation and disinformation is stunning, and other than perhaps Jon Stewart there doesn't seem to be any balance.
I'm not the only one who hesitates to further address the issue on account of this. Yves Smith had this on Friday in "The Health Insurers Have Already Won":
"[..] My bullshit meter went into high alert earlier this week with this New York Times story, "For Health Insurers’ Lobbyist, Good Will Is Tested," which was clearly a PR plant."
As Yves also rightly notes:
"One of the defining characteristics of Team Obama [is] its preference for spin in lieu of substance."
And that means the entire discussion, from all sides and ends, is drowning in bullshit. So yes, the industry has long since won this one.
It also means there will certainly never be any healthcare reform that is more substance than spin, either. Which is what the industry lobbyists have been aiming for ever since they got wind of any attempt at reform, long before you heard about it.
As I said last week, a reorganization along European principles might save the American people about $1 trillion per year. But it also might cost the insurance and chemical industries that same amount, and they’re simply not going to let that happen. No matter that this stalemate will blow up US health care in its entirety.
The industry K-Street spin campaign has managed to define the picture painted in the media to such an extent that Americans actually think they have the best health care system in the world, even as there are tons of reports available that say it is clearly and definitely not. It is in fact far worse and far more expensive, when viewed across the board.
It may be, in particular facets, seen as superior, but that will almost exclusively be the case for those who bring the money. The European view that even the poor(er) have a right to health, period, apparently doesn't exist in the US. Only those with money have the right to be healthy. And if that goes for health care, there is little reason to assume it’s any different when it comes to food, drinking water, shelter or even clean air.
Not that it is the way the issue is framed. That is done through for example a single case of a Canadian woman a few weeks ago, who claimed she couldn’t get care at home, as well as through similar "reports" from Europe. In yesterday's comment section here at The Automatic Earth, one reader posted this:
”Now tell me, when the government takes over the medical system, [..] how long do you think it will take before [a] shortage of American trained docs develops?”
And there was this gem:
"P.S. Can anyone explain to me the conversation I had with a friend yesterday? I asked her if she had planned on having more children. She responded that for the last four years she had been living in the Netherlands, and that she did not want to bear children under their socialist system. She said that the government would not allow epidurals, and would only allow them four hours in the hospital, as examples.
She said that now that she was moving back to Switzerland, she would reconsider, although at 39, she had to factor the age into the equation. So--socialists--how about a system that rations healthcare in a way that all receive some minimal level of care but a mother can't receive an epidural during labor? No thanks.”
The first comment is from someone who simply has no idea what happens elsewhere in the world (Western Europe has no systematic shortage of doctors), the second one comes directly from campaign headquarters. Apparently there is so much money available that economic blogs that address the American health care issue also merit covering. Which is somewhat amusing, I must admit.
The overall direction is clear: appeal to poorly defined fears that will always linger among a poorly educated population, in order to manipulate them for your own gains. The problem is that we've seen that film before. It uses Goebbels’ propaganda techniques to achieve Mussolini's ideals of a state run by faceless corporations.
While these ideas are inevitably bound for head-on failure, what the present events meanwhile tell me is that there is a very real possibility that screws and nuts like Sarah Palin and Glenn Beck will be serious contenders for the White House.
And this is what it reminds me of musically, courtesy of the only band that ever really mattered:
Spanish songs in Andalucia
The shooting sites in the days of '39
Oh, please, leave the vendanna open
Fredrico Lorca is dead and gone
Bullet holes in the cemetery walls
The black cars of the Guardia Civil
Spanish bombs on the Costa Rica
I'm flying in a DC 10 tonight
yo te quiero infinito
yo te quiero oh mi corazon
yo te quiero infinito
yo te quiero oh mi corazon
Spanish weeks in my disco casino
The freedom fighters died upon the hill
They sang the red flag
They wore the black one
But after they died it was Mockingbird Hill
Back home the buses went up in flashes
The Irish tomb was drenched in blood
Spanish bombs shatter the hotels
My senorita's rose was nipped in the bud
The hillsides ring with "Free the people"
Or can I hear the echo from the days of '39?
With trenches full of poets
The ragged army, fixin' bayonets to fight the other line
Spanish bombs rock the province
I'm hearing music from another time
Spanish bombs on the Costa Brava
I'm flying in on a DC 10 tonight
Spanish songs in Andalucia, Mandolina, oh mi corazon
Spanish songs in Granada, oh mi corazon
IMF puts total cost of crisis at $11.9 trillion
The cost of mopping up after the world financial crisis has come to $11.9 trillion (£7.12 trillion), enough to finance a $1,779 handout for every man, woman and child on the planet. The staggering total is equivalent to around a fifth of the entire globe's annual economic output and includes capital injections pumped into banks in order to prevent them from collapse, the cost of soaking up so-called toxic assets, guarantees over debt and liquidity support from central banks. Although much of the total may never be called on, the potential outlay still dwarfs any previous repair bill for the global economy.
The IMF calculations, produced ahead of the two-year anniversary of the crisis, underline the continually mounting cost. Most of the cash has been handed over by developed countries, for whom the bill has been $10.2 trillion, while developing countries have spent only $1.7 trillion, the majority of which is in central bank liquidity support for their stuttering financial sectors.
The IMF figures also show that Britain has been the biggest of all the spenders on emergency measures to support its financial sector, with its total bill for the clean-up amounting to 81.8pc of its gross domestic product, equivalent to £1,227bn. Britain's record bill is also unique in that it has also already spent much of it already, with 20pc of GDP having already supported struggling institutions. The countries that make up the G20 grouping will face a combined budget deficit of 10.2pc of GDP in 2009, the biggest since the Second World War. Although the biggest will be faced by the US, with 13.5pc of GDP, Britain also faces an 11.6pc deficit and Japan a 10.3pc one.
What Are They So Mad About?....
Reader B.A. asks a question about the health care debate via email: "I don't understand why the wingnuts are so angry. Conservatives will be better off if reform becomes law, just like liberals and independents. Please explain the rationale for the fury."
Well, I'm not sure I can. It seems like one of those easy, basic questions that should have an obvious answer: what do conservatives want out of the health care debate? "Wingnut, smash" isn't an especially compelling answer. B.A. is right about the broad benefits for Americans. Some of Rush Limbaugh's listeners are one serious illness away from bankruptcy. Some Michele Bachmann voters can't get coverage because of a pre-existing condition.
Some Glenn Beck viewers will see their insurance companies drop them when they need their coverage most. Many of Bill O'Reilly's fans already enjoy the benefits of government-run health care. Some RNC donors may want to start their own business, but can't because they can't afford to pay the monthly premiums. Some of the same people who attended "Tea Parties" in April saw the insurance for themselves and their families disappear after they lost their job.
There's nothing partisan or ideological about this -- everyone is getting screwed by the status quo. We're all paying too much for too little. A huge chunk of the country is uninsured, underinsured, or uninsurable, and the system is blind to how you voted in the last election. Now, this is not to say that the Democratic proposals are flawless; they're not. But what's striking about the opposition to reform -- at least the loudest opposition to reform -- is that the right has chosen to completely ignore the actual flaws in the plan(s) and focus on imaginary, delusional nonsense.
So why are far-right activists so apoplectic? Why would people who stand to benefit from health care reform literally take to the streets and threaten violence in opposition to legislation that will help them and their families? President Obama supports an approach to health care reform that emphasizes competition and choice, doesn't increase the deficit, and wouldn't raise middle class taxes ... and conservatives are comparing the plan to the Nazi Holocaust?
B.A.'s confusion is understandable. I don't get it, either. It's probably a mistake to lump all opponents of reform in together; different groups are fighting with different motivations. I tend to see them in five different groups:
- The Greedy: There's a fairly small group of people who profit handsomely from the broken status quo. Regular Americans are getting screwed by the system, but The Greedy are getting rich. Reform puts their profits at risk, so they're fighting back to protect their livelihood.
- The Partisans: If President Obama does what many presidents have failed trying to do, it will likely make him more popular and make his presidency successful. The Partisans care more about Republican gains than the national well being, so they're fighting to prevent a major Democratic victory because it would be a major Democratic victory.
- The Tin-Foil Hats: If reform passes, the government will kill their grandparents, create "death panels," lavish benefits on illegal immigrants, and mandate that ACORN volunteers live in your basement. The Tin-Foil Hats have active imaginations, and believe their own ridiculous conspiracy theories. They'll benefit from reform, but the voices in their head discourage them from believing it.
- The Dupes: Probably the largest group in opposition to reform, The Dupes tend to believe what The Greedy, The Partisans, and The Tin-Foil Hats have told them. When confronted with accurate information, The Dupes suspect the media, Democrats, and their lying eyes aren't to be trusted. After all, Sean Hannity wouldn't lie to them, would he? Like The Tin-Foil hats, The Dupes stand to benefit from reform, but are skeptical because they don't know who's telling the truth and who isn't.
- The Wonks: The smallest of the groups, The Wonks are conservatives who actually care about substantive policy details, have read the proposals, and believe there are better ways to improve the system. The Greedy, The Partisans, The Tin-Foil Hats, and The Dupes tend to ignore The Wonks, which is a shame.
The Wonks notwithstanding, the first four groups combine to make a force to be reckoned with, and the various teams feed off of one another nicely. The Greedy aren't a big enough group to disrupt a town-hall meeting, but if they can feed some ideas to The Tin-Foil Hats, they can get a lot done. The Partisans can't come right out and acknowledge their concerns, but if they can rope in The Dupes, the combined force is considerable. B.A. emailed, "I don't understand why the wingnuts are so angry." My suspicion is they're angry for different reasons, many of which will fade if/when Democratic policymakers can manage to do the right thing.
US banks make $38 billion from overdraft fees
US banks stand to collect a record $38.5bn in fees for customer overdrafts this year, with the bulk of the revenue coming from the most financially stretched consumers amid the deepest recession since the 1930s, according to research. The fees are nearly double those reported in 2000. The finding is likely to increase public hostility towards the financial sector, which has been under political pressure to ease the burden on consumers by increasing credit availability and lending more fairly after being bailed out by taxpayers.
The Federal Reserve is working on rules on overdraft fees, and rules on customer charges could be a priority of the Obama administration’s proposed Consumer Protection Agency if approved by Congress. Data from Moebs Services, a research company, show that the crisis has prompted many banks to lift charges on overdrafts and credit cards in order to boost profits. The median bank overdraft fee has this year rose from $25 to $26, according to Moebs, the first time it has gone up in a recession for more than 40 years. “Banks are returning to a fee-driven model and overdraft fees are the mother lode,” said Mike Moebs, the company’s founder.
Overdraft fees accounted for more than three-quarters of service fees charged on customer deposits, he said. The most cash-strapped customers are the hardest hit by such fees, with 90 per cent of overdraft revenues coming from 10 per cent of the 130m checking accounts in the US. Regular use of overdrafts is most common among consumers with low credit scores, Moebs discovered. Banks say that the fees compensate for the risk they incur when they pay on behalf of customers who do not have enough money in their accounts. “Overdraft fees are there for a reason, we take on a lot of risk,” a senior banker said. “It’s a service to our customers, they want us to pay their overdrafts.”
The highest overdraft fees were charged by the largest banks, said Mr Moebs. At banks with assets greater than $50bn – a group including Citigroup, Bank of America, JPMorgan Chase and Wells Fargo – the median overdraft fee is set at $33. At BofA, a customer overdrawn by as little as $6 could trigger a $35 penalty. If the customer does not realise they have a negative balance and continue spending, they could incur that fee as many as 10 times in a single day, for a total of $350. Failing to repay the overdraft within a few days results in an additional $35 penalty.
BofA said that the bank was “committed to ensuring that our fees are transparent and predictable. We have a range of tools and services to give customers more control over their accounts and to prevent these fees”. Chase has tiered overdraft fees – the first overdraft within a 12-month period is charged at $25, the second to fourth at $32 and the fifth at $35.
SunTrust Bank charges the highest overdraft fee for a single overdraft at $36, according to the Consumer Federation of America while Citizens Bank levies a $39 fee after three overdraft items and follows with two separate “sustained overdraft fees” for repeat offenders. SunTrust said it offered waivers and discounts as well as overdraft protection services that made it easy for customers to avoid those fees.
The survey by the Consumer Federation of America found that five of the ten largest banks have raised their overdraft fees in some way in the last year. Nessa Feddis, general counsel at the American Bankers’ Association said the higher fees are appropriate because big banks do not know their customers as well as small community banks, and need to be compensated for the higher risk.
Consumer advocacy groups point to very low loss rates on overdrafts for all banks and argue that overdrafts are the least risky form of credit, while being the most expensive for consumers. Eric Halperin, director of the Center for Responsible Lending said: “The banks own your pay check before you do, so the only way you can default on your overdraft is if you choose to open another account and deposit your income elsewhere.”
Unemployment Rate Drop = Decline in Labor Force
The country shed another ~250k jobs in July, but the unemployment rate dropped to 9.4%. How is that? It looks like individuals have left the labor force.
Month over Month Change (S.A.)
How does this work? The numerator in the unemployment rate is unemployed... the denominator is labor force. Simplified example:
- 19 people are unemployed out of 200 in the labor force = 9.5% unemployment rate
- 1 of those unemployed individuals leaves the labor force
- 18 people are unemployed out of 199 in the labor force = 9.0% unemployment rateThis also explains why the percent of those unemployed decreased at a greater rate than the labor force (1/19 = a 5.2% drop in the # unemployed, but 1/200 = a 0.50% drop in the labor force).
So, was the data better than expected? Absolutely (good to great news on a relative basis), but lets make sure we understand the math... and the continued trend.
Beware the government’s job figures
In a phone conversation yesterday, John Williams at Shadow Government Statistics warned me not to read too much good news from the better-than-expected jobs figure. The government’s seasonal adjustments aren’t, well, adjusting properly. They’re still keying off “typical” fluctuations in employment. But of course today’s economic climate is anything but typical. Yesterday the official unemployment rate ticked down a tenth of a percent to 9.4%, but according to Williams it should have ticked up a tenth of a percent to 9.6%.
There are big seasonal changes in employment that the Bureau of Labor Statistics corrects for in order to reduce the volatility of the unemployment rate. For instance, each year employment spikes ahead of the holidays as companies add workers, and then drops as those workers are let go.July usually sees a regular pattern of planned automobile production line shutdowns to accommodate retooling for the new model year, but recent disruptions to the auto industry have changed pattern this year. Without the usual pattern of shutdowns, the government’s computers nonetheless responded by creating the usual offsetting boost in jobs, not only in the auto industry, but in supporting industries as well. The auto industry itself was alone among durable goods manufacturing industries in showing a reported, seasonally-adjusted monthly gain in July, up by 28,000 jobs.
Besides bad seasonal adjustments, Williams has problems with the so-called “birth-death” model, which “adds a fairly consistent upside bias to payroll levels each year, currently averaging 76,000 jobs per month.” The genesis of the birth-death model was after the early ’80s recession, when employment figures didn’t catch jobs being added by new small businesses. However, when a company like Taylor Bean & Whitaker stops reporting its stats, say because all employees were fired en masse, BLS assumes the company is still in business. (For how long, I’m not sure) The bottom line is that, in recessions, you’re losing more jobs from failing businesses than you’re gaining from emerging ones. Hence the upward bias of the model during recessions.
But according to Williams the biggest problem with the official unemployment rate—”U-3″ in BLS parlance—is that it excludes both the underemployed and workers who have become “discouraged” and stopped looking for work:During the Clinton Administration, “discouraged workers” — those who had given up looking for a job because there were no jobs to be had — were redefined so as to be counted only if they had been “discouraged” for less than a year. This time qualification defined away the long-term discouraged workers.
Add all the underemployed and the disappeared and you have Williams “alternate” measure, which pegs unemployment at 20.6%, not 9.4%.
Job losses cast spotlight on stingy safety net
The longest U.S. recession since World War Two is exposing gaping holes in the social safety net, putting hundreds of thousands of people at risk of falling through. Some 6.7 million jobs have been lost since the downturn began in December 2007, and the unemployed are at the mercy of a confusing and complicated patchwork of aid programs. Many of the programs, such as unemployment benefits, are less generous than those available in Europe or Japan, reflecting deeply rooted American beliefs about who is deserving of help and what role government ought to play.
"Our safety net was always skimpy at best and it has frayed very substantially over the last 30 to 40 years, for reasons both ideological and financial," said Alex Keyssar, a Harvard University professor who studies unemployment and poverty. Providing a solid safety net is certainly costly, although that argument looks a bit thin when the United States is committing trillions of dollars to ensure Wall Street has a soft landing. "Where's MY bailout?" has become a common complaint heard across the country.
Yet there has been little activity inside or outside of Washington aimed at shoring up the safety net, and Keyssar and other policy experts say the system urgently needs repair. President Barack Obama's effort to patch one of the biggest holes -- ensuring health care even for those who lose their jobs -- has met fierce opposition, suggesting the chances for broader aid reform are slim.
Government figures released on Friday showed that the unemployment rate actually dipped to 9.4 percent in July from 9.5 percent in June, although many analysts attributed that to people giving up looking for work. The ups and downs of the business cycle mean regular recessions, and with that, spikes in joblessness. But countries differ on how far a society's responsibility runs to those who get caught in the downdraft.
In the United States, the answer has long been limited public sector support -- in terms of both the size and duration of unemployment relief -- compared with Europe and Japan. Keyssar sees that as a reflection of centuries-old American attitudes toward hard work, self-determination and the troubling concept of the "undeserving poor," or who is deemed worthy of public assistance. "Linked to it all is a presumption or a suspicion, particularly on the part of conservatives, that people who are unemployed aren't really involuntarily jobless and shouldn't be supported," he said.
Those undercurrents are apparent in the way the U.S. benefit system was designed. Compared with other rich countries, U.S. benefits run out far more quickly and the eligibility rules are more rigorous. Much of that was done intentionally to discourage freeloaders.
The result is a hard-to-navigate and often insufficient set of programs which can be hard to qualify for and challenging to collect. According to the U.S. Labor Department, only 36 percent of unemployed people received benefits in 2008. Many people who exhaust their weekly benefits simply fall through the cracks, said Edward Berkowitz, a public policy professor at George Washington University in Washington who studies U.S. social welfare. "We don't have any absolutely guarantees. It's not an automatic entitlement," he said.
Figuring out where to get help is tricky. For a start, the rules differ from state to state. That means if you live in Massachusetts, the maximum weekly jobless benefit is $628. In neighboring Connecticut, it's $519 and in Missouri just $320, according to the states' web sites. Many people get much less, based on their earnings before losing their jobs. The formula for determining the amount of aid is so complex that some states put calculators on their web site to help people figure it out.
For workers who still haven't found a job after six months or a year -- an increasingly common problem as the jobless rate hovers near a 26-year high -- benefits may run out before the next steady paycheck is secured. The National Employment Law Project estimates that 1.5 million people will exhaust their benefits by the end of 2009. The logistics can be a deterrent, too. The office that processes paperwork for unemployment benefits may be miles away from the one that gives out food aid, and the eligibility rules may be different. Losing a job often means losing health insurance, and perhaps a third trip to the Medicaid office, the health insurance program for the poor.
By contrast, in Japan, standard jobless benefits are paid for up to one year, even if a worker voluntarily quits, and that period can be extended up to three years if the recipient is ill, pregnant or raising a child. Those who are out of work in Japan head to a "Hello Work" office where services are centralized. The U.S. model does have its economic advantages. Requiring employers to pay into generous safety net programs and putting tough restrictions on job cuts can discourage companies from hiring, so in good times the jobless rate tends to be higher in Europe than in the United States.
Where U.S. public assistance falls short, private programs fill the gaps, and are often the last option for people facing homelessness and hunger. Many churches have soup kitchens or clothing donation programs. Other organizations such as the Salvation Army help people with drug and alcohol addiction who cannot qualify for government aid. Reforming the public welfare program is probably out of the question politically, although policy experts have no shortage of ideas about what could be done.
A national job bank that shows openings in each state may be useful, particularly for those in hard-hit places such as Michigan, where moving may be the best option. Other ideas include wage insurance, where the government would offer some financial support for those who end up taking lower-paid jobs, or expanding customized retraining to help people whose skills are no longer needed.
One program which has had considerable success in Germany compensates workers for shortened hours, encouraging companies to cut the work week instead of jobs. Germany's economy has lost only about 300,000 jobs since the financial crisis intensified last September, even though its economy has contracted even more sharply than the United States'. Isabel Sawhill, a senior fellow at the Brookings Institution, who is about to publish a book on improving the social safety net, said reforms were taking a back seat to the more pressing issue of repairing the economy, and she worries this may be a missed opportunity.
Sawhill would like to see government job programs to keep people active and provide a social good, and better training programs that help workers successfully move out of dying sectors and into growth industries. "The military can take raw recruits and turn them into terrific soldiers. Why can't we take laid-off auto workers and turn them into terrific green energy retro-fitters?" she said.
Do Fannie and Freddie Need a 'Bad Bank?'
As the Administration weighs options for reorganizing Fannie Mae and Freddie Mac in the wake of their dismal financial performance, a strategy that spawned a lot of chatter but little action earlier in the financial crisis may be back on the table. Months ago, policymakers and outside experts weighed the benefits of creating a "bad bank" to hold commercial banks' toxic assets, but the idea never gained traction. Now, some suggest, the concept could help to restructure the mortgage giants—but the hurdles that caused commercial banks to adopt a different solution remain.
Fannie Mae said on Aug. 6 that it lost $14.8 billion in the second quarter and plans to draw down another $10.7 billion from the federal government to balance its books. That brings to $85 billion the amount of funds that it and Freddie Mac have received from Uncle Sam since the government took over the companies last September, driving home just how shaky the government-sponsored entities remain. Small wonder, then, that speculation has resumed over what the government will ultimately do with the companies, which long functioned as publicly traded firms with a government-defined mission to bolster the housing markets.
One option: The "bad bank," which The Washington Post suggested on Aug. 6 could be the tool the Obama Administration uses to resolve the problem. By establishing a separate entity to hold Fannie and Freddie's toxic assets, the surviving companies could go forward with clean balance sheets, unencumbered by past mistakes and capable of raising fresh capital from the private sector. The bad assets would be unwound over time.
Sheila Bair, chairman of the Federal Deposit Insurance Corp., pushed for much the same approach to tackling the bad assets of commercial banks this winter as did others outside government. The argument: It would restore investors' faith in the newly scrubbed companies, letting them raise new capital without fear that it would be rapidly wiped out as the toxic assets deteriorated.
Instead, the Treasury Dept. funneled hundreds of billions of dollars directly into the nation's banks though its Troubled Asset Relief Program, shoring up the banks and temporarily reassuring investors. When government-supervised "stress tests" suggested most of the big banks only needed manageable amounts of additional capital to survive, despite their toxic assets, the capital markets rallied and the banks were able to raise funds quickly.
Direct investment won out in part because it was simpler. Banks' toxic assets consisted of a stew of highly complex mortgage-backed securities that had been bundled, repackaged, and leveraged, and banks proved unwilling to sell them at prices investors were willing to pay. Infusing banks with cash was less complicated then separating bad assets and building a new institution, and dealt more directly with one of the banks' biggest problems—lack of capital—than a bad bank could.
"I think they just decided to go the route of bailing out everybody who was big, which was easier than setting up the structure of bad banks," says Campbell R. Harvey, a professor of international business at Duke University's Fuqua School of Business.
Indeed, for the shakiest banks, separating bad assets from good assets might have made it abundantly clear how short of capital they were. "It doesn't really solve the problem of institutions with negative capital," says Phillip Swagel, a visiting professor at Georgetown University's McDonough School of Business and a former assistant secretary of the Treasury under Henry Paulson. "You somehow have to add more capital or take existing debt and turn it into capital."
So far, the government capital infusions, followed by private investment, seem to have done the trick. Some banks—Goldman Sachs, JPMorgan Chase, and Morgan Stanley among them—have already repaid their TARP funds, and most of the other big banks have shown strong earnings in recent months. "We did the right thing by recapitalizing the banking sector. The financial system is nearly at pre-Lehman levels," says Daniel Clifton, a Washington policy analyst at Strategas Research.
But that could change if the housing market continues to tank. In announcing its second-quarter results, Fannie Mae appeared to forecast a grim future for the housing market, with high unemployment pushing more homeowners toward foreclosure, including those with prime, or high-quality, mortgages. Some fear that financial institutions could see their newly raised capital rapidly eaten away. "It really is not beyond the realm of possibility that our big banks could come to the trough again," Harvey says. "Prime [mortgages] could be the doomsday machine."
As for Fannie and Freddie, it comes down to a question of how the government wants to structure them when they come out of conservatorship. Dividing their assets into good and bad banks makes sense if the government wants to keep a "quasi-private institution," says Albert S. Kyle, a finance professor at the University of Maryland Smith School of Business. The government-sponsored entities are so "deeply insolvent" that they'll need to divide the assets to attract investors, he says. "As long as it's done as a part of comprehensive reform and designed in a way to make buyers and sellers participate, it can't do any harm."
The White House said on Aug. 6 that it continues to mull its options, and that it's too early to call any one strategy likely. But clearly, the Administration believes any restructuring of the GSEs can wait. The Treasury doesn't plan to release a specific plan for Fannie and Freddie until February 2010, when the 2011 budget is due.
Plus, Swagel notes, the Administration needs control of the GSEs to execute its housing policy. Using Fannie and Freddie, the Administration can keep more people in their homes by guaranteeing their mortgages—essentially subsidizing refinancing by the banks. And perhaps most attractive of all, they can maneuver with limited political interference, Swagel says. "They're using the GSEs to write checks to people without having to ask Congress."
Paulson’s Calls to Goldman Tested Ethics
Before he became President George W. Bush’s Treasury secretary in 2006, Henry M. Paulson Jr. agreed to hold himself to a higher ethical standard than his predecessors. He not only sold all his holdings in Goldman Sachs, the investment bank he had run, but also specifically said that he would avoid any substantive interaction with Goldman executives for his entire term unless he first obtained an ethics waiver from the government.
But today, seven months after Mr. Paulson left office, questions are still being asked about his part in decisions last fall to prop up the teetering financial system with tens of billions of taxpayer dollars, including aid that directly benefited his former firm. Testifying on Capitol Hill last month, he was grilled about his relationship with Goldman. “Is it possible that there’s so much conflict of interest here that all you folks don’t even realize that you’re helping people that you’re associated with?” Representative Cliff Stearns, Republican of Florida, asked Mr. Paulson at the July 16 hearing.
“I operated very consistently within the ethic guidelines I had as secretary of the Treasury,” Mr. Paulson responded, adding that he asked for an ethics waiver for his interactions with his old firm “when it became clear that we had some very significant issues with Goldman Sachs.” Mr. Paulson did not say when he received a waiver, but copies of two waivers he received — from the White House counsel’s office and the Treasury Department — show they were issued on the afternoon of Sept. 17, 2008.
That date was in the middle of the most perilous week of the financial crisis and a day after the government agreed to lend $85 billion to the American International Group, which used the money to pay off Goldman and other big banks that were financially threatened by A.I.G.’s potential collapse. It is common, of course, for regulators to be in contact with market participants to gather valuable industry intelligence, and financial regulators had to scramble very quickly last fall to address an unprecedented crisis. In those circumstances it would have been difficult for anyone to follow routine guidelines.
While Mr. Paulson spoke to many Wall Street executives during that period, he was in very frequent contact with Lloyd C. Blankfein, Goldman’s chief executive, according to a copy of Mr. Paulson’s calendars acquired by The New York Times through a Freedom of Information Act request. During the week of the A.I.G. bailout alone, Mr. Paulson and Mr. Blankfein spoke two dozen times, the calendars show, far more frequently than Mr. Paulson did with other Wall Street executives.
On Sept. 17, the day Mr. Paulson secured his waivers, he and Mr. Blankfein spoke five times. Two of the calls occurred before Mr. Paulson’s waivers were granted. Michele Davis, a spokeswoman for Mr. Paulson, said that the former Treasury secretary was busy writing his memoirs and that his publisher had barred him from granting interviews until his manuscript was done. She pointed out that the ethics agreement Mr. Paulson agreed to when he joined the Treasury did not prevent him from talking to Goldman executives like Mr. Blankfein in order to keep abreast of market developments.
Ms. Davis also said that Federal Reserve officials, not Mr. Paulson, played the lead role in shaping and financing the A.I.G. bailout. But Mr. Paulson was closely involved in decisions to rescue A.I.G., according to two senior government officials who requested anonymity because the negotiations were supposed to be confidential. And government ethics specialists say that the timing of Mr. Paulson’s waivers, and the circumstances surrounding it, are troubling.
“I think that when you have a person in a high government position who has been with one of the major financial institutions, things like this have to happen more publicly and they have to happen more in the normal course of business rather than privately, quietly and on the fly,” said Peter Bienstock, the former executive director of the New York State Commission on Government Integrity and a partner at the law firm of Cohen Hennessey Bienstock & Rabin. He went on: “If it can happen on a phone call and can happen without public scrutiny, it destroys the standard because then anything can happen in that fashion and any waiver can happen.”
Concerns about potential conflicts of interest were perhaps inevitable during this financial crisis, the worst since the Great Depression. In the weeks before Mr. Paulson obtained the waivers, Treasury lawyers raised questions about whether he had conflicts of interest, a senior government official said. Indeed, Mr. Paulson helped decide the fates of a variety of financial companies, including two longtime Goldman rivals, Bear Stearns and Lehman Brothers, before his ethics waivers were granted. Ad hoc actions taken by Mr. Paulson and officials at the Federal Reserve, like letting Lehman fail and compensating A.I.G.’s trading partners, continue to confound some market participants and members of Congress.
“I think it’s clear he had a conflict of interest,” Mr. Stearns, the congressman, said in an interview. “He was covering himself with this waiver because he knew he had a conflict of interest with his telephone calls and with his actions. Even though he had no money in Goldman, he had a vested interest in Goldman’s success, in terms of his own reputation and historical perspective.”
Adding to questions about Mr. Paulson’s role, critics say, is the fact that Goldman Sachs was among a group of banks that received substantial government assistance during the turmoil. Goldman not only received $13 billion in taxpayer money as a result of the A.I.G. bailout, but also was given permission at the height of the crisis to convert from an investment firm to a national bank, giving it easier access to federal financing in the event it came under greater financial pressure.
Goldman also won federal debt guarantees and received $10 billion under the Troubled Asset Relief Program. It benefited further when the Securities and Exchange Commission suddenly changed its rules governing stock trading, barring investors from being able to bet against Goldman’s shares by selling them short. Now that the company’s crisis has passed, Goldman has rebounded more markedly than its rivals. It has paid back the $10 billion in government assistance, with interest, and exited the federal debt guarantee program. It recently reported second-quarter profit of $3.44 billion, putting its employees on track to earn record bonuses this year: about $700,000 each, on average.
Ms. Davis, the spokeswoman for Mr. Paulson, said Goldman never received special treatment from the Treasury. Mr. Paulson’s calendars do not disclose any details about his conversations with Mr. Blankfein, and Ms. Davis said Mr. Paulson always maintained a proper regulatory distance from his old firm. A spokesman for Goldman, Lucas van Praag, said: “Lloyd Blankfein, like the C.E.O.’s of other major financial institutions, received calls from, and made calls to, Treasury to provide a market perspective on conditions and events as they were unfolding. Given what was happening in the world, it would have been shocking if such conversations hadn’t taken place.”
Although federal officials were concerned that Goldman Sachs might collapse that week, Mr. van Praag said the only topics of discussion between Mr. Blankfein and Mr. Paulson at the time involved Lehman Brothers’ troubled London operations and “disarray in the money markets.” Mr. van Praag said Goldman was fully insulated from financial fallout related to a possible A.I.G. collapse in mid-September of last year.
However, Mr. Paulson believed he needed to request the ethics waivers during that tumultuous week, after regulators had become concerned that the same crisis of confidence that felled Bear Stearns and Lehman might spread to the remaining investment banks, including Goldman Sachs. At a conference call scheduled for 3 p.m. on Sept. 17, 2008, Fed officials intended to discuss the financial soundness of Goldman Sachs, Merrill Lynch and Morgan Stanley, and they had asked Mr. Paulson to participate, according to Mr. Paulson’s calendars and his spokeswoman.
That was the first time during the crisis that Mr. Paulson’s involvement required a waiver, Ms. Davis said. The waiver was requested that morning and granted orally that afternoon, just before the 3 p.m. conference call. A few minutes later, in an e-mail message to Mr. Paulson, Bernard J. Knight Jr., assistant general counsel at the Treasury, outlined the agency’s rationale for granting the waiver.
“I have determined that the magnitude of the government’s interest in your participation in matters that might affect or involve Goldman Sachs clearly outweighs the concern that your participation may cause a reasonable person to question the integrity of the government’s programs and operations,” Mr. Knight wrote.
For investors in the United States and around the world, the days after the A.I.G. rescue were perilous and uncertain; the Dow Jones industrial average fell 4 percent on Sept. 17 as credit markets froze and investors absorbed the implications of the insurance giant’s collapse. That day, Mr. Paulson and his colleagues at the Federal Reserve were scrambling to contain the damage and shore up investor confidence.
But Mr. Paulson has disavowed any involvement in the decision to use taxpayer funds to make Goldman and A.I.G.’s trading partners whole. In his July testimony to the House, he said: “I want you to know that I had no role whatsoever in any of the Fed’s decision regarding payments to any of A.I.G.’s creditors or counterparties.”
Ms. Davis reiterated this, saying that Mr. Paulson’s involvement in the A.I.G. bailout was meant to forestall a collapse of the entire financial system and not to rescue any individual firms exposed to A.I.G., like Goldman. However, she said, federal officials were worried that both Goldman and Morgan Stanley were in danger themselves of failing later in the week and it was in that context that Mr. Paulson received a waiver. “The waiver was in anticipation of a need to rescue Goldman Sachs,” Ms. Davis said, “not to bail out A.I.G.”
Treasury Department lawyers said a waiver for Mr. Paulson regarding A.I.G. was not necessary, Ms. Davis said, because the A.I.G. rescue was conducted by the Federal Reserve. The Treasury had no power to rescue A.I.G., she said. Only the Fed could make such a loan. But according to two senior government officials involved in the discussions about an A.I.G. bailout and several other people who attended those meetings and requested anonymity because of confidentiality agreements, the government’s decision to rescue A.I.G was made collectively by Mr. Paulson, officials from the Federal Reserve and other financial regulators in meetings at the New York Fed over the weekend of Sept. 13-14, 2008.
These people said Mr. Paulson played a major role in the A.I.G. rescue discussions over that weekend and that it was well known among the participants that a loan to A.I.G. would be used to pay Goldman and the insurer’s other trading partners. Over that weekend, according to a former senior government official involved in the discussions, Mr. Paulson said that he had been warned by lawyers for the Treasury Department not to contact Goldman executives directly. But he said Mr. Paulson told him he had disregarded the advice because the “crisis” required action.
Ms. Davis said: “Hank doesn’t recall saying that. Staff had advised that he interact one on one with Goldman as little as possible, not because it would be a violation but for appearances, recognizing someone would likely attempt to read too much into it.”
On Sept. 16, 2008, the day that the government agreed to inject billions into A.I.G., Mr. Paulson personally called Robert B. Willumstad, A.I.G.’s chief executive, and dismissed him. Mr. Paulson’s involvement in the decision to rescue A.I.G. is also supported by an e-mail message sent by Scott G. Alvarez, general counsel at the Federal Reserve Board, to Robert Hoyt, a Treasury legal counsel, that same day.
The subject of the message, acquired under the Freedom of Information Act, is “AIG Letter,” and it contains a reference to a document called “AIG.Paulson.Letter.draft2.09.16.2008.doc.” The letter itself was not released.
Ms. Davis said this letter was intended to confirm that the Treasury and Mr. Paulson supported the loan to A.I.G. and that its officials recognized that any Fed losses would be absorbed by taxpayers. She said the existence of the letter did not confirm that Mr. Paulson was extensively involved in discussions about an A.I.G. bailout. Since last September, the government’s commitment to A.I.G. has swelled to $173 billion. A recent report from the Government Accountability Office questioned whether taxpayers would ever be repaid the money loaned to what was once the world’s largest insurance company.
In the ethics agreement that Mr. Paulson signed in 2006, he wrote: “I believe that these steps will ensure that I avoid even the appearance of a conflict of interest in the performance of my duties as Secretary of the Treasury.” While that agreement barred him from dealing on specific matters involving Goldman, he spoke with Mr. Blankfein at other pivotal moments in the crisis before receiving waivers.
Mr. Paulson’s schedules from 2007 and 2008 show that he spoke with Mr. Blankfein, who was his successor as Goldman’s chief, 26 times before receiving a waiver. On the morning of Sept. 16, 2008, the day the A.I.G. rescue was announced, Mr. Paulson’s calendars show that he took a call from Mr. Blankfein at 9:40 a.m. Mr. Paulson received the ethics waiver regarding contacts with Goldman between 2:30 and 3 the next afternoon. According to his calendar, he called Mr. Blankfein five times that day. The first call was placed at 9:10 a.m.; the second at 12:15 p.m.; and there were two more calls later that day. That evening, after taking a call from President Bush, Mr. Paulson called Mr. Blankfein again.
When the Treasury secretary reached his office the next day, on Sept. 18, his first call, at 6:55 a.m., went to Mr. Blankfein. That was followed by a call from Mr. Blankfein. All told, from Sept. 16 to Sept. 21, 2008, Mr. Paulson and Mr. Blankfein spoke 24 times. At the height of the financial crisis, Mr. Paulson spoke far more often with Mr. Blankfein than any other executive, according to entries in his calendars.
The calls between Mr. Paulson and Mr. Blankfein, especially those surrounding the A.I.G. bailout, are disturbing to Samuel L. Hayes, a professor emeritus at Harvard Business School and a consultant in the past for government agencies, including the Treasury Department. “We don’t know what they talked about,” Mr. Hayes said. “Obviously there was an enormous amount at stake for Goldman in whether or not the A.I.G. contracts would be made whole. So I think the burden is now on Mr. Paulson to demonstrate that there was no exchange of information one way or the other that influenced the ultimate decision of the government to essentially provide a blank check for A.I.G.’s contracts.”
In a letter accompanying the government’s production of Mr. Paulson’s calendar under the Freedom of Information Act request, Kevin M. Downey, a lawyer for Mr. Paulson, raised questions about how comprehensive the schedules were. He noted, for example, that the calendars did not reflect the Treasury secretary’s attendance at several public events. Mr. Downey did not return phone calls or e-mail messages seeking further comment. Moreover, because the schedules include only phone calls made through Mr. Paulson’s office at Treasury, they provide only a partial picture of his communications. They do not reflect calls he made on his cellphone or from his home telephone.
According to the schedules, Mr. Paulson’s contacts with Mr. Blankfein began even before the height of the crisis last fall. During August 2007, for example, when the market for asset-backed commercial paper was seizing up, Mr. Paulson spoke with Mr. Blankfein 13 times. Mr. Paulson placed 12 of those calls. By contrast, Mr. Paulson spoke six times that August with Richard S. Fuld Jr. of Lehman, four times with Jamie Dimon of JPMorgan Chase and only twice with John Thain of Merrill Lynch.
Why was Goldman invited to the AIG bailout party?
by Matt Taibbi
During the week of the A.I.G. bailout alone, Mr. Paulson and Mr. Blankfein spoke two dozen times, the calendars show, far more frequently than Mr. Paulson did with other Wall Street executives. On Sept. 17, the day Mr. Paulson secured his waivers, he and Mr. Blankfein spoke five times. Two of the calls occurred before Mr. Paulson’s waivers were granted.
- via During Crisis, Paulson’s Calls to Goldman Posed Ethics Test – NYTimes.com.
I spoke with someone who was in the Fed offices the whole weekend prior to the AIG bailout, a government official, and he poses an interesting question. Aside from the Fed, the Treasury, and the New York State Department of Insurance, the main players involved in the AIG bailout that weekend were AIG (obviously), JP Morgan, Morgan Stanley, and Goldman Sachs. There were swarms of bankers from the latter three banks there that weekend, poring over AIG’s books, trying to figure out if AIG could be rescued without government help.
Now, we know why AIG was there, obviously. Morgan Stanley was there representing the Treasury (it had been hired to advise the Treasury on the bailouts by Paulson during the Fannie/Freddie mess, with the rumor being that it was the only bank willing to give up market positions that would have left it too conflicted to do the work). JP Morgan we know was there because AIG had hired them weeks before to come in and try to clean up its messes. Only Goldman Sachs did not have an official role at these proceedings.
So why was Goldman there? And why was Paulson calling Goldman two dozen times that week? This is one of the other problems with Gasparino’s account (”of course” Blankfein was there that weekend, he says, not telling us why this is so obvious). I’m not sure I’ve ever seen an official explanation for why Goldman was there that weekend; the ostensible explanation that most people seem to accept is that Goldman naturally was there because it was such a large counterparty to AIG.
But I suspect we’re going to find that Paulson was not on the phone two dozen times with executives from Deutsche Bank or Societe Generale or Barclays or Calyon, all of whom were significant counterparties to AIG as well. Goldman was not even AIG’s largest counterparty in the sec-lending wing of its business (Deutsche Bank was, and would eventually receive $7 billion via the bailout as a result), and yet as far as I know there were no Deutsche reps there that weekend at all. So what made Goldman special? This is a good question, I think.
Promises to the Drug Industry: Like Renegotiating NAFTA?
by Dean Baker
Apparently the Obama administration made a commitment to the drug companies that it would block efforts to reduce drug costs in the Medicare prescription drug program. This was apparently in exchange for a promise by Pharma to cut their prices to seniors by $80 billion over the next decade. While we may not know the full content of whatever agreement was actually struck, if this exchange is at its center, the taxpayers got a bad deal.
To give some context, the country is projected to spend more than $3.5 trillion on prescription drugs over the next decade. This is more than 2 percent of projected GDP over this period and comes to about $12,000 per family. That is real money even in the context of federal budgets. The industry's promised $80 billion in savings would be equal to less than 3 percent of its projected revenue. It is also important to remember that these savings are not well-defined and there is no obvious enforcement mechanism. Given the record of the drug industry, a certain amount of skepticism would certainly be warranted.
Even if the industry carries through with its promise, they would still be getting a very good deal. The United States pays nearly twice as much for its prescription drugs as do people in other countries -- or for that matter, as do our veterans who receive their health care through the Veterans Administration (VA). If Medicare were to pay VA type prices, it could easily save taxpayers and beneficiaries $600-$800 billion over the next decade.
There is a great deal of support among Democrats in Congress for having Medicare negotiate lower prices with the drug industry. The industry scored a real coup if it was able to head off this possibility with a vague promise of $80 billion in savings.
It is important to realize that high drug prices don't just cost us money, they are also likely to lead to bad medicine. The basic story is that drugs are almost invariably cheap to produce; the reason that prices are high is that the government grants the industry a patent monopoly. This monopoly allows Pfizer, Merck, and the rest to charge hundreds or even thousands of dollars for a prescription of life-saving drugs that would sell for $4 at Wal-Mart if we had a free market.
When there are huge gaps like this between price and cost of production, then the industry has enormous incentive to promote their drugs, even when they may not be the best medicine for patients. This is why it spends billions of dollars each year on ridiculous television ads and why it spends tens of billions of dollars hiring former cheerleaders to go to doctors' offices to push their drugs. Business responds to incentives, that's basic economics. And the incentives the government is giving the drug companies is to push their drugs to anyone they can get to buy them, whether or not the best medicine for their condition. Needless to say, this goes directly against President Obama's efforts to contain costs by promoting good medicine.
If we had drug prices more in line with production costs, we would take away the industry's incentive to lie in ways that are bad for our health. In short, we would get better medicine and pay less money for it. (Yes, we would have to find alternatives to patents for financing drug research, but there are better ways.)
Of course there is an alternative spin that we can put on the deal with the pharmaceutical industry. Politicians often have to make commitments to gain support in the middle of heated campaigns. Remember how all the leading Democratic presidential candidates promised to renegotiate NAFTA during the primaries? We haven't heard a lot about that one lately. Perhaps the pledge to block lower Medicare drug prices is like the commitment to renegotiate NAFTA. We better hope so.
For Private Equity, a Very Public Disaster
For Steve Feinberg, the onetime owner of Chrysler, the past year has been a crawl toward defeat. He lost billions of dollars. He lost prestige. He lost his privacy. And he ended up a ward and supplicant of the federal government. But, even now, Mr. Feinberg, a man who can play a decent game of chess while blindfolded, is hard-pressed to pinpoint many mistakes.
Sitting in his office on Park Avenue, far away from the detritus that surrounds Detroit, he grows pensive when asked what he has learned from his audacious — and failed — effort to privatize and resurrect the legendary and deeply troubled auto giant. “I don’t know what we could have done differently,” he says, crossing his arms on his chest. “From the day we bought it, we worked hard to improve it.” He pauses, pondering, as the clock ticks away. Then he shakes his head. “We were too optimistic on timing,” he says. “Maybe what we should have done was not bought it.”
Mr. Feinberg took over Chrysler almost exactly two years ago, promising to revive the company. Chrysler filed for bankruptcy protection at the end of April. So how he and his private equity firm, Cerberus Capital Management, choose to describe their journey with Chrysler is a delicate matter.
If he says he should have shelled out more money to help Chrysler, he could face the ire of investors who have already suffered heavy losses on his gambit. If he says he should have simply dumped Chrysler’s auto arm, while clinging to its more promising finance unit, he could be accused of caring more about his wallet than he did about Chrysler’s workers and the automaker’s role in the economy.
Mr. Feinberg’s education at the hands of Chrysler, the government and economic reality is emblematic of the limits private equity players have encountered as they’ve sought to reap outsize returns while also contending that they had the smarts and managerial prowess to repair companies of any size. Not too long ago, some pundits and analysts wondered whether private equity firms — backed with a rising tide of easy bank loans — could gain enough traction to make runs at seemingly untouchable behemoths like General Electric.
When Cerberus began poking around Detroit, some at the firm said they thought that the American automobile industry was going to be the biggest turnaround story in history. In sessions with potential investors in the last few years, the Cerberus team came across as passionate, skilled and incredibly confident that they could succeed where others had failed.
“I thought, wow, this really signals a real change in the landscape here,” recalls a person who attended a Cerberus session who asked to remain anonymous because of agreements he signed. “I guess it gave me hope. The auto companies needed an enormous amount of capital, and where else was it going to come from?”
John W. Snow, a former Treasury secretary in the Bush administration and Cerberus’s chairman, also heralded Cerberus as Chrysler’s savior, likening the firm’s investment to the government rescue of Chrysler in 1979. “Over 25 years ago, when Chrysler faced bankruptcy, it turned to the United States government for assistance,” Mr. Snow said at a National Press Club meeting in 2007. “Today, Chrysler again faces new financial challenges. But it is private investment stepping in to inject much-needed support.”
Cerberus and its co-investors ultimately invested $7.4 billion in Chrysler, a sum now worth an estimated $1.4 billion. Ideally, Cerberus hoped to wed Chrysler’s finance arm to another finance company it controlled, GMAC. To that end, the risks in Chrysler’s auto business were something that the Cerberus team thought it could manage and that wouldn’t stand in the way of making billions of dollars for investors.
“This will go down as one of the investments made at the very top of the credit bubble,” Josh Lerner, a professor who studies private equity at the Harvard Business School. “They don’t look good. This will be a black eye on their record.” Indeed, GMAC and Chrysler became so weak that they needed $22.6 billion in government aid in the last year to stay afloat. For Chrysler and its workers, investors, business partners and customers, was all of that worth it?
Mr. Feinberg defends his actions, saying he did everything possible to help the company. Known for avoiding publicity, he says that he was naïve not to anticipate the public attention that would surround him once he bought Chrysler and that he would have avoided the investment had he known. “I always view the press as something for guys who were trying to do big things,” he says, perhaps overlooking that Chrysler was, indeed, a very big thing.
Don Johnson, a former Chrysler employee, says he worked on initial production of the Jeep Liberty at a plant in Toledo, Ohio, in summer 2007, when Cerberus won the right to buy Chrysler from Daimler of Germany. To the surprise of some, Mr. Feinberg managed to woo the support of the United Automobile Workers for the deal. But Mr. Johnson says he was always skeptical about the carmaker’s new owners. “Cerberus did not have a clue about the automotive industry,” he says. “I don’t think anything could have been worse.”
Still, if you peel back Mr. Johnson’s argument, you quickly find a story of an automaker that was already in peril by the time Cerberus came on the scene. For example, he says the body shop at his plant couldn’t produce Jeep frames fast enough to keep up with the paint and assembly lines. Instead of fixing the problem, he says, the factory paid the body shop workers overtime to come in Sundays to keep up.
Cerberus took the helm about a week after Mr. Johnson’s team ran into problems with the Jeep. When Mr. Feinberg addressed workers at a town hall meeting at Chrysler’s headquarters in Auburn Hills, Mich., shortly after the deal, he spoke of his long love of American manufacturing, according to workers who attended the speech. In particular, he said he was proud to repatriate Chrysler’s ownership from Germany. “Steve saw this as a huge patriotic opportunity, in addition to a great investment,” says Robert L. Nardelli, the former Home Depot chief executive whom Cerberus installed at Chrysler’s helm.
Although some investors doubt that anything other than profits drove Mr. Feinberg’s investment, many say they believe that he was authentically excited by the prospect of reviving an American corporate icon — a theme that Mr. Feinberg is happy to support.
Surrounded by rifles, a motorcycle and model cars in his office, Mr. Feinberg mentions family members who have served in Iraq and a brother-in-law who worked at G.M. He apologizes for rambling and explains his motivation for investing in Chrysler: “I love this country,” he says. “I feel it’s been great to me. I had a great chance.”
Still, Mr. Feinberg, 49, has spent years as a dealmaker. The son of a steel salesman, he graduated from Princeton in 1982, where he studied politics. He went into finance so he could pay off his student loans. He worked at Drexel Burnham, the investment bank made famous by Michael R. Milken before it collapsed, and then, after a brief stop at a smaller firm, he was a co-founder of Cerberus in 1992.
For years, Cerberus was largely a trading shop specializing in distressed debt. But by the mid- 1990s, Mr. Feinberg expanded into buying and selling distressed companies and hired dozens of seasoned corporate executives to run them. Chrysler was the biggest prize he had ever bagged, and many co-investors say they always believed Cerberus’s stake in Chrysler’s auto operation was never the main reason the firm was interested in the company.
According to five people who heard Cerberus’s Chrysler pitch, all of whom requested anonymity because of confidentiality agreements, Mr. Feinberg’s deputies valued the financing unit more than the auto operation. In fact, the deputies believed, the finance unit’s value covered the cost of buying Chrysler, making the car company something of a bonus — if that part of the investment worked out, great; if not, Cerberus could still profit on the finance unit.
Mr. Feinberg says he believed the automobile operation had great potential value, perhaps even more than the finance arm if Cerberus could put the automaker on the right track. But that meant he and Mr. Nardelli (who had never overseen a car company) had to effectively manage the auto operation — no small feat. By October, only three months into Cerberus’s tenure, Mr. Johnson says it was becoming obvious to him and other workers that trouble was ahead. “We went from three shifts to two shifts to one shift within a year,” Mr. Johnson recalls. “Then there was just down week after down week.”
To reduce expenses, Mr. Nardelli cut excess factory capacity and billions of dollars in fixed costs. He improved the interiors of several models, which bolstered some of its approval ratings. But there still wasn’t a strong demand for Chrysler’s product line, which was packed with large vehicles like minivans and S.U.V.’s at a time when skyrocketing gas prices were making consumers interested in more fuel-efficient cars.
The company was aware that its lineup was far too limited. And Cerberus sent Chrysler executives around the world to seek partnerships with foreign automakers like Nissan. The hope was that those companies would help provide a broader product line for dealers. But there was not time for any of the efforts to bear fruit. Chrysler was burning through cash. “Once the car market stalled, the cash in the auto market evaporated,” says Maryann Keller, a longtime auto analyst and consultant, of Chrysler’s predicament. “The cash was leaving their balance sheet, and they weren’t selling cars to make money they could invest.”
That situation was made worse by hefty interest payments on more than $10 billion in debt that Cerberus arranged for Chrysler as part of the takeover, which left the automaker carrying piles of debt just as auto sales were about to plummet. While many private equity deals involved saddling companies with debt to pay off investors, Chrysler needed to take on more debt because it had so little cash on hand to finance its operations, some analysts say. The company paid back some of the debt in November 2007.
Ms. Keller says that the company that Mr. Feinberg took over was already suffering from myriad problems: a bad cost structure, a limited product line and no pipeline of more diverse offerings. In short, she says, Cerberus had simply bought “a basket case.” At the beginning of 2008, Mr. Feinberg sized up his investment in a private letter to his investors. “We do not need to be heroes to earn a good return on the investment in Chrysler,” he wrote. “We do not need to transition the car industry or even to return Chrysler to a much stronger relative position in the U.S. car market in order to be successful.”
His letter sent a chill around New York, where dozens of hedge funds had joined in his Chrysler bet. Although these firms had agreed to let Cerberus control decisions involving their investments, there was fear about how his harsh words might affect the industry’s image. After all, such a steely, hard-headed look at Chrysler didn’t mesh with the patriotic tone of Cerberus’s other statements about the company. Nor did it comport with the private equity industry’s broader arguments that its investments were good not only for its firms, but also for America.
Cerberus, meanwhile, was unable to stop Chrysler’s downward spiral. Last fall, Chrysler and General Motors tried to merge their operations, a scenario Mr. Feinberg supported, but a deal could not be struck. And in November, Chrysler announced a huge employee buyout. Mr. Johnson, the worker at the Toledo plant, joined thousands of others who signed up. “There was absolutely no hope” among employees accepting the buyouts, he says.
Mr. Feinberg says that he sympathizes with Mr. Johnson, but that he also believes business restructurings are, unfortunately, often brutal affairs. “It’s demoralizing when things go down,” he says. “But that’s a turnaround, you know. Some guys make it; some guys don’t want to deal with it. This was the most difficult environment. You couldn’t think of a worse storm for an employee to have to live through.” It was also, as it turns out, a bad storm for Chrysler’s owners.
Mr. Feinberg, a longtime free-market enthusiast and a Republican who never envisioned himself needing the government for help, suddenly found himself running a company that needed federal support to stay alive. By early last December, with Chrysler bleeding cash, he had become a vocal presence in Washington, circulating around Congressional offices to get his story out. He even offered to put tens of millions of his own money into Chrysler, a move that would have been largely symbolic.
“He said his dad was a blue-collar manufacturing type,” says Senator Bob Corker, Republican of Tennessee, who often spoke with Mr. Feinberg. “You sit there and you talk to Steve, and you can tell he’s from a background that greatly understands what the American worker is all about.” But Mr. Feinberg soon found himself negotiating with government officials who understood what Wall Street was all about.
When Congress did not pass a rescue bill for the automakers, the Treasury Department stepped in, using financial authority it had already assumed from its bailout of the banking system. Cerberus’s fate moved into the hands of Steven Shafran, a Goldman Sachs alumnus who represented the government and was regarded inside Treasury as a tough negotiator.
Mr. Shafran forced Cerberus to accept a painfully low valuation of its GMAC stake. He also quashed arguments by Cerberus that Chrysler’s financial arm shouldn’t be responsible for paying back bailout funds provided to Chrysler’s auto operation. At some point in December, Mr. Feinberg began to realize that Cerberus’s investment in Chrysler’s auto operations was largely unsalvageable. In a phone call with Mr. Shafran about 2 a.m. on Dec. 19, he offered to simply give the car company to the government, according to five people briefed on the call.
Mr. Feinberg says he was offering Cerberus’s stake in the auto company to the government as a bargaining chit for negotiating with bankers, the union and others. But some Treasury officials were worried that he was simply trying to avoid leaving the finance unit on the hook for $2 billion of the $4 billion the auto operation received in federal aid.
Treasury officials declined Mr. Feinberg’s offer and also were so wary of his motives that they put in a rule requiring that federal bailout money provided to Chrysler’s financial arm could be used only to help Chrysler’s auto unit. Despite all of that back and forth, Mr. Shafran says he believes that Cerberus behaved professionally. “They were prepared to work closely with us to ensure a smooth landing for the car company,” he says.
When the Obama administration took over this year, Mr. Feinberg got a second chance to negotiate. He faced yet another Wall Street refugee trying to save the auto industry, Steven Rattner, as well as Ron Bloom, a former banker who worked more recently for the United Steelworkers union. Mr. Feinberg was particularly focused on decreasing the $2 billion guarantee the previous administration had wrung out of Chrysler’s financial arm. He eventually knocked that amount down by hundreds of millions of dollars after agreeing to give up some other things the government wanted — something Mr. Feinberg regards as a fair outcome.
“Basically,” Mr. Bloom says, “they realized they made a poor investment and wanted to end it in a decent way.” Chrysler filed for bankruptcy protection on April 30 to help clear the way for a merger with the Italian automaker Fiat. Cerberus now values its Chrysler stake at 19 cents on the dollar. It is a humbling and embarrassing figure for Mr. Feinberg. But it’s better than zero cents on the dollar, which is what his stake might have been worth had the government not bailed him out.
Mr. Feinberg and his colleagues at Cerberus maintain to this day that their time at Chrysler was, in part, a reflection of their patriotism — a view that some analysts find hard to swallow.
“It’s hard to believe that any of these firms — including Cerberus — will be viewed as patriots in 10 years,” said John Rogers, a private equity analyst at Moody’s Investors Service, “because I don’t think their impact on any of these companies will be seen as so positive for the overall economy.” Mr. Feinberg still begs to differ, saying his experience at Chrysler has left him feeling like a good citizen. “There were times we could have been tougher and pushed harder and gotten more,” he says, “but it wasn’t the right thing for the country.”
Canada Supreme Court rules on treating pension surpluses
A Supreme Court of Canada ruling on how employers deal with surpluses in a defined-benefit pension plan has company lawyers cheering and employee lawyers jeering. In a 5-2 ruling, Canada's top court held that Kerry Canada Inc. did not violate a 55-year old trust document, when it used an actuarial surplus in its defined-benefit plan (DB) to fund the contributions and expenses of a defined-contribution plan (DC) it created for new employees in 2000, after closing access to its DB plan. It's the latest in a string of rulings on how pension surpluses should be treated and comes as more companies switch to DC from DB plans.
In DB plans, employers are responsible for any funding shortfalls whereas in a DC plan employers merely provide a set contribution. Ron Walker, a lawyer at Fasken Martineau DuMoulin in Toronto, who represented the company, said the ruling "vindicates a lot of arrangements that have been put in place. There's a great deal more clarity for both pension lawyers and actuarial consultants out there who have been structuring plans." Paul Timmins, a lawyer at WatsonWyatt, called the decision "comforting" because it recognizes that "employers should be able to evolve the nature of a plan from time to time."
Not everyone is pleased, however. Ari Kaplan, the Koskie Minsky lawyer who argued the case on behalf of the 80 employees still in Kerry's DB plan, said it is a "green light for employers to reduce DB coverage and shift into DC coverage. In the long run, that is not a good thing for Canadian workers." He said DB plans "reduce labour mobility and increase retirement security and reduces [pensioners'] need later in life to seek forms of social government benefits."
Steve Barrett, of Sack Goldblatt Mitchell, who represented the Canadian Labour Congress in the case, said "it's regrettable the court is saying that there's no impediment from employers taking a surplus in a defined-benefit plan and diverting it for its own purposes to pay contributions to employees in an inferior plan." In 2000, Kerry closed its DB plan, shifting new employees to a DC plan. The DB plan had an actuarial surplus, which meant there was more money in it than necessary to fund pension obligations that had accrued, so Kerry took an allowable "pension contribution holiday." It stopped paying into the DB plan and used surplus funds to pay $850,000 in plan expenses, a cost it used to cover on its own, and tapped $1.5-million to cover DC contributions.
DB plan members sued to prevent the funds from being converted. The Ontario Financial Services Tribunal backed the company's actions, but the Ontario Divisional Court disagreed and ruled the money could not be used in that manner. The Ontario Court of Appeal overturned that ruling and the pensioners appealed to the Supreme Court. Writing for the majority, Justice Marshall Rothstein said "the payment of plan expenses is necessary to ensure the plan's continued integrity and existence," and pension monies can be used to pay "reasonable and necessary" expenses, which Mr. Timmins said was an important ruling for employers.
On the issue of the surplus, Justice Louis LeBel argued in his dissent that allowing the surplus to fund the DC plan "disrupts this careful" balance between providing incentives for employers to create pension plans and the need to protect pensioners' rights. However, Justice Rothstein shot that down. "It is not the role of the courts to find the appropriate balance between the interests of employers and employees. That is a task for the legislature."
Labour sounds alarm over Canada Supreme Court pension loss
A top labour lawyer is calling for government action to protect pensions in the wake of a Supreme Court ruling that it was OK for a company to move pension plan money. The high court ruled Friday that Kerry Canada Inc. could transfer surplus cash from its defined-benefit pension plan to meet its obligations under a newer defined-contribution plan. The high court also concluded that the food company can pay its pension fund's "reasonable" administration costs from pension money.
The verdict could have implications for other companies that shift money between pension funds. It also bolsters a call this week by Canada's premiers for a national summit on pensions, said Steven Barrett of the Toronto-based law firm Sack Goldblatt Mitchell. "If anything, I think it reinforces the call for government and legislative action to enhance the pension plans of workers who are facing retirement with either pension plans that have been seriously eroded over the last year or so or workers who simply have no, or inadequate, pension coverage," said Barrett, who intervened in the case on behalf of the Canadian Labour Congress. "(The court) in fact says it is up to legislatures and governments to develop pension plans that protect workers."
At their meeting in Regina this week, the premiers jointly called on the federal government to hold a national gathering to find ways to assist Canadians who are facing retirement without adequate income. Ontario Premier Dalton McGuinty cited a recent study that showed that, by 2030, two-thirds of Canadians will not have enough retirement income to pay for their necessary living expenses. But David Vincent, a senior partner at law firm Ogilvy Renault, sees the decision as being about controlling costs and providing corporations with predictability in earnings.
The ruling confirms "the economic reality of today," Vincent's office said in an email to The Canadian Press. "Defined benefit pension plans are just too unpredictable and expensive for businesses to maintain while staying competitive," said the email. The Kerry Canada case pitted the company against some of its current and former employees and had been closely watched by business, unions and the pension industry. It stemmed from 1985, when
Kerry began paying administrative costs for the pension plan from the pension itself, and then took a contribution holiday. Then, in 2000, the company amended its plan, closing its defined benefit plan to new employees, and creating a defined contribution plan. Kerry employees asked the Ontario Superintendent of Financial Services to investigate the firm after it changed the plan. In June, 2007, the Ontario Court of Appeal ruled that an employer could stop paying pension plan expenses if there was nothing specifically in the plan to prevent it. It also concluded that the company would not have to pay back the money it took from the fund while it took a contribution holiday.
The Supreme Court agreed, saying there was nothing in the plan preventing the company from avoiding making payments if the fund was in surplus, and nothing stopping it from transferring funds from one part of the plan to the other. "The plan documents do not preclude combining the two components in one plan and nothing in these documents or trust law prevents the use of the actuarial surplus for the (define contribution) contribution holidays," Justice Marshall Rothstein wrote.
The high court ruled that Kerry was not obligated to pay pension expenses out of pocket, because those expenses were incurred for the benefit of pension plan members. "The payment of plan expenses is necessary to ensure the plan's continued integrity and existence, and the existence of the plan is a benefit to the employees," Rothstein wrote. "It is therefore to the exclusive benefit of the employees that expenses for the continued existence of the plan are paid out of the fund."
Over 30,000 British firms in danger of failing by end of 2010
Analysts predict that over 30,000 companies could go into liquidation before the end of next year, after official figures showed that company failures have reached their highest ever level. There were 5,055 company failures in England and Wales in the second quarter of 2009 on a seasonally-adjusted basis, the Insolvency Service said, which equates to an increase of 2.9pc compared with the previous quarter, and a 39.1pc year-on-year rise. An additional 1,027 companies went into administration in the period, a rise of 9.5pc year-on-year, and the number of companies going into receivership almost doubled from 177 to 345.
In all, around one in 120 active companies went into liquidation in the twelve months to June. The consensus amongst analysts was that the outlook was likely to worsen in the short-term, even if the economy recovers. Andrew MacCallum, managing director of Alvarez & Marsal, said: "More than 5,000 companies may have gone into liquidation in the last quarter, but we can expect to see that figure exceeded in every quarter until at least the end of 2010. "Credit is still tight and many businesses are loaded with debt that they cannot service.
Liz Bingham of Ernst & Young said: "In the last recession the insolvency peak lagged the economic trough by over a year. "Even though the number of corporate insolvencies has declined slightly compared to the previous quarter, we fear that the worst is still to come." Phil McCabe of the Forum for Private Business blamed the lack of finance available to small businesses as the most important factor in the rise in insolvencies.
"At the moment, we are seeing apparently viable businesses being labelled as 'high risk' by some banks," he said. The news comes on the same day that figures showed a record number of individuals were declared insolvent in the last quarter, and two days after Lloyds Banking Group announced losses of £19bn from bad corporate loans.
Vulture fund swoops on Congo over $100m debt
The government of the war-torn Democratic Republic of Congo is racking up fines of $20,000 a week in a case brought by a New York-based vulture fund over a debt incurred from Tito's Yugoslavia in the 1980s. Vulture funds are so called because they prey on the world's poorest countries, buying up their sovereign debt cheaply on capital markets and then going to courts, often in Britain or the United States, to enforce payment of the full value of the debt.
A Washington Court handed down a penalty against the DRC in March, starting at $5,000 a week and eventually rising to $80,000, for failing to comply with a demand to provide detailed information about all its assets throughout the world. The fine is the latest twist in the long-running effort by investment fund FG Hemisphere to collect a debt first incurred 20 years ago, when the notorious dictator Mobutu Sese Seko was in power in the DRC. The debt now amounts to $100m, including interest and penalties.
Lawyers for the African country have lodged an objection to the penalty, on the grounds that the district court has no jurisdiction over a sovereign state; but Stephen Cundra, of law firm Roetzel and Andress, who is representing the DRC, said no ruling has so far been handed down on whether the fine must stand. "Eight million people have died in the Congo for lack of healthcare... and the last thing they can do is find $100m for a vulture fund," Cundra said. As well as a series of moves to take control of the DRC's assets in Washington, the fund has also taken action in Hong Kong and South Africa.
FG Hemisphere, which was unavailable for comment, describes itself as "a New York-based investment company specialising in uncovering, investigating and managing alternative investment opportunities and special situations within the emerging markets." Nick Dearden, director of the Jubilee Debt Campaign, said: "The World Bank has made clear that DRC cannot afford to repay its debts. Today as DRC struggles to emerge from a past characterised by slavery, imperialism, looting and war, they are attacked again by financial vultures."
Tamara Gaw, in-house counsel at campaign group TransAfrica Forum, said the case underlined the urgent need for legislation to prevent vulture funds pursuing developing countries' debts on American soil. The Stop Vultures Act is on its way through the House of Representatives. Britain announced last month that it would also consult on bringing in a law to cap the amounts an institution could claim against a poor country.
But the government was spurred into more concrete measures by a group of 12 cross-party MPs who had called in parliament for a Developing Country Debt (Restriction of Recovery) bill that would seek to ban hedge funds and other creditors from taking legal action against the world's poorest countries. At least 54 companies are known to have taken legal action against 12 of the world's poorest countries in recent years, for claims amounting to over $1.8bn (£1.2bn).