Dancing class, WRC studio, Washington, D.C.
Ilargi: Money as Debt II: Promises Unleashed is out. And everybody has to see it. Paul Grignon expands on MaD I, also a must-see, if you haven't already watched it, as only he can do. The craziness of our money-system explained in animated form, MaD II takes off where its predecessor temporarily paused, and never looks back. Both masterpieces should be obligatory learning material in every highschool, college and household around the world, they fill in the awkward gaping gap left behind by an educational system that still seems to be predicated on the mad notion that people are better off not understanding where the money comes from that seemingly makes their worlds go round, that they work for every day in order to feed and shelter themselves and their families.
The two films are available on one DVD at moneyasdebt.net, or you can see them via youtube.com. I linked to a playlist below that provides Money as Debt II in an 8-part sequence, 77 minutes. It would be great if everyone orders the DVD, Grignon deserves the return on his investment, but I don’t have to feel bad about posting the youtube link here. A few years ago, he explained to me that he explicitly wants to provide his work through this channel, so he can reach as large an audience as possible. Still, I'd suggest you get a bundle and use them as Christmas presents this year.
Here goes, enjoy.
Money As Debt II: Promises Unleashed
Bailouts, stimulus packages, debt piled upon debt, where will it all end? How did we get into a situation where there has never been more material wealth & productivity and yet everyone is in debt to bankers? And now, all of a sudden, the bankers have no money and we the taxpayers, have to rescue them by going even further into debt! Money as Debt II Explores the baffling, fraudulent and destructive arithmetic of the money system that holds us hostage to a forever growing DEBT...and how we might evolve beyond it into a new era.
Bernanke's Jackson Hole Gets Deeper
by Kevin Depew
It was a full year ago while speaking at the Kansas City Fed's annual symposium in Jackson Hole, WY, that Fed Chairman Ben Bernanke explicitly outlined The Bernanke Put. But reading news stories previewing Bernanke's upcoming Jackson Hole speech, it seems few really listened to last year's version. "A year after speech, Bernanke may have to eat his words," says USA Today. No he won't. Let's review.
1. What Did Bernanke Say Last Year?
Speaking at the last year's symposium in Jackson Hole, Bernanke sought to reassure financial markets that The Bernanke Put remains firmly in place and that the Fed stands ready to limit damage to consumer spending and economic growth from a deepening housing recession.
2. What Was the Primary Concern Last Year?
Remember all that stuff about subprime mortgage issues being "well contained"? Well, that was wrong. and Bernanke admitted it. "The financial turbulence we have seen had its immediate origins in the problems in the subprime mortgage market, but the effects have been felt in the broader mortgage market and in financial markets more generally, with potential consequences for the performance of the overall economy," Bernanke said.
What happens when risk aversion grows? The velocity of money slows. In other words, the key engine of our economic growth begins to sputter. "More generally, investors may have become less willing to assume risk," Bernanke noted. Of course, the role of the Federal Reserve as it is seen from within, is to push risk assumption without letting it get too carried away. "Some increase in the premiums that investors require to take risk is probably a healthy development on the whole, as these premiums have been exceptionally low for some time," Bernanke acknowledged. "However, in this episode, the shift in risk attitudes has interacted with heightened concerns about credit risks and uncertainty about how to evaluate those risks to create significant market stress."
In other words, risk aversion at this time last year had spilled over into credit markets generally, threatening the whole ball of wax.
3. The Bernanke Put Clarified
In last year's speech, we learned quite a bit more about The Bernanke Put. Let's take a brief step back, what is the Bernanke Put? Back in May, 2007, in prepared remarks before a conference on bank structure at the Chicago Fed, my take is Chairman Bernanke essentially absolved the Fed of playing any role whatsoever in the subprime loan debacle, declared the subprime problem "isolated" from "responsible lending" and then waved around a gigantic put option just to let everyone know that, regardless, the Fed will step in and clean up whatever mess is left over.
But first, for those who are unfamiliar with options, what is a "put"? The purchase of a put option gives one the right, but not the obligation, to sell a specified amount of something at a specified price within a specified time frame. What does that mean? Ask your insurance agent. Seriously. Think about your car for a moment. Most states require you to buy some type of insurance on your car. That insurance requirement? That's basically a put option. How does it work? Well, in simplest terms, when you go to an insurance agent and take out a policy on your car, you are buying the right, should something bad happen to your car, to "put" (sell) it to the insurance company in return for an agreed upon amount over a specified time.
If you buy the most expensive insurance policy available, then you cover the total cost of replacing your vehicle. If you buy the most inexpensive insurance policy available, then you may be just covering the cost you would have to pay if your vehicle injures someone else. The Bernanke Put falls somewhere in between a full coverage insurance policy and the most basic liability insurance policy. How so? Let's go back to his speech from 2007. "It is not the responsibility of the Federal Reserve--nor would it be appropriate--to protect lenders and investors from the consequences of their financial decisions."
This is the statement from last year every news outlet and financial commentator in the world is focusing on. It suggests that the comprehensive policy is out of the question. But they are missing the point, which is: what IS covered by the Fed's insurance policy? "But developments in financial markets can have broad economic effects felt by many outside the markets, and the Federal Reserve must take those effects into account when determining policy," Bernanke added.
Bear Stearns, Fannie Mae and Freddie Mac certainly qualify as institutions where "developments" can produce "broad economic effects" even if the vast majority of Americans don't even know what any of those institutions really do (or did). Remember the velocity of money issue we discussed? The Bernanke Put means the Fed will essentially do whatever is necessary to try and maintain a certain velocity of money. "The further tightening of credit conditions, if sustained, would increase the risk that the current weakness in housing could be deeper or more prolonged than previously expected, with possible adverse effects on consumer spending and the economy more generally, Bernanke said. Yes, velocity of money, acceleration of credit demand and consumer spending must be maintained.
4. Coordinated Fiscal and Monetary Response
As I outlined in the the special Five Things on the Credit Crunch , the tools for halting a credit crunch will include monetary stimulus from the Federal Reserve as well as a Fiscal response.
5. It's A Loose Series of Events, Not A Linear Process
What about financial markets? Are we really lurching toward a full scale deflationary credit crisis? Remember, the end of this credit cycle will be a long-term series of events, not a defined process. What do we mean by that? If we do fall into a full-scale deflationary credit unwind, it will eventually look like this: stocks decline, interest rates move lower, bonds move higher, yet the dollar goes up. Because dollars are used to pay down debt, they become more valuable.
That is why the dollar can go up if deflation is at hand even though the central bank will be trying to fight it by doing everything they can to lower the cost of borrowing money and inject more credit into the system. But by the time deflation becomes front page news, almost by definition, any fiscal and monetary response will be too little and too late. This is a long-term series of events that will take years to unfold, not a domino process, and we are just now entering the second round of policy actions. That makes it difficult to understand why markets may continue to go up for a while.
Narratives are linear by design. Scenes are set, characters identified and defined, actions unfold over time in steps that lead toward a resolution. Unfortunately, while narrative is convenient in helping us understand things, it is useless in predicting how things unfold. Why? Because history does not unfold in a linear manner. Man, in retrospect, it all seems so clear. Have you ever thought that? I have. But why? Why does everything seem so clear in retrospect? Because we are hardwired to recount events in linear narrative fashion... even events that do not unfold in a linear manner!
In other words, our need for linear narrative colors our perception of history. Linear narratives unfold in steps, the output proportionate to the inputl e.g. the Federal Reserve Chairman lowers interest rates, the first a surprise 50 basis point cut, the stock market rallies, credit becomes less expensive, so people borrow and put that money back into the stock market, or in houses. That's the 2000-2005 period, right? It certainly seems that way. However in reality, in non-linear systems, the output is not directly proportional to the input. So it's not the case that, say, if the Fed does X, a proportional outcome will follow, or if the Fed and politicans implement Y and Z, a series of proportionate outcomes will follow.
On the one hand, this is why it is so very easy to sit back and laugh at the predictions of economists and market strategists. Hoho, the one prediction that is guaranteed to be correct? That their predictions will most likely be wrong. But this is not about "predicting" deflation. It's about discussing the most probable outcome of central banks continuing policies of attempting to maintain continued credit expansion. As long as credit expansion and demand for credit continues at an accelerating pace, the appearance of prosperity can conrtinue as asset prices increase.
The transition period, where we are now, sees asset prices pressured by slowing credit expansion. If the Fed cannot reverse this slowdown in credit expansion, then the deflationary unwind will kick into full gear. Nevertheless, this credit expansion comes at a price, a cost that must one day be repaid. That day has apparently arrived, and Bernanke's Jackson Hole isn't deep enough to bury it.
Fear over economy lead to more gun permits
Gun owners worried that a bad economy could lead to increased violence and suspicious that new stricter gun laws are on the horizon are rushing in record numbers to get concealed weapons permits. From Washington state to Florida, state officials say more people are deciding to pack heat. In some cases, states are reporting a near doubling in the number of concealed carry permits. The firearms industry has seen a big jump in sales and interest following last fall's elections, driven by a fear that Democrats could dig up old gun control policies. But the economy is also on the mind of many getting new permits to carry a hidden gun. Some worry the recession will get worse, leaving people to resort to theft and violence.
"I do think there are going to be people who have very little, and they are going to decide you have too much and come get it," said Rochelle Haughton of Billings, who described herself as a middle-aged housewife who likes to bring a gun when she travels on the open highway. In Montana, authorities are on pace to issue twice as many concealed weapons permits than last year - and this is in a state that only requires such permits if you go into an incorporated city. They are unnecessary everywhere else.
Gary Marbut, president of the Montana Shooting Sports Association, said students taking his gun training classes report underlying worries on gun control and violence. He said the economy is prompting anxiety over what could happen next - to the point some think social order could start to break down. "People are making decisions based on some anxiety, rather than having thought it totally through entirely," he said. Police in states around the country are unable to keep up with the pace of concealed weapons permits.
The Texas Department of Public Safety says it is hiring temporary workers to help process a surge in applications. Oklahoma also reports a near doubling in concealed carry permit applications. North Dakota officials say concealed weapons permit applications are up a third over last year. The trend stretches from Washington state to Florida, where police expect to process at least 50 percent more applications than a year ago. That state is also turning to temporary workers to help deal with the work.
Florida was one of the first states two decades ago to pass a concealed-carry law. Interest blossomed quickly, and now nearly all states have such a law. Gun advocates call the program wildly successful, pointing to the increased popularity of such permits. Critics say the laws - and interest in packing a hidden gun - are a result of senseless paranoia. Those closest to the big jump in permits this year cite the well-documented interest in buying guns and ammunition ever since the President Barack Obama's election - along with the unsettling nature of the recession.
Others point out that Obama and Democrats have not moved to restrict guns in any way - and in fact they have done the opposite. The president signed a bill in May that permits licensed gun owners to bring firearms into national parks - undoing rules that, ironically, came from the Reagan administration adored by many gun advocates. "The notion that there is some great threat looming on the horizon is horse manure," said Peter Hamm, spokesman for the Brady Campaign to Prevent Gun Violence. Hamm said he is mystified by people getting concealed weapons permits and buying new handguns over economic fears.
"I know in a tight economy, I think of things not to spend money on rather than on things I need to spend money on right away," he said. "If your response to anxiety is to buy a firearm, you should probably take a deep breath." The National Rifle Association fell just short of persuading Congress earlier this summer to force states to recognize the concealed weapons permits from other states. Some states voluntarily accept such "reciprocity," but the proposal would have forced all to do so on a widespread basis.
Edward Avilla, who runs a gun Web site called AR-15.com, lives in Rochester, N.Y., but got a new permit from Utah this year even though he already holds one in his home state. The Utah permits are popular with aficionados because nonresidents can get one through a distance class and because it is accepted in 17 other states. "The fall in the economy does make people feel insecure and want to defend their home," said Avilla. "I do know that it is motivation for a lot of people." Avilla runs a forum popular with assault rifle fans. But he also says he practices with his handguns very frequently - and self defense is on his mind. "I carry concealed basically for preservation of life. I value my life and that of others around me," said Avilla. "I do hope, however, I never have to use it in my entire life."
Longtime holders of permits are not surprised by the big surge in interest. "The reason is simple: People are afraid of what's going to happen," said Bart Bonney, a retiree living in Anaconda who recently renewed his own permit. Leslie Strangford of Baker said he primarily uses his permit so he can bring a gun when he travels with his wife. The rancher said he doesn't feel like he needs a concealed handgun around the small agricultural community where he lives, where guns are a common part of life and often hang in the back of pickup trucks. "I guess it's a sign of the times, every so often you hear about someone that is traveling and gets threatened," he said. "Being as I was traveling all over, I thought it was time to get a permit."
A Great New Bull Market? Unlikely
The strength of the stock market rally seems surprising in light of ongoing weakness in consumer spending and housing. The strength is not unusual, however. And it's not an indication that we're in a great new bull market.
In our opinion, the economy's fundamentals and the market's valuation still suggest that we're in the middle of a long bear market. We still have trouble seeing how the economy is going to go right back to 3%-4% sustainable growth in the face of our massive debt, increased consumer saving, debt reduction, overcapacity, tighter lending standards, high unemployment, and housing weakness. And we don't see how corporations will quickly generate the record-high profit margins that produced the previous market high without cutting so many more employees that they will kill the economy in the process.
Regardless of which economic outlook you favor, though, don't fall into the trap of thinking that the market's recent rally is confirmation that we're in a new bull market.
As John Mauldin observes, rallies like this one are par for the course in long-term bear markets.
Mauldin argues that we're still in a long-term bear that will take the market's valuation much lower than it was at the March low before everything finally turns around. Based on the market's behavior after previous bull market peaks, this argument is persuasive.
After the last three major bull markets--1900s, 1920s, and 1960s--the market went through nearly two decades of consolidation before a great new bull market began again. Valuations also got almost as extreme on the downside as they had on the upside. (See Robert Shiller's chart below)
Right now, we're ten years into this bear market--about a decade less than the usual long-term bear market. Valuations dropped from record highs in 2000 to modestly undervalued in March 2009, and they're now back to 10%-15% overvalued again.
Is it possible that we've entered a Great New Bull Market? Anything's possible. But the economic fundamentals and valuations make this seem unlikely.
Check out the charts from Ed Easterling at Crestmont Research in Mauldin's excerpt below. Note the magnitude of the bear-market rallies in the first chart, and the long-term decline in the market's PE ratio in the second chart (line at the bottom).
Yesterday my good friend Ed Easterling dropped by... He had a chart that I asked him to get to me for your perusal. The last secular bear market was 1966-82. He charted the ups and down in that market and noted the percentage rises and falls. It was as volatile then as it is now. There were some breathtaking ups and downs. With every rise, pundits declared the end of the bear market, only to have the market fall dramatically again. Take a few moments to gaze at the chart:
What drives the volatility? My contention is that bull and bear cycles should be seen in terms of valuation instead of price. Markets go from high valuations to low valuations and back to high. It is an age-old story. We have done about half the work we need to do to get back to low valuations. These cycles average of 17 years. We are less than ten years into this one.
I believe we are going to lower valuations in terms of price-to-earnings ratios. This can be done by the market going sideways and earnings rising, or the market dropping, or some combination. Look at the graph below, and notice the slow and steady drop in P/E ratios (bottom chart) and the very volatile markets that accompanied that fall. I agree with Ed; we should not be surprised at today's volatile markets. And we should expect more volatility and large price movements. Both up and down. (Some of the best charts anywhere are at www.crestmontresearch.com.)
The risk of a double-dip recession is rising
by Nouriel Roubini
The global economy is starting to bottom out from the worst recession and financial crisis since the Great Depression. In the fourth quarter of 2008 and first quarter of 2009 the rate at which most advanced economies were contracting was similar to the gross domestic product free-fall in the early stage of the Depression. Then, late last year, policymakers who had been behind the curve finally started to use most of the weapons in their arsenal.
That effort worked and the free-fall of economic activity eased. There are three open questions now on the outlook. When will the global recession be over? What will be the shape of the economic recovery? Are there risks of a relapse?
On the first question it looks like the global economy will bottom out in the second half of 2009. In many advanced economies (the US, UK, Spain, Italy and other eurozone members) and some emerging market economies (mostly in Europe) the recession will not be formally over before the end of the year, as green shoots are still mixed with weeds. In some other advanced economies (Australia, Germany, France and Japan) and most emerging markets (China, India, Brazil and other parts of Asia and Latin America) the recovery has already started.
On the second issue the debate is between those – most of the economic consensus – who expect a V-shaped recovery with a rapid return to growth and those – like myself – who believe it will be U-shaped, anaemic and below trend for at least a couple of years, after a couple of quarters of rapid growth driven by the restocking of inventories and a recovery of production from near Depression levels.
There are several arguments for a weak U-shaped recovery. Employment is still falling sharply in the US and elsewhere – in advanced economies, unemployment will be above 10 per cent by 2010. This is bad news for demand and bank losses, but also for workers’ skills, a key factor behind long-term labour productivity growth.
Second, this is a crisis of solvency, not just liquidity, but true deleveraging has not begun yet because the losses of financial institutions have been socialised and put on government balance sheets. This limits the ability of banks to lend, households to spend and companies to invest.
Third, in countries running current account deficits, consumers need to cut spending and save much more, yet debt-burdened consumers face a wealth shock from falling home prices and stock markets and shrinking incomes and employment.
Fourth, the financial system – despite the policy support – is still severely damaged. Most of the shadow banking system has disappeared, and traditional banks are saddled with trillions of dollars in expected losses on loans and securities while still being seriously undercapitalised.
Fifth, weak profitability – owing to high debts and default risks, low growth and persistent deflationary pressures on corporate margins – will constrain companies’ willingness to produce, hire workers and invest.
Sixth, the releveraging of the public sector through its build-up of large fiscal deficits risks crowding out a recovery in private sector spending. The effects of the policy stimulus, moreover, will fizzle out by early next year, requiring greater private demand to support continued growth.
Seventh, the reduction of global imbalances implies that the current account deficits of profligate economies, such as the US, will narrow the surpluses of countries that over-save (China and other emerging markets, Germany and Japan). But if domestic demand does not grow fast enough in surplus countries, this will lead to a weaker recovery in global growth.
There are also now two reasons why there is a rising risk of a double-dip W-shaped recession. For a start, there are risks associated with exit strategies from the massive monetary and fiscal easing: policymakers are damned if they do and damned if they don’t. If they take large fiscal deficits seriously and raise taxes, cut spending and mop up excess liquidity soon, they would undermine recovery and tip the economy back into stag-deflation (recession and deflation).
But if they maintain large budget deficits, bond market vigilantes will punish policymakers. Then, inflationary expectations will increase, long-term government bond yields would rise and borrowing rates will go up sharply, leading to stagflation.
Another reason to fear a double-dip recession is that oil, energy and food prices are now rising faster than economic fundamentals warrant, and could be driven higher by excessive liquidity chasing assets and by speculative demand. Last year, oil at $145 a barrel was a tipping point for the global economy, as it created negative terms of trade and a disposable income shock for oil importing economies. The global economy could not withstand another contractionary shock if similar speculation drives oil rapidly towards $100 a barrel.
In summary, the recovery is likely to be anaemic and below trend in advanced economies and there is a big risk of a double-dip recession.
China's ICBC bank lends its way to temporary greatness
Industrial and Commercial Bank of China is lending its way to greatness. The world's biggest bank by market capitalisation, weighing in at $231bn at Thursday's close, achieved an impressive 21pc return on equity in the first half of the year. Loan growth is the explanation. And the real costs of the expansion could be tomorrow's problem. Under orders from Beijing, ICBC has been hosing its customers with cash. The loan book expanded by 18.9pc, or $127bn, from the end of 2008, although lower rates meant net interest income fell 12pc on the same period a year ago. Recent results from Bank of Communications tell a similar story.
It is not just state bidding that is behind this extraordinary growth. ICBC is attracting deposits at a rate of knots. Some $192bn of additional funds lined ICBC's vaults in the first half, needing to be put to work. Chinese banks don't enjoy much fee and commission income from trading and the like, so they need to keep lending to earn their keep. There was only partial reassurance that lending discipline is being maintained. "Discounted bills" - short-term lending given to speculative use - slowed dramatically from the first quarter. Industry data for July show short-term loans are now being re-lent as longer-term, more productive borrowings. Those looking for a reason why Shanghai stocks fell 20pc in a month may find their answer there.
Chinese banks meanwhile proudly claim their bad debts are going down even as lending increases. But that is at odds with economic reality. The fear must be that the tide of liquidity is refinancing risky industrial loans and storing up more problems for later. Some lending may be life-support to unprofitable companies. For now, ICBC's balance sheet is iron-clad. Tangible common equity is a healthy 5pc of total assets. Loans are 58pc of deposits. That means there could be much more lending to come if the state wants it. But the crisis has shown that banks' sky-high returns on equity do not last, and for a reason. Tomorrow's shareholders may pay the price for today's profits.
The "Real" Mega-Bears
by Doug Short
Here is a chart I like better than my original Mega-Bear Quartet overlay. This "Real" Mega-Bear version shows the current S&P 500 from the top of the Tech Bubble in March 2000 and is thus more consistent with my preference for real (inflation-adjusted) analysis of long-term market behavior. When we adjust for inflation, the all-time high for the S&P 500 was in 2000, not 2007.
In previous weeks, this chart also included the NASDAQ from its 2000 peak. But "Rawb" in New York City emailed me with a good question:I'm a curious about the purpose or benefit of showing two bears that "started" approximately 2 weeks apart from each other, specifically the NASDAQ bear (started 3/10/2000) and the current bear which you claim started 3/24/2000, about 14 days later.
I agree. The NASDAQ was simply a carry-over from the original Mega-Bear Quartet chart. I'll keep it in the original, where it represents a nominal secular bear market following an obvious bubble. But it's redundant in the inflation-adjusted Mega-Bear overlay. The broader S&P 500 is the rightful representative of the "real" U.S. bear that started in 2000.
Millions face shrinking Social Security payments
Millions of older people face shrinking Social Security checks next year, the first time in a generation that payments would not rise. The trustees who oversee Social Security are projecting there won't be a cost of living adjustment (COLA) for the next two years. That hasn't happened since automatic increases were adopted in 1975. By law, Social Security benefits cannot go down. Nevertheless, monthly payments would drop for millions of people in the Medicare prescription drug program because the premiums, which often are deducted from Social Security payments, are scheduled to go up slightly.
"I will promise you, they count on that COLA," said Barbara Kennelly, a former Democratic congresswoman from Connecticut who now heads the National Committee to Preserve Social Security and Medicare. "To some people, it might not be a big deal. But to seniors, especially with their health care costs, it is a big deal." Cost of living adjustments are pegged to inflation, which has been negative this year, largely because energy prices are below 2008 levels. Advocates say older people still face higher prices because they spend a disproportionate amount of their income on health care, where costs rise faster than inflation. Many also have suffered from declining home values and shrinking stock portfolios just as they are relying on those assets for income.
"For many elderly, they don't feel that inflation is low because their expenses are still going up," said David Certner, legislative policy director for AARP. "Anyone who has savings and investments has seen some serious losses." About 50 million retired and disabled Americans receive Social Security benefits. The average monthly benefit for retirees is $1,153 this year. All beneficiaries received a 5.8 percent increase in January, the largest since 1982. More than 32 million people are in the Medicare prescription drug program. Average monthly premiums are set to go from $28 this year to $30 next year, though they vary by plan. About 6 million people in the program have premiums deducted from their monthly Social Security payments, according to the Social Security Administration.
Millions of people with Medicare Part B coverage for doctors' visits also have their premiums deducted from Social Security payments. Part B premiums are expected to rise as well. But under the law, the increase cannot be larger than the increase in Social Security benefits for most recipients. There is no such hold-harmless provision for drug premiums. Kennelly's group wants Congress to increase Social Security benefits next year, even though the formula doesn't call for it. She would like to see either a 1 percent increase in monthly payments or a one-time payment of $150.
The cost of a one-time payment, a little less than $8 billion, could be covered by increasing the amount of income subjected to Social Security taxes, Kennelly said. Workers only pay Social Security taxes on the first $106,800 of income, a limit that rises each year with the average national wage. But the limit only increases if monthly benefits increase. Critics argue that Social Security recipients shouldn't get an increase when inflation is negative. They note that recipients got a big increase in January — after energy prices had started to fall. They also note that Social Security recipients received one-time $250 payments in the spring as part of the government's economic stimulus package.
"Seniors may perceive that they are being hurt because there is no COLA, but they are in fact not getting hurt," said Andrew G. Biggs, a resident scholar at the American Enterprise Institute, a Washington think tank. "Congress has to be able to tell people they are not getting everything they want." Social Security is also facing long-term financial problems. The retirement program is projected to start paying out more money than it receives in 2016. Without changes, the retirement fund will be depleted in 2037, according to the Social Security trustees' annual report this year. President Barack Obama has said he would like tackle Social Security next year, after Congress finishes work on health care, climate change and new financial regulations.
Lawmakers are preoccupied by health care, making it difficult to address other tough issues. Advocates for older people hope their efforts will get a boost in October, when the Social Security Administration officially announces that there will not be an increase in benefits next year. "I think a lot of seniors do not know what's coming down the pike, and I believe that when they hear that, they're going to be upset," said Sen. Bernie Sanders, an independent from Vermont who is working on a proposal for one-time payments for Social Security recipients. "It is my view that seniors are going to need help this year, and it would not be acceptable for Congress to simply turn its back," he said.
Commercial Real Estate Is an Impending Disaster
Many of us know of people who have lost their homes through foreclosure. We also read about financial institutions bellying-up and big banks being weighed down by subprime home-loans and esoteric derivatives. To a lesser extent we hear about struggling commercial properties vying for a limited pool of tenants. The competition is forcing landlords to accept lower rents and in some cases, the aggregate rents are inadequate to pay their operating expenses.
In addition to distressed commercial real estate, there are also viable, cash-flowing properties that are looking at impending disaster. That is because an estimated $410 billion worth of commercial mortgage-backed securities are scheduled to come due between 2010 and 2013 according to Deutsche Bank Securities. They say that two thirds or more of the underlying properties will not qualify to refinance the existing loan balances. Furthermore, the original loan documents for CMBS-financed properties are inflexible. So loan mitigations, workouts and extending the terms beyond their original due dates are highly unlikely.
REITs, developers, investors and individual landlords will have to come up with a substantial amount of equity to refinance and save their properties from foreclosure. Alternatively, they may have to sell at greatly reduced prices and book huge losses. According to news reports a few months ago, Glimcher Realty Trust sold the Great Mall of the Great Plains in Olathe, Kan. for $20.5 million. That price represented approximately two-thirds of the $30 million mortgage balance secured by the property. The public REIT booked a big loss.
On June 2, 2009, The Equitable Building in Atlanta, Ga., a 35-story tower was put up for auction after defaulting on its loan. It was purchased by an affiliate of Capmark Bank for $29.5 million. Just two years earlier, Capmark made a $52 million purchase money mortgage to Equastone to buy the property. Significantly, there were no other bidders at the auction suggesting that the value was even lower than the amount that the bank paid to salvage part of its investment. Vacancies, increasing capitalization rates and a dearth of buyers played a role in the plunging values of these two properties. Similar scenarios are occurring nationwide.
To make matters worse, CMBS have over-leveraged many properties at 85 percent to 90 percent of value. Shortly after that, the CMBS financing vehicle dried up because Wall Street stopped buying them. The credit crunch, declining values and increasing foreclosures makes it unlikely that CMBS will return in the foreseeable future with such high leveraging. Insurance companies are willing to step in and refinance the best properties at 65 percent to 70 percent of value. That means borrowers who previously financed 90 percent will have to bring a considerable amount of equity to the table just to take out their existing financing.
In some cases, mezzanine lenders and equity partners may join hands with the owners in return for a sizable chunk of equity. But the fear is that battle-scared owners will give up the fight and simply turn the keys over to the CMBS servicers. The Obama Administration is mulling over the possibility of using Term Asset-Backed Securities Loan Facility to buy CMBS held by financial institutions. If that happens, some loan modifications may be possible. Alternatively, TALF might finance private investment groups to buy the securities at deep discounts. Of course there are no assurances that the financial institutions will be willing to book the sale of CMBS at deep discounts. The problem is far from being solved and the next couple of years could spell disaster for commercial real estate.
'Cash is king' in market for foreclosed homes
As an aspiring first-time home buyer, Jay Nielsen hoped to find a cheap, bank-held foreclosure in Vallejo that he could finance with a Federal Housing Administration mortgage. What he didn't expect was having to compete with buyers willing to pay in all cash. "Since January, I've put in 10 bids (on foreclosed homes); some were up to $80,000 over asking price and were still turned down," said Nielsen, 41, a medical assistant. Each time, the banks selected offers from investors with all-cash offers - even when those offers were lower than his, Nielsen said.
"Cash is king right now," said Glen Bell of Keller Williams Realty in Berkeley. For foreclosed homes, "a cash offer that hits the target price will many times trump a higher-priced offer with a loan. The ability to close has become just as important to banks as price. The prospect of a property being tied up longer, still on their books and then falling out is costly." Cash offers close escrow quickly and easily, while offers with a mortgage now often take 45 days or longer to close and can fall through if the financing hits any snags.
The result is that average consumers say they are being shut out because they can't compete against deep-pocketed investors snapping up homes to rent out or flip. The situation could have long-term repercussions as neighborhoods shift toward more heavily rental, and it has frustrated many who hoped that low interest rates and increased affordability would let them gain a toehold in the market.
All-cash sales are most common where prices are low and bank-owned properties account for the lion's share of listings. In foreclosure-ridden Pittsburg, for instance, 42.7 percent of home sales in the first three weeks of July had no record of a purchase loan, according to county data analyzed by MDA DataQuick. The median price for those transactions was $105,000. For the same period in San Pablo, 45.1 percent of sales appeared to be cash transactions; their median price was $110,000. In the Bay Area overall, 22.2 percent of sales in the July period looked like cash transactions; their median was $200,000, DataQuick said.
"Houses are less expensive than they've been in over a decade, and there is a Gold Rush mentality out there," said Andrew LePage, an analyst with San Diego's DataQuick. "If you want to be the one who gets the house, in some cases you just have to have cash." "As properties hit below 100 bucks a square foot and the cash-flow ratios are there, investors are out buying 10 properties at a time in some of the same areas where first-time home buyers are looking," said Kevin Kieffer, an agent with Keller Williams Realty in Danville. "If you buy a $150,000 home in Pittsburg, you can rent it out for $1,500 a month. But if you get a $500,000 home in Walnut Creek, renting it out for $5,000 is not going to happen."
Tim Garton of Coldwell Banker in Vallejo acts as a listing agent for many foreclosures. Another dynamic at work, he said: "Asset-management companies that handle sales for the banks are graded on how fast they can get properties off their books so they can get more properties." But Gary Kishner, a spokesman for JPMorganChase, said that banking giant accepts the highest offer on foreclosed homes, regardless of how offers are financed. The only time an all-cash offer might trounce a higher one with a mortgage, he said, would be if the financed offer were contingent on selling another house, or on rehabbing the foreclosed home to meet Federal Housing Administration requirements.
Cindy Kraeber of Hayward, who is relying on traditional financing, has bid unsuccessfully on nearly 30 homes from Fremont to Brentwood in the past four months. "People are jumping on homes so fast it is like combat house-hunting," said Kraeber, 49, an executive assistant. "You can't go see a house in person (before making an offer); once you see it online, you have to put in a bid as quickly as you can. If you wait, there are already six bids." She visits homes after making an offer to decide if she wants to proceed.
Of her 30 offers, Kraeber had just one accepted. But the deal for a house in Brentwood fell through when an appraiser said the house was worth $21,000 less than her $175,000 offer. Banks will not write mortgages for properties assessed below the sales price because there is not enough collateral. "If you come in with cash, the appraisal is not even an issue; most cash buyers don't ask for one," Kieffer said.
Kieffer offers tactics to help regular buyers compete. "If my client likes a property, I have them bring an inspector the day we look at it and get the inspection report that night, before we write an offer," he said. "Then we know what we're looking at and we can write an offer with no inspection contingency." The fewer contingencies, the better chance that a deal will go through. LePage, the DataQuick analyst, said some owner-occupant buyers may be strategizing to put together cash offers. "My hunch is, in many cases there are loans involved from family, friends, private individuals," he said.
Nielsen, who was looking for a property under $185,000, devised his own creative approach. He decided to sidestep foreclosures and went door to door in neighborhoods he likes, leaving notes explaining what he wanted to buy. His ingenuity paid off. A man called, saying his family wanted to sell their longtime home. They agreed on a price based on comparable local sales and are in escrow. "It was next door to one of my best friends, on a street I really like," Nielsen said. "It's a small house, but something I will be able to manage."
The Existing Home Sales "Bounce" Will Be Brief
The existing home sales number released today showed a slightly better than expected number for the month of July. Given that we are in the heart of home buying season, given all of the money pumped into the system by the Fed AND especially given the $8,000 first time home buyer tax credit, we shouldn't be surprised to see a small, seasonal bounce in home sales right now.
As pointed out by Clusterstock.com: Existing Home Sales would have been negative over June if not for the increase in Northeast Condo sales, Single Family Detached sales were DOWN 5000 units June to July, and in the all-important Western region, existing sales were down 10%.
But let's look at the underlying factors and data to understand what is really going on with the "seasonally adjusted" and polished-up-for-public-presentation number released by the National Association of Realtors. Here are the factors we see that will undermine this brief respite from the ongoing housing Depression:
1) The universe of qualified first-time home buyers gets exhausted; 2) Distressed investors step away as the ever-present "shadow" inventory becomes actual inventory (shadow inventory is bank-owned homes and would-be sellers waiting for "a bounce in the market"); and 3) The massive wave of prime mortgage foreclosures will flood the market, putting pressure on prices in every price-segment AND on buyer demand.
First-time home buyers and foreclosure/short-sale buyers - so-called distressed investors - represented 61% of the estimated sales for July. This metric is not a sign of a healthy, sustainable market for a couple reasons. First-time buyers are most likely "pulling" future sales into the present, as the first-time home buyer tax credit of $8,000 is set to expire in December. Home sales drop off anyway after August, so we would expect to see an even bigger drop in the third and fourth quarters, even if Obama extends taxpayer subsidization of first-time buyers.
As for the distressed investor segment, many of these buyers will look to "flip" their "distressed" purchase fairly quickly or they'll be forced to rent out the property to avoid the negative cash flow hit from holding investment homes. But renting will be made a lot more difficult by the record inventory of rentals units currently on the market, and growing. I would expect to see a lot of "investors" look to try and unload their property if they can't rent it out or become nervous about the market.
And finally, the inventory levels are still at unusually high levels. We know for a fact that banks have been withholding foreclosed homes on their books (REO, real estate owned) from the market in an attempt to reduce supply and hold up prices. We also know, as reported yesterday, that the percentage of properties in foreclosure or delinquency hit a record high of 13.2% of all single-family mortgages. What makes this metric even more severe in terms of housing market economics is the large jump in foreclosures in prime mortgages and FHA-insured mortgages.
Up to this point, the lower priced homes, typically bought by first-timers and distressed investors, have been by far the highest component of existing homes sales. With the impending tsunami of prime mortgage foreclosures will be a flood of much higher priced homes, which will ultimately put a lot of pressure on the lower end of the market. Of course eventually these banks will have to put a lot of their foreclosure inventory on the market, which will exacerbate the problem.
Ultimately this brief "bounce" in home sales will run into the problems discussed above and, because the Fed and the Government tried to put a floor under the market, the ensuing next leg down will be even worse than what we went through over the past 18 months. It will be interesting to see if the Government decides to spend some of the trillions of dollars it's printing to become a home buyer of last resort (I say this only half-facetiously because I bet it's been discussed). Let's not forget that the taxpayer now owns outright or de facto General Motors, Fannie Mae, Freddie Mac, Citibank and AIG. So in a way, via FNM and FRE, the taxpayer is already monetizing the housing market.
Five Reasons Why Negative Equity Could Kill GDP Growth
Negative equity on a residential mortgage means the owner of the residence owes more on the mortgage loan than the property is worth. This has become a big problem in the US and it’s an issue that needs to be taken into account as one forecasts the prospects for a recovery in consumer spending and overall GDP growth in the next few years.
How Big Is the Negative-Equity Problem?
According to data released by First American CoreLogic, as of June 30, about 15 million US residential properties were worth less than the mortgages owed on the properties. This represents about 32% of all mortgaged residential properties. The report also estimated that there are an additional 2.5 million mortgaged properties that were approaching negative equity. This means that negative equity and near negative equity mortgages represent almost 38% of all residential properties with a mortgage in the US.
Three states account for roughly half of all mortgage borrowers in a negative-equity position. Nevada at 66% had the highest percentage, followed by Arizona at 51% and Florida at 49%. Michigan at 48% and California at 42% were fourth and fifth in the rankings. According to the same report, the aggregate property value for loans in a negative-equity position was $3.4 trillion. This figure can be thought of as the value of a subset of properties that are at high risk of default. In California, the aggregate value of homes that are in negative equity was $969 billion, followed by Florida at $432 billion, New Jersey at $146 billion, Illinois at $146 billion, and Arizona at $140 billion.
In a recent report, Deutsche Bank estimated that the number of US mortgage holders facing negative equity would approach 48% within 2 years. Others have offered estimates of around 30%. Approximately two-thirds of owner-occupied housing in the US has a mortgage. This implies that currently, roughly 24% of US households are in a negative equity or near negative-equity position with respect to their home. If Deutsche Bank’s estimates were to prove accurate, this figure could rise to about 33% within 2 years.
The Consequences of the Negative-Equity Problem
1. The financial system faces grave risks.
According to the Mortgage Bankers Association, as of June 30, more than 13% of mortgage owners are either in default or behind in their payments. According to the report, approximately 4% are in foreclosure and 9% have missed at least one payment. The fact that somewhere between 25% and 50% of all residential mortgages will be in or near negative equity in the next couple of years implies that default rates will remain very high for an extended period of time in the US. Indeed, the fact that foreclosures in the US increased by 7% in July relative to June despite an uptick in economic activity is a potentially ominous sign.
Certainly, it must be recognized that not all mortgage holders with negative equity will default. In addition, even if home prices decline another 20% as some analysts are suggesting, a significant portion of the face value of the defaulted loans will be covered by the collateral value of the homes. Still, the phenomenon of negative equity is a problem of monumental proportions for the US financial system.
2. Negative equity could cripple consumer spending.
Being underwater on their mortgage makes people feel poor. This should significantly affect their propensity to consume. The Permanent Income Hypothesis (PIH) developed by Milton Friedman (the most prominent model of consumer behavior within the economics profession) posits that individuals take into account not only their current income, but their total wealth when making consumption decisions. And behavioral research suggests that wealth effects -- particularly large fluctuations in a short period of time -- may impact consumption far beyond what’s predicted by the PIH.
The increase in perceived wealth created by the housing boom fueled accelerated consumption on the part of consumers from the mid 1990s through 2006, well beyond what the standard PIH theory would predict. Keeping this in mind, it seems probable that the enormous damage done to the household balance sheets of vast numbers of Americans as a result of the housing crisis may similarly cause dramatic downward adjustments in household consumption.
The effects of negative equity on a very large segment of US consumers is one among several reasons why private consumption in the US is likely to significantly lag overall GDP growth in coming years -- an almost unprecedented state of affairs in modern US history. Since private consumption represents about 70% of US GDP, this implies that overall GDP growth will necessarily be highly constrained going forward.
3. Negative equity makes people feel trapped in their houses.
Many individuals don’t want to ruin their credit by defaulting on their mortgages. Additionally, many don’t want to “realize” their equity losses. This is due to the well known psychological phenomenon known as the “sunk-cost effect.”
4. Labor mobility is stymied.
People that feel “trapped” in their houses will tend to become immobile. Labor mobility is a critical component for a swift economic recovery. The high mobility of labor in the US has historically been a distinguishing factor versus mobility in Europe, in terms of the US’s ability to recover quickly from recessions. Labor supply must be able to respond rapidly to demand in the most dynamic areas. In this way, the virtuous cycle of employment, income, and consumption growth can be ignited quickly and efficiently. The effects of negative equity in immobilizing the population will greatly hinder this process and it will be reflected in economic variables such as velocity and productivity that are intimately tied to the rate of economic growth.
5. Enormous supply overhang.
Negative equity and the paralysis induced by the sunk-cost effect represents an enormous overhang of pent-up supply for the housing market. Any minor price recoveries in the housing market will be met with eager pent-up inventory by sellers that have been waiting for a bounce that will allow them to alleviate the psychological pressure created by not wanting to sell at a large loss or at a large cost to sunk household equity. This pent-up supply overhang implies that the housing market faces enormous obstacles for price recovery in the next few years.
Negative equity isn’t an issue that’s relevant for market timing. However, it’s an issue I believe many economists aren’t properly accounting for as they forecast economic growth in the next few years.
First, the extent and depth of the negative-equity problem implies that default rates may remain higher for longer than many are expecting, with negative repercussions for a financial system which will be constrained in its ability to finance the economic activities of consumers and businesses going forward. Second, I believe that the dramatic wealth effects caused by the housing crisis haven’t been properly accounted for in projections of private-consumption growth in the next few years. Finally, reduced labor mobility should act as a growth inhibitor that will affect the speed and character of the US economic recovery.
The effects of negative equity are just some of the oversights embedded into consensus economic forecasts that are setting financial markets up for significant disappointments going forward related to private consumption and overall GDP growth.
Analyst Bove sees 150-200 more U.S. bank failures
A prominent banking analyst said on Sunday that 150 to 200 more U.S. banks will fail in the current banking crisis, and the industry's payments to keep the Federal Deposit Insurance Corp afloat could eat up 25 percent of pretax income in 2010. Richard Bove of Rochdale Securities said this will likely force the FDIC, which insures deposits, to turn increasingly to non-U.S. banks and private equity funds to shore up the banking system.
"The difficulty at the moment is finding enough healthy banks to buy the failing banks," Bove wrote. The FDIC is expected on August 26 to vote on relaxed guidelines for private equity firms to invest in failed banks, after critics said previously proposed rules were too harsh and would actually dissuade firms from making investments. Bove said "perhaps another 150 to 200 banks will fail," on top of 81 so far in 2009, adding stress to the FDIC's deposit insurance fund. Three large failures this year -- BankUnited Financial Corp in May, and Colonial BancGroup Inc, Guaranty Financial Group Inc in August -- collectively cost the fund roughly $10.7 billion. The fund had $13 billion at the end of March.
Regulators closed Guaranty's banking unit on Friday and sold assets of the Texas-based lender to Banco Bilbao Vizcaya Argentaria SA. The FDIC agreed to share in losses with the Spanish bank.
Bove said the FDIC will likely levy special assessments against banks in the fourth quarter of this year and second quarter of 2010. He said these assessments could total $11 billion in 2010, on top of the same amount of regular assessments. "FDIC premiums could be 25 percent of the industry's pretax income," he wrote.
How toxic finance created an unstable world
by Wolfgang Münchau
Two years on, what do we know about the global financial crisis? We still lack a conclusive theory, but we know a lot more than we did in August 2007. We know, for example, that simple monocausal explanations are at best insufficient and most likely paranoid and lazy. If you still blame Alan Greenspan, former chairman of the Federal Reserve, or central bankers in general, you have not got it. Nor can you explain it by “soft” factors such as greed and bonus payments. These played a role but none can serve as an adequate explanation of why the crisis broke out when it did, since they had been present for many years.
My own gut feeling: this has been a crisis of economic policy first and foremost. The financial crisis was necessary for the economic crisis to occur but it was not sufficient on its own. Each depended on the other. The best description I have found of how economics and finance interacted is by Anton Brender and Florence Pisani*. The two French economists describe in great detail how money from European and Asian exporters ended up in US consumer or mortgage debt and how risk was transformed in the process. The main point is that global imbalances would not have become so extreme if global finance had not provided exotic new instruments.
Dollar-rich Chinese, Japanese and German investors did not lend the money directly to the subprime mortgage market but they invested in opaque credit products, such as collateralised debt obligations, which they mistakenly deemed to be as safe as US government bonds. Securitisation dumped the risk on those unsuspecting investors. It also transformed long-term debts, such as mortgages, into marketable short-term securities, which were in demand in countries with current account surpluses, particularly Germany and Japan. It is no surprise that those two countries ended up with large portions of the junk, as they had the greatest need to invest their surplus savings.
Without a global credit market, the pre-crisis level of imbalances would have created an intolerable degree of demand for US triple-A rated securities that could simply not be satisfied by the US government. The story was different in China. Chinese exporters gave the dollars to their central bank in exchange for domestic bonds. The central bank accumulated those dollar holdings, which it invested in securities, Treasury and agency bonds, and other seemingly secure dollar funds, some of which were also ultimately secured by dodgy private-sector loans. In the process, the Chinese central bank prevented a disorderly increase in the renminbi exchange rate, and this in turn helped to make global imbalances more persistent.
If this interpretation is correct, is it good or bad news for us today? On the surface, it is good news. If you add the absolute value of all global current account deficits and surpluses, then divide by two, you get a metric for global imbalances. These, according to the two French authors, were about 1 per cent of world output during most of the 1970s, ‘80s and ‘90s. Since 2000, the imbalances have trebled. Without securitisation, the world cannot sustain such extreme imbalances indefinitely.
There is no way that Wall Street and the City of London will recreate the pre-crisis levels of securitisation, even if we make no changes to financial regulation. Rebalancing is likely to occur eventually. The US will run a large budget deficit for a few years, which partially offsets the sudden increase in US private sector savings, but it cannot do this forever. It is theoretically possible that American households will have repaired their balance sheets in a few years and will return to binge spending by then, but I doubt it.
I am not comforted by this scenario. Both China and Europe are likely to continue with broadly the same policies, trying to rely on exports for future growth while failing to produce sufficient domestic demand. The noises we hear from Germany in particular suggest that politicians and industry are looking forward to returning to the status quo ante. So if all we do is stimulate the economy in the short term through monetary and fiscal policies, and tighten financial regulation, we are not really solving the problem. We can regulate to prevent another subprime crisis, but another subprime crisis is unlikely to occur even we did not regulate at all.
In the absence of another credit boom, which is improbable given the weakness of the global banking sector, imbalances will contract one way or the other. Without an increase in domestic demand from Europe and China, there is nothing to take up the slack created by the saving of the US private sector. Once the US stimulus expires, and the budget deficit starts to narrow, global demand will settle at a new lower level. Under those circumstances, it is difficult to see how the world economy can return to the pre-crisis levels of growth, or even close to them. This is why we should be worrying more about global economics right now than about global finance.
Goldman's Trading Tips Reward Its Biggest Clients
Goldman Sachs Group Inc. research analyst Marc Irizarry's published rating on mutual-fund manager Janus Capital Group Inc. was a lackluster "neutral" in early April 2008. But at an internal meeting that month, the analyst told dozens of Goldman's traders the stock was likely to head higher, company documents show. The next day, research-department employees at Goldman called about 50 favored clients of the big securities firm with the same tip, including hedge-fund companies Citadel Investment Group and SAC Capital Advisors, the documents indicate. Readers of Mr. Irizarry's research didn't find out he was bullish until his written report was issued six days later, after Janus shares had jumped 5.8%.
Every week, Goldman analysts offer stock tips at a gathering the firm calls a "trading huddle." But few of the thousands of clients who receive Goldman's written research reports ever hear about the recommendations. At the meetings, Goldman analysts identify stocks they think are likely to rise or fall due to earnings announcements, the direction of the overall market or other short-term developments. Some of their recommendations differ from ratings printed in Goldman's widely circulated research reports. Some Goldman traders who make bets with the firm's own money attend the meetings. Critics complain that Goldman's distribution of the trading ideas only to its own traders and key clients hurts other customers who aren't given the opportunity to trade on the information.
Securities laws require firms like Goldman to engage in "fair dealing with customers," and prohibit analysts from issuing opinions that are at odds with their true beliefs about a stock. Steven Strongin, Goldman's stock research chief, says no one gains an unfair advantage from its trading huddles, and that the short-term-trading ideas are not contrary to the longer-term stock forecasts in its written research. Former Goldman client George Klopfer of Park City, Utah, who was unaware of the trading tips until recently, says the practice is unfair. "When I joined Goldman as a client, I got all these fancy brochures saying they put the client first," he says. "I just don't want to have to worry about them or big clients trading on stuff like this. I was at the end of the food chain." He says he pulled out most of the $20 million in his account earlier this year after losing money on several Goldman funds. Goldman says individual clients like Mr. Klopfer typically have a long-term investing approach and are not focused on individual stocks.
Since the trading huddles began about two years ago, Goldman has supplied "trading ideas" on hundreds of stocks to the traders and top clients, according to internal documents reviewed by The Wall Street Journal. Goldman spokesman Edward Canaday says the tips are "market color" and "always consistent with the fundamental analysis" in published research reports. "Analysts are expected to discuss events that may have a near-term or short-term impact on a stock's price," he says, even if that is a different direction from an analyst's overall forecast. Goldman's published research reports include a disclosure that "salespeople, traders and other professionals" may take positions that are contrary to the opinions expressed in reports. But the firm doesn't disclose the trading huddles.
Mr. Canaday says analysts are told that any comment at a meeting that could result in a change in a rating, earnings estimate or stock-price target "must be published and disseminated broadly to all clients." He adds, however, that it is rare that tips arising from the meetings reach that threshold. He says ratings changes after the meetings also are rare. The tips usually go to top clients who have expressed interest in having the information and have short-term investment horizons, he says. Goldman doesn't want to overload other clients with information that isn't relevant to them, he says. "We are not in the business of serving thousands of retail customers," he says.
At least one competitor discloses such trading tips much more broadly. Morgan Stanley's research department sends blast emails with short-term views on various stocks to thousands of clients, and posts the information on its Web site. It doesn't call customers to convey the tips, because Morgan Stanley officials decided that could expose the firm to questions about selective disclosure, according to people familiar with the matter. "The spirit of the law is twofold," says Eric Dinallo, who in 2003, when serving as a deputy to former New York Attorney General Eliot Spitzer, helped negotiate a $1.4 billion stock-research settlement with 10 major Wall Street firms, including Goldman. "Analysts should give consistent advice to all their customers, be they small investors or big trading clients." Any views that differ from an analyst's published rating but are "worth sharing with certain customers," he says, should be made "available to everyone."
The 2003 case involved allegations that Wall Street firms were issuing overly optimistic stock research in order to win more lucrative investment-banking business. The settlement, in which Goldman and the other firms didn't admit or deny wrongdoing, erected walls between research and investment banking. Securities laws currently require research analysts to personally certify that their reports accurately reflect their views of a stock. Some analysts have gotten into big trouble by contradicting themselves. In 2003, former Merrill Lynch & Co. technology analyst Henry Blodget agreed to a lifetime ban from the securities industry after touting stocks that he disparaged in private emails.
These days, analysts must juggle growing demands from trading units at their firms. Such operations have emerged as big moneymakers, fueling the record $3.44 billion in net income at Goldman in the second quarter. A large portion of Goldman's profit came from trades done for mutual funds, pension funds, endowments, hedge funds and other big institutional investors. Proprietary trading, in which Goldman makes bets with its own capital, accounts for about 10% of its profits. Analysts have a financial incentive to give clients useful information. Goldman sets aside roughly 50% of money allotted each year to analyst compensation to distribute based on feedback from trading customers. The balance of analysts' pay is determined by the performance of their stock picks. That pay system is common among major Wall Street firms.
At many firms, traders, salespeople and analysts hold early-morning calls to review ratings changes, recommendations and market events. Throughout the day, analysts talk to key clients to help them interpret research reports and provide more detail on specific events such as earnings. The research business is considered a loss leader at most firms, despite persistent attempts by Goldman and other securities giants to squeeze more revenue from it. Goldman was looking for a leg up on rivals when it started the trading huddles in 2007. That year, Goldman ranked ninth in Institutional Investor magazine's annual list of the best equity analysts, as determined by a survey of big institutional investors. Goldman was rated eighth in last year's competition.
The huddles began in earnest around the time Goldman's research department got a new boss, Mr. Strongin. He came to the firm in 1994 from the Federal Reserve Bank of Chicago, where he had been director of monetary-policy research. At Goldman, he had run the commodities-research operation, then was co-chief operating officer of the whole research unit, before being asked to run it in April 2007. Mr. Strongin, 51 years old, set out to improve Goldman's research operations. The firm asked important clients for suggestions. One idea that took hold was giving certain customers and traders more access to stock tips. The idea was controversial with some Goldman research staffers. "I am not sure we should be giving recommendations that go against our research," said one Goldman employee at a meeting where the trading huddles were discussed, according to one attendee.
Laura Conigliaro, Goldman's co-head of research in the Americas region, replied at the meeting that the firm needed to respond to inevitable differences in the time horizons of investors. Issuing a short-term buy recommendation wasn't necessarily at odds with a lukewarm "neutral" rating for the long run, she added. One recipient of the trading tips, Steve Eisman, a managing director of hedge fund Frontpoint Partners LLC, says that he likes the back-and-forth he now has with Goldman's analysts, and that he pays attention to some of the tips. "A few years ago, Goldman wouldn't make a negative call on anything," he says. "Now they say it like it is."
The huddles can last from 20 minutes to one hour, according to participants. Analysts are encouraged to bring a trading idea. They talk with Goldman traders about the financial markets and events that could trigger movement of specific stocks. Goldman specifies how long each recommendation is in effect, often one week. At a huddle on July 31, for example, the firm's technology analysts and traders discussed more than a dozen stocks, ranging from Garmin Ltd. to Microsoft Corp. None of the analysts said anything that appeared to differ from their stock ratings.
Compliance officers sit in on almost all the meetings, Goldman says. Research analysts say they have been guided on what language to use in the huddles. Words like "buy" and "sell" are to be avoided, while "run up," "give back" and "oversold" are encouraged. Internal documents reviewed by the Journal initially tracked the trading-huddle tips as "buy" or "sell," but now refer to them as "up" or "down." Research-department employees prepare telephone scripts, then call top clients, typically several hours after the meeting has ended. Goldman says its in-house traders are prohibited from trading on the tips until after they've been relayed to clients.
Documents reviewed by the Journal indicate that anywhere from six to 60 clients are contacted, depending on the investment. For example, clients specializing in financial stocks are given recommendations about that sector. Each call typically includes comments about the overall market and the kinds of investors Goldman believes are propelling it, and ends with a stock tip. The meeting where Mr. Irizarry suggested that Janus shares were worth buying, held on April 2, 2008, was attended by Goldman's financial-research analysts and traders who handle customer orders. It also included another class of traders called "franchise risk managers," who sit with and advise the traders handling customer orders -- and make bets with Goldman's money.
Typically, traders who wager firm capital are walled off from those handling customer orders so that they don't take advantage of information about client trading, which securities regulations forbid. Goldman says its franchise risk managers don't trade on client information and must first share trading-huddle tips with clients before acting on the tips themselves. At the April 2 meeting, Goldman says, Mr. Irizarry was expressing a sentiment about Janus similar to one contained in a report Goldman published the previous day. A chart in that report, Goldman says, cited a report from mutual-fund-research firm Morningstar Inc. that was positive on Janus. While internal documents show Mr. Irizarry's rating on Janus stock at the time was "neutral," they note the "price action expected" was "up." Mr. Irizarry declined to comment.
The day after the meeting, Goldman told selected clients that "in particular, we highlight Janus," according to an internal document. At the same April 2 trading huddle, Goldman analyst Thomas Cholnoky said he favored MetLife Inc. over other insurers, according to notes from the meeting. Internal documents indicate he believed the stock would rise over the short run. Hours after the meeting, Mr. Cholnoky released a research report that reiterated his "neutral" rating on MetLife, saying he hadn't changed his estimates. Goldman says his view about the company's favorable short-term prospects is clearly conveyed in a research note issued prior to the huddle, which said the insurer "stands to be the biggest beneficiary from the steepening yield curve."
A week later, Mr. Cholnoky boosted his rating on MetLife to a buy, and Goldman added the stock to its "America's Buy List" of top stock recommendations. Mr. Cholnoky said he expected MetLife's quarterly results, due in a few weeks, to "surprise on the upside." (The quarterly results, when they came out, did slightly.) Mr. Cholnoky, who no longer works at Goldman, didn't respond to messages seeking comment. Goldman says that in both these cases the analysts' views were consistent with the published research, which included a 12-month price target that was above each stock's price at the time.
Morgan Stanley also generates short-term views on various stocks, which it calls "Research Tactical Ideas" and distributes widely via email and the firm's Web site. In May, for example, it told clients that insurer Aflac Inc.'s earnings guidance would be "softer than many investors expect." Its rating on Aflac at the time was "neutral." In its longer-term reports published by analysts, Morgan Stanley discloses that it issues such trading tips, and that the tips on any given stock "may be contrary to the recommendations or views expressed in this or other research on the same stock."
Last year, the Financial Industry Regulatory Authority, the industry's self-regulatory body, proposed new rules meant to clarify existing disclosure obligations under the rule requiring "fair dealing" with all clients. Firms could issue contradictory ratings as long as clients were told that such inconsistencies were possible. A Finra spokesman said the agency still is reviewing comment letters filed in response to the proposal. Goldman hasn't commented on the proposed rules.
Consumer Spending Probably Decelerated: U.S. Economy Preview
Consumer spending in the U.S. probably rose in July at half the pace of the previous month, showing the biggest part of the economy is struggling to rebound, economists said before reports this week.
Purchases increased 0.2 percent after a 0.4 percent gain in June, according to the median estimate of 61 economists surveyed by Bloomberg News before a Commerce Department report Aug. 28. Other figures may show orders for long-lasting goods jumped and sales of new homes improved.
The government’s “cash-for-clunkers” plan revived auto sales last month just as Americans cut back on items such as furniture and electronics. Depressed home values and the biggest employment slump since the 1930s will prompt households to save more, meaning an economic recovery will be slow to gain speed even as housing and manufacturing stabilize. “It’s hard to see consumer spending driving the economy forward given the losses of wealth that have occurred,” said Nigel Gault, chief U.S. economist at IHS Global Insight in Lexington, Massachusetts. “The consumer isn’t going to play a leading role in this recovery,” he said, in part because “employment is going to keep falling.”
Auto industry data showed sales of cars and light trucks rose to an 11.2 million unit annual pace in July, the most since September, after the government offered credits of up to $4,500 to trade in gas-guzzlers for more fuel-efficient vehicles under the cash-for-clunkers program. The government said last week that it will stop accepting dealer applications for the incentive at 8 p.m. New York time tomorrow. The $3 billion program has recorded more than 489,000 dealer transactions worth $2.04 billion in rebates, according to Transportation Department data released Aug. 21.
Sales at U.S. retailers in July unexpectedly fell 0.1 percent, the first drop in three months, government figures showed on Aug. 13. Purchases excluding automobiles dropped 0.6 percent, also more than anticipated, as Americans cut back on everything from groceries to sporting goods and furniture. Lowe’s Cos., the second-largest U.S. home-improvement retailer, said last week that sales in the three months ended July 31 fell 4.6 percent to $13.8 billion, below analysts’ estimates. “Consumers are still under tremendous pressure, given the continued decline in housing prices and that we’re still losing jobs,” Robert Niblock, chairman and chief executive officer of the Mooresville, North Carolina-based company, said in an Aug. 17 telephone interview.
Larger rival Home Depot Inc. reported second-quarter results on Aug. 18 that topped analysts’ estimates as the Atlanta-based company cut expenses to partially offset a 9.1 percent drop in sales. A weak labor market continues to sap consumers’ ability to spend. Payrolls fell by 247,000 last month, bringing total job losses to 6.7 million since the recession began in December 2007, the most of any contraction since the Great Depression. The job cuts, coupled with rising stock prices, are causing measures of consumers’ outlooks to diverge this month. The Conference Board’s confidence index, due Aug. 25, is forecast to rise, while the Reuters/University of Michigan gauge on Aug. 28 is projected to fall. The Standard & Poor’s 500 Index has climbed 52 percent since March 9, when it fell to a 12-year low.
The rebound in demand for automobiles likely contributed to an increase in bookings at factories. Orders for durable goods, those meant to last several years, probably jumped 3 percent in July, reversing the previous month’s 2.5 percent decline, economists projected an Aug. 26 report from the Commerce Department will show. Excluding demand for transportation equipment, which tends to be volatile, orders probably increased 0.9 percent. The worst housing slump in more than 70 years is showing signs of abating. The Commerce Department on Aug. 26 may report that purchases of new houses rose 1.6 percent in July to 390,000, the highest level since November, according to the Bloomberg survey.
A measure of home prices is projected to fall at a slower pace. The S&P/Case-Shiller index of property values in 20 U.S. metropolitan areas was probably down 16.5 percent in June from a year earlier, the smallest decline in almost a year, the survey showed. The report is due on Aug. 25. Last week the National Association of Realtors said purchases of existing homes jumped 7.2 percent in July to an annual pace of 5.24 million, the highest level in almost two years.
The government’s revised figures for second-quarter gross domestic product, due on Aug. 27, may show the economy contracted at a 1.4 percent annual rate, compared with the 1 percent estimated last month, according to the survey median. The revision will stem from even bigger declines in inventories than initially anticipated, economists said, which set the stage for a boost in production when sales stabilize.
Car Buyers Make 'Mad Dash' to Dealers as Clunkers Program Ends
Bernie Saric has watched the U.S. government’s “cash for clunkers” program burn through more than $2 billion in car-purchase assistance. As the program enters its last weekend, she said she decided to grab her share. Saric, who works for an auto-parts maker, plans to trade in her 1996 Ford Explorer this morning for a 2010 Ford Edge, two days before the program expires Aug. 24. “I definitely felt the pressure to make a decision and say, ‘If I felt good about a car I test-drive, I have to go for it,’ ” said Saric, of Howell, Michigan, who declined to give her age. “It’s like a mad dash to get a deal done now.”
The clunkers plan, which offers auto buyers discounts of as much as $4,500 to trade in older cars and trucks for new, more fuel-efficient vehicles, has recorded more than 489,000 dealer transactions valued at $2.04 billion in rebates, according to Transportation Department data released yesterday. Last-minute shoppers looking to capitalize on the trade-in program may have few cars or dealerships to choose from. AutoNation Inc. and Group 1 Automotive Inc., two of the country’s largest car dealership groups, said yesterday they will opt out of “cash for clunkers.” Some independent dealers have done so, too, citing cumbersome bureaucracy.
Bryan Mason, 40, of San Francisco, founder of an Internet start-up company, said he had planned to buy a new car to replace his red 2000 Jeep Cherokee with 133,000 miles during the next couple of weeks.
Filling Out Paperwork “When I heard the program was ending on the news last night, I was here this morning when the doors opened,” Mason said yesterday, while filling out paperwork to buy a 2009 Honda Fit from a dealership in Oakland, California. He said it was the only place that had the car in the color he wanted. “I’ve had my eye on it,” he said. “I am here today because I wanted to make sure all my paperwork is processed in time.”
The program, formally known as the Car Allowance Rebate System, or CARS, may help the industry’s new-vehicle retail sales in the U.S. top 1 million in August for the first time in 12 months, J.D. Power & Associates forecast. “Given that the funding could run out at any time, the government is erring on the side of caution so neither consumers nor dealers are left holding the bag,” said Jeremy Anwyl, chief executive officer of research firm Edmunds.com in Santa Monica, California. “We expect there will be a flurry of activity over the weekend as the program comes to a close.” That’s what happened with Philip and Caroline Rehill of San Francisco. The 28-year-olds came out to shop yesterday after learning on the Internet that the discounts would be gone soon.
“I was looking to get something by Labor Day weekend, but I’m out here now trying to make a deal,” Philip Rehill, said at Bay Bridge Auto Group, which sells Cadillac, Pontiac, GMC and Buick vehicles, in Oakland. The couple said they wanted to trade-in their 1997 gold Nissan Pathfinder, which had racked up 142,000 miles, including two-cross country trips. “Honestly, without this program, we wouldn’t be in the market,” Philip Rehill said.
The law that took effect July 1 offered consumers a $4,500 credit if the new car they are buying gets 10 miles-per-gallon better gas mileage than the model they are trading in. Light trucks must get 5 mpg better than the older model. For a $3,500 credit, the improvement for cars must be 4 mpg or better, and for light trucks, 2 mpg. The trade-in vehicle must be no older than a 1984 model and get 18 mpg or less in combined city/highway fuel economy. New passenger cars purchased with the discount must get at least 22 mpg in city/highway fuel economy, and light trucks must get at least 18 mpg.
Ryan Gangadeen, a 28-year-old engineer, was able to get a deal, though he wasn’t able to get exactly the diesel-powered Volkswagen Jetta of his dreams when he traded in his ‘94 Acura. He wanted a black one, but had to settle for white. It didn’t have the fog lamps or body molding he desired. “I didn’t have much of a choice. I had to take what I could get,” he said. And picking it up meant driving an hour from his home in Brooklyn, New York. “I had to go to New Jersey,” he said.
UBS chairman says clients "not harmless victims"
Clients of UBS facing disclosure of their accounts to U.S. tax authorities were not harmless victims and legal cases against former UBS bankers did not affect the bank, its chairman told Swiss Sunday newspapers. "The clients are not just harmless victims. They knew what they wanted to evade," Kaspar Villiger, chairman of the world's second-largest wealth manager, said in an interview with SonntagsBlick. "But they trusted the bank that it would work. Now we have to correct that," said Villiger, adding it was still not the responsibility of UBS to make sure clients paid their taxes.
Switzerland last week agreed to reveal the names of thousands of UBS's rich U.S. clients to Washington, settling a tax-avoidance dispute that had battered the bank's reputation and damaged Switzerland's prized bank secrecy. Villiger did not believe systematic tax evasion had been a problem in countries other than the United States, he said in a separate interview with NZZ am Sonntag, adding that legal action against former U.S. bankers did not affect the bank.
"The personnel consequences have been solved in so far as those responsible no longer work for UBS. We have not discovered any misdeeds relevant to Swiss criminal law," Villiger said. "That means we have no reason to take action against individual employees." Under Swiss law, tax fraud is a criminal offence, while tax evasion is punishable only with a fine. Villiger did not expect the introduction of an automatic exchange of client data between countries in future. "If Europe took unilateral action to introduce an information exchange and also forced this on Switzerland, money would flow to Asia in a big way," he said.
Switzerland sold its 9 percent stake in UBS, making a solid profit on last year's rescue of its largest bank, the day after the historic agreement with Washington. The buyers were international investors, showing confidence in the bank, Villiger told SonntagsBlick. Serious, systematic tax evasion should not be protected by bank secrecy, said Villiger, but Swiss banks would face increased competition in future as a result of the agreement.
"Swiss banks hid behind bank secrecy for years," said Villiger. "The competition has got bigger with the disappearance of the difference between tax fraud and tax evasion." Switzerland's Foreign Minister, Micheline Calmy-Rey, told SonntagsZeitung that the Swiss state could hand over the data of other clients to U.S. authorities if requested given cases of "tax fraud and the like" as set out in the agreement over UBS. "Accounts would only have to be disclosed in cases that are absolutely of the same kind. That can not be ruled out," she said in the interview.
UBS should pay for the costs of the Swiss government to reach the agreement with the U.S., though the legal basis for doing this still had to be cleared up, she added. "If the Federal Government wants to have the costs reimbursed, then we will do that," Villiger told SonntagsBlick. Villiger was pleased with the progress UBS had made in recent months on key issues like the U.S. tax case and improving its capital base, but said the bank, which booked the biggest loss in Swiss corporate history in 2008, still had a way to go. "The majority of the work is still in front. We have to return to profitability," he said.
Joseph Stiglitz Says Asia's Economies in 'Remarkable' Recovery
Nobel Prize-winning economist Joseph Stiglitz says Asia's economies are on the way to recovery after the most severe downturn in a decade. But he sees the need for greater regulation and monitoring of global financial markets. Joseph Stiglitz says Asia's economies are in a good position to reduce their dependence on exporting goods to the United States and Europe.
Speaking at a conference in Bangkok Friday, Stiglitz said he was upbeat over the economic outlook for the region. After slumping along with most other economies, Asian markets are rallying and some economies are expanding again, aided by government stimulus efforts. He said they should look more to the regional and domestic markets to boost growth.
"Asia's recovery has been remarkable. People are talking about a 'V' shaped recovery," he said. "The big issue that it raises is can Asia decouple from the West - the U.S. and Europe? You have a robust large economy here in Asia and so you have the basis of developing a regional economy."
Stiglitz, who won the Nobel Prize for economics in 2001, said that to protect economies, there needs to be global cooperation in regulating markets. He criticized the management of the U.S. financial system and the deregulation of markets, which he said "brought instability and risk without return." "The crisis is a failure of capitalism, American style. And it shows that the presumptions on which that kind of capitalism was based have not worked," he said. "In my mind it highlights the need for a balanced role of the state - a balance between the market, the state, and NGOs [non-government organizations] and other actors in society."
He also criticized the U.S. government's multibillion dollar rescue of the leading banks. Stiglitz says the rescue packages benefited companies and stock holders, but did little to help average Americans. Stiglitz advocated shifting away from using the dollar as the dominant global reserve currency. He says the dollar is "not a good store of value" given the high public debt and uncertain economic outlook in the U.S.
Thai Prime Minister Abhisit Vejjajiva also addressed the conference, calling for the creation of an international institution to regulate global financial markets. He said that emerging economies should have a greater voice in multilateral financial institutions such as the World Bank. The Thai economy is facing a contraction of three to four percent this year. But Mr. Abhisit says the outlook will improve later in the year.
Stiglitz Receives Hero’s Welcome in Bangkok
Joseph Stiglitz may just be the most popular Western economics professor in Thailand. On Friday, Stiglitz, a Nobel-prize winning economist who teaches at Columbia University, addressed an enthusiastic crowd of businesspeople at a conference in Bangkok about the failures of American-style capitalism. “The misallocation of capital over the last 10 years by the private sector is greater than anything done by any government,” the 66-year-old Stiglitz said. And the Obama administration’s policies to cope with the financial crisis are only making things worse, he said: “I call it socializing losses and privatizing gains.”
In comments that spilled well over his scheduled time slot, Stiglitz burnished his reputation for being undiplomatic with a few shots at former Fed chairman Alan Greenspan, who called the banking and housing crisis a “once-in-a-century credit tsunami.” “This crisis was man-made,” Stiglitz said. “It didn’t just happen.” He also dismissed Greenspan’s past assertions that there’s nothing he could have done to prevent a bubble in the housing market as “nonsense.”
Stiglitz’s fandom here love him largely for the way he wielded his sharp tongue eleven years ago in the midst of the Asian financial crisis, which began when Thailand effectively devalued the baht on July 2, 1997. Stiglitz was a member of the Washington establishment who challenged that establishment’s own remedies for coping with the Asian crisis. As chief economist at the World Bank, he openly criticized its sister organization the International Monetary Fund and the U.S. Treasury Department for worsening Asia’s problems by opposing government stimulus spending (how times have changed) and advocating high interest rates to restore confidence in Asia’s battered currencies. He was dismissed in early 2000, a year before winning the Nobel prize.
On Friday, Stiglitz took another contrarian stance by supporting suggestions earlier this year from China’s top cental banker, Zhou Xiaochuan, that the global reserve system needs an overhaul to avoid overdependence on the dollar. The Obama admistration, eager to avoid exacerbating speculation about the dollar’s stability, has given the Chinese comments a cool reception. “It is odd for the global financial system to be so depedent on the vagaries of one economy,” Stiglitz said, adding he was hopeful that “with the support of China,” an orderly approach to revising that system over the long term was possible.
Blow to UK Chancellor Alistair Darling as tax take falls 20%
The tax take has collapsed by 20% on last year — three times as much as Alistair Darling, the chancellor, forecast in this year’s budget. Official figures show that revenue raised from businesses has fallen dramatically, with last month’s corporation tax receipts sinking to £6.1 billion — 38% down on the same time last year. Meanwhile, the Treasury’s Vat take during July plunged 34%, from £10.5 billion last year to £6.9 billion, a collapse only partly explained by the government’s decision to cut the sales tax by 2.5% last year.
The collapsing revenues come amid conflicting signals on the health of the global economy. Home sales in America jumped at the fastest rate in 10 years in July, according to figures released last Friday by the National Association of Realtors. The news spurred rallies in share prices worldwide. The FTSE 100 index, which has soared almost 40% since its low point in March, closed at a 10-month high of 4,850 last week. Some fund managers believe that it could break through the psychologically important 5,000 level this week. The Dow Jones Industrial Average ended the week up 184.56 points, or 1.67%, at 9,505 — its highest point this year and a rise of 45% from March.
The housing news came as central bankers meeting at the Federal Reserve’s annual retreat in Jackson Hole, Wyoming, expressed cautiously optimistic views on the global economy. Ben Bernanke, the Fed’s chairman, told the meeting: “After contracting sharply over the past year, economic activity appears to be levelling out, both in the US and abroad, and the prospects for a return to growth in the next year appear good.” Forthcoming UK figures may show that the economy performed slightly better than initially expected in the second quarter. Some economists believe revised figures due on Friday will show it shrinking by 0.7%, rather than the 0.8% that was originally estimated.
Gerard Lyons, chief economist at Standard Chartered, said: “Even with a small upward revision, the data will confirm the economy was hit very hard in the first half of the year, justifying fully the policy stimulus that has taken place.” With unemployment widely expected to rise into next year, revenue from income tax and National Insurance is forecast to fall this year. Income-tax receipts fell to £15 billion last month, down from £17.6 billion in July 2008.
Ross Walker, chief economist at Royal Bank of Scotland, described the state of the public finances as “horrible”. In all, the total core tax take was £39.5 billion in July — down from £49.4 billion last year. The collapse in receipts will strengthen calls for urgent cuts to public spending and rises in taxes. The Institute for Fiscal Studies said that forecasts published alongside the budget showed that the Treasury expected its tax take to fall by 7.5% in 2009-10.
Native Americans to join London climate camp protest over tar sands
Native Americans are to join the Climate Camp protests in the City of London this week in an attempt to draw attention to corporate Britain's "criminal" involvement in the tar sands of Canada.
Five representatives from the Cree First Nations are coming to co-ordinate their campaign against key players in the carbon-heavy energy sector with British environmentalists. Eriel Tchekwie Deranger, from Fort Chipewyan, a centre of Alberta's tar sands schemes, said: "British companies such as BP and Royal Bank of Scotland in partnership with dozens of other companies are driving this project, which is having such devastating effects on our environment and communities.
"It is destroying the ancient boreal forest, spreading open-pit mining across our territories, contaminating our food and water with toxins, disrupting local wildlife and threatening our way of life," she said. It showed British companies were complicit in "the biggest environmental crime on the planet" and yet very few people in Britain even knew it was happening, said Deranger. She was speaking ahead of an annual Climate Camp that will be held for one week somewhere in Greater London from this Thursday. The exact site of the camp has not been revealed as green organisers are worried that the police might move to thwart their plans if they are notified in advance.
BP and Shell are two of the major oil companies extracting oil from the tar sands. The thick and sticky oil can only be removed from the sands by using a lot of water and power as well as producing far heavier CO2 emissions. RBS, now partly owned by the British government after its financial rescue, is also a target of environmentalists and aboriginals because it is seen as a major funder of such schemes.
The Climate Camp concept started with a protest outside the Drax coal-fired power station in North Yorkshire and was followed up by similar protests at Heathrow – against the proposed third runway – and Kingsnorth in Kent, where E.ON wants to construct a new coal-fired power station. There was also a Climate Camp in April at Bishopsgate inside the City of London, which became linked with bad policing after a bystander died following a clash with a constable.
The tar sands are seen by many as a particularly dangerous project providing enough carbon to be released in total to tip the world into unstoppable climate change. Shell was the first major European oil company to invest in the Canadian-based operations but BP followed under its chief executive, Tony Hayward. The oil companies both dispute the amount of pollution caused by tar sands and insist they must be exploited if the world is not going to run out of oil.
But George Poitras, a former chief of the Mikisew Cree First Nation, said the so-called heavy oil schemes were violating treaty rights and putting the lives of locals at risk. He said: "We are seeing a terrifyingly high rate of cancer in Fort Chipewyan, where I live. We are convinced these cancers are linked to the tar sands development on our doorstep."
Fury at plan to power EU homes from Congo dam
Plans to link Europe to what would be the world's biggest hydroelectric dam project in the volatile Democratic Republic of Congo have sparked fierce controversy. The Grand Inga dam, which has received initial support from the World Bank, would cost $80bn (£48bn). At 40,000MW, it has more than twice the generation capacity of the giant Three Gorges dam in China and would be equivalent to the entire generation capacity of South Africa.
Grand Inga will involve transmission cables linking South Africa and countries in west Africa including Nigeria. A cable would also run through the Sahara to Egypt. But controversially, it is understood that part of the feasibility study for the Grand Inga project would see the scheme extended to supply power to southern Europe, at a time when less than 30% of Africans have access to electricity - a figure that can fall to less than 10% in many countries.
Extending the scheme to Europe is part of a recent trend that includes the ambitious €400bn (£345bn) Desertec plan to take solar power from the Sahara to southern Europe. And last month Nigeria, Niger and Algeria, with the backing of the European Union, signed a $12bn agreement to transport Nigerian gas through a pipeline to Europe. "Under the guise of bringing power to poor Africans, development banks are looking to put tens of billions of public money into a flight of fantasy that would only benefit huge Western multinationals and quite possibly feed African energy into European households," said Anders Lustgarten of the Bretton Woods Project, which scrutinises the World Bank and IMF.
The scheme on the Congo river won support from World Bank president Robert Zoellick on a tour of the facility two weeks ago. Its progress is being keenly watched by a host of international power companies and infrastructure banks. World Bank officials concede there is concern that a project that has the potential to bring electricity to 500 million African homes might have some of its power diverted to Europe. But the Grand Inga project may hinge on the capacity to export energy to richer markets to ensure it receives financing from banks. "We need creditworthy anchor customers to subscribe so investment can go ahead," said Vijay Iyer, sector manager of the Africa energy group at the World Bank.
Grand Inga would be the final part of a three-phase project, the first of which is under way. That involves refurbishing a hydroelectric plant dating to 1972 that has fallen into disrepair due to the instability caused by Congo's civil war. The first phase will involve restoring power supply to South Africa and a host of neighbouring countries. The second 4,300MW phase is to power the Katanga mining region of the DRC, with a substantial amount of electricity distributed via cable to other African nations. FTSE 100 mining giant BHP Billiton is in negotiations about funding a feasibility study with the DRC government.
The more ambitious Grand Inga phase requires a new dam and a reservoir. The African Development Bank and the World Bank are working up plans for the scheme along with the World Energy Council. Plans will take five years to finalise, with construction taking another 10 years at least after that.