Greaseball, a mascot at the Stevens Airport, Frederick, Maryland
Ilargi: Dean Baker at the Center for Economic and Policy Research has in the past been at times a voice of at least a little reason. Or so it seemed. Turns out, though, that Baker suffers from an advanced case of Krugmanitis Stimulusis. When addressing the Central Budget Office's new $2 trililon in projected extra deficit over the next 10 years, to be officially announced tomorrow, Baker says:
To be sure, these are big deficits, but there is no reason to believe that the economy cannot support them. [..] The basic story is that we need to have large deficits now for the next several years in order to boost the economy back to full employment. Forcing a large portion of our workforce to endure a prolonged period of unemployment will inflict an enormous cost on these workers and on their children (i.e. the future generations whom the deficit hawks claim as their main concern).
Mr. Baker's assertion is as absurd as Ben Bernanke's self-coronation this weekend for leading the world out of the recession. Or, if you prefer, and perhaps even more accurate, as misguided as Tim Geithner telling Capitol Hill 5 months ago, when discussing his stability plan during a hearing on federal aid for AIG, that a back-up plan was not needed, because:
"Congressman, this plan will work. [..] It just requires will, it’s not about ability ... "
There is something awfully wrong with all three claims, with Baker's, Bernanke's, Geithner's, as well as with for instance Paul Krugman's incessant calls for more stimulus, and many like his.
What is wrong with them, however, is not that they are wrong. They don’t have to be.
In the last few months of the previous US administration and the first few of the present one, when trillions of dollars worth of plans were concocted, revealed, approved and eventually executed, not just in the US, but all over Europe too, there was a line that was quite common, even popular among politicians. "We are entering uncharted waters”.
Not everyone used it, but they might as well have, since it's true for every single one of them. And that goes to the core of what went on then, and at least as much to what happens today. There are no real life precedents to draw on when trying to make sense of the present crisis (if we can agree to leave out the Tulip Bubble). No matter how much one studied the Great Depression, another led the NY Fed, and yet another received home-knit awards in Stockholm, they were and are all charting seas unknown to mankind. And they would have to be extremely self-delusional not to admit that, at least to themselves.
Let’s go through the claims, in random order.
- Bernanke says he has led the world out of the recession. There is, however, no way for Bernanke or anyone else to know if he has. Today's Four Big Bears chart update from dshort.com shows why. 2 out of the 3 previous recessions he documents went down further after the 21-month mark the current recession is at. And not by a little either. Is Bernanke just overly boisterous? Or does he deliberately mislead? Why does he claim to know what he can't know?
- Dean Baker says that large deficits are needed now in order to create jobs tomorrow. That is slippery territory, since there is no proof for it, but it's not the worst of his claims. That comes when he asserts, when talking about multi-trillion dollar federal deficits, that "there is no reason to believe that the economy cannot support them”. There is, obviously, ample reason to believe so. It all depends on what lies ahead for the US and its economy.
Mr. Baker doesn't know anymore on that than you or I or anyone else does. It might be reasonable to wonder whether he even read the CBO report he refers to. It predicts high unemployment until at least 2013. It also ironically foresees plummeting tax revenues, which would seem to bear down directly on the assertion that "there is no reason to believe that the economy cannot support [huge deficits]. To summarize, Baker has no proof for his statement. But he still makes it.
- Paul Krugman never tires of calling for more stimulus. Even though he doesn't know if they will help. He can't know, they've never been applied. On top of that, he's chastised the likes of German Chancellor Angela Merkel for not doing what he claims, without any proof, must be done to prevent "really big bad things" from happening. Merkel has ignored him, and there are precious few visible signs to date that Germany is much worse off than the US in spite of the far more prudent financial policies adopted in Berlin. In other words, Krugman also claims to know things that can't be known.
- All three previous "experts" are not just as wrong as number 4, Tim Geithner, for claiming to know things they can't. They also share a second, if possible even more stunning, flaw, even though they may not put it into words the way Geithner did. That is, none of them talk about a back-up plan. You get the impression that the main condition for making themselves and others believe that what they claim is true, is to not even think about what might happen in case they prove to be wrong. Which, as we’ve seen, is a realistic possibility, given the fact that they simply cannot know of they are right or wrong. If and when sailing down into uncharted waters, wouldn't a Plan B be the first thing to pack?
Look, they may all turn out to be right, and geniuses, and worthy of strapping on a halo every morning for the rest of their lives. For reasons too numerous to mention here, I seriously doubt that they are. But that's not the point.
It's not about opinions, or different tastes, or ideologies. It's about a bunch of middle-aged men who claim to know things that we all know they don't. Because they can't.
Which doesn't keep them from being among the main policy- and opinion-makers in the country. What, pray tell, does that tell you?
Ben Bernanke to get second term as Federal Reserve chairman from President Obama
Ben Bernanke, the chairman of the Federal Reserve, will today be nominated to a second-four year term at the helm of the US central bank, as President Barack Obama seeks to keep in place a team fighting the gravest financial crisis since the Great Depression. Mr Bernanke, who was first appointed to the position by former President George W. Bush, is understood to have verbally accepted the offer made by President Obama before the President embarked on his week-long summer holiday to Martha's Vineyard just off Cape Cod.
President Obama is due to make an announcement at 9am London time at a local school near his holiday home on the exclusive holiday island. Mr Bernanke, whose current term expires at the end of next January, is expected to join President Obama for the announcement. Mr Bernanke, who was a professor at Princeton University and is a student of the Great Depression, has led the Fed in its efforts to combat a financial crisis that has turned into the worst recession for the US in decades.
Mr Bernanke has drawn criticism that as a member of the Fed's Open Market Committee - the body that sets interest rates in the US - he helped sanction the loose monetary policy under former Fed head Alan Greenspan that some blame for contributing to the crisis. However, his appointment to a second term is likely to be broadly welcomed by financial markets. Laurence Meyer, a former Fed governor, told Bloomberg that "Once he (Bernanke) did recognize the crisis, he moved extremely quickly, aggressively, very creatively and I think you have to step back and say that the efforts and the leadership he have brought the economy back from the edge of the abyss."
Rahm Emanual, the White House Chief of Staf, said on Monday night that the the President credits Mr. Bernanke for "pulling the economy back from the brink of depression." President Obama is believed to have made the offer to Mr Bernanke last week. Speculation regarding President Obama's choice of Fed chairman has been rife for months, with his special economic adviser Larry Summers viewed by some insiders as his most likely choice.
To date, the President has steered clear of over-praising Mr Bernanke, saying only that he has done a good job steering the economy through the worst recession in 70 years. Mr Bernanke's appointment is subject to confirmation by the Senate, which could prove to be controversial given some concern from Republican Senators over the expansion of both the Fed's balance sheet and its powers during the credit crisis.
Court Orders Federal Reserve to Disclose Emergency Loan Details
The Federal Reserve must for the first time identify the companies in its emergency lending programs after losing a Freedom of Information Act lawsuit. Manhattan Chief U.S. District Judge Loretta Preska ruled against the central bank yesterday, rejecting the argument that loan records aren’t covered by the law because their disclosure would harm borrowers’ competitive positions.
The Fed has refused to name the financial firms it lent to or disclose the amounts or the assets put up as collateral under 11 programs, most put in place during the deepest financial crisis since the Great Depression, saying that doing so might set off a run by depositors and unsettle shareholders. Bloomberg LP, the New York-based company majority-owned by Mayor Michael Bloomberg, sued on Nov. 7 on behalf of its Bloomberg News unit. "The Federal Reserve has to be accountable for the decisions that it makes," said Representative Alan Grayson, a Florida Democrat on the House Financial Services Committee, after Preska’s ruling. "It’s one thing to say that the Federal Reserve is an independent institution. It’s another thing to say that it can keep us all in the dark."
The judge said the central bank "improperly withheld agency records" by "conducting an inadequate search" after Bloomberg News reporters filed a request under the information act. She gave the Fed five days to turn over documents it told the reporters it located, including 231 pages of reports, and said it must look for more at the Federal Reserve Bank of New York, which runs most of the loan programs. The central bank "essentially speculates on how a borrower might enter a downward spiral of financial instability if its participation in the Federal Reserve lending programs were to be disclosed," Preska wrote. "Conjecture, without evidence of imminent harm, simply fails to meet the Board’s burden" of proof.
David Skidmore, a Fed spokesman who said the board’s staff was reviewing the 47-page ruling, declined to comment on whether the central bank would appeal. Bloomberg said in the suit that U.S. taxpayers need to know the terms of Fed lending because the public became an "involuntary investor" in the nation’s banks as the financial crisis deepened and the government began shoring up companies with capital injections and loans. Citigroup Inc. and American International Group Inc. are among those who have said they accepted Fed loans.
"When an unprecedented amount of taxpayer dollars were lent to financial institutions in unprecedented ways and the Federal Reserve refused to make public any of the details of its extraordinary lending, Bloomberg News asked the court why U.S. citizens don’t have the right to know," said Matthew Winkler, the editor-in-chief of Bloomberg News. "We’re gratified the court is defending the public’s right to know what is being done in the public interest."
The Fed’s balance sheet about doubled after lending standards were relaxed in the wake of the collapse of Lehman Brothers Holdings Inc. on Sept. 15, 2008. For the week ended Aug. 19, Fed assets rose 2.3 percent to $2.06 trillion as it continued to buy mortgage-backed securities under a program allowing the central bank to purchase non-government securities for the first time. The U.S. House may vote as soon as next month on a bill to require the Fed to submit to audits by the Government Accountability Office, said Representative Scott Garrett, a New Jersey Republican on the Financial Services Committee.
The judge’s ruling "is strikingly good news," Garrett said. "This is what the American people have been asking for." The Freedom of Information Act obliges federal agencies to make government documents available to the press and public. The Bloomberg suit, filed in New York, didn’t seek money damages. "The public deserves to know what’s being done with the money," said Lucy Dalglish, executive director of the Arlington, Virginia-based Reporters Committee for Freedom of the Press. "This ought to be a wake-up call for the public that they need to be far more educated about this."
The Trashiest Stocks Are On Fire
Since the market hit its lows in early March, the trashiest, most beaten-down stocks have been the big winners. Some are arguing that the trash stocks have to slow down soon. But in the meantime, it looks like investors are reaching for the trashiest of the trash. Check out the crazy runs in Fannie Mae, Freddie Mac, AIG and even the soon-to-be-liquidated GM over the last few weeks. This is the kind of behavior that might foretell the end of the junk rally.
Bond Bears Dumping Two-Year Treasuries Defy History
Bond investors that drove two-year Treasuries down on Aug. 21 by the most since early June after Federal Reserve Chairman Ben S. Bernanke said the economy is "beginning to emerge" from recession may find themselves wishing they had held onto the securities. While the comments sparked speculation that the central bank may soon raise borrowing costs as growth resumes, history shows the Fed is likely to keep its benchmark interest rate at a record low for a year or more. Policy makers didn’t boost rates after the 2001 recession until 12 months into the recovery, while it was 17 months following the 1991 economic contraction.
"It’s going to be very difficult for the Federal Reserve to raise rates simply because there’s no inflation," said Michael Cheah, who manages $2 billion in bonds at SunAmerica Asset Management in Jersey City, New Jersey. "The two-year at a yield of 1 percent is an excellent yield," said Cheah, who has been buying the securities. The yield on the benchmark two-year note rose almost 11 basis points at the end of last week, or 0.11 percentage point, to 1.1 percent, according to BGCantor Market Data. That was the most since it surged by the same amount on June 8. The note yielded 1.09 percent today as of 8:47 a.m. in London.
The slump came after the National Association of Realtors said sales of existing U.S. homes jumped 7.2 percent to a 5.24 million annual rate, the most since August 2007, and Bernanke said at a Fed-hosted central bankers’ symposium in Jackson Hole, Wyoming, that "prospects for a return to growth in the near term appear good." Trading positions show that the sell-off may be short- lived, even as the government prepares to sell $109 billion of Treasury notes this week, including $42 billion of two-year securities.
Speculative long positions on two-year notes, or bets prices will rise, outnumbered short positions by 158,041 contracts on the Chicago Board of Trade last week, the most since Dec. 7, 2007. That was just before the securities, which are more sensitive to changes in Fed policy than longer-term debt, posted their biggest quarterly gain since 2001, returning 3.26 percent, Merrill Lynch & Co. indexes show. Zurich-based Credit Suisse Group AG, whose February recommendation to buy Treasuries due in two years earned about 0.85 percent versus the overall Treasury market’s 0.7 percent loss, predicts yields will fall to 0.7 percent by the end of the year, according to data compiled by Bloomberg. If accurate that scenario would produce about a $100 return on a $10,000 investment.
Strategists at New York-based JPMorgan Chase & Co., the second-largest U.S. bank, said in an Aug. 21 report that they "recommend maintaining longs" on shorter-maturity U.S. debt. The firms are two of the 18 primary dealers of government securities that trade with the Fed. "Macroeconomic fundamentals continue to point to a Fed that is likely to maintain a low-for-long stance," the JPMorgan strategists, led by Srini Ramaswamy, wrote in the report.
The inflation rate was unchanged in July after rising 0.7 percent in June, the Labor Department in Washington said on Aug. 14. Investors are betting consumer prices will fall 0.26 percent over the next 12 months and rise 0.28 percent over the next two years, compared with an average increase of 2.7 percent the past five years, prices of inflation-protected Treasuries, or TIPS, show. Fed Vice Chairman Donald Kohn said the central bank’s current policy to keep rates low for a long time is aimed at promoting price stability and not at spurring inflation.
"The commitment to low rates is designed to keep inflation from falling and falling persistently below what we might want it to be for a long time," Kohn said on Aug. 22 during an audience-debate period at a the Jackson Hole symposium. "It’s not designed to raise inflation expectations. There’s no inconsistency there." Kohn was responding to a presentation by Carl Walsh, a professor at the University of California at Santa Cruz, suggesting the Fed’s stance is "potentially inconsistent" with its low-inflation goal and "requires careful balancing." The Fed cut its main rate to between zero and 0.25 percent in December and has pledged to leave it there for an "extended period."
In December 1992, the gap between two-year yields and the Fed’s target rate jumped to 183 basis points. By the following March, it had narrowed to 74 points after traders realized they’d jumped the gun in anticipating higher borrowing costs. Policy makers didn’t raise rates until February 1994. In September 2003, the spread hit 103 basis points before contracting to 44 in October, nine months before the Fed moved.
Even after the Aug. 21 tumble, the odds of a Fed rate increase this year are just 13 percent, down from 24 percent a month ago, futures data on the Chicago Board of Trade show. "The two-year yield will remain extremely low" as the Fed keeps rates unchanged "deep" into 2010, said Stephan Hirschbrich, who manages 1.3 billion euros ($1.86 billion) as head of international bonds at Union Investment in Frankfurt. Most forecasters are convinced two-year yields are heading up. Even Hirschbrich, who’s holding off on buying Treasuries until yields rise, foresees 1.25 percent within six months.
All but six of 47 economists and strategists in a Bloomberg survey see higher yields by January. The median forecast of 1.35 percent, up from April’s 1.05 percent prediction, would increase the spread to the Fed target rate for overnight loans between banks to as much as 110 basis points, more than twice the average of 46 basis points over the past 20 years. Bets for a quicker increase in yields are based on speculation that the economy’s recovery will resemble a "V" -- a rapid slowdown followed by a robust rebound. Economists including former Fed Governor Laurence Meyer and Stephen Stanley at RBS Securities Inc. say there’s a reservoir of consumer demand that will emerge and buoy the economy.
"It’s amazing how many shapes have been discussed," said Christian Cooper, an interest-rate strategist at primary dealer RBC Capital Markets in New York, referring to recovery scenarios. "We’ve heard an ‘L,’ a ‘V,’ a ‘UU,’ a ‘W.’ I heard someone talk about a square-root sign" -- a quick rebound followed by a sustained plateau. Critics of the "V" recovery include Mohamed El-Erian, the chief executive officer of Newport Beach, California-based Pacific Investment Management Co., manager of the world’s biggest bond fund. They say there’s been so much damage done to the economy during the crisis that growth will be restrained at 2 percent or less.
Bond bulls cite the Taylor Rule, an economics equation for predicting central bank policies based on policy-makers’ tolerance for inflation and unemployment. Using median Bloomberg survey predictions in that calculation, the rule shows the Fed keeping its benchmark rate near zero and pumping money into the economy at least through June 2010. "The end of the recession does not mean the end of the easing cycle," economists Christian Broda and Dean Maki at London-based Barclays Capital, another primary dealer, wrote in an Aug. 20 research report. "With a benign inflationary scenario and high amounts of slack in the economy, we expect the Fed not to raise overnight rates during 2010."
About 68.5 percent of the economy’s plants and equipment was in use in July, down from the pre-crisis capacity utilization average of 79 for the five years ended in 2007. June’s 68.1 percent was the lowest since at least 1967. Following the 2001 recession, the Fed waited until the measure rose to 77.9 percent in May 2004 before raising its benchmark rate a month later from 1 percent, where it had been since the previous June and its then-record low.
Ray Remy, head of fixed income in New York at primary dealer Daiwa Securities America Inc., is waiting for traders to misplay their hand again. He said he would buy once the yield, which touched a record 0.6 percent low on Dec. 17, hits 1.25 percent. "The market will be way, way in front of the Fed," Remy said. "Most pullbacks are a buying opportunity, in my opinion," he said, referring to bond prices. The two-year yield surged to 1.43 percent on June 8 and to 1.36 percent on Aug. 7 before falling back. Both jumps followed non-farm payrolls reports than were better than economists predicted.
The latter move came after the Labor Department said employers cut 247,000 jobs in July, the least since before the bankruptcy of Lehman Brothers Holdings Inc. last September pushed markets into the worst crisis since the Great Depression. "The Fed is going nowhere fast," said Cooper at RBC. "Two-year rates are going to come lower, and we have considerable problems globally that are not going to be resolved quickly."
Fitch: "Dramatic" Decrease in Cure Rates for Delinquent Mortgage Loans
by Calculated Risk
While the number of U.S. prime RMBS loans rolling into a delinquency status has recently slowed, this improvement is being overwhelmed by the dramatic decrease in delinquency cure rates that has occurred since 2006, according to Fitch Ratings. An increasing number of borrowers who are 'underwater' on their mortgages appear to be driving this trend, as Fitch has also observed.This really puts the recent rise in delinquencies in perspective. Look at this graph from MBA Forecasts Foreclosures to Peak at End of 2010
Delinquency cure rates refer to the percentage of delinquent loans returning to a current payment status each month. Cure rates have declined from an average of 45% during 2000-2006 to the currently level of 6.6%. ...
'Recent stability of loans becoming delinquent do not take into account the drastic decrease in delinquency cure rates experienced in the prime sector since the peak of the housing market,' said [Managing Director Roelof Slump]. 'While prime has shown the most precipitous decline, rates have dropped in other sectors as well.'
In addition to prime cure rates dropping to 6.6%, Alt-A cure rates have dropped to 4.3%, from an average of 30.2%, and subprime is down to 5.3% from an average of 19.4%. 'Whereas prime had previously been distinct for its relatively high level of delinquency recoveries, by this measure prime is no longer significantly outperforming other sectors,' said Slump.
... Furthermore, up to 25% of loans counted as cures are modified loans, which have been shown to have an increased propensity to re-default.
... 'As income and employment stress has spread, weaker prime borrowers become more likely to become delinquent in their loan payments and are less likely to become current again,' said Slump.
Regardless of aggregate roll-to-delinquent behavior, it will be difficult to argue that the market has stabilized or that performance has improved, until there is a concurrent increase in cure rates. This is especially true in the prime sector, which remains performing many times worse than historic averages. Prime 60+ delinquencies have more than tripled in the past year, from $9.5 billion to $28 billion total, or roughly $1.6 billion a month.
Click on graph for larger image in new window.
This graph shows the delinquency and in foreclosure rates for all prime loans.
Prime loans account for all 78% of all loans.
Back in the 2000 to 2006 period, 45% of those delinquencies cured. Now, according to Fitch, only 6.6% cure - and a large percentage of those "cures" are modifications - and there is a large redefault rate on those loans.
Death of the Consumer
by Expected Returns
Moving forward, the most critical indicator of the viability of our economy will be consumer spending. Simply put, without a buoyant consumer, there will be no recovery. Due no doubt to the negative characteristics of consumer data, the death of the consumer is receiving scant coverage.America is a nation whose growth in recent decades has been predicated on a model of consumption. From a nation that used to save to invest, we now borrow to consume. As buying power in Treasuries from foreign entities wanes, we will be forced to fund our consumption through currently non-existent savings. An increased savings rate will put pressure on consumption, which will in turn pressure GDP.In the following chart, notice how consumption as a percent of GDP remains above historical norms. Consumption would have to contract another $800 Billion for personal consumption expenditures as a percent of GDP to revert to historical levels.It is important to realize that what we are experiencing now isn't a classic inventory-led downturn, but a structural debt deflation. Since Americans have been wont to save, consumer credit has played an outsized role in our economic growth. As such, it is critical to be keen on developments in the availability of credit, which can be measured by consumer credit outstanding.Consumer credit outstanding, a measure of short and intermediate-term credit, is falling precipitously. Banks are, quite justifiably, not willing to service loans to deteriorating credit risks. Until the unemployment picture improves, banks are unlikely to rapidly increase the extension of credit.Notice that consumer credit outstanding has rebounded off of every single downturn besides the recession of 2001. Before we can realistically call for an end to the recession, we need to see a halt in the decline of consumer credit outstanding, and eventually a rebound. We are experiencing nothing of the sort yet.Retail SalesConsumption in the past decade, as reflected by retail sales, has enjoyed an impressive and inexorable rise. Year over year E- commerce sales growth remained robust even in the midst of the recession of 2001.; in fact, the rate of growth accelerated. As you can see from the following chart, E-commerce retail sales are declining dramatically.
Bank bail-outs weigh on some nations
Governments around the world are still sitting on multi-billion dollar losses from their direct shareholdings in banks, in spite of a strong rebound in equity markets in recent months. In contrast to Switzerland, which sold its 9 per cent UBS stake for a SFr1.2bn ($1.1bn) gain last week, the world’s other large economies – except the US – are sitting on combined losses of $10.8bn relating to their holdings in the equity of listed banks they bailed out over the past 12 months.
The US government, by contrast, is sitting on a paper profit of almost $11 billion on its 34 per cent shareholding in Citigroup, its only direct stake in a large financial institution. The US authorities received more than 7bn shares in the troubled financial group at $3.25 apiece, after converting $25bn of preferred stock into common equity at the end of last month. Since then, Citi’s shares have rallied, and closed on Friday at $4.70, increasing the value of the government’s stake by $11bn. That more than offsets the paper losses of all the other significant state interventions in listed banks – in the UK, Germany, the Benelux and France.
The UK is still sitting on the biggest losses – about £3.3bn ($5.5bn) – relating to the government’s 43 and 70 per cent stakes in Lloyds Banking Group and Royal Bank of Scotland respectively, although the number has shrunk dramatically in recent weeks. At the end of June, the shortfall was £11bn. The bounce has prompted the government to begin the process of appointing investment banks to advise on a possible sale. With the FTSE World Banks index up 130 per cent since its lows of early March, the paper losses that governments in France, Belgium, Luxembourg and Germany are sitting on have also shrunk. Berlin’s 25 per cent stake in Commerzbank’s common equity is now worth only 2 per cent less than the €1.8bn ($2.6bn) the German government paid for it.
In spite of criticism of the bail-outs of lenders such as Citi, Bank of America and Wells Fargo, the Treasury has reaped gains from the coupons payable under the troubled asset relief programme bail-out funding, most of which has been repaid. The government said it had earned an annualised return of 23 per cent from its $10bn investment in Goldman Sachs under Tarp. In June, Goldman returned the $10bn and later paid another $1.1bn to buy back warrants attached to Tarp aid. Morgan Stanley, American Express and other banks have done the same, leaving taxpayers with substantial profits.
However, critics of the bail-outs point out that Switzerland and the US cannot rightly claim to be turning profits from the schemes, given the remaining unknowns. They, and other countries, notably the UK, have put in place bad-debt insurance schemes, which could yet leave governments with vast deficits if loan losses end up being far worse than expected. Other lenders that were forcibly nationalised in their entirety – such as Northern Rock in the UK, Anglo Irish in Ireland, Fortis bank in the Benelux region and the Icelandic banks – are also big potential drains.
US suburbs become face of foreclosure
Apart from the piece of paper in the window, the house looks like every other Midwest suburban home in the Lakewood Springs development in Plano, a small town about 50 miles west of downtown Chicago. But the sign makes clear that the house has been repossessed by a local mortgage lender and warns against trespassing. Bob Hausler, Plano’s mayor, reads the notice aloud and then pauses. "People lose their jobs, then they lose their homes," he says quietly.
When Case-Shiller releases its home price index on Tuesday, investors may be cheered if, as they expect, the figures show the pace of decline in US residential property sales continues to slow. But good economic news seems remote in towns such as Plano, which are still mired in the foreclosure crisis.
Plano sits at the western end of Kendall County, at the edge of where metropolitan Chicago blends into rural Illinois. Ten years ago, the area’s flat prairie land was covered in corn and soyabean fields. But between 2000 and 2007, Kendall became the fastest-growing county in the US, as people moved out to Chicago’s far-west suburbs in search of more affordable property in its "bedroom communities". Dozens of developments such as Lakewood Springs were built and the county’s population doubled to about 100,000. In Plano the growth was even faster – doubling in the past five years alone.
With the economic downturn, the housing boom has turned to bust. Kendall County now has the highest foreclosure rate in Illinois, with one in every 26 households receiving a foreclosure filing in the first six months of the year – three times higher than the state average and well above the national average of one in every 84 homes. That underlines the changing nature of the US mortgage crisis. When the housing bubble burst about two years ago, some of the worst-affected areas were poor urban neighbourhoods in places such as Chicago’s predominantly African-American southside.
But in the past year, the far suburbs – overwhelmingly white and middle-class – have become the new face of foreclosure. The shift reflects a move away from the mortgage crisis as a "subprime" problem: one in three of the US’s new foreclosures between April and June were from prime, fixed-rate loans – up from one in five a year earlier, according to the Mortgage Bankers Association.
Lakewood Springs, a pleasant development of a few hundred homes next to a soyabean field on Route 34, exemplifies the problem. A total of 34 homes in the neighbourhood have been repossessed from their owners by lenders, with another two homeowners filing for bankruptcy. But Cole Taylor, a Chicago-area bank, has also foreclosed on its loan to the project’s developers, resulting in it taking over another 23 properties directly from them. Mr Hausler has been working with Cole Taylor to make sure the lawns are mowed on the foreclosed properties. But there are few signs of potential buyers returning.
In the postwar years, Plano proudly called itself "the biggest little industrial city in the world". The town remains largely blue-collar, but manufacturing jobs are hard to come by. One of the biggest local employers is Caterpillar, which makes earth-moving equipment at a plant in the outskirts of Aurora, in eastern Kendall County. The company has cut more than 1,400 jobs at the factory this year – about half of its workforce.
While the loss of industrial jobs has hit Plano and Yorkville, its neighbour to the east, the larger town of Oswego, on the more gentrified side of the county, has suffered from the end of the building boom. "One of my members, a big lawyer, used to make his money representing developers putting in planning applications. Now he’s representing them in bankruptcy filings," says Steve Hatcher, executive director of the Oswego Chamber of Commerce.
In April, the state of Illinois passed a Homeowner Protection Act, which blocks foreclosures in the first 30 days of delinquency, requires lenders to inform borrowers they have another 30 days to seek counselling and gives them a further 30-day grace period to work with a housing counsellor. Geoff Smith of the Woodstock Institute, a think-tank in Chicago, says that combined with the federal government’s Home Affordable Loan Modification Program, the Illinois initiative has helped, although he notes that the US Treasury reported this month that only 9 per cent of eligible US borrowers were receiving loan modifications.
"That’s a big concern," he says. "The state has done a little bit to try to slow down the foreclosure process, but the mortgage servicers haven’t been modifying enough loans to make a big difference. There needs to be more pressure put on lenders." Back in Kendall County, not all is doom and gloom. Sales of existing homes rose 19.7 per cent in July from last year, the fastest growth in the Chicago metropolitan area, according to the Illinois Association of Realtors. Michael Cassa, of the Oswego Economic Development Corporation, says he is seeing "a small uptick" in business activity. In Plano, Mr Hausler says he is receiving enquiries from industrial investors attracted by the town’s skilled labour force.
However, Valerie Burd, the mayor of Yorkville – who has held two foreclosure workshops to advise residents – expects the foreclosure problem to continue growing for some time yet. Unemployment is still rising and her constituents tell her that mortgage providers are still unwilling to lend money. "We lagged behind the rest of the country," she says. "We were somewhat insulated here but now – well, now it’s definitely hit us."
Local difficulties: Muni bonds
Matt Fabian, managing director of Municipal Market Advisors, a Massachusetts research firm, puts it bluntly: "The municipal bond industry is the backwater of the financial markets because it was designed that way." Although with $2,700bn (£1,640bn, €1,880bn) of bonds outstanding it had become a decidedly big backwater, for years the market where US state and local governments raise money for everything from roads and sewers to schools and sports stadiums operated with hardly a hitch. Default rates were low, many prices barely moved and bonds of some of the 50,000 issuers did not trade at all.
That tranquil backdrop masked vulnerabilities in a market where questionable relationships had developed among financial advisers and politicians – and derivatives arrangements had been made that turned out to be far riskier than many local finance officials ever imagined. The financial crisis left no doubt that municipal bonds were susceptible to some of the same problems that seized up other credit markets and felled titans including Lehman Brothers and AIG. The reputation of "munis" for being among the safest and steadiest of investments was tarnished when bond insurers – which guaranteed half of the market – collapsed, bond prices fell and the failure of a $330bn corner of the market, for so-called auction-rate securities, left investors high and dry.
Now, as regulators rewrite rules governing everything from energy futures and short-selling to executive compensation and credit ratings, they are also taking a hard look at municipal bonds – which have revealed a patchwork of regulation that leaves dangerous gaps. Mary Schapiro, the no-nonsense new chairman at the Securities and Exchange Commission, has declared: "It is time for those who buy the municipal securities ... to have access to the same quality and quantity of information as those who buy corporate securities." But there are barriers to how far she can cast her regulatory net. Any changes will, moreover, fail to help local governments struggling with arrangements made in better times and that they now have to reverse against the headwind of recession.
Rules governing "munis" have not kept up with changes in the market, where securities once bought largely by banks are now nearly two-thirds owned by retail investors, directly or through money market and mutual funds. In addition, "the level and sophistication of what governments are doing today are very different from what they were in the 1930s", says Martha Haines, chief of the SEC’s office of municipal securities.
Local governments shifted from issuing straightforward general obligation bonds backed by property taxes to participating in complex instruments. Some entered into interest rate swaps without, it seems, a full grasp of the risks. "The idea is that the states will regulate themselves, but state and local governments have been unable to become as sophisticated as the market," says Mr Fabian. The swaps were meant to lower interest costs on debt raised for projects but, for some, they backfired. A legislative package on over-the-counter derivatives sent to Congress by the administration of President Barack Obama would require issuers to be of a certain size to participate in interest rate swaps. As contracts rather than securities, swaps are outside SEC purview.
Muni issuers run the gamut from the state of California to a school district in the Pennsylvania countryside – a diffuse composition that can make securities hard to assess, especially for the individual investors drawn to them by tax breaks. But the homogenising factor developed over the years was bond insurance. Until about a year ago, half the market was "wrapped" with a triple-A guarantee that the insurer would honour the debt payments if the issuer could not.
That arrangement crumbled last year when bond insurers lost their top-notch ratings amid losses on mortgage debt they had also guaranteed. The removal of the triple-A guarantee sent interest rates soaring and produced a chain reaction for some issuers that exposed risks in the debt arrangements they had used. The suspicion is that by no means all local officials fully vetted the risks and that some bankers and advisers may not always have laid them out properly, although the fees they earned were higher than on traditional bonds.
Suspected irregularities in the muni market even disrupted Mr Obama’s cabinet plans when Bill Richardson, governor of New Mexico, withdrew in January as nominee for commerce secretary. It had emerged that a grand jury was investigating a California company that had donated funds to his political committees, allegedly in exchange for contracts to advise the state on bonds. (Mr Richardson has expressed confidence that his name will be cleared and the company, CDR Financial Products, has said the contracts had nothing to do with political contributions.)
Unlike other aspects of the financial crisis, the muni problems are peculiarly American. This in part reflects the much smaller size of municipal bond markets in Europe and elsewhere. German regions and city-states use the corporate bond markets but so far this year only €29bn ($42bn, £25bn) has been raised by the country’s local authorities, according to Dealogic, while some $453bn in US municipal debt was raised last year (see chart).
That leaves Jefferson County, Alabama, as worldwide poster child for soured swaps and nefarious relationships in the municipal bond market. Aggressive financing and alleged fraud related to revamping sewers have left the county, home to the city of Birmingham, on the brink of bankruptcy. "Jeffco", if it succumbs, would be the largest municipal bankruptcy ever. Banks led by JPMorgan Chase have renewed forbearance agreements for more than a year as the county tries to sort out its finances, but this summer Jeffco shed more than 1,000 workers to stay solvent. Larry Langford, the mayor of Birmingham, was charged by federal prosecutors last December with allegedly accepting $235,000 in bribes in exchange for steering county bond business to Blount Parrish, a broker-dealer in neighbouring Montgomery.
Taking a page from the corporate finance playbook, municipal bond issuers came to use derivatives in an effort to minimise interest costs. For sophisticated issuers the strategy worked well but some towns, school districts and hospitals have been scalded. "The swaps were premised on the assumption that the bond market would be boring and predictable over the long term and, in 2008, it was anything but," says Peter Shapiro of Swap Financial Group, a swaps adviser.
Most municipalities borrow long-term, but short-term and floating rates have historically been more attractive. So entities began to issue variable-rate debt, often guaranteed by bond insurance or with bank backing through a letter of credit. Then the issuer entered into a swap with a counterparty, usually a bank, to convert the floating-rate exposure to a fixed rate. The town or other issuer paid a fixed rate in return for a floating rate that was supposed to match the floating rate on its bonds. The arrangement worked well until the credit crunch hit.
When bond insurers and many letter-of-credit banks lost their top ratings, variable rates on the underlying debt skyrocketed. The remaining healthy banks, nursing their own wounds, stepped back from the market or increased prices for guarantees. But the variable rate the bank had agreed to pay the municipality remained much lower than what the municipality had to pay on its variable-rate debt. The borrower was out by the difference.
"The interest rates on the bonds wrapped in the swap were going higher and higher," Michael Tuten says he noticed after taking over as finance director in Claiborne County, Tennessee. From 3-4 per cent historically, rates neared 7 per cent on $18m borrowed for its schools. Many borrowers had to refinance in fixed-rate form, meaning the swaps needed to be terminated. But fees for that had become costly. Lancaster County, Pennsylvania, recently paid nearly $2m in such fees when it refinanced. Dennis Stuckey, chair of the county commission, says it will "priortise projects and delay capital improvements to match our ability to borrow funds and repay the debt". Claiborne refinanced too but the deal obliges it to repay $10m in principal. "In 2010, our cost will be whatever the prevailing rate is," says Mr Tuten. "If it stays as low as it is now, we will be blessed, but what if it bumps up to 6 or 8 per cent?"
William Blount, its chairman and owner, last week pleaded guilty to bribery and fraud and admitted plying Mr Langford with clothing from Ermenegildo Zegna and a $12,000 Tourneau watch in return for business. JPMorgan, meanwhile, disclosed that the SEC was filing an enforcement action related to "certain transactions" executed in 2002 and 2003 with Jefferson County but has otherwise declined to comment. Mr Langford, who is due to go on trial in October, has pleaded not guilty and his lawyer says: "We expect that a fair jury will find him not guilty."
The Jeffco affair is widely considered to be a "rogue" event but there were other accidents waiting to happen. "This was selling penny stocks out of a bucket shop to little old ladies," says Emily Evans, a former muni bond underwriter who is a city councilwoman in Nashville, Tennessee. Small towns and counties in Tennessee are grappling with the cost of soured swaps. Many public entities there and in other states have been trying to get out of their swaps and refinance debt, a process that can involve high fees at time when the recession is lowering their tax revenue. "It is the worst possible time for a local government to find itself in this position," says Ms Evans.
Robert Khuzami, the SEC’s enforcement director, recently described a number of areas as "ripe for scrutiny" in the muni market, including offering and disclosure issues. Even before the crisis hit, regulators were conducting an industry-wide probe into whether banks and others engaged in anti-competitive bidding for muni bonds and derivatives. "Public officials and their governments on the whole want to do the right thing. Many do not issue bonds routinely and are looking for guidance," says Ms Haines.
The SEC is considering rules that would improve the information available to investors in municipal securities but it is legally limited in what it can do. It regulates the banks and brokers that transact municipal securities and can take enforcement actions against issuers but lacks regulatory authority over them. States, cities, towns, school districts and other such entities that issue bonds are thus exempt from most disclosure rules that apply to companies. The so-called Tower amendment to the Securities Act of 1934, meanwhile, prevents the SEC and another regulator, the Municipal Securities Rulemaking Board, from requiring issuers to file disclosure documents.
The independent advisers that are involved in many muni deals are also not federally regulated. "Many financial advisers and intermediaries are highly qualified and do a great service for their issuer clients," says Lynnette Hotchkiss, MSRB executive director. "But some might be hired because of political connections or because of campaign contributions." Regulators and lawmakers are pushing for independent advisers to be regulated just as broker-dealers are. Market participants say that the SEC has been eager to gain regulatory power over the municipal bond market for years, against resistance from Wall Street and many muni issuers. High-profile blow-ups such as Jefferson County and the groundswell towards more regulation overall might create the climate to allow the SEC to get a crack at that.
Critics argue that requiring such a broad range of public entities to comply with the same cookie-cutter disclosure standards as corporations would be overly burdensome and costly to small issuers. It also fails to target the problem, they add. "Nothing organically muni went wrong," says one municipal bond banker. The big flaps, some market participants argue, occurred with bond insurers, banks, brokers and ratings agencies, all of which are overseen by at least one main regulator yet failed properly to assess risk. The greatest ammunition for those who wish to defend the status quo is that despite the unprecedented disruptions of late, the default rate on municipal bonds is still a fraction of what has historically been the case for corporate bonds.
Since issuers began selling so-called Build America Bonds, or Babs – which benefit from federal subsidies – the municipal market as a whole has recovered. Yet muni issuers as well as investors remain vulnerable – and some local officials are taking matters into their own hands. Justin Wilson, the state comptroller in Tennessee, thinks there should be national standards for the kind of complex swap arrangements that are wreaking havoc on his state and others. But he is not waiting for regulation to catch up. Mr Wilson has recommended guidelines for counties and towns issuing swaps in Tennessee, saying: "The focus of the SEC is the investor. My focus is the community and the taxpayer."
The Behavior of the Months
"Sell in May and go away", summer rallies, the January effect — all are familiar phrases to seasoned investors (pun intended). Is there any truth to market seasonality? The accompanying chart shows the monthly performance the S&P 500 since 1950. The blue bars represent the average monthly close variance from the previous month.
At least since 1950, there have been some broad patterns of good months and bad months. Of course, monthly performance in any given year is anyone's guess. But the chart shows some recurring patterns: January does tend to outperform, but so do March and April. July has often been host to summer rallies, certainly in comparison to the lackluster June and August. November and December tend to end the year on a high note. Together with January, March and April, they've combined to inspire the "Sell in May, buy Halloween" strategy. February is the naughty winter month. In some years, like the groundhog, the market must see its shadow and go into hibernation.
If February is often naughty, September has been worse, the chronic bad month. October appears to mark a rebound to average performance. But it has a history of deception. It is the most volatile month — the one with the widest range of interim highs and lows. It also has a bit of manic-depressive disorder disguised by its 0.61% average gain over the September close.
Of the eight previous bear markets since 1950, four of them bottomed out in October (1957,1966, 1974 and 2002). In 2008, this month was host to the worst monthly performance (-20.39%) since the Great Depression. It is also remembered by older investors for Black Monday, the worldwide market crash on October 19, 1987. In its happier mood, October 9, 2007 marked the all-time nominal high in the S&P 500. Later this week we'll look at another way of measuring historical monthly performance — one that provides significantly different results.
Financial Crisis Called Off
by James Howard Kunstler
Whew, what a relief! Everybody from Ben Bernanke and a Who's Who of banking poobahs schmoozing it up in the heady vapors of Jackson Hole, Wyoming, to the dull scribes at The New York Times, toiling in their MC Escher hall of mirrors, to poor dim James Surowiecki over at The New Yorker, to - wonder of wonders! - the Green Shoots claque at the cable networks, to the assorted quants, grinds, nerds, pimps, factotums, catamites, and cretins in every office from the Bureau of Labor Statistics to the International Monetary Fund - every man-Jack and woman-Jill around the levers of power and opinion weighed in last week with glad tidings that the world's capital finance system survived what turned out to be a mere protracted bout of heartburn and has been reborn as the Miracle Bull economy. Our worries over. If you believe their bullshit. Which I don't.
All this goes to show is how completely the people in charge of things in the USA have lost their minds. They seem to think this mass exercise in pretend will resurrect the great march to the WalMarts, to the new car showrooms, and the cul-de-sac model houses, reignite another round of furious sprawl-building, salad-shooter importing, and no-doc liar-lending, not to mention the pawning off of innovative, securitized stinking-carp debt paper onto credulous pension funds in foreign lands where due diligence has never been heard of, renew the leveraged buying-out of zippy-looking businesses by smoothies who have no idea how to run them (and no real intention of doing it, anyway), resuscitate the construction of additional strip malls, new office park "capacity" and Big Box "power centers," restart the trade in granite countertops and home theaters, and pack the turnstiles of Walt Disney world - all this while turning Afghanistan into a neighborhood that Beaver Cleaver would be proud to call home.
By the way - and please pardon the rather sharp digression - but does anybody know if they buried Michael Jackson yet? It's only been a couple of months. And, if not, is that the stench now wafting across the purple mountains' majesty from sea-to-shining sea? Isn't it a little indecent to keep the poor fellow waiting? Or is a really surprising comeback secretly planned, with product tie-ins and all?
America loves the word "recovery" as only a catastrophically sick society can. "In recovery" is the new universal mantra of loser individuals and loser nations. Everybody in the USA is in recovery. Even Michael Jackson (he may have given up on somatic activity but, on the plus side, as the Rotarians love to say, he's quit using drugs for once and for all, and the magazines have stopped publishing photos of him taken after 1990, when he turned himself into something out of the Hammer Films catalog).
To sum it all up, the US economy is in recovery. Paul Krugman says that we'll soon realize that Gross Domestic Product (GDP) is growing. He actually said that on the Sunday TV chat circuit. Not to put too fine a point on it, but I would really like to know what you mean by that Paul, you fatuous wanker. Do you mean that the Atlanta homebuilders are going to open up a new suburban frontier down in Twiggs County so that commuters can enjoy driving Chrysler Crossfires a hundred and sixty miles a day to new jobs as flash traders in the Peachtree Plaza? Do you mean that the Home Equity Fairy is going to wade into the sea of foreclosure and save twenty million mortgage holders currently sojourning in the fathomless depths with the anglerfish?
Do you mean that all the bales of deliquescing, toxic "assets" hidden in the vaults of Citibank, JP Morgan, Bank of America, et al, (not to mention on the books of every pension fund in the USA, and not a few elsewhere) will magically turn into Little Debbie Snack Cakes on Labor Day weekend? Do you mean that American Express and Master Card are about to declare a Jubilee on accounts in default everywhere? Do you mean that General Motors will produce a car that a.) anyone really wants to buy and b.) that the company can sell at a profit? Are you saying we get a do-over, going back to, say, 1981? Did we win some cosmic lottery that hasn't been announced yet? What's growing in this country besides unemployment, bankruptcy, repossession, liquidation, gun ownership, and suicidal despair? In short, are you out of your mind, Paul Krugman?
The key to the current madness, of course, is this expectation, this wish, really, that all the rackets, games, dodges, scams, and workarounds that American banking, business, and government devised over the past thirty years - to cover up the dismal fact that we produce so little of real value? these days - will just magically return to full throttle, like a machine that has spent a few weeks in the repair shop. This is not going to happen, of course. It is permanently and irredeemably broken - this Rube Goldberg contraption of swindles all based on the idea that it's possible to get something for nothing. And more to the point, we're really doing nothing to reconstruct our economy along lines that are consistent with the realities of energy, geopolitics, or resource scarcity.
So far, our notions about a "green" economy amount to little more than blowing green smoke up our collective ass. We think we're going to build "green" skyscrapers! We're too dumb to see what a contradiction in terms this is. The architects are completely uninterested in the one thing that really is "green" - traditional urban design - and most particularly the walkable neighborhood. That's just too conventional, not special enough, lacking in star power, not enough of a statement, boring, tedious, so not cutting edge! We blather about high speed rail, but you can't even get from Cleveland to Cincinnati on a regular train - and what's more amazing, nobody is really interested in making this happen. All we really care about is finding some miracle method to keep all the cars running.
What we've been seeing is nothing more than a massive pump-and-dump operation in the stock markets, most of it executed by programmed robot traders, with the trading nut provided by taxpayers current and future. These shenanigans add up to new risks and fragilities so extreme that the next time a grain of sand catches in the exquisite machinery they will sink the USA as a viable enterprise. We will end up discrediting not just capitalism, but also the idea of capital per se, that is, of deployable acquired wealth. As this occurs, of course, events on-the-ground will give new meaning to the term "reality television."
42 million clunkers to go
As Cash for Clunkers motors through its final day, it's time to ask the question: Just how effective was the government rebate program in getting gas guzzlers off the road? All told, about 750,000 clunkers will be traded in by the time the program officially ends at 8 p.m. ET on Monday, according to an estimate by George Pipas, sales analyst for Ford Motor Co. That would be roughly 2% of the approximately 42 million fuel hoggers still clunking along.
"Of course it's a very small fraction of the total of inefficient vehicles on the road," said Edward Osann, senior associate with the research group the American Council for an Energy-Efficient Economy. Osann said that "having inefficient vehicles go to the scrap heap generally is a good thing." But he added that the economy, not the environment, was the prime motive for Cash for Clunkers. "This was really a stimulus program tweaked to provide some energy-saving benefits, and looked at in that light, it was generally successful," said Osann.
Of course, the program has spurred sales at a time when the economic downturn is keeping American consumers out of the showroom. As of Monday morning, the U.S. Department of Transportation had received 625,000 applications from dealers for the Cash for Clunkers program, with vouchers totaling $2.58 billion. The program has been so popular that consumers used up about $1 billion in the first week, prompting Congress to approve an additional $2 billion for the program.
"Consumers, without anyone twisting their arm, blew through $3 billion worth of vouchers in three to four weeks," said Pipas. "Nobody anticipated this kind of success. Nobody saw this tsunami coming." As part of the government program, car dealers provided vouchers, of either $3,500 or $4,500, to consumers who trade in used vehicles with low fuel efficiency. The consumers used the vouchers to purchase new vehicles. The dealers destroyed the engines with a sodium silicate solution, and then the cars were scrapped.
But not everyone views this type of scrapping as beneficial to the environment. Michael Wilson, executive vice president of the Automotive Recyclers Association, described the destruction of the engine as a wasteful process. The transmission in a clunked car also becomes unusable, he said. The engine and the transmission are the most valuable parts of any vehicle and require the most resources to manufacture, Wilson said. "To produce an engine takes more energy than any other part," said Wilson. "We think that [Cash for Clunkers] is going to have a minimal environmental benefit to it, if any."
Maybe so, but Osann of the American Council for an Energy-Efficient Economy said the program may have pushed consumers to buy more fuel-efficient vehicles. "It appeared that most of the truck owners who participated in the program drove away in a car," said Osann. "We did not anticipate that." And Pipas, the Ford analyst, said the program had a "halo effect." He said it steered consumers toward fuel-efficient vehicles like his company's Focus.
The Focus was one of the most popular vehicles purchased by consumers participating in the program, according to the National Highway Traffic Safety Administration and Edmunds.com, along with the Toyota Corolla and the Honda Civic. "Programs that benefit the economy and benefit the environment are strange bedfellows," said Pipas. "They usually don't share the same hotel room, or the same hotel."
Bank of Israel Raises Key Rate, First Bank to Act
The Bank of Israel raised the benchmark interest rate by a quarter of a percentage point, the first central bank to lift rates since signs of an easing in the global recession started in the second quarter. Governor Stanley Fischer increased the lending rate to 0.75 percent, the Jerusalem-based central bank said today in a statement, after keeping it at a record low since March. Two of 12 economists surveyed by Bloomberg forecast the increase, while the rest expected Fischer to hold the rate steady.
The decision "strikes a balance between the need to moderate inflation and the need to continue to support the recent recovery in economic activity," the bank said. "Setting the interest rate at the low level of 0.75 percent continues to represent an expansionary monetary policy." Fischer has been backing away from economic stimulus measures since July 27, after the inflation rate slid into the target range for only one month before rebounding back out. The Israeli, French, German and Japanese economies all returned to growth in the second quarter, prompting Fischer to say on Aug. 21 that "the first signs of global growth have appeared."
"We have a picture of economic recovery right now, which you see elsewhere in the world," said Jonathan Katz, an economist at HSBC Securities who predicted the increase. At the same time, "Israel is one of the few countries in the world where inflation is running above target at three and half percent, and Fischer’s mandate is to try and bring it down between 1 and 3 percent." The shekel strengthened to 3.7957 per dollar at 6:06 p.m. from 3.8110 just before the decision. The benchmark Mimshal Shiklit closed down 0.05 shekel at 105.65 before the decision.
Israel posted inflation rates of 3.5 percent in July and 3.6 percent in June, above the 1 percent to 3 percent target range. Fischer had cut the key interest rate to a record 0.5 percent and purchased foreign currency and government bonds to bolster an economy that contracted an annualized 3.2 percent in the first quarter. The steps taken by the central bank appear to be working. The economy expanded an annualized 1 percent in the second quarter and an index of leading economic indicators increased a preliminary 1.2 percent in July, the third consecutive gain.
Fischer announced on July 27 that he would halt bond purchases and on Aug. 10 that he would end set purchases of foreign currency. He said the bank would buy foreign currency in the event of "unusual movements" in the shekel. The bank bought some $200 million in the foreign-currency market on Aug. 18, according to Moshe Nir, a currency trader in Tel Aviv at Mercantile Discount Bank Ltd.
Higher interest rates and an end to purchases of foreign currency run the risk of strengthening the shekel. Forty-five percent of Israel’s gross domestic product comes from exports and the shekel has gained about 3 percent against the dollar since June 30, reducing company profits. "If they start hiking rates there will be much more pressure on the currency to appreciate," said Tevfik Aksoy, an economist with Morgan Stanley & Co. "Exports have yet to recover."
Bank of America Shuns Sales of Card Debt, Ducks Subprime Label
Bank of America Corp., saddled with the worst credit-card default rates among its biggest rivals, is shunning the asset-backed securities market it tapped for $13.7 billion last year. JPMorgan Chase & Co., Citigroup Inc. and American Express Co. are among issuers that sold $21 billion of card-backed debt this year through the Term Asset-Backed Securities Loan Facility, a Federal Reserve lending program to spur bond sales. Bank of America, the only major card-issuer that didn’t sell any, lacks enough quality loans in its credit-card trust to sell TALF bonds without being labeled a subprime issuer.
"I don’t doubt that Bank of America would like to re- engage that market," said Michael Nix, who helps manage $600 million, including shares of the lender, at Greenwood Capital Associates in Greenwood, South Carolina. "The credit-card securitization market is starting to thaw, but there still isn’t a lot of demand, so the cost of issuance may be higher than the bank thinks is worthwhile." Bank of America’s 13.82 percent credit-card default rate in July, the highest among the biggest lenders, helps explain why loans in its credit-card trust are shy of the threshold that would allow it to sell debt through TALF and be labeled a prime issuer.
Just 68 percent of the loans have FICO scores above 660, Barclays Capital said in an Aug. 17 research note. Anything below 70 percent brands the issuer subprime, and investors who buy such debt can demand extra protection against the possibility of default. FICO scores are consumer-credit ratings compiled by Fair Isaac Corp. "It’s an artificial constraint on B of A," said Louisiana State University finance professor Joseph Mason, who is also a senior fellow at the Wharton School. "We’re beginning to see the perverse incentives of a lot of these emergency government policies that were set up on an ad hoc basis. They’re starting to skew funding availability for commercial banks."
Banks that don’t sell asset-backed bonds can find cash from other sources such as customer deposits to make new loans and pay down expiring debt. As cheap financing dwindles, credit-card profits may be squeezed, said Morgan Stanley analyst Vishwanath Tirupattur. Bank of America’s default rates are moving in the opposite direction from competitors. In July, the U.S. average fell to 10.52 percent, marking the first monthly decline since September, according to Moody’s. The only major card lender with a higher rate than Bank of America is Advanta Corp., which said it may not survive after cutting off almost 1 million small- business accounts. Advanta is unwinding its credit-card trust after defaults surged to more than 20 percent.
The top six U.S. credit card-backed bond issuers have a combined $375.1 billion in outstanding securitizations. Bank of America has the most securitized debt, at $93.9 billion, followed by JPMorgan, Citigroup, Capital One Financial Corp., Discover Financial Services and Amex, according to Morgan Stanley. While Bank of America stands out as the sole major issuer that hasn’t sold card debt this year, such sales are falling. They plunged 38 percent last year to $58 billion as the credit crunch sapped demand, according to data compiled by Bloomberg. There were no bond sales this year until March, when the Fed started TALF. The Fed last week extended TALF for three more months.
Some banks may be issuing less asset-backed debt as they prepare for accounting changes mandated by the U.S. Financial Accounting Standards Board to take effect next year. The rules will require banks to carry all securitized loans on their balance sheets, threatening the capital relief that had been one of the "hallmark benefits" of selling the debt, JPMorgan said in an Aug. 7 report. Bank of America, JPMorgan, Citigroup, Amex and Discover have taken steps to stanch losses and thwart ratings cuts on card-backed bonds. Remedies include removing weaker accounts and boosting the cash cushion that protects investors from losses by issuing new classes of securities and keeping them on balance sheet.
Capital One, whose defaults rose to 9.83 percent in July, is the only top credit-card issuer that hasn’t tried to support its trust, said Credit Suisse analyst Moshe Orenbuch. The McLean, Virginia-based bank in June sold $1.65 billion of card- backed bonds outside of TALF, Bloomberg data show.
Remember me? Wall Street repackages toxic debt
Wall Street may have discovered a way out from under the bad debt and risky mortgages that have clogged the financial markets. The would-be solution probably sounds familiar: It's a lot like what got banks in trouble in the first place. In recent months investment banks have been repackaging old mortgage securities and offering to sell them as new products, a plan that's nearly identical to the complicated investment packages at the heart of the market's collapse.
"There is a little bit of deja vu in this," said Arizona State University economics professor Herbert Kaufman. But Kaufman said the strategy could help solve one of the lingering problems of the financial meltdown: What to do about hundreds of billions of dollars in mortgages that are still choking the system and making bankers reluctant to make new loans. These are holdovers from the housing bubble, when home prices soared, banks bought risky mortgages, bundled them with solid mortgages and sold them all as top-rated bonds. With investors eager to buy these bonds, lenders came up with increasingly risky mortgages, sometimes for people who could not afford them. It didn't matter because, in the end, the bonds would all get AAA ratings.
When the housing market tanked, figuring out how much those bonds were worth became nearly impossible. The banks and insurance companies that owned them knew there were still some good mortgages, so they didn't want to sell everything at fire-sale prices. But buyers knew there were many worthless loans, too, so they didn't want to pay full price for the remnants of a real estate bubble. In recent months, banks have tiptoed toward a possible solution, one in which the really good bonds get bundled with some not-quite-so-good bonds. Banks sweeten the deal for investors and, voila, the newly repackaged bonds receive AAA ratings, a stamp of approval that means they're the safest investment you can buy.
"You've now taken what was an A-rated security and made it eligible for AAA treatment," said Richard Reilly, a partner with White & Case in New York. As for the bottom-of-the-barrel bonds that are left over, those are getting sold off for pennies on the dollar to investors and hedge funds willing to take big risk for the chance of a big reward. Kaufman said he's optimistic about the recent string of deals because, unlike during the real estate boom, investors in these new bonds know what they're buying. "We're back to financial engineering, absolutely," he said. "But I think it's being done at least differently than it was before the meltdown."
The sweetener at the heart of the deal is a guarantee: Investors who buy into the really risky pool agree to also take some of the risk away from those who buy into the safer pool. The safe investors get paid first. The risk-taking investors lose money first. That's how the safe stack of bonds gets it AAA rating, which is crucial to the deal. That rating lets banks sell to pension funds, insurance companies and other investors that are required to hold only top-rated investments. "There's no voodoo going on here. It's just math," said Sue Allon, chief executive of Allonhill, which helps investors analyze such hard-to-price investments.
Financial gurus call it a "resecuritization of real estate mortgage investment conduits." On Wall Street, it goes by the acronym Re-Remic (it rhymes with epidemic). "It actually makes a lot of fundamental sense," said Brian Bowes, the head of mortgage trading at Hexagon Securities in New York. "It's taking a bond that doesn't necessarily have a natural buyer and creating two bonds that might have a natural buyer for each." The risk is, if the housing market slips even more, even the AAA-rated investments may not prove safe. The deal also relies on the rating agencies, which misread the risk at the heart of the subprime mortgage crisis, to get it right.
And then there's the uncertainty about the value of the underlying investments, which FBR Capital Markets analyst Gabe Poggi called "totally combustible." Poggi likes the deals because they appear to have breathed some life into the market, but he said it only works if everyone knows exactly what they're buying. The Obama administration is also working on a plan to get banks buying and selling risky bonds. But the public-private partnership announced this spring is still in the works and has yet to help investors figure out what those bonds are worth. By creating Re-Remics, banks can help start the process themselves.
The concept has been around for years, but it has become increasingly popular lately as a way for banks to sell off bonds backed by commercial properties such as malls and office buildings. Analysts say they've seen a few dozen deals aimed at repackaging debt held over from the mortgage boom. Investment banks have also dabbled in turning collateralized debt obligations, or CDOs, into Re-Remics. That's where Allon gets nervous. "I think that's trouble," she said.
CDOs are already complicated. Repackaging them makes it harder to figure out what the investment is worth. The more obscure the concept, she said, the more likely the deal has gotten too creative. Wall Street has a tendency to push the boundaries of good ideas, Bowes said. But he said banks are still smarting from the market implosion and are unlikely to rush into new, risky ventures. "A lot of the market innovations, they all started out with this fundamentally good concept and they often tend to deteriorate over time, or just evolve into more and more risky versions of the same concept," Bowes said. "This time around, the likelihood is, it will take a lot longer for that to happen."
Taylor Bean Files for Bankruptcy, in Talks With FDIC
Taylor, Bean & Whitaker Mortgage Corp., the 12th largest U.S. mortgage lender, filed for bankruptcy protection from creditors as regulators question its involvement with Colonial BancGroup Inc. "The filing follows a series of events in recent weeks that have crippled the company’s business operation," Taylor Bean said in a statement. The company today listed both assets and debt of more than $1 billion in Chapter 11 documents in U.S. Bankruptcy Court in Jacksonville, Florida.
Taylor Bean will operate on a "scaled-down basis and begin work recovering, restructuring and possibly liquidating its assets," the company said in the statement. The Ocala, Florida- based company also announced the appointment of two directors, Bill Maloney and Bruce Layman, and the naming of Navigant Capital Advisors’ Neil Luria as restructuring officer. "This is a very complicated business, and the speed of its collapse has been stunning," Luria said in the statement. "Much remains to be done, but we are committed to creating and realizing the value of the company’s assets."
The announcement comes after Taylor Bean, based on Ocala, Florida, was expelled from the ranks of mortgage lenders approved to do business with government-sponsored mortgage agencies earlier this month. The government cited concerns about possible fraud. Taylor Bean said today it believes the decisions were related to its involvement with Colonial and that it has, or will soon, appeal the action. The government actions led Taylor Bean to fire about 2,000 employees on Aug. 5, the company said.
The terminations followed a failed attempt by Taylor Bean to lead an investor group that would pay $300 million for a controlling stake in Colonial, one of its lenders that has since failed and been taken over by BB&T Corp. Taylor Bean said it is in talks with the Federal Deposit Insurance Corp., the receiver for Colonial, on getting access to about 100 accounts frozen by Colonial. Closely held Taylor Bean does business across the U.S. through loan brokers and other lenders. It ranked 12th among U.S. mortgage originators in the first half of this year with $17 billion of loans, or 1.7 percent of the total, according to the industry newsletter Inside Mortgage Finance.
CBO Warns of Higher Unemployment: Washington Worries About the Deficit
by Dean Baker
The Congressional Budget Office (CBO) will release a new set of economic and budget projections for the next decade on Tuesday. These projections are likely to show a cumulative deficit over the next 10 years that is $2 trillion higher (at 1 percent of GDP) than the deficit CBO projected in January. The reason for the higher projected deficit is not that Congress has suddenly blown another 2 trillion of the taxpayers' dollars on frivolous projects. Rather, the main reason for the jump in the projected deficit is that CBO is now projecting lower growth and higher unemployment over this decade than it did last January.
In other words, CBO now believes that the collapse of the housing bubble will cause even more and longer lasting damage than it did back in January. As a result of slow growth and high unemployment, the government will collect considerably less in tax revenues over the next decade than would have been implied by the earlier set of economic projections. The government will also be paying out more money in unemployment benefits, food stamps and other transfer programs than would be the case if the economy were healthier.
The real story in the new CBO projections should be the more dire economic outlook. CBO now expects the unemployment rate to be near 10 percent through most of 2010. Its new projections will show that the unemployment rate will only return to more normal levels in 2013 or even 2014, more than six years after the collapse of the housing bubble threw the economy into recession. The implication of the new CBO projections is that millions more people will be needlessly suffering because of the economic mismanagement of the Greenspan-Bernanke-Bush crew.
CBO views 4.5 percent unemployment as being the sustainable rate of unemployment. If the unemployment rate is 10 percent, more than 8 million people are needlessly out of work, with another 5 million or so being forced to work part-time because they cannot find full-time employment. These people will be struggling to pay their health care bills, cover their mortgage or rent payments, and meet other necessary expenses for themselves and their families.
The rational response to the news that the economy will be far worse than had previously been projected should be a demand for more stimulus. After all, why should millions of people lose their jobs, their homes, and their health just because the people who managed the country's economic policy over the last decade were incompetent? Unfortunately, the same people who wrecked the economy are largely still running it and they still have the same set of economic priorities.
Therefore, instead of talking about the economic weakness implied by the new CBO projections, the discussion will focus almost completely on the larger projected budget deficit. Instead of discussing ways in which we can reduce the unemployment rate and stimulate growth, the media will be highlighting calls for tax increases and spending cuts -- measures that will slow the economy and raise the unemployment rate further. The deficit hawks who wrecked the economy will be insisting that the government cannot borrow this much money. They will do their best to scare people by talking about "trillion" dollar deficits. To be sure, these are big deficits, but there is no reason to believe that the economy cannot support them.
Japan now has a debt to GDP ratio of close to 180 percent. This would be the equivalent of a $27 trillion debt in the United States. Yet investors around the world are happy to hold yen and in fact hold 10-year Japanese government bonds at interest rates of less than 2.0 percent. Looking back to U.S. history, after World War II, the debt to GDP ratio rose to 120 percent. This would be $18 trillion in today's economy. Yet, the three decades following the war were the period of most rapid growth in U.S. history, and the debt to GDP ratio fell to less than 30 percent.
The basic story is that we need to have large deficits now for the next several years in order to boost the economy back to full employment. Forcing a large portion of our workforce to endure a prolonged period of unemployment will inflict an enormous cost on these workers and on their children (i.e. the future generations whom the deficit hawks claim as their main concern). The deficit hawks were hugely wrong in ignoring the $8 trillion housing bubble and the country is paying an enormous price for their mistake -- including much higher deficits. It is time to stop taking these birds seriously.
Healthcare insurers get upper hand
Lashed by liberals and threatened with more government regulation, the insurance industry nevertheless rallied its lobbying and grass-roots resources so successfully in the early stages of the healthcare overhaul deliberations that it is poised to reap a financial windfall. The half-dozen leading overhaul proposals circulating in Congress would require all citizens to have health insurance, which would guarantee insurers tens of millions of new customers -- many of whom would get government subsidies to help pay the companies' premiums.
"It's a bonanza," said Robert Laszewski, a health insurance executive for 20 years who now tracks reform legislation as president of the consulting firm Health Policy and Strategy Associates Inc. Some insurance company leaders continue to profess concern about the unpredictable course of President Obama's massive healthcare initiative, and they vigorously oppose elements of his agenda. But Laszewski said the industry's reaction to early negotiations boiled down to a single word: "Hallelujah!"
The insurers' success so far can be explained in part by their lobbying efforts in the nation's capital and the districts of key lawmakers. The bills vary in the degree to which they would empower government to be a competitor and a regulator of private insurance. But analysts said that based on the way things stand now, insurers would come out ahead. "The insurers are going to do quite well," said Linda Blumberg, a health policy analyst at the nonpartisan Urban Institute, a Washington think tank. "They are going to have this very stable pool, they're going to have people getting subsidies to help them buy coverage and . . . they will be paid the full costs of the benefits that they provide -- plus their administrative costs."
One of the Democratic proposals that most concerns insurers is the creation of a "public option" insurance plan. The industry launched a campaign on Capitol Hill against it, grounded in a study published by the Lewin Group, a health policy consulting firm that is owned by UnitedHealth Group. The lobbyists contended that a government-run plan, which would have favorable tax and regulatory treatment, would undermine private insurers.
Opposition increased this month when boisterous critics mobilized at town hall meetings held by members of Congress home for the August recess. The attacks, supplemented by conservative critics on talk radio and other forums, drew national attention. Leading insurers, including UnitedHealth, urged their employees around the country to speak out. Company "advocacy hot line" operations and sample letters and statements were made available to an army of insurance industry employees in nearly every congressional district.
Some insurers supplemented the effort with local advertising, often designed to put pressure on specific members of Congress. Late in the spring, Blue Cross Blue Shield of North Carolina -- the home state of several conservative Blue Dog Democrats -- prepared ads attacking the public option. Leading Democrats have fought back, with House Speaker Nancy Pelosi (D-San Francisco) last month calling the industry "immoral" for its past treatment of customers and suggesting insurers were "the villains" in the healthcare debate. Still, recent support for the public option has declined, and the stock prices of health insurance firms have been rising.
Undermining support for the public option wasn't the only gain scored by insurance lobbyists. In May, the Senate Finance Committee discussed requiring that insurers reimburse at least 76% of policyholders' medical costs under their most affordable plans. Now the committee is considering setting that rate as low as 65%, meaning insurers would be required to cover just about two-thirds of patients' healthcare bills. According to a committee aide, the change was being considered so that companies could hold down premiums for the policies.
Most group health plans cover 80% to 90% or more of a policyholder's medical bills, according to a report by the Congressional Research Service. Industry officials urged that the government set the floor lower so insurers could provide flexible, more affordable plans. "It is vital that individuals, families and small-business owners have the flexibility to choose an affordable coverage option that best meets their needs," said Robert Zirkelbach, spokesman for America's Health Insurance Plans, the industry's Washington-based lobbying shop.
Consumer advocates argue that a lower government minimum might quickly become the industry standard, placing a greater financial burden on patients and their families. "These are a bad deal for consumers," said J. Robert Hunter, a former Texas insurance commissioner who works with the Consumer Federation of America. Meanwhile, companies would probably see a benefit by providing less insurance "per premium dollar," Hunter said. "It would be quite a windfall," said Wendell Potter, a former executive at Cigna insurance company who has become an industry whistle-blower.
Consumer and labor advocates acknowledged the industry's lobbying success. In the first half of 2009, the health service and HMO sector spent nearly $35 million lobbying Congress, the White House and federal healthcare offices, according to data from the Center for Responsive Politics. With more than 900 lobbyists, that sector -- whose top spenders are insurance giants UnitedHealth, Blue Cross Blue Shield and Aetna -- was poised to spend more than in 2008, a record lobbying year.
UnitedHealth spent the most, $2.5 million in the first half of 2009, and hired some of Washington's most prominent political players, including Tom Daschle, the former Senate majority leader who served as an informal health policy advisor to Obama. "They have beaten us six ways to Sunday," said Gerald Shea of the AFL-CIO. "Any time we want to make a small change to provide cost relief, they find a way to make it more profitable."
Will the United States Default?
by Arnold King
Someone asked for my comments on the Jeffrey Rogers Hummel piece. I think that the U.S. government would enact a wealth tax rather than default on its debt. Other countries that have defaulted have not had the option of enacting wealth taxes. When you are in a banana republic with shaky government finances and you have a lot of wealth, you send that wealth over to the United States, where your government cannot get to it. That "safe haven" motive is what keeps the dollar so strong.
Anyway, by the time the banana republic gets around to enacting a wealth tax, all the wealth has fled the country and there is nothing left to tax. So the banana republic defaults. As the U.S. government's finances deteriorate, it will strengthen its hold on its citizens' wealth. My guess is that you will see tighter laws that restrict your ability to hide wealth overseas and much more enforcement of those laws. Basically, if a banana republic says to us, "Help us keep the wealth of our citizens," we can say no. On the other hand, if we tell another country, "Help us keep the wealth of our citizens," that country will co-operate. This asymmetry reflects the distribution of military power.
So what I am saying is that the ultimate guarantor against a U.S. government default is the U.S. Navy. Because of the navy, the U.S. government can control the policies of other governments. Because it can control the policies of other governments, the U.S. government is in a position to dictate whose wealth can flee where. Because the U.S. government can stop our wealth from fleeing, the U.S. could enact a wealth tax. Because it could enact a wealth tax, the U.S. is unlikely to default on its debt.
Resolving U.S. Indebtedness: Various Scenarios
"Winterspeak" wonders if I would bet on the U.S. defaulting. Here are the alternatives that I can think of, and the odds I would give to them:
1. Muddle through. No major change in policy, and no major change in economic growth, but somehow the ratio of debt to GDP remains stable. I give this a 10 percent chance, although it implies that I am miscalculating the path that we are on. I really don't see how it can happen.
2. Technology to the rescue. Some major technologies, probably either wet or dry nanotech, produce so much economic growth that the ratio of debt to GDP stays under control. I give this a 20 percent chance. Sometimes I think the chances are higher, maybe even 50 percent. It's a difficult estimate to make--today, I'm in a mood to say 20 percent.
3. Policy changes. Congress increases taxes (but does not enact a wealth tax) and/or takes steps to rein in Medicare and Social Security spending. I should point out that I have been writing about the race between Medicare spending and economic growth since 2003. I give this a 25 percent chance.
4. Inflate away the debt with moderate inflation (between 5 and 10 percent per year). I think this would be politically costly, and it might not be enough to really inflate away the debt (it depends on how quickly bond investors adjust expectations and raise the inflation premium in nominal interest rates). I gives this a 15 percent chance.
5. Wealth tax. The government takes, say, 5 percent of everyone's personal assets above $100,000. It does this on a one-time basis (or so it says). I give this a 25 percent chance.
6. Hyperinflation. This would certainly expunge the debt, but it would be political suicide. I interpret Winterspeak as taking this scenario seriously. I don't.
7. Default. The U.S. simply refuses to pay some or all of its debt. I interpret Winterspeak as saying that this would never happen. I am inclined to agree, although I would just say that it is highly unlikely.
I think that the combined chances of (6) and (7) are no more than 5 percent, with (7) even less likely than (6).
Investors Don’t See Bubble While Drunk on Lafite
One of the strangest developments in financial markets this year is the "Lafite effect." It offers a valuable lesson about investing. This financial crisis has walloped just about everything. It has even pushed down prices for fine wine. The Vintage Wine Fund, which invests "in fine wine with an objective of steady, high capital growth," declined 33 percent in 2008. This is newsworthy. In a 2008 paper, economists Lee Sanning, Sherrill Shaffer and Jo Marie Sharratt at the University of Wyoming demonstrated that wine investments provide enormous positive returns over time, with almost no correlation to the market as a whole.
Their study provides a textbook example of the problem with risk analysis. Until that time, the correlation of wine with the overall stock market was essentially zero. A hedge fund that bet on that remaining true would have lost big, because this time everything moved together. One set of wine investors survived unscathed: those who bought and held the fine French wine Chateau Lafite Rothschild. According to data compiled by wine exchange Liv-ex, the average list price for a bottle of 1982 Lafite was $3,386 in July, the highest ever. That’s about $280 higher than it was last year, and more than $1,100 higher than in 2007. Not bad for a bottle that you could have purchased for about $20 back in the 1980s.
So strong is the 1982 Lafite that its value largely withstood a downgrade, to 97 from a perfect 100, by U.S. wine maven Robert Parker. If you consider how much wealth has been destroyed in the past year, you would think that such a markdown would have devastated prices. Think again. The run-up appears to have affected all things Lafite, not just the 1982 vintage. The effect is so striking that Liv-ex created a new index to track the prices of the Lafite vintages from 2000 to 2006. That index is now only 4.4 percent below its long-term high. Few investments have done better.
The question for an investor is this: Is the Lafite price spike yet another bubble, or are there sound fundamental reasons? One sound argument that might explain the increase is that there is a special "Lafite effect" associated with Asia. As wealth has increased there, the demand for luxury commodities such as Lafite has skyrocketed. "Right now, it’s almost an insult in some places to serve something other than Lafite," Liv-ex’s director, James Miles, told me last week. With the Lafite supply limited, this high demand for the supreme trophy wine has pushed prices through the roof.
Since Asia will presumably continue to grow in wealth, one might expect that demand will skyrocket and that today’s prices will someday look cheap. The Lafite price might just as well drop sharply, and the argument for a decline is probably more compelling. For one thing, prices might be higher now because of a speculative bubble. Also, Asian consumers might become more sophisticated and grow to appreciate other wines, which they now shun, that are close substitutes for Lafite. If they do that, today’s prices might be a high water mark for some time. The 2000 vintages of both Lafite and La Mission Haut Brion both received perfect scores of 100 from Parker, for example. Right now Lafite costs more than twice as much.
The decision on investing today in Lafite probably turns on this question of whether it will become more socially acceptable to serve fine wines other than Lafite in the wealthiest corners of Asia. Today’s high prices suggest there are enough people willing to bet that Asian demand for Lafite continues on its trajectory. It’s a tempting bet, and a risky one. As Lafite prices have soared away from those of close substitutes, Lafite has begun to look -- especially to unsophisticated investors, and those who rely on past correlations -- like an increasingly safe investment, with steady and predictable returns.
In fact, the opposite is true. The risk of Lafite prices plummeting and wiping out your investment has skyrocketed along with the price. It might be possible to make money as Lafite prices continue to soar. But prudence demands that sensible investors stay on the sidelines. Whether you are buying wine for consumption or investment, I’d go with La Mission Haut Brion.
Goldman Busted Again
by Matt Taibbi
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%.
More good news for Goldman Sachs, which now has the WSJ taking a bite out of its posterior. Here it is reported that Goldman was handing out tips to favored clients that one of its analysts was about to publish favorable ratings of a mutual fund, giving those clients the opportunity to buy in six days before the analyst’s rating was published.
This is a practice that’s apparently been going on forever. You give an investment bank enough business, they will throw bon mots like this your way. Here’s Jim Cramer, formerly of Goldman and then of course a hedge fund manager in his own right, describing how his wife and partner Karen Backfisch taught him to butter up investment banks with commissions:How she did it was by gaming Wall Street, trying to anticipate moves of analysts before they were made, and placing big bets on the direction that analysts were going to go. That way, she said, you always had an edge, you never owned anything idly, and you always had an exit strategy…
Karen explained to me that the analyst game was a game of sponsorship. Analysts like to get behind stocks and bull them. You have to get in on the ground floor when they start their sponsorship campaign. If Merrill is the sponsor of a stock, it could be good for 5 points. If Goldman sponsored something, it could be good for 10. You want to buy something and flip it—sell it immediately—into the sponsorship. That’s the only sure thing on Wall Street.
When I asked her how we could find out about all of these wonderful things when I was jut a little hedge fund manager, she said one word: ‘commish.’… Commissions, she explained, determined what you are told, what you will know, and how much you can find out. If you do a massive amount of commission business, analysts will return your calls, brokers will work for you, and you will get plenty of ideas to make money, on both a short- and long-term basis… Commissions greased everything.
This comes on the same day that the New York Times ran a big story on Sergey Aleynikov, the guy who stole Goldman’s high-frequency trading program.The story is about the use of technology that banks use to make trades in fractions of milliseconds, taking advantage of tiny price discrepancies in the market.
Both of these stories have a common theme. The people who are actively innovating on Wall Street are all involved in the business of gaming the system to take advantage of short-term price swings. The people who invest money for the long-term and stick with their investments are punished in this environment.
Arrest Over Software Illuminates Wall St. Secret
Flying home to New Jersey from Chicago after the first two days at his new job, Sergey Aleynikov was prepared for the usual inconveniences: a bumpy ride, a late arrival. He was not expecting Special Agent Michael G. McSwain of the F.B.I. At 9:20 p.m. on July 3, Mr. McSwain arrested Mr. Aleynikov, 39, at Newark Liberty Airport, accusing him of stealing software code from Goldman Sachs, his old employer. At a bail hearing three days later, a federal prosecutor asked that Mr. Aleynikov be held without bond because the code could be used to "unfairly manipulate" stock prices.
This case is still in its earliest stages, and some lawyers question whether Mr. Aleynikov should be prosecuted criminally, or whether a civil suit may be more appropriate. But the charges, along with civil cases in Chicago and New York involving other Wall Street firms, offer a glimpse into the turbulent world of ultrafast computerized stock trading. Little understood outside the securities industry, the business has suddenly become one of the most competitive and controversial on Wall Street. At its heart are computer programs that take years to develop and are treated as closely guarded secrets.
Mr. Aleynikov, who is free on $750,000 bond, is suspected of having taken pieces of Goldman software that enables the buying and selling of shares in milliseconds. Banks and hedge funds use such programs to profit from tiny price discrepancies among markets and in some instances leap in front of bigger orders. Defenders of the programs say they make trading more efficient. Critics say they are little more than a tax on long-term investors and can even worsen market swings.
But no one disputes that high-frequency trading is highly profitable. The Tabb Group, a financial markets research firm, estimates that the programs will make $8 billion this year for Wall Street firms. Bernard S. Donefer, a distinguished lecturer at Baruch College and the former head of markets systems at Fidelity Investments, says profits are even higher. "It is certainly growing," said Larry Tabb, founder of the Tabb Group. "There’s more talent around, and the technology is getting cheaper."
The profits have led to a gold rush, with hedge funds and investment banks dangling million-dollar salaries at software engineers. In one lawsuit, the Citadel Investment Group, a $12 billion hedge fund, revealed that it had paid tens of millions to two top programmers in the last seven years. "A geek who writes code — those guys are now the valuable guys," Mr. Donefer said.
The spate of lawsuits reflects the highly competitive nature of ultrafast trading, which is evolving quickly, largely because of broader changes in stock trading, securities industry experts say. Until the late 1990s, big investors bought and sold large blocks of shares through securities firms like Morgan Stanley. But in the last decade, the profits from making big trades have vanished, so investment banks have become reluctant to take such risks. Today, big investors divide large orders into smaller trades and parcel them to many exchanges, where traders compete to make a penny or two a share on each order. Ultrafast trading is an outgrowth of that strategy.
As Mr. Aleynikov and other programmers have discovered, investment banks do not take kindly to their leaving, especially if the banks believe that the programmers are taking code — the engine that drives trading — on their way out. Mr. Aleynikov immigrated to the United States from Russia in 1991. In 1998, he joined IDT, a telecommunications company, where he wrote software to route calls and data more efficiently. In 2007, Goldman hired him as a vice president, paying him $400,000 a year, according to the federal complaint against him.
He lived in the central New Jersey suburbs with his wife and three young daughters. This year, the family moved to a $1.14 million mansion in North Caldwell, best known as Tony Soprano’s hometown. A video on YouTube portrays Mr. Aleynikov as a disheveled workaholic who suffers through romantic misadventures before finding love when he rubs a lamp and a genie fulfills his wish by granting him a wife. A friend, Vladimir Itkin, says the Aleynikovs are devoted to their children and seem very close.
This spring, Mr. Aleynikov quit Goldman to join Teza Technologies, a new trading firm, tripling his salary to about $1.2 million, according to the complaint. He left Goldman on June 5. In the days before he left, he transferred code to a server in Germany that offers free data hosting. At Mr. Aleynikov’s bail hearing, Joseph Facciponti, the assistant United States attorney prosecuting the case, said that Goldman discovered the transfer in late June. On July 1, the company told the government about the suspected theft. Two days later, agents arrested Mr. Aleynikov at Newark.
After his arrest, Mr. Aleynikov was taken for interrogation to F.B.I. offices in Manhattan. Mr. Aleynikov waived his rights against self-incrimination, and agreed to allow agents to search his house. He said that he had inadvertently downloaded a portion of Goldman’s proprietary code while trying to take files of open source software — programs that are not proprietary and can be used freely by anyone. He said he had not used the Goldman code at his new job or distributed it to anyone else, and the criminal complaint offers no evidence that he has.
Why he downloaded the open source software from Goldman, rather than getting it elsewhere, and how he could at the same time have inadvertently downloaded some of the firm’s most confidential software, is not yet clear. At Mr. Aleynikov’s bail hearing, Mr. Facciponti said that simply by sending the code to the German server, he had badly damaged Goldman. "The bank itself stands to lose its entire investment in creating this software to begin with, which is millions upon millions of dollars," Mr. Facciponti said.
Sabrina Shroff, a public defender who represents Mr. Aleynikov, responded that he had transferred less than 32 megabytes of Goldman proprietary code, a small fraction of the overall program, which is at least 1,224 megabytes. Kevin N. Fox, the magistrate judge, ordered Mr. Aleynikov released on bond. The United States attorney’s office declined to comment and the F.B.I. did not return calls for comment.
Harvey A. Silverglate, a criminal defense lawyer in Boston not involved in the case, said he was troubled that the F.B.I. had arrested Mr. Aleynikov so quickly, without evidence that he had made any effort to use or sell the code. Such disputes are generally resolved civilly rather than criminally, Mr. Silverglate said. "It is astonishing that the F.B.I. arrested this defendant at all," he said. Other firms have also sued former employees recently over concern about high-frequency trading software, though two similar cases are the subject of civil suits rather than criminal prosecution.
Six days after Mr. Aleynikov’s arrest, Citadel, the hedge fund, sued Mr. Aleynikov’s new employer, Teza Technologies, which was founded in March by three former Citadel employees. While Teza is not yet conducting any trading, Citadel claimed the former employees had violated a noncompete agreement with Citadel and might even be trying to steal Citadel’s code, causing "irreparable harm."
As part of the suit, Citadel detailed the extraordinary steps it takes to protect its software. Besides encrypting its programs, the firm discourages employees from writing down details about them. Its offices have cameras and guards, and there are secure rooms that require special codes to enter. The precautions are necessary because Citadel has spent hundreds of millions of dollars developing its software, the firm said. In its response, Teza said that it had never stolen or tried to steal Citadel’s software, did not ask Mr. Aleynikov to take code from Goldman, and had never seen the code he took. A lawyer for Teza did not return calls for comment.
Meanwhile, in March, the giant Swiss bank UBS sued three former members of its high-speed trading group in New York state court. UBS contended that the defendants had lied to the bank about their plans to work for Jefferies, another firm. Also, one defendant sent some UBS code to a personal e-mail account. Lance Gotko, a lawyer for the men, said that they had not used the code they took and that it might not be valuable to Jefferies in any case. A lawyer for UBS referred calls to a bank spokeswoman, who declined to comment. A spokesman for Jefferies declined to comment.
How Obama could prevent a second recession
Is the light at the end of the tunnel an oncoming train? That’s the worry of many economists who fret that after a couple of quarters of moderate growth, the U.S. economy will either lapse into a state of torpor or relapse into recession. In a new Financial Times op-ed, Nouriel Roubini says that weak labor markets, weak banks, weak consumers, weak profits and weak trade creates a strong risk of just such a "W-shaped" economic scenario.
If so, unemployment would remain really high. And, given that prospect, you just know incumbent Democrats facing re-election in 2010 would love to vote for Son of Stimulus. The big drawback: Doing so would risk the wrath of budget-conscious independents, as well as bond investors who share Warren Buffett’s stated concerns that all this red ink could sink the dollar. Plus, a backup in interest rates would negate any positive effects from more stimulus.
But Olivier Blanchard, chief economist at the International Monetary Fund, may have cracked the code on to boost the economy and not spook bond investors and budget hawks. Blanchard’s grand bargain, one I have been suggesting for months, is for government to spend more money in the short term to boost growth while simultaneously taking strong action to reduce the long-term budget deficit. "The trade-off is fairly attractive," Blanchard said in a report this week. "IMF estimates suggest that the fiscal cost of future increases in entitlements is 10 times the fiscal cost of the crisis. Thus, even a modest cut in the growth rate of entitlement programs can buy substantial fiscal space for continuing stimulus."
Fiscal space is good! When you’re dealing with gobsmacking budget numbers, small cuts (or even just nicks in the rate of growth) can make a huge, real-world difference. As the Peterson Foundation figures it, Uncle Sam has run up some $55 trillion in long-term liabilities. Minor tweaks that make that number a bit more manageable in the future would create huge fiscal opportunities for more pro-growth measures today.
One example: the Dartmouth Institute for Health Policy and Clinical Practice calculates that if Medicare spending across America "grew at the San Francisco rate of 2.4 percent per year instead of the current national average (3.5 percent), Medicare would achieve a cumulative savings of $1.42 trillion between now and 2023." That’s a nice chunk of change. Or, as an analysis I commissioned from the American Enterprise Institute revealed, extending the Social Security retirement age while at the same time indexing benefits to inflation rather than wages would turn a $5 trillion present value deficit into a $5 trillion surplus.
Can America afford to upgrade its rotting transportation infrastructure and electrical grid while also, say, lowering corporate and investment tax rates to a more internationally competitive level? Yes and yes. If entitlement liabilities are downscaled, the U.S economy can generate more than enough future economic growth and excess tax revenue tomorrow to "pay for" smart investments today. That would create jobs and strengthen America’s economic foundation -– and keep the bond vigilantes at bay.
Analysts brace for low third-quarter Canadian bank profits
Canadian banks will be rolling out what are expected to be lacklustre third-quarter profits this week despite their share prices having almost doubled, on average, since the height of the credit crisis in February. The rise in bank share prices shows investors are no longer worried about dividend cuts, but they shouldn't be looking for higher dividends any time soon. "There could be no dividend increases for a number of years," said James Cole, portfolio manager for AIC Investment Services Inc. "Their payout ratios are very high." His AIC Canadian Focused and AIC Canadian Balanced funds own Toronto-Dominion Bank. After the stellar rise in financial stocks since March, Mr. Cole has taken profits and reduced his holdings in other financials such as Sun Life Financial Inc. and Great-West Life Assurance Co., along with a quasi-financial Thomson Reuters PLC.
WHAT ARE THE EXPECTATIONS? If the earnings forecasts prove accurate, this quarter will mark the seventh consecutive quarter of year-over-year earnings declines for Canadian banks, Macquarie Capital Markets Canada Ltd. said in a report to clients. Sagging third-quarter results will likely reflect the continuing rise in loan-loss provisions and the effect of a 4-per-cent rise in the average number of shares outstanding on a fully-diluted basis, the report said.
The Bank of Montreal kicks off the bank earnings season tomorrow. Analysts forecast its third-quarter profit declined 14 per cent to 95 cents a share from a year ago, according to Thomson Reuters First Call.
Analysts think the Canadian Imperial Bank of Commerce will see its third-quarter profit drop 16 per cent to $1.39 a share when it reports on Wednesday. On Thursday, the Royal Bank of Canada is expected to post a 20-per-cent slump in third-quarter profit to 91 cents a share and the Toronto-Dominion Bank a 14-per-cent drop to $1.23 a share. Reporting by the five largest Canadian banks winds up on Friday, with the Bank of Nova Scotia forecast to see its profit decline 16 per cent to 84 cents a share.
HOW WILL THE MARKET REACT? Investors will be tuning in to hear what the banks have to say about the state of corporate and commercial lending, and how real estate loans are faring. Another key they'll be paying attention to is whether the credit environment is likely to improve, strategists say. Macquarie thinks the bank's share prices have already factored in all the short-term positives. "Given that our valuation methodology prices the stocks based on our outlook for profitability over the next four quarters, on aggregate the Canadian banks do seem expensively priced," said Macquarie analysts Sumit Malhotra and Bryan Brown.
Another issue is with the quality of bank earnings. As a result of the "characterization of 'operating' earnings put forth by management," which excludes one-time capital market-related writedowns, bank income based on generally accepted accounting principles now accountsfor only 56 per cent of so-called operating earnings, compared with 94 per cent in 2007, Mr. Malhotra and Mr. Brown said. They expect that differential will narrow as loan losses fall. Desjardins Securities has a more optimistic view and sees about a 10-per-cent upside for its "hold"-rated Canadian banks, and a potential 22-per-cent gain in share prices for "top pick" Toronto-Dominion Bank.
Major tests lie beyond 2009 as UK wary of sting in recession's tail
While the rest of the world is preparing for a post-recession party as growth returns to some of the biggest economies, the UK is still in sober mood. Some of the most powerful policy-makers in the world, not least Ben Bernanke, chairman of the US Federal Reserve, have declared the beginning of the end of the global recession. Not so in the UK, where Mervyn King, Governor of the Bank of England, has played down recovery, focusing instead on threats that remain.
The sobering message applies the world over: recovery may have started, but the major tests lie beyond 2009, when stimuli are unwound and consumers may not have the appetite, or the capacity, to spend. Without doubt the picture is rosier now than it was at the beginning of the year. Out of the blocks first in the global race for growth were Japan, Germany and France, which all reported expansion for the second quarter. Lagging behind were the US, Italy and the UK, where the economy shrank by 0.8pc in the second quarter, the most of the major economies,
So the UK is playing catch up, with growth at home expected to resume in the third quarter. As Simon Hayes, economist at Barclays, puts it: "The recovery is spreading." However, while growth elsewhere is good for sentiment, it does not necessarily have a significant or direct impact on prospects for the UK economy. There is still hope that a broader rebound in activity abroad will drive a significant increase in UK exports, and help to lift it out of recession, as the relative weakness of the pound makes the country’s goods more competitive.
Japan, however, is not one of the UK’s key export markets. Germany and France are important export markets for the UK, but so far there has been no evidence to suggest that recovery there is boosting demand for British goods. "The common factor in all three G7 economies that grew again in Q2 was a large positive contribution from external trade, with imports falling in every case. This is positive for GDP in these countries but not much use to anyone else," said economists at Capital Economists.
There can be no certainty yet of course that the German and French economies did actually grow in the second quarter, as the numbers so far have only been initial estimates. There were raised eyebrows among the senior echelons at the Bank England when the growth figures were published. Adam Posen, who will join the Bank’s Monetary Policy Committee next month, said he had been "surprised" by the news. Where growth did occur, economists at Capital Economists are underwhelmed. "It was never very likely that the G7 economies would continue shrinking as fast as they once were. Given this context, the recovery is much less impressive," they said in a note.
Back in the UK, the emphasis is still very much on caution. Earlier this month the MPC voted to pump an extra £50bn into the economy, extending its quantitative easing scheme to £175bn. A vote of no confidence, it would seem, in the economy, just as the market believed things were picking up. What is increasingly unclear, both for those ahead and behind in the race to recovery, is how long-lasting recovery will be. "The fear is that once monetary and fiscal stimulus winds down, recovery will be on very shaky ground," economists at Barclays Capital said in a note.
"We see the Japanese economy hitting a soft patch in the first half of 2010, as private consumption and public investment recoil after earlier stimulus-induced front-loading." The same applies elsewhere. "Some of the recent stabilisation in activity likely reflects temporary factors," said Colin Ellis, economist at Daiwa Securities. "In particular, in the cases of France and Germany, the car scrappage schemes that have encouraged households to bring forward consumption. These have offered some support to spending and production. But as the schemes expire, households will have to face up to high and rising unemployment and weak earnings."
Fiscal consolidation in the UK, where national debt is already approaching 60pc of GDP, is inevitable. So while the economy may be on the verge of growth, consumers face the unsavoury combination of tax rises, spending cuts, rising interest rates, and high levels of unemployment as the recession leaves scars on the economy. The emergence from recession may not be so sweet after all. The hope now is that global recovery does not prove to be a false start.
U.K. House Prices to Drop Further 13%, Bond Investors Forecast
U.K. house prices will plunge another 12.7 percent before bottoming out, according to bond investors surveyed by Royal Bank of Scotland Group Plc. Britain’s homes, which have already fallen 15 percent since October 2007, have further to fall, said 86.4 percent of respondents to RBS’s poll of mortgage-backed debt investors. The U.K.’s biggest bank controlled by the government distributed the result of the survey in an e-mail to clients on Aug. 21. "General opinion was that U.K. housing has another down leg to take," RBS said in the note.
RBS’s survey contradicts evidence U.K. real estate is starting to recover as the economy emerges from the worst recession in decades. House prices rose for a third month in July, according to Nationwide Building Society, while the Royal Institution of Chartered Surveyors said Aug. 6 that prices will increase this year, reversing an earlier prediction of a drop of as much as 15 percent. The RBS survey also forecasts the market for bonds backed by U.K. mortgages will deteriorate, the Edinburgh-based lender said. The poll showed that 63.6 percent of investors thought that bond yields, which move inversely to prices, will increase relative to benchmark rates. The remainder of respondents expected spreads to narrow.
Other data are signaling Britain’s real-estate market is already bouncing back, with Nationwide Building Society’s last monthly survey showing average house prices rose 1 percent in June, and the Bank of England saying last month U.K. mortgage approvals climbed to a 14-month high. In London, luxury-home prices gained for a fourth month in July, climbing 1.5 percent, according to brokers Knight Frank. The drop in house prices forecast in RBS’s survey adds to the 15 percent decline U.K. homes have already suffered since their peak in October 2007, Nationwide data show.
Federal Reserve Chairman Ben S. Bernanke and European Central Bank President Jean-Claude Trichet signaled last week that the worst of the global recession may be over. The U.S. housing market is already showing signs of recovery with sales of existing homes jumping 7.2 percent in July to the highest level since August 2007, the National Association of Realtors said Aug. 21.
Irish real estate values to plunge by 50% as property crash worsens
The price of the average house in Ireland is set to drop by nearly 50 percent from their eye-popping peaks. New figures from Ulster Bank show that housing prices have already dropped by 35 percent and another 10 percent is expected through the end of 2010. Mind you, that's a conservative estimate from the lending side of the equation, who clearly want to see an improvement soon. But developers fear it will be even worse. They say the value of development and commercial land will drop by about 70 percent which will push the house prices down even further. "What's happening here," said one developer, "is that people like me bought land at the peak with the idea of selling $500,000 apartments."
"Now we're left with over-priced sites which we can't get a loan to develop, and even if we could get a loan, no-one's going to pay $500,000 now for an apartment. We're up to our necks in it." In County Cork, Greencore Group has shelved plans to build a 400-acre development in Mallow. Greencore - which took over Irish Sugar in 1991 - planned to convert Irish Sugar's former factories which were idled when Irish Sugar closed its doors in 2005 and 2006. At the time, property prices were on a one-way climb and Greencore planned to build houses, offices and even golf courses at the former factories.
However, Greencore has shelved those plans and does not intend restarting the projects any time soon. "You would be insanely optimistic and absolutely naive to think there’s now a market for building out the sort of developments that were envisaged 18 or 24 months ago," said Greencore CEO Patrick Coveney. It’s "not clear at all that it’s bottomed out," said Coveney, 38. "I would question people who assert with seemingly absolute confidence that the property market is going to go up in years to come."
Ilargi: Nice background on "the world's most powerful woman".
Merkel’s Bargain With Ackermann Near Abyss Signaled Re-Election
Germany was minutes away from its biggest bank failure since 1931 when Chancellor Angela Merkel found herself bargaining with Deutsche Bank AG Chief Executive Officer Josef Ackermann on his mobile phone. The nation’s financial system was heaving after credit evaporated with the Lehman Brothers Holdings Inc. bankruptcy two weeks earlier. Merkel and Ackermann now were haggling over how much money banks would provide to avoid their mutually assured destruction if they didn’t come to terms before the Asian markets opened.
Europe’s largest economy and its bankers were "millimeters from the abyss," said Finance Minister Peer Steinbrueck, before Merkel broke the deadlock. When she accepted Ackermann’s final offer, the banks agreed to provide 8.5 billion euros ($12 billion) as part of a 35 billion-euro rescue package for Munich- based Hypo Real Estate Holding AG last Sept. 29. "If she hadn’t reached me at a quarter to one that morning, it would have been over," Ackermann told lawmakers on July 28. "I ran back to our room and shouted: ‘stop, stop, there is a solution.’"
If Merkel was engaging in brinksmanship for tactical reasons, "it went pretty far," Ackermann said. "It was dangerous." That political savvy, honed during East Germany’s transition to democracy 19 years ago and sharpened during the 25-month-old financial crisis, is yielding dividends as Merkel retains a lead of 15 percentage points in the weeks before the Sept. 27 election. As chancellor, she is more popular than the Christian Democrats she has led since 2000 and with whom she has been affiliated in the Bundestag since reunification in 1990.
"She puts out an aura of sober seriousness that’s just what people want" now, says Carl Graf von Hohenthal, a management adviser at the Brunswick Group and former deputy editor-in-chief of Die Welt newspaper, who has known her since 1990. At the same time, "Merkel comes across as utterly normal and the average German can really relate to her." Merkel, 55, and her second husband, Joachim Sauer, reject the sprawling living quarters in the chancellery and instead live in her 19th century apartment building in Berlin’s central Mitte district. She disdains the official retreat, a restored 18th century Prussian palace, spending weekends at the family country house in the village of Hohenwalde, 80 kilometers (50 miles) northeast of the capital.
Merkel wheels a shopping cart through her local food store, trailed by her security detail, at least once a month. She even bags her own groceries. "We don’t open a special check-out for her but make sure it doesn’t take too long when she comes," says Stefan Vetter, manager of the Ullrich Verbrauchermarkt outlet five blocks from the chancellery in Berlin. "She chooses her own fruits and vegetables and when she can’t find something, she asks."
The first female chancellor and first from the east has struck popular chords with her electorate, emphasizing holding down debt, limiting executives’ pay and battling what she calls the "arrogance" of financial markets that she says triggered the worst recession since World War II. "Germans don’t like a rah-rah leader in times of crisis," says Fred Irwin, head of the American Chamber of Commerce in Germany who also chairs the trust that controls General Motors Co.’s Opel unit based in Ruesselsheim, near Frankfurt. "They want a serious, thinking, down-to-earth individual that is worried about their interests."
Merkel’s government has fought the recession with measures that provide 115 billion euros of credit to companies and 85 billion euros in spending, including incentives to trade in old cars and subsidies to keep idled workers on the payroll. While she has sparked trans-Atlantic discord and faced criticism from economists such as Nobel Prize winner Paul Krugman that she underestimated the depth of the economic slump, those initiatives are paying off.
Germany’s economy defied analyst predictions and grew 0.3 percent in the second quarter, ending the recession. While unemployment has climbed to 8.3 percent, it’s still lower than the 11.5 percent when she took office, avoiding the spikes in joblessness that have punished France, Britain and the U.S. The DAX stock index is the only benchmark equity gauge among the Group of Seven nations that has avoided a decline during Merkel’s tenure, remaining unchanged since she took office on Nov. 22, 2005.
As she did with bankers over Hypo, Merkel is engaged in a battle with Detroit-based GM over the sale of Opel, pressing them for a decision this week. She has stressed her "clear preference" for a bid by car-parts maker Magna International Inc. of Aurora, Ontario, over a rival offer from Brussels-based private-equity group RHJ International SA. Merkel said it’s "regrettable" that GM’s board took no decision on a buyer for Opel when it reviewed bids on Aug. 21. "Every day counts for workers and for the economic situation" of Opel, Merkel said in an interview yesterday on ZDF television.
Merkel relies on a mix of charm, persistence and knowledge of detail in negotiations, says Gerd Langguth, author of "Angela Merkel," published in 2005. "She’s got a sustained kind of charm," Langguth, a University of Bonn political science professor, said in a phone interview. "It matches what you hear from Ackermann. She’s always friendly, but tough. When she wants something, she’ll keep coming back with new arguments."
Polls suggest Merkel will garner enough votes for her Christian Democratic Union to govern with her preferred ally, the Free Democratic Party. That would allow her to ditch the Social Democrats, led by Foreign Minister Frank-Walter Steinmeier, 53, and point Germany toward tax cuts, looser labor rules and halting the closure of some of its 17 nuclear plants. In her party’s election platform, Merkel pledged to pare the lowest income-tax bracket to 12 percent from 14 percent and raise the threshold for the 45 percent top rate to 60,000 euros from 52,000 euros. She also aims to build on Germany’s automotive expertise to make it a world leader in electric cars, putting at least 1 million such vehicles on the road by 2020.
Born in Hamburg in 1954 to a Protestant pastor and a schoolteacher, Merkel moved with her family to East Germany, where her father took up a church parish. She became a member of a communist youth group, though she never joined the Communist Party. Merkel gained a degree in physics from the Karl Marx University in Leipzig, then a doctorate in quantum chemistry from the Central Institute of Physical Chemistry at the Academy of Sciences in East Berlin, where she worked until 1990.
Merkel’s first big break came that year as East and West Germany raced toward reunification after the Berlin Wall fell on Nov. 9, 1989 -- and it came thanks to a colleague’s fear of flying. Lothar de Maiziere, East Germany’s only democratically elected premier, made Merkel his deputy spokeswoman in the months before the two Germanys merged in October 1990. His chief spokesman at the time so disliked planes that Merkel was pushed to the forefront during unity talks with the Soviet Union and the U.S., when her fluent Russian and English proved crucial, de Maiziere said in a telephone interview. He recommended Merkel for united Germany’s first Cabinet in 1991.
Chancellor Helmut Kohl was looking for an East German -- a woman, and someone "soft" -- to balance his Cabinet, says de Maiziere. Aged 36, she was named minister for women and youth, the youngest minister in the postwar era. Promoted after the 1994 election to minister for the environment and nuclear reactor security, Merkel was put in charge of a United Nations-sponsored climate conference that ran into "a morass of colliding interests," recalls Erhard Jauck, a career civil servant who was her deputy from 1995 to 1998.
After two weeks, the talks were going nowhere and Merkel sought out each delegation separately to hammer out a compromise. The Berlin Mandate, as the resulting declaration became known, contributed to the Kyoto Protocol that still guides efforts to cut the gases blamed for global warming. Merkel pulled off a "quite astonishing display of negotiating prowess" that got her noticed on the international stage, Jauck said in a phone interview.
She garnered more attention when she turned on her mentor. In 1999, with the Christian Democrats embroiled in a financing scandal, Merkel urged the party in a letter to the Frankfurter Allgemeine Zeitung newspaper to dump Kohl, who was chancellor for 16 years until 1998. Dubbed the "Iron Frau" by German media, she went on contest the elections as CDU leader in 2005. "My leitmotif is that my decisions are well thought out," Merkel said on ZDF yesterday when asked about her guiding principles. "Especially that I make the right decisions for the future."
When Gerhard Schroeder, the Social Democratic chancellor, called early elections in 2005, polls showed her CDU 20 points ahead three months before the vote. That edge shrank to one point on Election Day, forcing Merkel to govern with her Social Democratic rivals in a so-called grand coalition. About five weeks before this year’s election, polls show the CDU with a lead of between 12 and 15 percentage points. In personal popularity terms, she leads Steinmeier by 36 points, a Forsa poll of 2,506 voters published Aug. 19 in Stern magazine showed. The survey, conducted Aug. 11-17, had a margin of error of 2.5 percentage points.
As she makes the rounds of election TV talk shows, Merkel has offered glimpses into her personal life. She cooks on weekends and makes "a mean potato soup," she said May 17 at a town-hall style meeting broadcast on RTL. She says her Christian faith means "it’s OK to make mistakes and that you shouldn’t take yourself too seriously." She does her own laundry when time permits. "Chancellor Merkel sure knows how much a loaf of bread costs," supermarket manager Vetter says.
China powers ahead as it seizes the green energy crown from Europe
China is running away with the green technology prize. It has conquered a third of the world market for solar cells and is on a breakneck course to build 100 gigawatts of wind turbines by 2020, doubling again the global capacity for wind power across vast stretches of Inner Mongolia and Xinjiang. Suntech Power in Wuxi has just broken the world record for capturing photovoltaic solar energy, achieving a 15.6pc conversion rate with a commercial-grade module.
Trina Solar is neck-and-neck with America's First Solar, the low-cost star that has already broken the cost barrier of $1 (61p) per watt with thin film based on cadmium telluride. The Chinese trio of Suntech, Trina and Yingling all expect to be below 70 cents per watt by 2012, bringing the magical goal of "grid parity" with fossil fuels into grasp. The concept of grid parity is subject to fierce debate, mostly revolving around which form of fuel – nuclear, oil, coal, or renewables – enjoys the biggest implicit subsidy, and what the future price of crude is likely to be. Parity has already been achieved in hot spots. First Solar's 10-megawatt plant in Nevada can produce electricity without subsidies for 7.5 cents per kilowatt hour compared to 9 cents for fossil-based power.
Jeremy Leggett, founder of Britain's Solar Century, says that even this cloudy island can achieve grid parity for households by 2013, seven years sooner than expected. South-facing roofs and facades could one day provide a third of UK electricity needs. The credit crunch has been brutal for solar start-ups in the West, but not for Chinese firms with access to almost free finance from the state banking system. They have taken advantage of the moment to flood the world with solar panels, driving down the retail price from $4.20 per watt last year to nearer $2 in what some say is a cut-throat drive for market share.
German pioneers Solarworld and Conergy allege foul play and have called for EU sanctions, accusing Chinese rivals of practices that "border on dumping". China's finance ministry says it intends to cover half the investment cost of solar projects. It is a life-and-death moment for the German solar industry, pioneers who provide 75,000 jobs and once led the world. "A large number of German solar cell and solar module producers will not survive," said UBS's Patrick Hummel. Q-Cells is cutting four production lines and 500 jobs at its base in Thalheim, switching assembly to Asia. Goldman Sachs has added the company to its "conviction sell" list.
Roughly speaking, Chinese firms can undercut the Germans by 30pc. At root, it is a currency problem. China has stolen a march against Europe over the last five years by linking an already undervalued yuan to a weak dollar. While Beijing sheds crocodile tears about the falling greenback, it is deliberately riding dollar devaluation to protect its own export share. What is happening to German solar firms is a revealing case study of the slow-burn damage caused by currency misalignment. The solar glut will not last. China is orchestrating a big switch into solar power for its own households with a feed-in tariff that lets people sell electricity to the grid. But that may come too late to save German firms.
China has tripled its goal for wind power to 100 gigawatts by 2020. While the West bails out banks, China is spending a big chunk of its $600bn stimulus on "clean tech" projects and a smarter grid. Yes, you still have to wear a face mask to breathe in the soot-blackened industrial hubs of the interior. By the same token, the solar-and-wind hub of Baoding has become the first carbon-positive city in the world. Whether China is pushing the green agenda because it believes in global warming is almost irrelevant. The country fears being caught short as the global scramble for diminishing resources starts in earnest.
China's coal reserves are not as deep as often assumed. Coal imports surged 130pc in the first half of this year. Australia's Newcastle University expects the world to reach "Peak Coal" in 2026, much earlier than expected. Unfortunately, feckless Britain will be caught short by the energy crunch. Labour dithered for a decade as North Sea oil began to decline – failing to bite the bullet on nuclear, clean coal, or renewables until far too late. This Government simply failed to understand the impact of Asia's industrial revolutions.
While it makes much noise about CO2 emissions, Labour has been deaf to warnings of a power crunch. We may soon be moving into a phase of history when ill-prepared countries cannot be sure of obtaining energy – whatever the price. Ah yes, the Danish wind company Vestas has just closed its turbine plant on the Isle of Wight and shed 425 jobs, citing Britain's Nimby culture and the red tape of the planning bureaucracy. Vestas is switching to the US and China. Makes you weep.
Coal Rally Ending as China Shuns Imports, Opens Mines
China’s unprecedented appetite for imported coal is about to be sated, jeopardizing a five-month rally in prices by adding to a global surplus of the fuel used in power plants from Perth to Chicago. After importing a record 48 million tons in the first six months, China is opening mines idled by worker deaths this year following safety upgrades in a bid to bolster economic growth. Huadian Power International Corp. expects China’s largest coal- mining province, Shanxi, to boost output by 60 percent in the second half of the year. That would mean an increase of 150 million metric tons, almost twice what Germany burns annually.
With little need to buy coal outside the country, prices may tumble, falling as much as 7 percent in Europe alone, Barclays Capital says. China’s purchases will plunge 33 percent between June 30 and Dec. 31, based on the median estimate of four analysts surveyed by Bloomberg. "In the first half, China really supported the market and put a pretty firm floor under the thermal-coal price because it was sucking in so many imports," said Andrew Harrington, an analyst at Patersons Securities Ltd. in Sydney. "It’s difficult to be confident that it will continue at such a rate."
China’s July coal imports fell 13 percent to 13.9 million tons from 16 million tons in June, a record high, customs data show today. Demand from China, which uses coal to generate about 80 percent of its electricity, helped ease a global supply glut that sent U.S. inventories to an 18-year high. A retreat in prices may curb profit at Xstrata Plc, the mining company that is the biggest shipper of coal for power stations, said Nick Hatch, an analyst at ING Groep NV in London. Coal was the biggest contributor to operating earnings last year for Zug, Switzerland-based Xstrata, which boosted output of the mineral by 11 percent in the first half.
"If China stops importing as much coal, it clearly may mean lower coal prices in the seaborne market, and that could have an impact on earnings," said Hatch, who has a "buy" rating on Xstrata and mining companies Rio Tinto Group and Anglo American Plc, which also produce coal. Claire Divver, a spokeswoman for Xstrata, declined to comment. Murray Houston, the general manager for the company’s South African coal unit, said on Aug. 13 that shipments to China will increase "due to a tight domestic market." Six-month supply contracts signed by Chinese buyers in February and March are expiring and aren’t likely to be renewed at the same amounts as global costs remain high and as domestic supplies rise, said Huang Teng, the general manager of Beijing LT Consultant Ltd., a coal consultant based in the capital city.
Chinese provinces are accelerating the expansion of coal mines, the China Coal Transport and Distribution Association said in a statement on its Web site today. The reopening of small mines in regions including Shanxi will increase supplies and put pressure on prices. The benchmark price at Qinhuangdao port was unchanged for a third week at 570 yuan ($83.44) a ton on Aug. 24, according to the government-backed association. Coal futures for September delivery at Rotterdam, the benchmark for Europe, have risen 39 percent to $72 a ton on Aug. 21 from this year’s low of $51.75 on March 12. Prices rebounded from a 35 percent decline last year, when the recession slowed demand for electricity. Supplies for delivery in January are trading 7.6 percent higher than the September contract.
That premium for delivery early next year may shrink because China won’t be buying as much of the world’s surplus, said Amrita Sen, a commodity analyst at Barclays Capital in London. Coal delivered at Rotterdam will fall to an average of $67.20 a ton from $72 in the first six months, she said. "China has been a key factor in providing a floor to prices and any softening in Chinese buying will pressure coal," Sen said. "We will see a softening on a month-on-month basis in Chinese coal imports."
Prices of coal shipped from South Africa’s Richard’s Bay, which exports to Europe and Asia, posted a second straight drop last week. Export prices at the port fell 10 cents, or 0.2 percent, to an average of $64 a metric ton in the week ended Aug. 21, according to McCloskey Group Ltd. An end to the global recession may trim the surplus. China has spent 4 trillion yuan in a stimulus package designed to support its economy. The world’s third-largest economy grew 7.9 percent in the second quarter from a year earlier after expanding at the slowest pace in almost a decade the previous three months, the statistics bureau said July 16.
"Price momentum and volume momentum are so strong, it’s difficult to see why the price should go down," said Eugen Weinberg, a senior commodity analyst at Commerzbank AG in Frankfurt. "Measures to initiate demand are extraordinary." Drax Group Plc, the owner of western Europe’s biggest coal- fed power plant, has no plans to sell its surplus inventories of the fuel because the North Yorkshire, U.K.-based company expects the value of the commodity to increase. "We see the coal market rising," Chief Executive Officer Dorothy Thompson said on an Aug. 4 conference call with reporters. "It does not make sense to sell coal now."
China, the world’s largest producer and consumer of coal, ordered the closure of almost all 10,000 of the country’s small pits during the Spring Festival in January, and plans to open some were delayed following a deadly accident in February. An explosion at a shaft in Shanxi killed 74 and injured as many as 114 miners, leading to more intense safety checks. Small mines that account for about 25 percent of China’s production were told to merge and those deemed unsafe were closed.
The nation’s coal mines are the most deadly in the world, with 3,770 workers killed in 2007, more than 100 times the number of fatalities in the U.S., the second-largest producer, according to government data. Suppliers kept old pits open, ignoring safety rules and forgoing routine checks, to meet surging demand from the world’s fastest-growing major economy. The mine closures and lower prices led to an increase in purchases from overseas. Imports surged to 16 million tons in June, bringing the first-half total to 48 million, according to customs data. Thermal-coal futures in Newcastle, Australia, the world’s largest coal port, have rallied 22 percent from a low in March to $72.90 a ton on Aug. 21, according to ICE Futures.
While most of the world’s output is used near where it is mined, export prices are determined by the remaining 16 percent bought and sold internationally, data from the London-based World Coal Institute show. Thermal coal used in power plants accounts for 92 percent of global production and 72 percent of international trade, according to the U.S. Energy Department. The rest is mostly used in steelmaking. After completing safety checks and consolidating small pits that had an annual capacity of 300,000 tons or less, the province of Shanxi is accelerating the pace of mine openings to revive the worst-performing provincial economy in China. The region’s gross domestic product contracted 4.4 percent in the first half, according to government data.
"The province started approving restructuring plans in April and the process of consolidating mines has started," said David Fang, the director of the international department at the China Coal Transport and Distribution Association. "Small mines are reopening gradually." Of the 10,000 small mines in China, about 2,598 are in Shanxi, according to the China Daily newspaper. Output in Shanxi may rise to 400 million tons in the second half from 250 million tons in the first six months, said Chen Jianhua, the president of Huadian Power, the fourth-largest Hong Kong-listed Chinese electricity generator. Chen expects Shanxi production to reach 650 million tons in 2009.
China produced 2.6 billion tons last year, according to the national bureau of statistics, which compiles data for the government. China is likely to cut imports by 33 percent in the second half of the year to 32 million tons, according to four analysts and industry officials in a Bloomberg survey. Reduced demand may swell global supplies that ballooned during the recession. Stockpiles held by electricity generators in the U.K., Europe’s biggest importer of coal, rose 68 percent in May from a year earlier to 17.4 million tons, the most since at least 1995, government data show. "Europeans are fully stocked, but not reselling because they fear higher prices with an Asia-led economic recovery," said Emmanuel Fages, a Paris-based commodities analyst at Orbeo. "The cost of carry for storing coal is cheaper than buying the coal for later delivery."
In the U.S., inventories jumped 15 percent in the first four months of the year, compared with a 1.1 percent gain in 2008 and 2.4 percent in 2007, Department of Energy data show. Stockpiles at the end of last year totaled 199.2 million short tons (180.7 million metric tons), the highest since 1991. Global supply of internationally traded thermal coal is forecast at 633 million tons next year, exceeding demand by 14 million tons, according to forecasts from Macquarie Group Ltd., Australia’s largest investment bank.
The rapid increase in Chinese coal output may upset the calculations of producers in other countries, including the U.S., where exports rose 38 percent last year. St. Louis-based Peabody Energy Corp. sold 16 percent of its coal production outside the U.S. last year, regulatory filings show. The company’s sales outside the U.S. climbed 30 percent to 40.3 million tons, outpacing total sales growth of 8.2 percent to 255.5 million. "China has been an indirect market" for the U.S., said James M. Rollyson, an energy analyst at Raymond James Financial Inc. "It’s soaked up capacity from Australia, so it kind of makes waves into other markets."
World faces hi-tech crunch as China eyes ban on rare metal exports
Beijing is drawing up plans to prohibit or restrict exports of rare earth metals that are produced only in China and play a vital role in cutting edge technology, from hybrid cars and catalytic converters, to superconductors, and precision-guided weapons. A draft report by China’s Ministry of Industry and Information Technology has called for a total ban on foreign shipments of terbium, dysprosium, yttrium, thulium, and lutetium. Other metals such as neodymium, europium, cerium, and lanthanum will be restricted to a combined export quota of 35,000 tonnes a year, far below global needs.
China mines over 95pc of the world’s rare earth minerals, mostly in Inner Mongolia. The move to horde reserves is the clearest sign to date that the global struggle for diminishing resources is shifting into a new phase. Countries may find it hard to obtain key materials at any price. Alistair Stephens, from Australia’s rare metals group Arafura, said his contacts in China had been shown a copy of the draft -- `Rare Earths Industry Devlopment Plan 2009-2015’. Any decision will be made by China’s State Council.
"This isn’t about the China holding the world to ransom. They are saying we need these resources to develop our own economy and achieve energy efficiency, so go find your own supplies", he said. Mr Stephens said China had put global competitors out of business in the early 1990s by flooding the market, leading to the closure of the biggest US rare earth mine at Mountain Pass in California - now being revived by Molycorp Minerals.
New technologies have since increased the value and strategic importance of these metals, but it will take years for fresh supply to come on stream from deposits in Australia, North America, and South Africa. The rare earth family are hard to find, and harder to extract. Mr Stephens said Arafura’s project in Western Australia will produce terbium, which sells for $800,000 a tonne. It is a key ingredient in low-energy light-bulbs. China needs all the terbium it produces as the country switches wholesale from tungsten bulbs to the latest low-wattage bulbs that cut power costs by 40pc.
No replacement has been found for neodymium that enhances the power of magnets at high heat and is crucial for hard-disk drives, wind turbines, and the electric motors of hybrid cars. Each Toyota Prius uses 25 pounds of rare earth elements. Cerium and lanthanum are used in catalytic converters for diesel engines. Europium is used in lasers. Blackberries, iPods, mobile phones, plams TVs, navigation systems, and air defence missiles all use a sprinkling of rare earth metals. They are used to filter viruses and bacteria from water, and cleaning up Sarin gas and VX nerve agents.
Arafura, Mountain Pass, and Lynas Corp in Australia, will be able to produce some 50,000 tonnes of rare earth metals by the mid-decade but that is not enough to meet surging world demand. New uses are emerging all the time, and some promise quantum leaps in efficiency. The Tokyo Institute of Technology has made a breakthrough in superconductivity using rare earth metals that lower the friction on power lines and could slash electricity leakage. The Japanese government has drawn up a "Strategy for Ensuring Stable Supplies of Rare Metals". It calls for `stockpiling’ and plans for "securing overseas resources’. The West has yet to stir.