Mexican Central Railway train at station
Ilargi: Last week, James Lockhart, as head of the FHFA, the regulator of Fannie Mae and Freddie Mac as well as the FHA, announced that Fannie and Freddie‘s losses, totaling $86.9 billion and $63.7 billion, respectively, since the third quarter of 2007, will continue for “at least the next year or so”. Lockhart also said at the time that "some" of the money pumped in to Fannie and Freddie will never be repaid.
Today, Lockhart announced he is leaving his post imminently, shortly after Moody’s stated its belief that Fannie and Freddie will be dismantled by Washington. Coincidentally, sometime in the next ten days, Fannie and Freddie will present their second-quarter results.
Lockhart officially leaves because he is a republican, even a former W classmate, and wants time with his family; he did say, though, that he made so little money in government that he doesn’t have enough to retire yet.
My take on his reason to leave is just a tad more cynical than the spending time with the wife and pets one. I think Lockhart leaves because he has loaded up Fannie and Freddie, and through them the taxpayer, with all the debt he could possible cram into them.
Lockhart is one of the least known, yet most harmful Americans (oh, sweet combination... ) in recent history. He was brought in in 2006 at the OFHEO to facilitate and accelerate Fannie and Freddie's virtually limitless purchases of bad loans from Wall Street, and he leaves heading the FHFA, as no more toxics can be bought with your money without Lockhart and many others risking substantial prison terms.
Moreover, I think the forthcoming 2nd, 3rd and 4th quarter company results will be so bad that unwinding the two, a process that will take many years and be at least as profitable for Wall Street as the estimated $1 billion AIG unwind, is now inevitable.
Interestingly, Moody’s claims that, even though it has no idea what direction Washington wants to take Fannie and Freddie in, maybe a new company (?), either private or public (?), it does know that all bondholders will be made whole. So it should come as no surprise that stocks in Fannie and Freddie as well as AIG (63%!) soared today. The wager of course is that you can't lose on the shares, since any downside will be made up with public funds.
I would also wager that the suddenly appearing simultaneous reports on the demise of Fannie, Freddie and AIG are no coincidence. I think they are as much non-denial-like semi-prepared statements as the second stimulus and the rising tax rates are that we've seen on Sunday morning shows.
The reason lies in a report issued by Deutsche Bank analysts today, which says they expect half of all US mortgages to be underwater by 2011, with 89% of Option-ARM loans in that category (why does that make me think of an iceberg?). Fannie and Freddie hold about half of all US mortgages, with probably a substantially higher percentage of the “bad" ones, for a total portfolio between $5 and $6 trillion.
And that may not even be their biggest risk factor. They have issued mountains of securities based on those rancid loans, and that might be far more of a dealbreaker. Though we are obviously not allowed to know what lies in their vaults any more than what lies in Wall Street banks’ coffers.
As I've repeated till you must have gotten bored mindless -please Lockhart, never return!-, Fannie and Freddie should have been deconstructed ages ago. Which makes the fact that they now -obviously suddenly- will be all the more interesting. There's only one reason I can see to do so at this point of time: Washington has seen the upcoming loss estimates, and the entire Oval Office, including the wallpaper, went a whiter shade of pale.
If there are still people out there who believe there is a recovery underway, I strongly suggest you ponder why the administration chooses now, early August, to leak news on the unfortunate and "much too young" parting of the three semi-private corporations that have stuck the taxpayer with far more losses than all the rest of them combined. If that recovery thing were real, do you think that would happen? I think not. I think Fannie and Freddie have been such a great vehicle for transferring losses to the public that Wall Street will be crying real tears at their graves.
I think today marks a turning point in the financial crisis. A large part of the make-believe has -reluctantly- been let go. Not that no replacements have been set up, but it's hard to rival the real deal. Let's see how things play out through the rest of the month to see how accurate my antennas are.
About half of U.S. mortgages seen underwater by 2011
The percentage of U.S. homeowners who owe more than their house is worth will nearly double to 48 percent in 2011 from 26 percent at the end of March, portending another blow to the housing market, Deutsche Bank said on Wednesday. Home price declines will have their biggest impact on prime "conforming" loans that meet underwriting and size guidelines of Fannie Mae and Freddie Mac, the bank said in a report. Prime conforming loans make up two-thirds of mortgages, and are typically less risky because of stringent requirements.
"We project the next phase of the housing decline will have a far greater impact on prime borrowers," Deutsche analysts Karen Weaver and Ying Shen said in the report. Of prime conforming loans, 41 percent will be "underwater" by the first quarter of 2011, up from 16 percent at the end of the first quarter 2009, it said. Forty-six percent of prime jumbo loans will be larger than their properties' value, up from 29 percent, it said. "The impact of this is significant given that these markets have the largest share of the total mortgage market outstanding," the analysts said. Prime jumbo loans make up 13 percent of the total market.
Deutsche's dire assessment comes amid a bolt of evidence in recent months that point to stabilization in the U.S. housing market after three years of price drops. This week, the National Association of Realtors said pending home sales rose for a fifth straight month in June. A widely watched index released in July showed home prices in May rose for the first time since 2006. Covering 100 U.S. metropolitan areas, Deutsche Bank in June forecast home prices would fall 14 percent through the first quarter of 2011, for a total drop of 41.7 percent.
The drop in home prices is fueling a vicious cycle of foreclosures as it eliminates homeowner equity and gives borrowers an incentive to walk away from their mortgages. The more severe the negative equity, the more likely are defaults, since many borrowers believe prices will not recover enough. Homeowners with the riskiest mortgages taken out during the housing boom have seen the greatest erosion in equity, in part because they were "affordability products" originated at the housing peak, Deutsche said. They include subprime loans, of which 69 percent will be underwater in 2011, up from 50 percent in March, Deutsche said,
Of option adjustable-rate mortgages -- which cut payments by allowing principal balances to rise -- 89 percent will be underwater in 2011, up from 77 percent, the report said. Regions suffering the worst negative equity are areas in California, Florida, Arizona, Nevada, Ohio, Michigan, Illinois, Wisconsin, Massachusetts and West Virginia. Las Vegas and parts of Florida and California will see 90 percent or more of their loans underwater by 2011, it added. "For many, the home has morphed from piggy bank to albatross," the analysts said.
More Homeowners ‘Upside Down’ on Mortgages
Home price declines may be luring more home buyers back to the market, but they’re also leaving more American homeowners with negative equity. Some 24% of owner-occupied homes had mortgage debt that exceeded the values of those homes at the end of June, according to data from Equifax and Moody’s Economy.com. That number rises to 32% when looking at the share of homeowners with mortgages that don’t have equity left in their homes.
Overall, 16 million homeowners are “upside-down” on their mortgages, up from 10 million, or 15% of owner-occupied homes, one year ago. Nearly 10% of owner-occupied homes now have mortgage debt with loan-to-value ratios of at least 125%, and roughly half of those homes have mortgage debt with loan-to-value ratios of 150% or more. The rising share of homeowners without equity and the foreclosure crisis continues to be the biggest storm cloud facing any possible economic recovery, says Mark Zandi, chief economist at Moody’s Economy.com. “That such a high proportion of homeowners are underwater is testimony to the severity of the foreclosure crisis and the risk that it still poses to the broader economy,” he said.
To date, most foreclosure-rescue efforts have focused on lowering monthly payments by reducing interest rates, in part because the housing crisis began with mortgages that were resetting to higher payments. But the looming negative-equity problem could put more pressure on policymakers to come up with a modification plan that includes reducing loan balances, and not just lowering interest rates. “The modification plans that they have in place … will become increasingly ineffective as more homeowners fall deeply underwater,” says Mr. Zandi. Unsurprisingly, the negative equity issue remains most severe in the sand states. Some 40% of owner-occupied homes in Nevada are underwater, followed by Arizona (37%), California (33%), and Colorado (31%).
Just 9% of eligible homeowners have had mortgage modified
Some of the nation's largest servicers are making minor progress in reworking home mortgages into more affordable monthly payments for financially strapped homeowners. In total, just 9% of eligible homeowners who are delinquent have gotten a trial mortgage modification under a federal program, according to a report Tuesday by the Treasury Department. The report lists the modification progress of major lenders since the Obama administration first announced a $75 billion housing recovery plan in March.
"We have been disappointed …about the variation in service performance in helping people in a timely fashion and with the respect they deserve," says Michael Barr, Treasury's assistant secretary for financial institutions. "We're going to be requiring ramped up efforts across the board." Among major lenders, Bank of America trails other servicers in the number of mortgage modifications it has made: It has modified only 4% of the eligible mortgages in its portfolio that are 60 or more days delinquent.
In the lead is JPMorgan Chase, which has begun trial modifications for 20% of eligible homeowners. Wells Fargo has started modifications for 6% of eligible mortgage holders. Several smaller companies — including American Home Mortgage Servicing and PNC Financial Services Group — have yet to modify a single loan, according to the report. American Home Mortgage Servicing just started the program on July 22, a spokesman said. PNC, which owns National City, was up and running in early July. "National City is working with qualified customers to make mortgage modifications available. There are loan modifications in the process," said PNC spokesman Fred Soloman.
So far, about 235,000 trial modifications have begun. If the trial modifications work successfully for three months, they then go into full effect. During a meeting last month with representatives from 25 major servicers, the government announced its goal reaching 500,000 trial mortgage modifications by Nov. 1. Under the program, servicers covering more than 85% of loans in the USA are participating in the plan to modifying loans. More than 400,000 modification offers have been extended. While Treasury officials say the pace of modifications puts the program on track to offer assistance to up to 3 million to 4 million homeowners over the next three years, Barr says some servicers need to take steps such as ramping up capacity or treating borrowers better when they contact lender call centers.
Some lenders defended their progress, say they're making modifications at a fast clip and that their overall delinquency rates are low. Wells Fargo said in a statement that through the first seven months of this year they modified more than 240,000 mortgage loans, including 20,219 trial modification starts under the federal program. They say they've hired and trained 4,000 staffers in the first half of the year for a total of 11,500 U.S.-based staff. The company also says that within weeks it will eliminate its customer service backlog.
Fannie Mae, Freddie Mac Likely to Be Wound Down, Moody’s Says
The U.S. government is likely to decide within 18 months that Fannie Mae and Freddie Mac need to be wound down and replaced with a similar entity that would support U.S. housing, Moody’s Investors Service said. The government-chartered mortgage-finance companies, which were seized by regulators in September 2008 and since have used $85.7 billion of their capital lifelines, face mounting losses that will mean “it could take a decade or longer” before they are able to emerge from U.S. control as “viable standalone entities,” the New York-based ratings company said in a report.
The increasing losses that will be caused in part by government efforts to use Washington-based Fannie Mae and Freddie Mac of McLean, Virginia as tools to stem the housing slump, as well as the probability it will be “politically untenable to resurrect” the firms, mean the U.S. will likely create a new organization that won’t be owned by shareholders to play a similar role in the economy, Moody’s said. “This is not bad news for Fannie Mae and Freddie Mac bondholders as the U.S. government has become entwined with these companies and the creation of a new entity to support housing finance likely means the orderly conclusion of Fannie Mae and Freddie Mac,” Brian L. Harris, Craig A. Emrick and Robert Young, Moody’s analysts, wrote in the report yesterday.
Moody’s rates the companies’ senior debt Aaa because of their “very strong” government support, the report said. The companies can tap up to $200 billion of taxpayer capital, and can turn to an emergency financing facility at the U.S. Treasury through at least yearend. The Federal Reserve is buying as much as $1.45 trillion of the debt and mortgage securities through yearend in an effort to lower home-financing costs. The companies own or guarantee about $5.3 trillion of the $12 trillion in U.S. residential mortgage debt. A Treasury report in June said the Obama administration “will engage in a wide-ranging process and seek public input to explore options regarding the future” of Fannie Mae and Freddie Mac and will deliver a report to Congress when the president gives his fiscal 2011 budget in February.
Fannie and Freddie’s uncertain future
The future of those historic linchpins of the US housing market, Fannie Mae and Freddie Mac, is looking increasingly uncertain. Consider these two separate - though perhaps not unrelated - pieces of news. On Monday, analysts at Moody’s said they expected the US government to decide within the next 18 months whether to wind down the government sponsored entities as losses mount. From the report, emphasis ours:Moody’s believes that there is an increasing likelihood that a new organization will be created to replace Fannie Mae and Freddie Mac for two reasons. First, as losses continue to mount, it will become clearer that it could take a decade or more of government ownership before Fannie Mae and Freddie Mac are viable stand-alone entities. Second, it will be politically untenable to resurrect these companies as a long-term solution to the mortgage market even with changes to their organizational structure and regulation. These companies have always been lightening rods for criticism and their continued existence would likely increase the resistance. So, in all likelihood a new organization, with a role similar to Fannie Mae and Freddie Mac though with a different organizational structure (i.e., not shareholder owned) will result
In the interim, Moody’s said, Fannie and Freddie’s profitability outlook “is bleak in the near to intermediate term”:Since the third quarter of 2007, Fannie Mae and Freddie Mac have reported 7 straight quarterly losses totaling $86.9 billion and $63.7 billion, respectively. The primary drivers of the companies’ net losses were elevated provisions for loan losses, as well as mark-to-market losses on their securities portfolios and derivatives. The profitability outlook reflects the U.S. Government using these companies as instruments of public policy rather than profit maximization. Examples of their use in promoting public policy include the reduction of previously announced fee increases, as well as aggressive modification and re-financing programs. A recently announced program will allow refinancing of mortgages with loan-to-values of up to 125%. These programs are likely to extend the period of losses and the elevated levels of provisions at the companies
Second, and perhaps more importantly, various newswires on Wednesday reported James Lockhart, the regulator for Fannie Mae and Freddie Mac, would be stepping down “very soon.”>
Here’s Reuters, which cited an administration official:…no decision has been made about who might be a suitable long-term replacement, nor what role that person would have in shaping housing policy.>When asked by Reuters in an interview if he is leaving soon, Lockhart would not comment on any move but said he was proud of his work as a regulator and was looking forward to returning to private life.>Two strikes, or three if you count that epic weekend rescue last September.
FHFA’s Lockhart Plans to Leave Agency This Month
Federal Housing Finance Agency Director James Lockhart, who oversaw last year’s federal takeover of mortgage-finance giants Fannie Mae and Freddie Mac, said he plans to leave the agency later this month.
“The timing is appropriate,” Lockhart said in an interview today. Freddie Mac hired a new chief executive last month, and the housing market is showing some signs of recovery, the regulator said. President Barack Obama’s administration doesn’t have a candidate lined up to replace Lockhart, said a Treasury official who asked not to be identified. The role Lockhart’s successor will have in shaping housing policy hasn’t been decided, the official said.
Lockhart’s departure isn’t likely to shift direction of the FHFA because he has “already been quite accommodative to Obama,” said Mark Calabria, director of financial regulation studies at the Cato Institute, a Washington policy research organization. “He’s fully supported the Obama administration’s plan to use Fannie and Freddie for broader efforts beyond safety and soundness.” The companies’ shares surged today. Fannie Mae rose 30 percent to 74 cents, and Freddie Mac climbed 31 percent to 80 cents at 4:15 p.m. in New York Stock Exchange composite trading. Treasury Secretary Timothy Geithner “would have preferred I stayed,” said Lockhart, 63, a lifelong Republican who previously said he intended to resign soon after Democrats took control of the White House.
“It became very apparent to me in January that we were still in the storm, it made no sense to leave at that point,” Lockhart said. He said he has been discussing with Geithner the timing of his resignation over the last three months. Former President George W. Bush, a high school and college friend, appointed Lockhart to run the agency in 2006. Lockhart, who joined the Bush administration in 2002, said he plans to return to business. “It’s hard to retire on the money I’ve made over the last 7 1/2 years,” said Lockhart, who commutes from his home in Greenwich, Connecticut. “It’s time to get back there.”
During Lockhart’s tenure, Fannie Mae and Freddie Mac, which buy mortgages from lenders, posted $150 billion in combined losses as the housing market plummeted, leading to their takeover by the government in September. They have received $84.9 billion in federal aid since November, which Lockhart said last month they won’t be able to repay in full. Treasury has committed as much as $400 billion to keep the two from going bankrupt while policymakers figure out how to restructure their operations.
The Obama administration has been using Washington-based Fannie Mae and McLean, Virginia-based Freddie Mac in its efforts to revive the housing market and avert foreclosures. The administration and Congress are also considering restructuring the government-sponsored enterprises, possibly as public utilities, or liquidating their assets. The companies together account for about $5.4 trillion of the $12 trillion U.S. home loan market. Under Lockhart’s tenure, Fannie Mae and Freddie Mac expanded their business into riskier types of mortgages, such as subprime and Alt-A loans, which he has called the main catalyst for their losses. Alt-A loans are also called “liar loans” because they required little or no documentation of income.
“Every board meeting we had with the two boards we talked about the credit risk in their portfolios, and it was a hard slog convincing the companies and the market overall that there could be a problem,” Lockhart said. In March 2008, six months before the companies were placed in conservatorship, Lockhart lowered their capital requirements and lifted restrictions on their portfolio growth. Lockhart publicly described the two as “adequately capitalized” weeks before Treasury and FHFA seized their operations amid fears the two may fail.
“Everybody that was involved in the mortgage markets regrets that we didn’t see how bad things were going to get,” Lockhart said today. “The good news is we did cap their portfolios” in 2006, which prevented the companies from expanding further into riskier loan products, he said. Fannie Mae was created in the 1930s under President Franklin D. Roosevelt’s New Deal to revive the economy. Freddie Mac was started in 1970. The companies were designed primarily to lower the cost of home ownership by buying mortgages from lenders, freeing up cash at banks to make more loans. They make money by financing mortgage-asset purchases with low-cost debt and on guarantees of home-loan securities they create out of loans from lenders.
A Treasury report in June said the Obama administration “will engage in a wide-ranging process and seek public input to explore options regarding the future” of Fannie Mae and Freddie Mac and will deliver a report to Congress when the president gives his fiscal 2011 budget in February. Options considered by lawmakers include winding the companies down and liquidating assets or using Fannie Mae and Freddie Mac to provide insurance for covered bonds.
Lockhart was tapped to run FHFA after serving as the deputy commissioner and chief operating officer of the Social Security Administration from 2002 to 2006. He worked for four years before that as the chief financial officers of software consulting firm Netrisk Inc. and for two years as a managing director at Smith Barney. Earlier, Lockhart was executive director of the Pension Benefit Guaranty Corp. and was the treasurer of Gulf Oil Corp., which merged with Standard Oil in 1984. He attended prep school, Yale University and Harvard’s business school with Bush.
AIG, Fannie, Freddie: Dire straits, soaring stock
Well, it's official: Some pigs can fly. Or at least they can in that fantasy land known as Wall Street, where the laws of gravity and logic were suspended for the better part of Wednesday afternoon. American International Group Inc., Fannie Mae and Freddie Mac – a trinity of corporate fecklessness, if there ever was one – each posted staggering advances as investors appeared willing to gamble that even the shakiest pillars of the financial system were regaining a measure of strength. That could prove a dangerous bet.
AIG, one of the poster boys for the credit crisis, shot up 63 per cent in heavy trading Wednesday, the result of myriad factors – each depending on a healthy dose of guesswork. One of its competitors, Radian Group, reported good second-quarter financial results, prompting expectations that AIG could unveil a similar surprise when it releases its numbers Friday. Then there was the optimism about the insurer's new chief executive officer (its fourth in little more than a year) along with speculation it was on the verge of selling its aircraft leasing business – one of several units it is auctioning off to help repay its $182.5-billion (U.S.) government loan.
But the most persuasive explanation for AIG's sudden tear was technical: an old-fashioned “short squeeze,” exacerbated by the company's recent stock consolidation, which reduced the number of outstanding shares 20-fold. Shares have suddenly become harder to come by, making it difficult for the short sellers to cover their bets. That led to a raft of buying Wednesday, helping push the stock into an altitude AIG hasn't seen for some time –although it still trades at fraction of its pre-crisis peak.
Several analysts urged caution amid the exuberance, pointing out a couple of obvious caveats: that AIG remains a deeply troubled company, and that assessing any ward of the state is an unpredictable game. Standard & Poor's equity analyst Catherine Seifert noted AIG had negative tangible common equity of $336.62 a share during the first quarter. And just last month, a Citigroup analyst estimated there was a 70-per-cent chance that shareholders would be wiped out after the company made good on its commitments to repay Washington, which now owns 80 per cent of the company.
Dick Bove, a bank analyst with Rochdale Securities, suggested that the surge in AIG's share price could demonstrate an increased tolerance for risk among large investors – particularly in the financial sector. “Money is now pouring into the junk bonds, the high grades, commercial paper and everything financial,” he said. But the case for a Fannie and Freddie rebound looks even more tenuous. The two government-sponsored mortgage companies, like AIG, have been kept alive only by the infusion of tens of billions of dollars worth of emergency taxpayer loans. Since lawmakers moved to rescue them last summer, their shares have sunk to penny-stock status, making them the playthings of speculators.
Wednesday, Fannie gained 30 per cent in New York trading, while Freddie jumped 31 per cent, although both still trade hands well below the $1 mark. Analysts could not find much to explain their sudden moves, other than an unverified report that James Lockhart, the regulator who oversees them, is planning to resign soon. Even for risk-minded investors, that is pretty thin gruel. “Institutions under government conservatorship are speculative bets,” said Michael O'Rourke, chief market strategist at BTIG LLC.
AIG Breakup Is Fee Bonanza
Wall Street banks and lawyers could collect nearly $1 billion in fees from the Federal Reserve Bank of New York and American International Group Inc. to help manage and break apart the insurer, according to a Wall Street Journal analysis. That would represent one of Wall Street's biggest paydays -- four times the fees paid to break up AT&T Corp. in 1996, and nearly double those paid for Visa USA's 2008 initial public offering, the largest U.S. IPO ever. The federal government's bailout of AIG has left it with a nearly 80% ownership stake. The government has a multiyear plan to recoup the more than $100 billion in taxpayer money it put at risk in the rescue.
The plan requires hiring firms to handle public offerings of some AIG units and outright sales of others, to manage some toxic AIG assets, and for other tasks. Among the biggest beneficiaries is Morgan Stanley, which has earned about $10 million assisting the Fed, but could collect as much as $250 million from various AIG-related deals, according to some banking experts and documents released by the New York Fed. Goldman Sachs Group Inc., Bank of America Corp. and J.P. Morgan Chase & Co. have all gotten assignments in recent months to help dismantle AIG.
To calculate the possible fee total, The Wall Street Journal tallied estimated fees for deals already struck and others AIG is planning or considering or may have to pursue in the future. Thomson Reuters and Freeman & Co. provided fee estimates on some deals. Documents from the New York Fed indicate typical fee arrangements for various types of deals under consideration. The Journal used those figures, along with estimates of potential deal sizes, to help calculate the possible total. The actual fees could run higher or lower than $1 billion, depending on which deals AIG pursues, how those deals are structured, market conditions, and how successful the government is at extracting itself from its ownership stake, among other things.
AIG's restructuring could take years, adding another level of uncertainty. The situation puts the government in the potentially uncomfortable position of employing some of the same firms it regulates. In theory, actions the government takes in connection with those firms, for example, could affect how effective the firms are at handling their AIG assignments. "I'm confident we can separate the two" issues, said a spokesman for the Treasury.
AIG shares surged 63% to close at $22 on Wednesday in New York Stock Exchange trading, ahead of its second-quarter earnings report on Friday. AIG is planning two IPOs of multibillion-dollar insurance subsidiaries, is weighing a third, and is steadily selling off small units with the assistance of investment banks. The fee pool for all three IPOs could reach $570 million, documents released by the New York Fed indicate. AIG and the New York Fed, which helps oversee the government's ownership stake in AIG, are paying BlackRock Inc. to manage more than $35 billion of the insurer's toxic assets.
AIG is preparing to offer investors shares in a major Asian life insurance unit, American International Assurance Co., early next year. That initial public offering could raise more than $5 billion. Morgan Stanley and Deutsche Bank have been hired as lead underwriters. Each bank could pocket nearly $45 million in fees, according to documents released by the New York Fed. Accounting firm Ernst & Young has a New York Fed contract that could pay $10 million to $60 million, according to documents released by the New York Fed. Law firm Davis Polk & Wardwell LLP, which was brought into AIG at the peak of its crisis last September, is charging up to $950 per hour for partners' time. That reflects a 10% discount, which "is not a common practice," says Marshall Huebner, Davis Polk's lead attorney on the matter.
Goldman was part of a group of banks that helped AIG raise $1.14 billion this year by selling a large stake in a reinsurance company. The group of banks shared an estimated $39.7 million in fees, according to Thomson Reuters and Freeman & Co. Bank of America advised AIG on the recent sales of its car-insurance unit and a Tokyo building. Those deals generated $5.5 million and $1.9 million in fees, respectively, for the bank and others, according Thomson Reuters and Freeman & Co. Blackstone Group, which has been advising AIG since last fall, has already brought in around $50 million, according to a person familiar with the matter.
Morgan Stanley's work for the government dates back to last summer, when then-Treasury Secretary Henry Paulson called Morgan Stanley Chief Executive Officer John Mack to ask if Morgan would help the U.S. government's effort to shore up Fannie Mae and Freddie Mac. Soon after those companies were put under government control in September, the New York Fed called Morgan Stanley to start working on the growing problems at AIG. In October, the New York Fed and Morgan Stanley agreed that the investment bank would get an "advisory fee" of $4 million, and another $2.5 million each quarter, for its AIG work. In addition, Morgan Stanley would collect a separate "transaction fee" -- potentially up to tens of millions of dollars, according to New York Fed documents -- when AIG closed deals to sell units.
In recent months, AIG has begun preparing for possible initial public stock offerings for American International Assurance and another foreign life insurance unit, American Life Insurance Co. In June, the New York Fed and Morgan Stanley revised their pact to help ensure that Morgan Stanley would get some of that work, too. (AIG has also held preliminary talks with rival insurer MetLife Inc. about a possible deal for all or part of American Life Insurance, which would reduce underwriting fees.)
After any IPOs, AIG may need to sell more of the remaining stakes in those units in order to repay the government. Such transactions could generate tens of millions of dollars in additional fees. Roughly $75 million in fees has been paid for asset sales AIG has already completed, according to estimates by Thomson Reuters and Freeman. Separately, BlackRock's contracts call for it to get a minimum of $50.5 million and a maximum of $142.5 million, if the job managing toxic assets lasts three to five years. This work isn't always easy for those involved, said a number of bankers. One gripe: Bankers used to flying business class have to sit in coach when on government business.
American Incomes Head Down, Threatening Recovery in Spending
Household income in the U.S. is weakening as the influence of the government’s stimulus plan wanes, prompting economists, Federal Reserve officials and a Nobel laureate to warn that consumer spending may struggle. “Consumers have started to change their behavior and they are going to save more,” said Richard Berner, co-head of global economics at Morgan Stanley in New York and a former researcher at the Fed. “You have pressure on wages, you have employment still declining.”
Wages and salaries, which drive recoveries in spending, fell 4.7 percent in the 12 months through June, the biggest drop since records began in 1960, according to Commerce Department figures released yesterday. The Obama administration’s tax cuts, extended jobless benefits and a one-time Social Security bonus have helped mask the damage done by the worst employment slump since the Great Depression. Personal incomes, which include interest income, dividends, rents and other payments as well as wages, tumbled 1.3 percent in June, more than forecast and the biggest drop in four years, yesterday’s Commerce report showed. Excluding the effects of the stimulus plan, June incomes would have dropped 0.1 percent after no change in May, according to the report. In May, one-time additional payments to Social Security recipients boosted incomes 1.3 percent.
One of every 10 American workers will be without a job by early 2010, economists project, shaking the confidence of those still on payrolls and discouraging spending. It may take as long as 15 years for consumers to fully repair finances battered by the decline in home values, stocks and employment, said Edmund Phelps, winner of the Nobel prize in economics in 2006. Decreasing pay is not the only hurdle for consumers. Plunging home prices and stocks reduced household net worth by a record $13.9 trillion from the third quarter of 2007 through this year’s first quarter, according to figures from the Fed.
“Households are going to have to do an awful lot of rebuilding of their wealth,” Phelps, a professor at Columbia University in New York, said this week in an interview on Bloomberg Television. “Even if that rebuilding goes on at a pretty good clip, it will take 12 or 15 years for households to get to the wealth level that they had several years ago. Consumer demand is going to take a long time to rebuild to normal levels.” In the second half, incomes and spending will be hurt by the loss of transitory factors such as lower fuel prices, decreased tax rates and the one-time payment to retirees, William Dudley, president of the Fed Bank of New York, said in a speech last week.
“Consumer spending is unlikely to rise much faster than income” because of the need to boost savings, he said. “Weak income growth will be an effective constraint on the pace of consumer spending.” Companies continue to trim expenses, threatening further cuts in pay and benefits. Tenneco Inc., the world’s largest maker of vehicle-exhaust systems, temporarily lowered pay and hours worked to reduce labor costs by 10 percent. Earlier this year, the Lake Forest, Illinois-based company suspended contributions to employees’ 401(k) retirement accounts and cut pay for the top 50 executives.
Government assistance such as the “cash-for-clunkers” program will help postpone the inevitable increase in savings and slowdown in spending as more baby boomers approach retirement, said David Rosenberg, chief economist at Gluskin Sheff & Associates Inc. in Toronto. “Spending is in desperate need of gimmicks like cash-for- clunkers in order to grow on a short-term basis,” he said.
The program, which offers as much as $4,500 for trading in older, less fuel-efficient cars, ran through its $1 billion fund in about a week, and Congress is considering adding $2 billion. Auto industry data this week showed sales jumped to an 11.3 million annual pace last month, the highest level since September. Mounting joblessness is among reasons that economists such as Rosenberg say will prompt Americans to save more. Unemployment, already at a 26-year high of 9.5 percent in June, may top 10 percent by early next year, according to the median estimate of economists surveyed by Bloomberg last month.
Economists estimate that a Labor Department report at the end of the week will show employers cut an additional 328,000 workers from payrolls in July. That would bring the total loss of jobs since the recession began in December 2007 to 6.8 million. The savings rate in June fell to 4.6 percent as incomes dropped, yesterday’s Commerce Department report showed. The rate, which reached a 14-year high of 6.2 percent the previous month, is likely to keep climbing, Rosenberg said. A rate as high as 15 percent can’t be ruled out, he said. “This is a different consumer than we had in the past 20 years,” Rosenberg said. “People are going to increasingly be putting more money into cookie jars, rather than into buying more cookie jars.”
U.S. Stocks Retreat on Worse-Than-Estimated Jobs, Services Data
U.S. stocks fell, dragging the Standard & Poor’s 500 Index down from a nine-month high, after reports on job losses and service industries were worse than economists estimated. Procter & Gamble Co. slid 2.8 percent after profit fell on lower sales of higher-priced skin-care products and detergents. Electronic Arts Inc. sank 6.8 percent after reporting a quarterly loss. Declines were limited as financial shares rallied after mortgage insurer Radian Group Inc. posted better- than-estimated results and commodity producers gained as copper and aluminum rose to the highest prices in at least nine months.
The S&P 500 declined for the first time in five days, slipping 0.3 percent to 1,002.72 at 4:07 p.m. in New York. The gauge climbed yesterday to 0.1 point below its close on Nov. 4, the day President Barack Obama was elected. The Dow Jones Industrial Average fell 39.22 points, or 0.4 percent, to 9,280.97. “Data is less bad, but it’s still going to be weak,” said Tim Hartzell, who manages $300 million as chief investment officer for Houston-based Sequent Asset Management. “The talk is all about the smaller companies that are now into that next phase of downsizing. That’s what we have to go through. There’s going to be some smaller and midsize companies that have to go out of business to reduce capacity.”
Yesterday’s advance pushed the valuation of the S&P 500 to about 17.5 times its companies’ earnings over the past 12 months, the most expensive since May 2008, according to daily data compiled by Bloomberg. Since reaching a 12-year low of 676.53 on March 9, the S&P 500 has rebounded 48 percent, the steepest rally over the same number of days since the Great Depression. The S&P 500’s 14-day relative strength index, a measure of momentum, rose to almost 76 yesterday for its highest level since October 2006. An RSI above 70 is typically a sell signal to technical analysts.
Benchmark indexes opened lower after data from ADP Employer Services showed companies cut 371,000 workers from payrolls in July, more than the average estimate of 350,000 in a Bloomberg survey of economists. The figures from the world’s largest payroll processor have shown declines in employment since February 2008. The number of lost jobs has dropped each month since April and fell in July from 463,000 in June. “I don’t think the lessening of the recession will carry weight much longer,” said Ron Kiddoo, who oversees $500 million as chief investment officer for Cozad Asset Management Inc., based in Champaign, Illinois. “It helped for the past few months, but it’s not going help forever.”
Private Job Losses Slow, ADP Report Suggests
The pace of layoffs may be easing. Private-sector jobs in the U.S. fell 371,000 in July, according to a national employment report published Wednesday by payroll giant Automatic Data Processing Inc. and consultancy Macroeconomic Advisers. The expected loss was about on par with the 350,000 drop in the ADP survey projected by economists in a Dow Jones Newswires survey. The ADP survey tallies only private-sector jobs, while the Bureau of Labor Statistics' nonfarm payroll data, to be released Friday, includes government workers. Economists surveyed by Dow Jones Newswires expect the Bureau of Labor Statistics will report July job cuts totaling only 275,000, about half the loss of 467,000 reported in June. The July unemployment rate is projected to rise to 9.7% from 9.5% in June.
Economists think that economic output may have stopped contracting in the second quarter, but any turnaround in the labor markets is still months away. Joel Prakken, chairman of Macroeconomic Advisers, noted that the decline was the smallest since October 2008, but added, "Despite recent indications that overall economic activity is stabilizing, employment, which usually trails overall economic activity, is likely to decline for at least several more months, albeit at a diminishing rate."
The latest ADP report showed large businesses with 500 employees or more shed 74,000 jobs and medium-size businesses lost 159,000 workers last month. Small businesses that employ fewer than 50 workers cut 138,000 jobs in July. Service-sector jobs fell 202,000 in July, while factory employment dropped 99,000. ADP, of Roseland, N.J., says it processes payments of one in six U.S. workers, while Macroeconomic Advisers, based in St. Louis, is an economic consulting firm.
In another Wednesday job report, TrimTabs Investment Research estimated that job losses accelerated last month, with 488,000 workers laid off in July, worse than the ADP estimate. TrimTabs uses daily income-tax withholdings to the U.S. Treasury to estimate changes in employment. "While Wall Street is convinced the recession is over, the economy continues to shed jobs at an alarming rate," said Charles Biderman, chief executive of TrimTabs. Also on Wednesday, outplacement firm Challenger Gray & Christmas said that the number of layoffs announced by U.S. companies jumped 31% in July to 97,373. Challenger said that so far this year, employers have announced 994,048 job cuts, 72% more than the 579,260 announced in the first seven months of 2008.
Service Industries in U.S. Contracted at Faster Pace in July on Job Losses
U.S. service industries unexpectedly contracted at a faster pace in July as concern over rising unemployment gripped consumers. The Institute for Supply Management’s index of non- manufacturing businesses, which make up almost 90 percent of the economy, fell to 46.4 from 47 in June, according to the Tempe, Arizona-based group. Fifty is the dividing line between expansion and contraction. The report indicates that most of the economy has yet to benefit from government programs, such as the cash-for-clunkers plan, aimed at reviving manufacturing.
The highest jobless rate in a quarter-century, stagnating wages, falling home values and mounting bankruptcies mean consumer spending will be slow to recover. “The consumer is still facing a weak labor market,” said Joshua Shapiro, chief U.S. economist at Maria Fiorini Ramirez Inc., a New York forecasting firm. “There are still plenty of problems out there. To declare everything is fine is premature at this stage.” Economists forecast the index would rise to 48, according to the median of 77 projections in a Bloomberg News survey. Estimates ranged from 44 to 49.3. Other reports today showed the economy lost more jobs last month. Companies cut an estimated 371,000 jobs in July, more than economists had forecast, according to figures from ADP Employer Services.
Stocks dropped after the reports and Treasury securities rose, recovering from earlier losses. The Standard & Poor’s 500 index fell 0.9 percent to 996.28 at 1042 a.m. in New York. The yield on the benchmark 10-year note was 3.66 percent compared with 3.69 percent late yesterday. The ISM non-manufacturing industries employment index fell to 41.5 from 43.4 the prior month, and its gauge of new orders decreased to 48.1 from 48.6. The measure of new export orders slumped to 47.5 from 54.5. The Labor Department’s July jobs report is due Aug. 7. The U.S. has lost 6.5 million jobs since the recession began in December 2007, the biggest decrease of any economic slump since the Great Depression.
Simon Property Group Inc., the biggest U.S. shopping-mall owner, reported a drop in second-quarter earnings excluding items and a decline in revenue as the recession hurt consumer spending. The Indianapolis-based company yesterday cut its forecast for the year. “The economic and retail environments remain difficult,” Chief Executive Officer David Simon said in a conference call. Even companies seeing better times are concerned a recovery will be slow to develop. Wyndham Worldwide Corp., the franchiser of Ramada and Super 8 hotels, reported last week that it beat second-quarter earnings estimates.
“People are taking shorter vacations and staying closer to home,” Chief Executive Officer Stephen Holmes said in an interview with Bloomberg News after the earnings release on July 29. “We see that shift continuing through the rest of the year. We don’t see this as being a quick rebound.” Housing, a component of the ISM non-manufacturing index, is one area showing signs of improvement from its worst slump since the 1930s. Construction of single-family houses jumped in June by the most since 2004, figures from the Commerce Department showed last month. Combined sales of new and existing houses climbed in June for a third consecutive month, reaching the highest since October, figures from Commerce and the National Association of Realtors also showed.
Foreclosure Plan Is Off to a Bumpy Start
A report card released Tuesday by the Treasury Department showed wide variations in how quickly mortgage companies are helping financially troubled borrowers under the Obama administration's foreclosure-prevention plan. So far, more than 400,000 borrowers have been offered help. More than 235,000 borrowers, or roughly 9% of those eligible for the program and at least 60 days past due, have begun trial mortgage modifications, the first step to getting a loan reworked.
Among the largest mortgage-servicing companies, J.P. Morgan Chase & Co. has put the most borrowers on a trial modification, having begun the process for roughly 79,000 of them, or about 20% of those whose loans are at least 60 days past due. Saxon Mortgage Services, a unit of Morgan Stanley, has begun trial modifications for more than 21,000 borrowers, or roughly one-quarter of its delinquent borrowers eligible for the program. Other companies have made less progress. Bank of America Corp. has begun trial modifications for fewer than 28,000 borrowers, or about 4% of those who are delinquent, while Wells Fargo & Co. so far has started with about 6% of such borrowers.
Borrowers can get help under the Obama program if they are delinquent, or current but at risk of imminent default. Mortgage companies are often beginning trial modifications before receiving full income documentation. That suggests some trial modifications will ultimately fail or be reworked. Borrowers must document their income and make payments during the trial period to qualify for a full modification. Administration officials said they were releasing the data in an effort to hold mortgage companies accountable. "While the program has ramped up in an impressive way, there are significant variations among servicers in their performance," said Assistant Treasury Secretary Michael Barr. He said some companies need to boost capacity or improve employee training.
In September, the government will begin requiring mortgage companies to tell borrowers why their modification application was turned down, Mr. Barr said. Some borrowers say they are being denied help under the program even though they fall within its guidelines. The Obama program provides financial incentives to mortgage companies and investors to reduce loan payments to affordable levels. The administration has called on mortgage companies to boost the number of trial loan modifications to 500,000 by Nov. 1. Administration officials have said the program could ultimately help as many as three million to four million homeowners. Anthony Sanders, a real-estate finance professor at George Mason University in Fairfax, Va., said government officials should focus on the success rate for loan workouts, not the number being done.
The administration's figures don't present a full picture of each company's activities. Bank of America said it completed 150,000 loan modifications in the first six months of this year outside the Obama program. Wells Fargo said it completed 240,000 modifications in the first seven months, mostly outside the program. Unlike some companies, Wells Fargo has been requiring certain borrowers to fully document income, slowing the pace of its modifications under the program. Mortgage companies are facing increased pressure to step up the pace. Sanjiv Das, chief executive of Citigroup Inc.'s CitiMortgage unit, said he receives an update at 7:30 each morning on the number of completed modifications. CitiMortgage has begun trial modifications for about 15% of its delinquent borrowers eligible for the Obama program.
Mortgage servicers face substantial challenges. Call volume is running 500% above normal levels, said David Sisko, a director with Deloitte & Touche. Meanwhile, mortgage-servicing companies have boosted staffing by an average of 30% to 40%. Mr. Sisko said employees who evaluate borrowers for loan modifications now are responsible for an average of 200 to 300 loan files, up from 50 to 100 in the third quarter of 2008. J.P. Morgan put its modification program in place last fall and began gearing up for the Obama plan even before final details were announced, said David Lowman, who runs J.P. Morgan's mortgage business. Still, like its competitors, J.P. Morgan had trouble keeping up with customer calls, Mr. Lowman said.
Bank of America, meanwhile, has been slower than some companies to implement some parts of the program, such as help for borrowers who are current on loan payments but still at risk of default. The company is also operating two different loan-modification systems, one for legacy loans and one for mortgages originated by Countrywide Financial Corp., which it acquired last year. The Countrywide operation has gotten up to speed more quickly, a company spokesman said, largely because it had agreed to step up modifications as part of settling a lawsuit brought by state attorneys general regarding Countrywide's lending practices. Bank of America is "very supportive" of the program, said Steve Bailey, the company's mortgage-servicing executive. But "it's difficult to implement," he said.
What 'Better than Expected' Earnings Actually Means
Taking a big picture view of the current earnings environment shows just how much “better than expected” the current earnings have been. The following graph shows the timeline of analysts' Q2 estimate changes. As you can see, the estimates have been slashed by nearly 50%. Could the analysts have gotten it more wrong? And why is anyone now surprised that they were so far off again?
All of this has to make you wonder just how important “better than expected” really is. These numbers are for S&P 500 “operating earnings,” which exclude the allegedly one-time items; GAAP earnings, which can’t be gamed as much, are literally half as much this quarter, the largest divergence ever apart from 4Q08 — 44% below 2Q08 and 68% below 2Q07.
Don't Put Your Money on a US Recovery
by Bill Bonner
The future cometh... Cash for bankers! Cash for Detroit's clunkers! From one scam to the next...
But first, let us turn to the latest market update.The Dow rose again yesterday - up 33 points, to close at 9,320. We set 10,000+ as our objective for this bounce. We'll stick with it for a while longer. Make no mistake though. No one knows how long this rally will last - certainly no one here at The Daily Reckoning vacation headquarters. It will continue until it runs out of gas. That could be tomorrow. It could be months from now. It will run out of gas sooner or later, and probably this fall. A real, durable bull market would require an economic boom - a genuine recovery. We don't see that happening...
But people must think it is happening... "There are signs of a recovery in the US..." was a popular line at last night's cocktail party. Several friends mentioned it. Each time, we had the same reply - we wouldn't bet on it. Yesterday, the price of oil rose; it ended the day at $71. And the dollar stayed where it was - at $1.44 per euro. Investors are betting on recovery - despite our advice. And when the recovery turns out to be a clunker, they'll probably put these trades into reverse. Oil will go down; the dollar will go up. You want to speculate, dear reader? Sell oil...buy the dollar. Wait for another crash this autumn.
Why will there be another crash? Because people believe something that isn't true. People believe that there is a recovery...and that it is the result of stimulus efforts by the feds. The results from the second quarter show the economy still contracting...but at a slower pace, just -1% annually, rather than the -6.4% recorded in the first quarter. This is heralded throughout the world as proof that the crisis is receding. "It if weren't for stimulus spending, the contraction [in the 2nd quarter] would have been closer to 4%," says the editorial in the International Herald Tribune. "The stimulus is helping...and more stimulus would help even more."
Oh? Would it? Let's look at stimulus-in-action: 'Cash for Clunkers' is a hare-brained scheme...but that doesn't make it unpopular. The idea is to stimulate demand by, well, giving people money. But instead of just giving them money and letting them choose what to do with it, the feds decide they need a new car. In order to the get the money, people have to buy one. According to the press reports, the program has been a great success wherever it has been put in place - in France and Germany, as well as in the United States. If so, why not apply the concept elsewhere? How about cash for houses? Cash for liquor? Cash for newspapers? Cash for trips to Europe?
What's so special about autos, in other words? And why is it a good thing for people to buy cars? Oh c'mon, dear reader...don't pretend you don't know. The auto industry is huge...with many lobbyists and many organized groups interested in its wellbeing. It is an old and well-established industry with plenty of political clout. Tomorrow's industries, by contrast, have no lobbyists...no organized labor...no pet congressmen...no political action committees. So who gets the money?
Here's the problem: the meddlers are not only up against tomorrow's industries...they're up against tomorrow itself. It's not as if Americans needed cars. Not at all. They've got plenty of wheels already. Three car households are typical. And they're fairly new cars. Americans were on a buying spree during the bubble era, 2001-2007; they bought new cars along with everything else. So, the goal of the 'Cash for Clunkers' scheme is not to increase the size of the US auto fleet, it's to make it newer. People don't need more cars. They only need to replace cars that get worn out. If they bought a car five years ago, they may be ready to buy another one. Or, they could probably wait until next year. Along come the feds with cash...and the buyer decides to replace his car this year rather than next.
This is heralded as a success. The feds have stimulated demand. But what about next year? We'll have more to say about this on Friday...but the auto example helps us see what a scam these stimulus schemes really are. They claim to boost demand. But they can't really increase demand. All they can do is roll next year's buying into the present year. Sound familiar? That's the very thing that has been happening for the last two generations. Consumers didn't want to wait until they'd made the money to take their vacations or buy their houses. They turned to credit. They borrowed against future earnings.
They spent money they hadn't earned yet...thus bringing forward purchases that should have been made in the future. That's why we have a depression; now, we're in the future! It had to come sooner or later. After drawing consumption forward for decades, Americans had to stop. Time had to catch-up. Homeowners had to pay down debt. Ken Rogoff, Harvard professor of economics, believes it will take them 6-8 years to do so.
But consumers spent more than they could reasonably be expected to pay back. They out-spent the future! They bought a ticket to somewhere beyond the future...to a place where they would never actually arrive. In many cases - especially in the housing market - lenders discovered they couldn't get their money back, which is what led to the credit crunch and the collapse of Wall Street. Of the big five - Bear, Lehman, Goldman, JPMorgan and Merrill - only two survived intact. And we know now that Goldman only survived because Henry Paulson, former CEO of Goldman, then Treasury Secretary, arranged a hidden bailout. He had the government step in to save AIG, which owed Goldman $13 billion.
From one scam to another...that's the way the feds do it. From bailing out Wall Street they now turn to bailing out the entire world economy - in a similarly fraudulent way. Tim Geithner told the Chinese last week that the United States would revive thanks to increased private demand. But the feds cannot really increase demand in the private sector. Increasing real demand would mean increasing real wages. And there's no sign of that. To the contrary, incomes are going down.
Yesterday's news tells us that personal incomes went down 1.3% in June. Incomes had gone up in May, by precisely the same amount - 1.3%, thanks to stimulus payments. Then, too, commentators saw it as a sign of recovery. But what the feds gave in May was taken away in June. The future caught up with the Obama administration's stimulus efforts within 30 days. Net result = zero. The June number reflected the biggest drop in income in four years. It is not surprising. We're in a depression, remember? Salaries and wages fell 0.4% in June...the 9th drop in the last 10 months.
"It looks like there are finally some signs of recovery in the US," said more than one person we talked to last night. The occasion was a cocktail party...held on the grounds of a stately chateau. The summer social season is underway in Poitou. We are attending dinners, plays, cocktail receptions, barbecues and weddings. Last night, waiters in tuxedos passed out champagne, foie gras canapés, and desserts while hundreds of guests milled about and talked. "You might want to hedge your bets on this recovery," we told one Daily Reckoning reader. "It's probably not going to work out." "But I'm confused about something," he continued. "You've been urging me to buy gold for years. And now you seem to be changing your mind."
"No...no...not at all. I'm still a gold bug. It's just that I expect this rebound to end...and for stocks to go down, possibly down a lot. The dollar is what people want when they are frightened. The dollar is going down now because they think there's no longer anything to be frightened about. But when this recovery disappoints them, investors are going to be more frightened than ever. Because they'll realize that we're faced with a depression...and that the feds can't do anything about it. They're going to rush to the safety of dollars...at least for a while. Probably long enough to shake out a lot of gold buyers."
Goldman Sachs $100 Million Trading Days Reach Record
Goldman Sachs Group Inc. made more than $100 million in trading revenue on a record 46 separate days during the second quarter, or 71 percent of the time, breaking the previous high of 34 days in the prior three months. Trading losses occurred on two days during the months of April, May and June, down from eight in the first quarter, the New York-based bank said today in a filing with the U.S. Securities and Exchange Commission. The company made at least $50 million on 58 of the 65 trading days during the quarter, or 89 percent of the time.
Goldman Sachs, which was the biggest U.S. securities firm before converting to a bank last year, posted the biggest profit in its history during the second quarter as revenue from trading and equity underwriting reached all-time highs. The company, which has returned $10 billion to the U.S. Treasury and paid $1.42 billion in dividends and to cancel warrants, also made its largest market bets during the period. “It’s very counterintuitive to think that they’d be able to generate this much profit and this much revenue in the middle of an ongoing recession,” said William Cohan, a former banker at JPMorgan Chase & Co. and Lazard Ltd. and author of “House of Cards” about the collapse of Bear Stearns Cos. “But the fact that so many of their competitors are out of business or severely wounded has put them in a very strong position.”
In fiscal year 2008, the firm had 90 days in which traders made more than $100 million, compared with 88 in 2007. In fiscal 2006, the figure was 49 days, up from 18 in 2005 and 14 in 2004. Goldman Sachs changed its fiscal year in 2009 to end in December instead of November. Goldman Sachs’s trading results reflected the firm’s willingness to take on more risk during the period. Value-at- risk, an estimate of how much the firm could lose in any given day, rose to an average of $245 million in the second quarter from $240 million in the first quarter and $184 million in the second quarter of 2008. Most of the increase in the second quarter came from bets on equities, the company said.
“They take risks for their clients and for themselves and they’ve figured out a way in this market, with less competition bidding for these things, to make money,” Cohan said. Trading and principal investments accounted for 78 percent of the bank’s revenue in the second quarter of 2009, up from 59 percent in the second quarter of 2008. Net interest income, the difference between the interest the firm pays and what it charges, climbed 60 percent from the second quarter of 2008 as the company’s interest expense dropped 83 percent.
Banks such as Goldman Sachs are benefiting from lower borrowing costs after the Federal Deposit Insurance Corp. in October started guaranteeing bank debt issues that mature within three years. Goldman Sachs said in today’s filing it had $25.1 billion of debt guaranteed by the FDIC under the agency’s Temporary Liquidity Guarantee Program. The bank sold about $30 billion of the FDIC-backed securities between November and March, according to company filings. Today’s filing showed the weighted average interest rate paid by Goldman Sachs on its unsecured short-term borrowings dropped to 1.70 percent in June from 2.14 percent in March and from 3.37 percent in November.
Goldman Receives Inquiries On Pay, Derivatives
Goldman Sachs Group Inc. on Wednesday said its second-quarter results might have attracted some unwanted attention from the government. The investment bank said in a regulatory filing that the government has launched investigations into pay practices and credit derivatives trading. Goldman said it was cooperating with the request, but declined to give further details. The inquiries come after Goldman stunned Wall Street last month by posting the biggest quarterly profit in its 140-year history. And, less than a year after it received government aid, the firm reported it set aside $11.4 billion for employee compensation.
The company's resurgence comes at a sensitive time in Washington as lawmakers scrutinize exorbitant Wall Street pay packages as the rest of the nation grapples with a painful recession. The big bonuses for bankers and traders are widely blamed for encouraging the kind of risk taking that led to the financial crisis. Goldman's dominance of trading floors helped power the $3.44 billion of second quarter profits. In fact, the firm said in the regulatory filing that it made $100 million in trading revenue on a record 46 separate days during the quarter.
There were only two days during the quarter when Goldman logged trading losses, according to the filing with the Securities and Exchange Commission. The rest of the days Goldman made at least $50 million a day by taking bigger bets and taking advantage of the market's dislocation. Trading and principal investments drove the firm's overall revenue during the quarter. Goldman generated a record $6.8 billion in revenue from fixed income, currency and commodities trading during the quarter. Equities trading revenue totaled $3.18 billion during the quarter, and the firm racked up $811 million in revenue from principal investments.
Goldman's credit derivatives business also helped drive second-quarter earnings, and also piqued the interest of government investigators. The firm is a leader in issuing, and trading, derivatives that offer protection against bonds and other debt. The Justice Department's antitrust division launched an investigation this summer into big banks' dominance of credit-default swaps and other derivatives. The probe dovetails with a push by the Obama administration for more transparency in the market, which was blamed for helping deepen the credit crisis last year.
No end in sight for bank bailouts
After rescuing the nation's banking system from utter disaster last fall, Washington now faces an arguably much trickier task: putting the bailout genie back in the bottle. Several initiatives are on course to expire later this year, putting regulators and the White House in the difficult position of having to decide whether the nation's banking industry is strong enough to go it alone. "They would love to get out of the middle of all this stuff if they could," said John Douglas, a former general counsel at the Federal Deposit Insurance Corp, who now heads the banking regulatory practice at law firm Davis Polk & Wardwell. "The question really is whether the financial system and capital system is vibrant enough to exit without a government backstop."
So far, most of the signs from the banking industry lately have been somewhat encouraging. The credit markets seem to be returning to normal. The London Interbank Offered Rate -- or Libor -- a widely relied upon measure of bank-to-bank lending rates, is now well below the record high it hit after Lehman Brothers filed for bankruptcy last fall. At the same time, most banks are back in the black. Even embattled lenders Citigroup and Bank of America, both of which were widely believed to be on the verge of being seized by the federal government earlier this year, managed to report their second consecutive quarter of profits in the latest quarter.
Of course, much of the financial crisis has been defined by false bottoms, with investors thinking that the worst was over, only to face a more severe scenario just months later. Mostly for that reason, experts think that the programs that helped resolve some of the vicious liquidity issues banks were facing last fall might live on for several more months. "You don't want to take off a program and have the world end immediately afterward," said Mark J. Flannery, a professor of finance at the University of Florida's Warrington College of Business Administration.
The FDIC's Temporary Liquidity Guarantee Program, or TLGP, which regulators have been angling to wind down by the end of October, is one program that might be extended. The TLGP, which guarantees debt issued by banks and ultimately allows them to borrow from the public market at a discounted rate, still remains quite popular even as some large institutions have started to wean themselves off it. Through June, the running total of outstanding guaranteed bank debt stood at $277 billion, $50 billion more than when the program first started last November.
Looming troubles in the commercial real estate market have also prompted some lawmakers to push the Federal Reserve to extend its Term Asset-Backed Securities Loan Facility, or TALF, through 2010. That program, which was designed to rekindle the securitization market by providing cheap financing to investors, is set to end on Dec. 31. Last week, Rep. Paul Kanjorski, D-Pa., who chairs a key House Financial Services subcommittee, along with 40 other members of Congress, urged the central bank to give the program more time to help bridge the $1 trillion in commercial real estate coming due and prevent a massive loss of jobs.
"While I would like to wind down the government's emergency support for the private sector as quickly as possible, we need to provide more time for the TALF program to work in this [commercial real estate] industry," Kanjorski wrote in a letter to the Fed and Treasury Department. Other more recent proposals, such as the Treasury Department's Public-Private Investment Program, will also need more time to work. The PPIP, which was beset by multiple delays as regulators tried to figure out the best means of removing many of the troubled assets from banks' books, is still not up and fully running yet. Finally, Treasury still holds billions of dollars worth of preferred share stakes in hundreds of banks under the Troubled Asset Relief Program, or TARP.
Even as some financial firms have exited that controversial program, some strained institutions may have little choice but to retain the government's investment through the 2012 repayment deadline. The persistence of TARP and various other programs, however, will hardly change the American public's perception that the government is continuing to bail out corporate America. Mark Calabria, director of financial regulation studies at the Cato Institute, a Washington-based think tank that promotes libertarian views, notes that President Obama is already acutely aware of the stigma that many of these programs carry with them -- especially among taxpayers.
So while banking regulators may have the final say on which rescue plans stay and which ones go, Calabria said the White House will probably be offering its own suggestions behind the scenes. "I think the president is very much aware that at some point he can't keep saying it was all George W. Bush," said Calabria. "I think there is unwillingness on the part of the administration to associate itself with continuing bailouts."
Stimulus Slow to Flow to Infrastructure
Stimulus spending on infrastructure projects is moving slowly and many projects won't get started before the summer construction season ends, complicating the Obama administration's efforts to tout the impact of the $787 billion economic recovery act. The General Services Administration has decided how to spend $1 billion on federal building upgrades, but only about 1% of that money has been spent. The GSA will approve another $1 billion by year's end, but Anthony Costa, acting commissioner of the GSA's public buildings services, said it will take until 2011 before the agency picks projects for all of the $5.5 billion it was allocated for infrastructure work.
The Federal Transit Administration has spent about $500 million of the $8.4 billion it received. The Coast Guard has decided to spend the majority of its $240 million on four bridges, but a spokesman said the money "won't transfer hands for a while." California's transportation department has decided how to spend $1.7 billion of the $2.6 billion it is getting for highway infrastructure projects, but the agency says its spending on such projects probably won't peak until next year. "If we go any faster, we're going to be breaking people," said Earl Seaberg, deputy program manager for stimulus spending at Caltrans, the California department.
The gradual start means many projects won't get under way before the beginning of the fall, when many construction projects in the northern half of the country typically halt before the winter rain and snow. That is providing fodder to critics of the recovery act who say it was overhyped as a way to quickly boost the economy. It may also hamper any potential efforts to pass another stimulus bill later this year. House Minority Leader John Boehner (R., Ohio) on Tuesday criticized the act as "slow-moving government spending" that "hasn't provided the immediate jolt to the economy and the new jobs that Washington Democrats promised."
The White House Recovery Office said Tuesday that government agencies have decided how to spend about $31 billion of the $73 billion going directly to construction projects, but it couldn't offer a figure on how much has actually been spent. "The Recovery Act was designed to ramp up over time with more spending later this year and early next, ensuring that we're steadily laying the foundation for a real, long-term recovery," said Ed DeSeve, senior adviser to the president for implementing the recovery act. After meeting with economic advisers Tuesday, Vice President Joseph Biden said, "It's a fairly widespread and widely held view that the recovery act is working."
Some agencies are taking steps to speed up their spending. On Monday, the Education Department said it was sending out $11.4 billion in extra funding for school programs a month ahead of schedule. Education Secretary Arne Duncan attributed his department's pace to the fact that "our career staff has kicked butt," but said he couldn't make comparisons with other agencies. "We've just focused on getting our stuff out," he said. As infrastructure funds work their way into the economy, tax cuts and some other forms of stimulus spending, such as aid to states, are taking effect sooner. Tax cuts account for about a third of the package's price tag, and more than $53 billion of them have been paid out, the White House Recovery Office said Tuesday. A payroll tax credit, which adds about $8 a week to a worker's take-home pay, has been in place for several months.
The price of U.S. recession is paid in jobs
Long after President Barack Obama's first term ends in 2013, millions of U.S. families will still be paying the price for the recession. From auto workers in Detroit too old for retraining, to Hispanic migrants in Arizona with no homes to build, to new college graduates competing with experienced workers for scarce jobs, more and more people are facing long-lasting unemployment. Since the recession began in December 2007, the jobless rate has climbed 4.6 percentage points to 9.5 percent, the biggest jump since the Great Depression. Worse, the mean duration of unemployment is now almost 6 months, the highest on record.
Although Obama frequently points out he inherited the recession from his predecessor, George W. Bush, the fallout will frame his legacy, presenting a quandary for a president elected on a slogan of "Yes We Can." Unless Obama figures out how to repair the job market, the can-do attitude sparked by his election may be replaced by despair, leaving deep economic and social scars that undermine his political goals. Joblessness typically rises during recessions as weak demand prompts companies to cut production and jobs. Normally those workers are rehired once the economy recovers.
For example, in the back-to-back recessions of the early 1980s, the jobless rate peaked at 10.8 percent. Thanks to a strong recovery, that receded to 8.3 percent one year after the downturn ended.
This pattern has changed in recent years and jobs lost in recessions are much slower to return, if they come back at all. In the 2001 slump, unemployment peaked 19 months after the recession ended, and it was another three years before the jobless rate came close to pre-recession levels.
In the current recession, economists say high unemployment is likely to persist at least another four years. In Michigan, home to the battered U.S. auto industry, nearly 13 percent of jobs may be wiped out, according to research firm IHS Global Insight, and the state's labor market probably won't return to its pre-recession strength until after 2015. Alvin Gains, 56, a former worker at a Chrysler plant in the Detroit suburb of Sterling Heights, has given up on finding work in his home state and is leaving for Texas.
He left Michigan once before, when he was laid off by Chrysler in 1979. This time he doesn't expect to come back. "This downturn is so much worse, there's no work for people here," he said. The rise in long-term unemployment is a puzzle for economists. The Congressional Budget Office studied it in 2007 and concluded merely that the shift was "hard to explain." But what is clear is the longer people like Gains remain out of work, the worse their chances get. Skills become outdated, big resume gaps put employers off, and younger people step in.
Retraining is the usual prescription, but pay and benefits in new careers are often far worse. Ex-auto workers who once made $28 an hour can now expect more like $9. "The hardest thing for many auto workers who've been doing the same job for 25 years or so to accept is that instantly, permanently, their standard of living has been ratcheted down 80 percent," said Douglas Stites, chief executive of Capital Area Michigan Works, a career center in Lansing, Michigan.
The housing crisis has worsened the situation for job seekers because areas with high unemployment also have high foreclosure rates, making it hard to sell up and move on. Still, when local prospects are grim, sometimes the only choice is to leave. Outplacement consultancy Challenger, Gray & Christmas said that 18 percent of those finding employment in the second quarter relocated, up 14 percent from the previous quarter and the highest rate since 2006.
The pain of joblessness extends well beyond the workers themselves, hitting their families and entire communities as home foreclosures mount, neighborhoods decay and crime rises. "I see long-term unemployment as a real, treacherous disease. And it kills. It kills," said Boston University sociologist Thomas Cottle, ticking off side effects from stress and hypertension to depression, alcoholism and drug addiction.
Even the rate of dental cavities goes up as the unemployed tend to put off routine medical care, said Cottle, author of "Hardest Times: The Trauma of Long Term Unemployment." He worries that the recession is slowly eroding belief in the American ideal that if you work hard enough, you will get ahead. The longer unemployment endures, the more people will feel abandoned and betrayed, he said.
In many ways, Obama embodies the American Dream. He speaks of how his mother and grandmother sacrificed to provide him with opportunities they never had. With unemployment far higher than most economists expected when he took office, Obama will need to convince Americans that the dream is still attainable. Two groups hit hard by unemployment -- unionized labor and college students -- were also among Obama's strongest supporters in his presidential campaign.
Jason Harper, 22, can't find a job in his chosen field, advertising, despite a Princeton degree and more experience than most people his age. "I thought that it would be a bit easier than it is to find a job," he said. He's now looking for advertising jobs in Germany. While younger people still support Obama, the longer they go without jobs commensurate with their expensive educations, the less happy they will be.
A big test for Obama comes next year, when most members of Congress face mid-term elections. High unemployment breeds angry voters, and a normal response is to toss out the incumbent.
Obama's Democrats are unlikely to lose their big majorities, particularly in the Senate, where 18 of the 34 senators up for reelection are Republicans, but his party's power may be diluted. He is already discovering that one of his top agenda items, healthcare reform, is a tough sell, and a weakened Democratic party could make it even tougher to rally support for his agenda.
When Obama himself comes up for reelection in 2012, the job market will probably still be hurting. Global Insight estimates that, in more than half of the 50 states, it will be 2013 or later before the number of jobs gets back to pre-recession levels. But there is hope on parts of the horizon. The government's $787 billion stimulus package will bring construction jobs, says Joseph Brusuelas, an economist at Moody's Economy.com. That would be welcome news for states such Arizona, Florida and Nevada, where the housing bust has hit employment hard.
Christian Aguilar is one of the construction workers hit by the bust. He thrived painting new homes across the sprawling Phoenix valley until the work dried up. "They laid me off for two weeks, then that stretched out to a month, now I haven't worked since last August," he said. Now he touts for work at a day labor center in Phoenix, waiting for construction work to pick up again. Another group with prospects is out-of-work Wall Street financiers, who Brusuelas sees finding a niche at boutique investment banks or in developing financing for the start-up companies that sprout in bad times.
He likened their situation to defense industry workers in California in the early 1990s who found jobs in unlikely places such as Hollywood animation studios and Silicon Valley. Brusuelas also argues that firms overdid the job cuts in the panic of the fall of 2008 and will need to bring back workers quickly. But for one group, the hard-to-employ older men from the auto industry, economists agree: Those jobs are gone and they are not coming back.
Fidelity the Latest to Caution on ETFs
Fidelity Investments became the latest to warn its customers about leveraged exchange-traded funds. "Leveraged products are complex, carry substantial risks and are intended for short-term trading," a warning to customers on Fidelity's Web site said. "Most reset daily and seek to achieve their objectives on a daily basis. Due to compounding, performance over longer periods can differ significantly from the performance of the underlying index."
The move by the Boston mutual-funds company comes as some brokers place constraints on sales of leveraged or inverse ETFs, or stop them outright. Morgan Stanley Smith Barney, a joint venture of Morgan Stanley and Citigroup, said last week that it is reviewing its sales practices regarding leveraged ETFs. Earlier, UBS's UBS Wealth Management Americas suspended purchases of leveraged ETFs. LPL Investment Holdings of Boston prohibited sales of the leveraged ETFs that seek more than two times the long or short performance of their target index, and Ameriprise Financial of Minneapolis told its advisers to stop soliciting the purchase of the products.
Questions about the products' suitability as long-term investments also have raised regulators' concerns. Fidelity didn't return a call seeking comment. Asked last week about the issues surrounding leveraged ETFs, a Fidelity spokesman said that it makes the funds available to customers who wish to purchase them, and added, "We are aware of recent regulatory and industry discussion about these products, and we are carefully following that discussion." The Financial Industry Regulatory Authority in June issued a reminder to brokers and advisers, urging them to use care in selling inverse and leveraged ETFs.
As pressure mounts for target-date funds to lower expenses, some managers are cutting costs by removing management fees or investing in some combination of lower-cost underlying funds. Fidelity plans to launch the Fidelity Freedom Index Funds, a series of target-date index funds in five-year increments, from 2000 to 2050, in September. Strategic Advisers Inc. will invest each of the target-date funds in a combination of Fidelity index funds.
New Battery Stimulus Spending Is Another GM Bailout
The President announced today $2.4 billion in stimulus spending on advanced battery technology spread across 48 different projects. The money will go to a variety of battery makers, tech companies, automakers and Universities. General Motors appears to be the biggest winner, essentially receiving $392.8 million to advance development of its hybrid plug-in, the Volt. Of that sum, $151.4 million goes to Compact Power, a subsidiary of LG Chem, who is producing batteries for the Volt. The rest goes directly to General Motors.
The other U.S. automakers received considerably less money. Ford gets $40 million, and Chrysler is getting $70 million. Don't feel too bad for Ford, the company is supposed to receive $5.9 billion in a low cost loan from the DOE.
Nissan's plan to change the world gets a nice shot in the arm from this go round of government spending. Its partner, Electric Transportation Engineering Corporation is receiving $99.8 million to deploy charging stations in the nine markets--towns in Tennessee, Arizona, California, Washington, Oregon--where Nissan initially plans on selling its electric car at the end of 2010. The program will help out Nissan, but it will also help turn those parts of the country in electric vehicle hubs. They should have plenty of charging stations and infrastructure in place by the end of next year.
Other notable recipients include A123 and Johnson Controls, who will receive $550 million between them. EnerDel is also going receive $118.5 million. President Obama announced the funding in Elkhart, Indiana, where unemployment is 16.8%, highest in the country. The emphasis of this spending was on job creation and weaning America off the always hated "foreign" oil. Says Obama in the release, ""If we want to reduce our dependence on oil, put Americans back to work and reassert our manufacturing sector as one of the greatest in the world, we must produce the advanced, efficient vehicles of the future." Private matching funds will be spent by each company that receives stimulus money.
Why Nuclear Power Is Part of Our Future
America is falling behind in the race to develop green energy technologies. As John Doerr, a partner at the venture-capital firm Kleiner Perkins Caufield & Byers, recently told a U.S. Senate energy panel, “The United States led the world in the electronics revolution, and we led in biotechnology and the Internet. But we are letting the energy technology revolution speed by us.” Mr. Doerr noted that the U.S. is home to only one of the top 10 wind turbine producers, only one of the 10 largest photovoltaic solar panel producers, and only two of the top 10 advanced-battery manufacturers.
China is leading this race, and I saw this first hand during a recent trip there. China has doubled its wind-energy capacity each of the past four years, and it is expected to become the world’s largest manufacturer of wind turbines this year. It is already the world’s leading producer of solar panels. The Chinese understand that clean-energy technologies are the key to controlling their energy future. However, while the U.S. may be trailing on renewable energy and storage technology, we are still the world’s largest operator of commercial nuclear power.
We have 104 licensed commercial nuclear reactors—generating about 20% of our electricity and more than 70% of all carbon-free electricity. My company, the North Carolina-based Duke Energy, has seven reactors and we are planning three more. France operates 58 reactors and China has 11, but it is currently building 24 more. Additionally, the U.S. remains a leader in researching and developing nuclear technologies. Our national labs and private sector know-how provide the resources and the scientific foundation for the U.S. to compete as a global leader in commercial nuclear power.
Our private-sector expertise and interest in new nuclear plants is causing regional energy hubs to sprout up, creating thousands of well-paying jobs. In our headquarters city of Charlotte, N.C., Toshiba America Nuclear Energy recently announced it is adding about 200 new jobs and investing nearly $3 million to establish a nuclear power construction management center. Also in Charlotte, Siemens Energy is adding over 220 new jobs over the next five years and investing $50 million to grow its local power facility, which employs 780. The Shaw Group located and expanded its 1,000-employee Power Group here. Similar stories are being repeated around the country. This naturally occurring, market-driven expansion of nuclear jobs didn’t have anything to do with stimulus spending.
We must maintain this momentum. Not only is this a major shot in the arm for our local and national economies, but with zero greenhouse gas emissions, nuclear power is tailor-made for addressing climate change. This is critical as Congress prepares to put a price on carbon. Investing in new nuclear power plants, which produce electricity 24 hours a day and seven days a week, can be a major growth engine for our economy. Nuclear plants can be located close to growing demand centers, and next to existing transmission lines. Renewables, which produce power intermittently, must often be sited far from cities and the grid.
According to industry estimates, building a new nuclear plant can result in the creation of 1,400 to 1,800 jobs during construction, with peak employment as high as 2,400 jobs. Operating a new plant can generate 400 to 700 permanent jobs that can pay almost 40% more than average local salaries. These are good, long-term jobs—the kind you can raise a family on. Additionally, each year the average nuclear plant generates approximately $430 million in sales of goods and services in the local community and nearly $40 million in total labor income, including both direct and secondary economic impacts. Imagine the economic stimulus if the 26 or so new nuclear plants currently planned for the U.S. were fully developed.
To generate electricity that is affordable, reliable and clean as we transition to a low-carbon future, we must also invest in and expand our use of wind, solar and other new renewable energy technologies. Duke Energy alone is poised to become one of the 10 largest wind energy producers in the U.S. this year. When it comes to creating thousands of 21st century jobs—energy jobs on which we can rebuild the middle class—nuclear power clearly has the edge. We can and must grow our lead.
Mr. Rogers is chairman, president and chief executive officer of Duke Energy Corporation.
The debt-inflation myth, debunked by UBS
Here’s an interesting counterpoint to the theory that governments are attempting to inflate their way out of their financial crisis-related debt dilemmas.
It comes courtesy of UBS economist Paul Donovan, who argues:While most investors today acknowledge that deflation is likely to be a feature for the OECD economies during the second half of 2009, inflation pessimists cling resolutely to the belief that inflation will inevitably return. “Fiscal deficits are rising dramatically” goes the argument. “Governments will have to create inflation to reduce debt:GDP ratios, as they have done in the past.”
The problem with the idea of governments inflating their way out of a debt burden is that it does not work. Absent episodes of hyper-inflation, it is a strategy that has never worked. Government debt: GDP burdens tend to be positively correlated with inflation. Market mythology has created the idea that inflation will help reduce government debt ratios. The facts do not support the myth. OECD government debt rises as inflation rises. Meaningful reductions in government debt will require a low inflation future.
To wit — this chart, which purportedly shows year-on-year levels of inflation on the x-axis and change in government debt (as a per cent of GDP) over one year on the y-axis. The two axes cross each other at the 5 per cent inflation level because that’s deemed, by UBS, to constitute a genuine inflation shock.
The point then, is that there aren’t many instances in the lower right-hand quadrant, which would coincide with relatively high levels of inflation and a decline in government debt as a proportion of GDP. The picture is much the same, according to UBS, over a two-year period too.
But why? Here’s Donovan again:The fundamental obstacle to governments eroding their debt through inflation is the duration of the government debt portfolio. If all outstanding debt had ten years before it matured, then governments could inflate their way out of the debt burden. Inflation would ravage bond holders, and governments (with no need to roll over existing debt for a decade) could create inflation with impunity, secure in the knowledge that existing bond holders could do nothing to punish them. In the real world, of course, governments roll over their debt on a very frequent basis. As a result, governments are vulnerable to higher debt service costs if market interest rates change. If markets move to price in the consequence of higher inflation by raising nominal interest rates, then the debt service cost will rise and increase the debt. Thus a period of high inflation will tend to raise both the numerator and the denominator of the debt:GDP ratio.
As an example, the US can expect to roll over almost 45 per cent of its debt in the next 12 months and some 55 per cent over the course of the next two years. So according to UBS, if there is an inflation surge in the next 12 months, the US government would expect that to be reflected in higher borrowing costs — thus negating any ’sympathetic’ inflation-impact on its national debt. There’s also the issue of TIPS, or index-linked (inflation-linked) securities.
Add to that the notion that real yields tend to also rise in times of uncertain inflation — by as much as 100 to 150bp, according to UBS’s analysis, as investors demand a premium for the uncertainty — which further adds to government borrowing costs.
Thus, according to UBS, the problem governments face is that high inflation is likely to generate higher nominal and higher real interest rates. This means the rate of increase in debt servicing costs will probably exceed the rate of increase in nominal GDP, as a result of the higher inflation, and voila — you have very little government benefit associated with stronger inflation, according to the bank.
Donovan’s conclusion:The idea that governments can readily inflate their way out of their debt problems is a misnomer — arising, perhaps, from confusion between the fate of the individual bondholder and the response of the collective market. An individual holder of a long duration bond will lose out as a result of inflation. However, modern governments can not rely on markets to remain collectively indifferent to inflation. Inflation will raise the nominal cost of borrowing (of course) but through the inflation uncertainty risk premium it will also add to the real cost of borrowing.
The higher debt service cost becomes a problem for a government that is pursuing an inflation strategy because government debt does have to be rolled over. Unless a government is willing to pursue hyper-inflation as a strategy, raising inflation will not reduce the government debt burden. Indeed, history indicates that the reverse result will be achieved.
So caveat hyperinflation. Not sure that will appease the uber-inflation hawks, really.
U.S. Treasury to Sell $75 Billion in Long-Term Debt
The U.S. Treasury plans to sell a record $75 billion in its quarterly auctions of debt next week and indicated plans to expand inflation-indexed securities next year as it finances unprecedented budget deficits.
The Treasury plans to auction $37 billion in three-year notes on Aug. 11, $23 billion in 10-year notes Aug. 12 and $15 billion in 30-year bonds Aug. 13. The amounts matched the median forecast of analysts surveyed by Bloomberg News.
The Treasury’s current borrowing calendar is “sufficient” to meet the government’s needs and auction sizes are likely to rise in a “gradual manner” over the medium term, a Treasury statement in Washington said today. The Treasury signaled that issuance of Treasury Inflation-Protected Securities will rise in fiscal year 2010, and said it would consider replacing the 20- year TIPS with a 30-year security. “Near-term financing needs will rise as a result of weakness in the economy,” Karthik Ramanathan, the department’s debt-management director, told the Treasury Borrowing Advisory Committee yesterday, according to minutes of the meeting. The Treasury is “well-poised to meet the balance of its financing requirements not only for the remainder of the year but also fiscal 2010.”
The Treasury also said it expects to run up against the debt ceiling, which currently stands at $12.1 trillion, in the last three months of the 2009 calendar year. The Treasury said it would keep Congress and the markets apprised of developments, “given the uncertainty surrounding potential borrowing needs.” Treasury Secretary Timothy Geithner has pledged to return the budget shortfall to sustainable levels by 2013. Even so, the International Monetary Fund projects the U.S. will swell its deficit to the highest level as a share of gross domestic product among the Group of Seven industrial nations.
In a briefing with reporters today, Matthew Rutherford, the Treasury’s deputy assistant secretary for federal finance, said the government remains committed to reducing the budget shortfall. The department is hearing growing interest for TIPS, he said, declining to comment about any potential purchases by China or other individual buyers. Rutherford also said the Treasury is committed to keeping the size of a supplemental financing program with the Federal Reserve at $200 billion.
On Aug. 3, the Treasury cut its borrowing estimate for the July-to-September quarter to $406 billion, as spending on banking and housing rescue efforts is less than anticipated. The department cited lower purchases of Fannie Mae and Freddie Mac preferred stock, as well as banks repaying money from the Troubled Asset Relief Program. “The borrowing pressure on them remains acute,” said William O’Donnell, U.S. government bond strategist at RBS Securities Inc. in Stamford, Connecticut. “They seem to be satisfied with the current suite of nominal issuance. There doesn’t seem to be any imminent threat of bringing a new Treasury security.”
The Chinese government and other investors have expressed concerns that the inflation-indexed market may not be as strong as the broader Treasury sector, O’Donnell said. “Increased supply will help increase depth and liquidity,” O’Donnell said. “The Treasury now recognizes that and appears committed to doing something.” In a Bloomberg News survey of seven analyst forecasts, the median estimate for next week’s auctions was $37 billion in three-year note sales, $23 billion in 10-year note sales and $15 billion in bond sales. To help manage short-term borrowing needs, the Treasury said it plans to sell cash-management bills in the current quarter, with some of them “longer dated” securities.
Next week’s auctions of bonds and notes will raise $14.1 billion in new cash, with the rest of the proceeds going to pay off maturing debt, the Treasury said. For the first nine months of the current fiscal year, which ends Sept. 30, the deficit reached $1.1 trillion. The gap for all of fiscal 2009 is projected by the Congressional Budget Office to be $1.8 trillion, as the Obama administration spends to reverse the worst U.S. economic slump since the Great Depression. This quarter’s total long-term debt sales exceeded the $71 billion in notes and bonds sold at the last refunding in May, when the Treasury expanded its sales of 30-year bonds to once a month, up from eight auctions per year.
The Destruction of the Black Middle Class
by Dedrick Muhammad And Barbara Ehrenreich
To judge from most of the commentary on the Gates-Crowley affair, you would think that a "black elite" has gotten dangerously out of hand. First Gates (Cambridge, Yale, Harvard) showed insufficient deference to Crowley, then Obama (Occidental, Harvard) piled on to accuse the police of having acted "stupidly." Was this "the end of white America" which the Atlantic had warned of in its January/February cover story? Or had the injuries of class - working class in Crowley's case - finally trumped the grievances of race?
Left out of the ensuing tangle of commentary on race and class has been the increasing impoverishment-or, we should say, re-impoverishment--of African Americans as a group. In fact, the most salient and lasting effect of the current recession may turn out to be the decimation of the black middle class. According to a study by Demos and the Institute for Assets and Social Policy, 33 percent of the black middle class was already in danger of falling out of the middle class at the start of the recession. Gates and Obama, along with Oprah and Cosby, will no doubt remain in place, but millions of the black equivalents of Officer Crowley - from factory workers to bank tellers and white collar managers - are sliding down toward destitution.
For African Americans - and to a large extent, Latinos - the recession is over. It occurred between 2000 and 2007, as black employment decreased by 2.4 percent and incomes declined by 2.9 percent. During the seven-year long black recession, one third of black children lived in poverty and black unemployment-even among college graduates-- consistently ran at about twice the level of white unemployment. That was the black recession. What's happening now is a depression.
Black unemployment is now at 14.7 percent, compared to 8.7 for whites. In New York City, black unemployment has been rising four times as fast as that of whites. Lawrence Mishel, president of the Economic Policy Institute, estimates that 40 percent of African Americans will have experienced unemployment or underemployment by 2010, and this will increase child poverty from one-third of African-American children to slightly over half. No one can entirely explain the extraordinary rate of job loss among African Americans, though factors may include the relative concentration of blacks in the hard-hit retail and manufacturing sectors, as well as the lesser seniority of blacks in better-paying, white collar, positions.
But one thing is certain: The longstanding racial "wealth gap" makes African Americans particularly vulnerable to poverty when job loss strikes. In 1998, the net worth of white households on average was $100,700 higher than that of African-Americans. By 2007, this gap had increased to $142,600. The Survey of Consumer Finances, which is supported by the Federal Reserve Board, collects this data every three years -- and every time it has been collected, the racial wealth gap has widened. To put it another way: in 2004, for every dollar of wealth held by the typical white family, the African American family had only one 12 cents. In 2007, it had exactly a dime. So when an African American breadwinner loses a job, there are usually no savings to fall back on, no well-heeled parents to hit up, no retirement accounts to raid.
All this comes on top of the highly racially skewed subprime mortgage calamity. After decades of being denied mortgages on racial grounds, African Americans made a tempting market for bubble-crazed lenders like Countrywide, with the result that high income blacks were almost twice as likely as low income white to receive high interest subprime loans. According to the Center for Responsible Lending, Latinos will end up losing between $75 billion and $98 billion in home-value wealth from subprime loans, while blacks will lose between $71 billion and $92 billion. United for a Fair Economy has called this family net-worth catastrophe the "greatest loss of wealth for people of color in modern U.S. history."
Yet in the depths of this African American depression, some commentators, black as well as white, are still obsessing about the supposed cultural deficiencies of the black community. In a December op-ed in the Washington Post, Kay Hymowitz blamed black economic woes on the fact that 70 percent of black children are born to single mothers, not noticing that the white two-parent family has actually declined at a faster rate than the black two-parent family. The share of black children living in a single parent home increased by 155 percent between 1960 to 2006, while the share of white children living in single parent homes increased by a staggering 229 percent.
Just last month on NPR, commentator Juan Williams dismissed the NAACP by saying that more up-to-date and relevant groups focus on "people who have taken advantage of integration and opportunities for education, employment, versus those who seem caught in generational cycles of poverty," which he went on to characterize by drug use and crime. The fact that there is an ongoing recession disproportionately affecting the African American middle class - and brought on by Wall Street greed rather than "ghetto" values - seems to have eluded him.
We don't need any more moralizing or glib analyses of class and race that could have just as well been made in the 70s. The recession is changing everything. It's redrawing the class contours of America in ways that will leave us more polarized than ever, and, yes, profoundly hurting the erstwhile white middle and working classes. But the depression being experienced by people of color threatens to do something on an entirely different scale, and that is to eliminate the black middle class.
Bernanke's Shell Game
Fed Chairman Ben Bernanke is a man who knows how Washington works and uses that knowledge to great effect. His appearences on Capital Hill are always worth watching. He sits politely with his hands folded in front of him playing the bashful professor while one one preening congressman after another makes a fool out of himself. In contrast, Bernanke looks modest and thoughtful, faithfully upholding the public's trust. But things aren't always as they seem. The Fed chief is sticking it to the American people big-time and no one seems to have any idea of what's really going on. Former hedge fund manager Andy Kessler sums it up in a recent Wall Street Journal article, "The Bernanke Market". Here's a clip:
"By buying U.S. Treasuries and mortgages to increase the monetary base by $1 trillion, Fed Chairman Ben Bernanke didn't put money directly into the stock market but he didn't have to. With nowhere else to go, except maybe commodities, inflows into the stock market have been on a tear. Stock and bond funds saw net inflows of close to $150 billion since January. The dollars he cranked out didn't go into the hard economy, but instead into tradable assets. In other words, Ben Bernanke has been the market."
What does it mean?
It means the revered professor Bernanke figured out a way to circumvent Congress and dump more than a trillion dollars into the stock market by laundering the money through the big banks and other failing financial institutions. As Kessler suggests, Bernanke knew the liquidity would pop up in the equities market, thus, building the equity position of the banks so they wouldn't have to grovel to Congress for another TARP-like bailout. Bernanke's actions demonstrate his contempt for the democratic process. The Fed sees itself as a government-unto-itself.
Over at Zero Hedge, Tyler Durden did the math and figured that the recent 45 per cent surge in the S&P 500 had nothing to do with the fictional economic "recovery", but was just more of the Fed's hanky panky. Durden noticed that the money that's been sluicing into stocks hasn't (correspondingly) depleted the money markets. That's the clue that led him to the truth about Bernanke's 6 month stock rally.
Zero Hedge: "Most interesting is the correlation between Money Market totals and the listed stock value since the March lows: a $2.7 trillion move in equities was accompanied by a less than $400 billion reduction in Money Market accounts!
Where, may we ask, did the balance of $2.3 trillion in purchasing power come from? Why the Federal Reserve of course, which directly and indirectly subsidized U.S. banks (and foreign ones through liquidity swaps) for roughly that amount. Apparently these banks promptly went on a buying spree to raise the all important equity market, so that the U.S. consumer whose net equity was almost negative on March 31, could regain some semblance of confidence and would go ahead and max out his credit card. Alas, as one can see in the money multiplier and velocity of money metrics, U.S. consumers couldn't care less about leveraging themselves any more."
So, the magical "Green Shoots" stock market rally was fueled by a mere $400 billion from the money markets. The rest ($2.3 trillion) was main-lined into the market via Bernanke's quantitative easing (QE) program, of which Krugman and others speak so highly.
Wouldn't you like to know if Bernanke sat down with G-Sax and JPM executives and mapped out the details of this swindle before the printing presses ever started rolling?
So, how long can this kind of fakery go on before our creditors grow weary of dealing with chiselers and stop buying US Treasuries altogether? Here's a piece from Friday's Wall Street Journal on that very topic:
"Shaky auctions of Treasury notes this week reignited concerns about whether the government can attract buyers from China and elsewhere to soak up trillions in new debt.
“A fuse was lit this week when traders noted China's apparent absence from direct participation in two Treasury bond auctions. While China may have bought Treasurys just before the auctions, market participants read the country's actions as a worrying sign that China and other foreign investors may be ratcheting back purchases at a time when the U.S. is seeking to fund a $1.8 trillion budget deficit.
“This week alone, the U.S. deluged the bond market with more than $200 billion in record-size sales. The U.S. has had little trouble finding buyers in recent months. But that demand is fading, and the Treasury market has become volatile."
Uncle Sam is goosing the bond market just like he is the stock market. Take a look at Treasury's latest bit of chicanery which was stuffed in the back pages of the Wall Street Journal back in June:
>"The sudden increase in demand by foreign buyers for Treasurys, hailed as proof that the world's central banks are still willing to help absorb the avalanche of supply, mightn't be all that it seems.Nice touch, eh? So, someone doesn't want you and me to know when foreign demand drops off a cliff, so they just bend-and-twist the definitions so they meet the Fed's requirements. How's that for transparency?. Apparently, Bernanke et al. don't believe the Chinese have translators who can make sense of all this subterfuge. That may be a miscalculation, however, given recent rumblings from the Orient.
“When the government sells bonds, traders typically look at a group of buyers called indirect bidders, which includes foreign central banks, to divine overseas demand for U.S. debt. That demand has been rising recently, giving comfort to investors that foreign buyers will continue to finance the U.S.'s budget deficit.
“But in a little-noticed switch on June 1, the Treasury changed the way it accounts for indirect bids, putting more buyers under that umbrella and boosting the portion of recent Treasury sales that the market perceived were being bought by foreigners." ("Is foreign Demand as Solid as it Looks, Min zeng)
But, perhaps, Bernanke knows that foreign demand for Treasuries will dry up and has made other plans to stabilize the dollar already. Maybe he worked out an agreement with the banks that if he pumped up the stock market--which he has--and built up the banks equity position--which he has---the banks would return the favor by buying up the lion's-share of Treasuries.
This is from Bloomberg (August 3):
"U.S. lenders bailed out by the government are returning the favor by stepping up purchases of Treasuries, helping to temper a rise in borrowing costs.
“Bank holdings of U.S. government securities are up 15.6 per cent from a year ago, almost double the average annual growth rate of about 8 per cent since the Federal Reserve began tracking the data in 1973, according to the Greenwich, Connecticut-based trading and research firm MKM Partners LP. Purchases may accelerate as lenders look for places to park rising deposits as sales of federal agency debt of companies such as Fannie Mae and corporate bonds slow." (Bloomberg)
One hand washes the other. Funny how that works.
So, the bottom line is that the dollar is increasingly balanced on the rotting scaffolding of Bernanke's buyback programs (Quantitative Easing) and the circular purchases from collaborating banks that are concealing their backroom dealings with the Fed.
To keep this game going, Bernanke will have to keep juicing the market while the banks use the $850 billion in reserves (which the Fed has provided in the last year) to keep purchasing US sovereign debt.
Is anyone in Congress watching or is this shell game going to go on forever?
The Madness Of The Media
About a week ago, the cover story of Newsweek magazine dispensed happy talk to its readers, namely a firm declaration that the recession was over. On Wednesday, more happy media talk as the front pages of the New York Times, the Wall Street Journal and USA Today proclaimed to its readers that the three-year housing horror show appeared to be over. Maybe so, but it seems unlikely that the army of 14.7 million unemployed Americans, and counting, and the former owners of an estimated 2 million foreclosed and abandoned homes, and counting, will share their exuberance.
"Media madness" is the reaction of one top Morgan Stanley trader, who contends the economic facts of life are suddenly being replaced with economic fiction. "It reminds me of the lyrics from an old Johnny Mercer song," he says; "you've got to accentuate the positive, eliminate the negative." And that's what the media is doing, he says. "First, they accentuated the negative, and now they're eliminating it." Charles Biderman, the 62-year-old skipper of West Coast liquidity tracker TrimTabs Investment Research, which is partially owned by Goldman Sachs and boasts among its readership many of the country's top hedge fund managers. seems to agree, ridiculing what he characterizes as the media's current bullish nonsense. "The Newsweek cover," he predicts, "will become an historical cover as a contrary indicator."
A one time Barron's reporter, Biderman has frequently taken pot shots at the press, knocking it for what he regards as its excessively rosy views of both the economy and the stock market. In effect, he's suggesting that the media's desire to want things to be better may be clouding its editorial judgment. One example may well be its mounting characterization of economic data as "less bad" when, in fact, it's still downright negative. Biderman's thinking on this score should not be pooh-poohed. I've seen a number of examples where some in the media have gone off half cocked in their ultra-sunny economic market assessments. And then a day or week later, lo and behold, they turn out to be totally wrong.
A recent example of the preposterous can be seen in the comments from one talking head on the usually reliable Fox Business Network, who told viewers that both the Bush and Obama administrations deserved a pat on the back for their economic actions. That's utterly absurd since under watch of the current and previous administrations--blame whichever party you'd like or both--we've experienced the worst economic downturn since the Great Depression, with the national debt, the budget deficit, bankruptcies and unemployment going through the roof.
Uncle Sam just reported that the economy, turned in better than expected numbers, shrinking at only a 1% pace in the latest quarter. Biderman is not impressed. It's not a year-over-year number, he points out, but sequential, quarter over quarter. Further, he notes, the number is only a very preliminary estimate, which in the past has been so dramatically revised that it has become meaningless.
Meanwhile, Biderman seems to offer some compelling arguments that the media's housing and economic bulls could be skydiving without a parachute. Recently, there has been good news on the housing front. Namely, new home sales in June rose 11%, while existing home sales for the month rose for the third consecutive month. More recently and considered even more relevant, a survey of 20 metropolitan areas by the well regarded Case-Shiller folks showed that home prices rose in 8 cities in May, versus 4 in April.
In response, Biderman notes "the bulls are putting lipstick on the housing pig and it won't work." The reason, he says: the bad news on the housing front outweighs the good. For starters, he points out that as of the end of May, 11.3% of the 41 million total U.S. mortgagesoutstanding were delinquent, up from 8.5% or 3.5 million at the end of January. Likewise, he calls attention to some 5 million home owners who are no longer making their mortgage payments. As for the Case-Shiller news, he notes that on a seasonally adjusted basis, using month over month comparisons, home prices actually declined in June. He also argues that the housing bulls are ignoring a potential tidal wave of failures in option ARM and Alt-A mortgages.
(Option ARM mortgages are adjustable rate mortgages that allow you to choose among several payment options each month. Alt-A mortgages, more risky than conventional mortgages, are something of a step below loans for people who have better credit than sub-prime borrowers, but credit which may not qualify them for the best loans and lower rates.)
With job losses continuing to rise -- Biderman projects they'll top 400,000 in July--he sees a new downleg in housing starting in the fourth quarter or in early 2010, spurred by an additional wave of foreclosures, chiefly among higher-priced homes. "How are people expected to pay their mortgages if they lose their jobs?," he asks. "The answer," he says, "is they can't." One of the damaging offshoots of the continued housing slump, as he sees it: "Banks will be hit with a tremendous increase in non-performing loans."
Lately, Biderman has been negative on the stock market and he's been decidedly wrong, given the robust resumption of the March-June rally. To make matters worse, his model portfolio has been recommending a number of short sales (a bet stock prices will go lower). "The rally has been painful," he says, but he's convinced "it's fake and unsustainable." For the past 35 years, he notes, money managers have convinced themselves you buy stocks on dips, and it has worked. But that game, he believes, will come to an end because reality should soon come home to roost. On the liquidity side, he notes that buying by corporate insiders is way down, while insider selling is way up. In addition, there are virtually no corporate stock buybacks.
"You have unemployment going up, wages and salaries dropping more than expected, falling consumer confidence, and many people have stopped paying their mortgages," Biderman says. "The only real improvement is in the stock market, and common sense tells you it can't last." The economy, he predicts, will get worse, not better, and he believes the Dow Industrials, currently at around 9150, should return to their March low (6547). Accordingly, says our bear, investors should now be aggressive sellers of stocks. Or put another way, when it comes to the market, it's a good time to be a wimp.
Banking On A Suit
Madoff Litigator Chasing JPMorgan For Clawback
Joseph Cotchett, the San Francisco trial lawyer who last week made a splash when he sat down with convicted Ponzi schemer Bernie Madoff, is using the fruits of that interview to take aim at Wall Street, The Post has learned. Since emerging from his 4?-hour sit-down with Madoff at a federal prison in Butner, NC, where the fallen financier is serving a 150-year sentence, Cotchett and his legal team have been furiously amending their lawsuits to name new defendants.
Among those new targets may be big financial firms, sources close to the legal team told The Post. Cotchett and his army of lawyers "are investigating the investment banks -- the people who had knowledge that this wasn't a good investment, so to speak," said a person familiar with the litigator's plan. "If they had done the due diligence, the fraud could have been caught. I think those that had the responsibility to do the due diligence didn't do what they should have done."
A likely target could be JPMorgan Chase, which has been accused of pulling its money from Madoff ahead of the breaking scandal, leaving its clients behind. JPMorgan gave its clients access to Madoff through a product that let them lever their returns on funds that invested with the fraudster. The bank invested $250 million of its own money in the product, known as levered notes, but pulled out months before Madoff was arrested in December. A lawsuit filed in April by a Madoff investor claims JPMorgan Chase "unequivocally knew that Madoff's investment returns were false" as far back as September 2008.
A JPMorgan spokesman declined to comment, citing the lack of a formal complaint against the firm. The bank has previously cited "a wide-ranging review" of the firm's overall hedge-fund exposure, as well as concerns about "the lack of transparency" as reasons it pulled its money from Madoff investments last year. Cotchett declined to comment on which firms he may be going after, but suggested the list of victims' claims offers some clues, as it names investment banking executives. "If you have executives . . . investing in Madoff, you might want to see what their hedge funds are controlling," he said, in an effort to offer a clue to his thinking. Indeed, while the list of victims' claims filed with Madoff trustee Irving Picard aren't publicly available, JPMorgan shows up several times on a list of thousands of Madoff clients that emerged several months ago.
A Canadian doctor diagnoses U.S. healthcare
Universal health insurance is on the American policy agenda for the fifth time since World War II. In the 1960s, the U.S. chose public coverage for only the elderly and the very poor, while Canada opted for a universal program for hospitals and physicians' services. As a policy analyst, I know there are lessons to be learned from studying the effect of different approaches in similar jurisdictions. But, as a Canadian with lots of American friends and relatives, I am saddened that Americans seem incapable of learning them.
Our countries are joined at the hip. We peacefully share a continent, a British heritage of representative government and now ownership of GM. And, until 50 years ago, we had similar health systems, healthcare costs and vital statistics. The U.S.' and Canada's different health insurance decisions make up the world's largest health policy experiment. And the results? On coverage, all Canadians have insurance for hospital and physician services. There are no deductibles or co-pays. Most provinces also provide coverage for programs for home care, long-term care, pharmaceuticals and durable medical equipment, although there are co-pays. On the U.S. side, 46 million people have no insurance, millions are underinsured and healthcare bills bankrupt more than 1 million Americans every year.
Lesson No. 1: A single-payer system would eliminate most U.S. coverage problems.
On costs, Canada spends 10% of its economy on healthcare; the U.S. spends 16%. The extra 6% of GDP amounts to more than $800 billion per year. The spending gap between the two nations is almost entirely because of higher overhead. Canadians don't need thousands of actuaries to set premiums or thousands of lawyers to deny care. Even the U.S. Medicare program has 80% to 90% lower administrative costs than private Medicare Advantage policies. And providers and suppliers can't charge as much when they have to deal with a single payer.
Lessons No. 2 and 3: Single-payer systems reduce duplicative administrative costs and can negotiate lower prices.
Because most of the difference in spending is for non-patient care, Canadians actually get more of most services. We see the doctor more often and take more drugs. We even have more lung transplant surgery. We do get less heart surgery, but not so much less that we are any more likely to die of heart attacks. And we now live nearly three years longer, and our infant mortality is 20% lower.
Lesson No. 4: Single-payer plans can deliver the goods because their funding goes to services, not overhead.
The Canadian system does have its problems, and these also provide important lessons. Notwithstanding a few well-publicized and misleading cases, Canadians needing urgent care get immediate treatment. But we do wait too long for much elective care, including appointments with family doctors and specialists and selected surgical procedures. We also do a poor job managing chronic disease. However, according to the New York-based Commonwealth Fund, both the American and the Canadian systems fare badly in these areas. In fact, an April U.S. Government Accountability Office report noted that U.S. emergency room wait times have increased, and patients who should be seen immediately are now waiting an average of 28 minutes. The GAO has also raised concerns about two- to four-month waiting times for mammograms.
On closer examination, most of these problems have little to do with public insurance or even overall resources. Despite the delays, the GAO said there is enough mammogram capacity. These problems are largely caused by our shared politico-cultural barriers to quality of care. In 19th century North America, doctors waged a campaign against quacks and snake-oil salesmen and attained a legislative monopoly on medical practice. In return, they promised to set and enforce standards of practice. By and large, it didn't happen. And perverse incentives like fee-for-service make things even worse.
Using techniques like those championed by the Boston-based Institute for Healthcare Improvement, providers can eliminate most delays. In Hamilton, Ontario, 17 psychiatrists have linked up with 100 family doctors and 80 social workers to offer some of the world's best access to mental health services. And in Toronto, simple process improvements mean you can now get your hip assessed in one week and get a new one, if you need it, within a month.
Lesson No. 5: Canadian healthcare delivery problems have nothing to do with our single-payer system and can be fixed by re-engineering for quality.
U.S. health policy would be miles ahead if policymakers could learn these lessons. But they seem less interested in Canada's, or any other nation's, experience than ever. Why? American democracy runs on money. Pharmaceutical and insurance companies have the fuel. Analysts see hundreds of billions of premiums wasted on overhead that could fund care for the uninsured. But industry executives and shareholders see bonuses and dividends.
Compounding the confusion is traditional American ignorance of what happens north of the border, which makes it easy to mislead people. Boilerplate anti-government rhetoric does the same. The U.S. media, legislators and even presidents have claimed that our "socialized" system doesn't let us choose our own doctors. In fact, Canadians have free choice of physicians. It's Americans these days who are restricted to "in-plan" doctors. Unfortunately, many Americans won't get to hear the straight goods because vested interests are promoting a caricature of the Canadian experience.
Michael M. Rachlis is a physician, health policy analyst and author in Toronto
One in 25 Northern Rock customers in mortgage arrears
Almost one in 25 Northern Rock customers are three months or more behind with their mortgage repayments, the state-owned lender admitted yesterday as it revealed a jump in bad debts and deepening losses of £724m in the first half. The Newcastle-based bank, which owes the taxpayer £10.9bn, has a rate of arrears of 3.93% of its mortgage book – or 22,141 customers – compared with an industry average of 2.39%.
It has repossessed nearly four times more homes than the industry average although the 2,522 homes it has in possession is down from the peak of 4,000 and fewer than the 3,620 at the end of last year. Gary Hoffman, chief executive of Northern Rock, pinned the blame on the Together loan which allowed customers to borrow 125% of the value of their homes. "Together mortgages are a third of the book, half of the arrears and two thirds to the repossessions," said Hoffman. As a result 39% of the bank's customers are in negative equity after the 21% drop in house prices from their peak – a fact seized upon by the Conservatives.
Philip Hammond, shadow chief secretary to the Treasury, said: "Gordon Brown and Alistair Darling promised taxpayers our money would be safe and that Northern Rock was a good investment. They were wrong, and ordinary families up and down the country are paying the price in higher taxes to fund their write-offs." The charge taken to cover bad debts of £602m was up from £192m a year ago, although it was an improvement on the last six months of 2008.
As with HSBC and Barclays on Monday, Northern Rock is finding that the rate of problem loans is slowing. The City is waiting to see what guidance Lloyds Banking Group, owner of Halifax, gives on wednesday, when it is expected to report £10bn or more of bad debts. But the number of Northern Rock customers in early stage arrears – missing just one or two mortgage payments – is slowing because of low interest rates. "We are seeing some encouraging signs in our early arrears," Hoffman said.
The government, which took control of Northern Rock 18 months ago, is waiting for EU state aid approval to split the bank up. Approval is expected in the autumn when speculation will mount that the Treasury is looking for a buyer for the business. A new so-called BankCo will carry out £14bn of lending by the end of next year after being injected with more taxpayers' money but stripped of the existing government loans. A "bad bank" known as AssetCo, will hold the troubled mortgage book as well as the government loans, which could make it easier for the cleaned-up BankCo to find a private sector buyer.
Hoffman insisted both operations could be attractive to buyers and said he did not know which arm he would run once the split took place. He was adamant that despite speculation the government wanted to sell the businesses before the general election, there was "no process underway". The Treasury also insisted it was not looking for a sale. The Co-operative party, which sponsors Treasury select committee chairman John McFall and is affiliated to Labour, urged the government to remutualise the bank, which converted from a building society 10 years ago.
The Financial Services Authority is allowing Northern Rock to run on a depleted capital ratio while it awaits state aid approval, but even so Hoffman admitted that a target to lend £5bn for mortgages this year could not be met because of its weak capital cushion. He now expects to lend £4bn this year after resuming new lending in the middle of the year when the government reversed previous demands that the bank lose customers to enable it to pay off its taxpayer loan.
Rather than the £724m loss for the six months to June, caused by accounting technicalities, Hoffman highlighted the underlying loss, which narrowed to £270m compared with £443m a year ago. While the lender suffered a dramatic outflow of funds in September 2007 when its difficulties first emerged and then inflows during last year's banking crisis when it was regarded as a safe haven because of the government guarantee, £1bn was withdrawn in the first six months of the year as the banking system returned to normal.
The Recession Isn't Over, By a Long Shot
The “happy talk” campaign in the US media and coming from the White House is just that: Happy Talk. To get a real picture of what is happening with this economy, here are a few things to keep in mind. Yes, the rate of decline in economic activity has slowed. But that is to be expected. When an economy is going at full tilt, as the US economy was doing in early 2007, a slowdown of any significance yields huge numbers, in terms of falling production, falling factory utilization, falling car sales, or, this time around, falling housing prices.
But once you get to the same period in 2008, you’re already in a deep recession, and there really isn’t that much farther to fall. If, for example, the carmakers have basically shut down by fall of 2008, and are just working off huge inventories, then you are not going to see more factory closings and further reductions in production (how do you reduce production below zero?). The same can be said about unemployment, although here there is another twist or two. Yes, the huge layoffs that saw the number of new unemployed jumping by 6-700,000 per month in the early part of this year seem to be over, and now new unemployment is rising by “just” 500,000 a month or so, but that’s because all the major employers have already shut down or shut down entire shifts. There are not that many people who can be laid off any more, at least in large groups. This gets painted as “the pace of layoffs is slowing” as if that’s good news, but it is the opposite.
But there is more trickery and misinformation regarding unemployment statistics, too. One has to do with the oft-noted claim that the number of people collecting unemployment benefits is declining—especially the long-term unemployed. But the reason for this is not that people are finally finding jobs. It’s that unemployment benefits are being exhausted. The upper limit for collecting unemployment benefits in the US is 79 weeks, and that’s only in some states where unemployment is particularly high. In other states it is 72 weeks or even as low as 59 weeks.
Also, unemployment benefits, which reportedly average $300/week, but can be a lot less depending upon where a particular person worked and what state he or she lives in, are lost if a person does some part-time work, and since nobody can support a family on $300 a week, many people on unemployment end up getting part-time jobs and lose their unemployment benefits. That’s not a good sign either.
Finally, unemployment benefits only cover about half of American workers. The rest, because they have already only been able to find part-time jobs, or because they’ve been working “off the books,” or because they are so-called “independent contractors”—people like gardeners, freelance writers, lawyers, consultants, plumbers, etc.—aren’t covered by unemployment insurance. When they get laid off, they are on their own. And increasingly, the layoffs and job losses in this declining economy are falling on people in that category. The early lay-offs were done by managements of big companies which looked ahead, saw the downturn, and implemented “cost-cutting” measures, which meant slashing production and laying off workers. Independent workers and small businesses, whose owners are personally hit when they have to shut down production or operations, have struggled to stay in business as long as possible, but are now entering the jobless rolls at an accelerating rate.
But, and here’s a crucial point, many of them simply don’t get recorded by the government statisticians as being unemployed. Anyone who works even a few hours a week at some odd job, or for free in a family business, is not counted. Anyone who sees no job prospects out there and just gives up isn’t counted. Anyone who finds a half-time job, but needs a full-time job is counted as employed. It didn’t use to be this way. In a more honest time, more than three decades ago, such people were counted as unemployed, but politicians pushed to have them excluded to keep the official unemployment numbers looking lower. If all such people were added to the unemployment numbers we would have unemployment in the US at over 18 percent, and possibly closer to 20 percent. That’s one in five Americans out of work.
And remember, even though we are now in an economy that is functioning at a depressed level, it is still in decline, and those unemployment numbers are rising, not stabilizing. Put that together with the fact that Americans collectively have lost $14 trillion in wealth. They’ve lost invested savings, which are still down almost 20 percent from where they were a year ago, and don’t appear likely to recover any time soon. (Remember, even if the stock market falls 40 percent and then rises 40%, it will still be down.
Consider: If you had $1000 invested in a broad index like the S&P, and it dropped 40% as happened last fall, you lost $400, and have just $600. If the market then recovered 40%, though, which it hasn’t by a long shot, you only gain 40% of $600, or $240, so your portfolio is still only back to $840.) That $14 trillion also includes the lost value of people’s homes, which until 2008 were being used to prop up living standards as people borrowed on the rising equity in their property. With housing values in much of the country now down anywhere from 20% to 80%, many homes are now worth less than the amount of money still owed on people’s mortgages. They can’t sell, and often, they can’t pay the mortgage check.
Where is the consumer spending supposed to come from that used to represent a whopping 70% of economic activity in a United States that long ago stopped making things? The answer is: nowhere. The amount of lost wealth makes a joke of the celebrated Obama stimulus plan, which was less than $1 trillion, and which is spread out over two years. There is simply no money to rekindle the orgy of consumer spending that kept the US economy afloat for so long.
People can’t even borrow if they want to. Banks are not lending, because they know that the happy talk is nonsense, and they don’t want to loan money to people and businesses that are liable to go belly up as the recession continues. That’s why card companies like American Express and many Visa and MasterCard issuers, instead of just charging a late charge when card-holders miss a monthly payment deadline as in the past, are now just jacking up the interest rate they charge, --in American Express’s case to 28% or over 2% a month! That’s not the action of a bank that is expecting to get repaid by a valued customer—it’s the extortionate action of a usurer that wants to extract as much money as possible from a borrower that it expects to have go bust.
Banks are canceling personal and business credit lines right and left too, making a joke of the Obama administration’s claim that it bailed out the banks so that they would “start lending again.” Even the happy talk story about housing sales improving is misleading. The reason it is happening is that so many homes have foreclosed that the sale of foreclosed homes by banks is now a significant part of the total housing market. Again and again, much of the “happy talk” we hear, if examined closely, turns out to be bad news being misinterpreted, often deliberately.
Finally, it should be added that because of massive unemployment, which is approaching levels not seen since the Great Depression, and because of the massive loss of personal wealth, this recession is not likely to act like any of the other recessions of the post-World War II era. These have all been “U” or “V”-shaped affairs, where economic activity would either drop and then, after lingering at a low level for a while, recover at an accelerating rate, as in a “U”, or plunge precipitously to a sharp bottom and then quickly recover, as in a “V”.
This time, we are more likely to see an “L”-shaped recession, where the economy hits bottom at some point, and then operates for years at a much lower level. That lower part of that “L” might rise slowly, but it wouldn’t rise by much. In this case, we would see continued high levels of unemployment, lower wages, and no bounce-back in personal wealth. So if we want to make the correct policy decisions, not to mention the right political decisions and personal financial and basic life decisions, let’s cut the happy talk, and start keeping it real.
All About Picking Losers as Winners: Interview With Bob Feinberg
To gain some perspective on goings on in Washington, we return to our old friend Robert Feinberg, who reports on the financial services industry for his private clients. If you did not read our March 2008 interview with Bob, when he predicted much of the financial crisis and in particular Washington's embrace of the government sponsored entity or "GSE" as the preferred business model, please click this link: "GSE Nation: Interview with Robert Feinberg."
The IRA: Thanks for making time to talk to us this week. You are usually sitting in a hearing room somewhere, so you are not an easy man to find.
Feinberg: That's on purpose. To say that I don't like mobile devices is an understatement. Eventually these things will be implanted in our brains. In the meantime they are just destroying our brains.
The IRA: We look at them as a necessary vice, but always with a view to letting the battery die on weekends.
Feinberg: That's why they're called de-vices.
The IRA: So give us your view of the world after the first however many days of Barack Obama in the White House.
Feinberg: I see Obama as very reminiscent of both JFK and Jimmy Carter. Neither was prepared to do the heavy legislative lifting that we see going on now. By the time that JFK went to Dallas, his calls were no longer being returned and there were problems in the party -- not unlike what we see developing now. He was someone who really did not have a lot of national experience, having served only briefly in the Senate. The relationship to Carter is that Obama basically has experience at the state and local levels, which is reflected in his preference for town hall venues. The last election featured someone with little experience, Obama, versus someone with a lifetime of experience, John McCain (R-AZ), from which he either hasn't learned much. Maybe a better way to say it is that we don't know what McCain learnt.
The IRA: Yes Obama seems to be operating on a continuous campaign format. Reminds us of Vicente Fox in Mexico. Great campaigner, lousy manager.
Feinberg: Bill Clinton perfected the continuous campaign, but consider the Carter metaphor further. His legislative operation never got off the ground at all, ditto Obama so far. The Democrat leadership is driving the process. This is not to say that the Republicans will be able to take advantage of this. I think it is possible that Obama could face a self-financed independent candidate in 2012 a la Mike Bloomberg with the Republicans finishing third.
The IRA: Isn't it remarkable that the legacy of the Bush family has been to now twice leave the GOP in complete disarray? Our friend and mentor Noel Parmentel wrote in The Nation in 1993 that the GOP is "the stupidest party," this when Ross Perot was preparing to pluck the prize from Bob Dole. He actually borrowed the phrase from John Stuart Mill. If you consider the choice of McCain-Palin in the context of earlier Republican tickets like Dole, ending up with eight years of GWB makes some sense. So there is no sign that the Republican disintegration is ending? Do you see a leveraged buyout of the GOP by an outsider in the image of Perot as a possibility?
Feinberg: I've seen that quote attributed to Disraeli. Or maybe it was Yogi Berra. It's a shame so many of the best quotes were taken before our time. It seems that Mill has a quote for all occasions. My favorite is a quote I saw on a poster opposing a third term for FDR. It went something like, "A people may desire Freedom. But if they can be induced to lay their Liberty at the feet of even a Great Man, they will not long enjoy it." However, I've never been able to find the quote in such a pithy form.
No buyout is in prospect; more like a sellout. Not that the Bush People cared about the party, any more than Ike did, or Nixon did, or Ford did. My favorite slogan from the Dole campaign was "Dole IS 96." The Bushes hijacked the party and turned it into a family enterprise. They had the opportunity to do this because Reagan, apparently at the behest of Richard Allen, picked GHW Bush after negotiations for a co-presidency with Ford spectacularly, and fortunately, fell through. The GOP has been disintegrating for a while, and it is continuing. If you look at what they're doing on a day-to-day basis, as I do, you see that Republicans mouth the talking points of the bankers and health insurers. After a previous episode of the Financial Crisis, the Republicans opposed assessing deposit insurance premiums because the industry didn't want them. They said higher premiums would reduce the availability of credit.
The IRA: Nothing like a bank solvency crisis to boost lending.
Feinberg: I had a chance to talk to Chuck Schumer (D-NY) at one of his book presentations last Fall and pointed out that the Democrats won't have the Republicans to blame anymore. You see a reflexive tendency by Obama and the Democrats, though not necessarily Schumer, to blame the Republicans, to use them as a foil. Schumer told me that he knew that the Democrats would have a great opportunity, but he worried that they would not take full advantage of it. Now we seem to be in that circumstance. Today, the Republicans are a non-factor. Historically they have played the role of the Washington Generals to the Democrats Harlem Globetrotters.
The IRA: It sounds strangely like the political devolution visible in nations of the Americas like Venezuela, where the incumbent derechista tendency eventually collapses and flees the country, leaving the authoritarian left with a monopoly. But we still prefer Italy under Berlusconi for political metaphors about a future America. What happens to the Democrats in this scenario? Do they eventually split?
Feinberg: My model is Argentina. Under my scenario, Hillary was going to play Evita. The Democrats already have two parties within the greater whole, the so-called progressives and the Wall Street wing. Eventually the progessives must rebel or just go away. A year ago I ran into Bill Grieder and suggested that the Democrats were really going to owe the Wall Street crowd because Schumer and Ramm Emanuel had put together this tremendous victory in 2006 that presaged 2008 using Wall Street money. He refused to acknowledge that, so already the line was being drawn. But now look at how the progressives are complaining about the "conservative" tendencies of the Obama Administration and their ties to Wall Street.
The IRA: So given that Wall Street owns Barack Obama, what happens with regulatory reform? You have been telling us that the reform proposal was DOA, but that something would or could come out of the process given unforeseen externalities. Is that still the case?
Feinberg: There is something to be said about this. A while back, I realized that I had to come up with a new way of saying that the reform legislation was dead-on-arrival. The key from a journalistic standpoint is to be able to do that when you need to. So I came up with the concept of a Zombie proposal, like a Zombie bank. The reform staggers around in a state of essential death, one that can come back to life at any time, which is what happened with Sarbanes-Oxley in 2002. But there could be some kind of a disaster anytime from tomorrow to a year from now that will create a mad dash to get something into law. The odds of that occurring are pretty good. So people should pay attention to what is going on here as arguments are made and provisions are drafted. Interest groups are gaining and losing ground as we speak.
The IRA: So does another surprise like needing to inject tens of billions more public funds into AIG, for example, provide the catalyst for a stampede?
Feinberg: Some type of systemic failure or the failure of a Treasury bond auction will suffice. By the way, you seem to have thoroughly confused everyone on Capitol Hill by saying in your testimony that we can't measure Systemic Risk. Now everyone is saying that. The other day they had a whole panel, and none of them could define it beyond an institution capable of bringing down the system through its misadventures. Years ago, an anthropology professor at Penn named Anthony F. C. Wallace coined the term Disaster-Prone Organization in his book St Clair. He was talking about the coal industry.
The IRA: Ha! Well, objectively speaking, Systemic Risk is like fear. No way to describe or measure that with objective means. What we have said consistently is that if you increase transparency and lower "hidden" leverage, Systemic Risk goes away. Alan Blinder and others are wrong to say that there is no choice save giving the Fed more power when it comes to Systemic Risk. The clear choice is to compel the Fed to do its job as regulator, lessen leverage and increase transparency, then Systemic Risk will disappear.
Feinberg: "We have nothing to fear but Systemic Risk itself." Not very catchy. It's a classic case of regulators who failed demanding more power. The SEC did that after the mutual fund scandals, saying that if they had authority over hedge funds, they could see around corners and identify problems. A classic case is when W said we missed 9/11 because we didn't have a Department of Homeland Security.
The IRA: Well, people forget that risk management is about looking ahead; to identify risks and then implement policies to avoid these risks. Governments and banks are too worried about the present to be good risk managers.
Feinberg: We certainly are not doing anything about risk at present. Instead, the game is to Restore Confidence in the people and policies that haven't worked for the last forty years or so. Once confidence is restored, the stage is set for the next episode of the crisis. Our friend Alex Pollock is fond is saying, "A confident investor is a stupid investor." Henry Kaufman dates the beginning of this crisis to 1966. It's pretty clear watching the financial press that nobody is paying the slightest attention to risk reduction in the markets. On the contrary, with short-term rates so low thanks to the Fed, investors have no choice but to reach for risk. I'm reminded of the headline in The Onion: "American People Demand New Bubble To Invest In."
Here's one sleeper issue: Senator John Warner (D-VA) has been saying that any systemic solution must be pre-funded like SIPC and previous industry self-insurance efforts. It has also been suggested by others that SIPC needs to be beefed up with some sort of FDIC-like examination function. But obviously, if the markets believed that the industry would have to pay its way, we would never have seen the huge rally in banks stocks that occurred from the end of the first quarter until today. Even as we talk about Systemic Risk, the Fed and other authorities are working to create a new bubble in securities markets fueled with public money. The confidence of the markets in this arrangement is badly misplaced, in my view, and is simply another case of Irrational Exuberance, courtesy of the authorities.
Whenever the Fed decides to slip the Yield Curve again, they create a panic to get into financials. It actually damages the economy, because it distorts incentives and keeps the Zombie banks pumped up on steroids when they need to be shrunk to maybe a fraction of their bloated size. A host on CNBC's "Squawk Box" observed recently that banks really don't do very much, and Greenspan once told Senate Banking that some people would say banks exist only to feed off of the Yield Curve. This strategy is described as, "Borrow short, buy anything." One of the Lessons Learned from the S&L crisis was supposed to be not to do this, but no less a personage than Bill Isaac told an SEC roundtable that this is what banks do. My way of formulating this is that we can have the Zombie banks, or we can have the economy, but we can't have both.
The IRA: Yes, and all of this even as the fundamentals of the industry are under more stress than at any time in half a century. As we told subscribers to the IRA Advisory Service last week, maybe financials will have a different tenor when Capitol One Financial (NYSE:COF) is reporting double digit charge-offs and some of the large money centers are in high single digits. Do you sense that any of the Democrats other than say Schumer understand how fragile is the condition of the credit standing of the US? We watch the Obama Administration proposing to increase spending on health care and to increase the government's funding needs in the debt markets, thus the question.
Feinberg: Among the members there is not much discussion of anything besides stimulus measures. I say that what they're trying to do is to "simulate" the economy. This is what Larry Kudlow proposed at the last meeting of CMRE we were allowed to attend. He wanted to steepen the Yield Curve to help re-elect W by restoring pricing power, so that the economy would look healthy. It was another version of putting lipstick on a pig. One difficulty for the Democrats is that they are dealing with an honest regulator in the Congressional Budget Office. Alice Rivlin created an ethic at that agency of putting out honest numbers. The CBO has said that the Obama reforms do not change the cost curve in the health care really.
Likewise, the Obama regulatory reforms for financial services do not really change anything in the industry. Look at how we are not dealing with the GSEs like Fannie Mae and Freddie Mac, a circumstance we warned about back in 2004 or 2005. Congress created a World Class Regulator who certified the GSEs as Well Capitalized. The result is a financial sinkhole that will require hundreds of billions of dollars in public subsidies for years. I have come up with a formula that links the cost of these bailouts with the decline in asset values. I so warned the Reagan transition team, keep in mind.
Since then, we have been through four different episodes of crisis. Each time, the cost to the taxpayer goes up by an order of magnitude and the value of collateral goes down to a similar extent. Now we are into the range of $10-20 trillion in public claims as opposed to the billions we talked about under as Reagan, Don Regan and our friend Peter Wallison at AEI were taking office. Now a good deal of the collateral is worthless. We achieved this in just two decades. In fact, Special Treasury Department Inspector General to oversee the Troubled Assets Relief Program, Neil Barofsky, has even jumped ahead of IRA and our friend Nouriel Roubini in terms of estimating the maximum cost of this cycle.
The IRA: The numbers we are seeing from Charlie Biderman and other surveys on delinquencies in residential and commercial real estate are in low double digits and rising, while the banks are showing aggregate NPLs for the industry of 2.5%. Eventually these two lines must cross. First with the GSEs and now the banks, the regulators are employing forbearance with respect to recognizing bank losses and this will further reduce liquidity and the ability of banks to lend. By forebearing on closing Zombie banks, we are turning the banking industry into REITs.
Feinberg: That will suit the housing industry just fine. Another interesting data point came from Joe Mason the other day, when he pointed out that housing is still being built in many cases in competition with collateral that is coming onto the market. He said this is happening in places two and a half hours drive from major cities that are remote from public transportation and other services where no one would want to live.
The IRA: We have reported this. The Democrats would rather subsidize homebuilders than allow the real estate market to find a bottom more quickly.
Feinberg: That's why we call it the Housing Industrial Complex. The realtors, the suppliers, the builders represent a big slice of Americana that commands immediate and constant response from both parties. Also, people who work in various segments of the industry have populated Congress and state legislatures to an extent that hasn't been noticed or reported. A realtor, for example, is perfectly situated to run for Congress. All she has to do is change the legend on her lawn signs from Buy to Vote.
The IRA: Well, how do you think the Democrats will respond when home prices fall another 10-20% nationally, in part because states such as CA are subsidizing homebuilders who are adding units to a saturated, liquidation market? Between the shadow inventory of unsold homes and the mounting foreclosure backlog, there is no place for prices to go but lower in many markets.
Feinberg: We can answer that because it is already happening. The Congress is assembling a number of patchwork proposals to prop up the housing industry. I have not seen the letter yet but it was placed in a hearing record last week by the ranking Republican on the House Financial Services Committee, Rep. Spencer Bachus (R-AL). The effort could include things like accounting rules changes for so-called legacy assets, extending the period banks can hold REO, and jawboning the government to buy some of this toxic waste. Notice that Barney Frank (D-MA) and Gary G. Miller (R-CA), a former real estate developer, both took credit for taking measures early in the year to help housing and the banks by loosening the Mark to Market rules, so we are getting ready to do that again. There will be various efforts to buy bad assets from the banks above market via TALF, etc.
The IRA: The TALF has hardly been a success. And the banks are giving back their TARP money to qualify for bonus season - this so that they can become political targets next year. You really have to be impressed with the political acumen of the largest banks, especially Goldman Sachs (NYSE:GS).
Feinberg: Sen. Bob Corker (R-TN) has accused the administration of perpetually extending the TARP, so that its bureaucrats can prop up Zombie banks indefinitely. This would enable the Obama Administration to pick friendly winners and losers among the financials. Actually what they are doing is picking losers as winners. The cost of this will grow yet again if Joe Mason, Susan Wachter, Josh Rosner, you folks at IRA and others are right about the magnitude of the next wave of foreclosures due to schedules resets of option ARMs and mortgages hitting their maximum permissible LTV ratios. Don't worry, though. If this causes the market to crater, my prediction is that the TARP or TALF will start buying stocks before next November.
The IRA: So what happens with health care reform?
Feinberg: There is a remarkable commonality between financial regulatory reform and health care because both are languishing. The cynic in me - and I am never cynical enough - is still having a hard time coming to terms with the policy of combining Zombie banks and investment firms into ever larger entities. During the S&L crisis these were known as "phoenixes." We were told that "It Would Never Happen Again." At that time, I predicted it would happen. On the day Hank Paulson was appointed Treasury Secretary, I said there's a problem at Goldman, and we don't know what it is, but we're going to find out. Turns out it was AIG.
The cynical way to look at Washington is as a parallel universe after the Orwellian model. We can also use such examples to predict the form of future crises. The Obama Administration has picked up the mantra of the US banking industry being the "backbone of the economy," but in reality I think it is the inflamed appendix that threatens the life of the patient. We have been told that these Zombies are healthy and will be restored to their former glory. If this is the case, why is it that the largest banks are the worst run and that they failed to build capital during the longest expansion the economy has ever seen?
The IRA: We'll have to ask Chairman Bernanke that next time we speak to him. Thanks Bob.