Biloxi, Miss. "Alma Croslen, 3, daughter of Mrs. Cora Croslen, of Baltimore. Both work at Barataria Canning Co. (shucking oysters). The mother said, 'I'm learnin' her the trade.'"
Ilargi: I’ve always had this nagging feeling that China will play a different part in our deeply troubled world economy than what most people seem to believe. For instance, dumping its dollar reserves to hurt America has never seemed a likely move in my eyes. Most Westerners can't see through Chinese eyes, they can only think in terms of what they've learned, but not figure out what China is after. Which is not being a copy-cat imitation of America and, I’m sure.
In my view, those dollar reserves most of all mean power for Beijing. And not just the power of the threat of dumping them. Once that would happen, the power would disappear. How could that be good for China? It might be 10 or 20 years from now, in a greatly changed environment, perhaps, but not now. Seeing the foreign reserves lose some of their value along with the dollar has never been a major issue. There are so many commodities that China buys in the world markets that are denominated in US dollars they are laughing all the way to the bank on that one. All the more so since they still have the cash to buy what they want, something we can't say for every country these days.
That said, I also think that China's economic and internal political problems are way bigger than is generally recognized. There may be all sorts of jubilant numbers coming from the Forbidding City, but who believes those? They're as (in-)credible as what the White House issues. The US needs to create about 2 million extra jobs every year just to have employment numbers stay even. China needs a lot more. A massive movement has been set in motion in the country which can't easily be halted, and which is best summarized by pointing out that the by far largest mass migration in the history of mankind is ongoing in China as we speak. Tens of millions of people every year move from the countryside to the cities, and they come looking for jobs.
It's generally thought that China needs its economy to grow at 8%, just to prevent widespread social unrest. Of course that's the number Beijing says in being achieved right now, but look at the export numbers.
They’re down 20-30% or more. And there's no way you can grow your economy with numbers like that. Nor can you grow a domestic market for your products fast enough. And stimulus plans, as they do in the US, must eventually fail if they do nothing but shift money from one pocket in your pants to the other.
This all makes me think China's path to glory may well end up being strangled by its struggles at home. That is, except for the notion that expansionist policies are already firmly in place.
Today's news on China has a number of very interesting items to provide. Much of it has to do with power policies, delivered through economic means. First, the effects of the stimulus, which was executed with China's customary avalanche of bad loans, and which recently has seemed to come an abrupt halt, lead to ever more fear of a giant bubble, which indeed looks inevitable.
Some warn of deflating asset bubble in China
- The Shanghai composite index sank 6.7% Monday, worrying global investors and capping an August bear market that has stripped more than 23% from share prices. The nerve-jarring drop prompted some — including the head of China's $298 billion state-run investment fund and a former top Morgan Stanley economist — to warn of a deflating asset bubble. "Some of us were over-optimistic about the ability of China to become the engine of growth for the region and the global economy,"
- [..] Chinese stocks have been whipsawed by signs that the government is tightening the tap on its free-flowing fiscal stimulus. Beijing has battled recession by funneling unprecedented sums through state banks as part of a $586 billion pump-priming.
- Lou Jiwei, head of China Investment Corp., the government's investment fund, said this weekend that both China and the United States were "creating more bubbles" in trying to combat the global crisis. And Andy Xie, a prominent, former Morgan Stanley economist, told Bloomberg News that the Shanghai exchange is in "deep bubble territory."
- [..] with lending from state-dominated banks shrinking from a monthly average of about 1,230 billion yuan over the first half of 2009 to as little as 300 billion yuan in August, investors sense the government is pulling back.
Do note that the Shanghai market is somewhat peculiar, in that foreign investment is equal to less than 1% of total market capitalization. Still, to say, as some do, that it doesn't reflect the Chinese economy at all is a gross exaggeration in my view.
However, there are more curious topics to ponder. What happens if China decides to uni-laterally default on derivatives sold to its state corporations? US banks count on the income from derivatives for a large part of their revenues. What if, which may be a more interesting question, China demands full public exposure of the entire $1 quadrillion global derivatives market as a condition for payment of its liabilities in that market? This could potentially be a much more powerful weapon than a sell-off of $1 trillion in Treasuries and agency paper. It’s Axe of Damocles hanging over Wall Street. Take away just the income from the derivatives trade, and it's wave goodbye for many of the main banks.
Beijing's derivative default stance rattles banks
- A report that Chinese state-owned companies will be allowed to walk away from loss-making commodity derivative trades provoked anger and dismay among investment bankers on Monday as they feared it may set a damaging precedent. The State-owned Assets Supervision and Administration Commission (SASAC), the regulator and nominal shareholder for state-owned enterprises (SOEs), told six foreign banks that SOEs reserved the right to default on contracts [..]
- The warning from SASAC follows a series of measures from Beijing this year to crack down on the sale of derivative products by foreign banks to Chinese enterprises, principally big consumers, who bought protection against higher prices last year only to watch the market collapse -- leaving them with losses.
- "I wouldn't be surprised if more state firms emerge with big derivatives trading losses, otherwise SASAC wouldn't come out with such a radical move," said a Hong Kong-based derivatives analyst [..]
- "It's a handful of companies who are being encouraged by regulators to re-negotiate," said a second banking source. "It's outrageous, but it's China, so everyone is treading very carefully."
- The report follows an order from SASAC in July that required all central government-controlled state companies engaged in trading derivatives to make quarterly reports about their investments, including details of holdings and performance.
- The source, whose bank did not receive a letter, said that Air China, China Eastern and shipping giant COSCO -- among the Chinese companies that have reported huge derivatives losses since last year -- had issued almost identical notices to banks. "If it's in the name of the government, the impact will be very negative,"[.]
- SASAC took over the job of overseeing SOEs' derivatives trading from the securities regulator in February after several Chinese firms reported huge losses from derivatives.
Talking about power politics, how about having 90%+ of the supply of some of the most needed resources in the world in your hands? You also have to love the fact that for us to look "green" (God, I despise that term), we need China to utterly destroy its environment. Whatever green is, smart it ain't.
China Tightens Grip on Rare Minerals
- China is set to tighten its hammerlock on the market for some of the world’s most obscure but valuable minerals. China currently accounts for 93 percent of production of so-called rare earth elements — and more than 99 percent of the output for two of these elements, dysprosium and terbium, vital for a wide range of green energy technologies and military applications like missiles.
- Deng Xiaoping once observed that the Mideast had oil, but China had rare earth elements.
- Even tighter limits on production and exports, part of a plan from the Ministry of Industry and Information Technology, would ensure China has the supply for its own technological and economic needs, and force more manufacturers to make their wares here in order to have access to the minerals.
- In each of the last three years, China has reduced the amount of rare earths that can be exported. This year’s export quotas are on track to be the smallest yet. But what is really starting to alarm Western governments and multinationals alike is the possibility that exports will be further restricted.
- "Rare earth usage in China will be increasingly greater than exports," said Zhang Peichen, the deputy director of the government-linked Baotou Rare Earth Research Institute. Some of the minerals crucial to green technologies are extracted in China using methods that inflict serious damage on the local environment.China dominates global rare earth production partly because of its willingness until now to tolerate highly polluting, low-cost mining.
- A single mine in Baotou, in China’s Inner Mongolia, produces half of the world’s rare earths. Much of the rest — particularly some of the rarest elements most needed for products from wind turbines to Prius cars — comes from small, often unlicensed mines in southern China. China produces over 99 percent of dysprosium and terbium and 95 percent of neodymium. These are vital to many green energy technologies, including high-strength, lightweight magnets used in wind turbines, as well as military applications.
- To get at the materials, powerful acid is pumped down bore holes. There it dissolves some of the rare earths, and the slurry is then pumped into leaky artificial ponds with earthen dams, according to mining specialists.
Finally, not only has China cut short the delivery of it stimulus through its banking system (which is heavily burdened with loan losses already), it's also withdrawing to a substantial extent from global shipping. Something that comes at the worst possible time for an industry that has huge amounts of extra capacity lined up. What were they thinking?
Shipping Rates Seen Falling 50% on China, Fleet Size
- Just as global trade starts to recover, the shipping market is crashing for the second time in a year as China reduces raw-material imports and record numbers of new vessels set sail. The rate for leasing capesize ships, boats three times the size of the Statue of Liberty, will drop about 50 percent from the current price of $37,865 a day to as low as $18,000 before the end of the year.
- From their low of $2,316 in December, rates rebounded to $93,197 in June as China imported record amounts of everything from coal to iron ore, used to make steel. Almost two in every five tons of steel are made in China, according to the Brussels- based World Steel Association. The nation consumes the same proportion of the world’s coal, BP Plc estimates. Rates are poised to keep falling, the survey shows. China’s State Council, the nation’s cabinet, said it’s studying curbs on overcapacity in industries including steel and cement.
To summarize, China will be a formidable player in the world, economically and politically, but, if the feelings in my gut and the thoughts in my frontal lobe (if that’s where they are) prove to be right, not necessarily the way you've been thinking.
But yeah, you’re dead on, interesting times to be had for all.
Can Rally Run Without Revenue?
As stock investors turn their focus to earnings prospects for the second half and 2010, they are zeroing in on one of the market's biggest challenges: lackluster corporate revenue. The market barreled ahead this summer and is hovering near its high for the year, fueled in large part by stronger than-expected second-quarter earnings. But a significant driver of the good news was cost cutting. Many companies posted disappointing sales.
In the short-term, earnings prospects may remain favorable for the market. Aggressive expense control and modest inventory restocking could boost third-quarter numbers, while the fourth quarter has easy comparisons against an awful 2008 that will give the appearance of healthy profit increases. But in 2010, the ability of stocks to sustain or extend their advances will have to come from a revival in sales, strategists say. In an uncertain economic environment, that won't be an easy task. "You can not simply cut costs forever to have sustainable earnings. You need revenues to grow them over time," says Dirk Van Dijk, chief equity strategist at Zacks Investment Research. However, "it's going to be really, really tough" to increase revenue in the current economy, he says.
For now, stock prices suggest many investors are comfortable knowing that at least the decline in profits has been halted. Heading into September, a notoriously bad month for stocks, the Dow Jones Industrial Average is up 8.75% for the year at 9544.20. That is just off from the best levels seen since early last November. Though trading volume has been light in recent days, the market has been able to hold on to a rally that sent the Dow industrials up 12% since mid-July and up 45.8% from the March 9 low.
According to Goldman Sachs Group Inc., 46% of companies beat Wall Street's earnings expectations by a wide margin, but only 23% significantly bettered revenue forecasts. Sales among companies in the Standard & Poor's 500 stock index fell 16% in the second quarter from a year earlier, following a 14% decline in the first quarter. David Kostin, an equity strategist at Goldman, points to a decline in a key line item on corporate income statements known as "selling, general and administrative expenses" otherwise known as SG&A. Included in SG&A are salaries and costs of doing business, such as travel or advertising.
SG&A plunged 6.4% in the second quarter from the year-earlier period, Goldman says. In contrast, in the last recession, SG&A fell just 0.2% and in 1991, it dropped 4.1%. "There's been an unprecedented decline in overhead costs," Mr. Kostin says. A big part of the challenge for generating an upturn in sales is that consumers, whose spending has driven roughly 70% of economic activity in recent years, are hamstrung by a bleak job market. That was evidenced Friday by a weak reading on consumer confidence from the University of Michigan and government data showing incomes were flat in July.
This environment typically leads to disparate performances between sectors and stocks, according to strategists at Ned Davis Research. In the initial stage of a recovery from a bear market, the stocks that have fallen the most tend to be the ones that rebound the strongest. "After a bottom, the market shifts to more industry-specific and company-specific factors," says Amy Lubas, senior equity strategist at Ned Davis.
Such differentiation will most benefit those companies that have both cut their costs and have the best prospects for revenue growth, says Goldman's Mr. Kostin.
Among S&P sectors, materials stocks posted the biggest decline in SG&A costs -- down nearly 10% -- followed by information technology. Energy companies, too, have cut costs significantly. In contrast, SG&A costs rose at telecommunications companies and fell only 1% at consumer staples names. Mr. Kostin says the most likely sources for revenue growth are outside the U.S., where technology, energy and materials companies get the greatest percentage of revenue.
More narrowly, Brazil, Russia, India and China are likely to be the strongest performing economies, and, Mr. Kostin says, the best revenue prospects. Already, a basket of stocks that Goldman identifies as having the greatest business from those so-called BRIC nations has done 29 percentage points better than the S&P 500 this year. Barry Knapp, equity strategist at Barclays Capital, favors industrials as a play on the cost-cutting binge. "They've been cutting costs for nine years," he says. "That sector looks really well-poised for coming out of the recession."
In addition, technology companies, which have lifted the Nasdaq Composite Index 29% this year, also look good on the cost cutting and revenue metrics, Mr. Knapp says. "But once you get into the consumer discretionary, staples and services areas, it's not quite as good a story," Mr. Knapp says. Zack's Mr. Van Dijk says that short term there could be good earnings news for retailers. "You have a bunch of retailers who have really cut their inventories way down, and if they do see any pickup at all, their turnover will zoom and that lowers their costs significantly," he says, noting that already it is a group for which analysts have upgraded earnings forecasts.
Still, for retailers aimed at the middle-class, such as Macy's, J.C. Penney and Gap, the good news won't last long. "They may be good for a trade, but they're a lousy long-term investment," Mr. Van Dijk says. "They just have too many headwinds against them."
Wall Street stumbles into September
Markets tumbled Tuesday, as investors retreated at the start of what is typically a rough month, betting that the six-month stock advance has raced ahead of the economic recovery. "I think we've had a nice run and it's time for a bit of a pullback," said Tom Schrader, managing director at Stifel Nicolaus. "I wouldn't be surprised if we moved back to the 880 level (on the S&P 500) before moving back up." A drop to the 880 level would constitute a slide of about 12% from the current levels.
Investors nitpicked through the morning's better-than-expected reports on housing and manufacturing but found little reason to jump back into the fray. The Dow Jones industrial average lost 186 points, or almost 2%. The S&P 500 index fell 23 points, or 2.2%. The Nasdaq composite fell 40 points, or 2%. "I think the 'whisper number' for [the manufacturing report] was higher and once people digested that, the market swung in the other direction," said Schrader.
Schrader said that investors were also reacting to the "calendar influence," amid a variety of reports about the tendency for September to be a weak month on Wall Street. September is typically the biggest percentage loser of the month for the Dow, S&P 500 and Nasdaq composite, according to the "Stock Trader's Almanac." "The reports this morning were positive, but investors are basically saying that stocks have had a good run up and now it's time to take some profits," chimed in Phil Orlando, chief equity market strategist at Federated Investors.
Stocks have essentially been on the rise since March, as investors have welcomed extraordinary fiscal and monetary stimulus and signs that corporate profits and the economy have stabilized. The major gauges ended last week at the highest levels in 9 to 10 months. Financial shares took a beating Tuesday after enjoying a nice ride through the late summer, fueled largely by speculation and momentum. But with the S&P up 52% from the March 9 lows, market participants are now looking for concrete evidence that the economy is recovering. The morning's reports were positive, but perhaps not as positive as the most optimistic forecasts.
Wednesday preview: Two readings on the labor market are due Wednesday in the lead up to Friday's big August jobs report. Payroll services firm ADP is expected to report that employers in the private-sector cut 246,000 jobs from their payrolls in August after cutting 371,000 in July. Additionally, Challenger, Gray & Christmas, an outplacement firm, will report on the number of announced job cuts in August. A July reading on factory orders is also due in the morning from the Commerce Department. Other reports include the minutes from the last Federal Reserve policy meeting, the weekly crude oil inventories report and the July reading on factory orders.
Manufacturing: The Institute for Supply Management's manufacturing index for August showed growth in the sector for the first time since January 2008. The index rose to 52.9 from 48.9 previously. Economists surveyed by Briefing.com thought it would rise to 50.5. Pending home sales rose for the sixth straight month, jumping 3.2% in July, to the highest point in nearly two years, according to a report from the National Association of Realtors released Tuesday morning. The index rose 3.6% in June. Economists surveyed by Briefing.com thought sales would rise 1.5% in July. Construction spending fell 0.2% in July versus forecasts for an unchanged reading. Spending rose a revised 0.1% in June.
Financials: Many of the summer's big bank sector winners led the declines Tuesday. Dow component Bank of America slipped 6.4% in active NYSE trading. BofA was the biggest Dow gainer in the June through August period, rising 56%. Dow component American Express lost 5.4% Tuesday. Over the last three months, AmEx has gained 36% and was the second-best Dow performer. Dow component JPMorgan Chase lost 4.1% after rising 17% this summer. Among other movers, Citigroup lost 9% after rising 34% in the summer. Regional bank Fifth Third Bancorp lost 6.2% after rising 59% this summer. The KBW Bank index fell 5.8% after rising 20% over the summer.
Oil prices and stocks: U.S. light crude oil for October delivery fell $1.91 to settle at $68.05 a barrel on the New York Mercantile Exchange. Oil prices have been slipping since hitting a ten-month high just below $75 a barrel late last month. The decline in oil prices dragged on heavily-weighted energy stocks including Dow components Chevron and Exxon Mobil.
Auto sales: The government's popular Cash for Clunkers program gave a boost to sales in August, major automakers said. Although a plunge in sales in the last week of the month, following the program's end, suggests the impact will not be far reaching. In August, Ford Motor reported that sales jumped 17% versus a year ago, its best monthly gain in 4 years. However, the advance was short of expectations for a rise of 22%, according to analysts surveyed by Edmunds.com. Toyota, which had the most Clunker sales of any automaker, said August sales rose 6%, its first year-over-year gain in 16 months. General Motors and Chrysler Group both reported year-over-year declines in August on sales that improved from July.
Market breadth was negative. On the New York Stock Exchange, losers beat winners by five to one on volume of 1.63 billion shares. On the Nasdaq, decliners topped advancers by almost four to one on volume of 2.81 billion shares.
Cities Brace for a Prolonged Bout of Declining Tax Revenues
The recession is finally hitting city budgets, with overall city revenues inching down in fiscal 2009 for the first time since 2002, according to a report to be released Tuesday by the National League of Cities. Weak growth in property taxes, reflecting soft housing prices, did not counterbalance sharp declines in other sources of income, including sales taxes, income taxes and state aid, according to a survey of 379 league member cities.
Overall city revenues declined by 0.4%, even as expenses rose 2.5%, and city officials expect steep drops in tax collections in the next two years, making for the worst outlook in the 24 years the group has been surveying its members. Western cities were particularly downbeat. The gloomy mood "is indicative of the depths of the downturn, that they have the worst ahead of them, and the fact that the recession is universally hitting their revenue sources," said Chris Hoene, research director for the league.
Because employee wages, health care and pensions are a major component of municipal budgets, two-thirds of the cities reported hiring freezes or layoffs. Almost as many cities said they were postponing big construction projects. While a quarter of the cities said they raised property tax rates, far more -- 45% -- raised fees on everything from garbage collection to overdue library books.
On average, property taxes make up a third of cities' revenues, and have provided a stable source of funds, rising every year since 1995, even during and after the 2001 recession. But the housing bubble's pop has started to show up in tax collections that -- depending on local tax-assessment practices -- can take 18 months or more to reflect changing real-estate values. In fiscal 2009, which for many cities ended in June, property tax collections inched up just 1.7%, far behind 2008's 6.9% rise. The league is expecting property-tax collections to turn negative in fiscal 2010 and remain in the red in 2011 and 2012.
Close to half of the cities surveyed also levy a sales tax, and those revenues have dwindled as consumers have retrenched during the recession, with major impact on cities like Phoenix and Las Vegas. On average, sales tax collections fell 3.8% in fiscal 2009. Some cities, including New York and Kansas City, also collect income taxes. Those levies dropped on average by 1.3%, according to the survey.
Beijing's derivative default stance rattles banks
A report that Chinese state-owned companies will be allowed to walk away from loss-making commodity derivative trades provoked anger and dismay among investment bankers on Monday as they feared it may set a damaging precedent. The State-owned Assets Supervision and Administration Commission, the regulator and nominal shareholder for state-owned enterprises (SOEs), told six foreign banks that SOEs reserved the right to default on contracts, Caijing magazine quoted an unnamed industry source as saying in an article published on Saturday.
While the details of the report could not be confirmed, it was Monday's hot topic in financial circles from Shanghai to Singapore as commodity marketers feared that companies holding underwater price hedges could simply renege on the deals, costing banks millions of dollars in profit. The warning from SASAC follows a series of measures from Beijing this year to crack down on the sale of derivative products by foreign banks to Chinese enterprises, principally big consumers, who bought protection against higher prices last year only to watch the market collapse -- leaving them with losses.
While many companies including top airlines have come clean on the losses, some analysts fear another wave may follow. "I wouldn't be surprised if more state firms emerge with big derivatives trading losses, otherwise SASAC wouldn't come out with such a radical move," said a Hong Kong-based derivatives analyst, who like most other industry officials and bankers declined to be named due to the high sensitivity of the issue.
A SASAC media official said on Monday that he was waiting for the "relevant department's" official comment before he can clarify to media. A government official said that the Bureau of Financial Supervision and Evaluation under SASAC was handling the issue. The official declined to be named and did not elaborate. Spokespersons at Goldman Sachs and UBS declined comment, and media officials at Morgan Stanley and JPMorgan were not immediately available for comment. All are major global providers of commodity risk management.
No banks were named in the Caijing report. The SASAC media officer also declined to identify any specific banks. "It's a handful of companies who are being encouraged by regulators to re-negotiate," said a second banking source. "It's outrageous, but it's China, so everyone is treading very carefully." For banks that are hoping to sell more derivatives hedges in China, the world's fastest-expanding major economy and top commodities consumer, the danger goes beyond the immediate risk to existing contracts to the longer-term precedent that suggests Chinese companies can simply renege on deals when they like.
The report follows an order from SASAC in July that required all central government-controlled state companies engaged in trading derivatives to make quarterly reports about their investments, including details of holdings and performance. But the reported letter opened several important questions that could not immediately be answered. "If we were among the banks receiving that letter, we would be very angry. But now the key is to find out more details on the letter: In whose name the letter was issued, the government or the corporate's? And under what was the reason for defaulting?" said a Singapore-based marketing executive with a foreign bank.
The source, whose bank did not receive a letter, said that Air China, China Eastern and shipping giant COSCO -- among the Chinese companies that have reported huge derivatives losses since last year -- had issued almost identical notices to banks. "If it's in the name of the government, the impact will be very negative," said the source, who declined to be named.
Beijing-based derivatives lawyers said the so-called "legal letter" has no legal standing -- SASAC as a shareholder has no business relationship with international banks. "It's like the father suddenly told the creditors of his debt-ridden son that his son won't pay any of his debt," said a lawyer from the derivatives risks committee of the Beijing Lawyers Association.
It's also unclear why Chinese state firms, which have complained that their foreign banks sometimes did not disclose full information of potential risks when selling them complicated products, did not seek redress through the courts. "If that is the case, these firms should seek through legal measures to safeguard their rights, instead of turning to the authorities for political interference," said a different lawyer. SASAC took over the job of overseeing SOEs' derivatives trading from the securities regulator in February after several Chinese firms reported huge losses from derivatives.
Some warn of deflating asset bubble in China
A month-long plunge in the main Chinese stock market is raising questions about the outlook for China's economy. The Shanghai composite index sank 6.7% Monday, worrying global investors and capping an August bear market that has stripped more than 23% from share prices. The nerve-jarring drop prompted some — including the head of China's $298 billion state-run investment fund and a former top Morgan Stanley economist — to warn of a deflating asset bubble. "Some of us were over-optimistic about the ability of China to become the engine of growth for the region and the global economy," said Joshua Aizenman, professor of economics at the University of California-Santa Cruz and a former consultant to the Chinese government.
After doubling in value from their crisis low in early November, Chinese stocks have been whipsawed by signs that the government is tightening the tap on its free-flowing fiscal stimulus. Beijing has battled recession by funneling unprecedented sums through state banks as part of a $586 billion pump-priming. It worked: China has been a rare bright spot on the global horizon, growing in the second quarter at an annual rate of 7.9%.
"The government did a great job of stabilizing the economy. In the process, it created a bit of an asset bubble," said William Overholt, senior research fellow at Harvard University's Kennedy School of Government.
Lou Jiwei, head of China Investment Corp., the government's investment fund, said this weekend that both China and the United States were "creating more bubbles" in trying to combat the global crisis. And Andy Xie, a prominent, former Morgan Stanley economist, told Bloomberg News that the Shanghai exchange is in "deep bubble territory." Shanghai remains a speculative market, often buffeted by government whims. Investors spend as much time interpreting officials' signals as they do scrutinizing company balance sheets. Now, with lending from state-dominated banks shrinking from a monthly average of about 1,230 billion yuan over the first half of 2009 to as little as 300 billion yuan in August, investors sense the government is pulling back.
"Investors don't want to be in the speculative Chinese stocks or speculative Chinese real estate. Because if they are, they'll get burned," said former investment banker Overholt. Even with the cut in bank lending, the economy will still have plenty of fuel. Only 10% of China's stimulus was spent in the fourth quarter of 2008 and an additional 40% is expected to be paid out this year. The remaining half will be spent in 2010, according to AllianceBernstein.
Nicholas Lardy of the Peterson Institute for International Economics says the Shanghai market has little connection to the Chinese or global economies. Foreign investment is equal to less than 1% of total market capitalization, he said. "I don't think this (drop) is a harbinger of a Chinese slowdown," he said. "The Chinese economy is doing quite well."
Shipping Rates Seen Falling 50% on China, Fleet Size
Just as global trade starts to recover, the shipping market is crashing for the second time in a year as China reduces raw-material imports and record numbers of new vessels set sail. The rate for leasing capesize ships, boats three times the size of the Statue of Liberty, will drop about 50 percent from the current price of $37,865 a day to as low as $18,000 before the end of the year, according to the median in a Bloomberg survey of six analysts and fund managers. Forward freight agreements traded by brokers show the fourth-quarter average price will be 7 percent lower.
Shipping rates, which already fell 59 percent from this year’s high, are retreating as the Organization for Economic Cooperation and Development predicts a 16 percent drop in world trade for all of 2009. China’s State Council called for curbs on steel and cement production last week. A record 146 capesizes will be added this year, equal to 28 percent of the fleet, according to Fearnley Consultants A/S.
"The pressure of the new ships will be overwhelming," said Andreas Vergottis, the Hong Kong-based research director at Tufton Oceanic Ltd., which manages the world’s largest shipping hedge fund, with $1 billion of assets. "It will take a lot of time and a lot of pain before shipping recovers." The biggest-ever order book for new carriers, according to Lloyd’s Register-Fairplay, may hurt profits at shipping lines while providing higher returns for traders. Rates for capesizes have fluctuated more than 50 percent in seven of the past eight years.
Mitsui O.S.K. Lines Ltd. and Nippon Yusen K.K., both based in Tokyo, and China Cosco Holdings Co. operate the world’s biggest bulk-shipping fleets, Mitsui says. Nippon Yusen forecast its first full-year loss in 23 years last month, citing lower demand for container shipping, and expects capesize rates to average $55,000 in the six months through March 31. Mitsui cut its full-year profit estimate by 25 percent last month. China Cosco said on Aug. 27 its commodity ships lost money in the first half.
Estimates in the survey ranged from $10,000 to $25,000. Sverre Bjorn Svenning, the analyst at Fearnley Consultants who correctly predicted last year’s collapse in the Baltic Dry Index, which fell 92 percent, was at the lower end. The drop in capesizes is consistent with the Baltic Dry Index, a gauge of the cost of carrying dry bulk commodities such as iron ore, coal and grain. The index, which includes four types of vessels including capesizes, more than tripled this year. The index is 44 percent off its high for the year.
"We’ve seen several yards that have delivered their first ships, albeit delayed, and we expect them to increase the pace of deliveries in the second half," said Svenning, who is based in Oslo. "We will see more next year than we see this year." The 12-member Bloomberg Dry Ships Index fell 1.9 percent to 1,693.33 points as of 12:12 p.m. in London, paring its gain this year to 28 percent. Even at rates of $18,000 a day, most owners should make money, with daily operating costs estimated at $7,555 by London- based Drewry Shipping Consultants Ltd.
A rebound in trade may also limit the tumble. The Paris- based OECD said Aug. 19 that the economies of its 30 members collectively stopped shrinking in the second quarter. Japan, France and Germany emerged from recessions prompted by the collapse of U.S. real estate that froze credit markets and left the world’s biggest financial companies with $1.61 trillion of losses and writedowns.
Economies are showing signs of improving after the Group of 20 industrialized and emerging nations pledged about $12 trillion to combat the first global recession since World War II, according to International Monetary Fund data. The U.S. economy shrank less than economists anticipated in the second quarter and German business confidence exceeded their expectations in August. The median of 56 analysts surveyed by Bloomberg shows America will expand this quarter and the euro zone will grow in the first three months of next year.
World trade rose 2.5 percent in June, the biggest advance in almost a year, the Netherlands Bureau for Economic Policy Analysis said Aug. 26. Ships carry about 90 percent of world trade, The Round Table of International Shipping Associations estimates.
Rates for capesizes jumped to a record $234,000 a day in June last year as demand for commodities congested ports. In Newcastle, Australia, the world’s biggest coal export harbor, as many as 43 ships waited to load that month, Newcastle Port Corp. data show. Lined up end to end, that many capesizes would stretch more than 7 miles. Charter costs fell 99 percent in the following six months as the global economy slumped. The record 36 percent drop in the Reuters/Jefferies CRB Index of 19 of commodity prices last year destroyed demand for ships and the collapse in credit markets curbed bank financing for trade. At least 20 percent of capesizes were empty by November, Lorentzen & Stemoco A/S, a shipbroker, estimated at the time.
Industrial Carriers Inc. of Ukraine and Armada (Singapore) Pte were among shipping lines that sought protection from creditors amid the slump. From their low of $2,316 in December, rates rebounded to $93,197 in June as China imported record amounts of everything from coal to iron ore, used to make steel. Almost two in every five tons of steel are made in China, according to the Brussels- based World Steel Association. The nation consumes the same proportion of the world’s coal, BP Plc estimates. Rates are poised to keep falling, the survey shows. China’s State Council, the nation’s cabinet, said it’s studying curbs on overcapacity in industries including steel and cement. The government will provide more "guidance" over parts of the coal, glass and power sectors, the group said in a statement.
Imports of refined copper fell 23 percent in July from the previous month. Coal shipments shrank 13 percent, customs data show. Iron-ore purchases will likely average about 16 percent less in the remainder of the year than in the first seven months, according to Will Fray, an analyst at Maritime Strategies International Ltd. in London. "China could very easily turn the taps off," Fray said. "Rates will keep sliding."
China Tightens Grip on Rare Minerals
China is set to tighten its hammerlock on the market for some of the world’s most obscure but valuable minerals. China currently accounts for 93 percent of production of so-called rare earth elements — and more than 99 percent of the output for two of these elements, dysprosium and terbium, vital for a wide range of green energy technologies and military applications like missiles.
Deng Xiaoping once observed that the Mideast had oil, but China had rare earth elements. As the Organization of the Petroleum Exporting Countries has done with oil, China is now starting to flex its muscle. Even tighter limits on production and exports, part of a plan from the Ministry of Industry and Information Technology, would ensure China has the supply for its own technological and economic needs, and force more manufacturers to make their wares here in order to have access to the minerals.
In each of the last three years, China has reduced the amount of rare earths that can be exported. This year’s export quotas are on track to be the smallest yet. But what is really starting to alarm Western governments and multinationals alike is the possibility that exports will be further restricted. Chinese officials will almost certainly be pressed to address the issue at a conference Thursday in Beijing. What they say could influence whether Australian regulators next week approve a deal by a Chinese company to acquire a majority stake in Australia’s main rare-earth mine. The detention of executives from the British-Australian mining giant Rio Tinto has already increased tensions.
They sell for up to $300 a kilogram, or up to about $150 a pound for material like terbium, which is in particularly short supply. Dysprosium is $110 a kilo, or about $50 a pound. Less scare rare earth like neodymium sells for only a fraction of that. (They are considerably less expensive than precious metals because despite the names, they are found in much higher quantities and much greater concentrations than precious metal.)
China’s Ministry of Industry and Information Technology has drafted a six-year plan for rare earth production and submitted it to the State Council, the equivalent of the cabinet, according to four mining industry officials who have discussed the plan with Chinese officials. A few, often contradictory, details of the plan have leaked out, but it appears to suggest tighter restrictions on exports, and strict curbs on environmentally damaging mines.
Beijing officials are forcing global manufacturers to move factories to China by limiting the availability of rare earths outside China. "Rare earth usage in China will be increasingly greater than exports," said Zhang Peichen, the deputy director of the government-linked Baotou Rare Earth Research Institute. Some of the minerals crucial to green technologies are extracted in China using methods that inflict serious damage on the local environment. China dominates global rare earth production partly because of its willingness until now to tolerate highly polluting, low-cost mining.
The ministry did not respond to repeated requests for comment in the last eight days. Jia Yinsong, a director general at the ministry, is to speak about China’s intentions Thursday at the Minor Metals and Rare Earths 2009 conference in Beijing. Until spring, it seemed that China’s stranglehold on production of rare earths might weaken in the next three years — two Australian mines are opening with combined production equal to a quarter of global output. But both companies developing mines — Lynas Corporation and smaller rival, Arafura Resources — lost their financing last winter because of the global financial crisis. Buyers deserted Lynas’s planned bond issue and Arafura’s initial public offering.
Mining companies wholly owned by the Chinese government swooped in last spring with the cash needed to finish the construction of both companies’ mines and ore processing factories. The Chinese companies reached agreements to buy 51.7 percent of Lynas and 25 percent of Arafura. The Arafura deal has already been approved by Australian regulators and is subject to final approval by shareholders on Sept. 17. The regulators have postponed twice a decision on Lynas, and now face a deadline of next Monday to act.
Matthew James, an executive vice president of Lynas, said that the company’s would-be acquirer had agreed not to direct the day-to-day operations of the company, but would have four seats on an eight-member board. Expectations of tightening Chinese restrictions have produced a surge in the last two weeks in the share prices of the few non-Chinese producers that are publicly traded. In addition to the two Australian mines, Avalon Rare Metals of Toronto is trying to open a mine in northwest Australia, and Molycorp Minerals is trying to reopen a mine in Mountain Pass, Calif.
Unocal used to own the Mountain Pass mine, which suspended mining in 2002 because of weak demand and a delay in an environmental review. State-owned Cnooc of China almost acquired the mine in 2005 with its unsuccessful bid for Unocal, which was bought instead by Chevron; Chinese buyers tried to persuade Chevron to sell the mine to them in 2007, but Chevron sold it to Molycorp Minerals, a private American group.
A single mine in Baotou, in China’s Inner Mongolia, produces half of the world’s rare earths. Much of the rest — particularly some of the rarest elements most needed for products from wind turbines to Prius cars — comes from small, often unlicensed mines in southern China. China produces over 99 percent of dysprosium and terbium and 95 percent of neodymium. These are vital to many green energy technologies, including high-strength, lightweight magnets used in wind turbines, as well as military applications.
To get at the materials, powerful acid is pumped down bore holes. There it dissolves some of the rare earths, and the slurry is then pumped into leaky artificial ponds with earthen dams, according to mining specialists. The Ministry of Industry and Information Technology has cut the country’s target output from rare earth mines by 8.1 percent this year and is forcing mergers of mining companies in a bid to improve technical standards, according to the government-controlled China Mining Association, a government-led trade group.
General Motors and the United States Air Force played leading roles in the development of rare-earth magnets. The magnets are still used in the electric motors that control the guidance vanes on the sides of missiles, said Jack Lifton, a chemist who helped develop some of the early magnets. But demand is surging now because of wind turbines and hybrid vehicles. The electric motor in a Prius requires 2 to 4 pounds of neodymium, said Dudley Kingsnorth, a consultant in Perth, Australia, whose compilations of rare earth mining and trade are the industry’s benchmark.
Mr. Lifton said that Toyota officials had expressed strong worry to him on Sunday about the availability of rare earths.
Toyota and General Motors, which plans to introduce the Chevrolet Volt next year with an electric motor that uses rare earths, both declined on Monday to comment. Rick A. Lowden, a senior materials analyst at the Defense Department, told a Congressional subcommittee in July that his office was reviewing a growing number of questions about the availability of rare earths.
China is increasingly manufacturing high-performance electric motors, not just the magnets. "The people who are making these products outside China are at a huge disadvantage, and that is why more and more of that manufacturing is moving to China," Mr. Kingsnorth said.
The Yin and Yang of U.S.-China Relations
by Ian Bremmer and Nouriel Roubini
American and Chinese officials said all the right things during this summer's inaugural round of their Strategic and Economic Dialogue. President Barack Obama pledged to "forge a path to the future that we seek for our children." Chinese State Councilor Dai Bingguo wondered aloud whether America and China can "build better relations despite very different social systems, cultures and histories." He answered his own question, in English, with a "Yes we can."
They can, but they probably won't. Yes, Mr. Obama will visit China in November. But when it comes to international burden-sharing, Washington is focused on geopolitical headaches while China confines its heavy-lifting to geoeconomic challenges. The two sides have good reason to cooperate, but there's a growing gap between what Washington expects from Beijing and what the Chinese can deliver.
Many of the issues that create conflict in U.S.-Chinese relations are well known: an enormous bilateral trade deficit, disputes over the value of China's currency, protections for U.S. intellectual property, the dollar's role as international reserve currency, conflicts over human rights, naval altercations, protectionist threats from both sides, and disagreements over how best to handle North Korea's Kim Jong Il. But there are other, less obvious obstacles to partnership.
First, both governments remain largely focused on formidable domestic challenges. Mr. Obama knows his political fortunes depend largely on the resilience of the U.S. economy and its ability to generate jobs. He's occupied for the moment with a high-stakes poker game with lawmakers in his own party over ambitious health-care and energy-reform plans. China's leadership faces competing internal demands from those who want to stimulate the economy toward another round of export-driven growth and others who want to shift quickly toward greater dependence on domestic consumption.
Given the trade deficit, Washington would like Beijing to focus on the latter, but China won't move as fast as the U.S. would like, in part because the leadership recognizes that the loss of millions of manufacturing and construction jobs in recent months could fuel further turmoil in a country that already sees tens of thousands of large-scale protests each year.
Second, there's the bureaucratic problem. For the past several years, former U.S. Treasury Secretary Henry Paulson chaired a strategic dialogue with Chinese Vice Premier Wang Qishan. Washington and Beijing have now expanded the scope of talks to include the State Department and China's foreign ministry. Leaving aside the difficulties in building trust between U.S. and Chinese negotiators, State and Treasury don't coordinate well on strategy, and there's no guarantee that China's foreign and finance ministries will work seamlessly together either. The new formula for talks is bureaucratic infighting squared.
The third reason the U.S. and China won't build a durable strategic partnership is that Beijing has little appetite for the larger geopolitical role Washington would like it to play. Why should Beijing accept the risks that come with direct involvement in conflicts involving Iran and Iraq, Afghanistan and Pakistan, Israelis and Palestinians, Somalia and Sudan, and other sources of potential turmoil? It has more immediate problems at home.
On many issues where the U.S. wants China's support—on Iran's nuclear program, for example—Beijing's interests don't coincide with Washington's. Even in East Asia, China has good reason to avoid the heavy lifting on security, because the U.S. naval presence limits the risk that Japan, India, and other states will spend much more money on their militaries. It's not as though Beijing is enjoying a free ride. China's more than $2 trillion in foreign currency reserves gives its leadership enormous clout as international lender of last resort. Its considerable contribution to global stability is mainly in financing Washington's spiraling debt. By righting its own economy, China can be the primary engine of near-term global growth. Isn't that service enough, Chinese officials ask, at a time when economic crises aggravate so many international problems?
The one tangible result of this summer's Strategic and Economic dialogue, a "memorandum of understanding" on climate change, reveals the larger problem. It's valuable to have an agreement in principle, but there were no hard choices on the primary bone of contention—carbon emissions. That's a problem that will generate friction in months to come. Whenever U.S. and Chinese officials get together these days, they trigger a new round of speculation that the world's most important bilateral relationship might soon become its most valuable strategic alliance. It's wrong to entirely dismiss the value of effective speeches and positive political symbolism. But as U.S. and Chinese negotiators move from words to work, they're going to be pulling in different directions.
'No Underlying Value' in Fannie, Freddie, Miller Says
Fannie Mae and Freddie Mac fell in New York trading after FBR Capital Market’s Paul Miller said the mortgage-finance companies have no "underlying value" to justify a more than tripling in their share prices this month. "There is no fundamental value remaining in Fannie and Freddie, particularly since the government owns 80 percent of each company," Miller, a banking analyst based in Arlington, Virginia, said in a note to investors today.
Fannie Mae dropped 11 cents, or 5.4 percent, to $1.93 today in New York Stock Exchange composite trading. Freddie Mac declined 11 cents, or 4.6 percent, to $2.29. The shares last week climbed to their highest levels since regulators seized Fannie Mae and Freddie Mac in September as mortgage delinquencies climbed. Fannie Mae closed at $2.04 on Aug. 28, up 252 percent for the month. Freddie Mac finished at $2.40, a 287 percent jump for the month-to-date.
Miller’s note reiterated comments he made in an interview on Aug. 28 about the two government-sponsored enterprises. "There’s no value," Miller said in that interview. "This is all speculation." Investor speculation that Fannie Mae and Freddie Mac would pursue reverse stock splits to boost their share prices is overblown, and there’s "no relief in sight" to the companies record losses, Miller said. Miller noted that the companies said in securities filings that their boards didn’t support reverse splits.
The companies, the largest U.S. mortgage-finance companies, have booked a combined $165.3 billion in quarterly net losses over the past two years and have received or requested $95.6 billion in taxpayer aid since November. The Obama administration is considering options to restructure the companies next year, including a wholesale liquidation or splitting off their bad assets into a separate government-backed entity.
Bailout Propaganda Begins
by Matt Taibbi
Nearly a year after the federal rescue of the nation’s biggest banks, taxpayers have begun seeing profits from the hundreds of billions of dollars in aid that many critics thought might never be seen again.
It was inevitable that the same people who pushed through the multi-trillion-dollar bailout of Wall Street would come out later on and tell us what a great idea theirs turned out to be, in retrospect and under the light of evidentiary examination. And we’re getting that now, with a pair of reports, the above one in the New York Times and another in the Financial Times, telling us the bailout is working because the government has made some money on TARP. They came to this conclusion by quoting Fed officials, who apparently calculated how much interest the Fed earned on TARP investments above what it would have earned on T-bills. The amount so far, according to these worthy gentlemen: $14 billion.
This is sort of like calculating the returns on a mutual fund by only counting the stocks in the fund that have gone up. Forgetting for a moment that TARP is only slightly relevant in the entire bailout scheme — more on that in a moment — the TARP calculations are a joke, apparently leaving out huge future losses from AIG and Citigroup and others in the red. Since only a small portion of the debt has been put down by the best borrowers, and since the borrowers in the worst shape haven’t retired their obligations yet, it’s crazy to make any conclusions about TARP, pure sophistry. Moreover, a think tank set up to analyze TARP, Ethisphere, calculated in June that TARP was still $148 billion down overall, a debt of over $1200 per American. To start talking about what a success TARP is now is beyond meaningless.
The other reason for that is that it’s only a tiny sliver of the whole bailout picture. The real burden carried by the government and the Fed comes from the various anonymous bailout facilities — the TALF, the PPIP, the Maiden Lanes, and so on. The losses from the Fed’s purchase of distressed/crap Bear Stearns assets (Maiden Lane I) and AIG assets (MaidenLanes II and III) alone were as recently as late July calculated in the $8.6 billion range, and even that number is very conservative. Then there’s the trillion or so dollars that the Fed used on buying up mortgage-backed securities and Treasuries; we don’t know what their market value is now. And there are untold trillions more the Fed has loaned out in the last 18 months and which we are not likely to find out much about, unless the recent court ruling green-lighting Bloomberg’s FOIA request for those records actually goes through.
In light of all this, the Fed’s decision to brag publicly about a few loans that are actually performing is sort of scary — it speaks to a level of intellectual desperation and magical-thinking unusual even for a banker in the subprime/MBS era. Don’t be surprised if you hear more of this sort of thing in the coming years.
The Government Can
Goldman Sachs Wrong on Economic Recovery, Macro Hedge Funds Say
Paul Tudor Jones, the billionaire hedge-fund manager who outperformed peers last year, is wagering that Goldman Sachs Group Inc. and Morgan Stanley got it wrong in declaring the start of an economic recovery. Jones’s Tudor Investment Corp., Clarium Capital Management LLC and Horseman Capital Management Ltd. are taking a bearish stand as U.S. stock and bond prices rise, saying that record government spending may be forestalling another slowdown and market selloff. The firms oversee a combined $15 billion in so- called macro funds, which seek to profit from economic trends by trading stocks, bonds, currencies and commodities.
"If we have a recovery at all, it isn’t sustainable," Kevin Harrington, managing director at Clarium, said in an interview at the firm’s New York offices. "This is more likely a ski-jump recession, with short-term stimulus creating a bump that will ultimately lead to a more precipitous decline later." Equity and credit markets have rallied on hopes that government intervention is pulling the U.S. out of the deepest economic slump since the Great Depression. The Standard & Poor’s 500 Index jumped 51 percent from its 12-year low in March through yesterday.
The economy will expand at an annualized rate of 2 percent or more in four straight quarters through June 2010, the first such streak in more than four years, according to the median estimate of at least 53 forecasters in a Bloomberg survey. Tudor, the Greenwich, Connecticut-based firm started by Jones in the early 1980s, told clients in an Aug. 3 letter that the stock market’s climb was a "bear-market rally." Weak growth in household income was among the reasons to be dubious about the rebound’s chances of survival, Tudor said.
Yields on corporate bonds relative to U.S. Treasury benchmarks have sunk to levels unseen since before the collapse of Lehman Brothers Holdings Inc. in September, a positive sign for credit markets. Spreads on junk bonds fell in July to within 10 percentage points of Treasuries, lifting them out of the distressed category for the first time in almost a year. "We think the recession is ending right now," Abby Joseph Cohen, senior investment strategist at Goldman Sachs, said in a Bloomberg Radio interview Aug. 17. The New York-based bank forecasts 2 percent growth in U.S. gross domestic product in 2010.
Economists at New York-based Morgan Stanley in the past month have incrementally raised their GDP growth estimate for the current quarter to 4.8 percent annualized from 3.5 percent. President Barack Obama said a decline in July’s unemployment rate signaled "the worst may be behind us." GDP shrank 6.4 percent in the first quarter and 1 percent in the second, after a 4 percent contraction in the second half of 2008. A focus on misleading indicators is driving markets, macro managers say.
Clarium watches the unemployment rate that accounts for discouraged job applicants and those working part-time because they can’t find full-time positions, Harrington said. July joblessness with those adjustments was 16 percent, according to the Department of Labor, rather than the more widely reported 9.4 percent. The housing data isn’t as rosy as some see it, Harrington said. As existing U.S. home sales rose 7.2 percent in July from the previous month, distressed deals including foreclosures accounted for 31 percent of transactions, according to the National Association of Realtors, a Chicago-based trade group.
A report by the Mortgage Bankers Association, based in Washington, showed the share of home loans with one or more payments overdue rose to a seasonally adjusted 9.24 percent in the second quarter, an all-time high. Clarium, which oversees about $2 billion, is positioned for an equity bear market through investments in the U.S. dollar, Harrington said. Falling stock prices will strengthen the currency by forcing leveraged investors to sell equities to pay down the dollar-denominated debt they used to finance those trades, he said.
High unemployment, lower wages and potential missteps by policymakers around the globe may stifle economic growth in 2010, Tudor said. The firm, which manages $10.8 billion, is at odds with 55 economists projecting an average of 2.3 percent growth next year, according to the Bloomberg survey. Macro managers’ pessimism is fueled in part by the U.S. government’s response to last year’s financial crisis, which they say fails to address the root cause. Banks still hold hard- to-sell assets on their balance sheets, the managers said.
"Some critical initiatives have been cut short," Tudor said. "As a result, toxic assets remain on balance sheets and credit growth is likely to be subdued for a long period." Some firms, including Brevan Howard Asset Management LLP, see the recession at its end while dismissing the likelihood of robust growth. Brevan Howard, Europe’s largest hedge-fund manager with $24 billion in assets, told clients the U.S. could stumble when stimulus spending fades after the current quarter. The London- based firm, whose macro fund gained 20 percent last year, said consumer wealth erosion, scant bank lending and troubled world economies may result in a lackluster recovery.
The U.S. Federal Reserve and other policy makers took unprecedented steps in the past year to stave off financial disaster. The Fed’s Board of Governors used emergency powers to rescue markets for commercial paper, housing bonds and asset- backed securities. The Fed’s balance sheet swelled to $2.08 trillion last week, more than doubling from a year earlier. The Financial Accounting Standards Board voted in April to relax fair-value accounting rules. The change to mark-to-market accounting allowed companies to use "significant" judgment in gauging prices of some investments on their books, including mortgage-backed securities that plunged with the housing market.
Banks are reporting better earnings because they haven’t been forced to account for their losses yet, Clarium’s Harrington said. "We haven’t fixed the problem," he said. "We’ve just slowed down the official recognition of it." Hedge funds rose in July for the fifth consecutive month, returning an average of 2.4 percent as stocks advanced, according to data compiled by Hedge Fund Research Inc. Bearish stances prevented some macro funds from joining the rally. The category lagged behind the industry average in July, rising 0.6 percent.
Clarium, whose assets were mostly in fixed income, dropped 6 percent this year through June. Horseman’s fund slid 16.3 percent. Tudor’s BVI Global Fund Ltd. returned 11 percent. The funds held up in 2008 amid the industry’s record 19 percent loss. Horseman’s Global Fund USD, which focuses on stocks, made HSBC’s private bank list of top 20 performers by gaining 31 percent. Tudor’s and Clarium’s funds fell 4.5 percent. Macro managers are examining China for hints on how to place currency and commodities bets. Tudor said the country’s spending spree on raw materials inflated commodity prices and weakened the U.S. dollar.
A government mandate forcing banks to make about $1 trillion in loans during this year’s first half is spurring short-term growth that may not last, according to Clarium. China’s banking regulator drafted capital requirements Aug. 19 that may lead banks to rein in lending. Horseman, with $4.1 billion under management out of London, was investing in long-term U.S. Treasury bonds. The firm believes interest rates will stay low for longer than the market expects, benefiting the asset class. "Despite every effort by government in North America and Europe to avoid deflation," Horseman wrote, "the current numbers suggest they are losing the battle."
Is Unemployment the Worst Since the Great Depression?
The "Great Recession" is the name that has stuck for the economic decline that began in late 2007. But there's some reason to think that using the word recession is being kind. The U.S. gross domestic product has shrunk 3.9 percent in the past year, the worst drop since the Great Depression. Plenty of observers are willing to say that this recession is much deeper than anything we've seen since the 1930s—including the big dip in the early 1980s, generally accepted as the other candidate for the worst recession since the Great Depression.
"I think it's way worse today," says Ridgely Evers of Tapit Partners, a longtime entrepreneur and venture capitalist who founded the software company Netbooks (now known as WorkingPoint). In the recession of 1981 and 1982, "people recognized it as a dip. [Today,] nobody thinks we are going to come back out in relatively short order." This recession seems to have dragged on longer. According to the National Bureau of Economic Research (NBER), the U.S. economy was in recession from July 1981 to November 1982—16 months. But the current recession started in December 2007, says the NBER, so it's already longer than the last big one.
The NBER defines a "recession" based on the all-encompassing gross domestic product figure. That economy-wide statistic may not mean much to the average American. In other words, the question "What is the economy's output?" usually doesn't matter as much as "How hard is it to find a job?" When we look at that question, how does the "Great Recession" compare? The unemployment rate is a murky number. It seems simple enough to look at the national unemployment figures released every month by the Bureau of Labor Statistics. In July, that number was 9.4 percent. At the peak of the early '80s recession—December 1982—unemployment hit 10.8 percent.
So where's the murkiness? The problem is that many of the people one would think of as "unemployed" are not included in this unemployment rate. For one, the Bureau of Labor Statistics does not count unemployed people who have been discouraged by the labor market and have given up looking for work. You are counted as a "discouraged worker" if you are available to work, want to work, and tried to look for work in the past year but gave up within four weeks for reasons including the belief that no work is available. The fact that the national unemployment rate excludes these discouraged workers has led many observers to believe it does not reflect the "real" level of unemployment. "Ask the average person if he or she is unemployed, and there is little hesitation in giving you an answer, but that may not agree with government definitions," says John Williams, an economist who examines government statistics at shadowstats.com.
Other people who aren't counted in the official number are those who have been forced by the economy to work part time. The number of workers who wanted full-time jobs but could find only part-time work was 1.8 million last month, which amounts to 1.3 percent of the labor force. Still, that's not as bad as December 1982, when forced part-time workers accounted for 3 percent of the labor force. What happens when you start counting all these people who have been heavily battered by the labor market?
The Bureau of Labor Statistics has another rate that includes "marginally affected workers" and part-time workers. That number, referred to as U-6 because of its identification in bureaureports, was 16.3 percent last month—nearly 7 percentage points higher than the official unemployment rate. What's more, the number of people who have given up on finding work has been steadily rising over the past few months, from 685,000 in May to 796,000 in July. "If you have that number of people leaving the workforce, that seems to me a serious problem," says economist John Lott.
Many people are giving up because the labor market is so bad—but how bad historically? A U-6 rate of more than 16 percent certainly does not compare to the Great Depression, when a quarter of the workforce was unemployed. And Williams points out that a much larger number of workers were agricultural workers in the 1930s. These farm workers are not included in today's statistics. So, by his estimates, nonfarm unemployment was at 35 percent in 1933). Trying to compare that U-6 number with the early '80s recession gets a bit tricky. The U-6 measurement did not come into use until 1994.
Before that, the Bureau of Labor Statistics used a broader measurement, referred to as U-7, to figure out the number of unemployed plus workers dropping out of the labor force. In 1982, U-7 hit a peak of 15.3 percent, below the current U-6 of 16.3 percent. But 1982 should probably look even better compared with the labor market of today. U-7 overestimates the number of discouraged workers compared with how we measure them today. For example, the Bureau of Labor Statistics started asking people in surveys if they were actually available to work. These and other changes reduced the measurement of discouraged workers by 50 percent, according to some estimates.
So if you care not just about people who meet the official definition of "unemployed" but also about people who are dropping out of the labor force, 2009 seems to be trailing 1982 in terms of the health of the labor market. Williams says that when he takes into consideration people who haven't looked for work in more than a year because they can't find jobs, the real unemployment rate today goes all the way up to 20.6 percent by his calculations. "It won't take much to get it to the worst since the Great Depression," he says.
GM U.S. August sales fall 20.2%, Ford up 17%
General Motors Co. posted a 20.2 percent drop in U.S. sales in August from a year earlier, the highest sales of the year, supported by the U.S. government's "cash for clunkers" incentive program, the automaker said on Tuesday. GM, which emerged from bankruptcy as a state-owned automaker in July, said U.S. sales fell to 246,479 vehicles in August, down from 308,817 a year earlier when an employee pricing incentive promotion supported the automaker's sales. Retail sales fell 17 percent from a year ago and fleet sales were down 29 percent.
GM's results stand in contrast to a 17 percent sales gain at U.S. rival Ford Motor Co. in August. Chrysler sales fell 15 percent in August. In August, GM announced plans to increase North American production in the second half of 2009 due to a surge in sales from the "clunkers" program. The automaker added 60,000 vehicles of production for the third and fourth quarters. GM said U.S. inventory stood at 379,000 vehicles at the end of August, down about 357,000 from a year earlier.
Next for Auto Sector, Post-Clunker Hangover
The federal "cash for clunkers" program pushed auto sales to their highest levels in over a year, analysts estimate. But the boost is likely temporary and some anticipate falloff. Auto sales for August, due out by Tuesday afternoon, are expected to come in between 13 million SAAR, or the seasonally adjusted annual rate of car sales, and 16 million. Those figures would be eye poppers. Though auto sales regularly hit 16 million a month before the recession, they have since dipped, hitting a low in February of 9.1 million. In July, which saw some clunkers action, they reached 11.2 million.
Even within August, the numbers point to a pullback. On a weekly basis, dealers sold cars at an annualized rate of over 19 million in the first week of the clunkers program, followed by weeks of car sales at rates of 12 million or more, according to estimates by Edmunds.com. In the final week of August, after the program ended, sales slumped to eight million. Meanwhile, the clunkers program caused unintended consequences, such as some higher car prices and lower levels of supply, said Jeremy Anwyl, chief executive of Edmunds.com, a consumer-research firm. Dealers raised their prices on Toyota Corollas, for example, by approximately $445 while the clunkers program was in effect, according to Edmunds.com.
That could help send some car sales downward in coming months, offsetting somewhat the benefit to car makers and retailers of the government's $2.9 billion of rebates given to customers who traded in 700,000 old, gas-guzzling cars, for new ones in the cash-for-clunkers program. "We expect sales for the remainder of the year to fall well below August results," wrote Brian Johnson, analyst at Barclays Capital. Mr. Johnson warned that investors may use Tuesday's sales figures to take profits in auto stocks. Already, auto stocks that appeared to get a boost from the program have begun to sell off. Now investors need signs of more solid repair to consumer confidence and growth in demand for cars absent government coupons.
Merkel, Sarkozy Urge G-20 to Limit Bonuses, Bank Size
German Chancellor Angela Merkel and French President Nicolas Sarkozy will press fellow Group of 20 leaders to limit the size of banks, regulate the bonuses they pay out and tighten capital requirements. Merkel and Sarkozy, at a news conference in Berlin late yesterday, said they will outline the joint French-German proposals in a letter to the European Union to help formulate a unified EU position for the G-20 summit in Pittsburgh on Sept. 24-25.
"No bank must grow to a size that puts it in a position in which it can blackmail governments," Merkel said. "We need agreed international rules on how to ensure this." Merkel and Sarkozy, who head the euro region’s No. 1 and No. 2 economies respectively, have sought to present a joint agenda to overcome the global crisis and ensure that there is no repeat. Merkel, running for re-election on Sept. 27, backed Sarkozy over what he called "the bonuses scandal." "Bonus payments are the thing that quite rightly drives a lot of people up the wall," Merkel said, supporting proposals outlined by Sarkozy on Aug. 25 for tougher limits on banker pay.
U.K. Prime Minister Gordon Brown wants bankers’ pay and bonuses to be subject to clawback should performance suffer in subsequent years, and regulators should be able to impose higher capital requirements on financial institutions, the Financial Times reported today, citing an interview. Merkel and Sarkozy said the G-20 club of industrialized and emerging economies must make commitments in Pittsburgh to prevent any recurrence of the worst economic crisis since 1945, which has caused total writedowns and losses of $1.6 trillion.
"The excesses of speculation and finance that led to the crisis cannot resume as though nothing had happened," Sarkozy said. That also applies to banks’ capital requirements, Merkel said. "The riskier banks’ business is, the higher the capital requirement should be." Merkel said she intends to raise the topic of interest rates when G-20 leaders discuss exit strategies to rein in stimulus spending. Merkel and Sarkozy join the International Monetary Fund in urging the G-20 members to coordinate when they unwind emergency measures introduced to fight the global financial crisis.
As G-20 economic policy makers prepare to meet in London on Sept. 4-5, John Lipsky, the IMF’s No. 2 official, said in an interview that a lack of cooperation "could create strains and costs for other countries." German Finance Minister Peer Steinbrueck told his G-20 counterparts in a letter that failure to align so-called exit strategies risked "distortions of competition." Brown was quoted by the Financial Times as saying it was too early for Western economies to abandon stimulus measures.
A German Finance Ministry official told reporters yesterday that a proposal to limit the size of a bank’s balance sheet is an "extreme position." Systemically important banks may be subjected to higher capital requirements for certain business areas, according to another proposal, the official said on condition of anonymity. No preliminary decisions have been taken at G-20 level on how to prevent banks from growing too big to fail, the official said.
Merkel and Sarkozy joined forces ahead of the last G-20 summit in London in April to demand steps to control executive pay, plus rules governing hedge funds and new "architecture" for financial markets. Merkel has since voiced concern about possible backsliding on past G-20 commitments as the recession has eased. "We mustn’t waste this opportunity" in Pittsburgh, Merkel said. "To the surprise of many, we’re noting in several financial centers of the world that the banks that got back on their feet again are behaving just like they did before the financial crisis. This mustn’t repeat itself."
Sarkozy on Aug. 25 cajoled French banks into a promise to stretch two thirds of bonus payouts out over three years and making a third of them in shares. On top of that, France won’t give mandates to handle bond issues or other work to any banks that don’t follow those rules, he said. Sarkozy also called on the G-20 to consider caps on both the total bonus pools of banks and individual bonuses. Brown said such a move to cap bankers’ pay and bonuses would be difficult to enforce, the Financial Times reported..
The "Other" Real-Estate Issue Revisited
It was in early February of this year that we penned a discussion about the state of the commercial real estate markets. Of course at the time the Street’s eyes were collectively glued on the near free fall in residential real estate values and general activity. Our suggestion at the time was that CRE (commercial real estate) was about to make a very prominent guest appearance on the economic stage as being yet another meaningful real estate related issue for the financial sector, the economy, and for those holding significant investment positions in the asset class such as institutional pension funds. You know what has happened since, but the reality is that CRE will continue to be a problem child issue for some time to come.
As we’ll see in just a minute, relative to prior historical CRE reconciliatory cycles, we’re just getting started. Will this be yet another “challenge” for the banks ahead? You bet. But the miracle of the eraser the government allowed the banks to invoke sidestepping mark-to-market activity may delay the true realization of asset value declines. As you’d guess, we have a lot of charts that together tell quite the story of deflation in values and activity, both now and we expect also yet to come in the current cycle. And why is this issue important to really the broader US economy as we look ahead? Simple - its implications for bank lending and normalized functioning of credit markets ex the massive baling wire and duct tape support of the financial sector the Fed/Treasury/Administration (none of which has been removed as of yet, or can be if asset values such as CRE continue to deteriorate) has engineered.
We believe the CRE issue will forestall a return to credit flows from the banks as they privately (no mark-to-market) continue to nurse balance sheet wounds for some time to come. Let’s get started.
We want to kick off this analysis with some data we have never shown you before. But it is certainly very timely right now. Why? Because this data is both current and market value based. We’re NEVER going to see this type of data coming from the banks as they will lie as long as they can about CRE values on their books. They have the blessing of the government, so don’t hold your breath in terms of trying to find truth coming from the financial sector. Alternatively, and very importantly, the institutional investment community still marks their real estate assets to market each quarter in terms of keeping integrity in calculating ongoing total rates of return for their funds. Thank God someone is willing to tell the truth, right? It seems there’s less and less of it around each day.
The National Council of Real Estate Investment Fiduciaries (NCREIF) is an association of institutional real estate professionals who share a common interest in their industry. They are investment managers, plan sponsors, academicians, consultants, appraisers, CPA's and other service providers who have a significant involvement in pension fund real estate investments. They come together to address vital industry issues and to promote research. The NCREIF was established to serve the institutional real estate investment community as a non-partisan collector, processor, validator and disseminator of real estate performance information.
Now you know what we are talking about in terms of integrity of the data. No tier I, II and III assets for these folks to manipulate and massage in terms of values, just honest third party actual quarterly appraisals of real properties. The NCREIF publishes a National Property Index (NPI) on a quarterly basis that gives us some very good insight into what is happening quarter by quarter with the value of institutionally held commercial real estate investments. And you can be darn sure they are much closer to the truth of what is happening with CRE values than the banks in this country will ever let on. The NPI covers all “classes” of institutional investment in CRE including, office, retail, hotel, industrial and apartment properties.
The NCREIF Property Index is a quarterly time series composite total rate of return measure of investment performance of a very large pool of individual commercial real estate properties acquired in the private market for investment purposes only. All properties in the NPI have been acquired, at least in part, on behalf of tax-exempt institutional investors - the great majority being pension funds. As such, all properties are held in a fiduciary environment. NCREIF requires that properties included in the NPI be valued at least quarterly, either internally or externally, using standard commercial real estate appraisal methodology.
Each property must be independently appraised a minimum of once every three years. Because the NPI is a measure of private market real estate performance, the capital value component of return is predominately the product of property appraisals. As such, the NPI is often referred to as an "appraisal based index." At the moment there are roughly 6000 individual properties in the index whose value approaches $300 billion. Sorry for the knock down drag out description as to who these folks are and how the index is calculated, but we believe it is one of the most “transparent” pieces of data regarding ongoing CRE values we can find. Of course it seems the government alternatively believes that by wiping away mark to market we can just go back to lying to ourselves and everything will be just fine. That worked out really well in the prior cycle, no? In terms of honesty and integrity, we’ll take the NCREIF data any day of the week, thank you.
Finally to the point, below is the three decade-plus history of quarterly returns for the NCREIF property index. Get the picture as to current trends?
Of course you do. We’re currently looking at the most significant period of consecutive quarterly drops in value in what admittedly is the short history of the data (going back to 1978). Although we do not detail the quantitative numbers in the chart, over the last four quarters (3Q 2008-2Q 2009) the index has recorded a 22.5% contraction in value. And just what does this infer about bank holdings of CRE loan paper? Thanks to the current Administration’s financial sector “don’t ask, don’t tell” policy for bank assets, we’re not going to really know any time soon. Good thing the US banks can simply move forward reporting record earnings and ignore the current inconvenient truth of declining CRE values, no? We only see some glimpse of the truth in asset values every Friday when we see that week's US bank failures. Did you catch how BB&T wrote down Colonial Bank asset values by 37% after Colonial's essential failure and melding into BB&T? The write down never happened until Colonial hit the tarmac nose first, yet asset values had vaporized long ago. And this is the "transparency" we've been promised?
In the next chart we’ve taken CRE individual asset class quarterly returns from the NCREIF data and produced a compound rate of return series for each asset class since the beginning of the current decade. Please be aware that the NCREIF rate of return data includes two components - an income return and capital price change. Although we will not drag you through the specific quantitative data mud, you’ll just have to trust us in telling you that income returns have been positive each and every year. That means the capital return (price change) both primarily drives the direction of the data in the chart below plus is a bit worse than the actual numbers in the chart show due to the positive influence of the income flows.
In short, we are looking at some very substantial price declines to produce these compound annual rate of return trends for each property type. In the table below we delineate the NCREIF pure prior four quarter rate of return by property type for the period ending 2Q 2009. Again, it is the true reality of actual property price appraisals that is driving these numbers. C'mon, can't we allow the pension funds to simply make up "fair value" numbers like the banks do? It just doesn't seem fair they should have to take these types of asset value hits, right? They can't convert to bank holding companies, can they?
Certainly the numbers you see above are breathtaking, especially given that they only cover the prior four quarters through 2Q of this year. And to be totally honest, value declines in the third quarter of last year for all property types were less than 1%. Meaning that 95% of the price damage you see in the table above has occurred since September month end of last year to the present. Just how meaningful is this historically? How does the present CRE down cycle compare to historical cycles? We only wish we had the very long term data. But what we do have is a copy of a presentation done by Ken Riggs, President and CEO of Real Estate Research Corp. (RERC) given at the summer 2009 conference of the very same NCREIF. RERC bills themselves as “one of the first, and one of the most recognized, independent and objective commercial real estate research, valuation and consulting firms in the nation. For more than 75 years, RERC real estate research, publications, market studies, property valuations, investment criteria and trends analysis have proven visionary”. Anyway, the following is some data Mr. Riggs presented to the NCREIF crowd literally seven weeks ago in terms of prior CRE cycle character.
As you can see, his numbers for current magnitude of decline are not too far off what the NCREIF property index tells us. As we look at the data above, what is most striking is that it has only now taken really three quarters in the current cycle to produce 41% of the decline seen in the 24 quarter down cycle of the early 1990’s. And of course the early 1990’s CRE collapse was in good part driven by the vaporization of the S&L industry. Seven quarters of CRE decline early this decade produced a “rounding error” of price decline magnitude relative to the present cycle. And unfortunately, as we see it, we’re still in the first few innings of the current CRE cycle reconciliation game for now. And as far as the banks and their CRE assets are concerned, the national anthem has not yet even been played. We’ll just have to see how it all unfolds from here.
Final chart from the good folks at the NCREIF. As is often the case in any asset class where a very meaningful decline in values takes place over a very short period of time, activity simply dries up. You may remember our personal near and dear mantra courtesy of Ray DeVoe - “Liquidity is a coward. There’s always too much when it’s needed the least and it’s never around when it’s needed the most.” Please be aware that the 2009 number in the chart below has indeed been annualized. Quite the collapse in activity, right? In no way will this help "price", quite the opposite.
It’s a shame all the buyers have vanished, because as you may remember close to $300 billion-plus of CRE mortgage loans are up for renewal or reset this year. And as of now the asset backed market for commercial real estate loans is contracting as opposed to expanding. Much like the residential asset backed markets, the commercial asset backed markets are no longer open 24/7.
That really leaves the banks as the potential saviors for commercial real estate finance. But here unfortunately again, the banks are nursing their CRE wounds in the privacy and blackness of their non-mark to market balance sheets. What we do know is that per the most recent bank loan officers survey, over 65% of banks were still tightening standards for commercial real estate loans when these folks last answered the phone (a quarterly survey).
So just where does that leave CRE owners who need to refinance this year or early next? In trouble, that’s where. And if this were not enough, we can tell you from first hand knowledge that bank regulators have been crisscrossing the country examining bank CRE loans intently. They do not want another mortgage debacle as was residential real estate on their current watch. Like they have a choice, right? In many cases current CRE appraisals are being conducted against existing bank property loans and capital calls are going out to CRE owners who have always been model credits and have never missed a payment in their lives. And CRE values will improve in this type of a regulatory and available capital environment? Quite the opposite, as you already know.
An Empire of Consumption
by Byron W. King
Just reading the newspapers gives me a daily diet of economic gloom. For example, my pessimism for today (Aug. 26) started with the headline of my local newspaper this morning. The Pittsburgh Tribune Review delivered a banner message, "Record Red Forecast at $1.58 Trillion." (I think they printed the newspaper before the word came out that Sen. Ted Kennedy died.) Then for a national perspective, I looked at The Wall Street Journal, which published a slightly different alliteration, "Decade of Debt: $9 Trillion." And finally, for an international view, The Financial Times summed it all up in characteristic British understatement, with, "US Says Debt Outlook Worsening." Oh, you don't say.
The big problem - obviously, the headline issue - with the US economy is too much debt. (That's the BIG problem. There's a long list of other problems after that.) And the debt problem is getting worse, not better. Debt is ubiquitous across US society. Debt permeates the culture. Practically the whole nation has bitten off more than it can chew. Within the past two generations, the US economy has transformed from what Harvard historian Charles Maier calls an "empire of production" (which is what won the Second World War, for example) to an "empire of consumption."
The lunch bucket-toting factory worker, or the beam-walking riveter constructing a skyscraper, symbolized the former empire of production. Those iconic workers are no more. They've been replaced by the image of vast tracts of McHouses blanketing the landscape. Or of parking lots filled with new cars outside coast-to-coast malls, with their owners inside maxing out their credit cards. It's the difference between an economy that creates surplus capital and an economy that consumes capital to gross deficit. Professor Andrew Bacevich of Boston University summed it up this way in his recent book, The Limits of Power. "The evil genius of the empire of production was Henry Ford. In the empire of consumption, Ford's counterpart was Walt Disney."
Come to think of it, we should be so fortunate as to be indebted just because we collectively took too many trips to Disneyland. As a nation, the US has borrowed and spent far beyond its means. You know what I mean. I don't have to get into the details on that point. In particular, the political class just can't seem to say no. The other side of that debt coin is a widespread inability to repay. Households are so deep in debt that they've stopped buying, and I don't care what the so-called consumer confidence surveys say. Less buying means that business profits are down. Where businesses are showing profits, a lot of it is because they are goosing the bottom lines through layoffs and spending cuts.
Layoffs? That's putting it mildly. Many of the recent job losses are permanent. They're structural. It's not just the good old days, when the company said, "Go home and we'll call you back in a few months." No, in many cases, the jobs are gone forever. It's not just factory jobs, either. Those jobs were the first to go. The US economy lost millions of its old-line factory jobs over the past 25 years or so. It brought us into the age of the Rust Belt. Some economists and deep thinkers bragged about how this was somehow "good" for America. (Call me old-fashioned, but I could never quite figure that out.)
Now people with white collars are getting hit with permanent job losses in sectors like banking and law. Many parts of the nation's financial districts are the new Rust Belts of America. There are former lawyers waiting on tables, stealing jobs from the traditional class of table servers, starving artists. At many silk- stocking firms, even the formerly sacrosanct legal "billable hour" is under attack. And I know doctors and architects who've been laid off.
So joblessness is up, and it's not about to come down anytime soon. With joblessness up, tax collections are down across the board. Unemployment compensation accounts are running out of money. Public assistance accounts are running down. Some states want to give early release to prisoners to save the costs of incarceration. In Michigan, for example, some counties are no longer repaving the roads. They just grind the asphalt to gravel and save the cost of paving. It's a foretaste of things to come, I believe.
I don't see where the problems of indebtedness have been cured. We're not even close. Maybe it's my inner bankruptcy attorney at work. Where's the wipeout? Where's the discharge? How has all that bad paper out there been voided? It hasn't.
The Case Against a Super-Regulator
by Sheila Bair
The Obama administration has proposed sweeping changes to our financial regulatory system. I am an active supporter of the key pillars of reform, including the creation of a consumer financial protection agency and the administration’s plan to consolidate the supervision of federally chartered financial institutions in a new national bank supervisor. This consolidation would improve the efficiency of federally chartered institutions while not undercutting our dual system of state and federally chartered banks.
But some are advocating even more drastic changes, like the creation of a single regulator for all banks (and bank holding companies). We clearly need to streamline the system, but a single regulator is not the solution. Calls for consolidation beyond the administration’s plan fail to identify the real roots of last year’s financial meltdown. The truth is, no regulatory structure — be it a single regulator as in Britain or the multiregulator system we have in the United States — performed well in the crisis.
The principal enablers of our current difficulties were institutions that took on enormous risk by exploiting regulatory gaps between banks and the nonbank shadow financial system, and by using unregulated over-the-counter derivative contracts to develop volatile and potentially dangerous products. Consumers continue to face huge gaps in personal financial protections. We also lack a credible method for closing large financial institutions without inflicting severe collateral damage on the economy.
The creation of a single regulator for all federal- and state-chartered banks would not address these problems. Rather, it would endanger a thriving, 150-year-old banking system that has separate charters for federal and state banks. Within this system, state-chartered institutions tend to be community-oriented and very close to the small businesses and consumers they serve. They provide loans that support economic growth and job creation, especially in rural areas. Main Street banks also are sensitive to market discipline because they know that they’re not too big to fail and that they’ll be closed if they become insolvent.
Concentrating power in a single regulator would inevitably benefit the largest banks and punish community ones. A single regulator’s resources and attention would be focused on the largest banks. This would generate more consolidation in the banking industry at a time when we need to reduce our reliance on large financial institutions and put an end to the idea that certain banks are too big to fail. We need to shift the balance back toward community banking, not toward a system that encourages even more consolidation.
A single-regulator system could also hurt the deposit-insurance system. The Federal Deposit Insurance Corporation currently supervises state banks. The loss of a significant regulatory role would limit its ability to protect depositors by identifying and assessing risks in the financial system. We can’t put all our eggs in one basket. The risk of weak or misdirected regulation would be increased if power was consolidated in a single federal regulator. We need new mechanisms to achieve consensus positions and rapid responses to financial crises as they develop.
I have advocated the creation of a strong council of federal financial regulators. This council would monitor the financial system to help prevent the accumulation of systemic risks and would also have the authority to close even the largest institutions. But we don’t need — and can’t afford — to depend on one supreme regulator to have sole decision-making authority in times when our entire financial system is in flux. One advantage of our multiple-regulator system is that it permits diverse viewpoints. The Federal Deposit Insurance Corporation voiced strong concerns about the Basel Committee on Banking Supervision’s relatively relaxed rules for determining how much capital banks should have on hand.
In a single-regulator system, it’s very likely that these rules would have been put into effect much more quickly and with fewer safeguards, and our largest banks would have faced the current crisis with much smaller buffers of capital. This is not about protecting turf. This is about protecting consumers and the safety of our financial system. Working with Congress, we need to draw on the best ideas available to plug regulatory gaps as outlined in the administration’s proposal. We may never have a better opportunity to address the root causes of this crisis — and prevent it from ever happening again.
Sheila C. Bair is the chairman of the Federal Deposit Insurance Corporation.
You Can't Keep A Bad Man Down
Disgraced former Gov. Eliot Spitzer has been privately talking with friends about a possible comeback, and is considering a run for statewide office next year, several sources told The Post. Less than 18 months after he left Albany in a prostitution scandal, Spitzer has held informal discussions in recent weeks about the possibility of making a bid for state comptroller or the US Senate seat currently held by Kirsten Gillibrand, sources said. The hooker-happy Democrat has also discussed his own halfway-decent poll numbers in recent surveys, which have shown him more popular than Gov. Paterson, whose own numbers have tanked.
"He's weighing it," said one source. But Spitzer hasn't shown any interest in campaigning for the office he briefly held, sources said. The sources stressed that Spitzer, who also served two terms as state attorney general before his landslide election as governor in 2006, has not engaged in any active discussions with political consultants. Reached at his father's real-estate firm, where he has been working since he resigned as governor last spring, Spitzer declined comment. But a source close to him insisted, "It's not true," and two other close associates also insisted he was not interested in running for office again and was looking at a range of other options.
Two sources said Spitzer had thought about a gamut of different electoral choices in his months of political exile. But one ally insisted he's realized he can't do anything, at least not next year, saying, "There are people around him who want to see him [in office], and he sees himself there, too. He loves to be in the limelight. But he knows it can't happen."
Spitzer quit in disgrace in March 2008 after he was unmasked in Manhattan federal court as "Client 9" in a prostitution bust involving a major call-girl ring. He was revealed to have paid $4,300 for a romp with escort Ashley Dupre, then 22. Still, the sources said, Spitzer has been looking at avenues for a return to elective office, even if it means mounting a challenge against a fellow Democrat. State Comptroller Tom DiNapoli, appointed to his post by the state Legislature after Alan Hevesi resigned amid scandal two years ago, is widely seen in Democratic circles as a weak link on the ticket. Gillibrand is similarly viewed as ripe for a primary challenge, with large numbers of voters saying they have no opinion of her.
Spitzer has suggested in recent interviews that he's not interested subjecting his family to the rigors of another campaign -- although he has seemed to stop short of ruling it out. "If by politics you mean running for office again, I've a hard time seeing politics as a career. I wouldn't want to put my family through the agony," he told Vanity Fair magazine in its July issue. "But that doesn't mean I can't participate somehow in the public debate about the issues." Spitzer, who wasn't convicted of any crime in the hooker scandal, has been rehabbing his image in recent months, writing a column for the Web magazine Slate and giving a string of interviews on issues such as the financial crisis.
IATA: First-Half Airline Losses Top $6 Billion
The airline industry lost more than $6 billion in the first half of the year, but there are signs that passenger numbers and air-freight volumes are improving, the International Air Transport Association said Tuesday. In its bimonthly report on the financial health of the industry, IATA said airlines posted a combined net loss of $2 billion in the second quarter following $4 billion in losses in the first quarter. Its sample of airlines was incomplete, so IATA -- which represents 230 airlines world-wide that account for roughly 93% of scheduled international air traffic -- estimates that losses exceeded $6 billion.
Passenger numbers and freight volumes in July climbed 3% from June, but both remain below year-ago levels. "There was a material improvement (in travel) in July, but the future path is likely to be volatile and weaker than normal recoveries," the report said. Cuts in capacity have failed to keep pace with the drop in demand. Load factor, or the proportion of available seats that airlines fill with paying passengers, was 80.3% in July and could mark the high point for the year as the industry moves into a seasonally weak period and published schedules suggest some capacity growth ahead, IATA said.
"Elimination of excess capacity will be the key to stopping the decline in fares and stabilizing revenues as well as volumes," IATA added. Air-freight capacity utilization in July rose to 47.6% from a low of 40% in January, but excess capacity continued to drive down rates, which fell more than 20% year-on-year.
A spike in jet-fuel prices in August was worrying, even though some airlines reported mark-to-market gains on fuel hedging. "However, cash flows tell another story," the report said. "The cash impact of higher fuel prices remains negative, and particularly damaging given declines in passenger and cargo yields." Airlines in the first half took advantage of higher share prices to refill their coffers. They have pocketed $3 billion in new equity and $12 billion from debt issues. Airline share prices in August were up 7.4% since the start of the year.
Ilargi: Interesting notion, strange conclusions.
Job Losses Are Not the Problem
by Andy Harless
It is sometimes argued that recessions benefit the economy by allowing the destruction of old, inefficient economic structures so that newer, better ones can be created to replace them. On the surface, this story might seem to apply to the recent recession: ostensibly, a lot of useless jobs in finance, real estate, and construction were destroyed, as well as perhaps old manufacturing jobs that hadn’t caught up with the latest technology, and jobs in retail trade that needed to be replaced by the Internet, and so on. But there’s one problem with that point of view: overall (at least during the first four quarters of the recession, up through the end of 2008, for which we have the relevant data), there weren’t an unusually large number of total jobs being destroyed.
But...but...but...haven’t we been hearing about large numbers of job losses month after month since the recession began? Sort of. We’ve been hearing about large numbers of net job losses. That is, the number of jobs that have been lost has been a lot more than the number that have been created. And a lot of job losers have ended up collecting unemployment insurance for a long time, sending the figures for continuing claims up to records, instead of getting new jobs. But the gross number of jobs being destroyed has not been unusually large. In fact, relative to the overall level of employment, job destruction was happening at a faster rate during the boom of the late 1990s than it was during the last quarter of 2008.
How can that be? For one thing, when you take out the business cycle, there seems to have been a general downward trend in the rate of job destruction over the past 10 years. More important, the rate of job creation also had a downward trend, and it dropped to new lows during the recession of 2008. If you lost a job in 1999, you weren’t actually all that atypical, but it wasn’t a big problem, because typically, you could find a new job fairly easily. If you lost a job in 2008, you were (typically) out of luck.
source: Business Employment Dynamics data from the Bureau of Labor Statistics
The fact is, job creation and job destruction take place during booms at rates that are not dramatically different from the rates during recessions. It’s just the difference between the two that changes. In a typical boom quarter, about 7 million jobs are destroyed, and about 8 million are created. In a typical recession quarter, about 8 million are destroyed and about 7 million are created. There just isn’t much support for the idea that recessions give us a special ability to reallocate resources more intensely than we do during a boom or a period of normal growth. “Creative destruction” is a dynamic process that continues all the time, not one that occurs in separate phases of creation and destruction.
And the most salient feature of the current episode is that there has been unusually little creation. From the 1990’s to the 2000’s, the quarterly job creation rate fell from about 8% to about 7%. Since 2006, it has fallen to about 6%.
Some might argue that this type of slowdown in job creation is inevitable during times of structural change and that it is useless to try to oppose it with monetary and fiscal policy. It takes a long time (Arnold Kling, for example, would argue) for the economy to come up with ideas for new, productive uses of resources when the old uses are no longer productive. Monetary and fiscal policies can’t do much to speed up this process. They can’t make entrepreneurs more creative.
I’m skeptical of that view: entrepreneurs were plenty creative during the 90’s, once the booming stock market gave them a reason to apply their creativity. Monetary policy really did help speed up the process of finding new uses for resources: low interest rates led to high equity prices, which made it easy to raise capital and thereby made it advantageous to find new ways of using capital. Some would say the process went too fast in the end, with a large fraction of the uses proving ultimately unproductive, but statistics show aggregate productivity rising rapidly and continuing to rise during the subsequent years, even (atypically) during the recession that immediately followed the boom. There may have been a lot of froth, but there was plenty of good beer underneath, and monetary policy is what opened the tap.
In any case, even if I were to concede that monetary and fiscal policies don’t help speed up the adjustment process, they do help us get the most out of the economy in the mean time. With nearly 10 percent of the labor force unemployed, there are a lot of resources being wasted – people spending their time looking for jobs that many of them just aren’t going to find until we get a lot more economic activity. There are plenty of useful things that those people could be doing in the mean time.
Perhaps more important, monetary and fiscal policies help us reduce the risk that a weak economy – too weak for too long – will fall into a deflationary spiral. As long as job creation remains weak, employers have little incentive to raise wages, and competition will tend to push down prices. Even an “artificial” stimulus, one that doesn’t accelerate the structural adjustment process, will create a demand for labor and force employers to compete somewhat for workers. That competition, in turn, will prevent them from competing too aggressively in product markets and keep prices reasonably stable.
There is, of course (in theory, at least), the risk that policies will go too far and not just prevent deflation but produce excessive inflation. As I have argued before, we are nowhere near that point right now. I made the case against inflation using mostly the unemployment rate, but the case becomes even stronger when you consider the job creation statistics. This unemployment is specifically being induced by a slowdown in job creation. Job creation is specifically what leads to inflation: it’s when companies want to hire aggressively that they start raising wages excessively and competition becomes unable to keep prices in check. If unemployment – which arguably has a more tenuous relationship to inflation – is far, far away from the danger point, job creation – which has a direct relationship to inflation – is even further away.
Making Home Affordable Program has 'helped' only 6% of eligible homeowners
When President Obama unveiled the Making Home Affordable Program in March, he said it would help "responsible folks who have been making their payments" reduce their monthly mortgage bills and avoid losing their homes to foreclosure. But six months into the program, only 6 percent of the 4 million eligible homeowners have gotten help. A lot more say they've been frustrated with the runaround they've been getting from lenders. Are the new program's growing pains responsible for the slow start, as bankers say, or is pain to their bottom lines really preventing the program from working, as critics say?
The Making Home Affordable Program is supposed to work this way: In return for billions of dollars in taxpayer bailout money, banks would offer loans that would reduce troubled borrowers' monthly mortgage payments to 31 percent of their income. To qualify, a homeowner must have an income and must live in the house, and that house can't be worth more than $730,000. The bank is also allowed to calculate the value of the mortgage against the profit it would make from a foreclosure. Banks are prohibited from selling a house in foreclosure while the homeowner is being considered for an adjustment. The Treasury Department oversees the program, and the banks signed contracts with Treasury binding them to cooperate.
Treasury Secretary Timothy Geithner has been so unhappy with the program's pace that he called in lenders for a meeting and demanded they do better. In a July 9 letter to one servicer, JP Morgan, Geithner and Shaun Donovan, secretary of Housing and Urban Development, wrote "there is a general need for servicers to devote substantially more resources to this program for it to fully succeed and achieve the objectives we share." They called on the banks to hire more staff, expand their call centers and allow homeowners "an escalation path for borrowers dissatisfied with the service they have received."
The mortgage industry's top lobbyist says any problems to date are the growing pains associated with getting such a massive program up and running. "It is working, and it needs to be given some time," says John Courson, head of the Mortgage Bankers Association. He says banks are still staffing up and getting the program off the ground. "It took 90 days to get out the rules and the procedures and the forms, and so that's a fairly new program," he said. Courson says that lenders are still "training more and more staff as they are getting more and more people who are familiar with this program."
He insists that the banks want to cooperate. "It's in the banks' best interest to work with those borrowers to keep those loans on the books and avoid foreclosure," Courson said. But critics say that the program works against the banks' best interests, as the homeowners who most need the program are the riskiest bets. "If the borrower is really in trouble, [the lenders] probably don't want to do the modification, because they think there's a good chance the borrower will redefault, and they will do a lot of work and they won't collect money," said Paul Willen, an economist with the Boston Federal Reserve who has studied bank foreclosures and modifications.
"The problem with this is in some deep sense, you can't penalize the banks for acting in self-interest. It's a for-profit business." Others are critical of the voluntary nature of the program and the Obama administration's hands-off relationship with lenders. The Treasury Department official charged with overseeing the program insists it's "off to a strong start, with hundreds of thousands of trial modifications already underway." Assistant Secretary for Financial Institutions Michael Barr acknowledges that "servicer performance has been uneven, but servicers have committed to ramping up efforts to improve the process for borrowers," and he insists that "the administration will hold these institutions accountable for their progress." He says Treasury is on track to help 3 million to 4 million homeowners in three years.
Diane Thompson of the National Consumer Law Center has a theory on why the Obama administration isn't getting tougher with the banks: "This is a voluntary program. I think Treasury has been very concerned to make sure that servicers [the banks] are willing to participate." She's convinced that banks will improve their track record only if they're forced to make loans. "Until it's made a mandatory program, I think we will not see a significant drop in foreclosures," Thompson said.
Another problem with the program is that banks don't always have the final say. Many of these mortgages are held by private investors, and the bank simply acts as a middleman. If investors think they can make more money by foreclosing than modifying the loan, experts say the bank is powerless to override that decision. Susan Wachter, professor of real estate and finance at the Wharton School, explains, "These are contracts. The government does not have the right to rescind contracts. The government can legislate all they want, but there can be lawsuits." Willen adds: "What's upsetting about this is that with Making Home Affordable, what you ended up with may be worse [than doing nothing]. We're giving more money to banks, and not preventing many foreclosures."
The Treasury Department has begun stepping up pressure on banks. This month, it began publicly reporting the number of the program's loans the banks had offered, as a way to shame banks into better participation rates. While JP Morgan-Chase has enrolled 20 percent of its eligible customers and Citibank 15 percent, two banks that got the biggest bailouts have some of the lowest enrollment rates, according to Treasury: Wells Fargo has enrolled 6 percent of eligible customers, and Bank of America 4 percent. Both banks say that those numbers are misleading -- that they have many more offers in the pipeline and have increased staffing.
Bank of America also says it is bigger than other banks, so it has more applicants to process. Wells Fargo also says that it has refinanced many hundreds of thousands of loans outside of the government program. Courson said many other banks are also offering their own mortgage modification programs, and if you count those, "a million and a half borrowers were assisted in the first six months in this year." Multiple administration officials insist to CNN that there is adequate oversight of the program and that the Treasury Department has enlisted Freddie Mac to monitor the banks. A Freddie Mac official, who would speak only on the condition of anonymity because it is acting "at the direction of Treasury," told CNN that its investigators visit banks, but only after giving the banks' management notice that they're coming.
The agency reviews loan documents, but only those that lenders provide. There are no surprise visits, no tape recordings of bank calls to assure quality assurance, and no way to respond to individual homeowner complaints. Recently, Freddie Mac began random reviews of cases in which homeowners were denied Making Home Affordable loans. So far, Freddie Mac has not found a single instance of noncompliance worth referring to the Treasury Department for a penalty. The Treasury Department was unable to show CNN any instance of a lender being penalized for breaking the program's rules.
Ex-Countrywide Execs’ Firm Modifies Bad Loans for Taxpayer Cash
Among the servicers participating in the government’s mortgage modification program is a new recruit that’s not like the others. PennyMac, a firm founded by the former president and chief operating officer of Countrywide, buys distressed home loans on the cheap with the goal of modifying them and later selling them for a profit. The company, whose top management consists mostly of former Countrywide executives, now stands to receive up to $6.2 million in taxpayer money to modify those loans, through the Making Home Affordable program. The government’s incentive payments go primarily to the participating servicer, but some of the money could also go to borrowers and investors.
A March New York Times article profiled PennyMac, focusing on the fact that former top managers at Countrywide were looking to profit from rehabbing high-risk loans that had failed. Countrywide, which made high-risk loans that the company’s CEO himself called "toxic" and "poison" in internal e-mails, has been widely blamed for helping trigger the financial crisis. But PennyMac may be better suited to helping struggling homeowners than other lenders taking government subsidies are.
Housing counselors have accused many of the participants in the program of being reluctant to modify loans. As a whole, participating servicers have helped far fewer borrowers than anticipated, according to the Treasury Department’s latest data release. Overall, less than 9 percent of eligible loans had entered the trial modification period by the end of July — roughly four months since some servicers first began implementing the program – and the rate was even lower for some individual servicers. Bank of America, for instance, the nation’s largest servicer, checked in at just 4 percent of its eligible loans. Bank of America now includes Countrywide, which, with $5.2 billion earmarked for it, is the biggest participant in the program.
According to Guy Cecala, publisher of Inside Mortgage Finance Publications, servicers and investors are loath to modify loans because most aren’t convinced that it will reduce their losses.
But PennyMac’s business strategy revolves around modification, turning "sub-performing and non-performing loans" into "restructured and re-performing loans," according to a recent company prospectus.
PennyMac buys distressed loans at fire-sale prices. In January, it purchased nearly 3,000 mortgages from the Federal Deposit Insurance Corp., which sells loans taken over from failed banks. The book value for those loans was $560 million, but PennyMac paid just $43 million. As a result, it has much more leeway to drastically reduce loan payments than banks holding mortgages at inflated values. "It can afford to lose more," Cecala says. "If they’re in fact doing that, I think it’s a wonderful thing," says Margot Saunders, a lawyer with the National Consumer Law Center, who had initially been critical of the company’s provenance.
But PennyMac may have a hard time leaving behind its ties to the scandal-ridden Countrywide. PennyMac’s founder and CEO, Stanford Kurland, is facing a civil suit (PDF) brought by the New York state comptroller and New York City pension funds, blaming him for helping push Countrywide into risky lending practices and lax underwriting standards as president. Kurland admitted to the Times that he had advocated a foray into higher-risk lending but said that the riskiest practices occurred after he left the company, in September 2006. Kurland’s lawyer told the Times that the allegations were without merit.
The suit against Kurland says he was one of three executives who "became enormously—almost indescribably—rich from insider sales of Countrywide stock at artificially inflated prices." Kurland sold nearly $200 million worth of Countrywide stock before leaving the company, and PennyMac was funded in part by his personal treasure chest, according to the Times. But if you ask Cecala, "basically anyone who’s been successful in the mortgage business has been tainted" by their involvement with risky subprime loans. "At the end of the day, nothing really distinguishes PennyMac from anyone else."
As for whether PennyMac will outdo the other participants in the government’s loan modification program, "the proof will be in the pudding," he says.
Revenue-hungry Kansas will be owner of new casinos
In Kansas, Carrie Nation battled booze by smashing up saloons, the state school board once approved science guidelines questioning evolution and anti-abortion leaders have made their stiffest stands - all burnishing the state's conservative credentials. Now, Kansas is poised for an unlikely distinction: It's about to get into the casino business, not merely by blessing gambling and taxing the profits but by becoming the legal owner of the casinos themselves.
Kansas is believed to be the only state with such an arrangement. It already has four Indian casinos, but its first non-tribal one is set to open in December in Dodge City, the former cowtown and setting of television's "Gunsmoke." It's all because the state, known for its conservative history and a vibrant right wing within its dominant Republican Party, needs the money. Lawmakers in recent months have slashed money for schools and other state services, and the current state budget relies on $50 million in casino licensing fees to remain balanced.
"It's terribly ironic, and disappointingly so. I never dreamed that Kansas would be the first to try this experiment," said House Speaker Mike O'Neal, a Hutchinson Republican who fought unsuccessfully to block the 2007 law authorizing the new casinos and slot machines at racetracks. Developers will build the casinos, install slot machines, set up tables and manage dealers, all under contract with the state lottery. They pay upfront privilege fees: $5.5 million for Dodge City and $25 million each for casinos planned in the Kansas City and Wichita areas.
The state will own the games and control software determining who wins and may overrule management decisions. Contracts spell out how revenues are divided. "The whole ownership thing - it always struck me as a little bit squirrely," said Burdett Loomis, a University of Kansas political scientist. "You could imagine Louisiana owning the casinos, or New Jersey." But Kansas?
Voters here imposed prohibition in 1880 and kept it for nearly 70 years, well after the federal government repealed it. Afterward, the state constitution continued to condemn the "open saloon." The state school board went back and forth on evolution during the past decade, rewriting science standards four times and making Kansas the target of international ridicule. The state has been at the center of the national debate over abortion, too. Dr. George Tiller's clinic in Wichita was among a few in the nation that performed late-term abortions, spurring protests and laws designed to restrict his practice until the doctor was shot to death May 31.
All of it would appear to make the turn toward gambling unlikely - save for the state's troubled finances. The American Gaming Association says the U.S. already has 179 commercial and 420 tribal casinos outside Nevada, as well as 700 card rooms and 44 racetracks with slot machines. So, industry officials and analysts say, why not more casinos in Kansas? David Schwartz, director of the Center for Gaming Research at the University of Nevada-Las Vegas, notes other seemingly conservative states - Iowa is a frequent example - are awash in games of chance.
Also, as Loomis noted: "When revenue is a consideration, old-fashioned morality sometimes goes out the window." Twelve other states have non-tribal casinos and a dozen have racetracks with slots. Several own machines at tracks, but the American Gaming Association says Kansas is the first with the arrangement for an entire casino. Clark Stewart, chief executive officer of Butler National Corp., the Olathe company building the Dodge City casino, said the real issue is the 27 percent share of revenues for state and local governments. "We're at the top end, percentage-wise, of what we can do," he said.
The Kansas Constitution once banned any lottery - a term courts interpreted broadly enough to cover slots and table games - but resistance to gambling eroded over time. Constitutional amendments in 1986 made exceptions to the ban for the state lottery and betting on dog and horse races. Federal law allowed the Indian casinos to open in the 1990s, whetting some legislators' appetite for commercial ones. To get any constitutional change on the ballot for a vote, supporters need two-thirds majorities in the Legislature - something social conservatives have blocked when it comes to commercial casinos.
But state ownership through the lottery didn't require another constitutional change, only a new law approved with simple majorities in both chambers. In 2007, gambling supporters barely obtained the necessary margins. The state hopes to choose developers for casinos for the Kansas City and Wichita areas before year's end. The Dodge City casino plans to open with 575 slots and 10 tables, then expand within two years. "I guess it doesn't strike me as particularly odd," said Senate Majority Leader Derek Schmidt, an Independence Republican who voted for the casino-and-slots law. "Every state has its own historical contours."
Spain: The Hole In Europe's Balance Sheet
by Variant Perception
Dives sum, si non reddo eis quibus debeo.Themes
I am a rich man as long as I don't pay my creditors.
Titus Maccius Plautus (c. 254-184 BCE), "Curculio"
- Spain = Japan 2.0? - We argue that 1) the real estate crash in Spain is worse than is widely believed, 2) Spanish banks are hiding their losses, and 3) investors are smoking crack if they believe that Spanish banks are among the strongest in Europe, (see Forbes latest Spanish Banks In Top Form). If all these are true, Spain will soon have zombie banks like Japan.
- Banks are hiding losses - We believe that Spanish banks are not marking their real estate loans to market and are extending credit to zombie construction companies. They do this by 1) Getting a boost from accounting changes, 2) Not marking loans to market, 3) Continued lending to zombie companies, 4) Extending 40 year and 100% loan-to-value loans, and other bubble-like lending practices. We look at each of these in turn.
- Spain is in deflation - In a deflationary environment, servicing debt becomes even harder. Even when rates go to zero the real burden of debt goes up. That is why deflation is such a terrible thing. Eastern Europe, Spain and Ireland are now all experiencing the beginning of deflation. We believe that we will see much more deflation to come, which will have broad ramifications across the European banking sector.
- Who's holding the bag? - The periphery countries are net debtors, and the rest of Europe is the net creditor. When a debtor can't pay, the creditor suffers. Germany, France and others will need to cope with recapitalizing the periphery and Spain.
We recommend shorting or being underweight Spanish government bonds vs German bonds and short equities, particularly banks, builders and anything related to the consumer.
Spain = Japan 2.0?
We hate to bang on about Spain like an old Salvation Army drum, but we believe that Spain is a disaster waiting to happen. Misunderstanding the severity of the crisis will prove costly to investors as it will have profound implications to the European banking system.
Spain is set for a long, painful deflation that will manifest itself via a very high unemployment level for an industrialized economy, a real estate collapse and general banking insolvencies.
Spain had the mother of all housing bubbles. To put things in perspective, Spain now has as many unsold homes as the US, even though the US is about six times bigger. Spain is roughly 10% of the EU GDP, yet it accounted for 30% of all new homes built since 2000 in the EU. Most of the new homes were financed with capital from abroad, so Spain's housing crisis is closely tied in with a financing crisis.
The impact on the banking sector will be severe. Consider this: the value of outstanding loans to Spanish developers has gone from just €33.5 billion in 2000 to €318 billion in 2008, a rise of 850% in 8 years. If you add in construction sector debts, the overall value of outstanding loans to developers and construction companies rises to €470 billion. That's almost 50% of Spanish GDP. Most of these loans will go bad.
Spanish banks, in our view, are now facing a very bleak outlook. Spain's unemployment rate reached over 17%; there are now four million unemployed Spaniards and over one million families with not a single person employed in the family.
We argue and will document anecdotally in this report that:
If we are right, Spain will soon have zombie banks like Japan and it will face a prolonged period of deflation. However, Spain will be much worse. As Edward Hugh, the doyen of clear-headed analysts of Spain, points out, "Japan in 1992 could leverage its own savings, it had a current account surplus of 3% of GDP. Spain has massive external debt - in 2007 the current account deficit was 10% of GDP - and little in the way of major export industries."
- The real estate crash in Spain is worse than is widely believed, much as the subprime problem was much worse than people believed
- Spanish banks are hiding their losses and rolling over debt to zombie companies, much as Japan did in the last decade
- Investors are deluding themselves if they believe that Spanish banks are among the strongest in the world. (This is a new theme. See Forbes's latest "Spanish Banks In Top Form" for an example of the new fawning articles on Spanish banks.)
Putting Together A Mosaic
At Variant Perception, we try to stay away from writing too many words. Anything that cannot be explained with a few charts is most likely not worth explaining. In the case of Spanish banking's subterfuge and hiding of bad loans, we have had to assemble a mosaic of news pieces, interviews with banking insiders and others to piece together what is in fact happening. This reminds us very much of the early days of subprime where all the banking results looked good, until they didn't. We believe it will be the same with Spanish real estate.
The Situation In Spanish Housing Is Much Worse Than People Think
The standard line that most analysts buy about Spanish banks is the following:
However, despite dynamic provisioning, in the recent rally, Spanish banks have been rushing left, right and centre to shore up their capital. They have mainly done so by tapping their clueless retail customers for investment in preferred shares. It is a good start, but we believe they still have not done enough.
- Dynamic provisioning - In 2000, Spain's central bank introduced a system of "dynamic provisioning" that forced banks to build up reserves against future losses. Spanish banks reserved three to four times as much as most of their international competitors. In a sense, the Bank of Spain was building countercyclical buffers to prepare for an eventual credit crisis.
- Prudent lending - The large private Spanish banks claim that their risk management led them to concentrate mortgage lending on primary residences in the cities at reasonable loan-to-value ratios, leaving lending to developers and buyers of second homes to the Cajas.
The magnitude of the Spanish problem is staggering, and will overwhelm all the benefits of dynamic provisioning. Conservatively, Spain has over 1,000,000 unsold homes. Unfortunately, many of the homes are on the coast, and without a return of overleveraged British tourists, they are likely to remain unsold. Spain's homes are all in the wrong places.
Spain's building stocks bubble looks very much like the US bubble and other classic bubbles. It went up 10x and then went down 90%. The math is very simple.
Given this woeful state of affairs, you might assume Spanish house prices had suffered like US house prices. This is not the case.
As the following chart shows, according to official statistics, Spanish house prices are down little more than 10% from their peaks.
Why have Spanish banks not experienced the same fate as American, Irish and UK banks? We've often wondered how it is that our thesis for Spanish real estate and industrial collapse has not created more victims.
We believe that Spanish banks are hiding their problems. We explore how they are doing this through:
Let's look at them in turn.
- Getting a boost from accounting changes
- >Not marking loans to market
- Continued lending to zombie companies
- Making 40 year and 100% loan-to-value loans
1) Getting a boost from accounting changes
The Bank of Spain is thought of as a very conservative, prudent institution. That is true, but it is now changing its tune. It must now be very concerned for the fate of some Spanish banks and some analysts estimate it will help them avoid posting losses this year.
In July the Bank of Spain changed its provisioning rules on risky mortgages. Previously, banks have made provision for the full value of loans above 80% of a loan to value ratio after two years of payment arrears. Following the new directives from the Bank of Spain, banks now only need to reserve for the difference between the value of the loan and 70% of the property's market value. For many Spanish banks, this has allowed them not to lose money this year.
Not marking loans to market
We also believe that Spanish banks are not marking their books to market. According to an article from the 19th of April in Expansión, the Spanish equivalent of the Financial Times, entitled 'Spanish banks control half of all real estate appraisals.' , Spanish banks control 25% of appraisals directly and another 25% indirectly through their shareholdings.
In the words of Expansión:The valuation of the guarantees of the mortgage book of the cajas and banks and of its real estate gains importance. The thirteen companies tied to financial entities represented 47% of all real estate appraisals in 2007.
The valuation of these real estate assets has taken on new importance for banks in the context of the current economic recession. The valuation of the mortgage guarantees and of the real estate assets they are taking on through the courts and debt for equity swaps is key to calibrate the solvency of the financial system. This situation has placed the focus once again on the links between banks and the real estate appraisers that goes beyond in many cases a mere commercial relationship.
Official housing statistics are not corroborated by anecdotal evidence, web searches and the real estate sales by the banks themselves. According to a study by El Mundo, housing prices in many areas of the coasts have already dropped 30-50%.
Spain also confronts to problems of banks essentially taking on defaulted assets onto their books at the stated value of the mortgage. The following comes from a highly regarded foreign surveyor in Spain, describing what happened to a client who had run into problems:
On the banking side, he stated that one development had already been taken back by the bank. However, the bank had 'bought' the development from the developer for the price of the mortgage. Thus they had converted a non-performing mortgage into a property asset. However, the bank is now the owner of a development it cannot sell and is unlikely to for a number of years and has a debt of its own in the purchase price 'paid'. The banks are not experienced developers/property marketers and thus are building up problems for themselves, which must come to light at sometime, depending upon accounting practices. Alternatively, there is the potential that they are then bundling these discounted properties on to friends or holding property companies with notional loans and interest being rolled up until the property is sold.
3) Rolling over loans to zombie construction companies
In the last few weeks we've seen many Spanish property companies announce that they had refinanced their debt, which will postpone bankruptcy for a time. The latest to announce debt refinancing has been Realia, and before that Aisa, Afirma, Reyal Urbis, and Renta Corporacion. After the debacle of having to seize Colonial and Martinsa-Fadesa in 2008, Spanish banking stocks tanked and few Spanish bank executives want to see a repeat.
This lending to zombie developers will merely postpone the day of reckoning.
Banks have realized that instigating a bankruptcy process when builders can't roll their loans or sell houses isn't good for builders or for them. They now try to give as much rope to the builders as possible so that they don't have to report large defaults. In the words of a banking insider:
As soon as a small business becomes delinquent, even if it is a longstanding client, it is "everyman for himself" and everyone runs away as if he has the plague. But in the case of the big builders, the bank is fed up with taking on more assets and gives them a line of credit so that they can at least pay interests on their existing debts and give them room for two years to see if things fix themselves and if they can pay the loan back.
The willingness of banks to play ball with developers shouldn't come as a surprise. As they say in banking, "If you owe me a million, it is your problem. If you owe me a billion, it is my problem."
4) Offering 100% Loan to Value loans, 40 year mortgages and other bubble-like practices.
Spanish banks are now the largest real estate holders in Spain. They have come to own properties through many different avenues. In order to hide from the effects of the real estate crash, Spanish banks have been buying properties before the loans on them go bad and trying to dispose of them through their own real estate companies. They have also come to own dozens of thousands of homes through debt for equity swaps. Estimates put the value of property repossessed or swapped for debt by Spanish banks at about €16 billion.
Spanish banks have websites set up to move their stock. Among selling points are: pricing discounts of 25-50%, financial terms of Euribor plus 0% over 40 years, and guarantees to re-purchase the property in the future.
The lending to Spanish developers has been institutionalized in agreements between the banks and the main developer's body, the Asociación de Promotores Constructores de España (APCE). Spanish banks will provide 40 year, 100% loan to value mortgages for any home that is discounted by 20% by a developer. The buyer has no need for a down payment. Santander signed such a deal with the APCE in order to reduce the stock of housing outstanding. This is another way to provide credit indirectly to zombie developers.
What Is The Endgame For Spain?
As we pointed out in the last monthly commentary, Spain's problem is tied in with the problem of the entire European periphery. The boom years following the adoption of the euro provided 1) easy money via negative real interest rates, and 2) overvaluation of prices as measured by real effective exchange rates.
Spain, and the rest of the European periphery, can solve their problems either through massive productivity gains, which is highly unlikely, or through a reduction in wages and prices in the order of 20-30%, which is what will happen slowly and painfully. You could call such a reduction of wages and prices an "internal devaluation".
Such an internal devaluation will imply large losses to domestic banks and to external creditors. In the case of Eastern European countries, the damage will be bad, but not very large. In the case of Spain, writing off mortgage debt will be massive. We estimate that Spanish real estate losses will be over €250 billion when all is said and done. Clearly Spanish and foreign banks are unwilling to admit to the size of the problem and write off the debt. That is why the losses are being hidden.
Running large trade deficits is a form of dis-saving. Spain's large growth in consumption has had to be financed by the rest of Europe. Spain's trade deficit was among the highest in the world in absolute and relative terms at around 10% of GDP in late 2007.
Indeed, Spain's current account deficit at one stage was the largest in the world besides the United States in absolute terms. The Spanish economy acted like a giant consumer sucking up savings from the rest of Europe.
The high degree of consumption in Spain has mostly come from external borrowing and has not been financed out of existing savings.
How bad is that relative to other countries? Spain's external debt is extremely high in relative and absolute terms. It is among the highest in the world, the fifth largest:
Real Interest Rates: Deflation Is A Bitch
Eastern Europe, Spain and Ireland are now all experiencing the beginning of deflation. We believe that we will see much more deflation to come, which will have broad ramifications across the European banking sector. The periphery countries are net debtors, and the rest of Europe is the net creditor. When a debtor can't pay, the creditor suffers. Germany, France and others will need to cope with recapitalizing the periphery and Spain. In the words of Plautus, "I am a rich man as long as I don't pay my creditors." A deflationary spiral means that most of the debt will need to be written off, and the creditors will have to absorb the losses.
In a deflationary environment, servicing debt becomes even harder. Even when rates go to zero, prices and wages can go down faster and the real burden of debt can still go up. That is why deflation is such a terrible thing.
Spain now has negative CPI and PPI
Inflation in Spain has been negative for the last three months in a row. Spain has not experienced a similar decline in inflation like this in over 47 years. However, the Bank of Spain and the government are behaving like ostriches with their heads in the sand.
The problem with deflation is that even low interest rates are extremely high. Despite massive cuts by the ECB, real interest rates in Spain are still elevated due to negative CPI and PPI.
Spain is not the only country facing deflation. It is a problem for the entire European periphery. Ireland, for example, has the highest rate of deflation in the world. Prices in Ireland are falling at an annual rate of 5.9%, well ahead of the drops in other countries - only Thailand, at 4.4%, comes even close.
We believe that Ireland's experience is what Spain will see more of in the months ahead as the economy slowly adjusts to new realities. Almost all of Ireland's banks have been taken over by the government, and Ireland is struggling to decide how best to dispose of its bad assets. We believe Spain will be much more like Ireland than any of its European neighbours.
Oddly, even though inflation is negative, and unemployment is high, unions are still winning pay rises. Most wage agreements in Spain are reached through collective bargaining on an industry level. So far, wage increases are happening above the ECB's 2% target inflation rate. (It should come as no surprise that businesses try to get around wage bargaining. Last year almost five million jobs were temporary in Spain.)
Given how far out of line wages are with unit labor costs and the reality of deflation in Spain, we see Spain's unemployment level heading towards 25%. With a 25% unemployment rate and a debt deflationary dynamic, how exactly do the banks think they'll be paid back? Who will earn the money to pay the mortgage payments, and how will housing be affordable when wages have been deflated? Assuming the worst has passed in Spain does not pass the common sense test.
We believe Spanish politicians and international investors have grossly misjudged Spain, but events will force them to change their mind. In retrospect Spain will be viewed much like subprime where all the banking results looked good, until they didn't. This is typical of bubbles, and Spain will be no different.
Blackout Britain warning as Government predicts severe power shortages within a year
Britain faces the first widespread power blackouts since the 1970s because of looming energy shortages, Government documents reveal. For the first time, ministers are expecting that the supply of electricity will fail to meet demand at peak times. The Government is forecasting that by 2017 there will be power cuts of around 3,000 megawatt hours per year - the equivalent of the whole of Nottingham being without electricity for a day.
Official papers show that consumers will be hit by an 'energy gap' when a number of existing power stations are shut down. Nine oil and coal-fired power plants are to close by 2015 because of an EU directive designed to limit pollution and associated acid rain. At the same time, four ageing nuclear power plants will be shut. In all, experts say, the decommissioning of power stations will see 37 per cent of the UK's generation capacity disappear by 2015.
Ministers have recently embraced new nuclear power plants as a way of closing the gap, but replacements will not be ready in time. There are also fears of huge electricity and gas price rises as Britain is held to ransom by such foreign energy producers as Russia. Experts have been warning for years that Britain is running out of power, with some predicting the blackouts could be serious enough to spark civil disorder.
The last time there were widespread power cuts was during the miners' strikes in the 1970s. The expected gap of 3,000 megawatt hours a year could mean an hour-long power cut for 16million people simultaneously on a winter evening. The forecast is buried in an annexe to the Government's Low Carbon Transition Plan, which sets out how the UK will meet a pledge to cut greenhouse gas emissions by 34 per cent on 1990 levels by 2020.
Available only on the internet, the annexe projects the shortfall between generating output and consumer demand between now and 2030. Currently this is close to zero, but the chart shows that by 2025 the expected energy gap will be more than 7,000 megawatt hours per year - equivalent to an hour-long power cut for half of Britain. Tory energy and climate change spokesman Greg Clark said: 'Britain faces blackouts because the Government has put its head in the sand about Britain's energy policy for a decade.
'Labour have been forced to admit they expect power cuts for the first time since the 1970s. We have known for the best part of a decade that North Sea oil and gas is running out, that nuclear power stations are coming to the end of their shelf life and that most polluting coal-fired power stations are going to be shut down. 'But the Government has done nothing about it and now consumers are going to pay.' A spokesman for the Energy and Climate Change Department said: 'We are moving in the right direction towards low carbon energy but we are in transition. We can't just click our fingers and expect to end carbon emissions overnight.'
British manufacturing suffers surprise contraction in August
Britain's manufacturing sector dipped unexpectedly in August as employers cut jobs and inventories and the pace of pick-up in new orders slowed, purchasing managers' data showed on Tuesday. The headline manufacturing purchasing managers' index fell to 49.7 last month from a downwardly-revised 50.2 in July. That was the first fall since February and well below the consensus forecast for a rise to 51.5. However, a breakdown of the data suggested some reasons for optimism. Output rose at its fastest pace since December 2007 and stocks of finished goods fell at their second-fastest rate on record. "The data are a mixed bag," said Rob Dobson, senior economist at Markit, the compiler of the survey. The recovery in output continued to strengthen and came from a broad sector and company-size base. However, the slower growth of new orders, continued substantial job losses and the surprising weakness exhibited by the investment goods sector are all causes for concern."
The headline manufacturing index rose above the 50.0 mark that separates contraction from expansion for the first time in over a year in July, raising hopes the sector could capitalise on a more competitive currency and aid a return to growth. Tuesday's figures may provide a set-back to such hopes but will not dent them completely. The new orders index slipped to 52.4 in August from a downwardly revised 54.8 in July but held in expansionary territory for the second consecutive month. The new export orders index pointed to a stabilisation in August, ending more than a year of contraction, and a sharp fall in stocks of finished goods suggested firms may be forced to rachet up production should demand improve.
Indeed, the orders-to-inventory ratio, a forward-looking activity indicator, rose to its highest level since the start of 2004. "Manufacturers continued to focus on trimming costs and excess capacity in August," the survey noted. "This was reflected in lower staffing levels and holdings of pre- and post-production stocks." The way the PMI is calculated accentuates the pace of change rather than absolute levels and Markit's Dobson said it was not surprising the index should have tailed off after sharp rises earlier this year. "The recovery is likely to continue, but may become more muted later in the year once the initial rebound and monetary and fiscal stimuli have run their course," he said. Detailed PMI data are only available under licence from Markit and customers need to apply to Markit for a licence.
Canada Pension Agrees to Spend $300 Million for Skype Stake
Canada Pension Plan Investment Board, the country’s second-biggest pension fund manager, agreed to spend $300 million to join a group led by Silver Lake that bought 65 percent of EBay Inc.’s Skype Internet phone unit. Canada Pension will hold a 15 percent share of the majority stake in Skype, Joel Kranc, a spokesman for the Toronto-based pension fund, said today by telephone. That would give Canada Pension a 9.75 percent stake in the business. EBay will retain 35 percent of the unit. The Silver Lake- led group agreed to pay about $2 billion for the controlling stake.
Mexico's health care lures Americans
It sounds almost too good to be true: a health care plan with no limits, no deductibles, free medicines, tests, X-rays, eyeglasses, even dental work — all for a flat fee of $250 or less a year. To get it, you just have to move to Mexico.
As the United States debates an overhaul of its health care system, thousands of American retirees in Mexico have quietly found a solution of their own, signing up for the health care plan run by the Mexican Social Security Institute. The system has flaws, the facilities aren't cutting-edge, and the deal may not last long because the Mexican government said in a recent report that it is "notorious" for losing money. But for now, retirees say they're getting a bargain. "It was one of the primary reasons I moved here," said Judy Harvey of Prescott Valley, who now lives in Alamos, Sonora. "I couldn't afford health care in the United States. … To me, this is the best system that there is."
It's unclear how many Americans use IMSS, but with between 40,000 and 80,000 U.S. retirees living in Mexico, the number probably runs "well into the thousands," said David Warner, a public policy professor at the University of Texas. "They take very good care of us," said Jessica Moyal, 59, of Hollywood, Fla., who now lives in San Miguel de Allende, Mexico, a popular retirement enclave for Americans.
The IMSS plan is primarily designed to support Mexican taxpayers who have been paying into the system for decades, and officials say they don't want to be overrun by bargain-hunting foreigners. "If they started flooding down here for this, it wouldn't be sustainable," said Javier Lopez Ortiz, IMSS director in San Miguel de Allende. Pre-existing conditions aren't covered for the first two years, and some newer medicines and implants are not free. IMSS hospitals don't have frills such as televisions or in-room phones, and they often require patients to bring family members to help with bathing and other non-medical tasks. Most doctors and nurses speak only Spanish, and Mexico's overloaded court system doesn't provide much recourse if something goes wrong.
But the medical care doesn't cost a dime after paying the annual fee, and it is usually good, retirees and health experts say. Warner said most American retirees enroll in IMSS as a form of cheap insurance against medical emergencies, while using private doctors or traveling back to the USA for less urgent care. Medicare, the U.S. insurance plan for retirees, cannot be used outside the United States. The program has helped people such as Ron and Jemmy Miller of Shawano, Wis. They decided to retire early, but knew affording health care was going to be a problem. Ron was a self-employed contractor, and Jemmy was a loan officer at a bank. At ages 61 and 52, respectively, they were too young to qualify for Medicare, but too old to risk not having health insurance.
"We knew that we couldn't retire without Medicare," Jemmy Miller said. "We're pretty much in Mexico now because we can't afford health care in the States." The couple learned about IMSS from Mexico guidebooks and the Internet. They moved to the central city of Irapuato in 2006, got residency visas as foreign retirees, and then enrolled in IMSS. The IMSS system is similar to an HMO in the United States, Jemmy Miller said. Patients are assigned a primary care physician and given a passport-size ID booklet that includes records of appointments. The doctor can refer patients to specialists, a bigger hospital or one of the IMSS specialty hospitals in cities such as Guadalajara or Mexico City.
In 2007, Ron Miller got appendicitis and had emergency surgery at the local IMSS hospital. He was in the hospital for about a week and had a double room to himself. The food was good, the nurses were attentive, and doctors stopped by three or four times a day to check on him, he said. At the end of it all, there was no bill, just an entry in the ID booklet. The Millers may soon move back to the United States, but Jemmy Miller said they want to try to maintain the IMSS coverage. "If something big really comes up, we'd probably come back to Mexico," she said.
IMSS is one of several public health systems in Mexico, each with its own network of hospitals and clinics. The program, which was founded in 1943, is funded by a combination of payroll deductions, employer contributions and government funds. It covers 50.8 million workers. IMSS facilities are a step up from the state hospitals, but not as advanced as Mexico's private hospitals, which are often world-class, said Curtis Page, a Tempe, Ariz., doctor and co-author of a book about health care in Mexico.
Most patients seem grateful nonetheless. When Michael Kirkpatrick, 63, of Austin, fell off his motorcycle near his home in San Miguel de Allende, IMSS surgeons gave him a stainless-steel artificial hip. There was no physical rehabilitation after the surgery, just a checkup a few weeks later. "There was not the kind of follow-through and therapy that you would expect if you were doing this in the first world," Kirkpatrick said. "But it was satisfactory. The hip feels good."
Bob Story, 75, of St. Louis, had prostate-reduction surgery at an IMSS hospital in Mazatlán and discovered that patients were expected to bring their own pillows. It was a small price to pay, he said, for a surgery that would have cost thousands of dollars back home. "I would say it's better than any health plan I've had in the States," he said.
Forbes Polls the Wackosphere and Gets An Earful
by Lee Adler
The editors of Forbes have asked me to give them my economic forecast for the next year (cough, cough, guffaw). Don’t be impressed. They sent the same email to the whole financial wackosphere. I assume that their purpose, as with the entire financial infomercial media, is to poke fun at us wackos so as to minimize their own horrendous shortcomings as financial journalists.
OK, so I’ll give them an answer since they were nice enough to ask. But let me preface this for those of you who don’t know me by saying that I’m not an economist, thank goodness. What an embarrassment that would be. My educational background is in accounting (undergrad) and psychology (grad ). My professional career over the past 22 years has been spent mostly in real estate and financial market analytics. So I’ve had some exposure to the real economy and the financial economy.
I’ve had a particular interest throughout my life in manias and their aftermath. I’m a self taught technical analyst (aren’t we all), having first become interested in the art of TA at the ripe old age of 13 when I was introduced to point and figure charting. What I have learned about liquidity analysis, an area in which I specialize, has been through independent research, observation and study. My ideas are not polluted by the shibboleths of formal education. My interest in manias brought me back to my current job as an independent self-employed professional analyst and web publisher in 2000 when I founded Capitalstool.com. I founded The Wall Street Examiner in 2004.
In my late 20s I worked for several years as a sell side technical analyst for a couple of institutional boutique firms on Wall Street. Let’s just say that the Street and I did not mix.
I had morals.
While working on the Street in the early 1980s, thanks to reading people like Joe Granville, Richard Ney (The Wall Street Jungle), and Charles Mackay (Extraordinary Popular Delusions, etc.) I realized that the financial media was nothing more than the marketing arm of the Wall Street retail distribution network. Wall Street’s job is to distribute paper and transfer wealth from the many to the few, including, most importantly, itself. The media’s job is to transmit the sales pitch.
The financial infomercial media plays a crucial and integral role in that system, providing a platform for Wall Street’s professional shills to reach the masses. It is the greatest manipulative system in the world since Goebbels, mastering the art of repeating the Big Lie to perfection. When a shill comes on CNBC and says buy XYZ, his in house traders are the ones doing the selling.
One of the Big Lies is that the stock market discounts the future. We’ve had a big rally, so the economy must be about to get a lot better, so the story goes. But the truth is that the stock market is nothing more than a liquidity meter. It measures a very particular type of liquidity. It mostly measures how much cash is burning a hole in the pockets of the dealer community.
Right now, thanks to the Fed, the dealer community, particularly the Fed’s Primary Dealers who dominate not only the Treasury market but the stock market as well, are rolling in oceans of cash, pumped directly to them by the Fed. They are using most of it to pay down debt by selling much of their questionable assets to the Fed, particularly mortgage debt and corporate debt, but they are using some of it to manipulate stocks higher. They do that because, one, it’s easy for them to do it, and two, because it’s much easier to get the suckers, oops, I mean the buy side institutions, to take the other side of the trade when prices are rising.
So as long as the Fed pumps this cash to them, stock prices will go up. It has nothing to do with the economy. It has nothing to do with discounting the future. The idea that stock prices discount the future is ridiculous. Stock markets are comprised of people, or at least the people who wrote the computer programs that do most of the millisecond trading that dominates price action. People, by and large, are not very good at predicting the future. That’s especially true of economists, pundits, and most of all, portfolio managers, whose only real interest is in not doing anything different than what the majority of portfolio managers are doing. How in the world can a portfolio manager properly manage money when one of the mandates of the industry is to stay fully invested. The best they can hope for is to do better than their peers. They can do nothing to protect your assets in the event of systemic collapse, such as we are now facing.
In continuing to spread the lies this time around, the media helps to insure that for the foreseeable future there will be no recovery from this economic and financial mess. The media continues to feature the same people telling the same idiotic stories, pursuing the same tried and true practices of distributing insider stock, especially their own, at high prices to the masses. The cash goes right from our pockets to the pockets of the financiers, with the media getting a huge cut in the process. They are co conspirators in a massive criminal scheme, some of it legal, some of it not, to separate people from their money.
This time they did it a little too well, and therein lies a problem for the economy. Few have any money left to transfer. The Fed and Treasury have set up a scam over the past year to make it look as if there’s still money, but what they have actually done is to transfer risk from the private sector to the public sector, in other words us, current and future generations of US taxpayers. In the process they’ve pumped a couple of trillion of new government debt into the economy and the markets over the past couple of months making it look as though everything is gonna be all right.
But it’s not gonna be all right. In fact, things are getting worse as we speak, and they will continue to get worse for the short term, the intermediate term, and the long term– for as long as the same people are in charge who caused this mess in the first place; for as long as the media continues to give a platform to those same people who were responsible for all the–let’s call them what the are–crimes– that put us where we are. For as long as those in power in Washington give those same people the same power they have always had, rather than punishing them for their “mistakes”, we are going to be in this mess.
So now we have transferred trillions of bad debt, some of it completely worthless paper, on to the books of the Fed and the Federal Government. What can the outcome possibly be? Ultimately default? Devaluation? Hyperinflation? Slow motion economic collapse such as that which is currently under way? Even finally the collapse of government and society? Anything is possible, given how insane these policies are and how clueless our policy makers have been and continue to be.
For example, the government has committed to take on $1.45 trillion of mortgage debt in various forms. In most cases the equity has been wiped out. There’s no margin of safety in those mortgages. The government will lose countless billions on its investments. We, the people, will somehow have to pay for that. Meanwhile, the financiers in the middle of the mess in the first place are still there. If they’re not still running the show, they’ve run off somewhere with the billions that they have skimmed and scammed off the top.
Now the media reports that, gee! the government is actually making money from the investments it has made in bailing out the banks. But the Fed and the Government are just playing the same game the banks played, reporting the “operating profit” while not reporting the mushrooming mountain of bad debt on their books. This is the very same garbage that got us here in the first place, except now the government is taking a page from the banks and financial institutions that mastered the art of hiding bad debt. It’s sickening, but no one in the mainstream media questions it.
Where are the real journalists? Not working for the mainstream media, that’s for sure. They’re still giving a free pass to the power brokers.
Forbes has asked me what data I like to look at. One of the things I featured just today in one of my reports to subscribers is Federal tax collections so far in August. They were down 13% versus last August to date. July was down less than 6% year to year. Where are the green shoots? The government has disbursed $227 billion more into the economy this month than it did at the same point last August. And yet tax collections continue to collapse, indicating that economic activity is doing likewise.
Source: US Treasury
One of the problems is that zero interest rates forces both people and businesses to liquidate principle in order to pay the bills. So the capital pie shrinks. A shrinking capital base means shrinking income. Shrinking income means that people will need to liquidate even more capital. The system collapses in a chain reaction.
Government programs have done nothing to change that. They’ve masked the degenerative process for a time with all that spending, but they’ve done it only by adding more debt to the government’s balance sheet. At the same time, debt in the private sector, and hence money, is being destroyed. We see it in all manner of lending statistics, from bank loans, to mortgage credit, to commercial paper. And we see it in the rising tide of mortgage defaults. People can’t pay or won’t pay. So they don’t. This is what’s backing our “money”.
Source: Federal Reserve
Meanwhile lending institutions and now the government pretend that the losses don’t exist, reporting unbelievably, that the money supply hasn’t collapsed along with everything else. They have no choice. They have to keep the con going, lest there be one final, fatal run on the banks and/or the money market funds.
The Fed’s zero interest rate policy is causing the very contraction it is seeking to avoid because it does not allow anyone to earn a fair and reasonable return on their investments. In order to pay the bills people and business must liquidate assets. At the same time, they are desperately trying to pay off debt. So the pie shrinks and money disappears.
The media is fond of saying that no one in the mainstream saw this coming except Roubini. How stupid is this? The media is the sole decision maker about who we get to pay attention to. If they feature only liars and fools, then of course it will seem that no one saw this coming. And they feature almost entirely liars, fools, and criminal manipulators.
Let’s consider who got this right in addition to Roubini. How about Professors Case and Shiller, and Niall Ferguson. How about Nassim Taleb. What about Warren Buffet’s warnings about derivatives? How about George Soros? Jimmy Rodgers?
What about Ron Paul, whose warnings fell on deaf ears for years. Congressional hearings? Ron Paul? Oops, time to cut to a commercial!
What about Doug Noland of the Prudent Bear Funds’ Credit Bubble Bulletin who has correctly been chronicling and forecasting this mess for a decade. What about Bill Fleckenstein and David Tice, and Peter Shiff? What about John Hussman? What about Robert Prechter? Bill Bonner of the Daily Reckoning? Mark Faber? What about Martin Weiss? There were many more like them. Why did we almost never see these guys on the tube or in print. And why, when we did see them, was the usual purpose to ridicule and harass them?
Because the media was and is a co-conspirator, witting or unwitting, with the Wall Street criminal distribution machine. The media is populated by conformist morons, too fat and lazy, too coddled by their Wall Street sponsors to be bothered by anything so mundane as to search for the truth. I mean, it’s not like it was hard to find.
What about all those guys in the wackosphere like my colleague Russ Winter, or Mike Shedlock, or even me for goodness sakes? I know I don’t count because only a few thousand people have ever heard of me, and half of them only know me as Dr. Stepan N. Stool. But there were dozens, if not hundreds, of bloggers who saw this coming for years. I was far from alone.
What about all the thousands of ordinary people who have participated on our message boards down through the years? They knew. But again, the media decides what the public gets to see and hear. The media decided that the “Cassandras” were only to be featured on occasion as objects of ridicule. And now that the economic data has stopped going down for a couple of months and the stock market has been going up, they are once again the subject of scorn.
Then there’s the 5,000 people surveyed by the Conference Board every month. Look at how many of them had soured on things in 2006 and 2007, versus their level of optimism in 1999 and 2000.
A whole lot of ordinary people “got it.” Only the mainstream infomercial media didn’t get it, because they are, after all, on the payroll of the Wall Street Mob.
The fact is that the economy is not getting better. It is not healing. Nothing goes down in a straight line, especially when a government throws a couple trillion in debt at it. But those trillions are not endless. The kindness of strangers, namely foreign central banks who buy that debt, is not without limit. The time will come when the government will not be able to float more debt to pay off the existing debt, when the burden of paying back these wildly reckless bets will fall directly on the back of the US taxpayer.
We are facing a crisis much greater than any we have faced so far. The Fed will not continue to pump cash into the pockets of the Primary Dealers indefinitely as they have been doing since March. When that cash gusher stops, or even slows, the stock market will again collapse. It simply cannot be sustained at these levels without that subsidy.
As for the economy, over the next year, it will get worse, for all the reasons enumerated above. How much worse, I have no clue. I’m not an economist, thank goodness. What an embarrassment that would be. Obviously they have no clue either. They pretend. That’s all. They missed the biggest collapse in the last 75 years. Knowing what’s likely to happen is not their job. Their job is to talk a good game so that Wall Street can continue its game.
Ripping off the rest of us.
So Good Night, and Good Luck.
You’re going to need it.
Petition seeks apology for gay Enigma code-breaker Alan Turing
An online petition demanding a formal apology from the British government for its treatment of World War II code-breaker Alan Turing is gaining momentum. Turing was subjected to chemical castration in 1952 after being found guilty of the charge of gross indecency for having a homosexual relationship, an illegal act at the time. He committed suicide two years later. More than 19,000 people have added their names to the petition on the UK Government Web site since it opened three weeks ago, urging the government to "recognize the tragic consequences of prejudice that ended this man's life and career."
The petition was created by computer scientist John Graham-Cumming, who said he grew "mad" at the country's memory of a man he says should be considered one of its national heroes. "I'm looking for an apology from the British government because that's where I think the wrong was done. But Turing is clearly someone of international stature," Graham-Cumming said. Turing was best known for inventing the Bombe, a code-breaking machine that deciphered messages encoded by German Enigma machines during World War II.
The messages provided the Allies with crucial information from the British government's code-breaking headquarters in Bletchley Park where Turing worked full-time during the war. He was considered a mathematical genius and went on to develop the Turing machine, a theory that automatic computation cannot solve all mathematical problems, which is considered the basis of modern computing. However, to avoid a custodial sentence for gross indecency Turing agreed to undergo chemical castration. He was injected with estrogen, an experience that is widely believed to have led to his suicide just two years later. Turing was just 41 when he ended his life by eating an apple laced with cyanide.
Graham-Cumming has not yet received a response from the British government to his request for an apology, nor has he received a reply from Queen Elizabeth II to whom he wrote last week asking that Turing be considered for a posthumous knighthood. "There is no doubt in my mind," he wrote, "that if Turing had lived past age 41 his international impact would have been great and that he likely would have received a knighthood while alive."
Graham-Cumming's efforts to draw attention to Turing's life has attracted an international response. "This morning I woke up to an inbox stuffed full of e-mails and blog postings from around the world on Turing, and many people were saying 'it's a pity I can't sign the British petition,'" he said. The main online petition is only open to British citizens. Supporters have set up a second international petition which has attracted more than 5,000 signatures.
Graham-Cumming is not fazed. "My focus is really on Britain at the moment because I think that is where the greatest need is, but I'm very happy for anyone in the world to know about Alan Turing." High-profile signatories to the petition include author Ian McEwan, evolutionary biologist Richard Dawkins, and gay rights campaigner Peter Tatchell. Graham-Cumming said if the government would not extend an apology, "the least it could do is to put Bletchley Park on a sound financial footing in Turing's name." Earlier this year, the center's supporters created their own online petition urging the government to "save Bletchley Park."
The site receives no external funding and has been turned down for funds by the UK National Lottery, and the Bill and Melinda Gates Foundation. The government replied to the petition last week saying that, while it "agrees that the buildings on the Bletchley Park site are of significant historic importance and, although recognizing the excellent work being carried out there, at present it has no plans, nor the resources, to extend its sponsorship of museums and galleries beyond the present number."
Simon Greenish, director of the Bletchley Park Trust, said: "The work that Turing did during the war has never really been properly recognized and this is an opportunity [for the government] to do that." He said the government had also failed to recognize the contribution of Bletchley Park to the war effort: "What went on in those buildings was absolutely vital to the outcome of World War II." The center receives more than 100,000 visitors a year and is staffed mainly by volunteers. A portrait of Turing is currently on display at the National Portrait Gallery in London, as part of its "Gay Icons" exhibition. He was one of the six personal icons selected by contributor Chris Smith, Britain's first openly gay Member of Parliament.
Ilargi: It's somewhat curious, and most certainly an honour as well, to see my writing painstakingly translated into German. This is what August 27's How to grow your GDP while killing jobs looks like.
Wie das US-BIP anwachsen soll, während Jobs én masse kaputt gehen
Auf der Seite von automaticearth.com findet sich ein lesenswerter Artikel, der sich mit der Frage beschäftigt, wie das US-BIP anwachsen soll, während in einer Gesellschaft, die zu 70% vom Konsum abhängig ist, haufenweise Jobs kaputt gehen.
Ich hätte nichts anderes angenommen, aber jetzt bin ich mir sicher. Es ist wirklich nicht hilfreich, wenn Ihr Netzwerk für 30 ganze Stunden vom Netz verschwindet. Nicht dann, wenn man eine ausgiebige Runde des Lesens und des Schreibens vorhatte. Dennoch ließ mich ein kurzer Aufenthalt in einer lauten Bar mit einem funktionierenden Internet mit der Frage zurück, die ich jetzt Ihnen stellen möchte. Um eine adäquate Antwort zu finden, hätte ich ein wenig in Archiven graben müssen, und dies ist ganz offensichtlich nicht passiert. Davon einmal abgesehen ist das Thema interessant genug, um nach einem Feedback von Ihnen zu fragen. Denken Sie aber erst einen Moment darüber nach.
Das Wall Street Journal brachte gestern einen Artikel mit dem Titel "Dekade der Schulden: $9 Billionen" , der an das Weiße Haus gerichtet ist und auf dem CBO-Defizitbericht basiert, der in der letzten Woche publiziert wurde. Die Daten sahen für mich ziemlich grausig aus und ich glaube, dass der einzige Grund, warum sie in den Medien heruntergespielt werden, derjenige ist, dass sie mit einer Zukunft handeln, die noch so weit entfernt ist, dass das menschliche Auge eine prima Entschuldigung dafür findet, in die andere Richtung zu schauen. Ich glaube auch, dass trotz der Tatsache, dass die Zahlen so schlecht ausgefallen sind, sie von einer, nennen wir es einmal Fassade hedonistischer Kalkulation verhüllt sind, welche die BIP-Berichte so zweifelhaft erscheinen lässt. Das Gesamtbild fußt auf dem vertrauten Folgenden und genau das ist besorgniserregend, aber vielleicht finden „sie" in der Zwischenzeit etwas anderes oder zwischen den Zeilen.
Was mir an dem Wall Street Artikel aufgefallen ist, ist, dass in ungefähr einem Jahr das BIP- Wachstum an die 4% erreichen soll, während zur gleichen Zeit die Arbeitslosigkeit bei ca. 10% liegen wird. Tatsächlich steigen die Arbeitslosigkeit und das BIP für eine Weile gleichzeitig! Und als ich das bemerkte, war mein erster Gedanke: ich glaube nicht, dass so etwas möglich ist. Zumindest nicht in einer Situation wie der jetzigen. Ich glaube zwar, dass es in den USA eine kurze Zeit Ende der 1930iger Jahre gab, in der etwas Ähnliches passierte, aber ich wäre mir da nicht zu sicher. Vielleicht in den frühen 1940igern, eine Kriegswirtschaft folgt allerdings ihren eigenen Regeln. Was denken Sie? Ist es realistisch, von einem 4%igen BIP-Wachstum auszugehen, bei dieser hohen Arbeitslosigkeit?
Natürlich gibt es immer einige Randbemerkungen, denen man sich von Beginn an bewusst sein muss. Als erstes sagte Dennis Lockhart, Präsident und CEO der Federal Reserve Bank of Atlanta gestern komischerweise, dass die reale gegenwärtige US-Arbeitslosenzahl nicht bei 9,4% liege, wie offiziell berichtet wird, sondern bei etwa 16%: Real US unemployment rate at 16%: Atlanta Fed President . Er spricht dabei natürlich über den Unterschied zwischen den U3- und den U6-Zahlen. Wenn Menschen seines Schlages schon damit beginnen, mit derartigen Ansichten in der Öffentlichkeit aufzutreten, könnten wir uns wahrlich in einer interessanten Zeit befinden. Es würde auch irgendwie die gestellte Frage im Keim ersticken, denn es könnte schwierig werden, eine ernsthafte Stimme zu hören, die darauf bestünde, dass das BIP auf 4% anwachsen kann, wenn 1 von 6 Mitgliedern der Bevölkerung im erreichten Arbeitsalter keinen Job mehr finden kann.
Ein weiterer Punkt, der für eine Überprüfung ansteht, findet sich auf der anderen Seite des Defizitberichts. Dieser Punkt basiert auf der Annahme, dass die Kreditaufnahme und Verschuldung der Regierung keinen sofortigen negativen Effekt auf das BIP ausüben würden, während die Regierung damit fort fährt, das Kapital, das sie sich an den Märkten leiht sofort auszugeben, und dass diese Ausgaben des Staates tatsächlich einen positiven Einfluss auf die wirtschaftliche Entwicklung hätten. Die meisten Personen, die die wirtschaftliche Entwicklung verfolgen und beobachten sind nun bereits derart vertraut mit diesen Tricks, dass es sie noch nicht einmal mehr überrascht, jedoch verdient es die Situation immer noch nach dem Jetzt und Danach beurteilt zu werden. Die zugrunde liegende Vermutung basiert auf dem Glauben, dass die Regierung die heutigen ökonomischen Entwicklungen vorantreiben kann, indem sie sich Kapital leiht, dass ab heute erst einmal verdient werden muss. Und dies vielleicht sogar noch von denjenigen Generationen, die zukünftig geboren werden.
Das Ausmaß, in welchem die Regierung die Häuser- und Hypothekenmärkte durch ihr Eingreifen beeinflusst, ist sicherlich sehr groß. Wenn man die Entwicklung der Häuserpreise einfach dem Markt überlassen würde, würden sie fallen wie ein Stein, was wiederum schwer auf den Zahlen zum Bruttoinlandsprodukt lasten würde. Heute ist ein Bericht veröffentlicht worden, nach dem das US-BIP im 2. Quartal um nur 1% gefallen sein soll, jedoch ist diese Kennziffer zu vernachlässigen, solange nicht und bis die Effekte solcher Interventionen seitens der Regierung der vorherrschende Platz in der Analyse eingeräumt worden ist, den sie eigentlich einnehmen sollten. Und würde man die publizierten Daten aus diesem Blickwinkel betrachten, wäre es äußerst vermessen davon auszugehen, dass ein 4%iges BIP-Wachstum im Jahr 2010 erreichbar sei. Im Wesentlichen ist es eine lächerlich schlechte Bilanzierungsweise, wenn man versucht vorzugeben, dass man seine Wirtschaft wachsen lassen könnte, indem man sich dafür Kapital von sich selbst leiht. Wenn man derartige Bilanztricks zulässt und je mehr sich die Regierung leiht, umso höher werden die Erwartungen an das Wachstum, das man sich an den Märkten erhofft.
Als meine Internet-Verbindung gestern abbrach, begann ich schließlich mit dem Lesen von Les Leopolds „Die Ausplünderung von Amerika" (The looting of America). Es gibt in diesem Buch einen Graph, der dieselbe Thematik abbildet. Wenn man das BIP wachsen lassen möchte trotz hoher Arbeitslosenzahlen, muss man die Arbeitsproduktivität pro Arbeitnehmer dramatisch anheben. Leopold zeigt, dass die Produktivität und die Löhne zwischen 1947 und 1973 Hand in Hand anstiegen. Danach koppelten sie sich voneinander ab. Die heutigen Löhne befinden sich in den USA auf inflationsbereinigter Dollarbasis unterhalb ihres Niveaus aus dem Jahr 1973, während die Produktivität wahrlich stark gestiegen ist. Ist dies die Antwort, nach der wir auf der Suche sind? Oder müssen die Löhne ansteigen, um ein Wachstum des BIP zu erreichen, welches zu 70% von den Konsumausgaben der Verbraucher abhängig ist?
Wenn man all diese Dinge berücksichtigt, sollte meine Frage klar geworden sein, obwohl jetzt vielleicht ein wenig herausfordernder. Ist es möglich, die US-Wirtschaft um 4% wachsen zu lassen, wenn 10% ihrer Bevölkerung arbeitslos sind?