Miss Dorothy Parker has been selected as Miss Washington and will compete for the title of Miss America at the Atlantic City beauty pageant to be held during Labor Day week. 18 Years old, she weighs 112 pounds and is 5 feet, 4 inches in height. She is the daughter of Mr. and Mrs. C. Albert Parker of Washington D.C.
Ilargi: No matter what else happens today, there's no better story than Newsweek's William K. Black interview, in which the lawyer, professor of economics and law and former bank regulator puts his mouth where his money and credentials are, and calls US Treasury Secretary Timothy Geithner, a "disaster" who's "been wrong about everything in his career". There goes the cushy job for Black (if he'd want one). Instead, he gets our admiration and, more importantly, he gets to keep his conscience. Yes, he's talking about the man who's just about single-handedly spent trillions of dollars of Americans’ public funds on programs aimed at saving doomed financial institutions while letting job losses soar to their highest level in 75 years with no end in sight. If Black can't land a faux Nobel on Monday, let's make sure he gets an Oscar for his involvement in Michael Moore's "Love Story the Sequel, (Capitalism means never having to say you're sorry)".
Michael Panzner suggests that Goldman's recent record in calling bank stocks should perhaps have people sell when the firm upgrades their outlook. And I would agree wholeheartedly. There is money to be made now, but only as long as you do what Goldman does, and make sure you dump the shares at the exact same moment it does. Goldman's recommendations can lift (or, alternatively, sink) an entire market segment temporarily. It knows that and uses it to make a killing of cash. Since many people don't see this for what it is, everyone (and their pet hamster) is buying financial shares when Goldman says so. In doing so, they've lifted Wall Street over the past few days.
At some point soon Goldman will go short the banks, sell what it bought on the relative cheap, and leave Joe Blow holding a big hollow bag heavy with losses. Chris Whalen at Institutional Risk Analytics says he's "astounded" that Goldman would make the upbeat call in the first place, but deep down Chris knows as well how rewarding these things can be. Still, everyone who thinks of getting involved would do well to heed Whalen's forecast of a bloodbath among bank stocks in the 4th quarter. And though it might turn out to be one of the few remaining safe places, even Goldman can run into trouble. It can mitigate risk better than most, but not eradicate it. And when banks start tumbling all around it, chances are it won't prove immune.
While stocks are rising, the dollar goes in the opposite direction, a move apparently greatly facilitated by a report from renowned journalist Robert Fisk about "secret" talks between countries other than the US concerning the preferred currency to be used in the oil trade. Now, if you'll excuse me, I would say that while Fisk may be accurate on some of his facts, the interpretation of them leaves to be desired. There are so many uncertain factors surrounding the US dollar, international trade and the world economy as a whole, that it would be downright weird and scary if no talks were held between countries that have large interests in them.
These sorts of talks, I would venture, must be going on at any and all given point in time, some with the US, some without it. Are there countries who’d like the strangle the greenback and its power? Of course there are. Would they have a chance of succeeding? Not a chance, not for quite a while. Fisk brings up the idea of a basket of currencies that includes a Gulf currency that in all likelihood won't exist before 2018, if ever. It's all a nice theory, but it gets far too much attention. Man cannot live on theories alone.
Dumping the US dollar because Fisk suggests that by 2018 there MAY be a alternative to oil trade in oil dollars doesn’t look to be a particularly wise thing to do. The value of the dollar one year from now is not likely to be decided by something that may or may not happen in ten years. The 2018 date should perhaps serve to convince people that there is not much of a story here. If you take a good look around, and would for instance try to extrapolate some of today's trends, such as unemployment and foreclosures, that far into the future, you would invariably and necessarily conclude that there are bigger fish to fry, certainly in the US, but also all over the rest of the globe.
If, to name an example, Chris Whalen is right about that bloodbath in US bank stocks between now and the new year, Fisk's report will be utterly inconsequential by Christmas. And the US dollar's position will strengthen considerably simply for the lack of an alternative, shedding an eery light on all the talk of the demise of the currency. There is still, for the grace of the gods and legal liar accounting, far too much capital out there for the US markets and its currency to collapse at the same time. There's very simply not enough gold, oil, yuan, roubles, euros or anything else available, much as some parties may regret that.
And we may see reports such as these: Gold Jumps to Record as Inflation Outlook Fuels Investor Demand, but it's hard to figure where that inflation would originate. After all, and despite the legal lies, a bank shares bloodbath will be led by, and in turn lead to, writedowns and disappearance acts of massive amounts of toxic debt (or -assets, if you will). At the very least, then, if and when we take serious people like Michael Panzner, Christopher Whalen and William Black, we need to ask ourselves some serious questions regarding that dollar demise and the wisdom of buying gold on account of inflation worries.
We will have inflation, we will have a much lower dollar, and we will have a much higher gold price. But we won't have any of these for now, and not for a while. I'd give it a minimum of two years.
PS Monday, October 12 is the day the next Faux Nobel in the oxymoronic category of Economic Sciences will be awarded. This non-Nobel even made it to the front page of the nobelprize.org site, adding yet more fake legitimacy. Let's see if we can come up with a prediction, shall we? I suggest Alan Greenspan. Then again, he may be too controversial by now. They could elect to play it safe and pick some completely unknown theorist. But I’d like to hear suggestions, provided they're well founded, and not just made for ideological purposes. Economics is a field that today takes up far more media space than it's used to, and it may not survive all the attention, and instead wind up being exposed for the faith-based bag of pretentious hot air it is. Still, if we manage to constrain ourselves, we could see some interesting proposals. I would of course love to suggest William Black, but that just ain't happening.
William Black: "Geithner has been wrong about everything in his career. He's a disaster"
One year after the global economic collapse, the United States has yet to adopt any legislation to change the way it oversees or regulates financial industries. Banks that received bail-out money still don't have any restrictions placed on the way they spend the government's cash, and although President Obama wants Congress to create a new consumer financial protection agency to act as a watch dog against unfair lending practices and confusing credit card contracts, the idea has met massive resistance from Washington’s well-funded business lobbyists.
But there are ways to regulate businesses and financial transactions without spending piles of money or passing new laws, says William Black, a former federal regulator during the Savings & Loan crisis and a professor of economics and law at the University of Missouri-Kansas City. Black appears in Michael Moore’s new documentary "Capitalism: A Love Story", in which he acts as Moore's narrative Sherpa, guiding viewers through the history of federal financial reform. Black spoke with NEWSWEEK's Nancy Cook about the possibility of a new federal financial agency; the problem with current regulators like Timothy Geithner, Secretary of the Treasury; and the search for every industry's Achilles Heel. Excerpts:
NEWSWEEK: A few weeks ago marked the one-year anniversary of the bankruptcy of Lehman Brothers. Since the financial collapse, there have been no indictments. The Dow is ready to hit 10,000 again. Where is the outrage?
Black: During the Saving & Loans crisis, we had over 1,000 convictions that involved insiders and gigantic borrowers. Now we have zero. The FBI did not even begin to investigate the large subprime lenders until March 2007. People would be upset if they had the facts, or if you asked them how many criminal referrals there were for mortgage fraud. (There were 65,000 last year.) Meanwhile, the administration is saying there is no problem and that the financial crisis is over. That's the exact opposite of what you want to say and do if you want dramatic resources to change things.
In dissecting the financial collapse, what do you think went wrong?
Eighty percent of the toxic mortgages that were done were unregulated, but that still leaves 20 percent of a huge market. Had the examiners looked, the incident of the fraud was so great that they couldn't have missed it. The FBI warned about toxic mortgages years ago, but in response to the 9/11 attacks, the FBI transferred 500 white collar specialists to national security. The Bush administration refused to replace the FBI agents it transferred--even though Enron collapsed within about two months.
Now, you have to think in terms of lags. The Enron case was going to trial. There are over 100 FBI agencies assigned to Enron alone. With the lag, who was left to investigate white collar crimes? It's nice to have warned about toxic mortgages. It would have been nicer to stay on top of the warning, but there was nobody left in terms of the numbers. As late as 2006, there were only 180 FBI agents working on mortgage fraud. At its peak, we had 1,000 FBI agents working on the Savings & Loans fraud. Regulators can't bring criminal cases, but the regulators are the ones who have to create the road map for successful regulations for fraud. When you screw up the regulatory process, you have, de facto, decriminalized these elite complex frauds.
Do you think the team Obama has put in place can overhaul the regulatory agencies?The administration's officials have all been failures as regulators. [Chairman of the Securities Exchange Commission] Mary Shapiro's big thing was self-regulation. That worked real well: the self-regulation of the investment banks. Ben Bernanke [Chairman of the Federal Reserve] I'm also very critical of, but I do give him credit for being willing to drop a lot of his anti-regulatory ideology in the face of the crisis. He literally wrote the book on the Great Depression, but he was not going to go down in history as the person who caused the second Great Depression.Some of the things Bernanke did were very bad, but he is in sharp contrast to Geithner who has been wrong about everything in his career. When Geithner was once answering a question in response to Ron Paul, he said, 'I've never been a regulator.'
He was then the President of the New York Federal Reserve, and he purports that he was never a regulator? That is a demonstration of what is wrong with the Federal Reserve banks if the head of the unit doesn't think he's a regulator. He's a disaster.
What about the criticism that regulators are not paid enough, or well enough to attract talent and keep it?
The pay can be very bad, but it's not simply that the pay is low. The agency regulating the Savings & Loans was not permitted to pay as much as the U.S. Office of Personnel Management pays. So, in terms of the initial selection, the better people will go to the other agencies. At the SEC, leading up to WorldCom and Enron, the turnover also became obscene. The average lawyer at the SEC stayed barely over two years, and your first year, you're kind of useless. The far biggest thing is leadership. As long as the leader is some kind-of clown, the agency will fail.
What needs to happen now?
It's been two-and-half years since the secondary markets collapsed, and there is zero meaningful regulatory reform adopted by legislation. But you don't need laws to do things in the regulatory ranks. You'll never have enough regulators or top-of-the scale regulators, so you always look for the Achilles heel. In the Savings & Loans case, that was growth. In 1990 to 1991, there was going to be a subprime crisis. Lenders were starting to do the same practices, and we told them, 'No.' There was no crisis.
The SEC, for example, has never effectively regulated the credit rating agencies, but the rating agencies are the Achilles heel. There are only three rating agencies. If you send your 20 best people from the SEC into any of the rating agencies, they can evaluate credit risk. They can find out on day one that the rating agencies never check loan files. On day two, they can say that the rating agencies can't give out more ratings without checking loan files. On day three, the secondary market collapses and the bubble bursts early. Regulators have to be creative and have to be aggressive. They have to know how to succeed not having the resources, but there is nearly always is an Achilles Heel.
Does the Obama Administration have the political will to bring about financial reform?
No and no--although I'm not even sure that the central problem is will. The administration seems not to believe that you need fundamental change. I know they've given speeches recently. The rhetoric is starting to come around, but the proposals are still designed to create the status quo before the crisis. It's analytically bankrupt. Nothing they're trying for would have prevented the current crisis had it been in place, and it's very unlikely that it will prevent crisis in the future.
In particular, the administration want to create the secondary market that caused trillions of dollars of losses. They still want a massively, too-large financial structure -- so large that it clearly harms the economy. They still want to compete and be the place where finance will reside. That's like saying, "We want to be there when it blows up."
"Astounded" by Goldman's Upgrade: Banks "Heading Into the Storm," Whalen Says
Goldman Sachs making headlines again. Today, it’s on two accounts. First, Bloomberg is reporting Goldman could earn about $1 billion should the troubled lender CIT Group, enter bankruptcy or otherwise end a $3 billion financing agreement. I'm sure it's adding fuel to the fire for the "Government Sachs" conspiracy theorists, who probably see it as a repeat of what happened with the AIG bailout. For those that don't remember, Goldman received $12.9 billion from AIG after the government rescued the world's largest insurer. That raised suspicions of conflicts of interest and unfair treatment, since then Treasury Secretary Hank Paulson also happened to be a former CEO at Goldman.
Chris Whalen of Institutional Risk Analytics is a Goldman conspiracy sympathizer and someone who "doesn't like their politics." But, in this case, he doesn't necessarily think anything is askew. "Like any distressed lender they have a right to their payment. They took the risk," he admits. What strikes Whalen as more curious is Goldman's call on the big banks. Citing a positive outlook on earnings, Goldman analysts raised the outlook on banks from neutral to "attractive" this morning. They also upgraded Wells Fargo to "buy" from "neutral", Comerica to "neutral" from "sell", and added Capital One to their "conviction buy" list.
Whalen is "astounded" Goldman would make such a move "when the banking industry is heading into the storm." Contrary to the Goldman call, Whalen says the earnings outlook will get worse over the next two quarters, culminating in a bloodbath in the fourth quarter. Part of the problem for Wells Fargo, according to Whalen, is the bank still has plenty of write-downs to come associated with the Wachovia merger.
But Goldman employees and shareholders have no fear. Whalen is confident the firm will fare better than those it upgraded today, "because they're not a bank." Instead, he says, you must consider Goldman, "a trading operation with a private equity firm attached." If there is a risk for Goldman, it is political. "They are so visible and so high profile," Whalen speculates, "that if the economy doesn't recover next year I think Goldman is in for some severe criticism." And that, no doubt, would please the Goldman conspiracy crowd.
Goldman Sachs: The "Smart" Money?!
by Michael Panzner
U.S. stocks rebounded today, aided by a rally in financials. Why was the group strong? Because a team of analysts at a well-known Wall Street firm upgraded the large banks sector. And why did they do that? Bloomberg gives us the lowdown in "Wells Fargo, Biggest U.S. Banks Raised by Goldman":Wells Fargo & Co., JPMorgan Chase & Co. and the biggest U.S. banks were raised to "attractive" from "neutral" by Goldman Sachs Group Inc., which said share prices don’t reflect prospects for earnings growth.
"We believe this difference in earnings power hasn’t been fully reflected in share prices," New York-based analysts led by Richard Ramsden wrote in a note to clients today. "We estimate that normalized earnings for large banks are 39 percent higher than in 2007 despite the 36 percent decline in share prices."
Wells Fargo, based in San Francisco, was upgraded by Goldman to "buy" from "neutral" after its tangible assets per share increased 70 percent in the second quarter. "The reason is simple: Wells bought Wachovia at a depressed price," Ramsden said. Banks have increased earnings with acquisitions that will add to earnings over the "long term," he said.
Wow, pretty powerful stuff, eh? Then again, maybe not. You see, if you go back and look at what Goldman said in late-January, when most bank stocks were trading at far lower levels than they are now, the firm wasn't exactly upbeat on the group. Again, Bloomberg had the details in "U.S. Banks May Be the ‘New Utilities,’ Goldman Says":Large U.S. banks risk becoming the "new utilities" as governments introduce greater regulation and force lenders to increase capital ratios, Goldman Sachs Group Inc. analysts said.
Return on equity at the biggest U.S. banks will be limited by higher capital requirements and greater regulatory controls, analysts led by Richard Ramsden in New York said in a report to clients today. The measure of how effectively banks invest earnings may shrink to between 10 percent and 12 percent, from the 15 percent banks generated between 1990 and 2006, they said.
U.S. Bancorp was cut to "sell" because the Minneapolis- based company, while "a good bank," is already highly valued, the analysts wrote. Goldman also re-instated its sell rating on Citigroup Inc., saying "investors should avoid the stock given no core earnings power clarity."
Bank of America Corp. was cut to "neutral," the same rating given Morgan Stanley, Wells Fargo & Co. and PNC Financial Services Group Inc. The analysts recommend buying JPMorgan Chase & Co., which they said may show earnings improvement as the economic cycle turns.
Large banks, particularly Citigroup, U.S. Bancorp and Bank of America, have "thin" capital cushions compared with Goldman’s estimates for losses in the industry, the note said.
Not long after, the shares began a sharp recovery, and those crackerjack Goldman analysts probably felt pressure to reconsider. In May, after the sector had rallied more than a third from when the firm had issued its negative call, the banks team bit the bullet -- sort of -- as Bloomberg reported in "Goldman Sachs Upgrades Large U.S. Banks to 'Neutral'":
Goldman Sachs Group Inc. upgraded large U.S. banks to "neutral" [Note: to Bloomberg editor: might be helpful if readers knew the prior rating], saying strong mortgage and capital markets earnings will likely continue into the second quarter and new capital raised reduces leverage.
U.S. trust banks were upgraded to "attractive," as the Goldman Sachs analysts led by Richard Ramsden determined revenue will recover from the first quarter. The analysts also raised their recommendation for U.S. credit card companies to "neutral" and reiterated their "cautious" stance on U.S. regional banks, which are "not out of the woods yet."
Bank of America Corp., the biggest U.S. bank by assets, has more than tripled in New York Stock Exchange trading since hitting a low on March 6, while JPMorgan Chase & Co., the second largest, has more than doubled in the period. Regulatory stress tests of the 19 biggest U.S. lenders led firms to raise more than $100 billion in capital, the Goldman analysts said.
Unfortunately, Goldman's relative lack of enthusiasm for large bank shares -- after all, they were neutral -- meant that those who took their advice to heart likely missed the subsequent double-digit percentage rally in the sector.
In sum, while markets cheered today's news that Goldman Sachs -- who many consider to be the "smart money" -- was upgrading the large banks, based on their track record so far this year, shouldn't investors have been selling those shares -- and the overall market -- instead?
The demise of the dollar
by Robert Fisk
In the most profound financial change in recent Middle East history, Gulf Arabs are planning – along with China, Russia, Japan and France – to end dollar dealings for oil, moving instead to a basket of currencies including the Japanese yen and Chinese yuan, the euro, gold and a new, unified currency planned for nations in the Gulf Co-operation Council, including Saudi Arabia, Abu Dhabi, Kuwait and Qatar.
Secret meetings have already been held by finance ministers and central bank governors in Russia, China, Japan and Brazil to work on the scheme, which will mean that oil will no longer be priced in dollars. The plans, confirmed to The Independent by both Gulf Arab and Chinese banking sources in Hong Kong, may help to explain the sudden rise in gold prices, but it also augurs an extraordinary transition from dollar markets within nine years.
The Americans, who are aware the meetings have taken place – although they have not discovered the details – are sure to fight this international cabal which will include hitherto loyal allies Japan and the Gulf Arabs. Against the background to these currency meetings, Sun Bigan, China's former special envoy to the Middle East, has warned there is a risk of deepening divisions between China and the US over influence and oil in the Middle East. "Bilateral quarrels and clashes are unavoidable," he told the Asia and Africa Review. "We cannot lower vigilance against hostility in the Middle East over energy interests and security."
This sounds like a dangerous prediction of a future economic war between the US and China over Middle East oil – yet again turning the region's conflicts into a battle for great power supremacy. China uses more oil incrementally than the US because its growth is less energy efficient. The transitional currency in the move away from dollars, according to Chinese banking sources, may well be gold. An indication of the huge amounts involved can be gained from the wealth of Abu Dhabi, Saudi Arabia, Kuwait and Qatar who together hold an estimated $2.1 trillion in dollar reserves.
The decline of American economic power linked to the current global recession was implicitly acknowledged by the World Bank president Robert Zoellick. "One of the legacies of this crisis may be a recognition of changed economic power relations," he said in Istanbul ahead of meetings this week of the IMF and World Bank. But it is China's extraordinary new financial power – along with past anger among oil-producing and oil-consuming nations at America's power to interfere in the international financial system – which has prompted the latest discussions involving the Gulf states.
Brazil has shown interest in collaborating in non-dollar oil payments, along with India. Indeed, China appears to be the most enthusiastic of all the financial powers involved, not least because of its enormous trade with the Middle East. China imports 60 per cent of its oil, much of it from the Middle East and Russia. The Chinese have oil production concessions in Iraq – blocked by the US until this year – and since 2008 have held an $8bn agreement with Iran to develop refining capacity and gas resources. China has oil deals in Sudan (where it has substituted for US interests) and has been negotiating for oil concessions with Libya, where all such contracts are joint ventures.
Furthermore, Chinese exports to the region now account for no fewer than 10 per cent of the imports of every country in the Middle East, including a huge range of products from cars to weapon systems, food, clothes, even dolls. In a clear sign of China's growing financial muscle, the president of the European Central Bank, Jean-Claude Trichet, yesterday pleaded with Beijing to let the yuan appreciate against a sliding dollar and, by extension, loosen China's reliance on US monetary policy, to help rebalance the world economy and ease upward pressure on the euro.
Ever since the Bretton Woods agreements – the accords after the Second World War which bequeathed the architecture for the modern international financial system – America's trading partners have been left to cope with the impact of Washington's control and, in more recent years, the hegemony of the dollar as the dominant global reserve currency. The Chinese believe, for example, that the Americans persuaded Britain to stay out of the euro in order to prevent an earlier move away from the dollar. But Chinese banking sources say their discussions have gone too far to be blocked now.
"The Russians will eventually bring in the rouble to the basket of currencies," a prominent Hong Kong broker told The Independent. "The Brits are stuck in the middle and will come into the euro. They have no choice because they won't be able to use the US dollar." Chinese financial sources believe President Barack Obama is too busy fixing the US economy to concentrate on the extraordinary implications of the transition from the dollar in nine years' time. The current deadline for the currency transition is 2018.
The US discussed the trend briefly at the G20 summit in Pittsburgh; the Chinese Central Bank governor and other officials have been worrying aloud about the dollar for years. Their problem is that much of their national wealth is tied up in dollar assets.
"These plans will change the face of international financial transactions," one Chinese banker said. "America and Britain must be very worried. You will know how worried by the thunder of denials this news will generate." Iran announced late last month that its foreign currency reserves would henceforth be held in euros rather than dollars. Bankers remember, of course, what happened to the last Middle East oil producer to sell its oil in euros rather than dollars. A few months after Saddam Hussein trumpeted his decision, the Americans and British invaded Iraq.
Max Keiser: Dollar to be buried way before 2018
Arab Gulf Officials Deny Plan To Ditch USD Oil Trade
Arab officials in the Persian Gulf strongly denied Tuesday a report that they're in secret talks to replace the U.S. dollar with a basket of currencies to price oil. "We have never heard of this or discussed this, not even secretly," Qatar's oil minister Abdullah bin Hamad Al Attiyah told Zawya Dow Jones by telephone. Arab states in the Gulf account for about half the crude pumped by the Organization of Petroleum Exporting Countries, or OPEC.
British newspaper The Independent reported earlier that Gulf oil producers, including Qatar, Saudi Arabia, Kuwait and the United Arab Emirates, are negotiating with Russia, China, Japan and France to replace the dollar with a basket of currencies to trade crude. The basket would include the Japanese yen, Chinese yuan, Euro, gold and a new currency planned by Gulf Cooperation Council members, the report said. "We're not aware of any discussions on this matter," Kuwait's Finance Minister Mustafa Al Shamali told Zawya Dow Jones by phone. His comments were echoed by another senior Gulf oil official who said no discussions were underway to ditch the dollar as a benchmark for oil.
By 1120 GMT, the dollar had fallen to Y89.11 from Y89.54 late Monday in New York, according to EBS, while the euro rose to $1.4724 from $1.4651. The pound fell back to 1.5888 from 1.5942. Crude oil futures gained ground, boosted by the weak dollar and rising equity markets in Europe. The front-month November light, sweet, crude contract on the New York Mercantile Exchange traded $1.03 higher at $71.44 a barrel at 0943 GMT Tuesday.
Oil-rich Arab states shifting away from the dollar to price oil could add to mounting pressure on the greenback as the world's reserve currency. Dogged by concerns that rock-bottom interest rates and soaring government debt in the U.S. will undermine its value, the dollar has lost ground against a basket of rival currencies this year. "There is no genuine alternative to the dollar as a reserve currency therefore we are more likely to see oil continue to be priced in dollars," said Marios Maratheftis, regional head of research at Standard Chartered Bank in Dubai.
Iran, the second-largest producer in OPEC, would encourage Gulf Arab oil exporters to replace the dollar with a currency basket in oil trading, its OPEC Governor Mohammad Ali Khatibi said Tuesday. "Iran did this about three years ago. We replaced dollars with other valuable, stable currencies including the euro and yen for our oil income and we are very happy and not sorry we did this because the dollar is becoming weaker," Khatibi told Zawya Dow Jones by telephone from Tehran. "If anybody wants to use our experience we will be happy to help."
New York Income Tax Revenue Falls 36% in Year, Paterson Says
New York State’s income tax revenue has dropped 36 percent from the same period in 2008, Governor David Paterson said, “frustrating” his attempt to close a projected $2.1 billion budget deficit. “We added personal income tax, which we thought would make the falloff 10 percent to 15 percent,” Paterson, a Democrat, said on CNBC today, referring to $5.2 billion in new or increased taxes. “This is what is so frustrating. It’s still 36 percent, meaning our revenues fell more in 2009 than they did in 2008.”
Wall Street companies lost $42.6 billion last year and year-end bonuses to workers fell 44 percent to $18.4 billion. Income tax receipts were down 24 percent as of Aug. 31, according to the state comptroller’s office. Paterson’s estimate includes data since then. Besides boosting taxes for the fiscal year that began April 1, lawmakers made $5.1 billion in spending cuts. The plan also includes $6.2 billion in federal stimulus money and $1.1 billion in one-time revenue, according to the Assembly. The budget will still be $2.1 billion in deficit because spending plans exceed revenue projections, the state Division of Budget said July 30. The report predicted deficits of $4.62 billion in 2011, $13.3 billion in 2012 and $18.2 billion in 2013.
Paterson, 55, said New York needs to diversify so that it’s not as dependent on taxes from Wall Street firms, which account for more than 20 percent of the state’s tax revenue. “We are Ground Zero for the economic recession,” said Paterson. “What we’re recognizing now is what everybody recognizes in their own portfolio: you can’t overinvest in one area because, if it fails, you’ll have a debacle.” New York is depleting its options for balancing the budget, Paterson said. “What we want to do is bring the legislature back as soon as possible and make the tough decisions,” Paterson said.
Ilargi: Canada's biggest media company, Canwest, filed for bankruptcy protection yesterday. All's less rosy than some would have you believe.
Canadian household credit 'is defying gravity'
Household credit is growing at a year-over-year rate of more than 7%, the fastest seen in any economic recession in the post-war era on an inflation adjusted basis, a new CIBC Capital Markets report shows. "It's all about affordability. During the first six months of the year, total debt rose by $44-billion but interest payments on debt fell by $3-billion," Benjamin Tal, economist with CIBC, said in the report. "Household credit in Canada is defying gravity."
The mortgage market alone has grown 7.8% in the past year, reflecting a strong rebound in real estate activity. "The current rate is extremely strong given where we are in the economic cycle," he said. But Mr. Tal cautioned that the pace of growth is unsustainable. "Current activity reflects some utilization of pent-up demand as well as a realization by home buyers that this window of low interest rates will not last forever," he said. "In many ways, we are stealing activity from 2010 and 2011."
Meanwhile personal bankruptcies across Canada are up 32% for the year ended in July, with Alberta leading the rest of the country in consumer bankruptcies by a wide margin, registering a 72% year-over-year increase. "With the unemployment rate still rising, look for the number of bankruptcies to continue to rise," he said. Alberta's rapidly cooling economy will also drive this trend, Mr. Tal said. Overall household debt also rose 3.4% in the first half of the year while disposable income fell 0.2%.
Also, the bad debt rate in credit cards has jumped 30% since early 2008, to 1.2%. While consumer credit has increased 7%, the number of consumer loans in major arrears has also risen to 1.7% from 1.4% in late 2008. "That said, there are some signs that we are starting to level off. Note that the number of cards with minor delinquencies as a share of all trades has stabilized in recent months," Mr. Tal said. Debt interest payments as a share of disposable income is also at a low since 2006 of 7.7%. In the 1991 recession, this ratio was more than 10%.
Unemployment Becoming Leading Indicator for Pimco’s New Normal
Mohamed El-Erian says economists are wrong to dismiss unemployment as merely a lagging indicator, a sign of where the economy has been. For the chief executive officer of Pacific Investment Management Co., the 26-year high jobless rate is also an omen of things to come. The climb in the September rate to 9.8 percent, double the level at the start of last year, leaves the U.S. saddled with about 15 million people out of work and with limited prospects. That will further hurt the housing market and weigh on the wages of those still employed, threatening to undercut the economic recovery, according to Mark Zandi, chief economist at Moody’s Economy.com in West Chester, Pennsylvania.
"Today’s unemployment rate is much more than a lagging indicator," said El-Erian, whose Newport, California-based Pimco manages the world’s largest bond fund, in an e-mail after the Labor Department report on Oct. 2. "It is also a signal of future pressures on consumption, housing and the country’s social safety net." The job market tends to trail the economy in a recovery because companies hesitate to take on more workers until they are convinced the expansion will last. What’s different this time is the "large and protracted" rise in joblessness and the likelihood that it will stay high for years, according to El- Erian. That means unemployment will affect the economy going forward, not merely reflect where it has been.
El-Erian, 51, sees the U.S. entering what he calls a "new normal" -- a sustained period of annual growth of about 2 percent -- as Americans adjust to a world where credit and jobs are less plentiful. In the five years before the recession began at the end of 2007, gross domestic product expanded at an average annual rate of 2.8 percent. The struggle to generate jobs means the Federal Reserve will keep its benchmark interest rate near zero through next year, according to Bruce Kasman, chief economist at New York- based JPMorgan Chase & Co.
"Joblessness will be the number one public policy problem for 2010," added Allen Sinai, chief global economist at Decision Economics in New York. "The Democrats could get hurt by that in the November Congressional elections." The September numbers were "wall-to-wall ugly," said Chris Low, chief economist at FTN Financial in New York, in an e-mail to clients. Payroll cuts accelerated to 263,000 from 201,000 in August.
Unemployment would have topped 10 percent if not for the more than half million Americans who left the workforce. Long- term joblessness -- the percentage of the unemployed out of work for 27 weeks or more -- rose to a record 35.6 percent, or 5.4 million Americans. "I’ve never seen anything like this in terms of the severity and the broadness of recessions," said Gary Butler, chief executive officer of Roseland, New Jersey-based Automatic Data Processing Inc., which manages payrolls for one out of every six workers in the U.S. The 62-year-old executive added in an interview that the economy will probably recover more slowly than in past rebounds.
Even before the job figures, Fed Chairman Ben S. Bernanke told lawmakers on Oct. 1 that economic growth next year probably won’t be strong enough to "substantially" bring down the jobless rate, which may remain above 9 percent at the end of 2010. Lawrence Summers, director of President Barack Obama’s National Economic Council, said the country faces "critical economic problems" and also indicated the job report didn’t tell the whole story. "Employment and unemployment, economic experience suggests, is a lagging indicator," he told a forum in Washington on Oct. 2.
The last recovery started in December 2001; unemployment didn’t fall until five months later. In 1991, the expansion began in April and the jobless rate fell briefly in July, only to resume rising into the next year. While Sinai said the unemployment rate this time will again lag behind the recovery, which probably started in the third quarter, he agreed with El-Erian that the distress in the job market was also saying something about the future. "We have an army of unemployed," Sinai said. "That’s telling us a lot, in a leading way, about the picture for the consumer."
U.S. consumer bankruptcies rose past 1 million through the first nine months of the year, the highest since 2005 changes to bankruptcy laws. Employment expenses in the U.S. -- both wages and benefits -- increased at a record low year-on-year rate of 1.8 percent in the second quarter after a 2.1 percent increase in the first, as the high jobless rate held down worker compensation, according to an index compiled by the Labor Department.
Retailers are pulling back before the holiday sales season. U.S. retail job losses jumped to 38,500 in September from 8,800 in August as car dealers and other stores cut payrolls. Mattel Inc. and Hasbro Inc., the world’s two biggest toymakers, are shifting toward lower prices this holiday season as budget-conscious parents seek bargains. Eighty percent of El Segundo, California-based Mattel’s toys will cost less than $30 this year, compared with 75 percent last year, brand President Neil Friedman said in an Oct. 1 interview. Pawtucket, Rhode Island-based Hasbro is concentrating more on toys under $50, said John Frascotti, chief marketing officer.
Housing, which has traditionally led the economy out of recession, may also be hurt as the continued rise in unemployment boosts foreclosures, Zandi said. He sees home prices resuming their downward slide, after jumping by the most in almost four years in 20 U.S. cities in July, as the jobless rate rises to 10.5 percent in the middle of next year. Mortgages 60 days or more past due climbed to 5.3 percent of loans through June 30, up from 4.8 percent on March 31 and 3 percent a year earlier, the Office of the Comptroller of the Currency and the Office of Thrift Supervision said on Sept. 30. First-time foreclosure filings fell 0.4 percent from the first quarter, helped by Obama’s loan-modification program, according to the two government bank regulators in Washington.
U.S. homebuilders will have operating losses of more than $500 million in 2010 as mounting foreclosures and unemployment further erode home prices, Moody’s Investors Service said in a Sept. 30 report. The New York-based bond rating company extended its negative credit outlook for the industry for the next 12 to 18 months, meaning Moody’s may lower the builders’ debt ratings.
Banks, including New York-based JPMorgan, Charlotte, North Carolina-based Bank of America Corp. and San Francisco-based Wells Fargo & Co., will also be hurt as housing’s woes lead to more loan losses, said Dirk van Dijk, director of research for Zacks Investment Research Inc. in Chicago, in an Oct. 2 e-mail to clients. The depressed job market may take its toll on politicians. Democratic lawmakers in the House of Representatives are particularly vulnerable if voters blame Obama for a sour economy, according to Nathan Gonzales, political editor for the Rothenberg Political Report in Washington, in an interview.
Since 1945, the party that controls the White House has lost an average of 16 House seats in a president’s first midterm election, according to the Cook Political Report. Obama’s Democratic Party currently has 256 seats in the chamber, compared with 178 for the Republicans. The House approved legislation last month that would extend unemployment benefits by 13 weeks for people in 27 states with jobless rates of at least 8.5 percent in August. The Senate is considering the measure. "It’s very important for policy makers to remain very aggressive," Zandi said. "The severe stress in the job market is the most significant threat to the nascent recovery."
American Consumers Scale Back on Spending
Families cut back sharply on transportation and apparel spending last year, as wages failed to keep up with rising prices during the worst recession in decades. Consumer prices rose 3.8% last year from 2007, but pretax income climbed just 0.7%, or $472 an average family. To compensate, Americans made their priorities clear by slashing spending in less essential categories, and favoring thriftier options, such as eating at home.
Overall spending per consumer unit—which includes families, single people or people living together who share expenses—rose just 1.7%, or $848, in 2008 to $50,486, not adjusted for inflation, the Labor Department said Tuesday, as part of an annual survey. It was the smallest spending increase since 2003. As the U.S. economy spiraled downward into a recession, families cut transportation spending 1.8% in 2008, which includes everything from auto purchases to airline tickets. They also shelled out 4.3% less for apparel and services—about a $9.7 billion hit to the apparel industry.
Clothing spending has been slow to rise in the past two decades. While certain expenses like food and health care have steadily increased, families spent just $312 more last year on clothing than in 1988, not adjusted for inflation. Meanwhile, families spent 8.1% more on dining at home, or $279 a family, in 2008. Going out to eat suffered: Spending increased just $30 a family. "Of the $848 difference in all spending, food chewed up more than a third of that," said Peter Francese, a demographic trends analyst for advertising agency Ogilvy & Mather. "That says that the supermarket people, the packaged goods people…should be thrilled with this information."
Health-care spending also climbed 4.3% last year, and spending on personal insurance and pension plans rose 5%. The latter could be a sign that consumers started saving more as economic uncertainty persisted.
One mystery in the data was the 5.1% increase in entertainment spending, a category that seemed like it would have drawn fewer dollars as consumers tightened their budgets to compensate for stagnant wages and the threat of job losses. It equates to about $16.5 billion more spent on entertainment in 2008 than in 2007. "That was a real shocker to me," Mr. Francese said. "What are they doing, going to the movies?"
How the Fed Can Avoid the Next Bubble
by Ian Bremmer And Nouriel Roubini
Ben Bernanke and the Federal Reserve face a number of very difficult challenges in the years ahead. They include:
- Resisting pressure to monetize deficits, which would eventually cause high inflation.
- Implementing an exit strategy from the massive monetary easing of the past year.
- Maintaining the Fed's independence, which has been compromised by the direct and indirect bailout of financial institutions and congressional attempts to micromanage the central bank.
- Properly calculating asset prices and the risk of asset bubbles according to the Taylor rule, an important guideline central banks use to set interest rates.
- Supervising and regulating the financial system more effectively, particularly in the role of "systemic risk" regulator.
The first two tasks are closely related. In order to prevent a persistent monetization of deficits that would lead to inflation, the Fed must implement an exit strategy from the unconventional monetary easing that began in late 2008. If the fiscal and monetary stimulus is taken away too soon, there is the risk of relapsing into deflation. If it is taken away too late, we may eventually face a fiscal crisis and an inflationary recession, or stagflation. The Fed does not control fiscal policy. But to avoid a game of chicken wherein loose fiscal policy forces the Fed to monetize deficits to prevent a spike in bond yields, the Fed needs to pre-emptively state it won't be buying more Treasury bills.
As for the exit from monetary easing, the Fed must learn from the fateful mistake it made after the 2001 recession. Then, the central bank cut the federal-funds rate too much and kept it too low for too long. It also moved far too slowly when the normalization occurred—in small increments of 0.25% from summer 2004 until the summer of 2006, when it peaked at 5.25%. Normalization took two full years. It was in that period of slow normalization that the housing, mortgage and credit bubbles spiraled out of control. The lesson learned: When you normalize, move rapidly, or prepare for another dangerous bubble.
Of course, this is easier said than done. From 2002 to 2006, the Fed moved slowly because the recovery appeared anemic and because of significant deflationary pressures. This time around, the recession is more severe—unemployment is at 9.8% and is expected to peak above 10%, and we are experiencing actual deflation. Therefore, the incentive not to exit too soon will be greater and the risk of creating another bubble is greater. Indeed, the sharp increase in the stock market and commodities, and narrowing of credit spreads since March, are partly due to a wall of global liquidity chasing assets and already causing asset inflation.
If the conflict between economic growth and financial stability requires that monetary policy remain loose, then it is critical that the supervisors and regulators of the banking sector move aggressively to prevent another bubble from emerging. Thus they should quickly adopt the regulatory reforms agreed to by the G-20—including a new insolvency regime for financial institutions deemed "too big to fail," a serious approach to limiting "systemic risk," and appropriate rules governing incentives and compensation for bankers and traders.
It won't be easy to define systemic regulation and too-big-to-fail. There is a significant risk that doing so will provide an implicit guarantee for large and complex financial institutions. There is also a longer-term risk that actions taken by congressional and regulatory agencies will distort global financial markets. Western financial institutions now depend heavily on state financial backing, and several governments have tweaked rules and regulations to support the large financial institutions that are now at least partially taxpayer-owned. Further, governments could increasingly require domestic financial institutions to lend more at home, which will curtail their foreign operations. Creating a system of effective financial regulation—while resisting the impulse to favor domestic institutions—will be a real challenge for most countries, including the U.S.
Over time, once the fed-funds rate is normalized, incorporating asset prices into monetary policy making is also necessary to ensure financial stability. While it is correct that the fed-funds rates may not be the most effective instrument at controlling asset and credit bubbles, excessively cheap money is always a source of such bubbles. So faster normalization of the fed-funds rate will eventually be important. The Fed's involvement in quasi-fiscal operations creates other challenges. As long as the Fed remains involved in maintaining financial stability and in preventing other episodes of systemic risk, it will be hard to eliminate the perception that the Fed will be involved as a lender of last resort for too-big-to-fail firms. So far, this Pandora's Box remains open.
The way to prevent future moral-hazard distortions is to create a regulatory regime where too-big-to-fail institutions have much higher capital requirements: a greater liquidity buffer, lower leverage, and lower involvement in risky and illiquid investments if they are depository banks. They should be supervised internationally and must be able to be closed down in an orderly fashion should failure loom. The Fed is currently resisting a Treasury-led effort to review how it is organized out of concern it might forfeit its independence. Yet the governance structure of the New York and other regional Federal Reserve banks left them effectively controlled by large financial institutions last year, so such a review is necessary. While congressional interference in the Fed's jurisdiction is a danger, the recent quasi-fiscal activities of the Fed bear a review.
The Fed also needs a greater regulatory backbone. The Fed had the power to regulate mortgage markets but failed to use this power out of a misplaced deference to laissez-faire attitudes and Wall Street. Regulating mortgage markets requires a careful balance: short-term regulatory forbearance to avoid a greater credit crunch, along with medium-term countercyclical supervisory actions in order to prevent the emergence of further asset and credit bubbles. Establishing financial stability—in addition to price stability and growth—is the essential role of the central bank. Achieving this goal in a way that avoids moral-hazard distortions, as with the too-big-to-fail finance institutions, and prevents another bubble in the next years will surely be one of the greatest challenges ever faced by the Fed.
Fed Opens Credit-Rater Door for TALF
The Federal Reserve announced steps that could loosen the grip of the biggest credit-rating firms on the structured-finance industry, as the central bank looks to take a more-active role assessing the risk of a key lending program. The Fed on Monday said it plans to allow others besides the three largest rating firms -- McGraw-Hill Cos.' Standard & Poor's Ratings Services, Moody's Corp.'s Moody's Investors Service and Fimalac SA's Fitch Ratings -- to participate in its Term Asset-Backed Securities Loan Facility, or TALF, which was launched earlier this year to kick-start the market for consumer and business lending.
A proposed rule would enable the Fed to choose a credit-rating service for asset-backed securities based on "a certain minimum level of experience in rating deals of any particular type." The Federal Reserve Board said this "is intended to promote competition" among ratings firms "and ensure appropriate protection against credit risk for the U.S. taxpayer." Starting in November, the Federal Reserve Bank of New York will conduct a "formal risk assessment" of the collateral backing the asset-backed securities eligible for TALF. Debt issuers would have to provide all information they give the ratings firms to the Fed as part of this assessment.
The moves come amid scrutiny of the role credit-rating firms played in the recent financial crisis and conflicts of interest that may arise because raters are paid by debt issuers. In essence, the Fed, as a large investor, is becoming more involved in the process that leads to securities getting top triple-A credit ratings, which connote minimal risk of default and loss.
Fed Should Release Borrowers’ Names, Bloomberg Says
The Federal Reserve should be forced to identify companies that received loans from the central bank because it can’t demonstrate that borrowers would be harmed by the disclosure, according to lawyers who won a Freedom of Information Act lawsuit. There’s nothing proprietary in the details sought by the Bloomberg News unit of Bloomberg LP, the New York-based company majority-owned by Mayor Michael Bloomberg, attorneys for the company said today in court papers. The filing by Bloomberg opposes the Fed’s request for a court to halt disclosure of information while an appeal proceeds.
Bloomberg won a ruling from Manhattan’s chief federal judge on Aug. 24 affirming the right of U.S. taxpayers to know about the financial firms that borrowed money. The Fed last year began extending credit directly to companies that aren’t banks for the first time since it was created in 1913. Total lending by the Fed was $2.12 trillion on Sept. 30. Divulging specifics about the loan program might touch off a run by depositors, unsettle shareholders and hurt the central bank’s "ability to perform important statutory functions at a time of economic upheaval," Fed lawyers have said in legal filings.
Details about the borrowers and their collateral are "central to understanding and assessing the government’s response to the most cataclysmic financial crisis in America since the Great Depression," attorneys for Bloomberg said in the suit. The Freedom of Information Act obliges federal agencies to make government documents available to the public. The Bloomberg suit didn’t seek money damages. Bloomberg responded today to the Fed’s motion to keep the borrower information confidential while it seeks to overturn the Aug. 24 ruling in the U.S. Court of Appeals in New York, according to Thomas Golden, a lawyer at New York-based Willkie Farr & Gallagher LLP, who represents the company. Today’s filing couldn’t be immediately confirmed in court records.
Fed Needs Goldilocks for Roach Motel Check-Out
If only the moderator had called on me, I might have gotten an answer to my questions and left with more confidence in the Federal Reserve’s ability to pull off its exit strategy without a hitch. Speaking at a conference in Washington last week sponsored by the Cato Institute and Shadow Open Market Committee, a group of self-appointed Fed watchers, Fed Vice Chairman Don Kohn reiterated the conditions and tools for withdrawing excess liquidity already outlined by Fed chief Ben Bernanke.
The tools include raising the interest rate the Fed pays on reserve balances to put a floor under short-term rates; draining reserves via outright sales of securities or reverse repurchase agreements; and allowing loans made under the Fed’s "unusual and exigent circumstances" authority to wind down, paring the central bank’s balance sheet through natural attrition. That’s not an option with the long-term securities the Fed has purchased, and continues to purchase.
If the Fed perceives spreads between Treasuries and mortgages, for example, to be "distorted," or if long-term interest rates don’t rise with increases in the Fed’s target rate, the Fed "could consider sales of those assets," Kohn said. That statement presumes the Fed knows the right level for spreads, according to Ram Bhagavatula, managing director at Combinatorics Capital LLC, a hedge fund in New York. "In 2007, Bernanke said spreads were too tight. Last year, spreads were too wide," he said. "How do they know what’s right?"
In fairy-tale land, Goldilocks may be able to tell when the porridge is "too hot" or "too cold," but how do a handful of humans know when it’s "just right?" That’s a tough call in any environment; the difficulty is compounded when the discerner is also the distorter-in-chief. "Once the Fed got involved in the credit side of the equation," buying mortgage-backed securities to keep home-loan rates low, "they destroyed information in the private markets," Bhagavatula said.
Yields on all debt securities, not just MBS, have narrowed relative to Treasuries this year. How much is the result of the Fed’s outright purchases and how much is natural healing? Are investors buying junk bonds because they have absolute value or provide a good return on a risk-adjusted basis? There’s another problem with Kohn’s comment, one that had me squirming in my seat at the Sept. 30 conference. It was a little less than a year ago, in that same auditorium at Cato, that Kohn gave an elegant defense of the Fed’s hands-off approach to asset bubbles.
With the benefit of hindsight -- after fanning the bubble, watching it burst and cleaning up the mess -- Kohn said he was still skeptical about the Fed’s ability to identify an asset bubble in time to lean against it and unconvinced that using monetary policy to check speculation would have benefits that outweigh the costs. How is it the Fed can be so prescient when it comes to credit spreads and interest rates and so clueless when it comes to asset prices? And why is Kohn willing to intervene in one case and not lean in the other, using monetary policy to take some of the wind out of economy-destabilizing bubbles? Supervision isn’t a substitute for monetary policy. No amount of regulation -- more, better, different -- can counteract the powerful incentive of easy money.
I didn’t get a chance to ask my question, and I doubt Kohn would have answered it to my satisfaction. To think that the Fed, or anyone, can discern market distortions in a "structured economic environment," as a Tokyo reader referred to the U.S. economy, is ludicrous. "It makes the exit strategy difficult to execute," Bhagavatula said. Exiting is never easy. The history of Fed policy in the modern era is one of asymmetric responses, in more ways than one.
First, the Fed doesn’t tolerate deflation, or a decline in the price level, even if it’s the good kind. Technological innovation enables businesses to produce more with less. The economy grows, prices fall, real incomes rise. What’s not to like? Prices can also decline because demand collapses. That’s the Great Depression scenario, with prices, output and wages all falling. The second asymmetry is evident in interest-rate changes. The Fed is "quick to ease and slow to tighten," Bhagavatula said, pointing to the 1994 tightening episode as an exception. "The record shows rates go down precipitously and up slowly."
He doesn’t expect this time to be different. Yes, the Fed wants to do the right thing and raise rates preemptively to maintain price stability. Bernanke and Kohn are dedicated civil servants who made decisions under the worst of circumstances for the good of the nation, not for their personal aggrandizement. It’s always easier to check in to the Roach Motel than check out, politically and, this time, practically. Banks are holding $854 billion of excess reserves in their accounts at the Fed compared with an average of $1 billion to $2 billion before the crisis. Eventually the Fed will have to suck them up to avert inflation.
Add to that the age-old problem faced by policy makers, and you can understand why the exit is fraught with risks. The decision to withdraw monetary accommodation is based on "a forecast of economic developments, not on current conditions," Kohn reminded us last week. We all know how that worked out in the past.
Obama Weighs Spending, Tax Cuts to Stem Job Losses Without Second Stimulus
President Barack Obama is considering a mix of spending programs and tax cuts to respond to widening job losses that would amount to an additional economic stimulus without carrying that label.
The discussion of the initiatives, including a boost in transportation spending and an extension of an expiring tax credit for first-time homebuyers, comes as the White House is balancing rising concern about unemployment and a budget deficit the Congressional Budget Office estimates will total $1.6 trillion for 2009, and $1.4 trillion in 2010.
Administration officials have told allies in Congress that a broader transportation bill, and extensions of a homebuyer tax credit and unemployment benefits are all on the table, a Senate aide said. Representative Chris Van Hollen of Maryland, who chairs the Democratic Congressional Campaign Committee that is tasked with holding the party’s House majority in next year’s midterm elections, said additional transportation funding would be popular among Democratic lawmakers. "If there was to be another round of stimulus, additional infrastructure would be at the top of the list," Van Hollen said in an interview. Money for roads, transit and bridges would be a priority.
In considering the measures, the administration has to reconcile two potentially contradictory missions: combating rising unemployment through government intervention and the need to hold deficits down. White House Press Secretary Robert Gibbs yesterday highlighted those political sensitivities, saying there "were no plans" for a second stimulus like the $787 billion package passed earlier this year. Instead, he said, the administration is looking at "extensions" of existing programs. "The economic team is certainly looking at and working on any way that we can create more jobs," Gibbs said.
The items under consideration include an increase in infrastructure spending through expiring transportation legislation that Congress must reauthorize in the coming months, the Senate aide said, speaking on condition of anonymity. Other steps being weighed include an extension of a tax credit of up to $8,000 for first-time homebuyers that is due to expire later this year, and a renewal of a tax benefit for net operating losses that would benefit small businesses, the aide said.
"Clearly these things are a stimulus," said Dean Baker, co-director of the Center for Economic and Policy Research in Washington, who has called for more stimulus spending. "There’s no two ways about it." The Obama administration isn’t near a final decision on additional measures, said Jen Psaki, a White House spokeswoman. "As they continue to explore the best options, any notion that we are any farther along than preliminary discussions about new proposals is wildly inaccurate," she said.
The Labor Department reported last week that unemployment reached 9.8 percent in September, the highest level since 1983. Nonfarm payrolls dropped by 263,000, a steeper drop than economic forecasters had expected. At the same time, the federal deficit has risen sharply because of this year’s stimulus package and bailouts for the banking industry, auto industry and Fannie Mae and Freddie Mac. While the Obama administration has pledged that a health-care overhaul it is pushing through Congress won’t widen the deficit, it has stirred concerns among fiscal conservatives.
"More of a stimulus package is much more difficult at this point than it was in February," said Julian Zelizer, a professor of public affairs at Princeton University in New Jersey. "The deficit can become a political straitjacket to the Democrats." Obama and his aides have stressed that they expect employment growth to lag in an economic recovery. They now confront rising joblessness as they move toward midterm elections in November 2010. Since 1945, the party that controls the White House has lost an average of 16 House seats in a president’s first midterm election, according to the Cook Political Report, a nonpartisan publication in Washington. The Democrats have 256 seats in the chamber, compared with 178 for the Republicans.
The federal transportation funding program, which provides routine federal aid for highway construction and other transportation projects, expired Sept. 30 and is operating under a 30-day extension passed by Congress. While the transportation funding law typically is renewed in multiyear increments, the Obama administration has instead proposed an 18-month extension, a move backed by the Senate public works panel. That time frame limits the scope of the bill to the period in which economic forecasters expect high unemployment.
Representative James Oberstar, a Minnesota Democrat who chairs the House Transportation and Infrastructure Committee, has proposed a six-year $500 billion highway and transit bill. Most of the measure is financed through federal gasoline taxes, which haven’t been raised since 1993. At the current level, the tax would only generate about $350 billion over six years. A six-year bill would be "a better stimulus than a temporary, one-time, infusion of cash," said Jim Berard, a spokesman for Oberstar. Van Hollen said Congress’ first step would likely be to move forward with an extension of unemployment benefits. "We don’t want to get ahead ourselves here," he said.
The Real Misery Index: Unemployment Increases The Hardship
The rise in unemployment continues to prolong the hardship for millions of Americans, according to the latest update of the Huffington Post's Real Misery Index.
The index rose to 32.2 in August 2009, after peaking at 29.2 in July, largely due to the increase in the U6 unemployment rate, which tracks part-time workers looking for full-time employment and those who've given up looking for work. The index would be even higher if it weren't for a slight rebound in housing prices.
Rising unemployment -- and the accompanying increase in the number of Americans who have been out of work for more than 6 months (5.4 million as of September) -- threatens to diminish the chances of a speedy recovery.
"We're not at the beginning, and we're not at the end," American Bankers Association chief economist James Chessen told the Huffington Post's Shahien Nasiripour. "We're stuck in the middle of this cycle, and it's painful. I think it's a matter of working through the problems. The loans that were made that are problems today are loans that were made years ago. So it really is a matter of working through a difficult environment.
"The biggest issue affecting lenders today is the unemployment rate. Because not only does that affect consumer lending directly, but it impacts business lending as those consumers just don't have the income to buy the goods they did before."
Former Fed chairman Alan Greenspan told ABC News last weekend that prolonged unemployment translates into lost skills for the economy as a whole. "And people who are out of work for very protracted periods of time lose their skills eventually."
To formulate our index, which provides a better snapshot of the economy than the often-criticized misery index (inflation added to unemployment), we used a more accurate unemployment statistic (the U6 formulation), with the inflation rate for three essentials (food and beverages, gas, medical costs), and year-over-year percent changes in credit card delinquencies, housing prices, food stamp participation, and home equity loan deficiencies. We gave equal weight to the broad unemployment numbers and the combination of the other seven metrics (with housing prices having an inverse relationship to the index).
US Apartment Glut Expands
Apartment vacancies hit their highest point since 1986, surging in cities from Raleigh, N.C., to Tacoma, Wash., as rising unemployment continued to chip away at demand during the traditionally strong summer rental months. The U.S. vacancy rate reached 7.8%, a 23-year high, according to Reis Inc., a New York real-estate research firm that tracks vacancies and rents in the top 79 U.S. markets. The rate is expected to climb further in the fall and winter, when rental demand is weaker, pushing vacancies to the highest levels since Reis began its count in 1980.
Meanwhile, the air leaving the market is driving rents down, most sharply in markets that had been chugging along until a year ago, when unemployment accelerated, including Tacoma; San Jose, Calif.; and Orange County, Calif. In New York, Jennifer Hyman rented a one-bedroom apartment in July at a monthly rate of $1,950 -- down from $2,450 for the previous tenant -- when she returned to the city after graduating from Harvard Business School. Her first month's rent was free -- and her landlord painted the apartment, scrubbed the floors and added window coverings.
"The experience was night-and-day different from before," said Ms. Hyman, who had rented other Manhattan apartments between 2002 and 2007, each time paying a brokers' fee and feeling pressured to sign a lease the minute she found an apartment. Now, she says, "Renters are the ones with the power." Driving the change is the troubled employment market, which is closely tied to rentals. With unemployment at 9.8% -- a 26-year high -- more would-be renters are doubling up or moving in with family and friends during periods of job loss. Landlords have been particularly battered because unemployment has been higher among workers under 35 years old, who are more likely to rent. Nationally, effective rents have fallen by 2.7% over the past year, to around $972.
"When job losses stop, rents will firm and occupancies will firm," said Richard Campo, chief executive of Camden Property Trust, a Houston-based real-estate company. The second and third quarters typically are the strongest periods for rental landlords because they are popular times for people to move. But this year, "vacancies just continued rising," said Victor Calanog, director of research for Reis. During the third quarter, vacancies increased in 42 markets, improved in 26 markets and remained unchanged in 11 markets. Omaha, Neb., saw the largest rise in vacancies, with the rate rising 1.1 percentage points to 7.4%. Other big rises were seen in Memphis, Tenn., Indianapolis, Raleigh and Tacoma.
The deteriorating rental market comes amid some signs of stabilization in the housing sales market. An $8,000 tax credit for first-time home buyers and investor demand helped to boost sales of low- and moderately priced homes this summer. But some analysts warn demand could fall with the expiration of the tax credit and supply could increase with more foreclosed homes hitting the market. While a housing recovery could lead the best quality renters to move out and purchase homes, the move-out rate isn't expected to surpass levels seen during the housing boom earlier this decade. Mortgage credit standards have tightened considerably since then, which should keep more renters in place.
Apartment owners ultimately could gain from the housing bust because the U.S. home-ownership rate has fallen as foreclosures rise. But the housing bust has also flooded some of the most overbuilt housing markets with new apartment inventory as developers have converted unsold condominium developments into rentals. Reis projects that the vacancy rate will peak at well above 8% in mid-2010.
Dropping Rents Will Drag House Prices Down with Them
The vacancy rate for rental apartments in the U.S. is now 7.8% and climbing, says the Wall Street Journal. This is the highest vacancy rate in 23 years. Worse, the vacancy rate is expected to keep climbing through the winter, ultimately hitting the highest rate on record. This is good news for renters and bad news for landlords. It's also bad news for anyone who owns and would like to sell a house.
Why are rising rental vacancies bad news for homeowners? Because rising vacancies put pressure on rents, as landlords have to cut prices to woo a smaller pool of tenants. As rents drop, meanwhile, one of the key measures of house-price value--the price-to-rent ratio--also changes, and not for the good. All else being equal, when rents drop, the "Housing P/E ratio" -- price to rent -- increases as rents decrease. This is the same thing that would happen to the P/E ratio of a stock if the company's earnings began to shrink.
The more the rent/earnings shrink, the more expensive the house or company is as a multiple of the rent/earnings. Will people suddenly refuse to pay as much for houses because the price-to-rent ratio rises a bit? No. But they may decide to rent instead of buy, which will remove some demand from the housing market. And, this, in turn, will put pressure on house prices.
The chart below from Calculated Risk illustrates the price-to-rent ratio over the past 15 years. As you can see, it got way out of whack during the peak bubble years and has now fallen back within the realm of normal. As rents fall, however, the ratio will start rising again. That is, unless house prices fall, too, which is the more likely scenario.
Three Government Reports Point to Fiscal Doom
by Martin Weiss
When our leaders have no awareness of the disastrous consequences of their actions, they can claim ignorance and take no action.
Or when our leaders have no hard evidence as to what might happen in the future, they can at least claim uncertainty.
But when they have full knowledge of an impending disaster … they have proof of its inevitability in ANY scenario … and they so declare in their official reports … but STILL don’t lift a finger to change course … then they have only one remaining claim:
And, unfortunately, that’s precisely the situation we’re in today: Three recently released government reports now point to fiscal doomsday for America; and one of the reports, issued by the Congressional Budget Office (CBO), says so explicitly:
- The CBO paints two future scenarios for the U.S. budget deficit and the national debt. But it plainly declares that fiscal disaster will strike in EITHER scenario. Furthermore …
- The CBO states that its fiscal disaster scenarios could cause severe economic declines for decades to come, including hyperinflation and destruction of retirement savings.
- The CBO then proceeds to admit that even its worse-case scenario could be understated by a wide margin due to panic in the financial markets or vicious cycles that are beyond control.
- Separately, in its Flow of Funds Report for the second quarter, the Federal Reserve provides irrefutable data that we are already beginning to witness the first of these consequences in the United States: an unprecedented cut-off of credit to businesses and consumers.
- Meanwhile, the Treasury Department shows that America’s fate remains, as before, in the hands of foreigners, with the U.S. still owing them $7.9 trillion!
- And despite all this, neither Congress nor the Obama Administration have proposed a plan or a timetable for averting these doomsday scenarios. Their sole solution is to issue more bonds, borrow more, and print more without restraint.
That is the epitome of insanity.
Yes, the great government bailouts of 2008 and 2009 have bought us some time … but they have promptly proceeded to sell us into bondage.
Yes, they have given us safe passage over tough seas … but only to throw our assets onto the global auction block for the highest bidders.
The one bright spot: Unlike some governments, ours does not conceal the evidence of its folly. Quite the contrary, the proof pours forth from these three government reports in relatively blunt language and unmistakably blatant numbers …
Congressional Budget Office (CBO):
The Long-Term Budget Outlook
The CBO opens with a chart predicting the most dramatic surge in government debt of all time.
It shows that even in proportion to the larger size of the U.S. economy today, the government debt has ALREADY surpassed the massive debt loads accumulated during World War I and the Great Depression … and will soon surpass even the massive debt load of World War II.
“Large budget deficits,” write the authors of the CBO report, would …
- “Reduce national saving,” leading to …
- “More borrowing from abroad” and …
- “Less domestic investment,” which in turn would …
- “Depress income growth in the United States,” and …
- “Seriously harm the economy.”
Worse, on page 14, the CBO warns that:
- “Lenders may become concerned about the financial solvency of the government and …
- “Demand higher interest rates to compensate for the increasing riskiness of holding government debt.” Plus …
- “Both foreign and domestic lenders may not provide enough funds for the government to meet its obligations.”
The magnitude of the problem cannot be underestimated. The CBO declares on page 15 that:
- “The systematic widening of budget shortfalls projected under CBO’s long-term scenarios has never been observed in U.S. history” and …
- It will also be larger than the debt accumulations of any other industrialized nation in the post-World War II period, including Belgium and Italy, the two worst cases of all.
But the CBO admits that even these frightening projections may be grossly understated because:
- “The analysis omitted the pressures that a rising ratio of debt to GDP would have on real interest rates and economic growth.”
- “The growth of debt would lead to a vicious cycle in which the government had to issue ever-larger amounts of debt in order to pay ever-higher interest charges.”
- “More government borrowing would drain the nation’s pool of savings, reducing investment” and …
- “Capital would probably flee the United States, further reducing investment.”
But none of these are factored into the analysis. On page 17 of its report, the CBO writes …
“The analysis … does not incorporate the financial markets’ reactions to a fiscal crisis and the actions that the government would adopt to resolve such a crisis. Because [our] textbook growth model is not forward-looking, the analysis assumes that people will not anticipate the sustainability issues facing the federal budget; as a result, the model predicts only a gradual change in the economy as federal debt rises.
“In actuality, the economic effects of rapidly growing debt would probably be much more disorderly as investors’ confidence in the nation’s fiscal solvency began to erode. If foreign investors anticipated an economic crisis, they might significantly reduce their purchases of U.S. securities, causing the exchange value of the dollar to plunge, interest rates to climb, and consumer prices to shoot up.(Bolding is mine.)
U.S. Federal Reserve:
Flow of Funds Accounts of the United States
The Fed’s data on page 12 tells it all: The impact on the U.S. credit markets is not just a future scenario. It’s happening right now.
Yes, the government is getting its money to finance its exploding deficits (for now). But it’s hogging all the available supplies, while American businesses and average consumers are getting shut out or even shoved out.
- In the first half of last year, the U.S. Treasury raised funds at the annual pace of $411 billion in the first quarter and $310 billion in the second quarter.
- But if you think that was a lot, consider this: THIS year, the Treasury has stepped up its pace of borrowing to annual rates of $1.443 TRILLION in the first quarter and $1.896 TRILLION in the second quarter. That’s 3.5 times and over SIX TIMES MORE than last year’s, respectively.
Meanwhile, the private sector is getting killed …
- Last year, banks provided new credit at the annual pace of $472.4 billion in the first quarter and $86.7 billion in the second. This year, they’re not providing ANY new credit — they’re actually LIQUIDATING loans at the rate of $857.2 billion in the first quarter and $931.3 billion in the second. So if you’re running a business, you may want to think twice before asking your bank for more money. Instead, they may decide to TAKE BACK the money they’ve already loaned you!
- Ditto for mortgages. Last year, mortgages were being created at the annual clip of $522.5 billion and $124 billion in the first and second quarters, respectively. This year, on a net basis, mortgages haven’t been created at all. Quite the contrary, the Fed reports that, on a net basis, they’ve been liquidated at an annual pace of $39.3 billion in the first quarter and $239.5 billion in the second.
- Getting cash out of credit cards and other consumer credit is even tougher. Last year, folks were able to add to their consumer credit at annual rates of $115 billion and $105 billion in the first two quarters. This year, in contrast, they’ve been forced to CUT back on their credit at annual rates of $95.3 billion in the first quarter … and at an even faster pace in the second quarter — $166.8 billion.
Never before in my lifetime have I witnessed a more severe case of crowding out in the credit markets!
And never before has the CBO been so right in its forecasts of fiscal doomsday: One of its dire forecasts was already coming true even before it issued its report.
U.S. Treasury Department:
Each and every month, the Treasury reminds us of the single fact that no one in the Treasury wants to face:
The U.S. is deep in debt to the rest of the world, and on page 48, it provides the evidence: total liabilities to foreigners of $7,898,435 million (nearly $7.9 trillion)!
This isn’t a new record. It was actually slightly more last year. But the fact is NOTHING has been done to reduce our debt to foreigners. Quite the contrary, it is the deliberate policy of our government to pile up more — to sell foreign investors and central banks on the idea that they must continue to lend us money.
The fact that this could potentially put our nation into deeper jeopardy is overlooked. And the dire forecast by the CBO that foreign investors might pull the plug is pooh-poohed.
Reserve Bank of Australia gets it wrong again
by Steve Keen
The RBA has put rates up now on the belief that the financial crisis is behind us, and it has to return to its established role of controlling inflation.
That this decision was likely was flagged by the speech by Anthony Richards last week, which implied that the RBA, having ignored the house price bubble created by private credit growth in the preceding two decades, was worried about the renewal of the bubble initiated by the Government’s First Home Vendors Boost (I refuse to call it by its official name, since the money clearly went to the vendors, while the buyers copped only higher prices).
Needless to say I am all for trying to contain the house price bubble, which I regard as a disguised Ponzi scheme that has sucked Australian households into unsustainable debt levels. It is quite possible that the increase in interest rates (which is sure to be fully passed on by lenders and will add $20 a week to the servicing costs of a now commonplace $400,000 home loan), combined with the phasing out of the Vendors Boost, will be enough to prick the bubble–especially if it is followed by another rise next month.
But the RBA is doing this in the belief that the economy will return to normal after the recent mild recession–normal meaning growing at about 3% per annum in real terms, and faster than that as it rebounds from the recession.
Unfortunately “normal” in our post-War experience has also involved a return to a rising private debt to GDP ratio. Every recession has involved a fall in debt-driven demand, and every recovery has involved a return to debt rising faster than income. As the global financial crisis has made many people realise, this is simply a formula for avoiding a crisis now by having a bigger one in the future.
I doubt that the RBA appreciates this even today. It is still mired in a neoclassical way of thinking about the economy, which myopically ignores the impact of debt-driven demand on the economy. This is why it can put up rates now in the belief that this will merely fine tune the economy’s performance–reducing the likelihood of inflation in the future.
I think it is likely that the RBA will achieve far more than it intends. The last time the RBA put rates up to attempt to control an asset price bubble that was already out of hand was back in 1989. That exacerbated the economic downturn that was already in train as the debt bubble of the 1980s started to collapse. I expect the outcome of this rate rise will be similar: a downturn that is already in train as a debt bubble bursts will be made worse by this increase in rates at a time of greatly heightened financial fragility.
The problem this time is I believe far worse than 1990. Then the household sector had a relatively low level of debt–the mortgage debt to GDP ratio was a comparatively trivial 18 percent, compared to its now record level of 87.5%. It was therefore possible for the financial sector to lend willy-nilly to households, something neoclassical economists facilitated by their enthusiastic deregulation of the financial sector.
Who is there to lend to today? All sectors of the economy except the government are carrying record levels of debt. Thus while the Vendors Boost and other enticements encouraged some additional borrowing by the already massively leveraged household sector–and gave us a household debt to GDP ratio that now exceeds America’s–I simply can’t imagine who (apart from the government) the financial sector can now sell debt to.
As a result, I doubt that we will see any sustained acceleration in the debt to GDP ratio, with the consequence that the debt-financed component of aggregate demand will be anaemic at best. Since that has been the major source of growth in aggregate demand for many years now, I expect that economic growth will be substantially less than the RBA anticipates.
If so, just as it killed a dragon that wasn’t there by its inflation-fighting rate rises up until March of 2008, it may be taming a lion that is sound asleep with its rate rises now. If economic growth does in fact stay well below levels that reduce unemployment in the coming two years, then there will be very good grounds for revoking the independence that the RBA has had in setting monetary policy. We may as well hand it back to the politicians, if the alternative is to leave it with neoclassical economists who don’t understand the dynamics of our credit-driven economy.
European Economy Contracts More Than Estimated
Europe’s economy contracted more than estimated in the second quarter as consumer spending, investment and exports were weaker than earlier reported. Gross domestic product in the 16-nation euro region fell 0.2 percent from the first quarter, when it dropped 2.5 percent, the European Union’s statistics office in Luxembourg said today in publishing final figures on second-quarter GDP. The decline was sharper than the 0.1 percent decline estimated on Sept. 2.
While the euro-area economy is gathering strength after governments injected billions of euros through tax cuts and spending incentives to fight the worst recession since World War II, the International Monetary Fund projected last week that Europe’s recovery will be "slow and fragile." Confidence in the economic outlook rose to a one-year high in September and investors also grew more optimistic. "This report is slightly negative but adds nothing to the big picture," said Nick Kounis, chief European economist at Fortis Bank Nederland NV in Amsterdam. "The economy very likely returned to growth in the third quarter and a rather moderate recovery is likely to follow in the coming quarters."
From a year earlier, GDP decreased 4.8 percent in the second quarter, also sharper than the 4.7 percent drop estimated earlier. The economy may expand 0.2 percent in the third quarter and 0.1 percent in the three months through December, the European Commission forecast on Sept. 14. European government bonds rose and the euro declined against the dollar after the GDP report. The euro was at $1.4717 at 10:52 a.m. in London, having earlier risen as high as $1.4737. The yield on the 10-year bund slipped 1 basis point to 3.15 percent.
Investment declined 1.5 percent in the second quarter, compared with the 1.3 percent drop estimated earlier, today’s report showed. Consumer spending rose 0.1 percent, half the increase estimated last month.
Exports shrank 1.5 percent in the latest quarter, a sharper drop than the 1.1 percent decline estimated last month. Imports fell 2.9 percent, compared with the 2.8 percent drop estimated earlier. The world economy is emerging from the deepest slump in more than six decades following interest-rate cuts and $2 trillion of government spending, tax breaks and infrastructure projects. The European Central Bank tomorrow may keep its key interest rate at a record low of 1 percent, according to a Bloomberg News survey of economists.
The IMF said on Oct. 3 that monetary policy will "need to remain supportive for the time being" across Europe to bolster an economic recovery. The euro-area economy may shrink 4.4 percent this year before expanding 0.9 percent in 2010, the Washington-based lender forecast. The ECB will announce its rate decision at 1:45 p.m. in Venice tomorrow. ECB President Jean-Claude Trichet will hold a press conference 45 minutes later.
UK Industrial Output Plunges In August
British industrial output in August fell unexpectedly and at its sharpest monthly pace since January, official data showed on Tuesday, dampening expectations for a strong rebound in growth in the third quarter of this year. The Office for National Statistics said manufacturing output fell 1.9 percent on the month -- the steepest fall since January -- and compared with July's downwardly revised rise of 0.7 percent. That confounded analysts' expectations for an increase of 0.3 percent.
The wider measure of industrial output, which includes energy production, fell by 2.5 percent on the month, also the sharpest drop since January and against forecasts for an increase of 0.2 percent. August's falls in output more than offset the gains recorded in the previous two months, highlighting the fragile state of the British economy. "August's dismal industrial production figures will dampen some of the recent optimism about the economy's apparent bounce-back," said Vicky Redwood of Capital Economics. "Accordingly, a return to positive overall GDP growth in Q3 now looks less certain," she added.
The pound fell to a 1-week low against the euro and gilt futures hit a contract high as investors scaled back their expectations for a quick recovery and bet that monetary policy would have to remain loose for some time yet. "This is a bit of a reality check on the status of the UK economy," said Philip Shaw, economist at Investec. The bank has slashed borrowing costs to a record low of 0.5 percent and embarked on a 175 billion pound programme to pump cash into the economy. Policymakers are expected to maintain that stance at their monthly meeting this week and Tuesday's data are likely to reinforce their concerns about the strength of a recovery.
Still, other data on Tuesday painted a more upbeat picture of the economy. The Society of Motor Manufacturers and Traders said car sales jumped 11.4 percent on the year in September, partly due to a government incentive scheme. And mortgage lender Halifax said house prices rose 1.6 percent last month. Meanwhile, the ONS said all 13 categories of manufacturing output fell in August, with significantly large declines in paper and publishing, electrical and optical equipment and food and drink. Motor vehicle production, which had given a boost to manufacturing output in July, fell by 2.6 percent in August, the data showed.
The ONS also said there was anecdotal evidence that factories had shut down for the summer break in August and that part of July's strong increase in output had been due to firms ramping up production before the recess. And oil and gas output was affected by planned closures of plants due to annual maintenance work. Oil and gas output fell by 7.7 percent on the month -- the steepest decline since October 2008. That led some analysts to conclude that there might be a rebound in output in September.
UK industry weakest since 1987
Manufacturing output collapsed in August, dragging down overall industrial production to its lowest level since 1987 and adding to fears that the UK has not yet managed to shake off the recession. Production by the manufacturing industry contracted by 1.9 per cent in the month, the biggest drop since a 3.1 per cent decline in January, the Office for National Statistics reported. Analysts had expected manufacturing output to increase by 0.3 per cent in August. The last time that manufacturing output was at such a low was May 1992. Industrial production was at its weakest since September 1987.
The sharp fall in output – although monthly figures can be erratic – comes after the manufacturing industry had shown little change since the beginning of the year. The sector has now contracted 14.8 per cent from peak to trough. The weak official data for August follow other evidence that manufacturing may be facing new problems. The purchasing managers’ index for the sector registered contraction in the past two months, after showing a rapidly easing decline earlier in the year. "After a couple of months of stabilisation, UK industrial production collapsed in August ... The number was almost unbelievably weak – the monthly fall was on a par with those seen in the most intense winter months of the recession," said Neville Hill, economist at SocGen.
The most significant decreases in output over the month were in the paper, printing and publishing industries, the electrical and optical equipment industries and in food, drink and tobacco production. Overall industrial output was down by 2.4 per cent in August, as a fall in oil and gas extraction helped drag down mining and quarrying by 7.3 per cent. "On the basis of these numbers third-quarter GDP looks like being either very weak or negative. Given the Bank of England’s monetary policy committee is currently expecting an increase in GDP in the third quarter, if that doesn’t materialise in the numbers at the end of the month it would support the arguments of those on the committee pushing for a further increase in asset purchases," Mr Hill said.
Other data on the UK economy out on Tuesday were less downbeat. Sales of new cars in Britain increased by more than 11 per cent last month, offering signs that the motor industry is bouncing back from recession as drivers take advantage of the government’s car scrappage scheme. There were almost 368,000 new car registrations in September, 11.4 per cent more than the same month a year ago, the Society of Motor Manufacturers and Traders reported, following a rise of 6 per cent in August and 2.4 per cent in July. House prices also continued their upward trend, the Halifax reported. Prices rose for the third month in a row and by 1.6 per cent in September. Prices were up by 2.8 per cent in the third quarter, the first quarterly rise in two years and the strongest since the beginning of 2007.
Russian Steel Writedowns Loom; Slump Wrecks Ambitions
Russian steelmakers’ plans for world domination are in tatters. A spending spree on U.S. mills meant to lift their billionaire owners into the industry’s top rank is instead forcing them to renegotiate debt and write down assets. OAO Severstal, the biggest producer, may sell some of the U.S. plants it bought for almost $4 billion at fire-sale prices or seek bankruptcy for them, Uralsib Financial Corp. analyst Dmitry Smolin said.
Outstanding debt at Severstal and next- largest producer Evraz Group SA almost tripled after they ramped up buying in 2006, while the cost of funding debt in Russia has risen by about 50 percent, according to data Bloomberg compiled. "Russian steelmakers’ acquisitions in the U.S. were all unsuccessful," said Dan Yakub, a Citigroup Inc. analyst in Moscow who recommends investors sell Evraz and who has a "hold" rating on Severstal. "The management wanted a global business, to get more flags on the map. They overestimated the potential of the U.S. market and underestimated the depth of the price collapse."
While the Russians began buying U.S. mills in 2004, with Severstal’s purchase of Rouge Steel Co., it was rising steel prices two years later that fueled an acquisition binge, totaling $18 billion according to Moody’s Investors Service. Even as economies and prices retreated from May 2008, Evraz, Severstal and OAO Novolipetsk Steel kept buying to try to pick up bargains. Instead the prices fell further, wiping as much as 70 percent off asset values, according to VTB Group.
Steel demand at automakers and builders tumbled amid the global economic crisis, with North American prices plunging as much as two-thirds from their May 2008 peak. Lower-cost mills in China, the largest producer, grew as plants in the U.S., Japan and Europe cut back. U.S. output in August was down 40 percent from a year earlier while China’s rose 22 percent, according to data from the Brussels-based World Steel Association. Severstal owner Alexei Mordashov, 44, followed Rouge Steel with a stake in Italian steelmaker Lucchini SpA, before buying gold miner Celtic Resources Holdings Plc.
By January 2007, as banks such as Credit Suisse Group AG were warning about risky credit derivatives, Mordashov said he was seeking acquisitions around the globe. As late as 2008, while debt markets imploded, Severstal made another four purchases of steel and coal assets. "I have no idea how much these assets are worth now as there are probably few buyers interested, if any," said Jean- Louis Tauvy, who as a fund manager in Moscow at Atria Advisors Ltd. helps oversee $120 million in Russian stocks. "It’s more probably a liability rather than an asset for Severstal. Evraz assets are better quality but are still worth much less than what they were bought for."
Moscow-based Evraz, part owned by Roman Abramovich, agreed to buy Claymont Steel Holdings Inc. in December 2007 and spend $2.4 billion on the Canadian assets of Ipsco Inc. in June 2008. The billionaire steel magnates, while driven by personal ambition, also bought operations in North America and Europe as a way to avoid anti-dumping duties and import quotas on the steel they were shipping from their plants in Russia.
In addition, access to Russian electricity a third the cost of power in western Europe along with cheaper raw materials and labor meant the steelmakers had double the profit margins of foreign rivals, and an impetus to invest spare cash that was out of step with the global economic cycle. "It was natural for Russian steel companies to look for targets abroad," said Aivaras Abromavicius, who helps run $2.5 billion in Russian equities at East Capital in Moscow. "Looking back, of course, it seems it would have been wiser either to return more cash to the shareholders in the form of dividends or to use it to pay back some of the loans."
Both Evraz and Moscow-based Severstal may need to seek waivers or changes to loan agreements with creditors to avoid breaching so-called debt covenants this year, Standard & Poor’s said in a report on Sept. 24. "The moderate upturn" in the market "may not be enough to support current ratings." The two companies have already written off at least $2.6 billion from the value of their purchases of foreign assets and goodwill, according to Bloomberg calculations. "Russian steelmakers will probably test their foreign assets for impairment at the end of the year and may then do further write-offs," Alex Herbert, an analyst at S&P in London, said by phone. He declined to provide specific estimates.
Severstal remains "committed" to operating in North America, "one of the world’s most important long-term markets for steel," the company said in an e-mailed response to questions on Sept. 29. It declined to comment on any sales of assets, write-offs or the viability of its U.S. operations. "We consider our acquisitions in North America to be a real success," Pavel Tatyanin, Evraz’s senior vice president for international operations, said by phone from Johannesburg. "We bought assets related to infrastructure. They will be among the first to recover and will benefit from U.S. stimulus." Evraz doesn’t plan to sell the operations, Tatyanin said.
North American domestic hot-rolled coil has rebounded 57 percent from the more than five-year low of $370 a short ton on June 9, 2009. The benchmark for regional steel prices lost two- thirds of its value in the previous year from a record $1,125. As the worst of the economic slump passes, prices rebound and demand returns, pressure on producers to write down assets may ease. UBS AG on Sept. 23 raised its fourth-quarter forecast for North American hot-rolled coil 20 percent to $570 a ton.
"It would be a misconception to say expansion to the U.S. failed," Gregory Mason, Severstal North America’s former CEO, said in a phone interview from Pittsburgh. "Those who say it think tactically rather than strategically. Strategic decisions should be viewed over the entire steel market cycle. It would’ve been unwise to sit on cash in Russia."
Others say Russian dreams of expansion have been shattered. When Severstal pinned its U.S. ambitions on demand for cars, vehicle sales slumped to the lowest in almost three decades. After Mason said steel assets could be had in the country for "bargain" prices, the industry lost half its market value. "Severstal will definitely have to reveal the strategy for the market regarding its U.S. plants, which may include either direct sale or filing for bankruptcy for some of the assets," Smolin said. "Evraz has better-quality assets and doesn’t plan to sell them but may consider the sale of some overseas assets if it fails to pay creditors," though this remains unlikely. Severstal International, the steelmaker’s overseas arm, said on Sept. 7 that two of its five U.S. plants were idle and it would retain its "most efficient" units.
Evraz sold the Cape Lambert iron-ore project in Australia in August and allowed an option to increase a stake in China’s Delong Holdings Ltd. to lapse. Lipetsk, Russia-based Novolipetsk in November scrapped a planned $3.5 billion takeover of New Jersey-based John Maneely Co. OAO TMK, Russia’s largest steel- pipe maker, ran U.S. plants it bought last year for $1.75 billion at a third of capacity in the first half of 2009. TMK plans to boost capacity utilization in the U.S. to 70 percent by the year-end, it said in an e-mailed response to questions yesterday, adding that it doesn’t plan "significant" write-offs for its assets.
The company said its expansion has been successful, even with a drop in demand this year, because the U.S. is the world’s largest market for oil and gas pipes. Severstal’s operations in the U.S. "may have to file for bankruptcy," said Sergei Belyaev, who helps oversee $150 million in investments from Russia and former Soviet states at Kazimir Partners in Moscow. "The assets that don’t generate cash are basically worth nothing."
Banks brace for Latvia's collapse
The Baltic states are once again in the eye of the storm after leaked reports that Sweden is bracing for a full-blown economic and political "breakdown" in Latvia. The Svenska Dagbladet newspaper said Sweden's finance minister Anders Borg had told banks secretly that Latvia's political order was unravelling, advising them to prepare for the collapse of Latvia's rescue talks. Latvia has failed to deliver draconian spending cuts agreed to secure the next tranche of its €7.5bn (£6.85bn) bail-out from the EU, the International Monetary Fund, and Sweden, balking at 20pc cuts in pensions and a further 15pc cut in public wages.
The People's Party, the largest group in the coalition, voted against austerity measures last month, raising concerns that the country is ungovernable. Mr Borg said the world's patience is running out. "It will be very hard to continue with these international programmes if they don't fulfill the spirit and the content in the agreements they have signed." Latvia's economy contracted by 18.2pc in the twelve months to June, trumped only by Lithuania at 20.4pc.
"Latvia's currency peg is back on the agenda, " said Hans Redeker from BNP Paribas. "The government has to relax policy for social reasons. The hardship this winter is going to be unbelievable." Youth unemployment in Latvia is already 31pc, and concentrated among ethnic Russians. Premier Valdis Dombrovskis said his chief task is to "preserve social peace".
Neil Shearing from Capital Economics said the appetite for austerity has been exhausted. Latvia is "more likely than not" to devalue, toppling pegs in Estonia and Lithuania. "Financial markets elsewhere in the region are likely to be hit by contagion, with Hungary, Romania, and Ukraine most vulnerable." The area is better able to cope with shocks than during the panic this Spring. The G20 tripled the IMF's fire-fighting fund to $750bn in April, chiefly as an insurance for Eastern Europe. This has greatly reduced risk of a liquidity crisis. It does not alter the slow-burn damage of rising defaults.
The Baltic trio financed property booms in euros (and swiss francs) because rates were lower. It was taken for granted that eventual euro entry had eliminated the exchange risk. This has become a trap. They need to devalue to break the cycle of depression, but cannot do so because of euro mortgages. Instead they hope to claw back lost competitiveness through wage deflation. This takes years, and discipline. Mr Shearing said Latvia's economy would shink by 30pc whether it devalues or not. The peg merely draws out the agony, and slows the pace of inevitable defaults.
Washington's Center for Economic and Policy Research said the IMF is enforcing a"pro-cyclical contractionary policy" in Latvia. Foreign banks (mostly Swedish) are being rescued at the cost of local taxpayers. The IMF deal equals 34pc of GDP. Latvia is piling up debt to defend its peg. The policy may backfire in any case. Fiscal contraction is causing tax revenues to implode, feeding a vicious circle.
Lars Christensen from Danske Bank said Latvia's political class is chiefly responsible for clinging to the peg. "It's their choice, but if they want the bail-out money, they must do what they promised. They don't seem to understand that the IMF and EU are willing to walk away now that the global economy has improved and spill-over risks have been reduced," he said. Prospects are grim whatever happens "There is absolutely no sign of stabilisation. The economy is still contracting. It's paralysis," he said.
Why 23 October could be a bad day for the euro
The Irish voted for the Lisbon Treaty with a hearty 'yes' on Friday. They didn't have a lot of choice. Or at least, they felt they didn't. Ireland is in a deep hole right now. Apart from pretty-much bankrupt countries like Iceland, Ireland is the developed economy which has suffered the worst in the financial crisis. And the last thing the Irish felt like doing was embracing wholesale change, which might make things even worse.
Of course, things are going to be painful for Ireland either way. No one can wave a magic wand and make the recession go away. But at least the EU can breathe a sigh of relief at wiping out another threat to the European project. The real threat to Europe lies elsewhere... Few countries are having a tougher time in this recession than Ireland. Latvia is one of them. The Latvian economy shrunk by 18.2% in the 12 months to June. In other words, the country's economy is now nearly a fifth smaller than it was just a year ago. That's a lot to lose.
How did it end up in this mess? Latvia is a member of the EU, but has its own currency, the lat, which is pegged to the euro. Basically, the country fell victim to the "euro convergence" trade during the good times. This was the assumption by investors that most countries in eastern Europe would end up joining the euro, so therefore you could treat their obscure and previously somewhat dubious currencies as basically being just as good as euros.
This led to lots of foreign-owned banks piling into these countries – in Latvia's case, it was Swedish banks – offering cheap finance denominated in euros, or Swiss francs. Loose money led to property and other asset bubbles. Then when the easy money days vanished, so did the prosperity. And just like in Ireland, when you ripped the property bubble away, what you were left with was an uncompetitive economy with too-high wages and too much reliance on an over-inflated property sector. Meanwhile, with foreigners unwilling to lend any more money to the country, Latvia has already had to turn to the International Monetary Fund (IMF) for a bail-out. It is currently being propped up with loans from the IMF and the EU.
Normally, what would happen in such circumstances is that a country's currency would collapse – like Iceland's for example. But Latvia is defending its currency peg because it has its heart set on euro membership. That means that it has to devalue the hard way – wages and prices have to fall to make the country more competitive. On top of this, to secure further tranches of lending from the IMF, the country is having to meet tough austerity measures to show that it's serious about repaying its debts. But as Ambrose Evans-Pritchard has regularly pointed out in The Telegraph, this route out of a crisis is painful. And it's not the sort of thing that populations put up with for long.
Already, Latvia's governing coalition is falling out over the austerity measures. Last month, the government failed to push through a property tax raise which was a key aspect of the EU and IMF bailout conditions. Then at the weekend, the government announced it would make budget cuts of 225m lats, rather than the 275m expected. The IMF has asked for a total of 500m in cuts. If it doesn't meet these conditions, and the IMF decides to pull the plug, then Latvia can't continue to defend its currency peg, and it will basically go bust. And if the IMF ever felt over a barrel because of the risk to the wider global economy, it certainly doesn't any more.
As Lars Christensen of Danske Bank tells Evans-Pritchard: "They [Latvia] don't seem to understand that the IMF and EU are willing to walk away now that the global economy has improved and spill-over risks have been reduced." The Swedish press yesterday were reporting that Swedish finance minister Anders Borg had been holding secret talks with Sweden's big banks, Swedbank and SEB, to "prepare them for the fallout," says Izabella Kaminska on FT Alphaville. Borg has already warned Latvia that "lenders' patience is wearing thin".
However, the IMF and EU shouldn't get too complacent. If Latvia goes, we could see other countries in the region abandon their pegs and devalue too. And as the Asian crisis showed us all in the Nineties, when one domino topples, you can never be quite sure where the chain reaction will actually end. The IMF reckons that of all the banks in the world, Europe's are the ones sitting on the biggest pile of undisclosed toxic debts. A crisis in Eastern Europe could be just the thing to bring that weakness to light.
The Latvian government has to submit its budget proposal for 2010 to Parliament by 23 October. If it doesn't come up with a suitably austere package, then we'll soon find out whether Latvian devaluation will end up being a storm in a teacup, or the start of something much bigger. What does that mean for investors? Well, as my colleague David Stevenson pointed out yesterday, everyone is rather gloomy about prospects for the dollar right now. At the same time, investors seem somewhat complacent about prospects for the euro, particularly in light of the Irish 'yes' vote. It's another reason to believe the dollar is overdue a bounce while the euro is overvalued - and a crisis in Latvia could be just the catalyst.
Then of course, there's the threat to the wider global economy. The Federal Reserve always said that the subprime crisis was a small, easily-contained problem. They were wrong about that. Those who think Latvia's problems will be easily contained could be just as badly wrong. That's another reason to be cautious about prospects for stock markets. As we've said for a while now, investors should be very picky when choosing stocks. We've favoured big blue-chip defensive plays for a while now, but I've just been reading about an interesting stock-picking method based on looking at research and development spending. I don't have space to go into it in detail right now, but I'll have more from the chap behind the method, Dr Mike Tubbs, later this week – keep an eye out for it.
Iceland's steamy waters
Business is booming at the Blue Lagoon. One evening last week at the hot springs on the lava fields above Grindavik, dozens of bathers were still enjoying the warm geothermal waters even as the last trace of daylight faded from a sleet-filled Icelandic sky. Almost all were foreign tourists, part of a surge in visitors – August's numbers were up 12 per cent on 2008 – since last year's bank crash sent the krona plummeting.
But the thriving tourism trade, while welcome, is a rare piece of good news amid a mostly gloomy outlook for the storm-tossed island on the cusp of the Arctic Circle. A year ago on Tuesday, Geir Haarde, then prime minister, went on national television to declare that Iceland faced bankruptcy after the "fairytale" growth of its banking sector met a nightmare end. Over the next two days, all three main lenders – Landsbanki, Glitnir and Kaupthing – were nationalised and the country put itself at the mercy of foreign donors.
Iceland, previously among the world's richest nations per head, had become the worst-hit victim of the global credit crunch: a laboratory study in how a toxic mix of financial deregulation, free-flowing international capital and a reckless band of "Viking raider" entrepreneurs intent on conquering the world could bring a country to its knees. As such, its progress towards recovery represents another experiment – this time in how to rebuild a shattered economy.
Even without this wider significance, Iceland's fate carries greater importance than its size would imply. The country vies with Equatorial Guinea for the title of the world's 100th biggest economy and its population of 320,000 is one-third smaller than that of Luxembourg, the European Union's smallest member state. Yet in the decade before the crisis, Iceland's banking sector assets grew to 10 times annual gross domestic product and became a launch pad for frenzied international expansion by the businessmen, also dubbed the "Icelandic oligarchs", who built the financial empires.
When the edifice collapsed, many European investors suffered collateral damage. This gives foreign creditors a stake in Iceland's recovery as they try to salvage some of the billions of euros and pounds lost in the rubble. The foreign ministries of Europe and North America are also paying attention as the crisis strains at the geopolitical moorings of a Nato ally that sits in the middle – literally – of the transatlantic alliance.
Johanna Sigurdardottir, who succeeded Mr Haarde as prime minister in February, insists recovery efforts are on track. Healthy banks have been spun out from the failed ones and injected with capital. Control of two of the lenders has been offered as compensation to foreign creditors; and the economy has proved more resilient than expected as the weak currency aids exports. "We have done better in many ways than people predicted one year ago," she says. "Unemployment is lower than we feared and the contraction is not as severe."
The finance ministry expects gross domestic product to contract 8.5 per cent this year, only a little worse than the projected drop in Ireland – another prominent crisis victim – and the unemployment rate is less than in the US and several other developed countries at about 7.5 per cent. Yet such figures tell only part of the story. The collapse of an overblown banking sector has turned Iceland into one of the world's most indebted countries, the painful consequences of which have yet to fully materialise. "We are still in the danger zone," says Jon Baldvin Hannibalsson, a former finance and foreign minister, predicting that the next 12 months will be Iceland's true "annus horribilis".
Austerity measures imposed as a condition of the $5.1bn (€3.5bn, £3.2bn) bail-out led by the International Monetary Fund are only now about to kick in, with steep tax rises and spending cuts planned for 2010. A moratorium on home foreclosures is also soon to end, imperilling thousands of homeowners saddled with foreign currency loans they can no longer afford.
Little wonder that few ordinary Icelanders share the prime minister's rosy assessment of progress. "It's gone from bad to worse," said one man stood among a throng of protesters banging pots and pans outside parliament last week as lawmakers arrived for the new session. The crisis – or kreppa, as it it called locally – still looms heavily over life in Reykjavik, with half-built office blocks abandoned and shops almost deserted except for tourists.
For anyone with a stake in Iceland's future, the past few weeks have not been encouraging. Ms Sigurdardottir's left-green coalition government has teetered close to collapse amid agonised debate over a controversial deal to reimburse the UK and the Netherlands to the tune of nearly €4bn. Hundreds of thousands of British and Dutch citizens, charities and local authorities had poured money into Landsbanki's offshore Icesave accounts, lured by high interest rates as the bank expanded overseas.
Two days after Mr Haarde's address, the UK deployed anti-terror laws to freeze Icelandic assets in a vain attempt to save citizens' money. But the move succeeded only in hastening the collapse of Iceland's financial system and sparking a diplomatic dispute that has sapped political energy in Reykjavik for much of the past year.
The Icesave issue is crucial because the IMF and the Nordic countries that also contributed have refused to release additional funds until Iceland settles its dispute with the UK and the Netherlands. An IMF review, which must take place before more is disbursed, has been delayed since February. "The Icesave issue is of huge importance to us because most of our recovery efforts hinge on a solution being found," says Ossur Skarpheoinsson, foreign minister. "If we are not able to solve this, it would perhaps mean that a political crisis would be added on to the financial crisis."
Iceland's new government struck a deal with its UK and Dutch counterparts in June but parliament refused to ratify it amid public fury over the terms. Critics said the repayment plan, equivalent to about half the island's annual GDP, would penalise taxpayers for the recklessness of a private bank and stifle recovery by loading the country with debt. Lawmakers finally approved the deal last month – but only after adding a series of conditions to limit annual payments and open the possibility of future renegotiation. The UK and Dutch governments have signalled opposition to some of the changes, threatening to send the dispute back to square one.
Arni Thor Sigurdsson, chairman of parliament's foreign affairs committee, hopes the UK and the Netherlands will agree to a compromise. "It is not in their interests for the government to fail because that would make it less likely that they would ever get their money back," he says. But the issue has sapped the authority of Ms Sigurdardottir's coalition at a time when strong leadership is needed to push through unpopular budget cuts and further financial restructuring. Instead, the government finds itself struggling to paper over internal divisions while the conservative opposition, ejected from power in disgrace after the crisis, is exploiting anger over Icesave to revive its fortunes.
"The government has ended up looking like amateurs who went up against the tough, skilful British and Dutch negotiators and came back with a rotten deal," says Mr Hannibalsson. The dispute has poisoned attitudes towards the wider world. From the highest levels of government to ordinary citizens, Icelanders feel bitter about the IMF and other European countries for implicitly siding with the British and Dutch by linking aid to Icesave. "The IMF and the [European Union] are being used against us," says Ogmundur Jonasson, the former health minister whose resignation in protest over Icesave last week nearly brought the government down.
Complaints are hardly unusual from countries forced into the straitjacket of an IMF rescue programme. But as the wealthiest and most developed country to receive support from the IMF in recent times, Iceland provides a test of the fund's ability to work with nations hit by crisis. "I think if we get rid of the IMF, and the sooner the better, we will rise to our feet again," Mr Jonasson adds, accusing the fund of imposing excessive and hasty budget cuts that will hurt Iceland's long-term competitiveness. "They are behaving like an economic police force acting in the interests of foreign creditors rather than the best long-term interests of Iceland."
Much of the hostility is focused on the EU as a eurosceptic opposition succeeds in channelling public anger towards Brussels. Ms Sigurdardottir, an advocate of EU membership, hoped the crisis would encourage Icelanders to seek greater economic stability within the 27-member bloc – and eventually the eurozone. In July, she overcame divisions within the government to secure a narrow parliamentary vote in favour of starting talks with Brussels: a formal application was lodged days later. But public support for accession has eroded sharply since and polls show a clear majority opposed. "Iceland as a nation has become more inward-looking for the time being," says Mr Skarpheoinsson.
Mr Hannibalsson warns of a creeping "paranoia" in politics, highlighting calls by some opposition members to seek closer ties with Russia and China. Moscow was the first foreign power to rush to the aid of Reykjavik last October, with a €4bn loan a day after the crisis erupted. Iceland, which served as a mid-Atlantic aircraft carrier for Nato forces during the cold war, has a front-row seat in the increasingly strategic Arctic region. Almost all Icelanders agree that the country is culturally and politically part of Europe even if they are divided on EU membership. But the mere fact the issue is being discussed shows that everything about Iceland's future is up for grabs – including its place in the world.