Car ferry Michigan Central turning in ice, Detroit River
Ilargi: If and when the Federal Reserve moves out of the mortgage backed securities field -a move expected in the first quarter of 2010-, will private investors step in? Well, why should they? What profit can they expect to reap? US housing prices have been kept artificially high for at least the past two years (if not the past 70) by the combination of the Fed's recent $1.25 trillion MBS purchases and the aggressive securitization policies of Fannie Mae, Freddie Mac and the FHA/Ginnie Mae team.
But this can't go on forever. As the Washington Post says, the government has lost its "huge federal gamble on the politically popular cause of homeownership". And the administration may try to paint rosy and green pictures of an economic recovery, and the stocks markets may seem to be doing relatively well, but none of it means a thing with the housing market in a death spiral.
Now that Washington has lost that bet (a crucial admission for the WaPo, by the way), which investors will still be gullible enough in 2010 to buy securities based on grossly overvalued properties?
The Wall Street Journal warns of a double dip in housing. Color me blind, but when did the first dip end? President Obama also warns of a double dip, this time of the recession in whole US economy. And this time, color me obstinate, but I don't buy the numbers that supposedly show an end to the recession, or the first dip of it. I see trillions of dollars in lipstick applied to dead industries.
You can't end recessions or depressions by borrowing money from one neighbor and handing it to the next. That's not even shoddy accounting, hey it's not even fraud for that matter, it's simply nonsense.
Perhaps if some if the money would have been used in fields that produce actual products, if it would have provided useful jobs for Americans, then perhaps it would have alleviated some of the misery. Banks, though, do neither, and still they are the sole recipients of bail-out money so far. Yes, even of what went to Detroit or home-buyers, just follow the money.
And so, starting January 1st, some 30,000 Americans every day, or 1 million per month, will start losing ALL benefits, even those just agreed on last week by Congress, unless yet another plan is devised. And this will happen against the backdrop of $30+ billion in year end bankers' bonuses. $10 million for one guy, nothing for the other. Scrooge ain't dead, he's alive and well at 85 Broad Street.
And no relief in sight. Unemployment keeps seeping upwards, and the other pillar of the economy, housing, looks ever closer to its terminal breath. Oh, someone will always build a home somewhere, but that does not an industry make. The most blatant sign of pain this time around comes from a graph on multi-unit housing starts, a category routinely filed under "commercial real estate", which shows the lowest number on record since reporting started in 1958.
The lowest number on record! In case you hadn't realized it yet, the US population today is not that far shy of having doubled since the 1950's. Twice as many people, but less family housing is built.
Talking about commercial real estate, it should be obvious who everyone's betting against today. Regional banks, both big and small, have, in relative terms, much larger exposure to CRE than their national-sized brethren, as this Moody's graph shows:
The FDIC may feel well playing its part in the overall US government opacity (does anyone even remember the promises of greater transparency?), but hundreds of banks that Sheila Bair and co. have refused to tackle until now will be due to meet their makers regardless in the -very- near future.
And if you're still among the faithful believers despite what goes on in employment, housing and commercial real estate, here are a few things you might want to pay attention to.
House Rep. Peter Defazio claims a growing consensus among Democrats to call for the head of Treasury Secretary Tim Geithner. It's safe to assume that Larry Summers would have to go as well. Geithner's future may depend on the upcoming December unemployment summit in Washington.
Given the fact that the summit is at least one year late, that the public money spread around Wall Street can't be spent a second time, and that Geithner insists on using the remaining TARP funds for something other than jobs, it could be an interesting meeting. But in view of the control the Obama spin team has exercised so far, hopes for a revolt by their own party may be idle. And besides, what good would it do? Most important posts would still be in Goldman, JPM, Citi and Morgan Stanley hands.
More interestingly, perhaps, are two reports this week, in which financial giants Goldman Sachs and Société Générale, separate from each other, reveal that their view of the immediate future is not nearly as fine and benign as you may think. Société Générale singles out private and public debt as the possible instigator for economic collapse, and tells clients that sovereign bonds will get them good returns. Goldman simply bets heavily against financials and against gold!.
Where the two diverge is in their view of the dollar: Société Générale sees it plunge further, whereas Goldman Sachs sees the opposite. And as much as it may chagrin us to agree with Goldman on anything at all, we do when it comes to the US dollar. We think of it as sort of the wounded crippled last one standing when the first smoke will begin to clear and the bodies are carried out. We don't doubt that oil and gold have very good odds for a strong comeback down the line, but they are not the obvious choice in a situation such as the one we see coming short term.
What we see is not gold vs. the USD or oil vs. the USD. We see risk versus the US dollar. Investors have not been risk averse the past months. And they still are not (yet). And stocks are up, and gold is up, and so is oil. And the dollar is down.
Risk versus the US dollar. If one goes down, the other goes up.
We think that right there you can see what will happen when investors and speculators and everybody else except for a few bravehearts will want to get away from risk, lose their appetite. At that point, it'll be either risk or the dollar. If you think investors will want to take on additional risk, in the face of the numbers on housing and jobs and CRE, a bet against the dollar makes sense. If you don't, that bet, in our view, makes no sense.
Ilargi: Ilargi: You don't have to be just an observer on a couch, and you shouldn't. This is not TV. You can be part of the Automatic Earth. By donating.
Our Fall Fund Drive (please see the top of the left hand column) is on right now. Your donations -and visits to our advertisers- make this site possible. Without you, there can be no Automatic Earth. We're not talking multi-thousand dollar donations, even though these are very welcome and would allow us to take the next few steps towards what we think this site could and should be, but essentially, for now, the Automatic Earth is being kept alive with donations of $100 or even $10 at a time.
And of course we'd like to thank all our past, present and future donors for your confidence in us. That can never be said enough, and there never seems to be a suitable way to express that gratitude. But rest assured, you make us feel humble.
New Jobless Claims Flat at 505,000
The number of U.S. workers filing new claims for jobless benefits last week remained unchanged from the prior week, the Labor Department said in its weekly report Thursday. Total claims lasting more than one week, meanwhile, declined. Initial claims for jobless benefits remained steady at 505,000 in the week ended Nov. 14. The previous week's level was revised to 505,000 from 502,000. Economists surveyed by Dow Jones Newswires had expected a slight increase of 4,000 claims. Despite the fact claims were unchanged in Thursday's report, economists have said they've seen some good trends in jobless claims figures recently.
"Jobless claims have been trending steadily downward, which is a positive sign for the labor market," economists at J.P. Morgan Chase & Co. wrote in an economic analysis last week. "Payroll employment losses have been quite steady for the last three months, but the drop in claims suggests that job losses could start to moderate again soon." The four-week moving average of new claims, which aims to smooth volatility in the data, fell by 6,500 to 514,000 from the previous week's revised average of 520,500. That is the lowest figure since November 22, 2008.
Initial claims still remain at a fairly high level and remained stagnant last week, suggesting the job market continues to face a sluggish recovery. Recent data showed that the unemployment rate in the U.S. hit 10.2% in October, which was up from 9.8% in September. In the Labor Department's Thursday report, the number of continuing claims -- those drawn by workers for more than one week in the week ended Nov. 7 -- fell by 39,000 to 5,611,000 from the preceding week's revised level of 5,650,000. The unemployment rate for workers with unemployment insurance for the week ended Nov. 7 was 4.3%, unchanged from the prior week's unrevised rate. The largest increase in initial claims for the week ending Nov. 7 was in Michigan due to layoffs in the automobile, construction and service sectors. The largest decrease in initial claims occurred in Florida.
One Million Americans Face Loss Of Jobless Benefits In January
The National Employment Law Project says that the public’s perception of what will happen to insurance benefits for the unemployed early next year is flawed. Most press reports on Congressional action on the matter say that one million people have had their benefits extended well into 2010. That apparently is not so. The NELP released a new analysis which finds that one million workers will become ineligible for unemployment benefits in January 2010 unless Congress reauthorizes the American Recovery and Reinvestment Act’s unemployment insurance programs by the end of December.
The organization writes “The critical benefits provided to jobless workers by the ARRA are set to expire at the end of the year, which means that even with the latest 14 to 20 week extension enacted in November, 30,000 workers a day will be left without any jobless benefits in January. By March, the number without federal jobless benefits will swell to nearly three million workers.” It has been widely assumed that the benefits for many of the unemployed had already been extended by as much as several months. The New York Times points out the problem with that reasoning: “The added federal benefits were built on a series of previous extensions that are slated to end on Dec. 31, unless Congress renews these programs.”
The NELP analysis is devastating because it means that the “social safety net” for millions of people could disappear in the early part of 2010. That will almost certainly lead to a number of troubling consequences which will include a rise in mortgage delinquencies, adults who cannot regularly put food on the table, and an increase in ranks of the homeless who will need to rely on shelters or friend and relatives for a place to live and sleep. It also means that the tiny amount of money these people might have spent, a very modest addition to nationwide consumer activity, will go away.
The Obama Administration plans to have a jobs summit on December 3rd. The purpose of this is to draw together political and private sector leaders to discuss means for stopping the rise in joblessness which has taken national unemployment to 10.2% and which will likely stay above 10% for most if not all of next year. The trouble is that the jobs summit comes a bit late. Any program that goes into effect will not clear Congress until early next year and the effects will almost certainly not be felt until the end of the first quarter. By that point, the economy could be in another rut caused in large part by a drop in consumer spending based on unemployment and the fear of many workers that they will join the jobless ranks soon.
There does not appear to be any solution to improving the employment situation without a second stimulus package, whether it is called that or not. Consumer spending, a rise in exports, and the $787 billion already being pumped into the economy have been inadequate. That does not leave many options beyond federal programs aimed very directly at putting people back to work.
Société Générale tells clients how to prepare for 'global collapse'
Société Générale has advised clients to be ready for a possible "global economic collapse" over the next two years, mapping a strategy of defensive investments to avoid wealth destruction. In a report entitled "Worst-case debt scenario", the bank's asset team said state rescue packages over the last year have merely transferred private liabilities onto sagging sovereign shoulders, creating a fresh set of problems.
Overall debt is still far too high in almost all rich economies as a share of GDP (350pc in the US), whether public or private. It must be reduced by the hard slog of "deleveraging", for years. "As yet, nobody can say with any certainty whether we have in fact escaped the prospect of a global economic collapse," said the 68-page report, headed by asset chief Daniel Fermon. It is an exploration of the dangers, not a forecast. Under the French bank's "Bear Case" scenario, the dollar would slide further and global equities would retest the March lows. Property prices would tumble again. Oil would fall back to $50 in 2010.
Governments have already shot their fiscal bolts. Even without fresh spending, public debt would explode within two years to 105pc of GDP in the UK, 125pc in the US and the eurozone, and 270pc in Japan. Worldwide state debt would reach $45 trillion, up two-and-a-half times in a decade. (UK figures look low because debt started from a low base. Mr Ferman said the UK would converge with Europe at 130pc of GDP by 2015 under the bear case).
The underlying debt burden is greater than it was after the Second World War, when nominal levels looked similar. Ageing populations will make it harder to erode debt through growth. "High public debt looks entirely unsustainable in the long run. We have almost reached a point of no return for government debt," it said. Inflating debt away might be seen by some governments as a lesser of evils. If so, gold would go "up, and up, and up" as the only safe haven from fiat paper money. Private debt is also crippling. Even if the US savings rate stabilises at 7pc, and all of it is used to pay down debt, it will still take nine years for households to reduce debt/income ratios to the safe levels of the 1980s.
The bank said the current crisis displays "compelling similarities" with Japan during its Lost Decade (or two), with a big difference: Japan was able to stay afloat by exporting into a robust global economy and by letting the yen fall. It is not possible for half the world to pursue this strategy at the same time. SocGen advises bears to sell the dollar and to "short" cyclical equities such as technology, auto, and travel to avoid being caught in the "inherent deflationary spiral". Emerging markets would not be spared. Paradoxically, they are more leveraged to the US growth than Wall Street itself. Farm commodities would hold up well, led by sugar.
Mr Fermon said junk bonds would lose 31pc of their value in 2010 alone. However, sovereign bonds would "generate turbo-charged returns" mimicking the secular slide in yields seen in Japan as the slump ground on. At one point Japan's 10-year yield dropped to 0.40pc. The Fed would hold down yields by purchasing more bonds. The European Central Bank would do less, for political reasons.
SocGen's case for buying sovereign bonds is controversial. A number of funds doubt whether the Japan scenario will be repeated, not least because Tokyo itself may be on the cusp of a debt compound crisis. Mr Fermon said his report had electrified clients on both sides of the Atlantic. "Everybody wants to know what the impact will be. A lot of hedge funds and bankers are worried," he said.
Goldman Sachs Betting on Derivatives Collapse Sparked Financial Crash?
Earlier this month, I detailed 25 US commercial banks that had trillions (with a “T”) of dollars’ worth of exposure to derivatives on their balance sheets. At the time, I stated that even if 4% of the notional value of these derivatives was “at risk” and only 10% of that 4% went bad, that you would wipe out the total equity at the five large US banks. Given how mortgage backed securities turned out (and those securities WERE regulated, unlike derivatives), I believe that most, if not ALL major banks in this country are insolvent or would be recognized as such if you marked the assets on their balance sheets at anything resembling market values. As a review, here’s the chart I presented revealing the banks and their derivative exposure:
Paints quite a picture, doesn’t it?
This alone explains in no uncertain terms that the Financial Crisis is anything but over. Sure the Federal Reserve may have pumped $800+ billion into the financial system, yes the Fed is buying some $1.2 trillion in mortgage-backed securities, and of course there are the Fed’s off balance sheet arrangements, which we cannot even begin to quantify. But ALL OF THESE efforts amount to diddily-squat in the face of TRILLIONS and TRILLIONS in potential losses in the derivatives market.
Sure, the banks may not publicly state how much of their derivatives are “at risk” but when you’re talking about $200+ TRILLION (an amount equal to four times GLOBAL GDP) it doesn’t really matter how much is “at risk.” As I said before, if even 4% of this is “at risk” and 10% of that 4% goes bad, you’re talking $800 billion in equity wiped out (that’s the entire equity of the five largest commercial banks). I know this… as does anyone who does a little homework on the banking industry. Including… THE BANKS THEMSELVES.
Goldman Sachs recently published its 13F, a quarterly filing in which all asset managers reveal their largest holdings. In it, Goldman’s asset management group reveals their largest long positions and their largest short positions. Now, Goldie is widely held to be the “smartest” guys on Wall Street (not my opinion) so their net shorts (the stocks or companies they’re betting AGAINST) were particularly interesting to me:
The above positions combine Goldman’s long and shorts (stock and option based positions) for the NET short positions. In simple terms, Goldman MAY be long these companies, but because the bank is ALSO shorting them (and shorting more shares than it is going long) it has NET short positions. Put another way, these are the companies or positions that Goldman is betting the most money on falling in the future.
For starters, FOUR of the top 10 are financial companies. The largest financial short is Wells Fargo, which Goldman has committed $289 million to betting against. After that it’s Mastercard ($266 million), then PNC ($202 million), and finally AIG ($152 million). Looking at Goldman’s positions, it’s plain as day that Wall Street’s “finest” do NOT believe the financial crisis is over (why are they betting against the banks if they do?). It’s also clear that Goldman’s analysts have noted as I have that both Wells Fargo and PNC both have massive exposure to the derivatives market (the fact that Goldman ALSO has massive derivative exposure is beyond ironic).
However, where things get absolutely absurd is Goldman’s short position of AIG. Goldman, as has been widely documented, was one of the largest benefactors of AIG’s bailout (the then investment bank had MASSIVE counter party exposure to AIG’s toxic balance sheet). To see Goldman now betting AGAINST AIG after receiving $13 billion in tax payer money to insure the former didn’t go under along with the latter is outrageous (if not infuriating) to say the least.
On a final note, I wanted to point out Goldman is also shorting a Euro index (betting against that currency) as well as two gold mining companies (Barrick and Agnico Eagle Mines). This indicates that Goldie is bearish on both the euro and gold which hints that Wall Street’s finest are likely betting on a US Dollar rally (that would, after all, be the most obvious catalyst for a correction in gold and the euro). To be blunt, it’s clear that Goldman (like me) believes the financial crisis is nowhere near over: four of its top ten largest shorts are financial companies. It’s also worth noting that Goldman is betting against gold and the euro. Given Goldman’s incredible access to and close relationship with the regulators and federal government, I see this as further proof that we may be seeing another stock crisis triggered by a Dollar rally in the near future.
Fire Geithner and Summers, prominent Democrat says
'We may have to sacrifice just two more jobs to get millions back for Americans'
President Barack Obama "is being failed by his economic team" and should replace Treasury Secretary Tim Geithner and White House economic policy director Larry Summers, says US House Rep. Peter DeFazio. The prominent member of the Congressional Progressive Caucus told MSNBC's The Ed Show that he and other House members are growing increasingly frustrated by a White House economic policy that focuses on maintaining the financial stability of Wall Street firms while largely overlooking Main Street concerns.
"I think there is a growing consensus in the [Democratic] caucus [that] we need a new economic team that cares more about jobs, Main Street and the American people than it does about Wall Street and huge bonuses," DeFazio (D-OR) told host Ed Schultz. DeFazio suggested that the government "reclaim the unspent funds ... reclaim some of the funds that are being paid back, which will not be paid back in full, and we use it to put people back to work rebuilding America's infrastructure. "We may have to sacrifice just two more jobs to get millions back for Americans," DeFazio said.
DeFazio criticized Geithner for not being forthcoming about where TARP bailout money went, saying that the treasury secretary was "absolutely not" coming clean about how the government used $700 billion of taxpayers' money to rescue ailing Wall Street firms. A news analysis at CBS published yesterday says that the US Treasury "gave away the farm" when it bailed out insurance giant AIG, pointing out that, in normal bankruptcy cases, creditors would receive only a fraction of the money they lent the bankrupt company.
But because AIG did not declare bankruptcy and was bailed out by TARP instead, taxpayers ended up being on the hook for 100 percent of the insurer's debts. Investment banking giant Goldman Sachs was AIG's largest creditor, and many observers argue it was Goldman's involvement in the bailout that resulted in AIG creditors receiving all the money owed them. DeFazio has a long track record of liberal populism. During the Bush administration era, he voted against Republican-sponsored tax cuts and funding measures for the Iraq war.
Geithner Rejects Call to Resign, Faults Republicans
Treasury Secretary Timothy Geithner defended the Obama administration’s economic record and dismissed a call for his resignation from the senior House Republican on the Joint Economic Committee.
Geithner blamed the policies of the Republican party and President George W. Bush for the financial crisis that pushed the nation into the deepest recession since the 1930s. Republicans “gave this president an economy falling off the cliff,” Geithner told Representative Kevin Brady of Texas as the two men interrupted each other during a hearing today. “I can’t take responsibility for the legacy of crises you bequeathed the country.”
Gearing up for next year’s elections, Republicans are training their sights on Geithner, an architect of the Wall Street bailout as Treasury secretary and in his previous job as president of the Federal Reserve Bank of New York. A report issued earlier this week critical of Geithner’s handling of the rescue of insurer American International Group Inc. has also prompted calls for him to quit. Today, the Treasury chief fired back, saying that by “any measure” of consumer or investor confidence, the economy is “substantially stronger today than when the president took office” in January.
The “worst financial crisis in generations” happened after “almost a decade, certainly eight years, of basic neglect of basic public goods, in health care, in education, in public infrastructure, in how we use energy,” Geithner said. Brady told Geithner that a growing number of liberal Democrats as well as conservative Republicans think that he is handling the economy poorly. “For the sake of our jobs, will you step down from your post?” Brady asked. “The public has lost all confidence in your ability to the do the job, and it is reflecting on your president.”
Another Republican on the panel, Representative Michael Burgess of Texas, told Geithner that he disagreed with Brady. “I don’t think you should be fired,” Burgess told Geithner. “I thought you should have never been hired.” Democrats on the panel defended Geithner. “It just amazes me how there are some people here who are trying to pretend, and I think consciously and intentionally pretending, that the economic circumstances that we’re confronting, all of them, mysteriously materialized over the course of the last nine months or so, which is totally, completely false,” said Representative Maurice Hinchey, a New York Democrat.
Earlier this week, former Republican congressman Rob Simmons, seeking a U.S. Senate seat from Connecticut, called on Geithner to resign over his role in the AIG bailout. Simmons, who is bidding to challenge Democratic incumbent Christopher Dodd in the 2010 election, cited the report issued Nov. 16 by the watchdog of the $700 billion Troubled Asset Relief Program that faulted the New York Fed -- with Geithner at its helm -- for making “limited efforts” to protect taxpayer funds during last year’s rescue of AIG. Dodd chairs the Senate Banking Committee, which is considering legislation to toughen oversight of the U.S. financial system.
In today’s hearing, Geithner also told lawmakers that the Treasury wants to end the TARP as soon as possible. “We are working to put TARP out of its misery,” he said. The Obama administration is moving “aggressively” to shut down “the programs that defined TARP at the beginning of the crisis,” he said. The department has already completed its guarantee for money-market mutual funds and it has ceased making capital injections into large banks.
US October Housing Starts Down 10.6% To 529,000
October housing starts unexpectedly plunged by 10.6% to an annualized rate of 529,000 units, well below the 600,000 unit pace economists were expecting. October's decline followed a 1.9% rise in September to an upwardly revised 592,000 annual units (was 590k). The October decline was due largely to a 33.3% drop in multi-family homes (5 or more units) to a new record low 48,000 annual units. Single family housing starts, seen as a more reliable indicator of the housing sector, fell 6.8% in October to 476,000 units. Single family starts fell in all regions of the country: by 9.6% in the Northeast, by 4.8% in the Midwest, 7.3% in the South and 5.9% in the West.
October building permits fell by 4.0% to 552,000 annual units from an upwardly revised 575,000 units in September (was 573k). Economists were expecting the number of permits in the month to rise to an annualized rate of 580,000 units. Like housing starts, the decline in building permits was due largely to a huge drop in multi-family permits. Permits for buildings with five or more units fell 18.3% to 85,000 units. Single family permits fell 0.2% to 451,000 units. Single family permits fell in only two of the four regions: by 1.4% in the Midwest and by 1.3% in the South. In the Northeast, single family permits rose 2.2% while single family authorizations rose 2.1% in the West.
A record low 560,000 units are still under construction, down 3.4% from September. Single family homes under construction are down 1.6% to a record low 310,000 units while construction of multi-family homes fell 6.0% to 236,000 units, its lowest level since March 1997. The number of homes completed in the month rose 1.9% to 740,000.
Housing starts and building permits
by Dave Rosenberg
Housing starts were supposed to edge up to 600,000 units (annualized) in October, but instead they cratered 10.6% MoM to 529,000 units in the worst decline since the depths of despair last January; the level is at the lowest since April when the ‘shoots’ were still green (instead of brown).
Both single-family (-6.8% MoM) and multi-family (-34.6% MoM) starts were lower, but no doubt we will hear from economists that this plunge was before the announcement of the extension and expansion of the government tax credits for first-time and now trade-up buyers. But it is nice to know what the economy in general and housing in particular look like when the fiscal taps aren’t running at full tilt — it’s not a pretty picture. The tax credits for homeownership are not a win-win because they lure people out of rental units — so we now have a situation where multiple unit construction in October fell to a RECORD low of just 53,000 units at an annual rate (unreal).
The fact that permits also dropped 4% MoM (second decline in a row) and the soft 17 print on the NAHB housing market index for November suggest that the housing rebound was nothing more than a six-month deal. Even the home-buying intentions components of the consumer confidence surveys are signaling this. As an aside, if sales do not pickup, then we will likely see the inventory backdrop worsen again and prices deteriorate because what stood out in the data was the 10.7% surge in single-family completions — the largest increase in over a year and the highest level since April.
Mortgage applications came out for the November 13th week and were shockingly weak in view of the just-announced expansion of the government stimulus, which was announced at the end of October! Applications were down 2.5% but the really disturbing news was the 4.7% slide in the applications for new purchases, which is on top of the 11.7% plunge the week before — down 15% from last year’s depressed levels and the lowest since November 1997!
The FHA's nose dive
Another housing agency takes taxpayers for a dangerous ride.
The cost of the housing bailout continues to rise. The government-run mortgage giant Fannie Mae requested another $15 billion from the Treasury this month, to help cover a loss of $19.8 billion in the third quarter. That brings the total tab for rescuing Fannie to $60 billion so far. Fannie's twin, Freddie Mac, has received $51 billion. And now comes news that the capital reserves of the Federal Housing Administration (FHA) have fallen to $3.6 billion, which is just one-half of 1 percent of the $685 billion in loans insured by the agency and well below the statutory minimum of 2 percent.
Does this mean that Congress will soon be shoveling more billions into the FHA? Possibly. But it's important to understand the precise nature of the FHA's predicament. Whereas Fannie and Freddie are in the business of securitizing mortgages, the FHA insures them directly. Borrowers of modest means can get houses with as little as 3.5 percent down; if they default, the FHA pays off the lender from accumulated insurance premiums.
During the bubble, subprime firms "served" anyone with a remotely plausible ability to borrow, and the FHA's market share waned. The FHA tried to compete by accepting down payments supplied by sellers to borrowers via nonprofit organizations. These were, in effect, loans of very poor quality that required no down payment, and they have been defaulting in bunches. The FHA says that, without these clunkers in its portfolio, the agency could meet the statutory capital requirements today.
In the past year, as private investors have left the mortgage field, Congress and the White House (under President George W. Bush and President Obama alike) have encouraged the FHA to fill the void. The agency insured $360 billion worth of single-family loans in fiscal 2009 -- five times as much as it insured in fiscal 2005. Today, about half of first-time homebuyers turn to the FHA. Though quite a few of these new loans are of questionable quality, too, the FHA says that the average quality of its booming portfolio has increased, if only because good borrowers have so few alternatives.
Low as its reserves are, the agency estimates that the insurance premiums from a growing, new book of business will enable it to cover, just barely, losses from the rapidly decaying old book, after which it can rebuild reserves. You could compare the FHA to the pilot of an acrobatic biplane: in a nosedive but capable of pulling out of it in the nick of time. If the housing market performs worse than the FHA's current worst-case scenarios, however, the agency will crash and burn.
The problem here is that the government is taking taxpayers on such a death-defying ride in the first place.
Like Fannie Mae and Freddie Mac, the FHA represented a huge federal gamble on the politically popular cause of homeownership.
Now that Washington has lost that bet, it is doubling down, in a bid to prop up home prices just enough to prevent a wider collapse of the economy.
Perhaps this stopgap will work, perhaps not. Certainly it's odd that the FHA is helping people get houses with very little equity even as rental vacancies are running at an all-time high of 11.1 percent. But the broader lesson is that federal subsidies have made the entire economy dangerously dependent on single-family housing. The sooner Congress and the president go to work on a long-term fix for that fundamental problem, the better.
FHA-Backed Lending Is a 'Train Wreck,' Toll Says
The Federal Housing Administration, the agency that insures home purchases made with down payments as small as 3.5 percent, may create another lending crisis, Toll Brothers Inc. Chief Executive Officer Robert Toll said. “Yesterday’s subprime is today’s FHA,” Toll said today at a New York conference for builders sponsored by UBS AG. “It’s a definite train wreck and the flag will go up in the next couple of months: Bail us out. Give us more money.” Toll Brothers is largest U.S. luxury homes builder.
The FHA’s insurance reserve ratio fell to 0.53 percent, the lowest level in history, and more steps are needed to shore up the agency that guarantees one of every five single family loans, Housing and Urban Development Secretary Shaun Donovan said Nov. 12. While the insurance fund’s capital ratio is at an all-time low, Donovan said those who say FHA is the next subprime- mortgage crisis are “dead wrong.” The quality of the loans FHA insures is “actually very good,” Donovan said.
FHA’s total reserves are more than $31 billion, giving it an overall capital resource ratio of 4.5 percent, according to statement by FHA Commissioner David Stevens. The 0.53 percent net capital loan insurance ratio takes into account projected losses and is the yardstick Congress uses to determine the health of the fund. Congress requires the FHA to maintain a loan reserve ratio of at least 2 percent to protect the insurance fund from default.
The FHA said 456,000 of its loans, or 8.2 percent, were in default as of September. That was up from 5.6 percent in September 2008. The default rate for loans tracked by the Mortgage Bankers Association was a record 9.24 percent for the three months through June, the most recent period for which data is available. That was up from 6.41 percent a year earlier. FHA loans accounted for about 8 percent of the mortgages Toll Brothers closed in the past quarter, Robert Toll said. About 80 percent of the company’s financing is loans guaranteed by Fannie Mae or Freddie Mac, he said. Those government- supported agencies require larger down payments and better credit than loans insured by the FHA.
Toll Brothers has seen strong sales at its urban high-rise developments in New York City, Jersey City and Philadelphia, Toll said. “We started doing over $1 million product even in Hoboken and Jersey City,” he said. “We expect to expand to Washington, D.C., and perhaps some other strong markets.” Horsham, Pennsylvania-based Toll Brothers fel1 12 cents to $20.71 at 3:16 p.m. in New York Stock Exchange composite trading. The shares are down 2.8 percent this year through yesterday.
Investors strategize for Fed's exit from MBS market
Investors who reaped robust gains in U.S. mortgage-backed securities by piggy-backing on the Federal Reserve's $1.25 trillion buying program are bracing for the end to the central bank's support -- and positioning themselves for a new round of profits as prices cheapen. The $5 trillion market for bonds backed by the housing finance companies Fannie Mae, Freddie Mac and Ginnie Mae is in for a shock when the Fed stops buying at the end of the 2010 first quarter.
To keep market volatility from stripping away gains, investors have either cut their holdings in the bonds the Fed has been buying most, avoided that part of the market altogether, or resorted to hedging their positions. Fed buying, just over $1 trillion so far, has not only played a key role in bringing down mortgage rates and kick-starting the hard-hit housing market, but also boosted returns at some of the world's largest bond funds.
As the program winds down investors are preparing for greater volatility. Many are forecasting the sector could cheapen anywhere from 20 to 35 basis points versus Treasuries, which would pare some of sector's significant gains. Indeed, agency MBS have tightened by about 73 basis points against Treasuries this year. A much sharper cheapening of prices, however, may be warranted to boost enough buying to fill the Fed's big shoes.
"Based on current market conditions, I believe that U.S. agency MBS current coupon spreads would need to widen anywhere from 50 to 70 basis points relative to U.S. Treasuries in order to fill the demand currently provided by the Fed," said Joe Ramos, lead portfolio manager on the U.S. fixed income team at Lazard Asset Management in New York. The Fed's purchases of one-sixth of all MBS backed by Fannie Mae, Freddie Mac and Ginnie Mae has recently been focused on coupons yielding 4.50 percent through 5.50 percent.
Martin Sass, chairman and chief executive officer of New York-based MD SASS, said his firm has circumvented those securities, calling them "the most vulnerable." "We are buying the more seasoned, older mortgage-backed pools. They tend to be less efficiently priced and they are not the ones the Fed is buying," he said. In addition, Sass, whose firm holds roughly $2 billion in MBS and has been in the market since 1977, said he and others are keeping "dry powder" for an expected fall in prices, although he does not expect an overly dramatic drop.
He expects yields to remain supported by Fed buying of MBS through the end of the program after which spreads could potentially widen 30-35 basis points. Deutsche Bank's Bill Chepolis, a senior portfolio manager at its retail asset management unit DWS Investments, said in the last quarter his firm sold agency MBS. If the Fed keeps interest rates stable Chepolis said he would hold more benchmark U.S. Treasuries in anticipation of a weaker agency MBS market.
"We can also sell call options in forward months to make a bet that prices will be lower then," he said. "Another strategy people employ, ourselves included, is to buy interest-only MBS. These have negative durations, so go up in price as rates and MBS rates rise." Negative duration bonds, as opposed to a typical bond, go up in price when rates go up and down in price when rates go down.
Another popular move has been the so-called "up-in-coupon" trade which entails selling lower yielding coupons in exchange for higher yielding issues. This has occurred largely because U.S. interest rates have dropped sharply as investors have sought a safe haven during the economic crisis. At the end of the third quarter, Pacific Investment Management Co, the world's biggest fixed income fund manager, known as Pimco, highlighted its reduced exposure to mortgages over the course of this year in anticipation of the Fed's program running its course. "Pimco plans to maintain a flat to underweight position in mortgages as Fed purchases have driven agency MBS to their near richest levels ever. We look to reenter the market when valuations are more compelling," the firm said.
According to results of JPMorgan's October investor survey covering over 160 investors and over $2 trillion in mortgage assets, over half polled are now underweight mortgages, up from a mere 20 percent in July. "At current market levels we see no investors filling the void," said Lazard's Ramos. Ramos said until the decline in financial institutions subsides, the biggest holder of agency MBS away from the Fed will be retirement fixed income allocations that are benchmarked against U.S. aggregate indexes such as Barclays Aggregate Index.
Barclays reported on Nov. 12 that according to Federal Reserve data, the top 50 banks shed $34 billion worth residential MBS in the third quarter. "Interestingly, this decline was driven primarily by a select group of banks including Wells Fargo and Bank of America. Excluding these banks, the remaining top 48 banks increased their MBS holdings by $9 billion," Barclays said. At the end of September the top 50 banks held $964 billion in MBS, Barclays said.
"This is not like the market goes away when the Fed stops buying," said Jay Diamond, managing director of Annaly Capital Management in New York. "There might be some repricing but people chase yield and they'll find this at some point," he said.
Fear of Double Dip in Housing
The U.S. housing market is sputtering again, adding to doubts about the vigor of the economic recovery. Just a few months after housing showed signs of leveling off, bad weather and uncertainty over the extension of a home-buyer tax credit sent new-home starts in October tumbling 10.6% from the previous month. They fell to the lowest level since April, the Commerce Department said Wednesday. Starts of single-family houses fell 6.8%. Earlier this month, Congress expanded the tax credit and extended it through April, so building should improve. Still, the latest data portend poorly for the economy overall, and for fourth-quarter growth.
On Wednesday Pulte Homes Inc., the nation's largest home builder, warned investors of a grim outlook. "As we look out to 2010, we are expecting difficult conditions to continue," said chief executive Richard Dugas. Meanwhile, more Americans who bought homes during the boom are falling into mortgage limbo. About 3.4% of U.S. households -- or about 1.9 million homeowners -- are 120 days or more overdue on their payments, but not yet in foreclosure, according to LPS Applied Analytics, a research firm in Denver. That is up from 1.5% a year earlier. Many of these people are likely to lose their homes over the next few years. That means more bank-owned homes will hit a market already suffering from oversupply.
The housing-supply picture is tricky to read. The number of homes listed for sale was 3.63 million in September, down 15% from a year earlier, according to the National Association of Realtors. That is enough to last about eight months at the current rate of sales. Anything above about six months is considered a buyer's market, in which prices may come under downward pressure. But those numbers don't reflect the millions of homes expected to go through foreclosure over the next few years, adding to supply. Amherst Securities Group in September estimated seven million homes are headed for foreclosure in the next few years -- more than a year's home sales at the current rate.
"Housing faces important problems, including continuing high foreclosure rates," Federal Reserve Chairman Ben Bernanke said in a speech Monday. "But residential investment should become a small positive for growth next year rather than a significant drag, as has been the case for the past several years." For borrowers with strong credit records, 30-year home mortgages are available for fixed rates of just under 5%, near the lowest levels in 50 years. That is helping demand, but many people can't get such loans because they have too much debt or are unemployed.
One measure of the role of housing in the economy earlier this decade: During the boom, residential investment peaked to make up 6.3% of gross domestic product. That number fell to 2.5% in the third quarter, according to Macroeconomic Advisers. The average U.S. home price nearly doubled between January 2000 and April 2006, according to the First American LoanPerformance index. Since then, the average has dropped about 30%. In most parts of the U.S., prices are still down from year-ago levels, but prices in some markets, including San Diego and Orange County, Calif., have leveled off, at least temporarily.
Wednesday's data prompted some economists to revise their fourth-quarter forecasts down slightly. Macroeconomic Advisers moved its GDP estimate down to 3% from 3.2% and Nomura Securities is predicting 3.4% growth, down from 3.6%. The data adds to the suggestion "that the recovery is a little bit rickety," said Zach Pandl, a Nomura economist. Eventually, the steep drop in construction of new homes should help reduce the number of unsold vacant homes to the point where builders need to step up production. But the latest data highlight the fragility of the housing market, which has been propped up by the tax credit and the Fed's efforts to push down mortgage rates.
With the tax credit set to expire in April and the Fed scheduled to wind down its purchases of mortgage-backed securities by the end of March, housing faces a test of its ability to sustain a recovery without as much government aid.
Potential homebuyers are frustrated by the complications of a market dominated by distressed sellers. Tim Kolstad, a financial consultant renting in Scottsdale, Ariz., has been trying to buy a home for more than a year. But the homes he likes are all either foreclosed or being offered for less than the loan balance due -- which means any offer from a potential buyer must be cleared by the lender, and lenders often are slow to respond. "The offers just sit out there forever," Mr. Kolstad said.
Credit standards are "definitely tighter than they were" in previous years, said Bryan Mitchell, an agent Re/Max Associates in Las Vegas. At least two years of job history, low debt and a good credit score are essential to securing a loan. "You have to have all three, you can't be missing one," he said. But some economists see signs of better demand ahead. "I think that there's been a lot of doubling up in this recession," said Patrick Newport, an IHS Global Insight economist. "People lose their jobs so they move in with relatives. Your kid graduates from college, he can't get a job, so he stays at home. That's going to start going the other way."
Single family home-building is still 10.9% below year-ago levels. New homebuilding fell to a seasonally adjusted annual rate of 529,000 units, the lowest since April. And apartment-complex construction fell as high vacancy rates, declining rents and borrowing difficulties have deterred builders. Building permits, a sign of future construction, also decreased 4%.
The number of people awaiting foreclosure action has ballooned partly because the government has prodded lenders to consider reducing payments for many distressed borrowers in an effort to avert foreclosures. At the same time, loan-servicing companies, the firms that collect mortgage payments and handle foreclosures, are overwhelmed by the millions of distressed borrowers. "There is only so much volume that can be processed by the servicers each month," said Herb Blecher, a vice president at LPS. Overall, about 12.4% of American households with mortgages in October were 30 days or more overdue or in the foreclosure process, according to LPS. That's up from 12.3% in September and 8.6% in October 2008. In the latest month, about 6.9 million households fell into this category.
Obama warns on US public debt pile
US President Barack Obama warned that the US economy could head into a “double-dip recession” unless urgent steps were taken to rein in mounting public debt. The US president’s remarks – in an interview with Fox News in Beijing on Wednesday, towards the end of his eight-day tour of Asia – marked his strongest language yet on the necessity of putting public finances back on a sound footing.
“It is important though to recognise if we keep on adding to the debt, even in the midst of this recovery, that at some point, people could lose confidence in the US economy in a double-dip recession,” said Mr Obama. A 10.6 per cent plunge in housing starts in October – led by collapse in the apartment business – highlighted the dilemma facing him as he seeks to tackle the deficit without undermining a fragile economy. “It’s about as hard of a play as there is,” Mr Obama said, adding that his team was trying to set up a “pathway long term for deficit reduction” without pulling a lot of money out of the economy in the short term via tax rises or spending cuts.
The mood in the US has already swung in favour of deficit reduction, with Republicans attacking Democrats’ plans for more spending to support jobs. Washington-based analysts said the president was probably trying to prepare public opinion for a tough budget in February – while leaving open some space for measures to reduce unemployment, now at 10.2 per cent. “I have no doubt that the White House is going to produce a tough budget,” said Maya MacGuineas, director of the Peterson-Pew commission on budget reform. “The question is whether they are going to spend political capital and push their budget in Congress.”
The timing of Mr Obama’s remarks, which came at the end of his three-day trip to China, is likely to fuel speculation that his Chinese hosts delivered stern private warnings about the consequences of continuing high US budget deficits. China, the biggest foreign holder of US Treasury bonds, has become increasingly vocal in its fears on the value of its dollar assets. White House officials say the US fiscal situation had no impact on Obama’s interactions in Beijing, even though some observers presented his trip as that of a debtor visiting his banker. “He pulled no punches,” said Mike Froman, a senior national security adviser. A day earlier, White House budget chief Peter Orszag said the US had to bring down its deficit to about 3 per cent of gross domestic product within six years – a reduction of about one percentage point of GDP based on the administration’s current estimates.
Fannie, Freddie Woes Hurt Apartments
The deteriorating commercial real-estate market is hitting Fannie Mae and Freddie Mac, the housing-finance giants that were taken over by the U.S. last year after billions of dollars in losses on residential real estate. The firms, which together have taken more than $110 billion in capital infusions from the Treasury, stepped up their lending for apartment buildings as the commercial real-estate market peaked, and they are now facing rapidly rising loan losses.
Fannie, which has been more active than Freddie, faces the biggest problems. Its serious delinquency rate, or loans that were 60 days or more past due, stood at 0.62% at the end of September, up from 0.16% a year ago. One troubling sign: one-quarter of the $180 billion of apartment-building loans on Fannie’s books were originated near the top of the market in 2007 and those loans account for nearly half of all its commercial-loan delinquencies. Fannie increased to $1.2 billion its reserves for losses on multifamily loans at the end of September, up from $104 million at the end of 2008. In a statement, Fannie Mae said market fundamentals “will remain under pressure in the near term” and that the company is taking steps “to mitigate risks associated with weak rental demand.”
The losses from Fannie’s and Freddie’s $300 billion in apartment-building loans will be a fraction of their losses on single-family homes, where the two firms back $5 trillion of loans. But the bigger impact could be on the market for apartment buildings. The firms were responsible for 84% of all multifamily lending last year, up from 34% of the market in 2006, according to the Federal Housing Finance Agency.
A report published earlier this year by Harvard University’s Joint Center for Housing Studies warned that without Fannie’s and Freddie’s continued purchases, “apartment transactions could come to a near standstill” and that could spur a further unraveling where even “cash-flow-positive projects may not be able to get refinanced and will be pushed towards default.” Fannie and Freddie say they were conservative in underwriting of apartment-building loans. For example, 97% of Freddie’s loans are still worth more than the value of the underlying properties. “We were careful about our credit, but with the markets deteriorating, everybody will be impacted negatively in some form or another,” said Freddie spokeswoman Patti Boerger.
But, in recent years, critics say that the firms became more aggressive. Some deals that they financed wouldn’t have occurred without their participation. “By 2007, Fannie basically put more gas on the fire,” says Mike Kelly, president of Caldera Asset Management, a consulting firm fordistressed multifamily properties. For example, Fannie and Freddie together lent $9 billion to finance the buyout of apartment operator Archstone-Smith by Lehman Brothers Holdings Inc. and Tishman Speyer Properties. The original plan—to carve up the portfolio and flip assets—didn’t pan out as real-estate values softened. “There was no policy justification to provide billions of dollars of financing for a deal that in retrospect tested the limits of aggressiveness in financing,” says Sam Chandan, president of Real Estate Econometrics, a research firm.
Fannie and Freddie also bought $1.5 billion in commercial mortgage-backed securities backed by the sprawling Peter Cooper Village-Stuyvesant Town apartment complex in Manhattan, for which a Tishman-led partnership paid a record $5.4 billion in 2006. The new owners weren’t able to convert as many rent-regulated units to market rates, and the loan has been transferred to a special servicer. The property could be worth as little as $1.8 billion now, according to an estimate by Fitch Ratings, which last month said that the tranche of securities held by Fannie and Freddie faces a “medium-to-low” risk of severe loss.
Most of Fannie’s and Freddie’s multifamily loans won’t mature for several years—two thirds of Fannie’s multifamily debt won’t mature until after 2013, for instance—allowing time for rents and vacancies to recover before owners have to refinance. Still, delinquencies stood at 1.6% on some $4.5 billion in loans set to mature next year. And those looming maturities only add to the uncertainty about whether Fannie or Freddie will stay active in the multifamily space over the medium to long term.
So far, various proposals that address how to revamp Fannie and Freddie haven’t paid much attention to multifamily lending, but industry leaders say they aren’t concerned. While it would be a “very big blow” to the sector if Fannie or Freddie were forced to sharply curtail their multifamily lending, “that’s just not in the cards,” says Richard Campo, chief executive of Camden Properties Trust, an apartment company with some 62,000 units. “The idea that the government is going to do something negative to affordable housing in this interim period … seems pretty far fetched.”
Fears of China property bubble
A large bubble is forming in China’s property market as a result of Beijing’s credit-driven stimulus programme, one of the country’s most prominent real estate developers warned. Zhang Xin, chief executive of Soho China, one of the country’s most successful privately owned property developers, told the Financial Times the asset bubble was leading to rampant wasteful investment in the sector, undermining the country’s long-term growth prospects.
“Real estate prices should only go up because people want to actually use the space, but at the moment we can see more and more empty buildings across the whole country and in every real estate segment,” Ms Zhang said. “The rising prices are a direct result of so much money coming from the banks and the Chinese banks should be very worried.” Ms Zhang’s assessment was echoed by Fan Gang, a member of the central bank’s monetary policy committee, who warned on Wednesday that real estate in cities such as Beijing, Shanghai and Shenzhen was expensive and there was a growing risk of asset price bubbles.
Urban property prices in 70 big and medium-sized Chinese cities rose 3.9 per cent in October from a year earlier, accelerating from September’s 2.8 per cent rise, according to government figures. Price rises in top-tier markets such as Beijing and Shanghai have been much faster. Analysts say the rebound has largely been driven by an unprecedented government-led expansion of bank lending. It is also being driven by government policies, including tax breaks, low interest rates and smaller down-payment requirements. Investment in real estate development, a key driver of economic growth, rose 18.9 per cent in the first 10 months of the year on a year earlier, a marked acceleration from 17.7 per cent growth in January-September.
Ms Zhang said the current speculation should be a serious warning for the industry and the general economy. “In Manhattan, they have vacancy rates of 10-15 per cent and they feel like the sky is falling, but in Pudong [the central business district in Shanghai] vacancy rates are as high as 50 per cent and they are still building new skyscrapers,” she said. “If you look at GDP growth, then China looks like a new engine driving the global economy, but if you look at how growth is being created here by so much wasteful investment you wouldn’t be so optimistic.”
Core deflation in the US continues to gather pace
Core inflation for factory goods in the US fell to minus 0.6pc in October from a year earlier, edging the country closer towards Japanese-style deflation despite massive monetary stimulus. Factory gate inflation typically leads consumer prices by six months or so. The “core” measure favoured by the Federal Reserve strips out energy costs. Janet Yellen, the head of the San Francisco Fed, said emergency measures had prevented the US economy from sliding into a “black hole of deflation”, insisting that it is still far too early to talk of tightening policy. A combination of “enormous slack in the economy” and fading fiscal support raised the risk that prices could fall below the Fed’s safe level. “It seems probable that core inflation will move even lower over the next few years,” she said.
Unemployment has reached 10.2pc and the average working week has fallen to a record low of 33.0 hours, creating powerful deflation headwinds. Gabriel Stein from Lombard Street Research said the US “output gap” is currently at 6.2pc of GDP. The last time it was near this level – in 1982 – producer price inflation fell by 300 basis points over the next year. A repeat today would cause it to spiral to dangerous levels below minus 3pc. While the Fed appears split over its exit strategy, even arch-hawk Richard Fisher of the Dallas Fed said the sheer scale of excess plant will curb prices and wages for a long time. Capacity use in manufacturing is near a post-war low of 67.6pc.
Mr Fisher said the “peak impact” of the Obama fiscal blitz has already come and gone. “Several recent sources of strength are likely to wane as we head into next year. Cash-for-clunkers and the first-time-homebuyer tax credit have both shifted demand forward, increasing sales today at the expense of sales tomorrow. Neither of these programmes can be repeated with any real hope of achieving anywhere near the same effect. The more demand you steal from the future, the less future demand there is for you to steal,” he said. “Chastised by recent experience, businesses will continue to run tight ships. It may be some time before significant job growth occurs and even longer before we see meaningful declines in the unemployment rate.”
Bank credit has been shrinking at an accelerating pace since May, though bonds and commercial paper have partly stepped into the breach. “I haven’t been this bearish in a year,” said bank guru Meredith Whitney on CNBC. The M3 money supply has been shrinking at a 7pc annualised rate since June. Paul Ashworth from Capital Economics said it is not yet clear whether this is the harbinger of a crunch next year, or a blip caused by portfolio shifts. “We think deflation is still a bigger risk than runaway inflation,” he said.
How Fed Manages to Keep Inflation Fears Under Control
Sometimes stating the obvious and repeating it frequently can be a very effective policy, especially in managing inflation expectations. And that’s what the majority of the Federal Reserve’s policy-setting team is doing in dealing with the inflationary potential of the extraordinary monetary and fiscal stimulus at work in the economy.
Key central bank players know that the “Fed’s current monetary policy is inconsistent with its long-term policy of keeping inflation low,” says Bank of America Chief Economist Mickey Levy. “I think it’s important for the Fed to say, 'We know what we're doing, that there are but extenuating circumstances and that we still have our eye on long-term objectives.'” Fed Chairman Ben Bernanke, Vice Chairman Donald Kohn and San Francisco Fed President, Janet Yellen, who also served as a board governor, have all said as much this week. “The Fed had made the point that expectations are important,” says Robert Brusca, chief economist at Fact & Opinion Economics. “They affect the way people act.”
And think. And despite a rush into gold, most would say that inflation expectations have been well managed and are under control. The few telltale signs out there confirm that. Spreads between Treasury Inflation Protected Securities, TIPS, and regular cash-based Treasury bonds and notes of varying duration have drifted between 1.50 percent and 2.0 percent in recent months, which happens to fall within the Fed’s supposedly target range for inflation. And for all the worry about the Obama administration’s borrowing boom, Treasury auctions have drawn sufficient interest to avoid building a premium into the yields.
“We're a good ways from that happening,” says David Resler, chief economist at Nomura Securities. The difference between seven months ago and now is notable. Back then, when the Obama administration’s big spending ways were new and all too apparent and there were lingering doubts about the effectiveness of the Fed’s program to buy various kinds of government debt in the markets, yields jumped, with the 10-year note breaking 4 percent in the middle of a brutal recession.
Also back then, market pundits and fiscal conservatives in Congress were doing most of the talking about inflation and driving expectations — higher. It was hard to argue with the logic. In the past, easy monetary policy, or government spending, or both raised inflationary expectations and as a result interest rates. It happened during the Reagan and the Nixon administrations in what might be considered more normal circumstances. It even seemed to be on the verge of happening in the Greenspan-Bernanke handover period at the Fed.
Don’t even think about it now, say most analysts. Not that there still isn’t a vocal minority, which happens to include Fed presidents Jeffrey Lacker, Charles Plosser and James Bullard. Lacker Tuesday warned that concerns about “lingering weakness” in some areas of the economy are not reason enough to risk an inflationary outbreak. That group and others may remember the rare times when the Fed got it wrong, such as in the late 70s.
Then, as now, the operative word for the economy is slack. Growth — along with demand — is so weak that price or wage inflation is considered almost impossible. Inventory is sufficient. Hiring unlikely or minimal. “The Fed's public statements about the slack have helped allay concerns,” says Levy. What’s more, banks may be sitting on billions of dollars in cheap money, but they are not lending it and consumers are hardly rushing to borrow it. Wages are largely stagnant. “You’re looking for the beast, but all you have is rhetoric,” says Brusca, describing what some are calling a paradox.
Economists say the Fed appears confident it can withdraw monetary stimulus—especially the unconventional measures — when it needs to, fostering growth and job creation, with inflation remaining subdued “for several years", according to Yellen in comments after her speech Tuesday. Bernanke Monday talked about “exceptionally low levels of the federal funds rate for an extended period.”
On the same day Kohn said the Fed needed to be “alert to any tendencies for movements in prices for commodities and assets to result in a sustained increase in inflation and inflation expectations.” You’d think rhetorical barrages like the past two days would be enough for the markets. And it may be. But in a way even the people calling the shots may need some reassuring and repeating themselves may help. “We’ve never been through this before,” says Patrick Newport, an economist at Global Insight. “We're not a 100-percent sure this is going to work.”
What Stinkin' Inflation? PPI Edition
Briefing detailed the latest PPI release:The producer price index rose 0.3% in October, well below the consensus expectation of an increase of 0.5%.
Excluding food and energy prices, core PPI fell an astounding 0.6% over the month. For the year, core PPI has only increased 0.7% after posting a 1.4% year-over-year increase in September.
On the surface, the numbers would suggest an increasingly deflationary environment. However, the data for October was skewed.
The decline in core prices was due to large drops in vehicle prices. Passenger car prices declined 0.5% month-over-month after increasing 1.0%. Light truck prices fell 5.2% and heavy trucks prices declined 0.1%.
Briefing then poorly explains the drop in auto prices:The information on the decline in motor vehicle prices is sketchy. New 2010 model year vehicle prices were introduced in this month's PPI report. The drop in price would suggest that car manufacturers are planning on introducing new model vehicles at lower price points. If this hold true, prices should hold at these levels through next summer.But Market News quickly disproves this theory:Core was cut by -5.2% in light trucks and -0.5% in cars where quality changes/model year changes and slack demand cut prices. The Bureau of Labor Statistics said the value of quality changes for 2010 model cars was $250 and for light trucks $793, less than usual, and that this pricing was adjusted out.My thought of why there was an increase (and this could be wrong). Cash for clunkers. When the government was throwing cash at the end-user, this artificially increased demand for autos (by dealers) from producers. As the program ran out, the demand ran out, thus the pricing power ran out.
Ambac Faces 99% Chance of Default as Deadline Looms, Swaps Show
Ambac Financial Group Inc.’s bond- insurance unit faces a 99 percent chance of default, credit derivatives show, as financial institutions brace for the second-largest bond insurer to file a capital update with regulators later today. Five-year credit-default swaps on Ambac Assurance Corp. have jumped 3.2 percentage points since Nov. 9 to 78.3 percent upfront, according to CMA DataVision. That’s in addition to 5 percent a year, meaning it would cost $7.83 million initially and $500,000 annually to protect $10 million of Ambac obligations from default.
With market expectations that holders of Ambac-insured bonds would be able to recover 17.5 cents on the dollar, the price implies a 99 percent chance of default, CMA data show. Ambac faces a deadline today to update Wisconsin insurance regulators on its capital levels as of the end of the third quarter. Bond insurers regulated in Wisconsin are required to maintain minimum surpluses or risk being taken over. Regulatory intervention could accelerate demands against Ambac’s insurance unit.
“We believe that the most likely action by Wisconsin insurance regulators will be no action,” Rob Haines, an analyst with CreditSights Inc. wrote in a research report today. “Regulators are predisposed towards any work-out solution which could avoid the so-called ‘nuclear event.’” The company was stripped of its top bond insurance rating last year after surging loss projections on securities backed by soured home loans. Earlier this month, JPMorgan Chase & Co. analyst Andrew Wessel said Ambac’s regulatory capital is likely to have fallen into a deficit.
Delinquency proceedings against the company would trigger termination payouts of $23.1 billion by its insurance unit on credit-default swap contracts, Ambac said in a filing earlier this month. Ambac also may be required to accelerate the payment of $1.6 billion of holding-company debt, the New York-based bond insurer said in the filing. To prevent takeovers, insurers have paid holders to tear up credit-default swap contracts on their poorest-performing securities.
Credit-default swaps pay the buyer face value if a borrower defaults on its debts in exchange for the underlying securities or the cash equivalent. Banks that bought credit swaps from Ambac and other insurers to hedge against losses on mortgage- related securities used swaps on the insurers to protect themselves if the companies fail to make good on the guarantees. Peter Poillon, a spokesman for Ambac, didn’t immediately return a phone call seeking comment. Armonk, New York-based MBIA Inc. is the largest bond insurer.
Ambac Reports $856M Of Surplus, Easing Fears; Shares Rise
Ambac Financial Group Inc. (ABK) reported $856 million of surplus as of Sept. 30, more than double the second quarter's level, easing concerns the bond insurer would fall short of statutory minimums. Shares jumped 24 cents, or 34.3%, to 94 cents recently. The stock, however, is still down 17% this month. Some Wall Street analysts had speculated the insurer would come up short of $2 million in minimum capital needed under rules set up by its regulator, the Wisconsin insurance commissioner.
Meanwhile, Ambac said Wednesday it had negotiated to settle four derivatives contracts worth $5.03 billion for cash payments of about $520 million. Ambac said earlier this month that it had been working to negotiate a settlement. The capital figure, which came in filing made two days late, also included the impact from one-time items such as a $311 million gain on reinsurance recaptures and a $280 million impact from correcting an error in the second quarter's estimation of credit-derivative write-downs.
Ambac also said it will receive about $440 million in tax refunds because of recent legislation that will allow it to carryback 2008 and 2009 losses as far back as 2004. The tax refund will help the company's fourth-quarter surplus. Earlier this month, Ambac said it posted a third-quarter profit on big mark-to-market gains from credit derivatives, but it also reported growing insurance losses, particularly on mortgage-backed securities.
Japan Deflation Concern Rises Even as Growth Quickens
The acceleration of Japan’s economy to the fastest growth pace in more than two years masked a slide in prices of goods and services that threatens to temper the nation’s recovery. The domestic demand deflator, a measure of price levels that excludes the cost of imports, fell 2.6 percent in the third quarter from a year earlier, the most since 1958, Cabinet Office figures showed yesterday in Tokyo. At the same time, gross domestic product jumped 4.8 percent, the most since early 2007.
Sustained price declines threaten to curtail a corporate- profit rebound that’s already been insufficient to spur a rally in Japan’s shares this quarter. The report prompted Deputy Prime Minister Naoto Kan to say the government may outline an emergency-spending package as soon as today, adding that “I’m concerned we’re entering into a deflationary situation.” “This isn’t sustainable growth and the government knows it -- that’s precisely why they’re talking about the GDP deflator,” said Junko Nishioka, chief economist at RBS Securities Japan Ltd. in Tokyo. “On the face of it, 4.8 percent growth is a positive for the Democrats, but they’re not reading it as a reason to abandon their economic policies.”
A report today showed that demand for services unexpectedly fell for the first time in four months in September, a sign that the effects of government stimulus measures may be fading. The tertiary index, which captures 63 percent of the economy, slid 0.5 percent from August, the Trade Ministry said today in Tokyo. The median forecast of 23 economists surveyed by Bloomberg News was for a 0.2 percent gain. Kan said yesterday that the government should work with the Bank of Japan to tackle the price slump. The central bank has kept interest rates near zero to help rekindle growth.
Consumer prices in the world’s second-largest economy have fallen for seven straight months, undermined by the deepest recession in the postwar era. Deflation can undermine the economy by persuading companies and consumers to delay purchases in the anticipation of further price declines. It also increases the value of their debt.
“Deflation is great if you don’t have debt,” Nishioka said. “But debt drives most economic activity. Companies take out a loan to build factories or you get a mortgage to buy a house. Those burdens get heavier when incomes start to fall.” The yen’s 6 percent gain against the dollar in the past three months has exacerbated the price slump by making imports cheaper. Even after seven months of gains in factory output, about one third of Japan’s factories sit idle. The Democratic Party of Japan took power in September pledging to support households that have endured 16 months of wage declines and unemployment that climbed to a record in July.
“The biggest worry to us is that consumption growth has been too strong relative to incomes,” said Hiromichi Shirakawa, chief Japan economist at Credit Suisse Group AG in Tokyo, who used to work at the central bank. “It might be a decade before the job market returns to the level of health we had a year or two ago,” he said. “The number of jobs may recover but not wages. It’s very fragile.” A price war over jeans is a sign of that fragility.
Discount retailer Don Quijote Co. last month started selling jeans for 690 yen ($7.70), undercutting Aeon Co., Japan’s largest supermarket chain, which has been offering them for about $9. Fast Retailing Co., the operator of Uniqlo stores, started the battle in March with pairs at $11. “Japanese domestic demand is still dependent on price declines to grow,” said Naomi Fink, a strategist at Bank of Tokyo-Mitsubishi UFJ Ltd.
Without adjusting for prices, Japan’s economy shrank an annualized 0.3 percent last quarter, the sixth straight contraction. The Democratic Party of Japan has signaled that these nominal figures will play a greater role in its policymaking. “There’s been a tendency to focus on the price-adjusted figures,” Keisuke Tsumura, one of the DPJ’s top economic officials, said in an interview this month. “We’re going to try to strike a better balance in our decision-making that doesn’t ignore the nominal figures,” which he said better reflect the economy as households experience it.
The government’s heightened concern about deflation may put it at odds with the Bank of Japan. While the central bank last month forecast prices will keep falling through the year ending March 2012, Governor Masaaki Shirakawa has said deflation is unlikely to weigh on economic growth. The central bank won’t have room to raise the benchmark interest rate from the current 0.1 percent until at least the end of 2010, according to 15 of 16 analysts surveyed by Bloomberg News last month.
Still, most analysts said yesterday’s report suggests Japan will avoid a double-dip recession. Domestic demand, which includes consumer spending and business investment, contributed two-thirds of the country’s growth last quarter. In the previous three months, exports led the economy’s first expansion in more than a year. “The composition of these numbers was a lot more encouraging than the second-quarter numbers, said Richard Jerram, chief economist at Macquarie Securities Ltd. in Tokyo. “It wasn’t the net exports story, it was a swing in private domestic demand, which brings some promise of greater stability.”
Emergency $85 billion bailout of insurer AIG was botched, says report
The US government executed an emergency bailout of troubled AIG without sufficient planning, botching its initial $85bn (£50bn) effort to rescue the ailing business and further weakening the multinational insurer's financial position, according to a critical official report into last year's near collapse of the company. An inspector charged with overseeing the treasury's bail-out efforts concludes today that the intervention by the Federal Reserve and the treasury applied such onerous terms on a loan to AIG in September 2008 that it made matters worse.
The report also questions a decision to pay out $35bn in collateral to "make whole" all of AIG's counterparties on controversial credit default swaps, suggesting that government officials could have tried harder to squeeze concessions from top banks such as Goldman Sachs, Merrill Lynch and Barclays. The inspector general's findings could prove damaging to the US treasury secretary, Timothy Geithner, who was head of the Federal Reserve Bank of New York which led the AIG bailout efforts. The government intervened when AIG ran into trouble after Lehman Brothers collapsed.
The inspector, Neil Barofsky, who is answerable to Congress, says the government relied on an unsuccessful effort by Wall Street banks to raise a private sector rescue of AIG. When this failed, the Fed had no contingency plan and simply applied the private consortium's terms to an $85bn public loan which carried an interest rate of more than 11% and was in return for an 80% stake in AIG. "The decision to acquire a controlling interest in one of the world's most complex and troubled corporations was done with almost no independent consideration of the terms of the transaction, or the impact those terms might have on the future of AIG," says the inspector's report.
As AIG's position deteriorated further, the US government had to make two more interventions to prop up AIG, which was crippled by huge contracts written by a financial products arm largely run out of London. The counterparties in these credit default swaps received their total entitlements, avoiding a "haircut" that they would have taken if AIG went bust.
According to the inspector's report, the New York Fed asked AIG's eight leading counterparties to take discounts on their entitlements, but only one bank – UBS – offered to take a reduction of 2%. France's banking regulator, the Commission Bancaire, intervened by informing the Fed that it would be illegal under French law for two banks– Société Générale and Calyon – to take anything below their contractual entitlement. The inspector general says the banks received an amount "far above" the market value at the time for the swaps and were reimbursed without consideration of the government bailout, without which "they would likely have received far reduced payments as well as the indirect consequences of a systemic collapse".
Critics have suggested that the Bush administration was too soft on Goldman Sachs, the biggest counterparty to AIG, in part because of a close relationship between senior treasury officials and executives at the bank. The US treasury said a decision not to pay counterparties would have led to "defaults and cross-defaults" around the financial system.
General Electric Pursues Pot of Government Stimulus Gold
The financial crisis hasn't been kind to General Electric Co. Its stock has lost almost half its value, the government has stepped in to prop up its enormous financial arm, and sales have slumped in core industrial businesses. But Chief Executive Jeffrey Immelt now has his eye on a huge new pool of potential revenue: Uncle Sam's stimulus dollars. Mr. Immelt, a registered Republican, quips about the shift in thinking in the nation's corner offices: "We're all Democrats now."
GE has high hopes for the strategy. It says that over the next three years or so it could bring in as much as $192 billion from projects funded by governments around the globe, such as electric-grid modernization, renewable-energy generation and health-care technology upgrades. The company is just starting to see a payoff. Last month, for example, President Barack Obama announced $3.4 billion in government-stimulus grants for power-grid projects. About one-third of the recipients are GE customers. GE expects them to use a good chunk of that money to buy its equipment.
The government has taken on a giant role in the U.S. economy over the past year, penetrating further into the private sector than anytime since the 1930s. Some companies are treating the government's growing reach -- and ample purse -- as a giant opportunity, and are tailoring their strategies accordingly. For GE, once a symbol of boom-time capitalism, the changed landscape has left it trawling for government dollars on four continents. "The government has moved in next door, and it ain't leaving," Mr. Immelt said at the International Economic Forum of the Americas in Montreal in June. "You could fight it if you want, but society wants change. And government is not going away."
A close look at GE's campaign to harvest stimulus money shows Mr. Immelt to be its driving force. The 53-year-old executive supported the presidential campaign of Sen. John McCain, yet scored an invitation onto the President's Economic Recovery Advisory Board, led by former Federal Reserve Chairman Paul Volcker. Inside GE, he pushed his managers hard to devise plans for capturing government money. As part of that effort, GE has promoted policy proposals such as a government-backed power-grid modernization, and pressed the government to increase the size of stimulus grants for that purpose. It also has helped customers design projects and apply for government money, with the expectation that those customers will then buy GE equipment.
The initiative comes as a sluggish global economy is weighing on GE's core industrial businesses. Pursuing government contracts has become a centerpiece of its strategy around the globe. The company estimates $2 trillion in global infrastructure spending will get under way in coming years. It has announced a flurry of energy deals with foreign governments from Iraq to China. "I think we will do better than most on the stimulus," Mr. Immelt told analysts in April. He declined to elaborate on the effort for this article.
The strategy is not without risks, say two GE executives who have been critical of the plan. Government policy could change. Stimulus projects could roll out more slowly than GE expects and generate less revenue than forecast. GE could fail to win competitions to supply hardware and services to companies and public entities that receive stimulus dollars. GE isn't in agreement with the Obama administration on some proposals. Its GE Capital financial unit, which contributed nearly half of its earnings in recent years, received government backing for its debt when the credit markets seized up last fall.
Now GE is lobbying against proposals that would separate GE Capital or its industrial-loan company from the parent company. More regulation on its finance division seems inevitable. The company also is opposed to health-care proposals that would result in $40 billion in fees on health-care device makers such as GE. GE, whose businesses range from washing machines and lights bulbs to aircraft engines, wind turbines and nuclear reactors, has long done business with the U.S. government.
Over the years, the company has been associated with Republican politics. President Ronald Reagan, voice of GE ads and host of the GE Theater television show from 1954 to 1962, said the views he encountered at GE helped transform him into a free-market conservative. Former CEO Jack Welch, who handpicked Mr. Immelt to succeed him, was a prominent supporter of several Republican presidential candidates. Nancy Dorn, the current head of GE's government-relations office in Washington, served in the administrations of Mr. Reagan and both Mr. Bushes.
Mr. Immelt's push to corral federal money began even before Mr. Obama took office. In December, with the economy in a skid, Mr. Immelt was under fire from shareholders. Advisers to Ecomagination, the company's green-technology-development initiative, gathered at GE's boardroom in midtown Manhattan. Among other things, the group discussed how an Obama stimulus plan might shape the nation's energy future. Mr. Immelt concluded that the company needed to capitalize on the surge in government spending. According to two people present at the meeting, Mr. Immelt told the group that business people needed to support the Democrats' stimulus package.
By January, Mr. Immelt had become a leading corporate voice in favor of the $787 billion stimulus bill, supporting it in op-ed pieces and speeches. Reporters who called the Obama administration for information on renewable-energy provisions in the legislation were directed to GE. As the bill worked its way through Congress, GE lobbyists pressed for grants, tax cuts or rebates aimed at businesses GE is engaged in, including provisions worth more than $80 billion for energy projects, appliances, health-care information systems and wind farms. GE would have to compete with rivals for a share of these grants.
When the stimulus package was rolled out, Mr. Immelt instructed executives leading the company's major business units "to put together swat teams to get stimulus money, and [identify] who to fire if they don't get the money," says a person who heard him issue the instructions. In February, a few days after President Obama signed the stimulus plan, GE lawyers, lobbyists and executives crowded into a conference room at GE's Washington office to figure out how to parlay billions of dollars in spending provisions into GE contracts. Staffers from coal, renewable-energy, health-care and other business units broke into small groups to figure out "how to help companies" -- its customers, in particular -- "get those funds," according to one person who attended.
The group put together a colorful two-page fact sheet about how the stimulus plan works, then printed hundreds of copies for GE salespeople to distribute to customers, including local governments and power companies. The fact sheet said GE would be involved with setting national standards and energy-transmission policy. The sheet also said that GE could help regional utilities and governments win federal stimulus money earmarked for making the power grids more efficient.
Separately, Mr. Immelt got an invitation to serve on the President's Economic Recovery Advisory Board, which would afford him access to the president's economic inner circle. The bipartisan board is composed of industrial, finance and union leaders, and Mr. Immelt has become one of the administration's advisers on jump-starting manufacturing and creating jobs. "We think he is an important voice...we talk about energy being a place where America can produce jobs in the manufacturing space," says White House Chief of Staff Rahm Emanuel. "He has those interests, and they match ours. But we didn't come to them because of him."
At the board's first public meeting in May, Mr. Immelt and fellow board member John Doerr, a Silicon Valley venture capitalist and prominent Democrat, led a discussion of the advantages to business of a proposal to make companies pay for greenhouse-gas emissions. The board voted to adopt that position. "This was an early example of a group of business leaders willing to say that a clean-energy policy that put a price on carbon could create major opportunities for the economy if done right," says Austan Goolsbee, staff director and chief economist on the recovery board. A so-called cap-and-trade bill will likely not be considered by Congress until early next year.
One plank of the stimulus bill provides for energy grants for the development of "smart grids" -- sophisticated transmission systems in which power consumption and demand is carefully monitored to conserve energy. GE says it, along with others, urged the Department of Energy to increase its maximum energy grant 10-fold, to $200 million. Then GE helped some 100 customers, mostly power providers such as Florida Power & Light, to apply for money. GE General Counsel Brackett Denniston III says the company frequently provides expertise to governments and clients, and that its assistance on government-grant applications does not ensure its clients will win the resulting contracts.
GE makes a wide array of equipment that its customers can use in conjunction with smart grids. GE sells appliances, for example, designed to make use of power at quiet times of day or night, when rates could be cheaper. Of the 100 smart-grid grant recipients Mr. Obama announced last month, one-third were GE clients. GE declines to say what portion of the $3.4 billion in government money went to its customers. Its executives have told analysts that GE stands to reap up to $500 million in contracts from every smart-grid project built in a city with a population of more than one million.
GE has said that the state of Florida and partners plan to invest $800 million by 2014 to upgrade its power grid, and that the bulk of the equipment would come from GE. "If we can do this in Miami, we ought to be able to do this in 100 more large cities across the country," Steve Fludder, vice president of GE's Ecomagination green-technology initiative, told analysts at a conference in May. GE has said that its goal is to increase its Ecomagination revenues to $25 billion by 2010, from $18 billion in 2008. Ecomagination products accounted for about 17% of revenues of GE's industrial businesses, Mr. Fludder said.
GE spent $7.55 million lobbying in the second quarter, a 34% increase from the year-earlier period and more than any other single company, according to federal data compiled by the Center for Responsive Politics. GE does not disclose how much revenue it has gleaned from the government stimulus program. So far, the returns appear to have been modest, relative to GE's $182.5 billion of revenue in 2008. Nine months after Mr. Obama signed the stimulus bill, about half the federal money has been allocated. Most of it went to initiatives like individual tax cuts and aid to states, which don't directly benefit GE's businesses.
Mr. Immelt said last month that GE won't see a bigger impact on its revenues from stimulus spending until the current quarter, at the earliest. "We have a couple billion dollars of orders already into it," he said. "That's not just the U.S. It's China and other countries." The effort could be hampered if Congress or the administration, anxious about rising unemployment and a growing deficit, decides to cut back on stimulus programs or redirect money toward job-creating measures less beneficial to GE, such as employer-tax credits. GE shares have rallied in November on signs that troubles in the company's finance unit could be easing. But some analysts question the company's projections for added revenue from stimulus projects.
"We remain very skeptical on the stimulus, overall," says Scott Davis, an analyst at Morgan Stanley. He says GE's estimates of what it could reap from the stimulus programs is "way too high." Mr. Davis and other analysts at Morgan Stanley say they expect only $30 billion of the stimulus plan's $275 billion infrastructure spending to flow this year. Asked last month if its government-contracting estimates were too optimistic, Mr. Immelt replied: "We'll see. We'll keep the target out there."
Hands warns governments on banks
Guy Hands, head of private equity house Terra Firma, warned on Wednesday that unless governments pushed banks to restructure $7,000bn of leveraged loans that are due to mature by 2014, the US and Europe could face the “Japanese problem” of zero growth. “Unless the banks address this problem you will end up with the Japanese problem,” Mr Hands said on the sidelines of the Super Investor conference in Paris. “Japan could afford no growth because of its declining population, but it is not an option for the UK and America.”
Mr Hands’ comments come as the Terra Firma boss is negotiating with Citigroup to restructure the £2.6bn debts of EMI, the music group that is his private equity group’s biggest investment and one of the US bank’s largest single leveraged loans. Previous studies have estimated that private equity groups are sitting on about $400bn of leveraged loans that need repaying in the next five years. But Mr Hands said his $7,000bn figure included all forms of private equity, such as loans for property deals.
The Terra Firma chairman said banks were split between those not bailed out by governments, which were dealing with bad debts quickly, and those that had taken money from the state, which were avoiding taking writedowns. “It is those banks that have the most government support that are the most reticent to act,” he said. “You need to ask banks to do their bit, but as we’ve seen with EMI that is incredibly difficult to do.” The US government has a 34 per cent stake in Citi. He cited Royal Bank of Scotland’s £300bn portfolio of “non-core loans” as an example of the problem. “That takes a government decision, it is not a decision that any loan officer can make,” he said.
Terra Firma’s recent offer to put £1bn of fresh equity into EMI in return for Citi writing off £1bn of its debt has been rejected by the US lender, leaving negotiations deadlocked on one of the last deals from the leveraged buy-out bubble. “The Citi discussions [on EMI] are about how much pain each side can take,” said Mr Hands, one of the UK’s best-known private equity bosses. “The governments have done an amazing job of winning the war, by stopping the financial system from going under, but now they need to win the peace.”
In his speech earlier on Wednesday, Mr Hands outlined his view of how a smaller, more humble private equity industry would emerge from the crisis. “I believe the leveraged buy-out private equity model can be fixed but it is going to be a painful process,” he said. “The days of making a quick buck in private equity are over. “In the future the private equity industry will be smaller and more humble, but it will be considerably better at delivering long-term value.”
Bank of America, UBS, JPMorgan Sued Over Derivatives
Bank of America Corp., UBS AG and JPMorgan Chase & Co. were sued by a California public utility over claims they rigged sales of municipal derivatives and shared illegal profits through kickbacks. The lawsuit, filed by the Sacramento Municipal Utility District, is based on federal and state antitrust claims. It alleges Charlotte, North Carolina-based Bank of America and more than a dozen other banks conspired to pre-select winners of municipal derivative auctions, coordinated their pricing, and accepted kickbacks disguised as fees from co-conspirators.
The allegations resemble those made by a U.S. grand jury in New York last month, according to the lawsuit filed Nov. 12 in federal court in Sacramento. CDR Financial Products Inc. founder David Rubin and two employees of the Beverly Hills, California- based company were indicted for allegedly accepting kickbacks on investments sold to local governments. CDR is also named as a defendant in the Sacramento case.
The banks engaged in “allocating customers and markets for municipal derivatives, rigging the bidding process by which municipal bond issuers acquire municipal derivatives, and conspiring to manipulate the terms that issuers received,” according to the lawsuit. The charges against Rubin and the CDR employees were the first to result from a more than three-year investigation into bid-rigging in the municipal bond market. The probe is continuing and has already drawn in some two dozen banks, insurers and local government advisers.
Derivatives are unregulated financial instruments linked to stocks, bonds, loans, currencies and commodities, or linked to specific events such as changes in interest rates or weather. Shirley Norton, a Bank of America spokeswoman, didn’t immediately return a call seeking comment after regular business hours yesterday. SMUD, which provides electricity to Sacramento County and part of Placer County, is the sixth-biggest publicly owned utility in the U.S. by customers served, according to its Web site.
Insurers Face $23 Billion Loss on Commercial Property
U.S. life insurers, a group led by MetLife Inc. and Prudential Financial Inc., may lose as much as $22.6 billion on investments in commercial real estate through 2011, Fitch Ratings said. Losses on investments in apartment buildings, offices, shopping malls and other commercial real estate will begin to increase in the next 6 months to a year as rents decline and vacancies increase, said Fitch Senior Director Andrew Davidson. Life insurer losses on commercial real estate have been “virtually nil” so far, he said. “It will be more of a 2010 and 2011 issue,” Davidson said in an interview today. “It will put some stress on the capital positions as they realize the losses.”
Life insurers held more than $450 billion in commercial loans and mortgage-backed securities at the end of 2008, Fitch said in a related report. The delinquency rate on U.S. CMBS rose to 4.01 percent at the end of October, almost seven times what it was a year ago, Moody’s Investors Service said yesterday. MetLife has recorded three straight quarterly losses and Hartford Financial Services Group Inc. has lost money since June 2008 as investments that include those backed by commercial and residential mortgages dropped in value. New York-based MetLife and Prudential have said commercial mortgage defaults will climb in the next year.
“Losses in our commercial mortgage portfolio are going to accelerate over the next 18 months,” Bernard Winograd, executive vice president of Newark, New Jersey-based Prudential, said in an August conference call. “The fact that there have been very little in the way of delinquencies so far should not be taken as an indication that there won’t be losses.” MetLife’s Chief Investment Officer Steve Kandarian said in June the insurer would have “some issues” related to the holdings. “The worst is to come,” he said in an interview with Bloomberg Television. “Typically there’s a lag between when the economy softens and when the defaults actually occur.”
The credit crisis has driven $138 billion worth of U.S. commercial properties into default, foreclosure or debt restructuring, according to New York-based Real Capital Analytics Inc. Commercial real estate prices have plunged almost 41 percent since October 2007, the Moody’s/REAL Commercial Property Price Indices show. The dollar value of loans dropped 56 percent for office properties and 40 percent for apartment buildings, the Washington-based Mortgage Bankers Association said in a Nov. 5 statement. Loans for malls and shopping centers fell 62 percent and hotel loans declined 46 percent.
Life insurers’ underwriting profits and improved capital levels will mitigate losses related to commercial real estate, Davidson said. “They’ve got plenty of capital and they continue to have operating earnings, so in that regard we think the losses will be manageable,” he said. “They’ll be able to fill the holes that develop.”
California faces a projected deficit of $21 billion
The legislative budget analyst's projection, to be released Wednesday, threatens to send Sacramento back into gridlock and force more broad cuts to state programs.
Less than four months after California leaders stitched together a patchwork budget, a projected deficit of nearly $21 billion already looms over Sacramento, according to a report to be released today by the chief budget analyst.The new figure -- the nonpartisan analyst's first projection for the coming budget -- threatens to send Sacramento back into budgetary gridlock and force more across-the-board cuts in state programs.
The grim forecast, described by people who were briefed on the report by Legislative Analyst Mac Taylor, comes courtesy of California's recession-wracked economy, unrealistic budgeting assumptions, spending cuts tied up in the courts and disappearing federal stimulus funds. "Economic recovery will not take away the very severe budget problems for this year, next year and the year after," said Steve Levy, director of the Center for Continuing Study of the California Economy.
In fact, after two years of precipitous revenue declines, the new report projects relatively stable tax collections for the state, said those who were briefed. But that won't stop the deficit from climbing to nearly $21 billion. Gov. Arnold Schwarzenegger, who will present his next proposed budget to Californians in January as he begins his last year in office, started sounding the alarm last week. "I think that there will be across-the-board cuts again," he said at a San Jose news conference.
The task in 2010 could be even harder than it was this year, when record deficits and cash shortfalls drove California to issue IOUs for only the second time since the Great Depression. Lawmakers have already cut billions from education, healthcare and social services while temporarily hiking income, sales and vehicle taxes. "I can't think of any good solutions," said Assemblywoman Noreen Evans (D-Santa Rosa), who chairs the lower house budget committee.
The current budget year accounts for $6.3 billion of the deficit, the nonpartisan analyst projects. Prisons spending will outstrip what has been budgeted by more than $1 billion, and K-12 schools were underpaid by $1 billion under the complex formula that governs education funding, the report says. Another $14.4 billion of the deficit is for the fiscal year that begins next summer, say those briefed on the report. The governor's next budget will have to account for both years.
The state Department of Finance in August predicted a shortfall of at least $7.4 billion for fiscal 2010-11. But California's financial picture has darkened considerably since then, largely because the shaky summer budget pact relied heavily on borrowing, fiscal tricks and overly optimistic projections. It assumed receipts of nearly $1 billion from the federal government for Medi-Cal that the analyst questions. Another $1 billion was assumed from the sale of a quasi-public workers' compensation agency that has stalled. Next year's budget fight is expected to be as contentious as this year's. Republicans vow to block new taxes; Democrats say they are through with program cuts.
Powerful interest groups are already girding for battle. "There is no more to cut from our schools," California Teachers Assn. President David Sanchez said Tuesday. "There is no more meat on this bone. . . . The next step is amputation." In higher education, Chancellor Charles Reed of the Cal State University system said this month that he will plead for $884 million in funds from Sacramento next year. The University of California will ask for $913 million more for its 10-campus system, President Mark Yudof has said.
"If ever there was a time to fight for and invest in the institution best positioned to power this state from recession, now is that time," Yudof said in a statement. UC students, meanwhile, are coping with a staggering 32% fee hike. California's finances have been so bad that the governor's finance director, Mike Genest, told a budget forum in Washington last week that back in February he had combed through the U.S. Constitution to research whether California could legally declare bankruptcy -- or revert to some kind of territorial status. (Neither was realistic, he determined.)
The state's financial problems predate the current recession and the gimmicks used to paper over the deficit, experts say. Year in and year out, state government spends roughly $10 billion more than it collects in tax revenue. Political divisions in Sacramento, where support from both parties is necessary to pass a budget, have repeatedly stymied efforts to plug that hole. The task probably won't be easier next year as various interests try to muscle one another to the sidelines.
Some have even drafted potential ballot measures to aid themselves in the budget fight and are preparing to collect signatures in an effort to place the initiatives before voters. Among the ideas: raising tobacco taxes, curbing public pensions, repealing corporate tax breaks passed thisyear and last, splitting the tax rules for commercial and residential property, reducing the legislative votes needed to pass a budget and strengthening the firewall around local government and transportation money. "There's a lot of people putting chess pieces on the board right now," said Jon Coupal, president of the anti-tax Howard Jarvis Taxpayers Assn. "The question is which of those chess pieces will be moving."
America's Newest Land Baron: FDIC
In the waning days of the Great Recession, the federal government is still jumpstarting the economy and propping up financial markets. It is also trying to sell Dresden Heights, a failed condo development on a noisy freeway ramp next to a Motel 6, a Waffle House and a Do-It-Yourself Pest Control.
For more than a year, the Federal Deposit Insurance Corp. has been seeking a buyer for 36 partially built condos it inherited from a high-flying, short-lived Atlanta bank. The agency has been fending off vandals, haggling with architects and uncovering the developer's blunders, all in a bid to dispose of this condo project, just one of the 2,554 foreclosed assets dumped onto its books. "These are properties with a bad story," says Jim Gallagher, a senior official in the FDIC's Division of Resolutions and Receiverships. "What we're trying to sell is something that is rundown or not completed or has some property damage." The financial crisis started with Americans buying homes they couldn't afford. It is ending with the government struggling to sell buildings it never wanted.
In the past two years, the FDIC has taken over 150 failed banks. In the process, it has seized more than 5,000 houses, subdivisions, buildings, parcels and other foreclosed assets. The current backlog of property stuck on the agency's books, with an appraised value of $1.8 billion, ranges from an $18,700 clapboard home with stained carpets in Birmingham, Ala., to a $1.7 million mountainside lodge with a heated driveway in Steamboat Springs, Colo. Taxpayers will be grappling with this flotsam for years to come, one example of how the crisis will linger long after the economy begins to revive. At a recent FDIC auction in Atlanta, the agency offered a four-unit condo building it had already sold once before -- after the savings-and-loan crisis two decades ago.
These days, it takes the FDIC on average six to eight months to sell a property. Dresden Heights, tied up with unpaid bills, a lawsuit and complex right-of-way questions, is among its toughest prospects. The project was the brainchild of Quantum Homes and its chief executive, Ramsey "Jim" Salahat. In March 2006, just as Atlanta's housing market was peaking, Mr. Salahat took out a $3.78 million, 18-month loan from Main Street Bank in Covington, Ga., to purchase and prepare 5.3 acres abutting an interstate entrance ramp.
The developers brought in a crane, knocked down soaring oak trees, installed sewers and laid out two short roads, Heights Way and Quantum Lane. They planned 80 residential units and seven buildings. At the groundbreaking in May 2007, Mr. Salahat and Quantum President Eyal Livnat posed for photos, wearing white hardhats and digging red Georgia soil with shovels festooned in blue ribbons. They threw a cocktail party, serving wine, roast beef, quiche and cookies.
"Future homebuyers are quickly reserving space at Dresden Heights...so interested homebuyers should act fast to ensure they have a home at this great community," Mr. Salahat said in a news release afterwards. The release quoted Deanna Helie, a "prospective home buyer" who attended the event, as saying: "When this area begins to grow, I want to be in on that growth at an early point." Ms. Helie, who lives adjacent to the Dresden Heights property, said she was talking about the neighborhood only, and stopped by out of curiosity, not to shop. She wondered about the wisdom of building homes next to a pest-control outlet. "I was thinking, 'This isn't going to fly,'" said Ms. Helie, a computer programmer.
A few days after the groundbreaking, Mr. Livnat signed a two-year, $6.75 million loan from Alpha Bank & Trust, a startup bank in nearby Alpharetta, Ga., to finance construction of the first three buildings. Two dozen customers, most of them first-time home buyers, put down $500 to $1,000 deposits on the condos, which started at $194,900. The developers told the early buyers they would likely be able to move in within a year, according to Kristy Jeffries, who at the time was Quantum's saleswoman.
In early 2008, work on the project slowed, Ms. Jeffries recalls. People started asking for their money back, "and the builders weren't giving it to them," she says. In her office, located in the basement of a model home, she started receiving calls from disgruntled subcontractors complaining they hadn't been paid. She says one unhappy supplier repossessed Quantum's construction trailer, which still contained file cabinets with records of potential buyers. That spring, Mr. Salahat closed Quantum's headquarters in a lavish Atlanta office complex. He moved the company into a cramped, low-budget space behind a chiropractor's office outside of town, where Ms. Jeffries says she went for her paychecks.
The last time Ms. Jeffries saw Mr. Salahat was over a Tex-Mex meal in May 2008, when the developer told her the company was going bankrupt. Former associates say he has moved to Jordan. Neither they nor the FDIC could provide contact information. Mr. Salahat's listed phone numbers in the Atlanta area have been disconnected. During a brief interview on his stoop, Mr. Livnat, Quantum's former president, declined to discuss details of the Dresden Heights project. "It was an unfortunate time to start a company," Mr. Livnat said. "Things were at a peak, and it went down quick." Mr. Livnat was skittish about answering the door, and he said he is worried the FDIC or creditors might come after him.
Alpha Bank foreclosed on the three partly finished buildings a year after Messrs. Salahat and Livnat broke ground. On May 6, 2008, a bank representative stood outside the Dekalb County courthouse and offered the property for sale. No one was willing to beat the bank's $4.692 million minimum. Alpha Bank now owned Dresden Heights. The buildings sat exposed to rain, sun and wind through the summer of 2008, prompting bank officials to sign an agreement with McGuire Properties Inc., of Kennesaw, Ga., to finish construction. The company is run by George F. Nemchik, Jr., who was also an Alpha Bank shareholder, according to his attorney and Ms. Jeffries. Mr. Nemchik didn't return calls seeking comment.
Alpha Bank retained Ms. Jeffries to sell units. When she went to pick up her paycheck one day in October, a bank executive told her the lender was on the brink of collapse. He suggested the FDIC might want to keep her on as a sales agent for Dresden Heights. She demurred. "I think that property is cursed," she says now. The American government came to own Dresden Heights on Friday, Oct. 24, 2008, about six weeks after the collapse of Lehman Bros. Georgia regulators closed Alpha Bank and turned it over to the FDIC. That weekend, Stearns Bank of St. Cloud, Minn., took over Alpha's branches. It acquired just $39 million of the $354 million in assets. The FDIC took possession of the rest, including Dresden Heights.
The FDIC inspector general's post-mortem blamed Alpha Bank's failure on "management's aggressive pursuit of asset growth concentrated in high risk" residential real-estate development and construction loans. Former Alpha Bank chief executive Joe Briner, now a consultant with a corporate-turnaround firm in Atlanta, didn't return calls seeking comment. The FDIC wanted the property sold quickly, despite a series of obstacles, including hundreds of thousands of dollars in liens filed against Dresden Heights by building-material suppliers and McGuire Properties, the company that was finishing construction. If enforced by a court, any potential buyer would have to cover those bills before taking possession.
In January, the FDIC's outside property-management firm gave the listing to Atlanta real-estate broker Rob Jordan, a 40-year-old who had spent 10 years as a commercial banker before joining his father in the family firm. These days, Jordan Co. does virtually all of its business selling foreclosed commercial properties. Mr. Jordan and his colleague, David Walmsley, pulled the county records on Alpha's construction loan, a routine step. They stopped cold at the surveyor's description of the property put up as collateral. "Said tract of land contains 6,776 square feet," the documents said of the first parcel. The other two parcels were similarly small.
Messrs. Jordan and Walmsley realized that Alpha Bank and now the federal government owned the three buildings and the land immediately beneath them -- but not an inch more. "What about the sidewalks? The stairs? The stoops?" asks Mr. Jordan. "They're all on someone else's property." The brokers checked with the county and confirmed that even the two small streets running through the subdivision belonged to someone else. That someone else was BB&T Corp., a Winston-Salem, N.C., bank. BB&T had bought Main Street Bank, which made the original loan to Quantum that allowed the developer to buy the Dresden Heights land. When Quantum went bust, BB&T foreclosed on that land and put it up for sale for $1 million.
Rifling through court records, Messrs. Jordan and Walmsley discovered that Quantum had signed an easement allowing passage between the two properties. But it wasn't clear if the agreement would be legally binding on future owners.
The murky right-of-way made the sales job far more difficult. The FDIC would have to inform potential buyers there was no guarantee they could gain access to their property without trespassing. The brokers next sought to obtain the building plans, vital documents for anyone hoping to finish the development. In January, Mr. Jordan called Bill vonHedemann of Niles Bolton Associates, the principal architect on the project, to ask for copies. Mr. vonHedemann declined, politely. The developers, he said, owed his firm more than $60,000 in fees.
Anyone who wants the 85 or so computerized drawings will have to pay for them, he told Mr. Jordan. "We don't give the plans away," Mr. vonHedemann said in an interview. Mr. Jordan didn't worry, initially. Alpha Bank should have had plans on file and regularly sent an agent to the site to check progress. But the brokers found no evidence Alpha had kept such records. Meantime, the property was beginning to deteriorate. Over the winter, the outside pipes froze. In March, thieves broke into a model unit and stole the refrigerator, the range and the dishwasher. The FDIC boarded up the ground-floor windows on all of the townhouses, changed the locks, stowed the air conditioners in the garages and hired a full-time security service.
Messrs. Jordan and Walmsley fielded nearly a dozen offers, but none was close to the $2.8 million asking price. By May, the brokers worried the FDIC was shooting too high. The FDIC ordered two new appraisals, a process that took almost five months. The brokers put off would-be bidders by saying the FDIC was undertaking "internal adjustments," an intentionally vague phrase intended to keep shoppers interested without responding to offers. McGuire Properties, the company that had agreed to finish the Dresden Heights construction on behalf of Alpha Bank, dropped its liens on Aug. 17 in the face of a federal law making the FDIC immune to such claims. Instead, McGuire sued the FDIC in federal district court. McGuire contended that after seizing Alpha, the agency had directed the builder to continue work on the condos, and reneged on a promise to pay. The company demanded $653,014 plus interest.
In court filings, the FDIC denied the main allegations and asked the court to force McGuire to cover the government's legal costs. The two sides are in settlement talks. In September, the agency cut Dresden Heights's asking price 25%, to $2.1 million, and the brokers called the serious prospects. One repeat bidder was 39-year-old Ho Hyun Chung. Mr. Chung moved from Seoul to the U.S. in 1996 to study business. He stayed to work for the U.S. cell-phone unit of LG Group, a South Korean conglomerate. Frequently up late on conference calls with headquarters, Mr. Chung became hooked on TV infomercials touting DVDs and books that promised riches through foreclosed real-estate. "I bought most of them," he says.
In 2007, as the real-estate market was tanking, Mr. Chung quit LG and started a business with his wife. Their niche: Buying unfinished foreclosed townhouses and completing them. He says he owns 42 units in 11 properties around the Atlanta area, including five townhouses he bought from the FDIC in December. He says he makes money on some, and loses on others. Mr. Chung spotted Dresden Heights on the FDIC Web site. He liked that it was inside the perimeter beltway and near two universities. He figured he could make a good return if he put no more than $1.5 million into finishing the project and then sold the units for $130,000 to $145,000 each, generating almost $5 million in gross revenue. It's a plan, he says, that depends heavily on the federal government's $8,000 first-time homebuyer tax credit. The credit, just extended by Congress, expires at the end of April. "If that goes, I don't know how the market will react," he says.
In October, almost a year after the FDIC seized Dresden Heights, the FDIC and Mr. Chung signed a sales contract giving him 30 days to conduct due diligence. Neither side would disclose the price. Only then did Mr. Chung's lawyer notice that the FDIC's buildings were islands surrounded by BB&T's land. Mr. Chung acknowledges the FDIC disclosed the information, but says he "didn't quite understand" the problem until his lawyer raised it. "I need to clean that up first," he says. He also wanted to make sure the person who buys the BB&T land signs an agreement that allows for the development and sale of the three buildings. This month, he asked the FDIC for an extension on his 30-day contingency period. The FDIC turned him down, and the agreement expired.
Bank of England splits three ways over policy for first time since 2008
The Bank of England's Monetary Policy Committee is split three ways over how to tackle the worst recession since the 1930s, minutes of their meeting showed today. While all nine members of the MPC voted to hold interest rates at a record low of 0.5pc, there was disagreement over the radical policy of printing money, or quantitative easing. The decision to increase the scale of the programme by £25bn to £200bn was backed by seven members of the committee, including Governor Mervyn King, the minutes show. But David Miles, a new member of the committee, sought a £40bn increase while the Bank's chief economist, Spencer Dale, voted to hold the amount at £175bn.
The three-way split is the MPC's first since August 2008 and underlines the challenges facing the MPC as it grapples with how to pull the economy from recession without sparking inflation. The MPC also discussed the possibility of lowering the rate it pays banks to keep reserves with it in an effort to encourage lending to the wider economy. Last week's Inflation Report from the Bank surprised markets with the strength of their forecasts for growth and inflation given that the economy is still losing jobs and lending to companies and households is weak. "Overall then, the MPC may not yet be done – much will depend on the data between now and February," said Jonathan Loynes, an economist at Capital Economics. "But any tightening of policy is still a long way off."
Mr Dale argued that increasing QE, which is designed to hand financial institutions cash by buying Government bonds, or gilts, from them, "might result in unwarranted increases in some asset prices that could prove costly to rectify." Mr Miles, who joined the MPC from Morgan Stanley, said that pumping even more money into the economy would "provide greater insurance against the downside risks to growth and inflation arising from constrained credit supply."
Pension deficits in Britain underestimated by $450 billion
Lloyds Banking Group and Royal Bank of Scotland, the state-backed lenders, are among a raft of large European companies underestimating the size of their pension deficits by a combined €300bn (£268bn, $450 billion). Lloyds' stated pension obligations are €14.2bn shy of the real size of the deficit, while RBS's are €13.3bn behind, according to research from equity research house AlphaValue. British Airways, which is pursuing a merger with Spanish airline Iberia, boasts the third highest shortfall at €10.5bn. The size of BA's pension deficit is being monitored by the airline's shareholders as Iberia has retained the right to walk away from the agreed merger pending the outcome of a triennial review at the UK carrier's pension fund.
Other companies boasting sizeable differences between actual and stated pension obligations included Barclays, BT Group, GlaxoSmithKline and HSBC, according to the research. BT revealed last week that its final-salary pension scheme deficit had more than doubled in the past six months from £4bn to £9.3bn. The change came as a result of movements in bond yields and inflation expectations, as well as changes to accounting regulations. AlphaValue said many of the 430 companies monitored underestimated the true value of their pension deficits by assuming a low level of wage inflation and by adopting a high discount rate, a measure used to value pension funds' liabilities.
The research house said 31 companies had underestimated their deficits by 40pc or more, with UK firms among the worst offenders. "More than one-third of 2008 pensions obligations – some €1,100bn – are recorded at UK companies, as this is where the largest companies operate with the largest defined-benefit commitments. The bulk of the "non-accounted-for" pension deficit is also with UK corporates, especially the banks, as they use rather high discount rates compared with non-UK peers," said Pierre-Yves Gauthier, a director at AlphaValue.
Companies are believed to be attempting to reduce stated pension deficits by scaling back projected wage rises and maximising the discount rate. Last year, average wage inflation fell from 3.7pc to 3.6pc, while discount rates grew from 5.38pc to 5.57pc. AlphaValue said the "spread" helped save European companies about €51bn in 2008. Mr Gauthier said many companies had made efforts to correct valuations this year, but warned that volatile market conditions made it important to find consistent measurements, above all on discount rates. Official figures from companies' 2008 accounts show pension deficits at the European companies growing 22pc last year to €280bn. The AlphaValue research showed an additional €300bn of unrecognised deficits, the equivalent of 9pc of shareholders' equity.
Michael Panzner: Commercial Real Estate Is A "Tsunami Unfolding"
Michael Panzner is bearish, and you should listen.
The 25-year veteran of the global stock, bond, and currency markets was one of the few who called the crisis before it happened, with a book aptly titled "Financial Armageddon."
Today, Panzner calls a V-shaped recovery "ridiculous," says commercial real estate is a bubble sure to burst, and is fearful that there's far too much speculation on commodities, risky stocks and emerging markets. In short, he says "the world is a riskier place and will continue to stay that way going forward."
We caught up with Panzner at a panel on risk management sponsored by QFinance. Some notes from our conversation:
On recovery, Panzer says it's "a protracted process" but "talk about a 'V' bottom is ridiculous." He also said "talk about a jobless recovery is laughable, especially in the context of the U.S. being some 70% reliant on the consumer:"
In some respects the system is more broken than it was before. From my perspective at least the economic model of the banking system -- the operating model is essentially broken. Securitization doesn't work. The biggest supplier of funds and the biggest customer to the banking sector is the Federal Reserve. In some respects the whole concept of too big to fail has been complicated by the fact you have institutions that are now too connected to care. There's a hubristic element that remains from the crisis of the past two years.
On dealing with the financial crisis by spending:
[We've] learned the wrong lessons in terms of how to deal with the crisis. Before we had this notion that people could slice and dice risk and make it go away. The new version of that is the fact that large amounts of publicly created debt will somehow make the problems of large amounts of old, privately-created debt go away, which is a little bit of a non sequitur.
On the coming commercial real estate crash:
Commercial real estate seems to be the accident waiting to happen. In my mind at least there is no doubt...in fact it seems like a deja vu moment in terms of the way it's playing out. We're getting reassurances here that it's all going to be okay, it's this sort of contained phenomenon...it's very reminiscent in my mind of what took place with sub-prime and the failure to acknowledge that it was a broader problem -- an institutional problem in terms of credit, in terms of risk taking. It seems like there's a bit of an instant replay going on with commercial real estate. People are thinking 'well, it hasn't happened yet, so it's not going to happen.'
That's the old Hurricane Katrina line of reasoning. From what I can see it's a tsunami unfolding and it's going to be a real train-wreck over the next two to three years for the banking sector. I don't think there's any way around that issue. Zero.
Another deja vu moment for Panzner is government debt. The same problems of securitization and derivatives apply: faulty assumptions, faulty models with limited data, and over-confidence.
"They're assuming debt levels can go up forever, without putting that in any sort of reality context." But that rules out the black swan, which is "what happens if people don't want to buy your debt."
Panzer thinks we may see hyper inflation as the share of U.S. outlays relative to the deficit are about 40%. "It may not be such a good idea -- even though the Krugmans of the world think it is -- to spend unlimited amounts of money without thinking through the potential consequences."
On the next financial bubbles:
I'm a very long term bull on gold, however I believe that gold and commodities more generally, the short dollar trade, the long equity trade are all part of this gigantic risk play that is propagated by this huge amount of cheap money being pumped into the system...I would be looking for these things to correct, perhaps violently.
He adds: "The first real uptick you get in the dollar you'll see elephants running through a revolving door."
Panzner says gold is the perfect example. People say it's a safety hedge, but why are bonds not selling off and why are emerging markets going up? "If you look at that they're all moving together then you get a much clearer, coherent picture. It's another bubble, an echo bubble or whatever you want to call it."
Besides gold, Panzner counts oil, basic commodities, stocks, emerging markets -- and other riskier assets -- as the stuff of speculation and over-investment.
It's an Orwellian universe. People keep making non sequeters and everyone else shakes their heads and says 'yeah, that's okay' and no one is standing back and saying 'wait a minute, that doesn't make any sense at all.' People are saying these things and acting on them but not thinking thinking them through and saying 'wait a minute, this doesn't make sense.
Goldman On The Dollar Carry Trade: "A 20% Reversal In Either 3 Months Or 3 Days"
by Tyler Durden
As the decoupling between cause and effect continues: i.e., the economy and the stock market, more and more pundits focus on the dollar carry trade as the primary culprit for market appreciation. With the US market flat for the year when indexed for the decline in the dollar, the entire rally has been one big window dressing to prop up Obama's confidence boosting propaganda. Yet the entire rally, aside from the unique technical peculiarities underpinning it (short squeeze, low volume/high momentum algo participation) has been carried on the back of the dollar's decline: take away the concept of importing inflation at all costs (which is what Bernanke is happy to continue doing) and US deflation would have been rampant by now, proving the Fed's plan to liquefy the capital markets to be a disaster. As such, the only thing that allows the "rally" to continue, is the willingness of the Rest of the World to fund not only the skyrocketing US budget deficit, but the Chinese trade imbalance, courtesy of the yuan-dollar peg.
The rally will come to an abrupt end when one of two things happens: i) the Fed gives an indication it wants investors to stop chasing risky assets (likely not for at least 5 years) and ii) the rest of the world realizes that America has no leverage whatsoever, with its crumbling economy, and its loose monetary policy which as prominent Chinese figures have already determined, is currently causing asset bubbles worldwide (yet which the Chairman is unable to see). Possibility ii has a much greater probability of occurring, yet if and when it does, will be dependent in great extent on the future of the dollar carry trade.
Nouriel Roubini has already pointed out the great danger posed by every single trader in the world being short the dollar. As we saw on Monday, one word out of place by Bernanke, and the reversal will be disastrous. Below we present the thoughts from Goldman Sachs, which, as expected, is much more sanguine about the impact and the participation in the carry trade. To Goldman, the dollar value is merely a function of the US economy's weakness. Ironically, Goldman has been pumping up the strong economy story for much of H2, until recently when even 85 Broad has reversed its opinion.
While Goldman's observations are not surprising, the question emerges as to how the firm is positioned now to make the higher amount of money from a macro picture, as very few trade on company-specific alpha: courtesy of banks like Goldman, every asset class has become one big beta bucket. If Goldman is wrong, which it likely is in this case, the impact would be rapid and dramatic: as Goldman itself notes: a 20% reversal which would come in either 3 months or 3 days. Let's recall Goldman's stance on oil last summer to see just how spectacularly wrong the world's most riskless hedge fund can be in its "policy" guidelines.
Factors Driving Dollar Weakness besides Dollar-Funded Carry Trades
There has been a lot of focus recently on the extent of Dollar-funded carry trades contributing to the decline in the USD. The IMF in a report prepared for the recently concluded G-20 Finance minister's meeting cited ‘In addition to foreign funds moving into emerging market equities, led by expectations of higher growth, there are indications that the U.S. dollar is now serving as the funding currency for carry trades. These trades may be contributing to upward pressure on the Euro and some emerging economy currencies.'
We find the argument of Euro benefiting from this particular dynamic somewhat challenging though, given the minute rate differentials here. But overall, there are carry trades funded in USD and other commentators have expressed their worries over a new ‘carry bubble' emerging. While pinning down precisely the extent to which speculative Dollar funded carry trades are taking place is not an easy task, we can point to a few other factors behind Dollar weakness so far this year. Simply put, the Dollar's decline so far does not seem too out of line, especially when you consider that the US is still cyclically one of the weakest economies around.
While there has been a pick-up in investment in higher yielding currencies and assets, there is a distinction to be made between speculative carry trades and investments made on the basis of stronger EM fundamentals. It is hard to draw the line where investment activity becomes a speculative bubble but we do not think that we are in the midst of a 'carry bubble' at the moment. Yes, inflows into EM assets have accelerated rapidly over the last several months but this has also arguably been led by improving fundamentals in these countries in general.
US equity fund flows into EM markets have broadly tracked the widening growth gap between EM countries and the US. We use a simple measure of real GDP growth in EM countries minus US growth to track the latter, which shows that the EM-US growth differential had peaked in 3Q of 2008, bottomed in 1Q 2009 and has since widened out again over the last 2 quarters . Plotting this EM-US GDP differential versus US equity fund inflows into EMs, there does not seem to be any significant divergence. The point being that EM equity flows so far have been underpinned to a certain extent by relatively stronger recovery prospects.
Other factors underpinning Dollar weakness include hedging asymmetries. We have most recently discussed this in our latest November FX monthly publication. In a nutshell, this refers to the likelihood that overseas investors in US assets appear to be FX hedged to a greater degree than US investors of foreign assets. As a result, a rally in risky assets tends to result in Dollar selling to maintain hedge ratios.
Finally, part of the Dollar weakness trend observed so far since the crisis has also been due to the ongoing normalization in markets. This has been well described in a recent speech by Chairman Bernanke: ‘When financial stresses were most pronounced, a flight to the deepest and most liquid capital markets resulted in a marked increase in the dollar. More recently, as financial market functioning has improved and global economic activity has stabilized, these safe haven flows have abated, and the dollar has accordingly retraced its gains.' Indeed, our GS USD broad TWI has retraced to a large extent but even now is still slightly stronger than the levels of autumn last year.
USD-funded Carry Bubble vs Bubbles from Importing US Monetary Policy
Thus while there are Dollar-funded carry trades and certainly other cyclical factors behind the Dollar's weakness, we do not think we are seeing a speculative ‘carry bubble' for now. The difference being a 20% strengthening in the Dollar upon a reversal, over say 3 months as opposed to 3 days for the latter.
There is also a difference between a Dollar-funded carry bubble and asset price bubbles from importing loose US monetary policy. There is certainly a case to be made of certain parts of the world currently experiencing rapid asset price inflation, as a consequence of the accommodative monetary policy of the US. Hong Kong comes to mind, importing the low US interest rate policy with its currency peg, despite having a different economic backdrop and real exchange rate appreciation pressures. Domestic asset price inflation is thus one of the release valves in such an instance, while maintaining an undervalued nominal currency. Same goes for Singapore with its managed exchange rate basket and imported low nominal interest rates. But this is largely a consequence of the adopted exchange rate regimes of these countries, where one way to ease asset price inflation would be to allow more domestic nominal currency appreciation.