Free Christmas dinner for horses in Washington, D.C.
Ilargi: For once, I'm afraid, I have to agree with Paul Krugman, himself a highly dysfunctional man in my eyes: the US government is Dangerously Dysfunctional. Only, Krugman, ever eager to be my anti-thesis, -somewhat comfortingly for me- rolls off the rails right away again by claiming that this is a result of party politics, and the blame lies squarely with the party he happens not to like, the GOP. And while I have little sympathy for that particular party, I do know that Krugman's portrayal is false.
Eliot Spitzer and Wiilam K. Black, seemingly honest and (therefore?) marginalized voices, ask to see emails concerning the AIG bailout(s). Therein, they contend, we’ll be able to see what really went on when the world's -then- largest insurer received $180 billion of your money, much of which was transferred at an amazing speed to the likes of Goldman Sachs. Make the emails public and we’ll know, because then "a thousand journalistic flowers can bloom". They actually wrote that.....
Yves Smith at Naked Capitalism reacts, and wants more. She thinks we should know why no research was done into all the parties involved, why they could receive money without being scrutinized before, during and after the bail-out process. Yves provides a well-written overview of Goldman Sachs actions that involved parts of the AIG funds. Still, calling for investigations into the matter, with or without emails, and more than a year after the fact, largely misses the crucial points here. Which takes us back to my buddy Krugman.
The AIG decisions were made in Washington. There was another party on the throne, but what difference did that make? The decision-making problems don’t vanish when another party comes to power. That much, we can all agree by now, has been made exceedingly obvious by the Bush to Obama transfer. The reason behind this is that the real rulers stayed in place while the White House changed occupants. The US simply isn't governed by its elected politicians. Or at least not by their ideas and convictions, if, when and where these differ from those of their donors.
If a politician can be elected only when (s)he has enough money (i.e. millions of dollars, and for a president hundreds of millions) to run a campaign, then the resulting policies will be dictated by those who donate that money. And since one dollar equals one vote, the grandma who ate mac and cheese for a week to donate $10 to Obama has no say, while a financial institution that gave $10 million does.
Both parties partake of the exact same largesse, so claiming that one is to blame and the other is not is nonsense. The system itself is broken. And you can't fix it with a bit more openness here or a few published emails there. You can only fix it by separating politics and business, by taking a big old axe and cruelly cutting clear through the umbilical chords so carefully and profitably attended to on K Street. Anything else is mere make believe. Nobody in Washington seeks the truth behind all this. Everybody seeks a story that makes them look good for their voters.
Arnold Kling describes it like this in The Harvard-Goldman Filter:
As to libertarians, certainly in a world with no deposit insurance or government guarantees I could argue against government interference in the structure of private banks. But banks are not private in this country. They are quasi-public institutions [..].
There is a synergy between big banks and big government. Jefferson and Jackson were right. So breaking up big banks fits in with breaking up big government. Which is why we won't see the Progressive elite breaking up big banks.
The trouble in Denmark on Capitol Hill runs much deeper than a vote or an idea. The country is governed by a few hundred enlightened souls who are all for sale, or they wouldn't be where they are. And if a soul does get lost on the Hill and tries to follow his or her conscience, the rest of them will drown it out.
This is not a new issue, though it has rapidly grown more poignant in the past 3 decades. What is new today is that the dysfunctional system has to deal with a crisis that cannot be dealt with as previous crises were: with more growth.
And without growth, what wealth there is has to be redivided, or society as a whole becomes untenable. And yes, redivided it is, but not in a way that would warrant society's continued viability. On the contrary, those who always had much will have more, while those who had least will now have nothing. And I’ve said it before, it's not a political statement to say that if a society doesn't provide a minimum for its poorest, that society must of necessity fail.
Read all the emails you want, investigate all the crooked deals made in the bail-outs. It won’t matter one iota. Once growth is gone, you need to prevent the rich from lobbying themselves into ever and even more riches. because these will have to come from the mouths of the desolate.
Or you can choose not to, but then your society is over and done with. Now, I don’t really think people will think I’m right. When most read that the noughties were the worst decade for stocks ever, as in since the 1820's, almost 200 years, they’ll think: well, it should go up then, shouldn't it?
Who among them concludes that growth may be gone, even if they know it can’t last forever? It was inevitable that they'd still be expecting -nay, even seeing- growth when the world around them is shrinking.
PS: The Financial Times headline "Bank of Japan says it will not tolerate deflation" inspired a good friend to come up with this quote about King Canute, about a millenium or so old. It would be a valuable lesson for many, not in the least the economists and assorted financial types who overestimate governmental powers and good will of many sorts and stripes.
"Henry of Huntingdon, the 12th-century chronicler, tells how Cnut set his throne by the sea shore and commanded the tide to halt and not wet his feet and robes; but the tide failed to stop.
According to Henry, Cnut leapt backwards and said "Let all men know how empty and worthless is the power of kings, for there is none worthy of the name, but He whom heaven, earth, and sea obey by eternal laws." He then hung his gold crown on a crucifix, and never wore it again."
China or Bust
by Joel Bowman
When Dubai’s debt bubble burst a few weeks ago, few expected that it would precipitate, by itself, a complete collapse of the global economy. Even those who foresaw the mounting and crippling debt loads there weren’t that imaginative. After all, the Swarovski-clad emirate’s portfolio, packed with high-end New York retailers and Las Vegas casino projects, represented, in many ways, more super speculative hedge fund than measured, robust investment stratagem.
Likewise, when Greece, laboring under a deficit not dissimilar to that in the United States, fell prey to the ratings agencies’ wrath, few investors conjured up apocalyptic scenarios of mile-long soup lines around the world. The government there had a "poor history" of debt management, the agencies observed. What did we expect? These two debt-addled sovereigns are far from out of the woods, of course. Abu Dhabi might have thrown its meretricious cousin a $10 billion lifeline, for instance, but the emirate’s leader must still find a way to meet up to $80 billion in additional debts and liabilities. With soaring interest rates on bonds issued by the emirate and shattered investor confidence, that won’t be easy. The Greeks face similar problems, and already their fate weighs heavily on both the Eurozone and its currency.
But in any high stakes game, it is always the weakest hands that fold first. That is to be expected. The same casual indifference cannot, however, be indulged when one considers the possibility of a China bust-up. And with investors like Jim Chanos employing – possibly hyperbolic – descriptions like "Dubai times a thousand" to describe the Middle Kingdom’s economy, the possibility that we may see a spectacular collapse there is worth, at the very least, a moment of contemplation. Prima facie, China appears to be nursing along the world’s nascent recovery rather well. Forecasts of GDP growth around 10-10.5% for 2010 are not infrequent and, judging by the inflow of liquidity into the Asian region as a whole, most investors expect nothing less.
According to Nomura Holdings Inc., persistently low interest rates in the US, coupled with the perception that Asian economic growth is a one-way bet, is driving a "tsunami" of capital into the region. Data compiled by the Japan-based financial group show a half-trillion dollar reversal in foreign cash flows over the past year alone as investors pile their bets on a China-led economic resurgence. In the three quarters leading up to March of 2009, widespread economic meltdowns in the west saw some $262 billion vacuumed out of Asia’s red hot "tiger" economies as beleaguered funds in The City, Wall Street and elsewhere repatriated capital to meet crushing margin calls closer to home. However, over the past six months, almost all of that cash ($241 billion) has found its way back to Asian shores.
Even in a region as populous as this one, that kind of cash does not stay inconspicuous for long. Coupled with ample stimulus spending by local governments, those funds have helped inflate prices from equities through to the local property markets. The MSCI Asia-Pacific index (which excludes Japan) is up 62% for the year, en route to its best twelve-month performance in over a decade and a half. China’s own Shanghai CSI 300 measure is higher by more than 65% for the same period. Again, such a strong market performance one year does by no means guarantee a retracement the next, much less a total collapse. But in and of itself, a past rally does not support unbridled optimism for future rallies.
Indeed, some fissures are already starting to appear. The same Shanghai index that boasts such impressive year to date numbers slid over 4% last week, and several components of the China Stocks and ADRs Index have slipped by 10% over the same period. Real estate prices in China are also looking rather frothy. A recent editorial that appeared in China Daily ought to inspire at least some skepticism amongst once-bitten investors: "If there is anything more spectacular than the amazing V-shaped recovery of the Chinese economy this year," the paper reads, "it must be the jump in its housing prices which, after dipping for a while, are breaking records in many cities."
Statistics cited by the paper indicate prices in 70 major cities (yes, they have 70 major cities) are rising at an incredible pace, outstripping even their parabolic climb in 2008, before the last "dip." "It has been reported that prices for commercially built new residential units in Beijing, Shanghai and Shenzhen have jumped above 50 percent so far this year, outpacing the growth of local economies by more than 5 times," the paper continues.
On Friday, Zhang Xin, chief executive officer of property developer SOHO China Ltd, warned that prices in the red hot real estate market may already be overheated. "The government needs to realize how serious the asset bubble is," Zhang told newswire, Reuters. "It cannot control the asset bubble by just saying a few words. The most fundamental solution is to tighten credit." "There is a bubble in every city," Zhang added.
That’s the problem with central governments’ stimulus spending, of course: one never knows when enough is enough. According to Forbes, "More than 1.6 trillion yuan, or about one-sixth of China’s new loans, went to the property sector in the first 11 months, including mortgage loans to home buyers and lending to developers." All this is not to say that China will implode, of course, only that it might. Any recovery the world may or may not be experiencing is, at best, embryonic and, therefore, extremely fragile. In an era where Nassim Taleb-style Black Swans darken the skies and "six-sigma" events seem to defy conventional mathematics, it would be foolish to expect only the expected.
China: Harder to buy US Treasuries
It is getting harder for governments to buy United States Treasuries because the US's shrinking current-account gap is reducing supply of dollars overseas, a Chinese central bank official said yesterday.The comments by Zhu Min, deputy governor of the People's Bank of China, referred to the overall situation globally, not specifically to China, the biggest foreign holder of US government bonds.
Chinese officials generally are very careful about commenting on the dollar and Treasuries, given that so much of its US$2.3 trillion reserves are tied to their value, and markets always watch any such comments closely for signs of any shift in how it manages its assets. China's State Administration of Foreign Exchange reaffirmed this month that the dollar stands secure as the anchor of the currency reserves it manages, even as the country seeks to diversify its investments.
In a discussion on the global role of the dollar, Zhu told an academic audience that it was inevitable that the dollar would continue to fall in value because Washington continued to issue more Treasuries to finance its deficit spending. He then addressed where demand for that debt would come from. "The United States cannot force foreign governments to increase their holdings of Treasuries," Zhu said, according to an audio recording of his remarks. "Double the holdings? It is definitely impossible."
"The US current account deficit is falling as residents' savings increase, so its trade turnover is falling, which means the US is supplying fewer dollars to the rest of the world," he added. "The world does not have so much money to buy more US Treasuries." China continues to see its foreign exchange reserves grow, albeit at a slower pace than in past years, due to a large trade surplus and inflows of foreign investment. They stood at US$2.3 trillion at the end of September.
Chinese fund to receive new capital
China Investment Corp, the Chinese sovereign wealth fund, is expected to receive another injection of capital from the country’s foreign exchange reserves in the coming months, according to government officials and people familiar with the fund. While a final decision has yet to be made, these people said CIC would likely receive a similar amount to the initial $200bn it was given on its establishment in 2007.
Chinese media have also reported the government is considering a new capital injection of $200bn for the fund. Any infusion would amount to an acknowledgement from Beijing that CIC has performed well during a time of global turmoil. It would also mark a turnround from a year ago when the fund was under attack for its early lossmaking investments in Morgan Stanley and US private equity firm Blackstone.
Bankers say that despite those hiccups the fund has managed its funds well through the crisis. It stayed mostly in cash last year before switching into highly liquid US dollar assets as the greenback bounced back in November 2008 and again in March this year. As the global economy began to recover earlier this year, the fund was quick to make investments in commodities-related assets that benefit from a rebound in Chinese growth. In recent months the fund has clinched a series of deals and has committed more than half of the funds it had available for offshore investments.
"Their performance has been very good by most measures and they have gotten through the Blackstone-Morgan Stanley debacle, which really hurt and constrained them in 2008," said one person who works closely with the fund. China’s foreign exchange reserves increased by $326bn to a total of $2,273bn in the first nine months of 2009. Beijing has repeatedly expressed its intention to gradually diversify away from low-yielding US government securities, which make up the bulk of the reserves.
Another factor influencing the decision to give CIC more money is the fact that China’s largest banks are expected to raise roughly $50bn in new capital over the next couple of years to meet tighter regulatory requirements. Since CIC holds controlling stakes in most of China’s largest banks, the fund must provide much of this capital to avoid seeing its holdings diluted.
For stocks, the worst decade ever
Since End of 1999, U.S. Stocks' Performance Has Been the All-Time Clunker; Even 1930s Beat It
The U.S. stock market is wrapping up what is likely to be its worst decade ever. In nearly 200 years of recorded stock-market history, no calendar decade has seen such a dismal performance as the 2000s. Investors would have been better off investing in pretty much anything else, from bonds to gold or even just stuffing money under a mattress. Since the end of 1999, stocks traded on the New York Stock Exchange have lost an average of 0.5% a year thanks to the twin bear markets this decade.
The period has provided a lesson for ordinary Americans who used stocks as their primary way of saving for retirement. Many investors were lured to the stock market by the bull market that began in the early 1980s and gained force through the 1990s. But coming out of the 1990s, the best calendar decade in history with a 17.6% average annual gain, stocks simply had gotten too expensive. Companies also pared dividends, cutting into investor returns. And in a time of financial panic like 2008, stocks were a terrible place to invest.
With two weeks to go in 2009, the declines since the end of 1999 make the last 10 years the worst calendar decade for stocks going back to the 1820s, when reliable stock market records begin, according to data compiled by Yale University finance professor William Goetzmann. He estimates it would take a 3.6% rise between now and year end for the decade to come in better than the 0.2% decline suffered by stocks during the Depression years of the 1930s. The past decade also well underperformed other decades with major financial panics, such as in 1907 and 1893.
"The last 10 years have been a nightmare, really poor," for U.S. stocks, said Michele Gambera, chief economist at Ibbotson Associates. While the overall market trend has been a steady march upward, the last decade is a reminder that stocks can decline over long periods of time, he said. "It's not frequent, but it can happen," Mr. Gambera said. To some degree these statistics are a quirk of the calendar, based on when the 10-year period starts and finishes. The 10-year periods ending in 1937 and 1938 were worse than the most recent calendar decade because they capture the full effect of stocks hitting their peak in 1929 and the October crash of that year.
From 2000 through November 2009, investors would have been far better off owning bonds, which posted gains ranging from 5.6% to more than 8% depending on the sector, according to Ibbotson. Gold was the best-performing asset, up 15% a year this decade after losing 3% each year during the 1990s. This past decade looks even worse when the impact of inflation is considered. Since the end of 1999, the Standard & Poor's 500-stock index has lost an average of 3.3% a year on an inflation-adjusted basis, compared with a 1.8% average annual gain during the 1930s when deflation afflicted the economy, according to data compiled by Charles Jones, finance professor at North Carolina State University. His data use dividend estimates for 2009 and the consumer price index for the 12 months through November.
Even the 1970s, when a bear market was coupled with inflation, wasn't as bad as the most recent period. The S&P 500 lost 1.4% after inflation during that decade. That is especially disappointing news for investors, considering that a key goal of investing in stocks is to increase money faster than inflation. "This decade is the big loser," said Mr. Jones. For investors counting on stocks for retirement plans, the most recent decade means many have fallen behind retirement goals. Many financial plans assume a 10% annual return for stocks over the long term, but over the last 20 years, the S&P 500 is registering 8.2% annual gains.
Should stocks average 10% a year for the next decade, that would lift the 30-year average return to only 8.8%, said North Carolina State's Mr. Jones. It is even worse news for those who started investing in 2000; a 10% return a year would get them up to only 4.4% a year. There were ways to make money in U.S. stocks during the last decade. But the returns paled in comparison with those posted in the 1990s. Of the 30 stocks today that comprise the Dow Jones Industrial Average, only 13 are up since the end of 1999, and just two, Caterpillar Inc. and United Technologies Corp., doubled over the 10-year span.
So what went wrong for the U.S. stock market? For starters, it turned out that the old rules of valuation matter. "We came into this decade horribly overpriced," said Jeremy Grantham, co-founder of money managers GMO LLC. In late 1999, the stocks in the S&P 500 were trading at about an all-time high of 44 times earnings, based on Yale professor Robert Shiller's measure, which tracks prices compared with 10-year earnings and adjusts for inflation. That compares with a long-run average of about 16. Buying at those kinds of values, "you'd better believe you're going to get dismal returns for a considerable chunk of time," said Mr. Grantham, whose firm predicted 10 years ago that the S&P 500 likely would lose nearly 2% a year in the 10 years through 2009.
Despite the woeful returns this decade, stocks today aren't a steal. The S&P is trading at a price-to-earnings ratio of about 20 on Mr. Shiller's measure. Mr. Grantham thinks U.S. large-cap stocks are about 30% overpriced, which means returns should be about 30% less than their long-term average for the next seven years. That means returns of just 1.6% a year before adding in inflation. Another hurdle for the stock market has been the decline in dividends that began in the late 1980s. Over the long term, dividends have played an important role in helping stocks achieve a 9.5% average annual return since 1926. But since that year, the average yield on S&P 500 stocks was roughly 4%. This decade it has averaged about 1.8%, said North Carolina State's Mr. Jones.
That difference "doesn't sound like much," said Mr. Jones, "but you've got to make it up through price appreciation." Unless dividends rise back toward their long-term averages, Mr. Jones thinks investors may need to lower expectations. Rather than the nearly 10% a year that has been the historical average, stocks may be good for only about 7%.
US banks' Q3 trading revenues up on interest rate derivatives
U.S. commercial banks reported an 11 percent rise in trading revenues for the third quarter, boosted by strong trading flows and a wide, though declining, spread between the level at which they buy and sell positions, the Office of the Comptroller of the Currency said on Friday. Banks reported trading revenues of $5.7 billion for the third quarter, their fourth highest revenue generating quarter, up from $5.2 billion in the second quarter, said the OCC, the top U.S. regulator for large, national banks. In the first quarter of the year, banks had generated a record $9.8 billion in trading revenues.
"The return to more normal financial market conditions has allowed banks to generate more consistent trading revenues this year," said Kathryn Dick, deputy comptroller for credit and market risk at the OCC. Derivative exposure remained highly concentrated, with the largest five banks accounting for 97 percent of overall exposure and 88 percent of net credit exposure, the OCC said. Net current credit exposure, which is the amount banks risk losing upon the possible collapse of counterparties on their derivatives trades and a closely watched statistic by regulators, declined 13 percent during the quarter to $484 billion.
Derivatives, which are among the most profitable activities for banks, are under heightened scrutiny after fears over losses on the contracts helped sparked bank runs that led to the failure of firms including Lehman Brothers. Interest rate products generated the strongest revenues in the quarter, rising to $5.45 billion from $1.1 billion in the second quarter. Interest rate derivatives also comprised 84 percent of total derivatives volumes in the quarter, which stood at $204.3 trillion.
Meanwhile, foreign exchange contracts posted a loss of $1.5 billion in the quarter. Foreign exchange derivatives are closely aligned with interest rates as dealers use interest rate contracts to hedge foreign exchange risks. Credit trading generated $1.2 billion, while equity contracts yielded $154 million and commodity and other contracts earned $446 million, the OCC said. Volumes in credit derivatives fell 3 percent in the third quarter to $13 trillion.
JPMorgan Chase, Goldman Sachs, Bank of America, Citibank and Wells Fargo & Co, have the largest derivatives exposures of U.S. commercial banks. As of Sept. 30, these banks' notional derivative exposures stood at $78.97 trillion, $41.97 trillion, $40.1 trillion, $31.97 trillion and $4.47 trillion, respectively, the regulator said. JPMorgan, Bank of America, Goldman Sachs, Morgan Stanley and Citi had the largest derivative exposures of all holding companies, at $79.40 trillion, $75.03 trillion, $49.83 trillion, $41.83 trillion and $34.147 trillion, respectively.
Of the large banks, Goldman got the largest overall boost from its trading revenue, which represented 59 percent of the bank's gross revenue in the quarter, the OCC said. JPMorgan and Bank of America's trading revenue represented 14 percent and 3 percent, respectively, of their gross revenues while Citibank recorded a loss of 2 percent in gross revenues from its trading revenues. Wells Fargo revenues were flat in the quarter.
If The US Economic System Collapses As Some Economists Are Predicting, How Will Women Cope?
What’s Dead (Short Answer: All Of It)
Just so you have a short list of what’s at stake if Washington DC doesn’t change policy here and now (which means before the collapse in equities comes, which could start as soon as today, if the indicators I watch have any validity at all. For what its worth, those indicators are painting a picture of the Apocalypse that I simply can’t believe, and they’re showing it as an imminent event – like perhaps today imminent.)
* All pension funds, private and public, are done. If you are receiving one, you won’t be. If you think you will in the future, you won’t be. PBGC will fail as well. Pension funds will be forced to start eating their "seed corn" within the next 12 months and once that begins there is no way to recover.
* All annuities will be defaulted to the state insurance protection (if any) on them. The state insurance funds will be bankrupted and unable to be replenished. Essentially, all annuities are toast. Expect zero, be ecstatic if you do better. All insurance companies with material exposure to these obligations will go bankrupt, without exception. Some of these firms are dangerously close to this happening right here and now; the rest will die within the next 6-12 months. If you have other insured interests with these firms, be prepared to pay a LOT more with a new company that can’t earn anything off investments, and if you have a claim in process at the time it happens, it won’t get paid. The probability of you getting "boned" on any transaction with an insurance company is extremely high – I rate this risk in excess of 90%.
* The FDIC will be unable to cover bank failure obligations. They will attempt to do more of what they’re doing now (raising insurance rates and doing special assessments) but will fail; the current path has no chance of success. Congress will backstop them (because they must lest shotguns come out) with disastrous results. In short, FDIC backstops will take precedence even over Social Security and Medicare.
* Government debt costs will ramp. This warning has already been issued and is being ignored by President Obama. When (not if) it happens debt-based Federal Funding will disappear. This leads to….
* Tax receipts are cratering and will continue to. I expect total tax receipts to fall to under $1 trillion within the next 12 months. Combined with the impossibility of continued debt issue (rollover will only remain possible at the short duration Treasury has committed to over the last ten years if they cease new issue) a 66% cut in the Federal Budget will become necessary. This will require a complete repudiation of Social Security, Medicare and Medicaid, a 50% cut in the military budget and a 50% across-the-board cut in all other federal programs. That will likely get close.
* Tax-deferred accounts will be seized to fund rollovers of Treasury debt at essentially zero coupon (interest). If you have a 401k, or what’s left of it, or an IRA, consider it locked up in Treasuries; it’s not yours any more. Count on this happening – it is essentially a certainty.
* Any firm with debt outstanding is currently presumed dead as the street presumption is that they have lied in some way. Expect at least 20% of the S&P 500 to fail within 12 months as a consequence of the complete and total lockup of all credit markets which The Fed will be unable to unlock or backstop. This will in turn lead to….
* The unemployed will have 5-10 million in direct layoffs added within the next 12 months. Collateral damage (suppliers, customers, etc) will add at least another 5-10 million workers to that, perhaps double that many. U-3 (official unemployment rate) will go beyond 15%, U-6 (broad form) will reach 30%.
* Civil unrest will break out before the end of the year. The Military and Guard will be called up to try to stop it. They won’t be able to. Big cities are at risk of becoming a free-fire death zone. If you live in one, figure out how you can get out and live somewhere else if you detect signs that yours is starting to go "feral"; witness New Orleans after Katrina for how fast, and how bad, it can get.
The good news is that this process will clear The Bezzle out of the system. The bad news is that you won’t have a job, pension, annuity, Social Security, Medicare, Medicaid and, quite possibly, your life.
It really is that bleak folks, and it all goes back to Washington DC being unwilling to lock up the crooks, putting the market in the role it has always played – that of truth-finder, no matter how destructive that process is.
Only immediate action from Washington DC, taking the market’s place, can stop this, and as I get ready to hit "send" I see the market rolling over again, now down more than 3% and flashing "crash imminent" warnings. You may be reading this too late for it to matter.
UK property black hole threatens banks' lending
Britain is at risk of a mass sell-off of distressed properties that would send values into a double dip and impair the lending ability of banks. The dire warning is contained in the Bank of England's latest Financial Stability Report, which was published last week. In the report, the Bank revealed its concerns about potential writedowns on £200bn of loans made to commercial property by major UK banks. It warned of an increasing number of loan defaults given the 44pc fall in the value of shops, offices and warehouses since 2007.
However, the Bank also described how the approach of the lenders to withdrawing from the property sector could jeopardise the economy's recovery. Their exposures are almost six times greater than in the 1990s recession. Lenders may be forced into selling a wave of properties as the stock of repossessed assets grows, according to the Bank. This could disrupt the supply-and-demand balance and place "significant downward pressure" on recovering property values.
"That would reduce banks' recovery rates and could potentially prompt other banks to sell their assets, leading to further falls in property values," the Bank says in the report. "This would exacerbate problems for commercial property companies and firms in other sectors that have used property as collateral. If this risk was to materialise, it could leave banks less able to supply credit to the wider economy."
The concern is acknowledged by property bosses, who blame a mass sell-off by the banks of distressed properties for the severity and length of the property crash in the early 1990s. Lengthy talks have been held between property companies and banks, notably Royal Bank of Scotland and Lloyds, about joint ventures or the sales of properties where the loan has defaulted. But so far the banks have preferred to keep hold of most of their distressed assets while analysing their worth and planning how to increase their value. Lenders have avoided repossessions on many facilities where the loan-to-value covenant has been breached because interest payments are still being met. Also, in some instances, lenders have not even demanded the revaluation of properties because the loan is still performing.
However, according to the Bank of England, this policy may have to be reconsidered as declines in rents and increases in the number of empty properties threatens the income of landlords, meaning loans cannot be serviced. Also, from 2009 to 2013, around £160bn of loans need refinancing, but existing constraints on banks' balance sheets mean they will be reluctant to meet the requirements, potentially sending some companies to the wall.The banks have already taken impairment charges of £10bn in the 18 months to June.
ECB Banker Says No Bailouts for Member States
Greece Must Fix Public Finances on its Own
The European Central Bank won't bail out debt-stricken member states such as Greece, which must repair its public finances on its own, ECB governing council member Ewald Nowotny said. "One has to be very clear: The ECB has no mandate or intention to take into account the situation of a specific country, especially not with regard to public finances," he said in an interview late Friday. But Mr. Nowotny, who is head of the Austrian central bank, defended Austria's recent major bank bailout. The emergency nationalization of Hypo Group Alpe Adria contributed to jitters in European markets last week. Mr. Nowotny said that bailout didn't mean Austria's banks as a whole were in a similar condition.
The ECB said Friday that it expected banks in the euro zone to see much higher losses than it had previously thought, mainly from their exposure to Eastern Europe and commercial real estate. A number of euro-zone banks, including nearly all in Austria and Italy's UniCredit, expanded into Eastern Europe in the past decade. Loan and currency losses have sharply eroded the value of those investments. Mr. Nowotny's declaration that Greece wouldn't get a bailout was matched by a prediction that Greece would be able to avoid insolvency and won't require outside help. "Our baseline scenario is that the Greek government will be able to fulfill its promises," he said.
Greece has promised to reverse a severe slide in its finances. Right now, it is on track to report a fiscal deficit equal to 12.7% of gross domestic product for 2009, well above an European Union-mandated ceiling of 3% of GDP. This weekend the Greek parliament began five days of debate on the government's 2010 austerity budget, which aims to narrow the gap to 9.1% of GDP next year. Countries that can afford to do so shouldn't commit to winding down special fiscal stimulus packages until 2011 to avoid threatening an economic recovery, which is still surrounded by uncertainties, he said. But "those governments that face excessive debt burdens, must start to cut spending immediately," Mr. Nowotny said.
Austria's government decided to intervene because of the bank's dominant role in southern Austria and southeastern Europe, he said. "There was the danger that this would increase nervousness in a very specific region." Austria's move to rescue HGAA had the full support of ECB President Jean-Claude Trichet, as well as other key ECB governing council members, Mr. Nowotny said. He said some European banks nonetheless need to shore up their balance sheets, adding governments should refrain from withdrawing special support for banks too early. "Many countries have programs to support their banking system. Those programs will still be needed in 2010, and it would be dangerous to exit them prematurely," he said.
The ECB last week ended one of its own measures of support for banks and it expects to drop other forms of support in the months ahead. "We'll first stake steps with regard to our liquidity provisions; we do not, at this stage, consider changes in interest rates," Mr. Nowotny said. The ECB's updated loss estimates for all bank loans and securities -- which the ECB put at [euro ]553 billion ($796.57 billion) for 2007 to 2010 -- highlight the fragility of the currency bloc's recovery. Much of the projected losses have already been absorbed, the ECB said in its report Friday on the financial system. Of the total [euro ]553 billion estimate, banks could face [euro ]187 billion in additional write-downs before 2011.
The revised figures put the ECB closer in line with the International Monetary Fund, which early this year projected a worse effect on banks. But fiscal woes in individual euro-zone member states mustn't influence future enlargement of the region, the governor said. Mr. Nowotny said it's too early to call the recent reversal in the euro-dollar exchange rate a trend. "This is a development of the last week. I think it'd be advisable to observe medium-term developments in the euro's exchange rate," he added.
Bank of Japan says it will not tolerate deflation
The Bank of Japan vowed on Friday that it would "not tolerate" deflation, a statement interpreted as a signal from the bank to persuade markets that it would keep interest rates low for an extended period. The central bank’s statement follows political pressure from the recently elected government, concerned over a lack of growth in the economy and declining tax revenues, for BoJ action on falling prices.
"It is sometimes said that the Bank of Japan accepts a negative range or accepts deflation ... and if that mistake exists it is better to remove it, but our standpoint has not changed," said Masaaki Shirakawa, governor of the BoJ. The bank left interest rates unchanged at 0.1 per cent on Friday. Economists said any decision by the bank to keep rates low for an extended period would be aimed at weakening the yen and lowering borrowing costs, both measures that would assist Japanese exporters.
"The implicit message is that [the BoJ] is going to keep 0.1 per cent interest rates for as long as three years," said Hiromichi Shirakawa, chief economist at Credit Suisse in Tokyo. Despite the central bank’s strong words, the BoJ’s own policy board expects deflation to persist both next year and the year after, leading some analysts to conclude that its statement was more a response to political and public pressure than a genuine policy change.
Japan’s consumer prices index turned negative on a year-on-year basis in February and in October was down by 2.5 per cent on the previous year . "The BoJ is saying that they will not tolerate deflation but they are explicitly predicting that it will persist in [the fiscal years for 2010 and 2011], which looks like tolerance to me," said Richard Jerram, at Macquarie Securities in Tokyo.
The BoJ’s previous "understanding" of medium to long-term price stability – in essence its self-imposed objective on inflation – was that the year-on-year change in the consumer price index should be "in the range approximately between 0 and 2 per cent". It has now changed that to "a positive range of 2 per cent or lower". It is the first time the BoJ has said that it will only accept rising prices. On December 3, the BoJ held an unscheduled policy board meeting at which it agreed to offer Y10,000bn ($111.1bn, €77.2bn, £68.6bn) in loans to drive down three-month interest rates to 0.1 per cent.
That had seemed to quieten the political complaints, although economists said that the measure would have little effect because there is limited demand for loans from Japanese companies and consumers. The BoJ has so far avoided more substantial "quantitative easing", such as increasing its outright purchases of long-term government bonds. Officials point to the danger of being seen to fund the government’s fiscal deficit and also question the success of the policy when it was used between 2001 and 2006.
4 Big Mortgage Backers Swim in Ocean of Debt
Even as the biggest banks repay their government debt in what is being heralded as a successful rescue program, four troubled giants of the financial world remain on government life support. These companies, the American International Group, Fannie Mae, Freddie Mac and GMAC, are not only unable to repay the government, they are in need of continuing infusions that make them look increasingly like long-term wards of the state.
And the total risk they pose to the taxpayer far exceeds that of the big banks. Fannie and Freddie, in the final days of the year, are even said to be negotiating with the Treasury about greatly expanding the money available to them. Though the four are not in all the same businesses, they were caught in one of the same traps: They sold mortgage guarantees — in some cases to each other. Now when homeowners default, as they are doing in record numbers, these companies are covering the losses. Essentially, taxpayer money to these companies is being used partly to protect banks and other investors who own the mortgages.
Like the big banks, these four companies would no doubt prefer to be free of government assistance, which comes with pay and other restrictions on their executives. But they appear at risk of getting onto a debt merry-go-round, where they have to draw new money from the government just to keep up with their existing government debts. Fannie Mae recently warned, for example, that it could not pay the dividends it owes the Treasury, so "future dividend payments will be effectively funded with equity drawn from the Treasury."
All the companies have recently drawn new government money or are in talks to do so:
- Fannie Mae and Freddie Mac, which buy and resell mortgages, have used $112 billion — including $15 billion for Fannie in November — of a total $400 billion pledge from the Treasury. Now, according to people close to the talks, officials are discussing the possibility of increasing that commitment, possibly to $400 billion for each company, by year-end, after which the Treasury would need Congressional approval to extend it. Company and government officials declined to comment.
- GMAC, which finances auto sales, already has $13.4 billion from the Troubled Asset Relief Program, and has been in talks with the Treasury about getting up to $5.6 billion more, because a government "stress test" showed it was still too weak.
- A.I.G., the insurance conglomerate, recently drew $2 billion from a special $30 billion government facility, which was created in the spring after a $40 billion infusion proved inadequate.
Those capital commitments from the Treasury do not capture the full scale of government assistance to the companies. The government has also bought mortgage-backed securities and guaranteed corporate bonds, while the Federal Reserve Bank of New York has made an emergency loan. Timothy F. Geithner, the Treasury secretary, welcomed the repayment plans by Citigroup and Wells Fargo this week. Although Citi later ran into difficulty with the share sale to raise money for the repayment, Mr. Geithner said the actions meant that taxpayers were "now on track to reduce TARP bank investments by more than 75 percent." That means that of the $245 billion awarded to banks, more than $185 billion is either recovered or about to be.
But that is just a fraction of the money that the four troubled debtors have received or may still get. Together, they have been offered nearly $600 billion, and that lifeline could climb to nearly $1 trillion if the commitment to Fannie and Freddie is doubled, as some predict. What’s more, the companies seem short on persuasive strategies for extricating themselves from the government’s embrace. A spokeswoman for GMAC pointed out that the company had made all its scheduled dividend payments to the Treasury, as had Freddie Mac. While Fannie Mae has said it will have trouble paying its dividends, A.I.G. does not have to pay dividends.
A spokeswoman for A.I.G. said that the insurance company was committed to repaying taxpayers, but repayment would depend on market conditions. A Freddie Mac spokesman said that the company was dependent on continued support from the Treasury to stay solvent. A.I.G.’s latest request for money offers an example of why it needs more government aid to pay its debts. The company has a big aircraft leasing unit, International Lease Finance Corporation, which is considered a valuable asset but not a core part of its business. Ever since the company announced in 2008 that it would dismantle itself and sell subsidiaries to pay back the government, analysts have expected International Lease to be sold.
But there is a big catch. A.I.G. does not own International Lease outright. A big block of the unit’s stock is actually held by an insurance subsidiary, which uses the shares to secure its promises to pay claims. If A.I.G. sold International Lease and gave the proceeds to the Fed to pay down debt, it would strip too much money out of the insurer, making it insolvent. So A.I.G. used part of the $2 billion that it recently received from the Treasury to buy back the International Lease shares. That way, when a buyer finally appears, A.I.G. can sell the leasing business and pay the Fed.
"The irony is, for the government to recoup its value, it has to keep its support behind A.I.G.," said a former company executive, who requested anonymity because of the delicacy of the matter. "The thing is a total Catch-22." A.I.G. said it also recently used some money from the Treasury to restructure its mortgage-guaranty business — something GMAC, Fannie and Freddie are struggling to do as well. All four of the companies had businesses that provided mortgage guarantees. When defaults began soaring in 2007, they all suffered big losses. In some cases, they have insured each other; in other cases, banks or investors have to be paid.
Although GMAC’s main business is financing auto sales, its executives have said its biggest problem is containing the troubles in its mortgage business, known as Residential Capital. "What we want to do, to the best we’re able to, is draw a box around it and say that it is contained," Michael Carpenter, the new chief executive, told a trade publication in November. For its mortgage guarantee unit, A.I.G. used some Treasury money to reinsure $7 billion of obligations through a Vermont subsidiary. The terms call for the unit, United Guaranty of Greensboro, N.C., to pay the claims that it can afford and send the rest to the Vermont affiliate.
Little is known about the Vermont unit because the state does not require that type of company to file annual reports. If the Vermont company needs additional money, it presumably could turn to A.I.G., which can draw more from the Treasury.
The Age of Deleveraging
by John Mauldin
I did a very interesting one-hour show this week with Tom Ashbrook on his National Public Radio syndicated radio show called On Point. About 20 minutes into the show, Professor Jeremy Siegel of Wharton came on, and we had a pleasant debate and lively Q and A with listeners. Jeremy of course was the bull, expecting that next year the US will grow by 5-6%. I was the "bear," expecting growth in the 1-2% range. You can listen in at http://www.onpointradio.org/2009/12/an-economic-warning. It's also available as a podcast on iTunes ("On Point with Tom Ashbrook") for a few more days.
I have liked Jeremy the times we have been on the same platform, and we have traded emails over the past few years. He is a consummate gentleman. He is also the author of Stocks for the Long Run. His thesis is buy and hold. Long-time readers know that I find such thinking to be wrong, if not dangerous. I believe that stocks go in long cycles (an average of 17 years) based on valuations, and that we are still in a long-term secular bear phase. I want to see valuations come way down before I suggest that the index-investing waters are once again safe. That day will come. Just not for a while.
In the meantime, Jeremy has given us the reason for his very bullish call. Paraphrasing, he said, "Look at past recoveries from recessions. They were always strong in the first year. Suggesting 5-6% is not all that aggressive."
And I would agree with him - if the past recession was a typical recession. But we have just gone through a recession that was unlike any other we have experienced since the Great Depression. Typical recessions are inventory-adjustment recessions, caused by businesses getting too optimistic about sales and then having to adjust. You get temporarily higher levels of unemployment as inventories drop, and then you get the rebound. It is not quite as simple as that, but close enough for this letter's purpose.
This recession was caused not by too much inventory but by too much credit and leverage in the system. And now we are in the process of deleveraging. It is a process that is nowhere near complete. While the crisis stage is over (at least for now), there is still a lot of debt to be retired on the consumer side of the equation, and a lot of debt to be written off on the financial-system side. And this is true in Europe as well, and maybe more so; but today we will look at some data in the US.
Total consumer debt is shrinking for the first time on 60 years. And the decline shows no sign of abating.
Credit card companies have reduced available credit by $1.6 trillion dollars. And for good reason. My friend and London partner Niels Jensen sent me the following charts from UrbanDigs.com. Credit card delinquencies are hovering near all-time highs. Bank charge-offs for credit cards are going to rise as the unemployment numbers get worse:
And the strain is also in the housing sector. Residential delinquencies are up 1.2% just in the last quarter, and now stand at a stunning 9%. (For whatever reason the heading did not copy, but this is residential delinquencies.)
Frank Veneroso noticed something unusual in the latest Federal Reserve Flow of Funds report. They changed their methodology for analyzing housing prices to a model more like the Case-Shiller index, which most believe to be more accurate. That meant they deducted another $2 trillion from household net worth than in the previous quarter. They just caught up with reality, so no big news there. But there is some big news if you look closely.
About one-third of the homes in the US have no mortgages. Typically, these are nicer homes, as the "rich" have paid off their homes. So you can estimate that to be somewhere between 35-40% of the total value of US homes. Writes Frank:
"So now the flow of funds accounts tell us that the total value of residential real estate is $16.53 trillion. The share owned by households with a mortgage is probably $10 trillion to $11 trillion. Total mortgage household debt now stands at $10.3 trillion. In effect, for all households with a mortgage taken in the aggregate, their loan-to-value ratio is now close to 100% and perhaps close to half of them have a zero to negative equity."
The biggest single factor in foreclosures is negative equity coupled with unemployment. That makes sense, because if you could sell your house and get some equity, you would.
As I have written in past letters, we are going to see a significant increase in mortgage resets in 2010, which will result in even more foreclosures. There is a lot more pain to come. This is not an environment that is typical of past recessions. There is a lot of deleveraging to be done, both as banks write off bad debts on homes and as consumers walk away from mortgages badly underwater.
The coming debacle in commercial real estate loans is well-documented. Total loan delinquencies at banks are rising precipitously every month, just as total loans to commercial and industrial customers are falling at an unprecedented rate, over 17% in less than two years!
While Obama is urging banks to lend, bank regulators are telling banks to raise capital and shore up their balance sheets. One way they do that is to lend less to consumers and businesses and invest in US government bonds. Given the high rate of delinquencies and charge-offs of all sorts of debt, it is unlikely that we are going to see growth in loans in 2010. Further, the surveys I read suggest that consumers are working hard to reduce their debt. The New Frugal is part of the New Normal.
Past post-recession expansions have been built on growing credit and leverage. That will not be the case this time. We are going to see reduced lending and borrowing. Even though the federal government is running massive deficits, the stimulus portion of the debt will be running down in the latter half of 2010. There will be little political will to continue with massive stimulus and deficits. While this is good in the long run, in the short run it will reduce GDP. All of this suggest to me that while there will be growth in 2010, it will be tepid by past post-recession standards.
An Inflation of Confusion
by Chris Temple
In my December issue, the cover story is entitled "The Blind Leading the Blind." In it, I use many examples to demonstrate that virtually nobody in positions of leadership in government, the economy or markets can quite figure out which end is up as they try to make policy, guide their followers, etc. Policymakers in particular have been playing a game of financial "Whack-a-Mole" as they frantically lurch from one doomed attempt to another to deal with the economy's troubles. I daresay that most of these folks couldn't find their own backside if they used both hands.
When it comes to financial pundits and advisors specifically, they seem no better able to assess things or -- in their case -- provide their clients and followers with any kind of a viable outlook and game plan based on it. Usually, they follow the presently dominant movements and theme(s) of the market. For much of 2009, that has consisted of playing the weak U.S. dollar against just about everything else. At some point, of course (a point I've believed for weeks now we are at) too many are following the same trade, urging those with prescience to get out of it, if not move to a contrary position.
For just a moment, I want to put in my own two cents on one of the themes that has driven not only the trade in gold over the last several months, but also that of such disparate assets as copper, oil and emerging market equities. And that is, the notion that the U.S. in particular, due to our monstrous and exponentially growing fiscal deficits, is about to endure a bout of rapidly-rising inflation, if not hyperinflation.
A couple days ago I watched as CNBC's Sue Herrera and Tyler Mathisen interviewed a prominent economist regarding his inflation outlook. He suggested that, with the exception of gold (which he clearly disdained), the Federal Reserve's ongoing low interest rate policy would lead to broad-based inflation in the year ahead. Neither of the CNBC anchors thought to ask the question, "Why is it, then, that after two decades of rock-bottom interest rates Japan is still fighting DEFLATION!?"
This whole inflation-deflation debate is one I have weighed in on a few times; and, it's one I will be covering in even greater detail as the New Year commences. After all, I want to be able to provide the best and most profitable advice for my subscribers.
And getting this issue right will be a key to that.
It does not help that the very definitions themselves of inflation and deflation have changed over the years, and are so poorly understood by consumers and investors alike in any case. Others and I have often cited the infamous (and frankly, outrageous) public utterance way back in the early 1970's of Herbert Stein, then serving as President Nixon's chief economist. Asked about the misery being faced by Americans over the soaring costs for life's necessities, Stein had nothing to say about his boss' having taken the last step to break the U.S. dollar from any mooring in gold. Neither did he discuss the wildly inflationary Fed policy and devaluation of the dollar that followed. He shied from discussing the dismal failure (if not the idiocy in the first place) of the wage and price controls he urged on the president.
Instead, Stein blamed America's housewives. Paraphrasing, he opined that shoppers needed to be wiser and do most of their shopping when there are sales. Then, he said, "inflation" would not seem so bad. Sheesh!
As I stated above, I will over the next several weeks be spending a considerable amount of time in showing my subscribers the kind of "flations" that lie ahead. To some extent, I will need to walk our folks through a process of a re-definition of these terms, chiefly to take us back closer to the sources of these monetary phenomena. Only with an accurate understanding of this will we be able to craft a sensible investment approach. For present purposes, I want to share with you folks the two chief mistakes that the pundits and investors alike are making in looking at the inflation vs. deflation issue.
FIRST, they fail to understand the fact that America (and, to varying extents, other countries) has already endured many years of hyperinflation. As I explained in my September, 2004 Special Report entitled Understanding the Game, almost everyone was looking in the wrong place, and missed this HUGE event.
The volume of "money" in circulation exploded over the last three decades; just as many predicted back in the late 1970's. But evidence of this did not show up in the expected places. Instead, that hyperinflation was evidenced in the valuations of (primarily) financial assets such as stocks and bonds during the 80's and 90's, and in real estate, securitized financial assets and derivatives in this decade.
It is critical to understand here, as I wrote in a recent commentary for my subscribers, that what we have witnessed over the last few years in particular is the inevitable reversal of this previous hyperinflation. It is a DEFLATION still much closer to its beginning than to its end. If one wants to have some decent clue as to what lies ahead for America, he or she needs only to go back and look at the grueling, on-again, off-again deflation (of everything but the level of public debt, that is) that has gone on in Japan since its bloated asset bubbles started losing air in 1989.
SECOND -- and somewhat of a corollary to the above -- is that, in order to properly divine the future of inflation/deflation, we need to look at all the sources of such monetary happenings. Most are not doing so. They focus exclusively on Time magazine's Person of the Year Ben Bernanke and his fleet of helicopters, and scream "inflation!"
Yet Helicopter Ben's private central bank is not the only source of inflation (and, thus, deflation.) As I explained back in my July, 2009 issue, one must also consider the impact on the inflation vs. deflation equation of what has in recent years been dubbed the shadow banking system. And it has over the last year or so been -- and will continue to be -- a major source of deflation.
The shadow banking system is a menagerie of banks (with their off-balance-sheet operations), hedge funds, private equity funds, structured investment vehicles (SIV's), derivatives alchemists and all the others who have effectively taken on banking functions in recent years. These players -- all monsters created and/or enabled by our modern-day monetary Dr. Frankenstein, Alan Greenspan -- have superseded the import to much of the economy of the official central bank itself. These entities have created trillions of dollars' worth of "wealth" via financial instruments of various (often dubious) kinds, which permeated our entire economy and banking system, fostering -- for a while anyway -- what looked like prosperity.
Much of this has only just begun to reverse itself.
I cannot yet make any kind of case for the sort of "hyperinflation" being predicted by some when -- for every $1 created out of thin air by the Fed--$100 is vaporized that had been previously "created" one way or another by the shadow banking system. As I wrote back in the July piece, "Sure, the Fed has pulled a few trillion dollars out of its hat and dropped it from Ben's fleet of helicopters in the hopes that it will arrest the economy's circling the drain. Yet what does this mean in the face of a $50 trillion plunge in asset prices worldwide since the start of the financial debacle last September?"
One could make an open-ended commitment to assets deemed beneficiaries of inflation (such as gold, oil, stocks, emerging market paper and the rest) if it could be determined that all (or almost all) of the unwinding, asset devaluations, debt implosions and the rest is over. I do not believe that it is over at all. Thus, we must always be on the lookout for these deflationary forces to reassert themselves, perhaps without warning. In such an environment, the just-mentioned asset classes that normally benefit from an inflationary or expansionary environment will suffer the same fate they did about a year ago: they'll get flattened.
It is my view that we will shortly see a return to such an environment, if we are not already going through the transition.
Trillions Of Troubles Ahead
Not too long ago, a billion dollars in a governmental budget was a lot of money. Then we got into hundreds of billions. People understood that this was a lot, just because of all the zeros. Now, unfortunately, the number has become small: the world "trillion," as in $1.2 trillion for health care reform, seems so tiny. But it has 12 zeroes behind it, which is so easy to forget.
What is a "trillion?" According to the Web site www.100777.com, if you laid 1 dollar bills end to end, you could make a chain that stretches from Earth to the moon and back again 200 times before you ran out of dollar bills! One trillion dollars would stretch nearly from the Earth to the sun. It would take a military jet flying at the speed of sound, reeling out a roll of dollar bills behind it, 14 years before it reeled out 1 trillion dollar bills. If the government stays on the course it's been on for the past forty years without a radical change, the federal government will soon have a $10 trillion budget. In other words, the federal budget deficit will be $1.4 trillion. Just to make the size more visible, that's $1,400 billion.
Our colleague Rob Arnott, who always does terrific research, wrote in his recent report that "at all levels, federal, state, local and GSEs, the total public debt is now at 141% of GDP. That puts the United States in some elite company--only Japan, Lebanon and Zimbabwe are higher. That's only the start. Add household debt (highest in the world at 99% of GDP) and corporate debt (highest in the world at 317% of GDP, not even counting off-balance-sheet swaps and derivatives) and our total debt is 557% of GDP. Less than three years ago our total indebtedness crossed 500% of GDP for the first time." Add the unfunded portion of entitlement programs and we're at 840% of GDP.
The world has not seen such debt levels in modern history. This debt is not serviceable. Imagine that total debt is 557% of GDP, without considering entitlements. The interest on the debt will consume all the tax revenues of the country in the not-too-distant future. Then there will be no way out but to create more debt in order to finance the old debt. It assures a period of economic devastation. In a last, desperate attempt, politicians at the federal and local levels will raise taxes to astronomical heights to raise revenues. And that only assures destruction of the economy. Forget the fable of economic recovery. Unless there is a change in Washington by next year's election, there will be no way to turn back.
Japan's recession is now 19 years old. It has the highest debt-to-GDP level (227%) of any industrialized country. The Fitch rating agency is talking about a potential downgrade of Japan's debt. Japan's stock market is still down 75% from the high in 1990. We predict it will make new bear market lows next year. That will make it a 20-year-long bull market on the way to 25 years. The bulls in the U.S. should consider that possibility in the formerly great United States of America. I do not believe the bullish theory that the U.S. situation is different than Japan's. Ours is so much worse. Is it any wonder that our biggest creditors, China, Russia and the Middle East, are diversifying out of the dollar and into gold?
US jobseekers face bleak Christmas as unemployment rises
In his stylish, sleek and sparkling white Manhattan salon, hairdresser Cristiano Cora is trying to do his bit for those less fortunate. A top-of-the-range snipper, he usually charges $300 for a cut. But every Tuesday morning, at his minimalist Greenwich Village studio, unemployed Americans can get a spruced up coiffure for free. In a national crisis, Caro reasons, everybody should pitch in: "After 9/11, I was very surprised – people came together. Now people aren't helping each other as much. We need to help the people who need help."
A decent cut leaves job seekers feeling that bit more confident. "If somebody feels good, feels pretty and looks good, their attitude is better." Plus, he says, there's the therapeutic side, too: "To be a hairdresser isn't just making people look good. We talk to them as human beings. People have so much inside them, they want to talk."
A seemingly unstoppable epidemic of joblessness has swept across America over the past 24 months. The US unemployment rate, which began 2008 at 4.9%, has risen to 10% and despite a slight drop of 0.2 percentage points last month, many economists believe it is yet to peak. More than seven million jobs have evaporated since the recession began and President Barack Obama's newly minted administration is facing increasingly vocal criticism for underestimating the problem.
America's unemployment challenge is surging up the political agenda. The rate of joblessness in the US is significantly worse than in overseas economies which, in GDP terms, have suffered a deeper recession – although definitions may vary slightly, Britain's unemployment rate is 7.9%, Germany's is 7.5%, the European Union's is 9.3% and Japan's is 5.2%. The number of jobs lost in the US during 2009 surpasses any other year since the second world war. And in worst hit pockets, joblessness has reached apocalyptic proportions – scorched by the chronic problems of the motor industry, Detroit's unemployment by some measures, has reached 45%. In an effort to ease the pain, Congress has extended the duration of unemployment benefits, which typically expired after a year or so, to as long as 99 weeks.
A $787bn economic stimulus package intended to kick-start job creation has had only limited impact. The White House, which predicted unemployment would top out at 8%, is under pressure – a recent Gallup poll for USA Today found 55% of Americans disapprove of Obama's handling of the jobs crisis, putting employment equal with Afghanistan as the president's worst policy area.
"The media talks about the stockmarket recovering kind of as if it's a baseball team scoring – but it doesn't really make much difference to peoples' lives," says Dean Baker, co-director of the Centre for Economic and Policy Research in Washington, who warns that Democrats will get stung in November's mid-term Congressional elections unless employment improves. "What's really going to matter when people go to vote in November is whether they're working, whether they're getting a decent wage."
Left-leaning experts suggest that the surge in joblessness is a symptom of America's broader laissez-faire economic approach. Americans are typically on short notice periods, get less union protection and can be fired more easily than in Europe. Baker points out that in Germany, the government has provided incentives for companies to hang onto employees, albeit on shorter hours: "We're experiencing a downturn with double-digit unemployment. The Germans are experiencing a downturn with a shorter working week and longer vacations."
Some argue that gloomy predictions prompted American employers to cut jobs unnecessarily sharply at the height of the financial crisis, in anticipation of an epochal depression that proved to be far less dramatic. The former Federal Reserve chairman, Alan Greenspan, argued last week that businesses were "very frightened" and are now straining to operate with a skeleton workforce: "We have a level of employment at this stage which is barely adequate to staff the level of output."
This view is echoed by Barclays Capital's chief US economist, Dean Maki, who says there was an "over-reaction" in job cuts by employers, and that the next significant move in the unemployment rate will be down. "It relates back to the financial crisis last fall, when we had political and financial leaders talking about the possibility of another Great Depression," says Maki. "There was a palpable fear of an outcome that was much worse than what turned out to be the case."
But that does not mean jobs will recover thick and fast. Signs of a return to growth are likely to encourage "fringe" job-seekers, such as part-time employees and stay-at-home parents, back into the search for full-time work. Economists say that in normal times, it takes an addition of 100,000 jobs per month just to keep the unemployment rate steady, to compensate for a steady increase in the workforce as the population grows and people graduate from college.
Brian Bethune, chief US financial economist at IHS Global Insight, expects unemployment to edge slightly higher in the "low 10% range" with further job losses recorded for several months: "We don't expect any near-term turnaround in hiring. We'll probably see a few more months of negative numbers." He predicts that president Obama's stimulus package, designed to fund "shovel ready" projects in public infrastructure, will only end up creating 2.5m jobs, rather than the 3.5m projected by the government.
With hindsight, the White House may now regret opting against a bigger stimulus – the chairwoman of Obama's own council of economic advisers, Christina Romer, is known to have favoured a more ambitious $1.2tn injection but lost out to other voices within the administration, including Larry Summers, a Clinton-era veteran.
On the ground, the picture remains bleak. A New York Times poll found more than half of unemployed Americans have cut back on doctors' visits due to lack of funds, 55% have trouble sleeping and two-thirds consider themselves stressed. Among jobless parents, 38% have seen a change in their childrens' behaviour as a result of straightened financial circumstances. John Dodds, director of the Philadelphia Unemployment Project, a community support group, says things are as bad as he has seen them in his 34 years of working with jobless people: "There seems to be no end to the layoffs. And looking for work in an environment where people are still being laid off is very difficult."
One of his clients, Cameron Hurley, is a 46-year-old separated father of three teenage children who lost his job as a computer programmer some 13 months ago: "It was a Wednesday in November. The chief information officer came in, sat three of us down and told us that Friday would be our last day." He worries about maintaining support payments for his children, and about paying for healthcare. "As a programmer, I wasn't hurting for money. I kept it simple, I didn't have a lot of bills to pay and I did have some cushion. Now that's all gone," says Hurley. "It's just a mess."
A Dangerous Dysfunction
by Paul Krugman
Unless some legislator pulls off a last-minute double-cross, health care reform will pass the Senate this week. Count me among those who consider this an awesome achievement. It’s a seriously flawed bill, we’ll spend years if not decades fixing it, but it’s nonetheless a huge step forward. It was, however, a close-run thing. And the fact that it was such a close thing shows that the Senate — and, therefore, the U.S. government as a whole — has become ominously dysfunctional.
After all, Democrats won big last year, running on a platform that put health reform front and center. In any other advanced democracy this would have given them the mandate and the ability to make major changes. But the need for 60 votes to cut off Senate debate and end a filibuster — a requirement that appears nowhere in the Constitution, but is simply a self-imposed rule — turned what should have been a straightforward piece of legislating into a nail-biter. And it gave a handful of wavering senators extraordinary power to shape the bill.
Now consider what lies ahead. We need fundamental financial reform. We need to deal with climate change. We need to deal with our long-run budget deficit. What are the chances that we can do all that — or, I’m tempted to say, any of it — if doing anything requires 60 votes in a deeply polarized Senate? Some people will say that it has always been this way, and that we’ve managed so far. But it wasn’t always like this. Yes, there were filibusters in the past — most notably by segregationists trying to block civil rights legislation. But the modern system, in which the minority party uses the threat of a filibuster to block every bill it doesn’t like, is a recent creation.
The political scientist Barbara Sinclair has done the math. In the 1960s, she finds, "extended-debate-related problems" — threatened or actual filibusters — affected only 8 percent of major legislation. By the 1980s, that had risen to 27 percent. But after Democrats retook control of Congress in 2006 and Republicans found themselves in the minority, it soared to 70 percent. Some conservatives argue that the Senate’s rules didn’t stop former President George W. Bush from getting things done. But this is misleading, on two levels.
First, Bush-era Democrats weren’t nearly as determined to frustrate the majority party, at any cost, as Obama-era Republicans. Certainly, Democrats never did anything like what Republicans did last week: G.O.P. senators held up spending for the Defense Department — which was on the verge of running out of money — in an attempt to delay action on health care.
More important, however, Mr. Bush was a buy-now-pay-later president. He pushed through big tax cuts, but never tried to pass spending cuts to make up for the revenue loss. He rushed the nation into war, but never asked Congress to pay for it. He added an expensive drug benefit to Medicare, but left it completely unfunded. Yes, he had legislative victories; but he didn’t show that Congress can make hard choices and act responsibly, because he never asked it to. So now that hard choices must be made, how can we reform the Senate to make such choices possible?
Back in the mid-1990s two senators — Tom Harkin and, believe it or not, Joe Lieberman — introduced a bill to reform Senate procedures. (Management wants me to make it clear that in my last column I wasn’t endorsing inappropriate threats against Mr. Lieberman.) Sixty votes would still be needed to end a filibuster at the beginning of debate, but if that vote failed, another vote could be held a couple of days later requiring only 57 senators, then another, and eventually a simple majority could end debate. Mr. Harkin says that he’s considering reintroducing that proposal, and he should.
But if such legislation is itself blocked by a filibuster — which it almost surely would be — reformers should turn to other options. Remember, the Constitution sets up the Senate as a body with majority — not supermajority — rule. So the rule of 60 can be changed. A Congressional Research Service report from 2005, when a Republican majority was threatening to abolish the filibuster so it could push through Bush judicial nominees, suggests several ways this could happen — for example, through a majority vote changing Senate rules on the first day of a new session.
Nobody should meddle lightly with long-established parliamentary procedure. But our current situation is unprecedented: America is caught between severe problems that must be addressed and a minority party determined to block action on every front. Doing nothing is not an option — not unless you want the nation to sit motionless, with an effectively paralyzed government, waiting for financial, environmental and fiscal crises to strike.
Morgan Stanley: The Commodity Currencies Will Get Crushed
Which currencies might have the most to lose should the dollar-bounce continue? According to Morgan Stanley's currency team, two major commodity-backed currencies, the Australian Dollar and Brazilian Real, appear particularly overvalued against the dollar right now.Morgan Stanley's Spyros Andreopoulos:BRL remains heavily overvalued against the USD: even if our models are somewhat slow to incorporate the improved fundamental outlook for the currency stemming from the recent oil finds and the China pull, an overvaluation of 34% against the USD suggests that BRL looks stretched at current levels. (The China pull argument may also apply to AUD.)
Even though their valuation is based on rather opaque econometric models likely subject to substantial error, these are at least guidelines:
(Via Morgan Stanley, FX Fair Values, Spyro Andreopoulos, 17 December 2009)
A Crisis Is a Terrible Thing to Waste
In 2009 we wasted a perfectly good financial crisis. With disastrous economic events accumulating in March, President Barack Obama exhorted listeners during a weekly radio talk to "discover great opportunity in the midst of great crisis." It's an appealing conceit: seeking breakthrough achievement in a time of danger.
That's why it's such a shame we didn't take advantage of the Wall Street crisis of 2008 by making 2009 the Year of Real Financial Reform.
Instead, the Obama Administration offered half-measures. The financiers lobbied against even modest reforms, and a Congress drenched in Wall Street campaign cash has peppered proposed regulation with loopholes. At a conference in the U.K. on Dec. 8, Paul A. Volcker, the former chairman of the Federal Reserve and an Obama adviser, addressed an audience of bankers and executives who were insisting that Wall Street and big corporations can police themselves, without more government scrutiny. "Wake up, gentlemen," Volcker said, according to media reports. "Your response is inadequate."
The warning applies to regulators and politicians as well. The crisis of 2008 offered a once-in-a-lifetime opening to overhaul the U.S. financial engine. It's a machine that can do much good by raising and allotting capital and much damage when allowed to run unchecked. Now, as stock markets recover and bank earnings bounce back, mass amnesia has set in. Political momentum has waned. Financial reform legislation is getting weaker by the week. And Goldman Sachs Chief Executive Lloyd C. Blankfein says we should be grateful to investment bankers for "doing God's work."
The most fundamental failure has been the Administration's unwillingness to take seriously the murmurings of that shrewd old giant, Mr. Volcker, who wants to reverse course on bank gigantism. In the 1990s, Wall Street convinced both political parties that combining all manner of financial services into unfathomable Goliaths was necessary in a global economy. Poof went the safeguards instituted in the wake of the Great Depression separating the public-utility-like functions of the financial system—customer deposits, conventional commercial loans, and so on—and the casino of investment banking and high-stakes trading.
The consolidation accelerated a race for hugeness that gave us institutions that are "too big to fail": basket cases like Citigroup and risk factories like American International Group and Goldman. Without hundreds of billions of taxpayer rescue dollars flooding the markets, all of these firms, and many more, might have collapsed, bringing on Great Depression—The Sequel.
With popular skepticism toward Wall Street at a peak in early 2009, our political and business leaders did...nowhere near enough. The White House bought the Wall Street line that bigger is better, or at least unavoidable. Now the banks are larger and more intricate than ever. As The Wall Street Journal noted recently, the world's 10 biggest banks account for about 70% of global banking assets, up from 59% three years ago.
Maybe we'll eventually see new requirements for larger capital cushions at individual banks to absorb future losses. Maybe we'll see the establishment of a new bank-subsidized rescue fund to cover the costs of potential failures. We could even get greater regulatory authority to block certain bank mergers. But the too-big-to-fail mammoths are still just that. The implicit taxpayer safety net—now explicit—means that some bankers almost certainly will engage in the kind of risk-taking that brought us the subprime fiasco. Why not? Someone else will clean up the mess.
The tame alternative to real regulation is greater transparency. And, yes, we will have more disclosure of credit-derivatives trading. These are the insurance policies against bond defaults that helped tempt Wall Street to ratchet risk up to unprecedented levels. But with derivatives, as with bank heft, the politicians have bought what Wall Street is selling.
Lawmakers backed away from any serious attempt to slow the invention of novel exotic trades whose side effects few, if any, really understand. My colleagues at Bloomberg News have lately reported that some of the very same geniuses who brought us toxic credit-default swaps are now angling to juice the carbon-trading market with climate-change derivatives. If the pilfered e-mails from squirrelly British scientists weren't enough to cast doubt on the campaign against global warming, greenhouse-gas swaps surely will do the trick.
The list of missed opportunities is too long for one humane sitting. I'll wrap up with lawmakers' mishandling of the credit-rating scandal. Moody's, Standard & Poor's, and Fitch played a major role in the crisis by rubber-stamping their triple-A approval on mountains of mortgage-backed bonds that went bad. These companies enjoy their lucrative oligopoly only because of a publicly sanctioned system requiring mutual funds and money managers to buy securities given high ratings by the Big Three. But there's a rank conflict of interest: The issuers of bonds pay the credit agencies to rate the bonds. Why we take the ratings seriously remains one of the great mysteries of the financial world.
Congress roughed up some rating-agency executives at hearings and may yet require more disclosure here, too. But the basic conflict persists. Genuine reform fizzled. We'll regret it when the next crisis hits.
Show Us the E-Mail
by Eliot Spitzer, Frank Partnoy and William Black
We end this extraordinary financial year with news that the Treasury is in discussions with American International Group about selling the taxpayers’ 80 percent ownership stake in that company. The government recently permitted several banks to break free of its potential oversight by repaying loans made during the rescue. But with respect to A.I.G., the Treasury should not move so fast. There is one job left to do.
A.I.G. was at the center of the web of bad business judgments, opaque financial derivatives, failed economics and questionable political relationships that set off the economic cataclysm of the past two years. When A.I.G.’s financial products division collapsed — ultimately requiring a federal bailout of $180 billion — those who had been prospering from A.I.G.’s schemes scurried for taxpayer cover. Yet, more than a year after the rescue began, crucial questions remain unanswered. Who knew what, and when? Who benefited, and by exactly how much? Would A.I.G.’s counterparties have failed without taxpayer support?
The three of us, as experienced investigators and prosecutors of financial fraud, cannot answer these questions now. But we know where the answers are. They are in the trove of e-mail messages still backed up on A.I.G. servers, as well as in the key internal accounting documents and financial models generated by A.I.G. during the past decade. Before releasing its regulatory clutches, the government should insist that the company immediately make these materials public. By putting the evidence online, the government could establish a new form of "open source" investigation.
Once the documents are available for everyone to inspect, a thousand journalistic flowers can bloom, as reporters, victims and angry citizens have a chance to piece together the story. In past cases of financial fraud — from the complex swaps that Bankers Trust sold to Procter & Gamble in the early 1990s to the I.P.O. kickback schemes of the late 1990s to the fall of Enron — e-mail messages and internal documents became the central exhibits in our collective understanding of what happened, and why.
So far, prosecutors and regulators have been unable to build such evidence into anything resembling a persuasive case against any financial institution. Most recently, a jury acquitted Bear Stearns employees of fraud related to the collapse of the subprime mortgage market, in part because available e-mail messages suggested the employees had done nothing wrong.
Perhaps A.I.G.’s employees would also be judged not guilty. But we would like to see the record to find out. As fraud investigators, we would like to examine the trading patterns of A.I.G.’s financial products division, and its communications with Goldman Sachs and other bank counterparties who benefited from the bailout. We would like to understand whether the leaders of A.I.G. understood that they were approaching a financial Armageddon, and whether they alerted their counterparties, regulators and shareholders to the impending calamity.
We would like to see how A.I.G. was able to pay huge bonuses to its officers based on the short-term income they received from counterparties for selling guarantees that, lacking adequate loss reserves, the companies would never be able to honor. We would also like to know what regulators knew, and what they did with the information they had obtained. Congress wants answers, too. This month, during hearings on Ben Bernanke’s nomination to a second term as chairman of the Federal Reserve, several senators fumed about being denied access to his A.I.G.-related documents.
No doubt, some of the e-mail messages contain privileged conversations among lawyers. Others probably include private information that is irrelevant to A.I.G.’s role in the crisis. But the vast majority of these documents could be made public without legal concern. So why haven’t the Treasury and the Federal Reserve already made sure the public could see this information? Do they want to protect A.I.G., or do they worry about shining too much sunlight on their own performance leading up to and during the crisis?
A.I.G.’s board of directors, a distinguished group of senior business executives, holds the power to decide whether to publish the e-mail messages and other documents. But those directors serve at the behest of A.I.G.’s shareholders. And while small shareholders of public corporations generally do not have the right to force publication of internal documents, in this case one shareholder — the taxpayer — holds an 80 percent stake. Anyone with such substantial ownership has effective control over corporate decisions, even if the corporation is a large public one.
Our stake is held by something called the A.I.G. Credit Facility Trust, whose three trustees are Jill M. Considine, a former chairman of the Depository Trust Company and a former director of the Federal Reserve Bank of New York; Chester B. Feldberg, a former New York Fed official who was chairman of Barclays Americas from 2000 to 2008; and Douglas L. Foshee, chief executive of the El Paso Corporation and chairman of the Houston branch of the Federal Reserve Bank of Dallas.
Ultimately, these three trustees wield all the power at A.I.G., and have the right to vote out the 11 directors if the directors are unwilling to publish the e-mail messages. In other words, if these three people ask A.I.G.’s board to post the messages and other documents, the board will have no choice but to comply. Ms. Considine, Mr. Feldberg and Mr. Foshee have the opportunity to be among the most effective and influential investor advocates in history. Before A.I.G. escapes, they should demand the evidence.
The longer it remains hidden, the less likely we will be to answer many questions about the A.I.G. collapse and the larger economic crisis — including the most important one: how do we prevent a repeat? Time is the enemy of effective investigation; records disappear, memories fade. The documents should be released — without excuses, or delay.
Eliot Spitzer is a former attorney general and governor of New York. Frank Partnoy is a professor of law at the University of San Diego. William Black is a professor of economics and law at the University of Missouri-Kansas City.
Spitzer, Partnoy, Black Call for AIG Open Source Investigation (and Goldman Implications)
by Yves Smith
This is a good proposal, but I have a far more basic question: why was no forensic work done as a requirement of the bailouts? The Swiss Federal Banking Commission required UBS to perform an extensive investigation of exactly what it did so wrong that it needed a government handout, and it hired (presumably at the insistence of the regulators) third parties to conduct the investigation. It provided considerably more detail than any bank has provided so far of how a firm with a solid franchise drove itself into an abyss.
Why has there been NO serious investigation of ANY kind of the recipient of such extraordinary taxpayer largesse? Why has virtually NOTHING been demanded of them? Why the unseemly rush to let them off the hook and let them "pay back the TARP"? This is completely unwarranted in the case of AIG, which has had its deal with the government retraded in AIG’s favor a full four times. Why has AIG at every turn gotten a better and better deal, each time at the public’s expense, and is now allowed to lobby that it should be freed of its obligations? No private sector lender would allow a troubled borrower that could not meet its commitments to renegotiate and get IMPROVED terms.
The inability to meet the terms of the original funding (one on terms private sector lenders were willing to consider, and that per Sorkin, AIG itself proposed) only strengthens the case to continue with the original plan, which is to break up AIG and sell the pieces for what they can fetch. This is the course that would yield the highest returns to the public, and that program will not produce a systemic event, which should be the ONLY offsetting consideration. There is no business rationale to have an agglomeration of diverse insurance businesses, particularly one that has been as badly managed as AIG (Sorkin’s account also reveals a shocking lack of financial and operational controls).
So why have there been no investigations? In AIG, the Goldman conspiracy theorists have a real case. Consider this commentary from a reader who was a senior executive at a monoline, on an article that looked like a PR effort to get ahead of a possible source of trouble for Goldman. The Wall Street Journal story noted that Goldman guaranteed $23 billion of CDOs with AIG and allegedly made a mere $50 million…. which is utter bullshit. Normal CDO originating spread are 1.25% to 1.5%. Its profits on these deals, separate on how it might have booked its trades with AIG, was at least $287.5 million. Even more important, a some of these trades were part of its Abacus program, which was a series of synthetic CDOs that it used to lay off its real estate risk (both RMBS and CMBS). In other words, the "short subprime" trade that everyone has lauded Goldman for was in part, if not in significant measure, borne by taxpayers.
The most curious part of this pattern is that Goldman used ONLY AIG for its CDO guarantees; all other banks also used the monolines to a significant degree. So Goldman would benefit far more than other firms from an AIG rescue; they would all still lose out on their monoline exposures.
The monolines started hitting the wall before Goldman did; in fact, their wobbly state played a direct role in the failure of the auction rate securities market (Feb 2008), when it became clear that Eric Dinallo’s efforts to create a bailout for Ambac and MBIA were likely to come to naught (the monolines were major guarantors of municipal paper, and municipalities were major issuers of ARS). Both retail investors and municipalities suffered as a result (retail investors who needed access to their funds but could not get liquidity; issuers who had to pay penalty rates because their maturing paper could not be rolled). The monolines, who Goldman had not used, were allowed to twist in the wind, but AIG was rescued. And Goldman hands are far from clean. From a reader who was a senior executive at a monoline on the WSJ story:I find it amazing that after stuffing AIG with $23 billion of CDOs, which lead to AIG failing, Goldman’s spokesman has the audacity to blame the problem on AIG. meanwhile, Goldman researchers and CFO were criticizing Merrill and Citi for taking on so much exposure to the other bond insurers and insisting that these insurers not get bailed out. It also highlights again how outrageous it was that Goldman and the others gold paid off at par for taking a combination of CDO and AIG risk while the rest of the world (investors and insurers) got burned for taking CDO risk. The Goldman spokesperson acts indignant at the suggestion that somehow they shouldn’t have gotten this. This was the scam they played with the Fed.
While the subprime deals and CDOs were obviously going bad, an argument was made by many people at the time that the aggressive mark downs by AIG acelerated the death spiral for the market. It is pretty clear, here and elsewhere, that Goldman was the one that initiated the mark downs of collateral value. it would be interesting to explore this all the way through. Though not discussed in this article, Goldman shorted subprime through the Abacus deals, and perhaps elsewhere.
This gave them an incentive to force mark downs. the intermediation deals described in the article, combined with AIG’s collateral posting, gave them another incentive to be agressive with mark downs. they were acting like they wanted to grab the money before anyone else could get their hands on it. this would have raised some issues in an AIGFP bankruptcy. (note – Hank Greenberg suggested that this was going on in his october 2008 testimony but there was a chorus of attacks on him for being a crook and unreliable, thanks to his problems with Spitzer.)
So here we have the pattern:
- Goldman creates or sells $23 billion (or more) of CDOs and stuffs them into AIG.
- Goldman proclaims to the world they have no exposure to CDOs and warns that banks and insurers with CDO exposure will get downgraded.
- Goldman initiates the mark downs of CDOs with AIG and others, acelerating the market’s downward spiral.
- Huge mark to market losses lead insurer and bank credit to freeze, short term markets to lock up, ABCP to collapse.
- AIG posts as much collateral as it has to Goldman, who has more aggressively marked down the exposure.
- Bond insurers are downgraded, banks begin commutations with them.
- AIG fails, Fed steps in, Goldman gets bailed out at par.
Yves here. This looks like no accident. I suspect it was no accident. And no one in authority wants to find out where the truth lies.
The Harvard-Goldman Filter
My position on breaking up banks generates questions from two groups. Libertarians ask, how can I justify breaking up private sector institutions? Naive liberals ask, why is this policy not embraced by our political leaders? My answer to both relates to what I call the Harvard-Goldman filter.
The Harvard-Goldman filter works like this.
- To get into a position of power, you have to pass through a filter. The easiest way to show that you can pass through the filter is to go to Harvard and then work for Goldman.
- If you do not go to Harvard and work for Goldman, then you have to show that you can get along with people who did.
- The best way to show that you can get along with people who pass the Harvard-Goldman filter is to show that you believe in applying the Harvard-Goldman filter.
Why was Tim Geithner regarded as such an obvious, in fact necessary, choice to be Treasury Secretary? Because he satisfies the Harvard-Goldman filter, particularly point (3). He is not going to bring people from the wrong social caste into the policymaking arena. So that answers the question from naive liberals.
As to libertarians, certainly in a world with no deposit insurance or government guarantees I could argue against government interference in the structure of private banks. But banks are not private in this country. They are quasi-public institutions (and if you read Niall Ferguson you might conclude that large banks have always been quasi-public institutions). There is a synergy between big banks and big government. Jefferson and Jackson were right. So breaking up big banks fits in with breaking up big government. Which is why we won't see the Progressive elite breaking up big banks.
The best book to read on the topic of the Harvard-Goldman filter is David Halberstam's Vietnam era opus, The Best and the Brightest. Goldman was not such a big deal then, but Harvard was, and so was Wall Street. What Halberstam shows is that investment bankers certified who was reliable or not--to serve in foreign policy positions.
Are TBTF Banks Out of Danger? The Market Doesn't Think So
Down here it’s just winners and losers
And don’t get caught on the wrong side of that line
It started with a finger exercise during my daughter’s swim team practice:
Just in case you thought I was picking on The Big C in my previous post, let us look at the other major financial institutions (Too Big to Fail, or TBTF, Banks) over the same time period.
The Remaining Investment Banks:
While Goldman Sachs—as with most of the other so-called Winners—shows a significant upturn and major gains since the beginning of 2009, Morgan Stanley’s appreciation has been rather less apparent. However, both have returned only to approximately the price they held during the interregnum (after Bear Stearns fell but while Lehman Brothers ignored the warning and decided not to right the ship).
The Mortgage Lending Leaders:
Both firms show an increase in stock performance beginning in Q1 of 2009. Wells Fargo had a precipitous dive after LEH filed bankruptcy, but recovered in a similar amount of time. JPMorganChase, having acquired Bear for either a song or too much money, remains below the level it reached during the interregnum, but solidly in the middle of its range since 2006.
The Consumers-as-Profit-Center (“Retail”) Banks:
As is apparent, Capital One’s stock decline was not precipitated by the proximate solvency crisis itself, but rather by the decline in earnings and profits, and deflation in wages, that was in full swing by early 2006. While Bank of America does not have that preamble, it sees a similar decline in its stock price from the middle of 2007. By the time the recession is officially declared, the trend has started. And while Bear’s fire sale to JPM causes a decline in bank stocks, it is not until LEH that BAC mirrors its competitors above. More like MS than GS, BAC’s recovery to less than one-half of its pre-recession trading price suggests that the market is less confident than management that the firm’s major issues are behind it.
But one thing abides. The market isn't happy.
Even as we might divide this squad into Winners (GS, JPM, WFC), Losers (C, MS), and Also-Rans (COF, BAC), six of those seven (exception: JPM) appear to be viewed by the market as no stronger than they were during the interregnum, the time when everyone was waiting to see if the other shoe would drop.
There are certainly other reasons the stock price might be down: insider selling at the firms is at record or near-record levels, and sooner or later people will figure out that when insiders are selling at 82:1 levels is not the best time to buy. Their loans are down (post on that coming soon) while, as Linda notes at ataxingmatter:A recent study suggests that big banks in the TBTF category now enjoy a significant cost-of-funds spread compared to other banks. That is, they can borrow money more cheaply, leading to greater ability to make profits, than can other banks, because of the implicit guarantee that the federal government will step in and save them because they are TBTF and pose a systemic risk. That advantage may amount to as much as 48% of the TBTF banks' profits this year (or as 'little' as 9%, on very conservative assumptions). The government, by the way, gets nothing for this implicit guarantee--unlike a commercial guarantor, it is not being paid a regular premium for the service.
So maybe investors believe that this advantage will go away. (Or, as noted above, maybe investors have figured out that the Big Banks aren't taking advantage of this opporunity, expecting that it will never go away.)
The one certainty is that, with all of their advantages (the refusal of the Administration to support cramdowns for non-investment properties, leading to perverted accounting that makes banks solvent and mortgageholders underwater at the same time on the same property; the continuing payment of interest on Reserves in a deflationary environment, which has created a perverse incentive for the TBTF Banks not to lend; charging their smaller competitors for the TBTF Banks's failures by raising their FDIC contribution and collecting three years of it upfront after not having saved for a rainy day; having Administration economic policy run by Larry Summers, whose last foray into the financial markets was too embarassing even for him to explain (h/t Felix); Ben Bernanke having decided that doing only half his job should be enough (h/t Brad DeLong); and the general delusion that the banks are necessary to and helping with a recovery. And that's off the top of my head.
As The Epicurean Dealmaker observed last week vin a post everyone should read:Chancellor [of the Exchequer Alistair] Darling could not have been clearer:“I’m giving them a choice. They can use their profits to build up their capital base, but if they insist on paying substantial rewards, I’m determined to claw money back for the taxpayer,” he said.
[H]e plans to do this by making banks choose between their employees and their shareholders...
Economists have made this point repeatedly: the first priority of people who run a business should be their responsibility to their shareholders. (See Steve Randy Waldman's post yesterday for a clear explanation. And then see the post he pulled from comments after that, which saves me the trouble of hoisting from another person's comments again for the real ramifications of TARP and the bailout. Why do Megan McArdle and the Administration hate the troops?)
Paying large bonuses while the banks themselves remain near insolvency is bad for the shareholders. Goldman Effing Sachs realizes that, even if they didn't quite go far enough.
Why do I believe the state of the TBTF Banks ranges from near insolvency (C, MS) to on the edge of insolvency? The market tells me so.
Boost for Blavatnik against JPMorgan
Len Blavatnik, the billionaire entrepreneur, has won a partial victory in his legal battle to bring claims against JPMorgan Chase alleging that the bank invested about $1bn belonging to one of his companies in a portfolio "stuffed" with risky mortgage-backed securities. In a recent judgment, the Supreme Court of the State of New York agreed to hear claims from Access Industries, Mr Blavatnik’s industrial group, against JPMorgan’s asset management arm for breach of contract and negligent misrepresentation.
The court dismissed two other claims – for negligence and breach of fiduciary duty – brought by CMMF, a unit of Access Industries. The case could be heard in January unless the two sides reach a settlement.
Mr Blavatnik’s company has claimed that JPMorgan’s "ill-conceived investment strategies" just before the collapse of the US housing market caused a loss of at least $98m at CMMF, one of its subsidiaries. JPMorgan has said it would defend the lawsuit "vigorously". The legal row is emblematic of the many fall-outs between investors and their financial advisers in the aftermath of a credit crisis, which has led to the destruction of billions of dollars in wealth among both corporates and individuals.
Mr Blavatnik, whose business interests span chemicals, natural resources, media and real estate, suffered his own setback during the financial turmoil when Lyondell Chemical, a company that was controlled by Access Industries, had to file for bankruptcy protection in the US. Lyondell Chemical is a US unit of LyondellBasell, the Netherlands based parent company, formed in 2007 when Basell, which Mr Blavatnik controls, acquired Lyondell for $12.7bn. However, the US unit filed for Chapter 11 bankruptcy protection in January to facilitate a restructuring of its $26bn of debts.
The company filed a reorganisation plan last week. At the same time, LyondellBasell is evaluating an offer from India’s Reliance Industries. CMMF has claimed that when JPMorgan was retained in May 2006, it was given broad discretion in how it invested the funds but its goal was to "provide a high level of current income consistent with low volatility". In particular, JPMorgan had to invest no more than 40 per cent of the funds in asset-backed securities and a maximum of 20 per cent in mortgage securities, including the collateralised mortgage obligations that were at the centre of the crisis.
The two sides disagree on how JPMorgan allocated the funds, with CMMF alleging that, by July 2007, mortgage securities made up more than 46 per cent of the portfolio – a figure that is disputed by people close to JPMorgan. "Plaintiff’s position is that defendants had too much appetite for risk," the supreme court’s judgment says, before adding that CMMF claims the "portfolio was stuffed with risky residential real estate securities".
S&P ratings threat to covered bonds
Covered bonds have been one of the more resilient parts of the structured credit market this year. But this week the asset class was thrown into the spotlight when Standard & Poor’s threatened to downgrade the vast majority of the covered bond programmes it rates in Europe, US and Canada. The move affected €1,460bn ($2,154bn) of debt linked to 98 (mainly European) programmes, and follows the rating agency’s decision in February to revise globally its methodology and assumptions in light of the financial crisis.
The move, which came on Wednesday, shocked and disappointed some in the market who felt it did not reflect the fundamentals of the asset class. Most covered bond programmes have retained their triple-A ratings throughout the crisis and some are now at risk of losing it. Covered bonds are backed by pools of mortgages or public debt, but crucially, in the event of a default, investors also have recourse to the balance sheet of the bank that issued them. This year the market received a boost from the European Central Bank which said it would buy back €60bn of these securities, triggering an increase in demand from investors.
The new methodology set out by S&P will place greater emphasis on asset and liability mismatches in covered bonds when determining credit ratings and introducing a closer link to the rating of the bank issuers.
"We believe that, as recent events have shown, we need to take greater account of the potential refinance risk that a covered bond programme might be exposed to if its issuer becomes insolvent," said a spokesman for S&P. Previously covered bond ratings were independent of the bank that issued them. S&P will create three categories of risk, low moderate and high, for the asset liability mismatch in the pools of assets backing the bonds.
These categories will depend on the jurisdiction of the bond issuer, the ability to raise third party liquidity or sell the assets and the likelihood of government support.Analysts at Barclays said they did not believe the move would have substantial immediate implications for spreads. But as the final downgrades come into effect over the next four months, covered bonds from lower rated institutions with liquidity profiles categorized as poor by S&P would suffer higher spread volatility.
"The sheer scale of the watch action has come as a shock to the market," said Michael Cox, analyst at Chalkhill Partners, a boutique investment bank. He said investors were still trying to work out the implications of the downgrades for the covered bond market as a source of funding going forward. "If banks have to add more collateral that will make the programmes less efficient," he said. "The move by S&P is very disappointing," said Tim Skeet, head of covered bonds for Bank of America Merrill Lynch. "What (S&P) has done is mildly improved from what they initially proposed but still means a great swathe of issuers are going to be clobbered by this. Is this really the right way to treat this asset class given how resilient it has been in the face of the crisis?"
Mr Cox believes the downgrades could have a negative impact on other markets: "While many issuers could take action to boost the collateral in the pools to avoid downgrades (with a knock-on impact on unsecured bank creditors), there remains the potential for meaningful downgrades to a significant chunk of the covered bond market," he said. "This will undoubtedly cause disruption to a market that has been one of the principal sources of finance for mortgages this year, and it therefore has the potential to have a negative knock-on impact on the availability of finance in the residential and commercial property markets."
Other bankers believe it will do little to shake investor confidence. "This won’t halt issuance but it will create more of a tiering of spreads between different issuers, which will likely be welcomed by investors looking for yield." said Ted Lord, Head of European Covered Bonds at Barclays Capital. "As governments look to exit support packages, central banks have been encouraging financial institutions to stop funding through the central banks and turn instead to the markets and the first place they will do that will be in the covered bond market. "
Philadelphia suburb approves budget with 360% property tax increase
Buckingham supervisors approved a $20 million preliminary budget for 2010 that increases local property taxes by 360 percent - even after the township cut expenses by laying off three employees, eliminating another position and changing health care plans. Taxpayers will pay 5.5 mills in township property taxes, which equates to a bill of $271.15 for the owner of a home assessed at the average of $49,300.
The supervisors had previously kept property taxes low (at 1.5 mills) by pulling from the township's general fund surplus to pay operating expenses and defray debt incurred for open space preservation. The revenue gained from the 4 mill tax increase will be used to defray open space debt. Supervisor Chairwoman Maggie Rash said the supervisors agreed that they did not want to cut the township's open space program, but they also agreed that they could not continue to pull from the general fund surplus to pay open space debt.
"We always knew that that could not continue," said Supervisor Henry Rowan. "It couldn't continue because it was based on real estate transfer tax to a degree, which was going to slow down. And the economy, at some point, was going to slow down." Then the housing bubble burst and the economy crashed. Buckingham budgeted $950,000 in real estate transfer tax revenue for 2009, and township officials expect to collect about $599,000 - about 63 percent of what was budgeted.
The township cut spending in 2009; it had budgeted $6.5 million in general fund expenditures, but officials expect to spend only $6 million. The supervisors have budgeted $600,000 in real estate transfer tax revenue for 2010. Spending for 2010 is down about 6 percent from what the township budgeted in 2009, but is up about 1 percent from what the township expects to actually spend before the year ends. General fund expenditures are currently budgeted at $6.1 million. Rash said the supervisors cut a lot from the budget to keep expenses down.
The township will lay off one full-time employee and two part-time employees effective Dec. 31. Rash said two of the positions are in the building department and one is in administration. "We're looking closely at the staffing requirements, and the change in building and development. And we're making decisions based on projections to make sure the staffing meets the needs of the township," Rash said. "There's not as much building-related work coming in and that's what the projections are based on. Nobody's sitting around now, but you can see that over time, the work load is diminishing."
The Buckingham budget also eliminates an open full-time road crew position. Township Manager Dana Cozza estimates the elimination of that position will save the township $50,000 to 60,000 in salary and benefits. The budget also freezes salaries for all employees, except police. The police contract gives police officers a 4 percent pay raise this year, Cozza said. The budget calls for a 10 percent reduction in fees paid to consultants. The supervisors are soliciting proposals from professional consultants, including potential solicitors, engineers and land planners.
Whether Buckingham can hire any consultants at the price it has set remains to be seen. New consultants will be appointed at the township reorganization meeting in January. The budget cuts overtime for all employees except the road crew. Annual year-end bonuses were eliminated this year and are not in the 2010 budget. In the past, some employees received bonuses that ranged from $100 to $200, depending on township finances, Rash said.
The township has also changed its health care plan from one HMO to another. Under the previous plan, township employees paid a $2 co-pay to their primary care doctor and no co-pay for specialists. The new plan requires township employees to pay a $10 co-pay to their primary care doctor and a $20 co-pay to specialists. Cozza estimated that the change will save the township $246,000 in benefits. The supervisors are expected to review the final budget and vote on it at a meeting on Dec. 22.
Farmers may see large land tax increases under proposal from Missouri State Tax Commission
Many farmers may see substantial tax increases on their land if a proposal by the Missouri State Tax Commission stands. The commission last week agreed to change the tax rate for farmland in different categories, based on a study by the University of Missouri-Columbia of a 15-year cycle of farm income. The assessment is conducted every two years, though no changes were instituted this year.
Under the proposal, land suitable for cultivation would see taxes increase by as much as 29 percent, while taxes would decrease by up to 25 percent for land where crops generally aren't grown. The increase would benefit entities such as schools. Commission chairman Bruce Davis said that although he realizes the recession has affected all sectors of the economy, including farmers, the proposal wouldn't go into effect until 2011, if approved by the Missouri Legislature. "People need to remember that it would go into effect in 2011 and that's two years away," Davis said. "Those who oppose it use the argument that we're in tough economic times, and I agree. "But they're not looking into the future," he said. "They're looking at the situation now."
However, Dr. Jon Hagler, director of the Missouri Department of Agriculture, thinks the legislature should think twice about approving the proposal. "We continue to believe that this is the wrong time to increase farm productivity values," Hagler said in a written statement. "The current recession has greatly affected Missouri's farm families. "Volatile market prices and a severe lack of credit for refinancing have only made matters worse. Increases in land assessments would be detrimental to farm families and Missouri's overall economy."
Productivity values ranged from Grade 1 land, categorized as prime agricultural land, to Grade 7 land, where the soils are generally unsuited for cultivation and may have severe limitations for grazing and forestry. Under the proposal, Grade 1 land would increase from its current rate of $985 an acre to $1,270 an acre. Three other classes of land would also have rate increases, while three classes would see their rate decrease. Grade 5 farmland would see the biggest drop, decreasing from $195 an acre to $147 under the proposal.
State Sen. Jason Crowell plans to introduce a Senate Concurrent Resolution to prevent the proposal from becoming law. "We need to be finding ways to lower taxes for our farmers, not increase the costs of owning a farm," said Crowell, R-Cape Girardeau. "Farmers are the backbone of Missouri's economy and it is the state's job to provide every avenue possible for farmers to succeed, not to create roadblocks." The Missouri Farm Bureau is among those that have asked legislators like Crowell to fight the proposal.
"As we stated to the State Tax Commission, many Missouri farm and ranch families are facing financial strain like they have never seen. Extreme market volatility combined with record production expenses, unusually wet weather and weak demand have left many producers struggling to manage debt and cash flow," said Charles Kruse, president of Missouri Farm Bureau. "Missouri farmers are carrying some of the highest debt load in the nation, and clearly they cannot be expected to shoulder a tax increase."
John Lorberg, whose family farms nearly 1,000 acres in the Gordonville area, said the proposal would affect many farmers like himself. "There's no question if they raise taxes it will cost many of us more money," Lorberg said. Larry Strobel, who has a 4,000-acre farm in Bell City, Mo., is hopeful legislators will oppose the proposal. "With the economy the way it is, it's not good," Strobel said.
The harshest cuts
We had been thinking that Virginia's ascendant Republicans, champions of limited government and miserly state budgets, would be eager to take a whack at what many of them consider to be the commonwealth's bloated, out-of-control, wasteful spending. In fact, they'd rather that someone else do it -- namely, the Democratic governor with one foot out the door, Timothy M. Kaine.
On the verge of taking executive power for the first time in eight years, Republicans in Richmond are blanching at the prospect that they will be forced to wield the budget ax. As Mr. Kaine submitted his outgoing budget Friday -- a two-year spending blueprint that his successor, Republican Gov.-elect Robert F. McDonnell, is free to rewrite -- GOP spokesmen were outraged that Mr. Kaine did not do all the dirty work of slashing public outlays himself. Instead, he proposed to balance the state's budget with a prudent combination of spending cuts and tax increases.
This fight is partly ideological and partly about who will take the political hit for slashing spending. Counting the cuts included in Mr. Kaine's proposed budget, he will have cut $9.3 billion from state outlays over five years, measured against general fund spending of roughly $15 billion per year. That's a huge decrease, and the $7 billion in cuts that have already been implemented, starting in early 2007, have delivered hits to health care, education, colleges, mental health facilities, prisons and other state services, in addition to the layoffs of hundreds of state workers. Rather than cut deeper into the sinew and muscle of government functions, Mr. Kaine has proposed tax increases whose net yield is about $740 million in new revenue over two years.
Of course, Mr. Kaine knows that Mr. McDonnell and his Republican allies in the legislature will throw out the tax increases. In a letter to him last week, four top Republican lawmakers and Republican Lt. Gov. Bill Bolling expressed their flat opposition to tax increases. They ran on that stance, and they're entitled to it. But the only way to avoid raising taxes is to make further severe cuts to an already badly depleted state budget.
While GOP candidates opposed raising taxes in the fall elections, Mr. Kaine has made no such pledge. Accordingly, his two-year, $30 billion general fund budget includes a one-percentage-point increase in the state income tax (to 6.75 percent), the proceeds of which would go to localities to compensate for other cuts in state spending, including almost $1 billion annually in car tax relief.
More than 30 other states have raised taxes, in some cases by significant amounts; some of those states are run by Republicans. Mr. Kaine will be the first governor of the commonwealth in many decades to leave office after submitting a budget that includes no more spending than the budget he inherited four years earlier. (And bear in mind that Virginia's public spending was already modest by the standards of state government. Once you adjust for inflation and population growth, general fund spending rose by just 8 percent over the past decade, or less than 1 percent annually.)
Mr. Kaine's job, as he has rightly described it, is to submit a budget that is fiscally responsible and that preserves core functions of state government. It is not to spare the incoming Republican administration political pain. Meanwhile, Republican lawmakers in Richmond might consider the Spider-Man Rule: With great power comes great responsibility. If they don't like the new taxes Mr. Kaine has proposed, then let them assume the responsibility of cutting into the bones of state government.
Euro 'Diktats’ risk terrorist response across Southern Europe
It is becoming dangerous to associate with economic and ideological power in Southern Europe, or what Europol calls the "Mediterranean triangle" of anarchist violence. Greece's Revolutionary Struggle detonated a car bomb at the Athens Stock Exchange in September. Citigroup's branches have been targeted twice this year. Hooded extremists attacked the rector of Athens University in his office this month, sending him to hospital with head injuries.
In Milan, the Informal Anarchist Federation (FAI) planted 2kg of dynamite last week at Bocconi University, the symbol of the free market in Italy. The FAI left a note threatening a "bloodbath" for capitalists. Security forces have issued alerts for the Milan bourse, Unicredit, and Barclays. Italians have begun to ask whether their country is returning to the 1970s, the "years of lead" when the Red Brigades murdered ex-premier Aldo Moro.
The FAI is no friend of Europe either. It sent letter bombs earlier this decade to the heads of the Commission and the European Central Bank and to the European Parliament.
In Spain, Barcelona's anarchists have been conducting a low-level campaign against bank cash machines, supermarkets, and firms such as Manpower. Valencia and Galicia have seen a wave of attacks. "Activities by left-wing and anarchist terrorists and extremists are increasing in quantity and geographical spread in the EU," said Europol.
Portugal has its own twist. The Trotskyist-Maoist Bloco emerged as third party with 11pc of the vote in the June elections. Premier Jose Socrates is attempting to impose austerity by minority government. Good luck. The hard-Left resurgence cannot be blamed on monetary union as such, yet the two are linked. EMU has always been viewed as a capitalist conspiracy – a "bankers' ramp" – in Left-wing circles. While their view may seem odd to us, they are entirely right to think that poor people in certain countries are victims of the experiment.
Unemployment is 19pc in Spain (43pc for youth) on Eurostat data. Greece is catching up fast. Labour minister Andreas Loverdos said Greek joblessness has jumped above 18pc over the last two months as EU-funded workfare schemes expire. This will get worse. Southern Europe is being ordered to carry out IMF-style austerity, without the IMF-style devaluation required to rectify the massive imbalances that have built up between North and South under the euro. The victims are caught like France and Germany under the Gold Standard of the early 1930s, when society was broken on a wheel of deflation decrees.
The EMU system has condemned Club Med to structural depression, with no way out. The logical – yet politically absurd – response of German Chancellor Angela Merkel is to talk of overriding national democracies in order to save the euro. "The question arises over what authority Europe has to tell national parliaments what to do, in order to avoid damage to Europe itself? National parliaments don't like to be dictated to about such things, but we need to address the problem," she said.
I do not wish to paint this is as German bullying, let alone a conspiracy by Berlin. Germany is being swept along by events like every other country that entered EMU blindly. Yet here is a German Chancellor talking about "dictating" to the Hellenic Parliament, within living memory of the Axis occupation, the Swastika flag on the Acropolis, and the hated Security Battalions. Neither Greece's Communist unions, nor Greek army officers, will react well to such diktats. That goes double for Epanastatikos Agonas and fellow terrorists.
Matters will be tested over the next two to three years. Standard & Poor's said Greece's public debt will reach 138pc of GDP by 2012 (from 99pc last year) as it downgraded Greek bonds to BBB+.
The IMF expects Spain to contract by a further 0.7pc next year, even assuming a global recovery. Moody's delivered its axe-blow last week, downgrading a third of all Spanish mortgage bonds and a string of regions. Italy will bounce along in perma-slump, as it has for a decade. The country has lost 30pc in labour competitiveness against Germany since the late 1990s. Across Southern Europe there is a mood of national powerlessness, a feeling that events have moved beyond their control – as indeed they have.
Eurosceptics argued from the start that EMU would prove unworkable over time without a debt-union; that the inevitable euro crisis would be used (consciously or not) to create an EU central government; that weak states on the edges would be reduced to colonies and that far from binding Europe together, EMU would lead to acrimony and perhaps reopen Europe's can of historical worms. Were the critics wrong?
Pimco’s Gross Boosts Cash to Most Since Lehman Failed
Bill Gross, who runs the world’s biggest bond fund at Pacific Investment Management Co., cut holdings of government debt and boosted cash to the most since Lehman Brothers Holdings Inc. collapsed in September 2008. Gross increased cash in the $199.4 billion Total Return Fund’s to 7 percent of holdings in November from negative 7 percent in October, according to Pimco’sWeb site. The fund can have a so-called negative position by using derivatives, futures or by shorting.
The fund cut government-related debt to 51 percent of assets from 63 percent in October. Pimco’s government-related debt category can include conventional and inflation-linked Treasuries, agency debt, interest-rate derivatives and bank debt backed by the Federal Deposit Insurance Corp., according to the Web site. Cash and equivalent securities may include commercial paper, short-term government and mortgage-backed securities, short- maturity company bonds and money market derivatives, according to the Web site.
Meredith Whitney Pans Goldman & Morgan
Financial stocks were already looking mixed at best early this morning with the largest offering in capital markets history pricing last night for a trade today. But Meredith Whitney, of her own Meredith Whitney Advisory Group, has lowered her earnings expectations for both Goldman Sachs (NYSE: GS) and Morgan Stanley (NYSE: MS). Whitney has a "Neutral" rating on both stocks.
Whitney had previously been credited for a solid trading buy in the name of Goldman Sachs, but she always maintained that she was negative on the sector for the reasons of credit coming out of the system and because of a lack of earnings growth in the stocks. And she has been negative even on the solid names of late. So while many will take this as a downgrade because estimates are cut, many might actually just take this as a reiteration of caution rather than a new development.
Goldman Sachs estimates were slashed to $6.00, but remain above the Thomson Reuters estimate of $5.59. For fiscal-2010, Whitney cut estimates further down to $16.75 from over $21.00. Thomson Reuters is at $18.78 EPS. 2011 targets were taken down to $20.60 EPS from about $24.00; and she gave estimates as a base for 2012 of $21.45 EPS.
On Morgan Stanley, estimates were taken down similarly. Whitney has lowered 2010 estimates to $2.60 EPS from $2.63, while Thomson Reuters has a figure of $3.32 EPS. Her 2011 estimate was taken down to $2.75 EPS from $3.28; and 2012 estimates were initiated at $2.90 EPS.
Meredith Whitney Now Pouncing on JPMorgan
Meredith Whitney must be staggering her bank coverage news out to get more exposure, or at least that is a cynical take on the matter. Yesterday she hit Goldman Sachs Group Inc. (NYSE: GS) and Morgan Stanley on the earnings estimates for 2009 and 2010, with targets out to 2011 and 2012. Now she has hit JPMorgan Chase & Co. (NYSE: JPM) earnings estimates for this year and next. While this is under the consensus for this year and next, what we wanted to look at was beyond the Meredith Whitney call and look at what would be fair and effective forward valuations on the greatest money center bank in America based upon her estimates and Wall Street consensus estimates.
Whitney cut the current quarter for Q4-2009 earnings estimates to $0.45 EPS, down from $0.55 and down from a consensus reading of $0.64 from Thomson Reuters. That in turn has taken down the full year estimates by a similar amount to $1.95 EPS versus a Thomson Reuters consensus of $2.15 EPS. The good news for JPMorgan is that the earnings estimates for all of fiscal 2010 are now $2.00 EPS rather than $2.05 EPS Whitney had before. But the consensus estimate from Thomson Reuters for Fiscal-2010 is actually up at $3.22 EPS. Whitney’s Fiscal-2011 earnings estimate is $2.50, with an estimate of $3.75 EPS in 2012.
Here is the issue at hand when you consider not just what Meredith Whitney is saying, but when you consider consensus estimates. When you are in late-Q4 2009 or even early Q1-2009, most investors are buying based upon what they expect for 2010 earnings. With a $40 handle today, this leaves JPMorgan shares trading at 20-times 2010 earnings. There is almost no doubt that JPMorgan is the safest or highest caliber of the money center or super-regional banks. But this leaves the stock trading at 20-times forward earnings, which is very high considering ‘the new normal.’
So here is the real question… Can investors in 2010 stomach a two-year outlook to get the earnings multiples back on track? Jamie Dimon has already hinted about the return to ‘the dividend’ in 2010, although at what rate that payout will be is up for debate. The dividend before the $0.05 per quarter of 2009 was $0.38 per quarter. That comes to $1.52 paid out per year, and Meredith Whitney’s $2.50 target for 2011 does not technically give enough of a dividend coverage to make up for the old dividend. It would effectively have a dividend coverage ratio of 1.5 out in 2012.
If you blended the 2011 to 2012 earnings estimates for a normalized outlook for a two-year time horizon for investors, then JPMorgan on a 2011-12 blended normalized earnings estimate would be $3.125 or thereabouts. Back in the days of old before valuations started getting sky-high, the banks used to trade at 10-times and 12-times normalized earnings. Then it was 15-times. The two answers to all these points boil down to 1) ultimately what earnings multiple YOU are willing to pay for forward earnings estimates, and 2) how far out on the horizon YOU are willing to pay for forward earnings.
It seems that a multiple of 20-times forward earnings is too high, even if this is over a transitional or turnaround period coming out of the abyss. If you use a 15-times earnings multiple starting early next year with a two-year average blended earnings, then 15-times a $3.125 blended earnings would come to a share value of $46.87. The issue here now is that many investors in early 2010 will still have a hard enough time just using a 2011 estimate. If they use the $2.50 estimate there, the a 15-times earnings multiple for the following year would generate a share price of $37.50.
So there is a disconnect in the stock today versus tomorrow. That is not at all unusual during transition and turnaround periods, and no one can just expect that stocks always adjust to a fair earnings multiple in times of change. Investors often do not use straight math like this, and admittedly this is the second most simple math test to use other than a trailing P/E ratio.
But there is also another disconnect here. Unless ‘the new normal’ is going to have investors all in agreement that the proper value for banks is at 20-times a blended forward earnings multiple for two-years out, then either the market is very wrong here with its much higher earnings estimates or Meredith Whitney is very wrong here by having her earnings estimates far short of consensus. The market frequently gets its long-term bets wrong, and many pundits who make their reputation by being one of the first ultra-bearish pundits often stay bearish for far too long.
And then there is the flip-side to the argument. If you decide that 15-times earnings is a fair multiple to pay in early 2010 for all the way out to 2012 full earnings, effective a 3-year forward look, then Whitney’s $3.75 EPS target would generate a forward implied price target of $56.25 out into 2012. That would imply 40% upside total. And it needs to be considered again that Whitney is far under the consensus estimates in the near-term.
JPMorgan Chase shares are back in positive territory this morning at $40.040 after trading down close to $40.00 after the research note started circulating trading floors. Its 52-week trading range is $14.96 to $47.47. In early 2007 the stock was north of $50.00, and it brushed up right against the $50.00 handle twice in 2008 before the financial meltdown came to pass.
Religion shaping mountain-top removal debate
On a crisp morning at Jenny Wiley State Park in Floyd County, beneath Appalachian mountains wreathed in mist, dozens of religious leaders gathered to decry a mining practice they see an as affront to both God and nature. "Mountaintop-removal mining blasts away our souls, blasts away our communities, the souls of the workers who are doing the work and our cultural and natural heritage," said the Rev. Robin Blakeman, a West Virginia minister and environmental activist.
But a different view prevailed on a recent wintry Sunday at First Baptist Church in Pikeville, a congregation replete with miners and those in coal-related businesses who say they "thank God we've got the coal." God "wouldn't have put the coal and the other minerals here if it wasn't for the use of man," said church member Virgil Osborne. "But he expects us to be a good manager, good stewards of what he gives us." The use of coal has galvanized fierce debates worldwide over its environmental and economic effects, from local mountain communities to the policy-making corridors of Frankfort and Washington.
But religious values are flowing through these debates as well — and they're being waged here in the heart of the Appalachian coal country. The area is steeped in a Christian heritage, attested by the modest steeples that poke through the trees at almost every turn of the winding mountain roads. Some of the churches represent Baptist, Pentecostal and Holiness movements rooted in the mountains, while others have links to more prominent national denominations such as Southern Baptist and Presbyterian.
All are deeply embedded in a culture and economy that is defined by its century-old coal industry. Both sides — and those in between — cite as pivotal passages from the biblical creation account in which God commands humans to "work and take care of" the earth and to "subdue" it, exercising "dominion … over every living thing." They speak of a spiritual duty to strike a balance between jobs and nature, but they see that balancing point at different places.
Coal mining as God's work
Hundreds of worshipers sang out "Go Tell it on the Mountain" on a recent Sunday at First Baptist Church in Pikeville, a Christmas classic with special resonance in this valley city beneath the snow-dusted slopes. Member Billie Hefner said the sight of the mountains at sunrise is breathtaking. But, she adds: "You don't just see what's on the outside of the mountain. You look on the inside. It's just like a person. On the inside of those mountains, there are things that are good for energy, electricity and then once that is removed, it can be reclaimed, and then you have a beautiful home site for families to build upon. … We're doing something to help people to survive."
She and others touted the conversion of some former mining sites into natural preserves and others into level, developable sites in a region where flat land outside of floodplains is rare. The airports of Perry, Pike and Martin counties, as well as several of the region's newer stores and subdivisions, are built on land that was leveled after miners blasted away mountaintops and slopes to get at seams of coal scores of feet below the surface. Others have been redeveloped as wilderness and agricultural land.
Barbara Waddell applauded such work but added: "It also depends on the coal company that's doing the removal. Do they have a heart to restore it? … Or are they greedy and could they care less? Would they go in and destroy it? We need coal in this area, but we also need for the coal companies to take responsibility." Bennett Stewart, a Sunday school teacher, said he believed coal companies want to mine with "the least amount of damage to the environment and to try to restore it. … There's a lot of common ground, and you don't hear a lot about that." And Pastor Paul Badgett sees a natural bridge between mining and environmentalism: "I just pray we can mine responsibly and we do have to be good conservationists and be concerned about the environment. I think you can marry those two and be responsible."
The fight against "slash and burn" mining
But opponents say coal mining has never lived up to its promises of economic betterment, noting many coal-producing counties of Appalachia meet the federal definition of "persistently poor," meaning 20 percent or more of residents were below the poverty line in every U.S. census since 1970. They cite the losses of native species of plants and animals, damage to homes by blasting, contamination of water and the burial of hundreds of miles of streams that feed into major waterways like the Ohio River.
"When they blast that large, it's going to go into the good water, and it's going to be bad water," said McKinley Sumner, a Perry County resident who says his land has been affected by surface mining on neighboring property. "I've got more than that against mountaintop removal, but water is the most important thing we have." Many say they support traditional underground mining, which they say employed far more than the highly mechanized surface mine operations. On a remote slope in Floyd County in November, about 50 people gathered for a late-afternoon worship service alongside a pond designed to catch sediment from a surface coal mine.
As coal trucks rumbled over the ridge above them, the worshipers sang hymns customized for the occasion — extolling the beauty of nature and its vulnerability to "folks with wealth" who "slash and burn and clear the ground." Participants poured out vessels of water and soil to bless "the soil that has been damaged by this activity," said Sister Robbie Pentecost, a Roman Catholic nun who has worked for years on poverty and the environment in Appalachia. The trip was organized by the Center for Interfaith Relations in Louisville to mobilize state and national religious leaders to ask, "What does our faith say to us? How does it call us to act?" said Christy Brown, a founder and board member.
Pentecost noted that several denominations — such as the United Methodist Church, the Louisville-based Presbyterian Church (U.S.A.) and the Catholic Committee of Appalachia — have positions against mountaintop removal. One goal of the trip is to "link the local churches with the broader church and try to get support for local people who may be struggling to live with the results of mountaintop removal." Nearby resident Rick Handshoe told the group about water contamination, blasting damage and other hardships he said might drive him away from a region where his family has lived for 200 years. He was encouraged by the visit. "This gives me hope," he said.
Battling against the "war on coal"
But mining advocates also are drawing outside religious help to advance their cause. Jeff Fugate, pastor of a large independent Baptist church in Lexington, has launched a high-profile campaign in favor of coal, linking it to his opposition to expanded gambling. "We have environmentalists today that are shutting down the working of coal mining in the mountain region, deciding that we must save the streams and the animals there," he said in a November sermon at Clays Mill Road Baptist Church, which draws more than 1,600 a week. "… Then that same crowd wants to bring about predatory gambling to a state that is hurting financially and is struggling to provide jobs already."
The Perry County native said God "gave us these minerals to use and provide for ourselves," and like other mining advocates interviewed in the region, he dismissed as "junk science" the scientific consensus that carbon emissions are causing global warming. Mining advocates appreciate such support. "We definitely believe there's a war on coal," said David Moss, director of government affairs for the Kentucky Coal Association. He urged opponents to take a closer look before condemning an industry that employs more than 6,000 in the state and generates "a lot of economic activity for Eastern Kentucky."
Churches walking a fine line in coal country
While mountaintop mining and coal have galvanized some local churches and pastors, many others in the area remain neutral, said Allen Johnson of the West Virginia-based Christians for the Mountains. "You've got somebody in a congregation that's being negatively affected by mountaintop removal," he said. On the other hand, "Uncle Bill is sitting in that pew, driving a truck for a coal company, and we don't want to offend him." As a result, he said, many churches instead are "going to pray for the sick and talk about going to heaven and talk about building a new steeple for the church. It's an edgy thing for some ministers to deal with, even if they are at the point of dealing with it. … But doggone it, it's our job to be truth tellers."
At Corinth Baptist Church, a small congregation located across a two-lane state highway from a valley creek in Fleming-Neon, members have seen both sides. "Coal is good," said Dorothy Newsom. "Coal has raised a lot of us, put us through school, put a roof over our heads." But she noted that coal-related jobs have shrunken dramatically with the decline of mining unions and the growing mechanization of surface mines, and Corinth Baptist's congregation is largely middle-aged or older, the result of children moving out of the area in search of other jobs.
Johnny Williams Sr., a deacon at the church and a coal-miner's son who also worked for many years as a coal sampler (analyzing it for content), said God put coal "here for us to use" and that the industry "fed my family." He doesn't object to surface mining. "As long as you do it right. That's the thing I ask," he said. His wife, Doriss Williams, agreed — but said it often isn't being done right. "We're leaving a lot of desolated land with stagnant waters above the ground that's standing idle," she said.
Among those seeking to bridge the divide is the Kentucky Council of Churches, a coalition of 11 Protestant and Catholic denominations. It officially opposes mountaintop removal, but not all coal mining. Rather, it urges "more sustainable methods that protect water, soil, and people" while developing more renewable energy sources. "I keep coming back to (the biblical command of) loving your neighbor as yourself," said the Rev. Marian McClure Taylor of Louisville, executive director of the council. "There is a love of neighbor in wanting people to have employment. But I'm downstream, and I'm their neighbor, too, so I'm concerned about these issues of water and soil and the larger creation."