Men on 'Skid Row', Modesto, California
Ilargi: He really said it. The nation must "continue to spend our way out of this recession".
Obama presumably thinks such a thing is possible. And that in turn would seem to indicate that in his view it's been done before. But has any nation (note: what he means is "government") ever successfully spent its way out of a recession? At the very least any positive answer to that question would come dressed in question marks. For one thing, it’s much easier to see how a nation can spend its way into a recession than out of one.
No matter how you twist and turn it, it’s a desperate thing to say.
The "spend our way out of this recession" remark comes as part of a speech in which the president announced additional initiatives aimed at job creation. Which are necessary because what's been tried so far has all been a dismal failure, right? No, says the administration through White House Council of Economic Advisers chair Christina Romer. All the programs have been successful. Not a failure at all, we’re well on track to create the 3.5 million jobs foreseen in the February stimulus bill. And because it's been such a success, we so badly need to do more of the same.
But Christina, the president said in February that the $787 billion stimulus would prevent unemployment from rising above 8%. It's over 10% now. You may call the February stimulus a success. But if it is, how would you define failure? You would have to wonder (or is that shudder to think) where the White House thinks unemployment would have been today without the $787 billion. Or, to take another point of view, what an extra $70-$150 billion, numbers currently floated, could do that $787 billion could not.
Moreover, the jobs that allegedly have been added are just about all surrounded by a cloud of doubts and questions. Recovery.gov lists some 640,000 jobs created, but who believes them? Pay raises counted as saved jobs, non-existing districts that create thousands of jobs, it's a suspicious story. The latest in that line-up is the 1.5 million jobs that will be "created" to conduct the 2010 census, jobs that will last 6 months at most and then vanish again. I think we all know where to expect these numbers to pop up: in the long line of extend and pretend "successes". Like so often in politics, we’re left asking ourselves: is Christina Romer that dumb or is she that good a liar?
If we would look at more realistic job numbers, we see for example that the Economic Policy Institute puts the total number of under- and unemployed, marginally attached and involuntary part-time workers at 26.9 million. If we follow John Williams' SGS data, which include even more workers the government prefers not to count, we see that 22% of the non-institutionalized working-age population, some 33.9 million people, cannot find a job, or at least not a satisfactory one.
And, to take this one step further, if we assume that $700 billion of the original stimulus plan was intended for job creation, and the goal was 3.5 million jobs, we may also assume that it takes $200,000 to create one job. So in Obama's idea to use TARP funds for the purpose now, it would take $70 billion to make 350,000 jobs, and $150 billion to make 750,000. Creating satisfactory jobs for everybody on John Williams’ SGS list would cost $6.78 trillion.
Now we know of course that the underlying thought is that the private sector will start creating jobs again after the government has given the economy its "spend our way out of this recession" boost, but that remains to be seen. For one thing, there are plenty reasons to believe there are more storms about to appear on the economic horizon, and plenty people who see them approaching.
Bank of America and Citigroup rush like mad to repay their TARP funding, so their executives can go back to paying themselves the bonuses they want. They can try to do this because their bottom lines have been lifted by "investing" easy public money in wagers on a temporary rise in stocks and commodities markets.
What everybody is conveniently willing to forget is that these bank schemes, like the government's claims of improving economic conditions, can be broken into a thousand pieces if stocks and commodities would start falling. The S&P reached its peak on November 25. A rising dollar would also be a huge threat to the US economy. It has regained all it's lost over the past 3 months vs the Euro, and it keeps on rising.
The positive news we've seen over the past, say, 6 months, has all been based on markets, not on the real economy. Numbers on housing and employment, which seem to improve, are obviously subject to embellishment schemes that make them ever harder to swallow.
When it comes to jobs, criticism of the latest non-farm payroll stats is louder than ever, and for good reason. There are far more people out of a job than official numbers indicate, and the number of analysts and onlookers aware of that fact grows fast.
In housing, it's a very public secret that perhaps as many as 10 million properties are empty but not included in official numbers because they are not put up for sale. Also, the Fed will move away from mortgage backed securities in early 2010. No way but down there.
As for the banks that try to look healthy by repaying TARP, they still have trillions of dollars worth of toxic assets and bad and deteriorating loans on their books and sheets, as do all their peers that did not receive free money. There is a backlog of hundreds of banks that should have been closed, but were not, and their number rises, a process dead sure to accelerate.
The last few weeks of this year will be a good test of how much more foreign governments and central banks, as well as other large investors are willing to swallow. And how much they can swallow, not to forget: China's bubble problems are by no means over or forgotten: they’re just starting.
President Obama may have a majority of his voters believing what he says, but that's not anywhere near a proper way to measure the state of the nation. For that, you will have to look at what big money does. And if that moves into the safe haven territory only the US dollar can provide, stocks will plunge, as will gold.
The thin layer of lying veneer will peel off, the one that understates unemployment, commercial and residential real estate losses and inventories, as well as losses and writedowns in the financials’ pipelines. And then the depression can start for real.
Falling Unemployment "Not Good Enough," Christina Romer Says, Backing Obama's New Plan
Even after Friday's better-than-expected jobs data, President Obama unveiled a new effort on Tuesday to help the millions of Americans that can't finds jobs. "The President's view of that was…that's not good enough," Christina Romer, chair of the White House Council of Economic Advisers, says of the November data showing the unemployment rate falling to 10% from 10.2%. The President knows 10% unemployment does not bode well for his approval ratings, which slipped to a new low of 47% in the latest polling. In an effort to reverse that trend, Obama is attempting to "spend our way out" of the recession; his latest plan focuses on three objectives:
- More spending on infrastructure projects.
- Tax breaks and credits for small businesses.
- Tax incentives for homeowners to maker their homes more energy efficient, with the hope of creating more "green jobs."
Critics say this latest plan is proof the $787 billion stimulus bill passed last winter has been a failure. As you might expect, Romer disagrees, telling Tech Ticker: "We've always said that this was an evolving process -- that even if the Recovery Act did exactly what we anticipated, and we think it’s on track to create the 3.5 million jobs that we thought it would create, there's always the question of 'can you do more? can you do it better?' and we've been evolving." Just how does the President plan on paying for these new initiatives and maintain credibility with our foreign creditors? Stay tuned for Romer’s answers in a forthcoming segment.
Obama urges major new stimulus, jobs spending
Obama offers plans to help US 'spend our way out' of recession, promote creation of new jobs
President Barack Obama called for a major new burst of federal spending Tuesday, perhaps $150 billion or more, aiming to jolt the wobbly economy into a stronger recovery and reduce painfully persistent double-digit unemployment. Despite Republican criticism concerning record federal deficits, Obama said the U.S. has had to "spend our way out of this recession" with so many people out of work but insisted he was still mindful of a need to confront soaring deficits.
More than 7 million Americans have lost their jobs since the recession began two years ago, and the jobless rate stands at 10 percent, statistics Obama called "staggering." Congressional approval would be required for the new spending. "We avoided the depression many feared," Obama said in a speech at the Brookings Institution, a Washington think tank. But he added, "Our work is far from done." It was the third time in a week the president had presided over a high-profile event on jobs, responding to rising pleas in Congress that he spend more time discussing unemployment as midterm election season draws near.
Obama proposed new spending for highway and bridge construction, for small business tax cuts and for retrofitting millions of homes to make them more energy-efficient. He said he wanted to extend economic stimulus programs to keep unemployment insurance from expiring for millions of out-of-work Americans and to help laid-off workers keep their health insurance. He proposed an additional $250 apiece in stimulus spending for seniors and veterans and aid to state and local governments to discourage them from laying off teachers, police officers and firefighters. He did not give a price tag for the new package but said he would work with Congress on deciding how to pay for it.
On Capitol Hill, estimates of a potential jobs bill range from $75 billion to $150 billion, said Rep. Steny Hoyer of Maryland, the No. 2 Democrat in the House. "100 billion, 150 billion, 75 billion -- those are all figures that are being talked about," Hoyer told reporters. Those billions would be on top of money for separate legislation for safety-net initiatives such as extending unemployment benefits for the long-term jobless and providing them health insurance subsidies. Some lawmakers put the total cost of the new proposals at $200 billion or more.
White House economic adviser Jared Bernstein said the White House is considering spending $50 billion on infrastructure projects alone such as roads and bridges and water projects. Other figures, he said in an interview with The Associated Press, would be worked out with Congress. Republicans ridiculed the president's speech and his parallel call for doing more to hold down government deficits. "At least the president's proposal will result in one new job -- he'll need to hire a magician to make this new deficit spending appear fiscally responsible," said Sen. Judd Gregg of New Hampshire, the senior Republican on the Senate Budget Committee. House GOP leader John Boehner of Ohio declared the president "out of ideas and out of touch."
While Obama did not propose the kind of direct federal public works jobs that were created in the 1930s, he said government action could set the stage for more job creation by private business. Many of his proposals would extend or expand programs included in the mammoth $787 billion stimulus package passed last winter. While acknowledging increasing concerns in Congress and among the public over the nation's growing debt, Obama said critics present a "false choice" between paying down deficits and investing in job creation and economic growth.
"Even as we have had to spend our way out of this recession in the near term, we have begun to make the hard choices necessary to get our country on a more stable fiscal footing in the long run," he said. To find money to pay for the new programs, the administration is pointing to the Treasury Department's report on Monday that it expects to get back $200 billion in taxpayer-approved bank bailout funds faster than expected. Obama suggested this windfall would help the government spend money on job creation at the same time it eats into the nation's debt, which now totals $12 trillion. He called the bank bailout, under the 2008 Troubled Asset Relief Program, or TARP, "galling." "There has rarely been a less loved -- or more necessary -- emergency program," Obama said.
The program is due to go out of business at the end of this year, although Congress is expected to extend it to next October. The perception that the program mainly bailed out Wall Street bankers while doing little to help ordinary Americans has fed anti-Washington sentiment across the nation. In clear acknowledgment of this sentiment, Obama said the unexpected $200 billion in repaid loans and other savings "gives us a chance to pay down the deficit faster than we thought possible and to shift funds that would have gone to help the banks on Wall Street to help create jobs on Main Street."
But Republicans cried foul, claiming that the leftover and repaid TARP money must be used exclusively for deficit reduction or additional bank bailouts, as the law setting it up spells out, and not for what amounts to an expensive new stimulus program to create jobs. "The stimulus money clearly was a spending bill. TARP was a loan -- a loan to be paid back. And we know that a number of the banks are, in fact, paying it back," said Senate Minority Leader Mitch McConnell, R-Ky. "So I don't think raiding a loan program to launch another spending spree is the best way to create jobs."
David Walker, president of the Peter G. Peterson Foundation, a group that promotes fiscal responsibility, said that just because the government hasn't had to spend all the TARP money on banks "doesn't mean we should automatically spend it on something else." Walker, former head of Congress' Government Accountability Office, said in an interview that clearly defined objectives or conditions were missing from both the $700 billion bank bailout law passed in October 2008 and this year's $787 billion stimulus package. He said, "You can't change history, but you need to learn from past mistakes to make sure that you don't repeat them."
Liberal groups praised Obama's new initiatives. "We think that Obama made a step in the right direction," said Karen Dolan of the Institute for Policy Studies. "He's finally tapping into that moral outrage of the American people at the Wall Street bailouts." A major part of his package includes new incentives for small businesses, which account for two-thirds of the nation's work force. He proposed a new tax cut for small businesses that hire in 2010 and an elimination for one year of the capital gains tax on profits from small-business investments.
Obama also proposed an elimination of fees on loans to small businesses, coupled with federal guarantees of those loans through the end of next year. His proposal for new tax breaks for energy-efficient retrofits in homes is modeled on the now-expired Cash for Clunkers rebates for trading in used vehicles for more fuel-efficient vehicles. Some administration officials have dubbed the proposed new program "Cash for Caulkers." Although the unemployment rate inched down to 10 percent in November from 10.2 percent in October, more of America's largest companies will shrink their staffs than will hire in the next six months, according to a new survey by the Business Roundtable. A Labor Department report on Tuesday showed there were about 6.3 unemployed people, on average, for each job opening in October. Comparable November figures were not yet available.
Memo to Obama: "Less Is More" When It Comes to Stimulus, Ken Rogoff Says
President Obama laid out a framework for more government action to boost hiring Tuesday, featuring tax credits for small businesses, more infrastructure spending and incentives for clean energy initiatives. But Harvard Professor Ken Rogoff says Obama should have skipped the entire exercise, other than the part about extending the social safety net to unemployed Americans. "Less is more," Rogoff said in response to a question about what the administration should be doing. "Should there be additional fiscal stimulus? I don't think so."
In "This Time Is Different", Rogoff and co-author Carmen Reinhart detail the history of financial crises and their aftermaths. Much higher fiscal deficits are a common feature in these episodes; on average, they found government debts rose by 86% in the three years following a banking crisis. Rogoff is similarly concerned about the "legacy of debt" the U.S. is facing in the aftermath of the 2008 credit crisis. "We're going to have a debt problem at the end of this and we need to give our foreign creditors some assurance we'll put the economy on a stable track," the economist says. "I worry what will happen if we don't."
Obama did take pains in Tuesday's speech to cite the "hard choices" the administration is making "to get our country on a more stable fiscal footing in the long run." Whether such comments are enough to assuage concerns about U.S. deficits remains to be seen but long-term Treasuries rallied Tuesday along with the dollar. Ironically, that may be counterproductive to Obama's efforts; a weak dollar is "very, very helpful [and] probably does more than any jobs policy will do," according to Rogoff, who predicts the greenback will resume its "moderate depreciation" in the long run.
Jobs Crisis Fact Sheet, Economic Policy Institute
View in printer-friendly PDF format
(Note that all numbers are current as of December 4, 2009. States numbers are current as of November 20, 2009.)
The jobs crisis
- Number unemployed: 15.4 million (up from 7.5 million in December 2007)
- Portion of unemployed who have been jobless more than six months: 38.3%
- Total jobs lost during the recession: 8.0 million
- Jobs lost in November, 2009: 11,000
- Jobs needed to return to pre-recession unemployment rate: 10.9 million
- Number of jobseekers per job opening: 6.1
- Unemployment rate: 10.0%
- States with double-digit unemployment in October, 2009: 15
- White unemployment: 9.3%; black unemployment: 15.6%; Hispanic unemployment: 12.7%
- Manufacturing jobs lost since the start of the recession: 2.1 million (15.5% of sector’s jobs)
- Construction jobs lost in the recession: 1.6 million (20.8%, nearly one in five construction jobs)
- Mass layoffs (50 or more people by a single employer) in October 2009: 2,127; jobs lost: 217,182
- Underemployment rate: 17.2%; Share of workers un- or underemployed: more than 1 in 6
- Under- and unemployed, marginally attached and involuntary part-time workers: 26.9 million
Hardships and the safety net
- Americans with no health insurance in 2008: 46.3 million
- Drop in children covered through parents’ employers, 2000 to 2007: 3.4 million
- Annual Social Security benefit for average retiree: $13,922; Share of older Americans receiving all their income from Social Security: more than 1 out of 4
- Number of children in poverty in 2008: 14.1 million (over one-third)
- Drop in real median income from 2007 to 2008: 3.6% (largest one-year drop since 1967)
- Growth rate of nominal, hourly wages of production workers over the last three months: 1.7%
- Additional people covered by Medicaid/SCHIP in 2008: 3 million
American Recovery and Reinvestment Act
- Average weekly unemployment benefit in October (including additional $25 per week from the American Recovery and Reinvestment Act): $334
- Number of additional people each week receiving unemployment compensation because of ARRA in October: 3.9 million
- Average monthly cost of COBRA with American Recovery and Reinvestment Act subsidy: $370; Without American Recovery and Reinvestment Act subsidy: $1,057
- Jobs lost since February 2008: 2.7 million ; Jobs likely lost since February 2008 without passage of ARRA: 4.0 to 4.5 million
What's wrong with the November employment numbers
Regular readers of "A Dash" may be surprised to see that I have objections to the most recent payroll employment report results from the Bureau of Labor Statistics. Ironically, my objections come at a time when many critics say it is a "clean" report. In addition, I think that the problem relates to the measurement of job creation.
I hope that I have established some credibility on this subject. The BLS has a method for estimating the monthly job change, including job creation. For several years I have insisted that the right way to keep score was to look at the final results, which we eventually know from state employment data, and test the estimates against those results.
Until recently, the results were excellent.
Something happened. It did not happen at the onset of the recession, as many critics predicted. In fact, the BLS method had worked through the 2001 recession, something that everyone ignored.
Let's repeat my recent review of the BLS method for estimating job creation. If you take a moment to read this carefully, you will see why the critics were wrong before, and are also missing the problem now.
How the BLS Handles Job Creation
The BLS approach is to make an estimate of the total payroll jobs in one month, make another estimate for the next month, and subtract the two to determine the change. They use an excellent and sophisticated survey technique to do this. Their historical record, judged by the eventual count from the states, has been very good -- until quite recently.
The Survey Problem. Any time you do a survey, there will be non-respondents. When the question is something like "How many people favor health care with a public option?" the non-respondent problem takes a simple form. You need only ask whether the non-respondents are similar to those who actually answered. Most polls make this assumption.
The employment question is qualitatively different. We are not asking the opinions of non-respondents. We are asking whether they are even still in business. If the BLS were to assume that non-respondents had all ceased operations, they would seriously underestimate total employment. Historical data conclusively show that the non-respondents are split between those who did not answer and those who are out of business. The data also show that new job creation, running at about 2 million jobs per month even in recessions, are a predictable function of dying businesses.
Let me emphasize the difficulty. There are always non-respondents to the voluntary survey, despite the best efforts to get everyone. If the BLS assumed that the non respondents were all lost jobs, and that the impact was proportional, we would see a loss of 13 million jobs per month, a silly result. Instead they attempt to impute business deaths and births. At one point, they assumed a business birth for every death. This is the natural result from extrapolating the sample to the entire population.
This is not the +/- 100K jobs from sampling error; it is non-sampling error. This means that the non-respondents are different in an important way from those who answer the survey. We know this to be true, so the problem is how to compensate.
The Job Creation Estimation. Because of this, the BLS employs a two-step process. The imputation step forecasts job creation from job destruction, and includes a cyclical component.. The Birth/Death adjustment, (the only thing cited by most critics, who ignore the more important imputation step), is a residual. For many years this residual was stable. The most recent test against the state data indicated a significant error, showing that the BLS estimates have been wrong for nearly a year, especially since Q1 09.
The preliminary benchmark revisions show that as of March, 2009, the number of jobs was over-estimated by 824K jobs. When the official revisions are announced in February, for the January report, there will be three important effects:
- These job losses will be apportioned to the prior eleven months, lowering each by about 75K per month. (The actual adjustment may vary for technical reasons, but this is a good starting point).
- The months after March, 2009, will also be adjusted to conform to a new set of calculations.
- The Birth/Death adjustment, the calculation of the "residual effect" will also be adjusted. We may see dramatic downward adjustments for most of 2009.
Two years ago I asked BLS experts if the Birth/Death adjustment could ever be a negative number. The answer was that while it was theoretically possible, it had never occurred in the recession periods during the development of the model. It is possible that this adjustment will now become neutral or negative, assuming that the BLS maintains the current methodology.
There are several key conclusions.
- The universal focus on the Birth/Death adjustment is a blunder. The critics think that because the B/D adjustment added only 30K jobs (not seasonally adjusted) in November, that the problem does not lie with job creation. The problem lies in the imputation step -- far more important than the B/D adjustment.
- Something important happened at the start of the year - probably the loss of credit available to new businesses. The strong historical relationship used by the BLS finally broke down. Without a good estimate of job creation, the BLS monthly change is suspect.
- Private estimates are important. For many months, preceding the identification of the breakdown in the BLS method, I have emphasized the need to look at other approaches. This should now be clear to everyone.
There was a general sense of surprise at the November results, but no one has a clear concept of what went wrong. TrimTabs has entered an objection, and I agree. The estimates of job change from our model, and the other approaches that I report each month (including TrimTabs), will prove to be better estimates than recent BLS reports.
It will take some months before we see the actual data to prove this, but I intend to follow up with some estimates. Meanwhile, I doubt that employment has improved as much as the current report indicates. It is not consistent with other economic data.
And finally, readers should note that this had nothing to do with BLS bias, manipulating the numbers, or creating "phantom jobs" on demand for President Obama. It is all about methodology, and the inherent limitations on the survey approach. The BLS team devised a good approach and implemented it in consistent fashion. The change in the credit markets - not a normal recession -- seems to have undermined their empirical models.
I am reporting about data. My conclusions are based completely upon where the data leads me. For many years, the BLS method worked extremely well. We should now use a variety of methods to assess job changes.
I have a continuing concern about concurrent seasonal adjustment. More to come....
Meredith Whitney Continues The CNBC Doomsayer Tour
Such a bearish appearance must be the result of the rose-colored glasses affirmative action thing at GE Capital: we have yet to see what the Comcast policy vis-a-vis unbiased content is. Nothing substantially new from Meredith - same focus areas of concern including toxic mortgages on the Fed's balance sheet, non cash flow generating "assets," and consumer, consumer, consumer (apparently she has not read the David Bianco piece either - after all the US consumer now accounts for 100% of Kindle revenues and 0% of US GDP, or so Merrill will soon want you to believe).
Yet with Comrade Sam making sure all is good for ever (the alternative, just like falling housing prices in your average S&P model from 2005, simply did not compute at the most recent 5 year plenary session), is there any reason to worry about anything? After all the debt auction carnival begins afresh again today at 1PM with $40 billion in 3 years. So long as those keep getting gobbled up without a glitch, all shall be well.
The Amazing Spiraling Mortgage Delinquencies
The Mortgage Bankers Assocation is out with its latest look at loan delinquencies across a variety of investor groups.
The one trend: up.
CMBS has now crossed the 4% delinquency rate, though at least there are some signs of a turn, rather than just a pure straight line.
Gold Falls As Dollar Draws Safe-Haven Bid
Gold futures closed lower Tuesday in reaction to strength in the U.S. dollar that was encouraged by soft European economic data and ratings concerns. Much of the selling was described as an unwinding of bullish positions ahead of the approaching year-end. Most-active February gold fell $20.60 to $1,143.40 an ounce on the Comex division of the New York Mercantile Exchange. March silver fell 55.3 cents to $17.807. "The dollar has been rallying pretty much since we opened up this morning, and that's been the story," said Andrew Montano, director of precious metals at Scotia Mocatta.
Investors tend to move into gold as a hedge against dollar weakness, but then sell when the dollar recovers. As the Comex gold pit was closing, the December dollar index was up 0.445 point to 76.255. The greenback, in turn, drew "safe-haven" buying, said Ira Epstein, director of the Ira Epstein division of The Linn Group. Factors that he cited include a downgrade of Greece's debt by ratings agency Fitch, a warning from Moody's Investors Service that the U.K. and U.S. need to rein in their deficits in order to hang onto their triple-A credit ratings, and concerns China may cut back its stimulus program.
Still other events supporting the dollar included a Moody's downgrade of Dubai government- controlled companies and soft industrial production data in Europe. Prior to late last week, the dollar had been on a mostly weaker course, enabling gold to hit a record high on Thursday. "So with some strength in the dollar here, we're starting to weakness in gold," said Craig Ross, vice president of ApexFutures.com. "It's a good reason for guys who had a good year in gold to take some money off of the table before year-end."
Thus, these traders are selling to exit long positions. At last week's peak, February gold was up 38% for the year.Gold was probably due for a pullback after a steady string of record highs in recent weeks, Epstein said. "Gold and the silver got ahead of themselves and are pulling back but not necessarily changing the longer-term picture yet," he said. Support in February gold lies around $1,135, roughly the low around the time when credit problems at Dubai World were reported on Nov. 27, Ross and Epstein said. Ross put nearby support for March silver at the Nov. 27 low of $17.72. Epstein put further support in the area from $17.50 to $17.
Meanwhile, January platinum fell $4.20 to $1,440.40 an ounce, while March palladium managed a 10-cent gain to $375.35. These metals held up better than gold on an apparently improving outlook for the automobile sector, said George Gero, vice president with RBC Capital Markets Global Futures. Platinum and palladium are used in the production of catalytic converters. General Motors Co.'s North American chief said the company plans no further job cuts and aims to stabilize through improved sales and revenue.
Bank of Korea Sees 'Illusion' in Gold, No Cash Return
The Bank of Korea, diversifying foreign-exchange reserves away from a falling dollar, said additional gold holdings aren’t attractive as most other central banks aren’t buying and the metal offers no cash returns. "There’s an illusion in gold," Lee Eung Baek, head of the bank’s reserve-management department, said in an interview. "We follow the big trend. Gold isn’t the trend. Out of more than 200 nations, how many countries have bought bullion?"
Gold surged to a record this month after central banks including India added more of the metal to reserves, while funds and individuals boosted purchases to protect their wealth against the weaker dollar and potential increase in inflation. "Holding gold as part of reserves makes sense in terms of diversification, but I don’t think many central banks want to balloon their holdings with it," said Jerry Yoshikoshi, a senior economist with Sumitomo Mitsui Banking Corp. Gold for immediate delivery, on course for a ninth annual gain, touched an all-time high of $1,226.56 an ounce on Dec. 3, and has gained 31 percent this year as the dollar has dropped 6.7 percent against a basket of six currencies. The metal traded at $1,153.60 an ounce by 12:37 p.m. in London.
South Korea’s reserves -- the world’s sixth-largest after China, Japan, Russia, Taiwan and India -- rose to a record $270.9 billion in November as the central bank intervened in the foreign-exchange market. Central banks intervene by arranging purchases or sales of foreign exchange. "Like other central banks, we have been increasing the types of currencies consisting of the reserves outside the dollar," Lee said yesterday by phone, without identifying the currencies. Gold "offers little value," with "no cash returns," he said.
The Asian nation holds 14.4 metric tons of gold, equivalent to 0.03 percent of total reserves, according to figures from the Bank of Korea. That compares with the average of 10.2 percent held by central banks worldwide, according to data from INTL Commodities DMCC in October. The dollar has weakened this year as the Federal Reserve kept benchmark interest rates near zero percent since December 2008 to revive lending after the worst financial crisis since World War II. Record U.S. government borrowing has also driven investor concern that the currency may be debased. "Since India and Russia with large reserves bought gold, there’s speculation that Korea might buy it too," Lee said. "But we are not classified in the same category. There’s a slim chance that we will buy gold" from the IMF, he said.
Since the end of September, India, Mauritius and Sri Lanka bought more than half of the 403.3 tons of gold that the International Monetary Fund plans to sell to bolster its balance sheet. Bank Rossii, Russia’s central bank, also increased its gold holdings by 2.6 percent in October. Central banks will become net buyers of gold this year for the first time since 1988, according to New York-based researcher CPM Group. Analysts at Societe Generale SA, Barclays Capital and Bank of America Merrill Lynch have forecast more state purchases. "The volatility on gold is too big," Lee said. "And once gold is purchased, it’s just kept in a safe and is not put up for sale even if prices rise."
Many central banks "remember bullion’s ultra-bearish trend in the nineties," Sumitomo Mitsui’s Yoshikoshi said. Gold tumbled as low as $251.95 an ounce during the decade, in August 1999. "The recent rally is, for me, too much in an environment where aggravated inflation is hardly expected in the coming years," he said. South Korea has reduced its holdings of Treasuries to $38.8 billion at the end of September from as high as $72.8 billion in February 2006, according to U.S. Department of Treasury data. This year, its holdings climbed $7.5 billion as the nation’s reserves increased.
Japan GDP revised heavily downward
Official estimates of Japan's growth between July and September were revised down heavily on Wednesday, suggesting the country's recovery is more fragile than previously thought.
Growth on the previous quarter was revised down from 1.2 per cent to 0.3 per cent. At an annualised rate the revision was from 4.8 per cent to 1.3 per cent. The growth revision highlights the risk of a 'double dip' recession - with the economy turning down again by the second quarter of next year - that prompted Japan's government to announce a new Y7,200bn fiscal stimulus yesterday.
A recovery in business investment reported in the first release turned out to be an illusion. The figure was revised down from a 1.6 per cent rise on the previous quarter to a 2.8 per cent fall, accounting for two-thirds of the total revision. The second biggest revision was to private sector inventories, now judged to have contributed 0.1 per cent to quarter-on-quarter growth, rather than 0.4 per cent.
While the revision undermined the idea that businesses have regained confidence and are preparing to expand output, private consumption was a bright spot, with growth revised up from 0.7 per cent to 0.9 per cent quarter on quarter.
Fiscal stimulus - such as incentives to scrap old cars - has been a prime cause of increased consumer spending, and economists have feared it would drop back as stimulus measures expired at the end of the fiscal year next March. News that the economy was even more reliant on stimulus-driven growth in consumption than previously thought supports the government's decision to launch a new fiscal package.
The package includes Y3,500bn in transfers to local governments, Y1,200 billion in support for small businesses, and support for various environmental, employment and housing measures. Of the Y7,200bn, however, Y2,700bn represents funds saved from a previous fiscal stimulus announced by the last government, so there is only Y4,500bn in new money. Capital Economics said that the stimulus "will not transform the prospects for the economy" but that "the measures appear to be well-aimed to get the biggest bang for the yen".
Bankers, Start Your Debt Engines
The bank-funding race is on. The European Central Bank fired the starting gun Thursday on what could prove the critical challenge for banks in 2010: how to reduce reliance on extraordinary central-bank liquidity facilities, government-guarantee programs and meet regulatory demands to boost liquidity. Global banks have $5.1 trillion of debt rated by Moody's Investors Service coming due from 2010 to 2012. With some funding channels still on life support, this race is sure to produce winners and losers.
Thanks to guarantee programs, a precrisis system reliant on cheap short-term wholesale funding has become even more so. In the past five years, the average maturity of new wholesale debt issues from banks globally has fallen to 4.7 years from 7.2 years, the shortest in 30 years, Moody's says. U.S. and U.K. banks are funding at even shorter maturities. Meanwhile, central banks have offered copious cheap funding. The Bank of England provided £185 billionunder its Special Liquidity Scheme. The ECB has pumped in €517 billion ($779.33 billion) of one-year money at just 1%. On Thursday, the ECB signaled the bulk of its facilities will be withdrawn by the end of the summer.
Like subprime mortgage borrowers on teaser rates, banks have become more vulnerable to higher interest rates just as governments also are looking to refinance debt. This creates the potential for crowding out and for higher yields, amplifying the shock of moving off today's extremely cheap funding. In the U.S., banks that have issued government-guaranteed bonds at a cost of 3% or less, including the guarantee fee, already face an increase to 5% to 6% if they wish to issue five-to-10-year debt.
Sure, there are some encouraging signs. Euro-denominated bond issuance by banks not guaranteed by governments, which now stands at 144 billion, finally has overtaken guaranteed issuance in 2009, according to Société Générale. National Australia Bank last week sold a 12-year sterling bond, which would have been a rarity before the financial crisis. And the market for covered bonds, a form of secured funding, may act as a safety valve; at least 20 banks have issued debut deals this year.
But the battleground will be for unsecured bank bonds, particularly since the asset-backedmarket remains virtually shut .Performance after the Dubai shock showed bank bonds may bemore vulnerable to jitters about sovereign credit quality than their nonfinancial peers, in part because they still rely on implicit gurantees. The risk is that investors will discriminate on price and maturity terms, putting pressure on banks' margins, earnings and their ability to lend. A botched exit strategy could lead to volatility, a liquidity trap and the dreaded double dip. That points to policy makers erring on the side of caution. This race will be more a marathon than a sprint.
Moody's Puts U.S., U.K. on Chopping Block
Moody's Investors Service says the U.S. and U.K. must prove they can whittle down their ballooning deficits to avoid threats to their triple-A credit ratings. In a report released on Tuesday, Moody's set the two countries apart from other top-rated sovereign borrowers, calling them merely "resilient" rather than "resistant," a label it applied to Canada, France and Germany, where public finances are in better shape. Moody's released the report as part of an effort, spurred by investor demand, to examine the creditworthiness of the world's most highly rated countries. There are 17 such "triple-A"-rated countries, ranging from the U.S. to Australia.
In both the U.K. and the U.S., Moody's said, much will depend on the vigor of the economic recovery and the willingness of governments to shrink the deficits. Under the most pessimistic scenario put forward by Moody's, the U.S. would lose its top rating in 2013 if economic growth proves anemic, interest rates rise and the government fails to dent the deficit or recover most of its assistance to the financial sector.
Unlike several years ago, "now the question of a potential downgrade of the U.S. is not inconceivable," says Pierre Cailleteau, chief international economist at Moody's. "In a world that has lost its compass a bit, people want to understand what happens to risk-free assets." The report noted that in a situation of moderate growth and deficit reduction—the path Moody's considers most likely—"the trajectory of the debt metrics, while unfavorable in the near term, does not currently threaten the ratings" of countries like the U.S. and the U.K.
In the U.S., a "credible fiscal consolidation strategy" is necessary to prevent the debt load and associated interest costs from tipping into the ratings agency's most pessimistic scenario, the report said. The U.S. has advantages too, Moody's added. Despite registering a sharp increase in the amount of federal government debt outstanding in the year to September, interest payments as a percentage of government revenue actually declined, to 8.4% from 10%. That is a sign of strong investor demand for U.S. Treasury bonds and bills, which has allowed the country to borrow cheaply.
However, Moody expects the interest-to-revenue ratio to climb to 13% by 2012 in its most likely outcome. In its worst-case scenario, the figure could spike to 18%, a level only seen in the 1980s. Buying insurance to protect €10 million ($15 million) worth of U.S. government debt currently costs €32,000 a year, according to data from credit-information firm Markit. That is down from a high of €100,000 in March, but well above the €8,000 it cost in the summer of 2008 before the worst of the financial crisis.
Moody's noted that the major political parties in the U.K. have acknowledged the need to improve the state of public finances. Such discussions "will have to be validated by actions in the not-too-distant future to continue to provide support for the rating," it said. The rating rests less on the quality of public finances at the moment and "more on the ability of the government to repair its balance sheet in the future," said Arnaud Mares, Moody's lead analyst for the U.K. and France. Moody's plans to update the report, called its "Aaa Sovereign Monitor," every quarter.
Fitch strips Greece of A-grade credit rating
Greece saw its credit ratings downgraded on Tuesday because of the poor state of the country’s public finances. Fitch Ratings cut Greece’s credit ratings to BBB plus with a negative outlook, a day after rival ratings agency Standard & Poor’s threatened Athens with a downgrade. It is the first time in 10 years that one of the three leading ratings agencies has lowered Greece below the A grade category. Fitch said: "The downgrade reflects concerns over the medium-term outlook for public finances given the weak credibility of fiscal institutions and the policy framework in Greece, exacerbated by uncertainty over the prospects for a balanced and sustained economic recovery."
George Papaconstantinou, the Greek finance minister, on Tuesday said the downgrade by Fitch didn’t accord "with what has been accepted by the Eurogroup (of finance mministers) and the Eurpean Commission concerning the reduction of the deficit thorugh permanent structural measures". But he added that Greece would do whatever was necessary to narrow the country’s budget gap. "We will do whatever it takes for the reduction of the deficit in the mid-term,"he told reporters.
Fitch had cut Greece to A minus with a negative outlook at the end of October, after the new socialist government revealed deficits were much bigger than previously reported. Greek bonds on Tuesday saw their biggest one-day fall since November last year and the main Athens stock exchange tumbled close to 5 per cent at one point. Yield spreads between Greek and German 10-year bonds, one of the best gauges of stress in the eurozone, were the widest in seven months. The country’s banks were the worst hit amid worries about their exposure to the worsening economy. Piraeus Bank lost 5.6 per cent to €9.24, National Bank of Greece fell 4.8 per cent to €19.26 and EFG Eurobank declined 4.1 per cent to €8.44.
The Fitch downgrade makes Greece the first eurozone country to have its sovereign debt reduced below investment grade A by the credit rating agencies. The dollar rose 0.3 per cent versus the euro in early afternoon trading on Tuesday, following the move by Fitch, to $1.4774. Greece has been under pressure since the the socialist government unveiled its statistical revisions, which showed the public finances in a much worse condition than thought. This resulted in the European Commission changing its projections to show an expected deficit of 12.7 per cent of gross domestic product this year and 12.2 per cent in 2010.
Greek Debt Poses a Danger to Common Currency
As economic indicators have improved, concern about the financial crisis has abated. But the next big problem could be approaching. Greece's public deficit is skyrocketing and the country may become insolvent. The effect on Europe's common currency could be dire. Josef Ackermann, the CEO of Deutsche Bank, has given the all-clear signal many times in the past. He has repeatedly said that the worst was over, only to see the financial crisis strengthen its grip on the world economy.
Last week, however, Ackermann was singing a completely different tune. Although many indicators are once again pointing skyward, he said at a Berlin summit on the economy, Chancellor Angela Merkel, the assembled cabinet ministers, corporate CEOs and union leaders should not to be deluded. He warned emphatically that the financial situation could deteriorate once again. "A few time bombs" are still ticking, Ackermann told his audience, noting that the growing problems of highly leveraged small countries could lead to new tremors. And then, almost casually, Ackermann mentioned the problem child of the European financial world by name: Greece. Ackermann isn't alone in his opinion. Practically unnoticed by the public, an issue has returned to the forefront in recent weeks -- one that was a cause for great concern at the height of the financial crisis but then, as optimism about the economy began to grow, was eventually forgotten: the fear of a national bankruptcy in the euro zone. And the question as to whether such a bankruptcy, should it come about, could destroy the common European currency.
Greece was always at the very top of the list of countries at risk. But now the danger appears to be more acute than ever. The seismographs in the trading rooms at investment banks detected the initial tremors weeks ago. Today, when the code "Greece CDS 10Yr" appears on Bloomberg terminals, a curve at the bottom of the screen points sharply upward. It reflects the price that banks are now charging to insure 10-year Greek government bonds against default. The price of these securities has jumped dramatically since Greek Finance Minister Giorgos Papakonstantinou announced three weeks ago that his country's budget deficit would reach 12.7 percent of gross domestic product this year, instead of the 6 percent originally forecast -- and well about the 3 percent limit foreseen by European Union rules.
A second curve is the mirror image of the first. It depicts the price of government bonds from the euro-zone country. It points sharply downward. Greece already pays almost 2 percent more in interest on its debt than Germany. In other words, at a total debt of €270 billion ($402 billion), Greece will be paying €5 billion more in annual interest than it would if it were Germany. And, with rating agencies threatening to downgrade the country's already dismal credit rating, the situation is only likely to get worse. The finance ministers and central bankers of the euro-zone member states are as alarmed as they are helpless. "The Greek problem," says a senior administration official in Berlin, "will be an acid test for the currency union."
Greece has already accumulated a mountain of debt that will be difficult if not impossible to pay off. The government has borrowed more than 110 percent of the country's economic output over the years, and if investors lose confidence in the bonds, a meltdown could happen as early as next year. That's when the government borrowers in Athens will be required to refinance €25 billion worth of debt -- that is, repay what they owe using funds borrowed from the financial markets. But if no buyers can be found for its securities, Greece will have no choice but to declare insolvency -- just as Mexico, Ecuador, Russia and Argentina have done in past decades. This puts Brussels in a predicament. European Union rules preclude the 27-member bloc from lending money to member states to plug holes in their budgets or bridge deficits.
And even if there were a way to circumvent this prohibition, the consequences could be disastrous. The lack of concern over budget discipline in countries like Spain, Italy and Ireland would spread like wildfire across the entire continent. The message would be clear: Why save, if others will eventually foot the bill? On the other hand, if Brussels left the Greeks to their own devices, the consequences would also be dire. Confidence in the euro would be shattered, and the union would face a crucial test. What good is a common currency, many would ask, if some of the member states pay their debts while others do not? Furthermore, there is a threat of a domino effect. If one euro member falls, speculators will test the stability of other potential bankruptcy candidates. This could destroy the currency union. Because of this systemic risk, say the economists at the Swiss bank UBS, "we believe that if a country is facing a problem with debt repayment or issuance, it will be supported.
A default of a euro-group country doesn't worry the monetary policy hawks at the Bundesbank, Germany's central bank. "So what if Greece stops paying its debts?" one of the executive board members asked at a recent banquet in Frankfurt. "The euro is strong enough to take it." The real threat, he says, is if Brussels comes to the Greeks' aid. "Then the currency union will turn into an inflation union." But it remains to be seen whether politicians can maintain such an unbending approach. The prices for Greek government bonds plunged once in the past, until then German Finance Minister Peer Steinbrück, to the horror of the Bundesbank, publicly pledged to help the Greeks if necessary. There is much to be said for the government taking exactly the same position today.
A national bankruptcy in Greece would have a serious impact on Germany, where many banks have invested heavily in the high-yield Greek treasury bonds -- after borrowing the money to buy the bonds from the European Central Bank (ECB) or other central banks at rates of 1-2 percent. Making money doesn't get much easier -- as long as the Greeks remain solvent. But can a Greek bankruptcy even be prevented anymore? The answer, at least initially, depends heavily on the ECB. Will the custodian of the euro continue to accept Greek bonds as collateral for short-term liquidity assistance, or will it turn down the securities in the future? Another possibility is a compromise, under which the banks would pay additional interest when they submit Greek bonds. The next meeting of the ECB takes place on Dec. 17. "The subject will be on the agenda," say officials in Frankfurt. Time is of the essence.
Central bankers in the euro zone are already speculating, behind closed doors, what would happen if the Greeks started printing euros without ECB approval. There is no answer to the question, and that makes central bankers from Lisbon to Dublin even more nervous than they are already. And more mistrustful. In 2004, it was discovered, completely by accident, that Greece had only managed to qualify for entry into the currency union by massaging its budget figures. The Greeks have only complied with the Maastricht criteria once since the introduction of the euro, in 2006. Even those figures may have been doctored. At the time, the Greeks managed to increase their official gross national product by a hefty 25 percent, partly because they included the black market and prostitution in economic output. This brought down the deficit rate -- on paper, at any rate -- to 2.9 percent.
The figures representing Greece's budget deficit are constantly being revised upward. The most recent uptick, by close to 7 percent, is a record for Europe -- and it comes in a country that was relatively unaffected by the financial crisis. This year, the Greek economy will have shrunk by only 1.2 percent, say Greek economists. Next year they expect the economy to return to grown, albeit modest. Particularly vexing to the remaining EU countries is the fact that Greece has profited from its EU membership for decades. Year after year, net transfers from Brussels have exceeded payments moving in the opposite direction by €3 billion to €6 billion. These numbers, too, have often been suspect. At times, the land area declared for agricultural subsidies was incorrect, and sometimes approval conditions were not met.
Nevertheless, EU politicians find their hands tied. "The game is over," the chairman of the euro group, Jean-Claude Juncker, declared recently, only to turn around and assure the country of his solidarity. "I don't have the slightest suspicion that Greece could go bankrupt -- anyone speculating that this will happen is deluding himself," says Juncker. His resolute words were directed at investment bankers in London, Frankfurt and New York. They know full well that Greece is indeed on the brink of bankruptcy, but they don't know whether the EU will, as Juncker insinuated, come to the aid of member state Greece. Juncker's message, in other words, was that those speculating on a bankruptcy could be left out in the cold.
The EU has now begun a tougher approach to Greece. Three weeks ago, the government in Athens received a rebuke from Brussels, followed by another one last week. So far, however, the Greek government has shown little inclination to take any significant steps. It does intend to reduce the deficit, but only to 9.1 percent next year. This is far too little for many European foreign ministers. As the new Greek finance minister, Giorgos Papakonstantinou, recently announced, the country will need at least four years to get its deficit under control "without jeopardizing the economic recovery." But by then the government deficit will have reached about €400 billion, or about 150 percent of GDP. Servicing that amount of debt, even at current interest rates of about 5 percent, will make up at least one third of government spending. A London investment banker is betting on the continued decline of prices for Greek bonds in the short term, while simultaneously waiting for the right time to start buying the securities again. He jokes: "If someone has €1,000 in debt, he has a problem. If someone has €10 million in debt, his bank has a problem. And the bank, in this case, is Europe."
Max Keiser does Dubai
After Dubai, is China the Next Bubble to Burst?
Confidence in an endless era of Chinese growth is leading to a dangerous sense of complacency in Asia. That loud hissing noise you hear is coming from Dubai, where reality is catching up with an economy built on sand — literally and figuratively. Just don't let it drown out another one that's slowly, but steadily increasing in volume: China. The reference is to an imbalance of global significance: not the bubble in Chinese asset prices, which the world obsessed about in 2009, but the belief that the world's third-largest economy can grow close to 10 percent indefinitely, no matter what. That's feeding a dangerous sense of complacency in Asia.
The focus has been on China's stimulus efforts and low interest rates adding froth to stock and real-estate markets. The real bubble is the expectations China is creating — ones that will be devilishly hard to meet in 2010. China's plan was to tide the economy over until U.S. consumers begin spending again. Yet a stark reality awaits central planners in Beijing: the global demand its all-important export markets need to thrive won't turn up as planned. Here, think more Bill Gross than Nouriel Roubini. Gross, who runs the world's biggest bond fund at Pacific Investment Management Co., has been doing the media rounds warning about the absence of demand from China's trading partners. "It's gearing up for export that doesn't find an end consumer — that's the real problem in China," Gross told Bloomberg Television recently.
The China bubble of which New York University Professor Roubini speaks has more to do with easy money in Beijing, Tokyo and Washington. His worry is about "money chasing commodities" like gold, which is trading above $1,200 per ounce, and, of course, Chinese assets. Gross isn't ignoring this market exuberance. He says China "may abandon its dollar peg within six months' time and with it, its own easy monetary policy that has fostered more significant mini-bubbles of lending and asset appreciation on the Chinese mainland." The bust in Dubai is another sign the global credit crisis is far from over. Anyone who said even one year ago that Dubai's designs on regional economic supremacy were too grand or that it was overleveraged was shouted down as a village idiot. The place was said to be unstoppable. Well, Dubai World's debt troubles put an end to that silliness.
Let that be a wake-up call for China. It too must clamp down on speculation-driven property markets. All too often, officials in Beijing see rising real-estate values as a prerequisite for rapid growth. It's a worrisome mindset. Yet it's the expectations bubble that may prove more damaging. In Hanoi last week, officials I met seemed convinced Chinese growth would save the day. For all the worries about the unvalued yuan hurting Vietnam's exports, there's confidence that strong growth in a $4.3 trillion economy will buoy Asia. Asia's growth is feeding complacency. Take South Korea's Min Euoo Sung, who laments KDB Financial Group Inc.'s failed effort to buy Lehman Brothers Holdings Inc. in September 2008. "We missed a very good opportunity," Chairman Min told Bomi Lim of Bloomberg News on Nov. 16. "I think we could have avoided a situation where Lehman collapsed so rapidly."
Yeah, sure — and taken Korea down with you. Min's comments smack of a hubris Asia can't afford. Korea is doing well today, and can take pride in proving wrong those who said it might become the next Iceland. Some perspective is in order, though. Asia has indeed fared better than the U.S. and Europe. That's no reason to declare victory and move on. The region still needs to rebalance its growth model, deepen financial markets, improve the quality of government and cooperate more. Min's if-only-we'd-grabbed-Lehman musings are highly unwelcome. KDB is state-owned and Min was publicly scolded by lawmakers for even attempting the deal. Lehman's radioactive portfolio would've dented confidence in South Korea at the worst possible time. Free-market folks abhor governments interfering in business. In this case, Korea's leaders served their people well. Asia's confidence reflects its status as the only region still growing solidly. It also avoided the excesses that did in the U.S. financial system — not to mention the global one.
On Friday, a senior Chinese official, Li Wei, condemned Western investment banks for "fraudulent practices" that partly caused more than 11.4 billion yuan ($1.67 billion) of derivatives losses at state-owned companies last year. Expect more such charges from Asia. Just because Asia deserves a pat on the back doesn't mean 2010 will be an easy year. And that speaks to Gross's point. The stimulus efforts rolled out in China and the rest of Asia are keeping growth aloft. The sustainability of that growth is becoming less certain with the other major economies limping along. Friday's news that U.S. employers in November cut the fewest jobs since the recession began, and the unemployment rate fell, offered a ray of hope. It hardly means the kind of robust U.S. recovery Asia needs is afoot. Just as Dubai suddenly finds the ground below its economy shifting, Asia's export-driven economies may lose their footing amid shaky global demand.
Gross, Roubini Weigh Dueling Chinese Bubbles
That loud hissing noise you hear is coming from Dubai, where reality is catching up with an economy built on sand -- literally and figuratively. Just don’t let it drown out another one that’s slowly, but steadily increasing in volume: China. The reference is to an imbalance of global significance: not the bubble in Chinese asset prices, which the world obsessed about in 2009, but the belief that the world’s third-largest economy can grow close to 10 percent indefinitely, no matter what. That’s feeding a dangerous sense of complacency in Asia.
The focus has been on China’s stimulus efforts and low interest rates adding froth to stock and real-estate markets. The real bubble is the expectations China is creating -- ones that will be devilishly hard to meet in 2010. China’s plan was to tide the economy over until U.S. consumers begin spending again. Yet a stark reality awaits central planners in Beijing: the global demand its all-important export markets need to thrive won’t turn up as planned.
Here, think more Bill Gross than Nouriel Roubini. Gross, who runs the world’s biggest bond fund at Pacific Investment Management Co., has been doing the media rounds warning about the absence of demand from China’s trading partners. "It’s gearing up for export that doesn’t find an end consumer -- that’s the real problem in China," Gross told Bloomberg Television recently.
The China bubble of which New York University Professor Roubini speaks has more to do with easy money in Beijing, Tokyo and Washington. His worry is about "money chasing commodities" like gold, which is trading above $1,200 per ounce, and, of course, Chinese assets. Gross isn’t ignoring this market exuberance. He says China "may abandon its dollar peg within six months’ time and with it, its own easy monetary policy that has fostered more significant mini-bubbles of lending and asset appreciation on the Chinese mainland."
The bust in Dubai is another sign the global credit crisis is far from over. Anyone who said even one year ago that Dubai’s designs on regional economic supremacy were too grand or that it was overleveraged was shouted down as a village idiot. The place was said to be unstoppable. Well, Dubai World’s debt troubles put an end to that silliness. Let that be a wake-up call for China. It too must clamp down on speculation-driven property markets. All too often, officials in Beijing see rising real-estate values as a prerequisite for rapid growth. It’s a worrisome mindset.
Yet it’s the expectations bubble that may prove more damaging. In Hanoi last week, officials I met seemed convinced Chinese growth would save the day. For all the worries about the unvalued yuan hurting Vietnam’s exports, there’s confidence that strong growth in a $4.3 trillion economy will buoy Asia. Asia’s growth is feeding complacency. Take South Korea’s Min Euoo Sung, who laments KDB Financial Group Inc.’s failed effort to buy Lehman Brothers Holdings Inc. in September 2008.
"We missed a very good opportunity," Chairman Min told Bomi Lim of Bloomberg News on Nov. 16. "I think we could have avoided a situation where Lehman collapsed so rapidly." Yeah, sure -- and taken Korea down with you. Min’s comments smack of a hubris Asia can’t afford. Korea is doing well today, and can take pride in proving wrong those who said it might become the next Iceland. Some perspective is in order, though. Asia has indeed fared better than the U.S. and Europe. That’s no reason to declare victory and move on. The region still needs to rebalance its growth model, deepen financial markets, improve the quality of government and cooperate more.
Min’s if-only-we’d-grabbed-Lehman musings are highly unwelcome. KDB is state-owned and Min was publicly scolded by lawmakers for even attempting the deal. Lehman’s radioactive portfolio would’ve dented confidence in South Korea at the worst possible time. Free-market folks abhor governments interfering in business. In this case, Korea’s leaders served their people well. Asia’s confidence reflects its status as the only region still growing solidly. It also avoided the excesses that did in the U.S. financial system -- not to mention the global one. On Friday, a senior Chinese official, Li Wei, condemned Western investment banks for "fraudulent practices" that partly caused more than 11.4 billion yuan ($1.67 billion) of derivatives losses at state-owned companies last year. Expect more such charges from Asia.
Just because Asia deserves a pat on the back doesn’t mean 2010 will be an easy year. And that speaks to Gross’s point. The stimulus efforts rolled out in China and the rest of Asia are keeping growth aloft. The sustainability of that growth is becoming less certain with the other major economies limping along. Friday’s news that U.S. employers in November cut the fewest jobs since the recession began, and the unemployment rate fell, offered a ray of hope. It hardly means the kind of robust U.S. recovery Asia needs is afoot. Just as Dubai suddenly finds the ground below its economy shifting, Asia’s export-driven economies may lose their footing amid shaky global demand.
Japan unveils $80 billion of direct spending in $274 billion stimulus package
Japan announced a huge $274bn (£167bn) stimulus on Tuesday to jump-start a fragile recovery in the world's second largest economy, including more than $80bn in direct spending. The pump-priming is meant to boost a gradual return to health from Japan's worst post-war recession, a rebound that started early this year but is now threatened by deflation and the strong yen's impact on exports. "We must present an economic package promptly in order to make the economic recovery solid in the face of the current severe economic and employment situation, the yen's rise and deflation," the government said in a statement. "We will do our utmost to regain [Japan's] vigour."
The cabinet of centre-left Prime Minister Yukio Hatoyama decided the size of the package, to be financed by an extra budget for the fiscal year to March 2010, after disagreements in the ruling coalition delayed it on Friday. The extra budget, this fiscal year's second, will require approval by the Diet legislature which is next scheduled to convene in January. "We made a cabinet decision on the emergency economic measures," chief government spokesman Hirofumi Hirano told reporters Tuesday. "The scale exceeds 24 trillion yen in terms of the value of projects." The new package includes direct spending as well as loan guarantees and other measures that do not necessarily require government outlays, totalling 24.4 trillion yen ($274bn), the government said.
It would extend a reward programme for consumers who buy energy-efficient appliances, give loan guarantees for small and mid-size businesses, and include spending to help struggling companies retain workers. Deputy Prime Minister Naoto Kan said: "I believe we have made an economic package focussed on employment, the environment and economic measures." Japan's economy, after plunging into deep recession last year amid the global downturn, grew 4.8 percent on an annualised basis in the July-September quarter, the fastest rate in two and a half years, preliminary data showed. Unemployment fell to 5.1pc in October from 5.3pc in September. However, falling consumer prices and a surging yen, which hit a 14-year-high of about 84 to the dollar last month, have raised fears the recovery could stall. The dollar traded at around 89 yen in Tokyo Tuesday.
Mr Hatoyama has warned of the threat of a double-dip recession in Japan. The new stimulus package was held up on Friday when the financial services minister, Shizuka Kamei, boycotted a ministerial meeting while demanding additional spending. The package was later boosted by 100 billion yen. The package includes 4.1 trillion yen for environmental measures, such as incentives to buy energy-saving appliances, cars and houses. Economic and financial measures, such as helping smaller companies borrow money, total 18.6 trillion yen. Another 600 billion yen will be spent on measures including paying struggling companies to keep staff on their payrolls.
UK taxpayer backs £167 ($272) billion of overseas bad debt
Treasury reveals taxpayer is insuring more of RBS’s foreign toxic loans than British ones.
British taxpayers stand behind more than £167bn of toxic assets in the US, Ireland, the Middle East and beyond, it has emerged as the Treasury disclosed details of what Royal Bank of Scotland has dumped in the state insurance scheme for bad debts. Most of the £281.9bn of assets RBS has placed under taxpayer protection are based outside the UK, with loans secured against everything from negative equity properties in Dublin to hedge fund assets in Caribbean tax havens and container ships docked in ports around the world.
In a document released quietly on its website on monday, the Treasury revealed the full make-up of the portfolio of assets taxpayers are now supporting through the Government’s Asset Protection Scheme (APS). It includes:
- The overdrafts on 3.2m British bank accounts, and 70,000 UK mortgages at an average loan-to-value ratio of an alarmingly high 95pc.
- A vast portfolio of loans to Irish and Northern Irish businesses and customers, including £2.9bn worth of negative equity mortgages in Dublin and throughout Ireland.
- Some £3.1bn of loans to hedge fund managers, almost half of whom were based in the Cayman Islands and a third in the US.
- Almost £4bn worth of shipping loans secured against oil tankers and container ships.
The details underline the fact that at the peak of the banking crisis, RBS had become the world’s biggest bank in terms of assets, having expanded rapidly during the credit boom, swelling its size even further with its acquisition of ABN Amro. Similarly striking is the fact that in almost all of the asset classes, the majority of the loans now being supported by the taxpayer were made only very recently, some of them in 2008, only months before the bank was semi-nationalised. In total, £167.4bn of assets underwritten by British taxpayers are overseas. Only £114.5bn are in the UK.
Observers estimated that at least a quarter of the insured toxic debts came with RBS’s disastrous acquisition of Dutch bank ABN Amro. In all, the Government’s exposure to RBS’s European assets is £75.4bn, its US ones £43.6bn, and "other" foreign debts £48.4bn. The Treasury stresses in the document that its "central expectation is that overall net losses on the insured pool will not exceed the £60bn first loss [borne by RBS]. The direct cost to the taxpayer from the APS is therefore expected to be nil". Under the agreement, RBS will manage the assets in the scheme but hand control to a "step-in manager" appointed by the Treasury if losses reach £75bn. The bank has also been instructed to ensure "RBS personnel working on the APS are remunerated at an equivalent level to those working on non-APS assets".
The document reveals that the Treasury paid its advisers, including investment bank Credit Suisse, £71m to set up the APS – a sum that has been reimbursed by RBS and Lloyds. Lloyds, which withdrew from the APS earlier this year, has paid £26m and RBS "is paying" £45m. RBS has also agreed to pay the Treasury for the cost of running the Asset Protection Agency (APA), the body established to ensure RBS’s assets are being managed in the taxpayers’ best interests. It is expected to have a staff of 50, led by chief executive Stephan Wilcke, a former senior advisor of Cairn Capital.
U.S. Government's Wimpiness With Wall Street Hits A New High
Perception is reality. So it doesn't matter what really happened when pay czar Kenneth Feinberg agreed to exempt a bunch of AIG executives from pay caps because they whined and threatened to quit over them. This decision just looks like yet another wimpy, lame move from a government whose policies with respect to Wall Street have defined wimpy and lame. Ever since the waning years of the Bush administration, when Washington "service" became just another rung on the Wall Street career ladder, our government has gone out of its way to protect the interests of its once and future employer.
- Idiot bondholders--the folks who provided the money necessary to fund our debt binge--have been rescued to the tune of 100 cents on the dollar
- Massive, incompetent financial firms have been bailed out and nursed along
- Counterparties ready to take a major haircut on CDS contracts have been made completely whole
- Regulators have defended their actions by saying they "lacked the necessary legal authority"--as if the lender of last resort needs legal "authority" (Warren Buffett didn't have any "authority," and he cut himself much better deals than the US taxpayer got).
- And so on...
And now, on the heels of outrage about record Wall Street bonuses in the face of 10% unemployment, Obama's vaunted pay czar, Kenneth Feinberg, has revealed himself to be nothing more than a puppet:WE'RE GOING TO CAP YOUR OUTRAGEOUS PAY!!! WE'RE GOING TO MAKE SURE YOU DON'T USE TAXPAYER BAILOUT MONEY TO PAY YOURSELVES HUGE BONUSES!!!*
* Unless you complain, in which case we'll just forget the whole thing.
Is there another side to the story? Of course there is. Feinberg is in an impossible position. The US taxpayers now own AIG, so destroying it in the name of retribution for past sins would be just shooting ourselves in the foot. And when your firm value depends on your good people staying, you destroy the firm by making them leave. But Feinberg's predicament just reveals the insanity of our whole To Big To Fail bailout policy, for which Bush, Paulson, Geithner, Bernanke, Summers, and Obama are directly responsible.
Too Big To Fail was a bad idea at the time--another short-term emergency fix for a country that has gotten addicted to them--and President Obama wasn't the one who started it. But if he doesn't find a way to appear as though he can stop the madness and stand up to Wall Street, it will be the end of him.
Ex-Fed chief Paul Volcker's 'telling' words on derivatives industry
Paul Volcker, the chairman of President Obama's Economic Recovery Advisory Board, stunned a business conference in Sussex yesterday, saying there is "little evidence innovation in financial markets has had a visible effect on the productivities of the economy". The former US Federal Reserve chairman told an audience that included some of the world's most senior financiers that their industry's "single most important" contribution in the last 25 years has been automatic telling machines, which he said had at least proved "useful".
Echoing FSA chairman Lord Turner's comments that banks are "socially useless", Mr Volcker told delegates who had been discussing how to rebuild the financial system to "wake up". He said credit default swaps and collateralised debt obligations had taken the economy "right to the brink of disaster" and added that the economy had grown at "greater rates of speed" during the 1960s without such products. When one stunned audience member suggested that Mr Volcker did not really mean bond markets and securitisations had contributed "nothing at all", he replied: "You can innovate as much as you like, but do it within a structure that doesn't put the whole economy at risk."
He said he agreed with George Soros, the billionaire investor, who said investment banks must stick to serving clients and "proprietary trading should be pushed out of investment banks and to hedge funds where they belong". Mr Volcker argued that banks did have a vital role to play as holders of deposits and providers of credit. This importance meant it was correct that they should be "regulated on one side and protected on the other". He said riskier financial activities should be limited to hedge funds to whom society could say: "If you fail, fail. I'm not going to help you. Your stock is gone, creditors are at risk, but no one else is affected."
Debt Raters Avoid Overhaul After Crisis
When the financial crisis began, few players on Wall Street looked more ripe for reform than the Big Three credit rating agencies. It wasn’t just that Moody’s Investors Service, Standard & Poor’s and Fitch Ratings, played a crucial role in the epochal housing market collapse, affixing their most laudatory grades to billions of dollars worth of bonds that went bad in the subprime crisis.
It was the near universal agreement that potential conflicts were embedded in the ratings model. For years, banks and other issuers have paid rating agencies to appraise securities — a bit like a restaurant paying a critic to review its food, and only if the verdict is highly favorable. So as Washington rewrites the rules of Wall Street, how is the overhaul of the Big Three coming? It isn’t, finance experts say. "What you see in these bills are Botox shots," says Joseph A. Grundfest, a professor of securities law at Stanford Law School. "For a little while, everyone is going to be frozen into a grin, and then the shots are going to wear off."
What explains the timidity of Congress’ proposals? This is not a case of lobbyists beating back ideas that might hurt their clients, say those close to the discussions. Instead, Congress is worried that bold measures may backfire. The Big Three, by allowing companies and public entities to raise money by issuing debt, are an essential engine in the country’s vast credit factory, and given the still-fragile condition of the equipment, lawmakers are reluctant to try anything but basic repairs, patches and a new alarm system. In addition, legislators say, there is little consensus about what a top-to-bottom renovation should look like.
Under bills that legislators are currently considering, the rating agencies will have to contend with greater oversight, stiffer rules about disclosure and a provision that would make it easier for plaintiffs to sue the firms. But nothing in the laws tackles the critic-for-hire problem or threatens the 85 percent market share that Moody’s, S.& P. and Fitch now enjoy. "It’s fair to say we knew we were taking on a problem with no silver bullet," said Representative Paul Kanjorski of Pennsylvania, the chairman of the Financial Services subcommittee that has led reform efforts in the House. "I’m convinced that we’re getting more control over the rating agencies than ever before but not at all sure we’ve developed the perfect system."
While Congress may be happy with cosmetic surgery, law enforcement officials are getting more aggressive. Dozens of lawsuits have been filed against the rating agencies, including a case filed on Nov. 20 by the Ohio attorney general on behalf of public pension funds. The Ohio suit, as well as the earlier suits, seeks billions of dollars in damages from the rating agencies and accuses the firms of negligence and fraud. When he filed his suit, Ohio’s attorney general, Richard Cordray, said that the "rating agencies’ total disregard for the life’s work of ordinary Ohioans caused the collapse of our housing and credit markets and is at the heart of what’s wrong with Wall Street today."
After the suit was filed, Richard Blumenthal, Connecticut’s attorney general, said he planned to join the suit and thought that a "coalition of states" would also jump on the legal bandwagon — a potentially grim development for the rating agencies, which could find themselves contending with a phalanx of state officials like the one that aimed at big tobacco in the 1990s. The Big Three object that the legislation proposed by Congress could make them more vulnerable to legal action. But they otherwise do not sound particularly exercised about much else that is likely to become law.
"Moody’s shares the committees’ goal of increased transparency for the ratings process," said Michael Adler, a Moody’s spokesman. S.& P. is equally sanguine. "We support globally consistent, nondiscriminatory regulation that will help restore investor confidence and bring more transparency to the capital markets," said Catherine J. Mathis, a spokeswoman for Standard & Poor’s.
Without question, the credit rating system is one of the capitalism’s strangest hybrids: profit-making companies that perform what is essentially a regulatory role. The companies serve the public, which expect them to stamp their imprimatur on safe securities and safe securities alone. But they also serve their shareholders, who profit whenever that imprimatur shows up on a security, safe or not.
To make matters more complicated, rating agencies are deeply entrenched in millions of transactions. Statutes and rules require that mutual fund and money managers of almost every stripe buy only those bonds that have been given high grades by a Nationally Recognized Statistical Rating Organization, as the agencies are officially known. But even if there is no foolproof way to reform the rating agencies, the measures that Congress is now backing are strikingly weak, a number of critics say.
There is no talk, for instance, about creating a fee-financed, independent credit rating agency, one modeled along the lines of the Public Company Accounting Oversight Board, which was established to oversee auditors after the Enron debacle — an idea floated by Christopher J. Dodd, the Senate Banking Committee chairman as recently as August. That approach would attack the conflict of interest problem head on.
Nor is anyone on Capitol Hill suggesting a rewrite of all those rules that put rating agencies in the middle of so much Wall Street action. Instead of cajoling the Big Three into producing more accurate ratings, why not take away the special status of those ratings and make them less important? "There are a lot of complicated issues that nobody knows how to deal with, like water shortages in different parts of the world," says Jonathan Macey, a deputy dean at Yale Law School and a member of a bipartisan task force that has conferred with lawmakers about rating agency reform. "But this isn’t one of them. We could solve this one pretty easily with a modicum of political will. It’s just mortifying."
Meantime, to the consternation of detractors, the companies are now earning fees from a new source: re-Remics, an acronym for resecuritization of real estate mortgage investment conduits. These are transactions that take downgraded mortgage securities and separate the riskiest assets from the strongest, making the strongest easier to sell. The companies do not break out re-Remic revenue in financial reports, but to some, it seems to be a way for rating agencies to profit from a mess they helped make.
Academics and former rating agency employees who have been warning lawmakers about the Big Three for years say Congress is tiptoeing when it ought to be charging ahead. But for now, and for the foreseeable future, the market for ratings is sure to look uncannily similar to the one that helped usher in the crisis: three rivals, all of them paid by issuers, bestriding the market. It is a picture of the future so rosy and so rife with the potential for profits that some investors see a buy sign.
"I’ve had a few hedge funds call and ask me what I think of the rating agencies as investments," said Frank Partnoy, a professor of law and finance at the University of San Diego school of law, who has written extensively on the rating agencies. "If the dysfunctional regulatory structure stays put, the rating agencies soon will be back to business as usual, which will mean a continuing monopoly and sky-high operating margins approaching 50 percent."
In November 2005, the structured finance department of Moody’s held its annual off-site meeting at Chelsea Piers, a sports and entertainment complex in Manhattan. The day, according to several attendees, started as it always did, promptly at 8 a.m. There were hours of presentations, trust-building exercises and near dinnertime, a small concert by three top executives dressed as the Blues Brothers. Their song, an original called "The Compliance Blues," was all about the problems of dealing with Moody’s compliance department, the group in charge of maintaining the company’s ratings standards. A photo of the faux Blues Brothers later showed up in Moody’s in-house magazine.
The performance, according to several former Moody’s employees who requested anonymity because they have signed severance agreements, turned the company’s quality control team into comic fodder. And it came just as the Securities and Exchange Commission was publicly devising the Credit Rating Agency Reform Act of 2006. One of the act’s major new initiatives: bulking up the compliance departments. Mr. Adler, the Moody’s spokesman, says that the Blues Brothers skit "poked fun at the intensity of our own compliance efforts," and was meant to underscore "that while dealing with these compliance obligations could be cumbersome and time-consuming for analysts, it was nonetheless crucial to our business."
Others remember it differently. Scott McCleskey, a former F.B.I. agent and the man Moody’s hired as its "designated compliance officer," in accordance the 2006 act, testified on Capitol Hill last summer that he was marginalized almost from the start and excluded from important meetings at Moody’s, including those with the S.E.C. when it examined the company. He was fired in 2008, having been told little more than that he had lost the confidence of his bosses.
The ease with which Moody’s side-stepped provisions of the 2006 law — which also gave the S.E.C. more authority to inspect the agencies, among other measures — has some critics arguing that Washington is now simply pushing a stronger version of old and ineffective medicine. At minimum, much of what is in the House and Senate bills sounds familiar. Both bills enhance the power of the S.E.C. to supervise the rating agencies and both require the companies to bulk up their compliance teams. The Senate bill allows individuals to sue a rating agency for a "knowing or reckless failure to investigate or to obtain analysis from an independent source."
Mr. Kanjorski and Senator Jack Reed of Rhode Island, who led the Senate’s look at rating agencies, said in interviews that they thought their bills went as far as possible to change the system in a judicious manner. "We all understand the outrage," Mr. Reed said, "but our priority is to prevent this from happening again, rather than looking backwards and punishing." Mr. Reed has listened in recent months to lots of proposals that would have aimed at the issuer-pays system and promoted alternatives. He also looked at the idea of curtailing the importance of ratings by rewriting rules and laws that require mutual fund and money managers to stick to triple-A securities.
But he was concerned about the huge numbers of professional investors out there — like those working for small towns — who don’t have the resources to research every bond they buy. Mr. Kanjorski said he worried about remedies that undermined the Big Three because they were pretty much the whole system right now. "We want to do as much correction as we can," he said, "but we don’t want to kill the institutions because we have nothing to replace them with."
One senior Senate aide, who requested anonymity because the aide was not authorized to speak, said that the bill that would reach President Obama’s desk early next year would merely be a beginning. "Look at what happened in the 1930s," this aide said, "they passed bill after bill after bill. Now, we’re not going to do that, but credit rating agencies are so tied into the way business is conducted, so tied into rules, it’s going to be incredibly complicated to unwind, and we’re not going to fix it all in one bill."
Still, there is worry that if Congress doesn’t think ambitiously now, it never will. Mr. Macey of Yale Law School, who advocates rewriting the rules that now require nationally recognized statistical ratings organizations to bless countless deals, says that the ratings system as it currently stands encourages bubbles. "You have to ask yourself this question, in any matter of financial reform: Does the change increase the chances of lemminglike behavior?" he said. "Because that is the root of all great busts. The price of tulips doesn’t soar because a newspaper says that tulips are undervalued. It soars because everyone is buying them. And that’s the problem with ratings. They turn investors into lemmings."
Even after the disastrous performance of recent years, the Big Three remain deeply entrenched. In September, four companies — Bank of America, Nissan, Discovery and American Express — issued structured finance bonds, worth more than $6 billion, and paid Moody’s to rate them. None of the companies would comment on their transactions with the rating agencies. Business, of course, is down for the rating agencies compared with the boom years. Revenue at Moody’s will this year come in at approximately $1.8 billion, predicted Michael Meltz, an analyst for J.P. Morgan Securities, down about 20 percent from the peak in 2007. Shares that traded in the 70s two years ago now trade in the mid-20s.
"The brands have been hurt in the last five years, that’s a factual statement," Mr. Meltz said. "But when I look at these stocks and see where they’re trading relative to the market, given their earnings generating capacity, I find them attractively valued." Given how entrenched the ratings giants already are, some worry that the current legislative proposals will solidify their positions.
"I think these bills are misguided and wrongheaded because they will have the ironic effect of making the incumbents even more important," said Lawrence J. White, an economics professor at the Stern School of Business at New York University. "They’re going to encrust the procedures already in place and discourage new business models." The paradox is that everyone — even the Big Three — insist that the current system has to change. But somehow, what looked like the low-hanging fruit of financial reform is still dangling, right where it hung at the start of this calamity.
Tarp repayment blow for Citi
US authorities are split over how much capital Citigroup should raise before it repays $20bn bail-out funds - a disagreement that is hampering the bank's efforts to free itself from the government's grip. People close to the situation said the Federal Reserve, Citi's main regulator, and the Federal Deposit Insurance Corporation, another banking watchdog that is insuring $301bn of Citi's toxic assets, had taken a harder line than the US Treasury. The dispute - which follows similar disagreements on the strength of Citi's management team and board - highlights the different priorities of US banking authorities and politicians after the financial crisis.
The Fed and the FDIC, which insures savers' deposits, are concerned about Citi's stability and the effects that further problems would have on the financial system. The Treasury, on the other hand, has been under political pressure to get back the billions of dollars in taxpayers' money it injected into banks during the crisis. Sheila Bair, the FDIC chairman, recently warned that the government should be careful about letting big financial companies pay back bailout funds because such help would not be available in the future, noting that the Fed had so far been measured in its approach.
Citi, which is 34 per cent owned by the government, wants to return the funds from the troubled asset relief programme to extricate itself from the scheme's restrictions on pay and operations. Last week, Bank of America announced it would repay Tarp funds - leaving Citi and Wells Fargo as the only two big lenders still in the programme. The difference in opinion threatens to scupper Citi's plans for a swift exit from Tarp. Insiders believe the bank has about a week to launch an equity offering before its year-end financial process forces it to delay any capital raising until after its results in mid-January.
The Fed and the FDIC have argued that Citi must raise substantial levels of capital before it is allowed to repay Tarp, insiders said. At one point, a regulator told Citi it might have to raise up to $20bn in equity before paying back Tarp - a level that would make it virtually impossible for the bank to leave the programme in the short term. The Treasury, by contrast, is believed to have taken a softer stance and has been more responsive to Citi's arguments that it has ample cash reserves to repay Tarp without raising too much capital. BofA agreed to raise $18.8bn to repay $45bn in Tarp funds - well below the one-to-one ratio being mooted for Citi. Repayments from the banks have given a political boost to the Obama administration, which officials are looking to exploit as they go back to Congress to ask lawmakers to finance new stimulative programmes that target jobs, infrastructure and energy projects.
No Escape From TARP for U.S. Banks Choking on Real Estate Loans
As the U.S. economy pulls out of a recession and the biggest banks return to profitability, mounting defaults on commercial property may keep regional lenders from repaying bailout funds until at least 2011. Unpaid loans on malls, hotels, apartments and home developments stood at a 16-year high of 3.4 percent in the third quarter and may reach 5.3 percent in two years, according to Real Estate Econometrics LLC, a property research firm in New York. That’s a bigger threat to regional banks, which are almost four times more concentrated in commercial property loans than the nation’s biggest lenders, according to data compiled by Bloomberg on bailout recipients.
The concentration makes regulators less likely to let regional lenders like Synovus Financial Corp. and Zions Bancorporation leave the Troubled Asset Relief Program, analysts said. Smaller banks would remain stuck in TARP, while bigger lenders, including Bank of America Corp., repay the government and free themselves to set their own policies on executive pay. "Community and regional banks basically became real estate banks in the past 25 years, and now real estate is on its back," said Jeff Davis, an analyst at FTN Equity Capital Markets Corp. in Nashville, Tennessee. "The largest banks have other areas where they can make money, be it consumer lending, capital markets and asset management."
The stakes for taxpayers include whether they’ll get back $36.6 billion held by 35 of the largest regional lenders that received TARP money. Souring commercial real estate loans pose the biggest threat to the U.S. banking industry, according to October testimony to Congress by Sheila Bair, chairman of the Federal Deposit Insurance Corp., and Comptroller of the Currency John Dugan. Regulators have shut 130 banks this year, all regional or community lenders, costing the FDIC more than $33 billion. Non- performing commercial property loans caused a majority of the failures, said Chip MacDonald, a partner specializing in financial services at law firm Jones Day.
"Somebody that has a lot of CRE exposure is going to be held to a higher standard" to redeem TARP preferred shares, said Paul Miller, a former bank examiner and now an analyst with FBR Capital Markets in Arlington, Virginia. "You’ve got to be careful they don’t allow these guys to pay back TARP, and then a year goes by and have to give it back to them." Commercial real estate loans "absolutely could be a factor" in whether regional banks can repay TARP funds, Bair said in an interview on Dec. 4.
Among 35 of the biggest regional lenders that retain TARP funds, commercial real estate and construction loans average 37 percent of total loans, compared with 9.5 percent at Citigroup Inc. and Wells Fargo & Co., the two biggest U.S. banks that haven’t announced plans to repay the government, according to data compiled by Bloomberg. The figures were derived from holdings at regional lenders that still have bailout money whose stocks are listed in either the 24-company KBW Bank Index or the 50-company KBW Regional Bank Index.
Of the 35 firms, 25 hold commercial real estate and construction loans equal to 30 percent or more of their total loans, according to FDIC data; seven have more than half of their loans in commercial property.
Nine of the banks with more than 30 percent of their loans in commercial real estate won’t show a profit for 2010, including Birmingham, Alabama-based Regions Financial Corp., Columbus, Georgia-based Synovus and Zions in Salt Lake City, according to Bloomberg’s survey of analysts. "To pay back TARP, they need to return to profitability, and for them to return to profitability, credit problems have to start to decline," said Gerard Cassidy, a banking analyst at RBC Capital Markets in Portland, Maine.
Losses may hamper efforts of regional lenders to compete with bigger banks, such as Bank of America, ranked first by assets and deposits. The Charlotte, North Carolina-based lender, aided by profits from brokerage services and underwriting securities at its Merrill Lynch unit, announced last week that it would pay back the $45 billion it took from the government.
If Bank of America and Wells Fargo join JPMorgan Chase & Co. in redeeming TARP preferred shares, they’ll be free to press their advantage in markets they already dominate and to declare dividends and stock repurchases without seeking government approval. Bank of America and Wells Fargo finance about half of all U.S. home loans, and the four biggest banks -- Bank of America, JPMorgan, Citigroup and Wells Fargo -- account for more than a third of all U.S. deposits. Diversified banks are also better able to capitalize on close-to-zero borrowing costs to make money by trading currencies, commodities and other assets. Stocks of regional banks have taken a bigger hit than their larger peers. The KBW Regional Bank Index is down 28 percent this year. Bank of America and JPMorgan have posted gains this year, while Wells Fargo has dropped 9 percent.
There are more than 8,000 banks in the U.S., most of them community and regional lenders. Regional banks typically operate in several communities or states while lacking national or international operations.
Property owners and their bankers are facing losses because the recession cut into employment and consumer spending, pushing up vacancies at office buildings, shopping centers and hotels and bringing down asset values. Commercial real estate prices may drop as much as 55 percent from their October 2007 peak, Moody’s Investors Service said last month. Office vacancy rates may approach 20 percent in 2010, according to brokers at Jones Lang LaSalle Inc. and Grubb & Ellis Co.
Synovus, with $968 million in TARP money and two-thirds of its loans in commercial property and construction loans -- the highest of any TARP-holding bank in the KBW Bank Index -- posted five straight quarterly losses and is projected to lose money for all of 2010. The bank’s failures include a $220 million loan to Sea Island Co., a Georgia real estate development firm, which it renegotiated and declared non-performing in April. Last month, co-lender Wells Fargo took over the deed to Sea Island’s 3,000- acre Frederica community on St. Simons Island that features a course favored by professional golfer Davis Love III.
"We got out of whack in the last four, five years, where we were pushing for growth, trying to keep up with the herd," said Kevin Howard, Synovus’s chief credit officer. "Real estate, in the Southeast, is where you can get the growth. We let our percentages get higher than we normally have. We are fine, really, with moving it back." Zions, Utah’s biggest lender and recipient of $1.4 billion from TARP, has posted four straight quarterly losses, and analysts are predicting the bank won’t return to profitability next year, according to Bloomberg data. Commercial property loans make up 57 percent of Zions’ portfolio, second-highest among banks in the KBW Index that haven’t repaid the government.
Collateral values are "stabilizing," and while losses are expected to "increase somewhat," they will be "extremely manageable" when compared with earnings, bank spokesman James Abbott said in an e-mail. Other regional banks have seen defaults on projects ranging from a condominium-conversion project in Racine, Wisconsin, that was foreclosed on by Milwaukee-based Marshall & Ilsley Corp., the state’s biggest bank, to a subdivision in Oregon inspired by J.R.R. Tolkien’s "The Lord of the Rings."
Umpqua Holdings Corp., the Portland, Oregon-based bank that has 66 percent of its loans tied up in commercial property, sank $3.4 million into the Shire, a development in Bend, Oregon, with homes that have artificial thatched roofs modeled on the hobbit community in Tolkien’s trilogy. The developer defaulted in July, according to Oregon’s Bend Bulletin newspaper. Umpqua CEO Raymond Davis said that while the bank did not experience a "significant loss" on the Shire, its real estate portfolio was "showing signs of weakness." The bank has the highest commercial-property loan ratio of any lender in the regional bank index still holding TARP funds.
Davis said that Umpqua has set aside cash to repay the $214 million in TARP funds that it took from the government last year and is waiting for the economy to show further signs of stabilization before returning the money. The worst may still be ahead for regional banks, according to Moody’s, which calculated that the non-performing loan ratio for commercial mortgages is higher than for residential ones. "The commercial real estate problem is looming, and a bit like the rat going through the snake," said William Bartmann, CEO of Bartmann Enterprises in Tulsa, Oklahoma, and former chairman of Commercial Financial Services, which was among the first companies to purchase assets from regulators during the savings and loan crisis. "We can see that it’s coming, it just hasn’t shown up yet."
Citigroup Repaying TARP Doesn’t Make Us Whole
Talk of lower losses from the Troubled Asset Relief Program, and even profits within some parts of it, are the kind of gains only Washington would crow about. No matter how the numbers turn out, the program is no victory for taxpayers. TARP was a massive taxpayer bailout of banks, not an investment, loan or whatever other spin might be attached to it. The program called for taxpayers to take it on the chin so bankers could muddle through the crisis and, in many cases, sock away bonus checks to make payments on that Ferrari or Hamptons beach house.
At the same time, TARP gave rise to, and nurtured, the too- big-to-fail phenomenon. Bank of America Corp. or even possibly Citigroup Inc. repaying TARP funds won’t make up for that. So there is no reason to cheer as the U.S. Treasury Department prepares to report to Congress, possibly this week, that there were only about $42 billion in losses last fiscal year on $370 billion lent to ailing firms under the program. That’s still taxpayer billions, with a B, going down the drain.
There’s even less to be happy about when Congress and the president immediately try to think of ways to spend money returned by banks repaying TARP, rather than pay down debt. Possible TARP "profits" of about $19 billion, meanwhile, expected from money given to banks such as Bank of America and Citigroup, among others, aren’t any reason for joy. Dividend payments in one part of a portfolio aren’t profits when the program loses money overall.
That’s called counting your winners and ignoring your losers. If you or I tried to spend "profits" based on that premise, we’d end up in jail for passing bad checks. And profits will never be large enough to make up for the fact that TARP pumped up the federal deficit, helped weaken the dollar and set the stage for the kind of extend-and-pretend games -- all designed to mask souring bank loans -- that will damp long-term economic growth. Those costs are being forgotten.
TARP’s even-bigger sin was institutionalizing the too-big- to-fail policy. That’s ultimately why the program can never be considered a success. To understand how that happened, think back to late 2008, when TARP was born. Markets were falling apart following the collapse of Lehman Brothers Holdings Inc. and the bailout of American International Group Inc. With investors fleeing, then-Treasury Secretary Henry Paulson realized he needed to throw a circuit breaker. He came up with TARP as a way to divert investors, who otherwise were stampeding off a cliff.
It worked, momentarily. The problem was that Paulson didn’t have much of a what-next plan, besides asking Congress to give him $700 billion and carte blanche to run the program. Not surprisingly, Congress didn’t go for that. So it got involved, and things didn’t improve. Granted, TARP could have turned out a lot worse. As the name suggests, Paulson initially wanted to use the funds to buy troubled assets from banks, who saw that as a chance to cleanse fetid balance sheets at taxpayers’ expense.
Thankfully for taxpayers, the Treasury Department balked. Paulson eventually opted for direct equity injections into firms, usually in the form of preferred stock. This might have made sense if the funding had been used as a springboard to really clean up and resuscitate the banking sector. It wasn’t. Instead, TARP became a tool to allow banks to get by, a too-big-to-fail IV line that ran from the taxpayers’ purse directly into the arms of firms like Citigroup, Bank of America, JPMorgan Chase & Co., Goldman Sachs Group Inc., Wells Fargo & Co. and Morgan Stanley. Some, like Citigroup and Bank of America, received multiple doses.
That’s not to say the financial sector didn’t desperately need help, or that the government shouldn’t step in during a crisis. It’s just that the help should have been aimed at culling the sick and diseased from the banking herd, while strengthening those likely to survive. In other words, TARP funds should have funded a modern-day iteration of the Resolution Trust Corp., which was put in place to deal with the savings and loan crisis. An institution of that type, while injecting funds into the financial system, would have forced banks to own up to losses rather than engage in a game of kick-the-can.
If administered by the Federal Deposit Insurance Corp., such an approach also would have given Chairman Sheila Bair the financial wherewithal to act more quickly on troubled banks. As things now stand, the depleted FDIC has to string along problem banks so it doesn’t quickly push its insurance fund even deeper into the red. Granted, an RTC-like approach would have involved a lot more pain than we have seen. Swallowing the harsh medicine fast, though, would have put the economy on a sounder long-term footing.
It would also have brought about a needed purge of the banking system, forcing banks and their executives to pay the price of failure. Without it, we now have banks that will drip-feed losses into the system for years to come. And even as that happens, many will still succumb to the inevitable, but at greater cost to the FDIC and taxpayers. Simply put, TARP was really about deferring today’s losses to tomorrow, onto the shoulders of future generations. That’s why the program is a bust, no matter what numbers the government comes up with.
Bailout Refund Is All About Pay, Pay, Pay
by Andrew Ross Sorkin
Strike up the band! Bank of America is paying back $45 billion in taxpayer-provided bailout money, and the government now says it expects to get back $200 billion in those funds faster than it imagined. The banks are getting back on their feet, the markets have stabilized, even unemployment isn’t as bad as many feared. Great news, right?
Sorry for a little rain on this parade, but take a moment to consider why Bank of America was really in such a rush to pay back the money it borrowed from the Troubled Asset Relief Program, or TARP. Sure, its business had improved, somewhat. But there was another reason why the bank locked horns with Sheila C. Bair, chairwoman of the Federal Deposit Insurance Corporation, who was against the plan because she did not think the firm was healthy enough, according to people briefed on the conversations.
Bank of America was simply desperate to get out from under the thumb of government, and rid itself of the scarlet letter tainting its public image. With Bank of America trying to recruit a new chief executive to replace retiring Ken Lewis, the firm needed to repay the bailout money to offer a competitive compensation package. Indeed, people inside the Treasury told me that the No. 1 reason offered by the firm during weeks of back-and-forth — even when it was discussed indirectly — was compensation. Bank of America was so desperate, in fact, that it diluted its own shareholders by selling new shares worth $18.8 billion to replace some of the funds it is returning.
Just read the notes from research analysts the day that Bank of America announced the $45 billion payment. Virtually none of them focused on the idea that there was a sign of strength at the firm; instead they focused, as Morgan Stanley did, on how "it eliminates the competitive disadvantage relative to peers who had already repaid TARP." External candidates may be "more likely to talk" now that the bank is no longer restricted by the pay czar.
That may be all well and good, but what about the health of the bank — and any continuing risks to the system? Wasn’t the purpose of the bailout program to put the financial system on a much steadier foundation? And wasn’t repayment supposed to be based, at least in part, on banks beginning to lend again? Joseph Tibman, author of "The Murder of Lehman Brothers" noted on his blog that at Bank of America, its loans fell from $942 billion to $914 billion from the second to the third quarter. It also lost $1 billion in its third quarter. That’s not to say it isn’t healthier than it used to be — it’s all relative.
The rules for repayment seem to be squishy, and worse, are likely to create a two-tier system. While most of the biggest banks have been able to repay their bailout money — with the notable exceptions of Citigroup and Wells Fargo many community banks, holding bad commercial real estate loans, are still carrying the taint of being obligated to the government. They will likely now press to return the money as quickly as possible too, perhaps too quickly.
"Financial markets demand clarity and certainty," said David Nason, a former Treasury staff member who created the Troubled Asset Relief Program under President George W. Bush, and who is now a managing director at Promontory Financial Group. "Until they have that, there will be a drumbeat of questions as to what TARP repayments mean for the strength of particular institutions and of the banking system in general."
Just seven months ago, Treasury officials would have probably laughed if you told them banks would be rushing to repay. Remember those stress tests that had all of Wall Street stressed out for months about whether they’d pass and what it would all mean? By the way, what do all these repayments say about Treasury’s ability to make reliable forecasts? Just asking. Standard & Poor’s, the ratings agency that didn’t exactly cover itself with glory with its prognostications, recently wrote a remarkably candid research note that suggested the $45 billion repayment didn’t really matter, because if the bank got in trouble again, taxpayers would be there with another bailout.
"We consider BofA to be highly systemically important and therefore continue to believe that BofA would receive extraordinary government support if necessary," it said. But, it added, "we do not believe such support will be needed." Let’s hope S.& P. is right this time around.
If Mark Carney doesn’t want to be Alan Greenspan, the dude knows what to do. That was the word this week from some notables, including the New York-based chief economist for Societe Generale, Stephen Gallagher. The reason, adds C.D.Howe Institute economist and former Bank of Canada advisor David Laidler, is simple – a puffy housing bubble.
Of course, perfect hindsight tells us it was rock-bottom mortgage rates following Nine Eleven that led more or less directly to the American housing love-in. Then Fed boss Alan Greenspan was trying to do what Carney is now – keep recession at bay, goose demand and stoke the fires of inflation. Of course, the US real estate market overheated, spewed lava over the entire world, incinerating trillions of dollars and fried the American middle class.
The dangers of Carneynomics have been pointed out here often. And this blog has presented all the evidence little central bankers should need to know the people are smitten once again. Multiple offers. Condo madness. Surging prices and sales. No-condition offers. Two per cent mortgages. 5/35 euphoria. Vancouver princesses. The works.
Carney is the only central banker on the planet with the stones (or the lack of them) to tell people how long interest rates will stay in the dirt. That has fuelled a buying boom as folks scramble to purchase homes they could never afford otherwise. The fact they’ll probably not afford them in the future seems moot. The bubble grows. So, here’s the news: Economist Gallagher estimates Carney has no choice but to raise rates in 2010. By 1.25%.
What does that mean? Let’s take the average Toronto home now selling at its Carneynomics price of $450,000. With a 5% down payment ($22,500), plus mortgage insurance, the debt would be $437,500. At the current VRM rate of 2.25%, it would take an income of $68,500 to carry the monthly of $1,905. At a VRM of 3.5%, the income needed jumps to $79,200, as the payment rises $300 a month. With a 5-year closed loan now at 5.59%, the income needed to carry the monthly of $2,700 is $97,200, and with a five-year mortgage at 6.84%, the required income rises to $108,765 as the payment increases, also by $300.
That may be worrisome to some buyers on the edge, but not a disaster to most. However, that’s just next year’s increase. You should assume there’ll be another 1% a year added to the prime for the next two or three, which will get us back to a 'normal’ rate of about 8% or so by 2014 – renewal time. At 8%, that same house will need a family income of $122,400 with monthly payments of $3,400. Plus taxes and utilities, of course.
This is the danger of keeping interest rates too low for too long. People who don’t have enough money tend to buy things only because financing costs are so damn cheap. So, somebody snapping the average T.O. home in 2009 with an income of $70,000 or so might find in 2014 he or she needs to be making $120,000. The odds of that happening given what lies ahead – higher rates, higher taxes, government cutbacks, persistent unemployment, the HST – are nil.
But, that’s not the biggest concern. Instead, it’s what relentlessly rising interest rates over the course of a few years will do to the real estate market. Obviously given the above, as rates go up, fewer people can afford to buy homes, eating into demand. This will happen (as I have explained a tiresome number of times) as the Boomers start turning 65 in 2011 and think about cashing in their chips so they can take up bowling and early-bird dinners, as well as buy new electric wheelchairs, oxygen canisters and Rolling Stones downloads. In other words, the demand-supply overload we have experienced will turn into a supply-demand tidal wave.
So, what happens if the real estate market tweaks down a little in 2010? Say, 10%? Well, the average $450,000 Toronto house bought with 5% down ($22,500) would then be worth just $405,000. That’s negative equity, since the mortgage on the place would be $437,500 – or $30,000 more than the property was actually worth. Worse, the poor owner would have also coughed up $12,000 for mortgage insurance plus $10,200 for land transfer tax, meaning at least $46,500 went into the deal. The true loss in that case – with just a 10% market correction – would be well over $75,000, or 17% of the asset value. Isn’t leverage fun?
And if the equityless owner decided not to feed a mortgage (even at its low emergency rate) bigger than the value of the house, and bailed, it gets worse. After real estate commission of 5%, a three-month mortgage penalty, and paying off the principal, the owner would need to cut a cheque for $58,750 to get out on closing day. Add the cash put into the deal, and the loss on this house is $105,300 – or 24% of its value. This is how bubbles hurt average people. And why you’d swear a smart guy from Goldman Sachs would know that.
Hedge Funds Win Instant Profit on Chicago Sewer Debt at Taxpayer Expense
The "fair and reasonable" price financial advisers recommended to the Metropolitan Water Reclamation District of Greater Chicago for the biggest borrowing in its history cost taxpayers $8 million in unnecessary interest and resulted in a bonanza for bankers and investors, according to trading data and to documents initially withheld from the public.
Hedge funds bought almost a quarter of the AAA rated debt. Sellers reaped a profit of as much as 2.5 cents on the dollar by immediately trading their share of the $600 million of Build America Bonds because they realized the authority paid higher rates of interest than similarly rated and much less credit- worthy companies. The Texas Transportation Commission, with a credit grade one level below the Chicago agency, sold almost twice as much of the federally subsidized debt the next week at a lower cost to taxpayers.
The Aug. 11 Chicago sewer bond sale, arranged without competitive bidding like 84 percent of the $354.3 billion of municipal debt issued this year, "was a very lucrative deal for underwriters and investors and a very poor deal for the taxpayers of the district," Daniel Kaplan, president of Kaplan Financial Consulting Inc., said in a letter read at the district’s board meeting Nov. 5. "I am angry about that, and so we should all be," wrote Kaplan, of suburban Wilmette, Illinois, who said he has been a municipal-securities adviser since 1981. "Please don’t let bond sales like this ever happen again."
By choosing underwriters without soliciting bids, unlike how it selects vendors to refurbish valves and supply toilet paper, the 120-year-old Chicago agency showed the risks of shunning competitive debt sales. Issuers in such transactions save 0.17 to 0.48 percentage point over negotiated deals on average, with other factors being equal, according to the Winter 2008 issue of Municipal Finance Journal. The sewer agency’s underwriters, led by Chicago-based Mesirow Financial Inc., and advisers Scott Balice Strategies and A.C. Advisory Inc. were paid $4.9 million to work on the August issue.
"We relied on information from the underwriters as to what they were finding in the marketplace," said Harold Downs, the district’s treasurer for 27 years. "I’m satisfied with what we got." When asked why the agency didn’t seek alternative bids from other underwriters, Downs said, "Mesirow is one that I trust because of what they’ve done for us in the past."
While the agency said it saved money by setting the yield on the taxable Build America Bonds 1.25 percentage points higher than Treasuries, the Austin-based Texas Transportation Commission issued $1.15 billion of the securities on Aug. 19 at a so-called spread of 1.2 percentage points. The highway agency is rated Aa1 by Moody’s Investors Service and AA+ by Standard & Poor’s. Its general-obligation issue is backed by the state of Texas and might have been more appealing to investors than the Chicago bonds, said Jose Hernandez, the Texas commission’s debt management director. The Chicago issue depends on property levies and user charges.
A sewer authority is 90 times less likely to default than a corporate borrower with a similar credit rating. Yet, the Chicago agency wasn’t able to get a yield similar to those obtained for shareholders by Johnson & Johnson or Microsoft Corp., both ranked AAA. Bonds issued by the New Brunswick, New Jersey-based medical-products company traded at 0.39 percentage point less than the water district’s debt at the time of the sale, while the Redmond, Washington-based software maker’s 2039 obligations yielded 5.35 percent, 0.37 percentage point less than the Chicago securities.
The Build America Bond program, part of the $787 billion economic-stimulus approved in February, may be extended past its expiration at the end of 2010, Michael Mundaca, President Barack Obama’s nominee to be assistant secretary for tax policy at the U.S. Treasury Department, said during a Senate Finance Committee hearing on Nov. 4. With the Treasury paying 35 percent of interest costs, Build America securities provide savings compared with the $2.8 trillion tax-exempt municipal market, according to an Oct. 27 report by the Congressional Budget Office and Joint Committee on Taxation.
The sewer authority, with 5.3 million customers, said it saved $188 million in interest expense on the transaction. The bonds yielded 0.31 percentage point more than a Moody’s index of corporate debt with similar ratings. Customers sold more than $73.7 million of the issue, or about 12 percent of the deal, in the first two hours of trading, according to data compiled by Bloomberg. No investors sold bonds in the first day of a $206.5 million issue of Illinois Municipal Electric Agency securities on July 15. In another instance, Cook County’s $120.2 million Build America transaction on June 18, with Mesirow as the financial adviser, first-day sales by customers totaled $7 million, at slightly higher than the issue price.
Bloomberg filed a Freedom of Information Act request, asking the Metropolitan Water Reclamation District for all documents and correspondence related to its Aug. 11 bond issuance. The agency’s initial response didn’t include evidence that financial advisers provided advice counter to the underwriters. Asked again to demonstrate how the advisers gave independent counsel, the district provided an undated summary that in part stated: "The advisory team advocated on the District’s behalf suggesting that the underwriters tighten up the spread to the 120 to 130 basis point range with a target of 125." A basis point equals 0.01 percentage point.
While Downs is a member of the Government Finance Officers Association, he didn’t follow the group’s best-practices recommendations that advisers help select underwriters in negotiated sales and that issuers use software to track investor orders independently of the banks handling the bonds. "I didn’t see the need for it," Downs said. "I’m not going to bring anybody back that gives me the short end of a deal." Downs recommended hiring Chicago-based Mesirow and the financial advisers in July for a still-pending $300 million bond sale before there was an opportunity to evaluate the team’s performance on the $600 million issue in August.
The district also stipulated what the 12 underwriters led by Mesirow would be paid, regardless of how much debt they sold, Downs said. This practice is widespread in the municipal market and reduces bankers’ incentive to find as many buyers as possible, said David Johnson, a former executive at Citigroup Inc. and a senior managing director at Ziegler Cos. The Chicago-based investment firm started as a farm lender in 1902, according to its Web site.
The sewer district’s president, Terrence J. O’Brien, 53, was first elected as a commissioner in 1988 and is now seeking the Democratic nomination for the Cook County Board presidency. His agency didn’t use bids to hire Mesirow because of the "high degree of professional skill required," Downs said in a June letter to the board. The firm served as senior managing underwriter on $1.8 billion of municipal-bond sales in the past five years, according to its Web site. The yield on the Build America Bond sale was enough to attract $1.5 billion of orders, or 2.5 times the debt available, according to bond sale documents.
"Given the time and circumstance, I don’t think they could’ve done better," said James Tyree, Mesirow’s chief executive officer. The post-sale report showed that in addition to the 23 percent of the bonds sold to hedge funds, money managers acquired 35 percent; insurance companies 34 percent; pension funds 7 percent and individual investors 1 percent. Hedge funds aren’t a staple of every Build America Bond deal. Stefanie Devin, Iowa’s deputy treasurer, said her underwriter, Barclays Capital, "didn’t see any hedge fund accounts" listed after reviewing the initial sale of her state’s issue of the debt on July 14.
The authority’s $573 million annual revenue comes primarily from property taxes levied on residents of Chicago and 128 suburbs. Cutting the yield on the Build America Bonds by 0.05 percentage point, to match the spread above Treasuries the Texas Transportation Commission received, would have saved $8 million over their 29-year life, as much as the agency plans to spend to replace electric cables and conduits at a pumping station in suburban Stickney, Illinois.
"You really want all of this stuff to be bid out," said Ralph Martire, executive director of the Center for Tax and Budget Accountability, a public-policy group in Chicago. Instead of "insider deals" with favored bankers "you need to max the benefit to the public, which means lowest cost, especially on something as big as a bond finance deal." Scott Balice and A.C. Advisory pushed Mesirow to lower the yield premium over Treasuries to 1.25 from 1.3 percentage points in the week before the Aug. 11 sale after the district and the advisers reviewed pricing and trading in "several comparative" municipal-bond deals, according to the statement issued by Downs’s office.
Many potential buyers indicated that if the bonds were priced at a spread less than 125 basis points over Treasuries, "the deal might not get done," the agency said in a statement. While other underwriters said "their investors had already withdrawn" when the spread narrowed, according to the authority, the bonds’ price rose during the first day of trading. Yields fell to 1.1 percentage points over government bonds. The financial advisers agreed to work on behalf of the district to ensure the "maturity has been optimally priced," their engagement letters said. The two firms split a $331,000 fee, according to the district’s expense analysis.
The 5.72 percent yield on the 29-year bonds was the "best rate," according to a summary from the district treasurer’s office. After the sale, the authority’s advisers certified in a letter to the board that the figure was "fair and reasonable in light of the current conditions in the market." The agency’s net interest cost, after the federal subsidy, was the lowest since 1973, according to a Sept. 1 memo from Downs to district commissioners. The advisers declined personal, e-mailed and telephoned requests to discuss details of their work on the issue. As the leader of the underwriting group, Mesirow got $1.4 million of the $4.6 million in fees, the expense analysis stated.
Mesirow was the district’s financial adviser for sales in 2007 and its underwriter in 2006. The firm’s performance in earlier debt issues made it "natural for us to go with them," Downs said. Downs said he didn’t know how many investor orders would have disappeared with a narrower spread. To assure officials have this information, the Government Finance Officers Association recommends issuers and advisers "request access to the underwriters’ electronic order entry system in order to observe and evaluate the flow of orders." The sewer agency didn’t do so, Downs said. He said he relied on bankers’ assurances about investor orders because "they would know the best."
FlashForward: What Obama's sellout costs us
"FlashForward," the new ABC television series, is more than science fiction, more even than a Wall Street metaphor. An experiment searching for the "god-particle" in the CERN Large Hadron Collider in Geneva triggers a 137-second global blackout. Every human on Earth loses consciousness, enters a new reality, sees their future, threatening many.
At first, no one knows why. An FBI team is collecting individual flashes, building a collective "mosaic" of the world's future. Individuals fear: Is my destiny fixed? Does free will still exist? Can I change the future?
Now let your imagination run with this scenario: A year ago America had a "137-second blackout," elected President Obama. In our collective flash forward we saw a new world of hope. For many, that future is now unraveling. Destiny changes. Hope fades. Darker forces close in.
What is sabotaging the mosaic, our future? Deep within our collective soul, a relentless mantra haunts us: Why Bernanke, why Bernanke, why Bernanke? The mystery: Why has our man of hopes abandoned us, surrendered to the dark side? Why keep Bernanke? With the Senate spotlight targeting the Fed Czar, imagine the sequel, another "137-second blackout," triggering a new turning point, new mysteries.
What does the new mosaic mean for the future of the world, our nation's tomorrow, for you, your family? You can't trust the FBI. What changed? What's next?
FlashForward. 'Obama's big sellout,' Matt Taibbi in Rolling Stone
All eyes are on the Senate, on Bernanke's confirmation. Myopic senators never saw the mosaic. But Obama's the decider. And Bernanke is his biggest blunder in Taibbi's brutal flash forward: "Barack Obama, a once-in-a-generation political talent whose graceful conquest of America's racial dragons en route to the White House inspired the entire world, has for some reason allowed his presidency to be hijacked .... Instead of reining in Wall Street, Obama has allowed himself to be seduced by it, leaving even his erstwhile campaign adviser, ex-Fed chief Paul Volcker, concerned about a 'moral hazard' creeping over his administration ... Obama has pulled a bait-and-switch on us. If it were any other politician, we wouldn't be surprised. Maybe it's our fault, for thinking he was different."
FlashForward. Black Swan's Taleb stunned: 'Good-bye! The reappointment of Bernanke is too much to bear'
Bernanke's reappointment stunned Black Swan author, Nassim Nicholas Taleb, philosopher, mathematician, hedge trader, behavioral economist: "I cannot believe that we, in the 21st century, can accept living in such a society. I am not blaming Bernanke, he doesn't even know he doesn't understand how things work or that the tools he uses are not empirical," Taleb wrote in Huffington Post.
Rather, "it is the Senators appointing him who are totally irresponsible ... The world has never, never been as fragile," and we're stuck with an economist whose methods make "homeopath and alternative healers look empirical and scientific." Like his flawed god Greenspan, Bernanke is guided by wishful thinking, dogma and ideology. Worse, this raises serious questions of Obama's judgment.
Obama, Bernanke, the Senate: All are crass politicians using bad economics, making bad decisions. Obama's decision left Taleb so distraught he's "withdrawing" from public life "into the Platonic tranquility of my library, to work on my next book, find solace in science and philosophy, and mull the next step. I will also structure trades [betting on] the next mistake by Bernanke, Summers and Geithner."
Yes, a big tip for traders. If you're betting, head for the gaming tables with Soros, Paulson, Einhorn (he's already on record betting on a "currency death spiral.") They'll all make billions betting against Obama.
FlashForward. 'Bernanke's a part of the problem:' Sen. Bernie Sanders
The senator will vote "no" on Bernanke, forcing 60 votes in the Senate: "The middle class of America is collapsing; we have seen incredible greed, recklessness and illegal behavior on Wall Street," Sanders said. Bernanke "missed the boat on the most significant economic crisis since the Great Depression. We need a whole new direction in the Fed and in our economic policies. A direction that stands up for a change, not for the rich, not for the top 1%, not for the giant financial institutions, but for the working class and the middle class of this country. Nobody thinks that Ben Bernanke is that person."
FlashForward. 'Bernanke forgot his role causing the Great Recession'
Bernanke recently wrote "The Right Reform for the Fed," a defensive op-ed piece in the Washington Post, hustling a second term just before his Senate confirmation hearings. TPM's Dean Baker was furious about this brazen huckster: "The arrogance of Bernanke's column is almost beyond belief. This man is incredibly lucky to still have his job at a time when millions of other workers have lost theirs as a direct result of his incompetence."
Apparently "Bernanke's studies did not tell him the obvious, that allowing an $8 trillion housing bubble to grow unchecked would lead to an economic disaster like what we are now experiencing." He "either could not see, or did not care about, this huge bubble" yet "has been running around for much of the last year and a half telling us about his knowledge of the Great Depression." Yes, Bernanke has a mysterious split personality.
FlashForward. 'Greenspan haunts room:' David Wessel, the Wall Street Journal
"In a Senate Banking Committee hearing Thursday that otherwise went almost entirely according to script, a slip of the tongue by Sen. Jim Bunning offered a telling moment. About halfway through a diatribe about the Federal Reserve's inadequacies, the Kentucky Republican said to Fed Chairman Ben Bernanke: 'Now I want to read a quote to you, Mr. Greensp ...' Everyone, including Mr. Bernanke, laughed, as the senator corrected himself: 'Mr. Bernanke. That's a Freudian slip, believe me.'"
Wessel, author of "In Fed We Trust," went deeper: "Bunning's verbal misstep underscored a question that echoed in a cavernous Senate hearing room ... wasn't it your mistakes and those made while you were at Alan Greenspan's side that got us into this mess?" Chairman Christopher Dodd added: "the signs were so blatantly clear. And yet ... the Fed ... failed terribly."
FlashForward. GOP Sen. Jim Bunning: 'You failed as Fed chairman'
A brutal indictment: "You put the printing presses into overdrive to fund the government's spending and hand out cheap money to your masters on Wall Street, which they use to rake in record profits while ordinary Americans and small businesses can't even get loans for their everyday needs. You have decided that just about every large bank, investment bank, insurance company, and even some industrial companies are too big to fail. Rather than making management, shareholders, and debt holders feel the consequences of their risk-taking, you bailed them out. In short, you are the definition of moral hazard. Because you bowed to pressure from the banks and refused to resolve them or force them to clean up their balance sheets and clean out the management, you have created zombie banks that are only enriching their traders and executives. You are repeating the mistakes of Japan in the 1990s on a much larger scale, while sowing the seeds for the next bubble. From monetary policy to regulation, consumer protection, transparency, and independence, your time as Fed Chairman has been a failure."
FlashForward. "The Bernanke record:' Wall Street Journal editorial
Journal editors are clear: Bernanke should not be reappointed. Why? "The real problem is Mr. Bernanke's record before the panic, with its troubling implications for a second four years. When George W. Bush nominated the Princeton economist four years ago, we offered the backhanded compliment that at least he'd have to clean up the mess that the Alan Greenspan Fed had made. That mess turned out to be bigger than even we thought, but we also didn't know then how complicit Mr. Bernanke was in Mr. Greenspan's monetary decisions. Now we do ... the country needs a new Fed chief."
Elsewhere the Journal says Bernanke now admits he needs to "rethink" bubble policies. "Rethink?" This is not a college exam. He failed. We cannot risk giving him a retest. Let Bernanke get more "on-the-job training?" Fail us again? No. America really needs a new Fed chief.
FlashForward 2012. The Great Depression 2: Paul B. Farrell
My flash forward: The Senate confirms Bernanke, afraid to disappoint Obama's big-money Wall Street donors. But that blunder will eventually trigger another, bigger meltdown and the Great Depression 2.
My concerns: In early 2008 before Obama's nomination, I questioned Bernanke's character. He often testified before Congress siding with Wall Street's Trojan Horse, Henry Paulson, the ex-Goldman CEO running the Treasury. Both minimized credit, currency, derivatives and economic problems. Later we learned he was misleading us about how bad things were, how long he knew. My conclusion: Bernanke cannot be trusted, he's either a compulsive liar, or like Greenspan, Bernanke's driven more by blind ideology than facts, research and the public good.
More recently I went deeper, wrote "Dismantle Bernanke's happy conspiracy." At the Fed's annual meeting this summer Bernanke was bragging about how he saved the world from a "Great Depression." He's an egomaniacal dictator already writing his memoirs, like Greenspan, delusional, convinced of his legacy in history.
His character flaws isolate him from reality. He's either in denial or lying about his role for the bubble and meltdown. The man should not be trusted; for him the truth is negotiable, usually whatever's best for the Wall Street banks that will put him on retainer when he leaves. Sen. Bunning was on the money: Bernanke is "the definition of moral hazard." His soul sickness is hazardous to future of America's democracy, to capitalism, and to the global economy.
In my flash forward, confirming Bernanke creates a dark ending for America's collective mosaic. But is this destiny? Or can we still change our future? Maybe, if he withdraws. Otherwise, the Senate's confirmation will go down in history as Obama's Black Swan, as America's Black Swan.
So when the Senate finally does vote, please join me, imagine another 137-second blackout as they rubber-stamp this self-destructive decision.
FlashForward to 2012. Actually it doesn't take much imagination to know in your hearts that Wall Street's myopic mega-millionaires want their Trojan Horse to stay right where they can continue manipulating him, siphoning hundreds of millions and billions from the wallets of America's investors, consumers and taxpayers.
So my friends, be forewarned of the coming Black Swan: Even if you're not betting with Taleb, set your clocks, the countdown-to-meltdown begins, start counting the days till the next bubble pops, when the global economy goes off the cliff, when the credit markets freeze, when the stock market crashes. That's ground zero when chapters in the history books identify the start of the second Great Depression. Tick, tick, tick, Tick, TICK ...
Australian business profits soar in slump while wages at near record lows
In the middle of the worst global slump since the Great Depression, the profits of Australian business soared to record highs in 2008-09 - while wages fell to near-record lows. In the past, profits used to fall in recessions. In the recession of the '70s, the Bureau of Statistics estimates that they fell from 20.5 per cent of national income to 17 per cent. In the '90s recession, they fell from 24 per cent to 22 per cent. But this one has been something different. Corporate profits, which have been on a roll all through this decade, kept rolling serenely on through the recession, climbing from 27.4 per cent of national income to a record 27.7 per cent.
Wages took the brunt of the slowdown, falling from 54.3 per cent of the cake to 54 per cent as unemployment grew by 200,000 and hundreds of thousands of workers took cuts in paid hours to keep their jobs. A decade ago, the share of wages was 56.7 per cent and profits 22.5 per cent, both roughly in line with the long-term average. But since then the shares of wages and small business income have fallen sharply, while the share of the cake going to corporate profits has soared.
Much of the profit growth over the decade has been in finance and mining - both of which suffered little damage in the 2008-09 slowdown. By contrast, the Bureau's national accounts now reveal, manufacturing has been the biggest victim, with its output crashing by 6.4 per cent to a seven-year low. The Bureau estimates that manufacturing has lost 60,000 jobs in the downturn, tens of thousands of its remaining workforce have had to accept shorter hours, and its share of gross domestic product (GDP) has slumped to 9.4 per cent - barely a third of its share 40 years ago.
The Bureau estimates that Australia's output overall grew 1.1 per cent in 2008-09 - but it still can't explain how. Detailed GDP figures show its three data sources sharply disagree with each other. Its spending data suggests GDP grew by 2.2 per cent, but both its income and its production data suggest growth was about 0.5 per cent. There are usually small discrepancies between the three, but discrepancies on this scale are unparalleled.
GDP per head went backwards, falling 0.8 per cent, in its first fall since the 1990-91 recession. National income did much better, rising 3.1 per cent on the back of soaring mineral prices. The Bureau estimates that net exports generated much of the growth in 2008-09 - but then suffered a record plunge in the September quarter, as minerals prices and export volumes fell enough to slice 1.8 percentage points off the quarterly GDP figure to be released next week.
Markets Completely Ignore Brazil's Sudden Iron Export Slow-Down
In case you missed it, Brazilian iron ore exports fell in November, down 15% from the average monthly rate for the preceding three months, according to Goldman Sachs. Yet the commodities markets seem to have shrugged it off... or haven't yet digested its potential implications.
Goldman Sachs: Taken in conjunction with the recent slowdown in vessel bookings from Australia, this could indicate a slow start to 2010 for Chinese imports of iron ore. However, the market is clearly not pricing in a slowdown.
As the table below shows, the current [ore] spot price of $102.50/t CFR implies a 40% rise in Australian contract prices for JFY 2010/11 on a FOB netback basis while the forward price for 2Q10 implies a 34% rise - both well above our base case assumption of +20% for Australian fines.
Thing is, a 2010 Chinese iron ore slow-down would have negative implications for more than just steel prices. It would probably be indicative of a greater slow-down of commodity-consuming Chinese economic activity, such as construction. Thus a slow-down in Brazilian iron ore imports reflects a slow-down in Chinese demand. Given that China is such a massive proportion of commodities demand these days, thus could also be a red flag for generalized commodity-price weakness ahead. One month's data doesn't make a trend, but this Brazilian blip is surely something to stay aware of.
Goldman shows how iron ore prices haven't weakened at all lately:
(Via Goldman Sachs, Iron Ore Price Snapshot, Malcolm Southwood, 7 December 2009)