Mulberry Street, New York City
Ilargi: The bankruptcy filing of the Japanese -formerly national- airline JAL gets surprisingly little press beyond a litany of numbers. This may not be so wise, since the fact that the Japanese government lets the carrier go down is not exactly without meaning. Tokyo sends a message. And while that can vary from a strong message (we won't pay anymore) to a weak one (we can't pay anymore), there can be little doubt that the intended signal is that Japanese industries, even those too big or too beautiful to fail, may find themselves all alone when they get into trouble. And that is not what they've gotten used to over the past 20 years.
The message may, however, not -only- be for the companies. The liabilities that brought down JAL are to a large extent related to pensions. A slew of respective Japanese administrations has managed to keep the ship afloat and the country quiet by making sure that unemployment rates remained 'passable' and pension obligations stayed intact, if only in name. When JAL could not renegotiate its obligations with retirees (present employees had already accepted huge cuts -some reports claim as much as 50%-), Tokyo said simply: domo origato, but we will not make up the difference.
The first impression is that Japan simply can't pay. Or perhaps that can't and won't are closer than you might think. The country is, according to many reports, headed for a cliff. It’s had three finance ministers in a matter of months. The first died, and the cause was never clarified. The second left weeks ago, after mere weeks of service, because of stress and blood pressure issues. Maybe they know what's coming. And maybe all of Japan should too, when they take a good look at what happened with JAL. Which will continue to fly in a business as usual mode, by the way. Just with less or no debt to shareholders, bondholders and pensioners, and with a massive injection of taxpayers' money.
There's something in that picture that looks frighteningly similar to the US. Remember, Japan kept its head above water for 2 decades on borrowing and public funds, and it now has debts piled up sky high everywhere you look. But it achieved all this against a backdrop of a explosion of cheap credit among its customers, which allowed carmakers and electronics giants to exponentially grow their exports, which in turn poured badly needed tax revenues into public coffers.
That is one thing the US will not have going for it. Or the EU. Or anyone else for that matter. Everybody dreams of financing their deficits with more exports. Everybody dreams that hopefully China will be that next market that will pick up the slack left by the usual clientèle. But make no mistake.
America has run into overwhelming trouble for the simple reason that it has become a land of people who consume but don't produce. China, on the other hand, is a land of people who produce but don't consume. Neither is a viable concept in the medium- to long term. If you can't pay, you can't consume, and if you can't sell, it's no use producing. The one positive thing to take away from this for the Chinese is that they have a much less steep fall ahead of them. They remember where they came from.
So do the Greeks, presumably. Like for all nations that were once grand, it's hard to accept you're no longer king, though. Still, the demise of Greece is highly exaggerated. As I said earlier this week, Greece's financial troubles have become the tool the EU needed to bring down the Euro from its overvaluation vs the US dollar. I since found out that I'm not the only voice to address the issue. So does EU economist Paul De Grauwe :
..... Germany, France and other countries have too big a stake in the long-run viability of their new currency to see Greece do what its politicians might feel they have to do to preserve their alliance with the public sector trade unions—drop the euro, and re-establish their national currency, sufficiently devalued to stimulate exports and economic growth. It is unlikely to come to that—there is so much political capital invested in the euro by the political class that even the stern and parsimonious Angela Merkel will in the end contribute to a bailout fund if necessary. With conditions that turn effective control over Greece's fiscal policy to the ECB or some comparable organization in return for help from fellow members.
Meanwhile, Paul De Grauwe, a Brussels-based economist who advises European Commission President José Manuel Barroso, displayed more than a wry sense of humor when he told reporters:
"If there are fears now that a breakup of the euro zone will lead to a weakening of the euro, then that is good news. So we should congratulate Greece for getting us out of … having a euro that is too overvalued."
Works like a charm so far. The Euro got hammered again today.
Still, look at the numbers. Greece has 11 million people, Germany, the most populous EU country, has 82 million. The EU has over 500 million. Greek 2008 nominal GDP was $357 billion. Germany's was $3.65 trillion, the EU as a whole $18.4 trillion, the Eurozone (countries that use the Euro) about $12.5 trillion. The size of the Greek population and GDP is far too small to even entertain the notion of allowing it to break up the union.
Germany, France, Holland wouldn't dream of letting Greece fall. It's not even sure they could if they wanted to. They just don't know. A December 2009 paper by Phoebus Athanassiou at the European Central Bank says this:
This paper examines the issues of secession and expulsion from the European Union (EU) and Economic and Monetary Union (EMU). It concludes that negotiated withdrawal from the EU would not be legally impossible even prior to the ratification of the Lisbon Treaty, and that unilateral withdrawal would undoubtedly be legally controversial; that, while permissible, a recently enacted exit clause is, prima facie, not in harmony with the rationale of the European unification project and is otherwise problematic, mainly from a legal perspective; that a Member State’s exit from EMU, without a parallel withdrawal from the EU, would be legally inconceivable; and that, while perhaps feasible through indirect means, a Member State’s expulsion from the EU or EMU, would be legally next to impossible. This paper concludes with a reminder that while, institutionally, a Member State’s membership of the euro area would not survive the discontinuation of its membership of the EU, the same need not be true of the former Member State’s use of the euro.
In other words, the EU was conceived like a marriage without pre-nups.
It’s turned real quickly into a cat and mouse game. As long as Brussels doesn’t signal it will bail out Greece, in whatever form, the markets will go after Athens. CDS spreads grow like rabbits. The primary result of that is the downward pressure on the Euro, which happens to be just what Brussels wants. Of course it's a dangerous game as well. Still, all the ECB has to do is signal at the right moment that Greece is indeed covered. Brussels, Berlin, Paris play a game with the markets: though they would never let Greece fall, nobody except them is sure that they won’t. That way they do controlled demolition of the Euro.
An indication that Europe might indeed have the smarts to pull this off comes from New York. That Greece game is just as smart as the French banking regulator, the Commission Bancaire, telling the New York Fed in late 2008 that French law prohibit Crédit Agricole and Société Générale from receiving anything less than full face value, 100 cents on the dollar, on their AIG trades. Société Générale got more US taxpayer AIG bail-out funds than any other bank, including the American ones.
Now that is pretty clever from the French, But even way smarter is that they did it while a few blocks down the road US monoline Ambac was settling its AIG paper for 28 cents on the dollar. With the exact same banks. That is so well played by the French it makes you want to applaud.
Of course the New York Fed boss at the time was Tim Geithner. And this must really be the last straw for him. But then we’ve likely entered a new phase anyway for the Obama government, one in which heads will roll and bodies thrown overboard to satisfy the hungry pack of wolves that’s chasing the sledge. For all we know, by revealing this tidbit, Ben Bernanke threw out Geithner before they could get to him (he has a hearing scheduled on Friday). And also for all we know, Geithner may have been well aware of what was going on, and seen a great opening to get his Wall Street friends a great deal.
It's all water under the bridge now. Pretty soon, Obama can't afford to be seen with Tim in public anymore.
Ilargi: Gracious Montréal songstress Kate McGarrigle died Monday, January 18, of cancer.
The First 364 Days 23 Hours
AIG 100-Cents Fed Deal Driven by France Belied by French Banks
The Federal Reserve Bank of New York paid French banks 100 cents on the dollar to settle trades with American International Group Inc. in November 2008, the same month an AIG competitor negotiated payments of less than a third of that to retire similar bets. The decision to pay in full came after France’s bank regulator insisted that Societe Generale SA and Credit Agricole SA’s Calyon unit would be violating French law if they accepted less than they were owed, the New York Fed told a special inspector general. The Fed, which had rescued the insurer two months earlier after the collapse of Lehman Brothers Holdings Inc., paid face value to all 16 of AIG’s counterparties, including Goldman Sachs Group Inc., a move that may have cost U.S. taxpayers as much as $43.5 billion.
French law didn’t stop Societe Generale and BNP Paribas SA from taking $1 billion to settle $3.5 billion of trades the same month with New York-based bond insurer Ambac Financial Group Inc., according to three people familiar with the matter. Ambac’s ability to negotiate a discount while the central bank of the world’s biggest economy didn’t adds another question for lawmakers as they examine the most contentious transaction of the government’s bailout of the U.S. banking system.
"The Fed could have tried a little harder to get the French banks to take less than 100 cents on the dollar," said U.S. Representative Brad Miller, a North Carolina Democrat on the House Financial Services Committee, in an interview. "This creates the impression among the American people that the purpose was not to protect taxpayers or the economy but to protect the counterparty financial institutions."
Treasury Secretary Timothy F. Geithner, president of the New York Fed during the biggest financial crisis since the Great Depression, will answer questions about the AIG payouts on Jan. 27 from the House Committee on Oversight and Government Reform. The committee’s invitation came after Bloomberg reported that e- mail exchanges between the New York Fed and AIG show that the regulator asked the insurer to withhold details of the payments.
A statement posted by the New York Fed on its Web site yesterday said that "it is not in fact precisely accurate that counterparties received 100 percent" payments. The regulator also said in the statement that "the counterparties received essentially par value," or the full amount owed. The banks were paid $61.9 billion for securities with face value of $62.1 billion, or 99.7 percent, according to the Web site. Reimbursing the banks was "absolutely" the right decision, Geithner said in an interview with CNBC on Jan. 14. "We did it in a way that I believe was not just least cost to the taxpayer, best deal for the taxpayer, but helped avoid much, much more damage than would have happened without that."
Geithner recused himself from AIG matters when he was designated for the Treasury post on Nov. 24, 2008, Meg Reilly, a Treasury spokeswoman, said in an e-mail. That was the same day an AIG lawyer told the New York Fed that the insurer’s executives wanted to publicly disclose details about retiring the swaps. The negotiations between the Fed and the banks over the AIG payouts took place on Nov. 6 and Nov. 7. The New York Fed used the French regulator’s opinion to help justify paying the full $62.1 billion that AIG could potentially owe counterparties on credit-default swaps it had sold, according to a Nov. 17, 2009, report by the special inspector general of the Treasury Department’s Troubled Asset Relief Program.
"We believe that it would not have been appropriate to use our supervisory authority on behalf of AIG to obtain concessions from domestic counterparties in purely commercial transactions in which some of the foreign counterparties would not grant, or were legally barred from granting, concessions," Scott G. Alvarez, general counsel of the Fed Board of Governors, and Thomas C. Baxter Jr., the New York Fed’s general counsel, wrote in a letter included in an appendix to the special inspector general’s report. Federal Reserve Chairman Ben S. Bernanke said yesterday in a letter to the Government Accountability Office that he would welcome a GAO review of the transactions. Lawmakers subpoenaed all documents related to the AIG payouts last week.
Bernanke, who said he wasn’t "directly involved" in the negotiations, said it would not have been appropriate for the Fed to use its power as a regulator to force U.S. banks to make concessions, especially because that would have "provided an advantage to foreign counterparties over domestic counterparties." "We believe the Federal Reserve acted appropriately in conducting the negotiations, and that the negotiating strategy, including the decision to treat all counterparties equally, was not flawed or unreasonably limited," Bernanke wrote Dec. 15 to Kentucky Republican Senator Jim Bunning.
AIG tried to persuade its counterparties to accept payments of 60 cents on the dollar before the New York Fed took over negotiations, according to people familiar with the matter. The chairman of the House Committee on Oversight, Democrat Edolphus Towns of New York, and the committee’s top Republican, Darrell E. Issa of California, have both called the full repayments a "backdoor bailout" of financial institutions. Geithner told TARP’s inspector general that the financial condition of the counterparties was not a relevant factor in the decision to pay full value, according to the report.
Paris-based Societe Generale, France’s second-biggest bank by market value, received $16.5 billion from AIG, the most of any counterparty. It was followed by Goldman Sachs, with $14 billion, Frankfurt-based Deutsche Bank AG, with $8.5 billion, and Merrill Lynch & Co., now part of Charlotte, North Carolina- based Bank of America Corp., with $6.2 billion. Calyon received $4.3 billion. Spokeswomen Stephanie Carson-Parker of Societe Generale, Christelle Maldague of BNP Paribas and Anne Robert of Calyon declined to comment. So did AIG spokesman Mark Herr, Ambac spokesman Peter Poillon and Corinne Dromer, a spokeswoman for French regulator Commission Bancaire.
The French law that the Commission Bancaire may have cited is called "abus de biens sociaux," or misuse of company assets, said David Chijner, a partner with Fried, Frank, Harris, Shriver & Jacobson LLP in Paris who specializes in corporate restructuring and mergers. The law prohibits company executives from making decisions they know to be contrary to the interests of the company. Violators can be jailed for up to five years and fined as much as 375,000 euros ($545,000). "It could be considered an ‘abus de biens sociaux’ in extreme circumstances," Chijner said.
James D. Cox, a professor of corporate and securities law at Duke University School of Law in Durham, North Carolina, said it is "preposterous" that reaching a settlement for less than 100 cents "could be a criminal act in a developed Western country in the depths of a financial crisis." "Even if you concede the point, it was not a crime for Goldman Sachs to take less than 100 percent," Cox said. "Treating all the banks the same is a bunch of hooey."
New York Fed spokeswoman Deborah Kilroe declined to comment. William C. Dudley, who took over as president of the New York Fed after Geithner became Treasury secretary, told PBS last week that the Fed didn’t want to choose who would be hurt by an AIG bankruptcy. "When we made the decision to intervene to prevent the bankruptcy, we were protecting everybody," Dudley said. UBS AG, Switzerland’s largest bank by revenue, told the New York Fed that it would accept a 2 percent discount if other banks would, according to the special inspector general’s report. Kelly Smith, a spokeswoman for UBS in New York, declined to comment.
At a Jan. 13 hearing of the Financial Crisis Inquiry Commission, formed by Congress to report on the causes of the credit crisis and the recession that followed, Goldman Sachs Chief Executive Officer Lloyd C. Blankfein said New York Fed negotiators asked a Goldman employee if the investment bank would accept less than face value for AIG debts. The employee replied that it was a decision he couldn’t make at his level, Blankfein said. The Goldman employee wasn’t contacted again, Blankfein said, and neither was he. "It didn’t come up in any conversation that I can recall," Blankfein said. The French banks had a duty to "maximize recovery" of their investments, Chijner said. That may have meant accepting a discount, also known as a haircut, from Ambac and no less than face value from AIG, whose largest investor was the U.S. government.
"If Ambac had nobody’s backing and was in a near insolvency situation, then indeed the prudent French director would have a duty to try to maximize recovery," Chijner said. Even with government support, AIG had a greater chance of going under than Ambac did, according to credit-default swap pricing at the time. On Sept. 21, 2008, five days after the U.S. loaned AIG $85 billion and agreed to take a 79.9 percent stake in the insurer, then-Treasury Secretary Henry M. Paulson told the NBC-TV interview program "Meet the Press" that the action would "allow the government to liquidate this company." AIG had an implied 87 percent chance of missing debt payments on Nov. 7, 2008, the day the New York Fed negotiated the repayments, according to CMA DataVision, a London-based information provider. The chance of an Ambac default that day was an implied 77 percent.
Credit-default swaps pay the buyer of the insurance face value of a security if a borrower fails to make a payment. In exchange, the buyer hands over the security or the cash equivalent. AIG’s insurance contracts differed from Ambac’s because they required AIG to send collateral to counterparties when certain events, called triggers, occurred, said Jim Millstein, the Treasury Department’s chief restructuring officer. The agreements required the insurer to post collateral when the assets it guaranteed, such as home loans, declined in value or when AIG’s credit rating was downgraded, Millstein said. Ambac guaranteed assets without triggers, so no payments were required until the assets matured, he said.
"It was just AIG’s pure arrogance that led them to do this," Millstein said. "But they did it, and that was what the federal government inherited." Buying the assets underlying the credit-default swaps at face value and ripping up the guarantees to AIG’s counterparties stopped calls for collateral and staunched the bleeding from AIG’s balance sheet, Millstein said. It also may have prevented a run on AIG’s insurance business, he said. Maiden Lane III, an off-balance-sheet entity created by the Fed, purchased $27.1 billion of underlying securities from AIG’s counterparties, according to the inspector general’s report. That money, combined with $35 billion in collateral funded in part by the government’s original bailout, equaled the $62.1 billion value of the assets, the report said.
AIG and Ambac wrote insurance on mortgage-linked securities, and losses piled up when U.S. borrowers began to miss monthly payments at a faster pace at the beginning of 2007. Delinquencies of all home loans have doubled since then, to 9.6 percent of all homeowners in the third quarter of 2009 from 4.8 percent in the first quarter of 2007, according to the Washington-based Mortgage Bankers Association. Neither Ambac nor AIG has ever filed for bankruptcy. Neither Societe Generale nor BNP Paribas has been prosecuted for accepting a discounted payment from Ambac.
Bernanke Seeks 'Full Review' by Government Accountability Office of Fed’s AIG Aid
Federal Reserve Chairman Ben S. Bernanke invited congressional auditors to conduct a "full review" of the central bank’s aid to American International Group Inc. after lawmakers accused the Fed of trying to conceal information about the bailout. "The Federal Reserve would welcome a full review by GAO of all aspects of our involvement in the extension of credit to AIG," Bernanke said today in a letter to Gene Dodaro, acting head of the Government Accountability Office, that was released by the Fed.
Bernanke’s letter coincides with efforts by lawmakers to obtain more details on the Fed’s oversight of AIG after e-mails released this month showed that the New York Fed asked the company to withhold information from the public about payments to banks. The House Committee on Oversight and Government Reform last week subpoenaed all documents related to the New York Fed decision to fully reimburse banks that bought protection from AIG and efforts to persuade AIG to keep information about the payments from the public.
The New York Fed said today it delivered 250,000 pages of documents to the House panel. The materials show that the New York Fed’s actions "assisted AIG in ensuring the accuracy of its disclosures and protected important U.S. taxpayer interests," the bank said. The New York Fed reiterated that its former president and now-Treasury Secretary Timothy F. Geithner had no role or knowledge of the disclosure matters. Treasury Secretary Geithner, who was head of the New York Fed when AIG was rescued in 2008, agreed to testify Jan. 27 before the House oversight panel on the bailout. Geithner said last week on CNBC that he wasn’t involved in the decision to limit disclosures.
Chuck Young, a spokesman for the GAO in Washington, said the Fed’s request "will have to be reviewed in the context of our future work priorities, given our existing statutory requirements related to federal efforts to stabilize the financial system, as well as requests from congressional committees." Bernanke, 56, who may face a Senate confirmation vote this week for a second four-year term, said in today’s letter that a GAO audit would "afford the public the most complete possible understanding of our decisions and actions in this matter," and "provide a comprehensive response to questions that have been raised by members of Congress." Bernanke said the Fed will make all necessary records and personnel available to the GAO, which gained authority to audit the AIG rescue in a law that went into force in May.
"It’s just Bernanke’s way of saying, ‘Look, we did the things that were correct and we aren’t hiding anything, and if you’d like to audit us, that’s fine with me,’" said Douglas Lee, who runs Economics from Washington, a consulting firm in Potomac, Maryland, and is a former congressional economist. The bailout, which began with an $85 billion Fed loan in exchange for a stake of almost 80 percent in the New York-based insurer, was revised three times to prop up AIG. The rescue now includes a $60 billion Fed credit line, an investment of as much as $69.8 billion from the Treasury and up to $52.5 billion to buy mortgage-linked assets owned or backed by the insurer.
The assistance included "significant conditions and protections for the taxpayers," Bernanke wrote in the letter. "The Federal Reserve and Treasury Department required new management of AIG; we obtained for the U.S. Government a significant stock interest in AIG that materially diluted existing shareholders of AIG; and we required AIG to immediately begin to wind down its systemically risky operations." Representative Darrell Issa of California, the ranking Republican on the House oversight panel, and other lawmakers have called federal aid a "backdoor bailout" because of payments to Goldman Sachs Group Inc. and other banks.
In a Bloomberg Television interview today, Issa said Bernanke "seems unapologetic and unrepentant when it comes to the fact that he spent $62 billion of your tax dollars when $15 billion would have probably bought the paper on the street," referring to the payouts. "He doesn’t want light shed by Congress. He only wants the GAO."
Taxing Wall Street Down to Size
by David Stockman
While supply-side catechism insists that lower taxes are a growth tonic, the theory also argues that if you want less of something, tax it more. The economy desperately needs less of our bloated, unproductive and increasingly parasitic banking system. In this respect, the White House appears to have gone over to the supply side with its proposed tax on big banks, as it scores populist points against the banksters, too.
Not surprisingly, the bankers are already whining, even though the tax would amount to a financial pinprick — a levy of only 0.15 percent on the debts (other than deposits) of the big financial conglomerates. Their objections are evidence that the administration is on the right track. Make no mistake. The banking system has become an agent of destruction for the gross domestic product and of impoverishment for the middle class.
To be sure, it was lured into these unsavory missions by a truly insane monetary policy under which, most recently, the Federal Reserve purchased $1.5 trillion of longer-dated Treasury bonds and housing agency securities in less than a year. It was an unprecedented exercise in market-rigging with printing-press money, and it gave a sharp boost to the price of bonds and other securities held by banks, permitting them to book huge revenues from trading and bookkeeping gains.
Meanwhile, by fixing short-term interest rates at near zero, the Fed planted its heavy boot squarely in the face of depositors, as it shrank the banks’ cost of production — their interest expense on depositor funds — to the vanishing point. The resulting ultrasteep yield curve for banks is heralded, by a certain breed of Wall Street tout, as a financial miracle cure. Soon, it is claimed, a prodigious upwelling of profitability will repair bank balance sheets and bury toxic waste from the last bubble’s collapse. But will it?
In supplying the banks with free deposit money (effectively, zero-interest loans), the savers of America are taking a $250 billion annual haircut in lost interest income. And the banks, after reaping this ill-deserved windfall, are pleased to pronounce themselves solvent, ignoring the bad loans still on their books. This kind of Robin Hood redistribution in reverse is not sustainable. It requires permanently flooding world markets with cheap dollars — a recipe for the next bubble and financial crisis.
Moreover, rescuing the banks yet again, this time with a steeply sloped yield curve (that is, cheap short-term money and more expensive long-term rates), is not even a proper monetary policy action. It is a vast and capricious reallocation of national income, which would be hooted down in the halls of Congress, were it properly brought to a vote.
National economic policy has come to this absurd pass because for decades the Fed has juiced the banking system with excessive reserves. With this monetary fuel, the banks manufactured, aggressively at first and then recklessly, a tide of new loans and deposits. When Wall Street’s "heart attack" struck in September 2008, bank liabilities had reached 100 percent of gross domestic product — double the ratio of a few decades earlier. This was a measurement of the perilous extent to which bad investments, financed by debt, had come to distort the warp and woof of the economy.
Behind the worthless loans stands a vast assemblage of redundant housing units, shopping malls, office buildings, warehouses, tanning salons and fast food restaurants. These superfluous fixed assets had, over the past decade, given rise to a hothouse economy of jobs that have now vanished. Obviously, the legions of brokers, developers, appraisers, contractors, tradesmen and decorators who created the bad investments are long gone. But now the waitresses, yoga instructors, gardeners, repairmen, sales clerks, inventory managers, office workers and lift-truck drivers once thought needed to work at these places are disappearing into the unemployment statistics, as well.
The baleful reality is that the big banks, the freakish offspring of the Fed’s easy money, are dangerous institutions, deeply embedded in a bull market culture of entitlement and greed. This is why the Obama tax is welcome: its underlying policy message is that big banking must get smaller because it does too little that is useful, productive or efficient. To argue, as some conservatives surely will, that a policy-directed shrinking of big banking is an inappropriate interference in the marketplace is to miss a crucial point: the big Wall Street banks are wards of the state, not private enterprises. During recent quarters, for instance, the preponderant share of Goldman Sachs’ revenues came from trading in bonds, currencies and commodities.
But these profits were not evidence of Mr. Market doing God’s work, greasing the wheels of commerce and trade by facilitating productive financial transactions. In fact, they represented the fruits of hyperactive gambling in the Fed’s monetary casino — a place where the inside players obtain their chips at no cost from the Fed-controlled money markets, and are warned well in advance, by obscure wording changes in the Fed’s policy statements, about any pending shift in the gambling odds.
To be sure, the most direct way to cure the banking system’s ills would be to return to a rational monetary policy based on sensible interest rates, an end to frantic monetization of federal debt and a stable exchange value for the dollar. But Ben Bernanke, the Fed chairman, and his posse are not likely to go there, believing as they do that central banking is about micromanaging aggregate demand — asset bubbles and a flagging dollar be damned. Still, there can be no doubt that taxing big bank liabilities will cause there to be less of them. And that’s a start.
David Stockman, a director of the Office of Management and Budget under President Ronald Reagan, is working on a book about the financial crisis.
"We're a Mess": What the Backlash Over Bonuses and AIG's Bailout Says About America
With big banks revealing massive 2009 bonuses, Fed chairman Ben Bernanke now supporting a "full review" of AIG's bailout, and Treasury Secretary Tim Geithner due to testify on the same, this is shaping up to be a watershed month in the bailout backlash department. "This whole situation is a mess for Bernanke, it's a mess for the banks ultimately and I'm not sure how we get out of it because the public wants blood," says Christopher Whalen, managing director at Institutional Risk Analytics, and a longtime and critic of both Bernanke and Geithner.
Whether either regulator loses his job over this remains to be seen but Whalen says politicians are slowing awakening to the public's outrage, with election setbacks proving a big wake-up call to the Democrats. "They're sniffing the wind and realizing they weren't gauging the electorate correctly, maybe they weren't in harmony with what the voters were thinking on these issues, even though nobody [in Congress] understands AIG," he says.
If AIG is the most galling symbol of the government's inept response to the financial crisis, Goldman Sachs is viewed as the most cunning beneficiary. Later this week, Goldman is expected to report robust fourth-quarter results and a bonus pool approaching $20 billion. (On Tuesday, Reuters reported Goldman delayed telling its U.K. employees details about their bonuses, amid reports the Financial Services Authority (Britain's SEC) has raised concerns about the plans.)
"Despite the money, despite the supposed political savvy of Goldman, they still don't know how to manage their public image," Whalen says. A former Congressional staffer, Whalen laments the politicizing of these events because the theatrics mask the bigger issue: "We can't control ourselves in terms of the fiscal functions of our government," he says. "We're a mess. We can't even have a process in place that is transparent and easy for people to understand. That's why we have a problem - this was all done in the dead of night."
A bank levy will not stop the doomsday cycle
by Peter Boone and Simon Johnson
The last few weeks of political developments around the American-European financial system make us feel like we are back in the USSR. During the final years of communism’s decline, Soviet bureaucrats argued for futile tweaks to laws that would crack down on speculators and close "loopholes" – all in the vain hope they could keep the unproductive system of incentives intact. The US, UK and key European countries are now making the same errors. Rather than recognising the dangerous systemic failures in our financial system, their leaders are proposing bandages that can – at best – only postpone another, possibly much larger, meltdown.
There is growing recognition that our financial system is running a doomsday cycle. Whenever it fails, we rely on lax money and fiscal policies to bail it out. This response teaches the financial sector a simple lesson: take large gambles to get paid handsomely, and don’t worry about the costs – they will be paid by taxpayers (through fiscal bail-outs), savers (through interest rates cut to zero), and many workers (through lost jobs). Our financial system is thus resurrected to gamble again – and to fail again. Such cycles have been manifest at least since the 1970s and they are getting larger. This danger has even been recognised at the Bank of England, where Andrew Haldane, responsible for financial stability, recently published an eloquent critique of what he calls our "doom loop".
Not surprisingly, Ben Bernanke, chairman of the Federal Reserve, does not agree that blame rests squarely with our monetary authorities. In a speech in Atlanta, he (incredibly) argued that extremely low interest rates on his watch – and decades of similar bail-outs of the financial sector – did not play a role in the recent collapse. Like an old-time Soviet bureaucrat, he put the blame on bad regulators and argued that more complex rules are needed to make regulation "better and smarter".
When the Soviet Union fell apart, there were two competing views on what needed to be done: total change or tinkering. The establishment wanted tinkering – it felt much less threatening. This elite believed that if they could just get the rules right, the system would work well. But they completely missed the larger point – egregious loopholes in the rules were inherent to the system failing. In the Soviet Union then and in the US today, powerful lobbies profit from avoiding the rules, and a complex regulatory system actually serves them well as top lawyers and accountants seek out new flaws, or ensure they are represented in reform discussions. It is no surprise that Basel bank capital rules are discredited – the proposed Basel revision, with complex additional liquidity and risk-measuring systems, will fail just as surely.
This week, the US Treasury pulled its latest rabbit out of the hat: a tax on the liabilities of large banks. The Obama administration argues that, by penalising large institutions with such taxes, we can limit their future risk-taking. This logic is deeply flawed. Why would higher funding costs mean you gamble less? If you know Tim Geithner is waiting to bail you out, you may gamble more heavily in order to pay the tax. The UK "reforms" look equally unpromising. In this regard, America’s top bankers appear much more honest, and focused on clear goals, than our policymakers. In his testimony to the Financial Crisis Inquiry Commission last week, Jamie Dimon, head of JPMorgan Chase, argued that regulatory failure was a major reason for our latest financial collapse. He did not try to argue that we could make it work – he just made the obvious point that, if there is potential failure to exploit, banks will naturally press any advantage to make profits.
For our top bankers, the fact that the system will only change marginally is fine. Phil Angelides, chair of the Commission, nailed Lloyd Blankfein, head of Goldman Sachs, with a metaphor for the age: Wall Street is in effect selling cars with faulty brakes, and then taking out insurance on the buyers. Blankfein naturally retorted: "I do not think the behaviour is improper." Here we go again. To end the doomsday cycle and prevent even greater damage to the real economy, we need dramatic reforms.
First, we must sharply raise capital requirements at leveraged institutions, so shareholders rather than regulators play the leading role in making sure their money is used sensibly. This means tripling capital requirements so banks hold at least 20-25 per cent of assets in core capital.
Second, we need to end the political need to bail out every institution that fails. This can be helped by putting strict limits on the size of institutions, and forcing our largest banks, including the likes of Goldman Sachs and Barclays, to become much smaller. When the Soviet Union disintegrated, it took tough leaders and clear thinkers, such as Boris Yeltsin and Yegor Gaidar, to pick up the pieces and push for reform. It would have been easier and less messy if genuine reform had started before the collapse.
In the past few months it has become clear the US and UK don’t have sufficiently strong political leaders. There are good tough people around: Paul Volcker stands out in the US, as so does Thomas Hoenig, head of the Kansas City Fed, and Mr Angelides. In the UK, Lord Turner, Mr Haldane, and even Mervyn King are showing at least intellectual inclination towards more serious reform. Let’s bring more such clear thinking into top policy circles now, rather than wait for another collapse.
A "Bloodbath" By Any Other Name: More Pain Ahead for (Big) Banks, Whalen Says
A big week of bank earnings accelerates midweek with results expected from Morgan Stanley, Bank of America, US Bancorp and Wells Fargo on Wednesday, followed by Goldman Sachs, American Express and Capital One Financial on Thursday. So what should investors expect? More revenue disappointments, such as those already posted by JP Morgan and Citigroup, according to Chris Whalen of Institutional Risk Analytics.
"Right now the total egg - credit -- is shrinking [by 5-7% per year]," Whalen says. "The bank side is not a source of growth. Can you pull it out on the capital market side? Maybe, but I'm not sure where that comes from" given many of the big banks have loaded up on low-risk securities in the aftermath of 2008's bloodbath.
Speaking of "bloodbaths", I asked Whalen if he's sticking by the gruesome forecast he made here back in October. The answer is "yes", albeit with some caveats. "Loss rates for the industry will be very high," Whalen says, forecasting record charge-off rates, higher loan loss reserves and a lot of "minus signs" for banks' bottom lines. Still, the Fed's program of buying toxic securities means "everyone gets a pass on mark-to-market," with the biggest banks getting a disproportionate benefit, he says.
10 reasons Obama is failing 95 million investors
by Paul B. Farrell
An open letter to President Obama: You are failing us. Many now question voting for you.
A year ago, millions of Americans -- investors, taxpayers, consumers, voters -- came together uplifted by the "audacity of hope," inspired by a vision of "change we can believe in," by "bold and specific ideas about how to fix our ailing economy and strengthen the middle class, make health care affordable for all, achieve energy independence, and keep America safe in a dangerous world." "Yes, we can" was the rallying cheer. You were the game-changer after the Bush-Cheney fiasco. What happened? Today we just don't see, or expect to see, any real change we can believe in. America is more polarized than under Bush's GOP, dysfunctional as both parties tragically undermine our great nation.
There are many reasons future historians may rate your presidency average, or even a failure, at least based on the gap between the promise a year ago and the reality today, certainly for investors. But we also know that the future, seen through a broader historical lens, will reveal a natural cycle with you cast in the predictable final scene of a Shakespearean-style plot driven by fate, the same dramatic destiny of all great nations and civilizations. We know a dark conspiracy made up of Wall Street, corporate chief executives and the Forbes 400 controls Washington, limiting and manipulating you. So we know it's not all your fault -- for you are playing your role well in America's epic historical drama.
As Shakespeare put it: "All the world's a stage, and all the men and women merely players. They have their exits and their entrances." As this past year unfolded it became painfully obvious you are indeed playing a role in a historic drama, along with other leaders in a staged, life-cycle, endgame conspiracy that includes Presidents Reagan, Clinton and Bush, Fed Chairmen Greenspan and Bernanke, and Wall Street's bosses --Paulson and your fat-cat banker buddies. The final scene of this Shakespearean drama is playing out this very moment, with 10 improvisational plot points driving your character's role.
1. Failing to grasp John Adams' warning: All democracies commit suicide
"Remember, democracy never lasts long. It soon wastes, exhausts, and murders itself. There never was a democracy yet that did not commit suicide." John Adams, a great American president, made that famous prediction at the beginning of our great nation. And yet, paradoxically, when a democracy commits suicide, it also kills off the very capitalism that made it powerful, the economic system Adam Smith identified the same year our Declaration of Independence was signed. Today we are neither independent nor free; King George has been replaced by a far more powerful moneyed conspiracy that you sold out to last year.
2. Failing to sense the psychological impact of being an aging democracy
Our time is up, says Scottish historian Alexander Tytler, recently quoted by economist Marc Faber: "The average life span of the world's greatest civilizations has been 200 years." Then "once a society becomes successful it becomes arrogant, righteous, overconfident, corrupt, and decadent ... overspends ... costly wars ... wealth inequity and social tensions increase; and society enters a secular decline." We're on suicide watch, acting out the final scenes President Adams predicted for democracy, as Wall Street murders capitalism.
3. Failing to demand sacrifices, instead adding to Bush's massive war debt
Back in 2003, coincidental with the "greatest foreign policy blunder in American history," the Iraq war, Kevin Phillips, a political historian, published "Wealth and Democracy." Phillips warned: "Most great nations, at the peak of their economic power, become arrogant and wage great world wars at great cost, wasting vast resources, taking on huge debt, and ultimately burning themselves out." Three trillion wasted, says economist Joseph Stiglitz. And now, Mr. President, you're playing your role, along with Bush, Paulson, Bernanke and Congress, piling on an unsustainable $23.7 trillion in what is the greatest domestic blunder in American history.
4. Failing to lead with 'once-in-a-lifetime' systemic financial reforms
Former Fed vice-chair Alan Blinder recently wrote in The Journal: "When economists first heard Gekko's now-famous dictum, 'Greed is good,' they thought it a crude expression of Adam Smith's 'Invisible Hand' -- which is one of history's great ideas. But in Smith's vision, greed is socially beneficial only when properly harnessed and channeled," with incentives for risk-taking, honest competition, regulatory safeguards, and regulators who will actually enforce the rules. But "when these conditions fail to hold, greed is not good." Blinder fears "that a once-in-a-lifetime opportunity to build a sturdier and safer financial system is slipping away." No consumer protection, no mortgage clawbacks, no derivatives regulations, nothing. You are setting the stage for another, bigger meltdown, the "Great Depression 2," the last tragic act in this drama, dead ahead.
5. Failing to pick a cast of characters that could have changed history
Recently, John Kay of the Financial Times said: "Our banks are beyond the control of mere mortals." But it's not just banks: Our American government and economy is "beyond the control of mere mortals." Each president picks his own actors to play out this grand epic historical drama: 21 cabinet officers and 6,722 other senior bureaucrats.
Last year many voted for you fearing McCain might pick Phil Gramm as Treasury secretary. Unfortunately, Mr. President, your picks not only revived Reaganomics under the guise of Keynesian economics, you sidelined a real change-agent, Paul Volcker, and picked Paulson-clones like Geithner and Summers. But worse of all, you're reappointing Bernanke, a Greenspan clone, as Fed chairman, an economist who, as Taleb put it, "doesn't even know he doesn't understand how things work." And with that pick, you proved you also don't understand how things work. And yet forever true to the script, your decision fits perfectly in the final act captured by your predecessor, President Adams.
6. Failing to stand up to our 100 senatorial assassins and 261,000 lobbyists
Instead of leadership, you let Congress run the show, a strategy that may work in community organizing but in Washington reminds us of the old adage that "the inmates are running the prison." We now know why Adams used words like "murder" and "suicide" as the endgame in a democracy. Suicide was a theme in a third of Shakespeare's dramas: Romeo and Juliet, Brutus, Cassius, Othello, Lady Macbeth, Ophelia, Antony and Cleopatra. But Julius Caesar is the best comparison: Senators were Caesar's assassins -- a loyal friend even drew first blood. Today, any one of 100 self-interested senators can legally threaten to "assassinate" the entire nation. And you seem unwilling to stand up to their totally dysfunctional kamikaze mission.
7. Failing to act presidential, while fat-cat bankers hijack your presidency
Economist Peter Morici writes in the Baltimore Sun: "On banks, Obama talks tough, does little." Matt Taibbi is far more caustic in "Obama's Big Sellout," Mr. President: "A once-in-a-generation political talent" has "allowed his presidency to be hijacked. Instead of reining in Wall Street, Obama has allowed himself to be seduced by it ... pulled a bait-and-switch on us." And yet while it's so blatant and obvious, Wall Street gets away with it because your presidency has merged into a fat-cat bankers' conspiracy.
8. Failing to protect 95 million investors, letting Wall Street loot America
Wall Street bankers are stealing trillions: In "Not So Radical Reform," BusinessWeek says the "top five U.S. commercial banks ... were on track" earning at the rate of $70 billion "in 2009 trading unregulated derivative contracts." The Journal connects the dots: The same banks "allocated about $90 billion for overall compensation," with average bonuses of $500,000, ten times the income of most Americans. Yes, Wall Street looted that money from taxpayers as you turned a blind eye, Mr. President. One Journal commentator says "the government should make it clear that it will allow these institutions to fail." Except no one believes you have the guts or the will to do that, Mr. President. You are a Wall Street banker's dream. But you have failed America's 95 million investors and the consequences will be disastrous in the near future.
9. Failing to avoid the 'hubris virus' disease killing America's leaders
Before you took office Mr. President (and while Paulson was looting the American Treasury to save his old firm), Portfolio warned: For "every high flier who is chastened, another would-be mogul pops up elsewhere, convinced he's smart enough to game the system ... When things are very good, people take ridiculous risks, and then things come crashing down and the risk just moves somewhere else ... We don't know where it's going next, but someone will be making money somewhere." Why? Because "like a lethal virus, it seems, hubris never really disappears, it simply finds a new host." Yes, that deadly virus, that insatiable greed, mutates fast among Wall Street's fat-cat bankers.
10. Failing to see the ticking time-bomb scenario, the next big meltdown
"Bring Back Glass-Steagall," demands Journal columnist Thomas Frank, author of "The Wrecking Crew, How Republicans Rule." We hear the same message from Volcker, Stiglitz, McCain and others. But it'll merely delay the inevitable. The end-game is "never different," whether penned by Shakespeare, Adams, Tytler or Reinhart and Rogoff. As Frank says of the Financial Crisis Review Commission: Wall Street bankers will "skate away yet again by deflecting blame or mouthing pro forma mea culpas ... a sign that this inquiry, like so many other promises of reform since 9/15, is likely to leave Wall Street's status quo largely intact. That's the ticking-bomb scenario that truly imperils us all."
All the actors, cabinet officers, Fed chairmen, regulators, lobbyists are playing set roles in a well-known theater, waiting for their "entrance and exit" cues, "merely players" in a larger predestined historical drama re-written so many times, in the same repetitive plot. Like Shakespeare, economists Reinhart and Rogoff made clear in "This Time Is Different: Eight Centuries of Financial Folly," we are performing yet another revival of a 800-year-old history of self-destructive bull/bear, boom/bust cycles, with each ending in the same old Shakespearean-style final tragic act. For fact, you could break off Goldman's derivatives trading division from their commercial banking operations and I guarantee you their mega-bonus traders will find new ways to run Wall Street's gambling casino as fast as they were able to convert TARP billions into record bonuses in one year.
Epilogue: Midterms? Re-election? New GOP president 2012? All irrelevant!
The endgame script won't change. GOP-controlled House? 59 Dem senators? Romney? Palin as president? None of this matters, Mr. President. We're all "merely actors" in an epic drama well-known to Adams as well as Shakespeare. But don't get us wrong, we still do admire you. We know you'll honor your Nobel legacy, like Carter and Gore, after you leave office. But meanwhile, you are playing your role well in this tragic final act. Indeed, all of America's "merely actors" are right on cue with their "entrances and exits." Yes, even our 95 million investors are playing their designated roles too. In fact, it really doesn't matter much whether anyone goes to the voting booth, ever again, because the final scene has already been written ... by your predecessor, John Adams.
Greece CDS Hits Fresh Record; Funding Crisis Now Official
by Tyler Durden
The economic situation in Greece is getting worse by the day. Despite PM Papandreou's promises to the contrary, it is probably safe to say that the country is now in a full blown funding crisis; this is reflected in the country's fresh new record in its default risk as seen by credit traders.
At 346 bps, it is just a matter of time before all hedges cover positions and this number explodes. Now it is the Eurozone's turn to promise it will not expel Greece from the monetary union: we think the likelihood of this action is increasing proportional to the number of times this possibility is refuted.
The Greek tragedy deserves a global audience
by Martin Wolf
The Greek government has promised to slash its fiscal deficit from an estimated 12.7 per cent of gross domestic product last year to 3 per cent in 2012. Is it plausible that this will happen? Not very. But Greece is merely the canary in the fiscal coal mine. Other eurozone members are also under pressure to slash fiscal deficits. What might such pressure do to vulnerable members, to the eurozone and to the world economy? Having falsified its figures for years, violating the trust of its partners, Greece is in the doghouse. Yet, even if it bears much of the blame, the task it is undertaking is huge. In particular, unlike most countries with massive fiscal deficits – the UK, for example – Greece cannot offset the impact of fiscal tightening by loosening monetary policy or depreciating its currency.
Greece is a member of a currency union that has the tightest monetary policy of any large economy (see chart), as Paul de Grauwe of Leuven university pointed out in the FT this week. According to the Organisation for Economic Co-operation and Development, eurozone real final domestic demand will stagnate in 2010. Germany’s is forecast to grow by 0.2 per cent. The euro has also strengthened by more in real terms since its launch in 1999 than any other leading currency. To add insult to injury, Greece and the other peripheral countries have lost competitiveness within the zone. On one measure, Greek unit labour costs rose by 23 per cent against Germany’s between early 2000 and the second quarter of 2009. This is in line with the experience of other peripheral members (see charts).
Finally, even if fiscal tightening were to lower spreads on Greek bonds over German bunds – a measure of Greece’s default risk – the benefit for the public finances and the economy would not be large. True, early this week, the Greek spread over bunds was as big as 2.74 percentage points. But spreads have only been wide for two years. The impact of lower public sector interest rates on rates paid by the private sector is also likely to be quite small. Given these tight constraints, a big structural fiscal tightening will generate a deep recession. That is sure to increase the cyclical deficit. Assume, cautiously, that for every percentage point of structural tightening there would be 0.2 points of offsetting fiscal deterioration. Then the structural tightening needed to reduce the actual deficit to 3 per cent of GDP would be close to 12 percentage points. The Greek government would find that, for every step it takes forward, it would slip a bit backwards. So far Greece has not suffered a significant recession. That seems sure to change. The government will soon be facing miserable public and private sectors, with no policy levers.
The problems of Greece are extreme, because it alone of the vulnerable eurozone member countries has both high fiscal deficits and high debt. Other countries with large fiscal deficits are Ireland (12.2 per cent of GDP in 2009) and Spain (9.6 per cent). But, while net public borrowing was 86 per cent of GDP at the end of 2009 in Greece, according to the OECD, in Ireland and Spain it was only 25 and 33 per cent, respectively. Meanwhile, Italy, with a net debt ratio of 97 per cent, had a deficit of "only" 5.5 per cent. Portugal is in the middle, with net debt of 56 per cent of GDP and a deficit of 6.7 per cent of GDP. Thus, the challenge for Greece is larger and more urgent than for the others. In an article in the FT last week, Desmond Lachman of the American Enterprise Institute concluded that Greece will be forced to leave the eurozone. Simon Tilford of the Centre for European Reform in London argued on these pages that it must be bailed out, instead. There are two other possibilities: Greece toughs it out; or Greece just defaults.
Which is most likely? I do not know. But default cannot be a solution. Greece would then be forced to close its deficit in the midst of a national economic debacle. Leaving the eurozone would be a political catastrophe. Either of these eventualities (let alone both together) would also create lethal contagion for vulnerable members. Suddenly, the unthinkable would be thinkable. The eurozone could then confront a wave of sovereign debt and financial sector crises that would make what happened in 2009 look like a party. At the same time, a bail-out by the eurozone as a whole would create a monstrous moral hazard for politicians. It would only be possible if the eurozone subsequently exercised a degree of direct control over the fiscal decisions of member states. It would, in short, be the fastest route to the political union that many initially believed was a necessary condition for success.
Given the horrendous difficulty of all alternatives, I am sure the effort will be made to tough it out for as long as possible. That will also be the case elsewhere. All will be forced to accept lengthy recessions. But in the absence of either strong demand elsewhere in the eurozone or a weaker exchange rate, both of which depend on decisions by the European Central Bank, the competitive disinflation route to prosperity seems highly likely to fail. Some countries may find themselves stuck in long-term stagnation. Meanwhile, the eurozone as a whole, having lost its erstwhile internal demand engines, must now hope for faster growth of net exports. So do countries hit by the financial shock, such as the UK and US. So, too, does recession-hit Japan. So, not least, does China. Either the rest of the world has a spending binge, or these countries – which make up 70 per cent of the world economy – are going to be disappointed.
Some, knowing of my opposition to UK membership of the eurozone, may suppose that I find some pleasure in these looming difficulties. On the contrary, I fear the dangerous consequences. But these are certainly the sorts of difficulties that have worried me. Most of the time having an independent currency is nothing but a nuisance. But every so often and quite unpredictably, countries desperately need a safety valve. As Prof de Grauwe reminds us, the 1930s were a time when such relief was needed. Our own era is posing what look like similar challenges. Stuff does, indeed, happen. Having willed the creation of the euro, its members must overcome the difficulties that arise when, as now, stuff happens.
China targets $1.1 trillion in new loan issuance in 2010
Chinese regulators expect the nation's banks to issue about 7.5 trillion yuan ($1.1 trillion) in new loans this year, reflecting efforts to rein in bank lending after nearly doubling lending levels last year. China Banking Regulatory Commission Chairman Liu Mingkang cited the figure during an investment forum Wednesday in Hong Kong, according to Dow Jones Newswires. The new lending target means that outstanding yuan loans will rise about 16% to 18% this year, Liu said.
Chinese banks extended 9.59 trillion yuan of new loans in 2009, about 95% more than the 4.9 trillion yuan lent in 2008, and equivalent to nearly a third of the nation's economic output. The torrid pace of lending has helped China avoid an economic recession, but analysts have questioned the side effects of the lending growth, including possible credit-quality problems and the potential creation of asset-price bubbles. Liu also reportedly said some Chinese banks have been asked by regulators to limit their lending after they failed to meet capital requirements and other benchmarks.
No new loans this month?
Some Chinese banks have been asked to stop granting new loans for the remainder of January, the report cited the state-run China Securities Journal as saying. The report said regulators have given verbal instructions on lending to the nation's top four banks and several medium-sized financial institutions. The clampdown could indicate that new loans so far this year have already exceeded 1 trillion yuan, the report said. However, a subsequent Dow Jones Newswires report cited Liu as saying the China Banking Regulatory Commission has made no such request.
Separately, Premier Wen Jiabao said Tuesday that China will maintain "reasonable and ample" credit growth, while monitoring data, remarks that were seen as striking a more cautious tone than statements in recent months calling for continuity and stability in the nation's macroeconomic policy.
JAL rescuers forced to write off contributions
Trading partners of Japan Airlines that helped provide Y152bn ($1.7bn) of desperately needed capital to the company in 2008 will be forced to write off their contributions after JAL filed for bankruptcy this week. The losses will come on top of those of JAL creditors that are being asked to forgive Y730bn ($8bn) of the airline’s Y2,322bn of gross debt. Several banks, including UBS, also participated in the 2008 capital injection, though they are more likely to have offloaded their exposure through securitisation or other means.
On Wednesday, Sojitz, a trading house that sells in-flight meals and other items to JAL, said it would write off Y15bn of preferred shares issued to it by JAL. Other participants in the February 2008 capital injection are expected to follow suit. The Japanese carrier raised money from 14 banks and companies to pay down debt and finance its struggling effort to restructure. The move was one of several ultimately fruitless attempts to rescue the airline with government and private cash over the last decade. JAL’s bankruptcy filing made it the biggest local corporate failure outside the financial industry. All equity in the company will be wiped out, though the airline will remain in business thanks to a Y900bn government lifeline. Sojitz’s write-off amounts to a little over 40 per cent of its projected Y35bn operating profit for the year to March 31. The company said it was still evaluating the impact of the charge on its forecasts.
Earlier Tokyu, a railway and property group that had been one of the airline’s biggest common-stock investors with a roughly 3 per cent stake, said it had sold its holding at a Y9bn loss. It is not uncommon for Japanese companies to turn to their customers and suppliers for aid when they fall on hard times. Five other trading houses – Mitsui, Mitsubishi, Itochu, Sumitomo and Marubeni – participated in the 2008 fundraising, alongside fuel suppliers and banks. Mitsui, the Mizuho banking group and the state-owned Development Bank of Japan are the largest holders of JAL preferred shares with Y20bn apiece. UBS was the only non-Japanese participant in the fundraising, signing up for Y10bn, although it is understood not to have suffered a material loss.
Standard & Poors said total JAL-related losses for Japanese banks could amount to a of 10 per cent of their net profits for the year. S&P and Moody’s left their ratings on affected banks and trading firms unchanged. JAL had also been a popular stock with retail investors, who hold about 60 per cent of the company. JAL’s common stock will be delisted from the Tokyo Stock Exchange on February 20, although it continued to trade in large volumes on Tuesday, closing down Y3 at Y2. Brokers attributed the remaining demand for the stock to day traders looking to exploit price volatility – even a Y1 move now means a huge shift in percentage terms – and short-sellers needing to buy back shares to close out their positions.
JAL Bankruptcy Could Be Lengthy
Japan Airlines Corp.'s stint under bankruptcy protection isn't likely to be short or simple. The carrier, known as JAL, faces massive liabilities and has a sprawling business that covers everything from jet-fuel procurement to aircraft leasing, both in Japan and overseas. The case could also raise challenging questions about whether bankruptcy protection will be recognized as it does business in other countries.
"One thing that can become a big future problem is whether the court protection will be valid outside Japan as an international bankruptcy case," said Hideyuki Kobayashi, an attorney at Blakemore & Mitsuki law office in Tokyo. Citing also Japanese law and the uncertainty surrounding its fortunes, he added, "We can expect at least three years for JAL's revival." JAL said Tuesday it expects its international operations to continue as normal, though some detail may need to be sorted out.
JAL will use the nation's Corporate Rehabilitation Act, which is based on U.S. bankruptcy law. Under the act, current management is often dismissed from the troubled company's board and the company works through its finances with the help of court-appointed administrators. The bankruptcy protection also prohibits execution of the rights in collateral in Japan, meaning JAL will be able to continue operating leased aircraft, for instance. Japan's bankruptcy protection law has undergone several revisions to date, aimed at making it easier to use and bringing it closer into line with Chapter 11.
Among the 134 companies that filed for bankruptcy protection under the act between January 2004 and June 2009, around 50% have already managed to revive themselves, and only 1.5% actually went bankrupt and were liquidated, according to Teikoku Databank. Those companies took an average of 1.7 years to exit the reorganization process, data from Teikoku Databank showed, compared with 12.1 years for companies entering bankruptcy protection 10 years ago.
As JAL Bankruptcy Nears, Investors Rethink 'Too Big to Fail'
Japan Airlines Corp.'s expected bankruptcy filing could wipe out shareholders, cause the value of its bonds to plummet, and alter global investor attitudes toward Japan. Until now, shareholders had believed that Japan had a governmental safety net and would prop up ailing companies indefinitely. Blue-chip companies such as JAL were thought to be "too big to fail." "If investors can no longer assume some form of government safety net when investing in Japan, then we have to assume that this would ultimately be reflected in significantly wider corporate spreads than have been the norm to date," said BNP Paribas chief credit analyst Mana Nakazora.
JAL is scheduled to file for bankruptcy following Tuesday's 3 p.m. Tokyo stock market close. Individual shareholders, who accounted for 60% of JAL's 2.73 billion outstanding common shares as of September, will be the hardest hit by the possible subsequent delisting of the airline's stock, which has plunged from a peak of 200 yen ($2.20) last January to a close of 5 yen on Monday. Hidetaka Miyai, 34 years old, works for a mobile-phone content provider and spent 500,000 yen to buy 1,000 shares at around 500 yen apiece several years ago. "My purpose to hold JAL shares was purely to get discount coupons," he said. Twice a year, the airline issues flight discount vouchers to shareholders, which make the stock attractive to individuals. "I just missed the timing to sell them," he said. "I didn't think JAL would be facing the risk of delisting because it's the national flag carrier, isn't it?"
Even as JAL nears a bankruptcy filing, it is at the center of a tug-of-war between airlines in the Oneworld alliance, to which it belongs, and the SkyTeam alliance led by Delta Air Lines Inc., which is trying to lure it away. Both U.S. carriers believe closer JAL ties will give them access to the carrier's routes in Asia, the world's fastest-growing air market, and are offering JAL financial incentives. A spokeswoman for Air France-KLM, a leading member of the Sky Team alliance, said the talks "are progressing well." JAL also is in talks with AMR Corp.'s American Airlines, the leader of the Oneworld alliance.
A delisting from the Tokyo Stock Exchange is the primary concern for the stock market when JAL files for protection from creditors, the Japanese equivalent of Chapter 11 protection, and its rehabilitation process kicks off under the state-backed Enterprise Turnaround Initiative Corp. of Japan. A key question is whether the rehabilitation plan includes a 100% capital reduction, which would make JAL shares worthless and cause the stock to be delisted. TSE rules stipulate that shares then immediately enter "delisting post", with physical delisting taking place one day after the corresponding day of the TSE's notice in the following month. A TSE delisting announcement made on Jan. 19, for example, would result in delisting on Feb. 20. Market players can still trade in the stock during this one-month period.
Some of JAL's institutional investors already have sold their stake. In November, major trading house Mitsui & Co. said it had sold all of its common shares, while Tokyu Corp., JAL's largest shareholder as of September, said last week that it had sold all of its stake. While many retail investors rushed to offload their shareholdings late last year, according to local brokerages handling their orders, JAL has recently found many new buyers trying to make quick profit, either on any daily price volatility prior to a bankruptcy protection filing, or on the slim chance that the stock remains listed. The company's shares have traded heavily all week, with about 550 million shares trading hands Friday. The stock set the TSE single-stock trading volume record Thursday, as more than one billion shares changed hands.
Taro Matsugasako, 29, who works for a trading company, spent 28,000 yen to buy 4,000 JAL shares for seven yen apiece on Wednesday through an online brokerage account he opened in late December. It was his first investment in any stock and he intends to hold onto the shares, in case JAL remains listed. "In December, I bought 30,000 yen worth of lottery tickets and lost all of it," he said. "I don't mind spending about the same amount on JAL, because I think the chance of winning is at least higher than lottery tickets."
Tomohiro Nakayama, a 26-year-old day trader, is waiting to see if JAL shares fall as low as one yen prior to possible delisting. "That's when I would place massive buy orders, hoping that other people would follow and the shares will be two yen by any chance," he said.. The corporate bond market also is preparing to see a major cut in the value of JAL's bonds. The debt is held by institutional investors, mainly pensions and regional banks. "It's hard to imagine that JAL bondholders will be protected, as the firm won't be able to find sources to pay for the bonds with a massive debt already on their shoulders, and because major banks are moving to give up their loans to the company," said Yasuhiro Matsumoto, a senior analyst at Shinsei Securities.
The bond market's biggest concern is how much of about 67.2 billion yen outstanding in JAL bonds will be saved. About 47 billion yen of those are conventional bonds, while bonds that can be converted into shares account for about 20.2 billion yen. Bond players are looking at prices, rather than yields, of JAL corporate bonds in the secondary market, because they are certain that they won't be able to earn coupon income from the bonds.
The key now is how much of JAL bonds will be protected. JAL bonds in recent sessions were being quoted at around 25 yen to 30 yen, compared with their 100-yen face value. That's down from around 50 yen at the end of September, when it asked the government for public funds to boost its capital base. However, Mr. Matsumoto thinks the value of JAL bonds could be cut to less than 20% of face value if JAL applies for court-led rehabilitation. Still, given the relatively small size of JAL bonds compared to other heavyweights, any direct impact in the overall credit market is likely to be limited even if its corporate bonds do default, analysts said.
U.S. Housing Aid Benefits Banks, Not Homeowners
Government support for the economy has helped banks make all manner of windfall profits. But have outsize returns in banks' mortgage operations deprived borrowers of lower mortgage rates? In 2009, there was a big jump in an industry margin used to gauge the profitability of banks' main mortgage business, selling home loans to government-supported Fannie Mae and Freddie Mac. In theory, if that margin had remained at narrower, historical levels, mortgage rates for borrowers could have been lower. That might have created sizable savings for homeowners over the life of their loans and breathed more life into the housing market.
Banks' mortgage profits have come amid extraordinary government support for the housing market. Since 2008, the Treasury has spent $112 billion to shore up Fannie and Freddie. Further government support has come from the Federal Reserve's $1 trillion-plus of purchases of mortgage-backed securities since the start of 2009. All this has helped mortgage rates fall. But could they have been lower still? Consider what happens when banks sell their loans to Fannie or Freddie. A bank might write a mortgage at 5.1% and sell it to Fannie, which guarantees the loan and sells it with other loans packaged as mortgage-backed securities, perhaps with a coupon of 4.35%. The difference of 0.75 of a percentage point is booked by the bank, which uses some of that revenue to cover costs in its mortgage business.
From 2000 through 2008, that margin averaged 0.73 of a percentage point, according to data from Barclays Capital. But in 2009, the average was a much wider 0.98 of a percentage point. Any additional margin likely boosted banks' bottom lines. And by a lot, potentially, given that $1.4 trillion of mortgages were written in the first three quarters of 2009, according to Inside Mortgage Finance. Indeed, Wells Fargo and Bank of America, which together account for 45% of the market, reported blowout mortgage earnings last year.
The cause of the wider margin: The Fed's buying helped pull down coupons on Fannie and Freddie securities by more than mortgage rates. If banks had cut mortgage rates in line with those coupons, homeowners would have benefited. Instead, the benefit appeared to have accrued to the banks. Banks say the higher margin only offset higher expenses. But basic costs, like the guarantee fee banks pay to Fannie or Freddie as well as loan-servicing costs—roughly 0.25 of a percentage point each—likely haven't gone up excessively.
Jay Brinkmann, of the Mortgage Bankers Association, says banks needed to recoup a drop in the value of servicing-related assets last year. Lenders also face hedging costs when selling mortgages into a forward market, he says. Of course, since mortgage rates have come down so much, some might say it is nitpicking to focus on potential extra gains for banks. But mortgage rates are still relatively high on an inflation-adjusted basis. And though mortgage origination picked up in 2009 on the lower rates, it fell well short of previous low-rate years.
So should the Treasury have leaned on banks to charge lower mortgage rates, given the government's desire to help homeowners? Sure, intervention would have risked making banks skittish, perhaps leading to less lending. But the main lenders have all strengthened their mortgage operations through big mergers, and the price at which they sold mortgages benefited a lot from the Fed's buying. As the government spends huge sums shoring up the housing market, it may want to look more closely at who is benefiting.
Loan Modifications Prop Up the Housing Market
President Barack Obama's plan to ease mortgage terms for millions of distressed homeowners, announced nearly a year ago, now is widely panned for having fallen short of its ambitious goals. But some analysts say the program is a success in one sense: By slowing the flow of foreclosed homes to the market, it has helped prop up housing prices, at least for now. The administration's Home Affordable Modification Program, or HAMP, and other state and federal efforts to avert foreclosures have helped "buy time" for the housing market, preventing steeper home-price declines, said Ajay Rajadhyaksha, a managing director at Barclays Capital in New York.
The official goal of HAMP is to reduce monthly loan payments for distressed borrowers so they can afford to stay in their homes. But housing analysts at UBS Securities in New York, in a report last week, described HAMP as "a vehicle to delay the timing of new foreclosures hitting the market." Most analysts assume that a large share of the people who get modifications will default again within a year or two. Thus, some critics say the government and banks are merely "kicking the can down the road" on foreclosures that will hit the market eventually. The unresolved question is whether the housing market will be better able to absorb foreclosed homes in a year or two. That depends on whether the economy and job growth recover.
Treasury officials argue that the loan-mod program is working out well in terms of keeping many people in their homes, but they also acknowledge the broader effect on home prices: "I think it has had quite a strong stabilizing influence" on the housing market, Treasury Assistant Secretary Michael Barr said in a briefing Friday. In late 2008, banks dumped many of their foreclosed homes on the market, pushing prices down sharply in some areas. Around that time, though, banks began acquiring fewer homes through foreclosure. That was partly because of various moratoriums on foreclosures at the state and federal level, followed by HAMP.
Because of HAMP, banks feel heavy political pressure to carefully screen borrowers to see which ones might qualify for loan modifications before proceeding with foreclosures. That has extended the time it takes to decide whether to force through a foreclosure, creating a huge backlog of unresolved cases. As a result, there are fewer foreclosed homes on the market. The number of such homes available for sale dropped to 637,000 in November 2009 from 845,000 a year earlier, Barclays Capital estimated. Barclays expects the number to start rising again as people who don't qualify for a loan modification or don't want one lose their homes, and peak at 747,000 in April before declining gradually.
As recently as September, however, Barclays expected a peak of nearly 1.2 million foreclosed homes for sale in mid-2010. "Our projected peak keeps getting lower, the longer banks delay foreclosure sales," spreading the pain over a longer period, says Glenn Boyd, a senior researcher at Barclays. That has implications for pricing. The S&P/Case-Shiller 20-city home price index is down 29% from its peak in 2006 but has leveled off in recent months as fewer foreclosures have hit the market. As of Sept. 30, about 7.5 million households were behind on their mortgages or in the foreclosure process, according to the Mortgage Bankers Association, a trade group. It isn't clear how many of those homeowners can ultimately be rescued. HAMP so far has resulted in about 900,000 loan modifications, most of which are still in a trial period.
Louis Amaya, chief operating officer of National Asset Direct Inc., a New York-based asset manager whose affiliates purchase and service troubled mortgage loans, said the administration has used HAMP to shame lenders into offering lots of loan modifications but that a large share of those aren't sustainable. "The reality is that most people aren't going to qualify for a loan mod" that makes economic sense for both the borrower and lender, Mr. Amaya said. Those who can't afford their homes should be allowed to exit with dignity, such as through a short sale, in which the house is sold for less than the loan balance, he said. Instead, HAMP is "dragging out" the foreclosure process, Mr. Amaya said, and "we need to let the market correct itself." Until the huge backlog of loans headed for foreclosure is cleared, he said, the housing market can't recover.
Souring Mortgages, Weak Market Force FHA to Walk a Tightrope
David Stevens bought his first home almost 25 years ago, paying just 3% down with a loan backed by the Federal Housing Administration. "I had no money in the bank," he says. "If it weren't for the FHA, I wouldn't have gotten that home." Now, as FHA commissioner, Mr. Stevens has to decide how many others to let through that door. Souring FHA-insured mortgages are threatening the agency's finances. Congress is pressuring him to tighten the easy-money standards that once helped people like him, and he is expected to announce revisions as early as this week.
But raising the credit bar could have a dangerous side effect. In many of the nation's hardest-hit housing markets, the FHA backs around half of all new home loans. If the agency pulls back too quickly, the nascent housing recovery could fizzle, endangering the economy. The dilemma puts the 52-year-old former mortgage banker squarely in the middle of the debate over how much the government should do to prop up the housing market, and how much risk taxpayers should take on to do it. "How big a role do we need to play to keep the housing system functioning?" says Mr. Stevens, referring to the FHA. "Overcorrecting in either direction would be a terrible thing to do right now."
Mr. Stevens is finalizing possible revisions to credit standards. Options include raising the minimum down payment, establishing a minimum credit score, increasing the amount that borrowers have to pay for mortgage insurance, and reducing the amount of money sellers can kick in for closing costs. The FHA, created in 1934 to heal the U.S. housing market during the Great Depression, traditionally has helped first-time home buyers and underserved segments of the market. It doesn't lend money to home buyers, but insures lenders against default on loans that meet FHA criteria, collecting fees for that backing. For decades, thanks to a stable housing market, it turned a profit for taxpayers.
When the housing market was booming, subprime lenders drew away many of the borrowers who traditionally used FHA-backed loans by offering even more favorable terms. Unlike the FHA, subprime lenders didn't require borrowers to document their incomes. The FHA saw its share of the mortgage market fall to 2% in 2006. But when the subprime market collapsed, mortgage brokers began steering borrowers into FHA-backed loans. Politicians and policy makers encouraged the FHA to refinance at-risk borrowers into fixed-rate loans. Suddenly, the FHA had an enormous chunk of the market. Average credit scores of FHA borrowers dropped sharply at first. In last year's third quarter, the FHA insured 25% of mortgages, according to Inside Mortgage Finance, a trade publication.
"We should not play this large a role," Mr. Stevens says. "It's not healthy for the mortgage-finance system, it's not healthy for the economy, and it's certainly not sustainable for the long term." The FHA, which is part of the Department of Housing and Urban Development, isn't as nimble as private mortgage insurers. It must get approval from Congress for some major decisions. "They don't have the horsepower that they should, especially given the size of their operations," says Ann Schnare, a mortgage-industry consultant.
In testimony before Congress last month, HUD Secretary Shaun Donovan acknowledged that the FHA "we inherited" was "not properly managing or monitoring its risk. Credit and risk controls were antiquated. Enforcement was weak. And our personnel resources and IT systems were inadequate." Mr. Stevens knows the industry well. He is the first FHA commissioner in nearly two decades to bring extensive private-sector experience to the job. During the 1980s, he was a top salesman of complex adjustable-rate mortgages for World Savings Bank, a California thrift. He went on to hold senior jobs at housing-finance giant Freddie Mac and at Wells Fargo & Co.
In his off time, he plays guitar, rides his BMW motorcycle and skis the backcountry. On the job, he gets his way through sheer "force of personality," says Eugene McQuade, once Mr. Stevens's boss when they worked at Freddie and now chief executive of Citigroup Inc.'s Citibank unit. When Mr. Stevens arrived in July 2009, the FHA didn't have anyone in charge of monitoring risk, including whether certain loan products or lenders were exposing the agency to excessive losses.
In his second week on the job, Mr. Stevens suspended the FHA license for Taylor, Bean & Whitaker Mortgage Corp., one of the nation's top lenders, amid concerns that the company was originating too many bad loans. Taylor Bean closed its doors the next day. In November, he hired the agency's first chief risk officer and five Ph.D. economists to help evaluate risk. That same month, FHA cut off Lend America, another major lender, which also closed.
But there are still signs of trouble. At about 30 FHA-approved lenders with at least 1,000 loan originations, more than 12% of loans are in default two years after origination, nearly double the national average at the end of November. Last Tuesday, HUD's inspector general served subpoenas on 15 of those lenders as part of an examination of the practices of lenders with high default rates. The percentage of FHA-backed loans that defaulted after borrowers made just one payment—typically an indication of poor underwriting or fraud—has started to fall, but not as fast as needed to avoid future loan losses. FHA-insured mortgages made in 2007 and 2008 are largely responsible for the agency's precarious position, with default rates approaching 24%. FHA officials concede that the agency offers today's easiest underwriting standards.
Mr. Stevens, nevertheless, lashes out at critics who say the FHA is repeating the mistakes of subprime lenders. At a conference in November, Robert Toll, chief executive of luxury-home builder Toll Brothers Inc., referred to the FHA as "the new subprime" and "a definite train wreck" that will soon need a bailout, according to a transcript of his remarks. Mr. Stevens, in an interview, called the comparison "ludicrous," and said Mr. Toll has "no clue" about the agency's finances.
The agency is required by Congress to hold enough capital in reserve to cover 30 years of projected losses. An independent audit said reserves at the end of September exceeded projected losses by just $3.6 billion, about 0.5% of the $685 billion in loans outstanding, down from 3% a year earlier. Congress requires the agency to maintain a 2% capital-reserve ratio. FHA officials say they have enough cash to cover the current level of losses, and that the agency risks running out of money only if home prices take another big dive. "We've learned from recent history that the market is fragile, and we have to plan for the unexpected," Mr. Donovan, the HUD secretary, said last month.
But some analysts say the agency's assumptions about home prices and foreclosures are too optimistic. "FHA is, at best, running on empty, and probably is facing a negative capital situation," Ms. Schnare, the industry consultant, told a congressional panel last month. If the agency were to run short of cash to cover projected losses, it likely would have to ask Congress for money for the first time ever. The bad-loan problem stems, in part, from controversial programs that allowed home builders and other sellers to fund down payments for home buyers through nonprofit groups. After a lengthy effort, the FHA prevailed on Congress to shut the programs down in October 2008, but the damage already was done. The FHA's independent audit concluded that were it not for such programs, the agency's capital-reserve ratio would have stayed above the 2% mandated by law.
In another troubling practice, by late 2007, institutional investors were identifying at-risk mortgages in their portfolios and refinancing the borrowers into FHA-backed loans, thereby offloading their risk onto the agency. "It was an unintentional bailout of financial institutions," says David Lykken, a partner at Mortgage Banking Solutions, an Austin, Texas, consulting firm. One of the raft of measures Mr. Stevens is considering to protect and replenish the agency's reserves is raising the minimum down payment. The current minimum of 3.5% is far lower than what private lenders offer, making FHA-backed loans one of the last low-down-payment options left. Last year, through August, nearly seven in eight new FHA-backed loans carried down payments of less than 5%.
Home builders are worried. "It would be a game changer for the industry" if down payments were raised, says Eric Lipar, chief executive of LGI Homes, a Texas-based builder of entry-level homes. Not everyone believes that such low down payments are good. In markets where home values are still falling, buyers who put little money down could see their equity wiped out quickly. The FHA is "just manufacturing more upside-down homeowners by the truckload in Arizona, California, and Nevada," says Brett Barry, a Phoenix real-estate agent who specializes in selling foreclosed homes. If the agency were to raise down payments sharply in those markets, price declines would become a "self-fulfilling prophecy," says Mr. Stevens. "If you stop lending, you're going to perpetuate the declines."
Mr. Stevens says first-time buyers are key to clearing inventory in markets such as Las Vegas. James Smith, a 42-year-old air-conditioning repairman, might not have been able to buy a $188,000 home out of foreclosure recently in Henderson, Nev., were it not for the low FHA down payments. To make the 3.5% payment, he used around $4,300 of his own money and borrowed the rest from this father-in-law. "It was actually a great thing," he says. He repaid his father-in-law after receiving an $8,000 tax credit for first-time home buyers. Mr. Smith, who earns around $50,000 annually, makes monthly payments of $1,466. Mr. Stevens says he expects to get heat from industry and consumer groups no matter what he decides to do to tighten credit standards.
Even as the FHA considers how to scale back, some members of Congress are pushing it to expand its role. In 2008, in the midst of the credit crisis, Congress temporarily raised the maximum FHA loan from $362,790 to as high as $729,750 for the most expensive housing markets. Lawmakers have introduced a bill to make that increase permanent. "A $500,000 loan in Massachusetts is like a $300,000 loan in Nebraska," says Massachusetts Democratic Rep. Barney Frank, who favors raising limits to $800,000 in the most expensive markets. "All we're trying to do is control for geography." Mr. Stevens argues the expanded limits should stay temporary, in keeping with the FHA's traditional focus on first-time buyers.
The FHA says the loans it is guaranteeing these days will turn a profit because the credit profile of its borrowers has improved. The average credit score for FHA borrowers has risen to 681, from 630 two years ago. The median U.S. score is about 720. Much of the improvement came as the FHA's lenders raised their own credit standards. Mr. Stevens, for his part, is painfully aware of how far the housing market is from recovery. He listed his northern Virginia home for sale last fall and already has slashed the asking price by $100,000, to $1.4 million. Before Christmas, he pulled the five-bedroom colonial off the market with plans to relist it later this year. He says he wants to live closer to Washington. "The commute is very hard," he says, "and the hours are very long."
FHA to Lift Mortgage Insurance Fees
The Federal Housing Administration will announce more-stringent lending requirements and higher borrower fees on Wednesday to cushion against rising defaults and stave off the need for a taxpayer bailout of the agency. The FHA, which has taken on a major role in the housing market during the economic downturn, doesn't lend money to home buyers, but insures lenders against default on loans that meet FHA criteria. In exchange for that backing, borrowers who take out FHA-backed loans must pay an upfront insurance premium, currently set at 1.75% of the total loan amount. The premium can be rolled into the loan.
The FHA is set to raise that fee to 2.25%, the second increase in the past two years, according to people familiar with the matter. The value of the FHA's reserves to cover losses has fallen to $3.6 billion, about 0.5% of the $685 billion in loans outstanding, down from 3% a year earlier. Congress requires the agency to maintain a 2% capital-reserve ratio. If the larger upfront fee had been in place last year, the FHA would have boosted its reserves by more than $1 billion. Also to boost the reserve, the FHA will ask Congress to increase a separate insurance fee that borrowers pay annually, people said. If the agency were to run short of cash to cover projected losses, it likely would have to ask Congress for money for the first time ever. FHA officials declined to comment.
The FHA, which backs as many as half of all new loans in certain housing markets, has come under fire for insuring loans with little or no money down as home prices have plunged over the past three years. With its reserves falling, the agency has been forced to walk a tightrope between protecting taxpayer dollars and helping to facilitate the housing recovery. The FHA will keep minimum down payments at the current 3.5% level for most borrowers. But the agency will require riskier borrowers with credit scores below 580 to make a minimum 10% down payment. While the FHA doesn't have a credit-score cutoff, most lenders require a minimum 620 score.
Some housing analysts have pushed for higher down payments on FHA-backed loans, and a bill in Congress would raise down payments to 5%, from the current 3.5%. Instead, the FHA will reduce the amount of money that sellers can kick in for closing costs to 3% of the sale price, down from the current level of 6%. The higher cap led to abuses where sellers "heavily marked up the purchase price," says Lou Barnes, a mortgage banker in Boulder, Colo.
The FHA is also set to announce a series of measures to boost its ability to oversee and take action against lenders that originate loans with FHA backing. "Mortgage lenders will find the new rules painful but necessary," says Howard Glaser, an industry consultant. He says the rules were overdue given that "an 'anything goes' environment" had prevailed in recent years as former subprime brokers migrated into FHA-backed loans.
Citigroup Isn't Out of the Woods Yet, Says Bank Analyst Chris Whalen
"Big banks have lost more than they’ve made over the past 50 years"
Citigroup shares are trading higher today after the bank reported fourth-quarter EPS in line with estimates. Investors appear undeterred by the bank's tenth-consecutive quarterly loss and disappointing revenue, choosing to take a positive view on Citi's results, as did CEO Vikram Pandit. Bank analyst Christopher Whalen of Institutional Risk Analytics isn't as positive as the rest of the market. He maintains a "negative" outlook on the stock.
Whalen worries credit losses will remain high; forcing Citi to increases loan-loss reserves. "If your clients aren't doing well, you’re not doing well," he says, citing both Citi and JPMorgan's weak revenue figures. "I don't see this as a great value story," Whalen tells Aaron in the accompanying clip. That goes for all the large banks. "Remember they've lost more money than they've made in the last half century," he states.
Citigroup loss signals more trouble for commercial banks
Wall Street may be drawing attention for its rebounding profits, but not all big banks are rolling in dough. On Tuesday, Citigroup posted a $7.6-billion loss for the last three months of 2009, the banking giant's first unprofitable quarter since 2008. Similar bad news is expected today when Bank of America Inc., Wells Fargo & Co. and U.S. Bancorp report their earnings. Although these commercial banks may have substantial Wall Street operations, they rely heavily on bread-and-butter consumer lending -- a business whose problems only now may be peaking along with the joblessness and other financial woes of ordinary Americans.
The picture is very different at Wall Street pillars Goldman Sachs Group Inc. and Morgan Stanley, which mainly serve the financial needs of the world's largest companies. These investment banks were hit early in the financial crisis due to their heavy involvement in the market for mortgage-backed securities, which crashed in 2008. By the end of that year, of the five major Wall Street firms, only Goldman and Morgan Stanley were still standing as independent firms. And they recovered swiftly in 2009, allowing for the return of fat compensation packages. Morgan Stanley is expected to report strong fourth-quarter results today with Goldman Sachs following Thursday.
"In the case of Goldman and Morgan Stanley, you don't have to deal with the consumer -- and the outcome is good for them," said Richard Bove, a bank analyst at brokerage Rochdale Securities. "On the other hand, when you look at one of these big universal banks, they have these huge credit-card and automotive-loan divisions. They are all up to their heads in mud." Even JPMorgan Chase Inc., which last week reported a $3.3-billion fourth-quarter profit, had losses in its retail lending and credit-card operations. The profit came largely from its investment banking and private equity divisions.
At Citigroup, most of the fourth-quarter loss stemmed from an accounting charge linked to the company's exit from the government's Troubled Asset Relief Program. Even without that charge, Citigroup would have lost $1.4 billion in the period. The bank's ugliest results came in consumer banking, where losses widened from the third quarter. "U.S. consumer credit remains an issue," Citigroup Chief Executive Vikram Pandit said in a conference call Tuesday. Although the results were worse than expected, Citigroup's shares jumped 12 cents, or 3.5%, to $3.54, apparently because the company added less in the latest period than in the third quarter to its accounting provisions for future loan losses.
"Things have gotten worse, but at a much slower rate," said Gerard Cassidy, a bank analyst at RBC Capital Markets in Portland, Maine. Among the big banks, few have suffered as much as Citigroup from the mortgage meltdown and resulting crises and market downturns. For years, the company gobbled up firms from every corner of the financial realm, turning itself into a global financial supermarket. As a result, it got hit on all sides when the troubles began, especially on its stake in securitized mortgages. Last year, the company sold 14 divisions, including the storied Smith Barney brokerage.
Citigroup's fourth-quarter loss, amounting to 33 cents a share, was significantly better than its loss of $17.2 billion, or $3.40 a share, a year earlier at the height of the financial crisis. Still, Citigroup's stock fell 51% last year and remains down 47% from the end of 2008. The biggest contributor to the latest loss was Citigroup's swift push to leave TARP at least in part to escape the government's oversight on matters such as executive compensation. In December the company paid back the remainder of the $45 billion it received under TARP, but it also had to pull out of an agreement under which the government would have shared losses on some of Citigroup's loan portfolio. That helped lead to a $10.1-billion pretax charge against earnings for the quarter.
Citigroup's decision to pay back the government money was controversial, in part because to do so the company had to sell more common stock, diluting the stakes of its existing shareholders. Among the earnings reports due today, Bank of America has a massive credit-card operation that is expected to show big losses. Bank of America also has a large mortgage portfolio that it acquired when it purchased Calabasas home-loan giant Countrywide. Wells Fargo, based in San Francisco, acquired its own set of troubled loans in 2008 when it bought Wachovia and its California-heavy mortgage portfolio. "It's a meaningful chunk of the portfolio, and an even more meaningful chunk of their losses," said Bart Narter, senior vice president at consulting firm Celent in San Francisco.
Politically, the hottest numbers from Citigroup's earnings report are likely to be its compensation figures. The company put aside $6.3 billion in the fourth quarter to compensate its employees, an increase from the previous quarter and enough to give $94,290 to each of its 265,000 employees for the year. Citigroup did not follow the lead of banking giant JP Morgan Chase, which shrank its compensation pool in the fourth quarter compared with the third quarter amid the public uproar over banker bonuses. At the very top, however, Citigroup's Pandit has said he will forgo a bonus for 2009.
BofA, Morgan Stanley fall short; Wells Fargo sees profit
More banks on Wednesday followed the pattern set by earlier earnings reports from of JPMorgan Chase and Citigroup: continuing losses for their lending operations during the fourth quarter offset by investment bank strength. But Wells Fargo, reporting an unexpected profit, did say that while loan losses remain elevated, the bank's confidence is growing that the worst of the cycle is over. Bank of America said it lost $5.2 billion during the final three months of 2009 as consumers struggled to make their mortgage and credit card payments and the bank repaid its government bailout money.
Bank of America said its loss, which reflected payment of preferred dividends, compared with a loss of $2.4 billion a year earlier. The bank said its results were boosted by strong results from its Merrill Lynch investment banking operations. Bank of America, among the hardest hit financial companies during the credit crisis and recession, set aside $10.1 billion during the fourth quarter to cover soured loans, down nearly 14% from the previous quarter. But it also reported big losses in its mortgage and credit card businesses. The bank lost 60 cents a share, more than the 52 cents analysts were expecting, according to Thomson Reuters.
Bank of America said its global wealth and investment management unit saw its net income rise to $2.5 billion in the quarter, up from $1.4 billion a year earlier, driven by the addition of Merrill Lynch. JPMorgan Chase, which reported a $3.28 billion profit on Friday, also said its investment banking earnings offset loan losses. Many analysts predict loan losses should peak some time in the first half of 2010. On Tuesday, Citigroup said it lost $7.58 billion in the fourth quarter as consumers continued to struggle to repay loans and the bank repaid its government bailout. The bank said it set aside $8.18 billion to cover bad loans during the most recent quarter. Bank of America said $4 billion of its loss came from the costs of paying back $45 billion in government bailout money in December.
Morgan Stanley results miss expectations
Morgan Stanley said it earned $617 million during the last three months of 2009 as its investment banking operations profited from its Smith Barney joint venture. Morgan Stanley said it gained 29 cents a share on $6.8 billion in revenue. That was less than analysts' expectations of 36 cents on $7.8 billion in revenue, according to Thomson Reuters. But investors appeared pleased by the results, sending the company's stock up in pre-opening trading. Morgan Stanley said its revenue was hurt by an accounting charge resulting from the continuing improvement of credit markets. However, the bank said the Morgan Stanley Smith Barney joint venture more than doubled the revenue from its global wealth management operations to $3.1 billion.
Wells Fargo is seeing early signs of improvement in its lending portfolios as it reports an unexpected fourth-quarter profit. Wells Fargo said that while loan losses remain elevated, the bank's confidence is growing that the worst of the cycle is over. The bank said Wednesday it earned $394 million, or 8 cents a share, in the last three months of 2009. It lost $3.02 billion, or 84 cents a share, a year ago. Earnings were reduced by 47 cents per share tied to the repayment of $25 billion in government bailout money. Analysts were expecting a loss of 1 cent a share. Wells Fargo set aside $5.91 billion for loan losses during the quarter, down 30% from a year earlier.
Barclays faces £17bn shortfall
Barclays may have to axe its dividend and extend the begging bowl to shareholders again to fund a £17bn shortfall in capital under proposed new global rules for the banks. The forecast of "a potentially sizeable capital deficit" because of planned changes in regulation was made yesterday by analysts at Credit Suisse, the bank's broker. The predicted shortfall is even larger than the £12.8bn forecast last July by JP Morgan. According to Credit Suisse, capital requirements proposed by the Bank of International Settlements would cut so deeply into Barclays' core tier-one ratio that "an immediate move to 8pc would require £17bn of equity". If requirements are increased to 10pc, as some policymakers would like, Barclays would need to raise £28bn.
Credit Suisse said that "in theory, it is possible that Barclays can manage the transition to the new rules without an external capital raise" as a three-year transition period is planned. Doing so, however, will require "a substantial tightening up of the business, the potential disposal of [Barclays' 50pc stake in fund manager] BlackRock and the freezing or even removal of the recently reinstated dividend". "In practice, restraining the bank to such an extent might not be the preferred choice of management," analysts added.
"We think a capital raise at some point in the future cannot be ruled out." Regulators are imposing tough new capital requirements on banks in an attempt to make them viable without taxpayer support. Higher-risk investment banking is being targeted in particular. Last July, JP Morgan claimed Barclays needed to allocate an extra £14.9bn of capital to Barclays Capital, its investment bank. The rules have led to speculation that Barclays will spin off the investment bank.
Brown win could spark Obama war on Wall Street
Scott Brown’s stunning capture of the Massachusetts Senate seat held for decades by Ted Kennedy was a political black swan, a near-unpredictable event. The result ends the Democratic supermajority in the Senate and leaves key parts of the Obama agenda in deep trouble. But the biggest loser just might be Wall Street. Desperate Democrats may see anti-bank populism as a way of holding power as the November midterm elections approach.
The last days of the heated Senate race saw the first attempts at that political gambit. Democratic candidate Martha Coakley’s allies in Washington, both the White House and national Democratic officials, used President Barack Obama’s proposed bank tax as a cudgel to bash Brown via emailings and telephone calls. But the game was probably over by then for Coakley. A combination of high unemployment, an unpopular healthcare reform bill and the candidate’s own lack of charisma and effective experience were more than enough to clinch an easy Brown victory.
A historic victory, really. It is hard to overstate just how "blue" a state Massachusetts is. Obama won it by 26 percentage points in 2008. Until now the state’s 10 U.S House members, two U.S. senators and all statewide officers were Democrats. The state hasn’t had a Republican U.S. senator since 1979. And, of course, the seat Brown captured had been held by the late Edward Kennedy since 1962. Now Brown’s victory threatens the healthcare reform bill that Kennedy championed on his deathbed. Democrats could still ram it through before Brown makes it to Washington. But potential legal challenges make that unlikely.
As it is, Brown’s election is enough of a systemic shock to freeze the political process on Capitol Hill. Moderate Democrats in both chambers are nervous about their previous "yes" votes for healthcare. They may be unwilling to make any more. The prospects look even bleaker for cap-and-trade energy legislation, a bill with even less support than healthcare. Financial reform legislation was already likely to get milder rather than stronger. But not so the rhetoric. Unable to trumpet the economy, hitting Wall Street is one of the few political bullets Democrats have left.
So expect the Obama administration to go all out for the bank tax with increasingly harsh words for big financial institutions. Democrats may also be more willing to consider controversial proposals banks hate, like letting judges rework mortgages. But given the Massachusetts precedent, it may not be enough to save the party from a wipeout in the fall.
New York Governor David Paterson of Seeks Huge Cuts
Gov. David A. Paterson proposed on Tuesday what would be the largest cut to school aid in more than two decades and nearly $1 billion in new or increased taxes and fees as he unveiled his budget, a plan that is likely to be the first chapter in a prolonged battle with the Legislature. Searching for new sources of tax revenue amid a fiscal crisis, the governor proposed legalizing mixed martial arts, allowing the sale of wine in grocery stores, taxing bottled soft drinks, taxing cigarette sales on Indian reservations and deploying speed-enforcement cameras in highway work zones.
He even proposed charging fees to many families that enroll in an early intervention program for children with autism, attention deficit disorder and other special needs, and delaying one of his signature achievements a plan to increase monthly welfare allowances. Facing a $7.4 billion deficit this year, the governor is presenting a relatively lean budget by the standards of a state government accustomed to unrestrained spending. His office also delivered more sobering news, projecting that the state's income will not return to the levels seen before the financial crisis until 2013.
The overall budget, including federal matching funds, would grow to $134 billion, up $787 million, or 0.6 percent, from the current fiscal year, which ends on March 31. State spending would increase $745 million, or 0.9 percent, to nearly $80 billion. "This is not a budget of choice; this is a budget of necessity," Mr. Paterson said in a speech to the Legislature on Tuesday morning. "Ladies and gentlemen, the days of continuing taxation and the days of continuous spending have got to end," he added. "The era of irresponsibility has got to stop. The age of accountability has arrived."
Several dozen lawmakers skipped the speech, which took place in a large egg-shaped auditorium here, and those who did attend greeted the governor's remarks with polite, if tepid, applause. Mr. Paterson has had a tense relationship with fellow Democrats, who control the Legislature, sometimes by design as he has sought to capitalize on voter discontent with the array of scandals emanating from Albany. Lawmakers expressed a mix of caution and skepticism on Tuesday. "Some of the stuff is retreads from last year that never quite made it, and I imagine they'll probably meet the same fate," said Senator Diane J. Savino, a Democrat representing Brooklyn and Staten Island, who singled out the soda tax and the proposal to allow groceries to sell wine.
Senator Malcolm A. Smith, a Queens Democrat, said the governor should not have allowed for an even modest rise in spending. "I don't think we really should be increasing it at all," said Mr. Smith, the Senate president. Senator Dean G. Skelos, leader of the Senate Republicans, said, "The greatest danger" was "the one posed by Assembly and Senate Democrats who no doubt will push to further increase spending and taxes just like they did last year." The leaders of the Legislature Senator John L. Sampson of Brooklyn and the Assembly speaker, Sheldon Silver of Manhattan said they needed more time to review the proposals.
As he faces an uphill election battle, Mr. Paterson's budget is also a break from the typical practice of robust budgets in election years. With no money to throw at preferred interest groups, Mr. Paterson is betting that voters will reward him as a responsible steward instead of punishing him as a Scrooge. His plan would cut school aid by 5 percent in a state with the highest per-capita spending on education. It would also slow the growth of spending on Medicaid, reduce by $1 billion spending on state agencies and eliminate $300 million in undesignated annual aid to New York City.
But Mr. Paterson avoided harsher medicine. He has made no significant cuts to the state's work force and even assured union leaders that he would not seek layoffs this year, a risky move as the state faces huge deficits in the coming years. His plan also assumes that there will be a significant recovery this year in the state's tax collections and relies on a number of recycled proposals. A new tax on sugared sodas, $1.28 per gallon, would yield $465 million, similar to a proposal that Mr. Paterson made last year but dropped amid resistance from the Legislature and companies like PepsiCo Inc., which is based in Purchase, N.Y.
Mr. Paterson is also proposing an increase in cigarette taxes, raising the tax per pack by $1, to $3.75, a change that would bring total taxes in New York City to $5.25 per pack. One of the most controversial measures is Mr. Paterson's proposal to slash school aid. Under the plan, wealthier districts would be hit hardest, a strategy that has long been fought by the State Senate, especially by senators from Long Island. Billy Easton, executive director of the Alliance for Quality Education, called it "a colossal reversal of New York State's commitment to providing every child with a real opportunity to learn."
Mr. Paterson is also seeking to shrink the state's troubled youth prison system, which is facing federal scrutiny and a class-action lawsuit. He wants to close perhaps the most infamous institution, Tryon Boys Residential Center in Fulton County, where a 15-year-old boy died in November 2006 after workers pinned him to the floor. Mr. Paterson also proposes consolidating or shrinking three other youth centers.
Another proposal would introduce fees to a state program that provides early intervention services for about 74,000 special-needs children. Families would be charged on a sliding scale, with fees starting at $180 a year for those with a household annual income of at least $55,126 and topping out at $2,160 a year for those earning at least $198,451. Mr. Paterson is also proposing new assessments totaling $240 million on the state's powerful health care industry on top of the nearly $1 billion in cuts in payments to health care providers.
He would close two tax loopholes, including one that allows people earning severance packages to avoid paying state income tax if they move out of the state. And he is proposing to restructure the state's property tax relief program, known as Star, to make it less beneficial for the wealthy. Budget watchdogs had a mixed reaction, although most said that the governor's proposal lacked the gimmickry that had characterized many previous budgets. "It looks pretty clean," said Elizabeth Lynam, a deputy research director at the Citizens Budget Commission, a nonprofit organization. "On the whole, I think it makes a reasonable down payment on the problems the state is facing."
Edmund J. McMahon, director of the Empire Center for New York State Policy, a conservative-leaning research group, said the governor was still proposing to spend too much. "What they're saying is, 'Look, we're below inflation now isn't that great?' " Mr. McMahon said. "The problem is you were several multiples of inflation ahead of personal income during one of the steepest recessions in recent history and you've got a lot of catching up to do, so this isn't good enough."
Unfunded Benefits Dig States' $3 Trillion Hole
Everyone seems to know the current path of federal fiscal policy is a deathtrap over the long term. What's peculiar is the relative inattention to the balance sheets of state and local governments. Hidden behind accounting fictions, the politically unspeakable reality is that public employee pension systems are under-funded by more than $2 trillion. Add more than $1 trillion in unfunded health-care benefits for retired public employees, and state governments face protracted structural deficits ranging from challenging to insurmountable.
Unfunded promises are the equivalent of government debt. The burden of promises made by state governments to their employees -- effectively an invisible wealth transfer from future taxpayers to current and prospective public-sector employees -- amounts to about one quarter of U.S. gross domestic product. The strength and durability of the current economic recovery are unknowable; that state and local governments, which employ one in nine workers, will be a drag on that recovery is certain.
Ultimately, mathematically unsustainable trends must reverse. As with New York City in the late 1970s, eventually the federal government may get involved in redefining the services state and local governments provide, the benefits paid to public employees and the burdens on taxpayers. States cannot kick the can down the road ad infinitum.
The starting point for addressing the long-term policy challenge is recognizing the math. Government accounting standards make a series of benign assumptions about the future and ignore the actual market values of pension investment portfolios. By those standards, public pension plans are 88 percent funded. Unfortunately, government accounting rules create economic fictions.
If we tweak one variable and use estimated real market values of pension investment portfolios for Dec. 31, 2009, pensions are about 75 percent funded. Using the more conservative standards imposed on every corporate pension plan, state plans are only about 60 percent funded, which translates into a shortfall of more than $2 trillion relative to the funding that should exist today.
The severity of the problem and the short-term focus of the interested parties create powerful incentives for elected officials and others to avoid doing the math. In New Jersey, some of us for years publicly and repeatedly suggested that the real shortfalls were multiples of official government actuarial figures. Over time, those draconian assessments regrettably proved to be correct. But leading local newspapers showed zero curiosity about the limits of government accounting and refused even to publish the warnings on the grounds that readers would be confused.
In theory, exceptional investment returns could cover any funding gap. But beyond the improbability of sustained returns above historic norms, a skeptic might argue public pensions frequently tend toward an investment process heavily geared toward reputational risk control -- which means averting political criticism -- under the nominal guise of prudent investment management. Although it may be counterintuitive, systems geared toward perceived safety and political risk avoidance may in fact increase investment risk.
My impression is that too many fiduciaries think they can play it safe professionally by mimicking the investment decisions of their peers in other states. Consultants, in turn, tend to be too sensitive to the herding instincts of their clients, reinforcing the trend to invest in ways that are only perceived to be safe.
The investment risk is a perpetual pattern of arriving late in the game to asset classes. Late arrivals create adverse crowding effects that dilute returns. But individual managers avoid what they believe is the greatest risk: failing in isolation. The perception of safety is strongest for investment strategies that have produced recent success and enjoy widespread institutional support. In fact, investment risk is often lowest when perceived risk is highest.
The herding effect is powerfully reinforced by how we interpret our legal responsibilities as fiduciaries. We are held to a prudent man standard. At any point in time, many of us might differ as to what constitutes a prudently positioned portfolio.
But the law in effect creates a safe harbor for fiduciaries imitating the most common strategies of other fiduciaries. The fiduciary at legal risk is the one pursuing an unconventional strategy. So we have an anomaly. Investment success arises from purchasing assets that are cheap because they are undervalued by the crowd. But the only unassailable defense against legal exposure is pursuit of the crowd.
In looking at the pension problem, I would draw three broad inferences.
First, there is a correlation in government between the creation of long-term liabilities and the propensity to rely on fantasy math.
Second, the parties to the arrangement suffer to the extent they fail to understand the math.
Third, there is an inverse correlation between the magnitude of a shortfall and the visibility of the issue. Precisely because the size of the problem precludes easy answers, it lies beneath the surface of the public dialogue.
Dubai's debt could be as much as $170 billion
The total debt of cash-strapped Dubai could be as much as $170 billion, much higher than earlier reported, according to a report by EFG-Hermes regional investment bank. "The total debt held by Dubai Inc could well be in the range of 130-170 billion dollars," the bank said in its 2010 UAE Yearbook, a copy of which was received by media on Tuesday. Dubai Inc is a term used to refer to the Dubai government and its government-related entities.
Dubai shook world markets in November when it said it wanted to request a freeze on debt repayments by its largest and most-indebted conglomerate, Dubai World. At the time, Dubai's total debt, including that of its state firms, was reportedly 80 billion dollars, with Dubai World owing 59 billion dollars. EFG Hermes said it estimated Dubai Inc's capital market debt, including bonds and syndicated loans, to have risen to 96.6 billion dollars in 2009, including funds raised by the government to meet debt obligations.
But it pointed to upside risks, which could take the total debt to $170 billion, highlighting a lack of data on bilateral loans between Dubai Inc and banks. "Bilateral lending ... is a bigger concern to us since the scale of lending could be very large and data are practically non-existent," the bank said. It estimated that the local Emirates NBD bank alone has roughly $24 billion in bilateral loans to Dubai Inc. It also warned that there could be some capital market debt that is unaccounted for.
Meanwhile, EFG-Hermes said voluntary restructurings of Dubai Inc's debt are likely, as around 75 percent of Dubai Inc's debt, which falls due in 2010-2011, is from syndicated loans. "The creditors involved are a limited number of banks, which will most likely take a relationship-based, long-term view of these liabilities. Therefore, we expect a high degree of voluntary restructuring," it said. Last month, international fears loomed over Dubai's ability to repay maturing Islamic bonds worth 4.1 billion dollar owed by Dubai World's property arm, Nakheel, when they were due on December 14.
But the payment was made thanks to last-minute financial aid extended by oil-rich Abu Dhabi. Dubai World has already started negotiations with its creditors to restructure the debt of its troubled subsidiaries, amounting to 22 billion dollars. Abu Dhabi has so far pledged 10 billion dollars to help fellow emirate Dubai sort out the debt problems of its firms, in addition to 10 billion dollars made available by the Abu Dhabi-based central bank of the United Arab Emirates.
It's Time to Get Practical
Ham radio operators were fired upon when they tried to reach Port Au Prince to assist in setting up communications. They were fired upon by escaped convicts. Gangs return to Haiti slum after quake prison break. The gangs also went to the Justice Ministry and burned everything that still stood in order to destroy all criminal records forever in Haiti. They are armed with automatic weapons. They are killers. And now they are back in the population, en masse.
There are reasons why I tell people that they need to be prepared to defend themselves. Those of you who think you are safe in some gun control country like Canada or Britain and who live out in the countryside might want to ask some of the Serb rural folk how that turned out for them. Or maybe even how the wealthy fared in the former USSR as it crumbled. Those bent on evil towards their fellow man will always find a way to arm themselves. Britain has a larger firearms problem now than any time in the last 120 years and what is the British response? To propose more gun control laws. Gee, the definition of insanity is continuing to do the same thing over and over and expecting a different result.
Some of you don't like this. Some of you will rail against it. Too bad. Homo sapiens is the red toothed ape. He is a murderer and a thief, by evolutionary selection. Wishing won't change that. Wishing didn't help the people in Haiti either as the machinegun and machete armed gangs descended on their neighborhoods, did it? As civilization continues the slow slide into the abyss, you need several things, among them are remoteness from most people and a way to defend yourself.
If you don't have those, I don't care how much food you can grow or how many PV cells you have or how good your insulation is. No, I am not talking of living like a hermit in a cabin. Find a small rural town at least 4 hours from any city over 100,000 population, preferably from any over 50,000 population. Find that town, become a member, become part of the community, and be prepared to defend it, even while you plant your garden, tend your goats, and repair your house.
At its peak, Rome was a million people. Not long after it was 30,000. No, those people didn't just all migrate to the countryside to become peasants. Most of them died. A large number of them were deliberately killed. Past is prologue. Serbia, Haiti, Somalia, Iraq - As Matt Savinar occasionally says, "The future is already here. It's just not evenly distributed yet." You still have some time, people. Use it. And those of you who think things can still be fixed... good luck to you. You'll need that and an entire Santa Claus sleigh of miracles. Everyone else should be getting very practical already.
Moscow’s stray dogs
by Susanne Sternthal
Russians can go nutty when it comes to dogs. Consider the incident a few years ago that involved Yulia Romanova, a 22-year-old model. On a winter evening, Romanova was returning with her beloved Staffordshire terrier from a visit to a designer who specialises in kitting out canine Muscovites in the latest fashions. The terrier was sporting a new green camouflage jacket as he walked with his owner through the crowded Mendeleyevskaya metro station. There they encountered Malchik, a black stray who had made the station his home, guarding it against drunks and other dogs. Malchik barked at the pair, defending his territory. But instead of walking away, Romanova reached into her pink rucksack, pulled out a kitchen knife and, in front of rush-hour commuters, stabbed Malchik to death.
Romanova was arrested, tried and underwent a year of psychiatric treatment. Typically for Russia, this horror story was countered by a wellspring of sympathy for Moscow’s strays. A bronze statue of Malchik, paid for by donations, now stands at the entrance of Mendeleyevskaya station. It has become a symbol for the 35,000 stray dogs that roam Russia’s capital – about 84 dogs per square mile. You see them everywhere. They lie around in the courtyards of apartment complexes, wander near markets and kiosks, and sleep inside metro stations and pedestrian passageways. You can hear them barking and howling at night. And the strays on Moscow’s streets do not look anything like the purebreds preferred by status-conscious Muscovites. They look like a breed apart.
I moved to Moscow with my family last year and was startled to see so many stray dogs. Watching them over time, I realised that, despite some variation in colour – some were black, others yellowish white or russet – they all shared a certain look. They were medium-sized with thick fur, wedge-shaped heads and almond eyes. Their tails were long and their ears erect. They also acted differently. Every so often, you would see one waiting on a metro platform. When the train pulled up, the dog would step in, scramble up to lie on a seat or sit on the floor if the carriage was crowded, and then exit a few stops later. There is even a website dedicated to the metro stray (www.metrodog.ru) on which passengers post photos and video clips taken with their mobile phones, documenting the ?savviest of the pack using the public transport system like any other Muscovite.
Where did these animals come from? It’s a question Andrei Poyarkov, 56, a biologist specialising in wolves, has dedicated himself to answering. His research focuses on how different environments affect dogs’ behaviour and social organisation. About 30 years ago, he began studying Moscow’s stray dogs. Poyarkov contends that their appearance and behaviour have changed over the decades as they have continuously adapted to the changing face of Russia’s capital. Virtually all the city’s strays were born that way: dumping a pet dog on the streets of Moscow amounts to a near-certain death sentence. Poyarkov reckons fewer than 3 per cent survive.
. . .
Poyarkov works at the A.N. Severtsov Institute of Ecology and Evolution in south-west Moscow. His office is small, but boasts high ceilings and tall windows. Several wire cages sit on a table in the centre of the room. Inside them, four weasels scurry through tunnels and run on a wheel. Poyarkov and I sit near the weasels and sip green tea. He first thought of observing the behaviour of stray dogs in 1979, and began with the ones that lived near his apartment and those he encountered on his way to work. The area he studied came to comprise some 10 sq km, home to about 100 dogs. Poyarkov started making recordings of the sounds that the strays made, and began to study their social organisation. He photographed and catalogued them, mapping where each dog lived.
He quickly found that the strays were much easier to study than wolves. "To see a wild wolf is a real event," he says. "You can see them, but not for very long and not at close range. But with stray dogs you can watch them for as long as you want and, for the most part, be quite near them." According to Poyarkov, there are 30,000 to 35,000 stray dogs in Moscow, while the wolf population for the whole of Russia is about 50,000 to 60,000. Population density, he says, determines how frequently the animals come into contact with each other, which in turn affects their behaviour, psychology, stress levels, physiology and relationship to their environment.
"The second difference between stray dogs and wolves is that the dogs, on average, are much less aggressive and a good deal more tolerant of one another," says Poyarkov. Wolves stay strictly within their own pack, even if they share a territory with another. A pack of dogs, however, can hold a dominant position over other packs and their leader will often "patrol" the other packs by moving in and out of them. His observations have led Poyarkov to conclude that this leader is not necessarily the strongest or most dominant dog, but the most intelligent – and is acknowledged as such. The pack depends on him for its survival.
Moscow’s strays sit somewhere between house pets and wolves, says Poyarkov, but are in the early stages of the shift from the domesticated back towards the wild. That said, there seems little chance of reversing this process. It is virtually impossible to domesticate a stray: many cannot stand being confined indoors. "Genetically, wolves and dogs are almost identical," says Poyarkov. "What has changed significantly [with domestication] is a range of hormonal and behavioural parameters, because of the brutal natural selection that eliminated many aggressive animals." He recounts the work of Soviet biologist Dmitri Belyaev, exiled from Moscow in 1948 during the Stalin years for a commitment to classical genetics that ran counter to state scientific doctrine of the time.
Under the guise of studying animal physiology, Belyaev set up a Russian silver fox research centre in Novosibirsk, setting out to test his theory that the most important selected characteristic for the domestication of dogs was a lack of aggression. He began to select foxes that showed the least fear of humans and bred them. After 10-15 years, the foxes he bred showed affection to their keepers, even licking them. They barked, had floppy ears and wagged their tails. They also developed spotted coats – a surprising development that was connected with a decrease in their levels of adrenaline, which shares a biochemical pathway with melanin and controls pigment production. "With stray dogs, we’re witnessing a move backwards," explains Poyarkov. "That is, to a wilder and less domesticated state, to a more ‘natural’ state." As if to prove his point, strays do not have spotted coats, they rarely wag their tails and are wary of humans, showing no signs of affection towards them.
. . .
The stray dogs of Moscow are mentioned for the first time in the reports of the journalist and writer Vladimir Gilyarovsky in the latter half of the 19th century. But Poyarkov says they have been there as long as the city itself. They remain different from wolves, in particular because they exhibit pronounced "polymorphism" – a range of behavioural traits shaped in part by the "ecological niche" they occupy. And it is this ability to adapt that explains why the population density of strays is so much greater than that of wolves. "With several niches there are more resources and more opportunities." The dogs divide into four types, he says, which are determined by their character, how they forage for food, their level of socialisation to people and the ecological niche they inhabit.
Those that remain most comfortable with people Poyarkov calls "guard dogs". Their territories tend to be garages, warehouses, hospitals and other fenced-in institutions, and they develop ties to the security guards from whom they receive food and whom they regard as masters. I’ve seen them in my neighbourhood near the front gate to the Central Clinical Hospital for Civil Aviation. When I pass on the other side with my dog they cross the street towards us, barking loudly.
"The second stage of becoming wild is where the dog is socialised to people in general, but not personally," says Poyarkov. "These are the beggars and they are excellent psychologists." He gives as an example a dog that appears to be dozing as throngs of people walk past, but who rears his head when an easy target comes into view: "The dog will come to a little old lady, start smiling and wagging his tail, and sure enough, he’ll get food." These dogs not only smell who is carrying something tasty, but sense who will stop and feed them.
The beggars live in relatively small packs and are subordinate to leaders. If a dog is intelligent but occupies a low rank and does not get enough to eat, he will separate from the pack frequently to look for food. If he sees other dogs begging, he will watch and learn. The third group comprises dogs that are somewhat socialised to people, but whose social interaction is directed almost exclusively towards other strays. Their main strategy for acquiring food is gathering scraps from the streets and the many open rubbish bins. During the Soviet period, the pickings were slim, which limited their population (as did a government policy of catching and killing them). But as Russia began to prosper in the post-Soviet years, official efforts to cull them fell away and, at the same time, many more choice offerings appeared in the bins. The strays flourished.
The last of Poyarkov’s groups are the wild dogs. "There are dogs living in the city that are not socialised to people. They know people, but view them as dangerous. Their range is extremely broad, and they are ?predators. They catch mice, rats and the occasional cat. They live in the city, but as a rule near industrial complexes, or in wooded parks. They are nocturnal and walk about when there are fewer people on the streets." My neighbourhood is in the north-west of Moscow and lies between a large wooded park and one of the canals of the Moscow river. Leaving the windows open once the thaw of spring finally took hold, I found myself pulled out of a deep slumber by a cacophony that sounded as if packs of dogs were tearing each other apart in the grounds of our apartment complex. This went on for weeks. I later learned that spring is when many strays mate – "the dog marriage season", as Russians poetically call it.
. . .
There is one special sub-group of strays that stands apart from the rest: Moscow’s metro dogs. "The metro dog appeared for the simple reason that it was permitted to enter," says Andrei Neuronov, an author and specialist in animal behaviour and psychology, who has worked with Vladimir Putin’s black female Labrador retriever, Connie ("a very nice pup"). "This began in the late 1980s during perestroika," he says. "When more food appeared, people began to live better and feed strays." The dogs started by riding on overground trams and buses, where supervisors were becoming increasingly thin on the ground.
Neuronov says there are some 500 strays that live in the metro stations, especially during the colder months, but only about 20 have learned how to ride the trains. This happened gradually, first as a way to broaden their territory. Later, it became a way of life. "Why should they go by foot if they can move around by public transport?" he asks. "They orient themselves in a number of ways," Neuronov adds. "They figure out where they are by smell, by recognising the name of the station from the recorded announcer’s voice and by time intervals. If, for example, you come every Monday and feed a dog, that dog will know when it’s Monday and the hour to expect you, based on their sense of time intervals from their biological clocks."
The metro dog also has uncannily good instincts about people, happily greeting kindly passers by, but slinking down the furthest escalator to avoid the intolerant older women who oversee the metro’s electronic turnstiles. "Right outside this metro," says Neuronov, gesturing toward Frunzenskaya station, a short distance from the park where we were speaking, "a black dog sleeps on a mat. He’s called Malish. And this is what I saw one day: a bowl of freshly ground beef set before him, and slowly, and ever so lazily, he scooped it up with his tongue while lying down."
. . .
Stray dogs evoke a strong reaction from Muscovites. While the model Romanova’s stabbing of a stray demonstrated an example of one extreme, the statue erected in his memory depicts the other. The city government has been forced to take action to protect the strays, but with mixed results. In 2002, mayor Yuri Luzhkov enacted legislation forbidding the killing of stray animals and adopted a new strategy of sterilising them and building shelters.
But until Russians themselves adopt the practice of sterilising their pets, this will remain only a half-measure. One Russian, noting that my male Ridgeback is neutered, exclaimed: "Now, why would you want to cripple a dog in that way?" Even though the city budget allocated more than $30m to build 15 animal shelters last year, that is not nearly enough to accommodate the strays. Still, there is pressure from some quarters to return to the practice of catching and culling them. Poyarkov believes this would be dangerous. While the goal, he acknowledges, "is to do away with dogs who carry rabies, tapeworms, toxoplasmosis and other infections, what actually happens is that infected dogs and other animals outside Moscow will come into the city because the biological barrier maintained by the population of strays in Moscow is turned upside down. The environment becomes chaotic and unpredictable and the epidemiological situation worsens."
Alexey Vereshchagin, 33, a graduate student who works with Poyarkov, says that Moscow probably could find a way of controlling the feared influx. But that doesn’t mean he thinks strays should be removed from the capital. "I grew up with them," he says. "Personally, I think they make life in the city more interesting." Like other experts, Vereshchagin questions whether strays could ever be eliminated completely, particularly given the city’s generally chaotic approach to administration.
Poyarkov concedes that sterilisation might control the number of strays, if methodically conducted. But his work suggests that the population is self-regulating anyway. The quantity of food available keeps the total steady at about 35,000 – Moscow strays are at the limit and, as a result, most pups born to strays don’t reach adulthood. "If they do survive, it is only to replace an adult dog that died," Poyarkov says. Even then, their life expectancy seldom exceeds 10 years. Having spent a career studying the stray dogs of Moscow and tracing their path back towards a wilder state, he is in no hurry to see them swept from the streets.
"I am not at all convinced that Moscow should be left without dogs. Given a correct relationship to dogs, they definitely do clean the city. They keep the population of rats down. Why should the city be a concrete desert? Why should we do away with strays who have always lived next to us?"