"Guests of Sarasota trailer park picnicking at the beach, Sarasota, Florida"
Ilargi: Today we bring you another article from El Gallinazo, who provides the following summary of our financial trials and tribulations. One note on market timing: I can’t seem to make up my mind about what’s more boggling, the governments and banks that spend untold trillions in taxpayers' "money" in head-fake attempts to revive Charles Ponzi, or the gullibility of the taxpayers themselves who sit by idly watching their TV screens while their remaining wealth is being escorted out the front door. To each what they deserve, perhaps. And that's what makes the markets.
El Gallinazo: The Incredible Lightness of the S&P 500
The following is an e-letter which I just received from a dear friend of mine, originally, very much, a Brit. She is an occasional lurker at The Automatic Earth. Adds a personal touch to the debt rattle.
Upon leaving, we bumped into A. I mentioned I had seen you, and he made a comment which irked/perplexed me a bit: something to the effect that his wife (B) and some friends were mad because you told them to pull out of stocks and the 'end' (second crash) never came. I said I had a different take on that and he said he'd like to hear it. Now, I don't read up nearly as much as you do, and it's true I don't read up on any information or sites that might be professing something entirely different (i.e. more 'up-beat'), but even perusing the BBC website, and scanning the TimesFax, it's not a rosy picture out there: Greece, the UK, the elections in France, stuff going on in China....
It just goes to prove that the system as we know it is corrupt because it hasn't gone along with more prosperity and ease for the general public. The UK is letting people know there may be a double-dip coming, taxes on all sorts of extra things are being put into effect there, and I don't think it will be just contained in England. So, I wish I was more well-read and verbally able to make an intelligent response to his comment.
Well, it is irritating, but that's who they are. I am in direct contact by email (and even a Skype) with B, and she brought this up directly with me recently. I told her that I recommended strongly that she dump all her equities when I saw her in FL in early Sept. At that point the S&P was about 1030. It then went up to 1150 but fell back down to 1060 in late Jan), and now is at a post crash high of 1160. So I pointed out to B that even if she had a perfect crystal ball and could time her entrance and exit perfectly, since my advice, she didn't lose that much money (1160-1030), that a second crash is coming, and that safety is better than the risk. She never responded to my observation, but since her husband brought it up at the mention of my name, it would indicate that she is still angry about it. My lesson about all this is not to discuss investments with people of their personality type. It is a no win situation.
I will try to explain briefly what I think is going on in the equities markets. First, the market peaked at the end of the year of 2007 at 1550 (all index numbers are S&P500). The bottom of the drop was on March 9 2009 at 666. Since last year it has climbed back to 1160 as of Friday. Stoneleigh at The Automatic Earth predicted in late March that there would be a very strong suckers' rally, and that the crazy gamblers at The Automatic Earth might consider going long in the market for a while. It would be followed by a second crash even greater than the first, meaning that the index would fall well below 666. She figured it to be in the late summer or early fall. Well, it hasn't happened yet on the first day of Spring..
Timing of these things is very difficult. Stoneleigh goes along with Prechter that the market is a trailing but delicate and accurate thermometer of the herd regarding general optimism and pessimism. However, we are in uncharted waters. The Fed and Treasury have been pissing away about $1 trillion per month of future tax receipts of the American sheeple in order to prop up the banks' balance sheets and gambling losses, the stock market, and the real estate market. This, of course, is huge. They have spent or guaranteed well over the annual GDP of the USA (perhaps twice depending on how you figure it). Nothing like this has ever been done before, at least in the last 300 years. It is a last ditch, Hail Mary pass effort to save the old, corrupt system from collapse, hoping that some sort of miracle will intervene while they are stalling off the final deflationary depression.
In reality, things have continued to worsen in the meantime. Real unemployment is getting worse, but the BLS is hiding the reality through bogus statistics to their U3, which the media touts as "unemployment." They don't count people who have used up all their UE benefits, or people who have gotten one hour work per week, or people who have just given up. I made a recent sarcastic comment at The Automatic Earth that God help us when the "U3 unemployment" drops to 4%. I meant that most people would then be out of work and would have exhausted all their benefits.
The Fed, of course, is engaged in further criminal activity. It is creating and lending money to the former investment banks at essentially a zero interest rate. Some of the banks are borrowing that money and buying 30 year Treasuries at over 4% and pocketing the balance. This of course is total theft from the American people. Think about it - it's not rocket science. Particularly as the Constitution reads that only Congress may mint money. The Fed has also bought over one trillion dollars in GSE Fannie and Freddie toxic waste residential "securities" in order to prop up housing prices.
The government, if you include the Fed in that term, is roughly now issuing north of 85% of all residential mortgage debt. If they had not, housing prices would rapidly fall to a realistic level, which Ilargi and Stoneleigh at The Automatic Earth maintain will eventually be between around 10-20% of the peak 2005 prices. This would bankrupt all the banks so badly they could no longer hide their insolvency through mark-to-fantasy accounting. Many banks are no longer foreclosing on mortgagees who have not paid for half a year or more, because once they foreclose, then the bad debt is forced onto their books, although some banks are fraudulently valuing the foreclosed houses, now on their books, at the level of the original defaulted mortgage.
Additionally, foreclosure proceedings cost the banks an additional $30-50K. But banks can only hold so many houses as titular owners, and if the bank resells the house into the market, then there is no way for them to hide the loss. Ironically, many of the mortgagees, in their great wisdom, are now taking that large additional disposable income that they have acquired by defaulting on the payment on their mortgage, to buy another plasma Hi Res TV or a Caribbean vacation. Thus propping up the GDP number.
As to the stock (equities) market, interesting things are happening. Some of that free Fed money is also going into stocks to prop it up. Most of the trading is now being done by very high speed computers, referred to as 'bots, which react in milliseconds according to complicated algorithms. One wag describe the market as two guys selling a pig back and forth to each other at a slightly higher price each time. Goldman Sachs is also front running the trades with their superbots, plugged in directly to the NYSE computers, and extracting (illegally) about $100M per day from the general equity. In addition, the PPT (plunge protection team – see Wikipedia if necessary) is reversing dips by buying huge S&P futures and futures options, usually using Goldman Sachs or JPMorgan Chase as their proxies, which creates enormous leverage to hoist the market upwards. They are afraid of a herd stampede out of the market (until the trap is set), and don't want any downward movement strong enough to startle the herd.
With interest rates forced this low, the pension fund managers have been forced to double down (befittingly, a Vegas term) into stocks. They lost a shitload of money in the first crash in both equities and real estate, and no longer have nearly enough money to cover their obligations to the pensioners (pension funds and 401-k’s are the only remaining store of wealth of the former middle class, and as Matt Taibbi so vividly put it, they are the remaining prey for the blood funnel of the vampire squid).
And so, since pension fund managers are dealing with OPM (other people's money) and want to hold onto their lucrative jobs as long as possible, they are betting it all on 36 red on the wheel of fortune. When the next crash hits, the pensioners will be totally wiped out. Additionally, the banksters will naked short the equities at that point, which is technically a felony analogous to counterfeiting, but they own all the branches of government now, so no one will enforce it. The result will be that they will make a huge profit on the second crash coming out of the hide of the formerly middle class.
The net result will be a huge, deflationary collapse into a depression that will make the early 1930's look like a walk in the park. This will enable the banksters to buy up all the remaining assets for pennies on the dollar. The reason that Ilargi and Stoneleigh have been scornful of the hyperinflationistas is that the Ponzi "credit money" is so much greater in sheer volume than fiat (paper) money, that it is quite impossible for the central banks, including the Fed, to "print" fast enough and get the new money into the system with any velocity, to compensate for the collapse.
Stoneleigh says that we will probably go into hyperinflation, meaning that dollar currency will be worth next to nothing, in 2-5 years, and after the credit collapse is complete. Ilargi says that the collapse will be so devastating that it is difficult to predict what the financial landscape will look like afterwards. Sort of like trying to navigate in a city you have lived in your whole life after it has been carpet bombed.
So coming back to D's complaint about yours truly, how long can this bullshit Ponzi scheme continue? We really don't know. The central banks have shifted the bankster losses to the taxpayer, and the banksters are now gambling at the casino with more recklessness than ever, since they have proven that they have total control over the governments and central banks. Things have reached the point that private bond holders are getting worried about any more shift of debt to the taxpayer. This has become the last bubble and is referred to in the media as "the sovereign debt crisis."
The TPTB are now sailing between Scylla and Charybdis, and like Ulysses, the Slick Willie of classical times, is sticking wax in everybody's ears. The sovereign debt of the economically weakest governments, the PIIGS of the eurozone, and the recently "freed" Baltics, are starting to creak and pop rivets like a German WWII U-boat trying to dodge depth charges at pressures that it wasn't designed for. Like the U-boat, exactly when they will crush is a mystery other than it must happen eventually. The citizens of Iceland just voted by well over 90% to default on their Ponzi debt to the UK and Holland. Same thing with the equities markets. There is no one to bail out the governments themselves unless the United Federation of Galactic Republics wishes to get involved. Otherwise, sovereign debt collapse is the end of the line. The buck, quite literally, stops there. There are no more bubbles to inflate.
So why didn't the intelligent analysts (maybe 2%) who weren't total whores of the system see that the gangsters would be able to stall off collapse for as long as they have? There are two answers that I can figure:
- Some didn't think they had the capabilities to do so as the level of debt collapse so far exceeds sheer mass government and central bank ability to counter inflate.
- Some didn't think that they would be so reckless. They have gambled the entire future of the world's economy to stall the collapse off for a matter of months - how many months remains to be seen. With the governments also in a debt collapse, the crash will be even more severe than it would have been otherwise.
The clever investment advisers are telling their clients to get out of the stock market. They feel that, at best, the upward leg is stalling, and the chances of further upside gain is completely dwarfed by risk. Insiders, defined as the higher officers of a corporation, are selling 30 times more stock in their respective companies than they purchase. Some like Prechter and Stoneleigh say to go into currency, short term T-Bills, and (Stoneleigh) investing in your doomstead. Some say gold. But gold doesn't do that well in a deflation, particularly during the collapse phase. It also has other problems, like being confiscated by governments as FDR did in 1933.
So there you have it. Turned out to be more than a nutshell.
China Trade Deficit Likely in March
Minister warns China will fight back if declared currency manipulator
The country will probably see a "record trade deficit" in March thanks to surging imports, Minister of Commerce Chen Deming said on Sunday, while warning that Beijing will "fight back" if Washington labels China a currency manipulator. Speaking at the three-day China Development Forum that ends on Monday, Chen said: "I believe there will be a trade deficit in March" - which will be the first since May 2004. After China's exports rebounded in December, US legislators and economists have been demanding the Barack Obama administration label China a currency manipulator in a US Treasury report due out in mid-April, which will make it possible for Washington to slap duties on Chinese imports.
"China's trade surplus with the US has been turned into a key excuse by American economists to pressurize the Chinese government to revalue the yuan," but, ironically, the calls have been growing stronger even as the "surplus keeps falling", Chen said. "It's not rational (for China) to revalue the yuan, as it would hurt both Chinese exporters and American consumers." In the three decades up to the 2008 global financial crisis, China's exports registered annual growth of 20 percent but the surplus with the US contributed a big chunk to China's total. Last year, China had a surplus of $143.38 billion with the US, accounting for a hefty 73 percent of the total.
"The impact of currency revaluation on trade is limited," said Chen. From July 2005 to July 2008, the yuan gained a cumulative 21 percent against the dollar, but China's trade surplus with the US kept rising. When the yuan was steady against the dollar from 2009, the trade surplus dropped 34 percent. Chinese analysts said the Obama administration, under increasing pressure as mid-term Congressional elections draw near, is trying desperate measures to create more jobs and expand exports to placate voters, and the Chinese currency has been made a target. "If the (trade) issue is taken to the WTO, China will respond actively," Chen added.
"China, of course, wants to buy more to balance trade, but it is a pity there are so many things that we cannot buy from the US. The US has set restrictions on exports three times, and it added several categories in 2007, such as computers, aerospace technology and digital machine tools," said Chen. Nobel laureate and economist Joseph Stiglitz told China Daily on the sidelines of the forum that many other factors, such as restrictions on high-tech products, rather than the exchange rate contribute to the US deficit with China. He called on Washington to relax the curbs to balance trade.
The ministry also said on Friday that Washington's method of evaluating trade figures magnifies the deficit with China. "The deficit has been vastly overestimated based on American statistics," and according to the latest report prepared by both sides, the US deficit for 2006 is "26 percent higher than it should have been," Chen said.
China Accuses U.S. of Politicizing Yuan as Trade Surplus Sinks
China warned the U.S. against imposing sanctions over the value of the yuan, arguing that the exchange rate issue has been politicized and that a rise in protectionism threatens the global economic recovery. Pressure on China to strengthen the yuan does "no good to anyone," China’s Commerce Minister Chen Deming said at the China Development Forum in Beijing yesterday. China’s trade balance likely slipped into the red in March, although the yuan was stable, showing that exchange rate changes have a "limited" impact on trade, Chen said.
Tensions over China’s currency are mounting, with President Barack Obama facing increased calls from U.S. lawmakers to step up pressure on China for keeping its exchange rate artificially low. Chen yesterday warned that sanctions against China that amounted to protectionism would hinder growth and raise the risk of a "double dip recession." "No matter how tough both sides sound now, they’ll eventually come back to the negotiation table for a mutually beneficial solution" as any U.S. sanctions will be detrimental to both, Li Wei, an economist with Standard Chartered in Shanghai, said in a phone interview.
In March, China will probably record its first trade deficit since April 2004. The surplus had already narrowed to a one-year low of $7.6 billion in February after a 34 percent decline last year. The U.S. trade deficit was $37.3 billion in January, shrinking from a record $67.8 billion in August 2006 as American consumers slowed spending amidst the recession. The decline in China’s trade surplus failed to appease U.S. lawmakers because 73 percent of the gap was with the U.S., Chen said. That was mainly because of curbs on exports to China, including technologies and parts that China wanted, he said.
Chen said he contacted the U.S. Commerce Department on buying helicopter engines to aid rescue efforts after the Sichuan earthquake in 2008, but was told to wait for permission from the U.S. defense department. He never heard back, and China bought Russian engines instead. He also said he scrapped plans for a few "large-scale" purchasing delegations to the U.S. this year because what companies wanted to buy wasn’t what the U.S. was willing to sell. Chen didn’t give further details on what China wanted to buy. China’s leaders have repeatedly said that their yuan policy isn’t the cause of the U.S. trade gap.
The government has kept the yuan at 6.83 per dollar since mid-2008 to shield exporters from the global recession and a contraction in world trade. It allowed the currency to appreciate 21 percent in the three years before that. The yuan "actually isn’t particularly undervalued anymore," Goldman Sachs Group Inc. Chief Economist Jim O’Neill said last week. "It’s unfortunate that we have so much political angst around this. The key thing is that post-crisis, China is importing a lot."
Increased Chinese spending is a better way of reducing trade imbalances, Morgan Stanley Asia Chairman Stephen Roach said March 19 in a Bloomberg TV interview. "We’re lashing out at China rather than tending to our own business," which is raising U.S. savings, Roach said. China has accumulated a record $2.4 trillion of reserves, and $889 billion of U.S. government debt, partly a consequence of its exchange-rate policy.
Global economic growth would be about 1.5 percentage points higher if China stopped restraining the yuan and running trade surpluses, Paul Krugman, Princeton University professor and Nobel laureate in economics, said at an Economic Policy Institute event in Washington on March 12. He said the U.S. may need to get more aggressive in its talks with China, perhaps by treating the exchange-rate as a countervailing duty or other export subsidy. "We have a world economy which is depressed by China artificially keeping its currency undervalued," Krugman said in a March 19 interview. Five senators, including Charles Schumer of New York and Lindsey Graham of South Carolina, last week introduced legislation to make it easier for the U.S. to declare currency misalignments and take corrective action. The Treasury Department is to decide next month whether to label China as a currency manipulator.
China "won’t turn a blind eye" if the Treasury Department’s April 15 report labels the Asian nation as a currency manipulator and sanctions follow, Chen said in comments broadcast on China Central Television. The government will "deal with" any escalation of the dispute, he said. The government should be "very careful" in exiting anti- crisis measures, including the exchange rate policy, People’s Bank of China Governor Zhou Xiaochuan said March 6. Phasing out the stimulus package will be "gradual and mild" to ensure a "safe landing," Vice Finance Minister Wang Jun said yesterday at the same Beijing forum, according to a transcript of his comments on sina.com.cn.
Paul Krugman, the Nobel prize winner who threatens the world
by Jeremy Warner
When the self-proclaimed "conscience of liberal America" and a one-time free trader to boot starts arguing for protectionism, you know that things have come to a pretty pass. But that's what's happened over the past week. Paul Krugman, a Nobel Prize-winning economist, has taken to advocating a 25 per cent "surcharge" – he refuses to use the more descriptive term of "import tariff" – on goods from China as a way of bringing the Chinese leadership to heel over currency reform. So potentially dangerous and out of character is this idea that when I first read it, I assumed he was being ironic. But sometimes the cleverest of people can also be the most stupid, and he's now said it so often that you have to believe he's serious.
What he's advocating is trade retaliation so extreme that it would make the 1930s look like a stroll in the park. Contrary to Professor Krugman's naïve assumption that the Chinese would soon cave in and allow their currency to float if confronted by such hard-ball tactics, I am certain that nothing is more guaranteed to produce the opposite response. Professor Krugman's suggestion mines a rich seam of populist US thinking and rhetoric which grows ever more vocal and worrying as the recession persists. What makes Krugman and other highly regarded economists who toe the same line so dangerous is that they give intellectual respectability to a fundamentally disreputable idea.
Unlike Britain, America doesn't really do free-traders. Even progressives, though they may pretend otherwise, are protectionists at heart. And there is a good reason for it. The US is still a largely internalised, self-reliant economy for which trade with the outside world is relatively unimportant. Many Americans have long thought they don't much benefit from globalisation and that they would be better off behind high, protectionist walls. When times are tough, these arguments find ever more traction. I don't want to be unfair on Professor Krugman, for he proposes tariffs only as retaliation against China for supposedly manipulating currency markets to gain unfair competitive advantage. The evidence is admittedly overwhelming, and if next month's biannual currency report by the US Treasury were to set all diplomatic considerations aside, it would undoubtedly find China guilty of manipulation.
In the good times, the mercantilism of Chinese currency intervention was grudgingly tolerated. In return for carrying big current account deficits, America got cheap goods and cheap money. But now, with the advent of the Great Recession, the arrangement looks far from mutually beneficial. The US, it is argued, cannot forever be expected to keep accumulating debt to spend on other countries' exports. It's got to stop. According to estimates by the Washington-based Peterson Institute for International Economics, reducing the current account deficit to a more manageable level of 3 per cent of GDP, worth around $150 billion annually in export growth and import substitution, would create up to 1.5 million jobs. That's not huge in the context of a population of more than 300 million, but it's as good as any fiscal stimulus and, what's more, it is apparently cost-free.
Except of course that it is not. An outbreak of protectionism is just what the still-fragile economic recovery doesn't need. China makes an easy scapegoat for America's ills, but it is not the cause, nor would making it revalue its currency provide the solution. The debate is echoed in Europe, where Germany – an exporter second only to China – finds itself blamed for the eurozone crisis. If only Germany would make itself less competitive, if only Germany would save, invest and export less, then everybody else would be fine. The virtuous find themselves depicted as the villainous. If the argument were not so perverse, it would be laughable.
Let us briefly consider what would happen if Professor Krugman got his way and there was either a 25 per cent devaluation of the dollar against the renminbi or 25 per cent import duties. Almost overnight China would sink into a deep recession as exporters already operating on wafer-thin margins were plunged into insolvency. American business, which relies heavily on China as the assembly plant of choice (guess where iPods are made), would also find itself deep in the mire. Even in the long term, the revaluation would scarcely be more helpful. Over time, Chinese wages would merely deflate relative to US ones to make exports competitive again.
The answer to these trade imbalances lies in structural reform. Regrettably, the changes necessary to produce the virtuous circle of growing trade and prosperity that everyone aspires to cannot occur overnight. Even with a 25 per cent adjustment in the currency, American goods would still be far out of reach of most Chinese consumers. It will take time for domestic demand to reach the levels necessary to mop up the capacity of its formidable export machine. But China is transforming itself as fast as it dares. Sadly, the same cannot be said of the US, where even great thinkers like Krugman are drawn relentlessly back to the tried and failed policies of the past.
Why Should the S&P 500 Care if India Tightens? Hint: "Tighten" Is the Magic Word
by David Goldman
Equity valuation, as I reported last week, has a numerator (expected profits) and a denominator (the discount rate over time), and a discount rate that starts at 0% and slowly works its way up to 3.6% over ten years is as low as we’ve ever had. That extremely steep curve with an anchor at zero serves a central purpose in the post-apocalyptic world of finance: the global carry trade is financing deficits of the major industrial countries ranging from 8% to 15% of GDP. As I showed earlier this week, foreign banks and hedge funds are financing the US deficit at an $800 billion rate, on top of $300 billion in financing from US banks and a dollop from the Fed. The whole massive $1.6 trillion US deficit depends on the carry trade. It’s surreal, scary, and freaky, but them’s the numbers.
In effect the world has turned into the Japan of the 1990s, when the central bank pumped out liquidity at 0% which the banks reinvested in government securities at 50 to 100 bps. There is no reason that this sort of thing cannot go on for quite a while. Japan’s been doing it for almost 20 years. And for 20 years the sure-thing trade has been to short Japanese government debt, and for 20 years that trade has gone wrong. Of course, this sort of arrangement ensures that the zombie financial system eats the rest of the economy, so that the Wall Street zombies turn Main Street into zombies.
If anyone tightens–Paraguay, the Central African Republic, the Seychelle Islands–the word “tighten” will reverberate around the financial markets like the voice of doom. But don’t expect any of the major central banks to tighten any time in the foreseeable future. That really would have apocalyptic consequences.
Fuld, Geithner, Bernanke face Lehman repo quizzing
Lehman Brothers' chief executive and regulators face a testing congressional hearing into the bank's collapse next month after a report found a dubious accounting procedure helped Lehman conceal the extent of its financial -distress. Dick Fuld has kept out of the public eye since a dramatic congressional hearing in 2008 where his grim expression, the pink placards of protesters and haranguing by lawmakers made for telling images of the financial crisis. He now faces another interrogation by lawmakers, along with Tim Geithner, Treasury secretary, Ben Bernanke, chairman of the Federal Reserve, and Chris Cox, the former chairman of the Securities and Exchange Commission.
The hearing, tentatively scheduled for April, has been called by Barney Frank, chairman of the House financial services committee, following a report by Anton Valukas, a court-appointed examiner. The report highlighted Lehman's use of so-called Repo 105 transactions that improved the ailing bank's balance sheet by $50bn (€36.9bn, £33bn) by classifying temporary repurchase agreements as permanent asset sales. In a video interview for the Financial Times' View from DC series, Mr Frank said he would cede to Republican demands to invite Mr Geithner, who was previously president of the New York Federal Reserve, but he accused the party of "amnesia". He said: "They forget that there were Bush administration officials doing this. So we will have Tim Geithner, but also Ben Bernanke and Chris Cox."
Spencer Bachus, the senior Republican on the House financial services committee, said Mr Bernanke had to explain a report in the FT revealing that Merrill Lynch executives had warned the Fed and the SEC about Lehman's accounting practices. Mr Frank said he might call Lehman directors to testify because he believed insufficient attention had been paid to failures of corporate governance in the run-up to the crisis. "I think board directors have been too little accountable here. "The way boards of directors are functioning - it reminds me of what a late, great journalist, Murray Kempton, once said: 'I'm an editorial writer; our function is to come down from the hills after the battle is over and shoot the wounded.' They were supposed to have done something in advance. Firing a CEO after a disaster is not a very good thing to do."
The committee announ-ced the hearing last week but did not disclose the witness list or timing. Asked whether Mr Fuld would appear voluntarily and whether he would answer questions, his lawyer reissued a statement saying he was not involved with the Repo 105 transactions and had worked diligently for Lehman stakeholders. Today the Senate banking committee begins the mark- up of a financial regulation bill designed to prevent a repeat of the collapse of Lehman and AIG bail-out, eventually to be merged with Mr Frank's bill.
The FHA Is Being Run Like A Ponzi Scheme That Will Surely Implode
by John Carney
The FHA is no longer the modest agency that helped make homes more affordable to generations of Americans.
It has issued hundreds of billions of dollars of mortgages in the last two years. It’s support for the housing market is expected to redouble once again, growing to $1.5 trillion over the next five years.
Along the way to becoming a behemoth, the FHA has radically transformed its business. Very few people seem to understand how thorough going this transformation has been. In many ways, the FHA is being run like a Ponzi scheme. And like all such schemes, it is likely to eventually fail.
A recent paper titled “Reassessing FHA Risk” may have escaped your notice. It is written in a such a sober and academic tone that it hasn’t attracted the attention it deserves. What it describes is truly horrifying: The FHA is unable to assess the risks it is taken and the losses it will face will be massive. Because it does not appreciate its own risk, it is not adequately taking steps to limit the losses.
Prior to our financial crisis, the overwhelming majority of FHA loans were eventually refinanced into non-FHA loans. The authors of the paper take a loan by loan look at FHA insured mortgaged in LA Country. From 2004 to 2006, as many as 80% of loan terminations that the paper studies in LA Country were refinancing into non-FHA supported loans. Basically, people were refinancing to take advantage of better terms available elsewhere or to monetize more of their home equity. For the FHA, these exit refinancings completely removed the FHA’s exposure to these mortgages.
The FHA developed a risk model that allowed for a three-way classification of FHA insured mortgages.
- “Good” – The mortgages that terminate with no claim on FHA insurance. Usually a prepayment of a loan on a house that is refinanced into a non-FHA mortgage.
- “Bad” – Loans that terminate with an claim on the FHA. These were defaults where the mortgage holder was able to get the FHA to pay up.
- “Ongoing” – Loans that were neither good nor bad.
Getting the mix of “Good” and “Bad” loans is important because it gave the FHA a view on what to expect for the “Ongoing” category. If too many loans guarantees wound up in the “Bad,” the FHA could adjust its risk accordingly. If it discovered that too few guarantees were “Bad,” it could decide that it was being too cautious and increase the amount of “Ongoing” loans it took on.
As the paper shows, the refinancing picture has completely changed. These days the vast majority of terminations are refinanced back into FHA mortgages. There’s a scary symmetry to the graphs, which show FHA-to-FHA refinancings growing to 80% of the total in LA County.
Unfortunately, the FHA’s risk models haven’t kept up with this change. The FHA-to-FHA refinancings are categorized as “Good.” Since this is 80% of the FHA’s terminations, the Good group is artificially inflated. This, in turn, means that the FHA would wind up predicting low future losses in the “Ongoing” group. In truth, all these loans are “Ongoing” and the FHA-to-FHA refinancings tell us nothing about whether or not the FHA should expect to pay out on these loans.
“The model would recover the prediction that all FHA mortgages terminate successfully, and the ongoing risks to FHA would be completely mis-specified. That is, the new FHA mortgages that are created by these streamline refinances would be predicted to have too high a probability of terminating in the Good group in the future,” the authors of the paper write.
Obama Pays More Than Buffett as U.S. Risks Losing AAA Rating
The bond market is saying that it’s safer to lend to Warren Buffett than Barack Obama. Two-year notes sold by the billionaire’s Berkshire Hathaway Inc. in February yield 3.5 basis points less than Treasuries of similar maturity, according to data compiled by Bloomberg. Procter & Gamble Co., Johnson & Johnson and Lowe’s Cos. debt also traded at lower yields in recent weeks, a situation former Lehman Brothers Holdings Inc. chief fixed-income strategist Jack Malvey calls an "exceedingly rare" event in the history of the bond market.
The $2.59 trillion of Treasury Department sales since the start of 2009 have created a glut as the budget deficit swelled to a post-World War II-record 10 percent of the economy and raised concerns whether the U.S. deserves its AAA credit rating. The increased borrowing may also undermine the first-quarter rally in Treasuries as the economy improves. "It’s a slap upside the head of the government," said Mitchell Stapley, the chief fixed-income officer in Grand Rapids, Michigan, at Fifth Third Asset Management, which oversees $22 billion. "It could be the moment where hopefully you realize that risk is beginning to creep into your credit profile and the costs associated with that can be pretty scary."
While Treasuries backed by the full faith and credit of the government typically yield less than corporate debt, the relationship has flipped as Moody’s Investors Service predicts the U.S. will spend more on debt service as a percentage of revenue this year than any other top-rated country except the U.K. America will use about 7 percent of taxes for debt payments in 2010 and almost 11 percent in 2013, moving "substantially" closer to losing its AAA rating, Moody’s said last week. "Those economies have been caught in a crisis while they are highly leveraged," said Pierre Cailleteau, the managing director of sovereign risk at Moody’s in London. "They have to make the required adjustment to stabilize markets without choking off growth."
Advanced economies face "acute" challenges in tackling high public debt, and unwinding existing stimulus measures will not come close to bringing deficits back to prudent levels, said John Lipsky, first deputy managing director of the International Monetary Fund. All G7 countries, except Canada and Germany, will have debt-to-GDP ratios close to or exceeding 100 percent by 2014, Lipsky said in a speech yesterday at the China Development Forum in Beijing. Already this year, the average ratio in advanced economies is expected to reach the levels seen in 1950, after World War II, he said.
Obama’s unprecedented spending and the Federal Reserve’s emergency measures to fix the financial system are boosting the economy and cutting the risk of corporate failures. Standard & Poor’s said the default rate will drop to 5 percent by year-end from 10.4 percent in February. Bonds sold by companies have returned 3.24 percent this year, including reinvested interest, compared with a 1.55 percent gain for Treasuries, Bank of America Merrill Lynch index data show. Returns exceeded government debt by a record 23 percentage points in 2009.
Berkshire Hathaway’s 1.4 percent notes due February 2012 yielded 0.89 percent on March 18, 3.5 basis points, or 0.035 percentage point, less than Treasuries, composite prices compiled by Bloomberg show. The Omaha, Nebraska-based company, which is rated Aa2 by Moody’s and AA+ by S&P, has about $157 billion of cash and equivalents and about $52 billion of debt. P&G, the world’s largest consumer-products maker, saw the yield on its 1.375 percent notes due August 2012 fall to 1.12 percent on March 18, 6 basis points below government debt. The Cincinnati-based company, rated Aa3 by Moody’s and AA- by S&P, makes everything from Tide detergent to Swiffer dusters.
New Brunswick, New Jersey-based Johnson & Johnson’s 5.15 percent securities due August 2012 yielded 1.11 percent on Feb. 17, 3 basis points less than Treasuries, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. The world’s largest health products company is rated AAA by S&P and Moody’s. Yields on bonds of home-improvement retailer Lowe’s in Mooresville, North Carolina, drugmaker Abbott Laboratories of Abbott Park, Illinois, and Toronto-based Royal Bank of Canada have also been below Treasuries, Trace data show.
"It’s a manifestation of this avalanche, this growth in U.S. Treasury supply which is under way and continues for the foreseeable future, and the comparative scarcity of high-quality credit," particularly in shorter-maturity debt, said Malvey, whose Lehman team was ranked No. 1 in fixed-income strategy by Institutional Investor magazine from 1998 through 2007. Last year’s $2.1 trillion in borrowing by the government exceeded the $1.08 trillion issued by investment-grade companies, the biggest gap ever, Bloomberg data show. Malvey said the last time he can recall that a corporate bond yield traded below Treasuries was when he was head of company debt research at Kidder Peabody & Co. in the mid-1980s.
While Treasuries are poised to make money for investors this quarter, they are losing momentum. The securities are down 0.43 percent in March after gaining 0.4 percent last month and 1.58 percent in January, Bank of America Merrill Lynch indexes show. Benchmark 10-year Treasury yields will reach 4.20 percent by year-end, up from 3.69 percent last week, according to the median forecast of 48 economists in a Bloomberg News survey. Two-year yields will rise to 1.77 percent, from 0.99 percent.
Investors demand about half a percentage point more in yield to own 10-year Treasuries than German bunds of similar maturity, Bloomberg data show. A year ago, debt of Germany, whose deficit is 4.2 percent of its economy, yielded about half a percentage point more than Treasuries. President Obama’s budget proposal would create bigger deficits every year of the next decade, with the gaps totaling $1.2 trillion more than his administration projects, the nonpartisan Congressional Budget Office said this month. Publicly held debt will zoom to $20.3 trillion, or 90 percent of gross domestic product, by 2020, the CBO forecast.
There’s "a lack of a long-term plan to deal with the federal budget deficit," said Gary Pollack, who helps oversee $12 billion as head of fixed-income trading at Deutsche Bank AG’s Private Wealth Management unit in New York. "At some point in time the market may lose its patience." Deutsche Bank and Barclays Plc, two of the 18 primary dealers of U.S. government securities that are obligated to bid at the Treasury’s auctions, say balance sheets of high-rated companies make them more attractive than Treasuries.
Corporate borrowers are reducing debt at a record pace. Companies in the S&P 500 cut their liabilities by $282 billion to $7.1 trillion in the fourth quarter from the prior three months, Bloomberg data show. That represents 28 percent of assets, the least in at least a decade. Investors are accepting smaller premiums to lend to companies, with yields on bonds rated at least AA falling to within 107 basis points of Treasuries on average, Bank of America Merrill Lynch indexes show. That’s down from the peak of 515 basis points in November 2008, and approaching the record low of 36 in 1997.
New York Life Investment Management is adding to bets the difference in yields will continue to shrink. "As the balance sheet of corporate America continues to improve and the balance sheet of the government deteriorates, that spread should narrow," said Thomas Girard, a senior money manager who helps invest $115 billion at the New York-based insurer. "There is some sort of breaking point. The federal government can’t keep expanding its borrowing without having to incur some costs."
For all the concern about U.S. finances, Treasuries are unlikely to lose their role as the world’s borrowing benchmark, said Michael Cheah, who manages $2 billion in bonds at SunAmerica Asset Management in Jersey City, New Jersey. The U.S. has the biggest, most liquid securities markets, said Cheah. Speculating that Treasuries may lose their privileged position is "not a bet I want to put on," said Cheah, who worked at Singapore’s central bank. Yields on 10-year notes are about half their average since 1980.
The last time there was talk of the U.S. losing its status as the world’s benchmark for bonds was in the late 1990s, when the government began amassing budget surpluses in 1998 for the first time in almost three decades. The amount of Treasuries outstanding dropped 8 percent to $3.4 trillion in 2000, the biggest annual decline since 1946. Treasury supply resumed growing in 2001 after two rounds of tax cuts proposed by President George W. Bush led to deficits. Outstanding Treasury supply rose 53 percent to $4.5 trillion in 2007 from 2000 as the U.S. borrowed to finance tax cuts intended to revive a slumping economy. The amount has since risen 64 percent to $7.4 trillion.
More is on the way. The U.S. will sell a record $2.43 trillion of debt in 2010, according to the average forecast of 10 of the 18 primary dealers in a Bloomberg survey. At the same time Treasury sales are rising, the cash position of the largest corporations is swelling. Companies in the S&P 500 held a record $2.3 trillion as of the fourth quarter, Bloomberg data show. High-rated corporate bonds due in three to five years are most likely to yield less than Treasuries, according to Deutsche Bank’s Pollack. The growing supply of Treasuries with those maturities will make government debt a bigger proportion of indexes that fund managers measure their performance against, he said. Managers betting Treasury yields will rise may diversify into corporate debt, Pollack said.
"There’s no natural law that says a Treasury has to yield less than a corporate," said Daniel Shackelford, who is part of a group that manages $18 billion in bonds at T. Rowe Price Group Inc. in Baltimore. "It wouldn’t be the first time that I would scratch my head and say ‘this doesn’t make sense, the market’s behaving irrationally.’ And it can go on for much longer than you may think."
I.M.F. Gives Debt Warning for the Wealthiest Nations
The global economic crisis has left "deep scars" in the fiscal balances of the world’s advanced economies, which should begin to rein in spending next year as the recovery continues, the No. 2 official at the International Monetary Fund said on Sunday in Beijing. In a speech at the China Development Forum in Beijing, the I.M.F. official, John P. Lipsky, who is the first deputy managing director, offered a grim prognosis for the world’s wealthiest countries, which are at a level of indebtedness not recorded since the aftermath of World War II. For the United States, "a higher public savings rate will be required to ensure long-term fiscal sustainability," Mr. Lipsky said.
The American Chamber of Commerce in China released a separate study Monday morning in Beijing showing that American companies increasingly felt unwelcome in China as a result of policies aimed at increasing government procurement from domestic companies instead of foreign ones. The United States and other industrialized countries, as well as some developing countries, have been putting pressure on the I.M.F. to criticize China for its large-scale intervention in currency markets to hold down the value of the renminbi against the dollar. But Mr. Lipsky refrained from chastising China in his speech, which Chinese officials would have found particularly offensive if he had done so in Beijing.
The I.M.F.’s staff concluded in a report last summer that the renminbi was "substantially undervalued, " and that this was contributing to China’s large trade surpluses in recent years. China has blocked the release of that report, a prerogative of the I.M.F.’s member countries, although most allow the release of the I.M.F. staff’s reports on their economies. The Chinese commerce minister, Chen Deming, said Sunday at the same conference that China might run a trade deficit in March, after years of surpluses, said Xinhua, the official news agency.
A trade deficit for the current month would be a public relations bonanza for Chinese officials in pushing back against United States pressures for revaluation of the renminbi. China typically announces its monthly trade during the ninth to 12th day of the next month. If it follows that schedule next month, the trade surplus will be released shortly before the April 15 deadline mandated by the United States Congress to declare whether any foreign country, including China, manipulates the value of its currency.
Western economists have predicted that most, if not all, of China’s trade surplus will evaporate in March, but they have described this as a fluke of the calendar. Virtually all Chinese export factories closed for the last two weeks of February in observance of the Lunar New Year, which was unusually late this year. Many struggled to reopen at full capacity because migrant workers were slow to return after the holidays. The flow of goods to export ports slowed in March as a result, even as imports continued. Mr. Chen also said China would not sit back if the United States declared China a currency manipulator and imposed sanctions, Xinhua reported.
The Commerce Ministry tends to represent the views of exporters. Like the Commerce Department in the United States, the ministry does not have the authority to engage in international currency negotiations. But unlike commerce officials in the United States, who have a strict policy of not commenting on currency issues, commerce officials in China have been outspoken to the domestic Chinese media in recent months in condemning any appreciation of the currency. This has limited the room to maneuver for officials at the central bank and other agencies in charge of currency issues.
Mr. Lipsky said the average ratio of debt to gross domestic product in advanced economies was expected this year to reach the level that prevailed in 1950. Even assuming that fiscal stimulus programs are withdrawn in the next few years, that ratio is projected to rise to 110 percent by the end of 2014, from 75 percent at the end of 2007. The ratio is expected to be close to or to exceed 100 percent for five members of the Group of 7 countries — Britain, France, Italy, Japan and the United States — by 2014. Canada and Germany are the other G-7 members.
"Addressing this fiscal challenge is a key near-term priority, as concerns about fiscal sustainability could undermine confidence in the economic recovery," Mr. Lipsky said. Maintaining public debt at postcrisis levels could reduce potential growth in advanced economies as much as half a percentage point annually, compared with projections before the crisis, he said. To reduce debt ratios to the precrisis average of 60 percent by 2030, he said, would require an eight percentage point swing — to a surplus of about 4 percent of G.D.P. in 2020 from a structural deficit of about 4 percent of G.D.P. in 2010.
The I.M.F. estimates that the discretionary stimulus spending accounts for just 1.5 percent of G.D.P. Mr. Lipsky said that even if that spending were cut, advanced economies would have to take other steps, like changing pensions and health care programs, cutting spending elsewhere and increasing tax revenues. While it makes sense for the world’s largest economies to continue stimulus spending through the end of this year, "fiscal consolidation should begin in 2011, if the recovery occurs at the projected pace," Mr. Lipsky said. Mr. Lipsky also said a "global rebalancing of savings patterns" would be needed to sustain the recovery.
The United States and the European Union have become increasingly concerned about China’s accumulation of an estimated $2.5 trillion in foreign reserves, the result of a large current account surplus with the rest of the world, as well as actions to hold down the value of China’s currency. Many economists say China will eventually need to develop its domestic markets and wean its economy away from a dependence on exports. Mr. Lipsky said China was taking appropriate steps to shift public spending away from physical infrastructure and toward improvements in education, health and social security programs "that will increase productivity and also directly support consumption by lessening the perceived need for precautionary savings."
A sustained increase in China of 1 percent of G.D.P. on health, education and pensions could result in a permanent increase in household consumption of more than 1 percent of G.D.P., Mr. Lipsky said. China should also consider raising household income by shifting the tax burden away from earnings and toward property and capital gains, he said. Fiscal policy is expected to be a top item on the agenda when leaders of the Group of 20 nations gather for a summit meeting in Toronto in June.
UK bankers react with fury to 'bonkers' plan for levy
Bankers vented their anger at proposals from Britain's two main political parties to impose an industry levy that could raise tens of billions of pounds. Senior London bankers said they were "deeply worried" by the proposals that emerged over the weekend for a new tax, adding that if any measure were enacted unilaterally it could have disastrous consequences for the City of London and the financial services industry in the UK. Sources at the UK's major lenders said they were "concerned" and "uncomfortable" with the idea of Britain introducing a levy on the industry. They said that the tax could force banks to move operations overseas. "You feel people in Paris and Frankfurt will be punching the air, saying 'yes'," said one source at a major UK bank.
Nick Anstee, the Lord Mayor of London, said at the weekend that the City would lose out unless the levy was applied globally: "It would be bonkers to do this alone". On Saturday David Cameron, the Tory leader, said that his party will impose a bank levy – being dubbed a "pollution tax" – if it wins the general election. The party would introduce the tax even if there was no international consensus. Chancellor Alistair Darling, meanwhile, is keen on an internationally-agreed levy. He is likely to reaffirm his commitment to this in Wednesday's Budget.
The London-based head of one major international bank said any new tax could have damaging consequences for London as a financial centre. "London is a pretty fragile place at the moment. I'm not sure how much more these guys can mess around with things. Everybody thinks about leaving and banks have already begun moving businesses with no particular ties out of the country," he said. Neither the Government nor the Conservatives have yet given any detail on their proposals, but financiers are anxiously waiting to see what form the levies will take. A bank tax would be seen as a vote-winner, given the billions of pounds of taxpayers' money spent propping up banks such as Lloyds and Royal Bank of Scotland.
However, one senior banking executive said: "There are two things we find uncomfortable. Firstly we are worried that the impact of an additional tax on top of much higher capital requirements will make it impossible for us to maintain lending at its current level. "Secondly, we are concerned at the idea of the UK going it alone on this. There is a genuine feeling at the bank that if you punish the industry too much it will damage London as a financial centre and will force us to look at moving business elsewhere." Mr Cameron admitted a levy would not be popular with the industry but said he would not "shy away from confronting some of the biggest vested interests in our country – the banks". He said that the levy is "fair and necessary".
Mr Darling, speaking on the BBC yesterday, slammed the Conservatives' proposed unilateral levy and said Mr Cameron was "taking a hell of a risk" with jobs in the financial sector. "It is policy made on the hoof. They are getting big judgments wrong and making things up for the next big headline," he said. Lindsay Tomlinson, chairman of the National Association of Pension Funds, came out in favour of the levy. "If you have a situation where a bank is effectively guaranteed by the taxpayer it is not unreasonable that they should be asked to pay for that guarantee," he said.
However, he said it was important that any action should be done on a global basis. "It's very difficult to do anything without global co-ordination," he said. "It would be a little dangerous to do it unilaterally." The Labour and Conservative proposals mirror the action taken by US President Barack Obama, who has outlined a bank levy designed to repay the money lent by the US government during the financial crisis to prop up American banks.
Britain faces a possible Greek scenario, European Union warns
by Chris Marsden
The European Commission has warned that the British government could face a Greek scenario if it does not escalate its drive to impose austerity. EU commissioners stated in a report that Britain’s AAA credit rating was in peril because the Labour government of Gordon Brown had not proposed cuts savage enough to reduce indebtedness. At more than £178 billion, 12 percent of gross domestic product, Britain’s deficit is proportionately on a par with Greece and vastly larger in real terms. The report complains that the UK is not on course to cut its deficit in line with EU rules that government deficits must be below 3 percent of GDP by 2014. Britain is not in the Eurozone, but is heavily dependent on the European economy.
Labour’s pre-budget report announced plans to make cuts of £19 billion, which it said would cut the UK’s deficit to 4.7 percent by 2015. Estimates by the government of the scale of the additional cuts being demanded followed, ranging between £20 billion and £25 billion. The EC report bluntly states, "A credible time frame for restoring public finances to a sustainable position requires additional fiscal tightening measures beyond those currently planned." The report also questions the UK treasury’s forecasts for economic growth of 2 percent in 2010-11 and 3.3 percent throughout each of the following four years. A European official told the BBC, "Britain is being too optimistic about its chances of recovery. It thinks it will be able to come out of this quicker than we think it will."
The markets initially responded by selling off sterling, with the pound falling to a ten-month low against the dollar and below $1.50 to $1.4977. It climbed back after better-than-expected housing data, but remains the worst-performing major currency this year after weakening by 7 percent against the dollar. Bloomberg pointed out, "Futures traders are more bearish than ever on sterling, with wagers on the pound weakening against the dollar outnumbering futures that profit on a rise by eight times more than when George Soros made $1 billion betting against the currency in 1992."
Such speculation is only an expression of the insatiable demands of the global financiers for the working class to be made to pay for the bail-out of the banks and for a more general and sustained restructuring of economic and social life in their interests. They are intent on clawing millions out of the backs of working people to refill state coffers emptied in order to prop up finance houses that failed through unbridled speculation.
To do this they want essential public services to be wiped out and millions thrown into unemployment or put on starvation wages. In the meantime they are glutting themselves once more, making billions by hiking up interest rates on bonds purchased by those governments being denounced as heavily indebted. A withdrawal of an AAA credit rating escalates the cost of servicing a debt to the bankers which have been rescued by the very same governments, threatening entire nations with bankruptcy. These are the rapacious interests that are dictating the political agenda in every country.
The EC report was viewed by the government as more of a threat than a warning, particularly coming in the run-up to an as yet unannounced but probably May 6 general election in which the Conservatives are denouncing the government for being dishonest about the scale of cuts now required. Shadow Chancellor George Osborne said, "The Conservatives have been arguing that we need to reduce our record budget deficit more quickly in order to support the recovery." Tory leader David Cameron said that voters face a choice between a dishonest Labour government putting off difficult decisions and a Conservative party prepared to "roll up its sleeves and get on with the job." Liberal Democrat Treasury spokesman Vince Cable said to be credible, parties needed to show what they would cut.
Brown responded that the Conservatives would "wreck the recovery" by their planned budget cuts. Chancellor Alistair Darling’s budget will be delivered Wednesday this week. He insisted that the EC was "wrong" and that making faster cuts would be harmful to the recovery. Labour has in reality outlined austerity measures that it boasts of being the sharpest and fastest deficit reduction proposal in the G7 leading industrial nations, involving a £38 billion-pound cut in spending starting in 2011 and £19 billion tax increases from April. The government has made clear that it wants to go further, but fears that cuts imposed too quickly would tip the economy back into recession—a position shared by the Bank of England and most leading economists.
It is also aware that to pledge the measures now being called for would guarantee Labour losing the election. These are, however, only tactical differences. Should economic conditions worsen, or the demands for more decisive action continue to escalate, Labour will do what is expected. Chief Secretary to the Treasury Liam Byrne noted that the government’s predictions are based on £25 billion coming from economic growth. If that does not materialise, then the cuts figures outlined by the EC would have to be imposed. The UK economy is in dire straits, and there is every reason to anticipate a worsening of the domestic and global economic situation.
This week the Bank of England’s quarterly bulletin warned that families must expect an ongoing fall in living standards, including an effective pay cut. It was also too early to conclude that unemployment has peaked. Many workers have accepted pay cuts and working part time, but the Bank said that they must now realise that the costs of goods and services will likely continue to rise faster than wages. Wage rises are running at an annual rate of 1.4 percent, and in the private sector at just 0.7 percent—well below inflation. "While pay restraint helped save jobs during the recession, the dawning realisation that this will have to continue for some considerable time if jobs are not to be lost during the recovery will test the goodwill of UK workers to the limit," the report said.
It continued that "There remains a risk of further falls in employment.... Businesses may respond to any future squeeze in profits by shedding staff." Bank policymaker and Monetary Policy Committee member Kate Barker conceded that the economy would re-enter recession this year. John Philpott, chief economist of the Chartered Institute of Personnel and Development, commented, "The likelihood of a ‘jobs-light’ or, worse still, a ‘jobs-loss’ recovery has been of concern to the CIPD for some time."
Officially unemployment fell by 33,000 to 2.45 million in January, standing at 7.8 percent. However, the jobless fall only masks a 14-year low for UK employment. The Office for National Statistics has confirmed that 8.16 million people are now classed as "economically inactive." Fully one in five adults are no longer seeking employment. Long-term unemployment rose by 61,000 to 687,000. Youth unemployment stands at one million, and part-time employment is also at one million. An additional 100,000 people entered education because there are no jobs. This brings those in education to 2.3 million, a record high. The number out of job or economically inactive, therefore, totals 10.6 million or 28 percent of the working population.
It is under these conditions that further cuts will now be made. Jeremy Warner wrote in the Telegraph, "[D]on’t bet on the markets suspending judgement until after polling day. When they come, currency and fiscal crises tend to develop suddenly and without much warning. We may be quite close to that tipping point." The most significant depiction of the acute nature of the ongoing crisis came from the US credit rating agency Moody’s on sovereign debt. Ambrose Evans-Pritchard, again in the Telegraph, noted Moody’s verdict that the United States, the UK, Germany, France, and Spain are "walking a tightrope as they try to bring public finances under control without nipping recovery in the bud."
Moody’s warned of "substantial execution risk" in early withdrawal of stimulus measures, noting that an IMF study said quantitative easing had lopped 40 to 100 basis points off debt costs. But waiting too long was "no less risky." Pierre Cailleteau, the chief author of the report, ended with a sobering word of caution to the ruling elite of the possible implications of their own actions: "Preserving debt affordability at levels consistent with AAA ratings will invariably require fiscal adjustments of a magnitude that, in some cases, will test social cohesion.... We are not talking about revolution, but the severity of the crisis will force governments to make painful choices that expose weaknesses in society."
Interest-Rate Swaps Sting Cities, States
Buyer's remorse has hit some cities and states that did deals with Wall Street in different times. Hundreds of U.S. municipalities are losing money on interest-rate bets they made during the bull market in hopes of protecting themselves from higher rates. The deals backfired when rates fell, shriveling the sums paid to municipalities. Now some are criticizing Wall Street and trying to exit the contracts. The Los Angeles city council approved a measure this month instructing city officials to try to renegotiate an interest-rate deal with Bank of New York Mellon Corp. and Belgian-French bank Dexia SA. The pact, reached in 2006 to help fund the city's wastewater system, currently is costing the city about $20 million a year. The banks declined to say how they would respond to a request to renegotiate.
In Pennsylvania, 107 school districts entered into interest-rate swap agreements from October 2003 to last June. At least three have terminated them. Under one deal, the Bethlehem, Pa., school district had to pay $12.3 million to terminate a swap with J.P Morgan Chase & Co., according to state auditor general Jack Wagner. J.P. Morgan declined to comment. State lawmakers have proposed restrictions on municipalities' ability to use swaps. "It's gambling with the public's money," Mr. Wagner said. "Elected officials are simply no match for the investment banker that's selling the deal."
The Service Employees International Union said Chicago, Denver, Kansas City, Mo., Philadelphia, Massachusetts, New Jersey, New York and Oregon all are in the hole on swaps agreements they made with financial firms. The required payments range from a few million dollars to more than $100 million a year, the union said. Such deals are deepening the misery faced by state and local governments throughout the U.S., already facing their worst financial squeeze in decades because of shrinking tax revenue and stubbornly high pensions and other costs.
Government agencies that saw the transactions as a cushion against fiscal surprises now are being squeezed by the arrangements. The supply of municipal derivatives swelled to more than $500 billion before falling in the past two years, estimates Matt Fabian, managing director at research firm Municipal Market Advisors. Moody's Investors Service says the surge was fueled by Wall Street marketing efforts, demand from state and local governments and "relatively permissive" statutes on the use of swaps in Pennsylvania and Tennessee, both of which are taking steps to tighten rules. Many of the deals generated higher fees for securities firms than traditional fixed-rate debt. Government officials, for their part, entered the deals in hopes of reducing borrowing costs.
The swaps were introduced in many cases along with floating-rate debt that municipalities issued because it was cheaper than traditional fixed-rate debt. Lower interest rates have served them well on this; their borrowing got cheaper. But municipalities also added swaps to the mix, promising to pay a fixed rate to banks, often 3% or more, while receiving payments from banks that vary with interest rates. On the swaps, the municipalities generally have been losers, as the interest that banks have to pay them have often fallen below 0.5%. Government budgets are stretched thin, prompting officials to look for dollars wherever they can. The clashes over the swaps come amid growing scrutiny of the municipal-bond market, where the U.S. government is investigating whether there was bid rigging in certain cases.
Wall Street firms say no one was complaining when the deals were helping municipalities save. Defenders of swaps say they still can help cities if paired with the right borrowing strategy. Some securities-industry officials say they are open to renegotiating with municipalities so long as doing do doesn't cause a tidal wave of demands. "If they can't come to an agreement on how to modify, the contract should stand," said Michael Decker, a managing director at the Securities Industry and Financial Markets Association, a trade group.
Escaping isn't cheap or easy. Under a transaction between Oakland, Calif., and a Goldman Sachs Group-backed venture, Goldman paid the city $15 million in 1997 and $6 million in 2003, according to Oakland financial reports. But now, the city stands to lose about $5 million this year. That money "is coming out of taxpayers' pockets and could be used for other things," said Rebecca Kaplan, a city council member. She wants the city to renegotiate. But the city faces a $19 million termination payment. Oakland officials didn't respond to requests for comment.
Some deals have led to court. Last August, a unit of bond insurer Ambac Financial Group sued the Bay Area Toll Authority for payments it said it was owed under various swap agreements. The authority paid Ambac $104.6 million to terminate the swaps after the insurer's credit ratings were downgraded and bonds associated with the swaps were retired. Ambac claims it is owed $156.6 million under the agreements. The toll authority, which is fighting the claim, said it made the payment, and Ambac sued for the other part of what it says it is owed. An Ambac lawyer couldn't be reached for comment. Next month, Richmond, Calif., is expected to restructure a $65 million agreement with Royal Bank of Canada that could cost the struggling city an estimated $3.5 million a year, based on current interest rates. Under the revised deal, Richmond would make smaller, more regular payments to the bank over time.
In November, RBC and city officials rejiggered a separate transaction that would have cost Richmond about $2.5 million. An RBC spokesman said bank officials are working with the city to "restructure the underlying bonds in a way that best serves the city's interests and those of its residents." The "goal of the original transaction was to lower borrowing costs for the city," the bank spokesman said, adding that the bonds didn't perform s anticipated because of downgrades at bond insurers that backed them. Richmond's vice mayor, Jeff Ritterman, said he still is reviewing next month's proposed restructuring. Financial woes have forced Richmond to cut its budget and lay off employees.
Document: Interest Rate Swap Deals Across the Country
States Look Beyond Borders to Collect Owed Taxes
by Catherine Rampell
When Josh Beckett pitches for the Red Sox at Yankee Stadium, New York collects income tax on the portion of his salary that he earned in New York State. But what about a Boston Scientific sales representative who comes to New York to pitch medical products to a new client? New York has decided it wants a slice of that paycheck, too. Anyone who crosses a state border for work — to make a sales call, say, or meet with a client or do a road show on Wall Street — probably owes income taxes in that state. If you live in Boston but spend one out of 250 workdays this year in New York, you owe New York income taxes on 1/250th of your salary. And vice versa if you are a New Yorker visiting Boston — or Anywheresville, for that matter — for business.
Such laws have been on the books for decades, and they vary by state. But it is only recently, accountants and tax lawyers say, that many states appear to have picked up enforcement, expanding it beyond the wealthiest celebrities and athletes. "The states are all hungry for revenue," said Alan Clavette, an accountant in Newtown, Conn. "We are certainly seeing states like New York and Connecticut looking more and more for executives and everyday taxpayers who may be spending time across the border."
The states, for their part, say better techniques for tracking tax deadbeats, not pressure to fill their budget holes, have prompted them to become more vigorous at enforcing the provision. "We are just trying to make sure our tax laws are complied with," said Richard D. Nicholson, commissioner of the Connecticut Department of Revenue Services. "That’s not driven by a need for revenue. If we’re doing more, it’s because of advances in technology. We can do analysis we could never do before with just paper."
Once upon a time, state tax officials relied on the sports pages and celebrity magazines to see when well-known higher-earners came to town for work. (Yes, even the taxman reads Us Weekly.) For everyone else, it was largely a "don’t ask, don’t tell" world, says James W. Wetzler, the former tax commissioner for New York State, because it was not cost-effective for states to monitor every bricklayer and lawyer crossing a border.
"We tried to preserve a reasonable balance," said Mr. Wetzler, now a director at the firm Deloitte Tax. "We wanted to avoid imposing onerous burdens on people just for us to collect small amounts of revenue."
But now states have greater access to data warehouses that help them better track taxes owed. Real estate transactions, federal data from the Internal Revenue Service, commercial license plates, traffic tickets, bids for government construction projects — all this information, newly digitized and dumped into a computer system, can help states find tax scofflaws. "We’re sort of getting into ‘1984’ land here," said Kenneth T. Zemsky, an accountant and partner at Ernst & Young. "A lot of the reason they went after athletes and entertainers is that they couldn’t find the other people. Now they’re able to get those people, too."
Still, perhaps the best enforcement mechanism may be requiring companies to withhold additional taxes from their employees’ paychecks. State auditors may not be able to monitor every border-crossing, but with corporate payroll managers as their enforcers, they don’t need to. "Our employees call me the ‘Tax Nazi,’ " says Dee Nelson, the corporate payroll manager at the Koniag Development Corporation, a government contractor that works on military projects. "They get really angry at me when we withhold their pay if they do a project in Utah or wherever. And I have to explain this is the law, not me just trying to be a bully."
Ms. Nelson’s employer is based in Anchorage, but at any given time its employees are generally working in five states with five different withholding requirements. She estimates that the administrative work required for managing multistate employees adds about 10 percent to the cost of each project. Many Fortune 500 companies contacted for this article privately acknowledged having been slightly less vigilant than Ms. Nelson about tracking the minute-by-minute movements of their thousands of employees in the past. But these companies also say that they have been subjected to payroll audits more frequently in the last few years and that tax officials have requested travel logs for highly paid employees during these audits.
In some cases auditors check to see if, say, an employee who was reimbursed for airfare to California also had California income taxes withheld from his paycheck. If not, the company can be fined. Finding out that you owe income taxes across the border can raise your overall tax bill, if your home state has a low tax rate (or no income tax rate at all, as in a handful of states). But your tax bill may not rise by much, since most states allow you to deduct income taxes paid to another state.
The bigger burden associated with distributing your taxes to more state governments is the administrative effort it requires, for both employee and employer. Many states require filing a return for a single day’s work. For peripatetic workers like salesmen or consultants, filing a pile of additional state tax returns can become prohibitively expensive, not to mention frustrating. "There’s 50 states out there and 50 different laws," said Nola Wills, senior vice president and chief compliance officer at Harbor America, a financial services company near Houston. "It’s difficult for a small business to have all the information and resources to know that. In most cases their C.P.A. doesn’t know that, either."
So long as there is still a great deal of ignorance about these laws, the states with the most aggressive tax compliance teams have the most to gain. They can siphon off more revenue from their neighboring states than the other way around, all without fear of retaliation from anyone who has the power to vote them out of office. But as more states catch on and start investing in more payroll auditors and data mining tools to get money back, the end result may be an arms race until every state comes out more or less evenly. "If everybody goes after everybody, nobody wins," said Arthur R. Rosen, a New York tax lawyer and partner at McDermott Will & Emery. "In this interstate war of ‘you tax my rich guy and I tax your rich guy,’ it’s just a wash, a preposterous flurry of tax returns."
In the meantime, states may have a new prominent target. Last year President Obama visited at least 30 states. But, like other presidents before him, he plans to file in just one: his home state, Illinois, according to a White House official. State tax auditors, start your engines.
U.S. employer healthcare costs up 7.3 percent in 2009
Average healthcare costs for U.S. employers rose by 7.3 percent in 2009, surpassing inflation and the growth rate in overall healthcare spending, Thomson Reuters reported on Monday. Overall U.S. healthcare spending, including Medicare, Medicaid, and other payers, grew by 4.8 percent in 2009, the report found. "In a year when inflation was non-existent, employer healthcare costs continued to surge," Chris Justice of the Healthcare & Science business of Thomson Reuters, who wrote the report, said in a statement. "This analysis puts the real-world healthcare challenges facing employers into perspective. These cost increases have come at a particularly difficult time for U.S. companies."
Justice and his colleagues analyzed National Health Expenditures data from the Center for Medicare and Medicaid Services Office of the Actuary for the report, available here They said the year-over-year increase compared to a rise of 6.1 percent in 2008. The team at Thomson Reuters, parent company of Reuters, analyzed insurance claims data for 144 small, medium-sized, and large companies that provided health benefits to 9.5 million people. Smaller employers with 5,000 or fewer workers saw costs rise the most, with healthcare spending up 9.8 percent. Medium-sized employers of 5,000 to 50,000 people had a 10-percent rise in costs compared to 6.5 percent in 2008. For large companies with more than 50,000 employees, costs rose 5 percent in 2009, down from 5.8 percent in 2008.
Bernanke Says Large Bank Bailouts ‘Unconscionable,’ Must End
Federal Reserve Chairman Ben S. Bernanke said government bailouts of big financial companies are "unconscionable" and must be ended as part of a regulatory overhaul following the worst financial crisis since the 1930s. "It is unconscionable that the fate of the world economy should be so closely tied to the fortunes of a relatively small number of giant financial firms," Bernanke said yesterday in a speech in Orlando, Florida. "If we achieve nothing else in the wake of the crisis, we must ensure that we never again face such a situation."
Congress is considering a resolution mechanism for financial firms that are so large or interconnected to other institutions that their failure could damage the financial system. A plan by Senate Banking Committee Chairman Christopher Dodd, a Connecticut Democrat, would allow the Federal Deposit Insurance Corp. to liquidate a large firm after a panel of bankruptcy judges determines the company is insolvent and with approval of the Fed, FDIC and Treasury Department. The Fed chairman has faced criticism from Congress for bailouts that he said were intended to prevent a possible depression. Lawmakers including Dodd have criticized the Fed’s purchase of $29 billion of securities in March 2008 to facilitate the merger of Bear Stearns Cos. with JPMorgan Chase & Co., and loans to keep American International Group Inc. from default.
All large financial firms rather than just big banks should be subject to stronger regulation, Bernanke told bankers gathered for the Independent Community Bankers of America convention. Shareholders and creditors should not be protected from losses in any plan, he said. The Fed is revamping its approach to supervision of large banks, using economists and quantitative analysts to help with horizontal reviews targeting risks across the financial system, Bernanke said. "We at the Federal Reserve have been working with international colleagues to require that the most systemically critical firms increase their holdings of capital and liquidity and improve their risk management," he said.
The Fed chief also endorsed the concept of financial firms having "living wills," or plans on how to unwind should they become insolvent. Dodd’s proposal includes a provision that requires large, complex companies to periodically submit "funeral plans" for their quick and orderly shutdown in the event of failure. "An idea worth exploring is to require firms to develop and maintain a so-called living will, which will help firms and regulators identify ways to simplify and untangle the firm before a crisis occurs," Bernanke said.
While the FDIC has the power to take over failing deposit- taking firms and wind down assets, no such authority exists for financial firms that aren’t classified as banks, such as AIG or a hedge fund with extensive links throughout the banking system. The Fed chairman also defended the central bank’s structure, including 12 regional banks, as a useful decentralized network to monitor the financial system and economy. He said the oversight of small banks has been critical to the Fed in setting monetary policy. "A supervisory agency that focused only on the largest banking institutions, without knowledge of community banks, would get a limited and potentially distorted picture," he said.
Answering questions after his speech, Bernanke urged community bankers to help keep the central bank informed about changes in finance and the economy. "We greatly value the input and information we get from community banks all across the country," he said. "In the current crisis, understanding commercial real estate, understanding other problems in credit markets is greatly aided by knowing what’s happening in community banks."
John Bowman, acting director of the Office of Thrift Supervision, called yesterday for the creation of a federal agency to supervise community banks and thrifts. "Whether a community bank holds a state charter, a national bank charter or a federal thrift charter, that institution should not be supervised by the same agency that oversees complex commercial banks," Bowman said in a speech to the conference, according to an OTS release. Bernanke and Fed bank presidents are fighting efforts from Congress to shrink the Fed’s role in bank supervision. Dodd proposed that the Fed’s supervisory authority include only bank holding companies with more than $50 billion in assets, while the Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency would regulate other banks. A bill passed by the House of Representatives in December left the Fed’s current supervisory authority intact.
The Fed oversees about 5,000 bank holding companies and more than 800 state member banks. The Board of Governors in Washington delegates supervisory authority to the regional Fed banks which have examiners on staff. Smaller bankers are on the "front line" of coping with aftershocks from the financial crisis, including "high unemployment, lost incomes and wealth, home foreclosures, strained fiscal budgets," Bernanke said. The central bank chairman didn’t comment directly on the economy or outlook for monetary policy in his remarks. The Fed has kept the federal funds rate target for overnight loans between banks in a range of zero to 0.25 percent since December 2008. Policy makers began using the "extended period" language in March 2009 and have repeated it at each meeting since then.
Judges Rule Fed Can't Shield Discount-Window Use
A federal appeals court ruled Friday that the U.S. Federal Reserve's board of governors must disclose documents related to individual borrowing from its discount window and other "last resort" lending programs. In separate rulings Friday, the U.S. Second Circuit Court of Appeals upheld a lower court's decision granting a request by Bloomberg LP's Bloomberg News for documents related to use of the Fed's discount window and other programs and vacated a separate ruling denying a request for documents by Fox News Network LLC's Fox Business. Both news organizations had sought Fed documents under the Freedom of Information Act and ultimately brought lawsuits after the Fed denied their requests.
Matthew M. Collette, a lawyer for the Fed's board of governors, argued in January that banks would be less likely to use the discount window and other lending-of-last-resort programs if they know their use would be made public. He said at the time that accessing the window carries a negative connotation if use was made public, even when a healthy bank suffering a short-term liquidity issue does it. "The requirement of disclosure under FOIA and its proper limits are matters of congressional policy," U.S. Circuit Judge Dennis Jacobs wrote in the Bloomberg decision. "The statute as written by Congress sets forth no basis for the exemption the Board asks us to read into it. If the Board believes such an exemption would better serve the national interest, it should ask Congress to amend the statute."
Bloomberg sued the Fed's board of governors last year seeking records related to collateral posted in order to access the Fed's Primary Dealer Credit Facility, the discount window, the Term Securities Lending Facility and the Term Auction Facility between April 4, 2008, and May 20, 2008. Bloomberg also sought information about a portfolio of securities supporting a loan extended by the Fed in connection with J.P. Morgan Chase & Co.'s acquisition of Bear Stearns. Fox Business separately sued, seeking access to disclosure about borrowers, their loan amounts and pledged collateral after the Fed temporarily reduced rates and lengthened the terms for money lent through the discount window.
In December, several media companies, including Dow Jones & Co., New York Times Co., the Associated Press and Reuters America LLC, filed an amicus brief with the circuit court backing Bloomberg's request. (News Corp. is the parent company of Dow Jones, publisher of The Wall Street Journal, and of Fox News.) As part of its ruling, the appeals court ordered further searches of lending records held at the individual Federal Reserve banks that are considered administrative records of the Fed board. The case was remanded to the district court to determine if the fruits of those additional searches must be disclosed.
Fed Told to Hand Over Friedman Documents
Lawmakers demanded documents from the Federal Reserve relating to the purchases of Goldman Sachs Group Inc. stock by Stephen Friedman, the former Goldman executive who stepped down as chairman of the Federal Reserve Bank of New York last year because of a controversy over those purchases. Mr. Friedman's Goldman stock purchases, which occurred in December 2008 and January 2009, raised "serious questions about the integrity of the Fed's operations," Edolphus Towns, chairman of the House Committee on Oversight and Government Reform, said in a letter to Fed Chairman Ben Bernanke on Thursday.
Mr. Towns's staff has been investigating the incident, which involves potential conflicts of interest and revolves around complicated rules that oversee the boards of 12 regional Fed banks. A spokeswoman for the Fed said it had received Mr. Towns's request and planned to respond. Mr. Friedman is the former chairman of Goldman Sachs and remains a director of the firm. He served as chairman of the New York Fed from January 2008 until May 2009.
Mr. Friedman's position at the New York Fed board became problematic in September 2008, when Goldman converted itself from an investment bank regulated by the Securities and Exchange Commission to a Fed-regulated bank-holding company. Though executives and directors at investment banks were in the past allowed to serve as chairmen of regional Fed boards, executives and directors of commercial banks couldn't.
The Fed gave Mr. Friedman a temporary waiver from its rules so he could stay on as chairman. While he was waiting for the waiver, Mr. Friedman bought additional Goldman stock.
Mr. Towns asked Mr. Bernanke for a more detailed explanation of the waiver and any records it had related to the decision. "What was the basis for the decision by the Federal Reserve to grant Mr. Friedman this waiver in light of the obvious conflict presented by his role at the New York Fed and his simultaneous role as a Goldman director and shareholder?" Mr. Towns asked. A spokesman for Mr. Friedman said he never violated any Fed rules or policies and that he was asked by the Fed to stay on after Goldman became a bank-holding company. Fed officials have said they needed Mr. Friedman at the New York Fed in late 2008 to help select a president following the resignation of former President Timothy Geithner, who left to become Treasury secretary.
Germany's Merkel Says Greece Doesn't Need Financial Support
German Chancellor Angela Merkel on Sunday said Greece doesn't need financial support and European Union leaders shouldn't make the question of aid for Greece the focus of their summit later this week. In an interview with Deutschlandfunk radio, Ms. Merkel warned other European leaders against unsettling financial markets by raising "false expectations" that there will be a decision on aid for Greece this week. She said Greece should sort out its own debt problems despite growing calls from other European policy makers for Germany to back stronger support for Greece.
Tensions are growing between Germany and other EU countries over Greece's debt crisis and the bloc's wider economic strains ahead of the EU's summit in Brussels on Thursday and Friday. Other European policy makers are becoming frustrated at Germany's blocking of stronger action within the 16-nation euro-currency zone to end uncertainty over whether Greece can repay its debts. Germany's government faces strong domestic resistance from voters and lawmakers to any bailouts of euro-zone members that, unlike Germany, have pursued loose spending policies in recent years.
After Athens said last week that it might turn to the International Monetary Fund for help, European Commission President José Manuel Barroso urged EU member states to agree to a standby-aid package of bilateral loans for Greece at this week's summit. He said that action was needed rapidly. Ms. Merkel, whose approval is vital for any aid because of Germany's financial muscle, on Sunday rejected that assessment. "I don't see that Greece needs money at the moment, and the Greek government has confirmed that. That's why I'd urge us not to stir up turbulence in the markets by raising false expectations for Thursday's council meeting," she said. "I believe that as long as Greece doesn't need help this issue doesn't have to be at the forefront of our talks," she added.
EU leaders are nevertheless expected to discuss the issue, as many countries are eager to end the months of uncertainty surrounding Greece. "There's no looming insolvency," Ms. Merkel said Sunday. Later, the German government issued a statement saying Greek Prime Minister George Papandreou told Ms. Merkel in a telephone conversation Sunday that "Greece needs no financial aid." However, while Greek officials say they aren't asking for money, Prime Minister George Papandreou said last week he wants European governments to put a money offer on the table to show financial markets Greece has a safety net. That would allow Greece to borrow on bond markets at less-punitive interest rates, Mr. Papandreou said. He warned Greece might have to seek IMF help otherwise.
Ms. Merkel recognized that Greece is pressing the EU to make its contingency plans more explicit. "Greece would like to have a certain clarity for an eventuality it can't completely rule out," Ms. Merkel said. She added: "The best solution for the euro is for Greece to resolve its problems by itself—naturally with political support from European leaders." Many other euro-zone members fear that if Greece resorted to the IMF, it would be seen as a sign of weakness that would damage the currency union's credibility. If aid proves necessary, Ms. Merkel would prefer it to come jointly from the IMF and European governments, say people familiar with her thinking. But her finance minister, Wolfgang Schäuble, has expressed strong reservations about involving the IMF. "The messages coming out of Germany are not very clear right now," a Greek official said Sunday.
Ilargi: Ambrose Evans-Pritchard's tirades and rants become more amusing by the day. He now even has a "j'accuse!" in store. Court jester against his own will.
Has Germany just killed the dream of a European superstate?
by Ambrose Evans-Pritchard
So after weeks of Euro-bluff it looks ever more like an IMF rescue for Greece after all, and hence for any other eurozone nation driven to ruin by the wrong monetary policy. German and Dutch leaders have concluded in the nick of time that they cannot defy the will of their sovereign parliaments by propping up a country that lied about its deficits, or risk court defeats by breaching the no-bail-out clause in Article 125 of the EU Treaties. Chancellor Angela Merkel has halted at the Rubicon. So has Dutch premier Jan Peter Balkenende, as well he might in charge of a broken government facing elections in a country where far-right leader Geert Wilders is the second political force, and where the Tweede Kamer has categorically blocked loans for Greece.
The failure of EU leaders to cobble together a plausible bail-out – if that is what occurs at this week’s Brussels summit – is a 'game-changer' in market parlance. Eurogroup chair Jean-Claude Juncker said last month that such an outcome would shatter the credibility of monetary union. It certainly shatters many assumptions. There will be no inevitable move to fiscal federalism; no EU treasury or economic government; no debt union. It is Stalingrad for the federalist camp and the institutions of the permanent EU government. I remember hearing Joschka Fischer, then German Vice-Chancellor, telling Euro-MPs a decade ago that EMU was "a quantum leap ... creating an inexorable federal logic". Such views were in vogue then.
Any euro crisis would force Europe to create the necessary machinery to make it work, acting as a catalyst for full-fledged union. Yet the moment of truth has come. There is no quantum leap. We have a Merkel pirouette. Paris is watching nervously. As Le Monde put it last week, "behind the question of aid to Greece is a France-Germany match that pitches two conceptions of Europe against each other." The game is not going well for 'Les Bleus’. The whole point of the euro for the Quai D’Orsay was to lock Germany into economic fusion. Instead we have fission. EU leaders may yet rustle up a rescue package that keeps the IMF at bay, but alliances are shifting fast. Even Italy has slipped into the pro-IMF camp, knowing that rescue costs can be shifted on to the US, Japan, Britain, Russia, China, and the Saudis, lessening the burden for Rome.
Besides, too much has been said over the last week that cannot be unsaid. Mrs Merkel’s speech to the Bundestag was epochal, a defiant warning that henceforth Germany would pursue the German national interest in EU affairs, capped by her call for treaty changes to allow the expulsion of fiscal sinners from Euroland. Nothing seems so permanent about the euro any more. Days later, Thilo Sarrazin from the Bundesbank blurted out that if Greece cannot pay its bills "it should do what every debtor has to do and file for insolvency. This would be a suitably frightening example for every other potentially unsound state," he said, pointedly excluding France from the list of sound countries.
Dr Sarrazin should be locked up in a Frankfurt Sanatorium. It was such flippancy that led to the Lehman disaster, requiring state rescues of half the world’s financial system. A Greek default would alone be twice the size of the combined defaults by Argentina and Russia. Contagion across Club Med would instantly set off a second banking crisis. Some suspect that ultra-hawks in Germany want to bring the EMU crisis to a head, deeming delay to be the greater danger. How else to interpret last week’s speech by Jürgen Stark, Germany’s man at the European Central Bank, calling for tightening to head off inflation.
This is alarming. Core inflation in Euroland was 0.9pc in February, the lowest since the data series began. It is certain to fall further as the doubling of oil prices fades from the base effect. M3 money has been contracting for a year. Business credit is shrinking at a 2.7pc rate. So, it is not enough for the EU to impose a fiscal squeeze of 10pc of GDP on Greece, 8pc on Spain, and 6pc on Portugal, and 5pc on France over three years, we need a dose of 1930s monetary policy as well to make sure life is Hell for everybody. Be that as it may, Greece’s George Papandreou says his country is in the worst of both worlds, suffering IMF-style austerity without receiving IMF money – which comes cheap at around 3.25pc. So why allow his country to be used as a "guinea pig" – as he put it - by EU factions pursuing conflicting agendas?
The IMF option has its limits too. The maximum ever lent by the Fund is 12 times quota, or €15bn for Greece, not enough to nurse the country through to June. The standard IMF cure of devaluation is blocked by euro membership. So Greece will have to sweat it out with a public debt spiralling to 135pc of GDP next year, stuck in slump with no exit route. The deeper truth that few care to face is that under the current EMU structure Berlin will have to do for Greece and Club Med what it has done for East Germany, pay vast subsidies for decades. Events of the last week have made it clear that no such money will ever be forthcoming.
Let me be clear. I do not blame Greece, Ireland, Italy, or Spain for what has happened. No central bank could have tried more heroically than the Banco d’España to counter the effects of negative real interest rates, but the macro-policy error of monetary union washed over its efforts. Nor do I blame Germany, which generously agreed to give up the D-Mark to keep the political peace. It was the price that France demanded in exchange for tolerating reunification after the Berlin Wall came down. I blame the EU elites that charged ahead with this project for the wrong reasons – some cynically, mostly out of Hegelian absolutism – ignoring the economic anthropology of Europe and the rules of basic common sense. They must answer for a depression.
Uncertainties Pressure Greek Bonds
Doubts over whether European leaders can agree on a detailed financial-aid package for Greece this week put pressure on Greek government bonds Monday and drove up the price of insuring its debt against default. A senior Greek government finance official said there isn't a need to issue new debt until late April and the government hasn't decided when to set its next bond issue. Since the start of the year, Greece has successfully sold two longer-dated bond issues, in addition to raising funds through a private placement and some short-term bill auctions.
Greece needs to refinance more than €22 billion ($29.78 billion) in maturing debt by the end of May. Since the start of the year, Greece has successfully sold two longer-dated bond issues and also raised funds through a private placement and some short-term bill auctions. Greece has to raise about another €16 billion to meet the repayment deadlines, said Deutsche Bank investment strategist Michael Gittler. "Having raised €5 billion with the recent bond issue they now have €7 billion in cash, so the country isn't desperate—yet," he said. "This [summit] meeting and the discussions about Greece are probably the main risk to the markets this week."
Still, the overriding factor in increasing pressure on Greek debt was German Chancellor Angela Merkel's statement on Sunday that all but dashed hopes of an agreement at this week's Brussels summit. Ms. Merkel said Greece hadn't asked for help and warned financial markets against expecting a deal this week, saying it wouldn't materialize. Greek Prime Minister Papandreou asked leaders of the European Union to agree this week on financial backing to shore up investor confidence and bring down the "barbaric" interest rates Greece is forced to pay when issuing new debt. Ms. Merkel's refusal, despite hopes raised for a deal by the European Commission over the weekend, splintered market expectations that a Greek package could come this week.
Greek 10-year government bond yield spreads over euro-zone benchmark German bunds surged to 3.43 percentage points Monday mid-morning from 3.25 percentage points Friday, indicating rising uncertainty on the market. In yield terms, Greek 10-year yields rose to 6.52% Monday from 6.36% Friday. This is more than twice as high as 10-year German bunds trading at around 3.09%. The annual cost of insuring €10 million of Greek government bonds against default rose by €21,000 Monday to €351,400, according to CMA Datavision. Credit Agricole CIB analysts said in a note to clients that the main "supply unknown" for this week "is of course Greece."
Greece is scheduled to pay around €1.65 billion in coupons this week, according to the bank, and thus there will be some Greek liquidity in the market. Also disturbing bond investors were reports that the Greek government has sharply scaled back plans to privatize state-owned companies to around €800 million this year as it realizes that its previous €2.5 billion goal for 2010isn't feasible.
Meanwhile, the Bank of Greece said the Greek economy is due to contract 2% this year, after falling into recession for the first time in more than a decade last year and as the consequences of the country's debt crisis weigh on the economy. "The the most likely reduction in GDP will be in the order of 2%," the Greek central bank said in its annual monetary policy report. The report also said that Greece finds itself in a "vicious circle" as it tries to fix its troubled public finances, which makes forecasts uncertain.
U.S. FDIC shuts down 7 banks, 2010 total now 37
Regulators seized seven more U.S. banks on Friday, as high unemployment and troubled loan portfolios continue to weigh on the sector. The seven failures, which are estimated to cost the government's deposit insurance fund more than $1 billion, bring the 2010 tally to 37 failed institutions. Last year, 140 banks failed. At this week's frantic pace, 365 banks would be shut down by the end of the year.
The Federal Deposit Insurance Corp said Advanta Bank Corp of Draper, Utah; Appalachian Community Bank of Ellijay, Georgia; Bank of Hiawassee, Hiawasee, Georgia; First Lowndes Bank of Fort Deposit, Alabama; Century Security Bank of Duluth, Georgia; American National Bank of Parma, Ohio; and State Bank of Aurora in Aurora, Minnesota were closed. Advanta, at $1.6 billion in total assets and $1.5 billion in total deposits, was the largest of the seven, though the FDIC was unable to find a buyer. The regulator said checks for insured funds would be mailed to account holders on Monday. The FDIC said the banks had about $247,000 in uninsured deposits, though it cautioned that figure was likely to change.
Appalachian had about $1.01 billion in total assets. Community & Southern Bank of Carrollton, Georgia agreed to assume all of Appalachian's $917.6 million in deposits. Bank of Hiawassee had about $377.8 million in total assets. Citizens South Bank of Gastonia, North Carolina agreed to assume all of $339.6 million in deposits. First Lowndes had abut $137.2 million in assets. First Citizens Bank of Luverne, Alabama agreed to assume all $131.1 million in deposits. Century Security had $96.5 million in total assets. Bank of Upson of Thomaston, Georgia agreed to assume all $94.0 million in deposits. American National had $70.3 million in total assets. The National Bank and Trust Company of Wilmington, Ohio agreed to assume $66.8 million in total assets. State Bank of Aurora had about $28.2 million in total assets. Northern State Bank of Ashland, Wisconsin agreed to assume all $27.8 million in deposits.
The seven banks together would cost the FDIC's Deposit Insurance Fund about $1.28 billion. FDIC Chairman Sheila Bair this week said banks are making progress in working through their troubled assets. "We think this is going to peak this year, and it's going to get considerably better next year," Bair told an American Bankers Association conference on Thursday. In the fourth quarter, the banking industry reported a profit of $914 million, compared with a $37.8 billion net loss a year earlier. However, the recovery has been lopsided, with the largest banks enjoying a quicker return to profits.
Smaller institutions are particularly struggling with large concentrations in commercial real estate, a sector that has been slower to unravel. Bankers told Bair at the ABA conference this week that small banks are at a competitive disadvantage. They said larger banks are still considered "too big to fail" and therefore enjoy lower funding costs and an influx of deposits. The FDIC estimates that the total cleanup cost for the bank industry will be $100 billion from 2009 through 2013. Bair said this week that she does not expect the FDIC will have to tap its line of credit with the Treasury Department or charge a surprise fee on the industry to pay for bank failures.
The Most Important Chart of the Century
by Nathan A. Martin
The latest U.S. Treasury Z1 Flow of Funds report was released on March 11, 2010, bringing the data current through the end of 2009. What follows is the most important chart of your lifetime. It relegates almost all modern economists and economic theory to the dustbin of history. Any economic theory, formula, or relationship that does not consider this non-linear relationship of DEBT and phase transition is destined to fail.
It explains the "jobless" recoveries of the past and how each recent economic cycle produces higher money figures, yet lower employment. It explains why we are seeing debt driven events that circle the globe. It explains the psychological uneasiness that underpins this point in history, the elephant in the room that nobody sees or can describe.
This is a very simple chart. It takes the change in GDP and divides it by the change in Debt. What it shows is how much productivity is gained by infusing $1 of debt into our debt backed money system.
Back in the early 1960s a dollar of new debt added almost a dollar to the nation’s output of goods and services. As more debt enters the system the productivity gained by new debt diminishes. This produced a path that was following a diminishing line targeting ZERO in the year 2015. This meant that we could expect that each new dollar of debt added in the year 2015 would add NOTHING to our productivity.
Then a funny thing happened along the way. Macroeconomic DEBT SATURATION occurred causing a phase transition with our debt relationship. This is because total income can no longer support total debt. In the third quarter of 2009 each dollar of debt added produced NEGATIVE 15 cents of productivity, and at the end of 2009, each dollar of new debt now SUBTRACTS 45 cents from GDP!
This is mathematical PROOF that debt saturation has occurred. Continuing to add debt into a saturated system, where all money is debt, leads only to future defaults and to higher unemployment.
This is the dilemma created by our top down debt backed money structure. Because all money is backed by a liability, and carries interest, it guarantees mathematically that there will be losers and that the system will eventually reach the natural limits, the ability of incomes to service debt.
The data for the diminishing productivity of debt chart comes from the U.S. Treasury’s latest Z1 data.
On page two of that report is the following table showing the Growth of Non Financial Debt:
I included Financial debt onto the end of the table, that data comes from page 14 of the Z1 report.
This table makes clear what is happening. Business, household, and financial debt is trying to cleanse itself, to bring the level of debt back within the ability of incomes to support it. Our governments, armed with people who cannot explain the common sense behind debt saturation, are attempting to compensate by producing prolific amounts of Governmental debt.
They feel they must do this because if they do not, then debt and money – since debt backs our money – would both decrease and that would cause the economy to slow. But by adding money, and debt, they have created a sovereign issue where our nation’s income cannot possibly service our nation’s debt. In just the month of February, for example, our nation took in $107 billion, but spent $328 billion, a $221 billion shortfall. That one month shortfall exceeds all the combined shortfalls of the entire Nixon Administration – one month.
This is like an individual earning $5,000 but spending $15,000 a month. Would you lend your money to such an individual?
Last year we spent just under $400 billion on interest on our current debt, plus we spend another $1.5 Trillion buying down rates via Freddie, Fannie, and Quantitative Easing. That’s $1.9 Trillion spent on interest, most of which wound up in the hands of the central banks and their surrogates. Compared to our $2.2 Trillion in income, interest expense last year nearly took it all. That means that nearly all your productive effort used to pay Federal taxes last year were transferred to the central banks.
Modern monetary theory does not understand, nor does it correctly describe the debt backed money world in which we live. Velocity, for example, slows as debt saturation occurs. This is only common sense, and yet the formulas do not account for the bad math of debt, nor its non linear function. Velocity is blamed partially on the psychology of “consumers.” What nonsense. It is as mechanical as the engine in your car, it was designed that way. Once people, businesses, and governments become saturated with debt, new money/ debt when introduced can only be used to service prior existing debt.
Thus money creation at the saturation point stops adding to productive efforts and becomes a roll-over affair with only the financial services industry profiting via interest and fees. In other words, money goes out and circles right back around to the banks instead of rippling through a healthy non saturated economy. If you cannot follow that most simple logic, then going to Harvard will not help you.
Below is a chart of the Gross Federal Debt, it is now $12.6 Trillion dollars and headed straight up, a classic parabolic rise:
Below is a chart of the Gross Federal Debt expressed in year-over-year change in billions of dollars. The same phase transition of debt saturation is clear as a bell.
Below is a chart of Federal Net Outlays, parabolic and again headed straight up:
Clearly this is not sustainable and that means that change to our monetary system is rapidly approaching. No, it will not be left to your children or your grandchildren. It is an immediate problem and fortunately there is an immediate solution. That solution is called “Freedom’s Vision.” It can be found at SwarmUSA.com.
That chart of diminishing returns is the window to understanding why humankind is trapped in a central banker debt backed money box. No money for NASA manned space flight – NASA’s total budget a puny $18 billion in comparison to the $1.9 Trillion that went to service the bankers last year. One half the schools closing in Kansas City, states whose debts and budget deficits seem insurmountable all pale in comparison to how much money went to service the use of our own money system.
It doesn’t have to be like that, in fact it’s a ridiculous notion that the people of the United States, or any country, should pay private individuals for the use of their money system. Ridiculous!
It’s difficult to see this from inside the box, so let’s look at what happened to Iceland to illustrate. The central banks of the world created financial engineered products and brought them to the banks of Iceland. These products created a boom in the amount of credit. Prices of everything rose, and the people of Iceland then had no choice but to go along for the bubble ride. Then with incomes no longer able to service the bubble debt, the bubble collapsed.
To “save the day,” the IMF and central bankers around the world rushed in to “rescue” the people, banks, and government of Iceland. They did this by offering loans... documents that create money simply by signing a contract of debt servitude. That contract demanded ownership of Iceland’s infrastructure such as their geothermal electrical generating plants. It also demanded the future productivity of the people of Iceland in that they should work and pay high taxes for decades to pay back this “debt.” Debt that they did not create or agree to service in the first place!
There were some wise people who saw through this central banker game and started a movement. They DEMANDED that the President of Iceland put the debt servitude to a vote and the people wisely said, “Central Bankers Pound Sand!”
Thus they now control their own destiny, their future productive efforts still belong to them.
It’s easy to see from the outside looking in, but it’s not so easy to see that it's EXACTLY the same thing occurring in the United States and no one is rising up to stop it. No one, that is, except the movement of people at SwarmUSA.com.
To all the naysayers who think the people do not have the power to make the change, I say take a look at history and how humankind has overcome its obstacles to progress with each new step. Mankind is now teetering between the brink and the dawn of a new renaissance. A new renaissance is coming because mankind is about to free itself from the chains of needless debt that are holding humanity back.
U.S. Insurers Purchase Corporate Bonds in Market ‘Raining Gold’
U.S. insurers, holders of more than $2.2 trillion in corporate debt, bought the bonds at the fastest pace in five years in 2009, taking advantage of a market that Warren Buffett said was "raining gold." Insurers’ net purchases of corporate bonds climbed to $153 billion in 2009, with the greatest portion coming in the first quarter when yields were at their highest of the year, according to Federal Reserve data released last week. That compares with outflows of $59 billion in 2008, and accounts for the biggest inflows for the industry since $172 billion in 2004. "It has paid off very nicely," said Judy Greffin, chief investment officer for Allstate Corp., whose corporate-debt holdings swelled by 20 percent last year to $33.1 billion. "With the benefit of hindsight, I would have loved to have bought more."
A corporate-debt rally helped insurers including MetLife Inc. and Prudential Financial Inc. to recover capital lost in the housing and stock market slumps of 2008 and early 2009. Life insurer inflows were more than eight times those of property- casualty companies in 2009. Buffett, the property-casualty industry’s most visible executive, lamented that he didn’t invest enough in the debt. Corporate and municipal bonds "were ridiculously cheap relative to U.S. Treasuries" in early 2009, Buffett, Berkshire Hathaway Inc.’s chief executive officer, said in an annual letter to investors on Feb. 27. "Big opportunities come infrequently. When it’s raining gold, reach for a bucket, not a thimble."
Returns on corporate debt including reinvested interest totaled 26 percent last year after an 11 percent loss in 2008, according to Merrill Lynch’s U.S. Corporate & High Yield Master index. Life insurers may spend as much as $100 billion on corporate debt in the next 18 months, Barclays Capital credit strategists Matthew Mish and Alex Gennis wrote in a March 12 report. Allstate, the biggest publicly traded U.S. home and auto insurer, cut back on commercial real estate and municipal bonds to buy corporate bonds. Of the $100 billion portfolio managed by Greffin, almost a third was corporate debt as of Dec. 31.
"If you don’t like credit risk, you should not own our stock," Tom Wilson, CEO of the Northbrook, Illinois-based company, said in an interview in August. Insurers were joined in the market by mutual funds, which had $144 billion in inflows last year. Households and nonprofit organizations had $149 billion in outflows, and foreign banking offices in the U.S. had $156.9 billion of outflows, according to the Fed’s report. The Fed data for corporate debt includes some asset-backed securities.
MetLife acquired corporate debt last year even as it wrote down the value of existing holdings. Its $358 million in corporate-debt impairments in the first quarter of 2009 accounted for almost half of the firm’s total credit-related writedowns in the period. The New York-based company had net losses in the first three quarters last year, and after each period CIO Steven Kandarian reiterated to investors that he was buying more corporate debt. The extra yield investors demand to own U.S. corporate debt instead of Treasuries fell 520 basis points last year, a record rally in spreads, Merrill data show. Spreads were at 262 basis points as of yesterday, compared with 797 basis points a year earlier.
Life insurers, which can hold policyholder premiums for decades before paying claims, need to earn returns on those funds to pay workers, remunerate investors and ultimately satisfy customers. Companies that were shut out of debt markets during the credit freeze returned to selling bonds in 2009 as demand strengthened. Firms issued $1.2 trillion of dollar-denominated bonds in 2009, according to data compiled by Bloomberg. That’s the most since at least 1999, and a 42 percent jump from 2008, when Lehman Brothers Holdings Inc.’s bankruptcy prompted investors to withhold debt financing. "This trend could continue as long as this asset class makes sense," said Rajeev Sharma, who oversees $1.4 billion of investment-grade debt at First Investors Management Co. in New York. "So far, corporate credit is still the asset class of choice."
Credit Suisse restricts bankers' travel to Germany
Credit Suisse said it is restricting bankers' travel to Germany after authorities there said they had launched 1,100 tax evasion probes against the bank's clients and were investigating staff on suspicion of aiding evasion. The probe into Switzerland's second-largest bank by assets relates to a CD with client data bought by the German state of North Rhine-Westphalia. "We already have restrictions on travel in place and now these are being applied very strictly in the case of Germany," a Credit Suisse spokesman told Reuters on Sunday. "As far as I know we have had no contact with the German authorities and cannot comment further," he said.
Credit Suisse, which operates globally in investment banking and wealth management, gained market share at home in the crisis as larger domestic competitor UBS struggled with damage to its reputation caused by a bitter U.S. tax case and a state bailout. In 2008, Germany paid for stolen data from Liechtenstein's top bank LGT. Former Deutsche Post chief Klaus Zumwinkel's Liechtenstein trust was uncovered in that data and he admitted to tax evasion in a spectacular case. Germany's willingness to buy stolen bank data once again has increased the pressure on Switzerland's large private banking industry and stirred emotions in both countries. Germans hold an estimated 200 billion euros in undeclared funds in Switzerland.
Former German finance Hans Eichel called for Credit Suisse's German banking license to be revoked if its bankers were found to have helped German clients evade taxes, Swiss paper SonntagsBlick reported. "If a company does not respect the laws of the land, it cannot operate here ," Eichel said in an interview. "The United States already made this clear in the case of UBS. Germany has not acted as tough as this so far, but in view of the scale of the problem, this is what Germany will have to do," he said. German clients of other Swiss banks have nothing to fear from the probe. None of their accounts were included on the CD obtained by Germany, Swiss paper Sonntag reported German state prosecutor Nils Bussee as saying. "According to the current state of knowledge, no other banks are involved," Bussee said.
This Time, Canada Inc. Is Prepared for Dollar Parity
The last time the Canadian dollar hit parity with the U.S. dollar, it wreaked havoc with Mel Svendsen's business. This time, he is prepared. During the past three years, the chief executive of Canadian spring- and suspension-maker Standen's Ltd. trimmed exports to the U.S., boosted sales at home and built two factories in China. The changes will help, he says, even though Standen's and other exporters see margins shrink and products get pricier overseas when the home currency strengthens.
Across Canada, exporters are girding for the likelihood that the Canadian currency will keep getting stronger. The loonie, as Canadians dub their dollar, has risen 23% against the U.S. dollar during the past 12 months, and is soon expected to equal or exceed the greenback. In late trading in New York on Friday, one U.S. dollar bought 1.0164 Canadian dollar. "None of us who do most of our business in the export markets are happy about this," says Mr. Svendsen, who became CEO 15 years ago when one U.S. dollar was worth about C$1.40.
At the end of 2007, the weakening U.S. economy and high global prices for Canadian oil and mineral resources helped push the Canadian dollar past parity with the U.S. dollar for the first time since 1976. Canadian manufacturers' profits collapsed. The jump was so fast that Standen's saw the value of some U.S. dollar-denominated sales drop below profitable levels in the 60 days it took customers to pay their bills, Mr. Svendsen says. "That was a very big wakeup call for most Canadian manufacturers," he says.
Exports accounted for nearly a third of Canada's economy in 2007, with 77% going to the U.S. That has since shrunk to about one-fourth. For every cent the loonie strengthens, manufacturers lose about C$1.5 billion a year, estimates Jayson Myers, CEO of Canadian Manufacturers and Exporters, a trade group. Canadian exporters got some relief in 2008, when the credit-market crash drove investors to safe assets like the U.S. dollar. The loonie has been climbing for the past year as foreign investors pump a record $111 billion into Canadian securities, mostly bonds.
This time, economists say, Canada's relatively strong fiscal position means the currency's ascent is likely to last. "It looks like this is the brave new world we're going to be dealing with," says Douglas Porter, an economist at Toronto-based BMO Capital Markets, which forecasts the loonie will trade at parity with the greenback during the third quarter of this year, then continue strengthening gradually through 2011. Canada's public debt will hit 79% of gross domestic product in 2010, compared with 94% in the U.S. and 227% in Japan, according to International Monetary Fund estimates. Canadian banks weren't hurt by the crisis as much as those in the U.S. Strong demand for Canadian raw materials is again boosting the loonie, along with the currencies of other big resource producers like Australia and Brazil.
Canada's financial-policy makers appear content to let the markets have their way, particularly since Canada's economy looks to be growing faster than expected, even with the currency appreciation. That growth and higher-than-anticipated inflation is feeding speculation that the Bank of Canada could raise interest rates before the Federal Reserve does so in the U.S. Craig McIntosh, chief executive of Acrylon Plastics Inc., a producer of molded plastic parts, has spent the past few years reshaping the Winnipeg, Manitoba, company's business. In 2007, more than half its revenue came from U.S. dollar-denominated sales of parts like fuel tanks for tractors and playground slides. Yet all of Acrylon's five factories—and much of the associated costs—were in Canada.
Mr. McIntosh started asking suppliers to bill the company in U.S. dollars whenever possible to minimize exchange-rate risk. He pushed one wholesaler to bill Acrylon in U.S. currency for goods, such as nuts and bolts, sourced from the U.S. and in Canadian dollars for gloves and earplugs made north of the border. Acrylon also bought two companies that bring in more loonie-denominated revenue. Acrylon is now shopping for a plastic-molding factory in the U.S., Mr. McIntosh says, to shield itself even more from the highflying Canadian dollar.
Does GDP Understate Depth of the Recession?
by Justin Lahart
Gross domestic product figures show that in the recent downturn the economy experienced its sharpest contraction since at least the 1940s. But a Federal Reserve economist argues that the recession was even more severe than GDP suggests.
In a paper being presented Friday at the Brookings Panel on Economic Activity, Fed economist Jeremy Nalewaik examined the differences in GDP and a closely-related measure, gross domestic income. GDP measures the output of the economy as the sum of expenditures — consumption, plus investment plus government spending plus net exports. GDI measures total income in the economy.
In theory, the two measures should equal one another, in practice they don’t quite, and Mr. Nalewaik argues that GDI is the better of the two.
He finds that when the Commerce Department’s Bureau of Economic Analysis revises its national income and product accounts, GDP figures move more closely inline with GDI. GDI also appears to have a stronger correlation with other economic indicators, and its recent movement around turning points suggests it more closely tracks the economy.
He notes that GDI fell far more sharply in the teeth of the recession, dropping at a 7.3% annual rate in the fourth quarter of 2008, and 7.7% in the first quarter of 2009. GDP, in comparison, fell by 5.4% and 6.4%. Moreover, while GDP showed the economy began to grow in last year’s third quarter, GDI showed it continued to contract. (Fourth-quarter GDI figures aren’t yet available.)
"[T]he latest downturn was likely substantially worse than the current GDP… estimates show," he writes. "Output likely decelerated sooner, fell at a faster pace at the height of the downturn, and recovered less quickly than is reflected in GDP… and in conventional wisdom."
Why is Goldman willing to lose so much on deposits?
by Rolfe Winkler
Writing my Hotel California column earlier this week, I came across the following interesting tidbit in Goldman’s 10-K (page 206):The amount deposited by the firm’s depository institution subsidiaries held at the Federal Reserve Bank was approximately $27.43 billion and $94 million as of December 2009 and November 2008, respectively, which exceeded required reserve amounts by $25.86 billion and $6 million as of December 2009 and November 2008, respectively.
This seems a good indicator of the lack of lending opportunities in the economy. But I’m curious: Goldman is probably losing a lot of money parking customer deposits on reserve at the Fed. Why do it? But first let me try to explain what’s happening here… Goldman has a bank subsidiary — GS Bank USA — which collects deposits via brokerage accounts. It doesn’t have any bank branches anywhere. And Goldman has grown these deposits a fair bit, from an average of $13 billion in 2007 to $35 billion in 2009.
This is odd for two reasons. First, Goldman doesn’t have much use for deposits that I can see. They can’t be used to fund investment banking activities. And clearly they don’t see many good lending opportunities for these deposits. If they did, they wouldn’t park such a big proportion at the Fed, where they lose money.
[Aside: a common misconception is that holding reserves at the Fed is profitable for banks since the Fed now pays interest on reserves. But this ignores the other side of the balance sheet. Banks, after all, have to pay for the deposits that they then put on reserve at the Fed. Math in next paragraph]
Excess reserves held on deposit at the Fed pay 0.25%. But the average interest rate Goldman paid on U.S. deposits in 2009 was 1.06%, implying a negative net interest margin of 0.81%. Multiply -0.81% by total excess reserves of $25.9 billion held at December 2009, and you get an implied annualized loss of $210 million. That’s a decent chunk of change.* Another reason these deposits might not make good loans is old-fashioned asset-liability mismatch. Brokerage deposits aren’t sticky like retail deposits. They chase the highest return in the market. "Hot money" tied up in illiquid loans is a recipe for disaster…
Now, certain folks might use this as an excuse to bash Goldman ("why aren’t they lending to the real economy!"), but that’s wrongheaded. Don’t get me wrong: I’m no fan of Goldman Sachs. But the problem isn’t that banks are lending too little today, it’s that they lent way too much yesterday. The chief lesson of the financial crisis is that irresponsible lending has dire consequences for the economy. Better that banks err on the side of safety and soundness….better that they lose money parking reserves at the Fed than chase risk with dodgy loans. But the original question still stands. If Goldman can’t find anything profitable to do with deposits, why keep collecting them?
*A couple caveats here. The rate Goldman is paying on deposits could be lower today than the average in 2009. Also, to lose $210 million, Goldman would have to hold this balance at the Fed — at a NIM of -.81% — for a full year.
Wal-Mart to slash grocery prices
Wal-Mart Stores Inc will cut food prices and mount a new ad campaign over the next six weeks, a threat to other U.S. grocers that sent an industry shares index down more than 2 percent on Friday. A Morgan Stanley analyst first reported the world's largest retailer's plan, calling it a major setback for other U.S. grocers, and the company confirmed the promotions in an email. "While this helps address Walmart's traffic woes, we view this as a major setback for the grocery stocks, which have been rallying on hopes of a return to more rational pricing," Morgan Stanley analyst Mark Wiltamuth wrote in a note on Friday. The Standard & Poor's Food Retail Sub-Industry Index closed down 2.2 percent.
Walmart has used aggressive pricing in grocery and other units to bring shoppers into its stores. The grocery business is particularly pressured by such pricing, as its profit margins are already low. Investors in Walmart have been concerned about signs that shoppers who gravitated to its stores during the worst of the recession -- boosting sales and profits -- are returning to rivals. Traffic fell in Walmart's U.S. stores during its fourth quarter, despite the holiday season, when shopping is at its peak.
In the promotions, customers entering Walmart stores will be greeted by signs advertising price rollbacks on 10,000 items. The focus of the price cuts will be on food and other consumables. The changes, to hit stores by April 1, will be supported by a television and media campaign. That timing means the campaign would be in place just before Easter, which falls on April 4 and is a big time for home-cooked meals. Wiltamuth cited the "continued strain" on grocers' margins and questioned whether the market should begin to ask whether grocers will be able to pass inflationary costs through to consumers.
High-End Repo Man Takes Back Toys From the Over-Leveraged Rich
Ken Cage is racing through a private aviation terminal near Orlando when his BlackBerry buzzes with bad news. The plane he is about to repossess is scheduled to take off for Mexico in three minutes. Even worse, the Cessna's owner and pilot is on his way back from lunch—and he is rumored to be six-feet, six-inches tall. "I'd rather not stick around to find out," Mr. Cage says. Mr. Cage, 44, stands guard by the door as his partner Randy Craft walks onto the tarmac and approaches a shiny white turbo-prop. He quickly picks the lock on the door and ushers in the repo team's pilot, Dave Larson. The plane's propellers roar to life, and after clearance from the control tower, the $350,000 ride lifts off the runway and into the sky. Mr. Cage and Mr. Craft climb back into their Ford pickup and tear out of the parking lot, just as the plane's owner pulls in. "He's a minute late," says Mr. Cage, peering out the window. "Lucky for us."
Ken Cage isn't your typical repo man. Rather than snatch cars from an over-extended middle class, he takes back yachts, planes and other toys from the over-leveraged rich. Business is thriving, even as the economy begins to improve. His company, Orlando-based International Recovery Group, repossessed more than 700 boats, planes, helicopters and other property last year valued at more than $100 million. Business, he says, is up six-fold from 2007. He has reclaimed everything from $18 million Gulfstream jets and Bell helicopters to 110-foot Broward yachts, $500,000 recreational vehicles and even a racehorse. Before the financial crisis, most of the luxury items he pulled in were valued between $30,000 and $50,000. Today, they are valued at $200,000 to $300,000—meaning defaults are hitting people at a much higher income level.
Most repo men take cars and trucks. But Ken Cage and Randy Craft repossess yachts, planes, helicopters and other luxury toys of the formerly wealthy. WSJ's Robert Frank reports. The folly of the wealthy has been good news for an elite cadre of repo men. Nick Popovich, the self-proclaimed "Learjet Repo Man" and head of Indiana-based Sage-Popovich, and Michigan boat specialists like Harrison Marine report brisk business. Reality-TV producers have been knocking on their doors. Last year, says Mr. Cage, International Recovery's revenues soared to the eight figures, up from just a few hundred thousand when he and two partners bought the company in 2005.
Banks hire Mr. Cage to retrieve their collateral after a borrower has defaulted. Once he grabs the property, he cleans it up or makes needed repairs and sells it to a new buyer. He then gives the proceeds, minus his fees and expenses, back to the bank. While the standard commission for most repossessions is between 6% to 10% of the resale price, Mr. Cage has lowered his fee to as little as two percent as a way to beat back growing competition. "They're very quick in their response time," says Steve De Amico, vice president in charge of lending at Illinois-based Allied First Bank, which hires Mr. Cage for recoveries. "It's also helpful to have one company that can get the property, restore it and sell it for us."
Mr. Cage can't name names. But he estimates that 70% of his targets made and lost their money from real estate—either as developers, Realtors or contractors. Most of his jobs are in Florida, Arizona, California, Nevada and other sun states where real estate was hit hardest. The son of a Philadelphia-area trucking-company owner, Mr. Cage never planned to land in the rarefied repo ranks. He started out in the cash-management department of J.P. Morgan, then worked in the collections department at Chrysler Finance, where he hired repo companies to pick up cars. Even though he never did the repos himself, he said the work became depressing. "Here we were, taking minivans with child seats in the back, or going to someone's job to take their car," he says. "I had a tough time with that."
Separating flashy toys from their owners seemed to be much easier—especially from a logistical perspective. Unlike cars, which can be hard to find and take, yachts and planes are often traceable through Federal Aviation Administration or marine records. Mr. Cage relies on a vast a network of marine captains, tow-boat operators, jet-terminal crews, dock workers and aircraft pilots who feed him information. With his Phillies cap, jeans, scruffy goatee and genial smile, the stout Mr. Cage is an unassuming presence. For muscle, he relies on his partner Mr. Craft, a tall, broad-chested former professional wrestler known as "Rockin' Randy."
Mr. Craft prides himself on being able to break into just about anything, whether boat, plane or RV. Not that planes or yachts are that hard to steal. Mr. Cage says most yacht owners keep their keys near the ignition and rarely lock the doors. Plane doors can often be easily picked. "A jet is much easier to take than a car," he says. His company works with about 30 pilots, all of whom are experts at flying various kinds of aircraft. Occasionally, the rich rear up to protect their prizes. Mr. Cage says that he and Mr. Craft have been hit by cars, threatened with shovels and chased on foot countless times. Recently, Mr. Cage says he was on a yacht assignment in Jacksonville, Fla., when the owner boarded another boat and zoomed after him, Bond-style. He soon gave up the chase, and Mr. Cage kept his craft. Most repo targets never even know Mr. Cage is coming.
Early one morning at the Hontoon Marina just outside Orlando, Mr. Cage and Mr. Craft walk along the docks until they spot their prey—a 65-foot Sea Ray. Mr. Cage says they had been tipped off by a boat captain who saw the craft ease into the docks the night before without any running lights—a sign that the owner was trying to avoid notice. Mr. Craft hops onto the boat, finding no one aboard. A telltale pair of socks and sneakers near the door suggests someone may be headed back soon. After a quick check of the registration number, the team revs up the engine and backs away from the dock. As they motor down the river, Mr. Cage reclines in a plush leather chair and takes a moment to soak in the sun. "Someday I'd like to get a boat," he says. "But I'd pay all cash."
House Passes Historic Health Bill
The biggest transformation of the U.S. health system in decades won approval on Capitol Hill late Sunday, the culmination of efforts by generations of Democrats to achieve near-universal health coverage. Facing voters' judgment in the fall, Democrats bet they could overcome public misgivings on a bill that reshapes one-sixth of the U.S. economy. The final battle on the House floor exposed again the divisions that have riven Congress and the nation over the past year. The House gave final passage to the Senate's health legislation on a climactic 219-to-212 vote, as Democrats muscled the measure through on the strength of the party's big majority. In the final roll call, no House Republican voted for the bill, and 34 Democrats voted no, many of them representing Republican-leaning districts.
A short while later, the House, voting 220 to 211, approved a companion bill making changes to the Senate bill, a measure necessary to attract support in the House. Those changes now head to the Senate, where action is expected this week. All Republicans voted against the companion bill, as did 33 Democrats. President Barack Obama, who staked his presidency on the health-care overhaul, helped push it toward passage with a last-minute promise to issue an executive order making clear that no money dispensed under the $940 billion bill would pay for abortions. That persuaded Rep. Bart Stupak, a holdout Michigan Democrat, to vote yes and bring at least seven colleagues with him.
President Obama spoke just before midnight at the White House. "At a time when the pundits said it was no longer possible, we rose above the weight of our politics," he said in hailing the vote. "We proved that this government … still works for the people." It was a tumultuous sprint to the finish for legislation that has brought Washington many dramas over the last year, ranging from a Christmas Eve Senate vote to the surprise January election of Massachusetts Republican Sen. Scott Brown that upended Democrats' plans. "You will be joining those who established Medicare and Social Security and now, tonight, health care for all Americans," said House Speaker Nancy Pelosi (D., Calif.), urging Democrats to pull together. "This is an American proposal that honors the tradition of our country."
Minority Leader John Boehner (R., Ohio) condemned the legislation, and said Democrats are moving against the will of the public. "Shame on this body. Shame on each and every one of you who substitutes your will and your desire above your fellow countrymen," he said. "By our actions today we disgrace their value." Republicans hope to use the health overhaul to drive Democrats into the minority, citing polls that show a plurality of Americans oppose it, while Democrats believe the immediate benefits brought by the bill will work to their credit.
The legislation will extend health coverage to 32 million Americans now without insurance, according to the Congressional Budget Office. It will mandate that almost every American carry health insurance—a provision that opponents are set to challenge in the courts. To help people get covered, the legislation expands Medicaid, the federal-state health program for the poor, and gives subsidies to families making as much as $88,000 a year. Democrats are highlighting popular provisions, such as one that requires insurance companies to accept all comers, even people who are already sick. Republican critics are stressing new taxes in the bill and trims to Medicare spending needed to fund the subsidies.
The broad Senate bill was set to become law quickly following House passage. Some uncertainty remained over the package of changes now headed to the Senate. Democratic leaders there said they had the votes to approve it, but Republican efforts to torpedo it or change it could complicate passage. The changes would boost the value of the subsidies and nullify special deals for some senators that caused a storm of protest. The CBO estimates the package will hold the federal budget deficit $143 billion lower over 10 years than it would otherwise be. Republicans called the estimate unrealistic. The CBO also estimated that 95% of legal U.S. residents would have insurance by 2019, up from 83% today.
The march toward action Sunday was greeted by protests from hundreds of Tea Party activists, who filled the Capitol grounds, and Republican complaints about the last-minute bargaining among Democrats. "Where has the transparency been? Why all the back-room deals?" asked Rep. Jack Kingston (R., Ga.). The legislation, nearly left for dead in January after Democrats lost the 60-vote majority in the Senate needed to overcome Republican filibusters, fueled grass-roots anger. Tea Party activists chanted "kill the bill" at Democratic lawmakers as they walked through the hallways of Congress.
The focus Sunday was largely on resolving the abortion dispute. Several Democrats, led by Rep. Stupak, had been withholding support, saying the legislation didn't go far enough to keep federal funds from being used to pay for abortions. They praised Mr. Obama's executive order, while Roman Catholic bishops and other antiabortion groups said it wasn't good enough. Someone from the Republican side of the House floor called out, "Baby killer!" at Mr. Stupak late Sunday as he defended the bill on the House floor.
A large swath of the business community opposed the changes, arguing the legislation was too broad and had too many taxes. "This will make us one of the highest-taxed regions in the world, and that's going to have an impact on the appetite for people to invest in medical innovation," said Bill Hawkins, chief executive of Medtronic Inc., which makes medical devices. He said his company could cut at least 1,000 jobs to absorb a new 2.9% excise tax on medical-device makers. Insurers will see the heaviest regulations, with new rules that dictate how much they can reap in profit and whom they must cover.
Hospitals, doctors, drug makers and the seniors group AARP backed the overhaul, saying it will reduce the growth of health costs and make sure no one goes without care. "This is not about health care," said Rep. James Clyburn of South Carolina, the House Democratic whip. "It's about trying to extend a basic fundamental right to people who are less powerful." Francee Levin, a 57-year-old artist in Columbia, S.C., said she couldn't get health insurance after she was hit by a drunk driver. "I think I'll be able to get some kind of health insurance, which would be a godsend," she said.
But Catherine Calhoun of Saint Francisville, La., said she worried her husband's employer might drop coverage and force the family to go into newly created health-insurance exchanges to get coverage. That might force her to find new doctors for her 7-year-old son, Billy, who has a rare bone disease, she said. "I might end up having to negotiate with someone who doesn't have any idea what he needs just to get out of bed in the morning,'' said Ms. Calhoun. In the run-up to the vote, Mr. Obama urged House Democrats to focus on those helped by the bill and not worry about the difficult politics. "Good policy is good politics," he said.
Republicans said they expect big gains in the fall. "I'd rather be a Republican running against his bill and saying, 'Let's start over,'" said Sen. John Cornyn (R., Texas), chairman of the National Republican Senatorial Committee. "This will be the defining issue in November 2010, and if it passes, in 2012 when the president runs for re-election." Under the legislation, consumers will see changes within months. Insurers won't be able to place lifetime limits on coverage. Children will be able to stay on their parents' insurance policies until their 26th birthday. The changes could be bumpy, because insurers warn they won't be able to make them so quickly.
The bulk of the legislation wouldn't take effect until 2014. Once the tax credits and Medicaid expansion are in place, most Americans will be required to carry health insurance or pay a fee, topping out at either $695 a year or 2.5% of income. Employers would have to provide affordable insurance or pay a penalty of up to $3,000 per worker. Those figures assume the Senate ultimately adopts the package of changes the House approved.
Tax increases needed to finance the program would hit a range of industries, from insurers to tanning services. Over the next decade, $108 billion in new fees will fall on insurers, drug makers and medical-device companies. Families earning more than $250,000 a year will pay a higher Medicare payroll tax, and see that tax expanded to investment income such as dividends. High-value insurance plans would be hit with a 40% tax starting in 2018. As part of the second bill, headed to the Senate, Mr. Obama was poised to accomplish another big goal: overhauling the federal student-loan program. It would end subsidies to banks and shift lending responsibilities to the federal government. That is part of the package of changes still requiring Senate approval.