Five small Eskimo children sit bundled in fur garments, photographed by the official photographer for the Alaska-Yukon-Pacific Exposition
Ilargi: In the fall of 2009, I wrote a number of times about "the state of the US states", see States of shock, States of emergency and States of disbelief.
Today, I think it might be time to revisit the issue(s), and an article by Mary Willians Walsh in the New York Times offers a good start:
State Debt Woes Grow Too Big to CamouflageCalifornia, New York and other states are showing many of the same signs of debt overload that recently took Greece to the brink — budgets that will not balance, accounting that masks debt, the use of derivatives to plug holes, and armies of retired public workers who are counting on benefits that are proving harder and harder to pay. And states are responding in sometimes desperate ways, raising concerns that they, too, could face a debt crisis.
New Hampshire was recently ordered by its State Supreme Court to put back $110 million that it took from a medical malpractice insurance pool to balance its budget. Colorado tried, so far unsuccessfully, to grab a $500 million surplus from Pinnacol Assurance, a state workers’ compensation insurer that was privatized in 2002. It wanted the money for its university system and seems likely to get a lesser amount, perhaps $200 million.
Connecticut has tried to issue its own accounting rules. Hawaii has inaugurated a four-day school week. California accelerated its corporate income tax this year, making companies pay 70 percent of their 2010 taxes by June 15. And many states have balanced their budgets with federal health care dollars that Congress has not yet appropriated.
While Greece used a type of foreign-exchange trade to hide debt, the derivatives popular with states and cities have been interest-rate swaps, contracts to hedge against changing rates. The states issued variable-rate bonds and used the swaps in an attempt to lock in the low rates associated with variable-rate debt. The swaps would indeed have saved money had interest rates gone up. But to get this protection, the states had to agree to pay extra if interest rates went down. And in the years since these swaps came into vogue, interest rates have mostly fallen.
Swaps were often pitched to governments with some form of upfront cash payment — perhaps an amount just big enough to close a budget deficit. That gave the illusion that the house was in order, but in fact, such deals just added hidden debt, which has to be paid back over the life of the swaps, often 30 years.
Some economists think the last straw for states and cities will be debt hidden in their pension obligations. Pensions are debts, too, after all, paid over time just like bonds. But states do not disclose how much they owe retirees when they disclose their bonded debt, and state officials steadfastly oppose valuing their pensions at market rates. Joshua Rauh, an economist at Northwestern University, and Robert Novy-Marx of the University of Chicago, recently recalculated the value of the 50 states’ pension obligations the way the bond markets value debt. They put the number at $5.17 trillion.
After the $1.94 trillion set aside in state pension funds was subtracted, there was a gap of $3.23 trillion — more than three times the amount the states owe their bondholders. "When you see that, you recognize that states are in trouble even more than we recognize," Mr. Rauh said.
Ilargi: In the face of budget gaps that size, it would be sort of strange to see muni and state bonds sell like hot cakes, wouldn't it? Well, they do. Why? It's all about what all markets are about: risk perception. Business Insider's Gregory White tries for a shot at an explanation:
Everyone Is Freaking Out About Municipal and State Debt (Except For Investors)Municipal and state bond markets are under threat, the New York Times reminds us again this morning. California could collapse! New York is in trouble! Illinois just got downgraded! Everyone's freaking out... except investors. Why not?
Well, there's the presumption of a federal bailout (can you imagine Obama watching all his economic progress undermined by collapsing states?). They also have the advantage of being tax-free, which can be a useful shield when government taxes increase. In other words, they are spiraling higher: debt fears stoke tax fears stoking muni bond buying.
This chart from Bespoke tells it all:
Ilargi: White then continues with a video interview BI's Aaron Task had with James Altucher at Formula Capital (I swear I was going to write Fantasy Capital), who claims there are no problems with muni and state bonds, specifically because in the instance of for example California, the constitution states that bondholders have to be paid before anyone else, including employees, once the 40% of the budget allocated to education is paid. So bondholders must be paid ahead of policemen and firemen.
Altucher continues to say that both the housing markets and the employment situation are stabilizing, and we are very far removed from any kind of "breakdown of social order". Really, when you have to fire your police force in order to pay your debtholders? "Very far removed"?
At least that makes us realize where he stands. And/or dreams. Mr. Altucher may have an inkling of knowledge about capital and/or bond markets, but he's entirely out of whack when it comes to the real world.
Look, if Greece didn't have to pay its employees, there would be no problem there either, from a purely financial point of view. The problem with this "analysis" is that both Sacramento and Athens DO have to pay their employees. The alternative is to face ever more protesters, who grow ever more angry, with ever less police, who grow ever less motivated.
It’s not about defaults per sé, since as Mr. Altucher rightly observes, while companies can go bankrupt, states and countries can't (well, not really, they can't close their doors). He claims that since California has $90 billion in revenues and "only" $6 billion in outstanding -bond- debt, all’s well that ends well.
But here's the rub (-ber ducky), courtesy of Jan Norman at the OC Register:
California state tax collections drop 14% in '09State taxes collected in California dropped 13.94% in 2009 from a year earlier, according to a new report from the U.S. Census Bureau. That compares with an 8.6% drop nationwide. The report doesn’t include local or federal taxes or state unemployment compensation taxes. The state collected just over $101 billion in 2009, down $16.4 billion, even though the legislature and governor approved the largest tax increase in state history including hikes in sales, motor vehicle and income taxes.
Ilargi: In other words, of the $90 billion Mr. Altucher quotes as California's revenues, 13.94%, or $12,55 billion, evaporated last year. Which happens to be more than twice the value of just the outstanding bond debt. Obviously, the next claim then is: "they’re going to have to raise taxes". But that just so happens to be a death knell for any politician who seeks re-election, even in good times, let alone in a crisis.
From which I venture to conclude that the all the budget crises in the various US states and towns, just like the ones in many nation states, have only just begun to unfold their leaves and secrets, and the phenomenon the outcome of all this will most resemble is the tried and proven scorched earth strategy. The need to cling to the religion of economic growth till it's clawed from your cold dead hands has never been greater, at the same time that the chances such growth will materialize are rapidly shrinking.
The theme song that goes "all is fine" because debt holders must be paid before police officers, come to think of it, evokes visions of Mad Max and The Road. The "be careful what you wish for" kind. Because it should be obvious that if the debt holders keep being paid ahead of all others, there's no way you can not ask yourself on occasion how far removed we are from any kind of "breakdown of social order". Which should make those debt holders ask their own set of questions.
Will Obama bail out ALL states and municipalities that will run into trouble? Is that perhaps why the Federal Reserve wants to get out of the mortgage securities field? And what's up with the recent problems selling additional US Treasurys? How much longer can Washington pretend it will pay for everything that goes sour? How many trillions of dollars are left? The federal budget deficits announced recently look awful, and now we're supposed to believe the White House will take on state and municipal obligations to boot?
How much longer will the Mad Hatter reign supreme, and we all pretend that time can indeed stand still, and we'll continue to be actually capable of paying our debts?
It is possible only in fairy tales.
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State Debt Woes Grow Too Big to Camouflage
by Mary Williams Walsh
California, New York and other states are showing many of the same signs of debt overload that recently took Greece to the brink — budgets that will not balance, accounting that masks debt, the use of derivatives to plug holes, and armies of retired public workers who are counting on benefits that are proving harder and harder to pay. And states are responding in sometimes desperate ways, raising concerns that they, too, could face a debt crisis.
New Hampshire was recently ordered by its State Supreme Court to put back $110 million that it took from a medical malpractice insurance pool to balance its budget. Colorado tried, so far unsuccessfully, to grab a $500 million surplus from Pinnacol Assurance, a state workers’ compensation insurer that was privatized in 2002. It wanted the money for its university system and seems likely to get a lesser amount, perhaps $200 million. Connecticut has tried to issue its own accounting rules. Hawaii has inaugurated a four-day school week. California accelerated its corporate income tax this year, making companies pay 70 percent of their 2010 taxes by June 15. And many states have balanced their budgets with federal health care dollars that Congress has not yet appropriated.
Some economists fear the states have a potentially bigger problem than their recession-induced budget woes. If investors become reluctant to buy the states’ debt, the result could be a credit squeeze, not entirely different from the financial strains in Europe, where markets were reluctant to refinance billions in Greek debt. "If we ran into a situation where one state got into trouble, they’d be bailed out six ways from Tuesday," said Kenneth S. Rogoff, an economics professor at Harvard and a former research director of the International Monetary Fund. "But if we have a situation where there’s slow growth, and a bunch of cities and states are on the edge, like in Europe, we will have trouble."
California’s stated debt — the value of all its bonds outstanding — looks manageable, at just 8 percent of its total economy. But California has big unstated debts, too. If the fair value of the shortfall in California’s big pension fund is counted, for instance, the state’s debt burden more than quadruples, to 37 percent of its economic output, according to one calculation. The state’s economy will also be weighed down by the ballooning federal debt, though California does not have to worry about those payments as much as its taxpaying citizens and businesses do.
Unstated debts pose a bigger problem to states with smaller economies. If Rhode Island were a country, the fair value of its pension debt would push it outside the maximum permitted by the euro zone, which tries to limit government debt to 60 percent of gross domestic product, according to Andrew Biggs, an economist with the American Enterprise Institute who has been analyzing state debt. Alaska would not qualify either. State officials say a Greece-style financial crisis is a complete nonissue for them, and the bond markets so far seem to agree. All 50 states have investment-grade credit ratings, with California the lowest, and even California is still considered "average," according to Moody’s Investors Service. The last state that defaulted on its bonds, Arkansas, did so during the Great Depression.
Goldman Sachs, in a research report last week, acknowledged the pension issue but concluded the states were very unlikely to default on their debt and noted the states had 30 years to close pension shortfalls. Even though about $5 billion of municipal bonds are in default today, the vast majority were issued by small local authorities in boom-and-bust locations like Florida, said Matt Fabian, managing director of Municipal Market Advisors, an independent consulting firm. The issuers raised money to pay for projects like sewer connections and new roads in subdivisions that collapsed in the subprime mortgage disaster.
The states, he said, are different. They learned a lesson from New York City, which got into trouble in the 1970s by financing its operations with short-term debt that had to be rolled over again and again. When investors suddenly lost confidence, New York was left empty-handed. To keep that from happening again, Mr. Fabian said, most states require short-term debt to be fully repaid the same year it is issued. Some states have taken even more forceful measures to build creditor confidence. New York State has a trustee that intercepts tax revenues and makes some bond payments before the state can get to the money. California has a "continuous appropriation" for debt payments, so bondholders know they will get their interest even when the budget is hamstrung.
The states can also take refuge in America’s federalist system. Thus, if California were to get into hot water, it could seek assistance in Washington, and probably come away with some funds. Already, the federal government is spending hundreds of millions helping the states issue their bonds.
Professor Rogoff, who has spent most of his career studying global debt crises, has combed through several centuries’ worth of records with a fellow economist, Carmen M. Reinhart of the University of Maryland, looking for signs that a country was about to default. One finding was that countries "can default on stunningly small amounts of debt," he said, perhaps just one-fourth of what stopped Greece in its tracks. "The fact that the states’ debts aren’t as big as Greece’s doesn’t mean it can’t happen."
Also, officials and their lenders often refused to admit they had a debt problem until too late. "When an accident is waiting to happen, it eventually does," the two economists wrote in their book, titled "This Time Is Different" — the words often on the lips of policy makers just before a debt bomb exploded. "But the exact timing can be very difficult to guess, and a crisis that seems imminent can sometimes take years to ignite." In Greece, a newly elected prime minister may have struck the match last fall, when he announced that his predecessor had left a budget deficit three times as big as disclosed.
Greece’s creditors might have taken the news in stride, but in their weakened condition, they did not want to shoulder any more risk from Greece. They refused to refinance its maturing $54 billion euros ($72 billion) of debt this year unless it adopted painful austerity measures. Could that happen here?
In January, incoming Gov. Chris Christie of New Jersey announced that his predecessor, Jon S. Corzine, had concealed a much bigger deficit than anyone knew. Mr. Corzine denied it. So far, the bond markets have been unfazed. Moody’s currently rates New Jersey’s debt "very strong," though a notch below the median for states. Moody’s has also given the state a negative outlook, meaning its rating is likely to decline over the medium term. Merrill Lynch said on Monday that New Jersey’s debt should be downgraded to reflect the cost of paying its retiree pensions and health care. In fact, New Jersey and other states have used a whole bagful of tricks and gimmicks to make their budgets look balanced and to push debts into the future.
One ploy reminiscent of Greece has been the use of derivatives. While Greece used a type of foreign-exchange trade to hide debt, the derivatives popular with states and cities have been interest-rate swaps, contracts to hedge against changing rates. The states issued variable-rate bonds and used the swaps in an attempt to lock in the low rates associated with variable-rate debt. The swaps would indeed have saved money had interest rates gone up. But to get this protection, the states had to agree to pay extra if interest rates went down. And in the years since these swaps came into vogue, interest rates have mostly fallen.
Swaps were often pitched to governments with some form of upfront cash payment — perhaps an amount just big enough to close a budget deficit. That gave the illusion that the house was in order, but in fact, such deals just added hidden debt, which has to be paid back over the life of the swaps, often 30 years.
Some economists think the last straw for states and cities will be debt hidden in their pension obligations. Pensions are debts, too, after all, paid over time just like bonds. But states do not disclose how much they owe retirees when they disclose their bonded debt, and state officials steadfastly oppose valuing their pensions at market rates. Joshua Rauh, an economist at Northwestern University, and Robert Novy-Marx of the University of Chicago, recently recalculated the value of the 50 states’ pension obligations the way the bond markets value debt. They put the number at $5.17 trillion.
After the $1.94 trillion set aside in state pension funds was subtracted, there was a gap of $3.23 trillion — more than three times the amount the states owe their bondholders. "When you see that, you recognize that states are in trouble even more than we recognize," Mr. Rauh said. With bond payments and pension contributions consuming big chunks of state budgets, Mr. Rauh said, some states were already falling behind on unsecured debts, like bills from vendors. "Those are debts, too," he said.
In Illinois, the state comptroller recently said the state was nearly $9 billion behind on its bills to vendors, which he called an "ongoing fiscal disaster." On Monday, Fitch Ratings downgraded several categories of Illinois’s debt, citing the state’s accounts payable backlog. California had to pay its vendors with i.o.u.’s last year. "These are the things that can precipitate a crisis," Mr. Rauh said.
Everyone Is Freaking Out About Municipal and State Debt (Except For Investors)
Municipal and state bond markets are under threat, the New York Times reminds us again this morning. California could collapse! New York is in trouble! Illinois just got downgraded! Everyone's freaking out... except investors. Why not?
Well, there's the presumption of a federal bailout (can you imagine Obama watching all his economic progress undermined by collapsing states?). They also have the advantage of being tax-free, which can be a useful shield when government taxes increase. In other words, they are spiraling higher: debt fears stoke tax fears stoking muni bond buying.
This chart from Bespoke tells it all:
And James Altucher of Formula Capital says there is nothing to fear from municipal bond defaults for the time being.
California state tax collections drop 14% in '09
State taxes collected in California dropped 13.94% in 2009 from a year earlier, according to a new report from the U.S. Census Bureau. That compares with an 8.6% drop nationwide. The report doesn’t include local or federal taxes or state unemployment compensation taxes. The state collected just over $101 billion in 2009, down $16.4 billion, even though the legislature and governor approved the largest tax increase in state history including hikes in sales, motor vehicle and income taxes.
Among the declines:
Sales and gross receipts – 8.6%
Individual income -20.4%
Most categories of licenses collected more money, including:
Occupational and business +16.9%
Motor vehicle +10.1%
Alcohol beverage +3.4%
All 50 states collected $715.2 billion in 2009, almost $67 billion less than in 2008.
The nationwide declines include:
Sales taxes, $228.1 billion, -5.4%
Individual income, $245.9 billion, -11.8%
Corporate, $40.3 billion, -20.7%
These three categories made up 72% of all state government tax collections nationwide.
"The 2009 state tax collection data is the first component of government finance data released each fiscal year and provides an important indicator of the fiscal condition of state governments," said Lisa Blumerman, chief of the Census Bureau’s Governments Division. These declines help explain why at least 41 states have shortfalls in their 2010 budgets, according to the Center on Budget and Policy Priorities.
California’s 2010 budget has a $6.6 billion shortfall and faces a total $19.9 billion deficit through next year. Some states had by even greater revenue declines than California, according to Census data. For example, Arizona was hit with a 42.5% decline in individual income taxes in 2009, largest in the nation, followed by Southe Carolina, -29.6%; Tennessee, -23.8%; and New mexico, -23.2%. Michigan, hard hit by automaker bankruptcies, had the largest percentage drop in corporate taxes, down 63.5% followed by Oregon, -45.8%, New Mexico, -42.6% and Utah, -37.7%.
State Controller Chiang: Worst yet to come for California budget crisis
State Controller John Chiang said Monday the worst of California's budget crisis is still to come. Although lawmakers are challenged by a nearly $20billion deficit, "the bad year's 2012," Chiang said. That year, state finances will be hit with a trifecta of pain: The temporary tax hikes approved last year will be over; federal stimulus funds will be gone; and funds that the state "raided" from local governments will come due. The deficit at that point will be some $25billion, according to Schwarzenegger administration estimates. And finances in later years aren't great either: Last year, the Legislative Analyst Office released a report projecting a $20billion deficit every year for the next five years.
But not even those highly publicized numbers tell the full story, said Chiang, the chief fiscal officer for the state. Chiang said California also owes its own "special" state funds some $20billion that it has borrowed in recent years to close deficits, referring to pots of money outside the state's general fund. And state employee health and pension benefits are not being adequately budgeted, he said. "(A solution) is going to take a lot of legislators getting off the sidelines," Chiang said. Assemblyman Curt Hagman, R-Chino Hills, said lawmakers recognize 2012 will present them with even more challenges than they currently face. "Yet we haven't solved anything this year," he said.
Lawmakers last week approved a gas-tax maneuver that saves the state $1.1billion. Still, Hagman blames election year politics for lawmakers' inability to produce any large solutions in the first three months of the year. That excuse won't last through November, he said. "I don't think this will be a normal election year. Residents are paying attention. We can't just sweep it under the rug. The whole thing will collapse if we try to push it off another year," Hagman said. "The business community will not get healthy again until it feels like California is stabilized." Although an improved economy will help, Chiang said state leaders need to think long term when budgeting. "The state has been operating in a deficit since July 2007. It wasn't the recession that got us into this position, it was bad state budgeting," he said.
Florida lawmakers aren't facing up the state's budget crisis
Refusing to acknowledge the obvious need for more revenue and a fairer state tax system, the Republican-led Florida Legislature is once again cobbling together a roughly $68 billion state budget with duct tape, bailing wire — and considerable help from the feds. The House and Senate spending plans, due for floor votes this week, mop up money earmarked for long-term uses to fill short-term needs. Lawmakers have no real vision for the future, when the federal stimulus money will be gone and the state's needs will be more critical than ever. Republicans contend voters want the state to make do with existing resources. But what voters really want is a vision for building a better Florida — not a budget built on contradictions because legislators are too consumed with their political futures to tackle the state's funding crisis.
- After spending weeks bashing Congress over the growing federal deficit, Senate Republicans were only too happy last week to embrace an additional $880 million in Medicaid stimulus money Congress is expected to approve .
- Both chambers are poised to pass millions in new tax breaks for businesses and yacht buyers while they struggle to find money for education and social services.
- At 12.2 percent, the state's unemployment rate is the highest in at least 40 years. Yet the House wants to raid $466 million from a road-building fund that could be used to stimulate the economy and create more jobs.
- The Senate, which quietly raised some staffers' pay last year after voting for a state employee pay cut, is now contemplating cuts to public libraries and requiring state employees to contribute to pension and health care plans.
- The House wants to turn the Lawton Chiles Endowment, established with tobacco settlement proceeds as a long-term way to fund child and health care programs, into nothing more than another checkbook that can be drained whenever the budget appears headed for a deficit.
And in what can only be considered election-year gimmicks, both chambers are ready to restore back-to-school sales tax holidays. The Senate also wants to rescind last year's higher fees for driver's licenses and auto tags, worsening the bottom line. The lack of foresight now means 2011-12 will be even worse, after this year's more than $3 billion in federal stimulus funds are spent and Florida faces at least a $5 billion budget hole. No one, it appears, has a plan short of turning over the state's Medicaid system to HMOs, allowing offshore drilling or expanding gambling. All but ignored this session are ideas to make Florida's sales tax fairer — and increase revenue — by making it easier to collect sales tax on Internet sales, repealing some sales tax exemptions and closing other tax loopholes.
Only the possible compact with the Seminole Indian Tribe over expanded gambling offers a revenue bright spot. The deal, still in negotiation, could net a $430 million payment and another $150 million annually. Lawmakers have proposed spending an additional $100 million more for higher education — which has been decimated in recent years by budget cuts. But that's barely a first installment in a grand plan to double higher education funding to $4 billion by 2015. Republicans like to say they're building a budget for Florida to live within its means. They aren't. They're living on Uncle Sam's largesse and delaying for yet another year the real issue of how to pay for the services Floridians rely upon. That's not leadership.
New York State Budget Stalls on Finding $1 Billion More in Cuts
New York State lawmakers ended the week with little progress toward striking a budget deal on time, as the Paterson administration demanded that the Legislature find additional cuts of at least $1 billion, people involved in the negotiations said Friday. As budget staff members met behind closed doors to hash out revenue and spending targets, the State Assembly approved emergency legislation to keep the government running if a new budget is not passed by the March 31 deadline; Democrats in the Senate said they planned to pass the same bill on Monday morning.
While Democratic leaders in both houses said they would remain in Albany through the weekend in hopes of reaching a deal, senior officials in the Legislature and the Paterson administration privately conceded that there was little chance of a final agreement by early next week, when the Legislature is scheduled to begin a weeklong break. "We are taking a hard line on the cuts," said a senior administration official, who spoke on the condition of anonymity so as not to upset the negotiations. "The question is really to them as to whether they can get there."
The administration will not begin discussions about borrowing money to close the state’s $9 billion shortfall until more cuts are made, according to those involved in the talks. Sheldon Silver, the Assembly speaker, and John L. Sampson, the Senate Democratic leader, did not show their cards on Friday. They convened a public joint conference between the houses on Friday evening but acknowledged that there was little to confer about until agreement was reached on targets for revenue and spending. "There are no changes yet," Mr. Silver said of Senate and Assembly budget proposals. "We are now going through with the governor’s office a detailed analysis of both, finding where we have joint agreements, both as to cuts, as to revenues, and what further cuts or revenues will fit into a fiscal plan for the state."
Republicans attacked the joint meeting as window-dressing since no further meetings had been scheduled. "We’re being bluffed here," said Senator Tom Libous, the deputy Republican leader. "This is a bluff." The budget proposed by Gov. David A. Paterson in January included $4.8 billion in budget cuts and $1.4 billion in new taxes and fees, chiefly on cigarettes and sugared beverages. The Senate and the Assembly have separately agreed to about $3.3 billion of the governor’s proposed cuts, leaving at least $1 billion to go, the administration official said. Although Mr. Paterson submitted his plan in January, as the Constitution requires, the Senate and Assembly did not issue their draft budget plans until this week — in the Assembly’s case, with only two days of session scheduled before the budget deadline.
Still, Mr. Sampson and Mr. Silver suggested that the administration was at least partly to blame for the holdup, saying that they needed the administration to provide a more up-to-date accounting of the state’s current spending and revenue before they could negotiate broad budget targets for next year. "There’s a fiscal structure, a financial plan, that we need with help from the second floor so we can proceed," Mr. Sampson said. The Senate opposes the taxes on cigarettes and sugared beverages, Mr. Paterson’s core proposals for raising new revenue, and would replace them largely with "one shot" revenue measures that would last only one fiscal year. The largest is a proposal to borrow as much as $700 million against future payments from New York’s share of the national tobacco settlement.
The Assembly plan includes less in cuts to health and education spending but would borrow at least $2 billion, with no future revenue yet earmarked to repay it, in exchange for some restrictions on future spending. Details of those restrictions, based on a five-year deficit-reduction plan written by Lt. Gov. Richard Ravitch, remain unclear. Assembly officials say they intend to hew to the terms of Mr. Ravitch’s proposal, which imposes strict new accounting standards and empowers a new financial review board to make continuing assessments of whether the budget remains in balance, allowing governors to cut spending unilaterally when the Legislature fails to negotiate savings in a timely manner.
A draft of those restrictions was included in the Assembly’s budget proposal but quickly drew criticism that it kept the new borrowing but gutted the provisions that require spending discipline. Mr. Ravitch was more measured. On Friday, after presenting his plan to a construction industry conference in Manhattan, he said the Assembly version showed "a serious willingness to worry about tomorrow." One person close to the budget negotiations said, however, that the Assembly proposal was a nonstarter with the Paterson administration. "It’s not the Ravitch plan, it’s the Silver plan," said the person, who required anonymity to assess the administration’s reaction. "There’s no Ravitch in there. There is no mechanism for fiscal discipline." "As drafted," the person added, "this will never see the light of day."
Oklahoma atate budget picture darkens by the day
How quickly can a crisis become a catastrophe? Apparently, about as fast as a budget crunch becomes a budget crisis. To those who write definitions goes the power to modify meanings. To those who write budgets — or analyze them — goes the privilege of defining down or defining up the nature of a fiscal shortfall. Gov. Brad Henry started the year wearing rose-colored glasses, admitting the gravity of the budget crisis but offering mitigating ideas such as "revenue enhancements." We haven’t heard much from him since on that topic, but his spokesman says this is because negotiations are carried out away from the public eye, among a small group of players.
State Rep. Ken Miller, chairman of the House Appropriations and Budget Committee, sees a budget hole for fiscal 2011 "in the $500 million range." That’s a crisis. Oklahoma Policy Institute analyst David Blatt sees a shortfall of $850 million. That’s a catastrophe. Henry, Miller and Blatt know the state is running out of options for balancing a budget without meaningful "revenue enhancements." Tax increases aren’t being discussed (it’s an election year), only adjustments to tax credits. Blatt has said the effort to minimize cuts to education and public safety is putting severe pressure on other state services. Mental health is one of them, he said. The Rainy Day Fund is not sufficiently full to meet this crisis, catastrophe or whatever it is that we’re in. The people may ultimately be asked to decide if they think state government needs more revenue.
U.S. Decline, Sloth Look a Lot Like End of Rome
by Mark Fisher
Historians cite the late second century as the turning point of the Roman Empire, when the once- proud, feared society began its descent into infamy. As the ruling class was undermined by civil wars and attacks by outsiders, the Romans’ respect for law and social institutions began to erode. In the end, a combination of political and economic mistakes led to the empire’s downfall. The U.S. today is a mirror image of the Roman Empire as it tipped into chaos. Whether we blame our bloated government, a greedy elite or a lethargic population, the similarities between the two foreshadow a gruesome future. The Roman economy grew fat from the plunder of conquered territories and the added productivity offered by new lands. The waning of expansionism didn’t bode well for the empire.
While the U.S. ascended quite differently, it also used its position as a superpower to fuel economic expansion. Because the country had the strongest military and economy in the post-World War II era, the U.S. dollar became the de facto global reserve currency, ensuring endless competitive advantages -- which have vanished in the last decade. Americans have become less productive while relying more on social safety-net programs such as Medicare, Medicaid and Social Security -- and now expanded health-care insurance. Worse, like the ancient Romans, a sense of entitlement has replaced the drive and motivation we once championed. With easy access to abundant government handouts, it’s no wonder so many jobless people have stopped looking for work.
Bread and Circuses
In the fifth century, the Roman political elite began searching for ways to distract its population from the hopelessness at hand. Bread and circuses postponed the ultimate fall. The tactic stopped working when people realized their bread tasted stale and sensed the true scope of the impending disaster. The U.S. government’s version of bread offerings proliferated throughout the fiscal crisis, in which collapse was averted only by a massive financial bailout and an endless supply of paper money, along with the rest of the seemingly endless sustenance being shoved down America’s throat.
Meanwhile, the administration hasn’t yet tackled the most pressing issue: job creation. Given the current state of the labor market, American workers can’t possibly provide enough tax revenue to support the government’s swelling debt. Even more unsettling is the government’s inability to fix the financial crisis. After a stream of stimulus programs and bailouts, the Federal Reserve continues to print enormous quantities of dollars and buy the nation’s debt.
California Like Greece
Many state governments are in even worse shape. With California’s 10-year debt currently yielding about 4.5 percent (municipal debt typically yields less than 10-year Treasuries, which now yield about 3.9 percent), the state poses the same sort of danger to the U.S. that Greece does to the European Union. If the federal government decides to bail out California, what happens when Michigan and New York start demanding the same treatment?
The burden of underfunded pension liabilities will cause states’ budget deficits to further balloon. Since defined state benefit plans assume an unrealistic 8 percent rate of return -- zero percent, at best, is more likely -- we can only imagine the catastrophe to come once states have to make good on their obligations. As our society becomes increasingly immobile and sits on the couch doing nothing but surfing the Internet, using iPhones and watching "Jersey Shore," the hopelessness of the situation becomes clear.
Unless the government creates a massive jobs program, cuts spending and taxes, and gains control of the national budget and the balance of payments crises, we should fear for our future. Unless our fellow Americans relearn the value of hard work, no government plan stands a chance. Once the world realizes that the U.S. is the new Rome, the traditional tenets governing asset correlations will no longer hold, and we can expect a breakdown in traditional stock-bond portfolio theories. Since paper assets are ultimately shoved down to zero, expect hard assets to benefit -- especially gold, energy and grains -- along with commodity-related equities. The name of the game going forward -- let’s say the next five years -- will be buying ahead of whatever China and other developing nations are trying to accumulate and diversifying away from the U.S.
The China Factor
Consider the trading relationship between the U.S. and China. When the U.S. funnels its unfinished products to China, the Asian nation is able to send back manufactured goods -- thanks to its abundant supply of cheap labor -- in return for dollars. While the American people are busy tinkering with their newly manufactured playthings, the Chinese continue to use their new wealth to buy energy and commodity assets. Thus, China and the other developing countries that are amassing dollars, euros and pounds basically play a game of global hot potato, trying to pass the potato -- worthless paper currencies -- to others in exchange for energy, water and valuable food assets. As China continues to thrust its dollars at all things commodity-related, it’s hard not to laugh when hearing President Barack Obama speak about trying to identify "environmentally sound" opportunities in energy.
It’s only a matter of time before the mechanism that has allowed the government to sustain its trade deficit for longer than it should have -- similar to the Asian dollar peg of the 1990s -- causes a simultaneous decline in the U.S. currency, asset prices and the economy. Once people begin to realize that their paper currencies, stocks and bonds are all garbage, we can expect a meltdown. Although it may be too early to predict an impending collapse in paper assets and an immediate need to acquire hard assets, it’s clear that we’ve reached a turning point. The ship has begun to sink. As I await a global re-set of asset values and prices, I will continue to monitor the swelling federal and state tax revenue levels, the rising animosity between Main Street and Wall Street and the progress made by commodity-hungry nations as they continue to eat our lunch.
While I continue to hope for the best, it’s far wiser to prepare for the worst.
Ireland on the brink of full-scale bank nationalisation
The Republic of Ireland faced the prospect last night of having most of its banking system nationalised amid growing speculation that the Dublin Government would raise its stakes in both remaining private sector operators — Allied Irish Bank and Bank of Ireland. Shares in both slid yesterday after a report that the Government’s stake in AIB would rise from 25 per cent to 70 per cent and its holding in BoI would be lifted from 16 per cent to 40 per cent. Each bank will be offered less than originally expected for questionable loans and other toxic assets being transferred into the state-run "bad bank", the National Asset Management Agency, according to The Irish Times. Those "haircuts", bigger than anticipated, would erode capital and force the banks to tap the Government for fresh equity, analysts said.
The agency is due to issue a statement today about taking on €54 billion (£48.5 billion) of the assets, while the Irish Government is also expected to announce details of future capital requirements for the banks. The Government’s existing equity in the two banks was accepted in lieu of cash when they were unable to pay interest on preference shares issued to the Government in return for a previous rescue. With the Irish Nationwide and EBS building societies being merged and nationalised, and Anglo Irish Bank, the other large banking company, also nationalised, most of the industry would be in the State’s hands.
Ireland is the first significant Western country to be faced with the humiliation of wholesale bank nationalisation in this crisis, although the Republic took its three main banks into state ownership 18 months ago. In the mid-1990s Sweden was forced into bank nationalisation but emerged from it with a profit. Hank Celenti, a credit analyst with RBC Capital Markets, doubted that private shareholders would be able to find the necessary cash to bail out the Irish banks, partly because of the sheer scale of the bailout required: "We expect the Irish Government to be the largest single equity investor in each institution [in the absence of] an unexpectedly strong economic recovery or material private market-sourced equity capital."
BoI yesterday postponed publication of its nine-month results for 24 hours, until tomorrow. Davy, its broker, expects it to reveal bad debts of as much as €3 billion for the period, on the back of Ireland’s brutal recession and property collapse, and pre-exceptional losses of €1.9 billion. AIB is in an even worse position, requiring more capital, although it may be able to raise cash by selling its 22.5 per cent stake in M&T, the American bank, and other foreign assets. Yesterday it said it would issue a statement after talks with the financial regulator ended. It is thought to be calling for more time to orchestrate a private sector solution, but officials are thought to be impatient for an immediate deal. Final discussions were continuing last night.
Ireland’s banking crisis erupted in September 2008 when its Government issued a blanket guarantee for all deposits, provoking fury from other European Union countries whose guarantees were capped. Anglo Irish Bank was the first to attract real concern when, in December 2008, it revealed that Sean FitzPatrick, its former chief executive, had hidden loans of up to €122 million over eight years. Anglo was nationalised a month later. By February, Dublin was injecting €3.5 billion apiece into AIB and Bank of Ireland in return for preference shares. In April it set up the National Asset Management Agency to relieve banks of their toxic assets.
Mr FitzPatrick was arrested this month as part of a fraud investigation into Anglo’s collapse. AIB shares fell 17.5 per cent to €1.39, while Bank of Ireland was down 9.4 per cent to €1.25.
Ireland to launch €81 billion bad loan bank
Ireland will on Tuesday begin operating a new "bad bank" to house €81bn in bad property loans left over from the financial crisis and set out new capital requirements that are expected to see the further nationalisation of its banking sector. Irish bank shares fell sharply on Monday amid fears that the new financial requirements could prove crippling. The National Asset Management Agency, the government’s so-called bad bank, is set to reveal larger-than-expected "haircuts", or discounts, on €17bn of loans extended to Ireland’s top 10 biggest property developers – the first tranche of loans to be taken off the banks’ books. The announcement will have direct implications for the level of capital the banks will need in the future – and will in turn determine the extent of any increased government shareholding the banks may need to maintain regulatory capital levels.
Shares in Allied Irish Banks, Ireland’s second-largest bank, lost almost 20 per cent amid investor fears that Dublin could end up owning as much as 70 per cent of it after losses are crystallised on loans transferred to the government’s bad bank. Also hit hard were shares in Bank of Ireland, the country’s largest bank. Its shares closed down 10.4 per cent as investors speculated that Dublin could take up to a 40 per cent stake. The bad bank’s role is to purge the banking sector of €81bn worth of loans – or about a fifth of total loans – extended during the boom years to Ireland’s leading property tycoons, who are now facing ruin. Brian Lenihan, the finance minister, and Matthew Elderfield, the financial regulator, will set capital adequacy rules for the banks once the state has taken over their most impaired property loans. Banks are expected to have to increase their tier one equity – the strongest type of capital buffer – to about 7 per cent, far higher than current levels.
In total it is estimated that the banks will need €16bn in fresh capital. If much of this is provided by the government this could have implications for Ireland’s sovereign risk profile. The plan is the centrepiece of Ireland’s rescue of its shattered economy, and follows the revealing in December of severe public sector pay cuts, which helped restore investor confidence in Brian Cowen’s Fianna Fáil-led coalition government. Like Greece, Portugal and Spain, Ireland is facing a sovereign debt crisis, triggered by investor concerns over the hole in its public finances. At 11.7 per cent of gross domestic product in 2009, the budget deficit is the second largest in the eurozone after Greece. However, Ireland has already taken decisive action with a fiscal tightening since late 2008 of 6 per cent of GDP.
US Home Prices Mostly Flat Y-O-Y, Month-To-Month Declines Continue
U.S. home prices were mostly flat from a year earlier in January, according to the S&P Case-Shiller home-price indexes, but month-to-month declines continued for the fourth straight month. S&P's David Blitzer called the report "mixed," noting, "The rebound in housing prices seen last fall is fading." Prices in 10 major metropolitan areas were flat in January from a year earlier, while the index for 20 major metropolitan areas dropped 0.7% year over year. The readings last grew on a year-to-year basis in January 2007.
Compared with December, the 10-area index fell 0.2% and the 20-area index declined 0.4%. Adjusted for seasonal factors, the 10-city index rose 0.4% on month in January, while the 20-city composite climbed 0.3%. The recovery in the U.S. housing market has been fragile. Last week, the National Association of Realtors said sales of existing homes fell a better-than-expected 0.6% in February from a month earlier, as a glut of homes for sale and a wave of foreclosures and fire sales are holding down housing prices. Some stabilization has been seen as home prices and mortgage rates remain low and a host of consumers have taken advantage of an $8,000 first-time homebuyer tax credit.
Compared with a year earlier, Las Vegas continued to be hit the hardest, 17% lower than a year earlier. Month-to-month gainers, sans seasonal adjustment, were headlined by Los Angeles and San Diego showing slight improvements, while all the other markets showed a decline. Four markets -- Charlotte, Las Vegas, Seattle and Tampa -- reported new price lows for the current cycle.
U.S. Spending Increases, Incomes Stagnate
Consumer spending in the U.S. rose in February for a fifth consecutive month, a rebound that will require gains in employment to be sustained. The 0.3 percent increase in purchases matched the median forecast of economists surveyed by Bloomberg News and followed a 0.4 percent advance in January, Commerce Department figures showed today in Washington. Incomes were unchanged, falling short of expectations as winter storms hurt hiring and hours worked.
Best Buy Co. and Nike Inc., which have reported higher- than-anticipated profits, are among companies that may keep benefitting as the emerging recovery gives Americans the confidence to buy. The pickup in purchases has caused the household savings rate to drop to the lowest level in more than a year, underscoring the need for more jobs to ensure the recovery is maintained. "Considering the circumstances, this is a fine performance with the job market still not strong," said Michael Moran, chief economist at Daiwa Securities America Inc. in New York. "As the labor market comes back, we should see continued support from consumers." Stocks and commodities rose on signs the world’s largest economy will keep growing and as concern waned over the Greek government’s deficit. The Standard & Poor’s 500 Index advanced 0.6 percent to 1,173.22 at 4:10 p.m. in New York.
The median estimate of 70 economists surveyed called for a 0.3 percent increase in spending, after an originally reported gain of 0.5 percent the prior month. Projections ranged from no change to a 0.6 percent advance. The little change in incomes followed a 0.3 percent increase in January. The median estimate of economists surveyed called for a 0.1 percent advance. Wages and salaries were also little changed last month after climbing 0.4 percent in January.
Payrolls fell by 36,000 workers in February and the workweek shrank as blizzards in the eastern part of the country caused some plants to temporarily close. The median forecast of economists surveyed anticipate the government’s employment report on April 2 will show the economy created about 180,000 jobs this month, the most in three years. Because spending rose and incomes were unchanged, the savings rate fell to 3.1 percent last month, the lowest level since October 2008.
"Step one in lifting consumer spending was the lowering of the personal saving rate," Ken Mayland, president of ClearView Economics LLC in Pepper Pike, Ohio, said in a note to clients. "That’s pretty much played out. Now for step two, we need to see a good, old-fashion advance of employee compensation. Hopefully, we will begin to see that in March with the rise in payrolls." Nike, the world’s largest maker of athletic shoes, said this month that third-quarter profit more than doubled, beating analysts’ estimates, as North America posted a sales increase for the first time in a year. Best Buy, the largest U.S. electronics retailer, last week reported fourth-quarter profit that exceeded analysts’ estimates as the Richfield, Minnesota-based company boosted sales by cutting prices on flat-panel TVs and offering discounts during the holidays.
Adjusted for inflation, spending also climbed 0.3 percent, the best performance since November. Price-adjusted spending on durable goods, such as autos, furniture, and other long-lasting items, fell 0.2 percent in February. Purchases of non-durable goods increased 0.9 percent, the biggest gain since January 2009, as Americans stocked up on groceries and splurged on clothing. Spending on services, which account for almost 60 percent of all outlays, increased 0.3 percent. Auto dealers are among retailers that may see a pickup in demand this month, said industry analysts such as J.D. Power & Associates and Edmunds.com. Cars and light trucks will sell at a 12 million unit annual pace in March, up from a 10.4 million pace in February, according to a Bloomberg survey.
The economy grew at a 5.6 percent annual rate in the fourth quarter, the fastest pace in six years, figures from the Commerce Department showed last week. Consumer spending slowed to a 1.6 percent pace from 2.8 percent the previous three months. Household purchases, which account for 70 percent of the economy, are on track to expand at a 3.4 percent pace this quarter, the best performance in three years, according to a forecast issued after the government’s report by economists at Morgan Stanley in New York.
Today’s figures also showed prices cooled. The inflation gauge tied to spending patterns rose 1.8 percent from February 2009, down from a 2.1 percent increase in the 12 months ended in January. The Fed’s preferred price measure, which excludes food and fuel, was unchanged in February for a second month and was up 1.3 percent from a year earlier. "The risks are that inflation may continue to decelerate," John Herrmann, senior fixed-income strategist at State Street Global Markets LLC in Boston, said in a note to clients, supporting the view that Federal Reserve policy makers will hold interest rates low for a long time.
Low Interest Rates Are Squeezing Seniors
Charles R. Schwab
Today's historically low interest rates may be feeding banks' profitability, but they are financially starving our seniors. In February 2006, when Ben Bernanke was first sworn in as chairman of the Federal Reserve, the federal-funds target rate stood at 4.5%. That same year, the average yield on a one-year certificate of deposit was 5.4%. A retiree who diligently saved for a lifetime and had amassed a nest egg of $100,000 could count on an added $5,400 in retirement income per year. That may not sound like much to the average Wall Street Journal subscriber, but for a senior on fixed incomes that extra money improved the quality of his life.
Today's average rate for an identical one-year CD is roughly 1.3%. On the same nest egg, that retiree will now get annual payout of just $1,300—a 76% decline in four years.
Some would argue that today's low inflation rate offsets the decline. But even at an inflation rate of zero, a 76% decline in spending power is painful. And we're already seeing signs of inflation this year. The first two months of 2010 showed an annualized inflation rate of 2%, further exacerbating the spending power problem for retirees by eroding the value of their principal. To be sure, the country's recent financial crisis required unprecedented action by the Fed, including lowering rates to levels not seen in more than 50 years. In particular, the infusion of capital into the banking system through historically low fed-funds target rates pulled many banks from the precipice of collapse. By that measure it has been a resounding success.
Yet these unprecedented low rates have now been in place for almost 18 months. As a result, banks have enjoyed virtually free access to money while retirees have been deprived of any meaningful yield on their fixed-income portfolios. For a large segment of our population—people who worked long and hard, who followed the rules by spending less than they earned and putting the remainder away to keep themselves independent in retirement—the ultra-low interest rate is more than a hardship. It's a potential disaster striking at core American principles of self–reliance, individual responsibility and fairness.
To put the scale of this problem in context, consider the fact that more than $7.5 trillion in American household wealth is held today in short-term, interest-bearing products such as checking and savings accounts, retail money funds and CDs. At today's low interest rates, the return on those savings is hundreds of billions less than it would have been at 2006 interest rates. Retirees feel the consequences disproportionately, but because much of that income would have made its way into the economy, spending and job creation also suffer.
I see the pain that low interest rates have caused very directly. My company, Charles Schwab, serves millions of individual investors, many of whom are 65 and older. These people depend on cash savings for their financial well-being. Many in this age group are being forced to stretch for income one of three ways. One is to take on more risk just as they are progressing through retirement. Another is to go longer in maturity with their fixed income investments, locking them into a situation where inflation will bite further into their principal and purchasing power. And the worst is the slow erosion of principal that is already occurring as people cash out of savings to make up for needed income.
It's not just retirees on fixed income we should be concerned about. Let's not forget that savers of all ages—even the young person opening his first savings account—need some incentive of future reward for saving. Today, there is none. The large banks are well on the mend. Profits are improving and they're doing just fine. Our seniors are not. Those in Washington should keep their plight in mind as they consider Fed monetary policies going forward.
‘Canary in coal mine’ heralds bond trouble
by Gillian Tett
In recent years, a key axiom that every investment manager learnt at school (or, more accurately, in an MBA class) was that the rate at which triple A-rated countries such as America could borrow money could be labelled the "risk-free" rate – and corporate (and) other borrowing costs could be measured against it. But is it time to rethink that "risk-free" tag? If you look at what is happening in the US and UK interest rate markets right now, the answer is "yes". From time immemorial, it has been taken as self-evident that the swaps spread in debt markets should be "positive". What this so-called "swaps spread" essentially measures is the cost of borrowing funds in the Libor market (for a private companies, such as banks), minus the cost of raising government debt.
And, since the private borrowing costs are influenced by credit and counterparty issues (ie: whether banks default or fail to repay), logic suggests those Libor rates should be higher than sovereign borrowing rates. After all, triple A-rated central government is supposed to the safest thing about. But now, as my colleagues Michael Mackenzie and David Oakley first reported two weeks ago, something bizarre is going on. Back in late 2008, after the collapse of Lehman Brothers, the 30-year swap spread turned negative, when the markets froze amid wider financial chaos.
At the time, that swing did not grab many headlines, partly because the 30-year market garners little attention in the US. However, last week the closely watched – and vastly more influential – benchmark 10-year swap spread turned negative too, as 10-year Treasury yields spiralled up towards 4 per cent and above the 10-year swap rate. That may simply be a temporary aberration. After all, the swaps market is not a perfect barometer of macroeconomic conditions and some unusual supply-demand imbalances seem to be distorting the market.
One issue affecting spreads, for example, is that investors are changing the way that they hedge mortgage rate risk, since the Federal Reserve is due to stop buying mortgage backed securities on Tuesday. A second factor is that more pension funds are trying to use swaps for meeting long-dated liabilities, rather than commit capital to buying bonds, at a time when government bonds are losing their scarcity value because of massive issuance. At the same time, a flood of corporate issuance has left an unusually high number of entities swapping their fixed liabilities for floating exposures. More importantly still, there are rumours that some banks and hedge funds have recently suffered losses because they were wrong-footed by the swap swing. If so, they may be trying to cut their positions, thus exacerbating market movements.
However, there is another, less benign explanation for what is going on: namely that what we are seeing is a "canary in the coal mine" (to use the pithy image used by Alan Greenspan, former Fed chairman, last week), heralding future government bond market trouble and investor panic. Think back, for a moment, to the early summer of 2007, or just before the start of the subprime meltdown. Back then, it was not the equity and credit markets that signalled disaster. Instead, the main sign of spreading investor alarm was that prices started to swing in the more obscure world of credit derivatives indices (such as ABX) and asset-backed commercial paper (ABCP). This time round, is the swaps market another version of, say, ABX? Perhaps not yet. Personally, I will be astonished if countries such as the UK and US entirely avoid a government bond market shock; but I also suspect that this will occur some time down the road.
Nevertheless, if nothing else, the swaps spread swing does suggest that some investors are getting jittery. It also serves to underline that we do not live in "normal" markets right now. While the surface may look calm, the inner cogs of the financial system have been distorted by government intervention in ways that are still barely understood. That, coupled with spiralling levels of government debt, has the potential to cause all manner of investment assumptions to go awry. Some trading desks and hedge funds are probably already counting the cost of that; as I noted above, the swaps spread swing has almost certainly created losses somewhere, given that it was not factored into most trading models. But the story is unlikely to stop there. If we are moving into a world where government debt is no longer automatically deemed "risk-free", partly because it no longer has any scarcity value, this will be a different world to the one investors know. In the months ahead, in other words, investors and politicians had better keep watching this swaps "canary". Especially (but not exclusively) in the ever-expanding Treasuries world.
SEC launches 'Repo 105' probe
US regulators on Monday asked more than 20 financial groups whether they engaged in transactions along the lines of "Repo 105" – an accounting device that helped Lehman Brothers conceal its high leverage ratio during the financial crisis. The corporate finance division of the Securities and Exchange Commission wrote to chief financial officers of "close to two dozen" large foreign and domestic banks and insurers, demanding details of repurchase agreement deals.
The SEC probe includes whether companies booked repos as asset sales for accounting purposes over the past three years, and whether these deals were concentrated with certain counterparties or certain countries. Regulators also asked companies to quantify the amount of repos that were disclosed as asset sales and to explain the "business reasons" for use of these structures. The heightened scrutiny of repos is the result of a report by a court-appointed examiner this month which found that Lehman used the Repo 105 technique to book temporary repurchase agreements as permanent asset sales in 2008. This helped Lehman conceal about $50bn from its balance sheet, thus reducing its leverage ratio and appearing healthier to the eyes of investors and analysts.
"We are looking at the Lehman activity very, very carefully and all the issues surrounding Repo 105," Mary Schapiro, SEC chairman, told CNBC on Monday. The report on Lehman caused a flurry of activity in Washington. Chris Dodd, chairman of the Senate banking committee, called on the justice department to investigate alleged accounting wrongdoing at Lehman and prosecute any employees at the bank – or "other companies" – who might have broken the law. The Repo 105 furore highlights how fallout from the crisis continues to generate debate among policymakers, regulators and Wall Street executives even now the banking system has returned to profitability.
By now, the Obama administration was supposed to have a plan to reform Fannie Mae and Freddie Mac, the "government-sponsored" mortgage finance enterprises (GSEs) that have been under federal control -- and absorbing $126 billion in federal cash -- for the past 19 months. But last week Treasury Secretary Timothy F. Geithner told the House Financial Services Committee that all he can promise is a "public comment" period starting April 15, in which the various housing interest groups -- and there are a lot of them -- can submit their ideas. Thereafter, at an unspecified "time of greater market stability," legislation can be drafted, introduced and passed. In short, after a year of discussion, Mr. Geithner promises more discussion.
To be sure, there are reasons for this delay. The political system, already overtaxed by the health-care debate and a looming battle over regulatory reform, might not be able to handle another partisan war. Housing remains fragile, with a huge "shadow inventory" of soon-to-be foreclosed properties poised to flood the market and not nearly enough private capital available to take the place of Fannie and Freddie's limitless credit line with the Treasury. Still, there is no shortage of good ideas for restructuring Fannie and Freddie, and it's not clear that a few more months of debate will produce any brilliant discoveries. Presumably, everyone now recognizes that the old "government-sponsored" model encouraged excessive risk-taking, with private parties reaping the gains and taxpayers stuck with the losses.
The new model must abolish this fatal confusion. The country can probably get away with waiting until 2011 to do that, but not much longer. The worst possible outcome would be that housing lobbies succeed in using Mr. Geithner's "comment" period to limit the scope of reform. In that sense, Mr. Geithner's testimony last week was useful, because it endorsed some hard truths about Fannie and Freddie -- and the reasons for their failure -- that past Congresses and administrations have been loath to concede. Among these: that "a significant amount" of the enterprises' large, implicit subsidy was not passed along to homeowners as advertised "but instead benefited GSE shareholders, managers, mortgage originators and other stakeholders."
Also, Mr. Geithner acknowledged, the GSEs' "aggressive lobbying" helped them to thwart serious oversight or reasonable capital requirements. Looking ahead, Mr. Geithner argued -- correctly -- that goals for affordable housing must be pursued through agencies specifically devoted to them, and not "commingled" with the broader purposes of mortgage finance. "The housing finance system cannot continue to operate as it has in the past," he said. Right again.
Spurt of Home Buying as End of Tax Credit Looms
Nine hundred days after putting their house on the market, Andrew and Jane Palestini were beginning to think they might be stuck in Iowa forever. The looming expiration of the government’s housing tax credit pushed them into action. They dropped their price by an additional $10,000, to $235,000. Somewhat to their shock, a buyer emerged. The house is now under contract. "I can’t feel happy," said Mr. Palestini, a retired administrative law judge with the Social Security Administration. "Just relieved."
After several disastrous months for home sales across the country, when volume dropped by 23 percent, the pace appears to be picking up again. The number of Des Moines homes under contract in February rose by a third from the January level. The number of pending contracts jumped 10 percent in Naples, Fla., 14 percent in Houston and 21 percent in Portland, Ore. These deals will be reflected in the national sales reports when they become final, this month or next. There is no evidence that prices have begun to move in response to the higher volume. Indeed, so many homes are coming on the market that prices might well fall further.
Real estate agents say buyers and sellers are hurrying to take advantage of the tax credit, which is worth up to $8,000 for home buyers. But the last-minute rush is also prompting some foreboding about what will happen to the market on April 30 when the credit ends — and whether it is too risky to let it end at all. James M. Poterba, an economist at the Massachusetts Institute of Technology, calls this "the exit strategy problem." "If you have a short-run program to stimulate demand, it’s always tricky to figure out how you gently remove it without going off a precipice," he said.
Arguments for extending the tax credit a second time are just beginning. Robert Shiller, a professor of economics at Yale and co-developer of the Standard & Poor’s/Case-Shiller housing price index, is an early advocate. He thinks the credit was a bad idea that nevertheless the market cannot do without. "You don’t make drug addicts go cold turkey," Mr. Shiller said. "The credit interferes with the market in an arbitrary way, but ending it now would be psychologically powerful. People will be in a bad mood about buying a house." He advocates phasing it out gradually.
In some states, worries about the housing market are trumping fiscal considerations. They are adopting or extending tax credits or other supportive measures in hopes of bringing the market to life. California last week renewed a $10,000 credit that proved popular last year, allocating $200 million for it despite a state budget crisis. New Jersey legislators just introduced a bill that would give buyers a $15,000 credit spread over three years. South Carolina recently announced a $7,000 down payment assistance program for teachers, police officers and firefighters.
As it has been for several years, housing remains the most coddled and the most troubled sector of the economy. Outside the realm of real estate, many of the government banking programs created to deal with the crisis have ended, and credit markets have largely returned to normal. On March 8, the Federal Reserve held its final auction in a two-year-old program that offered banks emergency short-term loans. A few days earlier, however, government regulators extended a refinancing program for homeowners whose properties had plunged in value. Originally due to expire in June, the program has been renewed to the middle of 2011 "to support and promote market stability," the Federal Housing Finance Agency said.
On Monday, just three days after substantially expanding its antiforeclosure programs, the Obama administration announced another $600 million to finance innovative measures to help defaulting families in five hard-hit states: North Carolina, Oregon, Ohio, Rhode Island and South Carolina. The first round of financing, announced last month, provided $1.5 billion to states including California and Florida. Supported by an array of government programs aimed at both reducing foreclosures and encouraging traditional sales, housing was supposed to be on the road to a solid recovery. An earlier version of the tax credit created a rush to buy in the fall, when people thought it would expire Nov. 30. The housing industry argued that sales would fall off a cliff if the credit were not extended and broadened, so Congress went along.
Stan Humphries, the executive in charge of data and analytics at the housing site Zillow.com, said government support was crucial in breaking housing’s acute fall in 2007 and 2008, but that it had also obscured the actual weakness of the market. "Many people got the sense last year that we had bottomed out and were going to rebound in a V-shaped recovery," he said. Instead, the sales volume of existing homes declined in December more steeply than in any month in the four decades that such numbers have been tracked. Sales dropped again in January and February. Meanwhile, the sales volume of new homes fell in January to the lowest level since record-keeping began in 1963, a record broken again in February.
Buyers who want the tax credit must sign a deal by April 30 but would have until June 30 to close. Consequently, if sales volume is going to plunge after the credit expires, it will not show up until the numbers for July are reported. While Mr. Humphries says he does not expect sales that month to fall by December’s record rate, he predicts a long period of merely "dragging along the bottom," with prices to match. That was just what the Palestinis were worried about. If they did not sell by April 30, they anticipated having to lower their price yet again, to compensate any buyer for the credit he would no longer get. It also meant they would not get a credit themselves on buying a new home in Philadelphia, pushing down what they could afford to pay.
It has been an unexpected ordeal. The Palestinis bought their spacious ranch house in the Des Moines suburb of Clive for $185,000 in 1995, after looking for only three days. "My feeling was it would never be a problem selling," said Jane Palestini, a retired specialist in adoptions from China. "Ha, ha, ha." In early 2007, the house across the street sold in three days, but the Palestinis spent the summer getting their place ready. By the time they put it on the market that September for $265,000, prices were falling. For months, they lived in a state of readiness for prospective buyers. To minimize clutter, they carted off many of their possessions to self-storage. They bought new pillows and kept them mounded on the beds. They bought fresh flowers and baked hundreds of cookies.
The months became years. They know their mistake: They should have kept cutting the price until they sold. But every dollar they dropped their price was one dollar less for a down payment in Philadelphia. Their house is under contract for $225,000. After paying the agent’s commission and subtracting the cost of remodeling the kitchen, the Palestinis are at best breaking even. "You just have to ignore how much it’s going to hurt," Mr. Palestini said.
At least they have escaped whatever trouble is to come this summer. Their agent, Jim Heldenbrand, told them he hoped the credit would "get the momentum going." But he also mentioned the plans of a colleague in real estate: As soon as the credit expires, the man plans to get on his Harley and just keep riding south.
Banking on hypocrisy
by Elizabeth Warren
Banks or families?
For almost a year, the big banks and the American Bankers Association (ABA) have presented that choice to Congress. Lobbyists argue that meaningful consumer protection will jeopardize the safety and soundness of banks, telling lawmakers that they must decide between the two. While American families have made clear that they overwhelmingly support the reforms that a new consumer agency will produce – like clear, understandable terms and conditions for consumer credit products and accountability for the big banks — the lobbyists have made equally clear their plan to kill the agency.
ABA lobbyists now aggressively insist that separating consumer protection and safety and soundness functions would unravel bank stability. Yet just a few years ago, they heatedly argued the opposite—that the functions should be distinct. In 2006, the ABA claimed to act on principle as it railed against an interagency guidance designed to exercise some modest control over subprime mortgages. It criticized the proposal for "combin[ing] safety and soundness guidance with consumer protection guidance, creating confusion that is best addressed by separating them."
The ABA went on to argue that the "marriage of inconvenience between supervision and consumer protection appears to blur long-established jurisdictional lines." And then: "ABA recommends that the safety and soundness provisions relating to underwriting and portfolio management be separated from the consumer protection provisions." Read that again: the ABA in 2006 said that policymakers should separate safety-and-soundness and consumer protection—exactly the opposite of its position today. This 2006 memo illustrates the ABA’s real consistency— consistent opposition to meaningful reform.
If there is a smoking gun in the battle over financial regulatory reform, the 2006 ABA memo is it. In the memo, the ABA also argued that: 1) the proposed guidance "overstates the risk" of so-called "non-traditional mortgages"; 2) the non-traditional mortgages were not "inherently riskier" than traditional mortgages; and 3) the non-traditional mortgages "simply present different types of risks that may be well-managed by prudent lenders."
So much for the ABA’s expertise on what increases the riskiness of banks. The ABA’s efforts to block rules over subprime mortgages contributed directly to the economic crisis. They also offer irrefutable proof that bank lobbyists will say anything to block meaningful reform. If saying down is up and up is down – or, for that matter, that the CFPA’s consolidation of seven bloated, ineffective bureaucracies into one streamlined agency will create more bureaucracy – then the ABA lobbyists are willing to say it.
They were just as willing to argue against the integration of safety and soundness and consumer protection functions in 2006 as they are willing to argue for the integration of safety and soundness and consumer protection functions today—so long as it derailed any meaningful consumer protection. The lobbyists’ consistent theme is unmistakable: they oppose meaningful rules in the consumer credit market.
In 2006, they opposed any structure that might have produced rules to reign in subprime mortgage lending. In 2010, they oppose any structure that might reign in a broader array of tricks and traps. They are now lobbying hard to water down the consumer agency’s independence with oversight vetoes and other administrative roadblocks that have no precedent in the federal regulatory apparatus—not out of principle, but because they don’t want meaningful rules. The ABA’s reversal reveals that its safety-and-soundness argument is—and always was—a diversion.
The ABA’s premise that the country can’t have both meaningful consumer protection and safety and soundness is wrong. In fact, its defense against an independent consumer agency boils down to this: if banks can’t trick and trap people with fine print and legalese, they won’t be able to turn a profit. When other industries have argued that tricking their customers is an essential part of their profit model, they haven’t gotten far. For example, it might be profitable in the short run to substitute baking soda for antibiotics, but basic safety regulations prevent such moves—and the pharmaceutical industry still manages to do just fine. In fact, the industry flourishes, bringing better, cheaper products to customers.
Similarly, the consumer agency now before the Senate is designed to cut out tricks and traps pricing, fine print that no one can read, and sharp practices that strip billions of dollars from consumers. The ABA’s position is particularly galling because it was the lack of meaningful, independent consumer protection that helped bring down the entire banking system and cause the current crisis. Without billions pumped into subprime mortgage lending, the housing bubble could not have inflated; Lehman and other MBS traders would have lacked the raw material that fueled their excessive risk taking, and the destabilization of millions of families and neighborhoods would not have occurred.
In the weeks ahead, the Senate does not need to decide between safety and soundness and consumer protection. But the ABA is right about one thing: the Senate does need to decide between banks and families.
European Banks Face $209 Billion Shortfall on Real Estate Debt
European banks may face a 156 billion-euro ($209 billion) shortfall in funds needed to refinance commercial real-estate debt in the next two years, DTZ Holdings Plc estimates. About 480 billion euros of property loans will mature by the end of 2011, according to research by the London-based broker. Banks won’t be able to refinance all of the debt, particularly when loans exceed the value of the properties backing them. More than half of the shortfall will occur in the U.K. and Spain, DTZ said.
European lenders are grappling with the legacy of 1.8 trillion euros of loans given to buyers of stores, offices and warehouses in the five-year real estate boom that ended in mid- 2007. Many were granted near the market’s peak at more than 80 percent of building values. Prices then sunk by about 26 percent across continental Europe and 44 percent in the U.K, leaving many borrowers owing more than the value of the buildings. The shortfall "is the biggest short-term challenge to the European property markets," Nigel Almond, the study’s co- author, said in the report. "As many loans reach their maturity in the next few years, we expect defaults to become more likely."
Lenders have so far been able to maintain most of their problem loans due to central bank support. That includes asset- protection measures that allowed them to extend loans and ignore most defaults or breaches of borrowing terms. That will change because some of those policies are set to be reversed, DTZ said. When refinancing can’t be done, banks will have to consider selling or foreclosing on loans or agreeing with the borrower or a third party investor to add more cash into the deals, DTZ said. Companies are preparing to invest 116 billion euros in the European commercial real estate market over the next two years, DTZ estimates.
"European banks have not wanted to and have not been forced to sell loan books at distressed prices," Almond said. "Changes are at hand where both banks and equity investors will come under increased pressure to more urgently find effective solutions." The shortfall will be at least 115 billion euros, DTZ said. The U.K. will have the largest portion of that at 42 billion euros, or 36 percent of the total. Spain will have 20 percent of the total and France 11 percent, according to the report. DTZ described the 156 billion euro gap as its "pessimistic" scenario.
Greece's spending cuts are making debt crisis worse, says national bank
Greece's finances have "fallen into a vicious circle" after the ruling socialists announced drastic spending cuts to contain the debt crisis, the country's central bank said in its annual report. Hours after a senior official revealed the nation had enough money to get by until the end of April, the Bank of Greece forecast that the Greek economy would contract by 2% this year – worse than the government's predicted 1.7% and bound to exacerbate fiscal woes. The gloomy assessment, on the eve of a crucial EU summit in Brussels, was blamed squarely on the draconian austerity measures aimed at saving €4.8bn (£4.3bn) for the government.
As average wages drop for the first time since the restoration of democracy in 1974, the resulting reduction in spending power would inevitably extend the country's deep-seated recession, the bank said. Worse than expected growth last year had also played a role. The budget deficit, forecast at 12.7% of GDP in 2009, would hit 12.9%, the bank said, estimating public debt at 115% of annual output: "The Greek economy has fallen into a vicious circle with only one way out: the drastic reduction of the deficit and debt." Athens needs to borrow €16bn to refinance maturing debt by the end of May, said Petros Christodoulou, the new head of Greece's debt agency.
While that is less than the €25bn originally estimated, the EU's failure to agree a concrete formula to solve the crisis – support that Athens says will lower market pressure and allow it to borrow at "more logical" interest rates on capital markets – has infuriated Greeks. A bond sale by the Greek government on 4 March was heavily oversubscribed but at a punishing yield of 6.3%, with the result that the €5bn raised cost Athens €700m extra in interest. Today the risk premium on Greek debt rose to more than 340 basis points over benchmark German bonds.
Echoing public frustration at Berlin's perceived intransigence, the Greek deputy prime minister, Theodore Pangalos, used a business conference in Athens to attack Germany. He said Berlin's reluctance to come to Athens' aid was because its own banks and exporters were involved in the "deplorable game" of profiting from the debt crisis.
Greece Pays Bond Investors 5 Times Spain Yield Spread
Greece, the European Union’s most indebted member, offered more than five times the yield premium of comparable Spanish debt to lure investors to its first bond sale since a bailout was agreed for the nation. Greece priced the 5 billion euros ($6.7 billion) of seven- year bonds to yield 310 basis points more than the benchmark mid-swap rate, according to a banker involved in the transaction, who declined to be identified before the sale is completed. The bonds’ 6 percent yield equates to 334 basis points more than seven-year German bunds, Europe’s benchmark government securities. That compares with a yield premium, or spread, of 61 basis points for similar-maturity Spanish debt and 114 basis points on Portugal’s government bonds due 2017, according to composite prices on Bloomberg. Italy’s seven-year bonds yield 45 basis points more than bunds, the prices show.
"Greece’s borrowing costs exceed those of Spain and Portugal as it still needs to convince the market that it can roll over existing debt," said Michiel De Bruin, who will probably buy the securities for the $28 billion of assets he helps manage as head of euro government bonds at F&C Investments in Amsterdam. "Only then is it likely that borrowing costs will fall." Prime Minister George Papandreou’s government must raise about 53 billion euros this year, 15.5 billion euros of it by the end of May. Failure to do so could spark a new round of the fiscal crisis and trigger the use of the aid plan to help Greece finance its budget deficit by standing behind the nation’s debt crafted by EU leaders in Brussels March 25. The sale pushed up the cost of default insurance on Greece’s debt. Credit-default swaps on the nation climbed 15.5 basis points to 310.5 basis points, according to CMA DataVision. The price of the swaps soared to as high as 428 basis points on Feb. 4 when it seemed likely Greece’s debt crisis would spread to its southern European neighbours.
"This deal is likely to be first of many to get Greece through its April and May funding needs," said Peter Chatwell, a fixed-income strategist at Credit Agricole CIB in London. The 6 percent yield on Greece’s new notes compares with 6.30 percent on the nation’s 5 billion euros of 10-year benchmark bonds issued March 4. The country’s five-year notes sold on Jan. 26 now yield 5.76 percent, Bloomberg data show. "This looks a lot more confident than their other recent issues, which came with a decent discount," said Toby Nangle, director of asset allocation at Barings Investment Services Ltd. in London. Greek government bonds are the worst performers in the 16- nation euro region this year, handing investors a loss of 0.11 percent, compared with gains of 0.58 percent and 1.97 percent from Portuguese and Spanish debt, according to Bloomberg/EFFAAS indexes.
Petros Christodoulou, head of the debt management agency in Athens declined to comment on the bond sale in an interview today, other than to say it would be of "benchmark size." The aid mechanism removes the risk of Greece failing to repay bond investors and "should tighten the spreads materially," he said in an e-mailed response to questions on March 26. Papandreou demanded financial aid from the EU to help Greece reduce its borrowing costs, which he says were unsustainably high. Today’s bond sale pushed the extra yield investor require to hold 10-year Greek notes rather than benchmark German bunds 13 basis points wider to 318 basis points. The gap was 239 at the start of this year and as high as 396 in January. A basis point is 0.01 percentage point. Euro-area countries would grant more than half the loans and the International Monetary Fund would provide the rest in the deal struck last week to help stabilize the euro, which has weakened 6 percent against the dollar this year. Papandreou says he never expects to seek assistance.
It’s "counterproductive" to speculate about the scenarios, including developments on spreads, that would spur an aid request under the new facility, he said. Goldman Sachs Group Inc. Chief European Economist Erik Nielsen estimates Greece will ultimately need an 18-month package of as much as 25 billion euros, with the IMF providing about 10 billion euros of that. French Finance Minister Christine Lagarde said March 27 in Cernobbio, Italy, that the EU’s strategy shows the "determination" of policy makers to "keep the euro stable." Her German counterpart, Wolfgang Schaeuble, said in a Welt Online interview the same day that EU countries seeking IMF help must remain an exception and in the longer term "Europe must be able to solve" fiscal problems by itself. Greece faces about 12 billion euros of debt repayments in April, with 8.2 billion euros of five-year bonds and about 3.9 billion euros of bills maturing that month. It must repay 8.5 billion euros of 10-year bonds in May.
"The seven-year tenor on Greece’s new bond is the only viable option, as it does need to extend the average maturity of its debt," said Marc Ostwald, a fixed-income strategist at Monument Securities Ltd. in London. "I hope that the country boxes clever, and doesn’t upsize the offering as it did in January. If Greece does ramp up the deal size, a lot of long- term investors could be put off." While those are the only bond maturities Greece faces this year, the country needs an average of almost 2 billion euros a month to cover the budget deficit and interest payments on existing debt, its deficit reduction plan shows. Greece aims to cut its shortfall by four percentage points in 2010 from last year’s 12.7 percent of gross domestic product, before satisfying the EU’s 3 percent limit by 2012.
"The announcement of the bailout mechanism for Greece should end the immediate liquidity and therefore default risk for Greece," Laurence Mutkin, head of European fixed-income strategy in London at Morgan Stanley, wrote in a report to clients. "However, we think that the longer term trajectory for Greece remains uncertain." Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company or country fail to adhere to its debt agreements. A basis point on a contract protecting $10 million of debt from default for five years is equivalent to $1,000 a year. Greece hired Alpha Bank AE, Bank of America Merrill Lynch, Emporiki Bank SA, ING Groep NV and Societe Generale SA to manage the sale of new bonds, according to two other bankers.
The mañana syndrome
The government is not doing enough to tackle Spain’s economic problems
Om a small plot of land near Candeleda, in Ávila province, Antonio de la Cruz is planting tobacco. It is years since he grew anything. During Spain’s decade-long boom, he worked on construction sites, which paid better. But building has ground to a halt. "I’ve got to do something," he says. He is lucky: few of Spain’s 4.3m unemployed (almost 20% of the workforce) have bits of land to plough.
A morale-boosting advertising campaign, backed by 18 large banks and companies, tells glum Spaniards that their problems can be fixed "between us all". The opposition People’s Party disagrees. This has to be fixed by whoever broke it, says its spokesman, Esteban González Pons. He means that the Socialist prime minister, José Luis Rodríguez Zapatero, should do the fixing—and that he is failing.
The list of things that need repair is extensive. Spain’s structural faults were long hidden by a housing bubble and have been glaringly exposed now that it has burst. From unemployment and low productivity growth, and from troubled savings banks to creaky public finances, the problems are piling up. With the government unwilling to apply radical surgery, there are fears that Spain will fall further behind its neighbours. "The risk is that we will have a lost decade, like Portugal or Japan," says Lorenzo Bernaldo de Quirós, an economist at Freemarket International Consulting in Madrid.
Unemployment tops most people’s worries. Faster growth is needed to bring it down. Yet Spain has been in recession for seven quarters; the government expects GDP to shrink again this year; and the IMF forecasts growth of less than 1% in 2011. The public finances must also be fixed. Last year’s deficit ballooned to over 11% of GDP. In January Elena Salgado, the finance minister, produced an outline of austerity measures that calmed market fears about Spanish debt. But two months later the plan still lacks detail—and has an obvious flaw.
An optimistic Ms Salgado predicted growth of 3% in both 2012 and 2013, bringing added revenues to cut the deficit. Spain’s European commissioner, Joaquín Almunia, has warned against the sin of over-optimism. Growth will not go over 2% until 2014, says Ángel Laborda, an economist at FUNCAS, the savings banks’ foundation. He reckons that more tax rises and spending cuts are inevitable if the government is to hit its 3% deficit target by 2013. Ms Salgado is already raising value-added tax, with the top rate going from 16% to 18% in July. Mr Zapatero says this will finance the unemployed. "We can pay unemployment benefits to half a million people," he said in a television interview. Yet higher taxes will also dampen consumer spending, sending growth lower still.
Deeper reforms to Spain’s economy look unlikely. The Bank of Spain’s governor, Miguel Ángel Fernández Ordóñez, is calling for reform of a rigid labour market that makes most employees too costly to fire but condemns a third of workers to unstable, unprotected temporary jobs. Yet the government has repeatedly delayed pension and labour reforms. Mr Zapatero’s great goal is to conserve social peace. That means keeping trade unions happy, even if reforms (and growth) have to wait.
Some detect a whiff of cowardice. Mr Zapatero’s determination to avoid general strikes is proof that he will never take a difficult decision, says Artur Mas, head of the Catalan Convergence and Union coalition. And because broad agreements on public-spending cuts lack detail, they also lack urgency. A recent austerity deal with regional governments, responsible for over a third of Spain’s public spending, allows for two more months of haggling.
In the meantime Spain’s financial sector is jibbing at reform plans. Some cajas (savings banks) are heavily exposed to construction and housing loans. Mr Ordóñez says a third of the 45 cajas need to disappear (by being absorbed by others). A €99 billion ($132 billion) rescue fund is producing only limited consolidation so far, with perhaps seven Catalan cajas merging into two. Local politicians, who have a big say in their cajas, do not want to lose power. The Bank of Spain must act urgently, says Luis Garicano of the London School of Economics. The system cannot improve so long as doomed entities are kept alive, says Miguel Martín, president of the Spanish Banking Association.
The delay in sorting out the cajas adds to the sense of drift. Most Spaniards do not see the economy improving any time soon. Faith in the political class is at rock bottom. The Spanish now rate politicians as a bigger problem than their old bugbear, terrorism. Mr Zapatero’s Socialists are trailing in the polls—but an election is not due for two more years.
Morgan Stanley: The Rally Is Near Its End
When it comes to equity analysts Teun Draaisma is a must-read. The European equity analyst famously called for investors to sell stocks in June 2007 when the markets were flashing a “full house sell” signal. He then flipped bullish in November of 2008 as the markets were pricing in a much more severe situation than Draaisma saw unfolding. He’s one of the few investors who actually got the downturn and the upturn correct and was able to connect the dots between cause and effect. In his latest strategy note Draaisma is saying the rally has gotten ahead of itself and that we’re due to for a correction as good news becomes bad news. In addition to being bearish about 2010 (see here), Draaisma says the better than expected growth in the near-term is putting more pressure on the Fed to raise rates and will lead to tightening measures sooner than most investors suspect:“The rally since 5-February is nearing its end, we believe. Our thesis is that good growth will lead to tightening measures and struggling equity markets this year, just like in 1994 and 2004. The recent rally was larger than we expected, and in our eyes was due to:
1) there have been no positive payrolls or Fed language change yet (we even saw some loosening rather than tightening measures last week, with the Greek bailout, the ECB keeping its wide collateral pool for longer and the Obama plan for troubled mortgage borrowers).
2) sentiment had turned quite cautious in early February. Nevertheless, we do think the market peak associated with the start of tightening is near, and expect 2010 to show a volatile whipsaw pattern in equities. We expect good payrolls (April 2) and a Fed language change (April 30), some leading indicators are rolling over from multi-decade peaks (ECRI leading indicator for the US, OECD leading indicator for the world), and some sentiment surveys have turned more bullish.”
Draaisma believes the market will decline 11% in the next 3-6 months:“The 3-6 month outlook: tactical caution. The last 12 months have been characterised by record stimulus and rising economic leading indicators. We think the next 6 months will be characterised by some stimulus withdrawal (as a reaction to good growth in Asia and US), and softening leading indicators. We reduced our equity exposure two months ago. We recommend selling into strength, and we think MSCI Europe will reach 1030 at some point later in 2010, down 11% from here.”
On a longer time horizon Draaisma says the markets remain entangled in a bear market and that investors should not be fooled by the cyclical bull within a secular bear:“The multi-year outlook: the secular bear market that started in 2000 is not yet complete (pages 11-13). We believe the secular bear market is incomplete for a variety of reasons, including that banking crises and bailouts tend to precede debt crises; that the amount of debt has not been reduced yet (it only changed hands to the government); that equity valuations never reached end of bear market levels; and our historical analysis that equities tend to struggle for longer in the aftermath of secular bear markets. When the next earnings recession hits, perhaps in 2012, we expect equities to complete the bear market that started in 2000.”
Draaisma’s outlook isn’t exactly consensus, but then again, it never really has been. And that makes his research a breath of fresh air on Wall Street.
More "Boom and Bust" Cycles Coming: The Real Reason Buy and Hold Is Dead
With major averages flat or slightly negative for the past 10 years, many investors have given up on the "buy and hold" strategy that became a mantra in the 1990s. That, of course, has prompted some contrarians to declare that now is the best time to be a buy and hold investor. In this case, the conventional wisdom is right, says Lakshman Achuthan, managing director of the Economic Cycle Research Institute (ECRI). "I'm not saying 'buy and hold' is a bad thing, unless you're having more frequent recessions," he says. And that is precisely what ECRI expects in the coming decade because of two big patterns that Achuthan says are irreversible:
- One, sucessive recoveries from post WWII recessions have become weaker and weaker "on every count," including growth, sales, employment and production.
- Two, there's more volatility in the economy, with the big swoon in late 2008-early 2009 and surge in more recent months being a glaring example.
Achuthan predicts we have entered a period of "more ‘boom and bust'-type cycles," similar to what occurred in the 1970s. "The Great Moderation is history," he says, referring to the period starting in the mid-1990s when many economists (and policymakers like Ben Bernanke) believed the business cycle had been smoothed out, if not eradicated. "You don't have to be a mad scientist," he says; just "back off your risk in the stock market and buy bonds" if a recession appears imminent. "And if we see a recovery take more exposure and get out of bonds because the recovery is going to give you a little inflation."
If recessions are more likely - and more intense in scope - then investors will demand higher risk premiums for owning equities, Achuthan explains in the accompanying clip. Of course, the trick is predicting when those recessions and recoveries have begun -- or are about to begin -- something ECRI believes it has mastered. As noted here, the ECRI does have a good track record when it comes to predicting economic cycles. They correctly predicted last year's strong recovery after having correctly called the 2001 and 1990 recessions. However, ECRI waited until March 2008 to officially diagnose the last recession that they now agree began in December 2007. "I'm not suggesting we'll get it right all the time but we'll do a lot better than ‘buy and hold,'" Achuthan says.
Blaming China will not solve America’s problem
by Stephen Roach
America’s fixation on the "China problem" is now boiling over. From Google to the renminbi, China is being blamed for all that ails the US. Unfortunately, this reflects a potentially lethal combination of political scapegoating and bad economics. The political pressures are grounded in the angst of American workers. After more than a decade of stagnant real compensation and, more recently, a sharp upsurge in unemployment, US labour is being squeezed as never before.
Understandably, voters want answers. It is all because of the trade deficit, they are told – a visible manifestation of a major loss of production to foreign competition. With China and its so-called manipulated currency having accounted for fully 39 per cent of the US trade deficit in 2008-09, Washington maintains that American workers can only benefit if it gets tough with Beijing. However appealing this argument may seem, it is premised on bad economics. In 2008-09, the US had trade deficits with more than 90 countries. That means it has a multilateral trade deficit. Yet aided and abetted by some of America’s most renowned economists, Washington now advocates a bilateral fix – either a sharp revaluation of the renminbi or broad-based tariffs on Chinese imports.
A bilateral remedy for a multilateral problem is like rearranging the deckchairs on the Titanic. Unless the problems that have given rise to the multilateral trade deficit are addressed, bilateral intervention would simply shift the Chinese portion of America’s international imbalance to someone else. That "someone" would most likely be a higher-cost producer – in effect, squeezing the purchasing power of hard-pressed US consumers. The US would be far better served if it faced up to why it is confronted with a massive multilateral trade deficit.
America’s core economic problem is saving, not China. In 2009, the broadest measure of domestic US saving – the net national saving rate – fell to a record low of -2.5 per cent of national income. That means America must import surplus saving from abroad to fund its future growth – and run current account and trade deficits to attract the foreign capital. Thus, for a savings-short economy, there is no escaping large multilateral trade imbalances.
Yes, China is the biggest piece of America’s multilateral trade deficit. But that is because high-cost US companies are turning to China as a low-cost offshore efficiency solution. It also reflects the preferences of US consumers for low-cost and increasingly high-quality goods made in China. In other words, savings-short America is actually quite fortunate to have China as a large trading partner.
No, China is hardly perfect. Like the US, it, too, has a large imbalance with the rest of the world – namely, an outsize current account surplus. Just as responsible global citizenship requires America to address its savings deficiency, the world has every reason to expect the same from China in reducing its surplus saving. But these adjustments must be framed in the multilateral context in which the imbalances exist. Just as China is one of more than 90 countries with which America runs trade deficits, US-China trade now represents only 12 per cent of total Chinese trade. It is wrong to fixate on a bilateral solution between these two nations to address their multilateral imbalances.
Yet some of America’s most prominent economists are claiming that a revaluation of the renminbi vis-à-vis the dollar would not only create more than 1m jobs in the US but that it would inject new vigour into an otherwise anaemic global recovery. Economists should know better. Changes in relative prices are the ultimate zero-sum game – they re-slice the pie rather than expand or shrink it. Currency, or relative price, adjustments between any two nations are not a panacea for structural imbalances in the global economy. What is needed, instead, is a shift in the mix of global saving. Specifically, America needs deficit reduction and an increase in personal saving, while China needs to stimulate internal private consumption.
Washington’s scapegoating of China could take the world to the brink of a very slippery slope. It would not be the first time that political denial was premised on bad economics. But the consequences of such a blunder – trade frictions and protectionism – would make the crisis of 2008-09 look like child’s play.
Stephen Roach is chairman of Morgan Stanley Asia
Downtown New York Towers Empty as Best Office Market Falters
Downtown Manhattan, where demand for office space began to surge three years after the 9/11 terrorist attacks, is about to lose its spot as the best- performing U.S. market. Vacancies may exceed 14 percent of the area’s 87 million square feet by late 2011, empty space that’s equivalent to four Empire State Buildings and the highest rate since 1997, according to property broker Cushman & Wakefield Inc. That doesn’t include the 4.4 million square feet of offices in two towers now under construction at the World Trade Center site. Those are scheduled for completion in 2013. "The amount of space that’s potentially going to come to the market will increase availabilities and put pressure on pricing," said Kenneth McCarthy, Cushman’s head of New York- area research. "It will be quite awhile before it can be absorbed."
Lower Manhattan, dominated by financial firms, withstood the commercial property slump better than any other U.S. business district, with more than 90 percent of offices occupied at the end of last year even as the city lost about 352,000 jobs. Now open space is rising faster than demand, as Goldman Sachs Group Inc. moves into its new downtown building, American International Group Inc. relocates its headquarters, and Bank of America Corp. shifts operations to its new tower in Midtown.
Downtown New York’s success defied the most dire predictions after Sept. 11, 2001, that financial companies would flee. Within weeks of the World Trade Center’s destruction, executives of Lehman Brothers Holdings Inc., working out of makeshift offices at a Sheraton hotel, decided to leave the area rather than face a daily reminder of the terrorist attacks. They put their offices up for sale and sublease and paid $748 million for a 32-story building north in Midtown’s Times Square, according to a regulatory filing.
Goldman Sachs announced plans after 9/11 to move equity trading and research employees to Jersey City, New Jersey. The bank suspended plans for its new West Street headquarters in April 2005, citing uncertainty about the future of the nearby World Trade Center site. The city and state increased tax-exempt Liberty Bonds available to the company to $1.65 billion. Even the New York Stock Exchange considered opening a second trading floor outside of downtown as a backup in case of another attack. Downtown has "always been unduly reliant on the financial services sector," said Robert Freedman, executive chairman of property broker FirstService Williams.
The office market outperformed other U.S. cities through the first years of the financial crisis, thanks to government subsidies, rents that were lower than Midtown and a 28 percent gain in the Standard & Poor’s 500 Index from the end of 2001 through 2007 that helped boost Wall Street profits. Meanwhile, supply was restricted. Developer Larry Silverstein’s 7 World Trade, completed in 2006 north of Ground Zero, added just 1.7 million square feet of offices, compared with about 13 million square feet destroyed by the attacks. The biggest addition of space now comes with Goldman Sachs’s move to 200 West St. The company will leave behind about 2 million square feet at downtown buildings including 85 Broad St. and 1 New York Plaza.
AIG, the global insurance company bailed out by the U.S. government in 2008, last year sold its headquarters at 70 Pine St. and 72 Wall St. to raise cash. It is moving employees into space Goldman Sachs is vacating at 180 Maiden Lane. Bank of America has yet to tell landlord Brookfield Properties Corp. what it plans to do with the offices it inherited at downtown’s World Financial Center when it bought Merrill Lynch & Co. last year. The Charlotte, North Carolina- based company has been moving employees into its new skyscraper in Midtown at 1 Bryant Park. The Merrill Lynch lease expires in 2013.
"What’s going to happen with those big blocks is that they’re going to sit on the market for a while, because to divide them up and make them smaller and more marketable involves a huge capital investment, and a lot of landlords can’t afford it," said Ruth Colp-Haber, a partner at Wharton Property Advisors Inc., a New York-based brokerage that represents tenants. A partnership led by New York developer YoungWoo & Associates LLC bought AIG’s buildings and has said it plans to convert some of the property into residential condominiums. Other areas will remain commercial. "The question is, when is the demand going to come into the economy?" Haber said. "Most don’t see demand returning till the end of 2011. The real estate cycle moves slowly."
Donald Trump, whose company owns a 1.1 million square-foot tower at 40 Wall St., pushed for new leases ahead of the Goldman Sachs, Merrill Lynch and AIG vacancies. He put his son, Donald Trump Jr., in charge of the effort. "My father a year ago saw what was going on in the market and he called me up, and I remember it clearly because it was Christmas Day," Trump Jr. said in an interview. "He said ‘I want you to meet with me tomorrow and make 40 Wall part of your day-to-day life.’" The Trumps leased 268,000 square feet of space in the building last year and expect to sign more tenants this year.
In all, about 4.5 million square feet of downtown offices may be available by 2013, according to Cushman & Wakefield. That’s also the year the Port Authority of New York and New Jersey expects to complete the first building under construction at Ground Zero. One World Trade Center, formerly known as the Freedom Tower, is to be the Western Hemisphere’s tallest skyscraper, adding 2.6 million square feet to the market. Silverstein also is developing a second tower at the site, which he aims to complete in 2013, that will have 1.8 million square feet of offices. A third building may be started if Silverstein raises $300 million in equity, signs tenants for about 20 percent of the space, and meets other financing goals.
"That’s a lot of space to fill," said Robert Stella, principal of Boston-based brokerage CresaPartners, which represents Manhattan office tenants. "It’s going to have an impact." A little more than half the space currently under construction at the trade center site is spoken for by tenants, mostly government agencies. Federal and state agencies, including the U.S. Department of Homeland Security’s customs and border protection units plan to take about 1 million square feet, though they have yet to sign a lease. Chinese developer Beijing Vantone Real Estate Co. signed a contract for 190,000 square feet, making it the only private company agreeing to move to the 16-acre site.
At Silverstein’s 4 World Trade Center, the Port Authority and the city each agreed in 2006 to rent 600,000 square feet, leaving another 600,000 square feet to be leased. "We are not building for today’s market," John "Janno" Lieber, head of Silverstein’s World Trade Center unit, told a New York State Senate panel in September. "These buildings will take four or five years to build and when they open, the city will be in a much stronger position. We need to be ready." Both Silverstein and Lieber declined repeated interview requests for this story, saying through spokesman Dara McQuillan they were busy with Port Authority negotiations on financing for reconstruction at the trade center site.
Port Authority spokesman Stephen Sigmund said the agency isn’t worried about demand for One World Trade Center. "We’re not comparing and contrasting to other buildings downtown," he said. "One World Trade Center is certainly going to be a world-class building that will be attractive to tenants, many tenants." Brookfield Properties, lower Manhattan’s biggest office landlord, is planning to renovate its World Financial Center to help it face new competition. The space that Bank of America vacated there includes trading floors of greater than 65,000 square feet, almost the size of a World Cup soccer field. Those floors could be among the hardest to rent in the city, said Colp-Haber of Wharton Property Advisors.
Brookfield in December presented a plan to brokers that would split the trading floors in two and serve each of the spaces with its own elevator, according to a property broker who attended the presentation. The broker declined to be identified because he wasn’t authorized by his employer to speak publicly. The renovation also would link the 25-year-old World Financial Center to a pedestrian passageway through the trade center site, allowing access to a new subway hub at Broadway and Fulton Street. "This has got to be a front-burner issue, number one in Brookfield’s mind," said Michael Knott, a real estate analyst for Newport Beach, California-based Green Street Advisors.
The space available downtown may appeal to companies seeking accommodations at a time when rents in midtown Manhattan are expected to rise, said Mark Shapses, senior managing director at Studley Inc., a New York based brokerage that specializes in finding space for tenants rather than representing landlords. "It’s a place where people want to be," he said. "You’ve got water views from a lot of the properties. Mass transit is probably better than anywhere else in the city. It’s true there’s going to be some increased vacancy, but they usually end up working these out through markets. It’ll take some time to lease up but I think it will lease up."
While construction at the 16-acre World Trade Center site scared off some property investors, Brookfield Chief Executive Officer Richard "Ric" Clark said on a conference call last month that the area’s new transportation and infrastructure will be complete by 2014. "Most of our peers, we’ve heard them make comments that they’re not interested in lower Manhattan," he said. "That’s fine with us." His optimism is shared by William Rudin, president of the family owned Rudin Management Co., which owns six lower Manhattan office buildings. "If we continue to invest in lower Manhattan in terms of transportation and the memorial and all the things going on, at a certain price point, these spaces will find tenants," Rudin said.
U.S.-Bound Boxes Pile Up in Asia as Lines Avoid Adding Ships
South Korea’s biggest port, overwhelmed with empty containers a year ago, is now dealing with shipping lines that have more cargo than they can carry. Surging shipments of furniture, electronics and clothes to the U.S. and Europe, coupled with capacity cuts by shipping lines, has caused as much as 15 percent of containers to be delayed in Busan this year, often by more than a week, according to Park Jong Ho, assistant general manager at Busan International Container Terminal Co. "With the economy recovering, we have been seeing a lot of containers that didn’t make it out on time because there wasn’t enough space on ships," he said.
A capacity crunch on transpacific routes has disrupted deliveries of Asian and U.S. exports, prompting a probe by U.S. regulators. Container lines have cut trips and imposed higher rates on customers, or shippers, after slumping trade and an excess supply of vessels caused industrywide losses of about $20 billion last year, according to Drewry Shipping Consultants Ltd. "There is seething anger in the shipper community over the way rates have been raised," said Bjorn Van Jensen, who manages more than 100,000 container shipments a year as logistics head at appliance-maker Electrolux AB. "Carriers see a tight supply situation and they are looking to get rates back up."
Container shipments at Busan, the world’s fifth-busiest port, rose 21 percent in the first two months, rebounding from the slump last year that forced Park to lease extra space to help store more than 31,000 empty boxes. In the U.S., retail container traffic will likely rise 13 percent this month and by 17 percent in the first half as shops restock, according to the Washington-based National Retail Federation. That’s caused rates for ad hoc shipments on Asia-U.S. routes to jump about 50 percent this year to around $2,100 per forty-foot box, according to Johnson Leung, a Hong Kong-based analyst at Tufton Oceanic Ltd., the world’s largest shipping hedge-fund group. "The volume is surprisingly high," he said. "Still, rates were at low levels at the beginning of this year, and shipping lines have to increase them to break even."
U.S. customers have also contributed to the disruptions and higher rates by cutting inventories to two-year lows and placing more rush orders on concerns about holding stock. "The trend now is that orders are always made from Europe and the U.S. very rapidly and at the very last minute," said Ken Lee, a general manager in the sea-freight unit at Hong Kong- based Vinflair Shipping Ltd. The U.S. Federal Maritime Commission earlier this month began a "fact-finding investigation" into shipping capacity because of U.S. importers and exporters’ struggles to find space.
Lines haven’t added more vessels on transpacific routes, citing concerns about the sustainability of demand. The jobless rate in the U.S. remains near 10 percent. Building permits, a sign of future construction, also fell 1.6 percent last month after a 4.7 percent drop in January. "We have seen no reason to add extra ships as the trend is temporary," said A.P. Moeller-Maersk A/S Chief Executive Officer Nils Smedegaard Andersen. "With the problems this industry has had, I think we’re all be very cautious before sending new ships into service." Maersk expects a "modest" 2010 profit following its first loss in six decades last year. Industrywide, container lines may pare loses to about $7 billion this year, according to Drewry.
The surge in shipments coincides with annual contract negotiations between lines and customers. Maersk and Mediterranean Shipping Co., the world’s two largest container lines, and 13 others are seeking an extra $800 per cargo box on Asia-U.S. west coast routes. That’s about a 50 percent increase, according to Leung. "If we can get an agreement for that kind of rate increase, then a lot of the shipping companies will become profitable," said Kim Young Min, chief executive officer of Hanjin Shipping Co. and chairman of the Transpacific Stabilization Agreement, or TSA, whose 15 members carry almost 90 percent of Asia-U.S. boxes.
Lines in the group, which has limited U.S. antitrust protection, are already imposing a $400 per container "emergency revenue charge" to pare losses on contracts agreed last year during the worst of the trade slump. Rates fell by as much as half in those deals, according to the TSA. The charge will be discontinued when the new contracts start around May. Customers have to accept additional levies or lines won’t carry their cargo, Stockholm-based Electrolux’s Jensen said. That’s causing "enormous uncertainty" as shippers don’t know whether additional levies will follow, he said.
"I don’t know anybody who thrives on this kind of volatility except hardened gamblers," he said. Even so, "shippers understand that rates have to come back up" as the lines’ losses are unsustainable, he said. New ship deliveries may disrupt lines’ efforts to raise rates this year as shipyards hand over vessels ordered before the trade slump began. Shipbuilders hold container-vessel orders with a combined capacity equal to about 33 percent of the existing global fleet, according to data compiled by Bloomberg. "New capacity entering service this year could weigh on rates," said Jay Ryu, a Hong Kong-based analyst at Mirae Asset Securities Co. "This isn’t really a recovery because lines have reduced capacity and manipulated the market."
Amid last year’s slump, lines mothballed more than 500 ships worldwide to pare capacity. They also began operating vessels at slower speeds, which cuts fuel usage and reduces the total amount of cargo each ship can haul per month. Such steps are likely to continue because of the oversupply of ships, said Tung Chee Chen, chairman of Orient Overseas (International) Ltd., Hong Kong’s biggest container line. "We learnt a very bitter lesson last year," he said about the industry. "We will all be more careful and disciplined in managing our tonnage this year."
German Shipping Faces Wave of Financing Problems
As recently as 2008, container ships were transporting record amounts of products across the world's oceans. Now, many German shipping companies are struggling to pay for the vessels they ordered during the boom. Their banks could be in trouble, too. Major shipowner Bernd Kortüm and his wife were enjoying fresh snow in the Austrian ski resort of Lech last week. "The crisis is almost over," Kortüm, one of Hamburg's richest residents, said calmly, noting that things are beginning to look up for his industry. But the owner of a fleet of 102 container ships was exaggerating mightily.
Less than a year ago, Kortüm and his company, Norddeutsche Vermögen, were on the brink of collapse. Hamburg-based commercial lender HSH Nordbank had previously set aside risk reserves of close to €250 million ($338 million) to cover a credit line in the billions. "Because of the inadequate economic circumstances," the auditors of KPGM wrote, there were "acute risks of default." The lender was even threatening an extraordinary termination of loan agreements. It was only last November that Körtum was able to put together a financing agreement with HSH. And it only came about due to the shipowner's willingness to make a substantial contribution from his private fortune. He is unwilling to reveal how much he is paying, but he does admit that there are problems. "The recently concluded charter rates are not covering total costs yet," says Kortüm, adding that eight of his ships are "without revenue."
Things are hardly looking any better for the rest of the German shipping industry. Despite a slight recovery in the freight market, many shipowners and ship funds face critical questions about their financial survival. The crisis is also eating its way into the foundations of German banks. Institutions like HSH Nordbank, Commerzbank, Nord/LB, state-owned bank KfW's subsidiary Ipex and DVD Bank are the world's biggest ship financiers, with close to €100 billion in ship loans on their books. For many of the borrowers, it has become a question of survival, and the subject of profits hardly comes up at all anymore. Depending on the type of ship, charter rates are up to 80 percent lower than before the crisis, when they were at their highest point. In fact, writes Hamburg shipbroker Harper Petersen & Co., charter rates have arrived at "a painfully low level, and most shipowners are still losing money." For lack of contracts, almost 500 ships are currently at anchor in ports worldwide.
In the boom years, intoxicated with their success, German shipowners ordered $60 billion worth of new ships. Banks were expected to provide 70 percent of the financing, while shipowners planned to drum up the rest of the money from German small investors through so-called "ship funds" set up by brokerage firms like HCI, MPC and Lloyd. But now investors are balking. The supposedly safe ship funds, which had promised high returns subject to minimal tax rates, are suddenly requiring additional investments to cover their losses. With the first funds already capitulating, shipowners can no longer depend on selling shares in new ship funds to finance their current orders. Although brokerage firms and shipowners guarantee the equity shortfall for which the banks are now providing interim financing, they are unable to come up with the cash. "In theory, many are bankrupt," says Hamburg industry expert Jürgen Dobert. "But the banks are deferring debt service and are not enforcing their claims because they know that an entire house of cards could collapse if they did."
In the worst case, shipowners would have to sell ships from their fleets. "This would lead to new market distortions that would affect shipowners, shipyards and banks," one banker warns. Fire sales would depress already low ship prices even further, thereby reducing the value of the banks' collateral. Where, then, is the money supposed to come from? Not from the government, at any rate. Last fall, two major Hamburg shipowners, Claus-Peter Offen and Peter Döhle, tried in vain to obtain funds from the €115 billion German Economic Fund, which was passed in 2009 to help private companies weather the economic storm. The government's €1.2-billion loan guarantee for the Hapag Lloyd shipping line remains an exception. The German government's negative stance toward the shipping industry hasn't changed. At a crisis meeting in the Economics Ministry last Thursday evening, the industry's request for a €10 billion loan guarantee was not even brought up.
Instead, the roughly 50 industry representatives agreed to a 13-point plan with top government officials and Hans-Joachim Otto, the federal government's maritime coordinator. So far, the plan primarily calls for a number of studies. The goal is to examine whether the federal government can move up public shipbuilding orders, partly in connection with development aid, such as those for ferries in Africa. In addition, the industry wants to determine whether the government-owned KfW bank can relax the requirements for obtaining funding from the German Economic Fund. This will hardly be enough. Some 1,000 ships ordered by German shipowners have not yet been delivered. They include about 300 giant container ships, with an estimated value of about €30 billion. The maritime business is having a significant impact on bank balance sheets. The division of government-supported Commerzbank that is partly responsible for ship financing lost close to €850 million in 2009.
Ailing lender HSH Nordbank, the world's largest shipping industry financier, doubled its reserves to €1 billion for the 2009 fiscal year. Ship loans worth about €35 billion are languishing on the books of the Hamburg-based lender. An auditor's report on HSH Nordbank reveals how threatening many a ship loan was for the bank -- and, in some cases, still is. The auditors were particularly interested in the Kortüm case. With a credit line of €2 billion at the end of 2008, the shipowner is one of the bank's biggest customers. He had also succumbed to the temptations of the boom years. His floating cash machines were such tremendous moneymakers that he embarked on a veritable ordering frenzy shortly before the crisis erupted. Kortüm couldn't have picked a worse time to expand. He and his wife were on a sailboat headed for Australia on Sept. 15, 2008, the day US investment bank Lehman Brothers went under. The volume of freight orders for ships declined sharply, and the bankers at HSH became alarmed.
By now, all of Kortüm's new ships have charter agreements. But his company, Norddeutsche Vermögen, will be forced to acquire two new ships without the help of outside investors due to lack of interest in shipping funds. Indeed, leading ship fund businesses have their backs to the wall. In February, HCI was able to negotiate a moratorium with its creditor banks, deferring payments until Sept. 2013, in a move that saved them from bankruptcy. Other brokerage firms are still in talks. Cases like Kortüm's are the rule rather than the exception at HSH Nordbank. Another example is the Danaos Group, most of which is owned by Greek shipowner John Coustas. Until recently, the 53-year-old was counted among the world's richest men. But according to an audit report by KPMG, the group owed Hamburg banks more than half a billion euros by the end of 2008. In their report, the auditors wrote that the Coustas fleet was expected to include "30 new ships with delivery dates through 2011."
In 2008, HSH lent more than €400 million to Dryships Inc., a ship holding company, which even includes two mobile drilling barges in its fleet. It is now unclear whether the loans will be repaid in full. The financial markets, at any rate, have largely lost confidence in the company, whose stock price has declined sharply, from more than $80 to about $6 a share. HSH is unwilling to provide any information about individual borrowers. But bank executives are making a deliberate effort to appear unperturbed. No one at HSH is willing to admit that there are acute risks, not to mention a threat to the bank's very existence. CEO Dirk Jens Nonnenmacher is already promising profits for 2011.
"The ships have financing periods of 13 years, but lifespans of 25 years," says HSH division manager Harald Kuznik, who also attended last week's crisis meeting in Berlin. In other words, he adds, shipowners can defer debt repayment during the crisis "without losing money in the end." In addition, he says, the major shipping lines, such as Hapag Lloyd, are "operationally out of the woods." Industry expert Dobert, however, sees all of this as "nothing but cheap propaganda" since the future development of the economy is still up in the air. "If consumer spending doesn't pick up and remain strong," he warns, "the shipping lines won't have much to do soon."
Recession's untold story
It turns out the job of dog-kennel assistant is even less glamorous than it sounds. There are bad hours (lots of weekends and holidays). There's low-as-it-goes pay — as in minimum wage, $8.55 an hour.
But mostly there's the poop, says Guy Palumbo, owner of Roscoe's Ranch, a 24-kennel outfit north of Woodinville. You want to be the kennel helper? You're on the hook for the poop. You'll spend part of every day scooping it up (if all digestive systems work as designed) or mopping it (when they don't). "It's not most people's dream job," Palumbo laughs. "Usually I get high-school kids applying. Or maybe a college kid for the summer. "I've never seen anything like this."
Two weeks ago Palumbo posted a want ad on Craigslist for a part-time dog-kennel assistant. The ad does say that working with dogs can be fun but then goes into some gory detail about the hardships — including the poop. So far, 260 people have applied. And they say the recession is over?
I remember a few years ago when farms, kennels and horse outfits had trouble finding any workers, other than undocumented immigrants. So Palumbo went through the résumés with me, obscuring the names. I wanted to know: Who now wants to be a dog-kennel assistant? A laid-off graphic designer applied. So did a freelance photographer. Two out-of-work teachers sent résumés. Remarkably, so did someone in their mid-40s who had worked as a financial controller at an environmental-services company. "There are a few people in here, such as accountants, who are so overqualified for this job," Palumbo said. "I know people just want to work but I don't think it would make much sense for me to hire them."
The rest of the applicants read like a recession roll call. There are past customer-service reps from WaMu, AT&T, J.C. Penney and Sprint. A slew of retail clerks and cashiers, as well as out-of-work waiters. The biggest group, by far, is dozens of laborers, construction workers, landscapers and maintenance workers. Economists say the untold story of this recession is how it has devastated people in certain job and income categories, while leaving the affluent mostly alone.
Among the lowest-income — roughly the minimum-wage workers — unemployment nationwide is at true Depression-era levels of 20 to 30 percent, says a report last month by the Center for Labor Market Studies at Northeastern University. It's only 3 to 4 percent for those making $100,000 or more. Here, this state's Employment Security Department says that between February 2009 and February 2010, two-thirds of all job losses came in just three areas that make up only one-quarter of the total jobs — construction, manufacturing and the hospitality industry (mostly entertainment and restaurants). That what this recession has wrought — mainly an even greater widening of the gap between rich and poor than we had before — isn't getting more focus from the press and political leaders is a scandal, the Northeastern University economists suggest.
"Who will tell the people?" they write at the end of their paper. "Does anybody care?"
Palumbo says he's a believer. They may say the recession's over, on paper or on the nightly news. His electronic stack of résumés says otherwise. "It's simply amazing to me, and I still can't believe it," he said, "that from age 14 up into their 60s this many people are dying to be a minimum-wage dog-kennel assistant."
UN Says Dirty Water Kills More People Than War
Dirty water is killing more people than wars and other violence, the United Nations announced on World Water Day. Almost all dirty water produced in homes, businesses, farms, and factories in developing countries is washed into rivers and seas without being decontaminated. And up to 60 percent of supplies that have been purified to the point that they are potable are lost through leaky pipes and ill-maintained sewage networks, according to a report released today. Saving half of these lost supplies could give clean water to 90 million people without the need for costly new infrastructure, says the UN. "The sheer scale of dirty water means more people now die from contaminated and polluted water than from all forms of violence including wars," the United Nations Environment Programme (UNEP) said.
This includes 2.2 million people whose deaths are attributed to diarrhea, mostly from dirty water, and 1.8 million children aged under five who succumb to water-borne diseases. This equates to one infant every 20 seconds. The findings were presented during a three-day conference held in the Kenyan capital, Nairobi, to coincide with the annual focus on clean and sustained water supplies for a human population expected to grow by 50 percent in the next four decades. "If the world is to survive on a planet of 6 billion people heading to over 9 billion by 2050, we need to get smarter about how we manage wastewaters," Achim Steiner, UNEP's director, said in a press release. "Wastewater is quite literally killing people."
Less than five miles from the downtown conference center hosting the water conference, Grace Gathura spent Monday morning as she always does – queuing for water at a communal tap in Nairobi's Kibera slum. The shantytown, home to 1 million people largely ignored by the city authorities, is notorious for its "flying toilets." Without decent latrines in their iron-walled huts, people are forced to defecate into plastic bags, which are then unceremoniously thrown out of the door. The waste is among the 2 million tons of sewage and industrial or agricultural waste that ends up in rivers and streams each day.
Most of those water sources are then also used for cooking and cleaning water. "I have lived here in Kibera for 12 years, and it is only two years ago that this tap was constructed," Mrs. Gathura said. "Before, there were people selling clean water at prices which are too high for us. But even now, there are many of us who do not find clean water every day, and so many are sick." According to the UNEP report, more than half of the world's hospital beds are occupied by people struggling with illnesses linked to contaminated water. "It may seem like an overwhelming challenge but there are enough solutions where human ingenuity allied to technology and investments in nature's purification systems such as wetlands, forests, and mangroves can deliver clean water for a healthy world," said Mr Steiner.
Aside from recommending a focus on fixing leaky pipes, the World Water Day meeting called for water recycling systems and multi-million dollar investments in sewage treatment works. But, the UN added, just $20 million could pay for drip-irrigation and tread pumps to draw water from wells, which could lift 100 million poor farming families out of extreme poverty.
Judge Invalidates Human Gene Patent
A federal judge on Monday struck down patents on two genes linked to breast and ovarian cancer. The decision, if upheld, could throw into doubt the patents covering thousands of human genes and reshape the law of intellectual property United States District Court Judge Robert W. Sweet issued the 152-page decision, which invalidated seven patents related to the genes BRCA1 and BRCA2, whose mutations have been associated with cancer.
The American Civil Liberties Union and the Public Patent Foundation at the Benjamin N. Cardozo School of Law in New York joined with individual patients and medical organizations to challenge the patents last May: they argued that genes, products of nature, fall outside of the realm of things that can be patented. The patents, they argued, stifle research and innovation and limit testing options. Myriad Genetics, the company that holds the patents with the University of Utah Research Foundation, asked the court to dismiss the case, claiming that the work of isolating the DNA from the body transforms it and makes it patentable. Such patents, it said, have been granted for decades; the Supreme Court upheld patents on living organisms in 1980. In fact, many in the patent field had predicted the courts would throw out the suit.
Judge Sweet, however, ruled that the patents were "improperly granted" because they involved a "law of nature." He said that many critics of gene patents considered the idea that isolating a gene made it patentable "a ‘lawyer’s trick’ that circumvents the prohibition on the direct patenting of the DNA in our bodies but which, in practice, reaches the same result."
The case could have far-reaching implications. About 20 percent of human genes have been patented, and multibillion-dollar industries have been built atop the intellectual property rights that the patents grant. "If a decision like this were upheld, it would have a pretty significant impact on the future of medicine," said Kenneth Chahine, a visiting law professor at the University of Utah who filed an amicus brief on the side of Myriad. He said that medicine was becoming more personalized, with genetic tests used not only to diagnose diseases but to determine which medicine was best for which patient.
Mr. Chahine, who once ran a biotechnology company, said the decision could also make it harder for young companies to raise money from investors. "The industry is going to have to get more creative about how to retain exclusivity and attract capital in the face of potentially weaker patent protection," he said. Edward Reines, a patent lawyer who represents biotechnology firms but was not involved in the case, said loss of patent protection could diminish the incentives for genetic research. "The genetic tools to solve the major health problems of our time have not been found yet," said Mr. Reines, who is with the Silicon Valley office of the firm Weil, Gotshal & Manges. "These are the discoveries we want to motivate by providing incentives to all the researchers out there."
The lawsuit also challenged the patents on First Amendment grounds, but Judge Sweet ruled that because the issues in the case could be decided within patent law, the constitutional question need not be decided. The decision is likely to be appealed. Representatives of Myriad did not return calls seeking comment. But this month, the company’s chief executive, Peter Meldrum, told investors that "regardless of the outcome of this particular lawsuit, it will not have a material adverse effect on the company," or its future revenues, according to the Pharmacogenomics Reporter, "or on the future revenues of our products."
Myriad sells a test costing more than $3,000 that looks for mutations in the two genes to determine if a woman is at a high risk of getting breast cancer and ovarian cancer. Plaintiffs in the case had said Myriad’s monopoly on the test, conferred by the gene patents, kept prices high and prevented women from getting a confirmatory test from another laboratory. Janice Oh, a spokeswoman for the United States attorney’s office in Manhattan, which represented the Patent and Trademark Office in the case, had no comment.
One of the individual plaintiffs in the suit, Genae Girard, who has breast cancer and has been tested for ovarian cancer, applauded the decision as "a big turning point for all women in the country that may have breast cancer that runs in their family." Chris Hansen, an A.C.L.U. staff lawyer, said: "The human genome, like the structure of blood, air or water, was discovered, not created. There is an endless amount of information on genes that begs for further discovery, and gene patents put up unacceptable barriers to the free exchange of ideas."
Bryan Roberts, a prominent Silicon Valley venture capitalist, said the decision could push more work aimed at discovering genes and diagnostic tests to universities. "The government is going to become the funder for content discovery because it’s going to be very hard to justify it outside of academia." John Ball, executive vice president of the American Society for Clinical Pathology, one of the plaintiffs in the case, called the decision "a big deal." "It’s good for patients and patient care, it’s good for science and scientists," he said. "It really opens up things."
Hadron Collider breakthrough as beams collide
Scientists at the Large Hadron Collider managed to make two proton beams collide at high energy Tuesday, marking a "new territory" in physics, according to CERN, the European Organization for Nuclear Research. The $10 billion research tool has been accelerating the beams since November in the LHC's 17-mile tunnel on the border of Switzerland and France. The beams have routinely been circulating at 3.5 TeV, or teraelectron volts, the highest energy achieved at the LHC so far, according to CERN, the European Organization for Nuclear Research.
The first two attempts Tuesday failed, said Steve Myers, CERN's director for accelerators. He said the beams were lost before they reached their full energy. Experiments at the LHC may help answer fundamental questions such as why Albert Einstein's theory of relativity -- which describes the world on a large scale -- doesn't jibe with quantum mechanics, which deals with matter far too small to see. The collider may help scientists discover new properties of nature. The as-yet theoretical Higgs boson, also called "the God particle" in popular parlance, could emerge within two or three years, Myers said in November.
Evidence of supersymmetry -- the idea that every particle has a "super partner" with similar properties in a quantum dimension (according to some physics theories, there are hidden dimensions in the universe) -- could crop up as early as 2010. The collider has been dogged by problems. It made headlines late last year when a bird apparently dropped a "bit of baguette" into the accelerator, making the machine shut down. The incident was similar in effect to a standard power cut, said spokeswoman Katie Yurkewicz. Had the machine been going, there would have been no damage, but beams would have been stopped until the machine could be cooled back down to operating temperatures, she said.
The collider achieved its first full-circle beam in September 2008 amid much celebration. But just nine days later, the operation was set back when one of the 25,000 joints that connect magnets in the LHC came loose and the resulting current melted or burned some important components of the machine, Myers said. The faulty joint has a cross-section of a mere two-thirds of an inch by two-thirds of an inch.
Should Tuesday's experiment go as planned and scientists are able to establish 7 TeV collisions, the plan is to run them continuously for 18 to 24 months with a short technical stop at the end of 2010, CERN said. "It will be the beginning of a long period of running the accelerator with beams at this energy," Sutton said. "It's the period in which experiments will really start to collect data in this new energy region, where the potential for discoveries may be made."
Sutton compared the experiments to Christopher Columbus sailing for the New World in 1492, when he knew what he was looking for but didn't know what he might find. "It's going into a new energy region," she said. "It's a new territory in particle physics, so we're really just standing on the threshold of that, which is exciting for everybody here, of course."