"Accident at Michigan Central R.R. depot, Detroit"
Ilargi: Greece is saved, the Euro will be fine, so will the eurozone, it was all a storm in a teacup. Even Paul Volcker sounds less negative about the Euro than about America’s own finances. Maybe that should tell us something. There will be a European monetary fund down the line (perhaps many years), but since the power structure in the EU is overly clear, it doesn’t really matter. German influence in the union, both economical and political, will increase, but the Germans know very well what their limits are, so maybe that's not such a bad thing. Greece will certainly benefit from better accounting practices.
And then they’ll have to adapt to what is now called austerity, which is in reality nothing but a misnomer for what will befall us all, as it becomes everyday life in the 21st century. And not just for the Greeks, Portuguese, Irish and Icelanders, either, but for all everyday people all over the world. If they are among the lucky ones.
Meanwhile, many gamblers have lost fortunes shorting the Euro, while journalists like the FT’s Wolfgang Münchau - along with many of his peers in the English and American press- have once more shown that their knowledge and insights are exceedingly limited to their own few square inches of land and vision. The Euro lost about 10% of its value from the most recent top, but Europe’s export countries were shooting for a -much- bigger drop than that on the Greek scare. They’ll now have to find the next finance horror flick. A consolation for Germany is that the crisis will give them increased leverage to pressure southern Europe to buy more German instead of Asian products.
And that was why they all entered the European Union to begin with. Germany and Holland needed markets for their products, so they built them in their own backyards. Buy more German may sound like protectionism, but when your currency is 20-25% overvalued, the global playing ground is not exactly level to start with. And then you try to make it level. We've just seen part 1 of that film. America wants to China to to raise its currency, Europe wants America to do the same. beggar they neighbor.
Germany’s main fear today may be that California, Illinois, New York and New Jersey (just to name a few) will crumble before Portugal and Spain do, which will make it that much harder to bring the Euro back to par with the dollar. Some relief could be provided by the currencies that have nowhere to go but up from where they presently are, the yen, yuan and pound sterling. Devaluing your currency can be a beneficial target, as the US shows, but if you let the process run too far too fast, a whole new slew of issues creeps in, and you're looking at a de facto crippled coin. Britain and Japan have no room left to move when it comes to their interest rates, at the very moment they may need -or at least want- it most.
The British commentariat can’t stop waxing about how great it is to control one's own currency (if you do, you can play rate games, which in modern economics means you’re saved no matter what), but they miss out on the fact that Euro is at the same time a bastion of support for all its users, while the pound stands alone. 60 million Britons, 300 million Americans, 330 million Eurozone inhabitants (the EU has over 500 million). It may be nice to have your own currency, but is it really the best option when that currency is comparatively tiny? Do the pundits over there ever wonder why the Euro is so strong in the first place? Could it be because the same markets that are set to pounce the pound any day now have strong confidence in it, and have come to realize that they can’t go after the Eurozone anymore then they can go after the US as a whole? Who would rule out that possibility?
It's all about one question after all now, isn’t it? Who is the weakest link on the globe today that's worth going after? Like a pride of lionesses watching a herd of wildebeest, gazing through the long tall grass, patiently - but increasingly hungry- looking for the proper prey. The least risk and energy, for the most meat. As you know, for me, Greece never fit that description to begin with. Neither does Portugal, too small. Spain and Italy have strengths that will keep them standing for a while longer. Moreover, Europe has indicated it will protect its weakest for now, and nobody in their right mind places best against Germany, France or Holland. At least for now. I'd look outside of continental Europe for minimum the next half year. I’d look at Indonesia, or Argentina, or California, or Anglia. But I’d be hungry.
PS: I realize there’s many of my American and British readers who feel I’m biased in favor of the EU, and against their countries, or even can’t be trusted to understand these countries. Me, I think I need to provide for those exact same readers a balance versus the anti- EU bias inherent in British and American media, simply in order to paint the most realistic picture. We’ll see what happens through the rest of 2010, but for now, I can say that I’ve always from the beginning maintained here that Greece would never be allowed to fail, and the Eurozone is much stronger than some papers would have you believe, and so far I’ve quite simply been proven right. I think the players that went after Greece are looking even more eager than before for the next wounded animal, and that they won’t find it in continental Europe, that George Soros would never dare take on Berlin. And that means the pride have to move on, while their appetite keeps on growing. I’ll be the first to admit this is an intuitive call, but I can't see how they can stop now. They need food to maintain their status.
Iceland Rejects Icesave Depositors Bill in Referendum
Icelanders rejected by a massive majority a bill that would saddle each citizen with $16,400 of debt in protest at U.K. and Dutch demands that they cover losses triggered by the failure of a private bank. Ninety-three percent voted against the so-called Icesave bill, according to preliminary results on national broadcaster RUV. Final results will be published today. The bill would have obliged the island to take on $5.3 billion, or 45 percent of last year’s economic output, in loans from the U.K. and the Netherlands to compensate the two countries for depositor losses stemming from the collapse of Landsbanki Islands hf more than a year ago. The island’s political leaders say they’ve already moved on to talks over a new accord.
"The government’s survival doesn’t rest with this Icesave vote," Prime Minister Johanna Sigurdardottir told RUV after the preliminary count was announced. "The government coalition remains solid," Finance Minister Steingrimur Sigfusson told RUV. Failure to reach an agreement on the bill has left Iceland’s International Monetary Fund-led loan in limbo and prompted Fitch Ratings to cut its credit grade to junk. Moody’s Investors Service and Standard & Poor’s have signaled they may follow suit if no settlement is reached.
Iceland’s leaders are trying to negotiate a new deal with the U.K. and the Dutch that focuses on the interest rate payable on the loan, making the bill in yesterday’s vote "obsolete," Sigurdardottir said on March 4. Dutch Finance Minister Jan Kees de Jager in a statement posted on the Internet last night said he is "disappointed" the agreement hasn’t yet come into effect. The U.K. was "obviously disappointed," while "not surprised," said a Treasury official who declined to be identified in line with departmental policy. Iceland’s government pointed to "steady progress toward a settlement" in the past three weeks in a statement.
"The British and Dutch Governments have indicated a willingness to accept a solution that will entail a significantly lower cost for Iceland than that envisaged in the prior agreement," the statement said. The U.K. and Netherlands have offered an interest rate of the London Interbank Offered Rate plus 2.75 percentage points, according to the U.K. Treasury official. That’s the same as the rate for the loan from the Nordic countries that the Icelandic Government accepted in July 2009. The new offer also gave relief on the first two years of interest for the loan, amounting to 450 million euros. The three governments have declared their intention to continue the talks, the Iceland statement said.
Voters rejected the bill because "ordinary people, farmers and fishermen, taxpayers, doctors, nurses, teachers, are being asked to shoulder through their taxes a burden that was created by irresponsible greedy bankers," said President Olafur R. Grimsson, whose rejection of the bill resulted in the plebiscite, in a Bloomberg Television interview on March 5. The Icesave deal passed through parliament with a 33 to 30 vote majority. Grimsson blocked it after receiving a petition from a quarter of the population urging him to do so. The government has said it’s determined any new deal must have broader political backing to avoid meeting a similar fate.
Icelanders used the referendum to express their outrage at being asked to take on the obligations of bankers who allowed the island’s financial system to create a debt burden more than 10 times the size of the economy. The nation’s three biggest banks, which were placed under state control in October 2008, had enjoyed a decade of market freedoms following the government’s privatizations through the end of the 1990s and the beginning of this decade.
Protesters have gathered every week, with regular numbers swelling to about 2,000, according to police estimates. The last time the island saw demonstrations on a similar scale was before the government of former Prime Minister Geir Haarde was toppled. Icelanders have thrown red paint over house facades and cars of key employees at the failed banks, Kaupthing Bank hf, Landsbanki and Glitnir Bank hf, to vent their anger. The government has appointed a special commission to investigate financial malpractice and has identified more than 20 cases that will result in prosecution.
The island’s economy shrank an annual 9.1 percent in the fourth quarter of last year, the statistics office said on March 5, and contracted 6.5 percent in 2009 as a whole. Household debt with major credit institutions has doubled in the past five years and reached about 1.8 trillion kronur ($14 billion) in 2009, compared with the island’s $12 billion gross domestic product, according to the central bank. Icelanders, the world’s fifth-richest per capita as recently as 2007, ended 2009 18 percent poorer and will see their disposable incomes decline a further 10 percent this year, the central bank estimates.
Grimsson, who has described his decision to put the depositor bill to a referendum as the "pinnacle of democracy," says he’s not concerned about the economic fallout of his decision. "The referendum has drawn back the curtain and people see on the stage the matter in a new perspective," he said in an interview. "That has strengthened our position and our cause."
Iceland's Message: Don't Bail Them Out
by Hannes H. Gissurarson
In the national referendum Saturday, Icelanders sent a resounding message to the rest of the world: We are not paying the debts of reckless financiers. While we are few and powerless, we refuse to be bullied by our European neighbors. Some 93% said "No" to a recent deal negotiated by their government with its British and Dutch counterparts; only 7% voted for it.
The deal concerned the so-called Icesave accounts that an Icelandic bank, Landsbanki, operated from 2006 in the U.K. and later also in the Netherlands. When the Landsbanki collapsed in October 2008, the British and the Dutch governments rushed in to pay depositors in their respective countries the amount insured under EEA (European Economic Area) regulations. They then demanded reimbursement from the Icelandic government, which reluctantly agreed to pay, against the wish of the great majority of Icelanders.
The Icelanders argued that there was no legally binding government guarantee of the deposits. The Icelandic government had fully complied with EEA regulations and set up a Depositors' and Investors' Guarantee Fund. If the resources of that fund were not sufficient to meet its obligations (which was almost certainly the case), then the Icelandic government was not legally bound to step in with additional resources. Thus the British and the Dutch governments had no authority to create new obligations on the part of the Icelandic government by paying their nations' depositors. This legal position is indeed also that of the Norwegians, who are, with Iceland and Liechtenstein, the only non-EU members of the EEA. Arne Hyttnes, chairman of the Norwegian Depositors' and Investors' Guarantee Fund, is adamant that there is neither by law nor international agreements a government guarantee of deposits in Norwegian banks; there is only the guarantee of the fund itself.
Moreover, Jean-Claude Trichet, president of the European Central Bank, and Wouter Bos, the Dutch minister of finance, have both publicly admitted that European regulations on depositors' guarantees were not designed for the collapse of a whole banking sector—such as occurred in Iceland in 2008. For Icelanders, the stakes are high--possibly as much as $6 billion (depending on the eventual value of the Landsbanki assets). This is an enormous sum for a nation of only 330,000 people, while relatively small by British and Dutch standards. The Icelandic government was forced to sign the deal by not-so-veiled threats of financial isolation and by the use of the IMF as a bounty collector, as the Icelanders put it, for the British and the Dutch: The IMF refused, in effect, to render any assistance to the beleaguered Icelanders unless they signed the deal.
Obliged by the Icelandic president to refer the deal to the voters, its thunderous rejection greatly weakens the already shaky government of Johanna Sigurdardottir. It remains to be seen what will now happen but interestingly, Iceland's two powerful European neighbors have already become somewhat more conciliatory in tone.
There is however a more general point: If you reward recklessness, you will fill the world with reckless people. Why should any government accept the "Too Big to Fail" argument about banks? Why should depositors be able to shift the risk they take over to the public? In the case of Icesave, the British and Dutch governments chose to bail out their fellow countrymen for their own reasons, with an eye toward stemming a panic within their own banking system. This they were free to do, but it wasn't done to benefit Iceland or its banks, and Icelanders are right to question whether they should have to pay for decisions made in Amsterdam and London.
This in turn raises the broader question implicated in all the bailouts around the world during the panic that started in 2008: Should taxpayers have to cover the losses of reckless bankers, and their customers, while not sharing but indirectly in their possible profits? For their part, the Icelanders have answered: No.
Mr. Gissurarson, professor of politics at the University of Iceland, is a former member of the board of Iceland's central bank.
Volcker Says Too Soon to Cut U.S. Monetary, Fiscal Stimulus
White House adviser Paul Volcker said it’s too soon for U.S. policy makers to withdraw the stimulus measures and interest-rate cuts used to fight the worst slump since the Great Depression. "This is not the time to take aggressive tightening action, either fiscally or monetary-wise," said Volcker in an interview in Berlin yesterday, pointing to "high" unemployment. "So I think we have to, as best as we can, maintain the expectation that it will be taken care of in a timely way."
The Federal Reserve and the Treasury are trying to withdraw the emergency measures introduced during the financial crisis without causing a relapse in the economy. Fed Chairman Ben S. Bernanke said Feb. 24 the U.S. is in a "nascent" recovery that still requires keeping interest rates near zero "for an extended period" to spur demand once stimulus wanes. At the same time, the Treasury’s resources are under strain from the loss of 8.4 million jobs since December 2007, stimulus spending, wars in Afghanistan and Iraq and health care programs. The Obama administration predicts the budget deficit will swell to a record $1.6 trillion in the fiscal year ending Sept. 30.
Volcker, who wrote the blueprint for banking proposals that President Barack Obama sent to Congress last week, said U.S. lawmakers must now prove they can pass the "comprehensive" legislation needed to prevent another financial crisis. "That is the test," said Volcker. "Congress has not been very good at passing any comprehensive legislation in various areas." Banking rules "shouldn’t be a matter of partisan dispute. But everything seems to be infected by partisan disputes in the U.S. now." The so-called Volcker Rule bans banks from hazardous trading and imposes limits on how large they can grow.
Obama’s plan faces resistance in Congress. Lawmakers including Senate Banking Committee Chairman Christopher Dodd have called the plan a political ploy and said it could complicate efforts to overhaul rules governing financial companies. "There is a lot of lobbying out there on the other side," Volcker said. Volcker, who hasn’t seen the "precise language" of Obama’s legislation, said he doesn’t believe the bill has been "watered down." Asked whether responsibility for consumer protection should be given to the Fed, Volcker said it’s "not really central to the banking supervision question." "It is a very important question politically and some people think it’s the most important single element, but I think it’s not an element that’s crucial in terms of my concerns," he said.
The former Fed chairman said regulators will have to clearly define proprietary trading when supervising banks. "The legislation is quite clear that hedge funds and private-equity funds are prohibited for banks and so is proprietary trading, but then you have to interpret," he said. "Banks are ingenious in saying: ‘Well, this isn’t exactly a hedge fund.’ So the supervisor’s going to have to say: ‘No, sorry, whatever you call it, we call it a hedge fund.’"
Volcker Criticizes Greek Budget Derivatives 'Abuse'
White House adviser Paul Volcker said the "abuse" of derivatives to hide the size of Greece’s budget deficit highlights the need for regulation and European Central Bank President Jean-Claude Trichet said derivatives still pose risks to financial stability. "Surely the recent revelations about the use (and abuse) of complex derivatives in obscuring the extent of Greek financial obligations reinforces the need for greater transparency and less complexity," Volcker said in the text of a speech to the American Academy in Berlin. Speaking at the same event, Trichet said "what I fear really is that we are currently underestimating the systemic instability which is associated with" derivatives.
European and U.S. officials are examining the role that investment banks including Goldman Sachs Group Inc. may have played in Greece’s debt crisis, joining an outcry in the European Union over whether swaps contracts helped conceal the size of its deficit. Goldman Sachs helped Greek officials raise $1 billion of off-balance-sheet funding in 2002 through swaps, which EU regulators said they knew nothing about until last month.
German Chancellor Angela Merkel, who said on Feb. 18 it would be a "scandal" if banks helped Greece massage its budget, called for restrictions on derivatives to halt "speculators." "Credit-default swaps, where you insure your neighbor’s house just to destroy it and make money from it, that’s exactly what we have to curb," she said yesterday at a press conference in Berlin with Greek Prime Minister George Papandreou.
Volcker, who said it’s "important" to "corral the excesses in the derivatives markets," devoted most of his speech defending the principles of the so-called Volcker Rule. The proposal would ban banks from hazardous trading and impose limits on how large they can grow in an effort to help prevent a repeat of the worst financial crisis since the Great Depression. President Barack Obama sent Congress proposed legislation on March 3. "Can we reasonably continue with a financial system that, implicitly or explicitly, relies on a firmly-held expectations that major financial institutions will be protected from failure in the face of financial crisis?" he said.
Trichet, one of the most prominent voices drawing attention to the risks of excessive risk taking before the global crisis started in 2007, said today that "my intuition is that we are in a system that is much more instable now." Volcker said there’s a "growing consensus" in Europe and the U.S. on the need for resolution authorities that can wind up failing banks in an orderly way.
"In medical analogy, the arrangements would amount to euthanasia and a decent burial, not lengthy life support," he said.
The former Federal Reserve chairman said policy makers need to improve regulation by countering the speed at which banks develop new financial instruments. To do so, the U.S. government should assign responsibility to a new or existing agency "for system-wide surveillance, backed by clear legislative directives and authority," he said.
A.I.G., Greece, and Who’s Next?
As Greece has tottered on the brink of fiscal chaos, threatening to drag much of Europe down with it, Wall Street’s role in the fiasco has drawn well-deserved scorn. First came the news that Greece had entered into derivatives transactions with Goldman Sachs and other banks to hide its public debt. Then came reports that some of those same banks and various hedge funds were using credit default swaps — the type of derivative that kneecapped the American International Group — to bet on the likelihood of a Greek default and using derivatives to wager on a drop in the euro.
European leaders have called for an inquiry into the Greek crisis. Ben Bernanke, the Federal Reserve chairman, has told Congress that the Fed is "looking into" Wall Street’s deals with Greece, and the Justice Department is investigating the euro bets. That is better than turning a blind eye, but it is not nearly enough. The bigger problem is in America, where markets are supposed to be fair and transparent. These particular — and particularly complicated — instruments are traded privately among banks, their clients and other investors with virtually no regulation or oversight.
The Obama administration and Congress have been talking for a year about fixing the derivatives market. Big banks have been lobbying to block change. And the longer it takes, the weaker the proposed new rules become. Here are some of the problems that must be fixed:
Derivatives are supposed to reduce and spread risk. In a credit default swap, for instance, a bond investor pays a fee to a counterparty, usually a bank, that agrees to pay the investor if the bond defaults. But because the markets in which they trade are largely unregulated, derivatives can too easily become tools for dangerous risk-taking, vast speculation and dodgy accounting. A big part of the problem is that derivatives are traded as private one-on-one contracts. That means big profits for banks since clients can’t compare offerings. Private markets also lack the rules that prevail in regulated markets — like capital requirements, record keeping and disclosure — that are essential for regulators and investors to monitor and control risk.
That is why it is so essential to move derivative trades onto fully transparent exchanges. The administration originally embraced that idea, with exceptions only for occasional, unique contracts. But when the Treasury proposed legislation in August, it included huge loopholes, and a derivative reform bill that passed the House in December has many of the same problems. (The Senate has yet to introduce a reform bill.) Both the administration and the House would exclude from exchange trading the estimated $50 trillion market in foreign exchange swaps — similar to the derivatives Greece used to hide its debt. The rationale for the exclusion never has been clearly explained.
The Treasury proposal and House bill also would exclude transactions that occur between big banks and many of their corporate clients from the exchange trading requirement, ostensibly because those deals are only for minimizing business risks, not for speculation or for window-dressing the books. That’s debatable. But even if true, other derivatives users would almost inevitably find ways to exploit such a broad exemption. What is clear about the exemptions is that they would help to preserve banks’ profits. What is also clear is that they would defeat the goals of reform: to lower risk, increase transparency and foster efficiency.
LIMITED POWER TO STOP ABUSES
When the House put out a draft of new rules in October, it sensibly gave regulators the power to ban abusive derivatives — ones that are not necessarily fraudulent, but potentially damaging to the system. Derivatives investors who stand to make huge profits if a company or country defaults, for example, might try to provoke default — a situation that regulators should be able to prevent. In the final House bill, however, the ban was replaced with a requirement that regulators simply report to Congress if they believe abuses are occurring.
NO STATE REGULATION, EITHER
Current law also exempts unregulated derivatives from state antigambling laws. That means that states have no power to police their use for excessive speculation. Treasury and House reform proposals have called for maintaining the federal pre-emption of state antigambling laws. Pre-emption could be tolerable if derivatives were traded on fully regulated exchanges. But as long as many derivative products and transactions are exempted from fully regulated exchange trading, pre-emption of state antigambling laws is a license for, well, gambling.
The big banks claim that derivatives are used to hedge risk, not for excessive speculation. The best way to monitor that claim is to execute the transactions on fully regulated exchanges, pass rules and laws to ensure stability, and appoint and empower regulators with independence and good judgment to enforce compliance. Without effective reform, the derivative-driven financial crisis in the United States that exploded in 2008, and the Greek debt crisis, circa 2010, will be mere way stations on the road to greater calamities.
The Euro Has Been a Smashing Success
by George Melloan
Even small financial crises like the Greek embarrassment stir up a lot of fuss. Germans are complaining that the 1992 Maastricht Treaty did not have enough teeth to discipline states that broke its rules and that tougher measures are needed. In Athens, the public employee unions are loudly warning their socialist friends against any austerity measures that might cut employee benefits. For comic relief, there's the U.S. Senate, where Chris Dodd blames Greece's plight, not on the Greeks themselves but—of course—on "Wall Street."
Being Greek, the Athens demonstrators aren't likely to calm down. But everyone else should. The euro bloc is not threatened with collapse. Its members know that the creation of a single currency in 1999 was a truly historic achievement, perhaps the greatest of the 20th century. The euro now serves 329 million Europeans who in recent memory were organized into warring tribes. It has fulfilled the expectations of Nobel laureate economist and euro designer Robert Mundell, who said in 1999 that it would give Europe a world-class currency, second in importance only to the dollar.
Non-Europeans benefited as well. Mr. Mundell forecast that the euro would provide global investors with "another 'island of price stability' in addition to the dollar area, in which they can put their capital and use to value their investments." It surely is not a coincidence that the decade of the euro has also been a decade of remarkably rapid growth in global GDP, a truth that can be attributed to reductions in trade barriers, including currency exchange transaction costs. Europe may have other problems, especially heavy welfare state burdens, but it no longer has currency palpitations of the type it had before the euro.
It's hard today to imagine the Europe of 20 years ago. Drive in a straight line in any direction from Brussels and in less than an hour you were over someone's border. If you needed gas or wanted food you had to exchange your Belgian francs for French francs, German marks, or Dutch guilders, paying a commission to a money changer. Exchange rates were in constant flux, which meant that traders had to hedge exchange risks at a cost that also was passed on to consumers. And competition across borders, which was the point of the Common Market from its infancy, was inhibited by the fact that there was no single standard of value.
Had the benefits not been so obvious, the euro would have been a tough sell in a Europe where individuals cherish their national identity. But it not only won voter approval in the 11 original member states, it stirred Greece to take extraordinary measures to gain entry in June 2000. Greeks knew it would be a boon to taverna keepers to share a currency with rich German tourists. The government had to apply some clever window dressing to its accounts, but it's doubtful that the Germans or French were fooled.
The Maastricht percentage-of-GDP ceilings of 3% on government deficits and 60% on government debt were an effort to bring discipline to states with longstanding and disparate political traditions. Some, like Greece, were notorious for bad fiscal management. German Chancellor Helmut Kohl wanted to levy fines against violators, but it happily occurred to someone that fines would just make the deficits bigger. Not to worry. A far more powerful enforcement mechanism was inherent in monetary union. Since member states no longer controlled their own currencies, they could no longer inflate their way out of debt, the traditional escape hatch for profligate governments. The European Central Bank was given a single mandate, to maintain the value of the euro. In contrast to Federal Reserve legislation, there was no mumbo jumbo about maintaining full employment, a task beyond the competence of a central bank.
Given these circumstances, Greece's political class must either face up to the unions or go broke. As monetary analyst Axel Merk blogged this week, "Like most countries, Greece spent a great deal of money before and throughout the financial crisis. Governments have started to realize that financing all this debt costs money—and they are shocked. Stronger countries, like the U.S., are borrowing trillions in the market this year, crowding out access to credit for smaller countries. As of this writing, the U.S. government pays 3.64% to borrow money for 10 years; in the euro zone, Germany 3.11%; France 3.40%; Spain 3.90%; Italy 4.03%; Greece 6.64%."
Greece is thus a victim of not only its own, but U.S. excesses. Europe wants to help. After all, those Greek Isles are a lovely European playground and no one wants to see Greece fail. Germany's Angela Merkel and France's Nicolas Sarkozy suggest that the right austerity measures could attract aid. The only lever the Greeks have to counter the austerity pressure is to threaten to drop the euro, or in other words, commit suicide. The euro zone would never miss Greece, which accounts for only 2% of its total GDP, but Greece would sure miss the euro zone. The euro exchange rate for a revived drachma would look very unpalatable to Athenians shopping for German or Italian goods. A return to "Zorba the Greek" living standards would be a prospect. Of course, there's always the IMF hovering on the sidelines hoping to find a new client, but Germany and France have wisely told the IMF devaluationists to butt out.
It's hard to ignore the parallel between Greece and three American profligate states, New York, New Jersey and California. They all got themselves into trouble in large part through excessive generosity toward public employees, in America as in Greece a powerful political constituency. The Obama stimulus bill of early 2009, partly a backdoor bailout for over-borrowed states, was less than a success. The European Central Bank is not trying to inflate the euro bloc out of its troubles and for that it can be commended. The same cannot be said of the Fed, which has proved willing to finance the most profligate nation on the planet, the United States. As last week ended, skies were brighter over Greece. The markets were pleased enough by the austerity package to snap up $6.85 billion in Greek 10-year bonds. The 6.3% coupon no doubt helped as well.
George Melloan is a former columnist and deputy editor of the WSJ editorial page and author of "The Great Money Binge: Spending Our Way to Socialism"
Greece will come through crisis without bailout, IMF head says
The head of the International Monetary Fund believes Greece will resolve its debt crisis without an IMF bailout, and today dismissed fears that other European nations will be engulfed by the crisis. Dominic Strauss-Kahn insisted this morning that other eurozone countries with large public deficits would not be forced into the same predicament as Greece. Speaking to Reuters in Nairobi, Strauss-Kahn said the wider European economy was still strong - despite fears that Greece might default on its debts. While the IMF is poised to assist Greece if needed, Strauss-Kahn remains confident that Europe's leaders could resolve the issue.
"The eurozone wants to deal with the problem itself, and I can understand that," he said. "I think they can do it … and we're just here to help." Strauss-Kahn also argued that those who claim that Spain or Ireland could suffer a debt default are simply trying to "scare" the financial markets. "We have a problem with Greece. We don't have a problem with Spain to date. The eurozone has to deal with the Greek problem. They are doing this," said Strauss-Kahn. "No one knows what's going to happen tomorrow morning but there's no reason why the spillover to Portugal or to Spain will take place," he added.
Spain, Portugal, Ireland and Italy have been grouped with Greece as the "Pigs" (or sometimes "Piigs"). Each of them has seen the cost of insuring their debt rise, as the financial markets question whether they can repay their borrowings. Today, the Portuguese government announced an austerity budget in an effort to cut Portugal's deficit to below 3% of GDP by 2013. The country's deficit is currently running at over 8%. Those earning over €150,000 (£135,000) a year will see their tax rate rise from 42% to 45%, and public sector wages will be capped at the rate of inflation. Spending on social security and healthcare will be cut, and Portugal will also look to raise €6bn by selling stakes in various companies.
Strauss-Kahn's comments came just hours after Nicolas Sarkozy pledged French support for the beleaguered Greek economy. The president of France said the eurozone stood side by side with Greece because "That's what partners are for." Greek prime minister George Papandreou said he hoped Sarkozy's comments would help Greece to borrow money at more reasonable rates. With a €300bn national debt, Greece needs to borrow around €53bn this year alone - even with the public spending cuts and tax rises that have prompted a wave of strikes in recent weeks. A further two-day stoppage has been called for Thursday and Friday to protest at these austerity measures.
Last week Greece succeeded in selling €5bn of bonds to institutional investors - bolstering hopes that the country could fix its ailing economy without a formal bailout from the IMF. Papandreou is undertaking a whistle-stop tour of world capitals in an effort to drum up backing for Greece. He has now flown to America ahead of a meeting at the White House tomorrow, where he is expected to ask for President Barack Obama's support to resolve the crisis. The US administration is expected to push Papandreou to deliver on his commitment to send Greek troops to Afghanistan
Papandreou will also hold talks with the US treasury secretary, Tim Geithner.
Volcker Says Euro to Survive as Greek Budget Crisis Manageable
Former Federal Reserve Chairman Paul Volcker said European officials are lucky that the euro region’s first major crisis was sparked by one of its smaller members and he’s confident the currency will survive. "I’m still a believer in the euro," Volcker said in an interview in Berlin yesterday. The lack of a unified government to back up the European Central Bank is a "structural crack" and "maybe fortunately it’s tested with a country as small as Greece, which doesn’t present an insuperable financing problem."
The euro has dropped 8 percent in the past three months as Greece’s soaring budget deficit sparked concern it could default and cause the euro region to break up. The euro’s founding treaty sets out no rules on how a struggling member nation could be rescued and didn’t establish a single finance ministry, prompting billionaire investor George Soros to say on Feb. 28 that the currency "may not survive" the crisis. The lack of a unified fiscal policy has sparked a divergence of bond yields across the euro region as Greece’s crisis worsened.
The extra yield investors demand to hold Greek 10-year debt instead of German equivalents jumped to 396 basis points in January, the highest since 1998. The average gap over the past decade was 34 basis points. The Spanish and Portuguese spreads are about five times their respective 10-year averages. Greece, which announced a further round of deficit cutting measures last week, managed to sell 5 billion euros ($6.8 billion) of new 10-year bonds on March 4, which Volcker called "a good sign." At 12.7 percent of gross domestic product, Greece’s deficit was the highest in the 27-nation European Union last year.
A "combination of very strong measures and availability of money" may help solve the Greek problem and stop contagion spreading to other euro nations, Volcker said. Academics and investors have pointed to the lack of European political union as an inbuilt weakness of the euro since it was created in 1999. Volcker said most U.S. economists were skeptical the euro would survive when the currency was introduced in 1999 because of its "peculiar arrangement." "I would say about 99 out of 100 American economists said it was not a good idea, but I was the one who did," he said.
Harvard University Professor Martin Feldstein, who warned in 1997 that European monetary union would spark greater political conflict, said Feb. 12 that the euro "isn’t working." Soros said 10 days later that if EU members don’t take the next step toward political union, the common currency may disintegrate. While EU leaders on Feb. 11 pledged to safeguard financial stability in the euro area as a whole, no mechanism has been set up for doing that, Soros said.
Greece’s debt crisis has put the euro on its longest losing streak against the dollar since November 2008. Greek Prime Minister George Papandreou is visiting Luxembourg, Berlin, Paris and Washington after his government passed a 4.8 billion euro austerity package March 5. German Chancellor Angela Merkel, who met with him the same day, said the question of a bailout "absolutely doesn’t arise" and the steps taken in Greece to cut the deficit make her optimistic that a rescue won’t be needed. French President Nicolas Sarkozy, who meets Papandreou in Paris today, said yesterday the EU must support Greece or risk destroying the euro.
Brussels ready to back monetary fund
The European Commission on Monday signalled its willingness to swing into action with a plan for a monetary fund equipped with sufficient resources to assist highly indebted eurozone nations such as Greece. Commission officials said preliminary work was already in progress and a proposal for a European Monetary Fund could be prepared by June, when EU heads of state and government are due to meet for a summit. Antonio Tajani, the EU’s industry commissioner, said he and his colleagues were likely to have their first discussion of the plan at a regular weekly meeting of the Commission on Tuesday in Strasbourg.
The creation of a European Monetary Fund would mark a significant step forward in the integration of the eurozone economy, which for the past 11 years has had a single currency and a common central bank but has lacked a fiscal union and clear-cut arrangements for assisting a member-state in severe financial difficulty. Officials cautioned that EU governments and the Commission were unlikely to agree on the structure of a monetary fund quickly enough for it to be of immediate use to Greece, which must refinance more than €20bn ($27bn) of debt in April and May.
It is also unclear how the Washington-based International Monetary Fund will react to the European proposals, since they would implicitly curtail the IMF’s role, next to the G20 group of leading industrialised and emerging economies, as one of the world’s most important institutions for handling financial emergencies. Wolfgang Schäuble, Germany’s finance minister, said at the weekend that he imagined a European fund that would not compete with the IMF but would possess “comparable powers of intervention”.
Support for a European fund has come from Europe’s socialist parties, the second largest political group in the European parliament, which have proposed the creation of a “European mechanism for financial stability”, consisting of a trustee fund that would bring together the 16 eurozone governments and would be free to borrow on capital markets. The socialists said their proposal would not involve “any transfer of funds from member-states to their partners” and would be intended merely “to ensure that speculative attacks on sovereign debts in the euro area will quickly become a thing of the past”.
All such initiatives are circumscribed to some extent by the terms of the EU’s Lisbon treaty, which came into effect in December and does not contain provisions for a radical advance to economic and fiscal union – although it does allow for enhanced economic policy co-operation. The shape of the German proposal is dictated partly by the reluctance of political leaders, central bankers and the general public to bail out Greece, widely seen as responsible for its own troubles, and partly by the recognition that constitutional lawsuits could be launched in Germany against any attempt to provide financial aid to a fellow eurozone country.
However, diplomats predicted the German ideas might run into resistance elsewhere in the EU. Some countries would have misgivings about various punitive schemes that are under consideration in Berlin as accompaniments to a European monetary fund. One idea is the suspension of EU subsidies, known as cohesion funds, to countries that fail to observe fiscal discipline. These multibillion-euro programmes have played a large part over the past 20 years in raising living standards in less affluent member-states, such as Greece, Ireland, Spain and the former communist countries of central and eastern Europe.
Enforcement of stricter fiscal discipline in return for the establishment of a European monetary fund would risk running into other political obstacles. Although the EU’s stability and growth pact – the eurozone’s fiscal rulebook – already permits a country to be fined for persistent mismanagement of the public finances, governments have in practice avoided imposing such a punishment on one of their number for fear that the tables might one day be turned on themselves.
Another potential hitch lies in the different perceptions of eurozone countries about what constitute the main structural weaknesses of European monetary union. France and others take the view that the problems lie partly in the imbalances between states such as Germany, which are running large current account surpluses, and less competitive nations such as Greece and Portugal, which are burdened with deficits. However, German politicians and business people see their surpluses as a sign of Germany’s competitive strength.
Sarkozy Says EU Must Back Greece or Put Monetary Union at Risk
French President Nicolas Sarkozy said the European Union must support Greece or risk destroying the euro as Prime Minister George Papandreou heads for Paris to lobby support for the debt-laden country. "If we created the euro, we cannot let a country fall that is in the eurozone," said Sarkozy yesterday before a meeting with Papandreou in Paris today. "Otherwise there was no point in creating the euro. We must support Greece because they are making an effort."
EU leaders have so far refused to give financial aid to Greece and have ordered the government to cut its budget deficit, the EU’s highest, on its own. While Papandreou says steps taken this past week to slash the shortfall warrant more help from the EU, German Foreign Minister Guido Westerwelle said yesterday that his country is "not going to write a blank check." Papandreou is touring Luxembourg, Berlin, Paris and Washington after his government passed a 4.8 billion euro ($6.5 billion) austerity package on March 5. German Chancellor Angela Merkel, who met him yesterday, said the question of a bailout "absolutely doesn’t arise" and the steps taken to cut the deficit make her optimistic that a rescue won’t be needed.
Sarkozy, who didn’t say financial support would be forthcoming, will meet Papandreou in the Elysee Palace around 6 p.m. local time. They will brief reporters afterwards. Merkel is rebuffing any talk of a rescue even as EU nations are said to be working on a contingency bailout plan for Greece to be funded by member governments. Greece sold 5 billion euros of bonds on March 4, with investor demand more than three times the offering, the day after Papandreou announced the package of tax increases and spending cuts.
The 6.25 percent bonds Greece sold rose to about 99.4 cents on the euro to yield 6.32 percent, compared with an issue price of 98.94 cents, according to EFG Eurobank Trading prices on Bloomberg. The risk premium that investors demand to buy Greek bonds over comparable German debt, the European benchmark, fell 4 basis points to 293 basis points. Papandreou is indicating that Greece may still need financial support and is prepared to turn to the IMF if necessary, calling it a "final resort" on March 3. That prompted a rebuff from European Central Bank President Jean-Claude Trichet a day later as finance officials fret such a move would signal the EU isn’t capable of solving its own problems. Italian Finance Minister Giulio Tremonti is nevertheless refusing to rule out a role for the IMF in any aid package.
"The IMF should act as a bank" in any rescue, he told reporters in Venice yesterday. "We finance the IMF so it can use the funds around the world. Why not use that capital with the IMF acting as a bank with its know-how?" Tremonti also said that the EU could also issue "eurobonds" or coordinated the sale of euro-denominated government bonds to better counter "financial speculation." As Greece calls for more help, Merkel on March 5 turned her focus to restricting the use of derivatives to halt "speculators" from exploiting countries’ budget deficits. Greece has done its work and Europe and the U.S. must now ensure that financial-market speculators aren’t allowed to inflict further damage on Greece or on other countries, she said.
"Credit-default swaps, where you insure your neighbor’s house just to destroy it and make money from it, that’s exactly what we have to curb," Merkel said at a joint press conference in Berlin yesterday with Papandreou. The Greek prime minister said he will fight to ensure speculators don’t undermine his push to restore order to the country’s economy. It’s unjust and undemocratic that his efforts are being undermined "by some ‘kids’ in New York and elsewhere sitting in front of a computer," he said yesterday. Speaking in Venice, French Finance Minister Christine Lagarde said today that credit-default swaps "need to be much more and much better regulated."
Why the euro will continue to weaken
by Wolfgang Münchau
If you want to unnerve a European, the revelation of a secret dinner of New York-based hedge funds conspiring against the euro is hard to beat. Europeans are right to worry – but not about the collusion itself. They should be much more concerned that some of the world’s smartest investors are convinced the euro has only one way to go: deep down. At first sight, this flies in the face of a previous consensus. In Europe, in particular, the predominant view has been that the infidels at the Federal Reserve and the Bank of England will ultimately inflate themselves out of their debt, while the European Central Bank will hold firm. That scenario would be consistent with an overvalued euro.
So what has prompted some sophisticated investors to think the opposite? Greece? Probably not. This is a story about what will happen to the eurozone beyond Greece. Without political and legal constraints, this would be much easier. The eurozone would prescribe itself a crisis resolution mechanism, a procedure to manage internal imbalances, and perhaps move towards a common eurozone bond. Several economists have made concrete proposals: Daniel Gros, director of the Centre for European Policy Studies, and Thomas Mayer, chief economist of Deutsche Bank, have argued the case for a European Monetary Fund. Yves Leterme, the Belgian prime minister, has proposed a European debt agency.
While all of this sounds sensible, none of it may ever happen because of political and legal constraints. Some member states would argue that a new European treaty would be needed to implement such proposals. The route to getting the Lisbon treaty ratified was so tortuous that Brussels would rather go to hell and back than negotiate and ratify another treaty. In any case, German constitutional law imposes such tight constraints that any dilution of the no bail-out clause in the Maastricht treaty or the price stability target of the ECB might trigger a forced German exit. The most one can hope for during the next 10 years is improved voluntary co-ordination in the European Council.
So the question then becomes: what economic adjustment mechanisms are feasible against this political and constitutional backdrop? The options are limited. The one policy response we can almost take for granted will be an attempt to reduce budget deficits back towards the Maastricht treaty’s upper ceiling of 3 per cent of gross domestic product. This will be achieved, if not by 2012, then a year or two later. Meanwhile, Germany has unilaterally prescribed itself a deficit-to-GDP ceiling of 0.35 per cent from 2016. There will be some slippage here as well. But there can be no doubt that the eurozone will try – and probably succeed – to consolidate its fiscal position. The budget committee of the German Bundestag started last Friday, in fact, by cutting the finance minister’s 2010 budget by almost €6bn ($8.2bn, £5.4bn).
If we assume further budgetary consolidation as a given, how then will the eurozone economy adjust? It is an economic fact that the sum of public and private sector balances must equal the current account balance. So forcing up public sector balances implies either an offsetting fall in private sector balances, an offsetting improvement in the current account balance, or some combination of the two.
In scenario one, the eurozone’s current account balance remains broadly unchanged, and all the adjustment comes through a fall in private sector balances. In a similar way, Greece last week solved its fiscal problem by creating a private sector problem of identical size. The Greek state – the sum of its public and private sectors – is just as bankrupt today as it was a week ago. This means that, by following the fiscal policy rules, the eurozone would risk a private sector depression, which would almost certainly be concentrated heavily in Europe’s south. This scenario would greatly increase the probability of a eurozone break-up at some point in the future. Investors who believe in this scenario would be very afraid to hold euros.
In scenario two, all the adjustment comes through the eurozone’s current account balance, which would turn from slightly negative to strongly positive. It is difficult to see how this could be done without a significant further devaluation of the euro. The euro would join the long list of currencies that have seen their problems solved through competitive devaluation. So the consequences would be a significant devaluation of the euro against the dollar and a reversal of its appreciation against sterling. It would make life more difficult for the British. But, most importantly, it would contribute to a resurgence in global imbalances.
Whichever scenario you choose, the euro is going to be weak. Even if the eurozone were to allow more serious slippage in budgetary consolidation than I have suggested, that would probably not help the euro either, as markets would start to doubt the longevity of the currency union for political reasons. We have always known that a monetary union cannot exist without political union in the long run. Those smart New York investors are betting that the long run is closer than we thought.
Greeks ban hedge funds in bond sale
Greece ordered its bankers to exclude hedge funds from a bond offering this week in an effort to punish the speculators it blames for destabilising its debt markets. The decision came amid growing anger among European leaders over what they see as the role speculators played in undermining the Greek debt market and driving the country towards a possible default.
In a meeting in Berlin on Friday Angela Merkel, the German chancellor, and George Papandreou, the Greek prime minister, promised a joint push both in the European Union and the Group of 20 leading economies to clamp down on speculators who seek to exploit uncertainty over sovereign debt. Ms Merkel said that both countries would seek "to show that speculative instruments need to be contained, especially where it is speculation against states". She mentioned credit default swaps as one target of such an initiative, but gave no other clear details.
According to people familiar with this week’s €5bn Greek bond issue, authorities in Athens told banks handling the sale to make sure they did not allocate any bonds to hedge funds or any bodies that might be a proxy for them. Government bond managers prefer to sell their bonds to traditional "buy and hold" investors such as asset managers, pension funds and life insurance companies rather than hedge funds. Hedge funds can cause sharp swings in bond prices as they buy and sell quickly in an effort to make fast profits.
This week’s instruction from Athens went further than usual, according to people familiar with the deal. Petros Christodoulou, head of Greece’s debt management agency, said, "The vast majority of the issue went to real money investors." One hedge fund manager said, "Here is a country struggling to sell its bonds. Surely it should not be turning away buyers." He said hedge funds provided liquidity to markets enabling traditional funds to buy and sell their bonds more easily. The Greeks’ new 10-year bond attracted hardly any trading on Friday, which is worrying for those investors that might want to sell for reallocation purposes in the future.
Banks Defend Sovereign Default Swaps at EU Regulators’ Meeting
The banking industry argued at a meeting with European Union regulators that trading in sovereign credit-default swaps isn’t large enough to affect Greek bond prices. Swaps account for "only a small percentage of government bond trading volumes," so it isn’t likely speculation in the contracts is "dictating price levels in the larger government bond market," the International Swaps & Derivatives Association, an industry group, said in a statement yesterday. The group said the Brussels meeting offered a chance to address "misconceptions" about credit swaps.
Banks and regulators across Europe were summoned by the European Commission to an informal meeting to discuss regulation of the market for sovereign credit-default swaps in the wake of the Greek debt crisis. European leaders have said the products fuel speculation that can distort market perceptions, making it harder for countries to borrow. The commission, the EU executive agency, should ban naked swaps speculation, where investors insure bonds they don’t own, because "it is a demonstrably dangerous market," Richard Portes, founder of the Centre for Economic Policy Research, said in a telephone interview. "If I were the commission, I’d ask the banks to say what social function the trade in naked CDS has."
The roundtable yesterday was a "technical meeting," and the discussions will be taken into account for the commission’s planned derivatives proposals later this year, Chantal Hughes, a commission spokeswoman, told reporters in Brussels. Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a country or company default on its debt payments. "The absence of competition between banks also means that the possibilities of effective cartel behavior in the CDS market have increased," Portes said.
ISDA defended sovereign swaps, saying in its statement they "can be used to hedge financial, industrial and real estate investments in countries." The products allow investors to buy and sell default protection "without having access to government bond markets," the group said. German Chancellor Angela Merkel’s government is considering ways to tighten rules in the sovereign default swaps market. French Finance Minister Christine Lagarde said Feb. 17 "we should examine the suitability" of credit-default swaps.
The cost of such contracts on Greece rose to a record 428 basis points last month, according to CMA DataVision in London. That meant it cost $428,000 a year to insure $10 million of debt for five years. Efforts to limit sovereign swaps contracts were criticized by Citigroup Inc. analysts in a note March 2. The analysts said governments should address investor concerns about budget deficits, rather than ban derivatives that hedge against risks. "We would do better to spend our time addressing the defects the mirror shows than blaming the mirror," Citigroup analysts, led by Michael Hampden-Turner in London, wrote in a note to investors. "After all, banning mirrors does nothing at all to make the world a prettier place."
China looks at severing dollar peg
China’s central bank chief laid the groundwork for an appreciation of the renminbi at the weekend when he described the current dollar peg as temporary, striking a more emollient tone after months of tough opposition in Beijing to a shift in exchange rate policy. Zhou Xiaochuan, governor of the People’s Bank of China, gave the strongest hint yet from a senior official that China would abandon the unofficial dollar peg, in place since mid-2008. He said it was a "special" policy to weather the financial crisis. "This is a part of our package of policies for dealing with the global financial crisis. Sooner or later, we will exit the policies."
Mr Zhou’s comments contrasted with recent Chinese comments on its currency policy in the face of international criticism that the renminbi was undervalued. In December, premier Wen Jiabao said: "We will not yield to any pressure of any form forcing us to appreciate." Chinese officials have repeatedly emphasised the need for a stable exchange rate. However, while the recent increase in consumer prices in China has strengthened the hand of those officials who think the currency should now rise, it is not clear that this argument has yet won over the country’s senior leaders.
Indeed, Mr Zhou gave no hint about the possible timing of a shift in policy. Chen Deming, commerce minister, said the outlook for international trade remained "uncertain and unstable" and that it would take two or three years before Chinese exports recovered to pre-crisis levels. The argument over Chinese currency policy has been one of a string of disputes that have led to difficult relations in recent months between China and the US, including disagreements over Taiwan, Tibet, climate change and human rights. Mr Zhou’s different tone on the exchange rate came as the foreign minister said it was up to the US to improve relations between the two countries.
At a separate Sunday press conference on the margins of the National People’s Congress in Beijing, Yang Jiechi, foreign minister, said: "The responsibility for the difficulties in China-US relations does not lie with China. The US should take seriously China’s position and respect China’s core interests." He dismissed suggestions that China had been taking a more confrontational approach in diplomacy of late. "Resolutely adhering to one’s principled stance is not the same thing as being hardline," he said.
A long-planned oil pipeline between China and Russia would be completed this year, he said. Mr Yang also rebutted criticism that China’s economic ties with Africa were encouraging more corruption and hurting labour conditions. "I notice that some people in the world are not happy to see the development of China-Africa relations, and so they are always trying to find fault in energy cooperation between China and Africa," he said. "We as guests in Africa should all respect the host’s inclinations and freedom to choose cooperative partners and friends."
China to Nullify Financing Guarantees by Local Governments
China plans to nullify all guarantees local governments have provided for loans taken by their financing vehicles as concerns about credit risks on such debt surges. The Ministry of Finance will also ban all future guarantees by local governments and legislatures in rules that may be issued as soon as this month, Yan Qingmin, head of the banking regulator’s Shanghai branch, said in an interview. The ministry held meetings on the rules on Feb. 25 with regulators including the China Banking Regulatory Commission and the People’s Bank of China, Yan said March 5.
China’s local governments are raising funds through investment vehicles to circumvent regulations that prevent them from borrowing directly. A crackdown on local- government borrowing, estimated at about 24 trillion yuan ($3.5 trillion) by Northwestern University Professor Victor Shih, could trigger a "gigantic wave" of bad loans as projects are left without funding, Shih said this month. "Beijing’s fiscal situation probably isn’t as good as it looks at first glance," said Brian Jackson, an emerging markets strategist at Royal Bank of Canada in Hong Kong. "Perhaps at some stage the central government is going to have to bail out the banks or the regional governments and take it on its own balance sheet."
Central bank governor Zhou Xiaochuan said March 6 during the National People’s Congress that while "many" local financing vehicles have the ability to repay, two types cause concern. One uses land as collateral, while the other can’t fully repay borrowing, meaning that the local governments may be liable, leading to "fiscal risks." Premier Wen Jiabao, at the opening of the annual parliamentary meetings last week, said the central government would sell 200 billion yuan of bonds for a second year to help local governments fund infrastructure projects. Wen also warned of "latent risks" in China’s banking system as he pledged to continue a moderately loose monetary policy and a proactive fiscal stance. The parliamentary meetings will end March 14 with Premier Wen’s annual press conference in Beijing.
A few cities and counties may face very large repayment pressure in coming years because of debt ratios already exceeding 400 percent, a person with knowledge of the matter said in January. The ratio is of year-end outstanding debt to annual disposable fiscal income. The financing vehicles of large coastal cities are well-funded as most have publicly traded subsidiaries that can raise capital from the markets and rely less on bank loans. Entities in northern and western China are of particular concern, the banking regulator’s Yan said while attending the parliamentary meetings.
The 1998 collapse of Guangdong International Trust & Investment Corp., which borrowed domestically and overseas on behalf of southern China’s Guangdong province, left creditors including Dresdner Bank AG of Germany and Bank One Corp. in the U.S. with $3 billion of unpaid bonds. It marked the first time that Chinese authorities failed to bail out one of the nation’s state-owned trusts. Commercial banks have already been told to assess their exposure to such lending and stop providing further credit if problems are found, Yan said.
Bank of China Ltd. President Li Lihui said in an interview last week that the nation’s third-largest lender has reviewed its exposure to borrowings by local governments and identified some financing vehicles that didn’t have adequate liquidity to make payment. The bank plans to exit projects without proper collateral and reduce new advances to local governments this year, Li said. Industrial & Commercial Bank of China Ltd. Chairman Jiang Jianqing said the lender found some risks in such borrowing arms. These situations aren’t yet widespread, Jiang said. The bank has already inspected its loans extended to local government financing vehicles in 2008 and 2009 and "so far didn’t find many big problems," ICBC President Yang Kaisheng said yesterday.
China’s banks doled out a combined 9.59 trillion yuan in new loans last year, helping the government engineer a turnaround in the world’s third-largest economy. The credit binge sparked concern about more bad loans and asset bubbles. Northwestern’s Shih estimated that borrowing by China’s 8,000 local-government entities may have totaled 11.429 trillion yuan in outstanding debt by the end of last year and they had credit lines with banks for an additional 12.767 trillion yuan. That may result in bad loans of up to 3 trillion yuan. China’s banks had 497 billion yuan of non-performing loans as of Dec. 31, accounting for 1.58 percent the nation’s total advances, according to the banking regulator.
Ambac holdo/opco flip in CDS signals receivership bets are on the rise
The CDS market is signaling increased fears that Ambac operating company Ambac Assurance will enter receivership within the year as fear of a municipal bond crisis spreads. The cost of short-term credit default swaps written on Ambac’s holding company Ambac Financial widened significantly in February relative to the price of protection on Ambac Assurance. Investors repriced the differential between the credits on growing expectations that the opco will enter receivership this year, according to two CDS traders and three analysts.
Previously, investors believed that state regulators might order American Assurance to stop paying out insurance claims but would balk at placing the company in receivership. Under that scenario, the holdco would survive on dividends from the opco until at least 2011 that would be cut off immediately in a receivership scenario. The bankruptcy filing in February of Las Vegas Monorail Corporation (LVMC) and the prospect of proliferating municipal defaults forced fund managers to revisit those assumptions. Two investors who said that they placed a low probability on receivership in November indicated in interviews this week that they believe the chance of receivership has increased. Both sources cited fear of a municipal default epidemic and the opacity of Ambac’s finances as contributing factors.
“The logic is that the holdco wouldn’t survive a receivership at the opco,” said a buysider. If the Wisconsin Insurance Commission forced Ambac Assurance to stop paying policies but kept the insurer out of receivership, it would trigger failure to pay on the CDS referencing the opco without causing an immediate credit event for the holdco. However, receivership at the opco would likely force Ambac Financial into bankruptcy, triggering its CDS as well. CDS referencing both Ambac entities enjoyed a brief rally in November following the announcement of a surprisingly high statutory capital surplus. But as municipal and sovereign debt fears rose and Reuters reported in February that the monoline itself had hired workout specialist Blackstone Group, the credit lost its luster.
One-year holdco contracts traded roughly six points inside CDS on the opco in January at 37.5 and 43.5, respectively, according to dealers and a buyside trader. That differential tightened to two points by early February and to less than one point on 1 March when both contracts were quoted in the mid to low 50s. Five-year contracts on the companies followed a similar trajectory, starting the year four points apart before ratcheting in to trade virtually on top of each other around 65, the sources said.
Our very own Greece
The Chapter 11 bankruptcy filing of the LVMC last month, and Ambac’s exposure to the credit, reminded investors that the US has its own version of a sovereign crisis brewing in the municipal market, noted the first analyst. Ambac disclosed wraps on USD 47bn par value of tax-exempt securities as its largest selected exposure to the asset class as of September 2009. The next largest groupings are insurance written on USD 37bn of structured finance instruments and USD 35bn written on subprime RMBS bonds, respectively, according to data on Ambac’s website. The company is slated to release full 2009 earnings on 16 March.
Obama Has Unprecedented Opportunity To Pack The Federal Reserve
When a President has the opportunity to appoint several Supreme Court justices it's an opportunity to have a far-reaching, lasting impact on the entire nation, beyond the President's term. But you don't hear much about packing the Fed. Expect to hear a lot more about this, with Donald Kohn having announced his departure. Bob Eisenbeis of Cumberland Advisors wrote:Kohn's resignation creates the third current vacancy on the Federal Reserve Board, which will give the administration the ability to pick or reappoint six of the seven members of the Board. It has already appointed Governors Duke and Tarullo, neither of whom have experience in monetary policy, and the President reappointed Chairman Bernanke to a second term as Chairman of the Board of Governors. With Kohn’s departure, Chairman Bernanke is the Board’s only economist. While this might be fine with some, the fact is that such experience and background is critical to policy formation.
This clustering of appointments is not supposed to happen, given the legal structure of the Board, and it gives the current administration the chance to pack the Board with appointees with similar political and economic preferences and leanings. The economic perspective is especially critical, given the Federal Reserve's so-called dual mandate of low inflation and full employment and the potential tradeoffs between the two, which can critically affect policy and its timing. Our concern here is not whether the present administration is Democrat or Republican, but rather is simply the ability to pick so many governors at one time.
This ability is contrary to the intent of how the Board of Governors was structured. Specifically, each of the seven governors is appointed to a non-overlapping fourteen-year term, with a term expiring every two years. Theoretically, this would give an administration the ability to fill at most two vacancies within a President's four-year term. But of course, Presidents have had the opportunity to make more appointments than that, because governors have typically left long before their terms expired, but the current situation is an extreme. Most governors who have left recently had served substantially less than half their allotted terms (of course, some have filled unexpired terms). There are many reasons for early departures, one of the biggest being the low salary and high cost of living in Washington.
This will get some play in the media (though since the public doesn't understand monetary policy the way it does, say, abortion, it won't be nearly as much of a topic. But a fierce political battle will brew behind the scenes. Monetary policy is very divisive, as you can see by the ongoing squabbles between inflation hawks (the WSJ editorial board), and anti-inflation hawks (Krugman, Delong, etc.).
National debt to be $9.7 trillion higher than White House forecast, CBO says
President Obama's proposed budget would add more than $9.7 trillion to the national debt over the next decade, congressional budget analysts said Friday. Proposed tax cuts for the middle class account for nearly a third of that shortfall. The 10-year outlook released by the nonpartisan Congressional Budget Office is somewhat gloomier than White House projections, which found that Obama's budget request would produce deficits that would add about $8.5 trillion to the national debt by 2020.
The CBO and the White House are in relative agreement about the short-term budget picture, with both predicting a deficit of about $1.5 trillion this year -- a post-World War II record at 10.3 percent of the overall economy -- and $1.3 trillion in 2011. But the CBO is considerably less optimistic about future years, predicting that deficits would never fall below 4 percent of the economy under Obama's policies and would begin to grow rapidly after 2015. Deficits of that magnitude would force the Treasury to continue borrowing at prodigious rates, sending the national debt soaring to 90 percent of the economy by 2020, the CBO said. Interest payments on the debt would also skyrocket by $800 billion over the same period.
Obama's tax-cutting agenda is by far the biggest contributor to those budget gaps, the CBO said. As part of his campaign pledge to protect families making less than $250,000 a year from new taxes, the president is proposing to prevent the alternative minimum tax from expanding to ensnare millions of additional taxpayers. He also wants to make permanent a series of tax cuts enacted during the Bush administration, which are scheduled to expire at the end of this year. "Over the next 10 years, those policies would reduce revenues and boost outlays for refundable tax credits by a total of $3.0 trillion," wrote Douglas W. Elmendorf, the CBO director. Combined with interest payments on that shortfall, the tax cuts account for the entire increase in deficits that would result from Obama's proposals.
Obama is convening a special commission to bring deficits down to 3 percent of the economy, but the CBO report shows that Obama could accomplish that goal simply by letting the Bush tax cuts expire and paying for changes to the alternative minimum tax. Other policy changes, such as Obama's signature health-care initiative and a plan to dramatically expand the federal student loan program, would have significant effects on the budget, Elmendorf wrote, but they generally would be paid for and therefore would not drive deficits higher.
Treasury Restates Its Backing For Fannie, Freddie
The U.S. Treasury reiterated its commitment to protecting holders of debt in mortgage-finance giants Fannie Mae and Freddie Mac on Friday after comments from an influential lawmaker suggested that the companies' bonds might not be fully backed. The Treasury was forced to take the unusual step after Rep. Barney Frank (D., Mass.) said holders of the debt shouldn't assume they would be treated the same as investors in U.S. government bonds.
The government took control of Fannie and Freddie nearly 18 months ago and so far has injected $127 billion into them to cover heavy losses stemming mainly from defaults on the home mortgages they own or guarantee. The Treasury hasn't ever explicitly guaranteed the companies' combined $1.6 trillion in debt and $5 trillion in mortgage-backed securities. But it has twice increased the amount of money it said it would provide to the companies to keep them solvent. Last December, the Treasury said it would provide unlimited aid over the next three years, doing away with the previous ceiling of a combined $400 billion. That has been enough to soothe anxieties and to attract foreign investment that has kept mortgage rates low even as the companies continue to rack up huge losses.
"As we said in December, there should be no uncertainty about Treasury's commitment to support Fannie Mae and Freddie Mac as they continue to play a vital role in the housing market during this current crisis," the Treasury Department said in a statement Friday. Rep. Frank, who chairs the House Financial Services Committee, told reporters at a housing conference earlier Friday that investors shouldn't assume any government obligation to make them whole. That followed an interview with the Washington Post, published online Friday, in which the senior lawmaker said he would "absolutely" consider requiring investors in the two companies to take some losses.
Later, Rep. Frank said in a statement that he supported the government's recent actions and that his views shouldn't prevent the Treasury "from treating the debt of Fannie and Freddie in the manner that it believes best supports the important goal of stabilizing the financial system." Rep. Frank addressed the issue in the context of his opposition to a measure introduced by Republicans that would force the government to bring Fannie and Freddie's obligations onto the federal books. That move would explicitly guarantee the companies' debt and sharply increase the U.S. government's liabilities, which could force the government to more quickly address the future of the two companies.
The episode illustrates the challenges that have come with the ambiguous, open-ended commitment of the U.S. government and could rattle nerves of foreign investors who have recently shown a larger appetite for buying the companies' debt. Bond markets largely shrugged off the comments because the "Treasury has been very clear" about its commitment to bondholders, said Bose George, an analyst at Keefe, Bruyette & Woods Inc. But he said the incident was a reminder that of the problems posed by the uncertain future for Fannie and Freddie.
Banks scramble to raise cash after Fannie Mae cuts
Banks scrambled to raise cash this week after U.S. mortgage finance agency Fannie Mae abruptly slashed the number of financial institutions that hold its funds, market sources said on Friday. The move forced banks dropped by Fannie Mae to liquidate Treasuries and other short-term securities and borrow in the open market so they can return money Fannie Mae had with them, they said.
The banks had to collectively raise $100 billion to pay back Fannie Mae, said an analyst who declined to be identified. The cash scramble on Wednesday and Thursday led to a spike in overnight interest rates on federal funds and repurchase markets to their highest levels since December. It is unclear why Fannie Mae made the sudden move to reduce the number of banks to hold its cash. Nearly all the financial institutions cut by Fannie Mae were foreign banks, market sources said.
Ilargi: I’m no fan of John Carney in any way, and the site he writes for, Business Insider, is unfortunately fast turning into some sort of electronic yellow paper (more revenues, for sure), but here he's right. Although I wouldn’t be so certain that Barney Frank has no clue. It’s like the Tresury’s Herb Allison who last week said there’s no such thing as a bail-out guarantee for too big to fail banks. Denying it after you bail them all out is political pointlessness.
Barney Frank Has No Clue What He's Talking About When It Comes To Fannie Mae And Freddie Mac
by John Carney
Barney Frank demonstrated today that he is still so out of touch that there is no use in hoping for any useful financial reform from the Massachusetts Congressman. In a blog post on his Congressional website, Frank wrote that he "going forward, as we restructure housing finance, we will make sure that there are no implicit guarantees, hints, suggestions, or winks and nods. We will be explicit about what is and is not an obligation of the federal government." That sounds great. Unfortunately, we've been hearing similar things from Frank for years. Back in 2003 he said:So let me make it clear, I am a strong supporter of the role that Fannie Mae and Freddie Mac play in housing, but nobody who invests in them should come looking to me for a nickel--nor anybody else in the Federal Government. And if investors take some comfort and want to lend them a little money and less interest rates, because they like this set of affiliations, good, because housing will benefit. But there is no guarantee, there is no explicit guarantee, there is no implicit guarantee, there is no wink-and-nod guarantee. Invest, and you are on your own.
But it turned out that he was wrong. Lenders to Fannie and Freddie were not on their own. The government did come in and bail them out. The creditors were right about the likelihood that a guarantee existed. Frank was wrong. Why on earth would anyone find Frank more plausible now? He goes further to undermine his credibility when he says he supports giving the Treasury the flexibility to bailout Fannie and Freddie if necessary for the sake of stabilizing the financial system. The problem with that is that Frank is saying that he'd support a bailout in almost any possible situation when they would be at risk a defaulting on their debt. What's more, any default on the debt of Fannie and Freddie would likely destabilize the financial system.
So Frank opposes a guarantee of Fannie and Freddie debt in every single case except where it might actually be called upon. This kind of double talk inevitably leads to the creation of an implicit guarantee. And that implicit guarantee makes Fannie and Freddie able to raise debt capital cheaply despite their unsafe business practices, which then feeds into the creation of more systemic risk. The more systemic risk they create, the more likely they are to be bailed out.The fact that Frank is still blind to this is the clearest indicator there is that he has learned nothing from our crisis.
Four U.S. Banks Shut Down as Failure Count This Year Reaches 26
Regulators shut banks in Maryland, Illinois, Florida and Utah, pushing the number of U.S. failures to 26 this year and placing more pressure on the Federal Deposit Insurance Corp. to dispose of a growing pile of toxic assets. The FDIC was unable to find buyers for two banks -- Centennial Bank in Ogden, Utah, and Waterfield Bank of Germantown, Maryland -- according to statements posted on the agency’s Web site. In the largest of yesterday’s failures by assets, Boca Raton, Florida-based Sun American Bank was purchased by First-Citizens Bank & Trust Co.
"South Florida is a great market for our company, especially with our focus on individuals, small- to mid-sized businesses and the medical community," Frank B. Holding Jr., chief executive officer of First-Citizens, said in a statement. Lenders are collapsing at the fastest pace in 17 years amid losses on residential and commercial real estate loans made at the height of the market. U.S. "problem" banks climbed to the highest level since 1992 in the fourth quarter and FDIC Chairman Sheila Bair warned Feb. 23 that the pace of failures will "pick up" and exceed last year’s total of 140. The FDIC sold $1.81 billion of notes yesterday that are backed by mortgage securities collected from failed banks. It may issue $4 billion of bonds this month, people familiar with the matter said last week.
Sun American is First-Citizens’ second acquisition through the FDIC’s resolution process this year and fourth overall, according to the bank’s statement. The Raleigh, North Carolina- based lender bought Sun American’s $443.5 million in deposits and shared losses with the FDIC on $433 million of assets. Heartland Bank and Trust Co. of Bloomington, Illinois, will pay a 3.61 percent premium for Bank of Illinois’s $198.5 million in deposits, after state regulators closed the Normal, Illinois- based lender. The FDIC will share losses with Heartland on $166.6 million of assets, according to the statement.
Zions Bancorporation, the lender that operates banks in 10 western U.S. states, was named to take over some operations of Centennial Bank. Utah regulators closed Centennial and put Zions in charge of direct deposits related to government benefits like Social Security. Zions has said that similar arrangements in the past have steered banking customers its way. The Office of Thrift Supervision closed Waterfield Bank. The bank’s $155.6 million in assets and $156.4 million in deposits will go to a newly chartered lender that will stay open until April 5, the FDIC said. The FDIC said last month it had included 702 banks with $402.8 billion in assets on the confidential "problem" list as of Dec. 31, a 27 percent increase from the third quarter.
Illinois stuck in a 'historic, epic' budget crisis
Illinois government is staring down the barrel of an explosive financial mess, and perhaps nothing frames the danger better than two big numbers. The first is $26 billion, the grand total that lawmakers have allotted this year for the meat of what the state does: funding education, health care, child welfare, public safety and the machinery of government itself. The second number is $13 billion, the total of red ink in the state's main checking account that, by law, has to be erased — at least on paper — before a penny can be set aside for day-to-day operations in the fiscal year, which begins July 1.
In short, the deficit is half as big as the core of the state budget. To experts, that is an astoundingly scary ratio that ranks Illinois as one of the nation's worst fiscal basket cases — if not the worst. The budget deficit in Illinois is almost as big as the one facing California, a financially beleaguered state that has triple Illinois' population, according to the Center on Budget and Policy Priorities, a liberal Washington-based think tank. "This is historic, it is epic," said Laurence Msall, president of the watchdog Civic Federation. "It is impossible to overstate the level of peril." Signs of distress are bleeding out to schools, transit agencies and social service providers, all of which complain that it is getting hard to make ends meet because the state is chronically late with promised cash.
Meanwhile, the state's credit ratings are tanking, making it ever more expensive to borrow to make ends meet. Any resolution will almost surely require sacrifice from taxpayers and state workers as well as political courage from elected officials, a commodity always in short supply but especially so in an election year. Talk of major tax increases coupled with draconian spending cuts is building in Springfield. Despite the seeming urgency, it is not clear whether it will come to anything more than just talk. This time last year, the budget outlook was already plenty bleak, yet Gov. Pat Quinn and lawmakers ultimately avoided tough fixes. Delay only added billions of dollars more to the projected deficit.
Illinois is hardly the only state reeling from the recession. But a long and bipartisan history of wishing financial problems away has rendered state government here particularly vulnerable. Budget pressures began to mount in Illinois long before the economic downturn. But the fashionable response from political leaders was to avoid talk of tax increases or significant spending cuts and instead vow elimination of "waste, fraud and abuse," as if those items appeared in a line in the budget that could simply be cut out. Now, the state's fiscal woes have grown so deep that solid solutions defy such glib answers.
Consider this: The head count of state workers is 20 percent smaller than it was a decade ago. If the state payroll was magically purged of every single employee, the annual salary savings would amount to $4 billion, less than one-third of what is needed right now to dig out of the deficit hole. "Any elected official or candidate who says you can solve this without a tax increase is either incredibly math-impaired or intentionally deceiving voters," said Ralph Martire, executive director of the Center for Tax and Budget Accountability, another Illinois budget watchdog.
Last year, federal stimulus spending and a heavy dose of borrowing helped state officials skate around tough budget choices. But now the stimulus money is about to dry up, and the loans must be repaid. Adding to the challenge is a steep decline in sales and income tax revenue, off nearly $1 billion from what was projected last summer. The total budget for the current year stands near $55 billion, but about half of that is dedicated for items like road and building programs or earmarked federal funds that lawmakers have little leeway to divert or chop.
The only significant wiggle room resides in the other half of the budget, known as the general funds, which are tapped to pay for most common government operations. And whatever flex there is in the general funds, there's certainly not close to $13 billion worth — an amount equal to what is being spent this year on the State Board of Education as well as the departments of Human Services, Children and Family Services and Public Health combined.
More than $7 billion of the $26 billion in general funds appropriations this year is earmarked for elementary and secondary schools. Any cuts would only increase pressure on local property taxes, which already bear the brunt of public school funding and, as taxes go, are probably more unpopular than the income or sales tax. Another $8 billion was earmarked for public health care programs including Medicaid, the safety net for the poor that is often a target of criticism from the right. Federal stimulus aid that Illinois is now getting to help stave off financial disaster comes with strings that forbid any rollback in benefits to Medicaid recipients.
Without a tax hike, the Civic Federation estimates, just four key spending items — schools, Medicaid, deficit reduction and debt service on loans the state must repay — will eat through 80 percent of the cash available to pay for all general state programs. Experts have long warned that the financial reckoning in Illinois was coming, pointing to what they call an inherent "structural deficit" in the state budget. That's a fancy way of saying that revenues collected by the state through taxes, fees and other sources were clearly insufficient in the long run to pay for all the programs and benefits that state officials had put into place.
Rather than confront the imbalance head-on, standard practice in Springfield has been to resort to a combination of fiscal tricks. Revenue projections are unrealistically rosy, money is borrowed with full repayment pushed off years into the future, and multibillion-dollar backlogs of unpaid bills are allowed to fester. The system was already primed for calamity when the steep recession that began in 2008 knocked it over the edge. Perhaps the most chronic headache involves pensions. For decades, elected officials have shorted promised contributions to the state's public employee retirement funds. As a result, Illinois by far has the worst-funded pension systems in the nation.
It would be a tall order for the state to totally dig its way out of the hole in one year's budget. But playing catch-up is extremely expensive, and it grows more expensive the longer it takes. Because the state was so short of cash, it borrowed $3.5 billion to meet this year's pension obligations. Next year, debt service on that loan will cost $800 million. And that's in addition to more than $4 billion in pension obligations that the state will be on the hook for in fiscal 2011. As Msall sees it, Illinois is in such poor financial shape that it risks getting to the point where it can no longer make loan payments or meet state aid commitments to schools. If that happens, he says, "Illinois' ability to borrow will be eliminated and the state will come to a screeching halt."
Ilargi: Gretchen Morgenson got a lot of flack for confusing Greece's currency swaps with default swaps in the following article, but it's still a good read.
The Swaps That Swallowed Your Town
by Gretchen Morgenson
As more details surface about how derivatives helped Greece and perhaps other countries mask their debt loads, let’s not forget that the wonders of these complex products aren’t on display only overseas. Across our very own country, municipalities, school districts, sewer systems and other tax-exempt debt issuers are ensnared in the derivatives mess. Like the credit default swaps that hid Greece’s obligations, the instruments weighing on our municipalities were brought to us by the creative minds of Wall Street. The rocket scientists crafting the products got backup from swap advisers, a group of conflicted promoters who consulted municipalities and other issuers. Both of these camps peddled swaps as a way for tax-exempt debt issuers to reduce their financing costs.
Now, however, the promised benefits of these swaps have mutated into enormous, and sometimes smothering, expenses. Making matters worse, issuers who want out of the arrangements — swap contracts typically run for 30 years — must pay up in order to escape. That’s right. Issuers are essentially paying twice for flawed deals that bestowed great riches on the bankers and advisers who sold them. Taxpayers should be outraged, but to be angry you have to be informed — and few taxpayers may even know that the complicated arrangements exist.
Here’s how municipal swaps worked (in theory): Say an issuer needed to raise money and prevailing rates for fixed-rate debt were 5 percent. A swap allowed issuers to reduce the interest rate they paid on their debt to, say, 4.5 percent, while still paying what was effectively a fixed rate. Nothing wrong with that, right?
Sales presentations for these instruments, no surprise, accentuated the positives in them. "Derivative products are unique in the history of financial innovation," gushed a pitch from Citigroup in November 2007 about a deal entered into by the Florida Keys Aqueduct Authority. Another selling point: "Swaps have become widely accepted by the rating agencies as an appropriate financial tool." And, the presentation said, they can be easily unwound (for a fee, of course). But these arrangements were riddled with risks, as issuers are finding out. The swaps were structured to generate a stream of income to the issuer — like your hometown — that was tethered to a variable interest rate. Variable rates can rise or fall wildly if economic circumstances change. Banks that executed the swaps received fixed payments from the issuers.
The contracts, however, assumed that economic and financial circumstances would be relatively stable and that interest rates used in the deals would stay in a narrow range. The exact opposite occurred: the financial system went into a tailspin two years ago, and rates plummeted. The auction-rate securities market, used by issuers to set their interest payments to bondholders, froze up. As a result, these rates rose. For municipalities, that meant they were stuck with contracts that forced them to pay out a much higher interest rate than they were receiving in return. Sure, the rate plunge was unforeseen, but it was not an impossibility. And the impact of such a possible decline was rarely highlighted in sales presentations, municipal experts say.
Another aspect to these swaps’ designs made them especially ill-suited for municipal issuers. Almost all tax-exempt debt is structured so that after 10 years, it can be called or retired by the city, school district or highway authority that floated it. But by locking in the swap for 30 years, the municipality or school district is essentially giving up the option to call its debt and issue lower-cost bonds, without penalty, if interest rates have declined. Imagine a homeowner who has a mortgage allowing her to refinance without a penalty if interest rates drop, as many do. Then she inexplicably agrees to give up that opportunity and not be compensated for doing so. Well, some towns did exactly that when they signed derivatives contracts that locked them in for 30 years.
Then there are the counterparty risks associated with municipal swaps. If the banks in the midst of these deals falter, the municipality is at peril, because getting out of a contract with a failed bank is also costly. For example, closing out swaps in which Lehman Brothers was the counterparty cost various New York State debt issuers $12 million, according to state filings. Termination fees also kick in when a municipal issuer wants out of its swap agreement. They can be significant.
New York State provides a good example. An Oct. 30, 2009, filing describing its swaps shows that for the most recent fiscal year, April 2008 to March 2009, the state paid $103 million to terminate roughly $2 billion worth of swaps — more than a quarter of which resulted from the Lehman bankruptcy in September 2008. (You can find this report online at bit.ly/cS8ZFV.) As of Nov. 30, 2009, New York had $3.74 billion worth of swaps outstanding. Even so, New York doesn’t have as much of a problem with swaps as other jurisdictions. Still, New York could have spent that $103 million on many other things that the state needs.
The prime example, of course, of a swap-imperiled issuer is Jefferson County, Ala. Its swaps were supposed to lower the county’s costs, but instead they wound up increasing its indebtedness. Groaning under a $3 billion debt load, the county is facing the possibility of bankruptcy. Critics of swaps hope that increased taxpayer awareness of these souring deals will force municipalities to think twice. "When municipalities enter into these swaps they end up paying more and receiving much less," said Andy Kalotay, an expert in fixed income. Why is that? One reason, Mr. Kalotay said, is the use of swap advisers. "The basic problem is the swap adviser gets paid only if there is a transaction — an unbelievable conflict of interest," he said. "It’s the adviser who is supposed to protect you, but the swap adviser has a vested interest in seeing something happen."
What is especially maddening to many in the municipal securities market is that issuers are now relying on the same investment banks that put them into swaps-embedded debt to restructure their obligations. According to those who travel this world, issuers are afraid to upset their relationships with their bankers and are not holding them accountable for placing them in these costly trades. "We need transparency where Wall Street discloses not only the risks but also calculates the potential costs associated with those risks," said Joseph Fichera, chief executive at Saber Partners, an advisory firm.
"If you just ask issuers to disclose, even in a footnote, the maximum possible loss or gain from the swap they probably wouldn’t do it. And if they did that, then investors and taxpayers would know what the risks are, in plain English." Mr. Fichera is right. At this intersection of two huge and extremely opaque arenas — the municipal debt market and derivatives trading — sunlight is sorely needed.
Snow didn't skew the unemployment rate. But the census will.
In the end, major snow storms in the East didn't have much impact on the February jobs report. The unemployment rate in February was 9.7 percent, unchanged from January, according to the Department of Labor's unemployment report. The number of job losses was 36,000, not much different from January's revised loss of 26,000. But that could change in April and May, when the surge of hiring for the 2010 census could boost payrolls by half a million or more. The census could trim the unemployment rate by a few tenths of a percentage point and boost the nation's gross domestic product by 0.2 percentage points in the second quarter, according to a report last month by the Commerce Department’s Economics and Statistics Administration.
But what the census brings, the census taketh away. The job surge will begin to wind down in June, dampening the spending boost. By the latter half of the year, the census will act as a drag on economic growth, the report estimates. "This is the government's version of the Olympics," says Richard Gold, senior director of research and investment strategy for international property group Grosvenor Americas. The census will generate a frenzy of economic activity – a $17 billion bump in payroll – over a short period of time. But it's "a transitory, one-time event," he adds. The long-term effect will add little more than 0.1 percentage point to US personal income. "The best news about this is that the impact will be spread across the country," Mr. Gold says.
Ilargi: The end of US retail investors' (forex) currency trading?
Foes Take On Debt Curbs From CFTC
An attempt by regulators to protect investors from volatile global currency markets has triggered an uproar among lawmakers, currency dealers and thousands of small traders. The Commodity Futures Trading Commission has proposed rules that would reduce the amount of borrowed funds that retail investors can use when investing in the U.S. foreign-exchange market to as much as 10-to-1, from the existing 100-to-1 for major currencies.
Under current rules, a customer putting up a security deposit of $1,000 in cash will be able to trade a notional amount of $100,000, a common contract size for currencies such as the dollar and the Japanese yen. The new rule would cap that amount at $10,000. The rules also would require dealers to abide by new capital and disclosure requirements. If the rules come into force, investors would be required to either put more capital in their accounts or pare their positions.
Since the proposal was posted on the agency's Web site in mid-January, the CFTC has received an avalanche of comments—more than 6,000 and counting—from individual traders and brokers. By comparison, the Securities and Exchange Commission last year received 4,000 comments to its proposal to restrict short selling. Lawmakers grilled CFTC Chairman Gary Gensler over the plan at a hearing this past week. "If our leverage rules are 10-to-1 and leverage rules elsewhere are 100-to-1, the business is going to move elsewhere," House Agriculture committee member Jim Marshall (D., Ga.) said. He said investors could be even less protected if trading moves to a country with lax rules.
In the U.K., the powerhouse of global currency trading, there are no leverage restrictions for retail investors. U.S. laws prescribe uneven oversight for the retail foreign-exchange market, leaving the CFTC able to regulate only businesses under its jurisdiction, such as commodity brokers. U.S. banks and securities brokers that offer retail currency trading wouldn't be covered by the CFTC's regulations. Mr. Gensler said the intent is to "protect the public" and that the agency is reviewing the comments it has received.
The use of leverage by retail currency investors has long been a cause for concern among regulators. In what is by far the largest global financial market, with average daily turnover of about $3.2 trillion, currencies can move on an array of forces ranging from minor changes in interest-rate expectations to swings in economic data to cross-border corporate takeovers. Moves in major currencies often are small and the use of leverage can greatly ramp up the potential return, though the risk of being wiped out also is greatly enhanced. The huge risk-reward potential makes the market a hotbed for scams. From December 2000 through September 2009, more than 26,000 customers received $476 million in restitution in 114 foreign-exchange fraud cases pursued by the CFTC.
"The proposal in its entirety is intended to allow us to get on with our job of protecting customers and ensuring the financial integrity of firms engaging in retail forex transactions," said Bart Chilton, a CFTC commissioner. He said the comments from the public—largely centering on the leverage proposal—have come down on the agency "like a winter blizzard," noting that it was more than at any time in the agency's history.
In recent years, an increasing number of individual investors have joined the hedge funds and Wall Street banks that trade foreign exchange. At GAIN Capital, a large broker, new accounts have increased 35% annually, mostly from retail investors. "If the rule goes through, firms will close their U.S. offices and move their operations overseas, because they will be put out of business," said Muhammad Rasoul, chief operating officer at GFT, a division of Global Futures & Forex Ltd.
The National Futures Association, which self-regulates the futures industry, already has sought to implement some of the rules in the CFTC's proposal. In 2008 and 2009, the NFA phased in regulations requiring dealers to have substantially higher amounts of capital. Since that time, the number of CFTC-regulated retail foreign-exchange businesses has shrunk to 18 from about 40, as companies consolidated to meet the new standards, an NFA spokesman said.
Todd Lambrix, a currency day trader in Flint, Mich., is one of the many small investors opposing the CFTC plan. Mr. Lambrix has $5,000 in his currency account and often uses 100-to-1 leverage to trade currencies. Three years into trading foreign exchange, he said, he has learned how to control risk by setting enough technical limits that automatically close out trades. Last year, he broke even. "What right do you have to tell me that I can't spend my money on things I choose?" he said.
GM to Reinstate at Least 660 Dealers
General Motors Co. is reinstating at least 660 of the more than 2,000 showrooms it had planned to drop, a partial reversal of a consolidation plan that caused pain and fear in cities and towns across the country when first disclosed last year. Lawmakers had pressured GM on behalf of local businesses, forcing it to first offer arbitration to dismissed dealers. The auto maker agreed to reinstate dealers after acknowledging the process it used to weed out showrooms didn't properly consider such factors as location and customer loyalty—as the dealers had insisted. The company last year was bailed out by the U.S. government, which now owns 60%.
About 1,100 of the dealers targeted for elimination appealed their termination. GM said it would soon notify 661 by mail that they would have the right to continue operating their franchises. A year ago both GM and Chrysler Group LLC outlined plans to eliminate dealers from their sales networks as part of their federally funded bankruptcy reorganizations. "This is emotional. It is part of the rebirth as we try and start a company from a clean slate," the head of GM's North American operations, Mark Reuss said Friday. Mr. Reuss acknowledged Friday in a conference call that GM's sales have suffered in recent months as the auto maker stopped shipping vehicles to dealers slated to close. "We would have beaten Ford," if not for the move, Mr. Reuss said.
Mr. Reuss said the "vast majority" of the 660 will resume selling new cars, and it could be weeks before those that do star receiving new cars and trucks. Some have already shut down their businesses, or turned them into used car lots or begun selling new cars made by other manufacturers. Both auto makers hoped to eliminate weaker unprofitable stores and go forward with fewer but financially stronger dealers who could invest in their facilities, spend more on marketing and provide better service. GM had aimed to cut about 40% of its 6,246 stores. Some of those closings represent brands that GM is phasing out or selling—Hummer, Saab, Saturn and Pontiac. GM now expects to end up with about 5,000 stores for its remaining Chevrolet, Cadillac, Buick and GMC brands.
GM originally agreed to set up an appeals process to avoid long and costly legal battles with dealers that felt they were wrongly selected for elimination. But the move now has added significance now that Chairman and Chief Executive Edward E. Whitacre Jr. has made boosting sales in the U.S. a top priority. Reinstating dealers and taking orders to restock their lots could help GM improve its market share as Mr. Whitacre desires, and help the company regain the lead in U.S. vehicle sales.
Earlier this week GM shook up its sales organization to accelerate growth. It suffered an embarrassment when Ford Motor Co. on Tuesday reported it sold more vehicles than GM in February, the first time that has happened in more than 50 years, except in a few months when GM was hurt by labor strikes. Dealers around the country viewed the reversal with anticipation. Steve Baldo, 51 years old, appealed the termination of his Chevrolet store in Clarence, N.Y., and is hopeful he'll get a reinstatement letter next week. "We always scored very well in customer service and exceeded our sales targets." But reinstatement will also leave Mr. Baldo with a dilemma. He is nearly finished turning Baldo Chevrolet into a used car dealership and a Meineke Muffler repair shop. "I'll have to see if there's an opportunity to take back the franchise or possibly negotiate a settlement," Mr. Baldo said.
After years of sales declines and geographic shifts in the U.S. population, GM, Chrysler and Ford each have more dealers than they need in many parts of the country. Each has been trying for years to reduce the number of dealers. In many cities and towns, losing a Chevrolet or Chrysler showroom often meant losing a family-run business that had been a part of the local community supporting schools, Little Leagues and charities. "If we get reinstated we can do all the things we used to do before we had our legs cut out from under us," said dealer Rusty Wagner of Wagner Buick GMC in Belleville, Ill. "Our community will be very happy." Wagner said he and his wife sponsor sports teams, fundraisers and other local events, while donating time to serve on local boards and civic groups. "We all do that kind of thing," he said.
In many markets, GM, Chrysler and Ford dealers compete as much or more against other dealers of those companies, and undercut each other on price. After years of losing money, many have been left with old and outmoded facilities, while dealers for companies like Toyota Motor Corp. and Honda Motor Co. have been able to update and expand their showrooms and amenities. Toyota now has 1,452 dealerships in the U.S., each of which last year sold an average of 1,219 vehicles. GM has about 5,500 dealerships and sold 2.1 million vehicles last year, an average of about 376 a store.
Ed Larkin, general manager of Rose Chevrolet in Hamilton, Ohio, is hopeful he will be among the dealers GM opted to keep. He entered arbitration and argued that the store's solid sales, around 600 a year, along with high customer satisfaction scores make it a good dealership for GM. "We sell in volume and we take care of our customers," Larkin said. "The facts will prove themselves."
Gary Gorton On The Shadow Banking System Run, And The Interplay Of Shadow And Traditional Banking
There are few people as qualified to discuss the stresses of (and on) the financial system over the past several years as Yale and Wharton Professor Gary Gorton, who just incidentally has held positions at the Bank Of England, the Federal Reserve and the FDIC. In a submission to Zero Hedge, Professor Gorton provides some unique perspectives into what we have long claimed was the immediate catalyst for the near collapse of the banking system: the bank run, not so much on depository institutions, but on the much more critical shadow banking system. And when one considers the parallels between the two, whose existence in any case is merely contingent on the persistence of trust in the workings of the broader financial system, Gorton observes that the Great Panic which commenced really in August 2007 (with the first salvo fired by none other than the HFT quant community, on August 6, discussed extensively here previously and in Barron's today most recently), is really no different from the Panics of 1907 or 1893, except that in 2007 "most people had never heard of the markets that were involved, didn't know how they worked, or what their purposes were. Terms like subprime mortgage, asset-backed commercial paper conduit, structured investment vehicle, credit derivative, securitization, or repo market were meaningless." And just like deposit bank runs earlier, the securitized banking system, which is in essence a real banking system, "allowing institutional investors and firms to make enormous, short-term deposits" was vulnerable to a panic. What should be more troubling is that the event commencing with the August 2007 waterfall, were not a retail panic involving individuals, but a wholesale panic involving institutions, where large financial firms "ran" on other financial firms, making the system insolvent. As some other witty writer once put it best, "banks opened up their books to each other, and hated what they saw."
The scariest thing is that we have still done nothing to address the propensity for institutional panic to come back, which courtesy of money now being electronic 1's and 0's, will certainly take an even faster time to hit its plateau when it appears next. Keep in mind that post the Lehman crisis, it only took 3 days before the money markets locked up and were in need of governmental guarantees, while the broader repo market was shut down within 48 hours. As retail investors tend to enjoy obtaining physical delivery of their asset (read FRNs), for institutions, the wave can turn at a heartbeat, and next time around the administration will likely not even have 12 hours before a complete financial, systemic, and irrevocable lock-down is in place. The only backstop to this risk- the Federal Reserve. Yet the question remains: how long before nobody in the world dares to take the Fed head on. It is no secret that the entire investment community now realizes that the Fed's experiment is doomed. The US is no longer a viable going concern: when the CBO notifies the public that the debt/GDP in a decade will be 90% and that total marketable debt will double to $20 trillion, the game is over. And just like in any good old game theory construct, the first defector is the one to benefit the most. The Fed can not, be definition "defect"; so when one of the whale account does, and the avalanche of enjoinders jumps on board, the proverbial "you don't get in front of the Fed" will be a memory. What we know is that we now have a t-10 years timer before the US economy is certainly finished. But the real question is when the defections against Bernanke et al will begin in earnest.
Back to the repo system: As Gorton points out - "Times change. Now, banking has changed again. In the last 25 years or so, there has been another significant change: a change in the form and quantity of bank liabilities that has resulted in a panic. This change involves the combination of securitization with the repo market. At root this change has to do with traditional banking system becoming unprofitable in the 1980s. During that decade, traditional banks lost market share to money market mutual funds (which replaced demand deposits) and junk bonds (which took market share from lending), to name the two most important changes" [incidentally, this is precisely the reason why Paul Volcker has historically been so adamantly against money markets, and for a dramatic, and some say terminal, overhaul in the MM system, whose mere ongoing existence is a substantial destabilization of the financial status quo as investors funnel trillions of dollars to and fro MM's whenever the Fed plays around with the Fed Funds rate, adding massive instability to capital markets]"Keeping passive cash flows on the balance sheet from loans, when the credit decision was already made, became unprofitable. This led to securitization, which is the process by which such cash flows are sold."
Gorton goes on to demonstrate just how the traditional and parallel (shadow) banking systems are intertwined:
As the above Gordian Knot chart indicates, there is much as stake here, and much reason for the authorities to distract the general populace with such silly concepts as a Consumer Protection Agency and Healthcare Reform. Indeed, shadow economy investors stand to lose over $70 trillion dollars should the traditional-shadow banking linkage be broken and the cash flow transfer process be disrupted. The bigger question: how much longer will such cash flows sustain in the current day and age when real demand has collapse courtesy of record domestic unemployment. The biggest question: what happens when there is a secular change to the prevalent level of capital flows into shadow banking. One of the primary reasons for the massive expansion in the money system (via the credit pyramid), has been precisely the shadow banking system, which is second only to the credit and interest rate derivative market (incidentally we were fascinated by the race to the currency bottom, and the technical associated short squeezes in the Dollar and Euro, in May 2009, long before anyone even considered such now daily discussion pieces).
Yet should shadow baning disappear, the tranche above it (or below it by seniority) would disappear as well. And with 90%+ of global liquidity gone, and no additional source of "credit" money to fill the Fed's infinite demand for monetary supply, asset prices will explode (forget about gold - one apple will be $6,000 an ounce). Deflationists are right that ceteris paribus asset prices will decline, and that the Fed is powerless to stop this. Yet deflationists take one huge variable for granted: that the existing liquidity pyramid will persist. It is obvious that should another systemic stress episode emerge and money contract by a massive amount, the end consumer will matter little when total global credit collapses from $600 trillion to mid double digits, thereby decimating the real shadow monetary base, and realligning global assets with a liability side in flux. After all, the key offset to CPI going stratospheric over the past 30, 50 and even 100 years has been precisely the emergence of the alternative banking system, with its influx of tens if not hundreds of trillions of "shadow" dollars, which almost ceased to exist in the 2007-2009 crisis. The netting of intangible money to tangible currency in circulation would be a forced explosion in the money multiplier by the same amount as the shadow economy has sucked out in a vacuum of expiring credibility overnight.
For this, and much more we recommend a read of the attached "Q&A about the Financial Crisis" in which Gary Gorton discusses before the US Financial Crisis Inquiry Commission, in very clear language, the big dangers still facing shadow banking.
Should readers demand for additional information, Gary Gorton has recently written a book, "Slapped by the Invisible Hand, The Panic of 2007" (you know it's good because it is not available on the Kindle), which discusses more of the same fascinating topics (and to which a just as interesting intro written by Gorton can be found here).
President Obama, Replace Rahm With Me: An Open Letter From Michael Moore
Dear President Obama,
I understand you may be looking to replace Rahm Emanuel as your chief of staff. I would like to humbly offer myself, yours truly, as his replacement. I will come to D.C. and clean up the mess that's been created around you. I will work for $1 a year. I will help the Dems on Capitol Hill find their spines and I will teach them how to nonviolently beat the Republicans to a pulp. And I will help you get done what the American people sent you there to do. I don't need much, just a cot in the White House basement will do.
Now, don't get too giddy with excitement over my offer, because you and I are going to be up at 5 in the morning, seven days a week and I am going to get you pumped up for battle every single day. Each morning you and I will do 100 jumping jacks and you will repeat after me:"THE AMERICAN PEOPLE ELECTED ME, NOT THE REPUBLICANS, TO RUN THE COUNTRY! I AM IN CHARGE! I WILL ORDER ALL OBSTRUCTIONISTS OUTTA MY WAY! IF THE AMERICAN PEOPLE DON'T LIKE WHAT I'M DOING THEY CAN THROW MY ASS OUT IN 2012. IN THE MEANTIME, I CALL THE SHOTS ON THEIR BEHALF! NOW, CONGRESS, DROP AND GIVE ME 50!!"
Then we will put on our jogging sweats and run up to Capitol Hill. We will take names, kick butts, and then take some more names. If we have to give a few noogies or half-nelson's, then so be it. In our pockets we will have a piece of paper to show the pansy Dems just how much they won by in 2008 -- and the poll results that show the majority of Americans oppose the Afghanistan and Iraq wars and want the bankers punished. Like drill sergeants, we will get right up in their faces and ask them,"WHAT PART OF THE PUBLIC MANDATE DON'T YOU UNDERSTAND, SOLDIER?!! DROP AND GIVE ME 50!"
I know this is the job Rahm Emanuel was supposed to be doing.
Now, don't get me wrong. I have always admired Rahm Emanuel (if you don't count his getting NAFTA pushed through Congress in the '90s which destroyed towns like Flint, Michigan. I know, picky-picky.). He is what we needed for a long time -- a no-apologies, take-no-prisoners fighting machine. Someone who is not afraid to get his hands dirty and pound the right wing into submission. Far from being the foul-mouthed bully he has been portrayed as, Rahm is the one who BEAT UP the bullies to protect us from them.
That's certainly what he did in 2006. After six long, miserable years of the middle-class getting slaughtered and the poor being flushed down the toilet, Rahm Emanuel took on the job of returning Congress to the Democrats. No one believed it could be done. But he did it. Big time. He put the fear of God into the party of Rush and Newt. They had never been so scared. More importantly, though, he instilled a sense of hope in the Democrats that they could actually score the mother of all hat tricks in 2008 -- and with you, an African American no less, in the pole position!
It worked. The Darkness ended. The vast majority of the nation wept with joy on the night of the election (those who weren't weeping went out and bought a record number of guns and ammo). Unlike the last president, you didn't "win" by 537 votes in Florida (although Gore won the popular vote by a half-million), you beat McCain nationally by 9,522,083 votes! The House Democrats got a walloping 79-vote margin. The Senate Dems would caucus with a supermajority of 60 votes unheard of in over 30 years. The wars would now end. America would have universal health care. Wall Street and the banks would, at the very least, be reined in. Hardworking citizens would not be thrown out of their homes. It was supposed to be the dawning of a new age.
But the Republicans were not going to go quietly into the night. You see, instead of having just one Rahm Emanuel, they are ALL Rahm Emanuels. That's why they usually win. Unlike most Democrats, they are relentless and unstoppable. When they believe in something (which is usually themselves and the K Street job they hope to be rewarded with someday), they'll fight for it till the death. They are loyal to a fault to each other (they were never able to denounce Bush, even though they knew he was destroying the party). They dig their heels in deep no matter what. If you exiled them to a lone chunk of melting polar ice cap, they would keep insisting that it was just a normal "January thaw," even as the frigid Arctic waters rose above their God-fearing necks ("See what I mean -- this water is COLD! What 'global warming'?! Adam and Eve rode dinos...aagghh!!... gulp gulp gulp").
We thought we were all done with this craziness, but we were mistaken. Like a beast that you just can't cage, the Republicans convinced not only the media, but YOU and your fellow Dems, that 59 votes was a minority! Precious time was lost trying to reach a "consensus" and trying to be "bipartisan."
Well, you and the Democrats have been in charge now for over a year and not one banking regulation has been reinstated. We don't have universal health care. The war in Afghanistan has escalated. And tens of thousands of Americans continue to lose their jobs and be thrown out of their homes. For most of us, it's just simply no longer good enough that Bush is gone. Woo hoo. Bush is gone. Yippee. That hasn't created one new friggin' job. You're such a good guy, Mr. President. You came to Washington with your hand extended to the Republicans and they just chopped it off. You wanted to be respectful and they decided that they were going to say "no" to everything you suggested. Yet, you kept on saying you still believed in bipartisanship.
Well, if you really want bipartisanship, just go ahead and let the Republicans win in November. Then you'll get all the bipartisanship you want. Let me be clear about one thing: The Democrats on Election Day 2010 are going to get an ass-whoopin' of biblical proportions if things don't change right now. And after the new Republican majority takes over, they, along with a few conservative Democrats in Congress, will get to bipartisanly impeach you for being a socialist and a citizen of Kenya. How nice to see both sides of the aisle working together again!
And the brief window we had to fix this country will be gone.
Gone, baby, gone.
I don't know what your team has been up to, but they haven't served you well. And Rahm, poor Rahm, has turned into a fighter -- not of Republicans, but of the left. He called those of us who want universal health care "f***ing retarded." Look, I don't know if Rahm is the problem or if it's Gibbs or Axelrod or any of the other great people we owe a debt of thanks to for getting you elected. All I know is that whatever is fueling your White House it's now running on fumes. Time to shake things up! Time to bring me in to get you pumped up every morning! Go Barack! Yay Obama! Fight, Team, Fight!
I'm packed and ready to come to D.C. tomorrow. If it helps, you won't really be losing Rahm entirely because I'll be bringing his brother with me -- my agent, Ari Emanuel. Man, you should see HIM negotiate a deal! Have you ever wanted to see Mitch McConnell walking around Capitol Hill carrying his own head in his hands after it's just been handed to him by the infamous Ari? Oh, baby, it won't be pretty -- but boy will it be sweet! What say you, Barack? Me and you against the world! Yes we can! It'll be fun -- and we may just get something done. Whaddaya got to lose? Hope?