“A young heron among oil-covered mangroves in Barataria Bay, Louisiana"
Ilargi: As we are witnessing our coasts, our economies, our societies and the world as we've ever known it crumble, shatter and evaporate, it's high time to look beyond today, and towards the white swans we all know are out there approaching but prefer not to see.
Somewhat ironically, it may be the disaster called Deepwater Horizon, a name that will for future generations not just be mentioned in the same breath as Three Mile Island and Chernobyl, but many miles and way before them, that will tell the age old story of how an economical crisis driven too far inevitably must become a political one, once "our" politicians run out of excuses and, more importantly, other people’s money.
Those of you who're read me over the years are intimately familiar with the call, the prediction, the idea, the process, the cause and the effect. Those who haven't are welcome for the ride from here on in.
What we live today has long since ceased to be a financial crisis: it's all political now. A political apparatus that is wholly owned by the financial and corporate interests it’s legislated to control is bound to provide for a roller coaster that goes up and down for a while but must eventually end up in a place so down and deep and dark none of us have ever seen it, been there, nor would wish to . Which is where and why politics as we’ve come to know it is hell-bent to self-destruct. And what then?
Stoneleigh provides a peak into the inner workings:
Stoneleigh: On the Nature of Political Crisis
Given that we are facing not just a financial crisis, but a major political crisis, as Ilargi has pointed out many times, I thought it might be appropriate to explore the nature of politics - the art of the possible - in a little more depth . That will make the nature of political crisis much clearer.
To begin with, all human political structures, existing at all scales simultaneously, are essentially predatory. They exist to convey wealth and resources from the periphery to the centre, thereby enabling an enhanced level of socio-economic complexity. Each centre - whether municipal, regional, national or international - has its corresponding periphery – the region from which it can extract surpluses. (For more on this concept, see Entropy and Empire)
During expansionary times, larger and larger political structures -can- develop through accretion. Ancient imperiums would have done this mostly by physical force, integrating subjugated territories into the tax base by extracting surpluses of resources, wealth and labour. We have achieved much the same thing at a global level through economic means, binding additional polities into the larger structure through international monetary mechanisms such as the Bretton Woods institutions (IMF, World Bank and GATT, fore-runner of the WTO). The current economic imperium of the developed world is truly unprecedented in scale.
To simplify for a moment, one can build an analogy between layers of political control and levels of predation in a natural system. The number of levels of predation a natural system can support depends essentially on the amount of energy available at the level of primary production and the amount of energy required to harvest it. More richly endowed areas will be able to support -more- complex food webs with many levels of predation.
The ocean has been able to support more levels of predation than the land, as it requires less energy to cover large distances, and primary production has been plentiful. A predator such as the tuna fish is the equivalent, in food chain terms, of a hypothetiacl land predator that would have eaten primarily lions. On land, ecosystems cannot support that high a level predator, as much more energy is required to harvest less plentiful energy sources.
If one thinks of political structures in similar terms, one can see that the available energy, in many forms, is a key driver of how complex and wide-ranging spheres of political control can become. Ancient imperiums achieved a great deal with energy in the forms of wood, grain and slaves from their respective peripheries. Today, we have achieved a much more all-encompassing degree of global integration thanks to the energy subsidy inherent in fossil fuels.
Without this supply of energy (in fact without being able to constantly increase this supply to match population growth), the structures we have built cannot be maintained (see Joseph Tainter’s work for more on this).
However, while energy has been a key driver of global integration and complexity, the structures we have created do not depend only on energy. Because any structure with a fundamental dependence on the buy-in of new entrants, and therefore the constant need to expand, is grounded in Ponzi dynamics, these structures are inherently self-limiting (see From the Top of the Great Pyramid.
We have reached the limit beyond which we cannot continue to expand, there being no more virgin continents to exploit in our over-crowded world. The logic of Ponzi dynamics dictates that we will now experience a dramatic contraction, and that our financial structure, which is the most complex and most vulnerable part of our hypertrophic political system, will become the key driver to the downside during that period. Part of that contraction will be of our available energy supplies and ability to distribute energy to where it is needed, both of which will fall victim to many 'above-ground factors' in the years to come (see Energy, Finance and Hegemonic Power).
As a consequence, we will lose at least one level of political structure (predation), and likely more. We will simplify our 'food chains'. Certainly we will not live in the globalized world we have come to know, and maintaining central control at a national level may also be difficult in many places, although this will depend on many factors, not the least of which is scale. This has crucial implications for the long and vulnerable supply chains we have constructed in a world built on comparative advantage (where we make everything in the cheapest possible place and transport the resulting products over very long distances).
Our horizons will have to shrink to match our reach. The inability of any individual or institution to prevent this, or even to mitigate it much through top-down action, will be a major component of political crisis. What mitigation is possible will have to come from the bottom-up. While expansions lead to political accretion -forming larger and more complex structures- contractions lead to the opposite – division into smaller polities at lower levels of complexity.
To understand what this means in practice, we need to look at the psychological factors inherent in expansion and contraction.
Expansionist periods are optimistic times where the emphasis is on building economic activity and social inclusion. Trust -the most critical component of stable societies- expands, and populations move in the direction of recognizing common humanity. Old animosities tend to recede from the public consciousness and relative political stability can be achieved.
Whether a party of the left or right is in control, one will tend to see its more benign face during the early phase of a great expansion. On the right this might include elements of a 'can-do’ independent spirit, pride in self-reliance, thriftiness and frugality, tight-knit communities and effective self-regulation. On the left it could include an emphasis on the public interest, caring and sharing, public service to the collective, a concern to see no one left behind, a desire to protect through regulation, and preparedness to contribute time and resources to the common good.
Either of these constellations of characteristics is likely to deliver benefits and preside over a society whose institutions function relatively effectively. The structures which tend to be most stable are grounded in a form of social contract, where the process of wealth conveyance is muted to some extent, in order that the disparity between haves and have-nots is not too extreme, and the periphery gains something from the association despite their contribution of tithes.
The potential for social mobility is also important for acceptance by the less privileged. Under the favourable circumstances that accompany optimistic times, this combination delivers a political legitimacy which acts as a powerful stabilizing force.
Unfortunately, all human institutions tend to become progressively less functional as they age, and as periodic renewal, necessary to keep them healthy, ceases to occur. Transparency and accountability decrease, and the institutions become more and more bloated, sclerotic, self-serving and hostage to vested interests. By the end of a long expansion, socio-political institutions, including political parties, may retain their outward appearance and yet have largely ceased to function responsively in the way they once did.
At this point they go through the motions, but process becomes more important than substance. Many become corrupt and unreformable. This institutional decay constitutes a substantial component of political crisis in the latter days of imperium.
As expansion morphs into contraction, in accordance with the very exact same Ponzi logic that underlies our present financial crisis, institutions may collapse along with other higher order structures. While they are eventually to be replaced by something much simpler from the grass roots, to serve their essential functions, this does not happen overnight.
The psychology of contraction may well inhibit the formation of effective new institutions, even much simpler ones, for a long period of time. The psychology of contraction is not constructive, and leads in the direction of division and exclusion as trust evaporates. Unfortunately, trust – the glue of a functional society - takes a long time to build, but relatively little time to destroy.
Elites (top predators) will have a smaller peripheral pool from which to extract the tithes they have come to expect. No longer able to pick the pockets of the whole world, they will very likely squeeze domestic populations much harder in a vain attempt to maintain the resources of the centre at their previous level. This will be very painful for those at the bottom of the pyramid, who will be asked, told and eventually forced to increase their contributions, at the very moment their ability to do so declines sharply.
Whether the left or the right presides over contraction, we are most likely to see a much more pathological face emerge, and this will aggravate political crisis considerably. On the right this could be xenophobia, strict enforcement of tight and arbitrary norms dictated by the few, loss of civil rights, extreme poverty for most while a few live like kings, and fascism, perhaps grounded in theocracy.
On the left it could be forced collectivization, the elimination of property rights, confiscations, and a desire to punish anyone who appears to be doing relatively well, whether or not they achieved this legitimately through foresight, hard work and fiscal responsibility. In either case, liberty is likely to be an early casualty, and intolerance of differences is virtually guaranteed to increase.
Central authority, which is set to increase even as its legitimacy decreases, is very much a double-edged sword. While increased centralization may confer the power to ration scarce goods, which would be a public good if undertaken in the spirit of good governance, that spirit is likely to be noticeably lacking in years to come. We are far more likely to see pervasive corruption and a resurgence of the politics of the personal, where connections are everything.
That will aggravate the crisis of political legitimacy. Besides, powers and liberties taken, whether by popular consent or not, are never voluntarily given back to the people. They would have to be fought for all over again. Perhaps we will see that happen at some point in the future, but for now people seem all too prepared to trade liberty for security, which Benjamin Franklin described as a recipe for enjoying neither.
We have yet to see a full-blown political crisis in the US and elsewhere, but it is clearly coming. Argentina went through five presidents in a matter of a few short months at the height of its upheaval. The countries of the first world will likely experience much the same thing, primarily because there is simply nothing any politician can do to prevent the pain of depression, and not even much they can do to mitigate it.
The inevitable process of living through that period, which could last for many years, will probably consume many political careers, and indeed political parties. Leaders elected now have accepted the poisoned chalice. They are likely to go down in history as abject failures, no matter what they do.
My concern is that traumatized people will seek charismatic populist leaders representing extremist positions. Politicians of that stripe are adept at manipulating the herd in the direction of inflicting punishment on any group they happen personally not to like. Hitler comes to mind here. There can be no greater political crisis than repeating the mistakes of the past on the scale that implies.
Ilargi: Dear Readers:
At this point in time, we need you more than ever to either donate money directly and/or visit our advertisers. Don’t worry, we have no intention of selling you cheap. On the contrary, we want to, and will, expand TAE to a great extent, tentatively as per July 1. Having to prepare, organize and execute that on a scrape-by budget makes it that much harder. And believe us: we don’t take any of this lightly; we know how close we may be already to the real major economic changes we've long predicted but haven't yet seen. But then, that’s exactly why we feel we have to do more for our readers. Still, hard as we try, hard as we work, it’s just not going to happen without you.
'Political Stupidity': Democrat James Carville Slams Obama's Response to BP Oil Spill: 'We're About to Die Down Here'
by Jake Tapper and Huma Khan - ABCNews
The White House is seemingly making an increased show of pressuring BP, but President Obama is facing political heat from within his own party for what some say has been a lackluster response to the oil spill in the Gulf of Mexico. The "political stupidity is unbelievable," Democratic strategist James Carville said on "Good Morning America" today. "The president doesn't get down here in the middle of this. ... I have no idea of why they didn't seize this thing. I have no idea of why their attitude was so hands off here."
On Thursday, Obama will announce new measures the federal government will take to try to prevent any future BP oil spills, administration officials said. And on Friday, the president will visit the Gulf coast, his second trip to the region since the environmental disaster happened last month. But Carville said the Obama administration's response to the BP oil spill has been "lackadaisical," and that rather than place the blame on the previous administration, it should've done more to deal with BP and "inept bureaucrats," which would've in turn helped boost Obama's approval ratings.
"The president of the United States could've come down here, he could've been involved with the families of these 11 people" who died on the offshore rig, Carville said. "He could've demanded a plan in anticipation of this."
Warning: Crash dead ahead. Sell. Get liquid. Now.
by Paul B. Farrell - MarketWatch
"This game's in the refrigerator! The door's closed, the lights are out, the eggs are cooling, the butter's getting hard and the Jell-O is jiggling ..."
That was legendary Lakers' radio announcer Chick Hearn's signature way of calling a game early, telling fans the home team won ... you can head for the exits before the final buzzer. Chick wrote the book with popular sports phrases like "slam dunk," "air ball," "charity stripe," and a "bunny hop in the pea patch" for a traveling violation. Chick's our inspiration today: Last March I wrote "6 reasons I'm calling a bottom and a new bull." Today it's time for a new call. We've had a good year. Net gains over 50% in 2009. But now: "Game over, head for the exits." Bears beating bulls.
No, no, "it's a buying opportunity," says another legend, hedge fund manager, Barton Biggs. Buying opportunity? For who? Remember, Biggs isn't advising Joe Lunchbox about what to do with his little 401(k). Biggs' customers are mega-millionaires in his $1.5 billion Traxis Partners Fund. Main Street investors like Joe are prey in his casino. Read on, you decide: As you stare from high up in the nose-bleed bleachers watching the game, staring at a Dow that not long ago was above 11,000 and heading for 12,000. Now the Dow's sitting on the bench, ready for the showers, weak after a couple air balls around 10,000. No more timeouts. "This game's in the refrigerator."
How bad is your bookie's point spread in this game? A blowout? Will the Dow drop below 9,000 again? Now that it's broken technical supports, will it drop below 6,470, where the last bull rally started in early 2009? Can you handle the nerve-racking volatility generated by Wall Street's high-frequency traders playing the game at warp-speed with algorithms making thousands of micro-bets in milliseconds, betting billions daily? So who should you listen to? Barton and I arrived at Morgan Stanley about the same time. He stayed decades longer, became one of the world's leading strategists, advising the kind of high-rollers who also bet at private tables in a Vegas casino.
You remember Biggs: In his book "Wealth, War & Wisdom" he advises his high rollers to prepare for a "breakdown of the civilized infrastructure." Buy a farm: "Your safe haven must be self-sufficient and capable of growing some kind of food ... It should be well-stocked with seed, fertilizer, canned food, wine, medicine, clothes, etc. Think Swiss Family Robinson." Biggs is not advising small investors on what to do with their 401(k)s. If you're gambling at Wall Street's casino, folks, the odds-makers are betting against Biggs. It's "game over."
Main Street lost 20% last decade ... yet like sheep keep going back
Yes, if you're channeling Chick, here's your "mixed metaphor" cue card: "This game's in the refrigerator ... Wall Street won (proof, Goldman's $100-million-profit trading days and Blankfein's $68 million bonus) ... Main Street's headed for another losing streak ... Congress' lights are out ... the refrigerator door's closing on financial reforms ... the lobbyists are laying some rotten eggs, poisoning capitalism ... the Tea Party-of-No-No ideologies are hardening ... the bull's Jell-O is jiggling to a flat line ... and this market's going into hibernation, with the bears ... run, don't walk, to the exits, folks."
But will Main Street exit? Will we ever learn? No. The Wall Street casino makes mega-billions for insiders like Blankfein and the Goldman Conspiracy. Yet "The Casino" is still below the 2000 record of 11,722. So after accounting for inflation, Wall Street lost over 20% of Main Street's 401(k) retirement money between 2000 and 2010. Yes, Wall Street's a big loser the past decade. Their advice is self-serving. Period.
Given their miserable track record, only a fool would bet with Wall Street. Betting odds are Wall Street will lose another 20% in the next decade from 2010-2020. Yes, today's market is a "buying opportunity," but only for Wall Street casino insiders like Biggs, Blankfein and even low-level staffers inside "The Casino." But not for our 95 million Main Street investors, there's more pain ahead, this market's dropping.
Correction? New crash imminent, worse than 2008
More proof: Earlier economist Gary Shilling said price-to-earnings ratios are at a "nosebleed 22.5 level." The Dow was around 11,000. Money manager Jeremy Grantham recently said the market's overvalued 40%. That could mean a collapse to 6,600. Last week in Reuters' "Markets Could Be Derailed Again," George Soros echoed a "game over" warning with a "stark warning ... that the financial world is on the wrong track and that we may be hurtling towards an even bigger boom and bust than in the credit crisis." Now Dow Theory's Richard Russell is warning the public of an imminent crash: "Sell ... get liquid ... by the end of this year they won't recognize the country."
A bigger meltdown than the credit crisis? Yes, Bush's team drove America into a ditch. But now Obama and his money men, Summers, Geithner, Bernanke, are digging the hole deeper. Soros says we have not learned "the lessons that markets are inherently unstable." As a result, "the success in bailing out the system on the previous occasion led to a super-bubble." Now "we are facing a yet larger bubble." Worse than 2008? Yes, the game may be "in the refrigerator," the lights will go out, but as Soros hints, the electricity may get turned off too. Get it? This may not be a correction. Not even a bear. What's coming could be worse than the 2000 dot-com crash and the 2008 meltdown combined, a "Super-Bubble" says Soros.
And the biggest reason, Nouriel Roubini and Stephen Mihm tell Newsweek, is that "the president's half-measures won't fix our failed financial system" because he refuses to "bust up the too-big-to-fail banks." Yes, Congress will pass something. But unfortunately, as reported on MSNBC, Senator Dodd, the reform bill's sponsor, is a turncoat, working overtime with Wall Street lobbyists "to weaken financial reform," leave us vulnerable to a new, bigger crash in the near future. And Wall Street lobbyists are spending hundreds of millions to kill reform.
'White Swans:' 2000 and 2008 crashes were predictable, next one too
Recently Roubini was interviewed by Charlie Rose in BusinessWeek. His message confirms the worst. Roubini was questioned about his new book, "Crisis Economics." Rose began by asking, "what have we learned from these crises of capitalism?" Roubini could easily have said, "nothing, we learned nothing." His actual reply:"The first lesson is that crises are not 'black swan' events ... they're not just random outcomes. They are the result of a buildup of financial and policy vulnerability and mistakes -- excessive risk-taking, leverage, debt, and so on." They are 'White Swans' "because these events are predictable. But generation after generation, we seem to forget the past. When there's a bubble, there's euphoria. There's irrational exuberance. Consumers can use their homes like ATM machines. Governments and policy makers are happy because they get reelected. Wall Street makes billions of dollars of profits. Everybody's delusional."
Sound familiar? Yes indeed, in "This Time Is Different: Eight Centuries of Financial Folly," economists Carmen Reinhart and Kenneth Rogoff pinpoint the key signal that will blow the whistle and call the game: The "90% ratio of government debt to GDP is a tipping point in economic growth." For 800 years "you increase it over and beyond a high threshold, and boom!" Warning, fans, the numbers on the game-clock are flashing wildly. America's ratio is now 92%, thanks to Obama's $1.7 trillion budget, future deficits, exploding debt. Soon, Ka-Booom! Another great nation bites the dust. Depression follows. Goodbye retirement.
Warning: 800 years of history are calling 'game over'
But can't we change destiny? Or are Dodd, Congress, Obama, Wall Street, the Party of No-No and 300 million Americans all just playing their parts in a historical script well-known to historians like Reinhart and Rogoff, Kevin Phillips, Niall Ferguson and others? The message of "This Time Is Different" is very simple:"We have been here before. No matter how different the latest financial frenzy or crisis always appears, there are usually remarkable similarities from past experience from other countries and from history. ... no country, irrespective of its global importance, appears to be immune to it. The fading memories of borrowers and lenders, policy makers and academics, and the public at large do not seem to improve over time, so the policy lessons on how to 'avoid' the next blow-up are at best limited."
So please listen closely: All the TARP bailouts, stimulus debt and Fed loans won't work. Neither will a new conservative government. This is not a basketball game. We are not channeling Chick Hearn, calling this game before the final buzzer. While we prefer the illusion that "this time really is different," eight centuries of history suggest otherwise:"The lesson of history, then, is that even as institutions and policy makers improve there will always be a temptation to stretch the limits. ... If there is one common theme to the vast range of crises ... it is that excessive debt accumulation, whether it be by the government, banks, corporations, or consumers, often poses greater systemic risks than it seems during a boom. ... Highly indebted governments, banks, or corporations can seem to be merrily rolling along for an extended period, when bang -- confidence collapses, lenders disappear and a crisis hits. ... Highly leveraged economies ... seldom survive forever ... history does point to warnings signs that policy makers can look to access risk -- if only they do not become too drunk with their credit bubble-fueled success and say, as their predecessors have for centuries, 'This time is different'."
No, "this time" it's never different. Get it? In the end, it doesn't matter what happens to the Dodd-Obama financial reforms. The endgame's never a Black Swan, it's a very White Swan well known to historians -- guaranteed, inevitable and inescapable. This time is never different. The clock's flashing. Huge point spread. Think bear, think crash, think end of capitalism, think Great Depression II ... This is no buying opportunity, this game's in the refrigerator, call it.
Governor Chris Christie Says New Jersey 'Careening Toward Becoming Greece'
by Terrence Dopp - Bloomberg
New Jersey Governor Chris Christie said the state is "careening our way toward becoming Greece" and can’t afford the cost of benefits and pensions for current workers. The governor, speaking today to members of the Manhattan Institute, said his state must reduce its tax burden and control government spending. He has proposed a constitutional amendment to cap growth in property taxes, the main source of funding for schools and towns, at 2.5 percent a year. "Higher taxes are not going to solve the problem," said Christie, a Republican who took office Jan. 19. "We’ve got to change the course."
New Jersey’s tax revenue will fall $767 million short of targets over the next 13 months, the state Legislature’s chief budget analyst told lawmakers today. The $29.3 billion spending plan Christie proposed in March for the fiscal year starting July 1 "will have to be modified to respond to this reality," analyst David Rosen said. Christie already proposed $10 billion of spending cuts to close a record $10.7 billion budget deficit. He declined to say following his speech how he plans to close the additional gap.
Greece agreed this month to cut wages for government workers, raise sales, fuel and alcohol taxes and overhaul the state-run pension system in return for 110 billion euros ($136 billion) in emergency loans from the European Union and the International Monetary Fund. New Jersey, like Greece, has a high proportion of public workers who have been entitled to benefits such as free health insurance that outstrip taxpayers’ ability to pay for them, Christie said. In the past decade the state added 11,000 public- sector jobs as it lost more than 120,000 private positions, he said.
Politicians in New Jersey have bowed to public unions for too long, failing to cut teacher benefits and enacting civil- service laws that have tied governments’ hands in trimming workforces, Christie said. Over the last decade, municipal spending has grown by 69 percent, and property taxes have climbed by 70 percent, according to the governor’s office.
The average New Jersey household paid $7,281 in property taxes last year, the highest rate in the nation, according to the state Department of Community Affairs. "Things that used to be considered sacred cows, the third rails of politics, no longer are," said Christie. "They’ve been replaced by the issue of affordability." Christie’s proposed cuts include lowering aid to public schools by $820 million and to municipalities by $445 million. He also seeks to skip a $3 billion payment into the state’s $69.9 billion pension fund, which had a $46 billion deficit as of June 2009.
The governor’s spending cuts may lead to property-tax increases of as much as 8 percent next year, according to Senate Budget Committee Chairman Paul Sarlo, a Democrat from Wood- Ridge. Lawmakers in New Jersey’s Democrat-controlled Legislature on May 20 voted to raise income taxes on residents earning at least $1 million a year to help eliminate some of the governor’s proposed cuts. Christie, who has said he won’t raise taxes to balance the state budget, vetoed their proposal. "He’s the master of hyperbole," said Senate Majority Leader Barbara Buono, a Democrat from Edison, when told today of Christie comparing New Jersey to Greece.
U.S. cities face deepening fiscal problems
by Lisa Lambert - Reuters
Most U.S. cities face worsening economies, and local governments will have to cut personnel or stop construction over the next few years, according to a survey released by the National League of Cities on Monday. Three in four city officials reported that overall economic and fiscal conditions have worsened over the past year, the league reported, and more than six in 10 said poverty has intensified. Almost all -- 90 percent -- said unemployment was a problem for their communities and that joblessness has mounted over the last year.
"City budget shortfalls will become more severe over the next two years as tax collections catch up with economic conditions," the report said. "These will inevitably result in new rounds of layoffs, service cuts, and canceled projects and contracts." Already, 71 percent of cities have cut personnel and 68 percent have delayed or canceled infrastructure projects, it found. The worsening picture at the local level is the mirror opposite of what has been happening nationally, where gross domestic product, the broadest measure of the country's economy, was up 3.2 percent in the first quarter of the year and thousands of jobs have been added in the last three months.
Local and state economies take more time to recover from a recession than the national economy because demands for public assistance rise just as tax revenue falls. The survey was conducted from February through April. But just last week there were new signs of the toll taken on urban areas by the longest and deepest economic downturn since World War Two. The city of Central Falls, Rhode Island, was placed in temporary receivership on Wednesday, after the city petitioned for help in a debt restructuring after being buffeted by state budget cuts, weak revenues and the ballooning cost of pension benefits for its workers.
Also last week, Philadelphia passed a budget that will require laying off 300 people, while the mayor of Washington, D.C., took on the city council over proposed budget cuts that he said "will devastate an already under-resourced city." The National League of Cities, which advocates for 19,000 cities, towns and villages, said, "Many cities have also taken more unprecedented measures such as cuts to public safety, reductions in health-care benefits and revisions to union contracts." "Unfortunately for cities, the fiscal difficulties they are facing appear likely to continue beyond the current year," the report found.
Municipal Bonds: The Next Financial Land Mine?
by Janet Morrissey - Time Magazine
As Wall Street nervously watches the sovereign debt crisis unfold in Greece, another potential landmine is looming closer to home, one that could bring U.S. cities and towns to their knees, force the federal government to cough up another bailout package, and potentially send the unemployment rate much higher. The danger this time? Municipal debt. State and local government are frantically scrambling to meet budget shortfalls as high unemployment and shaky consumer confidence mean less income tax and smaller sales tax revenue for government coffers. At the same time, falling home prices and rising foreclosures will start to hit municipalities hard this year as all those property reassessments done over the past 18 months kick in.
A couple of municipalities, such as Los Angeles and Detroit, have even whispered the "B" word. Former Los Angeles Mayor Richard Riordan argued in an editorial in the Wall Street Journal earlier this month that the city will likely have little choice but to declare bankruptcy between now and 2014. Also, several smaller markets, such as Harrisburg, Pa., and Jefferson County, Ala., have openly talked about filing for Chapter 9 bankruptcy — a reorganization available only to municipalities.
In general, municipalities try to avoid Chapter 9 filings. Although such filings make it easier for a city to break onerous labor contracts or make other politically tough cost cuts, they can have hidden costs, such as distracting politicians, alienating business and making it more difficult for a city to raise cash in the capital markets going forward. The city of Vallejo, Calif., for example, has been in Chapter 9 since spring 2008, and observers say the process has been costly and hurt the city's ability to attract new business. "It's been two years and the case is still going on and there's still significant disputes with the unions," says Eric Schaffer, a partner at Reed Smith LLP. "Ultimately you hope to bring everybody to the table and share the pain, but that can be a messy process."
Bankruptcy is a particularly unnerving prospect for bondholders. Municipal securities are a $2.8 trillion market, according to Municipal Market Advisors. An avalanche of investors sought refuge in the sector in recent years, lured by the stable, tax-free nature of muni bonds. More than $69 billion flowed into long-term municipal bond mutual funds in 2009, up from only $7.8 billion in 2008 and $10.9 billion in 2007, according to the Investment Company Institute. Another $15.2 billion has been added so far in 2010.
But increasingly munis are seen as vulnerable to the same forces that have put companies and some sovereign governments in crisis. "The whole system is pretty fragile," says Brian Fraser, a partner at the law firm Richards Kibbe & Orbe LLP. "The assumption has always been that municipalities aren't going away and that they can always raise taxes to pay debt," but that's no longer the case, he says. He noted how Jefferson County, which is teetering on bankruptcy, was unable to raise sewer rates to meet its sewer bond obligation. Adds Richard Raphael, executive managing director at Fitch Ratings: "This is the worst downturn ... and most pressured environment for municipals in decades."
Since last July, 207 municipal issuers defaulted on bonds valued at $6 billion, and that number is expected to escalate, says Matt Fabian, managing director at Municipal Market Advisors. Of the 207 defaults, the large majority involved riskier bonds that were backed by land, casinos, residential developments, hotels, or specialty projects, such as Las Vegas' Monorail project, he says. Economic recovery may be showing up in corporate earnings, but it hasn't lifted the dark cloud over big-city muncipal budgets. A survey, released this week by financial advisory firm AlixPartners LLP, found that 90% of restructuring experts polled believe a major U.S. municipality will default on its debt in 2010, which is even bigger than the 63% who said a sovereign debt default would happen.
Adding to the muni-bond sector woes — the credit crisis caused many bond insurers to close shop, increasing the risk to muni bond investors. Currrently, less than 10% of new municipal bond issues are insured, which is down from about 50% in 2008, according to the Municipal Securities Rulemaking Board. All of this has prompted ratings agencies to downgrade muni bonds. "There are definitely a lot of municipalities out there that are in trouble, and it's important to do research on the actual bond rather than just rely on Ratings," says Greg Gurevich, a municipal bond trader at Legend Securities.
Some investors, smelling blood, are jumping into the credit default swap market to bet against cities, towns and states. CDS instruments, which are basically insurance contracts that protect a bond holder against default, can be bought or sold, depending on the investor's bet. "The spreads on CDS's have been growing and the dollar amount of CDS's on municipals has grown in the last year," says Fraser. "That's a clear warning sign that people are effectively starting to short the muni market."
Marilyn Cohen, president of Envision Capital Management, a Los Angeles bond investment firm, believes that if a major market, such as Detroit or L.A., filed for bankruptcy or had a major default, it could trigger panic through the entire muni market. "A major default by a major city would really set the muni market on its head because people would be frightened," she says. But some experts believe the risk of a nationwide muni bond crisis remains low.
"Just because something happens in the state of Washington or Michigan, that doesn't necessarily mean that the credit in Pennsylvania or New York is bad," says Tom Kozlik, an analyst at Janney Montgomery Scott. "I don't think it's going to be an all-out scare that leads to a municipal meltdown where people want to sell their securities like dominoes." Still, he says a default by a city such as L.A. or New York could have wide repercussions. Market experts say they're keeping a particularly sharp eye on Detroit and Los Angeles, as well as markets that were hit hard by the boom-and-bust housing meltdown, such as Las Vegas, Phoenix, Miami, Jacksonville, Orlando and Orange County.
Cohen says many investors believe that if such a doom-and-gloom scenario becomes reality, the federal government will step in. "I think there is a complacency mentality that if something big happens, well, the government will bail us out," says Cohen. Indeed, even billionaire investor Warren Buffett expressed a similar sentiment during Berkshire Hathaway's annual meeting earlier this month. "It would be hard in the end for the federal government to turn away a state having extreme financial difficulty when they've gone to General Motors and other entities and saved them," said Buffett, while addressing shareholders. "I don't know how you would tell a state you're going to stiff-arm them with all the bailouts of corporations."
US house prices decline continues
by Simone Baribeau - FT
The US housing market continued its recent decline in March as the impending end of the homebuyer tax credit further pressured prices. The 20-city Case Shiller index fell 0.5 per cent on a non-seasonally adjusted basis. The fall was not as steep as it had been in February, when it dropped 0.9 per cent, but was faster than any other month since April 2009. Prices, which more than doubled between 2000 and their 2006 peak, have since fallen 31 per cent. So far, all but seven of the 17 cities for which data is available have returned to near or below their 2000 levels, after adjusting for rental inflation.
Detroit, Minneapolis, and Chicago were the hardest-hit cities, with prices falling by 4.1 per cent, 2.7 per cent, and 2.3 per cent, respectively. Californian cities experienced drastically different fortunes in March, with San Diego and San Francisco showing the index’s strongest gains, and Los Angeles extending its declines. An alternative index on Tuesday also showed prices declined in the first quarter of 2010. The purchase-only housing price index of the Federal Housing Finance Agency (formerly Ofheo) fell 1.9 per cent in the first quarter, compared with the fourth quarter of last year, though the index showed a small gain for March. The index, which, unlike Case Shiller, includes only mortgages acquired by Fannie Mae and Freddie Mac, the government-sponsored enterprises, has fallen 13 per cent since its 2007 peak.
The homebuyer tax credit, which was worth up to $8,000 before its April 30 expiry, had breathed some temporary signs of life into the US housing market, helping to boost prices at the end of last year. Prices have resumed their declines, but the 20-city index remains 2.8 per cent above its April lows. A separate report suggested that consumers might not yet be feeling the pain of the renewed decline in home prices and recent market turmoil. The Conference Board’s consumer confidence index showed an unexpectedly strong rise to 63.3 in May, up from 57.7 in April. The jump was boosted by the expectations index subcomponent, which rose to near its pre-recession levels.
"The confidence figures are clearly encouraging, but it remains to be seen whether consumers can stay so upbeat if equity prices keep falling and house prices suffer a double-dip," said Paul Dales, economist at Capital Economics. With foreclosures flooding the market, further house price falls are a real risk, say some analysts. "While a return to month-on-month declines anywhere near the magnitude suffered late in 2008 and early in 2009 is highly unlikely, we do expect mild month-on-month declines to reassert themselves after the strongest effects of the tax credit begin to wane," wrote Joshua Shapiro, Chief US Economist at MFR.
Commercial property troubles U.S. banks
by Ilaina Jonas - Reuters
The default rate for commercial mortgages held by banks in the first quarter hit its highest level since at least 1992 and is expected to surpass that by year-end and peak in 2011, according to a study by Real Capital Analytics. That could spell prolonged problems for larger banks and even greater trouble for regional and small banks where commercial real estate loans comprise a greater percentage of all loans.
The default rate for bank-held commercial mortgages reached 4.17 percent in the first quarter, up from 3.83 percent in the fourth quarter 2009, according to a report released on Monday by the real estate research firm. The figures do not include bank-held mortgages on apartment buildings. Commercial real estate loans are contributing to banks' elevated levels of loan losses, two years after the height of the financial crisis, as commercial property typically lags the economy by about 18 months to two years.
Deteriorating values, high vacancy rates and low rents are expected to push that rate past the 4.55 percent default rate reached in 1992 before year-end and peak at 5.4 percent in 2011. Sam Chandan, Real Capital's global chief economist, said that even though rents are starting to stabilize, lucrative leases signed during 2006 and 2007 are now expiring. "Those prevailing rates in the market are going to be lower than what's expiring," said Chandan.
Commercial real estate prices in March were off 42.1 percent from their peak reached in October 2007, according to Moody's/REAL All Property Type Aggregate Index. Some $45.5 billion of bank-held commercial mortgages were in default in the first quarter up $3.7 billion from the fourth quarter 2009, according to Real Capital. While the volume of commercial mortgages in default continued to rise, the quarter-to-quarter increase of $3.7 billion was the smallest single-quarter increase since the fourth quarter of 2008, Real Capital said.
About 48 percent of all bank-held commercial mortgages were at institutions with $10 billion or more in assets. This group has the highest default rate for commercial mortgages, at 5.04 percent. But at 11.9 percent, the combined multifamily and commercial real estate concentration as a percentage of all loans was relatively low in the first quarter. On the other hand, about 50.2 percent of all bank-held commercial mortgages were at small- and medium-sized institutions with between $100 million to $10 billion in assets. Although the 3.77 percent commercial mortgage default rate was lower than at the largest banks, the combined multifamily and commercial real estate concentration at these institutions was much higher at 33.4 percent.
How Big Banks Window Dress Their Debt
by Michael Rapoport and Tom McGinty - Wall Street Journal
Three big banks—Bank of America Corp., Deutsche Bank AG and Citigroup Inc.—are among the most active at temporarily shedding debt just before reporting their finances to the public, a Wall Street Journal analysis shows. The practice, known as end-of-quarter "window dressing" on Wall Street, suggests that the banks are carrying more risk most of the time than their investors or customers can easily see. This activity has accelerated since 2008, when the financial crisis brought actions like these under greater scrutiny, according to the analysis.
The Journal reported last month that 18 large banks, as a group, had routinely reduced their short-term borrowings in this way. The new analysis looks at individual banks. Over the past 10 quarters, the three banks have lowered their net borrowings in the "repurchase," or repo, market by an average of 41% at the ends of the quarters, compared with their average net repo borrowings for the entire quarter, according to an analysis of Federal Reserve data. Once a new quarter begins, they boost those levels. The banks' overall "leverage"—that is, their use of borrowed funds to boost returns—frequently has declined at the end of quarterly periods as well, the analysis shows.
The data suggest "conscious balance-sheet management," said Robert Willens, an accounting specialist who heads Robert Willens LLC. If there are big gaps between average quarterly and quarter-end data, he said, the quarter-end numbers "are at best meaningless and at worst misleading and disingenuous." Repos let financial firms borrow cash short term by putting up securities as collateral, enabling them to make bigger trading bets with borrowed money. Investing borrowed money magnifies profits in good times, but aggravates losses in bad times.
Officials at Bank of America, Deutsche Bank and Citigroup said they are doing nothing improper and that the fluctuations reflect the business they do for clients, among other things. Bank officials said the firms provide extensive disclosure of their finances, including average quarterly borrowing data. In a statement, Bank of America said: "From time to time, the size of our balance sheet will fluctuate due to market liquidity, client financing needs, the company's risk appetite and balance-sheet-management functions."
Deutsche Bank said in a statement that repos are "just one aspect of our liability-management program" and that it "regularly adjusts the mix of its secured and unsecured short-term borrowing to optimize its funding." Intentionally masking debt to deceive investors violates Securities and Exchange Commission guidelines. Before sliding into bankruptcy in 2008, Lehman Brothers Holdings Inc. reduced its reported quarter-end borrowing by classifying repo loans as sales, a bankruptcy examiner found—creating what the examiner said was a "materially misleading" picture of Lehman's financial condition. Other banks have denied using the same kind of transaction, which Lehman dubbed "Repo 105s."
The SEC is now considering stricter disclosure and a clearer rationale from firms about quarter-end borrowing activities. The agency may extend these rules to all companies, not just banks. The agency's disclosure, made by SEC Chairwoman Mary Schapiro at a congressional hearing last month, came two weeks after the Journal's initial story about banks' repo activity. That story reported that 18 large banks—known as "primary dealers" because they trade directly with the Federal Reserve—had reduced short-term borrowings as a group by an average of 42% at the ends of the past five quarterly periods, compared with quarterly peaks.
At the congressional hearing, a representative asked Ms. Schapiro about those findings. Ms. Schapiro said the commission is gathering detailed information from large banks "so that we don't just have them dress up the balance sheet for quarter-end and then have dramatic increases during the course of the quarter." Some big firms, including Goldman Sachs Group Inc., JPMorgan Chase & Co. and Morgan Stanley, haven't regularly lowered their quarter-end borrowing
Financial institutions have become sensitive about showing high levels of risk on their books, as the financial crisis has led investors and regulators to focus on some firms' levels of borrowing and risk-taking. Bank of America, Deutsche Bank and Citigroup account for about one-quarter of all repo borrowings by the 18-firm group of primary dealers. The three stand out among banks examined in the new analysis because they showed the most consistent, repeated pattern of quarter-end declines in repo debt from average levels for the same quarters.
For this recent examination, the Journal looked at eight of the 18 primary dealers, the only ones in that group which file average quarterly numbers with U.S. regulators. The eight firms represent two-thirds of all repo borrowings by the 18-firm group. The other 10 are either foreign banks that don't have U.S. entities that report the numbers, or are securities firms not required to file the numbers with bank regulators. Bank of America's average net repo borrowings have exceeded the bank's reported period-end debt by 32%, on average, over the past 10 quarters, according to the analysis. It exceeded the totals at the end of the previous periods as well.
The differences were particularly pronounced since 2009, after the bank bought Merrill Lynch & Co. During 2009's fourth quarter, Bank of America had average net repo debt of $109.1 billion. That fell 52%, to $52.5 billion, at the end of the same quarter, the analysis shows. During the first quarter of 2010, Bank of America's average net repo debt rose to an average $130.1 billion, then dropped 61%, to $50.6 billion, at the end of the same quarter.
Bank of America's overall leverage declined in each of the 10 quarters as well, although by more modest amounts. That's because the repo debt was just a relatively small slice of the bank's overall balance sheet, or assets and liabilities. Over the same period at Deutsche Bank, the quarterly average net repo debt at Taunus Corp., a holding company for the German bank's U.S. units, has been an average 39% higher than the total at quarter-end. It was also higher than the ends of the previous periods nine times.
At Citigroup, average net repo borrowings have exceeded the bank's reported period-end debt by an average of 52% over the past 10 quarters, according to the analysis. However, in each of the past two quarters, Citigroup appears not to have borrowed in the repo market in this way. in both quarters it was a net lender, rather than a borrower, both on an average basis across the entire quarter, and at quarter's end. Bankwide leverage also declined from average to period-end in most of the quarters at both Citigroup and Deutsche Bank, according to the analysis.
S&P: No Bank Downgrades At Least Until a Bill Passes
by Mark Gongloff - Wall Street Journal
Standard & Poor's said it wouldn't immediately downgrade major U.S. banks in response to last week's passage of a Senate financial-overhaul bill and may take months to evaluate bank ratings even after passage of a final bill. The rating agency, a unit of the McGraw-Hill Cos., said in a special report released late Tuesday that it continued to believe Citigroup Inc., Bank of America Corp., Goldman Sachs Group Inc. and Morgan Stanley, receive boosts to their credit ratings in light of implied government support. It said it would consider downgrading those banks after studying the impact of a final reform bill, a process that could take several months. The Senate last week passed a reform bill widely considered to weaken those supports, but it must be reconciled with a House of Representatives bill.
Could Take Months
"We do not expect [the bill's] effect, if any, on the ratings of financial institutions to be clearer until more information is available concerning implementation details and transition issues," S&P analysts wrote. "This assessment could take several months, even after the bill is passed into law." As it has in the past, S&P ascribed three notches of ratings "lift" each to Citi, Bank of America and Morgan Stanley and two notches of lift to Goldman Sachs due to government support. It also kept its outlook on all four banks "negative." The prospect of downgrades to bank credit ratings has troubled investors, contributing at least partly to the higher financing costs they have been paying lately in short-term borrowing markets.
Short-Term Market Relief
Even a downgrade of one notch could cost banks billions in additional funding costs. Any delay in downgrading the banks could offer some short-term market relief, suggested David Havens, analyst at Nomura Securities International. Moody's Investors Service, a unit of Moody's Corp., has said that it will release a similar update on its deliberations about the banks in coming days. It has suggested that several more banks beside the four mentioned in S&P's report enjoy ratings boosts of one or more notches due to government support.
Is Europe Turning Japanese?
by Stephen Fidler - Wall Street Journal
The dismal growth prospects of many European countries has raised an increasing number of questions about whether large parts of the continent will emulate Japan of the 1990s and endure a decade-long economic stagnation. On the face of it, a long-lasting Japan-style post-bubble slump with deflation seems a plausible outcome for a large part of the continent. But then not many people who understand European economies also understand Japan’s. One person who does is Adam Posen, member of the Monetary Policy Committee of the Bank of England.
Most of his comparisons are related to the U.K., though there are lessons for the rest of the European Union. And for those who worry that Europe is "turning Japanese," he has some good news and some bad news. Here’s the good news: it takes more than a bubble to become Japan. There was nothing inevitable about Japan’s Great Recession. It was, he said in a speech last night, "the result of a series of macroeconomic and financial policy mistakes." His main point "is for people to stop thinking of 'turning Japanese’ as a syndrome, some sort of strange condition into which an economy can fall. Instead, we should think of Japan’s Great Recession as largely demonstrating the validity of much textbook, even old fashioned Keynesian, macroeconomics."
He said Japan’s recession was not a flat line of zero growth, but a sawtooth in which a series of recoveries were choked off by policy errors. The unsung Japanese growth story from 2002-08 suggests technological innovation was undimmed in the 1990s — and that the recession was a result of a lack of demand or because the banking system was in bad shape and was unwilling to lend. He concluded the UK and U.S. are at low risk of turning Japanese in the sense of having repeated recessions because of macroeconomic policy errors. But the U.K. worryingly combines a couple of financial parallels to Japan, with less room than Japan had to compensate.
On the positive side of the ledger, the U.K.’s more active investors and its greater openness may be able to turn this around. In many ways, Japan in the 1990s was where an active fiscal policy should have worked best: A closed economy — meaning fiscal stimulus did not leak out via imports; with passive home-biased savers not worried about government deficits, and a large economy with almost no foreign debt. A low government share in the economy and a low tax base also meant the distortions created by sustained fiscal expansions were relatively low cost.
Around the world today, Mr. Posen said that only the U.S. shares these attributes with Japan, and can thus afford to engage in ongoing fiscal stimulus in a protracted recession, though the greater saver activism and growing American foreign debt suggest limits to this. "For smaller, more open economies, with larger state sectors, like the U.K., the news is not as good," he said. The fiscal stimulus will leak abroad and the willingness of the markets to rollover public debt will be limited — "especially if the size of the public sector and the tax share are reaching diminishing returns."
That means fiscal policy loses its effectiveness in the U.K. before it does in Japan. The impact of public spending cuts on the economy will be softened by the same factors that cause fiscal stimulus to leak abroad. But there will be no bonus in lower interest rates because they’re already close to zero. In fact, curbing public spending is about preempting an interest rate rise. Reorienting the U.K. economy (and many in the euro zone) towards exports will also be harder than in Japan. Japan’s inefficient industries were (and are) in its nontraded sector: health care, retail, food production and distribution, and construction. Japan’s export industries were and remain highly competitive.
But the U.K. has to reallocate labor and capital into export-oriented industries from where there has been domestic growth — such as health care, other services and construction — or where there is a structural decline, such as in financial services. "The challenge should not be overstated, for the U.K. has one of the most flexible economies in the world, past adjustment of the trade-weighted pound should ease the process, and many recent survey-based and orders indicators suggest that U.K. manufacturing is responding well to the shift in demand," he said. (He didn’t comment on southern Europe but it goes without saying that flexible economies and an adjustable exchange rate are in short supply in that part of the world.)
A third advantage for Japan was access to growing export markets. Today, the U.S., U.K. and many euro-zone economies must adjust in the face of weak export demand. The sinking euro zone is the U.K.’s biggest market. Britain also remains, like Japan in the 1990s, vulnerable to financial fragility. U.K. companies have limited alternative sources of corporate finance to its few big banks, some of which are "impaired," and all of which must increase capital bases or shrink their balance sheets.
However, British companies have boosted their own financial surpluses, ruling out a recession caused by a corporate balance sheet adjustment. (Households have adjusted, too.) This would be worrying if the trend were to last because it "would represent a lack of faith in future U.K. economic prospects." On the other hand, Britain’s economic openness helps it — whereas Japan’s closed corporate culture hindered it. U.K. companies have been consistently more willing to invest abroad than Japan, where corporations sat on their cash, which should mean returns on savings and corporate profits will be higher than they were for trapped capital in Japan, which in turn will more sustainably feed consumption and productivity growth.
EU faces €2 trillion debt time bomb
by Sam Fleming - Daily Mail
The financial sector risks being catapulted into a new crisis by a €2trillion debt time bomb in southern Europe, investors were warned yesterday. The cost of borrowing charged on loans between banks rose to its highest level since last summer amid new concerns about foreign liabilities racked up by Spain, Greece and Portugal. Research from economists at The Royal Bank of Scotland showed the three stricken eurozone countries have issued public and private debt worth €2.16trillion (£1.9trillion) - or 22pc of the region's gross domestic product - to foreign banks, pension funds and insurers.
That is considerably more than previous estimates, which focused on cross-border bank loans alone, and it will deepen fears that debt defaults or restructurings in any of the three nations could trigger sub prime-style shockwaves abroad. Spain has emerged as a particularly acute concern, given the large size of its economy and the painful impact of the deflation of its property and construction bubble. Some €1.49trillion of Spanish debt is held by overseas institutions, RBS calculated.
Yesterday the International Monetary Fund told Madrid to accelerate attempts to consolidate and restructure its banking sector, which has been hit by difficult-to-value repossessed properties and an unemployment rate that has hit 20pc. The Bank of Spain on Saturday said it had taken over regional lender CajaSur following the failure of a planned merger, highlighting the fragility of the country's lenders. Concluding its annual assessment of Spain, the IMF said: 'The challenges are severe: a dysfunctional labour market, the deflating property bubble, a large fiscal deficit, heavy private sector and external indebtedness, anaemic productivity growth, weak competitiveness, and a banking sector with pockets of weakness.'
The euro shed 1.5pc to $1.238 against the dollar and lost 1.1pc to 86 pence amid widespread concerns about the financial fissures spreading across the single currency region. The cost of three-month and 12-month sterling loans between banks rose to its highest level since the end of August, even as the European Central Bank snapped up another 10bn euros of bonds to alleviate market strains. Separately, Bank of England policymaker Adam Posen flagged up new concerns about the UK's prospects. He said there are 'worrying' financial parallels between Britain and Japan, which has suffered a 'lost decade' of ebbing growth. Yet our overstretched public sector finances make it harder to use fiscal firepower to escape, he added.
No end in sight for euro's slide
by Julianne Pepitone - CNN
The euro got no relief Tuesday, continuing its steady slide amid a global stock sell-off as worldwide concerns weighed on the shared currency. The euro has taken a huge hit recently, sliding toward parity versus the U.S. dollar, as debt concerns in European countries have left investors unsettled. The pressure continued Tuesday as global markets took a dive, sending investors to the safe-haven greenback. The zone's currency is down more than 15% year-to-date against the dollar, and it's fallen almost 10% over the last month alone.
The euro has been entrenched in its downward spiral for several weeks, and even major moves have failed to put a floor under the currency. Bailout optimism wanes: Earlier this month, the euro got a boost after European Union officials met May 9 to discuss problems in debt-choked Greece and to approve a $1 trillion rescue package with three main components. The biggest provision provides nearly $570 billion for government-backed loans, with the aim of shoring up confidence in shaky credit markets.
That plan is meant to throw the weight of larger, stronger economies such as Germany and France behind weaker members of the European Union, such as Greece, Portugal and Spain. Global stocks surged, the euro soared and investors seemed optimistic that the bailout would stem debt contagion in the euro zone. But that quickly faded -- just one week after the EU announced the rescue package, theeuro plummeted to four-year lows. Investors' attention turned back to long-term problems on the Continent as troubling news trickled out of European nations.
For example, Germany announced plans to ban "naked" short selling on some European bank stocks and government bonds of debt-ladened euro zone countries. Traders saw this as an indication that the troubled nations are not yet out of the woods. The concerns have continued to weigh on the euro, and there is some speculation that the European Central Bank may move to intervene in the currency market -- which it hasn't done since 2000.
What experts are saying: "It's abundantly clear that the euro is under pressure, but frankly, I think the concerns are overblown," said Brian Dolan, chief currency strategist at Forex.com. Though a moderate degree of concern is to be expected, Dolan said, typical to "the broader concern of global recovery being threatened by Europe's stagnation is too much." Europe's growth estimates for 2011 and 2012 were weak even before the debt contagion concerns sprung up, Dolan noted. "You've got to remember the euro's long-term average is $1.18," Dolan added. "Given that, plus the zone's debt and growth outlook, it's right that the euro should not be a strong currency." Outlook: The euro will hit technical levels at $1.22 and $1.215, Dolan said, and hitting those marks would likely prompt a sell-off to $1.17 and $1.18 "in relatively short order."
Despite the recent decline, the euro won't reach parity against the dollar until 2011 or 2012, Dolan said. Tuesday's exchange rates: The dollar was up 0.2% on the euro to $1.2345, paring gains seen earlier Tuesday as U.S. stocks rallied from session lows in afternoon trading. The greenback jumped 0.1% versus the British pound to $1.4405. But it was down 0.1% against the Japanese yen at ¥90.19.
Libor May Rise Further on Cascade of Bank Downgrades
by Mary Childs and Tom Keene
Bank borrowing costs may climb further after reaching the highest level since July as U.S. legislation threatens the credit ratings of lenders, according to Michael Pond, an interest-rate strategist at Barclays Plc. A provision in the financial regulation bill barring the government from rescuing failing banks may mean a cascade of downgrades and a surge in interest rates lenders pay, Pond said in an interview with Tom Keene on Bloomberg Radio. "Rating agencies essentially keep two books of ratings -- one with an implicit government backing, one without," Pond said. "To the extent that this regulation strips away government support and banks are left to stand on their own, there’s certainly concern and a possibility that if banks get downgraded, that has an impact on their ability to borrow at the short end of the curve, and that could push Libor up."
The rate banks say they pay for three-month loans in dollars has more than doubled this year on concern Europe’s sovereign-debt crisis will impair assets used as collateral. The London interbank offered rate, or Libor, for three-month dollar loans climbed today for an 11th day and reached the highest level since July 7, according to data from the British Bankers’ Association. Standard & Poor’s said in February that the removal of implicit government support by Congress would probably lead to downgrades on some banks. The financial regulation bill gives the Federal Deposit Insurance Corp. the power to unwind failing financial firms and explicitly bars the use of taxpayer funds to rescue them.
Citigroup Inc., Bank of America Corp., JPMorgan Chase & Co., Morgan Stanley and Goldman Sachs Group Inc. said in filings they would have to post a total of at least $8 billion as additional collateral or spend to terminate trading deals if their ratings were cut one level. Barclays is the largest trader of U.S. inflation-linked debt and one of 18 primary dealers obliged to bid at U.S. Treasury auctions. Three-month Libor is a benchmark for about $360 trillion of financial products worldwide, ranging from mortgages to student loans.
Double-dip fears over worldwide credit stress
by Ambrose Evans-Pritchard - Telegraph
The global credit system is flashing the most serious warning signals in almost a year on triple fears of a Spanish banking crisis, escalating political risk in Asia, and a second leg to the US housing slump. Flight to safety drove yields on 10-year German Bunds to 2.56pc, below the levels touched in the depths of the Great Depression. The spreads over peripheral European debt rose sharply again, jumping to 137 basis points for Italy, 157 for Spain and 220 for Ireland. The strains in Europe's sovereign debt markets are nearing levels that forced EU leaders to launch their "shock and awe" rescue package. "If a $1 trillion (£700bn) bail-out did not finally turn sentiment, I struggle to see what can," said Tim Ash, an economist at RBS.
Dollar Libor rates gauging stress within the interbank lending market have jumped to a 10-month high of 0.5363pc, with credit contagion spreading to every area. The iTraxx Senior financials index – banks' "fear gauge" – rose 20 basis points on Tuesday to 184. "It turns out we weren't seeing the light at the end of the tunnel after all, but a train with a big light on it coming towards us of double-dip," said Dr Suki Mann, at Societe Generale. While the Libor rate is still far below peaks reached during the Lehman crisis, the pattern has ominous echoes of credit market strains before the two big "pulses" of the credit crisis in August 2007 and September 2008. In each case a breakdown of trust in the interbank market was a harbinger of violent moves in equities and the real economy weeks later.
RBS's credit team said Libor strains were worse than they looked since most banks in Europe were paying much higher spreads, especially in Spain. The "implied" forward spreads were nearer 1.1pc. The damage has spilt over to corporate bonds, effectively shutting the market for new issues. May will be the worst single month for debt issues since December 1999, with seven deals being cancelled in recent days. Volume has collapsed to $47bn from $183bn in April, according to Bloomberg. Mr Ash said North Korea's decision to cut all ties with the South and abrogate its non-aggression pact – coming days after Thailand sent tanks into Bangkok to crush the Red Shirts – has played into the chemistry of angst gripping markets, adding it was a reminder that Asia has "political/social stress points". This risk was overlooked during the honeymoon phase of emerging markets when investors were intoxicated by the China story.
Fears that America may slip back into a double-dip recession are returning. Larry Summers, the White House economic tsar, has called for a second stimulus package to keep the recovery on track, warning that the US economy is still in a "very deep valley". The S&P Case-Shiller index of home prices is declining again as incentives for homebuyers expire and the slow-burn effect of rising delinquencies exacts its toll. Prices fell 3.2pc in the first quarter of this year. "There are signs of some renewed weakening in home prices", said David Blitzer from S&P.
The epicentre of the credit crisis is moving to Spain where the seizure by the central bank of CajaSur over the weekend has torn away the veil on credit damage from Spain's property crash. Bank stocks fell 6pc in Madrid in early trading on Tuesday on fears that funding will dry up for the cajas – or the savings banks – setting off a broader credit crunch. The cajas hold the lion's share of loans to property companies and developers, estimated at €445bn (£380bn) or 45pc of GDP by Goldman Sachs. Spanish construction reached 17pc of GDP at the height of the bubble as real interest rates of minus 2pc set by the European Central Bank for German needs played havoc with the Spanish economy. This was almost double the level in the US during the sub-prime booms.
The result is an overhang of unsold Spanish properties equal to four years' demand. Markets have been rattled by reports in the German media that the Greek rescue deal contains two secret clauses. The package will be "immediately and irrevocably cancelled" if it is found to breach the EU Treaty's "no bail-out" clause, either in a ruling by the European court or the constitutional courts of any eurozone state. While such an event is unlikely, it is not impossible. There are two cases already pending at Germany's top court in Karlsruhe, perhaps Europe's most "eurosceptic" tribunal.
The second clause said that if any country finds it cannot raise funding for the rescue at interest rates below the 5pc charge agreed for Greece, it may opt out of the bail-out. BNP Paribas said this would escalate quickly into a systemic crisis if Spain were in such a position, because the other countries cannot carry an ever-rising burden. The bank warned the euro project itself may start to disintegrate rapidly if these rescue provisions are ever seriously put to the test.
Germany May Broaden Its Ban on Naked Short Selling to All Domestic Stocks
by Karin Matussek and Rainer Buergin - Bloomberg
Germany’s Finance Ministry proposed legislation extending a partial ban on naked short selling adopted last week to all German stocks and certain euro-currency derivatives. The plan would ban naked short selling in stocks of all German companies listed on a domestic exchange and would also outlaw naked credit-default swaps on some euro-region bonds as well as certain euro-currency derivatives, the ministry said in what it termed a "discussion paper," distributed to banks and industry groups. "The financial crisis has curbed confidence in the financial markets and has revealed the need for further substantial improvement of oversight rules," according to the document.
"The crisis has reached a new dimension with turbulence increasing on the European Union member countries’ bond markets and the volatility of the euro." Germany was criticized for issuing a temporary ban on naked short selling of some financial shares and sovereign debt securities as well as naked credit-default swaps through the BaFin regulator last week. Stocks around the world fell and Germany’s benchmark DAX Index has dropped more than 8 percent since the ban was announced. The draft defines "naked" as a transaction where the seller doesn’t own the stock or doesn’t have an unconditional claim to get the stock in question.
German Stocks, Euro Decline
The benchmark DAX Index slid 2.3 percent to 5,670.04 in Frankfurt, a fifth day of declines for the longest falling streak since October. The U.S. dollar pared its gains against the euro, trading at $1.2258 per euro as of 5:06 p.m. in Berlin, according to data compiled by Bloomberg. The proposed legislation would also introduce disclosure requirements on short-selling, according to the draft. The proposal would restrict currency-derivative trades on the euro and credit-default swaps on euro-region government bonds to cases in which an underlying asset is to be hedged, the ministry said.
The ban is required because the forms of transactions put the stability of the financial markets at risk and set "economically damaging incentives" to market participants, the ministry said. The Finance Ministry invited banks and industry groups to comment on the draft within the next two days. A hearing on the draft will take place on May 27 in Berlin.
Plan Lacks Coordination
The plan, like Germany’s temporary ban last week, lacks coordination within the European Union, Frank Dornseifer, chief of Bundesverband Alternative Investments e.V., a lobby group that has also been invited to comment on the draft, said in an interview today. "The draft shows that the plan isn’t mature and hasn’t been really thought to the end," Dornseifer said. "At the moment, the markets aren’t in turmoil because of speculative trading but because of actionism by regulators and politicians who come up with new rules that are hardly practical." In response to Germany’s restrictions, the Committee of European Securities Regulators said today that national regulators are "closely monitoring the situation with national finance ministers and central banks."
Paris-based CESR’s role is to coordinate national market watchdogs and make policy recommendations to the European Union on securities regulation. Razeen Sally, an international political economist at the London School of Economics, said that extending the ban wouldn’t serve any concrete purpose. "It plays to the domestic political gallery but further shreds the credibility of German, and by extension European, economic management," Sally said in an e-mailed answer to questions.
British pensioners fear tax trap
by Ian Cowie - Telegraph
Pensioners fear the coalition government plans to freeze their personal allowances, catching more of them in the clawback poverty trap, and accountants predict "impact on people of modest means". The Queen’s Speech set out government plans to raise the state retirement age to 66 and restore the link between the basic state pension and earnings inflation but was silent about older people’s personal allowances.
Allowances are slices of income everyone can receive before needing to pay tax. Pensioners have enjoyed higher allowances than younger people for many years but now accountants and older people fear the government intends to remove that distinction. Unless this issue is addressed in the emergency budget on June 22, more people will be affected by the age allowance clawback, which already means pensioners lose £1 of allowance for every £2 of income above a threshold that is set lower than the national average wage.
Norma Hudson, a pensioner in Lincolnshire, said: "The Lib Dems have made much of their plans to raise the personal allowance for everybody to £10,000 by the end of the current parliament. "I believe they have also said that such rise will compensate pensioners for the planned extortionate capital gains tax (CGT) hike. But pensioners aged 65 and over already have a personal allowance of £9,490, and those 75 and over have £9,640 – subject to the age allowance clawback.
"So, do the Lib Dems intend to freeze the personal allowances of pensioners for the next four years to bring us in line with everybody else in five years? That would be pretty despicable, since such a freeze – plus the CGT hike – would make pensioners far worse off." Mike Warburton of accountants Grant Thornton agreed. He said: "There has been a stunning silence from the coalition on the tax position of pensioners. "As your reader says, pensioners could loose out from higher CGT bills , particularly if the annual CGT exemption is reduced, and may not benefit from the rise in personal allowances.
"It is possible that this anomaly will be addressed but, so far, this important issue seems to have been ignored. If, as I expect, VAT goes up this will also come as an added blow to many pensioners."
John Whiting, a director of the Chartered Institute of Taxation, is also concerned about the coalition government’s plans for pensioners. He said: "This is one of the issues that I and many others have been wondering about. "There was a commitment to get the personal allowance for people aged over 65 to £10,000 from the previous government – and it is almost there.
"Nothing has been said about the future of the 65 plus allowance by the current government and with the commitment to steadily work towards the £10,000 level for the main personal allowance, people are wondering whether that means it’s simply going to catch the 65 plus allowance and effectively subsume it. "Whilst there might be some logic in that, there would be a real need to evaluate the impact on the less-well off pensioner. After all, pensioners on incomes above £22,900 start to lose their extra allowance in any event so we are talking about an impact on people of modest means."
Obama adviser Summers calls for new $200 billion 'mini-stimulus'
by James Politi and Edward Luce - FT
The Obama administration made a strong plea to Congress on Monday to grit its teeth and pass a new set of spending measures – dubbed the "second stimulus" by some economists – in order to help dig the economy "out of a deep valley". The call for action, which was made by Lawrence Summers, Barack Obama’s senior economic adviser, who urged Congress to pass up to $200bn (£138.9bn) in spending measures, came at the same time as Mr Obama asked Capitol Hill to grant him powers to cut "unnecessary spending".
The combined announcements were made amid rising concern that centrist Democrats, or those representing marginal districts, might vote against the spending measures, which include more loans for small businesses, an extension of unemployment insurance and aid to states to prevent hundreds of thousands more teachers from being laid off. The move comes at a time when last year’s $787bn stimulus is wearing off. Mr Summers argued that it would be a premature move at this stage in the cycle to move to fiscal discipline. "I cannot agree with those who suggest that it somehow threatens the future to provide truly temporary, high-bang-for-the-buck jobs and growth measures," he said. "Spurring growth, if we can achieve it, is by far the best way to improve our fiscal position."
Taken together, Mr Summers’s speech and Mr Obama’s announcement show an administration walking a fine line between the need to signal strong medium-term fiscal discipline and not jeopardising what they fear may be a fragile recovery. "The observation that the economy is again ascending does not mean that we are out of a very deep valley," said Mr Summers. Mr Obama’s proposal would allow the White House to present lawmakers with a package of "rescissions" – or cuts – from any spending bill. Congress would then have to vote on changes within a set time frame.
The move is a variation on the "line-item veto", which many governors have used to cut earmarks from state budgets and which was briefly used by President Clinton in the 1990s before it was struck down by the Supreme Court as unconstitutional. George W. Bush tried unsuccessfully to secure similar authority during his second term as president but his efforts were blocked in the Senate. Peter Orszag, director of the White House office of management and budget, said the measure would not only reduce spending but also discourage waste.
"This is critically important both because we should never tolerate taxpayer dollars going to programmes that are duplicative or ineffective and because, especially in the current fiscal environment, we cannot afford this waste," he said on Monday. Previous efforts to give more powers to the White House on spending bills have been met with scepticism on Capitol Hill because lawmakers would have less control over the fate of any special projects they support. "We look forward to reviewing the president’s proposal and working together to do what’s right for our nation’s fiscal health and security," said Nancy Pelosi, House speaker.
Junk-Rated Companies Get Shut Out
by Michael Aneiro
Investors continue to punish risky corporate debt amid sovereign-debt concerns and market volatility, with speculative-grade U.S. companies finding it harder to sell bonds. One such company, Allegiant Travel Co., withdrew a planned $250 million bond sale Monday, citing adverse market conditions. It was the seventh high-yield deal to have been withdrawn or delayed since April 29, according to KDP Investment Advisers. Other deals pulled or postponed in that time include offerings from Essar Steel Holdings, Penske Automotive Group Inc. and Regal Cinemas Inc.
After an average of $8.7 billion of new high-yield bonds per week in March and April, last week brought just seven deals totaling $2.2 billion, according to J.P. Morgan. That is the lightest weekly volume since mid-February. "Issuance has been very light in May," said Matt Toms, head of credit at ING Investment Management. "The high-yield [new issuance] market isn't closed; it's open for strong companies that are willing to price on what investors would view as attractive terms and covenant packages, while those companies that have the option may choose to wait."
The selloff in high-yield bonds since April 26 is the biggest reversal since the market began to climb back from its lows of December 2008, said Martin Fridson of Fridson Investment Advisors. Risk premiums on high-yield bonds have widened by 1.5 percentage points between April 26 and May 20. The reversal followed a blockbuster two months in March and April, which set records for new high-yield debt issuance. Mr. Fridson said problems in Europe are causing investors to question assumptions that the U.S. economy will expand as forecast and that high-yield companies will be able to refinance maturing debt at rates they can afford.
Large intraday market swings have added to the unease for investors, issuers and underwriters. "Increased volatility definitely makes pricing new-issue securities much more challenging," said John Cokinos, head of high-yield capital markets at Bank of America Merrill Lynch. "We're adjusting to an environment with more volatility going forward, and we need to be more tactical and opportunistic." Other deals still in the market this week include $500 million offerings from Capella Healthcare and Cedar Fair LP, and a $200 million issue from DriveTime Automotive. Issuance of high-yield, or junk, debt is vulnerable to uncertainty stemming from Europe, according to Moody's Investors Service, which noted that recent proposed changes in bank regulation add to that uncertainty.
An extended climb in revenue and enhanced access to financial capital would be needed for risk premiums to fall, again, Moody's said. Many analysts said increased U.S. growth and diminishing concerns from the euro zone are the likely requisites for a healthy new-issuance market for the rest of the year. "Looking ahead, we believe the credit markets will, for the most part, be able to tune out the noise from Europe and benefit from improving domestic fundamentals and the fact that credit still looks attractive relative to most other fixed income assets," Morgan Stanley Smith Barney wrote in a note Monday. "However," it added, "the recent market jitters over sovereign solvency will not fade away easily, making it difficult for [risk premiums] to tighten significantly from current levels."
Defaults on Apartment Building Mortgages Held by U.S. Banks Rise to Record
by Hui-yong Yu - Bloomberg
Defaults on apartment-building mortgages held by U.S. banks climbed to a record 4.6 percent in the first quarter, almost twice the year-earlier level, as more borrowers failed to repay debt approved near the market peak, said Real Capital Analytics Inc. in a report. Defaults on so-called multifamily mortgages rose from 4.4 percent in the fourth quarter and from 2.4 percent during the same period in 2009, the New York-based real estate research firm said today. Commercial-mortgage defaults also rose in the first quarter for loans against office, retail, hotel and industrial properties, Real Capital said.
"Apartment defaults are leading other commercial real estate," Sam Chandan, global chief economist at Real Capital, said in an interview. "Banks tended to make more aggressively underwritten apartment loans earlier during this last cycle. Credit and pricing reached their peaks for office properties and other commercial assets later." The global recession cut demand for U.S. apartments, office space, retail shops, hotels and warehouses during the past two years as jobs disappeared and consumers cut spending. Defaults on apartment-building mortgages surpassed the previous record, set in 1993, for the past three consecutive quarters.
The U.S. savings-and-loan crisis drove apartment-building defaults to 3.4 percent in 1993. Defaults on other types of commercial property debt peaked at 4.6 percent in 1992, according to Real Capital. The proportion of defaults on office, retail, hotel and industrial properties rose to 4.2 percent in the first quarter of this year, the company said. U.S. apartments may lead a rebound in commercial real estate as vacancies peak in 2010 and the economy adds jobs, property research firm Reis Inc. said May 19. Reis estimates apartment vacancies will peak at 8.2 percent in 2010, the highest level since the firm began tracking the number in 1980. The number should start to decline in 2011, Reis said. Real Capital bases its analysis on bank filings and data from the Federal Deposit Insurance Corp.
820 replaces 157, level 2 messed up
by David - Deus Ex Macchiato
Even for me, I will admit that is a cryptic title. It gets worse. It’s about accounting.
Let me explain. The principal US accounting standard about fair value was Federal Accounting Standard 157, or FAS 157 to its (few but loyal) friends. As part of its update, 157 has acquired a new number, and it is now FASB ASC Topic 820, Fair Value Measurement and Disclosure. The FASB text is here.
Why should you care, dear reader? Well, there are two things in 820 that struck me as apposite; one good, one bad.
(At this point if you don’t know about the three levels of FAS 157 you might either like to read about them or skip to the next post.)
The good one first.Financial statement users indicated that information about the effect(s) of reasonably possible alternative inputs [to level 3 valuation models] would be relevant in their analysis of the reporting entity’s performance.
So, with a reasonable amount of luck, 820 will require firms not just to state the value of their level 3 assets, but also to assess uncertainty in that value. This would be a major step forward in accounting disclosures for financial instruments, and I commend the standard setters for it.
Now the bad part. They have made this a lot less useful than it would otherwise be by extending (or at least clarifying the extent of) level 2.
I used to think that level 2 assets were things valued using a model, but where all the model inputs were current market observables. In other words, a swap valued using a discounted cashflow model calibrated to the quoted libor rates is level 2, but a quanto option valued using historic correlation isn’t, as correlation is not a current market observable (but rather an historic property). In fact anything valued using a model where one input is an historic property – historic vol, historic prepayment rates, etc. – should be level 3.
Unfortunately the text of 820 now includes the clarification that anything based on a market input is in level 2. And since historical volatility is based on a price history, an option priced using historic rather than implied is in level 2. This is not good. There is a crucial difference between a current price used as an input (or equivalently a convention for quoting prices, like implied vol) and anything else. Level 2 should be kept for purely price based model inputs. That, of course, would also make the level 3 uncertainty disclosures much more useful.
China’s Stock Market Has Become a Poor Man’s Casino
by Andy Xie - Bloomberg
A bartender at my neighborhood pub recently asked me how the Shanghai stock market was performing. I said it was at about 2,600 points. He jumped and said, "No! The Communist Party wouldn’t let that happen." He spent the next 10 minutes trying to convince me that the Communist Party would make the market rise to 8,000 in the next three to five years. "Look, the Hong Kong market is at 20,000," he said. "Shanghai at 8,000 would be very reasonable." China’s stock market involves more investors than any other market in the world. There are 124 million brokerage accounts.
From what I can gather, the collective enthusiasm of the investing community is still quite strong. The market capitalization is small at 53 percent of gross domestic product and 31 percent of money supply. Prices are at a historical low of 2.5 times book value. Why is the market still going down? When the central government introduced tightening measures for the real-estate market, many were hopeful the money would flow out of property into the stock market. A popular yo-yo theory says money travels only between property and the stock market, never anywhere else. The property market hasn’t dropped much, while the stock market is down 20 percent.
Politics and liquidity drive China’s stock market. Neither is favorable. Though the government desires a soft landing, the bubble debate over the property market is over: Tightening is the consensus. The question is speed. When the government squeezes liquidity in the property market, it inevitably decreases it for the stock market. Both markets lose. The stock-market pain isn’t just collateral damage. Real-estate price appreciation is the biggest source of profit for businesses, especially in the financial industry. The total stock of properties, work-in-progress, and land banks may exceed three times GDP in value. When the price rises 20 percent, the gain is 60 percent of GDP.
In a normal economy, corporate profit is about 10 percent of GDP. When capital appreciation is six times that, businesses try to play financial games to turn appreciation into accounting profit. When property prices stop rising, or even fall, very profitable companies suddenly become unprofitable. The state-owned banks are lining up for mega fund-raising of as much as 500 billion yuan ($73 billion) in the stock market. While two-thirds is supposed to be raised in Hong Kong, one-third is still a lot for the A-share market on the mainland to bear. About 456 billion yuan was raised in all of 2009.
Banks are normally profit machines. But in one day they can lose it all. A good moment to buy bank stocks is right after a banking crisis. But when lenders are trying to raise so much capital to prepare for a property-market correction, it may not be the best moment to purchase shares in banks. Valuations have never presented a strong case to enter China’s stock market. They are now getting there. The current price-to-book ratio isn’t cheap, but it’s reasonable by international standards. I advise you not to pay too much attention to price-earnings ratios. Asset bubbles can distort them so much. The decline in valuation, however, may just be part of a normalization process.
For a long time, China’s stock market behaved like an Internet stock with a small free float. The recent reforms have made all the shares liquid. Maybe China’s valuations are becoming normal because stocks aren’t valued by off-market trading at a discount anymore. It is a sign of progress. The conclusion: The Shanghai market won’t head back to its record of almost 6,000 pointsanytime soon. That will disappoint many.
Rich people aren’t in the stock market anymore. They are in the property market. An overwhelming majority believe real- estate prices only go up, not down. The people in the market today have no recollection of the market crash of 1997. The stock market, on the other hand, experienced a crash in 2007-08 -- from 6,000 points to less than 1,700 in one year. Those who can afford to play the property market find the stock market a bad place to be. This is why real estate has kept booming since 2007, while equities have been struggling. Of course, when the property market drops like shares did in 2007, the stock market will be treated more fairly.
Stock-market investors in China often can’t afford to enter the real-estate market in big cities. They wish to get lucky, make enough money, and move on to the property market. This force caps the market upside, but not the downside. My bartender finally asked me to recommend a stock. He said he had 70,000 yuan and wanted to make enough money to buy a car. "I can’t buy a car with my wage income," he said. "Look at how hard my job is. But, if I make 200,000 yuan in the stock market, I can buy a nice car." As long as property prices don’t collapse, ordinary investors can forget about getting free lunches and new cars from the Chinese stock market.
FDIC’s Bair Says Europe Should Make Banks Hold More Capital
by Rebecca Christie - Bloomberg
Federal Deposit Insurance Corp. Chairman Sheila Bairsaid European regulators need to force their banks to hold more capital to help stabilize financial markets and promote economic growth. "In Europe they do need to focus more on the adequacy of the capital base of their banking institutions," Bair said in an interview yesterday in Beijing, on the sidelines of the U.S.- China Strategic and Economic Dialogue. She said European banks should face leverage limits and be required to hold more and higher-quality capital to insulate the global economy from financial instability. Greece’s budget woes have triggered a debt crisis in Europe that has dominated this week’s discussions between U.S. and Chinese economic officials.
U.S. Treasury Secretary Timothy F. Geithner and Chinese Vice PremierWang Qishan sparred over how much global spillover will result from Europe’s difficulties, with Geithner predicting a small effect while Wang voiced concern it would trigger a "chain reaction." European officials should be "making it clear to the markets and the international community they have good strong rules in place to ensure the capital base of the banking system going forward, which would help their economic recovery, which in turn would help the rest of the global economy," Bair said. "There have been a lot of concerns about what will happen in Europe and to what extent it could impact the Chinese economy and the U.S. economy."
Geithner and Secretary of State Hillary Clinton are leading a U.S. delegation of about 200 officials during the two days of talks. Geithner will then depart for London, Frankfurt and Berlin to meet with European officials and reinforce his call for coordinated efforts to fight off the crisis and rein in government spending. Federal Reserve officials including Fed Governor Daniel Tarullo have voiced concerns of a threat to the U.S. and world economies as trade shrinks and banks incur losses on European investments. Drew Matus, a senior U.S. economist at UBS Securities LLC in New York, said that financial stability is the true source of concern, even though there may be little direct impact on the U.S. economy. "The concern should be the stability of financial markets, which the Fed seems to have focused on," Matus said in an e- mail. "There is a lot of good news in the U.S. economy that seems to be getting ignored because the world’s focus is elsewhere."
Bair said regulators around the world need to work together on the next round of capital standards for banks, known as the Basel rules because of the town in Switzerland where banking policy makers meet. Negotiations are under way for the next round of international standards, known as Basel III, which Bair said must meet "very aggressive" goals. Bair rejected financial-industry concerns that a U.S. proposal would derail the Basel effort by legislating bank capital standards as part of the financial overhaul under debate in the Congress. The Senate passed a proposal, offered by Senator Susan Collins, a Maine Republican, that would require lenders with more than $250 billion in assets to meet capital standards that are at least as strict as those that apply to smaller banks. The measure would set a "common-sense floor" for big banks, without forcing specific methods on regulators, Bair said. She said the practical outcome would mean that all banks, regardless of size, would be subject to the same leverage limits and barred from letting their risk-based capital ratio fall below about 8 percent.
"As we get further from the crisis and hopefully continue with a more vigorous economic recovery, there obviously will come pressures again for the banks to start becoming more leveraged because it would increase their returns on equity," Bair said. "Having some good rules in place now to make sure that those capital cushions remain relatively permanent, I think would be a good thing." The American Bankers Association wrote regulators on May 19 asking for their support in getting Congress drop the provision before the final vote on the financial regulation package. The Senate and the House of Representatives have each passed versions of the legislation that now must be reconciled.
"The Collins amendment raises significant issues with respect to cross-border capital regulation and disrupts long- standing U.S. policy on such regulation," ABA President Edward Yingling. "It would undermine critical efforts to coordinate global capital standards and invite retaliation by foreign governments." Bair said Congress needs to put some "overarching constraints" on regulators to avoid a repeat of the 2008 financial crisis, which she said was exacerbated because of the "absurdity" of policies that allowed big banks to reduce their capital holdings based on risk-modeling practices. She said the FDIC would work with Congress to keep the measure in the final bill.
Defaults on European Commercial Mortgages to Rise, Moody’s Says
by Esteban Duarte
Defaults on European commercial mortgages will increase as banks restrict lending to prime properties, according to Moody’s Investors Service analysts. Of 18 commercial real-estate loans due in the first quarter, seven defaulted and only one was refinanced, the New York-based rating company said in a report on the commercial mortgage-backed securities that it covers. "We do not expect CRE loan performance to improve" in the coming quarters, analyst Manuel Rollmann wrote. "We still expect that many CMBS loans will default during their term, or at maturity."
Banks cut new lending for U.K. commercial real estate by 69 percent last year as they repaired balance sheets battered by the financial crisis, according to a survey of lenders by England’s De Montfort University published last week. U.K. commercial loans make up the largest share of collateral included in European commercial mortgage-backed securities.Commercial mortgages backed by prime properties account for a "small" portion of loans backing the debt, Moody’s analysts wrote.Banks create mortgage-backed securities by pooling loans and selling them to investors as notes. The bonds allow lenders to raise capital more cheaply than by issuing unsecured debt.
Europe's Banks Hit by Rising Loan Costs
by Carrick Mollenkamp,Randall Smith and David Enrich - Wall Street Journal
European banks are being forced to pay more for short-term dollar borrowings than banks in the U.S. and Asia—suggesting that lenders world-wide are increasingly nervous about the risks ahead for European banks as financial pain cascades across the continent. On Monday, the London interbank offered rate, or Libor—the rate at which banks lend money to each other, and thus a vital sign of their mutual trust—rose to its highest level for the three-month dollar rate since last July. While the current Libor, at just above 0.5%, is far below the sky-high levels of 4.81875% reached at the height of the financial crisis in 2008, it is still a significant jump from 0.25% as recently as March.
But Libor's jump is more pronounced at European banks. On Monday, German state-controlled lender WestLB AG said it cost 0.565% to borrow dollars for three months, up from 0.38% a month earlier. U.S. banks are reporting lower costs: Bank of America Corp., said its three-month dollar Libor stood at 0.48%. J.P. Morgan Chase & Co. reported a 0.47% rate. The markets "have already downgraded the European banking system," said George Goncalves, head of U.S. interest-rate strategy in the Americas at Nomura Securities in New York.
Libor's rise is diminishing the hope for sustained global financial health: The increase in banks' borrowing costs can translate into higher rates for consumers on mortgages, credit cards and corporate loans. Strains in the global financial system are likely to push Libor higher, some analysts predict, as European banks find it tougher to borrow and investors around the world limit how much they're willing to lend to U.S. and European banks. The benchmark rate could go as high as 1.5% in the next several months, Citigroup Inc. analyst Neela Gollapudi concluded in a report last week. Individual borrowing rates are posted by a panel of 16 banks every day around lunchtime in London to calculate dollar Libor.
In recent days, concerns about the banking system have deepened, following Saturday's failure of a Spanish savings bank and a confluence of other events. Also troubling investors is the pending overhaul of financial regulation in the U.S. At the same time, some banks in the U.K. and North America are moving more quickly to assess how they could be hurt by a downturn in the euro-zone economy, and pulling back on loans to banks in the troubled region.
Another key indicator, a measure of credit protection on bank debt known as a "bank-fear index," remains elevated. As of Monday, the cost of five-year default insurance on 10 million euros of European financial-firm debt was 163,789 euros, according to the Markit iTraxx Senior Financials index. That's slightly below last week's level, but substantially above the 90,715 euros the protection cost in March. Markets are getting "twitchy," said Howard Archer, economist at IHS Global Insight in London. Nervousness is overshadowing confidence-bolstering efforts such as a plan by the Federal Reserve to funnel dollars to the European Central Bank, and subsequently euro-zone banks.
"The banking world is extremely interconnected and still very fragile," Nikolaus von Bomhard, chief executive of Munich Re AG and president of the Geneva Association, a research group that includes CEOs of major insurers, said in an interview. "The confidence that has been built since the Lehman crisis is vanishing to some extent, and the challenges for the banking industry are not yet resolved," he said, referring to the 2008 bankruptcy filing of Wall Street giant Lehman Brothers Holdings Inc. Another problem: Even financial institutions with no direct exposure to Greece or other troubled economies likely are exposed to banks that are, Mr. von Bomhard said.
In another sign that investors are recoiling from risk, Allegiant Travel Co. withdrew a planned $250 million debt offering. Since April 29, seven high-yield deals have been withdrawn or postponed, according to KDP Investment Advisers. The rise in the cost of short-term borrowings by banks began early last month amid new jitters about Europe's economy. Those worries have accelerated in the past several days as investors who buy short-term bank debt (thus helping to fund the daily operations of lenders around the world) reassess their views of the risks facing those firms, according to Mr. Gollapudi, the Citigroup analyst.
In the U.S., the financial-overhaul legislation moving through Congress would cover insured bank deposits if a firm fails. But a narrow protection of only those deposits could force investors such as money-market funds and other banks to ask a higher price for short-term loans or IOUs. Meanwhile, credit-rating firms say they are prepared to cut bank-bond ratings amid a belief that the legislation would limit the extent of bank bailouts. These concerns also are helping increase Libor. In Europe, investors have grown wary that governments have lost their appetite to save a bank. Money-market funds already were leery of lending to banks beyond one month.
Rising Libor in part reflects concerns about European bank exposure totaling $2.8 trillion to debt originating in Portugal, Greece, Ireland, Spain and Italy. The countries say they are determined to reduce their deficits. But that is almost certain to stunt economic growth and make it tough for companies to pay their borrowing costs. The result: European banks could see losses rise and be forced to pay more to borrow. Some of these concerns were crystallized with Saturday's bank failure. The Bank of Spain seized CajaSur, one of some 45 Spanish savings banks. Controlled by the Roman Catholic Church, the 146-year-old lender financed real-estate projects on Spain's southeastern Mediterranean coast.
HSBC Suffers Euro Collapse as Greek Debts Roil Banks
by Alexis Xydias - Bloomberg
Europe’s credit crisis is punishing Spanish and U.K. companies as if they were Greek, luring investors with valuations that suggest risk is the same everywhere in the region. The price-earnings ratio of London-basedHSBC Holdings Plc, Europe’s biggest bank by market value, slipped below Greece’s EFG Eurobank Ergasias SA last week, according to data compiled by Bloomberg. Spain’s Banco Santander SAtraded at 8 times projected profit, the lowest relative to Athens-based Piraeus Bank SA in more than three years. The Stoxx Europe 600 Index fell 4.6 percent last week, heading toward its biggest monthly retreat since February 2009.
"I have had Greek stocks in the past but at the moment there are much better things to do elsewhere," said Katherine Blunden at HSBC Private Bank in Paris, whose $346 million Europe Value fund is outperforming the Stoxx 600 for an eighth year. "I have Spanish or Italian positions and I keep them because they are attractive. I’m very definitely keeping Santander and may even reinforce it as its valuation improves." European equities are the cheapest in a year after rising concerns about sovereign defaults wiped out about $2 trillion from the region’s market value this month. While the Athens Stock Exchange General Index has fallen 27 percent in 2010, shares in countries with less default risk are trading at bigger discounts to their earnings, according to data compiled by Bloomberg. The Stoxx 600 rose 0.4 percent to 238.02 today, breaking a three-day losing streak.
HSBC, which has $2.4 trillion in assets and branches in 88 countries, has fallen 11 percent since Dec. 31, giving it an earnings multiple using 2010 forecasts of 13.2, Bloomberg data show. Santander, Spain’s largest bank, has slid 26 percent this year. The Santander, Spain-based lender, which employs more than half of its 171,000 staff in Latin America, will post a 3.1 percent rise in net income to 9.2 billion euros ($11.6 billion) in 2010, according to the average estimate in a Bloomberg survey of 19 analysts. Intesa Sanpaolo SpA, Italy’s second-biggest bank, costs 9.6 times projected profits. Milan-based Intesa forecast higher profit for 2010 on May 14 after posting better-than-estimated net income of 688 million euros for the first quarter.
Eurobank, trading at 13.3 times predicted earnings, saw its valuation climb above HSBC’s on May 19 for the first time since January 2008. The Athens-based lender has a market capitalization that is one-fiftieth of HSBC’s and generates about two-thirds of its revenue in Greece, with the rest coming from former communist countries in eastern Europe. Analysts have cut their estimates for Eurobank and now say profit may slump 23 percent to 236 million euros from a year earlier instead of increasing 51 percent as they predicted as recently as January, according to data compiled by Bloomberg.
Eurobank commanded a premium even after Greek equities tumbled the most this year among 93 countries tracked by Bloomberg except for Venezuela, on concern the nation won’t be able to rein in its budget deficit, which touched 13.6 percent of gross domestic product in 2009. The slump has left the ASE Index valued at 8.6 times its members’ estimated 2010 profits, compared with almost 13 times for the MSCI World Index, Bloomberg data show. As contagion from the Greek crisis has spread around Europe, valuations for markets outside of Greece have become compressed. The U.K.’s FTSE 100 Index is valued at 10.2 times this year’s estimated earnings, down from 12.7 times in January, the data show. The ASE now trades at just a 6.3 percent discount to Spain’s benchmark IBEX 35, down from 25 percent in January.
'Cheap as Greece’
"Other markets are as cheap as Greece, probably with more stability," saidDietmar Schmitt at SAM Capital Partners Ltd., a London-based manager whose long-short European equity hedge fund made money in 16 of the last 18 months. "In Spain, at least you know the exchange is going to open if the market collapses." Greek workers staged their fourth general strike last week with thousands marching in Athens to protest spending cuts that Prime Minister George Papandreou must push through to qualify for international aid. Three people were killed on May 5 after demonstrators set fire to a bank in the Greek capital. Greece’s economy will shrink 4 percent this year, according to government and EU estimates.
Spain’s government approved the first public wage reductions last week since returning to democracy in 1978 and cut its forecast for economic growth for next year to 1.3 percent as it seeks to tame the euro region’s third-largest budget deficit. "My current position is out of Greece and Portugal, but we are still in the large international banks in Spain and Italy on the basis that they have diversification into overseas markets," said Mark Bon, who helps oversee about $750 million at Canada Life Ltd. in London and recently added to holdings of Santander. "Some of the valuations are attractive relative to other banks. Greece should be cheaper than the international financials." Credit-default swaps on National Bank of Greece SA, which pay holders in the event the issuer fails to pay its debt, show a 36 percent possibility of default by the largest Greek bank, according to prices from CMA DataVision. Contracts on Santander and HSBC suggest 15 percent and 8.6 percent chances, respectively.
"We’re getting to a situation where now is a very good time for investors to be looking around, not necessary buying the region, but certainly looking at companies and asking, 'Is this mispriced?’" said Andrew Milligan, the Edinburgh-based head of global strategy at Standard Life Investments, which oversees about $221 billion. "Investors are still looking for growth opportunities." Standard Life is bullish on Lisbon-based Jeronimo Martins SGPS SA, Portugal’s biggest retailer, Bagsvaerd, Denmark-based Novo Nordisk A/S, and Munich-based MAN SE, Europe’s third- biggest truckmaker, Milligan said. Jeronimo Martins has an estimated P/E of 17.3, compared with 20.3 for Novo Nordisk and 21.3 for MAN.
Coca-Cola Hellenic Bottling Co., the world’s second-largest supplier of Coke beverages and Greece’s biggest company by market value, trades at 13.8 times estimated earnings, the highest level relative to Group Danone SA’s 15.7 and Nestle SA’s 15.8 since the second quarter of 2008. Paris-based Danone bottles Evian and Volvic water while Nestle, in Vevey, Switzerland, owns the Perrier and San Pellegrino water brands.
"The companies in Germany, France and Switzerland, those are the places where the sovereign situation is not as bad, but the overall selloff is making those places attractive," said Wasif Latif, vice president of equity investments at USAA Investment Management Co., which oversees $45 billion in San Antonio. "This isn’t the time to back up the truck, but if the weakness persists or gets worse, investors need to start taking a look at the high quality, fundamentally sound companies and start adding because they can probably get some bargains." Europe’s banks remain too exposed to the worsening debt crisis, which makes spotting value harder, said Colin Mclean, who helps manage 650 million pounds ($936 million) at SVM Asset Management Ltd. in Edinburgh.
"The problem with banks is the same as in 2008, that it’s very difficult to get visibility in the underlying metrics," Mclean said. "It is quite difficult to ascertain what true value is. We don’t hold long positions in either Spain or Greece. We still have remaining short positions." SVM is underweight European banks, meaning the stocks represent a smaller slice of assets than their weighting in benchmark indexes. Credit Suisse Group AG’s London-based strategist Andrew Garthwaite says southern European lenders should trade at 0.5 times their tangible book value, a measure of what the company would be worth in liquidation, as the countries may experience falling consumer prices.
Alpha Bank AE and Piraeus Bank, based in Athens, trade at an average of 0.85 times tangible book, more than double the ratio for Edinburgh-based Royal Bank of Scotland Group Plc, according to Bloomberg data. The valuation is in line with that of Barclays Plc, the London-based bank that analysts estimate will report 2010 net income of 4 billion pounds, and 30 percent more expensive Paris-based Credit Agricole SA, France’s biggest bank by branches. With Europe’s Stoxx 600 closing last week at its lowest level in more than six months, valuations are becoming increasingly attractive for Hans-Peter Schupp, manager of Fidecum AG’s $77 million Contrarian Value Euroland fund near Frankfurt, which has outperformed the market this year. "Spanish companies are starting to pop up in our screens," said Schupp, who looks for the cheapest shares in Europe’s equity markets and already owns Credit Agricole. "We don’t find opportunities in Greece."
Spanish Banks With $167 Billion of Assets Plan Four-Way Merger
by Ben Sills and Charles Penty - Bloomberg
Four Spanish savings banks plan to combine to form the nation’s fifth-largest financial group with more than 135 billion euros ($167 billion) in assets, as regulators push ailing lenders to merge with stronger partners. Caja de Ahorros del Mediterraneo, Grupo Cajastur, Caja de Ahorros de Santander y Cantabria and Caja de Ahorros y Monte de Piedad de Extremadura submitted a proposal to Spain’s central bank to pool their businesses, they said in a filing yesterday. The Bank of Spain is urging mergers for the regional "cajas," mutually owned banks that boosted lending more than fivefold during Spain’s 10-year housing boom and account for about half the country’s loans. Spain is seeking to shore up the lenders as the nation’s sputtering economy and widening budget deficit, forecast at 9.3 percent of gross domestic product this year, drive away investors.
"Many of them are half bankrupt," said Rafael Pampillon, head of economic analysis at the IE Business School in Madrid. "They have loans to property developers and mortgages that have turned toxic, and by mixing them with other savings banks the risk is diluted," he said in an interview, not referring specifically to the four that are combining. The extra yield investors demand to hold 10-year Spanish government bonds instead of the benchmark German bund touched a euro-era record of 1.64 percentage points this month, prompting Prime Minister Jose Luis Rodriguez Zapatero to announce the most severe spending cuts in at least 30 years. Concern a sovereign debt crisis in Greece would spread to countries such as Portugal and Spain prompted the European Union and International Monetary Fund to pledge almost $1 trillion earlier this month to backstop the debt of member nations.
Spain’s central bank seized CajaSur, a savings bank in Cordoba owned by the Catholic Church, after the caja’s board refused a merger plan four days ago. The takeover was the first under a new state-financed rescue plan that Standard & Poor’s estimated may cost as much as 35 billion euros, increasing the burden on the nation’s finances. CajaSur lost 596 million euros on 426 million euros in revenue last year, company reports show. The four-way merged group will have a solvency ratio of 12.1 percent, according to figures from the end of last year, and Tier 1 capital of 9.4 percent, Alicante-based Caja de Mediterraneo, said in a separate e-mailed statement. Spanish banks are grappling with rising loan defaults, weakened credit demand and low interest rates after the country’s worst recession in 60 years.
Savings banks, which have no shareholders and traditionally distribute a portion of profit to social programs, have been criticized by analysts for lacking accountability. The Socialist-led government and main opposition party support changing laws to let cajas sell shares with voting rights to improve their capital and governance. Finance Minister Elena Salgado said yesterday that more savings banks would merge in coming weeks, and urged regional governments, which appoint directors to many cajas’ boards, not to delay transactions for political reasons. "All the regional governments should be aware that decisions have to be made quickly," Salgado said in an interview with Cadena Ser radio. The Bank of Spain’s move in seizing CajaSur was a sign of "firmness, control and solvency," she said.
Euro Turmoil Hits Leveraged-Loan Market
by Toby Lewis - Wall Street Journal
The turmoil in the euro zone is spilling over to the financing markets used by private-equity firms, threatening the fragile recovery of the buyout industry. European leveraged loan prices have declined over three consecutive weeks, the longest run of price declines since the height of the global financial crisis in late 2008, according to data provider S&P LCD. Offerings of new high-yield bonds have shrunk, although the market remains more active than in 2008.
While these markets don't appear to be shutting down, as they did in 2008, their renewed weakness suggests financings could become more expensive and difficult, buyout advisors say. Strength in the high-yield and leveraged loans markets in 2009 helped private-equity-backed companies refinance their debts at relatively cheap rates. "With a cautious leverage market, exuberance disappearing in the high-yield market and the equity capital markets stalling, you have almost got the makings of a perfect storm," said Mark Vickers, a partner at UK law firm Ashurst. "The next six to nine months are going to be challenging."
Adding to private equity's woes is the near-closure of the initial public offering markets this month, which is making it difficult for the industry to exit its mature investments. In the leveraged-loan market, prices of the most actively traded European leveraged loans tracked by S&P LCD fell from 97% of their face value three weeks ago to 95.38% of face value at the end of last week.
Similarly, sales of high-yield bonds have slowed this month as investors have sought the safety of high-quality government bonds. In the first three weeks of May, issuers sold $5.8 billion of such debt in the U.S. high yield bond market, which is deeper and more liquid than the European market. The last time monthly issuance in the U.S. was below $10 billion was in March 2009. High-yield bond sales in Europe have eased to EUR4.2 billion ($5.2 billion) so far this month, although that is above the recent low seen in February, as investors became more concerned about Greece's fiscal problems.
Jon Herbert, head of acquisition finance at Lloyds Banking Group, said banks would find it a challenge to syndicate private-equity debt. "Any volatility will always make life more difficult from the syndicating perspective," he said. "This is more negative than positive, certainly." Although leveraged loans are falling in value, prices are still higher than in the throes of the credit crisis in 2008-2009, when they traded for as little as 60% of their face value. Similarly, some companies have continued to sell high-yield bonds this month even as investors have turned increasingly jittery about other highly indebted members of the 16-nation euro zone. During the credit crisis, several months passed without a single high-yield bond sale in Europe.
Last year's recovery in financing markets, where loans traded back toward 100% of face value and companies sold a record amount of high-yield bonds, fueled a rise in confidence in private-equity circles. That led investment bankers to speculate about large buyouts returning. However, last week, the first private-equity buyout worth more than $10 billion in three years fell through, when a consortium led by Blackstone Group ended talks with Fidelity National Information Services Inc.
Your Household's Share Of The September 2008 Economic Collapse: $104,350
by Meg Marco
A recent report from the Pew Charitable Trusts tallies up each US household's share in the economic collapse. Your household's share? $104,350. That includes lost income, government bailouts, and both reduced home values and reduced stock values. Pew says:
- Income - The financial crisis cost the U.S. an estimated $648 billion due to slower economic growth, as measured by the difference between the Congressional Budget Office (CBO) economic forecast made in September 2008 and the actual performance of the economy from September 2008 through the end of 2009. That equates to an average of approximately $5,800 in lost income for each U.S. household.
- Government Response - Federal government spending to mitigate the financial crisis through the Troubled Asset Relief Program (TARP) will result in a net cost to taxpayers of $73 billion according to the CBO. This is approximately $2,050 per U.S. household on average.
- Home Values - The U.S. lost $3.4 trillion in real estate wealth from July 2008 to March 2009 according to the Federal Reserve. This is roughly $30,300 per U.S. household. Further, 500,000 additional foreclosures began during the acute phase of the financial crisis than were expected, based on the September 2008 CBO forecast.
- Stock Values - The U.S. lost $7.4 trillion in stock wealth from July 2008 to March 2009, according to the Federal Reserve. This is roughly $66,200 on average per U.S. household.
- Jobs - 5.5 million more American jobs were lost due to slower economic growth during the financial crisis than what was predicted by the September 2008 CBO forecast.
Legendary Investor Is More Worried Than Ever
by Jason Zweig - Wall Street Journal
Seth Klarman is worth listening to, especially when markets go mad. Mr. Klarman is president of the Baupost Group, an investment firm in Boston that manages $22 billion. His three private partnerships have returned an annual average of around 19% since inception in 1983—and nearly 17% annually over the past decade, as stocks went nowhere. To measure Mr. Klarman's importance as an investor, you need only see the value his rivals place upon his words. You could have earned at least a 20% average annual return since 1991—better than twice the performance of the market—merely by buying and holding Mr. Klarman's book, "Margin of Safety": Published that year at a cover price of $25, hard copies now fetch up to $2,400.
But the professorial Mr. Klarman speaks in public about as often as the Himalayan yeti. He made an exception last Tuesday, when I interviewed him in front of a standing-room-only crowd of 1,600 financial analysts at the CFA Institute annual meeting in Boston. He then made another exception, speaking with me over the phone later to clarify points that he feared had been misconstrued. Mr. Klarman specializes in buying securities that nauseate other investors. As the credit crisis exploded, he put more than a third of his assets into high-yield bonds and mortgage-related securities. I asked him what he had meant, in a recent letter to his clients, when he compared the financial markets to a Hostess Twinkie.
"There is no nutritional value," he said. "There is nothing natural in the markets. Everything is being manipulated by the government." He added, "I'm skeptical that the European bailout will work." Some members of the audience gasped audibly when Mr. Klarman said, "The government is now in the business of giving bad advice." Later, he got more specific: "By holding interest rates at zero, the government is basically tricking the population into going long on just about every kind of security except cash, at the price of almost certainly not getting an adequate return for the risks they are running. People can't stand earning 0% on their money, so the government is forcing everyone in the investing public to speculate." "We didn't get the value out of this crisis that we should have," Mr. Klarman told the audience.
"For our parents or grandparents, it was awful to have had a Great Depression. But it was in some ways helpful to carry a Depression mentality throughout their later lives, because it meant they were thrifty with their money and prudent in their investment decisions." He added: "All we got out of this crisis was a Really Bad Couple of Weeks mentality." You could have heard a pin drop as Mr. Klarman proclaimed, "I am more worried about the world, more broadly, than I ever have been in my career." That's because you can make good investing decisions and still end up with bad results if you reap your profits in currencies that do not hold their purchasing power, he explained.
"Will money be worth anything," asked Mr. Klarman, "if governments keep intervening anytime there's a crisis to prop things up?" To protect against that "tail risk," said Mr. Klarman, Baupost is buying "way out-of-the-money puts on bonds"—options that have no value unless Treasury bonds plummet. "It's cheap disaster insurance for five years out," he said. Later, I asked Mr. Klarman what he would suggest for smaller investors who share his worries. "All the obvious hedges"—commodities and foreign currencies, for example—"are already extremely expensive," he warned.
Especially gold. "Near its all-time high, it's a very hard moment to recommend gold," said Mr. Klarman. Mr. Klarman pointed out that his own ideas "on bottom-up opportunities in undervalued securities are more likely to be accurate than my top-down views on what's going to happen in the world at large." In other words, while you might want to insure against a disaster scenario, you shouldn't bet the ranch on it. And, said Mr. Klarman, one of the best ways to protect against a decline in purchasing power is to buy whatever is "out of favor, loathed and despised." So forget about gold or other trendy hedges. Instead, wait patiently for markets—European stocks, perhaps—to get so cheap that they turn most investors' stomachs. Then you can pounce. As Mr. Klarman put it, "Sometimes, when you can't figure out a good defense, the best thing to do is to go on offense."
WaMu shareholders want to investigate JPMorgan
by Tom Hals - Reuters
Shareholders of bankrupt Washington Mutual Inc asked a federal judge for permission to investigate JPMorgan Chase & Co for its role in the failure of Washington Mutual Bank, according to court documents filed on Tuesday. The equity committee wants information that could lead to potential claims against JPMorgan if they can show that the investment bank had a role in the bank's failure, the largest in U.S. history. Washington Mutual Bank was seized in September 2008 during a bank run at the height of the financial panic.
The Federal Deposit Insurance Corp sold the bank immediately after it was seized to JPMorgan for $1.9 billion. The shareholders are seeking to pick up where Washington Mutual left off. The holding company was locked in a battle for documents and depositions from JPMorgan when it reached a settlement now at the heart of the company's proposed reorganization. The proposed plan leaves nothing for shareholders and distributes around $7 billion to creditors. It also provides a range of liability releases.
Shareholders have estimated the company may have assets worth up to $20 billion when factoring in potential legal claims. An attorney for shareholders told the judge earlier this month that there were "multibillion-dollar claims against JPMorgan for causing the bankruptcy." Shareholders focused their investigation request on what it said was an untapped source of information -- the pre-seizure business records of Washington Mutual Inc, or WMI, and its bank. JPMorgan took control of those documents when it bought the seized bank.
Shareholders said those records could contain information about JPMorgan's supposed interest in Washington Mutual Bank prior to its seizure and "intelligence about market rumors concerning WMI's financial condition that JPMC (JPMorgan) may have had a hand in generating." Shareholders made similar arguments earlier this month when they argued for a court-appointed examiner to investigate many of the same issues. Judge Mary Walrath denied that request because she said the bank failure had been widely investigated.
However, she also said the equity committee could conduct its own investigation. The shareholders also want to investigate the circumstances that led to the settlement between the company and JPMorgan. JPMorgan declined to comment, as did Washington Mutual. Shares of Washington Mutual rose 2.7 percent to close at 11.3 cents in pink sheet trading on Tuesday. The case is In re Washington Mutual Inc, U.S. Bankruptcy Court, District of Delaware (Wilmington), No. 08-12229.
Hedge Funds Sell Crude Fastest in Eight Months: Energy Markets
by Asjylyn Loder - Bloomberg
Hedge funds sold oil at the fastest pace in almost eight months, cutting their bullish bets by 32 percent as crude prices plunged on concern Europe’s debt crisis will hurt energy demand. The speculative net-long position in crude oil futures and options combined on the New York Mercantile Exchange fell to 89,335 in the week ended May 18, the biggest percentage decline since Sept. 29, according to the U.S. Commodity Futures Trading Commission’s Commitments of Traders Report on May 21.Crude dropped 20 percent from a 19-month high of $87.15 a barrel May 3 on concern Europe will undermine a recovery from the worst recession since World War II. Supplies of oil and all petroleum-based fuels jumped to 1.81 billion barrels in the week ended May 14, the highest stockpiles on a seasonal basis based on Energy Department data back to 1990.
"Wall Street was bailing out of the market," said Stephen Schork, president of the Schork Group Inc. in Villanova, Pennsylvania. "The latest sell-off is confirmation that money managers are exiting. I expect next week’s report will show another significant sell-off." Crude oil for July delivery rose as much as 61 cents, or 0.9 percent, to $70.65 a barrel on the New York Mercantile Exchange, and was at $70.33 at 11:09 a.m. in Singapore. Today’s gain snapped a nine-day losing streak for the July contract, during which it shed 13 percent.
In other markets, hedge funds, commodity trading advisers and commodity pool operators, classified as managed money by the CFTC, decreased net-long positions in gasoline by 16 percent to 33,157. Gasoline prices fell 15.21 cents, or 6.9 percent, to $2.0431 per gallon on the Nymex from May 11 to May 18. Since then, gasoline has fallen to $1.9612 a gallon. The price hasn’t gained since May 12. Bullish bets on heating oil futures and options dropped 12 percent to 17,331 contracts. Heating oil for June delivery declined 8.3 percent in the week ended May 18 to $1.9615 a gallon.
The euro-area economy expanded 0.2 percent in the first quarter, faster than the 0.1 percent forecast by economists. The International Monetary Fund said last month that the region’s economy may expand only 1 percent this year, even as the Washington-based fund raised its global growth forecast for this year to 4.2 percent from 3.9 percent, citing a faster expansion in emerging economies including China. The euro lost 12 percent against the dollar this year amid concern the Greek fiscal crisis will spread to other nations as governments work to reduce deficits.
"There is a tipping point that has occurred that would suggest that the economic recovery has lost momentum, and that the European crisis is taking the momentum out of this market," said Peter Beutel, president of Cameron Hanover Inc., the trading adviser in New Canaan, Connecticut. Demand growth in North America was little changed for the first three months of the year, according to preliminary figures this month from the International Energy Agency in Paris. Demand for gasoline sank to a six-week low in the week ended May 14, according to data from the Energy Department. If hedge funds and other large speculators can push prices below so-called support at $67 to $68 a barrel, then oil may plunge as low as $60 to $62 a barrel, Schork said. If crude fails to get below $67, then prices may rebound into the mid $70s a barrel, he said. "We know that fund managers are liquidating length," Schork said. "The question now is will they start building up a short position and try to push this market down further."
Overseas Madoff Investors Receive $15.5 billion In Settlement With Banks
by Raphael Minder and Diana B. Henriques
About 720,000 investors outside the United States who lost money to the convicted swindler Bernard L. Madoff have settled with their banks, receiving about $15.5 billion in all, according to law firms representing those victims of the fraud. The settlements cover about 80 percent of the clients represented by the firms, said Javier Cremades, founder of Cremades & Calvo-Sotelo, a Madrid law firm, who helped organize the global alliance of 60 firms a year ago.
The $15.5 billion figure represents, in theory, 100 percent of the amount clients had invested, Mr. Cremades said, but excludes in almost all cases the bogus paper gains that were listed on investor statements. Mr. Madoff’s United States investors are unlikely to see similar compensation any time soon, partly because their investments were made directly with Mr. Madoff or through conduits that lack the deep pockets of the big European banks.
One exception to the overseas settlements was the Bank of Kuwait, which settled early last year with about 20 clients who had invested via its Swiss bank. The bank reimbursed about $50 million, covering both principal and paper gains. Some banks also set specific payment conditions that make comparisons difficult, Mr. Cremades said. For instance, Santander, the Spanish bank whose clients lost up to 2.33 billion euros ($2.89 billion) — the third-biggest Madoff casualty worldwide — settled by issuing preferential shares redeemable in 10 years. Still, Mr. Cremades described the level of settlements reached in a dozen, mostly European, countries as a success. ’I would have thought that only about 30 percent would reach an agreement, but really the banks have had to invest in not destroying their image and retail networks," he said.
He said the law firms would pursue efforts on behalf of the 20 percent of clients who have yet to receive compensation for their losses. Mr. Cremades would not estimate these losses, however, because they are confidential and subject to judicial actions. Nine institutions have not offered global settlements, Mr. Cremades said, though talks are continuing with some firms. He identified them as Credit Suisse, Vontobel, Mirabaud, Julius Baer, EFG and BBVA Switzerland, all based in Switzerland, as well as Banco Espirito Santo of Portugal, the Dutch bank ABN Amro and Barclays Spain.
Efforts to reach the banks on Friday and Monday were mostly unsuccessful. Some stressed that they were not facing litigation. Rebeca Garcia, a spokeswoman for Credit Suisse, said, "We are in any case very confident that if any claim was brought forward by a client, we will defend ourselves vigorously." Mr. Cremades said that the 60 law firms, in 25 countries and employing 5,000 lawyers, had received a combined $65 million in fees from settlements so far.
The Madoff fraud totaled $64.8 billion in paper losses, and the alliance estimates that it affected a record three million investors, although there were slightly more than 4,900 active direct accounts shown in the Madoff records available to investigators. Mr. Madoff was sentenced last June to 150 years in prison. In his most recent update, the Madoff trustee said he had recovered $1.5 billion that can be used to compensate 2,085 verified claims by American investors totalling $5.45 billion. North Americans invested mainly through money managers, feeder funds and other hedge funds, while outside the United States, the common intermediaries were banks, using their networks in countries like Spain to offer Madoff-linked products to retail customers.
So far, settlements have been less common in the American courts because both the indirect feeder fund investors and the conduits they invested through have some incentive to stall. At present, indirect investors in the United States are not eligible for compensation through the Securities Investors Protection Corporation, the industry-financed organization that provides limited cash advances to customers of failed brokerages. But recently, the court-appointed trustee liquidating the Madoff firm asked the federal bankruptcy court in Manhattan to rule on whether SIPC coverage extended to indirect investors. Hearings are scheduled for later this year, so some indirect investors may want to see if they can qualify for relief before they pursue out-of-court settlements.
The intermediaries may be less quick to settle, as well. Some early private lawsuits against investment advisers, giant accounting firms and custodial banks are constrained by the tighter limits that Congress imposed on securities fraud cases in the mid-1990s. Thus, the defendants may wait to see if the courts simply dismiss the cases before settlement talks become necessary. A further complication is that the primary Madoff conduits in the United States tended to be free-standing hedge funds, midsize accounting firms, pension consultants and independent investment advisers — not big global banks with deep pockets.
So beyond a few exceptions like Tremont Partners, part of MassMutual’s financial services , and Ivy Asset Management, owned by Bank of New York Mellon, the potential defendants may simply not have the money for significant settlements.
Stalled on the road to security
by Bonnie Miller Rubin - Chicago Tribune
Even though he's nearing his 30th birthday, Andy Gleeson's life is far from settled. In June, the bookstore where he has worked for five years is scheduled to close. The lease on his Logan Square apartment will run out, and a long-term relationship has ended. So he is packing up his possessions and moving to New York, lured by nothing more than a buddy with an empty couch. "I thought that by the time I reached 30, I'd be a lot further along in my career," said Gleeson, who has a marketing degree from University of Illinois Chicago. "But most of my friends are in the same situation." The class of 2010 is hearing lots of stirring speeches about the end of a journey. But for a wide swath of young people, earning a diploma or notching a 21st birthday won't be the culmination of anything. Their trajectories will stall — like Gleeson's — or go in reverse as they move home, propped up by parents.
But parents shouldn't look at their basement-dwellers and wonder where they went wrong. The transition to adulthood is a long and winding road that can stretch into the early 30s, say some of the country's most prominent researchers, who spent two years analyzing data on what it means to be a grown-up in modern America. "The world has changed … and it's just a lot more difficult to establish an independent household," said Mary Waters, a sociology professor at Harvard University and one of the contributors to the recently released "Transition to Adulthood," a collaboration of the Brookings Institution and Princeton University's Woodrow Wilson School of Public and International Affairs.
In 1960, 77 percent of women and 65 percent of men had acquired certain traditional markers of maturity by age 30: leaving home, completing school, full-time employment, marriage and family. In 2005, the figure had plummeted to 27 and 39 percent, respectively, according to the MacArthur Research Network. Given the economic realities, it can take up to age 34 to step into those adult roles, said Waters, citing the "ratcheting up of everything" – from academic requirements to the labor market to explain the lag. The provision in the new health care law extending coverage to children beyond age 22 is an example of government addressing this revised timetable. Compared to some other countries, the United States invests little in this demographic..
"We're in this period of rapid change…and institutions just haven't caught up," Waters said. Gleeson may be living independently, but in every other way his life bears little resemblance to that of his mother, who married at 19, became a parent at 25 and, with just a high school diploma, landed a good job at State Farm Insurance in Bloomington – where she has been since.Even so, there was never a question of continuing his post-secondary education – a message embraced by other Millennials. The number of students who enrolled in college swelled from more than 5.9 million in 1965 to about 17.5 million in 2005, according to the National Center for Education Statistics. In fall 2009, 70 percent of high school graduates were headed to campus, an all-time high.
But Gleeson has yet to reap many benefits. As a manager at Barbara's Bookstore in Oak Park, he earns less than $30,000. He's survived, by living "really cheaply." He doesn't own property, a car or even a computer. "A bachelor's degree just doesn't get you very far these days," he explained. "If I would have known all this was just a setup for graduate school, I would have done things differently…such as learning a specific skill." In 1970, 1.03 million Americans continued their schooling beyond college versus almost 2.3 million in 2007, according to the National Center for Education Statistics.
But Asha Gray — also 29 — has discovered that an advanced degree is no ticket to financial security. The Rogers Park resident received a master's degree in forensic psychology in 2009, on top of a bachelor's degree in animal science from the University of Illinois. But she has yet to use her credentials on the job — make that three jobs. Gray has cobbled together a trio of part-time gigs, one as a nanny and two waiting tables, to cover expenses and student loans. The psychology degree was supposed to lift her out of the wage cellar, but she finished just as Illinois slashed its mental health budget, forcing her to compete against laid-off employees with experience, said Gray, who estimates she has sent out 200 resumes in the last year.
"Honestly, I thought I'd have a job that paid enough to support a family and to afford a vacation once a year. It doesn't seem like that crazy of a desire … but it's almost impossible to make happen right now." Graduating in a recession doesn't just mean fewer opportunities, but smaller paychecks compared to peers who launch in a robust economy. The first 10 years of employment is when workers see 70 percent of their overall wage growth, reports the National Bureau of Economic Research.The slow start penalizes twentysomethings whose families have limited resources, say the researchers. Not only have "real" jobs evaporated, but this group must often pass on unpaid internships and valuable training that might pry open doors.
When money gets tight, Gray doesn't even think of asking her parents. "They help me out when they can, but I have three younger siblings behind me … so I try to pull my own weight." Jennifer Park, 28, is grateful for her safety net. She recently jettisoned her dream of being an artist to pursue a degree in nursing. She has moved back home to Schaumburg, which has enabled her to cut expenses while picking up prerequisites at Harper Community College. It's not the script she envisioned, but the stigma has faded. The job site CollegeGrad.com's online poll reports that 64 percent of 2009 college graduates are back in the nest. Her U-turn isn't just about the bottom line. Park was diagnosed with a brain tumor in 2007, and while she has fully recovered, exposure to dedicated practitioners also influenced what she calls her "much wiser" decision.
Because Park also holds down a full-time job at the Apple Store at Woodfield Mall, it will be awhile before she's in scrubs. This is where government and institutions could offer a boost, conclude the researchers: from more "learning communities" at community colleges (keeping commuter students more engaged, reducing the drop-out rate) to expanding Pell Grants. "Not only is it an investment in our future labor force," Waters said, "but it would also shift the high costs off families and onto society, which will ultimately benefit." Until then, the additional buttressing will come from Mom and Dad. But when does assistance turn into enabling? Jeffrey Jensen Arnett, a psychology professor at Clark University in Worcester, Mass., and author of "Emerging Adulthood," said that knowing when to cut off aid is more art than science. The key question: Is the support helpful or counterproductive?
"Look for a plausible plan on how your child plans to move themselves toward self-sufficiency," Arnett explained. If your rudderless child is intensely job-hunting, making contacts and searching Web sites it could be smarter than taking a minimum-wage job. "But if they're not going anywhere, it's a drain on you and not good for them," said Arnett, who is working on an advice book for this phase, due out next year. Whatever happens in the future, Park has learned that career plans are best written in pencil. "I never would have thought I'd be where I'm at now. I thought I'd be doing art, and married. But we're all doing the best we can … just trying to figure out life."
BP faces extra $60 billion in legal costs as US loses patience with Gulf clean-up
by Tim Webb and Ed Pilkington - Guardian
The oil disaster unfolding in the Gulf of Mexico could present BP with much higher costs than previously thought as a result of US government penalties of up to $60bn (£40bn), according to City analysts.
The penalties are in addition to BP's already huge bill for the clean-up mission, which stood at $760m yesterday, and potentially unlimited damages payable by the company to fishermen and other affected local communities. BP also faces billions of dollars of lost earnings as a result of its damaged reputation in the US, which could result in it being barred from bidding for future contracts.
The Guardian has obtained a confidential briefing, from a top-level US environmental lawyer who specialises in oil industry litigation, to stockbroker Canaccord, assessing the financial impact of impending legal action on BP. He warned that, under US law, BP is liable for $1,100 in civil penalties for each spilt barrel of oil and gas, to be paid to the US federal and affected state governments. If BP is found to have acted with gross negligence – and there is no evidence so far that it has – this fine would rise to $4,300 for each barrel.
The issue of legal liability for the accident is complex, involving US federal and state laws. City analysts' calculations of the bill faced by BP have ignored the potentially ruinous cost of civil penalties. They also highlight the implications for BP of establishing how much oil is leaking from the damaged pipeline, which is hard to measure – unlike a leaking tanker, which holds a finite amount of oil. BP had been relying on official estimates for the spill of 5,000 barrels per day, which are based on satellite images taken of the surface of the sea above the leaking pipeline. But BP has been pumping hundreds of thousands of gallons of chemical dispersant close to the leak, resulting in vast underwater oil slicks.
The company recently admitted that the actual figure is likely to be higher and some scientists say 115,000 barrels of oil per day are spewing into the Gulf. BP would be liable for $60bn in civil penalties if oil continues to leak at the highest estimated level for the next two months, when a relief well being drilled to plug the reservoir is completed. With the spill in its fifth week, pressure is mounting as all attempts to stem the leak have been delayed or largely failed. The Environmental Protection Agency has indicated BP faces fines over the disaster, and there is speculation that it could eventually face a criminal investigation.
BP is preparing to carry out its latest attempt to staunch the flow of oil from the damaged Deepwater Horizon well. The operation, which the firm hopes to start tomorrow, will involve pumping heavy fluids into the broken pipe and then capping it with cement. The technique has proven successful in previous surface oil spills but it has never been tried at a depth of 1.6km under the sea and BP can only hazard that it has a 60% or 70% chance of working this time. BP said last night it will broadcast live video of the "top kill" during the procedure.
The crisis began on 20 April with the explosion of the Deepwater Horizon rig about 50 miles off the coast of Louisiana. Eleven workers died in the blast, and a private memorial service was to be held yesterday afternoon in Jackson, Mississippi. The Obama administration is increasingly feeling the heat over why it has taken so long to contain the crisis. As a sign of how seriously the spill is being taken, Obama will break off a long weekend in Chicago on Friday to travel to Louisiana to witness the clear-up efforts.
Bobby Jindal, the governor of Louisiana, is increasingly acting as the conduit of criticism of both the oil giant and the government, vowing to mobilise the local National Guard to protect the sensitive ecosystems on the Gulf of Mexico in the absence of an adequate federal response. "We are not waiting for them," he said. Senior figures in the Obama administration continued to voice frustration with BP, but also displayed internal confusion about what should be done to deal with the slipping timescale. The US interior secretary, Ken Salazar, hinted that unless BP gets a grip on the crisis the federal government would "push them out of the way". This was almost immediately contradicted by Thad Allen of the US Coast Guard: "To push BP out of the way would raise a question – to replace them with what?"
BP's chairman, Carl-Henric Svanberg, accepted that the accident had damaged the company's reputation but said that critics should remember that BP was "big and important" for the US. "The US is a big and important market for BP, and BP is also a big and important company for the US," he said in an interview with the Financial Times. Svanberg said the company's board felt that chief executive Tony Hayward was doing a "great job", in spite of criticism. "This is not the first time something has gone wrong in this industry … Of course our reputation will be tarnished, but let's wait and see how we do with plugging the well and cleaning up the spill," he said.