"Mr. and Mrs. Wardlaw at entrance to their dugout basement home, Dead Ox Flat, Malheur County, Oregon"
Ilargi: Stoneleigh today, in between speaking engagements, tackles the slowly but surely creeping closer threat of being in debt. We may no longer -or maybe should we say not yet- have debtors' prisons, but that doesn’t mean that everyone is safe from debt collectors, including state officials who often -illegally- work as such. The Star Tribune recently ran a striking article on the topic, which Stoneleigh addresses. For those who don’t see this as a serious threat, here's two of today’s headlines: Obama Warns Of 'Massive Layoffs Of Teachers, Police, And Firefighters' and Investors are betting on a Black Monday-style collapse, Bank of England warns. The stock markets may suggest recovery, but they are deceptive. to say the least.
Trickles, Floods and the Escalating Consequences of Debt
We have often said here at The Automatic Earth that there are many things that -still- function today, but once a trickle becomes a flood, will cease to function. Bank runs are the most obvious example - as soon as more than a handful of people withdraw their deposits, banks close their doors. Those who expect to be bailed out by deposit insurance are in for a nasty surprise, as deposit insurance won't be worth the paper it's written on in a systemic banking crisis. It's all merely a confidence game in the first place - a mechanism to convince you that there's actually nothing to worry about. If it worked there would never be any bank runs. However, if (when) the bluff is called, it will be game over.
Another problem area will be early pension withdrawals. Pension funds are generally underfunded (or sometimes even unfunded), and they have been trying to make up for the shortfall by chasing yield, without perhaps realizing that this meant they were chasing risk. The insiders who sold the riskiest high-yield 'investments' to pension funds called it 'land-filling toxic waste'. They knew perfectly well that they were crippling the future ability of pension funds to meet their obligations. Many pension fund assets will be worth pennies on the dollar as soon as extend and pretend can no longer be maintained and there is a serious price discovery event.
The structure of the credit default swap market virtually guarantees that such an event will take place in the next phase of the credit crunch. One can insure assets one does not own, which then confers a perverse incentive to burn things down for profit. Even more perversely, the complete lack of capital adequacy regulation in the CDS market means that one may force something to fail but not be able to collect on a 'winning bet'. The price discovery that could sink many vulnerable 'assets' could happen completely in vain.
In short, pension funds are in serious trouble, as we have pointed out many times before. The more people attempt to make early withdrawals, despite the tax penalties, the greater the risk that the lack of funding will become obvious. As a result, we are already seeing moves towards preventing early withdrawals, ostensibly to 'prevent people from impairing their retirement'. In actual fact such moves are meant to cover up the lack of funding for as long as possible. As with bank runs, the first few to make withdrawals may get their money, but, again, once a trickle becomes a flood, the door will close.
Another such problem area is the consequences of indebtedness. Presently bankruptcy is relatively civilized in comparison with earlier eras, if harder to get than it used to be. Discarded 'remedies' for indebtedness have included debtors' prison, indentured servitude (perhaps inter-generational) and being strong-armed into the military. These are generally no longer in use, although the military option is already regaining a foot-hold. People in the US can often walk away from debt, either through bankruptcy or strategic default on underwater mortgages. As (un-refinanced) mortgages are often non-recourse loans in the US, people can choose to walk away with the only damage being to their credit score. If they buy or rent another property prior to default, the damage can be minimal. However, such a situation is highly unlikely to persist.
Apart from the arguments about trickles and floods, such strategic default is very socially divisive, which means it will be easy to generate a mandate to prevent it in the future, whether or not doing so would violate existing contract terms. Those who expect contract terms to remain inviolate are likely to be very disappointed in many instances. Governments don't 'fight fair'. When push comes to shove, they are perfectly capable of changing the rules abruptly, and retro-actively if they perceive it to be necessary. After all, we are already witnessing the demise of the rule of law in many obvious ways. The rule of law exists only when the centre agrees to be bound by the same rules as others, and that is less and less the case all the time.
I think it wise to expect margin calls on a grand scale in the months and years to come. I also expect the less civilized methods of dealing with debt to resurface. In fact, they already are. See for instance this article from the Minnesota-St.Paul Star Tribune:
In Jail for Being in Debt:It's not a crime to owe money, and debtors' prisons were abolished in the United States in the 19th century. But people are routinely being thrown in jail for failing to pay debts. In Minnesota, which has some of the most creditor-friendly laws in the country, the use of arrest warrants against debtors has jumped 60 percent over the past four years, with 845 cases in 2009, a Star Tribune analysis of state court data has found.
Not every warrant results in an arrest, but in Minnesota many debtors spend up to 48 hours in cells with criminals. Consumer attorneys say such arrests are increasing in many states, including Arkansas, Arizona and Washington, driven by a bad economy, high consumer debt and a growing industry that buys bad debts and employs every means available to collect.
Whether a debtor is locked up depends largely on where the person lives, because enforcement is inconsistent from state to state, and even county to county. [..]
"The law enforcement system has unwittingly become a tool of the debt collectors," said Michael Kinkley, an attorney in Spokane, Wash., who has represented arrested debtors. "The debt collectors are abusing the system and intimidating people, and law enforcement is going along with it."
How often are debtors arrested across the country? No one can say. No national statistics are kept, and the practice is largely unnoticed outside legal circles. "My suspicion is the debt collection industry does not want the world to know these arrests are happening, because the practice would be widely condemned," said Robert Hobbs, deputy director of the National Consumer Law Center in Boston.
Debt collectors defend the practice, saying phone calls, letters and legal actions aren’t always enough to get people to pay….. Taxpayers foot the bill for arresting and jailing debtors. In many cases, Minnesota judges set bail at the amount owed. In Minnesota, judges have issued arrest warrants for people who owe as little as $85 — less than half the cost of housing an inmate overnight. Debtors targeted for arrest owed a median of $3,512 in 2009, up from $2,201 five years ago.
Those jailed for debts may be the least able to pay…. The laws allowing for the arrest of someone for an unpaid debt are not new.
What is new is the rise of well-funded, aggressive and centralized collection firms, in many cases run by attorneys, that buy up unpaid debt and use the courts to collect. Three debt buyers — Unifund CCR Partners, Portfolio Recovery Associates Inc. and Debt Equities LLC — accounted for 15 percent of all debt-related arrest warrants issued in Minnesota since 2005, court data show. The debt buyers also file tens of thousands of other collection actions in the state, seeking court orders to make people pay.
The debts — often five or six years old — are purchased from companies like cellphone providers and credit card issuers, and cost a few cents on the dollar. Using automated dialing equipment and teams of lawyers, the debt-buyer firms try to collect the debt, plus interest and fees. A firm aims to collect at least twice what it paid for the debt to cover costs. Anything beyond that is profit….
Stoneleigh: People too often assume that the consequences of debt will remain minimal, even to the point of deliberately maxing themselves out before a default they know is inevitable. This is a very dangerous practice. As the article points out, debts which are at risk of non-payment are often sold on to those lower down the financial foodchain, who reckon they have enough of a chance of collecting to justify the amount they pay to buy the debt from the original issuer.
If they have paid very little, they do not need to actually collect on many debts to make a profit overall. Debts can be sold on multiple times, to operators prepared to use harder and harder tactics, until the debt can end up in the hands of 'Vinny the Knee-Capper', or equivalent. Long before that people can suffer a multitude of lesser consequences, beginning with harassment and moving on to jail. It doesn't appear to matter that debt is not a criminal matter. Expect existing authority to be abused, left, right and centre. This is the way much of the world lives already, in fear of corrupt authority or authority exercised on behalf of powerful vested interests, even if it constitutes a clear violation of legal principles.
We are seeing the early stages of the return of debtors' prisons and other less palatable consequences. Debtors beware.
Obama Warns Of 'Massive Layoffs Of Teachers, Police, And Firefighters'
by Ricardo Alonso-Zaldivar - AP
If Chuck Lacasse had gotten his pink slip four days earlier, Uncle Sam would have covered most of his family's health insurance while he looked for a new job. But Congress allowed emergency health care assistance for unemployed workers to expire May 31, and seems unwilling to renew it despite pleas from President Barack Obama. On Saturday night, the White House released a letter Obama sent to congressional leaders of both parties asking for nearly $50 billion in emergency aid to state and local governments to fend off "massive layoffs of teachers, police and firefighters" and to prevent a possible double-dip recession.
"We are at a critical juncture on our nation's patch to economic recovery," the president warned. "It is essential that we continue to explore additional measures to spur job creation and build momentum toward recovery, even as we establish a path to long-term fiscal discipline. At this critical moment, we cannot afford to slide backwards just as our recovery is taking hold." In an interview with the Washington Post, White House Chief of Staff Rahm Emanuel "said the letter is intended to settle the growing debate over the opposing priorities of job creation and deficit reduction and 'where you put your thumb on the scale.'"
Not three months after lawmakers passed his $1 trillion insurance overhaul, Obama is facing a rare defeat on health care at the hands of his own divided Democrats. So-called "moderates" have rebelled against adding billions more to the deficit in a treacherous election year. "The same Congress that spent all this political capital trying to get people health insurance is going to take a crucial benefit away from unemployed people," said Andrew Stettner, deputy director of the National Employment Law Project, which advocates for the unemployed.
On June 4, Lacasse lost his job as advertising director for a company that makes nutritional supplements. He'll soon have to pay the entire $1,500 monthly premium to keep his family covered under his former employer's health insurance plan. Until May 31, under Obama's economic stimulus law, the government provided a 65 percent subsidy. That would have lowered his cost to $525. "This really isn't about welfare," said Lacasse, 40. "It's about buying people some time. In a position as specialized as mine, it would have been nice to know that I had some time to look for the right job." He lives near Green Bay, Wis., with his wife and two children.
Democratic Sens. Bob Casey of Pennsylvania and Sherrod Brown of Ohio have introduced a measure that would allow the program to continue helping people who get laid off through Nov. 30. That would cover Lacasse. The lawmakers, who are seeking a vote this coming week, want to attach their nearly $7 billion provision to must-pass legislation that would extend unemployment benefits and make changes in dozens of federal programs. But a similar proposal was dropped from the House-passed bill, and Senate Democratic leaders also omitted it from their version.
"I'm concerned about it," said Washington Sen. Patty Murray, a member of the Democratic leadership. "There will be people who fall through the cracks." Under a 1980s law known as COBRA, laid-off workers generally can stay on their former employers health plan for up to 18 months, provided they pay the full premium plus a small administrative charge. But with family premiums averaging about $13,500, the cost is prohibitive for most people. That changed under the 2009 stimulus bill and subsequent expansions, which provided a 65 percent federal subsidy for up to 15 months. Workers laid off through May 31 can qualify for the benefit through their former employer.
"It has been a significant program and it has helped many middle-class families to keep their health insurance at a time when maintaining health insurance was difficult because of the high rate of job loss," said Alan Krueger, the Treasury Department's chief economist. Official statistics on how many people were helped have yet to be compiled, but Krueger estimates that as many as one-third of eligible unemployed workers enrolled in subsidized coverage.
Melanie Miller, 34, who suffers from debilitating neurological problems, said the COBRA program allowed her to maintain her independence after losing her ad agency job. "Without the subsidy, I probably would have had to move back and live in my mother's house in the basement," said Miller, an artist who lives in Philadelphia. With the unemployment rate hovering just under 10 percent and with 15 million people looking for work, advocates say it's premature to withdraw assistance. "We're recovering, but we haven't recovered fully," said Casey. "Now is not the time to pull up the ladder on people who are hanging on, in some cases to the last rung."
Some conservative Democrats, however, say they don't understand why the government should subsidize workers who lose jobs with employer coverage and not others who are equally deserving - for example self-employed people priced out of the private market. "You're paying 65 percent of (one) family's health care costs, but the neighbor next door, there's no help for," said Rep. Dennis Cardoza, D-Calif. "So we're picking and choosing. There's an inequality there between our constituents." Not to mention that Congress has treated the program as emergency spending, adding its cost to the deficit.
In Marietta, Ohio, boiler operator Neil Davis is facing the loss of his job as the coal-burning power plant he works at prepares to shut down for good. Davis, 33, has marketable skills but he's unsure how quickly he'll be able to find comparable work. His wife is a stay-at-home mom raising two elementary-age children. "Being able to have coverage at an affordable rate, we wouldn't be afraid to take the kids to the doctor if they get sick," said Davis. "The economy might be getting better some place, but I don't know where at."
Investors are betting on a Black Monday-style collapse, Bank of England warns
by Edmund Conway - Telegraph
Investors are placing bets on a Black Monday-style crash in the British stock market at the fastest rate since the collapse of Lehman Brothers bank in 2008, the Bank of England has warned. In a survey of markets, the Bank warned that widespread fear over the possible collapse of a sovereign debtor, including Greece and Portugal, had sparked a mass of bets on a 20 per cent fall in the FTSE 100.
The warning coincides with calculations from the Bank for International Settlements (BIS) showing that Britain has major exposure to the Irish and Spanish banking systems, which many fear could be at risk in the next round of the financial crisis. The Bank of England used its Quarterly Bulletin to warn that markets were under increased strain following the International Monetary Fund and European Commission's bail-out of Greece. It said that investors had fled into safe haven assets, including Treasury bonds, gold and, to some surprise, UK government bonds.
However, it pointed out that the number of investors betting on a 20 per cent fall in the FTSE 100 index, based on their purchase of options connected to such a scenario, had risen from below 5 per cent to about 13 per cent in the past month alone. Although this is below the 25 per cent level around the time of the Lehman implosion, the rate of increase is similar.
Share prices have been hit by the fears surrounding sovereign debt in recent weeks. Some analysts fear problems surrounding government bonds could trigger a repeat of Lehman-style events. The BIS used its own Quarterly Report to point out that, although the strain had worsened throughout the international banking system, banks' balance sheets were slightly healthier than in the early stages of the subprime mortgage crisis that led to the Lehman collapse.
However, it also pointed out that various countries in the euro area were particularly exposed to each other – both in terms of sovereign and private debt. Banks headquartered in Britain had larger claims on Ireland ($230 billion, £158 billion) than banks based in any other country. Britain has a $150 billion (£103 billion) exposure to Spain.
UK watchdog slashes growth forecast
by Chris Giles - Financial Times
George Osborne will have to frame his Budget next week against the backdrop of significantly weaker economic forecasts, making the process of deficit reduction all the more difficult. The new and independent Office for Budget Responsibility on Monday cut the forecast for growth in 2011 and in subsequent years as it assessed the previous outlook for the economy as too rosy. The chancellor has said he will use these forecasts as the basis for his Budget next Tuesday and the worse medium-term outlook for the public finances suggests there is a more urgent need for announcements of deferred spending cuts and tax increases.
Even though the OBR expects lower borrowing in 2010-11 than Alistair Darling predicted in the March Budget, this benefit is offset by a weaker medium-term outlook for the economy and for tax revenues. Instead of predicting the economy would grow by 3.25 per cent in 2011 and by 3.5 per cent in the subsequent three years, the OBR cautions that growth is likely to be only 2.6 per cent next year and an average of 2.7 per cent into the medium term. The market reaction was muted, with the FTSE 100 unchanged and UK gilt futures paring their losses, rising 10 basis points. Sterling remained at a session high thanks to the OBR’s improved public sector borrowing requirement numbers.
The OBR said in its document: "Our conclusion is that there is a smaller amount of spare capacity and that future trend growth is likely to be weaker than was estimated in the March Budget." The long-term growth rate of the economy is estimated at 2.25 per cent over the next three years, slowing to 2 per cent thereafter instead of the 2.75 per cent the Treasury said as recently as March. The OBR said this slowdown in the likely rate of longer-term growth was a result of a slowing growth in the number of potential workers.
On the public finances, the OBR accepts that tax revenues have been flowing into the exchequer faster than expected and this is likely to leave borrowing standing at £155bn in 2010-11 and £127bn in 2011-12 compared with Mr Darling’s worse figures of £163bn and £131bn respectively in the March Budget. But the lower growth assumption into the medium term slows tax revenue growth thereafter and the borrowing figures are only marginally better by 2014-15. The OBR says it is most likely that the country will still be borrowing £71bn in 2014-15 on unchanged policies, compared with £74bn in the Budget forecast..
The OBR said the lower deficit forecast was the result of higher inflation and strength I some receipts such as value added tax, but it added that "the judgment that growth will be lower than assumed in the March Budget ... leads to less medium-term strength". The OBR stressed that the new forecasts were not certain and insisted on putting wide margins of error around its growth and deficit predictions.
Obama Plans First Oval Office Speech to Put Pressure on BP
by Jackie Calmes - New York Times
President Obama will use his first Oval Office speech Tuesday night to outline a plan to legally compel BP to create an escrow account to compensate businesses and individuals for their losses from the oil spill in the Gulf of Mexico, administration officials said on Sunday. It would be part of a week of activities intended to convey presidential command of a crisis that continues to test both the government and the company.
Mr. Obama will press for the escrow account if BP does not establish one voluntarily. The board of the London-based company will discuss the idea and other spill-related issues — including a brewing controversy over a big dividend for shareholders coming due this summer — at an emergency session on Monday, company officials said. But it does not expect to announce decisions until after its chairman and chief executive speak with Mr. Obama at a meeting he has called for midweek. "We are considering all these issues and look forward to constructive conversations on Wednesday in the White House," said Andrew Gowers, a senior BP spokesman.
On Monday, the president will begin a two-day tour of three gulf states and return in time for Tuesday’s prime-time, nationally televised speech. As critics continue to fault Mr. Obama less for his administration’s overall response to the spill than for what they say has been his own slow and reactive leadership style, the ultimatum to BP and the president’s use of the solemn setting of the Oval Office escalate his personal engagement to a new level.
Sunday’s developments came after the administration gave BP engineers until the end of the weekend to speed up containment of oil that has been spilling into the gulf since the April 20 explosion aboard the Deepwater Horizon drilling rig that killed 11 men. The company used underwater robots on Sunday to position sensors inside the well to measure how much oil is spilling, The Associated Press reported. The robots were expected to insert the sensors through a line used to inject methanol, an antifreeze meant to prevent the buildup of icy slush, into the containment cap over the ruptured pipe, said a BP spokesman, David Nicholas. The work should be completed by Tuesday.
The actions reflect the administration’s efforts, nearly two months into the crisis, to telegraph a take-charge decisiveness when Mr. Obama and the federal government are all but powerless to actually resolve the calamity, given the sheer technological challenge of plugging a leak a mile below the gulf’s surface. Mr. Obama’s actions this week, together with events in Congress, put BP on the defensive more than at any other time since the explosion.
While the BP board meets on Monday, Mr. Obama will make his fourth trip to the Gulf Coast since the disaster struck. It will be his first overnight visit and, after three trips to Louisiana, his first tour of the states to the east — Mississippi, Alabama and Florida — that are in the direction of the spewing oil’s drift. With each trip, he has grown more critical of BP’s response, channeling the increasing anger and desperation of coastal residents and politicians.
On his return, Mr. Obama will speak to Americans from the Oval Office, a setting that past presidents have often used but which Mr. Obama never has, despite the gravity of the issues his administration has already faced, including the wars in Iraq and Afghanistan, the worst economic downturn since the Great Depression, and the president’s signature domestic initiative, overhauling the health care system.
The president’s meeting the next day will be his first face-to-face contact with top company officials, after weeks of questions about why he has not done so before. BP has notified the White House that, as requested, the chairman of BP’s board, Carl-Henric Svanberg, will come. He will bring along the company’s embattled chief executive, Tony Hayward, who has been much criticized for statements that have been considered insensitive and self-serving.
Mr. Hayward will be in the hot seat on Thursday as well, testifying before one of several Congressional committees investigating the spill. Although a containment cap has apparently reduced the amount of oil surging from the gulf floor, BP will face questions about last week’s determination from government scientists that the volume of spilled oil has been as high as 40,000 barrels a day — many times higher than BP ever acknowledged. Adm. Thad W. Allen of the Coast Guard, Mr. Obama’s designated chief of the federal response, said on CBS’s "Face the Nation" on Sunday that the "mid-30,000 range is what we’re looking at." The installation of the sensors on Sunday was done at the request of the team of scientists, according to The A.P.
Admiral Allen also said he was expecting an answer later on Sunday to the administration’s request that BP provide "a faster plan" to siphon off and collect the gushing oil, one with "greater redundancy and reliability." The administration has said that while BP alone has the technological capability to stop the leak, it must take direction from Admiral Allen and other senior administration officials. The administration’s demand for an escrow account, an idea that some gulf state officials had suggested earlier, in effect forces BP’s hand. Administration officials did not suggest an amount.
They said a fund, using BP’s money, should operate like the fund established for victims of the terrorist attacks on Sept. 11, 2001, which was financed by the government, with a third-party administrator to provide transparency and guard against BP too narrowly defining who is entitled to payments and how much. "We want to make sure that money is escrowed for the legitimate claims that are going to be and are being made by businesses down in the gulf — people who’ve been damaged by this," David Axelrod, Mr. Obama’s senior White House strategist, said on NBC’s "Meet the Press" on Sunday. "And we want to make sure that that money is independently administered" so those who have suffered losses "won’t be slow-walked on these claims."
Administration officials said that since last week, White House lawyers have been researching Mr. Obama’s legal authority to compel BP to set aside money for claims, based on the 1990 Oil Pollution Act. The president decided to seize the initiative after reports from Britain on Friday that BP planned an escrow account, either to hold shareholders’ dividends in reserve or to set aside money for victims’ claims, turned out to be more speculative than the White House initially thought, officials said. If BP goes along with the concept now, the administration has put itself in a position to take credit.
The issue of BP’s planned $10.5 billion dividend looms as another potential point of contention. Mr. Obama has said BP should not be paying stockholders when gulf fishermen, oil workers and small business owners are saying they cannot get the company to pay their loss claims. Legal experts are divided over the government’s power to block a dividend. "I’m not aware of any legal precedent that would give the government any authority that would preclude British Petroleum from paying dividends," said Joseph A. Grundfest, a professor at Stanford Law School and former member of the Securities and Exchange Commission.
BP’s status as a foreign corporation further complicates matters, he said. "There’s no suggestion that British Petroleum lacks the money necessary to pay all claims or damages that might result from this calamitous spill," Mr. Grundfest said. But John C. Coffee Jr., a law professor at Columbia University, said courts have broad authority to issue injunctions. He also said the Justice Department or even state attorneys general could try to argue that the dividend would represent a "fraudulent conveyance" to keep money from flowing to claimants, though the burden of proof would be high.
As one of the richest oil companies in the world, BP has nearly $7 billion in cash on hand and the capacity to borrow about $15 billion, according to Wall Street investment reports. The company is expected to generate $34 billion from continuing operations this year, from which it had planned the $10.5 billion in dividends and $20 billion for capital investments. BP officials say that on Monday, the board would consider suspending or cutting the quarterly dividend, or paying it as an i.o.u. Executives said they could both meet their obligations from the spill and pay the regular dividend, but they conceded that political pressures could argue for suspending the dividend.
U.S. Wants BP to Set Up Account for Oil Spill Damages
by Jordan Burke and Susan Decker - Bloomberg
President Barack Obama wants BP Plc to set up an escrow account to pay the claims for damages caused by its oil spill in the Gulf of Mexico, White House adviser David Axelrod said. "We want to make sure the money is escrowed for the businesses and want to make sure the money is independently administered so it’s not slow-walked," Axelrod said today on NBC’s "Meet the Press."
Axelrod’s comments came as the Obama administration steps up pressure on BP to control the spill and pay for cleanup. The U.S. Coast Guard gave BP until tomorrow to find more capacity to contain the leak. BP’s board meets tomorrow to discuss whether to reduce or defer its second-quarter dividend. "The board will be looking at a number of options when it meets tomorrow," Sheila Williams, a spokeswoman for BP, said after Axelrod spoke. "No decision is expected this week."
Obama will address the nation after he returns from a two- day visit to the Gulf Coast beginning tomorrow to check on the oil spill progress, Axelrod said. The president is scheduled to meet June 16 at the White House with BP’s chairman, Carl-Henric Svanberg, and other company officials. Establishing the reserve account will be a subject for "discussion between us and BP, but it has to be substantial enough to meet the claims," Axelrod said. "BP has the resources to meet the claims and we’re going to make sure they do," he said.
Scientists and researchers doubled their estimates of the spill’s size on June 10, and BP’s efforts don’t "provide the needed collection capacity consistent with the revised flow estimates," said Rear Admiral James A. Watson, the federal on- scene coordinator, in a letter dated June 11. It was sent to Doug Suttles, BP’s chief operating officer for exploration and production, and was released yesterday.
BP plans to almost triple its capacity to capture oil from its leaking well to as much as 50,000 barrels a day by mid-July, the Coast Guard said June 11. The plan calls for two pairs of production ships and shuttle tankers to replace a cluster of vessels at the site, Coast Guard Admiral Thad Allen, the government’s national incident commander for the spill, said June 11 at a press conference in Washington.
BP collected about 15,040 barrels of oil and flared 32.9 million cubic feet of gas yesterday, the company said today in a statement on its website. The well was releasing between 20,000 barrels and 40,000 barrels a day, twice as much as previously estimated, before BP cut away a kinked pipe on June 3, U.S. government scientists and independent researchers reported June 10. They are still studying the current leak rate. BP recovered about 7,570 barrels of oil from midnight to noon yesterday.
Based on government estimates, the drillship isn’t capturing as much of the spill as BP predicted earlier this month. In a June 4 interview with CBS, Suttles said the system would be capable of capturing as much as 90 percent of the flow. The additional ships planned next month will give BP backup pumping ability in the event that one of the vessels can’t be used, Allen said. "The issue is for BP to move quickly," Allen said.
In its application for the well, BP told the government it was prepared for a worst-case oil spill of 250,000 barrels a day. U.K. Prime Minister David Cameron and President Obama, meantime, talked yesterday and Cameron expressed his "sadness" at the "human and environmental catastrophe" caused by the spill. "The president and prime minister agreed that BP should continue -- as they have pledged -- to work intensively to ensure that all sensible and reasonable steps are taken as rapidly as practicable to deal with the consequences of this catastrophe," Cameron’s office in London said in an e-mailed statement.
In the Florida panhandle, the city of Pensacola began taking additional steps to protect its marshes and inlets from oil creeping closer to the coast. Officials closed the area’s two main entries for boats June 11 in an attempt to capture the oil before it gets to the inter- coastal waterways and sensitive areas, Pensacola Mayor Mike Wiggins said in an interview yesterday. The oil could do "grave damage," he said. "The oil is very close to our shores," he said. "The weekend is going to be very challenging for us."
A plume of oil was detected June 11, 9 miles (14.5 kilometers) south of Pensacola Pass, and another plume of oil was seen six miles (9.7 kilometers) south of Escambia County, Florida, Sonya Daniel, a county spokeswoman, said. The spill began after the drilling rig Deepwater Horizon sank April 22, following a blowout of BP’s well that killed 11 of its crew. It has closed as much as 37 percent of the Gulf of Mexico to fishing, cut offshore drilling in the nation by half, polluted 140 miles (225 kilometers) of shoreline from Louisiana to Florida, and cost BP more than $1.43 billion.
Largest BP shareholders cut stake as price falls
by Richard Fletcher, Helia Ebrahimi and Harry Wilson - Telegraph
BP's largest shareholders have cut their holdings in the troubled oil giant – with five of the group's top 10 shareholders selling shares in recent weeks. Analysis by The Daily Telegraph of data compiled by Citywatch shows that major UK institutions including Legal & General, M&G, Scottish Widows, Threadneedle and Axa have all trimmed their holdings since the Deepwater Horizon rig sank with the loss of 11 lives in April.
A number of so-called "FTSE tracker funds" will have been forced to sell as BP's share price fell – reducing its relative size in the FTSE 100. Scottish Widows has been one of the heaviest sellers. BP's ninth largest shareholder has cut its stake from 1.86pc before the disaster to 1.27pc at the start of the month. Traders believe that much of the stock has been bought by UK hedge funds. More than 34bn BP shares have changed hands since the rig sank. Seven times the volume of shares during the same period last year. There has been a similar spike in the volumes of the group's New York-listed ADR's being traded.
BP's share price has almost halved since the disaster on April 20, wiping nearly £50bn off the company's market. On Friday the shares rallied 7pc to 391.9p on the view that the markets had overreacted to the tragedy and subsequent oil spill. According to the Citywatch data US pension funds – including Calpers, the Teacher Retirement System of Texas and Ohio Public Employees Retirement System – have held their stakes in the company despite the dramatic fall in the share price. Traders believe that Britian's top hedge funds have used BP's share price weakness to build stakes in the group.
GLG and Blackrock are said to be amongst UK based hedge funds to have bet on a recovery in BP's fortunes – with some funds buying stakes in excess of 1pc costing more than £600m. Despite the sharp share price falls and continued political uncertainity just one City analyst – Dougie Youngson of Arbuthnot Securities – has recommended that clients sell their shares in the troubled company. Of the 39 other analysts that cover the stock 28 are "buyers", 10 recommend clients hold any shares they own and one has his recommendation under review.
"The market has become increasingly sensitive to speculation and unfounded claims, highlighting the effect of the absence of hard facts on which to work," wrote Jon Rigby, a UBS analyst, in a recent note to clients. "While progress on dealing with the spill continues, the share price falls now appear to reflect continued pressure from President Obama's administration."
BP Options Show 63% Drop as Hayward Faces Washington
by Brian Swint and Jeff Kearns - Bloomberg
The fastest-growing bet on BP Plc in the U.S. stock-options market shows traders expect a 63 percent plunge in about a month as costs surge for its uncontrolled well spewing oil into the Gulf of Mexico. Options to sell BP’s American depository receipts in July at $12.50 recorded the largest jump in open interest of any contract during the last two weeks, soaring to 33,445 outstanding from zero as the month began, according to data compiled by Trade Alert LLC.
Investors buying the put options are wagering the shares will extend their drop from $33.97 and wipe out $140 billion from BP’s market value since April 20, when the Deepwater Horizon rig exploded. BP Chief Executive Officer Tony Hayward is set to testify before Congress this week and Chairman Carl-Henric Svanberg will answer a summons to the White House as politicians demand BP stops its dividend and pays laid off oil-rig workers. The spill’s cost may reach $40 billion, bank Standard Chartered Plc estimated last week, triple the $12.5 billion price tag Sanford C. Bernstein & Co. projected on April 30.
"The government has a lynch mob mentality," said Fadel Gheit at Oppenheimer & Co. in New York, rated by StarMine as the most accurate active analyst on BP. "It’s in nobody’s interest to bankrupt BP, but that’s what Obama is doing right now. Crippling BP is not going to make them clean the spill better." BP’s shares fell as much as 3.2 percent in London today and were the biggest loser in the benchmark FTSE 100. The stock traded at 382.5 pence as of 8:14 a.m. local time.
Obama wants BP to set up an escrow account to pay claims, an aide said yesterday, and the Coast Guard gave BP an ultimatum until today to find more capacity to contain the leak. The company is currently collecting about 15,000 barrels a day through a cap on the damaged well. Government scientists raised their estimates for the pace of the spill to between 20,000 and 40,000 barrels a day last week, double earlier figures.
In a phone call this weekend, Obama told British Prime Minister David Cameron he wasn’t trying to undermine BP’s value, U.K. Foreign Secretary William Hague said in an interview with the British Broadcasting Corp. BP shares touched a 13-year low last week in London as the administration stepped up the rhetoric on BP, the largest U.S. oil producer. President Barack Obama said he would have fired Hayward, 53, if he were working for him. In the U.S., where the majority of options trading in the company’s shares occurs, the volume of put contracts changing hands last week was 100 times the level before the accident.
"People are still concerned that BP could go bankrupt," said Chris Rich, head options strategist at JonesTrading Institutional Services LLC in Chicago. "The puts are saying that people have such a high level of fear. There’s just a huge amount of put buying right now." BP’s ADRs closed at $33.97 in New York last week, down 44 percent from April 20. Sheila Williams, a spokesman for the company in London, declined to comment on trading in the shares.
Cameron’s phone call to Obama took place as concern mounted that the crisis at the U.K.’s largest non-financial company will hurt investors. BP paid 14 percent of the total dividends from the London stock market’s largest companies last year, according to Morgan Stanley. BP has so far spent $1.6 billion trying to stop the spill and cleaning up crude that’s reached the coastline in northwest Florida. A cost of $40 billion would be more than double BP’s expected profit this year. A permanent solution to capping the Macondo well a mile below the Gulf of Mexico must wait for the completion of relief wells, expected in August at the earliest.
Credit default swaps for BP, contracts linked to the likelihood of the company failing to make debt repayments, soared to a record last week. The cost to protect $10 million of BP debt for a year reached $695,000, according to CMA DataVision. It was $29,000 on April 30. "Market speculation can hurt the company because it sends a signal that it’s in trouble," Alastair Syme, an analyst at Nomura Holdings Inc. in London. "BP might find it difficult to access cheap credit today. But they don’t rely on credit for their day-to-day business. They are cashflow long and have great assets."
More likely than default is BP will cut or defer its $10 billion-a-year dividend payments to appease politicians demanding it sets money aside to pay spill costs. Hayward said last week the company was "considering all options" for the second-quarter dividend. BP’s board will meet today to discuss the dividend, a spokesman said during the weekend.
Dividend swaps trading in the over-the-counter market imply a cut of about 50 percent over the next year, according to Bhavin Patel, an equity derivatives strategist at Royal Bank of Scotland Group Plc in London. BP’s December 2011 dividend swaps traded at 18 pence on June 11, he said, compared with a total payout of 36.42 pence in 2009. Most equity analysts in London and New York remain positive on BP, pointing to the company’s ability to generate cash from oil and gas fields worldwide. BP has 27 buy recommendations, 12 holds and one sell, according to analysts surveyed by Bloomberg.
BP’s leaders will have to last through their week in Washington. Svanberg, 58, is scheduled to meet Obama on June 16, and Hayward testifies to Congress the following day. "The political rhetoric is certainly heating up," said Jason Gammel, an analyst at Macquarie Securities USA Inc. "We need a discussion of how this is going to be fixed and not all the finger pointing. I hope that’s the endgame."
US banks set to lose swaps fight
by Tom Braithwaite - Financial Times
Banks are likely to lose a key lobbying battle in the US over whether they will be forced to spin off their lucrative swaps desks, according to people familiar with financial reform negotiations in Congress. Defeat, which would be a further blow to Wall Street, has been made more likely by Paul Volcker, the influential former Federal Reserve chairman, softening his opposition to the provision.
Blanche Lincoln, the Senate agriculture chairman, is the lead proponent of the plan, which would force banks to create a separately capitalised subsidiary to house the derivatives dealing operations -- a significant source of profits for big banks, such as JPMorgan Chase. The expensive restructuring could drive activity out of the largest Wall Street banks and into more lightly regulated rivals and overseas competitors, according to the Federal Reserve and Federal Deposit Insurance Corporation, which oppose the plan.
Mr Volcker -- who has become a talisman of the financial reform effort ever since the "Volcker Rule" to force banks to end proprietary trading was embraced by Barack Obama, US president, in January -- previously opposed the Lincoln provision. Although he declined to say whether he now supported it, Mr Volcker told the Financial Times that his earlier criticism was based on the belief that a stricter spin-off was in the works and it was now a "relevant question" whether damage would be done if swaps desks could be kept within a bank holding company. "I tend to think of the bank holding company as the relevant organisation," he said.
Mr Volcker added that it would be a mistake to ban banks from using swaps to hedge risk or from facilitating a customer who wants to hedge risk. "There was confusion about that -- that's the kind of thing I certainly would not do," he said. There remains disagreement over whether the legislation as currently drafted would prevent a newly capitalised swaps desk from selling a swap to a customer or from using them for its own hedging purposes. Ms Lincoln says it does not; many lawyers say it does.
Negotiations over the text, which is due to go to the White House to be signed into law by the end of next week, are focused on ensuring that those activities are preserved rather than removing the rule entirely, according to people familiar with the talks. However, that does not satisfy the industry or its regulators. Some senators want to modify the Volcker Rule, which also prevents banks from owning or sponsoring hedge funds in the name of risk reduction, to allow banks to "organise" a hedge fund and make an investment in a small amount of capital alongside a customer.
But Mr Volcker thought that would be the thin end of the wedge, adding "from my point of view, I'd like it pure". Mr Volcker, 82, has told members of Congress that he is cancelling his normal salmon fishing trip to be on hand to provide advice. "Normally I go to Canada -- where the banking system is all healthy and straightforward," he said.
In jail for being in debt
by Chris Serres and Glenn Howatt - Star Tribune
You committed no crime, but an officer is knocking on your door. More Minnesotans are surprised to find themselves being locked up over debts.
As a sheriff's deputy dumped the contents of Joy Uhlmeyer's purse into a sealed bag, she begged to know why she had just been arrested while driving home to Richfield after an Easter visit with her elderly mother. No one had an answer. Uhlmeyer spent a sleepless night in a frigid Anoka County holding cell, her hands tucked under her armpits for warmth. Then, handcuffed in a squad car, she was taken to downtown Minneapolis for booking. Finally, after 16 hours in limbo, jail officials fingerprinted Uhlmeyer and explained her offense -- missing a court hearing over an unpaid debt. "They have no right to do this to me," said the 57-year-old patient care advocate, her voice as soft as a whisper. "Not for a stupid credit card."
It's not a crime to owe money, and debtors' prisons were abolished in the United States in the 19th century. But people are routinely being thrown in jail for failing to pay debts. In Minnesota, which has some of the most creditor-friendly laws in the country, the use of arrest warrants against debtors has jumped 60 percent over the past four years, with 845 cases in 2009, a Star Tribune analysis of state court data has found.
Not every warrant results in an arrest, but in Minnesota many debtors spend up to 48 hours in cells with criminals. Consumer attorneys say such arrests are increasing in many states, including Arkansas, Arizona and Washington, driven by a bad economy, high consumer debt and a growing industry that buys bad debts and employs every means available to collect. Whether a debtor is locked up depends largely on where the person lives, because enforcement is inconsistent from state to state, and even county to county.
In Illinois and southwest Indiana, some judges jail debtors for missing court- ordered debt payments. In extreme cases, people stay in jail until they raise a minimum payment. In January, a judge sentenced a Kenney, Ill., man "to indefinite incarceration" until he came up with $300 toward a lumber yard debt. "The law enforcement system has unwittingly become a tool of the debt collectors," said Michael Kinkley, an attorney in Spokane, Wash., who has represented arrested debtors. "The debt collectors are abusing the system and intimidating people, and law enforcement is going along with it."
How often are debtors arrested across the country? No one can say. No national statistics are kept, and the practice is largely unnoticed outside legal circles. "My suspicion is the debt collection industry does not want the world to know these arrests are happening, because the practice would be widely condemned," said Robert Hobbs, deputy director of the National Consumer Law Center in Boston. Debt collectors defend the practice, saying phone calls, letters and legal actions aren't always enough to get people to pay. "Admittedly, it's a harsh sanction," said Steven Rosso, a partner in the Como Law Firm of St. Paul, which does collections work. "But sometimes, it's the only sanction we have."
Taxpayers foot the bill for arresting and jailing debtors. In many cases, Minnesota judges set bail at the amount owed. In Minnesota, judges have issued arrest warrants for people who owe as little as $85 -- less than half the cost of housing an inmate overnight. Debtors targeted for arrest owed a median of $3,512 in 2009, up from $2,201 five years ago.
Those jailed for debts may be the least able to pay. "It's just one more blow for people who are already struggling," said Beverly Yang, a Land of Lincoln Legal Assistance Foundation staff attorney who has represented three Illinois debtors arrested in the past two months. "They don't like being in court. They don't have cars. And if they had money to pay these collectors, they would."
The collection machine
The laws allowing for the arrest of someone for an unpaid debt are not new. What is new is the rise of well-funded, aggressive and centralized collection firms, in many cases run by attorneys, that buy up unpaid debt and use the courts to collect.
Three debt buyers -- Unifund CCR Partners, Portfolio Recovery Associates Inc. and Debt Equities LLC -- accounted for 15 percent of all debt-related arrest warrants issued in Minnesota since 2005, court data show. The debt buyers also file tens of thousands of other collection actions in the state, seeking court orders to make people pay. The debts -- often five or six years old -- are purchased from companies like cellphone providers and credit card issuers, and cost a few cents on the dollar. Using automated dialing equipment and teams of lawyers, the debt-buyer firms try to collect the debt, plus interest and fees. A firm aims to collect at least twice what it paid for the debt to cover costs. Anything beyond that is profit.
Portfolio Recovery Associates of Norfolk, Va., a publicly traded debt buyer with the biggest profits and market capitalization, earned $44 m illion last year on $281 million in revenue -- a 16 percent net margin. Encore Capital Group, another large debt buyer based in San D iego, had a margin last year of 10 percent. By comparison, Wal-Mart's profit margin was 3.5 percent. Todd Lansky, chief operating officer at Resurgence Financial LLC, a Northbrook, Ill.- based debt buyer, said firms like his operate within the law, which says people who ignore court orders can be arrested for contempt. By the time a warrant is issued, a debtor may have been contacted up to 12 times, he said. "This is a last-ditch effort to say, 'Look, just show up in court,'" he said.
Go to court -- or jail
At 9:30 a.m. on a recent weekday morning, about a dozen people stood in line at the Hennepin County Government Center in Minneapolis. Nearly all of them had received court judgments for not paying a delinquent debt. One by one, they stepped forward to fill out a two-page financial disclosure form that gives creditors the information they need to garnish money from their paychecks or bank accounts. This process happens several times a week in Hennepin County. Those who fail to appear can be held in contempt and an arrest warrant is issued if a collector seeks one. Arrested debtors aren't officially charged with a crime, but their cases are heard in the same courtroom as drug users.
Greg Williams, who is unemployed and living on state benefits, said he made the trip downtown on the advice of his girlfriend who knew someone who had been arrested for missing such a hearing. "I was surprised that the police would waste time on my petty debts," said Williams, 45, of Minneapolis, who had a $5,773 judgment from a credit card debt. "Don't they have real criminals to catch?"
Few debtors realize they can land in jail simply for ignoring debt-collection legal matters. Debtors also may not recognize the names of companies seeking to collect old debts. Some people are contacted by three or four firms as delinquent debts are bought and sold multiple times after the original creditor writes off the account. "They may think it's a mistake. They may think it's a scam. They may not realize how important it is to respond," said Mary Spector, a law professor at Southern Methodist University's Dedman School of Law in Dallas.
A year ago, Legal Aid attorneys proposed a change in state law that would have required law enforcement officials to let debtors fill o ut financial disclosure forms when they are apprehended rather than book them into jail. No legislator introduced the measure. Joy Uhlmeyer, who was arrested on her way home from spending Easter with her mother, said she defaulted on a $6,200 Chase credit card after a costly divorce in 2006. The firm seeking payment was Resurgence Financial, the Illinois debt buyer. Uhlmeyer said she didn't recognize the name and ignored the notices.
Uhlmeyer walked free after her nephew posted $2,500 bail. It took another $187 to retrieve her car from the city impound lot. Her 86-year-old mother later asked why she d idn't call home after leaving Duluth. Not wanting to tell the truth, Uhlmeyer said her car broke down and her cell phone died. "The really maddening part of the whole experience was the complete lack of i nformation," she said. "I kept thinking, 'If there was a warrant out for my arrest, then why in the world wasn't I told about it?'"
Jailed for $250
One afternoon last spring, Deborah Poplawski, 38, of Minneapolis was digging in her purse for coins to feed a downtown parking meter when she saw the flashing lights of a Minneapolis police squad car behind her. Poplawski, a restaurant cook, assumed she had parked illegally. Instead, she was headed to jail over a $250 credit card debt.
Less than a month earlier, she learned by chance from an employment counselor that she had an outstanding warrant. Debt Equities, a Golden Valley debt buyer, had sued her, but she says nobody served her with court documents. Thanks to interest and fees, Poplawski was now on the hook for $1,138. Though she knew of the warrant and unpaid debt, "I wasn't equating the warrant with going to jail, because there wasn't criminal activity associated with it," she said. "I just thought it was a civil thing."
She spent nearly 25 hours at the Hennepin County jail.A year later, she still gets angry recounting the experience. A male inmate groped her behind in a crowded elevator, she said. Poplawski also was ordered to change into the standard jail uniform -- gray-white underwear and orange pants, shirt and socks -- in a cubicle the size of a telephone booth. She slept in a room with 12 to 16 women and a toilet with no privacy. One woman offered her drugs, she said.
The next day, Poplawski appeared before a Hennepin County district judge. He told her to fill out the form listing her assets and bank account, and released her. Several weeks later, Debt Equities used this information to seize funds from her bank account. The firm didn't return repeated calls seeking a comment. "We hear every day about how there's no money for public services," Poplawski said. "But it seems like the collectors have found a way to get the police to do their work."
Threat depends on location
A lot depends on where a debtor lives or is arrested, as Jamie Rodriguez, 41, a bartender f rom Brooklyn Park, discovered two years ago.Deputies showed up at his house one evening while he was playing with his 5-year- old daughter, Nicole. They live in Hennepin County, where the Sheriff's Office has enough staff to seek out people with warrants for civil violations. If Rodriquez lived in neighboring Wright County, he could have simply handed the officers a check or cash for the amount owed. If he lived in Dakota County, it's likely no deputy would have shown up because the Sheriff's Office there says it lacks the staff to pursue civil debt cases.
Knowing that his daughter and wife were watching from the window, Rodriguez politely asked the deputies to drive him around the block, out of sight of his family, before they handcuffed him. The deputies agreed. "No little girl should have to see her daddy arrested," said Rodriguez, who spent a night in jail.
"If you talk to 15 different counties, you'll find 15 different approaches to handling civil warrants," said Sgt. Robert Shingledecker of the Dakota County Sheriff's Office. "Everything is based on manpower."Local police also can enforce debt-related warrants, but small towns and some suburbs often don't have enough officers.
The Star Tribune's comparison of warrant and booking data suggests that at least 1 in 6 Minnesota debtors at risk for arrest actually lands in jail, typically for eight hours. The exact number of such arrests isn't known because the government doesn't consistently track what happens to debtor warrants. "There are no standards here," said Gail Hillebrand, a senior attorney with the Consumers Union in San Francisco. "A borrower who lives on one side of the river can be arrested while another one goes free. It breeds disrespect for the law."
Haekyung Nielsen, 27, of Bloomington, said police showed up at her house on a civil warrant two weeks after she gave birth through Caesarean section. A debt buyer had sent her court papers for an old credit-card debt while she was in the hospital; Nielsen said she did not have time to respond. Her baby boy, Tyler, lay in the crib as she begged the officer not to take her away. "Thank God, the police had mercy and left me and my baby alone," said Nielsen, who laterpaid the debt. "But to send someone to arrest me two weeks after a massive surgery that takes most women eight weeks to recover from was just unbelievable."
The second surprise
Many debtors, like Robert Vee, 36, of Brooklyn Park, get a second surprise after being arrested -- their bail is exactly the amount of money owed. Hennepin County automatically sets bail at the judgment amount or $2,500, whichever is less. This policy was adopted four years ago in response to the high volume of debtor default cases, say court officials.
Some judges say the practice distorts the purpose of bail, which is to make sure people show up in court. "It's certainly an efficient way to collect debts, but it's also highly distasteful," said Hennepin County District Judge Jack Nordby. "The amount of bail should have nothing to do with the amount of the debt." Judge Robert Blaeser, chief of the county court's civil division, said linking bail to debt streamlines the process because judges needn't spend time setting bail."It's arbitrary," he conceded. "The bigger question is: Should you be allowed to get an order from a court for someone to be arrested because they owe money? You've got to remember there are people who have the money but just won't pay a single penny."
If friends or family post a debtor's bail, they can expect to kiss the money goodbye, because it often ends up with creditors, who routinely ask judges for the bail payment.
Vee, a highway construction worker, was arrested one afternoon in February while driving his teenage daughter from school to their home in Brooklyn Park. As he was being cuffed, Vee said his daughter, who has severe asthma, started hyperventilating from the stress. "All I kept thinking about was whether she was all right and if she was using her [asthma] inhaler," he said. From the Hennepin County jail, he made a collect call to his landlord, who promised to bring the bail. It was $1,875.06, the exact amount of a credit card debt.
Later, Vee was reunited with his distraught daughter at home. "We hugged for a longtime, and she was bawling her eyes out," he said. He still has unpaid medical and credit card bills and owes about $40,000 on an old second mortgage. The sight of a squad car in his rearview mirror is all it takes to set off a fresh wave of anxiety. "The question always crosses my mind: 'Are the cops going to arrest me again?'" he said. "So long as I've got unpaid bills, the threat is there."
Emergency Bans on Naked CDS Trades Considered by EU
by Ben Moshinsky - Bloomberg Businessweek
National regulators may be given "emergency powers" to "prohibit or restrict" naked credit- default swaps trades, under proposals being considered by the European Union in the wake of the Greek debt crisis. The measures would be "temporary in nature and subject to coordination" by the European Securities and Markets Authority, the European Commission said in a statement. The European Parliament is scheduled to vote tomorrow on a separate plan to restrict trading in credit-default swaps. Bans may be considered in case of "adverse developments which constitute a serious threat to financial stability or to market confidence," the commission, the EU’s executive body, said today.
French President Nicolas Sarkozy and German Chancellor Angela Merkel called on the commission last week to speed up curbs on financial speculation, saying some bets against stocks and government bonds should be banned as markets suffer a resurgence of "strong volatility." Germany banned some naked short-selling last month. The debt crisis sent the euro to a four-year low against the dollar on June 7 and has wiped out more than $4 trillion from global stock markets this year. European leaders unveiled a 750 billion-euro ($910 billion) rescue mechanism last month to stem contagion from Greece, initially reversing a surge in the risk premium on Spanish and Portuguese bonds.
Commission president Jose Barroso and Financial Services Commissioner Michel Barnier last week promised to accelerate their plans to regulate credit-default swaps, without saying if they would favor a ban on some transactions. They’ve said the German measures would have been more effective had they been coordinated across the 27-nation bloc. The commission said today it’s seeking views on its swaps plan as part of public consultations on possible rules that also include over-the-counter derivatives. Respondents have until July 10 to submit views on the policy options. In a separate report, members of the European Parliament’s economic and monetary affairs committee called for a ban on "CDS transactions with no underlying credit which are purely speculative transactions involving bets on credit defaults."
"There are some political groups that want to ban naked sovereign CDS," said Werner Langen, the sponsor of the report at the EU assembly, whose role is to amend proposed laws drawn up by the commission. Langen, a German Christian Democrat member of the Parliament, said he personally doesn’t support calls for a ban, inserted by socialist and Green lawmakers on the committee. He said he favors giving "regulatory authorities the possibility to check on a case by case basis."
Credit-default swaps are derivatives that pay the buyer face value if a borrower -- a country or a company -- defaults. In exchange, the swap seller gets the underlying securities or the cash equivalent. Traders in naked credit-default swaps buy insurance on bonds they don’t own. "Financial firms and some sovereigns are dependent on market funding in the short term," Richard Portes, professor of economics at London Business School, said in a telephone interview. "That’s where naked CDS can do the most damage."
Debt Burden Falls Heavily on Germany and France
by Jack Ewing New York Times
French and German banks have lent nearly $1 trillion to the most troubled European countries and are more exposed to the debt crisis than the banks of any other countries, according to a new report that is likely to add pressure on institutions to detail their holdings. French banks had lent $493 billion to Spain, Greece, Portugal and Ireland by the end of 2009 while German banks had lent $465 billion, according to the report by the Bank for International Settlements, an institution based in Basel, Switzerland, that acts as a clearing house for the world’s central banks.
The report sheds light on where the risks from Spain and other troubled euro-zone countries are concentrated, but left open the question of which individual banks would be most endangered by declines in the prices of sovereign bonds or a surge in bad loans made to companies and individuals. The B.I.S. did not identify individual institutions, in line with its confidentiality rules.
Voluntary disclosure by banks has been uneven. Hypo Real Estate Holding, a real estate and public-sector lender based near Munich, has put its exposure to government debt from the four countries plus Italy at more than €80 billion, or $97 billion. Deutsche Bank, in Frankfurt, says it holds €500 million in Greek government bonds and no Spanish or Portuguese sovereign debt. But there has been little disclosure from the hundreds of smaller mortgage lenders, state-owned banks and savings banks that dominate banking in countries like Germany and Spain.
"More information and disclosure on bank and financial institutions’ holdings of periphery paper would be beneficial," Jacques Cailloux, an economist at Royal Bank of Scotland, said Sunday. Mr. Cailloux had not seen the report — which was released to news organizations on the condition that they not publish the findings until late Sunday — but he was one of the authors of a Royal Bank of Scotland study in May that anticipated many of the B.I.S. findings.
All told, Spain, Ireland, Portugal and Greece owe nearly $1.6 trillion to banks in the 16-country euro zone, either in the form of government debt or credit to companies and individuals in the four countries, the report said. Credit from French and German banks accounted for 61 percent of that total. Uncertainty about which banks may be at risk from Greece and the other countries has fed mistrust among financial institutions, causing interbank lending to wither and leading European Union leaders to take extraordinary steps to prevent a financial collapse.
The European Central Bank has been pressuring E.U. regulators to release data on which banks may be most at risk, to separate the healthy banks from those that may be in trouble. "We are encouraging them to do whatever is necessary to improve the sentiment of the market because that is the real issue today," the E.C.B. president, Jean-Claude Trichet, said at a news conference last week. Mr. Cailloux said that releasing the results of so-called stress tests, which examine banks’ ability to withstand market shocks, would be useful if the tests were based on realistic possibilities and there were measures in place to bolster the banks that prove vulnerable.
The lack of information about which banks could suffer most from Europe’s debt crisis led to the near-seizure of money markets in early May. That, along with plunging prices for sovereign bonds from the weakest countries, prompted the European Union and the International Monetary Fund to pledge nearly $1 trillion in debt guarantees for euro-zone governments. The European Central Bank also took the unprecedented step of buying European government bonds in the open markets, where trading had nearly come to a halt. "There is mounting evidence that the blind don’t want to lend to the blind," Ed Yardeni, president of Yardeni Research, wrote in a research note last week.
The B.I.S. figures confirm estimates of the level of risk by analysts at Royal Bank of Scotland and others, which had been extrapolated from B.I.S. data and other sources. But the B.I.S. report provides more detail on country-by-country exposure, and the organization’s imprimatur means it will be difficult for critics to dismiss the information as exaggerated. Most of the claims held by the French and German banks were from companies, individuals or other banks, and Spain was the biggest debtor country. But much of the holdings were government debt — $106 billion for French banks and $68 billion for German banks. The figures, which the B.I.S. presented in dollars, may offer a clue why the French government, in particular, has been keen to provide aid to Greece and the other troubled countries.
Private-sector debt from Spain, Greece, Portugal and Ireland has also become a concern, because government austerity programs and economic downturns in those countries may also take a toll on the ability of companies and individuals to repay loans, and lead to a surge in defaults. The risk from the so-called peripheral countries is by no means limited to France and Germany. British banks have lent $230 billion to Ireland, while Spain — besides being one of the countries with a debt problem — has lent $110 billion to residents of Portugal. The B.I.S. put total exposure by U.S. institutions to Spain, Greece, Portugal and Ireland at less than $200 billion.
France plans to cut spending by $54.5 billion
France joined other European nations in announcing on Saturday an austerity plan that would involve 45 billion euros (54.5 billion dollars) in spending cuts over the next three years. Prime Minister Francois Fillon said the cuts were aimed at bringing France's public deficit back down to the European Union's limit of three percent of gross domestic product by 2013. "We've made a commitment to bring down our deficit from eight to three percent by 2013 and we will concentrate all of our efforts on it," Fillon said at a meeting of new members of his UMP party.
France's first announcement of austerity measures came as bond markets have mounted pressure on eurozone nations to get their public finances under control in the wake of the devastating Greek debt crisis. Fillon said the government would cut the public deficit by 100 billion euros, with half coming from slashing spending and half from increasing revenues. The prime minister broadly outlined where the savings would come from, including 45 billion euros in spending cuts and five billion euros from closing tax loopholes.
The centre-right premier is also counting on a rebound in the economy to bring in an additional 35 billion euros. "As and when growth returns, revenues will grow once again," said Fillon. The remaining 15 billion euros will come from halting temporary measures to boost the economy, he added. Up to now, Paris has not adopted an outright austerity plan, only imposing a spending freeze. France has prided itself on supporting the economy through the worst of the global slump despite the cost of an expanding budget deficit. However, Germany's quick readiness to wield the budget knife has made Europe's economic powerhouse even more attractive in the bond market, putting more heat on France to do likewise.
After a record deficit of 8.0 percent of GDP this year, Fillon says the austerity measures aim to reduce the deficit to 6.0 percent by 2011, 4.6 percent in 2012 and 3.0 percent in 2013. The markets have wanted to see action and have been fretting over what has been seen as a lack of political will in Paris to take the stiff medicine adopted by Germany, a problem investors fear could get worse in the run-up to the 2012 presidential elections. France nevertheless still enjoys the support of international investors and its top credit rating does not seem in any immediate danger, analysts say.
The Bank of France this week said that the French economy would grow by 0.5 percent in the second quarter of the year, even as a first estimate from the official statistics institute for the first quarter showed that growth was only 0.1 percent. The government is counting on the economy growing by 1.4 percent for the whole of this year, having experienced the severest recession in 2009 since World War II with a contraction of 2.5 percent.
Sources close to Economy Minister Christine Lagarde said that the target for 2010, which requires average growth of 0.4 percent in each of the last three quarters of the year, had not been undermined by the weak growth figure for the first quarter. The government's forecast is in line with an estimate from the International Monetary Fund that the French economy would grow by 1.5 percent this year and by the European Commission foreseeing growth of 1.3 percent.
Rising Tension as China Weighs a Double Dip
by Wang Xu and Wang Changyong - Caixin
Credit policy, real estate controls, export fears and local government investment trends are casting a shadow over growth in China
Nerves started fraying for a Shanghai property developer named Xue just a few weeks after he scraped together several million yuan from family and friends for a private, high-interest loan to a Wenzhou electrical equipment company. Xue had expected substantial returns after the borrower agreed to a 30 percent interest rate and signed the loan deal last November. But his optimism started fading fast when interest rates for private loans began to rise, bank credit tightened, and the government introduced new real estate market controls that affected his core business.
Meanwhile, Wenzhou business owners started comparing conditions in late 2009 to the second half of 2008, when local companies foundered in the global financial crisis and private borrowers failed to repay. Sensing trouble, an anxious Xue called the loan. In so doing, he acted on increasingly cautious sentiments – and sometimes confusing signals – surrounding China's latest economic trends.
Since at least mid-April, investors have lowered expectations for commodities and stock markets. Prices for non-ferrous metals and other commodities have fallen from highs posted earlier in the year, and the Shanghai A-share market index declined 19.5 percent between April 15 and June 4. Government measures in the first quarter pinched some sectors as regulators sought to prevent overheating, especially in the real estate industry. Debt controls were ramped up for local government funding platforms, affecting local investment behavior.
Meanwhile, Europe's ongoing sovereign debt crisis and other external factors cast a pall over China's foreign trade. The changes that Xue sensed in December were generally hidden behind strong first quarter statistics for China's economy. But by April, the party was obviously over. "April and May saw important changes for domestic and foreign policy, as well as financial trends," said Ha Jiming, chief economist at China International Capital Corp. (CICC). And rising concerns that the global economy may be headed toward the second trough of a double dip have further underscored the challenges to China's future growth.
A State Council decision April 14 to tighten property market controls was the first in a series of policy moves affecting loans, land auctions and new construction. Housing prices cooled as hoped, but so did the market and investor sentiment. Another round of controls came in late May, when the State Council outlined a plan to gradually introduce property taxes. The cooling for real estate also slowed overall investment. Leading the turnaround were stricter bank lending policies that started in March.
China Index Research Institute data indicated that many potential investors started taking a wait-and-see approach to housing purchases in the wake of the regulatory policies. As a result, the combined property area sold in China's major cities fell about 44 percent in May from last year, which in turn lowered overall investment levels. Urban fixed asset investment officially grew 26.1 percent during the first four months of the year, 4.4 percentage points below the growth posted the same time last year and down 0.3 percentage points from the first quarter this year. But these figures reflected substantially higher prices, not the physical volume of fixed asset investment, which grew at a much slower rate.
According to CICC analysts Xing Ziqiang and Xu Jian, April's real investment growth probably declined to 19 percent – far below the 38 percent tallied in December 2009. Likewise, the number of new construction projects was expected to fall substantially through 2010. Wang Binqing, a real estate industry researcher at Century Securities, said he now expects new construction starts to decline 23 percent month-on-month in April, although the year-on-year figure jumps nearly 72 percent for the same month.
For developers such as Xue, the affects of real estate regulation have been apparent. "After just a few short months," he said, "I already have friends who can't start projects because they can't get loans." And not only developers are worried; the real estate industry has a powerful impact on market sentiment nationwide, since property investment accounted for 12.8 percent of China's GDP last year as well as 22.1 percent of all urban fixed asset investment.
Just as real estate investment was slowing, local governments started reducing their investments on infrastructure and other projects through government funding platforms. The spending stream narrowed after the China Banking Regulatory Commission (CBRC) ordered commercial banks to clean up and consolidate loans to platforms. Beginning in the second half of 2009, CBRC and the central bank had investigated funding platforms. They planned to unleash new platform management practices in May, but had to delay after local governments complained.
Less investment by local governments as well as in real estate were just what the central government was looking for to counteract concerns of overheating in the national economy – concerns exacerbated by an 11.9 percent increase for China's GDP in the first quarter. However, experts say if investment restrictions continue along with weak foreign demand for Chinese exports, growth may falter. A soft real estate market would put even more pressure on Chinese investor outlook.
A New Engine?
Might a new growth engine be waiting in the garage? Some say an increase in affordable housing construction this year could serve as a hedge, averting a slowdown for real estate investment growth and helping to keep overall economic growth at least at 2009 levels. "Over the next 12 months, the government will take relatively significant action on low-rent housing," predicted Lou Gang, a China strategist at Morgan Stanley.
Recent policy moves supported Lou's prediction. On May 19, for example, the Ministry of Housing and Urban-Rural Development signed a commitment with provincial and city governments to add a record 7 million affordable units this year. Some 5.8 million new, affordable homes would be added to the nation's housing stock, and 1.2 million substandard homes would be renovated. Assuming each home averages 60 square meters, those 7 million additional homes would equal 420 million square meters, an area equal to 36.5 percent of the new construction nationwide last year.
Deputy Director of the State Council Research Institute of Finance Ba Shusong said strict accountability mechanisms have been put in place at the local governments to guarantee the target is met. And real estate controls may be loosened in the second half of the year with a possible easing of credit restrictions on government investment. While in Tianjin on mid-May, Prime Minister Wen Jiabao said China "must focus on macroeconomic policy coordination and regulate the overall adjustment control efforts, while also preventing negative effects from the overlay of the number of policies."
A key goal, the premier said, is "to always have a reasonable grasp of the intensity of the policies." These comments prompted some analysts to predict more fine-tuning for policies originally implemented to tighten credit and investment. Indeed, municipal and local bond sales were quickly approved by the central government, giving veracity to this opinion. On May 14, the Ministry of Finance said the central government had allocated more than 24.8 billion yuan for rebuilding in earthquake disaster zones in Sichuan, Gansu and Shaanxi provinces. Emphasis was placed on city and town infrastructure, public services, disaster relief, industrial reconstruction and other projects – some 4,000 projects in total.
Over the past half-year, the Ministry of Finance has allocated all disaster reconstruction funding. In early May, municipal bonds for Anshan, Ordos, Fushun and other cities were approved and successfully issued. An analyst at China Chengxin International Rating Co. Ltd. who worked on municipal bond ratings told Caixin the municipal bonds had stalled after being filed with the National Development and Reform Commission (NDRC) early this year. "We don't know why they were never approved, despite constant pressure," he said. "But recently, more than a dozen were approved."
Altogether, officials have started to distribute 200 billion yuan in local government bonds managed by the finance ministry. They're being divided among every province, municipality, district and designated city. An economic development official at the finance ministry told Caixin the local bond issuance plan had been ready for some time but was waiting to be released at an appropriate time. "First quarter economic growth was so high, how could the government further speed up investment?" he asked.
Last December, the National Audit Office said 9 billion yuan in local government funds designated by the central government for projects aimed at expanding domestic demand had yet to be committed. These represented 45 percent of these project funds. But the latest slowdown period was apparently the appropriate time. "If real estate investment is to come down, there needs to be a supplement," said Zhang Hanya, an NDRC researcher. "In general, this year is about controlling new construction projects and guaranteeing current projects. But some reconstruction projects last year lacked local money and were not completed. "So it's best to give local funding platforms some degree of comfort," Zhang said.
Gao Huiqing, a member of the State Information Center Expert Committee, said the slow pace of municipal and local bond issues at the beginning of the year are now weighing on local funding platforms, raising credit risks and risking economic decline. "But the government doesn't want to see a bunch of unfinished projects," Gao said. "Therefore, it is a controlled pace, not a complete block."
But the European sovereign debt crisis is out of the government's hands, prompting a cautious outlook toward exports. Even Wen Jiabao is raising a red flag. "Some say the global economy has already recovered and now we can consider exit mechanisms," said the Chinese premier May 31 at a luncheon sponsored by the Japan Business Federation. "I believe this judgment is premature.
"We cannot be 100 percent certain" that the global economy will not experience a second dip, he said. "So we must closely watch and take precautions against such risks." Some analysts think the debt crisis that began in Greece will spread to Spain, Portugal and other southern European countries. As these countries weaken, consumer demand for Chinese goods may soften as well. At the same time, a debt crisis may intensify a devaluation of the euro against the U.S. dollar and yuan. This could further affect China's exports. So far this year, the yuan has appreciated 15 percent against the euro, putting more pressure on Chinese exporters.
"Devaluation of the euro will certainly seriously affect us, but we haven't seen it yet," said Kang Quan, international affairs manager at a cable manufacturer in Shenzhen. "This year's pre-September orders were all made at the end of 2009 or the beginning of 2010," he said. "The effect of the euro's devaluation will be apparent in the fourth quarter this year and the first quarter next year. And the seesaw in prices over the next few months will be difficult for both buyers and sellers."
Afghanistan ‘Holds $1 Trillion In Mineral Deposits’
Afghanistan has nearly $US1 trillion in untapped mineral deposits, far more than previously thought and enough to turn a country devastated by decades of war into one of the most important mining centres in the world, according to senior US officials. The deposits, which include large veins of iron, copper, cobalt, gold and lithium are so large they could alter the Afghan economy, American geologists said after discovering the resources. An internal Pentagon memo says that the country could become the ‘Saudi Arabia of lithium’, a key industrial metal.
"There is stunning potential here," General David Petraeus, the head of US Central Command, told The New York Times. "There are a lot of ifs, of course, but I think potentially it is hugely significant." The Afghan government and President Hamid Karzai have been briefed, US officials said. The devastated country has already emerged as the latest frontier in the rush for mineral resources. In April, plans were announced to start mining copper in the Aynak valley, soutwest of Kabul, which holds one of the world’s biggest untapped copper deposits, estimated to be worth up to $88_billion (£44 billion) – more than double Afghanistan’s entire gross domestic product (GDP) in 2007.
In November, a 30-year lease was sold to the China Metallurgical Group for $3 billion, making it the biggest foreign investment and private business venture in Afghanistan’s history. However despite the latest finds, with no mining industry in place it would take decades to develop an infrastructure to exploit the vast mineral reserves which are scattered throughout the country including along the border with Pakistan where some of the most intense fighting has taken place. But US authorities are hopeful that the scale of the deposits is such that they will attract huge investment regardless. "This will become the backbone of the Afghan economy," Jalil Jumriany, an adviser to the Afghan minister of mines told the newspaper.
'Act two' of crisis begins: Soros
by Henry Blodget - Business Insider
George Soros recently gave a speech at a conference in Vienna. Here's a transcript, courtesy of Australia's The Age. We've highlighted the important bits.
In the week following the bankruptcy of Lehman Brothers on Sept. 15, 2008 — global financial markets actually broke down, and by the end of the week, they had to be put on artificial life support. The life support consisted of substituting sovereign credit for the credit of financial institutions, which ceased to be acceptable to counterparties.
As Mervyn King of the Bank of England brilliantly explained, the authorities had to do in the short term the exact opposite of what was needed in the long term: they had to pump in a lot of credit to make up for the credit that disappeared, and thereby reinforce the excess credit and leverage that had caused the crisis in the first place. Only in the longer term, when the crisis had subsided, could they drain the credit and re-establish macroeconomic balance.
This required a delicate two-phase maneuver just as when a car is skidding. First you have to turn the car into the direction of the skid and only when you have regained control can you correct course.
The first phase of the maneuver has been successfully accomplished — a collapse has been averted. In retrospect, the temporary breakdown of the financial system seems like a bad dream. There are people in the financial institutions that survived who would like nothing better than to forget it and carry on with business as usual. This was evident in their massive lobbying effort to protect their interests in the Financial Reform Act that just came out of Congress. But the collapse of the financial system as we know it is real, and the crisis is far from over.
Indeed, we have just entered Act II of the drama, when financial markets started losing confidence in the credibility of sovereign debt. Greece and the euro have taken center stage, but the effects are liable to be felt worldwide. Doubts about sovereign credit are forcing reductions in budget deficits at a time when the banks and the economy may not be strong enough to permit the pursuit of fiscal rectitude. We find ourselves in a situation eerily reminiscent of the 1930s. Keynes has taught us that budget deficits are essential for counter cyclical policies, yet many governments have to reduce them under pressure from financial markets. This is liable to push the global economy into a double dip.
It is important to realize that the crisis in which we find ourselves is not just a market failure but also a regulatory failure, and even more importantly, a failure of the prevailing dogma about financial markets. I have in mind the Efficient Market Hypothesis and Rational Expectation Theory. These economic theories guided, or more exactly misguided, both the regulators and the financial engineers who designed the derivatives and other synthetic financial instruments and quantitative risk management systems which have played such an important part in the collapse. To gain a proper understanding of the current situation and how we got to where we are, we need to go back to basics and re-examine the foundation of economic theory.
I have developed an alternative theory about financial markets which asserts that financial markets do not necessarily tend toward equilibrium; they can just as easily produce asset bubbles. Nor are markets capable of correcting their own excesses. Keeping asset bubbles within bounds have to be an objective of public policy. I propounded this theory in my first book, “The Alchemy of Finance,” in 1987. It was generally dismissed at the time, but the current financial crisis has proven, not necessarily its validity, but certainly its superiority to the prevailing dogma.
Let me briefly recapitulate my theory for those who are not familiar with it. It can be summed up in two propositions. First, financial markets, far from accurately reflecting all the available knowledge, always provide a distorted view of reality. This is the principle of fallibility. The degree of distortion may vary from time to time. Sometimes it’s quite insignificant, at other times it is quite pronounced. When there is a significant divergence between market prices and the underlying reality I speak of far from equilibrium conditions. That is where we are now.
Second, financial markets do not play a purely passive role; they can also affect the so-called fundamentals they are supposed to reflect. These two functions that financial markets perform work in opposite directions. In the passive or cognitive function, the fundamentals are supposed to determine market prices. In the active or manipulative function market, prices find ways of influencing the fundamentals. When both functions operate at the same time, they interfere with each other. The supposedly independent variable of one function is the dependent variable of the other, so that neither function has a truly independent variable. As a result, neither market prices nor the underlying reality is fully determined. Both suffer from an element of uncertainty that cannot be quantified. I call the interaction between the two functions reflexivity. Frank Knight recognized and explicated this element of unquantifiable uncertainty in a book published in 1921, but the Efficient Market Hypothesis and Rational Expectation Theory have deliberately ignored it. That is what made them so misleading.
Reflexivity sets up a feedback loop between market valuations and the so-called fundamentals which are being valued. The feedback can be either positive or negative. Negative feedback brings market prices and the underlying reality closer together. In other words, negative feedback is self-correcting. It can go on forever, and if the underlying reality remains unchanged, it may eventually lead to an equilibrium in which market prices accurately reflect the fundamentals. By contrast, a positive feedback is self-reinforcing. It cannot go on forever because eventually, market prices would become so far removed from reality that market participants would have to recognize them as unrealistic. When that tipping point is reached, the process becomes self-reinforcing in the opposite direction. That is how financial markets produce boom-bust phenomena or bubbles. Bubbles are not the only manifestations of reflexivity, but they are the most spectacular.
In my interpretation equilibrium, which is the central case in economic theory, turns out to be a limiting case where negative feedback is carried to its ultimate limit. Positive feedback has been largely assumed away by the prevailing dogma, and it deserves a lot more attention.
I have developed a rudimentary theory of bubbles along these lines. Every bubble has two components: an underlying trend that prevails in reality and a misconception relating to that trend. When a positive feedback develops between the trend and the misconception, a boom-bust process is set in motion. The process is liable to be tested by negative feedback along the way, and if it is strong enough to survive these tests, both the trend and the misconception will be reinforced. Eventually, market expectations become so far removed from reality that people are forced to recognize that a misconception is involved. A twilight period ensues during which doubts grow and more and more people lose faith, but the prevailing trend is sustained by inertia. As Chuck Prince, former head of Citigroup, said, “As long as the music is playing, you’ve got to get up and dance. We are still dancing.” Eventually a tipping point is reached when the trend is reversed; it then becomes self-reinforcing in the opposite direction.
Typically bubbles have an asymmetric shape. The boom is long and slow to start. It accelerates gradually until it flattens out again during the twilight period. The bust is short and steep because it involves the forced liquidation of unsound positions. Disillusionment turns into panic, reaching its climax in a financial crisis.
The simplest case of a purely financial bubble can be found in real estate. The trend that precipitates it is the availability of credit; the misconception that continues to recur in various forms is that the value of the collateral is independent of the availability of credit. As a matter of fact, the relationship is reflexive. When credit becomes cheaper, activity picks up and real estate values rise. There are fewer defaults, credit performance improves, and lending standards are relaxed. So at the height of the boom, the amount of credit outstanding is at its peak, and a reversal precipitates false liquidation, depressing real estate values.
The bubble that led to the current financial crisis is much more complicated. The collapse of the subprime bubble in 2007 set off a chain reaction, much as an ordinary bomb sets off a nuclear explosion. I call it a superbubble. It has developed over a longer period of time, and it is composed of a number of simpler bubbles. What makes the superbubble so interesting is the role that the smaller bubbles have played in its development.
The prevailing trend in the superbubble was the ever-increasing use of credit and leverage. The prevailing misconception was the belief that financial markets are self-correcting and should be left to their own devices. President Reagan called it the “magic of the marketplace,” and I call it market fundamentalism. It became the dominant creed in the 1980s. Since market fundamentalism was based on false premises, its adoption led to a series of financial crises. Each time, the authorities intervened, merged away, or otherwise took care of the failing financial institutions, and applied monetary and fiscal stimuli to protect the economy. These measures reinforced the prevailing trend of ever-increasing credit and leverage, and as long as they worked, they also reinforced the prevailing misconception that markets can be safely left to their own devices. The intervention of the authorities is generally recognized as creating amoral hazard; more accurately it served as a successful test of a false belief, thereby inflating the superbubble even further.
It should be emphasized that my theories of bubbles cannot predict whether a test will be successful or not. This holds for ordinary bubbles as well as the superbubble. For instance, I thought the emerging market crisis of 1997-98 would constitute the tipping point for the superbubble, but I was wrong. The authorities managed to save the system and the superbubble continued growing. That made the bust that eventually came in 2007-8 all the more devastating.
What are the implications of my theory for the regulation of the financial system?
First and foremost, since markets are bubble-prone, the financial authorities have to accept responsibility for preventing bubbles from growing too big. Alan Greenspan and other regulators have expressly refused to accept that responsibility. If markets can’t recognize bubbles, Greenspan argued, neither can regulators — and he was right. Nevertheless, the financial authorities have to accept the assignment, knowing full well that they will not be able to meet it without making mistakes. They will, however, have the benefit of receiving feedback from the markets, which will tell them whether they have done too much or too little. They can then correct their mistakes.
Second, in order to control asset bubbles it is not enough to control the money supply; you must also control the availability of credit. This cannot be done by using only monetary tools; you must also use credit controls. The best-known tools are margin requirements and minimum capital requirements. Currently, they are fixed irrespective of the market’s mood, because markets are not supposed to have moods. Yet they do, and the financial authorities need to vary margin and minimum capital requirements in order to control asset bubbles.
Regulators may also have to invent new tools or revive others that have fallen into disuse. For instance, in my early days in finance, many years ago, central banks used to instruct commercial banks to limit their lending to a particular sector of the economy, such as real estate or consumer loans, because they felt that the sector was overheating. Market fundamentalists consider that kind of intervention unacceptable, but they are wrong. When our central banks used to do it, we had no financial crises to speak of. The Chinese authorities do it today, and they have much better control over their banking system. The deposits that Chinese commercial banks have to maintain at the People’s Bank of China were increased 17 times during the boom, and when the authorities reversed course, the banks obeyed them with alacrity.
Third, since markets are potentially unstable, there are systemic risks in addition to the risks affecting individual market participants. Participants may ignore these systemic risks in the belief that they can always dispose of their positions, but regulators cannot ignore them because if too many participants are on the same side, positions cannot be liquidated without causing a discontinuity or a collapse. They have to monitor the positions of participants in order to detect potential imbalances. That means that the positions of all major market participants, including hedge funds and sovereign wealth funds, need to be monitored. The drafters of the Basel Accords made a mistake when they gave securities held by banks substantially lower risk ratings than regular loans: they ignored the systemic risks attached to concentrated positions in securities. This was an important factor aggravating the crisis. It has to be corrected by raising the risk ratings of securities held by banks. That will probably discourage loans, which is not such a bad thing.
Fourth, derivatives and synthetic financial instruments perform many useful functions, but they also carry hidden dangers. For instance, the securitization of mortgages was supposed to reduce risk through geographical diversification. In fact, it introduced a new risk by separating the interest of the agents from the interest of the owners. Regulators need to fully understand how these instruments work before they allow them to be used, and they ought to impose restrictions guard against those hidden dangers. For instance, agents packaging mortgages into securities ought to be obliged to retain sufficient ownership to guard against the agency problem.
Credit-default swaps (C.D.S.) are particularly dangerous. They allow people to buy insurance on the survival of a company or a country while handing them a license to kill. C.D.S. ought to be available to buyers only to the extent that they have a legitimate insurable interest. Generally speaking, derivatives ought to be registered with a regulatory agency just as regular securities have to be registered with the S.E.C. or its equivalent. Derivatives traded on exchanges would be registered as a class; those traded over-the-counter would have to be registered individually. This would provide a powerful inducement to use exchange traded derivatives whenever possible.
Finally, we must recognize that financial markets evolve in a one-directional, nonreversible manner. The financial authorities, in carrying out their duty of preventing the system from collapsing, have extended an implicit guarantee to all institutions that are “too big to fail.” Now they cannot credibly withdraw that guarantee. Therefore, they must impose regulations that will ensure that the guarantee will not be invoked. Too-big-to-fail banks must use less leverage and accept various restrictions on how they invest the depositors’ money. Deposits should not be used to finance proprietary trading. But regulators have to go even further. They must regulate the compensation packages of proprietary traders to ensure that risks and rewards are properly aligned. This may push proprietary traders out of banks, into hedge funds where they properly belong. Just as oil tankers are compartmentalized in order to keep them stable, there ought to be firewalls between different markets. It is probably impractical to separate investment banking from commercial banking as the Glass-Steagall Act of 1933 did. But there have to be internal compartments keeping proprietary trading in various markets separate from each other. Some banks that have come to occupy quasi-monopolistic positions may have to be broken up.
While I have a high degree of conviction on these five points, there are many questions to which my theory does not provide an unequivocal answer. For instance, is a high degree of liquidity always desirable? To what extent should securities be marked to market? Many answers that followed automatically from the Efficient Market Hypothesis need to be re-examined.
It is clear that the reforms currently under consideration do not fully satisfy the five points I have made, but I want to emphasize that these five points apply only in the long run. As Mervyn King explained, the authorities had to do in the short run the exact opposite of what was required in the long run. And as I said earlier, the financial crisis is far from over. We have just ended Act II. The euro has taken center stage, and Germany has become the lead actor. The European authorities face a daunting task: they must help the countries that have fallen far behind the Maastricht criteria to regain their equilibrium while they must also correct the deficiencies of the Maastricht Treaty which have allowed the imbalances to develop. The euro is in what I call a far-from-equilibrium situation. But I prefer to discuss this subject in Germany, which is the lead actor, and I plan to do so at the Humboldt University in Berlin on June 23. I hope you will forgive me if I avoid the subject until then.