"Knight House, Fredericksburg, Virginia. Taken on commission of Mrs. Devore of Chatham"
Ilargi: More than enough has been said about Obama's Oval Office speech yesterday, and little of it was positive. I have just one thing to add, specifically about the "deal" reached today between the White House and BP, in which it was agreed that the oil company is on the hook for a $20 billion escrow fund, to be paid over several years (BP only has some $8.5 billion in cash presently, and will not pay second quarter dividends, which would have cost $10 billion). This escrow fund only covers Gulf of Mexico residents. What, one wonders, will happen to residents of Atlantic states once the oil imperils their beaches and livelihoods for years to come?
For the other major news item of the day, here's Stoneleigh:
Stoneleigh: So, Fannie Mae and Freddie Mac are to be delisted from the NYSE. Stocks on the exchange must either act to boost the share price or delist if they show an average share price below $1 for over 30 days, which has been the case for Fannie Mae. It's hardly surprising that the companies should be perceived as virtually worthless, considering that they preside over about half ($5.5 trillion) of a mortgage market in terrible trouble. Moving away from even the limited accountability of public listing is also no surprise. Confidence games require reality to be obscured for as long as possible. While the move is being spun, especially in the case of Freddie Mac, as compatible "with a goal of conservatorship and the preservation and conservation of assets", in reality there is little future value to protect.
Taxpayers have pumped in $145 billion already, as the alternative would have been a property price collapse. That is still clearly on the cards if support were to be withdrawn, hence the unlimited nature of the guarantee that has been offered, meaning unlimited liability for the taxpayer. Support has been greater than for other noted basket-cases such as AIG, and there is no end in sight to the red ink these companies seem capable of generating.
A worst case scenario of $1 trillion in losses has been mentioned, based on a further 20% decline in house prices and a tripling of the default rate. However, I find it inconceivable that such a mild outcome could be viewed as a worst case. Bubbles always show an undershoot to the downside as they implode. Even if one takes an incredibly optimistic view of the scale of the bubble, defining it as only the last few years of excess, that undershoot will cause larger losses than 20% from here. Likewise the default rate is set to skyrocket, never mind merely triple. The losses accruing to Fannie and Freddie are likely to be vastly larger than even the most pessimistic mainstream commentators can imagine.
As longtime readers will know, my forecast for a real estate prices is for a decline of 90% on average, albeit with considerable local variation. For those who think this is not possible, you might want to look at what you can buy a house for right now in Detroit. It is considerably less than the price of a second-hand car, and in a market where the price of second-hand cars is depressed. In places where there is no work for miles around, and no access to mortgages in dying neighbourhoods, the pool of buyers will be limited to those who can afford buy a property in cash and would choose to spend what will be extremely scarce cash on that particular purchase. The price support that will convey will be minimal, to say the least.
As unemployment takes a moonshot in the coming years, purchasing power will be far more limited than most can imagine. The liquidity crunch we are moving into will cause the same kind of economic seizure as we saw in the depression, when a lack of money alone made it exceptionally difficult to connect buyers and sellers, or producers and potential consumers. Money is the lubricant in the engine of the economy in the same way that oil is the lubricant in the engine of your car. Running an engine with too little lubricant will cause it to grind to a halt.
The 'assistance' currently being provided in the form of downpayments is only going to make the situation worse in the long run. Bailouts are never for the little guy. Offering inducements to further indebtedness is merely a trap. It will do nothing but increase the pool of future debt slaves. This is not a benefit for the people it is ostensibly aimed at. Instead it is a cynical move intended to keep our game of extend-and-pretend going a little longer. Rising unemployment will cruelly expose the fragility of buying power and the ability to service debt in the relatively near future. Defaults are likely to be shockingly high, and with them losses to Fannie and Freddie.
As John Stuart Mill observed, "Panics do not destroy capital, they merely reveal the extent to which it has already been destroyed by betrayal into hopelessly unproductive works." The construction of much of suburbia has been a giant exercise in the creation of negative added value. It is this decades-long commitment of resources to living arrangements with fatal structural dependencies that has been destructive of value, and there is a limit to how long we can stave off the day when that will be generally recognized. That is all we are doing in supporting Fannie and Freddie.
Now that it appears the credit markets have turned again, the real economy will inevitably follow. The long rally facilitated a suspension of disbelief that was kind to policy makers while it lasted. The resumption of the downtrend will conversely strip away their credibility, making everything they do fail conspicuously and ignominiously.
Fannie, Freddie Delisting Signals Firms Have No Value
by Jessica Holzer And Jacob Bunge - Dow Jones Newswires
The regulator for Fannie Mae and Freddie Mac ordered them to voluntarily delist their shares from U.S. stock exchanges Wednesday, underscoring that the once-mighty mortgage behemoths no longer have value as private firms. The move comes as the Obama administration begins to shift its focus to the future of the companies, which were seized by the federal government in September 2008 and are on track to becoming the largest recipients of bailout dollars in the financial crisis. The company's regulator, Federal Housing Finance Agency Acting Director Edward J. DeMarco, cited stock-exchange rules related to minimum share-price levels as the basis for his action. But his hand was not forced by such rules.
"This is a positive step," Phillip Swagel, a former Treasury Assistant Secretary for Economic Policy during the Bush administration, argued. "It signals that these guys are going to come out [of conservatorship]in a different form and that the existing shareholders are not going to get anything." Facing criticism from Republicans for not spelling out the fate of Fannie and Freddie, administration officials have indicated they will turn to the matter once Congress wraps up work on financial-overhaul legislation. Treasury spokesman Andrew Williams said Wednesday's action "does not imply any direction of any future reforms or preference of corporate form" for the companies.
Freddie Mac said it expects the delisting of its common and preferred stock will happen by July 8. Fannie Mae indicated it will be delisted in early July. The companies' shares will now be traded in the over-the-counter market where they will be quoted on the OTC Bulletin Board, typically the domain of untested companies and more speculative stocks. They will still file disclosures with the Securities and Exchange Commission. The companies' share prices plummeted on the morning announcement; Fannie's and Freddie's stock closed down nearly 40% to 56 cents and 76 cents, respectively, in Wednesday trading. Meanwhile, the roughly three dozen publicly- traded preferred securities issued by Fannie and Freddie were punished nearly as severely, posting declines of 14% to 46% in Wednesday afternoon trading.
Fannie's and Freddie's shares have limped along since the federal government seized them. The U.S. Treasury acquired ownership of 80% of each company's common stock and agreed to pump in capital as needed to keep the companies solvent. The government has so far injected $145 billion and losses at the company continue to mount. In exchange for the capital, the federal government has received preferred shares in the same amount carrying a 10% coupon. Any money the companies make goes to paying the dividend on the government's shares.
Fannie's and Freddie's shares had become the province of day traders taking bets on the company's future after institutional investors fled the stocks and Wall Street equity analysts dropped them from their coverage. Trading has remained intense, however, with the shares often making the New York Stock Exchange daily list of most heavily-traded shares. The two mortgage giants have struggled mightily since the housing bust. In May, Fannie requested another $8.5 billion in government aid. Meanwhile, Freddie said it would need a $10.6 billion injection from the Treasury.
Since their federal takeover, Fannie and Freddie have functioned as tools of the administration's strategy to keep mortgage credit flowing and help homeowners avoid foreclosure. The Treasury's preferred stock agreements with Fannie and Freddie effectively guarantee the companies' debt. The shares of both companies first sank below the New York Stock Exchange's $1 30-day average price requirement in the fall of 2008. Companies that see their stock trade below that level for 30 consecutive days typically are given six months to correct the issue or face delisting.
When Fannie and Freddie slipped into the warning zone, they got a longer-than- usual period to buoy their stock price thanks to a temporary suspension of NYSE Euronext's listing standards in late February 2009. Those listing standards were reinstated in August 2009, but both companies traded above the minimum price at that time. Over the past 30 days, Fannie Mae's average share price sank once again below NYSE's minimum requirement. Freddie's share price didn't violate the $1 minimum, however. DeMarco, in a press release, said it "simply makes sense" for Freddie to delist because it "fits with the goal of a conservatorship to preserve and conserve assets."
Pulling their stocks off the NYSE will save the two companies $500,000 apiece in annual listing fees, as both companies paid the maximum amount due to the large number of shares outstanding, according to NYSE Euronext. Fannie and Freddie watchers weren't surprised by the regulator's move. "De-listing is the appropriate message: That these companies have no value and they shouldn't be traded as if they're real companies," said Bose George, an analyst for Keefe, Bruyette & Woods Inc.
Fannie-Freddie Fix at $160 Billion With $1 Trillion Worst Case
by Lorraine Woellert and John Gittelsohn - Bloomberg
The cost of fixingFannie Mae and Freddie Mac, the mortgage companies that last year bought or guaranteed three-quarters of all U.S. home loans, will be at least $160 billion and could grow to as much as $1 trillion after the biggest bailout in American history. Fannie and Freddie, now 80 percent owned by U.S. taxpayers, already have drawn $145 billion from an unlimited line of government credit granted to ensure that home buyers can get loans while the private housing-finance industry is moribund.
That surpasses the amount spent on rescues of American International Group Inc., General Motors Co. or Citigroup Inc., which have begun repaying their debts. "It is the mother of all bailouts," said Edward Pinto, a former chief credit officer at Fannie Mae, who is now a consultant to the mortgage-finance industry. Fannie, based in Washington, and Freddie in McLean, Virginia, own or guarantee 53 percent of the nation’s $10.7 trillion in residential mortgages, according to a June 10 Federal Reserve report. Millions of bad loans issued during the housing bubble remain on their books, and delinquencies continue to rise. How deep in the hole Fannie and Freddie go depends onunemployment, interest rates and other drivers of home prices, according to the companies and economists who study them.
The Congressional Budget Office calculated in August 2009 that the companies would need $389 billion in federal subsidies through 2019, based on assumptions about delinquency rates of loans in their securities pools. The White House’s Office of Management and Budget estimated in February that aid could total as little as $160 billion if the economy strengthens. If housing prices drop further, the companies may need more. Barclays Capital Inc. analysts put the price tag as high as $500 billion in a December report on mortgage-backed securities, assuming home prices decline another 20 percent and default rates triple.
Sean Egan, president of Egan-Jones Ratings Co. in Haverford, Pennsylvania, said that a 20 percent loss on the companies’ loans and guarantees, along the lines of other large market players such as Countrywide Financial Corp., now owned by Bank of America Corp., could cause even more damage. "One trillion dollars is a reasonable worst-case scenario for the companies," said Egan, whose firm warned customers away from municipal bond insurers in 2002 and downgraded Enron Corp. a month before its 2001 collapse. A 20 percent decline in housing prices is possible, said David Rosenberg, chief economist for Gluskin Sheff & Associates Inc. in Toronto. Rosenberg, whose forecasts are more pessimistic than those of other economists, predicts a 15 percent drop. "Worst case is probably 25 percent," he said.
The median price of a home in the U.S. was $173,100 in April, down 25 percent from the July 2006 peak, according to the National Association of Realtors. Fannie and Freddie are deeply wired into the U.S. and global financial systems. Figuring out how to stanch the losses and turn them into sustainable businesses is the biggest piece of unfinished business as Congress negotiates a Wall Street overhaul that could reach President Barack Obama’s desk by July. Neither political party wants to risk damaging the mortgage market, saidDouglas Holtz-Eakin, a former director of the Congressional Budget Office and White House economic adviser under President George W. Bush. "Republicans and Democrats love putting Americans in houses, and there’s no getting around that," Holtz-Eakin said.
With no solution in sight, the companies may need billions of dollars from the Treasury Department each quarter. The alternative -- cutting the federal lifeline and letting the companies default on their debts -- would produce global economic tremors akin to the U.S. decision to go off the gold standard in the 1930s, saidRobert J. Shiller, a professor of economics at Yale University in New Haven, Connecticut, who helped create the S&P/Case-Shiller indexes of property values."People all over the world think, 'Where is the safest place I could possibly put my money?' and that's the U.S.," Shiller said in an interview. "We can't let Fannie and Freddie go. We have to stand up for them."
Congress created theFederal National Mortgage Association, known as Fannie Mae, in 1938 to expand home ownership by buying mortgages from banks and other lenders and bundling them into bonds for investors. It set up theFederal Home Loan Mortgage Corp., Freddie Mac, in 1970 to compete with Fannie. The companies’ liabilities stem in large part from loans and mortgage-backed securities issued between 2005 and 2007. Directed by Congress to encourage lending to minorities and low- income borrowers at the same time private companies were gaining market share by pushing into subprime loans, Fannie and Freddie lowered their standards to take on high-risk mortgages.
Many of those went to borrowers with poor credit or little equity in their homes, according to company filings. By early 2008, more than $500 billion of loans guaranteed or held by Fannie and Freddie, about 10 percent of the total, were in subprime mortgages, according to Fed reports. Fannie and Freddie also raised billions of dollars by selling their own corporate debt to investors around the world. The bonds are seen as safe because of an implicit government guarantee against default. Foreign governments, including China’s and Japan’s, hold $908 billion of such bonds, according to Fed data.
"Do we really want to go to the central bank of China and say, ‘Tough luck, boys’? That’s part of the problem," said Karen Petrou, managing partner of Federal Financial Analytics Inc., a Washington-based research firm. The terms of the 2008 Treasury bailout create further complications. Fannie and Freddie are required to pay a 10 percent annual dividend on the shares owned by taxpayers. So far, they owe $14.5 billion, more than the companies reported in income in their most profitable years. "It’s like a debt trap," said Qumber Hassan, a mortgage strategist at Credit Suisse Group AG in New York. "The more they draw, the more they have to pay."
Fannie and Freddie also benefited by selling $1.4 trillion in mortgage-backed securities to the Fed and the Treasury since September 2008, bonds that otherwise would have weighed on their balance sheets. While the government bought only the lowest-risk securities, it could incur additional losses. Treasury Secretary Timothy F. Geithner has vowed to keep Fannie and Freddie operating. "It’s very hard to judge what the scale of losses is," Geithner told Congress in March. One idea being weighed by the Obama administration involves reconstituting Fannie and Freddie into a "good bank" with performing loans and a "bad bank" to absorb the rest.
That could cost taxpayers as much as $290 billion because of all the bad loans, according to a May estimate by Credit Suisse analysts. At the end of March, borrowers were late making payments on $338.4 billion worth of Fannie and Freddie loans, up from $206.1 billion a year earlier, according to the companies’ first- quarter filings at the Securities and Exchange Commission. The number of loans more than three months past due has risen every quarter for more than a year, hitting 5.5 percent at Fannie as of the end of March and 4.1 percent at Freddie, according to the filings.
Surge in Delinquencies
The composition of the $5.5 trillion of loans guaranteed by Fannie and Freddie suggests that the surge in delinquencies may continue. About $1.98 trillion of the loans were made in states with the nation’s highest foreclosure rates -- California, Florida, Nevada and Arizona -- and $1.13 trillion were issued in 2006 and 2007, when real estate values peaked. Mortgages on which borrowers owe more than 90 percent of a property’s value total $402 billion. Fannie and Freddie may suffer additional losses as a result of the Treasury’s effort to prevent foreclosures.
Under the program, banks with mortgages owned or guaranteed by the companies must rewrite loan terms to make them easier for borrowers to pay. The Treasury program is budgeted to cost Fannie and Freddie $20 billion. The companies have already modified about 600,000 delinquent loans and refinanced almost 300,000 more, in some cases for an amount greater than the houses are worth. The government is using Fannie and Freddie "for a public- policy purpose that may well increase the ultimate cost of the taxpayer rescue," said Petrou of Federal Financial Analytics. "Treasury is rolling the dice."
If the plan works and foreclosures fall, that could help stabilize Fannie’s and Freddie’s balance sheets and ultimately protect taxpayers. "Avoiding foreclosures can be a route to reducing loss severity," said Sarah Rosen Wartell, executive vice president of the Center for American Progress, a Washington research group with ties to the Obama administration. Loans issued since 2008, when the companies raised standards for borrowers, should be profitable and help offset prior losses, Wartell said. Republicans attempted to include a phase-out of the mortgage companies in the financial reform bill.
Democratic lawmakers and the Obama administration opted for further study, and the Treasury began soliciting ideas in April. Representative Scott Garrett, a New Jersey Republican and co-sponsor of the phase-out amendment, said eliminating Fannie and Freddie would force the government and the housing market to confront the issue. "It’s somewhat impossible to predict the magnitude of their impact if they continue to be the primary source of lending," Garrett said in an interview.
Caught in ‘Quandary’
Democrats dismissed the phase-out idea as simplistic. "We need to have a housing-financing system in place," Senate Banking Committee Chairman Christopher Dodd said last month. "If you pull that rug out at this particular juncture, I don’t know what the particular result would be. We’re caught in this quandary." By delaying action, the Obama administration keeps losses off the government’s books while building a floor under housing prices during a congressional election year. Keeping Fannie and Freddie functioning could also support an overall economic recovery. Residential real estate -- the money spent on rent, mortgage payments, construction, remodeling, utilities and brokers’ fees -- accounted for about 17 percent of gross domestic product in 2009, according to the National Association of Home Builders.
Allowing the companies to go under and hoping that private financing will fill the gap isn’t realistic, analysts say. It would require at least two years of rising property values for private companies to return to the mortgage-securitization market, said Robert Van Order, Freddie’s former chief international economist and a professor of finance at George Washington University in Washington. The price tag of supporting Fannie and Freddie "needs to be evaluated against the cost of not having a mortgage market," said Phyllis Caldwell, chief of the Treasury’s Homeownership Preservation Office.
Whatever the fix, the money spent will not be recovered, said Alex Pollock, a former president of the Federal Home Loan Bank of Chicago who is now a fellow at the Washington-based American Enterprise Institute. "It doesn’t matter what you do or don’t do, Fannie and Freddie will cost a lot of money," Pollock said. "The money is already lost. There’s an attempt to try to avert your eyes."
BP agrees to $20 billion escrow fund; cancels dividends
by Mike Memoli and Peter Nicholas, Los Angeles Times
The Obama administration has reached a preliminary agreement with BP executives that would see the oil company pay $20 billion over several years into an independently controlled escrow account to be established to compensate Gulf of Mexico residents affected by the disastrous oil spill, and BP's board of directors has eliminated the company's stock dividend, at least temporarily.
The agreement on the escrow account was negotiated in a meeting at the White House on Wednesday morning, the first face-to-face gathering between President Obama and senior BP leadership. A White House official said that, under the terms of the deal, the fund would be administered by attorney Kenneth Feinberg, currently serving as the special master for executive pay under the Troubled Asset Relief Program. Feinberg ran a fund that compensated victims of the terrorist attacks of Sept. 11, 2001.
Immediately after the meeting, BP Chairman Carl-Henric Svanberg said that the oil company's board of directors has decided not to pay any more dividends this year. BP has been under intense pressure from the Obama administration to cut or eliminate the $10.5 billion it distributes annually to shareholders. Svanberg, speaking to reporters outside the White House, didn't say how long the dividend would be suspended.
The meeting comes 57 days after the April 20 explosion at BP's Deepwater Horizon oil rig. Before Wednesday, Obama had yet to speak with BP Chief Executive Tony Hayward. Half a dozen other BP executives joined a phalanx of Cabinet and senior administration officials in the meeting in the Roosevelt Room. It was not yet known how long the president remained at the meeting. Obama was scheduled to address reporters in the Rose Garden this afternoon.
Wednesday's session was the final piece in a choreographed three-day series of events intended to showcase Obama's handling of the gulf oil crisis. He made his fourth visit to the gulf region, with stops Monday in Mississippi and Alabama and Tuesday in Florida. After returning to Washington, he delivered his first address to the nation from the Oval Office, outlining what he called a "battle plan" for cleaning up the spill, providing assistance for those affected and, ultimately, to "make sure that a catastrophe like this never happens again."
BP executives were in Washington for several congressional committee hearings on the oil spill. Hayward is scheduled to testify Thursday morning at a House Energy and Commerce subcommittee hearing specifically on the role of BP in the spill.
America's Municipal Debt Racket
by Steven Malanga - Wall Street Journal
State and local borrowing as a percentage of U.S. GDP has risen to an all-time high of 22% in 2010. New Jersey officials recently celebrated the selection of the new stadium in the Meadowlands sports complex as the site of the 2014 Super Bowl. Absent from the festivities was any sense of the burden the complex has become for taxpayers. Nearly 40 years ago the Garden State borrowed $302 million to begin constructing the Meadowlands. The goal was to pay off the bonds in 25 years.
Although the project initially went according to plan, politicians couldn't resist continually refinancing the bonds, siphoning revenues from the complex into the state budget, and using the good credit rating of the New Jersey Sports and Exposition authority to borrow for other, unsuccessful building schemes. Today, the authority that runs the Meadowlands is in hock for $830 million, which it can't pay back. The state, facing its own cavernous budget deficits, has had to assume interest payments—about $100 million this year on bonds that still stretch for decades.
This tale of woe has become familiar in the world of municipal finance. Governments have loaded up on debt, stretched out repayment times, and used slick maneuvers to avoid constitutional borrowing limits. While the country's economic troubles have helped expose some of these practices, a sharp decline in tax revenues has prompted more abuse as politicians use long-term debt to kick short-term fiscal problems down the road. It hasn't always been this way.
Government debt has long fostered the expansion of the American republic, helping to build roads, bridges and water works to serve a growing population. But there have also been spectacular failures. In the mid-1970s, New York City almost defaulted on its debt after it used borrowing to fund an aggressive and ultimately unaffordable expansion of services (like the nation's most generous Medicaid program) inaugurated by Mayor John Lindsay. Gotham was bailed out by New York State and the federal government. But Cleveland, whose spending outpaced tax revenues thanks to borrowing, did default on $14 million in bonds in 1978.
The 1970s debt crises woke politicians up. Over the next 20 years the municipal fiscal picture improved, with debt rising only slightly. But memories of past busts have since faded, and outstanding debt has soared to $2.2 trillion today from $1.4 trillion in 2000. State and local borrowing as a percentage of the country's GDP has risen to an all-time high of 22% in 2010 from 15%, with projections that it will reach 24% by 2012. Even more disconcerting is what the borrowing now often finances.
One favorite scheme for muni debt is giant and risky development projects. California's redevelopment regime is an object lesson. Starting in the 1950s, the state gave localities the right to create public agencies, funded by increases in property taxes, which can issue debt to finance redevelopment. A whopping 380 such entities now exist. They collect 10% of all property taxes—nearly $6 billion annually—and they have amassed $29 billion in debt never approved by voters for projects ranging from sports facilities to concert venues to retail malls, museums and convention centers.
Critics, including taxpayer groups, say most such agency projects add little economic value. Sometimes the outcome is much worse. In 1999, Fresno conceived plans to revive its downtown area with various projects, including a baseball stadium for the minor-league Grizzlies, which it had lured from Phoenix. The city's redevelopment agency floated some $46 million in bonds to build the stadium. But the Grizzlies fizzled in their new home, demanded a break on rent, threatening to skip town and stick taxpayers with the entire $3.4 million annual bond payment on the facility. The team is now receiving $700,000 in annual subsidies to stay in the city.
Adding to the city's woes: Last June, another development project, the Fresno Metropolitan Museum, went bust, leaving the city's taxpayers on the hook for three-quarters of a million dollars in annual debt payments. Cities now also use taxpayer-financed debt to engage in fierce bidding wars that benefit private enterprises. Charlotte, N.C., for instance, won the bidding for the new Nascar all of Fame with a $154 million offer, funded by a new hotel tax dedicated to servicing bonds for constructing the hall. But the venue employs only about 115 people—and an economic development study estimated the increased annual tourism from the venture won't even equal what a single Nascar race generates.
Why did politicians offer the deal? For the dubious and hard-to-quantify purpose of "branding" the city with a major attraction, according to the Charlotte Observer. Voters have wised up to the failings of many grand, politically inspired projects, and when given the chance they've defeated new taxes and borrowing for them. But much state and local debt now exists in independent authorities whose borrowings are not subject to voter approvals.
Some of these agencies have operated recklessly. In 2000, Massachusetts moved to make the entity that runs Boston area mass transit, the Massachusetts Bay Transportation Authority, financially independent. As part of the plan the authority was supposed to gradually pay down some $5.6 billion in debt and use cash from operations to finance capital projects. Instead, the agency deferred payments on its debt, put off capital projects, and borrowed more money, so that it now owes $8.5 billion. Today, the authority is paying a staggering $500 million yearly in debt service, forcing it to neglect maintenance, shelve expansion plans, and cut service. Even so, last year the agency needed a $160 million bailout from taxpayers to close a budget deficit.
Another weapon in the debt arsenal is the so-called pension-obligation bond. For two decades, governments have played a risky arbitrage game in which they issue bonds and then deposit the money in their pension funds to be invested in the stock market with the hope that the money will outperform the interest rate on the bonds. In a stock market that's been stagnant for years, pension bonds have become fiscally toxic. As the Center for State and Local Government Excellence noted in a report earlier this year, most pension bonds issued since 1992 have been money losers for states and cities, exacerbating severe underfunding of pension systems in places like New Jersey.
These abuses came to a head in the second half of 2008, when spooked investors were unwilling to bet on more municipal debt after several insurers who typically back these bonds exited the market. Then Washington stepped in with a new Build America Bond (BAB), allowing states and municipalities to issue them. Thanks to a federal subsidy, they carry attractive interest rates. Last year municipalities used BABs to rack up another $58 billion in debt.
Taxpayers are only slowly realizing that their states and municipalities face long-term obligations that will be increasingly hard to meet. Rick Bookstaber, a senior policy adviser to the Securities and Exchange Commission, recently warned that the muni market has all the characteristics of a crisis that might unfold with "a widespread cascade in defaults." If that painful scenario materializes, it will be because we have too long ignored how some politicians have become addicted to debt.
States come to grips with pricey pension promises ...
by USA Today
One of the most troubling social trends in recent years has been the pension gap between state and local employees (who can retire early often very early with instant, guaranteed, taxpayer-paid benefits) and the private sector workers whose taxes pay for those pensions. Their retirement benefits are largely self-financed and subject to market upheavals.
Now, through a combination of fiscal necessity, changed accounting rules and realization that millions of public workers have become a kind of privileged new class, the politics of public pensions appear to be changing. Last month, Michigan enacted a teacher pension reform that Gov.Jennifer Granholm says will save about $3 billion over 10 years by, among other things, increasing the amount workers must contribute. Illinois has raised its retirement age for newly hired public workers from as low as 55 all the way to 67.
In California, Gov.Arnold Schwarzenegger, who has tried for years to enact pension reform in his financially troubled state, believes that the ground has shifted and that he can succeed in his final months in office. And several other governors, most notably Chris Christie of New Jersey, have decided that bruising clashes with public worker unions can be both economically necessary and politically advantageous.These developments could not come soon enough. States, without the federal government's ability to print money and with limited ability to borrow, are facing disturbing questions about how they are going to pay for worker pay and benefits, along with their share of Medicaid.According to the Pew Center on the States, state pensions and other retiree benefit programs are underfunded by $1 trillion. And that estimate was made before the stock market swoon of 2008.
That number is an aggregate of all states, some of which are in relatively decent shape, and some of which are courting disaster. Too many states and localities created pension plans that are way too generous, allowing some workers, particularly those in law enforcement and other emergency response areas, to retire as early as their 40s, to "double dip" by collecting a salary and pension at the same time, or to manipulate pay in a way that inflates their pensions. In New Jersey, for example, a local lawyer and Democratic Party official cobbled together some part-time work for local government to claim a pension of more than $100,000.The shortfall is made worse when cash-strapped governments make unrealistic projections about investment returns or underfund their plans by failing to make adequate annual contributions.
The obvious long-term solution is for states to shift to 401(k)-type programs, which the federal government has partially accomplished. For Americans to maintain their faith in government, they can't have civil servants easing into comfortable and early retirement while private sector workers toil away. And even if that problem didn't exist, what sense does it make to encourage able-bodied people to retire early?The vast majority of private companies long ago recognized the problem and addressed it. For governments, pensions invite abuse. Candidates find that they can mollify demanding public-employee unions by making future promises that won't come due until long after they leave office.In the short run, it is at least encouraging to see some states grapple with their existing pensions. Many more need to follow suit before America becomes a nation of pension haves and have-nots.
San Diego May Use Bankruptcy to Roll Back Benefits
by Joe Mysak - Bloomberg
The city of San Diego should consider Chapter 9 municipal bankruptcy to help it reduce fringe benefits, pension and health obligations. That’s one of the suggestions made by the San Diego County Grand Jury, which does the normal duties of recommending indictments as well as reporting on local governments and special districts.
S an Diego is the fifth major city in the U.S. this year, and the second in California, where people are talking about bankruptcy as a means to "restructure and reorganize their assets and debts while providing relief from current and future obligations," in the words of the grand jury’s 22-page report, published on June 8. San Diego has unfunded liabilities of $2.2 billion in its pension plan and $1.3 billion for health care, which the report calls "unsustainable." More than two years of cutting budgets and the mounting public pension crisis have made the unthinkable an option, maybe even an attractive one.
"Municipalities are not required to raise taxes or cut costs to the bone before filing for reorganization under Chapter 9," the grand jury report says, quoting from a presentation at an October 2009, San Diego County Taxpayers Association seminar. San Diego has been wrestling with pension and benefits costs for years. In 2006, the city settled fraud allegations by the Securities and Exchange Commission for failing to disclose to investors that its pension system was underfunded.
The recommendation that the mayor and city council convene a panel of municipal bankruptcy experts to talk about it is the last of 16 suggestions made by the grand jury. That it was made at all, in a wealthy city like San Diego, is disturbing. "It will be difficult to make the case that the city is insolvent," said Natalie Cohen of National Municipal Research Inc. in New York in an e-mail this week. "It seems the grand jury report is looking to bust open the discussion about the irrevocable nature of pension obligations -- which will continue to eat up the city’s budget."
As the report says in its introduction: "One of the underlying causes of the current structural imbalance is the underfunding of the city’s pension obligation by previous city administrations." This is a familiar story, both in California and around the country. As of June 30, 2009, the San Diego City Employees Retirement System has only 66.5 percent of the money needed to pay for future pension obligations, according to the report.
Punish the Public
The report contains an extensive discussion of San Diego’s retirement system, and recommends that the city investigate replacing it with some sort of alternative. Among the report’s other recommendations are having someone else run the libraries, selling portions of parks and charging for trash collection: a fairly standard grab bag. There’s also a little discussion on how to reduce headcount.
Did you ever have a feeling that there’s a vindictive element to some of the cuts governments do manage to make? That is, when they are absolutely at the end of their tethers and are forced to fire people, did you ever think that the government somehow (and unbelievably, if you ask me) tries to punish the public? It’s almost as though those in charge say, "Fine, we’ll cut back, but you’ll never have clean streets again." In other words, if the city makes cuts as painful and obvious as possible, we’ll all learn our lesson. I’m not sure what the lesson is. I suspect it depends upon who you are. Don’t lose your job? Offer to pay more taxes? Don’t ask if government might run more efficiently ever again?
There’s a hint of this in the grand jury report. The city, it says, acted "improvidently" in cutting the public safety workforce, such as mounted patrolmen and the canine unit. Meanwhile, "there are now anywhere from seven to nine layers of costly management between the mayor and a blue- collar worker in the field." The recommendations: "Eliminate redundant positions and extraneous levels of management and supervision as employees leave city service through attrition," and "Restore the cuts to public safety personnel as a priority."
There’s a startling level of clarity in the grand jury report on the city of San Diego’s financial crisis. I just hope it hasn’t come too late.
Lenders go after money lost in foreclosures
by Dina ElBoghdady - Washington Post
After the bank foreclosed on Fernando Palacios's Gainesville home in March, he thought he was done with what he described as the most stressful financial situation of his life. The bank sold the home for far less than Palacios owed on it, as often happens with foreclosures. What Palacios did not see coming was the letter from his lender demanding that he pay the shortfall: $148,064.02. "I really thought I was through with this house," said Palacios, who fell behind on payments when the economy soured and his cleaning business stumbled.
Over the past year, lenders have become much more aggressive in trying to recoup money lost in foreclosures and other distressed sales, creating more grief for people who thought their real estate headaches were far behind. In many localities -- including Virginia, Maryland and the District -- lenders have the right to pursue borrowers whose homes have sold at a loss to collect the difference between what the property sold for and what the borrower owed on it, also called a deficiency.
Before the housing bust, when the volume of foreclosures was relatively low, lenders seldom bothered to chase after deficiencies because borrowers had few remaining assets to claim and doing so involved hassles and costs. But with foreclosures soaring, lenders are more determined to get their money back, especially if they suspect borrowers are skipping out on loan they could afford, an increasingly common practice in areas where home values have tanked.
Palacios said he was committed to staying in his house, which he bought in 2005. He sunk $20,000 into improving it and hoped to raise his children there. But his lender refused to modify his loan, he said. To avoid personal liability for the deficiency, Palacios is filing for bankruptcy protection, as many people do who are in similar situations, said Nancy Ryan, his bankruptcy attorney. "I am definitely seeing more people come through my door who walked away from houses a year or two ago and thought they were as free as the dead," Ryan said. "They're stunned when they realize they're not."
Several lenders contacted for this story declined to say how often they pursue deficiencies. But many said they try to collect the debt if they conclude the borrower can repay all or part of it. "Lenders are not going after people who face a hardship," said John Mechem, a spokesman for the Mortgage Bankers Association. "If they can't pay their mortgage because they have a loss of income, there is no point in going after them."
Those who had a second mortgage, such as a home-equity line of credit, in addition to their primary mortgage may find themselves particularly vulnerable, especially if they tapped into the equity line for cash. Second lenders are last in line to get paid when a distressed property is sold. There's usually little or no money left over for them, making it more likely that they will pursue large deficiencies, several attorneys said.
Gretchen Somers said she and her husband understood the risks last year when they completed a "short sale," a transaction that allowed them to sell their Manassas home for about $150,000 less than they owed on it. But they felt they had no other options. Somers said her family hung onto the house as long as possible. They tried but failed to sell it when her husband was transferred to Arizona for his job in early 2006, just as home prices were softening. They moved back into the house then tried to sell it again in 2008, after their adjustable-rate mortgage reset and their monthly mortgage payment nearly doubled. But home prices had plunged further by then, making it even tougher to sell.
Last year, their first lender and their home-equity line lender granted permission for the short sale. But the second lender reserved the right to come after the couple. Six months later, a collection agency called demanding $85,000 for related losses. In hindsight, Somers said she and her husband should have just walked away from the house. "We took care of the house because we wanted it to sell," Somers said. "If they were going to come after us anyway, we shouldn't have done them the favor of making sure it looked good and cutting the grass even after we moved out, We should have mailed them the key and said: 'Here you go.' "
Carlos Cortez and his wife managed to escape that fate after their second lender came after them for $70,000 when their short sale was completed on his Manassas Park townhouse in 2008. Cortez knew that was a possibility, but he went through with the sale because his real estate agent said the lender was engaging in scare tactics. James Scruggs, an attorney at Legal Services of Northern Virginia, said the lender appears to have backed off after Cortez argued that that the loan officer falsely qualified him and his wife for a home-equity line by fabricating key details about their finances.
A handful of states do not allow lenders to pursue deficiencies, nor does a federal program that took effect April 10. Lenders participating in that initiative are paid for approving short sales and as a condition, they cannot go after outstanding debt. In many states, lenders can go after deficiencies, though laws vary widely, said John Rao, an attorney at the National Consumer Law Center. Some states limit how long the banks have to file a claim or collect the debt. Others may calculate deficiencies based on the fair-market value of the house, Rao said. For instance, if a home sells for $200,000 yet its fair market value is $250,000, "the borrower who owes $240,000 on the mortgage would not have a deficiency," he said.
Borrowers should get a waiver in writing from their lenders to protect themselves, said Diane Cipollone, an attorney at the nonprofit Civil Justice. "Nobody should assume the deficiency is forgiven," she said.
US housing starts tumble in May
by Alan Rappeport - Financial Times
New home construction in the US collapsed in May, as building activity stalled after the government withdrew measures to prop up the housing market. Separately on Wednesday, the labour department said that US wholesale prices fell back last month due to tumbling energy prices. Housing starts fell by 10 per cent to an annual rate of 574,000 last month, the commerce department said on Wednesday. The figures were far worse than the 3.7 per cent decline economists had predicted and highlighted the market’s reliance on government support. Homebuilders’ shares fell in pre-market trading after the data was released.
“The end of the tax credits has generally depressed housing data and tended to add a degree of caution to the market,” said Alan Ruskin, strategist at RBS Securities. Since May 2009, home construction has climbed by 7.8 per cent as the market rebounded due to falling construction costs and the first-time homebuyer tax credit, which spurred new building. However, last month’s total was the lowest this year. Analysts had been optimistic about renewed homebuilding activity, although some worried that a greater supply of new homes would put downward pressure on prices. Tight credit and a glut of foreclosed properties languishing on the market have been a drag on the sector in the absence of stimulus measures.
“We’re lacking a catalyst for a robust recovery, especially when you consider the lacklustre state of the US labour market ,” Mike Larson, a real estate analyst at Weiss Research, said ahead of the report. “So don’t look for the housing or construction industries to hit the ball out of the park any time soon.” Building permits were also weak last month, signalling that future construction could continue to be slow. Permits fell unexpectedly, declining 5.9 per cent, to 610,000. Year-on-year permits were up by 4.4 per cent. The drop in housing starts was concentrated among single-family homes, where construction plunged 17.2 per cent compared with April. Regionally, the south and the north-east recorded the biggest declines, while homebuilding picked up in the midwest and west.
Homebuilders have also started feeling more pressure, as evidenced by the National Association of Homebuilders’ survey that showed builder confidence falling in June to the lowest level since the start of the year.
Meanwhile, the US producer price index fell by 0.3 per cent from April to May, with prices pushed lower by a 1.5 per cent decline in the cost of energy. Core prices, which exclude food and energy, ticked up a mild 0.2 per cent. Wholesale prices have climbed by 5.3 per cent since May 2009, but the modest increases confirm the Federal Reserve argument that inflation remains “subdued” and supports its policy of keeping interest rates “near zero” for the time being.
Forget what we said – things are going to get worse, not better
by Leo Lewis - Times of London
The Japanese Government will rip up the promises it used to win last summer’s general election in an attempt to impose austerity and discipline on the most strained public finances in the developed world. Pledges of generous child benefits, reduced motorway tolls and aid for farmers are likely to evaporate first, followed by the expected reversal of the promise not to raise consumption tax before 2013. The dramatic policy U-turns were flagged yesterday by Yoshihiko Noda, the Finance Minister still less than a week into his new job and, like his predecessors, faced with defusing Japan’s explosive 200 per cent ratio of debt to gross domestic product.
By the standards of Japanese finance ministers, he is already talking tough. Describing Japan’s situation as "severe", Mr Noda said that while he could not undo his party’s spending pledges in one go, he would start to do so "steadily". Spending plans announced under the previous prime minister Yukio Hatoyama were savaged by economists as being impossible to achieve without eye-watering levels of new debt issuance. Fiscal 2010 is expected to be Japan’s first since the Second World War where new bond issuance is greater than tax revenues — and even then the public purse was bolstered by raids on various "buried treasures" in special government accounts. The only way to keep any spending promise, analysts say, would be to raise consumption tax, a manoeuvre of such political sensitivity that no prime minister has yet survived it.
Japanese VAT stands at only 5 per cent, far below that of most leading economies. When it was introduced in 1950, the public was so furious that the law had to be repealed before it came into effect. In 1989, it was brought in at 3 per cent and cost the ruling party an Upper House election. When it rose from 3 to 5 per cent in 1997 it destroyed consumption and brought down the prime minister. Nicholas Smith, a strategist at MF Global, said that a rise in consumption tax , even by the 2 or 3 per cent being discussed, could again prove devastating. "There are two real concerns here: first is the psychological effect it has on consumption, which has in the past been huge; second is the more worrying risk that consumers just can’t afford it," he said.
Mr Noda’s comments came two days after Naoto Kan, Japan’s new Prime Minister, said that the country could face a Greek-style financial crisis if it did not act immediately to rein-in spending and start chipping away at the country’s spectacular mountain of public debt. Mr Kan, a known fiscal hawk, warned parliament that Japan’s long addiction to debt issuance had to end and told the country that he would try to deliver "minimum unhappiness" — a phrase seen as heralding an era of austerity and pain for many households. Mr Kan’s blunt warning to parliament brings Japan in line with the prevailing view of the G20, which agreed at a summit in South Korea last week that fiscal consolidation should now take priority over stimulus spending.
Julian Jessop, international economist at Capital Economics, said that developments in Japan may even be about to mirror those in Britain, where the departure of an unpopular prime minister finds a new administration facing ominous fiscal challenges and vowing to do battle with them. Mr Noda’s appearance on a prominent politics show was designed to prepare both the domestic audience and global financial markets for what some believe could be Japan’s financial "zero hour" later this month. Around June 22 — before the next G20 summit in Toronto — the Kan Administration will offer-up its proposed remedy for Japan’s dismal fiscal position. Credit ratings agencies have threatened to downgrade the sovereign debt of the world’s second-biggest economy if that consolidation plan is "not credible".
It’s time to bite the bullet
Japanese households have launched a mass smash-and-grab raid on their own jewellery boxes, sock drawers and even teeth in a liquidation scramble that has generated a record exodus of gold. The rush to trade in the precious metal marks a spectacular reversal of more than three decades of gold accumulation by individual Japanese and is viewed by economists as a symptom of the largely invisible — but profound — financial stress that many households are under. Analysts believe that the sell-off in Japan is a foretaste of darker economic times for the average household, with unemployment hovering around historic highs and amid stagnant wage growth. Nicholas Smith, a strategist at MF Global, said that households were locked into a "struggle to maintain living standards".
Japanese have also been forced into more fundamental changes to make ends meet: household savings rates are, at 2.8 per cent, the second-lowest in the Organisation for Economic Co-operation and Development, after Australia. Sales staff at Tanaka Kikinzoku Kogyo, a precious metals dealer in Tokyo, said that the big sellers were Japanese on the brink of retirement. Many bought gold as investments and have been hiding it in their homes in the form of ingots or sovereigns, Takashi Ono, a manager in the over-the-counter operations of Daiichi Commodities, said. "But increasingly we are seeing people bringing in rings, necklaces and gold teeth — things that were never intended to be sold off."
'Doomsday Capitalism:' Local virus? Global pandemic?
by Paul B. Farrell - Marketwatch
Warning: "Capitalism as we knew it is dead." What a grabber! A flashing neon sign on Times Square near Morgan Stanley? No, it's the headline on a promo ad for the new book co-authored by the highly regarded American editor of the world's leading business magazine, the Economist.
Yes, "capitalism as we knew it is dead." Who killed it? The usual suspects. Everybody. And it was easy. First we killed democracy. Yes, democracy as we knew it is also dead. Next question: What'll take its place? In "The Road from Ruin," Matthew Bishop, the Economist's business editor and co-author Michael Green tell us "capitalism as we knew it" died on "Sept. 15, 2008, the day Lehman Brothers went bust. That much is clear. What we don't know yet is what will replace it and whether that version will be any better than what went before." Wrong: We do know exactly what will replace it. We also know it won't be better. In fact, far worse, far more self-destructive. The "Doomsday Capitalism" virus is spreading:
1. The Economist's doomed Capitalism 2.0
Start with "The Road From Ruin." Four "big ideas," a grand vision of what a revival of capitalism must have to succeed: First, "rethink economics." Second: "redesign global governance," including loss of the dollar's reserve currency status to create "a stabler global financial system." Third, "capitalism must rediscover its soul," put "values back into business," and "serve the greater good." Fourth, "promote financial literacy." Four "Big Ideas." All doomed. Why? America hates them. Everyone: Palin, McConnell, Beck, the GOP's Tea Party of No-No. Yes, even the White House, Congress, Geithner, Bernanke and Dodd.
And certainly the Goldman Conspiracy of Wall Street too-greedy-to-fail fat-cat bankers. All guaranteed to hate the four big ideas, hate them more than Cormac McCarthy's bleak post-apocalyptic "The Road." Hate? Yes, here's why: The GOP does not want to "rethink" economics. No compromise. They want to reinstate their beloved free-market Reaganomics ideology. Period. Also non-negotiable: They'll never surrender the dollar as reserve currency. Un-American. Worse than surrendering America's divine right as the world's sole superpower.
What about "soul?" Wharton economists warn: Washington's financial reforms are not "game-changers," will leave "plenty of risk in the system," thanks to hundreds of millions spent by Wall Street lobbyists. So America will continue sliding deeper into an economic sinkhole with no-soul, no-values, no 'Invisible Hand.' Fourth: The big idea of "promoting financial literacy" is a perennial hoax, a cleverly disguised Wall Street marketing gimmick. As Richard Thaler, the godfather of behavioral economics puts it: The last thing Wall Street wants is an informed, rational investor wise to their con game. Sorry, folks, but these four big ideas will only mislead us into letting our guard down, make us more vulnerable to "Doomsday Capitalism," a viral WMD along "The Road."
2. Inside Michael Lewis's 'Doomsday Capitalism'
In "The Big Short: Inside the Doomsday Machine," Michael Lewis details what really happened in the 2008 meltdown of capitalism, leaving us with the eerie doomsday feeling: This will happen again, bigger, soon. Happen because today's weak reforms are no game-changer like the '30s, will leave Wall Street in a business-as-usual mode, with the same old shadowy derivatives game already blowing a new bubble. Prediction: Another meltdown, then finally the Great Depression II dodged in 2000 and 2008. Inside the "Doomsday Machine" is the story "of a giant bet gone wrong," Lewis tells the Los Angeles Times: "In the simplest terms, a machine got built to enrich people for taking really stupid financial risks.
The way it worked was it disguised the risks in a number of ways, but complexity was a chief tool. It made it too complicated for people in the end to understand the risks they were taking. And the machine ended up being fooled by its own deceit." Too complex? Self-deception? No reform transparency? Oh yes, it will repeat. Why? As the Timesonline's reviewer put it: "The titans of Wall Street were not simply the corrupt, flash bankers Lewis chronicled in 'Liar's Poker,' but something far, far worse. They were stupid. They had unwittingly created a monster that they did not understand and could not control." Worse, so stupid they're now building a newer, deadlier monster.
3. Peter Morici predicted the death of 'Democratic Capitalism'
Yes, democracy is dead. In his Chicago Tribune article, economist Peter Morici echoes "The Road," pulls no punches: "Democratic capitalism is in eclipse. From Berlin to Tokyo, governments struggle to instigate enough growth to pay their bills and gainfully employ workers. Meanwhile China enjoys breakneck progress. Democratic capitalism is not flawed; rather, government policymakers are destroying a system that took mankind from dark feudal superstitions to cracking the secrets of life with deceptions, delusions and abuse."
Yes, we've gotten "too stupid to fail," a self-fulfilling doomsday prophecy. Morici warns that "politicians have deceived voters" with endless unsustainable promises of high pensions, cheap health care and education benefits, with favorable taxes, tariffs and regulations. "From Barack Obama to Angela Merkel the system is suffering from delusions of grandeur, self deception and good old-fashioned abuse by leaders who address the world as Ivy League intellectuals think it should, rather than how the facts of physics, demography and economics define it."
4. Reich's 'Supercapitalism' fueling 'Doomsday Capitalism'
Former Labor Secretary Robert Reich echoes Morici: "Capitalism and democracy go hand in hand," live and die together. Before the Supreme Court granted human rights to cash-rich soulless corporations, Reich reminded us that corporations only answer to shareholders, never taxpayers. Worse, their clever CEOs know how to shift costs to taxpayers. BP is the latest example. Reich warned that while we "have done significantly better ...in our capacities as consumers and investors ... in our capacities as citizens seeking the common good, however, we have lost ground." Power has shifted "away from us in our capacities as citizens and toward us as consumers and investors." And that trend is rapidly killing democracy: "The same competition that fueled supercapitalism has spilled over into the political process." We spent nearly a billion in the Obama election cycle, and more than $100 million in the recent California GOP primary.
5. Reaganomics, godfather of new 'Doomsday Capitalism'
In "The Shock Doctrine: Rise of Disaster Capitalism," an earlier version of "Doomsday Capitalism," Naomi Klein exposed the dark economic ideology driving the GOP's Reaganomics the past three decades: "During boom times it's profitable to preach laissez faire, because an absentee government allows speculative bubbles." But "when those bubbles burst, the ideology becomes a hindrance and goes dormant while big government rides to the rescue." Then, free-market "ideology will come roaring back when the bailouts are done," as did happen. And "the massive debts the public is accumulating to bail out the speculators will then become part of a global budget crisis," as with Greece and the EU. So today Wall Street banks that were insolvent back in 2008 are not only stronger than before the meltdown, they control the White House, Congress, Treasury.
6. Anarchist-Lobbyist wars driving 'Doomsday Capitalism'
The rise of uncontrolled corporate greed killed the "Invisible Hand," the "soul" of capitalism that Adam Smith saw in 1776 as a divine force serving "the common good." Today the system has no moral compass. Wall Street's insatiable greed has destroyed capitalism from within, turning America's economy into a soulless zombie. The "Invisible Hand" Adam Smith saw as essential to capitalism in "The Theory of Moral Sentiments" died in endless battles fought by 261,000 lobbyists each wanting a bigger piece of the $1.7 trillion federal budget pie plus favorable laws protecting, vesting and increasing the power and wealth of their special interest clients. Future historians will call this ideological battle replacing democracy the new "American Capitalists Anarchy."
7. America's new competitors: 'Doomsday State Capitalism'
Warning: Everywhere external global competitors threaten America. Ian Bremmer's new book, "The End of the Free Market," is an eye-opener, proof the "Doomsday Conspiracy" of Wall Street, Washington, Corporate American CEOs and the Forbes 400 is sabotaging America from within. Yes, this greedy, myopic, narcissistic conspiracy is fast making America vulnerable to external economic forces. As a New York Times reviewer put it: Nations like "China and Russia are using what he calls 'state capitalism' to advance the interests of their companies at the expense of their American rivals."
Global pandemic? Unfortunately while America wastes trillions to bail out inefficient too-stupid-to-fail banks, our competition is bankrolling healthy state-controlled corporations to destroy us: "The stakes could be enormous. If the United States and its allies can prevail, their leading businesses will have access to natural resources and growing numbers of middle-class consumers in these nations. But if they fail, the West could be shut out of the very markets where much of the world's economic growth is expected to occur in the next few years."
Since "state capitalists are in a very strong position at the moment," when "the global economy finally recovers, guess which nation is leading the way? Not America, but China where the economy is still tightly controlled by the Communist Party." Yes folks, this is the new "Doomsday Capitalism" in action. The "Doomsday Machine" is fully operational, will soon trigger the dreaded Great Depression II. Hopefully, this time, trigger a new American Revolution freeing us from this narcissistic, self-destructive "Doomsday Conspiracy."
You can read more about how I see this dark trend unfolding. Read a few earlier columns in my archive, especially: "Death of the Soul of Capitalism: Bogle, Faber, Moore," "The New Capitalist Anarchy and the Lobbyist Bubble," and one about Oliver Stone's new movie, "'Wall Street' sequel is an Omen of U.S. Collapse." When Stone was asked about why he waited 20 years to do a sequel, he replied without hesitation: "It's about the collapse of capitalism and the collapse of our society." Get it? He sees the endgame of "Doomsday Capitalism" ... where American capitalism, as we know it, really is dead.
50 mile oil 'patch' just south of Florida Keys by June 19: Forecast
Oil Spill May End Up Lifting GDP
by Luca Di Leo
The continuing oil spill in the Gulf of Mexico could end up adding a bit of growth to the U.S. economy as the huge cleanup efforts in some ways outweigh negative factors, analysts at J.P. Morgan Chase said. Underlining that gross domestic product measures are often not a good guide to an economy’s well being, the bank said in a research note its best guess is that the impact on the U.S. economy of BP’s Gulf Coast spill would be minimal.
"The spill clearly implies a lot of economic hardship in some locations, but given what we know today, the magnitude of these setbacks looks dwarfed by the scale of the US macroeconomy," said chief U.S. economist Michael Feroli. If anything, he added, U.S. GDP could gain slightly from it. The six-month moratorium on deep-water drilling may cut U.S. oil production by around 3% in 2011 and cost more than 3,000 jobs, according to J.P. Morgan’s energy analysts.
Commercial fishing in the Gulf is also likely to suffer, but that’s only about 0.005% of U.S. GDP. The impact on tourism is the hardest to measure, although it’s fair to expect that many hotel workers who lose their jobs will find it hard to get new ones. Still, cleaning up the spill will likely be enough to slightly offset the negative impact of all this on GDP, J.P. Morgan said. The bank cites estimates of 4,000 unemployed people hired for the cleanup efforts, which some reports have said could be worth between $3 and $6 billion.
"If realized, this would likely mean a near- to medium-term boost to activity that might offset the drags," Feroli said. U.S. Democrats Monday asked BP to set aside $20 billion in a special account to be used to pay for economic damages and cleanup costs. President Barack Obama said on Monday that his administration has begun "preliminary conversations" with BP about setting up such a fund.
What Was The Point Of That TerribleSpeech?
by Jason Linkins - Huffington Post
President Barack Obama took to the Oval Office to address a nation worried to death over the Deepwater Horizon oil spill, a location used so much more often by Saturday Night Live than by actual presidents that my brain actually released a small dollop of dopamine in anticipation of comedic parody. And then, over the next seventeen minutes, nothing much happened to challenge my brain's autonomic preconceptions.
I am really not entirely sure what the point to this Oval Office address was! Were you looking for something that resembled a fully-realized action plan, describing a detailed approach to containment and clean up? Or perhaps a definitive statement, severing the command and control that BP has largely enjoyed, in favor of a structured, centralized federal response? Maybe you were looking for a roadmap-slash-timetable for putting America on a path to a clean energy future? Well, this speech was none of those things.
I mean, don't get me wrong. Obama really, really wants to stop the oil spill. And he really, really wants to hold BP accountable for the damage they've done. And he really, really wants the Gulf Coast to come through this hardship and he really, really wants to wean us from our dependency on foreign oil, and oil in general. But "really, really wants" is not a plan, and only the bitterest and most brain-dead of political opponents would have presumed, going into tonight, that Obama had not yet properly sentimentalized his opinions on any of those matters.
And yet, basically what we got, in spades, was sentiment. To be sure, it was no doubt deeply felt. And for all anyone knows, there may be, already codified, a whole series of plans in the works related to stopping the oil gusher, cleaning the gulf coast, and implementing a new series of energy policies. And they may be great plans! But if you were hoping that some of that stuff would be revealed on actual teevee cameras, in prime time, well, you were S.O.L.
Here's what we learned, instead: there was a huge oil spill, did you hear? And a team of "scientists and engineers" were assembled. Somehow, by dint of this assemblage ("As a result of these efforts," said Obama), BP has been "directed... to mobilize additional equipment and technology." And from there, somehow, "In the coming days and weeks, these efforts should capture up to 90% of the oil leaking out of the well." I don't know how any of that works, at all, but that's the story: up to 90% of the oil will soon be captured, with "equipment and technology" because some dudes met in a room.
Obama went on to remind viewers that the federal government had mobilized its efforts to help the stricken region right away, and that further efforts are forthcoming, but that the oil spill -- which is an "assault" and an "epidemic" -- will continue to damage the region. Some good news, I guess, is that Ray Mabus has been given oversight of a Gulf Coast Restoration Plan and that Michael Bromwich will be the new head of the heretofore terrible regulatory agency known as the Minerals Management Service. It may also cheer you to learn that if all goes according to plan and all the lobbyists in the world drop dead tomorrow and legislators stop behaving like a bunch of politically-compromised ass-clowns, BP will be forced to pay for the damages and the Gulf Coast will be restored.
Did you hear any good rumors about how the White House would use this opportunity to make a huge push for a new set of energy policies? Well, the spirit was there: Obama cited the shared sacrifice of Americans at war and the motivating force of setting our sights on the moon. What's the specific plan, however? Well... the House passed an energy bill? And it'd be really swell, I guess, if the Senate would do the same? And haven't we heard this before?When I was a candidate for this office, I laid out a set of principles that would move our country towards energy independence. Last year, the House of Representatives acted on these principles by passing a strong and comprehensive energy and climate bill -- a bill that finally makes clean energy the profitable kind of energy for America's businesses. Now, there are costs associated with this transition. And some believe we can't afford those costs right now. I say we can't afford not to change how we produce and use energy -- because the long-term costs to our economy, our national security, and our environment are far greater.
So I am happy to look at other ideas and approaches from either party - as long they seriously tackle our addiction to fossil fuels. Some have suggested raising efficiency standards in our buildings like we did in our cars and trucks. Some believe we should set standards to ensure that more of our electricity comes from wind and solar power. Others wonder why the energy industry only spends a fraction of what the high-tech industry does on research and development - and want to rapidly boost our investments in such research and development.
All of these approaches have merit, and deserve a fair hearing in the months ahead. But the one approach I will not accept is inaction. The one answer I will not settle for is the idea that this challenge is too big and too difficult to meet.
Are we operating off a booklet of Mad Libs, written by Jon Favreau, or something? I think you can swap out the references to energy and add back references to health care, and we can all take a trip down memory lane, to the time we all wondered why Obama wasn't out there, actively pushing for something specific in the arena of health care reform. Right down to the "I am happy to look at other ideas and approaches from either party" part, which basically commits Obama to a lengthy period of Chuck Grassley jacking himself off as the Republican Party returns with the idea of doing nothing that even remotely looks like it might be helpful to his Presidency.
But the good news is that I did learn something about local Gulf Coast traditions:Each year, at the beginning of shrimping season, the region's fishermen take part in a tradition that was brought to America long ago by fishing immigrants from Europe. It's called "The Blessing of the Fleet," and today it's a celebration where clergy from different religions gather to say a prayer for the safety and success of the men and women who will soon head out to sea - some for weeks at a time.
The ceremony goes on in good times and in bad. It took place after Katrina, and it took place a few weeks ago - at the beginning of the most difficult season these fishermen have ever faced. And still, they came and they prayed. For as a priest and former fisherman once said of the tradition, "The blessing is not that God has promised to remove all obstacles and dangers. The blessing is that He is with us always," a blessing that's granted "...even in the midst of the storm."
So that's the plan: pray like you were a bayou fisherman. Fantastic.
PS: One very specific action Obama could have taken tonight was to make it clear that BP's ongoing clampdown on the media attempting to cover the oil spill was not to be tolerated and must end immediately. Didn't even merit a mention!
Obama’s Address to the Nation: A Missed Opportunity to Tell It Like It Is
by Robert Reich
The man who electrified the nation with his speech at the Democratic National Convention of 2004 put it to sleep tonight. President Obama’s address to the nation from the Oval Office was, to be frank, vapid. If you watched with the sound off you might have thought he was giving a lecture on the history of the Interstate Highway System. He didn’t have to be angry but he had at least to show passion and conviction. It is, after all, the worst environmental crisis in the history of the nation.
With the sound on, his words hung in the air with all the force of a fundraiser for your local public access TV station. Everything seemed to be in the passive tense. He had authorized deepwater drilling because he "was assured" it was safe. But who assured him? How does he feel about being so brazenly misled? He said he wanted to "understand" why that was mistaken. Understand? He’s the President of the United States and it was a major decision. Isn’t he determined to find out how his advisors could have been so terribly wrong?
Tomorrow he’s "informing" the president of BP of BP’s financial obligations. "Informing" is what you do when you phone the newspaper to tell them it wasn’t delivered today. Why not "directing" or "ordering?"
The President distinguished what has happened in the Gulf of Mexico from a tornado or hurricane because they are over quickly while the leak is an ongoing crisis, lasting many weeks and perhaps months more. He likened it to an "epidemic." But the real difference has nothing to do with time. Tornadoes and hurricanes are natural disasters. Epidemics occur because germs mutate and spread. The spill occurred because of the recklessness and ruthlessness of a giant oil company in pursuit of profit.
And what has the nation learned from all this? The same lesson we’ve known for decades, according to the President. We must end our dependence on oil. But if we’ve known this for decades, why haven’t we done anything about it? The President endorsed the cap-and-trade bill that emerged from the House (without calling it cap-and-trade) but didn’t call for the only thing that may actually work: a tax on carbon.
I’m a fan of Barack Obama. I campaigned for him and I believe in him. I think he has a first-class temperament. I have been deeply moved and startled by his ability to speak about the nation’s most intractable problems. But he failed tonight to rise to the occasion. Is it because he’s not getting good advice, or because he’s psychologically incapable of expressing the moral outrage the nation feels? Or is it something deeper?
Whether it’s Wall Street or health insurers or oil companies, we are approaching a turning point as a nation. The top executives of powerful corporations are pursuing profits in ways that menace the nation. We have not seen the likes since the late nineteenth century when the "robber barons" of finance, oil, railroads and steel ran roughshod over America. Now, as then, they are using their wealth and influence to buy off legislators and intimidate the regions that depend on them for jobs. Now, as then, they are threatening the safety and security of our people.
This is not to impugn the integrity of all business leaders or to suggest that private enterprise is inherently evil or dangerous. It is merely to state a fact that more and more Americans are beginning to know in their bones. I’m sure our president knows it too. He must tell is like it is — not with rancor but with the passion and conviction of a leader who recognizes what is happening and rallies the nation behind him.
BP Well Gushing as Much as 60,000 Barrels of Oil a Day, U.S. Says
Jim Polson - Bloomberg
BP Plc’s well in the Gulf of Mexico is gushing as much as 60,000 barrels of oil a day, the government said yesterday, again increasing a figure officials put at 1,000 barrels more than seven weeks ago. The new estimate, of a range between 35,000 and 60,000 barrels a day, has increased accuracy because scientists used additional and better data, Energy Secretary Steven Chu and Interior Secretary Ken Salazar said yesterday in a statement posted on the official spill response website.
The estimate dwarfs the rate that BP is capturing oil at the site and comes before today’s meeting between President Barack Obama and BP Chairman Carl-Henric Svanberg. Obama said in an address from the Oval Office last night he will tell Svanberg the company must set aside "whatever resources are required to compensate the workers and business owners who have been harmed as a result of his company’s recklessness."
A drillship has been collecting about 15,000 barrels a day while crude continues to gush from the well a mile below the surface. The disaster was triggered by the April 20 explosion and collapse of the BP-leased Deepwater Horizon rig, which killed 11 workers and prompted the worst U.S. oil spill. "I’m glad that they’re finally getting a handle on it, but my heart sinks at how much this is," said Ian MacDonald, an oceanographer at Florida State University in Tallahassee. He estimated the spill rate at 25,000 barrels a day on April 29, when the official estimate was 5,000 barrels a day. "This is a phenomenal formation that they drilled into." Exceptional Gulf of Mexico wells yield 30,000 barrels a day, MacDonald said yesterday.
The latest estimate was based in part on detailed pressure measurements in the past 24 hours and more than a week of high- resolution video of the plume of oil spewing from the well, according to yesterday’s statement. "The increased flow rate numbers are a result of better data that bring together the work of several scientific teams representing the most comprehensive set of government estimates to date," Kendra Barkoff, spokeswoman for the U.S. Department of Interior, said in an e-mailed statement.
On June 10 the same group, a team of government and academic researchers, estimated the well was gushing 20,000 to 40,000 barrels a day, perhaps 50,000, before BP removed a damaged riser pipe from the well a week earlier. Yesterday’s statement didn’t elaborate on whether the team concluded that removing the pipe, which enabled BP to begin recovering oil on the drillship, increased the amount escaping from the leak.
Oil isn’t the only threat to the environment escaping from the well, said Florida State’s MacDonald. "The emphasis has been on the discharge of oil, but at these rates, the discharge of gas has also been truly phenomenal," he said. "That gas is dissolving below the surface, with the potential to reduce the amount of oxygen and carry forth huge amounts of benzene and other toxic compounds." BP resumed collecting oil yesterday afternoon aboard the drillship after recovery was interrupted for five hours by a fire, Robert Wine, a BP spokesman, said yesterday in an e-mail.
Crew members suspended operations as a safety precaution about 10:30 a.m. New York time after discovering a fire atop the ship’s derrick that may have been caused by lightning, Wine had said earlier in an interview yesterday. The fire was out in a few minutes and caused no injuries or damage, he said.
BP captured about 5,610 barrels oil from midnight to noon yesterday, the company said on its website. On June 14, the company gathered about 15,420 barrels of oil. BP is installing a second processing vessel and aims to boost its recovery capacity to 53,000 barrels a day by June 30 and 80,000 barrels a day by mid-July, the London-based company has said. It is drilling relief wells that will be used to seal the leak and which the company, the government and independent petroleum engineers regard as the best hope to plug the flow permanently. These will be completed no sooner than August.
After initially attributing oil found on the ocean surface to residue from the fire that engulfed the Deepwater Horizon and caused it to sink April 22, BP and the U.S. Coast Guard estimated the leak at 1,000 barrels a day on April 24. They increased that fivefold to 5,000 barrels a day April 28 after oil was found to be escaping from two points. The flow rate technical group, led by U.S. Geological Survey Director Marcia McNutt, estimated on May 27 that oil was gushing at a rate of 12,000 to 19,000 barrels a day, before doubling that estimate six days ago.
BP had no comment on the new spill rate estimate, Wine said. Earlier projections were "presented as just estimates with a wide margin of uncertainty," he said. The new estimate isn’t final, McNutt said in yesterday’s statement. "We will continue to revise and refine," she said.
BP Engaged in Massive Coverup of Oil Damage, Human Health Crisis
by Michael Whitney - Firedoglake
Dr. Riki Ott, a marine toxicologist, former commercial fisherman, and Exxon Valdez survivor, appeared on Countdown with Keith Olbermann last night to discuss what she called a massive coverup by BP of all aspects of the disaster. Dr. Ott explained that volunteers walking the beaches at night find carcasses of birds, turtles, and baby dolphins that, once found, are "disappeared" by men that drive on the beach with flashlights within minutes of their discovery. She also alleges that BP is using technology to disrupt cellphone and email communication at spill sites to suppress images and evidence.
In addition, BP continues to deny that residents, let alone cleanup workers, are exposed to dangerous toxins from exposure to crude oil. Residents in four states report identical symptoms, including "headaches, sore throats, nausea, dizziness, stuffy noses" – typical symptoms of exposure to crude oil
The Dangers and Difficulties of 'Bottom Kill'
by Philip Bethge - Der Spiegel
BP has only one arrow left in its quiver, a method known as 'bottom kill.' The idea is for relief wells to stop the gushing oil from below, but the technical challenges are formidable. Past experiences show that the oil may continue flowing into late autumn. For the engineers, it was a blessing in disguise. They had drilled to a depth of up to 3,500 meters (11,500 feet) below the sea floor when gas and oil suddenly began shooting upward. But there was no explosion. The 69 workers at the site were evacuated and no one was killed.
It was the morning of Aug. 21, 2009, when engineers lost control of the well beneath the West Atlas oil rig in the Timor Sea off Australia's northern coast. It took 10 weeks to stop the flow of oil.
By that time, about 4,300 tons of oil had flowed into the sea. It was only by drilling a so-called relief well that the Thai company overseeing the operation managed to pump enough mud into the well to cap the flow of oil.
For the BP engineers attempting to stop the out-of-control well still gushing oil into the Gulf of Mexico following the explosion of the Deepwater Horizon oil rig on April 20, the relief well method -- so-called "bottom kill" -- is also seen as the last solution available.
The company began drilling the two relief wells in May, and BP CEO Tony Hayward says that he is confident that "the relief wells ultimately will be successful." He expects that the spill in the Macondo oil field will finally be capped by early August. Hayward's forecasts, however, have not always proven to be reliable and independent experts warn that relief wells, like any well, are not without risk. "More oil could leak than before, because the field is being drilled into again," says Fred Aminzadeh, a geophysicist at the University of Southern California. Ira Leifer, a geochemist at the University of California in Santa Barbara, voices similar concerns: "In the worst case, we would suddenly be dealing with two spills, and we'd have twice the problem."
Making the Situation Worse
Leifer is a member of a team of experts deployed by US President Barack Obama to estimate the volume of oil currently flowing in the Gulf of Mexico. Just last week, the scientists almost doubled their estimate and now say that between 25,000 and 30,000 barrels of oil a day is gushing out of the well into the Gulf of Mexico. On Tuesday, they once again upped their estimate -- to between 35,000 and 60,000 barrels per day. BP's most recent efforts to stop the flow of oil have only made the situation worse, says Leifer. The engineers' attempt to seal off the well from above, using a method known as "top kill," failed and only enlarged the borehole, according to Leifer. Now, he adds, there is almost nothing stopping the oil from flowing out of the well.
Most experts now believe that the relief wells, despite the risks, are the only option left. The principle of the method sounds simple enough. The engineers start by drilling vertically, and then diagonally toward the out-of-control well. Once they've reached the well, they drill into it from the side and pump large amounts of mud into it. The material fills up the well from below and eventually acts as a plug. In the end the well, like a decayed tooth, is capped with cement. As straightforward as it sounds, this approach has not always been easy to implement in the past. The disaster in the Timor Sea, for example, ended in a debacle. It took engineer five tries to even find the borehole under the sea floor. Shortly before the end, the West Atlas oilrig went up in flames, after all.
Repeat of History?
Another case is also a warning sign for BP. In June 1979, engineers with the Mexican oil company Pemex lost control of the Ixtox I, an exploratory well in the Gulf of Mexico. Just as BP is now attempting to do, engineers at the time drilled two relief wells. The first relief well was finished by the end of November, but it took until March 1980, more than nine months after the accident, to cap the well. By then, 480,000 tons of crude had flowed into the Gulf, the second-biggest oil spill the world has seen to date.
Is history repeating itself? The spill in the Macondo oil field could also continue to gush uncontrollably well beyond BP's August deadline. Pemex Director Carlos Morales, currently providing BP with technical advice, expects the spill to continue for another "four to five months." Leifer also believes that the disaster on the sea floor could drag on "until late fall." Although the BP engineers have already completed two-thirds of the first relief well, it is extremely difficult to find the out-of-control well in the middle of the bedrock, says David Rensink, incoming president of the American Association of Petroleum Geologists.
"You're trying to intersect the well bore, which is about a foot wide, with another well bore, which is about a foot wide," Rensink said recently. Hitting it with the first attempt, he adds, "would truly be like winning the lottery." Instead, the engineers will presumably have to repeatedly pull back the drill head to adjust the direction, Rensink predicts. "If they get it on the first three or four shots, they'd be very lucky."
Rensink is particularly concerned that BP, in drilling the relief wells, will penetrate into precisely those rock formations in which extreme pressure and temperature conditions facilitated the April blowout in the first place. Gas bubbles and gushing oil from the depths are real possibilities. "Any relief or kill well needs to be drilled with more caution than the first well," Donal Van Nieuwenhuise, a geologist at the University of Houston, told the New Orleans daily Times-Picayune. "You don't want a repeat performance."
Still, most geologists are confident that the bottom kill method will ultimately be successful. Van Nieuwenhuise says he has never seen the method fail entirely and points out that BP has ultra-modern drill bits bristling with sensors scanning the bedrock. Furthermore, the bits can quickly change direction. Once the stricken well is found, the drilling mud that will be pumped in is heavy enough to stop even the most high-pressure oil flows. Rensink too believes that the relief well method will eventually plug the leak. "The question is only when exactly that will happen," he says.
Indeed, the engineers aren't only facing a formidable technical challenge. Weather will also play a significant role. Forecasters have already predicted that this hurricane season, which began this month, could be one of the most active on record. Drilling would have to be ceased for the duration of each strong storm.
Bank of America Merrill Lynch to limit duration of trades with BP
Bank of America Merrill Lynch has ordered its traders not to enter into oil trades with BP Plc that extend beyond June 2011, a market source familiar with the directive told Reuters. The order to the bank's traders came from a high-level executive and was made on Monday, according to a source familiar with it. It told traders not to engage in trade with BP for contracts beyond one year from this month. The directive didn't state a reason for the limit on longer-duration trades with the oil company, which comes as the British oil giant scrambles to stop an oil spill in the U.S. Gulf of Mexico for which it could eventually face billions of dollars in economic liabilities.
Limiting the duration of trades with a counterparty is one way in which banks can seek to protect themselves against risk that a company will be unable to meet its long-term obligations. BP spokesman Toby Odone said the company doesn't comment on market rumors or speculation. The company's U.S.-traded shares, which have plummeted around 47 percent since the disaster, rose 2.4 percent on Wall Street during Tuesday trading, then fell after the closing bell. At 5:45 p.m. EDT (2145 GMT), BP's shares traded at $30.66, after closing at $31.40. Also after hours, a team of scientists appointed by the government to assess the flow-rate of the BP spill in the Gulf, boosted its estimate to as much as 60,000 barrels per day.
A source familiar with BP's trading operations said they have not been curtailed since the oil spill in April. BP wasn't informed of any new trading limits with BofA, which is a relatively small player in oil markets and not among BP's top trading counterparties, the source said. The source familiar with the BofA directive said it reflects a cautionary stance toward trading with BP. However, the directive did not reference any reduction in overall credit volume the bank would extend to BP.
BP's credit rating was downgraded six notches on Tuesday by Fitch Ratings, which cited the high costs BP may face for compensating victims of the company's Gulf spill. Fitch downgraded BP to BBB from an AA rating. A source familiar with the BofA directive said it could include any trades in physical commodities, derivatives and swaps for crude oil and products. The British energy giant ranks among the world's top oil producers and traders in physical energy markets and derivatives. BP's Macondo well in the U.S. Gulf of Mexico continues to spill oil into the Gulf after deadly explosions sank the Transocean Horizon rig in late April.
The potential for soaring liabilities related to clean up costs, economic damages and legal penalties that BP could face after the Gulf spill has led some analysts and bankers to speculate that the oil giant may throttle back its trading operations. Several fuel oil traders have recently resigned from BP, including four traders from its Singapore office last week, industry sources told Reuters. Banks typically require companies like BP to put up collateral to back trades in the private derivatives market, though for highly rated firms such as BP, the collateral may be a small portion of the size of the exposure.
BP's credit default swap costs have surged in the past two months on increasing concerns over the company's credit worthiness, and traders and analysts have said some of the increase has come from banks hedging exposure to the oil company. Credit default swaps are used to protect against the risks of a company or other borrower defaulting on its obligations, or to speculate on its credit quality. BP's five-year CDS costs have jumped to 515 basis points, or $515,000 per year to insure $10 million for five years, from around 40 basis points in April, according to Markit Intraday. BofA Merrill equities analysts maintained a "buy" rating on BP's London-traded shares on June 10, but cut their price target to 575 pence a share, down from a previous 700 pence.
BP Swaps Put Odds of Default at 39%
by John Detrixhe and Shannon D. Harrington
Credit investors are pricing in a 39 percent chance BP Plc will default within five years as it tangles with the Obama administration over cleanup costs and claims for the biggest oil spill in U.S. history. The default risk implied by credit-default swaps is up from 7 percent a month ago, according to CMA DataVision. BP swaps climbed as much as 124.5 basis points to a record 630.6. BP debt due next year traded today at distressed levels, with investors demanding as much as 1,251 basis points in yield more than Treasuries.
BP, whose executives met today with President Barack Obama at the White House, has tentatively agreed to place about $20 billion over several years into a fund to pay compensation to residents along the Gulf of Mexico, a person familiar with the talks said. The company, which had $27.7 billion in cash flow from operations in 2009, was cut six levels to BBB -- two levels from junk -- from AA by Fitch Ratings because of mounting costs from the underwater well that’s spewed crude for eight weeks.
"There’s still so much uncertainty as to what ultimately the liability is and what the government is going to do," said Jason Chen, a partner and head of research at hedge fund Sancus Capital Management in New York, founded in August by former JPMorgan Chase & Co. traders. BP’s $750 million of 1.55 percent notes due in 2011 rose 0.25 cent to 92.5 cents on the dollar as of 12:26 p.m. in New York, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority, after earlier trading as low as 88 cents before news of the escrow fund. The bonds traded the most ever yesterday, according to data compiled by Bloomberg.
The securities, which rose as high as 101.2 cents in February, pay a spread of 887 basis points. Bonds that trade with relative yields of more than 1,000 basis points, or 10 percentage points, are considered distressed. Credit-default swaps on BP debt were up 110 basis points, paring the earlier rise. The credit swaps price doesn’t necessarily reflect a fundamental belief the company is at risk of bankruptcy. The contracts are used by everyone from bondholders to derivative trading partners to protect against or speculate on declines in the company’s creditworthiness. Demand from banks to hedge against losses on derivatives trades or loans can often overwhelm investor appetite to sell protection on companies.
The movement in credit swaps also was exacerbated as at least some traders increased the annual fixed payments they demand for the contracts to 500 basis points from 100 basis points. Tristan Vanhegan, a spokesman for London-based BP, declined to comment on default-swap and bond prices. BP scheduled an investor briefing at 7 p.m. today in London with Chief Financial Officer Byron Grote.
Credit swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a protecting $10 million of debt. Swaps typically rise as investor confidence deteriorates and fall as it improves. In his first address to the nation from the Oval Office, Obama said he would force BP Chairman Carl-Henric Svanberg to set aside "whatever resources are required to compensate the workers and business owners who have been harmed as a result of his company’s recklessness." Kenneth Feinberg, who also oversaw the fund that paid families of the Sept. 11 attacks, will act as an independent third party to judge claims and authorize payments to Gulf Coast residents.
BP’s shorter-term borrowing costs are rising in a signal lenders are increasingly concerned they may face losses. BP notes due in 2011 yield 208 basis points more than the company’s 4.75 percent bonds due in 2019, Trace data show. The shorter- maturity debt yielded 326 basis points less as of April 29. Investors typically demand additional yield on shorter- maturity debt when risk is concentrated in the nearer term, causing the so-called yield curve to invert.
BP’s cost to clean up the spill may escalate enough to threaten the oil company’s future, said former Shell Oil Co. President John Hofmeister, who now runs the advocacy group Citizens for Affordable Energy. "The current political movement by the U.S. government is basically an unlimited liability," Hofmeister, who ran the U.S. operations of Royal Dutch Shell Plc, Europe’s largest oil company by market value, from early 2005 through mid-2008, said yesterday at a Bloomberg Link Boards & Risk Conference in Washington. "At some point the entity will have to defend itself."
The BP well is gushing as much as 60,000 barrels of oil a day, the government said, raising for the fifth time an official estimate that had begun at 1,000 barrels a day in April. BP had $6.84 billion in cash and near-cash as of the end of the first quarter, according to a regulatory filing. It has spent $1.6 billion to stop the leak, clean it up and compensate local businesses and residents, according to figures posted on the company’s website. Liabilities may reach $37 billion, Credit Suisse Group AG estimated in a June 2 report.
Interest rates on some floating-rate municipal bonds guaranteed by BP have surged to as much as 10 percent on concern the costs of the cleanup and litigation are spiraling higher. Yields on short-term bonds backed by BP to build sewage and solid-waste disposal facilities at a chemical plant in Will County, Illinois, and a refinery in Texas City, Texas, were as low as 0.5 percent at the beginning of the month. BP backs more than $3.5 billion of U.S. municipal obligations, according to Bloomberg data.
BP bonds have lost 14.6 percent this month, after declining 2.62 percent in May, according to Bank of America Merrill Lynch index data. The overall U.S. energy company index has fallen 1.3 percent in June. The fall in BP’s bond prices has to be seen in the "context of the asset values and the earnings capability of this company," said Joel Levington, managing director of corporate credit at Brookfield Investment Management Inc. in New York. "When you’re talking about a company that can earn $20 billion in 2011, before its dividend, that’s significant flexibility."
Bonds of some companies associated with drilling and the spill may be attractive because their liabilities are more easily understood than BP’s, according to Chen. The leak began after an explosion on the Deepwater Horizon rig owned by Transocean Ltd. Anadarko Petroleum Corp. owns 25 percent of the well. Anadarko’s $750 million of 6.2 percent bonds due in 2040 fell 1.625 cents to 81.375 cents on the dollar, the first decline in five days, Trace data show. The debt traded as low as 75 cents on June 9. Transocean’s $1 billion of 6 percent debt due in 2018 dropped 2.06 cents to 86 cents on the dollar, the first decline in four days.
Elsewhere in credit markets, Bank of America Corp. sold $1.25 billion of bonds backed by auto loans, according to a person familiar with the transaction. GMAC Inc.’s Ally Bank plans to sell $792.3 million of bonds backed by auto loans, according to another person familiar with that transaction.
BP Builds 'Responders Village' for Cleanup Crews
by Ángel González - Wall Street Journal
BP PLC is erecting a small village to house workers laboring to clean up the environmental disaster in the Gulf of Mexico. Oil-spill responders have just started moving in to the camp-like collection of trailers, tents and portable toilets about eight miles from Venice. It will house up to 1,500 of the workers battling the spill in this southeastern corner of Louisiana. The "Responders Village" is expected to cost $1 million to $5 million. BP is also fitting out ships to serve as floating hotels that can be moored by imperiled marshes, saving time and sparing workers watery commutes of up to two hours from land.
The "flotels" will cost about $200,000 a day to operate, the British energy company says. The disaster has already cost BP $1.6 billion, and experts predict BP, which owned the well now gushing crude, is likely to incur many billions more in costs associated with the cleanup, claims and litigation. Until now, most of the 2,000 personnel working in the oil-response effort in the Venice area have been living in hotel rooms and condos as far north as Belle Chasse, some 70 miles from here. About 400 sleep in trailers at the operations center where crews are dispatched offshore, south of Venice.
The Venice command center is the largest of about a dozen that have popped up along the Gulf Coast as a massive federal, regional and private-sector effort is organized to fight the spill. The influx of respondents has doubled the population of Venice and Boothville, small communities previously dedicated to commercial and sport fishing, as well as oil services. "This is the tip of the spear," said Lt. Cmdr. Pat Eiland, with the U.S. Coast Guard, branch commander for the site. Plaquemines Parish, where Venice sits, is the largest Louisiana parish affected by the spill, and has the most sensitive coastline, he said. BP and federal agencies have faced criticism over the speed and organization of their response to the spill.
At a meeting with other officials last week, Cmdr. Eiland said the operation was progressing "from disorganized complexity to organized complexity," seven weeks after its start. The massive buildup is changing the face of the community. Hundreds of cars and trucks crowd the once sleepy highway that leads north to New Orleans. Helicopters constantly criss-cross the skies. In the early part of the day, National Guard members do their morning run along marshes full of heron and alligators. The newcomers seem poised to dig in.
"We plan to stay here for months," said Frederick Lemond, Plaquemines Parish director for BP. Mr. Lemond moved here from Wyoming, accompanied by his wife—a sign that the cleanup may require putting down some roots. More than 100 managers have moved here from other places to guide the response effort. Immigrants to Venice face daunting challenges, among them the relentless heat. The temperature hit 90 degrees Fahrenheit Monday, with the "real feel" temperature, which factors in humidity, climbing to 103. Mr. Lemond said crews were supposed to work 40 minutes out of every hour and take the remaining time off. If they're wearing cumbersome protective gear, they're to work for only 20 minutes and rest for 40. The accommodations are spartan.
Long white trailers each house 36 people, who sleep in three rows of bunk beds. Each bunk space has electrical outlets for plugging in entertainment devices. Gear goes in lockers. A tent is being put up as a recreation hall, where workers can watch television. BP is providing laundry service. Shopping is limited largely to convenience stores, unless people are willing to drive 20 miles to Port Sulphur. Another 1,200-square-foot air-conditioned tent serves as a mess hall. The caterer, Jim Keller, owner of Cashio's Catering, said he was hired to provide a variety of cuisines, including Vietnamese, Thai and vegetarian.
BP rivals struggle to explain why plans look so similar
by Erika Bolstad - McClatchy Newspapers
Top executives from four of the five largest oil companies operating in the U.S. tried Tuesday to show that their own engineering and management practices include safeguards that would prevent them from making the same mistakes that led to BP's runaway deepwater oil well. The executives, however, struggled to explain to an irate and insistent House of Representatives subcommittee why, as McClatchy reported on June 2, their regional response plans for catastrophic Gulf of Mexico spills are nearly identical to the BP plan — a document that's now widely considered inadequate for containing a gush of oil that's now estimated at 35,000 to 60,000 barrels each day.
Testifying together for the first time since they were questioned about high gasoline prices in 2008, the executives from Shell, Chevron, Exxon Mobil and ConocoPhillips repeatedly said they wouldn't have allowed the same drilling risks as their counterpart at BP, Lamar McKay, who was grilled about the company's progress in capping and cleaning up the spill. "We would not have drilled the way they did," said Rex Tillerson, the chief executive of Exxon Mobil.
Tillerson, whose corporation is among the biggest in the U.S. and has been rated as the most profitable non-state-owned oil company in the world, was often the most outspoken and opinionated of the five executives. Tillerson told the committee that he had brief conversations with President Barack Obama and several top White House aides about the spill and the response. He rattled off a list of what Exxon would have done differently than BP, beginning with the well design, the type of pipe the company would have run from the ocean floor deep into the Earth, what sort of cement it would have used and the decisions it would have made about the unusual pressure and test results that its BP counterparts saw.
"What we do know is when you properly design wells for the range of risk anticipated, follow established procedures, build in layers of redundancy, properly inspect and maintain equipment, train operators, conduct tests and drills, and focus on safe operations and risk management, tragic incidents like the one we are witnessing in the Gulf of Mexico today should not occur," Tillerson said.
Shell's Marvin Odum, whose company saw its exploratory drilling plans in Alaska's Arctic waters put on hold by the government after the April 20 rig explosion, told the committee that his company has reviewed its safety practices following the Gulf accident. Their reassurances rang hollow to the chairman of the energy and environment subcommittee of the House Energy and Commerce Committee, Rep. Ed Markey, D-Mass., who focused on the similarities of the response plans.
Some of the "cookie cutter" response plans even mention walruses, Markey said, a marine mammal that he pointed out hasn't lived in the Gulf of Mexico for 3 million years. "The only technology you seem to be relying on is a Xerox machine to put together your response plans," Markey said. "Obviously, it is embarrassing," acknowledged Jim Mulva, the chairman and chief executive officer of Conoco Phillips.
McClatchy reported that plans for 31 deepwater exploratory wells that are now subject to a moratorium mimicked those of BP's. They were so similar to BP's that the Minerals Management Service recently asked the companies to resubmit them. There was one notable difference in the plans, said Rep. Bart Stupak, D-Mich. Exxon's response plan included a public relations response plan based on its experience with the 1989 Exxon Valdez tanker spill in Alaska's Prince William Sound — but at 40 pages, it's longer than what company devotes to the cleaning up a spill, Stupak said.
"It could be said that BP is the one bad apple in the bunch," Stupak said. "But unfortunately, they appear to have plenty of company. Exxon and the other oil companies are just as unprepared to respond to a major oil spill in the Gulf as BP." On paper, the plans "might seem reassuring, but reality shows you can't prevent the oil from reaching the Gulf shores," Stupak said.
How, Stupak asked Exxon's Tillerson, would the company handle a 160,000-barrel a day spill — its worst-case scenario — when BP can't handle one that's now estimated at 35,000 to 60,000 barrels each day? "We are not well-equipped to handle them," Tillerson said. "There will be impacts, as we are seeing. And we've never represented anything different than that." "And that's why the emphasis is always on preventing these things from occurring because, when they happen, we're not very well-equipped to deal with them," Tillerson said. "And that's just a fact of the enormity of what we're dealing with."
Republicans on the committee said the hearing should have just one focus: how to stop the leak and contain the spill. Many of the panel's Republicans said they feared the hearing would be hijacked for political ends — including pushing climate change legislation.
Some, such as Rep. Michael Burgess, R-Texas, urged the Obama administration to avoid any "knee-jerk" reactions on energy policy in the wake of the spill and asked for the moratorium on new deepwater drilling to be relaxed, a request echoed by the oil companies. "In some ways, this committee undermines its own credibility when it capitalizes on a tragedy — and this is a tragedy, 11 lives were lost — when we capitalize on a tragedy to push forward a political agenda," Burgess said.
Another Fed Official Supports Plan Forcing Banks To Spin Off Derivatives Units; Obama's Treasury STILL Opposed
by Shahien Nasiripour - Huffington Post
The president of the Federal Reserve Bank of St. Louis supports a Senate plan that would force Wall Street megabanks to spin off their derivatives units and raise significantly more capital to cover their bets, becoming the third Fed official outside Washington and New York to support a hotly contested measure that's turning into a Wall Street versus Main Street issue. James Bullard, the St. Louis Fed chief, joins Dallas Fed President Richard Fisher and Thomas Hoenig, who heads the Kansas City Fed, as the three Fed officials who publicly support the provision, authored by Senate Agriculture Committee Chairman Blanche Lincoln (D-Ark.), according to one of his spokesmen. The Obama administration and the Fed's Washington-based Board of Governors oppose the measure and are working to kill it.
Bullard's support is key to a measure vehemently opposed by Wall Street. The plan would force financial behemoths that run their swaps-dealing operations out of their banks to reorganize those desks into separately-capitalized affiliates, compelling them to collectively raise tens of billions of dollars in capital to back up potential losses. JPMorgan Chase, Goldman Sachs, Bank of America and Citibank are the biggest dealers in over-the-counter swaps in the country, according to the most recent figures from the Office of the Comptroller of the Currency. Swaps are a type of derivative contract.
Last week, Hoenig and Fisher sent letters of support to Lincoln, referring to her measure as one "of utmost importance to our nation's long-term financial and economic stability." Though Bullard supports the measure, he's presently out of the country and unavailable for comment, said Robert J. Schenk, a senior vice president in charge of public affairs at the St. Louis Fed. The three regional Fed chiefs represent the Fed and bankers in the broad middle of the country stretching from Kentucky to Colorado. Bullard and Hoenig are voting members of the Fed's main policy-making body, the Federal Open Market Committee. The FOMC sets the main interest rate, the federal funds rate.
Meanwhile, Treasury, led by Timothy Geithner, representing the White House, and the Fed's Board of Governors, led by Ben Bernanke, find themselves on the side of Wall Street money center banks. "It shows the access of the major Wall Street banks in the Treasury Department in spades," one Senate aide told the Huffington Post earlier this week on the condition of anonymity. "I think this shows that the [Fed's] Board of Governors and Treasury are out of touch with how a lot of other people are thinking about this stuff."
House Speaker Nancy Pelosi is among the provision's more high-profile supporters. Federal Deposit Insurance Corporation Chairman Sheila Bair opposes it, though spokesman Andrew Gray says the agency is "optimistic our concerns can be addressed." Bair believes banks should be able to hedge against interest rate and currency risk for themselves and their customers. During a May 5 speech on the Senate floor, Lincoln said banks can continue to do exactly that even if her proposal is adopted into law. "Banks that have been acting as banks will be able to continue doing business as they always have," Lincoln said. "Community banks using swaps to hedge their interest rate risk on their loan portfolio will continue to be able to do so. Most important, we want them to do so."
This week, Lincoln sent around Capitol Hill a possible clarification to her provision. The legislation will still allow banks to appropriately hedge against changes in interest rates and currency valuations, and will be able to continue to offer swaps to customers in conjunction with traditional bank products like loans, according to her office. Other supporters of her measure include the Independent Community Bankers of America, the Consumer Federation of America, AARP, and various labor unions and leading economists, including Nobel Prize-winning economist Joseph Stiglitz.
House Agriculture Committee Chairman Collin C. Peterson indicated his support for the measure last week during House-Senate negotiations over combining the chambers' separate versions of financial reform legislation.
Earlier this week, a White House spokesman said of Lincoln's spin-off measure that "we continue to see this specific provision as only one small piece of the sweeping derivatives reform that Senators Dodd and Lincoln and Chairman Frank have championed."
Lincoln's measure aims to "let banks be banks," supporters say, by forcing them to shed their riskiest Wall Street operations from the deposit-taking bank. Banks are explicitly supported by taxpayers in the form of federal deposit insurance and access to cheap funds from the Fed's discount window. Supporters argue that taxpayers shouldn't subsidize banks' swaps dealing when they're not offered to customers wishing to hedge risk in conjunction with traditional banking products.
By forcing megabanks to divest their units into separate affiliates, which in turn would compel them to raise money to capitalize these affiliates, Lincoln's measure could force them to scale down their operations. At the least, supporters say, it would force them to have enough cash on hand in case their bets began to sour, saving taxpayers from having to step in to prop up the banks like they did in 2008 -- an explicit level of support that continues today.
Treasury bonds defy expectations
by Michael Mackenzie - Financial Times
As the first half of the year draws to a close, US Treasury bonds have confounded the predictions of doom prevalent at the start of 2010, largely thanks to the eurozone debt crisis, which has boosted demand for the US dollar and American government debt. With US equities currently faltering in and out of negative territory for the year after a torrid May, investors are once more in a position of having to make a choice; bonds or shares. It is a decision that hinges on whether the US economy can escape contagion from the eurozone – and its various austerity programmes – and keep growing, forestalling concerns about disinflation and possibly even a double-dip slowdown. “It’s a nerve-wracking time, the range of possiblities for the economy and markets facing investors is very wide,” says Stuart Schweitzer, global market strategist at JPMorgan’s Private Bank. “It’s jobs that count for keeping the US consumer going.”
The jobless nature of the US economic recovery is just one factor that has confounded the ranks of bond bears, who were growling loudly at the start of the year. Back in January, many professional investors, including the likes of Pimco and the large banks, were heavily underweight government bonds. They fully expected interest rates to start rising by late summer, with momentum coming from the Federal Reserve implementing the initial stages of ending its easy monetary policy. Six months later, a smouldering sovereign debt crisis in the eurozone – now focused on Spain – and worries about the possible knock-on effect on the US and global economy has the 10-year Treasury yield parked at 3.25 per cent, after hitting a low of 3.06 per cent last month. This reflects expectations that rate hikes by the US Federal Reserve will not be starting until next March.
Given that the 10-year note was above 4 per cent back in April, the subsequent pronounced drop in yield is a testament to how bearish investors have scrambled to get back into the market. “A lot of investors were caught out,” says Rick Klingman, managing director at BNP Paribas. “There has been a very quick switch back into Treasuries as people have re-evaluated their opinion of where the US economy and inflation are heading in the wake of the problems in Europe.” This week, RBS announced “a large downward revision” to its US treasury interest rate forecast, with the yield on 10-year notes now seen falling to 2.75 per cent during the fourth quarter. At the start of January the bank had a target of 4.40 per cent. “US growth has underperformed past recoveries and the effects of fiscal stimulus are set to wane in the second half of 2010,” says William O”Donnell, strategist at RBS.
Not everyone in bond land, however, has been caught out this year. David Ader, strategist at CRT Capital, expected that the market would keep 10-year yields inside a range of 3 per cent to 4 per cent. Also confounding the bond sceptics have been record inflows into Treasuries from outside the US. This week, the latest official data released by the US Treasury showed that for the first four months of the year – at the height of bearishness over bonds – private Treasury inflows had been a cumulative $250bn. Bearish investors started reversing their views about Treasuries as the eurozone problems intensified during April. As of January, Pimco’s flagship $225bn total return fund, managed by William Gross, held 31 per cent of assets in US government-related interest rates. By the end of April, the total return fund was up to a 36 per cent weighting for US government exposure.
“There is not great value at 3.25 per cent in a 10-year, but we view Treasuries as insurance for portfolios with equities or equity-like exposure,” said Tony Crescenzi, portfolio manager at Pimco. Owning Treasuries this year has easily outperformed the S&P 500 and riskier corporate bonds. The Barclays Capital US Treasury index is up 4.1 per cent this year, rebounding from a loss of 3.6 per cent in 2009. But the real gains have come from owning longer-dated Treasury paper, as an index of bonds beyond 20 years in maturity is up 9 per cent so far in 2010, after a slide of 21.4 per cent. The value of long-term bonds is primarily determined by expectations of inflation, which has seen the core consumer price index hit a 44-year low. A weaker economy in the second half of this year, accompanied by further downward pressure on prices, would be a plus for bonds.
Lombard Street Research notes that broad money in the US has contracted for the past six months – and for 15 months of the past 18 – at a time when the Fed has maintained easy monetary policy. “The message from the US broad money and credit trends over the past two years is clear; there is little likelihood of a return to sustained trend rate, let alone above-trend, growth in the near future,” says Gabriel Stein, director at Lombard. Against that backdrop, the debate now turns on whether bond yields will break the lower band of their range, accompanied by stocks hitting fresh lows in the coming months. Mr Ader says: “There is a clear risk we make a stab through 3 per cent, due to an anticipation of a weaker economy, tax hikes coming next year and worries about disinflation.”
Banks resist restructuring pain: Blackstone
by Sinead Cruise and Daryl Loo - Reuters
Banks unwilling to take losses on their troubled property assets are limiting restructuring experts to giving them one-dimensional deleveraging strategies, possibly extending a credit logjam for a decade. Simon Davies, managing director in the restructuring and reorganization group at Blackstone, said real estate had degenerated into a "amend and extend business" where stressed creditors tended to view active restructuring as a last resort. "The ideas they don't want to hear about are ideas where you take a haircut to the debt's notional price," Davies told the Reuters Global Real Estate and Infrastructure Summit in London.
"So long as an asset is producing sufficient income and cashflow to cover debt costs, for the bank's purposes of being not a loss-making instrument ... I think you will probably see banks hanging in for a longer period of time," he said. Standard & Poor's has warned European lenders face higher impairment charges on real estate loans in 2011, likely a major issue for banks such as RBS, Lloyds, Allied Irish Bank and Spain's BBVA. This followed a report earlier in 2010 showing an estimated 207 billion euros ($252.3 billion) of unpaid commercial property loans in Europe, one-fifth of the total, were secured by problematic, low-quality assets.
Davies blamed slow deleveraging of European lenders for restricting the flow of credit to businesses and consumers, which he said was likely to exacerbate sluggish economic conditions across Europe for a "painfully long time." "I'm concerned personally that I could be 47 -- not 37, which I am this year -- before we actually feel there's economic growth filtering through on a sustainable basis," he said. The age of austerity was likely to be more severe than people are hoping for, Davies warned, citing particular concerns for the value and income streams of consumption-backed real estate like upmarket malls and trophy real estate. "It's going to be a slow and steady, problematic issue because fundamentally consumption will have to drop, and it will drop in stages as people get taxed more and get unemployed more, and as fiscal spending is cut back," he said.
Resistance to active restructuring was also evident in the global real estate opportunity funds sector, Davies said, where major operators including Morgan Stanley and Goldman Sach's Whitehall were counting the costs of highly-leveraged, ill-timed investments at the peak of the boom. "We've looked at talking to limited partners, to funds whether its real estate or private equity (for restructuring advisory) ... but there's limited appetite, is the best way of putting it," he said. "They seem to be resigning to a certain amount of losses, but not really in the mood for change."
Cap Bankers’ Bonuses at Half Pay, EU Lawmakers Say
by Ben Moshinsky - Bloomberg
Bankers’ bonuses should be capped at 50 percent of their pay, lawmakers on a European Parliament committee said, as they voted on tougher capital and remuneration rules for banks. Directors at banks that received public funds would also have their salaries capped at 500,000 euros ($616,000), and at least 40 percent of any bonus would be deferred for five years, under the measures approved by the assembly’s Economic and Monetary Affairs Committee in Strasbourg, France yesterday.
"If bankers and traders want to leave and go to other jurisdictions, it just shows that they do not have confidence in their own performance," Sharon Bowles, chairwoman of the committee, said in an e-mailed statement today. "To those that would leave I say good riddance." Lawmakers around the world have blamed bonuses for the excessive risk-taking that contributed to the worst financial crisis since World War II. Sweden proposed laws last year that would force bankers in Europe to defer part of their bonus for three years and receive at least 50 percent in shares. The plans for bankers’ pay will be voted on by the whole EU Parliament in July. The measures are proposed changes to draft rules on bank capital published last year by the European Commission, the 27-nation EU’s executive body.
"I think it’s extremely short-sighted," David Buik, a market analyst at inter-dealer broker BGC Partners in London, said in a telephone interview today. "I understand the political expediency, I’m quite happy with capital requirements, but don’t kill off invention and innovation." Under the Parliament plan, bankers would be forced to hold on to 90 percent of up-front bonus payments for at least five years, in case their employers needed the money back to cope with short-term funding problems.
Directors at banks that received public money would be barred from getting a bonus until the state funds had been repaid. Royal Bank of Scotland Group Plc’s chairman Philip Hampton was booed by investors at the bank’s annual general meeting in April after saying that investment banking salaries were "high," though not "obscene." The bank received a 45.5 billion-pound taxpayer rescue following record losses in 2008. "RBS has led the way in reforming the structure of pay -- no reward for failure, full clawback and deferral and no cash bonuses for all but the most junior staff," Michael Strachan, a spokesman at RBS, said in an e-mailed statement.
"We want the interest of the person receiving the bonus to be positively aligned with the customers and the shareholders," Syed Kamall, a U.K. conservative member of the EU parliament, said in a telephone interview today. "If we start capping bonuses it’s possible we’ll end up with a situation where there’s a much higher basic salary and less of an incentive to perform well," Kamall said. Draft EU laws need the approval of governments and the Parliament before they can take effect, a process that can take more than a year. "The public won’t accept, in the era of austerity, people to make such huge amounts of money," Peter Skinner, a U.K. Labour member of the EU parliament, said in a telephone interview today. "I saw people in the middle, left and right support it," Skinner said.
Fresh ideas on curbing fat cats' appetite for risk
by Gillian Tett - FT
What is the best way to pay top bankers? That is a question that has haunted western politicians since the credit crisis started. After all, in the past two years the pay of most non-bankers - ie voters - has been flat or falling. But many bankers - or financial "fat cats", as they are dubbed - have continued to earn vast sums. And while regulators widely agree that this banking compensation system is flawed, there has hitherto been little practical change. In Europe, some governments have tried to impose taxes on banker bonuses, or impose guidelines. Some, like the Dutch, are even imposing curbs.
Such moves have had limited bite, partly because in the US there has been virtually no change to the compensation system at all. Indeed, the current financial reform bills barely mention the topic, since the idea of Big Government trying to determine banker pay is something that still looks profoundly "un-American". However, in one place, at least, banker compensation is provoking some intriguing debate: namely the academic research arm of the New York Federal Reserve. Hamid Mehran, a senior economist at the New York Fed, has been brainstorming the issue with colleagues and academic economists. Mr Mehran and others have concluded that one of the biggest problems with the fat cat financiers is that their pay is linked to share prices.
America's vision of capitalism has tended to assume that the best way to run efficient companies is to give top executives incentives to maximise shareholder value, by linking pay to share prices. But even if that creed works for non-financial companies, there is a basic problem with applying this principle to banks. The average non-financial company is composed of 60 per cent equity and 40 per cent debt. But at banks, leverage has been so high that debt can account for 95 per cent of value, and equity only 5 per cent. Thus, if bank executives focus only on equity prices - say, by raising profits - but have less incentive to protect the long-term value of debt - most notably by creating a stable business - that creates a mismatch, particularly since bank debt is typically protected by governments. Or as a paper* recently co-authored by Mr Mehran says: "Structuring CEO incentives to maximise shareholder value in a levered form tends to encourage excess risk- taking." Hence the credit boom.
Economists propose one obvious solution: bank boards and regulators should also link executive pay to the performance of bank debt, measured either by bond prices or the cost of insuring bank bonds against default using credit default swaps. That, they argue, would provide both a capitalist incentive and one to keep banks stable - and, better still, without Big Government control. Could this fly? Don't hold your breath. To most politicians and taxpayers the scheme probably sounds too complex or subtle to work. The CDS market is pretty politically controversial right now and the compensation committees of most investment banks are so shell-shocked by the crisis that they are keeping their heads down, not trying radical experiments.
Nevertheless, Mr Mehran's idea certainly does deserve a wider audience, not least because it exposes a fundamental paradox in the current Washington financial reform debate. Americans have taken it for granted that banks were designed to make profit and maximise shareholder value. But the crisis has shown that many politicians and voters also think banks have a wider public function as a utility. This second goal is driving much of the reform. The bitter truth is that it is extremely difficult to chase both goals, without endless government meddling. Banks cannot be safe utilities performing a social function and profit-maximising ventures, unless the state wraps the banks in endless rules to protect them from their own profit-seeking bankers. There is little sign the US wants that. But if it keeps paying bankers to boost the share price, it will be hard to build a stable system of finance - even with all the reforms being debated in Washington.
Spain, Portugal Debt May ‘Snowball,’ EU Draft Says
by Meera Louis - Bloomberg
Debt levels in Spain and Portugal may "snowball" in coming years and additional budget cuts are needed to meet deficit targets announced just a month ago, according to a draft European Commission document. The deficit-reduction measures announced by the two nations as part of a European Union agreement on May 10 to create a 750 billion-euro ($920 billion) financial backstop for indebted countries aren’t sufficient, the report obtained by Bloomberg News said. Spain pledged to cut the EU’s third-highest deficit to 9.3 percent of gross domestic product this year and to 6 percent in 2011. Portugal vowed to lower its shortfall to 7.3 percent of GDP in 2010 and to 4.6 percent in 2011.
"While the newly announced measures are significant and the targets imply impressive budgetary consolidation, more measures are needed to meet those targets, in particular for 2011," according to the draft report, which is dated May 26. The document, titled "Consolidation Requirement in Spain and Portugal," was prepared by the European Commission, the EU’s executive arm, for the region’s finance ministers. Portugal will need additional measures worth 0.3 percent of GDP this year and at least 1.5 percent next year to meet their May 13 deficit goals, the commission document said. Spain could meet this year’s target with only "marginal" adjustments and will have to cut at least 1.75 percent of GDP next year to meet its targets.
Spanish Finance Minister Elena Salgado said on June 8 that her government will take "any measures necessary" to meet the 2011 deficit target. The EU praised Portugal and Spain’s efforts to cut their budget shortfalls, while warning that the austerity measures needed to trim the deficit are taking place in "adverse context of low GDP growth, poor competitiveness, stable or declining prices and wages and high real interest rates. These conditions result in a high ‘snowball’ effect on the government debt."
The draft report said that only by implementing "frontloaded consolidation" in addition to meeting the deficit targets for the next two years will debt in both countries decline by 2020 from next year’s projected levels of 70.5 percent of GDP for Spain and 80.5 percent for Portugal. In the worst-case scenario considered in the report, both countries would have debt of more than 130 percent of GDP in 2020. In a public report today on the deficits of 12 EU countries including Spain and Portugal, the commission cited the required budget cuts for 2011 while refraining from mentioning the "snowball effect."
"It is essential to substantiate these new measures" to meet the revised deficit targets for next year, EU Economic and Monetary Affairs CommissionerOlli Rehn told a press conference on the public report in Strasbourg, France. The yield premiums investors demand to buy the countries’ benchmark bonds instead of comparable German debt "remain high," according to the report, and it called their deficit- cutting tasks "daunting." The yield premium, or spread, on 10-year Portuguese securities over bunds widened 14 basis points today to 272 basis points, the most in a week, with the Spanish-German spread was little changed at 205 basis points, according to Bloomberg generic data.
"Our assessment should be taken as early guidance for next year’s budget in line with recent proposals to enhance economic governance in Europe," Rehn said. EU finance ministers last week backed a Rehn proposal to police national budgets at an early stage and introduce a wider range of sanctions on excessive deficits.
The euro mutiny begins
by Ambrose Evans-Pritchard - Telegraph
The rebellion against the 1930s fiscal and monetary policies of the Euro-complex is gathering pace. Il Sole has published a letter by 100 Italian economists warning that the austerity strategy imposed by Brussels/Frankfurt risks tipping Europe into a self-feeding downward spiral. Far from holding the eurozone together, it will cause weaker countries to be catapulted out of EMU. Others will leave in order to restore sovereign control over their central banks and unemployment policies.
At worst it will blow the EU apart, leading to the very acrimony that the European Project was supposed to prevent. For readers of Italian, it’s here. While I don’t share the big-state Left-Keynesian perspective of these professors — nor their implicit hostility to the free market — I do agree with much of their overall analysis. My rough translation:
"The grave economic global crisis, and its links to the eurozone crisis, will not be resolved by cutting salaries, pensions, the welfare state, education, research …….. More likely, the `politics of sacrifice’ in Italy and in Europe runs the risk of accentuating the crisis in the end, causing a faster rise in unemployment, of insolvencies and company failures, and could at a certain point compel some countries to leave monetary union. The fundamental point to understand is that the current instability of monetary union is not just the result of accounting fraud and over-spending. In reality, it stems from a profound interweaving of the global economic crisis and imbalances within the eurozone …..
It blames the crisis on the "deflationary economic policies" of the richer states. "Especially Germany, geared for a long time to holding down salaries in relation to productivity, and to the penetration of foreign markets, gaining European market share for German companies… They say the policy has led to growing surpluses in Germany, offset by growing debts in Southern Europe. The adjustment mechanism has not only failed. Matters have got worse, and worse.
"This is the deeper reason why market traders are betting on a collapse of the eurozone. They can see that as the crisis drags on this will cause tax revenues to fall, making it ever harder to repay debts, whether public or private. Some countries will progressively be pushed out of the eurozone, others will decide to break away to free themselves from a deflationary spiral… It is the risk of widespread defaults and the reconversion of debts into national currencies that is really motivating bets by speculators.
The economists denounced the "obstinacy" with which the EU authorities and governments are pursuing "depressionary policies", and called on the European Central Bank to abandon its policy of "sterilizing" purchases of Greek, Portuguese, and Spanish bonds, and move to fully-fledged quantitative easing to boost the money supply. "We must have an immediate debate on the extremely grave errors in economic policies now being committed…
Si, Signori .. Bravissimi.
Just to be clear, I do not share their Krugmanite view that huge fiscal deficits are benign. In my view, it is imperative that the whole western world reduces debt in a orderly fashion over 10 to 15 years. Pacing is crucial. Too fast can be self-defeating. Too slow is not an option. My objection with the EU’s mix of policies is that extreme fiscal austerity is being imposed on a string of countries without offsetting monetary stimulus. (Yes, I know, some will say that I am mixing apples and oranges).
Ireland, Spain, and Portugal have already tipped into outright deflation. Ireland’s nominal GDP has contracted 18.6pc since the peak. They are falling deeper into an Irving Fisher debt-deflation trap. This is reactionary folly. The College of European Commission should be taken out and horse-whipped outside the Breydel Building for demanding yet further cuts from Spain — which is already cutting wages 5pc this year, in an economy where total public /private debt is 280pc of GDP or more. Can nobody think of a more coherent way out of this?
As for Germany, frankly it is hard to know what to say. It is astonishing that Chancellor Merkel should unveil an €80bn package of fiscal retrenchment without consulting with the rest of Europe. This has raised the bar for everybody else, forcing them into yet further contractionary policies to keep up. Mrs Merkel does not begin to understand the nature of commitment made by Germany when it launched monetary union. EMU has become an infernal machine. This will not be the last letter by angry economists.
Nightmare vision for Europe as EU chief warns 'democracy could disappear' in Greece, Spain and Portugal
by Jason Groves
Democracy could ‘collapse’ in Greece, Spain and Portugal unless urgent action is taken to tackle the debt crisis, the head of the European Commission has warned. In an extraordinary briefing to trade union chiefs last week, Commission President Jose Manuel Barroso set out an ‘apocalyptic’ vision in which crisis-hit countries in southern Europe could fall victim to military coups or popular uprisings as interest rates soar and public services collapse because their governments run out of money. The stark warning came as it emerged that EU chiefs have begun work on an emergency bailout package for Spain which is likely to run into hundreds of billions of pounds.
A £650 billion bailout for Greece has already been agreed. John Monks, former head of the TUC, said he had been ‘shocked’ by the severity of the warning from Mr Barroso, who is a former prime minister of Portugal.
Mr Monks, now head of the European TUC, said: ‘I had a discussion with Barroso last Friday about what can be done for Greece, Spain, Portugal and the rest and his message was blunt: "Look, if they do not carry out these austerity packages, these countries could virtually disappear in the way that we know them as democracies. They've got no choice, this is it." ‘He's very, very worried. He shocked us with an apocalyptic vision of democracies in Europe collapsing because of the state of indebtedness.’
Greece, Spain and Portugal, which only became democracies in the 1970s, are all facing dire problems with their public finances. All three countries have a history of military coups. Greece has been rocked by a series of national strikes and riots this year following the announcement of swingeing cuts to public spending designed to curb Britain’s deficit. Spain and Portugal have also announced austerity measures in recent weeks amid growing signs that the international markets are increasingly worried they could default on their debts.
Other EU countries seeing public protests over austerity plans include Hungary, Italy and Romania, where public sector pay is to be slashed by 25 per cent. Deputy Prime Minister Nick Clegg, who visited Madrid last week, said the situation in Spain should serve as a warning to Britain of the perils of failing to tackle the deficit quickly. He said the collapse of confidence in Spain had seen interest rates soar, adding: ‘As the nation with the highest deficit in Europe in 2010, we simply cannot afford to let that happen to us too.’ Mr Barroso’s warning lays bare the concern at the highest level in Brussels that the economic crisis could lead to the collapse of not only the beleaguered euro, but the EU itself, along with a string of fragile democracies.
GREECE: Georgios Papadopoulos was dictator from 1967 to 1974. The Colonel led the military coup d'etat in 1967 against King Constantine II amid political instability. He was leader of the junta which ruled until 1974.
Papadopoulos was overthrown by Brigadier Dimitrios Ioannidis in 1973. Democracy was restored in 1975.
SPAIN: General Francisco Franco led Spain from 1936 until his death in 1975. At the end of the Spanish Civil War he dissolved the Spanish Parliament and established a right-wing authoritarian regime that lasted until 1978. After his death Spain gradually began its transition to democracy.
PORTUGAL: Antonio de Oliveira Salazar's regime and its secret police ruled the country from 1932 to 1968. He founded and led the Estado Novo, the authoriatan, right-wing government that controlled Portugal from 1932 to 1974. After Salazar's death in 1970, his regime persisted until it eventually fell after the Carnation Revolution.
But it risks infuriating governments in southern Europe which are already struggling to contain public anger as they drive through tax rises and spending cuts in a bid to avoid disaster. Mr Monks yesterday warned that the new austerity measures themselves could take the continent ‘back to the 1930s’. In an interview with the Brussels-based magazine EU Observer he said: ‘This is extremely dangerous. 'This is 1931, we're heading back to the 1930s, with the Great Depression and we ended up with militarist dictatorship. ‘I'm not saying we're there yet, but it's potentially very serious, not just economically, but politically as well.’
Mr Monks said union barons across Europe were planning a co-ordinated ‘day of action’ against the cuts on 29 September, involving national strikes and protests. David Cameron will travel to Brussels on Thursday for his first summit of EU leaders since the election. Leaders are expected to thrash out a rescue package for Spain’s teetering economy. Spain is expected to ask for an initial guarantee of at least £100 billion, although this figure could rise sharply if the crisis deepens.
News of the behind-the-scenes scramble in Brussels spells bad news for the British economy as many of our major banks have loaned Spain vast sums of money in recent years. Germany’s authoritative Frankfurter Allgemeine Newspaper reported that Spain is poised to ask for multi-billion pound credits. Mr Barroso and Jean-Claude Trichet of the European Central Bank are united on the need for a rescue plan. The looming bankruptcy of Spain, one of the foremost economies in Europe, poses far more of a threat to European unity and the euro project than Greece. Greece contributes 2.5 percent of GDP to Europe, Spain nearly 12 percent.
Yesterday’s report quoted German government sources saying: ‘We will lead discussions this week in Brussels concerning the crisis. It has intensified to the point that the states do not want to wait until the EU summit on Thursday in Brussels."’ At the end of last month the credit rating agency Fitch downgraded Spain, triggering sharp falls on stock markets. On Friday the administration in Madrid continued to insist no rescue package was necessary. But Greece said the same thing before it came close to disaster. Yesterday the European Commission and the statistics authority Eurostat met to consider Spain‘s plight as many EU countries consider the austerity package proposed by the Madrid administration insufficient to deal with the country‘s problems.
Angela Merkel's government threatened with collapse
by Kate Connolly - Guardian
German chancellor Angela Merkel's centre-right coalition government looked to be close to collapse today, weakened by a string of disagreements and intense infighting over austerity cuts, policy reform and the departure of senior conservatives. Less than eight months after it took office, the government was given only a narrow chance of running to a full term by the majority of Germans, 53% of whom said in a poll they expected it to fall.
"Either we get things sorted out in Berlin, or it will soon be the end for the coalition," said Jorg-Uwe Hahn, head of the Hessen branch of the Free Democrats (FDP), the junior coalition allies of the Christian Democrat Union (CDU) and its Bavarian sister party, the CSU. Renate Künast, leader of the opposition Greens, said: "The phrase 'new elections' is in the head and the heart of anyone who is thinking in a politically responsible way." Merkel called at the weekend for the government partners to bury the hatchet over their disagreements after a week when relations reached such a low that members of her government had variously referred to each other as "wild pigs" and "gherkin troops" (rank amateurs).
But much of the mistrust and anger is being directed at Merkel herself. This week's Spiegel magazine called her the Trummerfrau, a reference to German women who cleared away the rubble after second world war bombings. It painted a picture of a woman presiding over a government in ruins and used its title page to request the government in one word to "Aufhören!", or stop. Criticised at home and abroad for mishandling the euro crisis, Merkel's latest political headache is the four-year €80bn (£67bn) austerity package passed last week in an attempt to reduce Germany's deficit. Many of Merkel's own CDU MPs fear a voter backlash after growing criticism that the cuts are socially imbalanced.
Almost 80% believe the cuts to be socially unfair, while 67% want an increase in the top rate of tax, which Merkel has strongly resisted. Public anger at the package spilled over at the weekend when thousands of demonstrators took to the streets. The package has also stoked the anger of Merkel's French counterpart, Nicolas Sarkozy, who has accused the Germans of creating an atmosphere that will stifle growth in Europe at a time when it should be stimulated. Sarkozy arrived in Berlin for talks with Merkel tonight – a meeting which the German leader cancelled at the last minute a week ago, adding to speculation that relations between the two politicians are at an all-time low.
The recent departure of CDU heavyweight Roland Koch, the state premier of Hessen, and the unexplained resignation of Horst Köhler, another CDU man, from the post of president have also left Merkel looking increasingly exposed. Two further ministers have covertly expressed their desire to quit Merkel's government, including its most popular politician, defence minister Karl-Theodor Guttenberg of the CDU, who has faced a backlash over his attempts to scrap compulsory military service, and Philip Rössler, the FDP health minister, whose efforts to reform the health system have been rejected by parts of the bickering government.
The chaos has led commentators to refer to Merkel's administration as a "constipated institution". Writing in the Süddeutsche Zeitung, commentator Daniel Brössler said: "Governments need to be steered, but the Merkel cabinet is no longer steering. It resembles a car where the only thing that's working is the brakes." All eyes are now on June 30, when politicians will vote for Germany's new president – either the Merkel-backed candidate, Christian Wulff, state premier of Lower Saxony, or the opposition-backed, East German-born Protestant vicar and human rights activist Joachim Gauck.
A growing number of FDP politicians are pledging to support the pastor, snubbing Merkel. If Merkel's candidate loses, the common consensus is that the chancellor's position would become untenable. She would then be likely to face a vote of no confidence in parliament – an event that has happened three times since 1949 – which could ultimately lead to a switch in coalition partners, or more likely, new elections. The last coalition government to collapse before completing its elected term was the Social Democrat-Green alliance under Gerhard Schröder, which collapsed in 2005.
Plea to Buy Is Hard Sell in Germany
by Jack Ewing - NY Times
Germany’s trading partners want the country to go on a shopping spree, increase imports and help countries like Greeceand Spain grow faster so they can pay off their debts. But a look at recent history suggests that it might be a bad idea to rely on German consumers for a European recovery. Consumer spending has been in decline in Germany since well before the crisis hit, and the country has been a quagmire for retailers over the last decade. Gap, Marks & Spencer and even Wal-Mart tried and failed to establish profitable operations in the country.
"The German consumer didn’t join in the spending party when times were good and they are even more reluctant to join in now," said Chris Williamson, chief economist at Markit, a data provider that surveys sentiment in the retailing industry. Retail sales in Germany have been on a downward trend since late 2006, well before anyone worried about Greek bond spreads. While store sales in April were up a modest 1 percent from March, they were still down 3.1 percent from a year earlier. Germans tend to be stereotyped as a country of skinflints who always seem to be girding themselves for the next crisis.
There may be something to that; the French and British have continued to spend through most of the financial crisis. Europewide, consumer spending started to decline only last year. According to European Union figures, in recent years Germany has had the fastest-growing population of residents older than 65, a demographic that is less likely to buy big-ticket items like furniture. Germans also traditionally save more than their neighbors and export more products than they import.
The United States Treasury secretary, Timothy F. Geithner, and the French finance minister, Christine Lagarde, are among leaders who have recently urged the German government to take steps to persuade its residents to spend some of their savings on imports and not reach too far in cutting the country’s budget. "Fiscal consolidation should be ‘growth friendly,’ " Mr. Geithner said at a Group of 20conference in Busan, South Korea, this month. The statement did not prevent ChancellorAngela Merkel of Germany from introducing a plan two days later to cut 85 billion euros ($104 billion) in spending by 2014.
Mr. Geithner’s comments reflect a larger debate about how Europe should respond to its sovereign debt crisis. While some political leaders and economists fear that austerity programs could undercut growth, others insist that even countries without dire budget problems should cut outlays. They argue that Germans and other Europeans will return to the shopping malls only when they believe their Continent is not headed toward fiscal ruin. "The debt crisis has certainly created insecurity," said Rolf Bürkl, who surveys consumer sentiment for the market research company GfK Group.
"There is a fear that political leaders no longer have the situation under control." The demographic and economic trends that have brought misery to German retailers are in full view in Hanau, a working-class community east of Frankfurt. On a warm day recently, an elderly man slowly pushed a walker past the windows of what used to be a Karstadt department store that filled half a block in Hanau’s pedestrian zone. Karstadt, once the largest department store chain in Germany, has been closing its least profitable outlets as it tries to emerge from bankruptcy. Denuded of logos and swept clean inside, the only color on the store’s gray facade was a poster advertising a concert by Unk, a rapper from the United States.
Next door, a store called Billig Kaufhaus, or Cheap Department Store, had taken over space once occupied by a sporting goods chain. Billig Kaufhaus offered an eclectic selection of goods, from luggage and World Cup souvenirs to decorative wooden statues of cats. Nearby stores did not exactly fit with the upscale image that Karstadt had tried to portray. They included a secondhand clothing store and a manicure salon with a sideline in sexy lingerie. "There’s nothing happening. People don’t know where to go," said one passerby, Margrit Jügel of Hanau. Lowering her voice as if confiding a secret, Ms. Jügel mentioned another German department store chain still operating a few blocks away.
"I hear they’re not doing so well either," she said. Even if German leaders were inclined to try to stimulate spending, it is questionable whether tax cuts or other government encouragement would do much for shops in places like Hanau, economists say. German wages have been stagnant for years, and the aging population is focused on saving for retirement. In fact, a tax cut could even backfire by heightening fears that the government will not have enough money to pay pensions. "They say, ‘What’s going to happen when I’m 90? I have to start saving now,’ " said Francesco Giavazzi, a professor of economics at Bocconi University in Milan who has studied the German response to pension overhauls.
That argument is endorsed by central bankers, who say austerity measures will raise confidence by reassuring Europeans that government finances are sound. "The view that fiscal consolidation is generally negative for growth is too narrow," Jean-Claude Trichet, president of the European Central Bank, said Thursday in Vienna. Germany also takes heat for its trade surplus, which is by far the largest in Europe. But no one has yet come up with a formula to bring its imports more closely in line with exports. "You can’t reduce the surplus by reducing exports, that would be nonsense," said Christian Dreger, an economist at the German Institute for Economic Research in Berlin. He said Germany should increase demand by making it easier to start businesses and by reducing barriers to competition, like standardized fees for tax advisers and other professionals.
The German government already tried direct stimulus last year, cutting payroll deductions and raising the allowance parents receive for each child. "That is already a clear impulse. That raises disposable income," said Simon Junker, an economist at Commerzbank in Frankfurt. "But the Germans save the money and that cancels out the effect." A cash-for-clunkers program helped German auto sales surge last year. But new registrations plunged 25.5 percent in the first four months of 2010 after the incentives expired. "It’s a question of creating the conditions for growth," Mr. Dreger said. "Consumer giveaways or scrappage schemes are a flash in the pan." The most important factor in consumer confidence is people’s assessment of future employment prospects, said Mr. Bürkl, the market researcher.
GfK calculates that for every person who loses a job, three friends or family members become more cautious about spending out of fear they will be next. German joblessness has risen during the financial crisis, but less than in the United States because of programs that let companies cut working hours, with the government reimbursing part of the lost income. The government may be on the right track with such programs, Mr. Bürkl suggested. "Ultimately the best thing for consumption would be better prospects for jobs, because it raises income and also expectations," he said. For Mr. Williamson, the economist at Markit, "It’s a case of persuading the population that we’re over the worst."
UK Chancellor Osborne needs to find £34 billion in Budget
by Chris Giles - Financial Times
George Osborne is likely to announce additional public spending cuts or tax increases of £34bn a year in his emergency Budget next week, economists warned on Monday night after examining revised official economic forecasts. The new measures would be necessary, the Institute for Fiscal Studies said, if the chancellor wanted to meet his previous pledges of accelerating deficit reduction. They would hit every family in Britain by more than £1,000 a year on average.
Foreshadowing the difficult decisions he must take, Mr Osborne said the new forecasts showing a weaker economic backdrop to the Budget were "damning evidence that the mess the previous government left behind is even bigger than we thought". The newly established Office for Budget Responsibility on Monday cut the growth forecast for 2011 from 3.25 per cent to 2.6 per cent. For the medium term, it cut the assumption of the economy’s potential growth from 2.75 per cent to 2.1 per cent.
Even though the public finance forecasts from the OBR were not significantly different from thosein Alistair Darling's March Budget, their detail highlighted the pain that will follow fromthe new coalition government's determination to bring down borrowing rapidly from its current record levels.The previous Labour government had already planned, but had not detailed, 51bn a year of spending cuts and tax increases. The new forecasts suggest a need to go further if borrowing is to be brought down as fast as Mr Osborne said was necessary in opposition.
If all of the additional budgetary reduction was taken from non-protected government departments in line with the Conservatives’ ambition to concentrate on spending cuts to reduce the deficit, their real budgets would be slashed by a third, the IFS said. This would be more than 10 times as much as the £6bn spending cuts announced by the Con-Lib Dem government so far and the IFS said "may be deemed prohibitively large".
Carl Emmerson, deputy director of the IFS, said the budgetary calculation implied "a combination of deep cuts to welfare and public services and it may still prove too difficult so a combination of a softer [budgetary] target and net tax increases may be required". Sir Alan Budd, chairman of the OBR, shied away from estimating how much any further spending cuts or tax increases would hit growth and the public finances, but promised to revisit that subject on Budget day when the OBR releases updated forecasts. Those are likely to show even lower growth as the vast majority of economists, including the Bank of England, has said that budgetary tightening is likely to prove a "headwind" to expansion.
Spain sees credit squeeze and denies EU rescue bid
by Nigel Davies and Carlos Ruano - Reuters
Spain said on Monday that foreign banks were refusing to lend to some of its banks in the latest twist to the euro zone debt crisis, but denied it was on the brink of seeking a Greek-style European financial rescue. Treasury Secretary Carlos Ocana acknowledged officially for the first time a liquidity freeze on some Spanish banks in the interbank market and said the government was working to restore confidence through budget cuts and structural economic reforms. "It's definitely a problem," Ocana told a conference of business leaders in the northern town of Santander when asked about the reported credit squeeze. But he said Madrid was not negotiating any financial aid package. "Spain does not need additional financing from any international institution. The rumor is false and I deny it," he said.
The fourth largest economy in the euro area, Spain needs to refinance 16.2 billion euros of bonds in July. It has been able to borrow on the markets but at a rising premium, paying an average 3.317 percent to sell three-year bonds last Thursday. Banking sources said last week the liquidity freeze was affecting savings banks and small banks but not the country's biggest financial institutions. Finance ministers of the Group of Seven nations -- the United States, Japan, Germany, Britain, France, Italy and Canada -- were due to confer by telephone on Monday, a spokesman for euro zone chairman Jean-Claude Juncker said. He declined to say what the talks concerned. The German Finance Ministry and the European Commission denied a report in the Frankfurter Allgemeine Zeitung quoting German government sources as saying EU countries would hold talks on aiding Spain in Brussels this week.
Spanish banks have been under pressure since the Bank of Spain stepped in last month to take over CajaSur, a small, 146-year-old lender controlled by the Catholic Church, highlighting the precarious position of other savings banks. The chairman of Spain's second-largest bank BBVA said the country's top task was to restore market confidence through a mixture of deficit cutting, structural reforms and recapitalizing and slimming down its financial sector. "We need a solvent and stable financial system, a substantial reduction in the installed capacity in the sector and a sufficient injection of funds," BBVA's Francisco Gonzalez told the same conference, adding that Spanish banking faced a "difficult and uncertain future."
The euro and European stocks rallied at the start of a decisive week for reforms in Europe aimed at preventing a repeat of Greece's debt crisis. German Chancellor Angela Merkel and French President Nicolas Sarkozy were due to seek an accord between Europe's two biggest economies on new rules for the single currency area at postponed talks in Berlin, three days before an EU summit. "The crisis has gone by and it's clear that we are accountable to each other. We've seen it lately with the Greek crisis and we must play by the rules, and the rules have to be changed," French Economy Minister Christine Lagarde said. "... But I'm not suggesting that the crisis has gone, has disappeared, vanished," said told BBC radio. EU finance ministers have drafted stricter rules designed to enforce the bloc's budget deficit limit of 3 percent of national output by applying earlier and tougher sanctions to countries in breach, and extending greater discipline to public debt.
On financial markets, the euro rose 1 percent to above $1.22 and European stocks were up 1 percent to a four-week high amid optimism about the global economic recovery. In one sign that recovery may be gathering pace, industrial production in the euro zone in April surged year-on-year more than in any month in almost two decades, data showed on Monday. Merkel and Sarkozy will also try to reconcile Franco-German differences on the notion of a European "economic government" to coordinate national economic policies within the 16-nation euro area and the wider 27-member EU. France wants regular summits of euro zone leaders, backed by a dedicated secretariat, to harmonize economic, social and tax policies and rebalance the European economic between surplus and deficit countries. A German government spokesman reiterated that Merkel wants all 27 EU states involved in economic governance to strengthen budget discipline and increase economic competitiveness.
In the latest of a wave of structural reforms designed to adapt strained public finances to long-term challenges and make euro zone economies more competitive, France is set to announce an overhaul of its pension system and Spain a shake-up of its labor market, both on Wednesday. European governments are taking advantage of the sense of urgency instilled by last month's $1 trillion financial backstop for the euro zone and, critics say, of voters' distraction by the soccerWorld Cup, to push through unpopular measures. Elections in the last week have added political uncertainty in three euro zone states -- the Netherlands, Slovakia and Belgium -- which face protracted coalition negotiations after voters punished incumbents and boosted protest parties.
Inspectors from the European Commission, International Monetary Fund and European Central Bank are visiting Greece, the country that triggered the euro zone sovereign debt crisis, to check progress in reducing a massive budget deficit. European Central Bank Governing Council member Patrick Honohan, trumpeting a concerted message from the ECB, said the market response to perceived euro zone fiscal risks had been overblown. "This (nervousness) led to the situation a few weeks ago where you had effectively frozen money markets, interbank and the like, reflecting what seems to be an overblown response to perceived fiscal risks," the Irish Central Bank chief told a conference in Dublin.
Spain sells debt at premium after rescue denial
by Paul Day and Sarah Marsh - Reuters
Spain paid an increased risk premium at a debt auction on Tuesday, after having had to deny German media reports that it may soon be the next euro zone state to need a Greek-style bailout. Germany's ZEW economic sentiment indicator suffered its biggest monthly drop since the height of the financial crisis in October 2008, right after the collapse of Lehman Brothers -- partly due to rumors about debt problems in Spain. A German government official said he did not think that Spain, the latest focus of concern about euro zone sovereign debt, would be on the agenda of a European Union summit about stricter fiscal rules and economic reform on Thursday. A day after admitting that some Spanish banks were being frozen out of international credit markets, Madrid raised 5.2 billion euros in 12- and 18-month T-bills at an auction, but paid a significantly higher average yield than last month.
Marc Ostwald, bond strategist at Monument Securities in London, noted that Spain had paid far more than does France, which also has a top-notch rating from agencies such as Moody's Investor Service. "It also begs the question how Moody's can rate Spain triple-A when you have an auction result like this ... This must now put pressure on Moody's to downgrade Spain," he said. Last Friday Spain's economy ministry denied it had made a request for economic aid from the EU, after a German newspaper report that Brussels was preparing to activate a package in case Madrid asked for it.
Moody's shocked markets on Monday by abruptly downgrading Greece's sovereign debt by four notches to junk status. EU Economic and Monetary Affairs Commissioner Olli Rehn described the timing of Moody's decision as "astonishing and unfortunate," saying it had not taken into account latest developments in the country. That move reversed a four-day rally by the euro and European stocks, but both turned positive again after briefly dipping further on the weak German confidence indicator.
Sarkozy Bows To Merkel
The Mannheim-based ZEW economic think tank's monthly poll tumbled to 28.7 in June from 45.8 in May. The consensus forecast in a Reuters poll of 40 analysts was for a fall to 42.0. ZEW economist Peter Westerheide said increased uncertainty on financial markets about debt problems in Spain had caused a significant weakening in German sentiment despite an improving economic situation. Ahead of Thursday's summit, French President Nicolas Sarkozy bowed to German demands for tougher European budget rules and dropped his call for a separate "economic government" of the 16-nation euro zone with a dedicated secretariat. After talks in Berlin on Monday, Sarkozy accepted a German proposal that euro zone states which persistently breach budget deficit limits should have their voting rights in the bloc suspended, even if that requires changing the EU treaty.
He also yielded to Chancellor Angela Merkel's insistence that closer "economic government" should involve all 27 European Union members and not just those that share the common currency. In Rome, Italian Foreign Minister Franco Frattini threatened Italy could veto new EU budget rules unless they covered private debt as well as public debt. Italy has the euro zone's second highest debt-to-GDP ratio after Greece but lower private debt than many European partners. The risk premium investors charge for holding the debt of peripheral euro zone countries such asGreece, Spain, Italy and Ireland rather than benchmark German bonds rose on Tuesday. The cost of insuring those countries' debt against default also spiked.
Amid persistent worries about the solvency of European banks, the Spanish daily El Pais quoted government sources as saying Madrid wants the European Commission to publish the results of stress tests of individual banks to restore confidence. Spain believes that publishing the findings of tests being carried out on the main European banks, including Spanish banks, would help to dispel rumors that the country is preparing to seek EU aid, the left-wing newspaper said. The Spanish Banking Association said on Tuesday the stress test results should be made public.
There was no comment from the government or the Bank of Spain, but a German government official, briefing reporters ahead of the EU summit, said publishing the data "would be possible to dispel concerns, but there are also other options." Germany, France and the European Central Bank have so far opposed such a move, advocated forcefully by U.S. Treasury Secretary Timothy Geithner, because they fear it could trigger more speculation against some European banks.
Economists say Europe could face a prolonged period of economic stagnation with zombie banks as Japan did in the 1990s unless governments act decisively to force banks to resolve bad debts and recapitalize, merge or shut down those in trouble. "Banking reform has become as urgent as fiscal adjustment, and as important for stability as enhancing Europe's growth potential and fixing the euro zone's fiscal policy framework," Nicolas Veron of the Bruegel economic think-tank wrote last month.
Ahead of the EU summit, France and Spain are both due to announce major structural economic reforms on Wednesday. A reform of France's generous pay-as-you-go pension system is expected to raise the legal retirement age from 60 to 62 or 63, extend the contribution period required to receive a full pension and introduce extra levies on higher earners. Spain's minority Socialist government, fighting a 20 percent unemployment rate, is seeking support among regionalist parties to enact a major shake-up of the country's rigid labor market to make it easier to hire and fire, and reduce layoff payments.
Spanish banks break ECB loan record
by David Oakley and Ralph Atkins - Financial Times
Spanish banks are borrowing record amounts from the European Central Bank as the country’s financial institutions struggle to gain funding from the international capital markets. Spanish banks borrowed €85.6bn ($105.7bn) from the ECB last month. This was double the amount lent to them before the collapse of Lehman Brothers in September 2008 and 16.5 per cent of net eurozone loans offered by the central bank. This is the highest amount since the launch of the eurozone in 1999 and a disproportionately large share of the emergency funds provided by the euro’s monetary guardian, according to analysis by Royal Bank of Scotland and Evolution. Spanish banks account for 11 per cent of the eurozone banking system.
The rise in borrowing from €74.6bn in April, or 14.4 per cent of the net liquidity pumped by the ECB into the eurozone financial system, provides further evidence of the acute tensions in the Spanish banking system. “If the suspicion that funding markets are being closed down to Spanish banks and corporations is correct, then you can reasonably expect the share of ECB liquidity accounted for by the country to have risen further this month,” said Nick Matthews, European economist at RBS. Some investors believe the difficulties increase the chances that Spain will have to use emergency loans from the newly created €440bn stability fund.
However, the euro strengthened against the dollar on Tuesday while Spanish bonds held steady as the government managed to raise €5.2bn from two short-dated debt auctions. It was forced to pay three-quarters of a point more in yields to attract demand. The big moves in the eurozone bond markets were in Greece, where 10-year yields rose 74 basis points to 9.06 per cent in reaction to Moody’s decision to lower the country’s long-term credit status to junk. Only Fitch, of the main rating agencies, gives Greece investment grade status. Moody’s move forced investors to offload the country’s debt. Many can no longer hold these bonds in their portfolios because the rating action means the country’s bonds will be removed from indices that these investors track.
Greece will be removed from Citigroup’s World Government Bond Index, the EMU Government Bond Index and the World Broad Investment-Grade Index. Greek bonds will also no longer be eligible for Barclays Capital’s Global Aggregate, Global Treasury, Euro Aggregate and Euro Treasury Indexes. Greek government bonds will also attract an extra 5 per cent penalty when banks use them as security for ECB funds because of Moody’s action. The extra haircut means commercial banks will receive less money for Greek bonds than for bonds from any other eurozone nation.
Spain to reveal bank ‘stress tests’ results
by Victor Mallet - Financial Times
Spain’s central bank has thrown down the gauntlet to bank regulators elsewhere in Europe, saying it plans to publish the results of “stress tests” on the country’s financial institutions in the near future to clear up doubts about Spain’s banking system. Spanish officials and bankers believe that international investors and speculators are harbouring exaggerated fears about the potential problems of Spanish banks, when the banks of other countries are often weaker than Spanish lenders or have already been bailed out with massive injections of government money. Miguel Angel Fernández Ordóñez, governor of the Bank of Spain, said on Wednesday in a speech to launch the Bank’s 2009 annual report, that it had carried out stress tests to verify that commercial banks, savings banks and co-operative lenders had enough capital available to support even difficult growth scenarios.
“The Bank intends to make public the results of these stress tests, showing estimated loan losses, the consequent capital requirements and the contribution of promised balance sheet reinforcements, so that the markets have a perfect understanding of the circumstances of the Spanish banking system,” he said. Mr Fernández Ordóñez gave no further details of when the test results would be published or in how much detail, but Bank officials said the decision had already been taken and they would be released in the near future. As a result of strict regulation by the central bank, and a cushion of reserves arising from counter-cyclical “dynamic” provisions built up during profitable years, the stronger Spanish banks have so far weathered the crisis in relatively good shape.
Several of the 45 unlisted savings banks, or cajas, however, have proved vulnerable to the collapse of the domestic property market and are being forced into mergers to cut costs and rationalise operations. The Bank of Spain has seized control of two small, struggling cajas, one in the centre of the country and one in the south. Spanish financial officials on Wednesday denied repeated suggestions from hedge funds and bank analysts that the Fund for Orderly Bank Restructuring, known as the Frob from its Spanish acronym, will need to raise tens of billions of euros to recapitalise the country’s lenders.
They said the Frob was likely to pay out €11bn in loans to support mergers among the cajas, including €4.5bn for the merger among seven lenders led by Caja Madrid. To cover this, the Frob has €12bn of funds available – €9bn from its initial capital and a further €3bn from a bond issue last November. The Frob is expected to try to raise a few billion euros more after the summer to give it extra funds for emergencies.
AXA fears 'fatal flaw' will destroy eurozone
by Ambrose Evans-Pritchard - Telegraph
Analysts at the French financial group AXA see a serious likelihood that the eurozone will break in half or disintegrate, dismissing Europe's €750bn (£623bn) rescue package for Club Med debtors as a stop-gap measure that misdiagnoses the problem. "The markets are very nervous because they can see that there is a fatal flaw in the system and no clear way out," said Theodora Zemek, head of global fixed income at AXA Investment Managers. "We are in a very major crisis that has even broader implications than the credit crisis two years ago. The politicians have not yet twigged to this."
Ms Zemek said the rescue had bought a "maximum" of 18 months respite before deeper structural damage hits home, with a "probable" default by Greece setting off a chain reaction across Southern Europe. "It would be the end of the euro as we know it. The long-term implications are at best a split in the eurozone, at worst the destruction of the euro. It is not going to end happily however you slice it," she said. The warning came as Spain's authorities were forced to shoot down German media reports that Madrid was preparing to tap the rescue facility after ructions in the inter-bank market. Carlos Oocaña, Spain's treasury secretary, said smaller Spanish banks are struggling to roll over debts but denied that the country is seeking outside help. "The rumour is false," he said. Spanish banks increased reliance on funds from the European Central Bank to a record €86bn in May.
Berlin said Spain "does not meet the conditions" for the aid package in any case, even though the socialist premier Jose Luis Zapatero has already provoked a general strike by cutting public wages by 5pc. It is becoming clear that German demands for austerity across EMU are nearing the limits of political tolerance, and may prove self-defeating as 1930s-style wage deflation sets off a vicious circle. Greece's woes increased further as Moody's downgraded Greek debt to junk status, saying the "macroeconomic and implementation risks associated with the programme are substantial". The move is largely symbolic at this point since the European Central Bank has suspended its rating requirements for use of Greek debt as collateral for loans.
Greece is almost entirely shut out of the capital markets. Private investors are believed to have offloaded €25bn of Greek debt on to the ECB as it steps in to shore up the market, shifting the credit risk on to tax payers. Axa said there was "no chance" that the EU's €750bn "shock and awe" shield will succeed since it treats Club Med's debt trap as a short-term liquidity crisis. In the case of Greece the joint IMF-EU policy will increase Greek public debt from 120pc to 150pc of GDP by 2014, arguably making matters worse.
A number of ex-IMF officials have said the policy is doomed to failure since there is no devaluation or debt relief to offset the ferocious fiscal squeeze, and may endanger the credibility of the Fund itself. The IMF had floated the idea of a debt restructuring but this was blocked by the Brussels. The strategy assumes that voters in Greece and other Club Med democracies will endure years of pain for the sake of foreign creditors. "It's a pipedream," said Ms Zemek. Contagion from a Greek default would be harder to control than fallout from the Lehman collapse. "This has huge implications for banks. These bonds didn't just disappear; they went somewhere, allegedly into French money markets and insurance companies, or on to French balance sheets," she said.
The Bank for International Settlements said French and German lenders have $958bn (£650bn) in exposure to Greece, Ireland, Portugal and Spain, mostly in mortgage and company debt rather than sovereign debt. The distinction has become meaningless in Greece. The ECB has lent Greek banks €85bn, mostly in exchange for collateral in the form of Greek government bonds. This has kept Greek lenders alive as they suffer a slow bank run, losing 7pc of their deposit base since last June as wealthy Greeks shift their funds abroad.
The ECB support is equal to 20pc of their non-equity funding, according to Lombard Street Research. Axa said the America's currency union is successful because Washington has over-riding legal powers over the 50 states. "It is a precondition for the system to work but it doesn't exist in Europe and the bond markets are starting to figure this out. We are looking at a noble experiment on the brink of failure," said Ms Zemek.
Nasa warns solar flares from 'huge space storm' will cause devastation
by Andrew Hough - Telegraph
Britain could face widespread power blackouts and be left without critical communication signals for long periods of time, after the earth is hit by a once-in-a-generation "space storm", Nasa has warned. National power grids could overheat and air travel severely disrupted while electronic items, navigation devices and major satellites could stop working after the Sun reaches its maximum power in a few years. Senior space agency scientists believe the Earth will be hit with unprecedented levels of magnetic energy from solar flares after the Sun wakes "from a deep slumber" sometime around 2013, The Daily Telegraph can disclose.
In a new warning, Nasa said the super storm would hit like "a bolt of lightning" and could cause catastrophic consequences for the world’s health, emergency services and national security unless precautions are taken. Scientists believe it could damage everything from emergency services’ systems, hospital equipment, banking systems and air traffic control devices, through to "everyday" items such as home computers, iPods and Sat Navs. Due to humans’ heavy reliance on electronic devices, which are sensitive to magnetic energy, the storm could leave a multi-billion pound damage bill and "potentially devastating" problems for governments. "We know it is coming but we don’t know how bad it is going to be," Dr Richard Fisher, the director of Nasa's Heliophysics division, said in an interview with The Daily Telegraph.
"It will disrupt communication devices such as satellites and car navigations, air travel, the banking system, our computers, everything that is electronic. It will cause major problems for the world. "Large areas will be without electricity power and to repair that damage will be hard as that takes time." Dr Fisher added: "Systems will just not work. The flares change the magnetic field on the earth that is rapid and like a lightning bolt. That is the solar affect." A "space weather" conference in Washington DC last week, attended by Nasa scientists, policy-makers, researchers and government officials, was told of similar warnings. While scientists have previously told of the dangers of the storm, Dr Fisher’s comments are the most comprehensive warnings from Nasa to date.
Dr Fisher, 69, said the storm, which will cause the Sun to reach temperatures of more than 10,000 F (5500C), occurred only a few times over a person’s life. Every 22 years the Sun’s magnetic energy cycle peaks while the number of sun spots – or flares – hits a maximum level every 11 years. Dr Fisher, a Nasa scientist for 20 years, said these two events would combine in 2013 to produce huge levels of radiation. He said large swathes of the world could face being without power for several months, although he admitted that was unlikely.
A more likely scenario was that large areas, including northern Europe and Britain which have "fragile" power grids, would be without power and access to electronic devices for hours, possibly even days. He said preparations were similar to those in a hurricane season, where authorities knew a problem was imminent but did not know how serious it would be. "I think the issue is now that modern society is so dependant on electronics, mobile phones and satellites, much more so than the last time this occurred," he said. "There is a severe economic impact from this. We take it very seriously. The economic impact could be like a large, major hurricane or storm."
The National Academy of Sciences warned two years ago that power grids, GPS navigation, air travel, financial services and emergency radio communications could "all be knocked out by intense solar activity". It warned a powerful solar storm could cause "twenty times more economic damage than Hurricane Katrina". That storm devastated New Orleans in 2005 and left an estimated damage bill of more than $125bn (£85bn). Dr Fisher said precautions could be taken including creating back up systems for hospitals and power grids and allow development on satellite "safe modes". "If you know that a hazard is coming … and you have time enough to prepare and take precautions, then you can avoid trouble," he added.
His division, a department of the Science Mission Directorate at Nasa headquarters in Washington DC, which investigates the Sun’s influence on the earth, uses dozens of satellites to study the threat The government has said it was aware of the threat and "contingency plans were in place" to cope with the fall out from such a storm. These included allowing for certain transformers at the edge of the National Grid to be temporarily switched off and to improve voltage levels throughout the network. The National Risk Register, established in 2008 to identify different dangers to Britain, also has "comprehensive" plans on how to handle a complete outage of electricity supplies.