"Heat wave. Free ice in New York"
Ilargi: The pressure on state and muni bonds is increasing, and we haven't even entered the first inning of that one, the players are still tossing balls in the outfield.
David Goldman writes in the Asia Times that everyone who needs to be, will eventually be bailed out:
The Bank-Insurance-Municipal Daisy Chain (Why the Federal Government Will Bail Out the States and Municipalities)If municipal debt actually defaulted, the capital position of the banking system would be impacted, bank preferred debt might stop paying, and the holders of bank preferred debt–starting with the insurers–would be in serious trouble. The $800 billion bailout package for Europe’s PIIGS (Portugal, Ireland, Italy, Greece, Spain) in May was in fact a bailout for the banking system, which holds hundreds of billions of dollars worth of such debt. [..]
It’s a pretty safe surmise that the global banking system’s holdings of non-US government debt is not much different than the profile of American banks’ purchases of US government debt.[..]
Why buy munis? For all of Warren Buffett’s dire warnings about municipal finances, the fact is that the federal government can’t let major municipal debtors (at the level of states, for example) go under without also bringing down the banking system and everything else.
If it goes, it all will go together. That’s why munis ultimately will be bailed out. A Democratic administration whose core constituency is public employee unions will do everything in its power to keep them happy (and a Republican Congress, which we likely will have in 2011, may frustrate this). But ultimately it’s a matter of survival.
Ilargi: Now that sounds nice and all, but it still has to be practically possible, just to name a minor detail. I for one would like to see explained what mechanism would be used for such a bail-out, who decides how much money to send to all 10,000+ places that will claim to need it etc. Or will the Fed and Treasury simply buy up all the paper it can find? There'd be a few issues with that one as well. Or will all counties and towns get to issue new paper and send it directly to Washington in exchange for cash? What would that mean for the value of existing bonds?
A second problem, of course, is the sheer amount of money involved in such purchases. Will a) the people and b) the Republican Party react favorably? In the run-up to such largesse, the lower level governments will still have to continue pink-slipping their employees on a grand scale. it will therefore become real obvious that the hundreds of billions spent are nothing but another bank bail-out, not exactly the easiest political topic anymore.
Bloomberg's Dakin Campbell notes that the state and local government debt market presently stands at $2.8 trillion. That's real money. And it doesn't have to go down that much either:
U.S. Banks Risk 'Untold Problem' as Muni Debt SwellsCitigroup had an unrealized loss of $1.8 billion in the third quarter of 2008, when the municipal market sank 3.8 percent. [..]
In 2009, state and local government debt rose 14.5 percent. U.S. states are likely to face $140 billion in cumulative budget gaps in the coming year, according to the Center on Budget and Policy Priorities. Last year, 187 tax-exempt issuers defaulted on $6.4 billion of securities, the most since 1992, according to data from Distressed Debt Securities in Miami Lakes, Florida.
“It’s a market where it’s clear that the underlying fundamentals are lousy,” said Michael Aronstein, chief investment strategist at Oscar Gruss & Son Inc.[..]. “People can say fundamentals don’t matter but I’ve been doing this for 32 years. They do.”
Ilargi: Campbell cites a lot of banks whose spokesmen declare that they have little exposure to the muni market, and what they have is only of the highest quality (Always is, after all; these are the smartest people in the world). He also says that lenders hold only 8% of the total $2.8 trillion market. So who holds the rest? Maybe you should ask your pension fund manager about that.
Warren Buffet said a month ago before the Financial Crisis Inquiry Commission that there would be a “terrible problem” for municipal bonds. He wasn't kidding. Tax revenues will keep on falling, forcing huge numbers of lay-offs, which in turn will lead to lower tax revenues as well as foreclosures, which in turn also lead to lower tax revenues.
This is a circle that won't be broken for years to come. And if the Federal government decides to bail out states and munis, will that raise those revenues, being back jobs, keep people in their homes? No, of course not, it will only (and only temporarily) help those who hold the bonds.
But if the government decides not to do another bail-out, markets will push banks and other large investors to take a giant haircut (think: lawn mower size), which will threaten to topple the entire financial system.
There is no way out of this. But step one should be to let investors take the losses that come with the risk of the assets they've invested in. Instead of loading the public up with those losses as well, on top of those incurred by their pension funds, and on top of all the lost jobs and services that now lie inevitably ahead of us, just around the corner. Given the history of the last few administrations nad their bail-outs, it's not hard to guess who will be forced to pay the piper. And still be left holding an empty bag.
Sovereign Debt: The Death of Nations vs. the Wealth of Nations
by Damon Vrabel - Zero Hedge
The gap between the truth vs. the lies that pass for truth in the media has never been so wide. But living a lie is very destructive, so it’s important to cross this gap. Today I want to clear up one of the most important lies reinforced by the media–the idea that we have sovereign countries.
No doubt most of you have heard of the sovereign debt crisis that so many countries are facing. We hear endless economists, reporters, and billionaire hedge fund raiders talk about it. But the phrase they use is fictitious. It is a fabrication of the Ivy League, Wall Street, and erudite periodicals like the Financial Times of London. Sovereign debt is an impossibility. It cannot exist.
It seems ridiculous to point this out, but sovereign debt implies sovereignty. Right? Well, if countries are sovereign, then how could they be required to be in debt to private banking institutions? How could they be so easily attacked by the likes of George Soros, JP Morgan Chase, and Goldman Sachs? Why would they be subjugated to the whims of auctions and traders?
A true sovereign is in debt to nobody and is not traded in the public markets. For example, how would George Soros attack, say, the British royal family? It’s not possible. They are sovereign. Their stock isn’t traded on the NYSE. He can’t orchestrate a naked short sell strategy to destroy their credit and force them to restructure their assets. But he can do that to most of the other 6.7 billion people of the world by designing attack strategies against the companies they work for and the governments they depend on.
The fact is that most countries are not sovereign (the few that are are being attacked by CIA/MI6/Mossad or the military). Instead they are administrative districts or customers of the global banking establishment whose power has grown steadily over time based on the math of the bond market, currently ruled by the US dollar, and the expansionary nature of fractional lending. Their cult of economists from places like Harvard, Chicago, and the London School have steadily eroded national sovereignty by forcing debt-based, floating currencies on countries. So let’s start being honest and stop describing their debt instruments as sovereign.
We long ago lost the free market envisioned by Adam Smith in the "Wealth of Nations." Such a world would require sovereign currencies, i.e. currencies that are well-regulated rather than floating, and an asset rather than an interest-bearing debt. Only then could there be a "wealth of nations." But now we have nothing but the "debt of nations." The exponential math of debt by definition meant that countries would only lose their wealth over time and become increasingly indebted to the global central banking network.
So thanks to debt-based, free-floating currencies, the "wealth of nations" transitioned to the "debt of nations" which is now transitioning to the "death of nations." The new world economic order with one currency, one banking system, one government, and one integrated corporate empire is on the horizon. Perhaps that’s a good thing, but if it were, why would the establishment concoct oxymorons like "sovereign debt" instead of telling the truth? That’s my only goal here–I think people can be trusted with the truth. Lies harm not only the population hearing them, but also the powerful people telling them.
Those powers have the best salesmen in the world, so why don’t they just sell the population on the truth? Apparently they don’t think you’d like it. Well now you have it. And it’s coming unless countries follow Iceland’s lead and recover their sovereignty. The choice is ours.
U.S. Banks Risk 'Untold Problem' as Muni Debt Swells
by Dakin Campbell - Bloomberg
Citigroup Inc., State Street Corp. and U.S. Bancorp are among U.S. banks whose municipal bond holdings have reached a 25-year high just as state budget deficits swell to $140 billion, the most since the start of the recession. Commercial lenders added more than $84 billion to their holdings since 2003, according to the Federal Reserve, pushing total investments to $216.2 billion at the end of the first quarter. Bank regulators and ratings companies are ramping up scrutiny of banks most at risk of being forced to raise more capital should debt prices slide.
"There is a huge untold problem here," said Walter J. Mix III, a former commissioner of the California Department of Financial Institutions who closed 30 banks during the last banking crisis in the 1990s. "The economics lead to the conclusion that there will be downward pressure on these bonds." At Cullen/Frost Bankers Inc., the biggest Texas lender, holdings of municipal debt exceeded Tier 1 capital, a key measure of a bank’s ability to absorb losses, by $491 million at the end of the first quarter, data compiled by Bloomberg show. For State Street, based in Boston, the holdings make up 50 percent of Tier 1 capital. U.S. Bancorp, the Minneapolis lender, has a ratio of 28 percent. It’s 11 percent at Citigroup, the data show.
Municipal Bond Yields
Default speculation and a move by investors to the safest securities drove municipal bond yields to a 13-month high relative to U.S. Treasuries in the first half of the year. Now, the Federal Deposit Insurance Corp. has asked analysts to look into the issue, according to spokeswoman Michele Heller. The 9.5 percent U.S. unemployment rate and slump in property prices have slashed local governments’ ability to pay bills. Billionaire investor Warren Buffett, speaking at a June 2 hearing of the Financial Crisis Inquiry Commission in New York, predicted a "terrible problem" for municipal bonds. Buffett has said a U.S. state facing default may need a federal rescue.
Analysts and investors remain divided about the level of risk. Lenders hold just 8 percent of the $2.8 trillion state and local government debt market, and municipal bonds are only about 2 percent of total bank assets, according to the Fed.
"The open issue is whether it’s a slowly emerging train wreck," said Jeff Davis, an analyst at Guggenheim Securities LLC, a unit of Guggenheim Partners LLC, whose executive chairman is former Bear Stearns Cos. Chief Executive Officer Alan D. Schwartz. "It’s hard to paint all general obligation and all revenue bonds with the same brush. The portfolios won’t go to zero." Municipal defaults are a slender risk, according to Moody’s Investors Service, which said in a February report that the investment-grade rate during the past four decades was 0.03 percent, compared with 0.97 percent for similar corporate issues. Investors eventually recoup an average of 67 cents on the dollar for defaulted municipal bonds.
While the historical default-rate risk for municipal debt is below corporate obligations, sudden declines in prices have already created losses at some banks. Citigroup had an unrealized loss of $1.8 billion in the third quarter of 2008, when the municipal market sank 3.8 percent, the biggest quarterly decline since 1994, company filings and Bank of America Merrill Indexes show. The loss was deducted from the firm’s equity.
"Citi’s exposure to the municipal market is of the highest quality," Danielle Romero-Apsilos, a spokeswoman for the New York-based firm, said in a statement. "We conduct rigorous stress tests under a variety of scenarios and are comfortable with our position." Citigroup had the largest municipal holdings among the biggest banks as of March 31, with $13.4 billion of state and local government bonds, according to FDIC call reports. That’s down from $13.8 billion at the end of last year. Bank of America Corp. held $8.5 billion, Wells Fargo & Co. owned $7.6 billion and JPMorgan Chase & Co. held $4.5 billion. Each accounted for less than 8 percent of Tier 1 capital, according to the FDIC.
Bank of America, based in Charlotte, North Carolina, has made "significant progress" boosting capital and reducing risk-weighted assets, spokesman Jerry Dubrowski said. The lender trimmed its municipal investments by more than $800 million in the first quarter. JPMorgan spokeswoman Jennifer Zuccarelli didn’t return a call for comment.
Wells Fargo, based in San Francisco, boosted its municipal holdings by more than $2 billion in the first quarter, data compiled by Bloomberg show. The investments are in municipalities "we know very well," Chief Financial Officer Howard Atkins said on May 13. State Street, the second-largest independent custody bank, owned $6.2 billion of state and local government debt at the end of March, the data show. State Street is "very comfortable" with its portfolio and has had no material credit issues, spokeswoman Carolyn Cichon said. At Minneapolis-based U.S. Bancorp, which owned $6.6 billion of municipal bonds, spokeswoman Jennifer Wendt also declined comment.
Cullen/Frost, which says it’s the only one of the 10 biggest Texas banks to survive the 1980s savings-and-loan crisis, is "extremely comfortable" with the municipal investments, CFO Phillip Green said in a July 1 interview. The 142-year-old lender, based in San Antonio, bought $1 billion of municipal bonds in the 12 months through February, Green said that month. Most were issued by Texas school districts and insured by the state’s Permanent School Fund guarantee program, he said in last week’s interview. Municipal debt gained 2 percent in the second quarter underperforming Treasuries by 2.7 percentage points, according to Bank of America Merrill indexes. In 2009, state and local government debt rose 14.5 percent.
U.S. states are likely to face $140 billion in cumulative budget gaps in the coming year, according to the Center on Budget and Policy Priorities. Last year, 187 tax-exempt issuers defaulted on $6.4 billion of securities, the most since 1992, according to data from Distressed Debt Securities in Miami Lakes, Florida. "It’s a market where it’s clear that the underlying fundamentals are lousy," said Michael Aronstein, chief investment strategist at Oscar Gruss & Son Inc., a New York- based brokerage. "People can say fundamentals don’t matter but I’ve been doing this for 32 years. They do."
The Bank-Insurance-Municipal Daisy Chain (Why the Federal Government Will Bail Out the States and Municipalities)
by David Goldman - Asia Times
Bank preferred debt, I argued on March 1, 2009, would not be allowed to go under after the fashion of Fannie and Freddie preferred, because shutting off payment on bank preferreds would ruin the insurance industry. Credit protection on the insurers was trading at over 1,000 basis points above LIBOR that week, which marked the nadir for the banks. As I wrote then,…the global insurance industry took down 40% or more of the commercial bank "hybrid" Tier I capital securities issued in the past six years, or over $320 billion of the $800 billion float. That’s not counting preferred stock and other yield-hog favorites. Haircut these bonds, and the insurers will do the dead man’s float. AIG isn’t the only insurance company that wrote protection for the banks (although it was the most aggressive).
That’s why the federal government has no choice but to bail out AIG, and no choice but to bail out the banks — unless it wants to let the insurers go down, or separately bail them out. Banks and insurers are tied together in a daisy-chain in which all survive or all fail.
Of course, were insurers to let it be known that whole life insurance policies aren’t paying quite what they expected to, or that they might have to stagger life insurance payouts over time, the result would be a level of panic that the Obama administration doesn’t want to think about. Pension plans already are cutting payments because of the commercial mortgage disaster. Word is getting around: nothing is safe. Your bank deposits might be safe, but not your pension, or your insurance policy, or your annuity.
The same applies with a vengeance to the banks and municipal debt. As Bloomberg reported yesterday, the banking system owns well over $200 billion in municipal bonds:Citigroup Inc., State Street Corp. and U.S. Bancorp are among U.S. banks whose municipal bond holdings have reached a 25-year high just as state budget deficits swell to $140 billion, the most since the start of the recession.
Commercial lenders added more than $84 billion to their holdings since 2003, according to the Federal Reserve, pushing total investments to $216.2 billion at the end of the first quarter. Bank regulators and ratings companies are ramping up scrutiny of banks most at risk of being forced to raise more capital should debt prices slide.
"There is a huge untold problem here," said Walter J. Mix III, a former commissioner of the California Department of Financial Institutions who closed 30 banks during the last banking crisis in the 1990s. "The economics lead to the conclusion that there will be downward pressure on these bonds."
At Cullen/Frost Bankers Inc., the biggest Texas lender, holdings of municipal debt exceeded Tier 1 capital, a key measure of a bank’s ability to absorb losses, by $491 million at the end of the first quarter, data compiled by Bloomberg show. For State Street, based in Boston, the holdings make up 50 percent of Tier 1 capital. U.S. Bancorp, the Minneapolis lender, has a ratio of 28 percent. It’s 11 percent at Citigroup, the data show.
If municipal debt actually defaulted, the capital position of the banking system would be impacted, bank preferred debt might stop paying, and the holders of bank preferred debt–starting with the insurers–would be in serious trouble. The $800 billion bailout package for Europe’s PIIGS (Portugal, Ireland, Italy, Greece, Spain) in May was in fact a bailout for the banking system, which holds hundreds of billions of dollars worth of such debt. We don’t know quite how much, because European banks don’t have the same reporting requirements as American banks (and American banks’ overseas branches don’t have the same reporting requirements as their domestic branches).
It’s a pretty safe surmise that the global banking system’s holdings of non-US government debt is not much different than the profile of American banks’ purchases of US government debt.
Banks are shedding non-government, i.e., corporate risk in their securities portfolios at the same time:
Why buy munis? For all of Warren Buffett’s dire warnings about municipal finances, the fact is that the federal government can’t let major municipal debtors (at the level of states, for example) go under without also bringing down the banking system and everything else.
If it goes, it all will go together. That’s why munis ultimately will be bailed out. A Democratic administration whose core constituency is public employee unions will do everything in its power to keep them happy (and a Republican Congress, which we likely will have in 2011, may frustrate this). But ultimately it’s a matter of survival.
Expect lots of government layoffs at state, local level
by Paul Davidson, USA TODAY
Here's another headwind for a sputtering job market: State and local governments plan many more layoffs to close wide budget gaps. Up to 400,000 workers could lose jobs in the next year as states, counties and cities grapple with lower revenue and less federal funding, says Mark Zandi, chief economist for Moody's Economy.com. The development could slow an already lackluster recovery. Friday, the Labor Department said employers cut 125,000 jobs, mostly because 225,000 temporary U.S. Census workers completed their stints. The private sector added 83,000 jobs, fewer then expected, as the jobless rate fell to 9.5% from 9.7%.
Layoffs by state and local governments moderated in June, with 10,000 jobs trimmed. That was down from 85,000 job losses the first five months of the year and about 190,000 since June 2009.
But the pain is likely to worsen. States face a cumulative $140 billion budget gap in fiscal 2011, which began July 1 for most, says the Center on Budget and Policy Priorities. While general-fund tax revenue is projected to rise 3.7% as the economy rebounds in the coming year, it still will be 8%, or $53 billion, below fiscal 2008 levels, according to the National Association of State Budget Officers.
Meanwhile, federal aid is shrinking. Money for states from the economic stimulus is expected to fall by $55 billion, says the National Governors Association. And the Senate last week failed to pass a measure to provide states $16 billion for extra Medicaid funding, an initiative that would have extended benefits from last year's stimulus. The House approved $25 billion in enhanced Medicaid funding. Philippa Dunne, who surveys state financial officials for a newsletter, the Liscio Report, says most plan to intensify layoffs the coming year after relying largely on furloughs. "The downturn has gone on so long, all the low-hanging fruit has been taken," says Scott Pattison, head of the state budget officers group.
Wells Fargo economist Mark Vitner expects state and local governments to cut about 200,000 workers this year if Medicaid benefits aren't extended. That's largely why Wells Fargo cut forecasts for third-quarter economic growth to 1.5% from 1.9%. Even if Congress extendsMedicaid subsidies, Zandi expects 325,000 job cuts the next year, though Vitner says losses could be far less.
Among cuts planned and made:
- New York City is planning 4,500 layoffs, and more if the Medicaid subsidies aren't approved, says the Center on Budget and Policy Priorities.
- Washington state would have to chop 6,000 jobs without the Medicaid money.
- The city of Maywood, Calif., laid off all 68 of its employees July 1 and is contracting out police services, partly because of a $450,000 budget deficit.
It's Time For A Marshall Plan To Save Disastrous State Budgets
by The Mad Hedge Fund Trader
On a map, it appears that the United States is made up of 50 states. The fiscal reality is that we have 20 Portugal's, 15 Italy's, 10 Irelands, 3 Greece's, and 2 Spain's. In Q1, state and local GDP shrank by 3.8%, chopping growth at the national level by 0.5%, the sharpest drop since that last year from hell, 1981. States are shoveling money out of the economy nearly as fast as Obama is shoveling it in.
During the bubble, the states thought incomes were higher than they really were, were richer than they really were, and bulked up on services as if the party would go on forever. As a result, services grew faster than the economy for many years, especially when it came to building new prisons. Because of the ephemeral nature of property and stock gains, that movie now has to run in reverse, and state services have to shrink down to what they can afford. During the last two recessions, state and local governments hired, easing some of the pain at the local level.
Not this time. Teachers, policemen, and firemen have been laid off with reckless abandon, the oldest and most expensive usually targeted to go first. Obama is going to have to come up with some sort of "Marshall Plan" for the states to enable them to transition out of their structural deficits towards fiscal soundness. Target number one is going to have to be entitlements, primarily state employee pension payments, which in many cases now exceed those in the private sector. The headache is so huge that it is mathematically impossible for any tax increase to address the shortfall alone.
No action now brings slower economic growth, fewer jobs, and a paucity of votes in November. This is all one reason why I am pounding the table for a long term growth rate of 2%-2.5% which the financial markets have only recently started to embrace.
Richard Suttmeier: US Home Prices Could Fall Another 50%
by Peter Gorenstein - Yahoo
The housing market continues to deteriorate. Thursday's report on May pending home sales was down 30% from the prior month and nearly 16% vs. a year ago. The market weakness spans the country. Sales in the Northeast, Midwest and South fell more than 30%, the bright spot, the West, only fell 21%. The news comes after last week's record low new home sales in May, which plummeted nearly 33%. Experts say the expiration of the new homebuyer tax credit is to blame for the sudden market softness.
Unfortunately, the market could get worse and prices could fall further, says Richard Suttmeier of ValuEngine.com. High unemployment and struggling community banks are two main causes. Saddled with bad housing and construction loans, local banks will continue to restrict lending. Plus, the failure of the Obama administration's mortgage modification program means a steady flow of short sales. "People are going to be surprised when they see there have been short sales," which negatively impact appraisals in the local community, says Suttmeier.
How low can prices go?
Using the S&P/Case-Shiller index as his guide, Suttmeier suggests homes across the country could lose half their value. "If it gets back, like stocks, back to the 1999-2000 levels, that’s another 50% down in home prices," he says.
Why British house prices must fall by 25% or more
by Ian Cowie - Telegraph
An increase in the supply of properties for sale helped reduce house prices marginally by 0.6 per cent this month, according to Halifax. But, while Britain’s biggest mortgage lender predicts prices will end the year "broadly unchanged" much bigger falls are likely as the coalition government presses ahead with the biggest spending cuts in living memory and rising unemployment brings tens of thousands of new forced sellers into the market.
Some estate agents report that the number of properties for sale has already increased by more than a fifth since last year. Nigel Lewis, property analyst at online estate agents FindaProperty.com, said: "It is no surprise that the latest Halifax house price index shows a dip in house prices; our own figures show that there has been an influx of stock over the past few months which has served to drive prices down.
"There are currently 23 per cent more properties for sale on our site than there were a year ago and this imbalance between supply and demand is now affecting pricing. We are reverting back to a buyer’s market and therefore sellers must vie for their attention with more competitive prices." That makes a change from estate agents trying to talk prices up. But, confronted supply rising more rapidly than demand, most market commentators remain determined to avoid the obvious conclusion about what this must mean for prices.
As usual at market turning points, the most comforting option is to forecast a soft landing. For example, Catherine Penman, head of research at property consultants Carter Jonas, said: "What is clear from the latest Halifax figures and last week’s figures from Nationwide, is that any thoughts being entertained that the housing market was through the worst and well on the road to recovery were a touch premature. "The price gains at the start of the year were never likely to continue, with a market underpinned by a scarcity of good stock rather than a healthy flow of buyers and sellers, and with public sector cuts and higher taxes looming on the horizon, we are likely to see price stagnation for the remainder of the year."
Similarly, Martin Ellis, housing economist at Halifax, said: "House prices fell by 0.6% in June following a similar decline in May. Prices in the April to June quarter were largely unchanged compared with the first three months of the year. This pattern is in line with our view that house prices will be broadly unchanged over 2010 as a whole. "A shortage of properties for sale in 2009 contributed to an imbalance between supply and demand and was a key factor driving up house prices last year. An increase in the number of properties available for sale in recent months has helped to reduce the imbalance, relieving the upward pressure on prices. The low level of interest rates, however, continues to support housing demand."
Nobody expects interest rates to rise soon. But what will happen to demand when they do rise? More importantly, what will happen to supply when tens of thousands of new public sector jobs created by the last government are cut by the coalition as it struggles to reduce budget deficits? Even if we suffer a double-dip recession, most homeowners will sit out this downward correction, comforting themselves with the knowledge that their properties often gained more in value than their owners earned after tax in the good years. But rising numbers of buyers will no longer have that option if their income is terminated and they cannot afford to meet monthly bills. Some may feel forced to sell at almost any price; others will simply send the keys back.
House prices have fallen by less than a fifth – 17 per cent to be precise, as measured by Halifax – from the all-time peak they reached in August, 2007. The obvious conclusion is that they have much further to fall. A decrease of about 25 per cent in prices would bring them into line with the increase in supply we have already seen. But government spending cuts mean more sellers look set to enter the market, depressing prices further.
Initial claims drop last week but remain high
by Christopher S. Rugaber - AP
New claims for unemployment benefits dropped sharply last week, signaling that layoffs are slowing but not enough to signal strong job creation. The Labor Department said Thursday that requests for jobless aid dropped by 21,000 to a seasonally adjusted 454,000. The decline takes claims to their lowest level since early May, erasing the increases of the last two months. But even as first-time claims fall, the number of unemployed Americans receiving benefits is dropping sharply because their aid is ending.
About 350,000 people saw their benefits cut off in the week of June 19 after Congress left for weeklong recess without extending federal jobless aid. That brings the total to about 1.6 million people who have had their benefits end since May. Those numbers could reach 3.3 million by the end of the month if Congress doesn't pass an extension when it returns from recess. Initial claims have fluctuated in recent weeks. They have remained stuck near 450,000 all year, after dropping steadily last year from a peak of 651,000 in March 2009.
The four-week average of claims dropped slightly to 466,000. In a healthy economic recovery with rapid hiring, claims usually fall below 400,000. The tally of people continuing to claim benefits plunged by 224,000 to 4.4 million, the department said. But that doesn't include another 4.6 million people who received extended benefits paid for by the federal government in the week ended June 19, the latest data available.
The number of people receiving extended benefits is dropping quickly. During the recession, Congress added up to 73 weeks of extra benefits on top of the 26 weeks typically provided by states. But those extensions expired in late May, leaving about 1.6 million people without unemployment insurance, according to the Labor Department. That figure is expected to grow to 3.3 million by the end of this month. Democrats in the House and Senate are seeking to renew the extended benefits and continue them through November. But Senate Republicans have blocked the extension, citing deficit concerns.
Federal Reserve weighs steps to offset slowdown in economic recovery
by Neil Irwin - Washington Post
Federal Reserve officials, increasingly concerned over signs the economic recovery is faltering, are considering new steps to bolster growth. With Congress tied in political knots over whether to take further action to boost the economy, Fed leaders are weighing modest steps that could offer more support for economic activity at a time when their target for short-term interest rates is already near zero. They are still resistant to calls to pull out their big guns -- massive infusions of cash, such as those undertaken during the depths of the financial crisis -- but would reconsider if conditions worsen.
Top Fed officials still say that the economic recovery is likely to continue into next year and that the policy moves being discussed are not imminent. But weak economic reports, the debt crisis in Europe and faltering financial markets have led them to conclude that the risks of the recovery losing steam have increased. After months of focusing on how to exit from extreme efforts to support the economy, they are looking at tools that might strengthen growth. "If the economic situation changes, policy should react," James Bullard, president of the Federal Reserve Bank of St. Louis, said in an interview Wednesday. "You shouldn't sit on your hands. . . . I think there's plenty more we could do if we had to."
One pro-growth strategy would be to strengthen language in Fed policy statements that the central bank's interest rate target is likely to remain "exceptionally low" for an "extended period." The policymakers could change that wording to effectively commit to keeping rates near zero for even longer than investors now expect, perhaps adding specifics about which economic conditions would lead them to raise rates. Such a move would be opposed by many members of the Fed policymaking committee who are wary of the "extended period" language, arguing that it limits their flexibility.
Another possibility would be to cut the interest rate paid to banks for extra money they keep on reserve at the Fed from 0.25 percent to zero. That would give banks slightly more incentive to lend money to customers rather than park it at the Fed, although it also could cause technical problems in the functioning of certain credit markets. A third modest possibility would be to buy enough new mortgage securities to replace those on the Fed balance sheet that are paid off as people take advantage of low interest rates to refinance.
Role of mortgage rates
None of those steps amounts to the kind of massive unconventional effort to drive down mortgage rates and prop up growth that the Fed took in late 2008 and early 2009, when the economy was in a deep dive. Then, the Fed began buying Treasury bonds, mortgage securities and other long-term assets -- more than $1.7 trillion worth by the time the purchases concluded in March. Some economists have encouraged the Fed to launch a new asset-purchase program, saying that with the unemployment rate at 9.5 percent and little apparent risk of inflation, the Fed should use every tool at its disposal to get the economy back on track.
Fed leaders view such a strategy as likely to have only a small impact on the economy and as carrying a risk of slowing growth. One of the key ways the earlier securities purchases stimulated the economy was by driving down mortgage rates, which in turn propped up the housing market. But with mortgage rates near all-time lows, it is not clear that actions to lower rates another, say, quarter percentage point would result in much additional home sales or refinancing activity.
Moreover, the Fed's purchases of mortgage securities have reduced the role of private buyers in that market, and some leaders at the central bank fear that further intervention could delay the resumption of normal market functioning. "The Fed probably believes that unconventional policy does not have much traction as market functioning gets better," said Vincent Reinhart, a resident fellow at the American Enterprise Institute and a former Fed official.
Another risk is that global investors could lose faith that the Fed will be able or willing to pull money out of the economy in time to prevent inflation. That would lead the investors to demand higher interest rates on long-term loans, which could reverse the rate-lowering effects of the Fed's asset purchases. When the Fed was buying $300 billion in Treasurys in mid-2009, part of its try-everything approach to dealing with the crisis, rates on 10-year bonds temporarily spiked amid concerns that the Fed was "monetizing the debt," or printing money to fund budget deficits. With deficit concerns having deepened in the past year, such fears could be even more pronounced now.
All that said, Fed officials do not rule out launching a major new asset-purchase program. Rather, they say they would consider one only if their basic forecast -- of continued steady expansion in the economy -- proves to be wrong. A key factor that would build support for new asset purchases would be a rise in the risk of deflation, or a dangerous cycle of falling prices -- which has become more of a concern as the world economy slows.
Fed officials express confidence that they have tools to address the economy further if conditions worsen. "I think we do have a variety of tools available, and we shouldn't rule any tool out," Eric Rosengren, president of the Federal Reserve Bank of Boston, said in an interview. "If we're uncomfortable with how long it's going to take us to reach either element of our dual mandate [of maximum employment and stable prices], we'll have to make some adjustments to policy."
Hedge Funds 'Frozen in Headlights' Cut Trading
by Saijel Kishan and Katherine Burton - Bloomberg
Hedge-fund managers, Wall Street’s best compensated and supposedly smartest investors, are dazed and confused. Reeling from the worst second-quarter performance in a decade, hedge funds have scaled back trading as they struggle to figure out where markets are headed amid sometimes vicious crosscurrents in stock, commodities and other markets, according to brokers and managers. "There’s a degree of being frozen in the headlights, of not knowing what sectors to emphasize, of what securities to emphasize," said Tim Ghriskey, chief investment officer of Solaris Asset Management LLC, a firm in Bedford Hills, New York, with $2 billion in hedge funds and conventional stock funds.
Hedge-fund managers, who oversee $1.67 trillion in assets, are reluctant to put money to work as they are buffeted by a wide range of often conflicting political and economic forces, from fiscal policy in Europe and the U.S., to what regulations will be imposed on the financial-services and energy industries, to the growth prospects in China. In turn, smaller and fewer trades may make it harder for funds to rebound from losses incurred since May, when the industry suffered its worst decline in 18 months. "For many people, it’s a frustrating market given the high volatility and low volumes," said Aaron Garvey, portfolio manager at MKP Capital Management LLC, a New York-based hedge fund overseeing $3.5 billion. "We are seeing strong opposing forces in the markets, which makes generating strong convictions difficult for the medium- and long-term."
Prime brokers such as Credit Suisse Group AG and JPMorgan Chase & Co. that service hedge funds report that managers are borrowing less money and are sitting on more cash. Credit Suisse’s hedge-fund clients held 24 percent of their assets in cash in June, compared with 19 percent three months earlier, according to the Zurich-based bank’s prime brokerage unit. "People are in cash for the most part and nobody’s really taking out any big bets," said Blaze Tankersley, chief market strategist at Bay Crest Partners LLC, a brokerage firm in New York. "Nobody wants to take risk in either direction. It’s a weird time in the market."
U.S. stock market trading last month had its steepest June decline in at least 13 years. Daily trading volume for the Standard & Poor’s 500 Index of the largest U.S. companies averaged 1.09 billion shares in June, 20 percent less than in May. The 15 percent decrease last year was the second-biggest slump between May and June in Bloomberg data going back to 1997.
No ‘Summer Lull’
Hedge funds account for 20 percent of the equities volume in the U.S., according to Tabb Group LLC, a New York-based adviser to financial-service companies. Trading of options on stocks, indexes and exchange-traded funds on the eight U.S. exchanges also fell in June, declining 2 percent from last year to 309 million contracts for the month, according to the Chicago-based Options Clearing Corp. Options are contracts that give the right to buy or sell assets at a set price by a specific date.
"This is much more than a summer lull," said Sam Hocking, global head of prime brokerage sales at BNP Paribas SA. "Given the uncertainty out there, many hedge funds have felt it wise to pull back and take risk off the table." Credit Suisse says its hedge-fund clients have cut their borrowing, or gross leverage, to about 2.5 times assets in June compared with 2.8 times assets in March.
Stock Market Decline
"We’re trying to reduce risk by downsizing of our trades," said Max Trautman, a former Goldman Sachs Group Inc. proprietary trader and co-founder of Stoneworks Asset Management LLP, a $460 million macro hedge fund based in London. "It’s not that we have stopped taking views but we’re just putting less risk in them." Global stocks posted the biggest losses in the second quarter since the bull market began last year, as the sovereign- debt crisis in Greece threatened to spread to other European countries.
Chinese government restrictions on lending and real estate, intended to prevent the world’s third-largest economy from overheating, added to concerns global growth may slow. In the U.S., slowing growth in manufacturing, an unexpected jump in jobless claims and a slump in home sales have fueled concern the economic recovery is faltering.
Barton Biggs, whose purchase of stocks in March 2009 gave Traxis Partners LLC a 38 percent gain last year, said last week he sold about half his stock investments because of concern governments around the world are curtailing stimulus measures too soon. "I’m not wildly bearish, but I don’t want to have a lot of risk at this point," Biggs, who manages $1.4 billion, said in a telephone interview. "I’m not putting my money into anything. I’m raising cash."
Hedge-fund managers say they’re also worried about the impact of financial reform being introduced as a result of the Wall Street meltdown, and energy regulation following the BP Plc oil spill in the Gulf of Mexico, the largest in U.S. history. Among managers sticking to convictions is John Paulson, who is betting on a U.S. economic recovery after making $15 billion with a wager against home mortgages during the financial crisis. Paulson lost 6.9 percent in June in his Advantage Plus hedge fund and 4.4 percent in his Advantage fund, according to two investors briefed on the returns.
The funds were positioned to profit from a jump in stocks including financial-services companies, said the clients, who asked not to be named because the fund is private. Paulson, who runs the $33 billion New York-based Paulson & Co., hasn’t changed his bullish views after the stock market’s decline and last week’s data showing weaker-than-expected private-sector employment in June, according to the investors. Almost two-thirds of the firm’s assets are in his Advantage funds, which invest in corporate events such as bankruptcies and mergers.
Paulson, 54, has told clients he expects inflation to increase over the next three to five years, which is why he has also been buying gold and mining shares, including AngloGold Ashanti Ltd. and Kinross Gold Corp. Gold has risen about 10 percent this year. Paulson’s Gold Fund climbed 7.3 percent in June and 13 percent for the year, the investors said. Armel Leslie, a spokesman for the fund firm, declined to comment.
Hedge funds declined 0.94 percent in June and 2.79 percent in the three months ended June, the worst second-quarter performance since 2000 when the industry lost 3.42 percent, according to Hedge Fund Research’s HFRX Global Hedge Fund Index. The index dropped 1.2 percent in the first half of this year. There’s "a high degree of correlation among stocks, so it’s not the best environment for stock picking, or sector allocation," said Solaris’s Ghriskey. "Investors are not moving money around between sectors, nor are they aggressively moving between fixed income and equities."
Trading of U.S. corporate bonds fell 4 percent in June from the previous month, the first decline between May and June since 2006, according to data compiled by the Financial Industry Regulatory Authority. Some hedge-fund investors prefer that managers don’t place large bets to offset losses this year.
"It’s all about capital preservation at the moment," said Amit Shabi, a Paris-based partner at Bernheim Dreyfus & Co., which farms out client money to hedge funds. "The losses of 2008 are still fresh in investor’s memories and so managers should be cautious." Hedge funds lost an average 19 percent in 2008, the worst returns since Chicago-based Hedge Fund Research started tracking data in 1990. While the industry rebounded 20 percent last year, almost half of the 2,000 funds that make up the HFRI Fund Weighted Composite Index ended the first quarter of 2010 below their high-water mark, or peak net asset value, meaning they can’t charge investors performance fees.
Some hedge-fund managers say the outlook for the U.S. economy will become clearer after companies report second- quarter earnings in the latter half of July, and executives talk about their outlook for the rest of the year. Investors are also looking to results from European banks’ stress tests, due out later this month, and data on U.S. economic growth scheduled to come out on July 30.
‘Cogs in the Wheel’
Companies in the S&P 500 Index increased profit by 34 percent during the second quarter, according to the average analyst estimates collected by Bloomberg. The U.S. economy will grow at a 3.2 percent annual rate this quarter, down from a prior estimate of 4 percent, JPMorgan said in a July 1 note to clients. Sylvan Chackman, global co-head of prime brokerage at Bank of America Corp. in New York, said he expects hedge funds to increase trading this quarter. "They need to put their capital to work to generate returns," he said.
John Trammell, chief executive officer of New York-based Cadogan Management LLC, said it might take until the end of the year or the start of 2011 for managers to get clarity about the direction of markets. "There are so many cogs in the wheel," said Trammel, whose firm invests about $2.7 billion of client money in hedge funds. "We need more details on the fiscal positions in Europe and then have to wait to see whether the policies will work or not."
EMU break-up risks global deflation shock that would dwarf Lehman collapse, warns ING
by Ambrose Evans-Pritchard - Telegraph
A full-fledged disintegration of the eurozone would trigger the worst economic crisis in modern history, devastate every country in Europe including Germany, and inflict a deflationary shock on the US. There would be no winners, warns the Dutch bank ING in a new report "Quantifying the Unthinkable".
"Complete break-up would have effects that dwarf the post Lehman Brothers collapse. Governments would find themselves having to bail out banks again, worsening already fragile government finances. The risk of at least a temporary break-down in payments systems would be enormous, " said the report by Mark Cliffe, Maarten Leen, and Peter Vanden Houte. "Initial trauma is sufficiently grave to give pause for thought to those who blithely propose EMU exit as a policy option," it said, a rebuke to those German politicians and economists who have talked openly of shaking out weaker members.
The new Greek drachma would crash by 80pc against the new Deutschemark. The currencies of Spain, Portugal, and Ireland would fall by 50pc or more, causing inflation to soar into double-digits. "The impact is dramatic and traumatic," it said. ING has attempted to unpick the complex consequences of break-up scenarios, concluding that even a surgical exit by Greece alone would hurt everybody, and be suicidal for Greece. Both weak and strong states would suffer violent downturns if EMU unravelled altogether, though each in very different ways. "In the first year, output falls by between 5pc and 9pc across the various former member states," it said.
The German sphere would face a "deflationary shock". The US dollar would rocket to 85 cents against the euro equivalent, with a "temporary overshoot" to near 75 cents. This would tip the US into acute deflation, threatening North America with a double-dip recession. East Europe would contract 5pc in 2011 alone. Safe-haven flows to core debt markets would drive down yields on 10-year US, German, and Dutch bonds to near 0.5pc, by far the lowest ever. Club Med yields would decouple brutally, rising to between 7pc and 12pc, "capital controls, notwithstanding."
This is the picture of a world falling apart. It is an outcome that Angela Merkel, the German Chancellor, now seems determined to avoid, after dragging her feet over the Spring. The Bundestag has backed Germany's share of the €110bn rescue for Greece, and the €750bn EU-IMF bail-out for future casualties should they need it. The Bundesbank has lifted its de facto veto on purchases of Club Med bonds by the European Central Bank. Yet markets have failed to stabilise. Spreads on 10-year Greek bonds are still 750 basis points over Bunds. Investors clearly doubt whether the Greek austerity policy of wage deflation can ever work, or whether EU states will back their words with money, or both. The spreads are 285 for Portgual, 272 for Ireland, and 213 for Spain.
The markets perhaps sense that the bail-out battles in Germany are not yet over. There are four complaints lodged at the German constitutional court arguing that the rescues breach EU treaty law and therefore German basic law. While the court has refused an immediate injunction to block aid, it has not yet ruled on the cases. A group of five professors has just expanded its original complaint against the Greek rescue to cover the EU's €440bn Stability Facility, describing the methods used to ram through the measures as "putschist" and anti-democratic. "This course is leading Germany to ruin," they said.
Germany's Centre for European Politics in Freiburg has joined the fray with a report arguing that the use of €60bn of EU money under Article 122 of the Lisbon Treaty to support the rescue package is illegal. "It is a complete violation of our constitutional law and the judges at the court will have to say so if a case reaches them, even though they are afraid of the economic consequences," said the author, Dr Thiemo Jeck. Bavarian politician Peter Gauweiler aims to file a fresh case along these lines.
ING's global strategist Mark Cliffe said any Anglo-Saxon Schadenfreude at a euro break-up would be short-lived. The UK economy would shrink by 4.5pc from 2011-2012. "It would be a very unpleasant experience," he said. Safe-haven flows pouring into Britain would drive sterling through the roof. Eurozone demand for UK exports would contract viciously. Pension funds would suffer fat losses on eurozone assets. UK lenders would face havoc again though a web of cross-border linkages.
The Dutch bank does not make any judgement on the merits of EMU, or on whether it is an 'optimal currency area', nor does it explore half-way options such as a split into a hard Teutonic euro and a weak Latin euro. The report said break-up talk is "no longer just a figment of fevered Anglo-Saxon imaginations". It has spread into top policy-making circles in the eurozone and must now be analysed as a serious tail-risk. A survey of 440 heads of global banks and companies by RBC Capital Markets found that 50pc expect at least one country to leave EMU by 2013, and a quarter expect a complete collapse.
ING said heavily indebted states such as Greece would not gain relief by escaping EMU and devaluing since their debt burden would remain, even if government bonds are switched into the new currency. This is a controversial point. If Greece devalues and defaults as well, the calculus is different. Many big bust-ups entail both, such as the Argentine crisis in 2001. Some Argentines argue that their trauma proved cathartic, pulling the country out of a destructive downward spiral. If Greek, Portuguese or Spanish leaders ever start to ask their own Argentine questions as austerity grinds on, and unemployment grinds higher, events will run their ineluctable political course regardless of the greater risks.
As World Cup ends, Europe's stress tests loom
by David Callaway, MarketWatch
The unique ability of sports to bring people together and make them forget -- at least for a spell -- their troubles with each other is never more on display than during the World Cup soccer tournament every four years -- even more so than the Olympics. And this summer has been no exception. The last four weeks marked a welcome relief from the climate of fear that gripped world markets in April and May, as names like Villa, Sneijder, Kaka, and Muller rose to prominence in the headlines and action photos, replacing the tired old shots of names like Trichet, Blankfein, Geithner, or Hayward, entering hearing rooms or press conferences.
People gathered throughout Europe -- from the Villa Borghese Park in Rome to the Santiago Bernabeu stadium in Madrid -- not to light fires and protest the dreaded "austerity" measures from their governments, but to watch "the football" on big screen televisions together. Predictably, the games caused more heartbreak and controversy than joy. After all, 31 countries have to lose before one can win it all.
But the excitement everywhere on game days was palpable, one of the reasons I've been here the last few weeks, conducting my own special series of "stress tests" on the great bars of Europe. Markets reflect public perception and were quick to fall in step with the sports-induced lull. The plunging euro recovered a bit against the dollar during the tournament. So did the British pound. Credit markets were calm while stocks in Europe -- and indeed globally -- were flat, rising earlier in the tournament then falling back to end a terrible quarter weaker. But lack of fear and nervousness about China's economy or the future of the euro helped pave the way for some feel good stories that have the bulls rearing their bruised heads again.
Europe's banks survived a deadline for repaying short-term loans to the European Central Bank last week, and borrowed far less than expected going forward. Agricultural Bank of China got its massive initial public offering launched this week amid high hopes from investors tied to the China growth story. And bankers from London to New York took advantage of the break in hostilities toward their industries to make a series of bold, new money grabs. Three ex-Goldman Sachs bankers in London priced a money-losing online grocery service called Ocado Ltd. this week, and hope to make away with some 90 million pounds ($136 million) in an initial public offering before investors realize the company is simply Webvan with a British accent.
And two of the co-founders of Kohlberg Kravis Roberts -- the original barbarians at the gates -- hope to throw open the doors and make a dash for it in a public stock offering to investors next week, a la Blackstone Group's success.
But the stress of the last six months in global markets, particularly in Europe, is set to resume almost immediately after the final whistle at Sunday's World Cup final in South Africa. Earnings season in the U.S and in Europe begins on Monday, and with it expectations for some dire forecasts on business conditions for the rest of the year. Oil giant BP remains in critical condition as investors bet heavily on its future ahead of its earnings at the end of the month. But the most important event for the market right now at least is the coming stress tests for banks in Europe, results of which are set to be announced in about two weeks.
There is great concern that some of the 100 or so banks tested -- particularly the regional German landesbanks or the Spanish cajas -- will reveal enough weakness to trigger more concerns about larger bailouts and sovereign debt defaults in places like Greece, Portugal, and Spain. These concerns are likely unfounded. Anybody that remembers the U.S. stress tests on banks last year will recall that they were designed by the Treasury specifically not to add to the stress levels of investors. Indeed, weeks of concern about the U.S. stress tests ended with a rally in the market after Wall Street realized the last thing the Treasury was going to do was announce a major fault line in the banking system. Expect the ECB to finesse the European stress tests in the same way, causing a rally in stocks and bonds in Europe later this month.
But after that artificial event, there is indeed real reason for concern in Europe. Indeed, my personal stress tests revealed beneath the veneer of World Cup fever a deep fear about the economic future in specific countries. In Spain, a series of transportation strikes in Madrid layered on pain to a population suffering 20% unemployment, and facing a restructuring of its financial services system, with thousands of more job losses. In Italy, residents spoke of tourism being down noticeably and of concern that the contagion in other parts of Southern Europe could spread there. In the U.K., financial engine to Europe if not the world, the new government's emergency budget has staved off debt concerns for now.
But nobody is under the illusion about the challenges that Prime Minister David Cameron's new coalition government faces in turning the economy around while also cutting billions of pounds in costs. So while the true European holiday season begins this month, it's unlikely the lull in the markets will make it until September. Market historians note that August is one of the worst months on record for stocks, something to remember before heading to the beach.
Still, any trip around Europe, its museums and its landmarks, reminds the observer that it's an ancient place, which has survived countless wars, crisis and lately, terrorist attacks, specifically in Madrid and London. This morning in London, commuters were quietly reminded of the fifth anniversary of the July 7 tube and bus bombings that killed 52 innocent people and injured more than 700. A heightened police presence around Trafalgar Square and the Houses of Parliament, combined with a surge in auto traffic in the city's already jammed streets to reflect a society that remains cautious, but steadfast in its desire to move ahead.
That's a pretty good way for investors to look at opportunities in Europe and globally in the markets in the coming months. There are many reasons to be cautious, but keep looking ahead. The economic recovery is still coming; it just might take a while longer. Alas, after Sunday we can no longer count on the World Cup for help. The next one isn't for four years, in Brazil.
'Soft as butter' European stress tests draw lukewarm response
by Simon Kennedy - MarketWatch
European plans to test the financial strength of the region's 91 biggest banks got a lukewarm reception Thursday amid worries they aren't tough enough, with one analyst calling the tests "soft as butter." The stress tests are intended to check whether banks would be able to withstand another sharp economic downturn and European regulators have promised to publish the results of the tests later this month.
However, regulators reportedly spent much of their time arguing over what level of decline should be factored into the tests and whether they should publish full details of the assumptions, amid worries that they might be seen as an economic prediction and further undermine confidence in the markets. In the end the Committee of European Banking Supervisors, which is overseeing the tests, listed the 91 banks that will be tested and said the assumptions include that economic output will be three percentage points below current European Union estimates.
In May, the European Commission forecast 1% GDP growth in 2010 and 1.5% in 2011 in European Union countries. CEBS didn't give any details on the losses banks would have to be able to withstand on their sovereign debt holdings, but the tests are widely reported to assume a 17% loss on Greek sovereign debt, 3% on Spanish government bonds and no losses on German debt.
"If the delay of the announcement suggests any tensions among individual regulators in the euro zone on the test then this is even more the case with the content released. What we got is only fragmental information, hardly suitable to spark confidence," said UniCredit analyst Stefan Kolek. "The assumptions look soft as butter," said Kolek, who added that the tests aren't even looking at an extreme scenario such as the break-up of the euro zone, which would result in both much greater losses on periphery government bonds as well as a bigger drop in GDP.
Seymour Pierce analyst Bruce Packard said that, in comparison the loss -- or haircut -- on Argentina's bonds earlier this year was 66%. In other recent crises, haircuts ranged between 44% for Russia and less than 15% in Ukraine and Pakistan, he added. "Credible stress tests in the U.K. and U.S. generated confidence in the banking system last year. However, there is a fine line between tests that are suitable demanding, and reverse engineering a testing process so that everyone passes the test," Packard said in a note to clients.
Still, bank stocks got a lift from the CEBS announcement, with the sector rallying late Wednesday and continuing to gain Thursday. Shares in BNP Paribas rose 2.9%, Societe Generale rose 2.2% and Barclays added 2.7%. While some analysts argued the tests won't be tough enough, others said the assumptions could easily have been even less strict. "Overall we regard the release as a mild disappointment, if not quite as bad as we feared," said Matt Spick, an analyst at Deutsche Bank.
Spick said he believes that most European banks will pass the tests, with National Bank of Greece and Allied Irish Banks the most likely to fail among the banks he covers. Shares in National Bank of Greece and AIB rose along with the rest of the banking sector Thursday, with both stocks adding around 3% in early trading.
Spick said there remains a risk there could be a capital shortfall in selected German banks or Spain's unlisted savings banks, known as cajas. This could be due to either low capital levels or greater-than-expected losses on sovereign bonds. He added that in total that would likely require less than 100 billion euros of new capital and that it would largely be in the unlisted sector. See earlier story on unlisted banks.
European banks use gold reserves to raise cash in swaps
by Jack Farchy - Financial Times
European commercial banks have begun using their holdings of gold to raise cash with the Bank for International Settlements, in a further sign of strains in the money markets on which many rely for funding. The BIS, the so-called "central banks’ central bank", took 346 tonnes of gold in exchange for foreign currency in "swap operations" in the financial year to March 31, according to a note in its latest annual report.
In a gold swap, one counterparty, in this case a bank, sells its gold to the other, in this case the BIS, with an agreement to buy it back at a later date. In the past the BIS has occasionally engaged in gold swaps. There has been no mention, though, of any such operation in recent years. The gold swaps detailed in the annual report began in December last year, according to monthly data from the International Monetary Fund, and have surged since January, when the Greek debt crisis erupted.
The amount raised in the operations, just over $13bn at current prices, is small compared with the wholesale money markets. But the fact that banks are using their gold holdings to raise capital is a further indication of the stress in the sector. Euribor, the rate at which eurozone banks lend to each other, has risen for 27 successive days, while markets are nervous about the impending release of bank stress tests in Europe, scheduled to be published at the end of the month.
The BIS annual report says the gold received in the swaps was held "at central banks". Talk of the swaps caused a stir in the gold market, with some traders citing it as a reason for gold’s fall to a five-week low below $1,200 a troy ounce.
Greece Pushes Through Pension Overhaul Despite Protests
by Niki Katsantonis - New York Times
The Greek government took a major step forward in overhauling its debt-plagued economy by forcing through, in principle, a pension bill that would dramatically cut the cost of Greece’s welfare state by increasing the retirement age and slashing benefits. For Prime Minister George Papandreou, who commands a seven member majority in his country’s fractious parliament, the bill’s many provisions represent the beginning of end of the cradle-to-grave state compact that his father put in place in the early 1980s.
The plan was approved in principle by a vote of 159-137 late Wednesday. Individual provisions were to be voted on Thursday before a final vote on the whole package. Three months into an historic bail program worth 110 billion euros — about $140 billion or half of Greece’s annual gross domestic product — the government has so far exceeded the deficit cutting benchmarks set by the International Monetary Fund. Government officials here see the bill’s passage as further evidence for still-skeptical international investors that Greece is committed to pushing through painful reform measures.
"This is our passport out of hell," said Yannis Stournaras an Athens-based economist who has advised past Socialist governments. "It represents the toughest challenge for Papandreou and goes to the very heart of his party. No politician has ever been able to do this." Greece’s generous pension system has allowed many employees to retire before they turn 50 and earn the right to rich payouts calculated on the basis of bonus-laden salaries. The bill would unify the retirement age at 65 years of age for both men and women and would reduce payouts by calculating salaries on lifetime income as opposed to a worker’s highest, most recent pay.
It would also make it easier for Greek companies to fire workers. Athens was to a large extent shut down Thursday as public sector workers gathered in protest before the parliament building in Syntagma square. According to police estimates, the numbers were between 5,000 and 10,000 and despite a few challenges by hooded youths carrying sticks and axes, riot police with gas masks and shields seemed to be in control of the situation.
"Nobody expected this — this is worse than the occupation under the Germans," said Nikos Stathas, 60, a plumber who is just retiring now. He says he has just got his pension, but he is worried about his children and grandchildren. "This will demolish their retirement," he added. Such strong sentiments aside, by most accounts protests have been relatively restrained since three people was killed in an attack on a bank in May — a sign perhaps that Greeks, while angry and unhappy at the sacrifices forced upon them, understand that they face little other choice than to tighten their belt.
Mr. Papandreou, a life-long Socialist, has managed to keep control of his party despite protests among influential advisers like his economy minister, Louka Katseli. A team from the I.M.F. and the European Union is due in Athens next month to examine the government’s progress, before the next 9 billion euro tranche is to be released. Mr. Stournaras pointed out that the Greek economy performed better than expected in the first quarter, sustained by a surprisingly robust showing for private consumption, which was up by 1.5 percent.
A sharp cutback in public investment caused growth to decline by 2.5 percent for the quarter, but Mr. Stournaras expects the economy to shrink by less than the I.M.F. estimate of 4 percent and he forecasts a budget deficit this year of about 7 percent. According to a presentation by the government’s debt management agency, sharp decreases in public sector wages and investment, plus an increase in taxes have driven the improved deficit picture.
"The government's popularity is holding up very well," said Paul Mylonas, chief economist at the National Bank of Greece. "But after several years of reform, adjustment fatigue may set in if light does not appear at the end of the tunnel." Indeed, senior government officials concede that they have yet to win back the confidence of foreign bond investors, many of whom believe that some form of a debt restructuring is inevitable, as the 10 percent-plus yields on the government’s long term debt show.
"No one in Greece is looking at a debt restructuring. It’s just not going to happen," said Petros Christodoulou, the head of the debt management agency insisted last month at an investor conference in London. Still, doubts abound that the economy can survive the dramatic public sector retrenchment and continue to generate needed tax revenues to make a dent in a debt that even within three years will still be at around 120 percent of G.D.P.
Europe's Got Balls
by Randall Lane - Daily Beast
It’s Management 101: Employees act in accordance with how you pay them. Managers with long-term contracts stick around. Executives compensated in stock act like owners. Salespeople paid commission-only hock their first-born. Wall Street reacts that way, too. If you want to trace virtually every stupid risk, every trend that’s turned the markets into a casino, every root cause for the meltdown that nearly imploded the global economy, just follow the tyrannical path of the five sweetest letters on Wall Street: the almighty bonus.
Europe, collectively, seems to understand this. On Wednesday, the European Parliament voted overwhelmingly, 625-28, to limit to 30 percent the amount of a bonus that can be paid in cash. The rest of the loot, pending a rubber stamp from the continent’s finance ministers next week, will essentially be deferred over three years, to ensure that the risks taken to get the bonus don’t subsequently blow up the bank or the economy.
Yet on this side of the pond, we seem to be entirely unwilling to address the destructive nature of the bonus system head-on. The tepid financial-reform package that continues to weakly stumble through Congress doesn’t tackle the topic directly. And while the Federal Reserve issued guidelines last month that make it clear it agrees with the actions in Europe, its enforcement boils down to vague threats about vetoing compensation plans that don’t meet "standards." The obscene numbers don’t make the Wall Street bonus system destructive. Paying a 25-year-old commodities trader $20 million a year is no more inherently stupid or illogical than paying 25-year-old LeBron James $20 million. It’s how bonuses get paid.
At a typical Wall Street bank, 80 or 90 percent of annual compensation arrives in one giant check, generally determined before Christmas and then paid in February. All that pent-up uncertainty—a "bonus," by definition, is discretionary—creates paranoia pretty much all year. For those on the lower rungs, each bank and fund has compensation committees that divide the loot by group based on how the firm did overall, and how much each unit contributed to it, and then the head of each desk, like a Mafia boss, divides the spoils among his crew, based on individual performance and other intangibles. While I was making calls for my book, The Zeroes, one manager, who determines the bonuses of a few dozen traders, put it to me this way: "I have some guys who work for me, who I take $50,000 from just because I think they’re a dick."
So much money. All in one check. All dependent on how much you make managing other people’s money. This warped system corrupts even good people. "If I’m going to get paid zero," another money manager told me about his autumn mindset during down years, "I might as well take some risk and try to make some money." The only risk to his bonus, in other words, is not taking risks. A dangerous way to think when you can borrow roughly 20 times the amount of your initial bet to really raise the stakes.
In this system, long-term performance is irrelevant. Bonuses deal with the year at hand, and if that means buying or selling junk that explodes later, that hasn’t been an issue. "All you worried about was whether you could sell it," says one Wall Street sales executive, describing the attitude pre-meltdown. Wall Street’s musical chairs meant you’d be at another firm, or somewhere else in your current firm, when the song stopped. And stop it did.
Why does our country tip-toe around this problem, while Europe hits it over the head with a hammer? A lot of it has to do with entitlement. Try to muck with a Wall Streeter’s bonus, and you’ll get a reaction similar to what you’d hear after telling a 70-year-old you’d like to reform Social Security. No matter that bonuses are a recent phenomenon. Until 1971, almost every single major bank was a private partnership. At the end of the year, the partners simply divided the profits among themselves; the vast majority of employees got regular paychecks like schoolteachers and firemen and other normal working people. Only once the big banks went public—and faced shareholder pressure for consistent bottom-line performance—did the talent demand fat checks at year-end.
There’s also something slightly un-American about the idea of capping salaries. And rightly so. But what Europe is launching isn’t a cap; it’s just a glorified escrow account. And banks are different. When a hedge fund blows up, whether Amaranth or Madoff, it makes headlines, but really only affects the rich people or institutions that willingly chose to invest or deal with them. Ever since the bone-headed repeal of Glass-Steagall, and the ensuing co-mingling of the Jimmy Stewart/It’s a Wonderful Life bank ideal with the Al Pacino/Dog Day Afternoon version, the risky casino half of the bank can take out the essential deposits-and-loans side. (See Lehman Brothers, Bear Stearns, and Merrill Lynch.) That’s why the way bankers get paid affects all of us. America generally leads on this kind of stuff—for once, it’s time to follow.
Cap on Bank Bonuses Clears Hurdle in Europe
by Liz Alderman - New Yoek Times
As Wall Street drags its feet on reining in bonuses, the European Union is forcing its banks — by law — to show some self-restraint. The European Parliament on Wednesday approved one of the world’s strictest crackdowns on exorbitant bank pay, going beyond some of the limits that many banks were pressed to adopt in the wake of the financial crisis.
The action comes as the Federal Reserve accuses U.S. banks of not moving fast enough to change compensation practices that stoke excessive risk-taking. While American and British regulators have adopted the principles of Europe’s new measure, officials here are going a step further by legislating minimum caps for cash bonuses and other changes to compensation.
Bankers in the 27-nation bloc will be barred from taking home more than 30 percent of their bonus in cash starting next year, and risk losing some of the remainder if the bank’s performance erodes over the next three years. Banks that don’t curb the salaries of their biggest earners will have to set aside more capital to make up for the risk. "The exercise here is to make sure that bonuses are not a one way bet, so that if you take risks and lose in a big way that will affect what you get," said Nick Dent, an employment law partner at Barlow Lyde & Gilbert LLP who monitors financial compensation.
Large cash bonuses have been blamed for encouraging the type of excessive risk taking that stoked the global financial crisis. Under political pressure, banks in Britain, Germany and France had already moved to limit bonuses last year. The legislation, passed by a vote of 625-28, codifies a compromise clinched last week between European governments and lawmakers. National finance ministers are expected to endorse it on Tuesday, and it then will take effect Jan. 1.
The measure reflects agreements among Group of 20 leaders about how to limit bank pay, and is intended to affect high-bonus cultures at banks with operations in Europe like Deutsche Bank, Barclays and Goldman Sachs, and at some hedge funds. About 70 percent of a bonus would have to be deferred for up to three years and paid in a new class of security, called contingent capital, that would decline in value if the bank’s financial performance deteriorates -- and potentially even be forfeited.
For particularly large bonuses, cash could constitute only 20 percent of the payout. "If within that three years something happens with the performance of the bank or a staff member, he won’t get the payments that were deferred," said Guido Ravoet, secretary-general of the European Banking Federation. "And the clawback means that even if he had been paid the full bonus, he must reimburse the bonus."
If regulators determine that a bank’s pay structure encourages risk, they can force the bank to place hundreds of millions of euros more in its capital cushion as insurance, placing a kind of back-door financial penalty on the bank. Banks that received government bailouts would also have to justify the pay of their directors to regulators, and report the number of employees earning more than 1 million euros, or $1.26 million. European Parliament members said the move would radically transform the bonus culture at banks.
But it is still unclear is just how far the rules reach into the ranks of any given bank: Lawmakers are leaving it up to European governments, which will have to enforce the new rules, to decide whether the pay curbs apply only to a bank’s top executives in their country, or also to traders who take big risks to reap big money. Last month, the Fed outlined a series of compensation principles to try to rein in risk taking at around two dozen of the largest banks in the United States. U.S. officials, unlike the Europeans, are mainly focused on the form and structure of banker compensation, not gauging excessive amounts.
At a Congressional hearing last month, Ben S. Bernanke, the Federal Reserve chairman, said that "many banks have not modified their practices from what they were before the crisis." He promised to push them "to move as quickly as possible to restructure their compensation packages so that they will not be engendering excessive risk-taking."
The Obama Administration’s federal pay czar, meanwhile, is preparing to release the findings of a comprehensive pay review of high-earners at 180 financial companies. Other regulators are making compensation a crucial element of their bank exams, and may use it to help determine the fees a bank pays into the U.S. government-administered deposit insurance fund.
Britain’s financial watchdog must also revise its remuneration guidelines to reflect the more stringent E.U. law, including the use of contingent capital for bonus payments. The Financial Services Authority has favored paying portions of bonus in bank stock, which theoretically would give individuals an incentive to make sure the bank’s performance remained strong.
Mr. Ravoet said bankers are concerned that compensation restrictions will drive the best people offshore to places like Singapore, Switzerland or Dubai, which don’t have similar rules because they are not part of the G20. "There is competition for talent, and it should not be that financial institutions have a competitive disadvantage vis a vis other companies recruiting highly skilled individuals," he said.
Europe’s decision to codify bonus caps could also tilt the playing field with the United States, which has so far steered clear of legislation. In Washington, "they don’t think it can be a cookie cutter approach, the same approach for every firm, but it needs to be thoughtful and reflect the risk taking appetite for each firm," Vicki Eliot, head of financial services consulting at Mercer Consulting, said. "The European Parliament statement seems to be very rules-based in terms of what they are suggesting with specific numbers," she said. "It’s a little bit concerning."
It also is unclear whether banks will increase compensation in other ways to stay competitive. "When bonuses are so constrained, I can’t see that companies will be able to do anything other than increase fixed pay," said Simon Garrett, a director and compensation expert at the Hay Group. However, a number of banks raised salaries last year to avoid a one-time 50 percent tax in Britain on bonuses, and might not want to go further down that path this year, analysts said.
Austerity is not the only option
by Michael Hudson - Financial Times
As Europe’s banking crisis deepens and the US economy stalls, most discussions of how to stabilise national finances assume only two options: "internal devaluation" (shrinking the economy by cutting public spending) and currency devaluation. Both aim to make countries more competitive: the first using unemployment to lower wages and imports, the second lowering export prices.
The Baltic states, in particular, have applied the first option to an extreme degree. Government cuts have shrunk the gross domestic product of Latvia and Lithuania by more than 20 per cent in two years, while wages in Latvia’s public sector have fallen by 30 per cent. The hope is that falling wages and prices will see economies "earn their way out of debt", creating a trade surplus to earn euros that, in turn, can pay the debts that fuelled the post-2002 property bubble.
The second option has been tried less often. Those eastern European countries that have not yet joined the euro know that currency depreciation would delay their planned European Union membership. It would also raise the price of energy and other essential imports, aggravating the economic squeeze and trade deficit. Most leaders therefore find currency devaluation so unthinkable that, at first glance, austerity seems to be the only choice.
The problem is that austerity prompts strikes and slowdowns, which, in turn, shrink the domestic market, investment and tax receipts. As unemployment spreads and wages fall, mortgage arrears and defaults soar. Property prices have plunged too. Some business owners are even now taking a novel approach to escaping their debts: emigration.
Facing these two unpalatable options, some of eastern Europe’s leaders have begun to realise that there is, in fact, a third option: radical reform of the tax system. Taxes in most post-Soviet eastern European economies, along with countries such as Greece, are regressive. They add to the price of labour and industry while under-taxing property. Latvia is an extreme example: its flat taxes fall almost entirely on employment, meaning workers take home less than half of what employers pay.
The good news is that these high taxes on labour leave open the option of shifting taxes on to other areas, in particular land. Lowering taxes on wages would reduce the cost of employment without squeezing take-home pay and living standards. Raising taxes on property, meanwhile, would leave less value to be capitalised into bank loans, thus guarding against future indebtedness.
Hong Kong, for example, promoted its economic take-off by relying mainly on collecting the land’s rental value, enabling it to minimise employment taxes (currently 15 per cent). Yet throughout the former Soviet sphere, real estate taxes often have been only a fraction of 1 per cent until this year. This low tax on land was part of the reason for the property bubbles in these countries, because untaxed land value was paid to banks, which, in turn, lent it out to bid up prices all the more. Shifting the burden of tax from labour to land would actually hold down the price of housing and commercial space, because rental value that is taxed would not be recycled into new mortgages.
Housing costs typically absorb 40 per cent of family budgets in eastern European countries. Lowering this rate would help to boost demand elsewhere in the economy. A reduction to 20 per cent – the typical rate in Germany’s much less indebted economy, where lending has been more responsible – could even provide further scope for wage moderation without lowering living standards.
The main issue in eastern Europe and beyond over the coming years will be whether economies can free themselves from the twin burdens of heavily taxed wages and inflated housing prices, while avoiding an overdose of needless austerity. The clear alternative is a reformed system that focuses on taxing the rising land values created by general prosperity, or economic rent. It is worth remembering that taxing the "free lunch" of rising land values was part of the original liberalism of Adam Smith, John Stuart Mill and the Progressive Era reformers in the US, all of whom sought to make their economies more competitive. Today, tax reform is again the best option to help countries around the world regain their competitiveness.
The author is chief economist of the Reform Task Force Latvia think-tank
Yes, Gold Is A Decent Inflation Hedge -- But It's 3X Overvalued And A Lousy Investment
by Henry Blodget - Business Insider
The Economist has helpfully published a chart that should help resolve two age-old arguments:
- whether gold is good inflation hedge, and
- whether gold is a good investment.
Based on this chart of inflation-adjusted prices since 1800, the answer to the first question is "yes--gold's a good inflation hedge."
Of course, being a good inflation hedge is not the same thing as being a good investment. Yes, gold has been a better investment than currency over the past 200 years, but that's not saying much. For most of this period, gold has done vastly worse than the stock market and worse than most bonds and real-estate. Basically, it has done about as well as T-bills, which generally offset inflation but provide little return beyond that.
Specifically, on an inflation-adjusted basis, gold has generally traded between $300 and $600 an ounce for the past 200 years. And so how does gold look now, relative to that level? Less than the peak in the 1980s. But still about 2.5X overvalued. In other words, if you're buying gold today, you believe the following (whether you know it or not):
- Gold is going to trade to a much higher level than it has traded for most of the past 200 years and stay there because the world has changed ("This time it's different")
- Gold is in the early stages of a crazy bubble that is going to briefly drive prices into the stratosphere before they collapse back to normal $300-$600 levels ("Yes, it's a bubble, but I'm going to be smart enough to sell before it bursts.")
Those, by the way, are the two beliefs that are common in every investment bubble. Some people think the world has changed and that it's "different this time." (It usually isn't.) Other people think that it's just a bubble but they'll be smart enough to get out ahead of the crowd. (Most don't). So now you know! (By the way, if you buy gold now thinking it will be a good inflation hedge and gold prices collapse to their normal levels, gold will not have been a good inflation hedge--unless the currency collapse is even worse. Your entry price matters...)
China on the cusp of real estate slump: Standard Chartered
by Chris Oliver - MarketWatch
Real estate prices in major Chinese cities are set to decline significantly in the coming months as developers grapple with bloated inventories and skittish buyers, according to recent research. China's leading cities could see prices plummet 20% to 30% by year's end, while lesser-known cities could see declines of 10% to 20%, Standard Chartered Bank Ltd. said in a research note Tuesday. "With new supply meeting a still-reticent buying public, we believe developers will be forced to cut prices," said the bank's analysts headed by Steven Green in Shanghai.
Analysts say China's housing market turned lower after anti-speculative policies were unveiled in mid April. The regulations eliminated ultra-low mortgage rates, tightened down payment rules on purchases of second homes and luxury apartments and blocked bank financing for third-home purchases. In an effort to cool lending to the property sector, banks were required to set aside more cash as reserves.
From their highs earlier this year, real estate prices have eased about 20% in Beijing and 19% in Shenzhen, while in Shanghai they are off about 8%, though low transaction volumes may distort the magnitude of the drop, Standard Chartered said. In fact, Green says overly-fast price declines could force Chinese authorities to abandon tightening measures and switch to a loosening stance by year's end. "Market fears that overall policy would become even more stringent have faded over the past month," Green said in the note.
He added more cities are likely to follow Shanghai's lead in resisting the full implementation of the State Council's policies designed to curb prices. Such delays in following the directive from China's top law making body "could suggest government reluctance to further dampen market sentiment," Green said. In a further sign of weakness, about two-thirds of the 61 property developments in Shanghai and Beijing that were scheduled to be released for public sale in June had their marketing debuts indefinitely shelved, according to Standard Chartered.
Steel Industry Cuts Back as Prices Fall
by Robert Guy Matthews - Wall Street Journal
Steel prices in the U.S. are declining after holding firm for months, potentially a bad omen for the nation's economy as manufacturing activity slows and consumers grow more cautious about big-ticket purchases, such as cars and appliances. Steel prices tumbled in June, and U.S. steel mills are responding by cutting production. Earlier this year they were ramping up capacity to meet the growth in demand they hoped would emerge from the economic recovery. Instead, demand has been spotty.
Another wild card for the industry is China. While the rest of the world was reducing steel production and consumption during the recession, China's voracious appetite for building bridges, autos and appliances, helped support global steel prices. For the most part, China has stepped back from exporting raw steel, in favor of higher-value finished goods. But a recent easing in demand by China's domestic steel consumers has raised fears the country could step up steel exports to the U.S. and other markets.
"There is a very real risk of steel from China being dumped illegally into the U.S. market, despite all the recent trade action," said Michelle Applebaum, of Steel Market Intelligence, a steel consulting firm.
Over the past several years, the U.S. has been aggressive in filing trade cases and using trade laws to prevent China from dumping steel—or, exporting it at less than home-market prices. The U.S. has laws or quotas restricting several types of Chinese-made steel products, including hot-rolled steel, plate steel, pipes and tubes, but Ms. Applebaum said those measures aren't as effective as the ones used by Europe and Canada.
Amid the slump in U.S. steel prices, which is expected to persist at least through much of the summer, ArcelorMittal, the world's largest steelmaker, is planning production cuts at its Indiana mills.
Russia's Severstal, which operates several mills in the U.S., is expected to idle its blast furnace in Maryland this month due to slack demand. Severstal spokeswoman Elizabeth Kovach said the facility is being idled because of a slowdown in the construction-steel market.
Analysts don't expect demand to pick up anytime soon. That means steelmakers are likely to keep a tight rein on production for fear of sending prices even lower. Further steel-price declines could be good news for big steel consumers, lowering costs for builders, heavy-equipment makers and others. But prices would have to stay low for a while to have a lasting impact, since most heavy steel users rely on annual or biannual contracts to lock in prices from their suppliers.
Other steel consumers order on an as-needed basis. "We are seeing some of our customers canceling orders for hot-rolled coils out of Houston,'' said Alex Marshall, a sales manager at Texas-based steel distributor A&M Steel Co. "Customers are putting off orders thinking that they can pick up the same steel, but at a cheaper price, a couple weeks from now,'' he said.
U.S. steelmakers, expecting the economy to be stronger by now, restarted too much capacity earlier this year, a move that has come back to haunt them, said Charles Bradford, an analyst at New York-based consulting firm Affiliated Research Group LLC. Domestic steel prices for hot-rolled steel coil, used for a wide range of products, such as automobiles and appliances, fell 4.5% in June to about $630 a short ton. Mr. Bradford said he thinks the price could fall an additional $80 a ton in coming weeks. He estimated that the price of hot-rolled coil could fall as low as $550 a ton.
Steel buyers don't think prices are likely to head back up until August at the earliest, when steel demand tends to increase as the seasonally slow summer draws to an end. Mitchell Ryan, a middleman who buys hot-rolled coils to makes appliance parts, said his inventory is growing. "I stopped buying coils in late May," he said. "Right now, I am going to work through some inventory and buy more later because prices are going to continue to fall."
Up until recently, the U.S. steel market avoided the softening that began this spring in other parts of the world. That's because the U.S.'s ample domestic supplies of steel's raw materials, including iron ore and coal, and the high cost of ocean shipping keep the U.S. relatively isolated from the global market. Still, imported steel typically accounts for about 20% of the U.S.'s steel needs. U.S. steel imports have increased slightly over the past few months, rising about 4% in May, as domestic output expanded and overall demand crept higher. In June, American steel mills were operating at about 72% of capacity, up from around 64% at the beginning of the year.
Steel prices outside the U.S. dropped 5.1% in June, exceeding the U.S. decline, according to MEPS International, a British steel consulting firm. Hot-rolled steel prices in China fell 2.4% in April and 3.6% in May, and are now around $590 a metric ton, about $40 a ton less than in the U.S. The falling global price of steel is also affecting prices of other commodities. Spot prices for iron ore, one of the main ingredients used in steel production—have fallen by about 6% since May to about $138 a metric ton on the global market, according to the Steel Index, a steel research firm.
Vancouver home sales drop sharply
by Steve Ladurantaye - Globe and Mail
Vancouver's housing market slowed considerably in June, with 30 per cent fewer sales than a year ago. Still, the 2,972 sales made it the second-busiest June on record for the West Coast city. The sharp drop is further evidence that the real estate market is beginning to cool after its sharp post-recession runup after a similar drop in May. Observers have been projecting a slower market, though not one that will come crashing down, in the face of higher mortgage rates and tighter mortgage rules.
National numbers are released by the Canadian Real Estate Association in the middle of the month, but individual real estate boards around the country often release their sales data earlier. In May, buyers backed away from Canada's housing market, driving sales lower in what is traditionally the busiest month of the year for the country's real estate agents. Sales fell 8.5 per cent to 40,393 units in May compared with April. Sales remain elevated by historical markers, but are 15 per lower than last fall's peak.
The housing market has been key to Canada's economic recovery, as low interest rates and pent-up demand drove buyers into the market after months of stagnation in 2008. But with interest rates likely heading higher in the second half of the year, many buyers who would have preferred to buy in the fall or early winter chose to buy sooner. Tougher mortgage rules imposed by the federal government in mid-April also prompted buyers to act sooner. Meanwhile, tens of thousands of homeowners have seen the rampant demand and listed their houses for sale to take advantage of high prices.
The Real Estate Board of Greater Vancouver reported yesterday that home sales fell 30.2 per cent in June from the inflated levels of a year earlier, and 5.8 per cent from May. New property listings rose 1.2 per cent from May and 32 per cent from a year earlier. "The number of new listings coming on the market is not as dramatic as we saw over the previous three months and demand remains at a healthy level for this traditionally quieter time of year," said Jake Moldowan, the president of the Real Estate Board of Greater Vancouver.
The Calgary Real Estate Board, meanwhile, reported sales of single family homes fell 16 per cent in June from May and 42 per cent from June of 2009, while condo sales fell 14 per cent from a month earlier and 40 per cent from a year earlier. Notable is that sales of high-end properties worth $1-million or more are rising, the group said. "We are seeing continued moderation in Calgary’s home sales in the face of higher mortgage rates, increased inventory levels and a decreasing number of fist-time home buyers entering the market," said board president Diane Scott.
New US Loan Delinquencies on the Rise Again
by Diana Olick - CNBC
Just when you thought things might be turning around, the mortgage crisis takes yet another little dip to the downside. Lender Processing Services just put out its May "Mortgage Monitor," and some promising trends aren't so promising anymore, specifically new delinquencies and cure rates. While the total delinquency rate rose 2.3 percent, which is not surprising given how much is in the pipeline, the 30-day delinquent bucket jumped 10 percent. That is surprising because the that number had been coming down of late. The LPS data report says that's because the "seasonal improvement period has expired," but I'm not sure normal seasonal patterns really apply to this market anymore.
More likely is that home prices are not rebounding at the expected/hoped for pace, prompting more borrowers who are underwater on their loans to choose not to pay. And while the job market isn't bleeding so much anymore, it's not adding jobs back at the rate we need, nor is it re-instituting those full time jobs that were slashed to part-time, leaving many borrowers still "underemployed." So the delinquency rate nationwide now stands at 9.2 percent from this particular data set, and with the rise in new delinquencies, it won't be coming down any time soon.
How do I know this? Because the report also finds that the "cure rate," which is the rate at which bad loans actually get better, i.e. the borrowers start to pay again, is getting worse. After a two-month decline, deterioration ratios increased, with 2.5 loans rolling to a "worse" status for every one that has improved. The number of delinquent loans that "cured" to a current status declined for every stage of delinquency, except in the "greater than six months delinquent" category. This improvement was likely the result of trial modifications made through the Home Affordable Modification Program (HAMP) that transitioned into permanent status.
Oh good, so the HAMP program is helping "cure" those 6 month+ delinquencies. No, they're just delaying them yet again, since we know that the re-default rate on HAMP is only rising. Forget cure and think remission.
Well, the report shows that both delinquency and foreclosure rates have stabilized. The trouble is that they've flat lined at "historically high levels." And what does that mean for the rest of the world? Continued pressure on home prices. Yes, we will see a bunch of new reports this month, looking backward two months, that show slight improvements in home prices thanks to the run-up to the end of the home buyer tax credit; that's not reality, that's subsidy.
Bank Fix for Unpaid Commercial Property Loans: 'Extend and Pretend'
by Carrick Mollenkamp and Lingling Wei
Some banks have a special technique for dealing with business borrowers who can't repay loans coming due: Give them more time, hoping things improve and they can repay later. Banks call it a wise strategy. Skeptics call it "extend and pretend."
Banks are applying it, in particular, to commercial real-estate lending, where, during the boom, optimistic borrowers got in over their heads to the tune of tens of billions of dollars. A big push by banks in recent months to modify such loans—by stretching out maturities or allowing below-market interest rates—has slowed a spike in defaults. It also has helped preserve banks' capital, by keeping some dicey loans classified as "performing" and thus minimizing the amount of cash banks must set aside in reserves for future losses.
Restructurings of nonresidential loans stood at $23.9 billion at the end of the first quarter, more than three times the level a year earlier and seven times the level two years earlier. While not all were for commercial real estate, the total makes clear that large numbers of commercial-property borrowers got some leeway. But the practice is creating uncertainties about the health of both the commercial-property market and some banks. The concern is that rampant modification of souring loans masks the true scope of the commercial property market weakness, as well as the damage ultimately in store for bank balance sheets.
In Atlanta, Georgian Bank lent $13.5 million to a company in late 2007, some of it to buy land for a 53-story luxury Mandarin Oriental hotel and condo development. The loan came due in November 2008, but the bank extended its maturity date by a year. The bank extended it again to May 2010, with an option for a further extension to November 2010, according to court documents.
Georgia's banking regulator shut down the bank last September. A subsequent U.S. regulatory review cited "lax" loan underwriting and "an aggressive growth strategy…that coincided with declining economic conditions in the Atlanta metropolitan area." Some of Georgian Bank's assets were assumed by First Citizens Bank and Trust Co. of Columbia, S.C., which began foreclosure proceedings on the still-unbuilt luxury development. The borrowers contested the move, and settlement talks are in progress.
Also in Atlanta, Bank of America Corp. has extended a loan twice for a high-end shopping and residential project. Three years after a developer launched the Streets of Buckhead project as a European-style shopping district, all there is to show for it is a covey of silent cranes and a fence. The developer, Ben Carter, says he is in final negotiations for an investor to come in and inject $200 million into the languishing development.
Regulators helped spur banks' recent approach to commercial real estate by crafting new guidelines last October. They gave banks a variety of ways to restructure loans. And they allowed banks to record loans still operating under the original terms as "performing" even if the value of the underlying property had fallen below the loan amount—which is an ominous sign for ultimate repayment. Although regulators say banks shouldn't take the guidelines as a signal to cut borrowers more slack, it appears some did.
Banks hold some $176 billion of souring commercial-real-estate loans, according to an estimate by research firm Foresight Analytics. About two-thirds of bank commercial real-estate loans maturing between now and 2014 are underwater, meaning the property is worth less than the loan on it, Foresight data show. U.S. commercial-real-estate values remain 42% below their October 2007 peak and only slightly above the low they hit in October 2009, according to Moody's Investors Service. In the first quarter, 9.1% of commercial-property loans held by banks were delinquent, compared with 7% a year earlier and just 1.5% in the first quarter of 2007, according to Foresight.
Holding off on foreclosing is often good business, says Mark Tenhundfeld, senior vice president at the American Bankers Association. "It can be better for a bank to extend a loan and increase the chance that the bank will be repaid in full rather than call the loan due now and dump more property on an already-depressed market," he says. But continuing to extend loans and otherwise modify them, rather than foreclosing, amounts to a bet that the economy will rebound enough to enable clients to find new demand for the plethora of offices, hotels, condos and other property on which they borrowed. If it doesn't work out this way, the banks will end up having to write off the loans anyway.
At that point, if they haven't been setting aside sufficient cash all along for potential losses on such loans, the banks will face a hit to their earnings. Banks' reluctance to bite the bullet on some deteriorating commercial real estate can have economic repercussions. The readiness to stretch out loans puts a floor under commercial real estate and keeps it from hitting bottom, which may be a precondition for a robust revival. More broadly, the failure to get the loans off banks' books tends to deter new lending to others. It's a pattern somewhat reminiscent, although on a lesser scale, of the way Japanese banks' failure to write off souring loans in the 1990s contributed to years of stagnation.
It's a Catch-22 for banks. As long as some of their capital is tied up in real-estate loans that are struggling—and as the banks see a pipeline of still-more sour real-estate debt that will mature soon—their lending is likely to remain constricted. But to wipe the slate clean by writing off many more loans would mean an even bigger hit to their capital. "It does not take much of a write-down to wipe out capital," says Christopher Marinac, managing principal at FIG Partners LLC, a bank research and investment firm.
Federal bank regulators tackled the issues in October with a 33-page set of guidelines. Bank regulators have said they were concerned about commercial-property losses and debts coming due on commercial property. Another problem they sought to resolve was that banks and their examiners weren't always on the same page. In some cases banks weren't recognizing loan problems, while in other cases, tough bank examiners were forcing banks to downgrade loans the bankers believed were still good.
The guidance was intended "to promote both prudent commercial real-estate loan workouts by banks and balanced and consistent reviews of these loans by the supervisory agencies," said Elizabeth Duke, a Federal Reserve governor, in a March speech. The guidelines came from the Federal Financial Institutions Examination Council, which includes the Fed, the Federal Deposit Insurance Corp. and the Comptroller of the Currency.
Although one goal was greater consistency in the treatment of commercial real-estate loans, in practice, the guidelines appear to have fed confusion in the markets about how banks are dealing with commercial real-estate debt. "I just don't believe that the standard is being applied consistently across the industry," says Edward Wehmer, chief executive of Wintrust Financial Corp. in Lake Forest, Ill. In a May conference call with 1,400 bank executives, regulators sought to clear up confusion. "We don't want banks to pretend and extend," Sabeth Siddique, Federal Reserve assistant director of credit risk, said on the call. "We did hear from investors and some bankers interpreting this guidance as a form of forbearance, and let me assure you it's not."
Restructurings increased at some banks, like BB&T Corp. of Winston-Salem, N.C. Its total of one type of restructured commercial loan hit $969 million in recent months, the bank reported in April. That was a huge jump from six months earlier, when the figure was just $68 million. The increase was "basically a function of implementing the new regulatory guidance," the bank's finance chief, Daryl Bible, told investors in May. "We are working with our customers trying to keep them in the loans." BB&T's report showed a significant number of cases where it was extending loan maturities and allowing interest rates not widely available in the market for loans of similar risk.
Banks don't have to disclose how terms on their loans have changed, making it hard to know whether they are setting aside enough cash for possible losses. In a large proportion of cases, modifying the terms of loans ultimately isn't enough to save them. At the end of the first quarter, 44.5% of debt restructurings were 30 days or more delinquent or weren't accruing interest, up from 28% the first quarter of 2008.
A case in Portland, Ore., shows how banks can keep treating a commercial loan as current, despite the difficulties of the underlying project. A client called Touchmark Living Centers Inc. in 2007 borrowed $15.9 million, in two loans, to buy land for a development. The borrower planned to retire the loans at the end of the year by obtaining construction financing to build the Touchmark Heights community for empty-nesters. Because the raw land produced no income, the lender, Umpqua Bank, had provided "interest reserves" with which the developer could cover interest payments while obtaining permits and preparing to build. The bank extended Touchmark a $350,000 interest reserve—in effect increasing what Touchmark owed by that amount.
In December 2007, the U.S. economy slipped into recession. When the loans came due that month, Touchmark didn't pay them off. Umpqua extended the maturity to May 31, 2008. The bank also added $600,000 to the interest reserves. Though supplying interest reserves is common at the outset of a loan, when an unbuilt project can't produce any income with which to pay debt service, replenishing interest reserves is frowned on by regulators. Asked to comment, a spokeswoman for the bank said, "Umpqua and Touchmark had determined that the project was still viable but not yet ready for development." Touchmark said it didn't pursue construction financing at that time because "it was not prudent to proceed with developing the property until the economy improves," as a spokeswoman put it.
In 2008 the bank extended the loans again, to April 2009. During this time, Touchmark began paying interest on the loans out of its own pocket. Then in May 2009, Umpqua restructured the loans, lumping what was owed into one $15 million loan that required regular payments on both interest and principal. Touchmark paid down the principal a little and Umpqua set a new maturity date—May 5, 2012.
Meanwhile, the value of the land Touchmark had borrowed to purchase has been eroding. The bank says it was worth $23.5 million by the most recent independent appraisal, but that was in 2008. The county assessment and taxation department pegged the land's value at about $20 million at the start of 2009. An appraiser for the department estimates raw-land values in the area fell by another 25% to 30% last year, Touchmark executives declined to estimate the land's value. They said the property has retained "significant" value, partly because of its location, with a view of 11,240-foot Mount Hood. Umpqua Bank says the loan is accruing interest, and it expects the loan to be repaid.
'Bulk Sales' of Condos Clear Supply, at a Cost
by Robbie Whelan
The financial clouds hovering over the Monteverde condominium development in Boynton Beach, Fla., were driven away in late spring when an investor bought 118 of the project's 219 units in a "bulk sale," a popular method of moving large numbers of condos in one transaction. But Dan Berwitz, a sales representative for a computer company who paid $204,000 for a unit in the Monteverde in 2007, has mixed feelings about the deal. He is pleased that the sale will bring financial stability to his building, but he isn't happy that the bulk-sale buyer plans to sell the units far below what he paid, in some cases as low as $100,000. "But unfortunately, right now, there's nothing we can do," he said.
In Florida, one of the nation's hardest-hit housing markets, prices of single-family homes and condos have been falling for the past three years due to rising foreclosures, an abundance of supply and tight credit conditions. While there are signs that prices for homes are starting to stabilize in some Florida cities, that may not be the case for condos due in part to bulk sales such as the Monteverde transaction, which could put more downward pressure on prices.
Research firm Real Capital Analytics, which follows condo markets nationwide, tracked 27 bulk deals valued at $850 million, or $250,000 per unit, in 2007. Transaction volume dipped the following year, then rose to 82 deals valued at $839 million in 2009. "I would think we're on pace to have a record year for these types of transactions," said Dan Fasulo, a managing director of Real Capital Analytics. It isn't just Florida. Brokers say bulk-sale transactions are becoming more widespread in San Diego, Phoenix, Las Vegas and other markets in which condo projects mushroomed during the housing boom. It is easy to see the attraction for investors, who are buying units at a sharp discount and in some cases paying less than what it would cost to build.
Condo Developer LLC, a Delaware-based company, in late spring closed on the $25.9 million auction sale of 165 units in the Vue at Lake Eola, a 375-unit luxury condo complex in Orlando, Fla., that had been operating under bankruptcy protection. The Vue, which has floor-to-ceiling windows, 20-foot ceilings and a rooftop terrace, cost $340 per square foot to build, but this latest purchase price works out to about $126 a square foot. The new owners plan to sell the condos, one at a time, at a price of about $225 a square foot, at a profit of about $75 a square foot, when factoring in carrying costs including maintenance and real-estate taxes.
To remain competitive, developers of neighboring buildings must reduce their prices. "Bulk sales in general can depreciate value of an asset and it does trickle down and affect other properties," said Carolyn Block Ellert, co-owner of Premier Sales Group, a brokerage that is marketing units in the Promenade near the Monteverde in Boynton Beach. The owner of the Promenade has slashed condo prices 40%, to the $150,000 to $600,000 range, since the beginning of the year. "We're lowering them to sell," Ms. Ellert said. Bulk sales in some states may soon accelerate as projects work their way through bankruptcies, foreclosures and restructurings and as lawmakers in some states make it easier for investors to buy in bulk to deal with gluts of distressed units.
For example, in late June, Florida Gov. Charlie Crist signed into law a measure that would decrease liability for bulk-sale buyers. Under current law, any company that buys seven or more units in one building is considered the "developer," and is thus responsible to warranties related to the quality of the units throughout the building. As of July 1, this is no longer be the case, says Mark Grant, a condo lawyer in Fort Lauderdale who helped the Florida Home Builders Association craft the bill.
Some competitors are philosophical about the market impact. For example, Toll Brothers Inc., has been trying to sell condos on Ocean's Edge at Singer's Island in Florida for $1.1 million to $3.5 million. Last month, a tough new competitor entered the market: Miami-based investment firm Lionheart Capital and Elliott Management Corp. of New York, which closed on a deal to pay for $120 million for 2700 North Ocean Drive, a two-thirds empty Singer Island development.
Condos there originally sold for $1 million to $6 million apiece, or about $650 per square foot. Ophir Sternberg, a managing partner at Lionheart, said the units will go back on the market starting at $500 a square foot, "with no rush to sell." Jason Snyder, a regional official for Toll, acknowledges that "in the short term, [bulk sales] could hurt some people." But Toll doesn't see it as a "negative thing," he said. "Anything that gets that inventory down is a good thing. The bottom line is that we have to get the inventory down in order to get back to normal."
OECD warns on long-term jobless
by Norma Cohen - Financial Times
Unemployment levels worldwide are set to remain high amid increasing fears that some elements of joblessness could become entrenched and even more difficult to solve, the Organisation for Economic Cooperation and Development warned on Wednesday. Although unemployment levels have probably peaked, the OECD says in its annual employment outlook that the strength of the current economic recovery is unlikely to be strong enough to absorb the millions of workers who are now jobless.
The Paris-based international organisation for advanced economies adds that jobless rates among its member states may still be above 8 per cent by the end of 2011, with sharp differences between countries as economies emerge from the greatest period of job losses since the early 1970s. In the two years to the first quarter of 2010, the employment rate across the OECD fell by 2.1 per cent, leaving 17m more workers unemployed than at the start of the period. Prior to that, unemployment had been at a 28-year low, averaging 5.8 per cent across the OECD.
"With many unemployed experiencing long periods of joblessness, the risk that the sharp increase in cyclical unemployment will become structural in nature is rising," the OECD says, adding that the risk varies greatly across countries. The OECD says that a high priority should be given to efforts that minimise persistent labour market slack as economies recover. It notes that marginal employment subsidies (MES) appear to be able to increase the number of jobs created in the early stages of recovery and do so at a relatively modest cost.
The report notes that there are also big differences between countries in the way the burden of joblessness is shared. In some economies there are very high levels of unemployment but in others there have been reductions in the number of hours worked but lower levels of those out of work completely. For economies in the first group, there is a risk that unemployment will become entrenched unless there is significant growth in the number of available jobs, while for countries in the second category, it is likely that new job creation will be very weak while the economy recovers, the OECD says. Among the countries that have adjusted the number of hours worked, Japan, Germany, the Slovak Republic and Austria stand out.
Moreover, the OECD says unemployment rates have risen much more in some countries than in others and these differences cannot be explained simply by looking at the rate at which output has contracted in each economy. The report says unemployment is particularly acute in economies where a boom-bust pattern in the housing market has had a role in the subsequent recession, most notably Spain, the US and to a lesser extent, Ireland. The report highlights so-called short-time work schemes and the role they have played in preserving jobs during the crisis, particularly in Germany and Japan where they saved more than 200,000 and almost 400,000 jobs respectively.
Job losses have been much greater among men than women, probably reflecting the fact that men form the majority of the workforce in industries such as mining, manufacturing and construction that have been hit hardest by recession. On the upside, the report notes that employment for older workers continued to rise throughout the period, even as joblessness soared among younger workers.
Young Americans Learn That Trying To Find Work Is Pointless
by Vincent Fernando, CFA and Kamelia Angelova - Business insider
While the U.S. has experienced some job creation during the rebound so far, unemployment for America's youngest job seekers continues to get worse, not even slightly better. That's because the new jobs of today aren't open to them, according to a study called "Unemployment Among Young Workers" by the U.S. Congress Joint Economic Committee:"Employers added over half a million jobs in the last four months, yet the unemployment rate for young workers reached a record 19.6 percent in April 2010, the highest level for this age group since the Bureau of Labor Statistics began tracking unemployment in 1947... The youngest workers (16 to 17 years) experience the highest rates of unemployment. The unemployment rate for 16 to 17 year olds was 29 percent in April."
The chart below shows how the unemployment rate for America's youngest (in red) continues to get worse, even while other age groups' unemployment rates have plateaued or slightly declined (in blue or green). The rebound so far, however small, hasn't even started for the young. One reason explained in the report is that older workers are now taking jobs previously reserved for the youngest due to a dearth of opportunities. Another is that industries which employed young workers were hit disproportionately hard during the downturn, such as hospitality and retail. Education is also now more important than ever in securing an available job, with higher education massively reducing one's probability of being unemployed.
Yet education doesn't explain everything. For example, one disturbing figure from the report shows that young black college graduates have double the unemployment rate (15.8%) of other young college graduates. For many of America's budding job seekers such as these, hitting the pavement and trying to work has proven itself completely futile. Take it as a lesson from the New Normal.
American Dream Is Elusive for New Generation
by Louis Uchitelle - New York Times
After breakfast, his parents left for their jobs, and Scott Nicholson, alone in the house in the comfortable suburb of Grafton, Mass., west of Boston, went to his laptop in the living room. He had placed it on a small table that his mother had used for a vase of flowers until her unemployed son found himself reluctantly stuck at home. The daily routine seldom varied. Mr. Nicholson, 24, a graduate of Colgate University, winner of a dean’s award for academic excellence, spent his mornings searching corporate Web sites for suitable job openings. When he found one, he mailed off a résumé and cover letter — four or five a week, week after week.
Over the last five months, only one job materialized. After several interviews, the Hanover Insurance Group in nearby Worcester offered to hire him as an associate claims adjuster, at $40,000 a year. But even before the formal offer, Mr. Nicholson had decided not to take the job. Rather than waste early years in dead-end work, he reasoned, he would hold out for a corporate position that would draw on his college training and put him, as he sees it, on the bottom rungs of a career ladder. "The conversation I’m going to have with my parents now that I’ve turned down this job is more of a concern to me than turning down the job," he said.
He was braced for the conversation with his father in particular. While Scott Nicholson viewed the Hanover job as likely to stunt his career, David Nicholson, 57, accustomed to better times and easier mobility, viewed it as an opportunity. Once in the door, the father has insisted to his son, opportunities will present themselves — as they did in the father’s rise over 35 years to general manager of a manufacturing company. "You maneuvered and you did not worry what the maneuvering would lead to," the father said. "You knew it would lead to something good."
Complicating the generational divide, Scott’s grandfather, William S. Nicholson, a World War II veteran and a retired stock broker, has watched what he described as America’s once mighty economic engine losing its pre-eminence in a global economy. The grandfather has encouraged his unemployed grandson to go abroad — to "Go West," so to speak. "I view what is happening to Scott with dismay," said the grandfather, who has concluded, in part from reading The Economist, that Europe has surpassed America in offering opportunity for an ambitious young man. "We hate to think that Scott will have to leave," the grandfather said, "but he will."
The grandfather’s injunction startled the grandson. But as the weeks pass, Scott Nicholson, handsome as a Marine officer in a recruiting poster, has gradually realized that his career will not roll out in the Greater Boston area — or anywhere in America — with the easy inevitability that his father and grandfather recall, and that Scott thought would be his lot, too, when he finished college in 2008.
"I don’t think I fully understood the severity of the situation I had graduated into," he said, speaking in effect for an age group — the so-called millennials, 18 to 29 — whose unemployment rate of nearly 14 percent approaches the levels of that group in the Great Depression. And then he veered into the optimism that, polls show, is persistently, perhaps perversely, characteristic of millennials today. "I am absolutely certain that my job hunt will eventually pay off," he said.
For young adults, the prospects in the workplace, even for the college-educated, have rarely been so bleak. Apart from the 14 percent who are unemployed and seeking work, as Scott Nicholson is, 23 percent are not even seeking a job, according to data from the Bureau of Labor Statistics. The total, 37 percent, is the highest in more than three decades and a rate reminiscent of the 1930s.
The college-educated among these young adults are better off. But nearly 17 percent are either unemployed or not seeking work, a record level (although some are in graduate school). The unemployment rate for college-educated young adults, 5.5 percent, is nearly double what it was on the eve of the Great Recession, in 2007, and the highest level — by almost two percentage points — since the bureau started to keep records in 1994 for those with at least four years of college. Yet surveys show that the majority of the nation’s millennials remain confident, as Scott Nicholson is, that they will have satisfactory careers. They have a lot going for them.
"They are better educated than previous generations and they were raised by baby boomers who lavished a lot of attention on their children," said Andrew Kohut, the Pew Research Center’s director. That helps to explain their persistent optimism, even as they struggle to succeed. So far, Scott Nicholson is a stranger to the triumphal stories that his father and grandfather tell of their working lives. They said it was connections more than perseverance that got them started — the father in 1976 when a friend who had just opened a factory hired him, and the grandfather in 1946 through an Army buddy whose father-in-law owned a brokerage firm in nearby Worcester and needed another stock broker.
From these accidental starts, careers unfolded and lasted. David Nicholson, now the general manager of a company that makes tools, is still in manufacturing. William Nicholson spent the next 48 years, until his retirement, as a stock broker. "Scott has got to find somebody who knows someone," the grandfather said, "someone who can get him to the head of the line." While Scott has tried to make that happen, he has come under pressure from his parents to compromise: to take, if not the Hanover job, then one like it. "I am beginning to realize that refusal is going to have repercussions," he said. "My parents are subtly pointing out that beyond room and board, they are also paying other expenses for me, like my cellphone charges and the premiums on a life insurance policy."
Scott Nicholson also has connections, of course, but no one in his network of family and friends has been able to steer him into marketing or finance or management training or any career-oriented opening at a big corporation, his goal. The jobs are simply not there.
The Millennials’ Inheritance
The Great Depression damaged the self-confidence of the young, and that is beginning to happen now, according to pollsters, sociologists and economists. Young men in particular lost a sense of direction, Glen H. Elder Jr., a sociologist at the University of North Carolina, found in his study, "Children of the Great Depression." In some cases they were forced into work they did not want — the issue for Scott Nicholson.
Military service in World War II, along with the G.I. Bill and a booming economy, restored well-being; by the 1970s, when Mr. Elder did his retrospective study, the hardships of the Depression were more a memory than an open sore. "They came out of the war with purpose in their lives, and by age 40 most of them were doing well," he said, speaking of his study in a recent interview. The outlook this time is not so clear. Starved for jobs at adequate pay, the millennials tend to seek refuge in college and in the military and to put off marriage and child-bearing. Those who are working often stay with the jobs they have rather than jump to better paying but less secure ones, as young people seeking advancement normally do. And they are increasingly willing to forgo raises, or to settle for small ones.
"They are definitely more risk-averse," said Lisa B. Kahn, an economist at the Yale School of Management, "and more likely to fall behind." In a recent study, she found that those who graduated from college during the severe early ’80s recession earned up to 30 percent less in their first three years than new graduates who landed their first jobs in a strong economy. Even 15 years later, their annual pay was 8 to 10 percent less.
Many hard-pressed millennials are falling back on their parents, as Scott Nicholson has. While he has no college debt (his grandparents paid all his tuition and board) many others do, and that helps force them back home. In 2008, the first year of the recession, the percentage of the population living in households in which at least two generations were present rose nearly a percentage point, to 16 percent, according to the Pew Research Center. The high point, 24.7 percent, came in 1940, as the Depression ended, and the low point, 12 percent, in 1980.
Striving for Independence
"Going it alone," "earning enough to be self-supporting" — these are awkward concepts for Scott Nicholson and his friends. Of the 20 college classmates with whom he keeps up, 12 are working, but only half are in jobs they "really like." Three are entering law school this fall after frustrating experiences in the work force, "and five are looking for work just as I am," he said. Like most of his classmates, Scott tries to get by on a shoestring and manages to earn enough in odd jobs to pay some expenses.
The jobs are catch as catch can. He and a friend recently put up a white wooden fence for a neighbor, embedding the posts in cement, a day’s work that brought Scott $125. He mows lawns and gardens for half a dozen clients in Grafton, some of them family friends. And he is an active volunteer firefighter. "As frustrated as I get now, and I never intended to live at home, I’m in a good situation in a lot of ways," Scott said. "I have very little overhead and no debt, and it is because I have no debt that I have any sort of flexibility to look for work. Otherwise, I would have to have a job, some kind of full-time job."
That millennials as a group are optimistic is partly because many are, as Mr. Kohut put it, the children of doting baby boomers — among them David Nicholson and his wife, Susan, 56, an executive at a company that owns movie theaters. The Nicholsons, whose combined annual income is north of $175,000, have lavished attention on their three sons. Currently that attention is directed mainly at sustaining the self-confidence of their middle son. "No one on either side of the family has ever gone through this," Mrs. Nicholson said, "and I guess I’m impatient. I know he is educated and has a great work ethic and wants to start contributing, and I don’t know what to do."
Her oldest, David Jr., 26, did land a good job. Graduating from Middlebury College in 2006, he joined a Boston insurance company, specializing in reinsurance, nearly three years ago, before the recession. "I’m fortunate to be at a company where there is some security," he said, adding that he supports Scott in his determination to hold out for the right job. "Once you start working, you get caught up in the work and you have bills to pay, and you lose sight of what you really want," the brother said.
He is earning $75,000 — a sum beyond Scott’s reach today, but not his expectations. "I worked hard through high school to get myself into the college I did," Scott said, "and then I worked hard through college to graduate with the grades and degree that I did to position myself for a solid job." (He majored in political science and minored in history.) It was in pursuit of a solid job that Scott applied to Hanover International’s management training program. Turned down for that, he was called back to interview for the lesser position in the claims department.
"I’m sitting with the manager, and he asked me how I had gotten interested in insurance. I mentioned Dave’s job in reinsurance, and the manager’s response was, ‘Oh, that is about 15 steps above the position you are interviewing for,’ " Scott said, his eyes widening and his voice emotional. Scott acknowledges that he is competitive with his brothers, particularly David, more than they are with him. The youngest, Bradley, 22, has a year to go at the University of Vermont. His parents and grandparents pay his way, just as they did for his brothers in their college years.
In the Old Days
Going to college wasn’t an issue for grandfather Nicholson, or so he says. With World War II approaching, he entered the Army not long after finishing high school and, in the fighting in Italy, a battlefield commission raised him overnight from enlisted man to first lieutenant. That was "the equivalent of a college education," as he now puts it, in an age when college on a stockbroker’s résumé "counted for something, but not a lot."
He spent most of his career in a rising market, putting customers into stocks that paid good dividends, and growing wealthy on real estate investments made years ago, when Grafton was still semi-rural. The brokerage firm that employed him changed hands more than once, but he continued to work out of the same office in Worcester. When his son David graduated from Babson College in 1976, manufacturing in America was in an early phase of its long decline, and Worcester was still a center for the production of sandpaper, emery stones and other abrasives.
He joined one of those companies — owned by the family of his friend — and he has stayed in manufacturing, particularly at companies that make hand tools. Early on, he and his wife bought the home in which they raised their sons, a white colonial dating from the early 1800s, like many houses on North Street, where the grandparents also live, a few doors away. David Nicholson’s longest stretch was at the Stanley Works, and when he left, seeking promotion, a friend at the Endeavor Tool Company hired him as that company’s general manager, his present job.
In better times, Scott’s father might have given his son work at Endeavor, but the father is laying off workers, and a job in manufacturing, in Scott’s eyes, would be a defeat. "If you talk to 20 people," Scott said, "you’ll find only one in manufacturing and everyone else in finance or something else."
Scott Nicholson almost sidestepped the recession. His plan was to become a Marine Corps second lieutenant. He had spent the summer after his freshman year in "platoon leader" training. Last fall he passed the physical for officer training, and was told to report on Jan. 16. If all had gone well, he would have emerged in 10 weeks as a second lieutenant, committed to a four-year enlistment. "I could have made a career out of the Marines," Scott said, "and if I had come out in four years, I would have been incredibly prepared for the workplace."
It was not to be. In early January, a Marine Corps doctor noticed that he had suffered from childhood asthma. He was washed out. "They finally told me I could reapply if I wanted to," Scott said. "But the sheen was gone." So he struggles to get a foothold in the civilian work force. His brother in Boston lost his roommate, and early last month Scott moved into the empty bedroom, with his parents paying Scott’s share of the $2,000-a-month rent until the lease expires on Aug. 31. And if Scott does not have a job by then? "I’ll do something temporary; I won’t go back home," Scott said. "I’ll be a bartender or get work through a temp agency. I hope I don’t find myself in that position."
European Parliament Seeks Ban on Foods From Cloned Animals
by James Kanter - New York times
The European Parliament appealed on Wednesday for a ban on the sale of foods from cloned animals and their offspring, the latest sign of deepening concern in the European Union about the safety and ethics of new food technologies. The chamber, meeting in Strasbourg, also called for a temporary suspension of the sale of food containing ingredients derived from nanotechnology, which involves engineering substances down to very small sizes.
Members were voting on legislation that would have regulated the sale of foods based on new production processes, including cloning. That legislation would have required companies to ask permission to market food derived from cloned animals. But the chamber rejected that plan and instead called for separate legislation on cloning because of potential problems with the technology and concerns about animal cruelty.
"Although no safety concerns have been identified so far with meat produced from cloned animals, this technique raises serious issues about animal welfare, reduction of biodiversity, as well as ethical concerns," said Corinne Lepage, who is a French member of the European Parliament and a deputy head of its environment committee. Governments now will have to negotiate with E.U. legislators to finalize the rules, starting in September.
There are no E.U. rules to specifically allow or ban dairy products and meat from cloned animals, according to a statement from the European Parliament. But Europeans could also be eating cloned meat imported from the United States, according to Struan Stevenson, a British member of the Parliament. Additionally, some of the bull semen imported from the United States for inseminating cattle in the European Union "could be coming directly from cloned livestock," he said. Mr. Stevenson called for labels on all meat imports warning that the product might come from a cloned animal if no procedure could be devised to test it.
Gulf awash in 27,000 abandoned wells
by Jeff Donn and Mitch Weiss - AP
More than 27,000 abandoned oil and gas wells lurk in the hard rock beneath the Gulf of Mexico, an environmental minefield that has been ignored for decades. No one — not industry, not government — is checking to see if they are leaking, an Associated Press investigation shows. The oldest of these wells were abandoned in the late 1940s, raising the prospect that many deteriorating sealing jobs are already failing. The AP investigation uncovered particular concern with 3,500 of the neglected wells — those characterized in federal government records as "temporarily abandoned."
Regulations for temporarily abandoned wells require oil companies to present plans to reuse or permanently plug such wells within a year, but the AP found that the rule is routinely circumvented, and that more than 1,000 wells have lingered in that unfinished condition for more than a decade. About three-quarters of temporarily abandoned wells have been left in that status for more than a year, and many since the 1950s and 1960s — eveb though sealing procedures for temporary abandonment are not as stringent as those for permanent closures.
As a forceful reminder of the potential harm, the well beneath BP's Deepwater Horizon rig was being sealed with cement for temporary abandonment when it blew April 20, leading to one of the worst environmental disasters in the nation's history. BP alone has abandoned about 600 wells in the Gulf, according to government data. There's ample reason for worry about all permanently and temporarily abandoned wells — history shows that at least on land, they often leak. Wells are sealed underwater much as they are on land. And wells on land and in water face similar risk of failure. Plus, records reviewed by the AP show that some offshore wells have failed.
Experts say such wells can repressurize, much like a dormant volcano can awaken. And years of exposure to sea water and underground pressure can cause cementing and piping to corrode and weaken. "You can have changing geological conditions where a well could be repressurized," said Andy Radford, a petroleum engineer for the American Petroleum Institute trade group. Whether a well is permanently or temporarily abandoned, improperly applied or aging cement can crack or shrink, independent petroleum engineers say. "It ages, just like it does on buildings and highways," said Roger Anderson, a Columbia University petroleum geophysicist who has conducted research on commercial wells.
Despite the likelihood of leaks large and small, though, abandoned wells are typically not inspected by industry or government. Oil company representatives insist that the seal on a correctly plugged offshore well will last virtually forever. "It's in everybody's interest to do it right," said Bill Mintz, a spokesman for Apache Corp., which has at least 2,100 abandoned wells in the Gulf, according to government data. Added spokeswoman Margaret Cooper of Chevron U.S.A., which has at least 2,700 abandoned wells in the Gulf: "It is our experience that the well abandonment process, when performed in accordance with regulation, has been accomplished safely and successfully."
Greg Rosenstein, a vice president at Superior Energy Services, a New Orleans company that specializes in this work for offshore wells, maintained that properly plugged wells "do not normally degrade." When pressed, he acknowledged: "There have been a few occasions where wells that have been plugged have to be entered and re-plugged." Officials at the U.S. Interior Department, which oversees the agency that regulates federal leases in the Gulf and elsewhere, did not answer repeated questions regarding why there are no inspections of abandoned wells.
State officials estimate that tens of thousands are badly sealed, either because they predate strict regulation or because the operating companies violated rules. Texas alone has plugged more than 21,000 abandoned wells to control pollution, according to the state comptroller's office. Offshore, but in state waters, California has resealed scores of its abandoned wells since the 1980s. In deeper federal waters, though — despite the similarities in how such wells are constructed and how sealing procedures can fail — the official policy is out-of-sight, out-of-mind.
The U.S. Minerals Management Service — the regulatory agency recently renamed the Bureau of Ocean Energy Management, Regulation and Enforcement — relies on rules that have few real teeth. Once an oil company says it will permanently abandon a well, it has one year to complete the job. MMS mandates that work plans be submitted and a report filed afterward. Unlike California regulators, MMS doesn't typically inspect the job, instead relying on the paperwork.
The fact there are so many wells that have been classified for decades as temporarily abandoned suggests that paperwork can be shuffled at MMS without any real change beneath the water. With its weak system of enforcement, MMS imposed fines in a relative handful of cases: just $440,000 on seven companies from 2003-2007 for improper plug-and-abandonment work. Companies permanently abandon wells when they are no longer useful. Afterward, no one looks methodically for leaks, which can't easily be detected from the surface anyway. And no one in government or industry goes underwater to inspect, either.
Government regulators and industry officials say abandoned offshore wells are presumed to be properly plugged and are expected to last indefinitely without leaking. Only when pressed do these officials acknowledge the possibility of leaks. "Once a well is plugged with cement, it's deemed no longer a risk," said Eric Kazanis, an MMS petroleum engineer for the Gulf of Mexico. "It's not supposed to leak." He said no special financial guarantees are required to assure that repairs can be made if they are needed.
Despite warnings of leaks, government and industry officials have never bothered to assess the extent of the problem, according to an extensive AP review of records and regulations. That means no one really knows how many abandoned wells are leaking — and how badly.
The AP documented an extensive history of warnings about environmental dangers related to abandoned wells:
- The General Accountability Office, which investigates for Congress, warned as early as 1994 that leaks from offshore abandoned wells could cause an "environmental disaster," killing fish, shellfish, mammals and plants. In a lengthy report, GAO pressed for inspections of abandonment jobs, but nothing came of the recommendation.
- A 2006 Environmental Protection Agency report took notice of the overall issue regarding wells on land: "Historically, well abandonment and plugging have generally not been properly planned, designed and executed." State officials say many leaks come from wells abandoned in recent decades, when rules supposedly dictated plugging procedures. And repairs are so routine that terms have been coined to describe the work: "replugging" or the "re-abandonment."
- A GAO report in 1989 provided a foreboding prognosis about the health of the country's inland oil and gas wells. The watchdog agency quoted EPA data estimating that up to 17 percent of the nation's wells on land had been improperly plugged. If that percentage applies to offshore wells, there could be 4,600 badly plugged wells in the Gulf of Mexico alone.
- According to a 2001 study commissioned by MMS, agency officials were "concerned that some abandoned oil wells in the Gulf may be leaking crude oil." But nothing came of that warning either. Told of his employer's supposed worry nearly a decade ago, Kazanis conceded the possibility that sealing jobs "could be bad."
The study targeted a well 20 miles off Louisiana that had been reported leaking five years after it was plugged and abandoned. The researchers tried unsuccessfully to use satellite radar images to locate the leak. But John Amos, the geologist who wrote the study, told AP that MMS withheld critical information that could have helped verify if he had pinpointed the problem. "I kind of suspected that this was a project almost designed to fail," Amos said. He said the agency refused to tell him "how big and widespread a problem" they were dealing with in the Gulf.
Amos is now director of SkyTruth, a nonprofit group that uses satellite imagery to detect environmental problems. He still believes that technology could work on abandoned wells. MMS, though, hasn't followed up on the work. And Interior Department spokeswoman Kendra Barkoff said agency inspectors would be present for permanent plugging jobs "only when something unusual is expected." She also said inspectors would check later "only if there's a noted leak." But she did not respond to requests for examples.
Companies may be tempted to skimp on sealing jobs, which are expensive and slow offshore. It would cost the industry at least $3 billion to permanently plug the 10,500 now-active wells and the 3,500 temporarily abandoned ones in the Gulf, according to an AP analysis of MMS data. Many such jobs take more than $200,000 and 10 days. Difficult jobs in deep water can cost several million dollars, and some companies own hundreds of wells.
The AP analysis indicates that more than half of the 50,000 wells ever drilled on federal leases beneath the Gulf have now been abandoned. Some 23,500 are permanently sealed. Another 12,500 wells are plugged on one branch while being allowed to remain active in a different branch. Government records do not indicate how many temporarily abandoned wells have been returned to service over the years. Federal rules require only an annual review of plans to reuse or permanently seal the 3,500 temporarily abandoned wells, but companies are using this provision to keep the wells in limbo indefinitely.
Petroleum engineers say abandoned offshore wells can fail from faulty work, age and drilling-induced or natural changes below the seabed. Maurice Dusseault, a geologist at the University of Waterloo in Ontario, Canada, says U.S. regulators "assume that once a well is sealed, they're safe — but that's not always the case." "Many of the wells are leaking because they had been inadequately plugged," added Dusseault, who co-authored a study in 2000 about why oil wells leak.
Even fully depleted wells can flow again because of fluid or gas injections to stimulate nearby wells or from pressure exerted by underlying aquifers. In a 2007 report, the EPA said of depleted inland wells: "Although no longer producing, these wells still represent significant sources of oil pollution and must be properly plugged." "Even though the fields are depleted, you don't get all the hydrocarbons out," acknowledged Radford of the petroleum trade group.
Permanently abandoned wells are corked with cement plugs typically 100-200 feet long. They are placed in targeted zones to block the flow of oil or gas. Heavy drilling fluid is added. Offshore, the piping is cut off 15 feet below the sea floor. Wells are abandoned temporarily for a variety of reasons. The company may be re-evaluating a well's potential or developing a plan to overcome a drilling problem or damage from a storm. Some owners temporarily abandon wells to await a rise in oil prices.
Since companies may put a temporarily abandoned well back into service, such holes typically will be sealed with fewer plugs, less testing and a metal cap to stop corrosion from sea water. "Remember, the sea water penetrates," said Iraj Ershaghi, a University of Southern California petroleum engineer who has also worked commercially and for the state of California on regulating offshore wells. In the Deepwater Horizon blowout, investigators believe the cement may have failed, perhaps never correctly setting deep within the well. Sometimes gas bubbles form as cement hardens, providing an unwanted path for oil or gas to burst through the well and reach the surface.
The other key part of an abandoned well — the steel pipe liner known as casing — can also rust through over time. "I've seen casing they've pulled out of these old wells. It looks like a worm has eaten it," said petroleum geologist Norman J. Hyne, who owned inland oil and gas wells in the 1980s as a small independent producer. Any holes, cracks or spaces can open a path for repressurized oil or gas to surge to the surface slowly or, in extreme cases, as a bigger blowout.
Petroleum engineer John Getty, who studies cement properties at Montana Tech, said it is reasonable to expect that some abandoned offshore wells would leak after decades of aging. At sea, huge blowouts, like the one at BP's well, would presumably be noticed by nearby rigs or passing ships. But otherwise these environmental violations generally go unnoticed. MMS personnel do sometimes spot smaller oily patches on the Gulf during flyovers. Operators are also supposed to report any oil sheens they encounter. Typically, though, MMS learns of a leak only when someone spots it by chance.
In the end, the Coast Guard's Marine Safety Laboratory handles little more than 200 cases of oil pollution each year.
And manager Wayne Gronlund says it's often impossible to tell leaking wells from natural seeps, where untold thousands of barrels of oil and untold millions of cubic feet of gas escape annually through cracks that permeate the sea floor. Oily patches are often attributed to natural leaks. A 2002 report by the National Academy of Sciences estimated that 60 percent of the oil in North American waters comes from natural seeps, with most of the remainder from urban runoff, polluted rivers, discharges from boats — and very little from oil drilling operations.
But no industry or government records are kept on oil leaks from abandoned wells. And the academy's report cautioned: "Even a small amount released at the wrong time or place can have a severe impact." Barkoff, the Interior Department spokeswoman, said discussions are under way on possible ways of finding leaks from offshore abandoned wells, including the use of undersea robots. Without strong federal encouragement, though, few researchers are working on the problem.