"A landing on the Tomoka, Florida"
Ilargi: US small business sentiment is down. Consumer income is down. Consumer spending is down. Pending home sales are down. Worldwide, crops are threatened by drought and floods. And while some claim that a US bumper crop will ease the problems, American corn is not exactly a perfect substitute for Russian and Ukrainian wheat, which go a long way towards feeding extensive segments of Middle East and Northern African populations.
Global financial markets, though, are up. So everything must be fine after all?! Perhaps not. Perhaps what we witness is an ongoing and deepening chasm that divides the world of finance and politics on the one hand and the world of everyday people on the other, as Rasmussen Reports indicates: 67% of Political Class Say U.S. Heading in Right Direction, 84% of Mainstream Disagrees. This chasm was greatly facilitated by governments relying on policies based on the notion that too-big-to-fail -financial- institutions needed to be bailed out at any cost. Later in the year, as a direct consequence of these policies, we will see another round of insane banker and trader bonuses, just as citizens’ sentiments and incomes fall, and unemployment and poverty keep rising.
It’s very hard, when you work at a too-big-to-fail institution, not to make a profit. When you have access to discount window money at an interest rate of 0.25%, money which you can -electronically- carry across the street to purchase US Treasuries that pay, say, 2.75%, you are set for a 1000% profit margin (even "only" 500% is not that shabby either). You try losing money that way; it ain't easy.
Of course, behind the scenes plays another government policy: the same banks that are handed all this money and profit for free don't have to fess up to their losses either. The free dough is handed to a group of financials that are nothing but the proverbial walking dead. If they were obliged to clean up their balance sheets with the inclusion of all the securities and other paper that hasn't been worth more than pennies on the dollar for several years now, they'd no longer be able to raise nearly enough capital on the open market to continue their dead man's walk, let alone heal.
There are articles appearing these days that claim the Fed wishes to force financials to buy back the worthless paper the central bank took over from them, but how would they see that work out? They would, in all likelihood, have to pass them more of the 0.25% credit, so they could buy more Treasuries, which the Fed could than buy outright from them. Other than that, it's hard to see a way to execute a scheme such as that.
Then again, in our present system, it's inevitable that speculators, creators of derivatives, and high-frequency traders will at some point in time, and sooner rather than later, end up focusing their monetary power on basic human necessities. And then, it will all get a lot uglier than it already is today. We should, as will become even more obvious soon than it is today, have bannned all speculation on food, water and shelter, but it is too late in the game already.
Paul B. Farrell at MarketWatch launches a first and stern warning:
Commodity ETFs: Toxic, deadly, evilCommodity ETFs are rapidly becoming a malicious virus breeding chaos in the global markets pricing all commodities: food, farm lands, metals, oil, natural gas, livestock, water and other natural resources are the assets under commodity derivatives and their ETFs, pricing that's now controlled more by Wall Street speculators than the weather, adding wild swings in volatility and trillions in global derivative risks.
And once again the usual suspects, the Goldman Conspiracy of Wall Street Banksters, are in the lead. Today, Wall Street is making a killing on commodity ETFs. And yet at the same time they are rapidly accelerating global market conditions that'll eventually kill the goose that laid their golden egg, those high-profit-generating commodity ETFs. But unfortunately this new ideology, Chaos Capitalism, is rapidly moving past economic pricing wars into military conflicts, a trend the Pentagon predicted years ago, an ever-increasing cycle of global wars over increasingly scarce nonrenewable commodities.
[..] .... thanks to ETFs, Wall Street is already creating a dangerous new kind of global weapon of mass destruction -- a bomb primed to detonate like the 2000 dot-coms, the 2008 subprimes -- and detonation is dead ahead.
Vanguard founder Jack Bogle added: "It's insanity ... this is a case of Wall Street trying to capitalize on the worst instincts of investors." [..] ETF managers are competing against Wall Street's elite traders. And the playing field's not level: "Professional futures traders ... make easy profits at the little guy's expense. [..]
As one Wall Street trader put it: "I make a living off the dumb money... index funds get eaten alive by people like me." [..]"Just as they did with subprime mortgage-backed securities, Wall Street banks are transferring wealth from their clients to their trading desks." One commodity trader adds: "You walk into a casino, you expect to lose money ... same with these products." [..]
Suddenly Wall Street speculators ruled the commodity-pricing market. What used to be a hedge for farmers became just another way for Wall Street traders and their sophisticated algorithms to make easy profits off "dumb money." So profitable Goldman even "owns a global network of aluminum warehouses," says B/W, and my old firm, "Morgan Stanley chartered more tankers than Chevron last year."
Rolling Stone's McKenzie Funk [..] focuses on Phil Heilberg, a former AIG commodity trader who is one of the new "Capitalists of Chaos." Heilberg is a self-proclaimed pure Ayn Rand capitalist hustling Africa, making "land grab" deals to control millions of acres and commodity rights in unstable nations.
Heilberg "makes no apologies for dealing with warlords: 'This is Africa ... The whole place is like one big Mafia, and I'm like a Mafia head.'" [..] The "essential lesson in capitalism" is "that no one is actually in control." In this new Chaos Capitalism, there is no rule-of-law, democracy is dead, chaos and anarchy rule.
And the new players include nations as well corporate giants: China, Russia, Australia, Kazakhstan, etc. A global land grab is on. And while commodity ETFs are making bankers and traders rich today, most know that soon the ETF business will go the way of a small farmer hedging the season's crop in a grain silo. They also know that the "Food Bubble" they're collectively blowing will also explode, triggering wars across the planet, wars fought over ever-scarcer non-renewable commodities. [..]
Commodity-index ETFs are a global threat far more dangerous to the world than nuclear attacks from terrorist nations. [..] "Heilberg's bet on chaos is beginning to play out on the streets." The toxic trail of commodity ETFs is already proving to be deadly, starving thousands worldwide, while the new Capitalists of Chaos only see incredible profit opportunities, as they make huge bets that they'll get even richer in the next round of catastrophes, disasters, poverty, starvation and wars.
Susanne Amann and Alexander Jung have more on the topic in German magazine Der Spiegel
Speculators Rediscover Agricultural Commodities[..] The turbulence in the cocoa market is the most recent sign that speculation is back, and that the international financial markets have rediscovered agricultural commodities. They are now betting big again on commodities like wheat, coffee, rice and soybeans. As a result, prices are no longer determined by supply and demand, but by investment banks and hedge funds.
Cocoa isn't the only commodity that has become significantly more expensive in recent months. The price of wheat has gone up by 17 percent since April, and soybeans by 12 percent. At the beginning of the year, sugar prices climbed to their highest level in three decades in the space of only a few months and then plunged by almost half. But now sugar prices are back up, climbing by almost 6 percent since April. The food price index of the United Nations Food and Agriculture Organization (FAO), which aggregates price movements for key agriculture products, climbed to 163 points in June. This is only 15 percent lower than the all-time high of 191 points in 2008 [..]
Last year, Goldman Sachs earned $5 billion in profits with commodities alone. Other major players include the Bank of America, Citigroup, Deutsche Bank, Morgan Stanley and J.P. Morgan. They are no longer merely offering classic funds, but are now trading in financial instruments that function similarly to the subprime mortgage loans on the now-collapsed US real estate market. With these instruments, known as collateralized commodities obligations, or CCOs, profits are based on market prices. The higher the trading prices of wheat, rice and soybeans, the bigger the profits.
[..] ... only about 2 percent of commodities futures now end with a real exchange of goods, the FAO concluded in a June study. "As a result, these deals attract investors who are not interested in the commodity itself, but merely in speculative profit," the FAO concludes morosely. The finding is all the more remarkable given the widespread political and social outrage aimed at food speculators just two years ago.
In the Financial Times, Javier Blas and Isabel Gorst paint the following picture of world harvests:
Rise in wheat prices fastest since 1973Wheat prices have seen the biggest one-month jump in more than three decades on the back of a severe drought in Russia, prompting warnings by the food industry of rising prices for flour-related products such as bread and biscuits. Food executives are also warning about surging prices for feeding and malting barley, which could push higher the retail cost of products from poultry to beer. European wheat prices jumped 8 per cent on Monday to €211 a tonne, the highest in two years.
Wheat prices have risen nearly 50 per cent since late June. Crop failures and a price rally have revived memories of the 2007-08 global food crisis, which saw the cost of agricultural commodities from corn to rice surge to record highs and food riots in countries from Haiti to Bangladesh. "This is the fastest wheat price rally we have seen since 1972-73," said Gary Sharkey, head of wheat procurement at UK-based Premier Foods [..]"The industry will be unable to ignore a 50 per cent rise in wheat prices," Mr Sharkey added [..]
Needless to say, if you’re speculating on food commodities like wheat, whether it be through Commodity ETF's or elsewhere, and you fancy yourself to be a Capitalist of Chaos, what's not to like about failed crops and rising price uncertainties? You can corner markets, the way cocoa honcho Anthony Ward has, you can sell derivative instruments to pension- and market fund managers chasing yield without sufficient savvy, and at the end of the day, you can be filthy rich. Just don’t feel too bad about the hungry, starving and dying, or about those who see their pensions and other savings vanish. Hey, if you didn't do it, someone else would, right?
The biggest irony in all of it, of course, remains that the biggest players in these ultimate dog eat dog Darwinian capitalist schemes use US and EU taxpayer money to play the games. They wouldn't be here anymore, sitting at their crap tables, if you wouldn't have handed them the money to play their ultimate to-the-death fighting games with.
If nothing else, it seems to be a fitting end to yet another economic system doomed by a lack of morals.
Commodity ETFs: Toxic, deadly, evil
by Paul B. Farrell - MarketWatch
The warning screams at you: "Do Not Buy Commodity ETFs!" Yes, this Bloomberg BusinessWeek cover reads like National Enquirer or a flashing neon sign on the Vegas Strip. And just in case you didn't get the warning, B/W repeats it twice more, on the cover: "Do Not Buy Commodity ETFs ... Do Not Buy Commodity ETFs." Then, as if afraid you still won't get it, they scream even louder: Commodity ETFs are "America's worst investment."
Worst? Add toxic, deadly, evil. Commodity ETFs are rapidly becoming a malicious virus breeding chaos in the global markets pricing all commodities: food, farm lands, metals, oil, natural gas, livestock, water and other natural resources are the assets under commodity derivatives and their ETFs, pricing that's now controlled more by Wall Street speculators than the weather, adding wild swings in volatility and trillions in global derivative risks.
And once again the usual suspects, the Goldman Conspiracy of Wall Street Banksters, are in the lead. Today, Wall Street is making a killing on commodity ETFs. And yet at the same time they are rapidly accelerating global market conditions that'll eventually kill the goose that laid their golden egg, those high-profit-generating commodity ETFs. But unfortunately this new ideology, Chaos Capitalism, is rapidly moving past economic pricing wars into military conflicts, a trend the Pentagon predicted years ago, an ever-increasing cycle of global wars over increasingly scarce nonrenewable commodities.
'Next financial time-bomb ... stuffed with derivatives'
In Bloomberg Markets' "ETFs Gone Wild," investors are warned that many ETFs are "stuffed with exotic derivatives," at risk of becoming "the next financial time bomb." In short, thanks to ETFs, Wall Street is already creating a dangerous new kind of global weapon of mass destruction -- a bomb primed to detonate like the 2000 dot-coms, the 2008 subprimes -- and detonation is dead ahead.
Vanguard founder Jack Bogle added: "It's insanity ... this is a case of Wall Street trying to capitalize on the worst instincts of investors." Actually both Wall Street and Main Street are incapable of avoiding their "worst instincts." And if you're betting the trend you know Wall Street's immune to criticism, already adjusting its strategies to keep a steady supply of naïve, clueless investors buying their toxic commodity ETFs, "dumb money" investments that "make lousy buy-and-hold investments" for Main Street investors while making Wall Street traders filthy rich.
Commodity ETFs: Wall Street's newest casino scam
Why lousy? Because ETF managers are competing against Wall Street's elite traders. And the playing field's not level: "Professional futures traders ... make easy profits at the little guy's expense. Unlike ETF managers, the professionals don't trade at set times. They can buy the next month ahead of the big programmed rolls to drive up the price or sell before the ETF, pushing down the price investors get paid for expiring futures."
As one Wall Street trader put it: "I make a living off the dumb money... index funds get eaten alive by people like me." Proof: Bloomberg data shows that "10 well-known funds based on commodity futures ... since inception ... have trailed the performance of their underlying raw materials ... The biggest oil ETF, the U.S. Oil Fund ... has dropped 50% since it started in April 2006, even as crude oil climbed 11%."
The indictment's brutal: "Just as they did with subprime mortgage-backed securities, Wall Street banks are transferring wealth from their clients to their trading desks." One commodity trader adds: "You walk into a casino, you expect to lose money ... same with these products." Another: "Turning commodity futures into securities unleashed a much larger sales force, stockbrokers selling a product many of them didn't understand."
Commodity index ETFs now a lethal WMD threat to Earth's survival
But far more chilling is BusinessWeek's warning of future consequences. Remember Bill Gross's "New Normal?" As future returns drop, investors are chasing riskier deals, like commodity ETFs: "Passive buy-and-hold investors at one point in mid-2008 held the equivalent of three years of production of soft red winter wheat. Wall Street's success in attracting those buyers boosted demand for futures contracts, which helped determine what consumers would pay for baked goods. Wheat prices jumped 52% in early 2008, setting records before plunging again, and sugar more than doubled last year even as the economy slowed." Warning: Capitalism's competitive pricing model is dead.
And if all these warnings from the likes of Bogle, Gross, Bloomberg Markets and BusinessWeek seem a bit hysterical, remember how hysteria drove past bubbles: dot-coms in 1999, subprimes in 2007. Euphoria blinds investors to dangers lurking in every bubble. And today that risk is magnified as 21st century bubbles are blowing bigger, more powerful and more dangerous, adding the new risk of nuclear "food fights."
In "The Food Bubble: how Wall Street starved millions and got away with it," Harper's Magazine's Frederick Kaufman offers another powerful indictment: "The history of food took an ominous turn in 1991 ... Goldman's analysts went about transforming food into a concept," by creating "the Goldman Sachs Commodity Index." Other bankers invented more indexes. Money flooded in.
Suddenly Wall Street speculators ruled the commodity-pricing market. What used to be a hedge for farmers became just another way for Wall Street traders and their sophisticated algorithms to make easy profits off "dumb money." So profitable Goldman even "owns a global network of aluminum warehouses," says B/W, and my old firm, "Morgan Stanley chartered more tankers than Chevron last year."
New Capitalists of Chaos love tragedies, famine, poverty, war
Rolling Stone's McKenzie Funk adds another brutal critique in "Will Global Warming, Overpopulation, Floods, Droughts and Food Riots Make This Man Rich?" Funk focuses on Phil Heilberg, a former AIG commodity trader who is one of the new "Capitalists of Chaos." Heilberg is a self-proclaimed pure Ayn Rand capitalist hustling Africa, making "land grab" deals to control millions of acres and commodity rights in unstable nations.
Heilberg "makes no apologies for dealing with warlords: 'This is Africa ... The whole place is like one big Mafia, and I'm like a Mafia head.'" Don't like his bluntness? But he does express a very dark truth driving this new ideology: The "essential lesson in capitalism" is "that no one is actually in control." In this new Chaos Capitalism, there is no rule-of-law, democracy is dead, chaos and anarchy rule.
Capitalists of Chaos like Heilberg have a warped sense of the long-term, out beyond the micro-myopic brains of Wall Street's commodity traders whose algorithms limit thinking to milliseconds. He sees a fatal flaw in Wall Street's short-term brain. The 2008 meltdown was the turning point: Wall Street's in "the death knell of the financial instrument, of the paper world" and "the rise of the commodity." Big investors demand hard assets. Proof: When Funk was in New York and London he met "leading investors who, like Heilberg, are stepping away from the paper world to make commodity plays."
And the new players include nations as well corporate giants: China, Russia, Australia, Kazakhstan, etc. A global land grab is on. And while commodity ETFs are making bankers and traders rich today, most know that soon the ETF business will go the way of a small farmer hedging the season's crop in a grain silo. They also know that the "Food Bubble" they're collectively blowing will also explode, triggering wars across the planet, wars fought over ever-scarcer non-renewable commodities. That's why the new Capitalists of Chaos -- not just Heilberg and Goldman, but Monsanto, Exxon, China -- and their competitors are in the short race to buy up and hoard rights to hard assets, positioning themselves for global catastrophes dead ahead.
Commodity ETFs, new WMDs more lethal than terrorist nuclear bombs
Commodity-index ETFs are a global threat far more dangerous to the world than nuclear attacks from terrorist nations. Nuclear WMDs have the power to wipe out major urban areas killing tens of thousands instantly, like Japan in 1945, leaving massive scars across humanity for many decades. And yet, as Funk puts it: "Heilberg's bet on chaos is beginning to play out on the streets." The toxic trail of commodity ETFs is already proving to be deadly, starving thousands worldwide, while the new Capitalists of Chaos only see incredible profit opportunities, as they make huge bets that they'll get even richer in the next round of catastrophes, disasters, poverty, starvation and wars.
Bottom line: Commodity ETF/WMDs are mutating into a toxic pandemic fueled (and protected by) the insatiable greed of banks, traders and politicians whose brains are incapable of giving up their profit machine, won't until it implodes and self-destructs. The Wall Street Banksters have no sense of morals, no ethics, no soul, no goal in life other than getting very rich, very fast. They care nothing of democracy, civilization or the planet.
They are in a race to become the richest man in the world, to control more assets, more commodities, more rights, more land, more money than Warren Buffett, Bill Gates and Carlos Slim combined. It's a contest and the other 6.3 billion humans on the planet are just profit opportunities (and collateral damage) in the dangerous high-stakes games played by the new Capitalists of Chaos ruling the world.
Speculators Rediscover Agricultural Commodities
by Susanne Amann and Alexander Jung - Der Spiegel
With the financial crisis fading into the past, speculation on agricultural commodities markets has returned in force. Food prices are climbing once again as hedge funds rediscover the immense profits that can be made -- led by a British chocolate baron.
Even by the standards of London's exclusive Mayfair neighborhood, businessman Anthony Ward leads a luxurious lifestyle. He and his family live in a 500-square-meter (5,380-square-foot) townhouse with five bedrooms, each with its own bath. There are separate quarters for the staff. When Ward opens a bottle of wine on his veranda in the evening, it's likely that it comes from his own vineyard at the foot of Paardeberg Mountain near Cape Town.
Ward's fabulous wealth comes as a result of his involvement in the cocoa business. The 50-year-old Briton with the nickname "Choc Finger" heads Armajaro, a commodities business and hedge fund he co-founded in 1998. In recent weeks, the hedge fund has caused a furor in the commodities markets. Traders report that Ward has purchased a vast number of futures contracts for the delivery of 241,000 tons of cocoa worth $1 billion (€770 million).
The cocoa represents about 7 percent of annual world production, enough to supply Germany with chocolate for an entire year. It was also enough to substantially drive up prices on the cocoa market. Last week, the price of cocoa climbed to a 33-year high. What is so unusual about the British investor's coup is that he did not resell the contracts on the London International Financial Futures and Options Exchange (LIFFE) before they expired, but instead took delivery of the beans. As a result, Armajaro now controls almost all the cocoa beans currently stored in registered warehouses in Europe, from Liverpool to Rotterdam to Hamburg.
Turbulence in the Cocoa Market
Processors and traders are now accusing Ward of trying to corner the cocoa bean market. "The market is increasingly being manipulated by a few people who control the market positions," says Hamburg cocoa dealer Andreas Christiansen, adding that speculators are taking advantage of the lack of transparency on the LIFFE. This, he says, harms smaller traders, whose hedge transactions are now no longer adding up. "A lot of people have been harmed here." Ward himself has declined to comment on these accusations.
The turbulence in the cocoa market is the most recent sign that speculation is back, and that the international financial markets have rediscovered agricultural commodities. They are now betting big again on commodities like wheat, coffee, rice and soybeans. As a result, prices are no longer determined by supply and demand, but by investment banks and hedge funds.
Cocoa isn't the only commodity that has become significantly more expensive in recent months. The price of wheat has gone up by 17 percent since April, and soybeans by 12 percent. At the beginning of the year, sugar prices climbed to their highest level in three decades in the space of only a few months and then plunged by almost half. But now sugar prices are back up, climbing by almost 6 percent since April. The food price index of the United Nations Food and Agriculture Organization (FAO), which aggregates price movements for key agriculture products, climbed to 163 points in June. This is only 15 percent lower than the all-time high of 191 points in 2008, the year of the financial crisis.
At the time, rice prices rose by 277 percent within only six months, and corn became so unaffordable that millions of Mexicans could no longer afford tortillas, a staple in the country. Hunger riots erupted in Haiti, Egypt and more than 30 other countries. Driving the price explosion was the growing use of agricultural commodities to produce biofuel. But 2008 was also the year in which, for the first time, the public realized that grain merchants were no longer the only ones trading on the exchanges (in their case, by buying grain futures to hedge against poor harvests), but that the major players in the financial markets had discovered the lucrative trade in agricultural commodities.
Last year, Goldman Sachs earned $5 billion in profits with commodities alone. Other major players include the Bank of America, Citigroup, Deutsche Bank, Morgan Stanley and J.P. Morgan. They are no longer merely offering classic funds, but are now trading in financial instruments that function similarly to the subprime mortgage loans on the now-collapsed US real estate market. With these instruments, known as collateralized commodities obligations, or CCOs, profits are based on market prices. The higher the trading prices of wheat, rice and soybeans, the bigger the profits. The market's behavior reminds one of the Internet bubble at the beginning of last decade and the fluctuations just prior to the financial crisis, then-Merrill Lynch President Gregory Fleming said in May 2008.
Indeed, only about 2 percent of commodities futures now end with a real exchange of goods, the FAO concluded in a June study. "As a result, these deals attract investors who are not interested in the commodity itself, but merely in speculative profit," the FAO concludes morosely. The finding is all the more remarkable given the widespread political and social outrage aimed at food speculators just two years ago. But little has changed since then. "Paradoxically, the financial crisis resulted in a brief pause for breath on the agricultural markets, but as the global economy picks up steam, the problems of scarcity are getting worse again," warns Joachim von Braun, an agricultural economist at the Bonn-based Center for Development Research and director of the renowned International Food Policy Research Institute in Washington.
Even as trading in agricultural commodities is on the rise again, the underlying factors that have driven up food prices for years have not been eliminated. The production of ethanol and biodiesel still competes directly with food production. Energy is still so expensive that the costs of fertilizer and transportation make agricultural production unprofitable. And with 2010 shaping up to be possibly the hottest year on record, droughts in Eastern Europe and West Africa are threatening harvests.
Officials at the United Nations World Food Programme (WFP) already fear the worst. "The situation in many countries is already dramatic now," says Ralf Südhoff, director of the WFP office in Berlin. The sad record of more than a billion starving people worldwide could be surpassed this year.
The dire situation has prompted experts like Braun, as well as aid organizations and companies, to call for tighter regulation of financial markets. In March, Andreas Land, the managing partner of baked goods maker Griesson-De Beukelaer, complained that certificates were being traded for 60 million tons of cocoa, which he said was 20 times the annual volume of cocoa that was physically available. "This is neither good nor tolerable," said Land. "Speculating with food products shouldn't be allowed, unless you actually take delivery of the products."
Strictly speaking, it is re-regulation that many would like to see. In the United States, for example, the Commodity Exchange Act of 1936 limited speculation in agriculture commodities for decades. But thanks to the targeted lobbying activities of the financial industry, the law was watered down in the 1990s, leading to a sharp increase in the trading of food commodities. This shift has prompted agricultural economist Braun to call for more transparency, particularly when it comes to the question of who buys which contracts. "And second," says Braun, "we need to require higher capital investments on the part of traders, which would make speculating in basic food products less attractive."
Not Behaving as Planned
US President Barack Obama has already taken a step in this direction by making derivatives trading more transparent. The Europeans, on the other hand, are balking at taking even this first step to contain speculation. EU Commissioner for Internal Market and Services Michel Barnier, who has described speculation with food products as "scandalous," plans to introduce legislation this year to impose stricter regulations. But the British have already announced their intention to create their own, less stringent rules for the London exchange. This comes as no surprise; London is the world's largest market for agricultural commodities outside the United States.
Cocoa king Ward, in other words, need not fear that his business will be restricted any time soon. Nevertheless, it is far from certain that his current massive bet will turn out in his favor. Worldwide demand for cocoa is growing, especially in Asia. But bad weather in the Ivory Coast, which produces 40 percent of the world's cocoa, does not bode well for a good harvest this fall. Ward is betting that chocolate makers like Lindt & Sprüngli or Kraft will soon have no choice but to order from him at higher prices, especially now that the Christmas business is around the corner.
The markets, for their part, have not behaved as planned. Immediately after Ward's coup, the price of cocoa beans dropped by more than 7 percent in three days. But even should it turn out that Choc Finger made a bad bet, traders and processors are no longer willing to put up with such escapades. A group of 20 companies and associations has written a letter to the LIFFE demanding that it make trading more transparent, using the New York markets as a model. The New York exchanges regularly publish information on who is trading in the market, whether they are speculators or agricultural commodities traders, how many contracts they hold and what their positions are.
This week, critics of speculation were to hold talks with the managers of the LIFFE. "Everyone should be given the same opportunities," says cocoa dealer Christiansen. Still, it is hardly likely that new rules will be in place by the next maturity date for cocoa contracts in mid-September. In other words, cocoa speculator Ward still has some time left to win his bet.
Rise in wheat prices fastest since 1973
by Javier Blas and Isabel Gorst - Financial Times
Wheat prices have seen the biggest one-month jump in more than three decades on the back of a severe drought in Russia, prompting warnings by the food industry of rising prices for flour-related products such as bread and biscuits. Food executives are also warning about surging prices for feeding and malting barley, which could push higher the retail cost of products from poultry to beer. European wheat prices jumped 8 per cent on Monday to €211 a tonne, the highest in two years.
Wheat prices have risen nearly 50 per cent since late June. Crop failures and a price rally have revived memories of the 2007-08 global food crisis, which saw the cost of agricultural commodities from corn to rice surge to record highs and food riots in countries from Haiti to Bangladesh. “This is the fastest wheat price rally we have seen since 1972-73,” said Gary Sharkey, head of wheat procurement at UK-based Premier Foods, which makes the popular Hovis brand of bread.
“The industry will be unable to ignore a 50 per cent rise in wheat prices,” Mr Sharkey added, echoing a view widely shared by other food industry executives. The rally comes as the worst heatwave and drought in more than a century continues to devastate grain crops in Russia, Ukraine and Kazakhstan. The trio are among the world’s top-10 wheat exporters and key suppliers to countries in North Africa and the Middle East – the largest importing region in the world. Executives and traders fear the three countries could restrict their grain exports or even impose an export ban in an effort to keep their local market well supplied and prices low.
Dmitry Rylko, the director of the Institute for Agricultural Market Studies, said the market could not ignore the possibility that Moscow would introduce grain export controls as it did during the 2007-08 crisis. “The scale of the drought is so severe we must be prepared for any option,” he said. Wheat traders and analysts said Russia’s wheat production could drop in 2010-11 to 45-50m tonnes, down as much as 27 per cent from last season’s 61.7m tonnes. Ukraine and Kazakhstan would also produce less. Heavy rains during the planting season are also expected to affect Canada’s wheat output. The Canadian Wheat Board, the marketing agency for the country’s farmers, is forecasting a drop of 35 per cent in the wheat harvest.
The Biggest Lie About U.S. Companies
by Brett Arends - Marketwatch
Healthy balance sheets? They owe $7.2 trillion, the most ever
You may have heard recently that U.S. companies have emerged from the financial crisis in robust health, that they've paid down their debts, rebuilt their balance sheets and are sitting on growing piles of cash they are ready to invest in the economy.
You could hear this great news pretty much anywhere — maybe from Bloomberg, which this spring hailed the "surprising strength" of corporate balance sheets. Or perhaps in the Washington Post, where Fareed Zakaria reported that top companies "have accumulated an astonishing $1.8 trillion of cash," leaving them in the best shape, by some measures, "in almost half a century." Or you heard it from Dallas Federal Reserve President Richard Fisher, who recently said companies were "hoarding cash" but were afraid to start investing. Or on CNBC, where experts have been debating what these corporations are going to do with all their surplus loot. Will they raise dividends? Buy back shares? Launch a new wave of mergers and acquisitions?
It all sounds wonderful for investors and the U.S. economy. There's just one problem: It's a crock. American companies are not in robust financial shape. Federal Reserve data show that their debts have been rising, not falling. By some measures, they are now more leveraged than at any time since the Great Depression. You'd think someone might have noticed something amiss. After all, we were simultaneously being told that companies (a) had more money than they know what to do with; (b) had even more money coming in due to a surge in profits; yet (c) they have been out in the bond market borrowing as fast as they can. Does that sound a little odd to you?
A look at the facts shows that companies only have "record amounts of cash" in the way that Subprime Suzy was flush with cash after that big refi back in 2005. So long as you don't look at the liabilities, the picture looks great. Hey, why not buy a Jacuzzi? According to the Federal Reserve, nonfinancial firms borrowed another $289 billion in the first quarter, taking their total domestic debts to $7.2 trillion, the highest level ever. That's up by $1.1 trillion since the first quarter of 2007; it's twice the level seen in the late 1990s. The debt repayments made during the financial crisis were brief and minimal: tiny amounts, totaling about $100 billion, in the second and fourth quarters of 2009.
Remember that these are the debts for the nonfinancials — the part of the economy that's supposed to be in better shape. The banks? Everybody knows half of them are the walking dead. Central bank and Commerce Department data reveal that gross domestic debts of nonfinancial corporations now amount to 50% of GDP. That's a postwar record. In 1945, it was just 20%. Even at the credit-bubble peaks in the late 1980s and 2005-06, it was only around 45%.
The Fed data "underline the poor state of the U.S. private sector's balance sheets," reports financial analyst Andrew Smithers, who's also the author of "Wall Street Revalued: Imperfect Markets and Inept Central Bankers," and chairman of Smithers & Co. in London. "While this is generally recognized for households," he said, "it is often denied with regard to corporations. These denials are without merit and depend on looking at cash assets and ignoring liabilities. Cash assets have risen recently, in response to the fall in inventories, but nonfinancials' corporate debt, whether measured gross or after netting off bank deposits and other interest-bearing assets, is at peak levels." By Smithers' analysis, net leverage is nearly 50% of corporate net worth, a modern record.
There is one caveat to this, he noted: It focuses on assets and liabilities of companies within the United States. Some U.S. companies are holding net cash overseas. That may brighten the picture a little, but the overall effect is not enormous, and mostly just affects the biggest companies. That U.S. companies are in worse financial shape than we're being told is clearly bad news for those thinking of investing in U.S. stocks or bonds, as leverage makes investments riskier. Clearly it's bad news for jobs and the economy.
But why is this line being spun about healthy balance sheets? For the same reason we're told other lies, myths and half-truths: Too many people have a vested interest in spinning, and too few have an interest in the actual picture. Journalists, for example, seek safety in numbers; there's a herd mentality. Once a line starts to get repeated, others just assume it's correct and join in. Wall Street? It's a hustle. This healthy balance-sheet myth helps sell stocks and bonds. How many bonuses do you think get paid for telling customers the stark facts, and how many get paid for making the sale?
You can also blame our partisan age too. Right now, people on the right have a vested interest in claiming businesses are in healthy shape. That makes the saintly private sector look good, and demonizes President Barack Obama and Big Government for scaring away investment. Vote Republican! Meanwhile, people on the left have an interest in making businesses sound really healthy too: If greedy companies are hoarding cash instead of hiring people, they can cry "Shame on them! Vote Democratic!" As ever, the truth is someone else's problem and no one's responsibility. When it comes to the economy, let's just hope the public is too hopped up on painkillers and antidepressants to notice. If they knew what was really going on, there'd be trouble.
67% of Political Class Say U.S. Heading in Right Direction, 84% of Mainstream Disagrees
by Rasmussen Reports
Recent polling has shown huge gaps between the Political Class and Mainstream Americans on issues ranging from immigration to health care to the virtues of free markets.
The gap is just as big when it comes to the traditional right direction/wrong track polling question.
A Rasmussen Reports national telephone survey shows that 67% of Political Class voters believe the United States is generally heading in the right direction. However, things look a lot different to Mainstream Americans. Among these voters, 84% say the country has gotten off on the wrong track.
Twenty-four percent (24%) of Mainstream voters consider fiscal policy issues such as taxes and government spending to be the most important issue facing the nation today. Just two percent (2%) of Political Class voters agree.
With a gap that wide, it’s not surprising that 68% of voters believe the Political Class doesn’t care what most Americans think. Fifty-nine percent (59%) are embarrassed by the behavior of the Political Class.
Just 23% believe the federal government today has the consent of the governed.
Most voters believe that cutting government spending and reducing deficits is good for the economy. The only group that disagrees is America’s Political Class. In addition to the policy implications, this highlights an interesting dilemma when it comes to interpreting polling data based upon questions that make sense only to the Political Class. After all, if someone believes spending cuts are good for the economy, how can they answer a question giving them a choice between spending cuts and helping the economy?
Mainstream Americans tend to trust the wisdom of the crowd more than their political leaders and are skeptical of both big government and big business.
Fifty-eight percent (58%) of voters currently hold Mainstream views. In January, 65% of voters held Mainstream views. In March 2009, just 55% held such views.
Only six percent (6%) now support the Political Class. These voters tend to trust political leaders more than the public at large and are far less skeptical about government.
When leaners are included, 76% are in the Mainstream category, and 14% support the Political Class.
"The American people don’t want to be governed from the left, the right or the center. The American people want to govern themselves," says Scott Rasmussen, president of Rasmussen Reports. "The American attachment to self-governance runs deep. It is one of our nation’s cherished core values and an important part of our cultural DNA."
In his new book, In Search of Self-Governance, Rasmussen explains, ""In the clique that revolves around Washington, DC, and Wall Street, our treasured heritage has been diminished almost beyond recognition. In that world, some see self-governance as little more than allowing voters to choose which of two politicians will rule over them. Others in that elite environment are even more brazen and see self-governance as a problem to be overcome."
The book can be ordered on the Rasmussen Reports site or at Amazon.com.
The Political Class Index is based on three questions. All three clearly address populist tendencies and perspectives, all three have strong public support, and, for all three questions, the populist perspective is shared by a majority of Democrats, Republicans and those not affiliated with either of the major parties. We have asked the questions before, and the results change little whether Republicans or Democrats are in charge of the government.
In many cases, the gap between the Mainstream view and the Political Class is larger than the gap between Mainstream Republicans and Mainstream Democrats.
The questions used to calculate the Index are:
-- Generally speaking, when it comes to important national issues, whose judgment do you trust more - the American people or America’s political leaders?
-- Some people believe that the federal government has become a special interest group that looks out primarily for its own interests. Has the federal government become a special interest group?
-- Do government and big business often work together in ways that hurt consumers and investors?
To create a scale, each response earns a plus 1 for the populist answer, a minus 1 for the political class answer, and a 0 for not sure.
Those who score 2 or higher are considered a populist or part of the Mainstream. Those who score -2 or lower are considered to be aligned with the Political Class. Those who score +1 or -1 are considered leaners in one direction or the other.
In practical terms, if someone is classified with the Mainstream, they agree with the Mainstream view on at least two of the three questions and don’t agree with the Political Class on any.
Initially, Rasmussen Reports labeled the groups Populist and Political Class. However, despite the many news stories referring to populist anger over bailouts and other government actions, the labels created confusion for some. In particular, some equated populist attitudes with the views of the late-19th century Populist Party. To avoid that confusion and since a majority clearly hold skeptical views about the ruling elites, we now label the groups Mainstream and Political Class.
Pending Homes Sales Hit New Record Low Again. When Will the Deja Vu Be Over?
by Michael David White - Housingstory.net
The index of pending home sales fell to a new record low and replaced last month’s reading of a new record low. If that sounds like a broken record you have listened carefully.
Pending-home sales have fallen below the worst numbers seen in the housing crash and going back to the inception of this measurement.
The chart above shows a veritable death march in the state of American residential property. It clearly proves shallow demand. The inventory of signed contracts cannot sustain current price levels. That means prices are falling unless we experience divine intervention.
The National Association of Realtors (NAR) announced the figures today, but made no mention of the record low in its press release. This is exactly the same method the NAR followed in last month’s release when they made no mention of a record fall or a new record low. They did report the raw data which is a great courtesy.
We also find again this month that major news outlets are dumb and incapable of understanding this most obvious of indicators (Headlines from the big sites follow at the end of this post. They did figure out there was a fall in the index. And that it fell 2.6%. So they read two paragraphs of the press release.). Last month was also a record low and the first report on pending sales following the April 30th expiration of the free-down-payment program.
The pending-home-sales stat gives us our best view of buyer demand without the hugely popular down-payment prop from the federal government. The news is not good and it flew right over the head of our correspondents at 15 major mainstream publications including Bloomberg, Associated Press, Reuters, and Marketwatch.
The chart of pending contracts above is literally a fall into the abyss. The May and June pending-sale figures are as bad as it gets; at least so far. HousingStory.net estimates current inventory for sale of 4 million units is 1.3 million units higher than it should be, and not too far away from the record high 4.5 million for sale.
Two months in a row of pathetic pending-home sales inventory figures will surely change months of units for sale. They are currently at 8.9 months and far above the average 5.8 months. The record high inventory is 11.3 months in April 2008.
Prices for residential real estate have been flat since August 2009, but are down 30% from their peak. Pending home sales suggest a new fall – for those with eyes to see and ears to hear.
Lawrence Yun, NAR chief economist, has a different take on it. "Since home prices have come down to fundamentally justifiable levels" Dr. Yun said today, "there isn’t likely to be any meaningful change to national home values." That’s a brave forecast. I wonder if Dr. Yun is a renter or an owner? Is his home on the market?
Hedge Fund Preparing For Deflation
by Reuters and Courtney Comstock - Business Insider
Clarium Capital's Peter Thiel told Reuters that he's preparing for deflation in an interview recently.
Here's what he's thinking:
- The proper view right now is deflationary, we're not headed towards a runaway inflationary situation.
- The consensus seems to be on the inflationary side. People are nervous about the government printing money. But that's not right.
- The economy is going to have a slow recovery for a number of years.
- There might be a double dip recession.
- Don't go long equities
- Government bonds are probaly fine
- The dollar is probably fine
- Avoid gold
He says to look 40 miles outside of major cities (SF, NYC), and remember that you're still in the housing bust. "There are lots of problems."
Then he waxed nostalgic for the good ol' days. If the whole US was like Silicon Valley, we'd be in good shape. But now, the entire US is not driven by technology, is not driven by innovation. The model of the US economy is that we are the country that does new things. But over the past few decades, that's changed. Now we have people that do crazy things, like weigh 600 pounds. We have to get back to being the country where people do things that are new. We're headed towards government austerity in a lot of countries, we're not going to eep on piling on debt, but growth is going to be slow.
It’s the derivatives, stupid
by Jeremy Grant - Financial Times
If you only have time to focus on one figure in today’s second quarter earnings from NYSE Euronext, you should pick this one: its derivatives business represented 49 per cent of operating income. In other words, the company that runs the good old New York Stock Exchange – complete with opening and closing bell ceremonies that you see on business TV every day – is really a derivatives shop.
Okay, I exaggerate somewhat. Technology is also becoming increasingly important. Operating income from technology rose to 7 per cent, from 5 per cent in the second quarter of 2009. Duncan Niederauer, chief executive, wants technology to be generating annual revenues of $1bn by 2015. But the real showstopper is derivatives, where net revenue was 34 per cent higher than the previous year’s quarter.
That was mainly due to European derivatives like euribor futures and options on NYSE Liffe in London – proof, if any were still needed, of why it made sense for John Thain, Niederauer’s predecessor, to buy Euronext in 2007. Thain’s then-counterpart at Euronext, Jean-Francois Théodore, laid the groundwork by snatching what was then the London International Financial Futures Exchange from under the nose of former London Stock Exchange chief executive Clara Furse.
What looked like the acquisition by NYSE of the Euronext collection of cash equities bourses – Paris, Amsterdam, Brussels and Lisbon – was actually a clever move to get hold of a fast-growing derivatives franchise. Thain knew that cash equities would become increasingly commoditised as competition from the likes of BATS and Direct Edge turned it into a lower margin business. The same analysis has forced consolidation of cash and derivatives exchanges around the world in recent years.
BM&FBovespa is the product of a merger of the Brazilian stock and commodity derivatives exchanges. So is TMX Group in Canada, as well as Australia’s ASX, where 24 per cent of total revenue comes from derivatives (including trading and clearing). None of this will make comfortable reading in Paternoster Square, current headquarters of the LSE, where Dame Clara’s successor, Xavier Rolet, is busy trying to figure out how he will make good on his declaration – at an industry conference in June – that the LSE plans to get serious about derivatives and take on Liffe and Eurex, owned by Deutsche Börse.
The LSE has a small derivatives business in the EDX Nordic and Idem Italian platforms. But together they account for only 3 per cent of LSE group revenue (the exchange doesn’t break out derivatives clearing revenue). Rolet – who, like Niederauer and Thain is ex-Goldman Sachs - knows this will be a tough hill to climb.
That is not the only challenge, however. With a nice derivatives trading business comes the opportunity to earn clearing fees too – that is, if you own your own derivatives clearing house. NYSE Euronext has this in the form of NYSE Liffe Clearing. The LSE doesn’t yet have a clearing solution in place for its planned derivatives drive. But with NYSE Euronext showing numbers like this already, they’d better get a move on.
ISM survey confirms sharp slowdown in US economy
by Gavyn Davies - Financial Times
The ISM Survey of the US manufacturing sector (published on Monday) offers the first reliable glimpse of activity in the US economy in the third quarter of the year. It is not encouraging.
Although the headline reading was rather better than widely anticipated (an out-turn of 55.5 compared to 56.2 in June), the details of the survey showed that new orders are now slowing markedly, and inventories have started to rise more rapidly than companies may be intending. Taken together with the GDP data for Q2, the ISM survey points to a significant danger that the US economy will continue to slow sharply in the months ahead.
The ISM surveys in the US are among the few items of monthly information which are capable of moulding market sentiment in a profound way. This is because they have an excellent track record of picking up changes in trend in US activity, because they are never revised, and because they are published earlier than most other data series on the economy.
The manufacturing survey tends to get the most attention, because it comes out first, and because it has a much longer series of historical data, than the non manufacturing series. In fact, it would be only a slight exaggeration to say that once the ISM series are published, very little else is likely to change market psychology on the course of the economy during the coming month. (OK, I accept that the employment data which are due on Friday will often do so, but very little else will.)
The headline figure for the manufacturing sector in July had been expected to fall to about 54.5, but in fact it fell only to 55.5, down by 0.7 on the previous month. Although superficially encouraging, the details lying behind the headlines were much worse than expected. Economists tend to track two series in particular, because they can be combined to provide a useful leading indicator for the manufacturing sector in the months ahead.
The first of the key series is new orders, which this month fell by a horrible 5 points to 53.5. This speaks for itself. The second is inventories, which rose by 4.4 points in July, suggesting that companies may have been forced to build their stock holdings because they have not been able to maintain their sales at expected levels. The difference between new orders and inventories, which is the leading indicator mentioned above, therefore plummeted by 9.4 points this month (see graph). Although this can be a somewhat volatile series on a monthly basis, the underlying trend in the series (also shown in the graph) is now definitely headed downwards.
It is surprising to me that the stock market has so far been so resilient in the face of the mounting weight of evidence that growth rate in the US economy has dipped below trend, with no knowing where this will end.
Wells Fargo/Gallup Small Business Index Hits New Low in July
by Dennis Jacobe - Gallup
Small-business owners' expectations turn negative for first time since index's inception
The Wells Fargo/Gallup Small Business Index -- which measures small-business owners' perceptions of six measures of their current operating environment and future expectations -- fell 17 points to -28 in July. This is its lowest level since the index's inception in August 2003.
Record Pessimism in Future Expectations
Most of the decline in the overall index came in the Future Expectations Dimension of the index, which measures small-business owners' expectations for their companies' revenues, cash flows, capital spending, number of new jobs, and ease of obtaining credit. The dimension fell 13 points in July to -2 -- the first time in the index's history that future expectations of small-business owners have turned negative, suggesting owners have become slightly pessimistic as a group about their operating environment in the next 12 months.
Small-business owners' future expectations for their operating environment show significant declines in their revenue, cash-flow, capital-spending, and hiring expectations for the next 12 months. Forty-two percent expect it to be "somewhat" or "very difficult" to obtain credit -- no improvement from April and January. One in five (22%) small-business owners expect their companies' financial situations a year from now to be "somewhat" or "very bad."
More Negativity About Present Situation
The Present Situation Dimension of the index declined by a more moderate four points to -26 in July -- the second-lowest rating for this dimension that hit its low of -29 in January 2010.
When evaluating the past 12 months, small-business owners suggest there has been a modest further decline in their current operating environment, driven largely by a significant decline in the percentage of companies having good cash flows.
The sharp deterioration in small-business owners' economic perceptions and expectations in July is fully consistent with Gallup's tracking of a steady decline in consumer confidence over the past three months. So is the weaker-than-expected growth of the U.S. economy during the second quarter, as well as the general expectation of a further slowing of the economy during the second half of 2010.
The Wells Fargo/Gallup Small Business Index seems to be something of a precursor of future economy activity. It peaked at the end of 2006; matched that peak once more in June 2007; consistently declined thereafter as the recession deepened, before bottoming out in mid-2009; and finally, improved modestly until its July 2010 decline.
Small-business owners are the embodiment of America's entrepreneurial and optimistic spirit. As a result, their increasing concerns about their companies' future operating environment do not bode well for the economy in the months ahead. Nor do small-business owners' intentions to reduce capital spending and hiring: 17% of owners plan to increase capital spending in the next 12 months -- down significantly from 23% in April -- and 13% expect jobs at their companies to increase, while 15% expect them to decrease over the year ahead.
Big-firm earnings and global growth may drive profits on Wall Street, but small business is the major source of U.S. job creation. And most small-business owners are unlikely to hire as long as they are becoming increasingly uncertain about the revenues and cash flows of their companies in the months ahead.
America's Incredible Shrinking Safety Net
by Arthur Delaney - Huffington Post
President Obama's 2009 stimulus bill expanded federal aid for people affected by the worst recession since the Great Depression, but congressional heartburn over deficit spending has prompted a campaign to reduce the deficit impact of further spending almost entirely through slashing the safety net. On Wednesday, Senate Democrats hope to pass a bill that, to offset the cost of $16 billion in Medicaid assistance for states and $10 billion to prevent teacher layoffs, will cut $6.7 billion in future food stamp funding. The cut is the latest in a series of drop-in-the-bucket efforts to avoid adding to a federal budget deficit expected to top $1.4 trillion this year.
The first cuts came in May, when Democratic leaders hoping to move a broad domestic aid package in the House of Representatives, bowed to deficit demands and dropped $24 billion in state Medicaid assistance and $7.7 billion in subsidies for laid-off workers to maintain their health insurance via the COBRA program. "It's obscene," said Rep. David Obey (D-Wisc.). House Democrats also shortened the extension of unemployment benefits for the long-term jobless by one month, saving roughly $6 billion.
When the scaled-down bill landed in the Senate, Democratic leaders discovered they'd need to make further cuts to win the support of conservative Democrats and moderate Republicans. A handful of senators fought to replace the COBRA subsidy and the state Medicaid assistance (known as FMAP), but the amendment that prevailed instead cut $25 per week from unemployment benefits, saving $5.8 billion.
Another program that fell by the wayside was the TANF Emergency Fund, a welfare-to-work program that has subsidized more than 240,000 jobs. Extending the program through next year would have cost $2.4 billion. Each of the programs cut was put in place by the stimulus bill, formally known as the American Recovery and Reinvestment Act, enacted in February 2009 when the unemployment rate stood at 8.2 percent. The rate is now 9.5 percent and few economists expect it to drop much further down anytime soon, but compassion for the unemployed has been replaced in Washington with the suspicion that extended jobless aid discourages people from looking for work.
After a 50 day delay, Senate Democrats finally passed a reauthorization of unemployment benefits with a $33 billion deficit impact at the end of July. Democrats have attempted to pay for their domestic aid packages by closing tax loopholes exploited by investment fund managers and companies that ship jobs overseas, but those measures have failed. The bill coming up for a vote in the Senate on Wednesday would revive one of them and raise $9 billion by eliminating foreign tax credit loopholes, but Democrats have apparently lost their appetite for trying to drum up support for hiking taxes on hedge fund managers.
Before it went away, that provision was weakened every time a different piece of jobless aid disappeared, deficit reduction needs notwithstanding. At first, closing the loophole would have raised $18.685 billion. In the next draft of the domestic aid bill, it raised $14.157 billion. Then $13.905 billion, and then $13.594 billion. (In Obama's budget, raising taxes on "carried interest" would have raised $23.89 billion.) The Obama administration has encouraged Congress to reauthorize the programs, but the pressure hasn't been overwhelming.
Meanwhile, Republicans have done everything they can to stand in the way of reauthorizing jobless and state aid, a strategy that will continue this week. "The $1 trillion stimulus bill was supposed to be timely, targeted and temporary," said Senate Republican leader Mitch McConnell on Tuesday. "Yet here we are, a year and a half later, and they're already coming back for more."
The Death of Market Fundamentals
by CIGA Pedro/Jim Sinclair
If the past three years has taught us anything about markets, it is that they will do what they are set up to do. OTC Derivatives, financial Ponzi schemes (Madoff etc) and gyrating Fed policy are but a few of the machinations determined by the new market Fundamentals… the Fundamentals of government policy.
The political and legislative environment creates new Fundamentals that economic realities were supposed to. As government becomes more self-indebted, and politically captured by special interests, the markets reflect these political realities instead of the economic fundamentals they should.
None of this is news. It has been going on for years. But it is not as benign as it used to be. At the outset its just favouritism: a (usually no-bid) government contract is awarded and a company share price roars on the back of it. Legislative tweaking portends winners and losers. But then things get out of hand.
An early signal was found not only in the insanity of the mortgage backed securities markets and their attendant derivatives, but was also evident in the energy industry. Nobody in their right mind believes that fundamentals had the slightest thing to do with crude oil’s move from 2006 to 2008 – but the shrill cry of "Peak Oil" (Hat Tip Media) sure did help. (Where is it now?) Far more likely is that a couple of market participants decided to clear some competition from the market by running it to ridiculous levels, and make a large amount of money along the way… and enlisted the Media’s help. A natural bull market presented a great opportunity to push the market to unnatural levels and then drop it like a stone. Fundamentals had no role. Not even the first Gulf War when the borders of Kuwait and Saudi Arabia fell, produced a similar event in terms of scale, though the market was overrun with fear. Even before the Algos started ripping markets up and down for fun and profit the game was on.
The West Coast electricity market did a similar thing – by creating unscheduled maintenance that somebody had (personally) "scheduled". $40 million+ people got their eyes gouged out for months on end, but it sure was fun for someone. A similar situation occurred (several times) in the German power market around the turn of the millenium. An American utility or marketer would simply buy every KwH in sight, along the curve, bar none, in a one or two hour space of time, until people who needed the physical power position to meet actual customer demand were forced to follow them, whereupon the relentless buyer would line up every bid in the market and try and unload everything in one shot. Many times it worked. But the US utility industry blew itself up in fraud, and the main German companies refused to trade with them after a while. Deregulation had happened – but the fall back for the near-monopoly German utilities was to say, "I don’t like you as a credit risk. So I can only trade in very, very small size with you." The gamers were forced out. They killed their own game in the rush for personal glory.
The charade of options expiry in the Gold market is similar. Get the market up, knowing that call buyers are the public and liked to go naked, and the put buyers are usually market makers trying to butterfly their position and get short the at-the-money strike in expiry. Just before expiry the market is whipsawed down. The public goes out worthless on the call side and the market makers (volume traders) get expired near or at their long strike (i.e. max. loss) and are forced out. Next time around – spreads are wider. It’s an attractive strategy if you can control the underlying for a few hours at the right time of the month. If you can’t – tough luck. Only a fool would trade in such a game. People should roll out weeks before expiry – but the public never does. They hang right on in there every time because the market gets so close to going in the money. (Like the Bbanks aren’t aware of this psychology!). The professionals have a name for these people: They’re called Screen Jockeys… and in case you didn’t know – it’s a term of derision.
A similar situation now exists in that bastion of public interest – the stock market. Trading is simply impossible. Stop-losses can’t be held as orders because they will be used against anyone with a position. As related in M. Lewis’ latest book, the Chinese Walls that supposedly exist in the multiple platforms that trade a single stock should be properly considered as "Bullshit". Charts are painted to flush people out. What passes for a market is now just a serious of raids up and down the flagpole to shake the hell out of its minor participants. If you aren’t equipped to play "chase the algos" (entry ticket c. $40 million for the technology and servers), your money will simply be taken. The market has for hundreds of years taken money from weak hands, but now anyone without a first class algo can be considered and proven as weak.
Fundamental analysis will not help the small trader. It’s simply pointless to participate. Instead of tree-shaking… now the whole damn forest is being shaken. As explained in the book "A Pocketbook of Gold", any individual with the slightest amount of margin will be destroyed by the hyper-over-leveraged banks that don’t have to mark to market, never have a margin call, and have a government guaranteed, taxpayer funded bailout. These are the NEW fundamentals. You want to participate on the other side of this, so call "trade"? If you do, you need serious help. Do you want to play with the take-down artists, the chart painters and algo-drive market-bashers? (To Mr Sinclair’s "haters" of the past fortnight please recall his relentlessly iterated warning to abandon all Gold trading and margin at $548 per ounce, and hold the core as insurance only.)
The result is that retail has had it with the so-called "market". Outflows are increasing steadily, while liquidity swamps financial institutions unwilling to do anything other than sit on the liquidity. The bail-out looks like a bail-in. Only idiots like the zero-return in a decade (and a lot less if properly numerated against Gold) pension funds are left. The suckers have woken up and are refusing to play. Computer driven markets go from awash with liquidity to zero liquidity and back again in seconds. It’s enough to make a schizophrenic look balanced. Risk is fully on, then fully off, then fully on again several times in a given day, soon to be in a given hour, minute, second, mille and then micro-second. Trade if you have a death wish only. As the public exits, the algos will now attack each other in a macabre pas de deux of death dance.
Government, of course, is playing its part too in the death of the markets by destroying the value of fundamental analysis. The capitulation of FASB to a government/Fed dictated policy of suspending the assessment of fair value has, as its corollary, the suspension of even the possibility that ‘fair value’ can still, in fact BE determined. Since the government now determines market outcomes, reading Maoist "Wall Posters" is now all one has. ("If one knows the nuances, the walls tell all" was the nod for Deng Xio Peng’s political destruction. This is what we have been reduced to.) As if analysing Greenspan’s FedSpeak wasn’t enough to live through, we now must be scanning the horizon all day for the QE II, instead of analysing a company’s worth and prospects. Resistance may be futile, but participation is now idiocy. Money supply is viciously ramped up and then completely shut-off, at a whim, and with few but opaque methods for observation. When people are buying the stock market only because they envision a Bernanke money-printing induced melt-up, it’s time to leave. That is no reason to be in the marketplace, it is a reason to avoid it.
Previous market participants are sick of trying to decide the level of deceit in Government statistics. No one can anticipate whimsical "on the hoof" policy (like occupying Iraq), so everyone is fearful of investing. Money is going to the mattress like a Spaniard living under Franco. Germans and other Europeans are rushing into the Swiss Franc in outright fear of what politicians might do next. The level of trust from the investing public has never been lower. Government won’t let Fundamentals play out, just like they refused to take a recession ten years ago. The Fed can trump all fundamentals until, of course, they can’t any longer, and they blow up everyone including themselves (i.e. sovereign default). When proper valuation is suspended for as long as possible and seemingly, hopefully, forever, one would be advised to spend their time building a nuclear resistant financial bunker, preferably lined with Gold. It could give a whole new meaning to the old adage that the "Fundamentals always win in the end". In the new intonation, the emphasis is on the word "end". An "end" that seems to be in the process of being succinctly arranged.
In the search for absent fundamental indicators, "Shadow Stats" became preferred, but that only detracts from confidence. It does nothing to enhance it. Mr. Williams does not sit at the Fed or in Government. Most likely, it will be QE to infinity, because the disastrous outcome of a Treasury market implosion could be even more devastating than perpetuating a depression. QE is a government played trump card that destroys Fundamental analysis by moving the pricing numerator. Desperation is palpable. It’s why the Government is actively destroying any attempt at fundamental analysis. The sustaining of the smoke and mirrors game demands it. If Government continues to spend, they eventually go bust from debt. If they head down the austerity path, you’ll never have enough GDP to SERVICE the debt. They’re cornered. Devaluation de facto or de jure (i.e. default) is the only possible outcome short of waiting for inevitable systemic collapse along with the hyper-inflation which will give you about as much warning as a Tsunami on your visible horizon. As Mr. Sinclair has related, "Gold is financial High Ground, when a Global Tsunami hits." Prepare accordingly.
China Said to Test Banks for 60% Home-Price Drop
by Philip Lagerkranser - Bloomberg
China’s banking regulator told lenders last month to conduct a new round of stress tests to gauge the impact of residential property prices falling as much as 60 percent in the hardest-hit markets, a person with knowledge of the matter said. Banks were instructed to include worst-case scenarios of prices dropping 50 percent to 60 percent in cities where they have risen excessively, the person said, declining to be identified because the regulator’s requirement hasn’t been publicly announced. Previous stress tests carried out in the past year assumed home-price declines of as much as 30 percent.
The tougher assumption may underscore concern that last year’s record $1.4 trillion of new loans fueled a property bubble that could lead to a surge in delinquent debts. Regulators have tightened real-estate lending and cracked down on speculation since mid-April, after residential real estate prices soared 68 percent in the first quarter from a year earlier, according to estimates from Knight Frank LLP, the London-based property adviser.
A deep slump in China’s property market may further slow the nation’s economy, which grew at a less-than-forecast 10.3 percent pace in the second quarter. China is still the fastest growing major world economy. Concern that China’s economy may cool due to a real-estate slump erased an early rally in U.S. stocks. The market rebounded on economic data showing stronger- than-estimated growth in American service industries.
The China Banking Regulatory Commission said in a July 20 statement that banks should “continue to deepen” stress tests on lending to property and related industries, citing a speech by Chairman Liu Mingkang during a meeting attended by regulatory officials and bank heads. The release didn’t give details. Officials at CBRC didn’t return calls seeking comment.
Results from previous stress tests show that the ratio of non-performing real estate loans among Chinese banks would rise by 2.2 percentage points if home prices drop 30 percent and interest rates rise by 108 basis points, the person said. Pretax profits would fall 20 percent under that scenario. A basis point is 0.01 percentage point. Measures to cool property-price gains included raising minimum mortgage rates and down-payment ratios for second-home purchases, and a suspension of lending for third homes. Property prices in 70 Chinese cities dropped 0.1 percent in June from the previous month, the statistics bureau said July 12. Prices rose 11.4 percent from a year earlier, the second monthly slowdown after April’s record expansion.
Bank of China Ltd.’s bad-loan ratio would climb 1.2 percentage points under the worst-case scenario drawn up in the latest stress tests, Li Lihui, president of the nation’s third- biggest lender by market value, said May 27. Record lending last year in China and the ensuing surge in home prices have stoked concern that a bubble is forming that may threaten the banking industry. Property stocks are the worst performers on the Shanghai Composite Index this year with an average 21 percent drop, data compiled by Bloomberg show.
“There is a perception in the real-estate development community that banks and the market cannot tolerate much more than a 25 to 30 percent drop in prices,” said Nicholas Consonery, an Asia specialist at Eurasia Group in Washington. Still, the government probably doesn’t expect prices to drop by 60 percent, Consonery said in a phone interview. It’s seeking to “signal to the market that banks are sound even with a significant drop in prices,” he said.
China’s property market is beginning a “collapse” that will hit the nation’s banking system, Kenneth Rogoff, a Harvard University professor and former chief economist of the International Monetary Fund, said July 6. Average prices may fall as much as 20 percent over the next 12 to 18 months, with declines of up to 40 percent in “big bubble” cities, Nomura Holdings Inc. said in a July 2 report. The impact on banks’ asset quality will still be “limited” as long as borrowers have adequate income to keep paying their mortgages, Nomura said. Regulators testing banks for a 60 percent correction in “only the most bubbly markets” will probably find lenders “will not pose a systemic risk to the banking system,” said Daniel Rosen, principal of the Rhodium Group, a New York-based advisory company.
The banking regulator has reminded lenders that some developers with high debt burdens and large land reserves already face the risk of a funding collapse, the person said. Banks were told to gauge developers’ real borrowing needs by monitoring the progress of projects under construction and to “strictly” control the pace of lending, the person said. “Special mention” real-estate development loans have climbed in Shanghai since April and rose by 1.4 billion yuan ($207 million) in June, Xinhua News Agency reported Aug. 1, without saying where it got the information.
Fed Propaganda Machine Credits Bernanke Bailouts For Ending The Great Recession
by Dr. Pitchfork - Daily Bail
The ruling class just can’t let it go. They bailed out the banksters and their bondholders; they bailed out the UAW and state bureaucracies; they made us perpetual cash cows for Big Pharma and Big Insurance; and yet...you still complain about bailouts and deficits. What’s your problem? Our wise and benevolent rulers saved us from fighting in the streets over scraps of rat meat, but you’re still not grateful. What gives?
Not to worry. Now we know (if there were ever any doubt), that TARP and the “stimulus” and all the various bailouts helped prevent a "Second Great Depression." According to an article from the NY Times, Alan Blinder of Princeton and Mark Zandi, Chief Economist at Moody’s, have proven “empirically” that the bailouts worked. Even though the bailouts were politically unpopular, and even though there is still a great deal of “populist” anger about them, Blinder and Zandi have shown us the “wisdom” of the bailouts, and proved conclusively that our rulers saved us all from financial and economic armageddon. Of course, there’s just one little problem with this narrative: Blinder and Zandi have done no such thing. For all their charts, appendices and footnotes, they’ve proven nothing whatsoever. Nada. Zip. What they have done, however, is puke up a pretty little piece of bailout propaganda when the ruling class needed it most.
All the more galling, the Blinder-Zandi paper was originally titled "How We Ended the Great Recession." Given such hubris, I was fully prepared to delve deep into their methodology, examine carefully all their assumptions, and offer a full critique of the arguments implicit therein. Alas, no such critique will be forthcoming. I've read the "paper" from beginning to end, from cover page to footnotes to appendices. Everything. But I still have no idea how they arrived at any of the results laid out ever so neatly in their ostentatiously detailed charts. That's because their model, and the assumptions they used, are nowhere to be found. If these were third graders, they'd get a zero for not showing their work.
What’s in the Model?
Although they don't give any specifics, the authors nonetheless offer a few hints about their model and some of its components. According to "Appendix B: Methodological Considerations," the economic effects of the financial interventions (i.e. the bailouts) were modeled in terms of their effects on interest-rate spreads (e.g. the TED spread).
[The] so-called TED spread is one of the two key credit spreads in the Moody's model, and thus one main channel via which the unconventional financial policies operated. (18)
Moreover, changes in consumer spending and capital investment were modeled in terms of various interest-rate spreads (like the TED spread).
The investment equations in the model are specified as a function of changes in output and the cost of capital. The cost of capital is equal to the implicit cost of leasing a capital asset, and therefore reflects the real after-tax cost of funds, .... More explicitly, the cost of funds is defined as the weighted-average after-tax cost of debt and equity capital. The cost of debt capital is proxied by the "junk" (below investment grade) corporate bond yield, which is the second of the two key credit spreads in the Moody's model. The cost of equity capital is the sum of the 10-year Treasury bond yield plus an exoenously set equity risk premium. Changes in the cost of capital, which have a significant impact on investment, reflect...the policy efforts to stabilize the financial system. (18)
Sound convoluted? “You betcha.” In a nutshell, the Blinder-Zandi model assumes that:
- interest-rate spreads have large, significant effects on economic activity;
- financial interventions (such as TARP) are best modeled in terms of credit spreads;
- these financial interventions, in fact, significantly reduced the various credit spreads;
- (and finally) without financial interventions like TARP these spreads would have remained elevated for a much longer period of time.
Is it any wonder then, that the model shows a massive difference between the bailout scenario and the non-bailout scenario? After all, that’s what the model has been designed to do. Based on the assumptions Blinder and Zandi made at the very start, there could be no other possible outcome than one that shows a large, signficant deviation between the bailout scenario and the non-bailout scenario. It's already baked in. The precise “results” are just numerical icing on the bailout cake.
Excellent Penmanship, No Argument: D-
Still, are the assumptions they make about credit spreads and economic activity realistic? Are the assumptions they make about how the financial interventions (TARP, MBS purchases, e.g.) affected these credit spreads plausible? And what about the assumptions they make about these spreads in the absence of any intervention – are those assumptions credible?
The short answer is, we have no idea – because Blinder and Zandi don’t tell us. They don't tell us exactly what their assumptions are, or how they were derived. Their assumptions, we are told, are based on certain "historical relationships" between various data sets.
The slightly longer answer is, regardless of the precise formulation of their assumptions, regardless of the source of their figures and coefficients, and regardless of the methodology used to obtain them, we still have no sustained, detailed and credible argument – whatsoever – about what would have happened in the absence of various bailout measures. No argument. None. All we have, ultimately, is a gut feeling that things would have been very, very bad without them. But how bad? For how long? And why? Neither Blinder nor Zandi, nor indeed the entire pro-bailout establishment, have put forward anything other than sound bites and scare tactics to describe the likely outcome had market forces been allowed to work.
Cross Your i's and Dot Your t's?
Aside from the claim that the bailouts were instrumental in saving our bacon, the authors also conclude that the financial interventions (i.e. the bailouts) and the “stimulus” spending worked in concert, each reinforcing the effects of the other. But this raises a particularly thorny question concerning the 'historical relationship" between interest-rate spreads and spending and investment. What “historical relationships” are we talking about here? If Blinder and Zandi are talking about the very recent past alone, or if they give significant weight to the very recent past, then how are the effects of interest-rate spreads on consumption and investment distinguished from the effects of “stimulus” spending? Here’s what I mean: between the fall of 2008 and the present, the TED spread, for example, has dropped from an all-time high to its historically low trend.
During this same time period, government deficit spending (“stimulus”) has gone through the roof.
In macro-tard terms, GDP has gone up at the same time that credit spreads have come down. Feel free to model that "historical relationship." But if you back out deficit spending from total reported GDP, as Karl Denninger delights in pointing out, we’re still in a DEPRESSION. Credit spreads have shrunk, but so has real, organic GDP -- and aside from government spending, it's still shrinking!
That is to say, depending on how (or if) you separate the GDP effects of government spending from the GDP effects of the compression of credit spreads, you could just as plausibly argue that a reduction in these spreads has had NEGATIVE effects on GDP! Absurd? Obviously. But this is what happens when economists confuse symptoms with underlying realities, confusing effects with causes. To be fair, without access to their model, there is no direct evidence to suggest that Zandi and Blinder do anything like what I describe, but there is also no evidence to suggest that they don’t. Indeed, their results would make very little sense unless they do, in fact, conflate the effects of “stimulus” spending with the relationship between credit spreads and consumption and investment.*
E for Effort, P for Propaganda
But whether Blinder and Zandi realize it or not, all they have shown with their modeling exercise is that they believe in bailouts, that they believe (very much so) in Bernanke, and that their belief extends to two decimal places. Their paper represents nothing more than a high-level guessing game which has been given a veneer of empiricism and mathematical rigour. And they don’t even tell us exactly what their guesses are, or why they make them. They just give us the results and stamp them with their ostensible authority – which is all the ruling class really needs or desires, anyway: Princeton, “chief economist,” two decimal places. That is to say, “Fall in line, plebs; do as you’re told; forget what has been done to you. THE BAILOUTS WORKED." Economist Arnold Kling is right, the Blinder-Zandi paper is little more than "propaganda dressed up as research."
*The only caveat I can offer here is that not all of the deficit spending is, of course, due to fiscal "stimulus," and Blinder and Zandi include a good portion of deficit spending is included in their "baseline" scenario. This much is standard practice. But if we follow Denninger's analysis, the financial interventions, on their own, merely kept GDP from shrinking more than it in fact did. The methodological difficulties in accounting for the effectiveness of TARP, e.g. still stand, however.
22 Statistics About America’s Coming Pension Crisis That Will Make You Lose Sleep At Night
by Michael Snyder- Economic Collapse
As the first of the 80 million Baby Boomers have begun to retire, it has become increasingly apparent that the United States is facing a pension crisis of unprecedented magnitude. State and local government pension plans are woefully underfunded, dozens of large corporate pension plans either have collapsed or are on the verge of collapsing, Social Security is a complete and total financial disaster and about half of all Americans essentially have nothing saved up for retirement.
So yes, to say that we are facing a retirement crisis would be a tremendous understatement. There is simply no way that we can keep all of the financial promises that we have made to the Baby Boomer generation. Unfortunately, the crumbling U.S. economy simply cannot support the comfortable retirement of tens of millions of elderly Americans any longer. The truth is that we are all going to have to start fundamentally changing the way that we think about our golden years.
Once upon a time, you could count on getting a big, fat pension if you put 30 years into a job. But now pension plans everywhere are failing. State and local governments are cutting back and are raising retirement ages. A majority of Americans have even lost faith in the Social Security system, which was supposed to be the most secure of them all.
The reality is that we are moving into a time when there is not going to be such a thing as "financial security" as we have known it in the past. Things have fundamentally changed, and we are all going to have to struggle to stay above water in the economic nightmare that is coming.
Part of the reason we have such a gigantic economic mess on the way is because we have promised vastly more than we can deliver to future retirees. When you closely examine the numbers, it quickly becomes clear that a financial tsunami is about to hit us that is going to be so devastating that it will change everything that we know about retirement.
The following are 22 statistics about America's coming pension crisis that will make you lose sleep at night....
Private Pension Plans And Retirement Funds
1 - One recent study found that America's 100 largest corporate pension plans were underfunded by $217 billion at the end of 2008.
2 - Approximately half of all workers in the United States have less than $2000 saved up for retirement.
3 - According to one recent survey, 36 percent of Americans say that they don't contribute anything at all to retirement savings.
4 - The Pension Benefit Guaranty Corporation says that the number of pensions at risk inside failing companies more than tripled during the recession.
5 - According to another recent survey, 24% of U.S. workers admit that they have postponed their planned retirement age at least once during the past year.
State And Local Government Pensions
6- Pension consultant Girard Miller recently told California's Little Hoover Commission that state and local government bodies in the state of California have $325 billion in combined unfunded pension liabilities. When you break that down, it comes to $22,000 for every single working adult in California.
7 - According to a recent report from Stanford University, California's three biggest pension funds are as much as $500 billion short of meeting future retiree benefit obligations.
8 - In New Jersey, the governor has proposed not making the state's entire $3 billion contribution to its pension funds because of the state's $11 billion budget deficit.
9 - It has been reported that the $33.7 billion Illinois Teachers Retirement System is 61% underfunded and is on the verge of total collapse.
10 - The state of Illinois recently raised its retirement age to 67 and capped the salary on which public pensions are figured.
11 - The state of Virginia is requiring employees to pay into the state pension fund for the first time ever.
12 - In New York City, annual pension contributions have increased sixfold in the past decade alone and are now so large that they would be able to finance entire new police and fire departments.
13- Robert Novy-Marx of the University of Chicago and Joshua D. Rauh of Northwestern's Kellogg School of Management recently calculated the combined pension liability for all 50 U.S. states. What they found was that the 50 states are collectively facing $5.17 trillion in pension obligations, but they only have $1.94 trillion set aside in state pension funds. That is a difference of 3.2 trillion dollars.
14 - According to one recently conducted poll, 6 out of every 10 non-retirees in the United States believe that the Social Security system will not be able to pay them benefits when they stop working.
15 - A very large percentage of the federal budget is made up of entitlement programs such as Social Security and Medicare that cannot be reduced without a change in the law. Approximately 57 percent of Barack Obama's 3.8 trillion dollar budget for 2011 consists of direct payments to individual Americans or is money that is spent on their behalf.
16 - 35% of Americans over the age of 65 rely almost entirely on Social Security payments alone.
17 - According to the Congressional Budget Office, the Social Security system will pay out more in benefits than it receives in payroll taxes in 2010. That was not supposed to happen until at least 2016. The Social Security deficits are projected to get increasingly worse in the years ahead.
18 - 56 percent of current retirees believe that the U.S. government will eventually cut their Social Security benefits.
19 - In 1950, each retiree's Social Security benefit was paid for by 16 U.S. workers. In 2010, each retiree's Social Security benefit is paid for by approximately 3.3 U.S. workers. By 2025, it is projected that there will be approximately two U.S. workers for each retiree.
20 - The shortfall in entitlement programs in the years ahead is mind blowing. The present value of projected scheduled benefits surpasses earmarked revenues for entitlement programs such as Social Security and Medicare by about 46 trillion dollars over the next 75 years.
21 - According to a recent U.S. government report, soaring interest costs on the U.S. national debt plus rapidly escalating spending on entitlement programs such as Social Security and Medicare will absorb approximately 92 cents of every single dollar of federal revenue by the year 2019. That is before a single dollar is spent on anything else.
22 - Right now, interest on the U.S. national debt and spending on entitlement programs like Social Security and Medicare is somewhere in the neighborhood of 15 percent of GDP. By 2080, those combined expenditures are projected to eat up approximately 50 percent of GDP.
Reckless Europe beats reckless America at property bubbles
by Ambrose Evans-Pritchard - Telegraph
Once and for all, let us nail the lie that the global credit crisis was basically a US sub-prime property bubble that went wrong, and that Europe was merely an innocent bystander hit by shrapnel.
This is the property bubble chart on Page 12 of the IMF’s latest report (Article IV) on France. If you read the whole report – (click “Staff Report” here) – note the horrendous decline in French export share. But that is another story.
As you can see, France had the most extreme price rises from 1997 to 2009, followed by Spain and Italy some way below.
The Anglo-Saxons were more moderate. The US bubble was tame by comparison (measured by price: inventory overhang is another matter) and has largely corrected. This the American way, a short sharp purge. The Club Med bubbles have not corrected, by a long shot.
The UK is sui generis. Chronic lack of construction (nimbyism, and draconian planning laws) means that the equilibrium price of houses is higher. There has not been a large glut of unsold properties.
This is not to condone Anglo credit excesses in the Greenspan era of silly money. But the fact is that real interest rates were as low – or even lower (Spain, Greece, Italy, Ireland) – in the eurozone than in Greenspan-land for much of the boom.
Indeed, the eurozone debt bubbles were larger in aggregate, if you add sovereign bubbles to household credit bubbles, and corporate loan bubbles (Spain) –and if you add euro-peggers (Denmark, Baltics, Balkans, etc) and dirty-floaters (Hungary) in Eastern/Central Europe where countries acted like eurozone states because they were “pre-ins”.
No doubt there are many other layers to this. We all know that Chinese and Asian reserve accumulation depressed global bond yields, mispricing credit at the long end and making it easier for Greece to borrow globally at 28 basis points over Germany, and Spain to borrow at 4 basis points over Bunds. (Ah, those halcyon days). We all know too that Japan’s zero-rate carry trade leaked massive amounts of liquidity into Icelandic, Hungarian and British assets. Hence, a mega-mess.
However, Europe generated its own home-grown bubble when the ECB let the M3 money supply grow at 11pc, failed to meet its inflation target ever for a decade, and poured petrol over the Club O’Med flames.
Judging by comments from policy-makers in Germany, France, Italy, (I exempt the excellent Bank of Spain and Ireland’s central bank) it is clear to me that the political elites cannot seem to understand what has happened.
For top German ministers to continue blaming this on the US after all that has since happened indicates to me that they are either remarkably ill-informed or psychologically unhinged, or perhaps they are just country bumpkins.
Federal Reserve to start the deflation fight next week, expert claims
by James Quinn - Telegraph
The Federal Reserve is set to kick-start a new phase of monetary easing, a leading Wall Street economist claims. Paul Sheard, Nomura's chief global economist, argues that the current conditions are ripe for the American central bank to take affirmative action to put the US recovery back on track. In the first call of its kind from a Wall Street economist, Mr Sheard says that given subdued growth and concern about inflation, the Federal Open Markets Committee will act when it meets a week today.
His comments follow those of James Bullard, president of the St Louis Fed, who last week said the central bank needs to equip itself with a plan for further quantitative easing should it be required, and after the latest US growth figures showed the American economy deteriorated somewhat in the second quarter. The Fed is thought unlikely to make any change to its base Federal funds interest at the meeting, which has been held at a range of 0-0.25pc since December 2008. "We now believe that current conditions have moved policymakers into action and that the FOMC will adopt a more accommodative stance at its 10 August meeting," Mr Sheard wrote in a research note. "We expect the Fed to at least stop the passive contraction of its balance sheet."
Such a step is one of three possible options the Fed has in its arsenal, as outlined by Ben Bernanke, chairman of the Federal Reserve, before the US Congress last month. The other two are restarting the asset purchase programme that ended in March, and changing the language in the FOMC's statements to make it clear deflation will not be tolerated. However Mr Sheard argues that stopping the Fed's balance sheet from contracting further seems a sensible move. "To the extent that the size of the Fed's balance sheet matters, this, in effect, amounts to a gradual tightening of monetary policy. Further shrinkage of its asset holdings now seems inappropriate in light of downside risks to growth," he continued.
Concerns about the health of the US economy shone through in the fate of the dollar yesterday, with the dollar index – which values it against a basket of currencies – hitting a three-month low on fears that US recovery is stalling. The index touched 81.354, as sterling hit a six-month high against the greenback, touching $1.5820. A string of recent disappointing US data was to blame, along with fears over the latest US unemployment figures, to be published on Friday. The dollar failed to be revived by news that construction spending rose 0.1pc in June, thanks mainly to a 1.5pc increase in public spending on infrastructure projects.
Meanwhile the Institute of Supply Management index edged down slightly, slipping to 55.5 in July from 56.2 at the end of June, on a scale whereby anything above 50 suggests that the manufacturing economy is expanding. "Forward momentum is slowing in the manufacturing sector, but there are no signals in this report that a sharp growth slowdown is in the cards," said Brian Bethune, chief US financial economist at IHS Global Insight.
Fed Mulls Symbolic Shift
by Jon Hilsenrath - Wall Street Journal
Federal Reserve officials will consider a modest but symbolically important change in the management of their massive securities portfolio when they meet next week to ponder an economy that seems to be losing momentum.
The issue: Whether to use cash the Fed receives when its mortgage-bond holdings mature to buy new mortgage or Treasury bonds, instead of allowing its portfolio to shrink gradually, as it is expected to do in the months ahead. Any change—only four months after the Fed ended its massive bond-buying program—would signal deepening concern about the economic outlook. If the Fed's forecast deteriorates significantly, it could also be a precursor to bigger efforts to pump money into the economy. Moving to stop the Fed's portfolio from shrinking would prevent monetary policy from slightly tightening in the face of a weakening recovery. The central bank's $2.3 trillion portfolio has nearly tripled in size since 2007.
Buying new bonds with this stream of cash from maturing bonds—projected at about $200 billion by 2011—would show the public and markets that the Fed is seeking ways to support economic growth. It could also be a compromise that rival factions at the Fed support, as officials differ about whether and how to address a subpar recovery. Whether the Fed makes any move next week depends in large part on economic data, particularly the government snapshot of the jobs market due Friday. Since Fed officials last met in June, data on consumer confidence and spending have softened and job data haven't improved. But overall financial conditions have improved somewhat, with a rebounding stock market.
Officials in the Fed's anti-inflation camp aren't convinced the economy is slowing significantly and are wary of taking new actions. Others are eager to consider new steps to address recent signs of a slowdown and persistent high unemployment. Fed officials aren't yet prepared to take the larger step of resuming large-scale purchases of mortgage-backed securities or U.S. Treasurys. But they are holding open that option if the economy deteriorates. Private forecasters generally expect real GDP to grow by an annual rate of about 2?% in the second half of 2010. If the picture deteriorates and they forecast growth falling below 2%, the Fed would be more likely to act.
In a speech in South Carolina Monday that was more somber than his testimony to Congress last month, Fed Chairman Ben Bernanke said: "We have a considerable way to go to achieve a full recovery in our economy, and many Americans are still grappling with unemployment, foreclosure and lost savings." Mr. Bernanke said Monday that the Fed must avoid raising interest rates too soon and urged the government to proceed cautiously in cutting spending and raising taxes. "We need to be careful about tightening too quickly," Mr. Bernanke said, promising that monetary policy would remain loose until "sustained" growth is seen, especially in jobs.
A few months ago, many investors expected the Fed to begin raising its key interest-rate target by the end of this year; futures markets now indicate traders don't expect that until late 2011. Mr. Bernanke highlighted what he called the "battered" shape of state and local budgets. "Many states and localities continue to face difficulties in maintaining essential services and have significantly cut their programs and work forces. These cuts have imposed hardships in local jurisdictions around the country and are also part of the reason for the sluggishness of the national recovery."
The Fed is in a difficult spot. As Mr. Bernanke noted, inflation, now about 1%, is likely to run below the central bank's unofficial target of 1.5% to 2% for the next couple of years. That is stoking worries of deflation, a debilitating fall in prices across the economy. Unemployment is expected to remain high even longer. The Fed already has pushed short-term interest rates to near zero and purchased about $1.7 trillion in Treasury debt and mortgage bonds to drive down long-term interest rates. The purchases ended in March, and many officials are reluctant to resume them.
"We run the risk of doing things in an effort to solve a problem that we're not well-equipped to solve," Charles Plosser, president of the Federal Reserve Bank of Philadelphia, said in an interview last week. Too many people, he said, "have come to believe that monetary policy is always the solution to our economic problems." But Mr. Plosser said he was open to reinvesting proceeds from maturing mortgage bonds into Treasury securities. Part of the appeal of such a move is that the Fed in the long-run wants its portfolio to be in Treasury bonds and not mortgage debt, and this would move it in that direction.
Fed officials aren't sure buying more mortgages or bonds would have a big effect on rates. Mortgage rates and other long-term interest rates already are very low. It also would saddle the Fed with an even larger portfolio to unwind later. As mortgages are refinanced and mortgage bonds mature or are prepaid, the Fed's holdings shrink. The Fed's mortgage holdings inched down from $1.129 trillion in mid-July to $1.117 trillion at month's end. The Fed's mortgage buying pushed investors to buy other assets, including corporate bonds and stocks. Any extension of that program, even in the form of reinvestment, could help support the recent rally in such riskier assets.
Like Mr. Plosser, Richard Fisher, president of the Federal Reserve Bank of Dallas, worried that the Fed could be expected to do too much. He said in an interview that choosing to hold the balance sheet steady for now "could be" an area where Fed officials have common ground. "I'm more comfortable with that debate than I am with the debate about adding to the balance sheet," he said. Another regional Fed bank president, James Bullard of St. Louis, last week warned of deflation risks and said the Fed should expand its portfolio if those risks mount. In an email exchange Monday he said he didn't want to prejudge what actions the Fed might take at its next meeting, saying that there are many "technical issues" that needed to be considered when the Fed makes decisions about its balance sheet.
Another option, he said and Mr. Bernanke has noted, is changing the language in the Fed's policy statement to influence markets by altering its message to the public. Another idea—pushing down short-term interest rates by reducing a rate called the interest on excess reserves—is on the table, but doesn't have a big following at the Fed. That rate is already low, at 0.25%, and the Fed's target federal funds rate is below that most days. The Fed wouldn't get much benefit by pushing the rate lower, and reducing it could disrupt the money-market mutual fund industry.
N.Y. Fed May Require Banks to Buy Back Faulty Mortgages, Assets
by Dawn Kopecki and Jody Shenn - Bloomberg
The Federal Reserve Bank of New York may seek to require banks to buy back its holdings of faulty mortgages and other assets acquired through the rescues of Bear Stearns Cos. and American International Group Inc., a spokesman said.
“We are involved in multiple efforts related to exercising our rights as investors in non-agency RMBS or CDO securities,” New York Fed spokesman Jack Gutt wrote in an e-mail, referring to residential mortgage-backed securities and collateralized debt obligations. Steps include “those that require originators to repurchase ineligible loans,” Gutt wrote, referring to ones that aren’t backed by federal entities and violate bond contracts. “These efforts support our primary goal of maximizing the value of these portfolios on behalf of the American taxpayer.”
The Federal Reserve, Fannie Mae, Freddie Mac and other mortgage investors are seeking to force buybacks to rid their books of bad assets amid persistent losses from soured housing loans. Debt buyers and insurers, who can rescind their coverage, are combing through loan documents for faulty appraisals, inflated borrower incomes and missing documentation that can trigger contractual agreements to repurchase ineligible assets as insurers seek ways to void coverage or recoup costs. “Of course the Fed should pursue ‘efforts to exercise our rights as investors,’” said Chris Kotowski, a bank analyst at Oppenheimer & Co. in New York. “The only real question is, what took them so long?”
Regulators of Fannie Mae and Freddie Mae last month issued 64 subpoenas to loan servicers and mortgage-bond trustees. Investigators are seeking loan files that may prove the two government-supported companies bought securities backed by loans that sellers should buy back because they misrepresented their quality.
The New York Fed holds $69.1 billion of assets that were placed in three holding companies that it established to bail out AIG and Bear Stearns in 2008. Maiden Lane LLC, named for the street bordering the New York Fed’s Manhattan headquarters, acquired about $30 billion of Bear Stearns assets that JPMorgan Chase & Co. didn’t want when it bought the company. Maiden Lane II and III, which were involved in AIG’s rescue, hold the remaining assets. Issuers of so-called non-agency mortgage securities held by the three Maiden Lane companies include Countrywide Financial Corp., which was bought by Bank of America Corp., Bear Stearns, Goldman Sachs Group Inc. and UBS AG, as well as defunct lenders such as New Century Financial Corp., according to Fed disclosures.
Any potential losses won’t hit bank earnings for some time to come, said Scott Buchta, a mortgage-bond strategist at Braver Stern Securities in Chicago. “As far as making actual recoveries goes, this process just begins with the Fed receiving loan files,” Buchta said. “They then need to comb through all of the files and try to find the breaches.” Many of the assets in the Fed’s portfolio are distressed. About 78 percent of the assets backing Maiden Lane II, valued at $16.2 billion on the Fed’s balance sheet as of July 28, were considered junk bonds at the end of the first quarter, compared with 65 percent a year earlier, according to the Fed.
Violations of so-called representations and warrantees of loans sold directly to or insured by Fannie Mae and Freddie Mac cost the four biggest U.S. lenders about $5 billion last year. The statement by the New York Fed, which is being advised by BlackRock Inc. on the portfolios, comes as investors in the almost $1.5 trillion non-agency mortgage bond market, which doesn’t have government backing, escalate efforts to minimize their losses.
A group of investors holding more than $500 billion of the debt last month sent letters to trustees seeking their help in getting more bad loans bought back, according to Dallas lawyer Talcott Franklin. Franklin wouldn’t name the investors, and declined to comment today on whether they included the Fed. Investors suspect that loan servicers -- who are responsible for pursuing repurchases and handling billing, collections and loan modifications -- may not be seeking as many as possible, in part because other units of their companies would be the ones required to take back the debt, according to the letters.
Investors who are sharing information and coordinating through Talcott Franklin PC collectively own bonds giving them 25 percent of “voting rights” in about 2,300 deals, and more in a smaller number, the lawyer said in a July 22 interview. Those levels exceed thresholds that allow them to force actions such as declaring loan servicers in default of their contracts, requiring them to share loan files, and replacing trustees, with details varying by the deal, he said.
US Treasury yields fall to record low on Fed's 'QE lite' plan
by Ambrose Evans-Pritchard - Telegraph
Yields on short-term US Treasury debt have fallen to the lowest in history on mounting expectations of extra stimulus from the Federal Reserve. Two-year rates fell to 0.52pc after a further batch of grim data hinted at a sharp slowdown in the second half of the year. Factory orders fell 1.2pc in June, while consumer spending fell flat. The savings rate has risen to a one-year high of 6.4pc as Americans adapt to the new era of austerity and build a safety buffer against unemployment. "Households are repaying debt at a rapid clip," said Gabriel Stein from Lombard Street Research. "With an output gap at around 3pc, the US economy could move into outright deflation in 2011 for the first time since records began."
The latest figures follow a sharp drop in GDP growth to 2.4pc in the second quarter, prompting fears that the economy may stall altogether as the boost from fiscal stimulus and inventory cycle both fade. The data has strengthened the hand of the Fed board led by Ben Bernanke as it pushes for a return to quantitative easing (QE), against fierce resistance from the Fed's regional hawks. A closely-scrutinised article by the Wall Street Journal – described by some analysts as kite-flying by the Fed board – said the bank may announce some form of compromise at its crucial meeting next week, agreeing to roll over bonds purchased during the credit crisis rather than letting them expire gradually as previously planned. This would entail a slow shift from mortgage debt to Treasury bonds.
The Fed would keep its balance sheet steady at $2.3 trillion (£1.44 trillion). The effect would be neutral rather than adding any fresh stimulus. It has already dubbed 'QE lite' by Barclays Capital, as opposed to full 'QE2'. However, Fed watchers say it would be a crucial first step in a broader shift in policy. The bank has bought $1.7 trillion in bonds. Experts say key governors have been mulling a net increase to stave off possible deflation, pencilling in a rise in the balance sheet to $5 trillion in extremis.
Mr Bernanke said on Monday that US states have been "battered" by a budget crisis, forcing them to cull staff. This is holding back recovery. "We need to be careful about tightening too quickly," he said. Jan Hatzius, chief US economist at Goldman Sachs, said fiscal policy is turning contractionary, draining 1.7pc of GDP next year after adding 1.3pc in early 2010. This leaves the Fed as the last line of defence.
"The disappointing economic data has clearly taken a toll on the confidence of at least a few Fed officials," he said, citing warnings by James Bullard from the St Louis Fed that the US risks a Japan-style deflationary trap. As the keeper of the monetarist flame within the Fed family, Dr Bullard is usually viewed as a hawk. However, the Fed presidents from Richmond, Philadelphia, Kansas, and Dallas fear that US monetary policy is moving into dangerous waters, stoking asset bubbles rather than letting the debt purge run its course. The risk of moral hazard is growing as markets assume they will be rescued. "I don't think there is any role for the Fed at least in the near term," said Philadelphia chief Charles Plosser last week.
Tim Congdon from International Monetary Research said the Fed has been wasting its powder by using the wrong mechanism to inject monetary stimulus. Instead of buying bonds from pension funds, insurance companies and other bodies outside the banking system, as the Bank of England did with its £200bn gilts purchase, it has been buying from banks. This method has different effects. It has gained less traction because banks have sat on "dead cash". This has not increased the deposits held by companies and households.
"A really powerful way for the Fed to boost the economy is to buy bonds directly from the public, which will increase the quantity of broad money. They won't do that because they have a totally different model and in my view they are confused about the transmission mechanism. If they bought say $1.5 trillion of long-dated Treasuries from non-banks I believe they would get the US out of its liquidity trap very quickly," Mr Congdon said.
For Fannie Stock, Even Betting Pennies Is a Risk
by David Gillen - New York Times
It is flotsam of the housing wreck, a stock no longer worthy of the Big Board. But penny by penny, the mortgage giant Fannie Mae is being salvaged in the stock market. Nearly two years after it was effectively nationalized, Fannie Mae has become the nation’s hottest penny stock — and, perhaps, its most dangerous. Even though the shares are almost worthless, they are changing hands at a furious pace. Since June, about 31 million of them have been traded on a typical day, more than triple the average for Goldman Sachs shares.
All those Fannie Mae shares do not add up to much money. The stock closed at 40 cents on Wednesday, about the cost of a first-class postage stamp. In mid-2007, before the housing market deflated, it fetched nearly $85. “The volumes are astonishing,” said Bose T. George, a financial analyst at Keefe Bruyette & Woods “It’s like a casino.”
The knockdown price partly explains why Fannie Mae typically ranks among the liveliest financial shares in the market: It doesn’t cost much to take a flier on Fannie. But the Lilliputian price also explains why Fannie Mae might have buy-and-hold types feeling queasy. A penny or two change in the price translates into a big move in percentage terms. Last week, for instance, Fannie Mae’s shares jumped 47 percent one day, only to sink 14 percent the next.
Behind all of this commotion are day traders, those creatures of the dot-com era. Mutual funds and other institutions have mostly abandoned Fannie Mae, as well as shares of its cousin Freddie Mac. The big money has ceded the marketplace to individuals who are bold enough, or perhaps foolish enough, to gamble on these stocks for a few hours. Just don’t hold Fannie Mae too long, Mr. George advised. He predicted the stock would eventually fall to zero. It is difficult to know what other analysts think, since Mr. George is just about the only one who still covers Fannie Mae’s stock. His recommendation is an understated “underperform” — Wall Street code for sell. “It’s not really a stock anymore — everyone knows this is going to zero,” he said.
Well, not everyone, at least not right away. But the running interest in Fannie Mae’s stock might seem surprising, considering that this company was the Titanic of the mortgage market. During the bubble years, Fannie Mae and Freddie Mac bought up so many toxic mortgages that the government was forced to take them over. Their stock prices promptly plunged. The federal government today owns almost 80 percent of Fannie and Freddie, and few people, in Washington or on Wall Street, seem to know what to do with them.
Despite the trading frenzy, Fannie and Freddie have become pariahs. Most big investors won’t touch them. As of March 31, Fannie’s shareholders included two big money management companies, the Vanguard Group and BlackRock. But together they owned a mere 1.2 percent of the company, a pittance given the size of those investment companies. Big institutions typically sell if a stock price sinks below $5. Fannie Mae has not traded that high in two years. Last month, both Fannie Mae and Freddie Mac were ignominiously tossed off the New York Stock Exchange because their share prices had languished below $1 for more than 30 days straight.
And so the once-mighty Fannie Mae and Freddie Mac have been banished to OTC Bulletin Board, home to lowly penny stocks and thinly traded “microcap” companies. As the Securities and Exchange Commission says in its guide for investors: “Investors in penny stocks should be prepared for the possibility that they may lose their whole investment.” The question of what to do with these troubled giants vexes policy makers and bankers alike. Together, Fannie Mae and Freddie Mac own or guarantee roughly half of the nation’s $11 trillion home mortgage market. The new overhaul of financial regulation did nothing to address the companies, even though they played a central role in inflating the housing bubble.
The Obama administration plans to hold a conference on the future of housing on Aug. 17 to seek advice about reforming the rules governing mortgage finance. The goal is to deliver a proposal to Congress by January. What that proposal will say is anyone’s guess. Fannie and Freddie’s harshest critics want the companies shut down. But even banking executives concede that, for now, the federal government will probably have to play some role in mortgage finance, given the industry’s dependence on Fannie and Freddie.
“The fundamental problem with Fannie and Freddie is that no one really knows what to do with them,” said Bert Ely, a financial and monetary policy consultant based in Alexandria, Va., and a longtime critic of the companies. Until Washington comes up with answers, the day traders will no doubt try to ride the swings in Fannie Mae and pocket some more pennies while they still can.
Leverage 'mirage' under fire as banks' profits soar
by Philip Aldrick - Telegraph
Life is looking up for the bankers. Since their brush with calamity two years ago, the industry has staggered to its feet and got back to its old ways – bar a proprietary trading tweak here and there. Full financial reform has been delayed seven and a half years (roughly the same amount of time it took Sir Fred Goodwin to build and then destroy Royal Bank of Scotland), salaries have doubled and, although bonuses may be lower, total pay is back on the march. To cap it all, strict new rules requiring bankers to take their bonuses largely in shares have put them on course for their biggest payday ever.
Take RBS. Since the March bonus round, the state-backed lender's stock has risen 40pc – at least partially due to the delayed regulatory reforms. Life is certainly looking up. If the general public is bemused by the bankers' apparent Teflon-coating, they are not the only ones. One senior executive at a leading British bank privately expresses similar surprise. Delaying financial reform is vital if the economic recovery is to be supported, he says, but the banks will have to do their bit by cutting bonuses. That way, the industry can demonstrate that "we are all in this together", as George Osborne is fond of reminding us. So far, though, there is little evidence that bankers are even nearby.
City bonuses this year are expected to rise from £6bn to £6.8bn, according to the Centre for Economics and Business Research. Yesterday, HSBC revealed that it had set aside $2.52bn (£1.6bn) for its investment bankers in the first half, a $300m increase on last year despite a 1pc drop in net operating income to $10.3bn. "Performance-related costs were $246m lower, as performance declined from the exceptional levels reported in the first half of 2009," the bank said. Higher salaries, though, more than offset the decline in bonuses.
Remuneration reform is beset with difficulties, as bankers will remind you at every opportunity. The marketplace is global and competition fierce. UBS banned all bonuses in 2008 and lost so much talent profits in its investment bank collapsed. Politicians dare not take that risk on a national scale. Changes in the structure of bonuses have been implemented, with as much as 60pc paid in shares and deferred for three years, but size has been left unregulated. As a result, a lot of mediocre bankers are still vastly overpaid, as one top investment banker readily admits. "Put it this way," he said. "There are an awful lot of Emile Heskey's getting paid far more than they are worth."
One problem, according to the bank executive, is how to measure pay. Investment banks use a compensation-to-income ratio that tended to settle at about 50pc. Barclays' annual report defines the ratio as "staff compensation compared to total income net of insurance claims". But the measure excludes provisions on bad debts, so strips out the worst mistakes made by staff in previous years. Barclays' ratio in 2009 was 38pc, which was applauded. But, including the £2.6bn of provisions, the ratio was 49pc. The bank executive reckons a simple improvement would be to measure the ratio "net of insurance claims and provisions".
Policymakers want to go further still. Andy Haldane, the Bank of England's executive director of financial stability, has described much of banks' profits in the past decade as a "mirage" and believes an entirely new measure of shareholder return needs to be developed to better capture the cost of risk. "Banks' profits may have been flattered by the mismeasurement of risk," he wrote in a recent paper. "Risk illusion, rather than a productivity miracle, appears to have driven high returns to finance. The recent history of banking appears to be as much mirage as miracle."
The mirage is clearly evident when return on equity is measured against return on assets. Think of a £100,000 house bought with a £10,000 deposit. If prices rise 10pc, the house is worth £110,000. As the mortgage remains £90,000, the homeowner's return on equity is 100pc. However, the return on assets is just 10pc – the growth in value of the home. As Mr Haldane puts it: "Virtually all of the increase in the return on equity of the major UK banks during this century appears to have been the result of higher leverage. Banks' return on assets – a more precise measure of their productivity – was flat or even falling over this period."
In other words, bankers were not being smart, just borrowing more. And reward structures encouraged them to do so. Little surprise, then, that "those banks with highest leverage are also the ones which have subsequently reported the largest writedowns", Mr Haldane notes.
Knight Vinke, the activist investor known for its forensic analysis, has been even more explicit – arguing that return on assets is the only measure by which bankers should be measured. In a submission to the Future of Banking Commission, it said: "Management compensation schemes should reward real returns on assets, not leverage. Incentive schemes need to be overhauled." The idea is that real performance, stripped of the multiplying force of debt and the risk that carries, should be recognised.
So far, though, there is no momentum to change compensation structures. Global regulators prefer to align staff incentives with those of shareholders, which misses the point that both have been incentivised in the wrong way. Lehman Brothers was a paragon of share-based remuneration, yet the risks it took nearly destroyed free-market capitalism.
George Osborne and Vince Cable are now threatening to crack down on bonuses if the banks fail to support the recovery by lending to business. Behind their words lurks the threat of another tax, on top of the £2.5bn balance sheet levy already in place. Lenders are far from impotent here. According to the Bank of England, they could set aside £10bn this year to support lending by restraining bonuses and dividends. It is unlikely they will, but the pressure for bonus reform is mounting.
Goldman Sachs Plans To Spin Off Proprietary Trading
by Huffington Post
Goldman Sachs is "seriously considering spinning off its proprietary trading unit" according to CNBC's Kate Kelly. The group plans to do so to comply with the Volcker Rule, which bars banks from making certain speculative investments with their own money as opposed to a customer's. The rule is part of the financial reform legislation passed last month. Paul Volcker, for whom the rule is named, blames proprietary trading for the current economic crisis.
Ryan Grim previously reported, when news broke several prop traders were being moved to asset management, "The law does allow firms to trade a small amount of taxpayer-backed capital for their own profit, fueling fears that banks would use the leeway to continue to trade large positions. But, noted a Democratic aide, 'the mere fact that the firms are putting people in asset management is a good sign, not a bad one. The talk about loopholes and weak Volcker Rule is really just uninformed.'"
Banking system on verge of new crisis, hedge fund Noster Capital warns
by Harry Wilson - Telegraph
The banking system could be on the brink of another crisis, according to one hedge fund manager who has taken a series of short positions against some of Europe's largest financial institutions. London-based fund Noster Capital is betting against five major European banks, including Barclays in the UK, Spain's BBVA, and Switzerland's UBS.
Pedro Noronha, chief executive of Noster Capital, said he thought many people still failed to understand the extent of the problems facing many banks and were "complacent" about the risks the industry faces. "Two months ago everybody was in a panic about the sovereign debt crisis, and now it's like everybody is going on holiday and everything is fine," he said.
Talking about the results of last month's stress tests of 91 major European banks, Mr Noronha was scathing, saying the process was flawed. "The point of a stress test is that you stress something until it breaks. These tests included a ridiculous definition of tier-one capital and allowed some banks with... 1.7pc to show levels above 6pc," he said. The other banks being shorted by Noster Capital are Italy's Intesa Sanpaolo and UBI, which Mr Noronha said faced significant dangers over their exposure to Eastern Europe and a stuttering Italian recovery.
However, he claims the biggest danger remains the US housing market, where he said there was the potential for a new shock as more Americans default on home loans as mortgages come up for refinancing. Mr Noronha points to a new wave of low-quality "Alt-A" and "Option ARM" mortgages that face refinancing, which he warns could lead to a new fall in US real estate values, which could translate into a further series of losses for financial institutions still exposed to the US property market, which triggered the original crisis in 2007.
Dual Role in Housing Deals Puts Spotlight on Deutsche
by Carrick Mollenkamp and Serena Ng - Wall Street Journal
Federal probes of the collapsed mortgage-bond boom are shedding light on how Wall Street firms sometimes created securities and sold them to one set of investors, while advising others to bet against them.
One firm that was a major player in mortgage securities, Deutsche Bank AG, illustrates a pattern investigators are looking at. While creating and selling mortgage securities to some of its clients, the big German bank was not only advising other clients to bet the other way, but also sometimes doing so itself. A Deutsche trader helped create an index that made it easy to bet against housing, and the bank itself then used the index to do just that.
After the collapse of mortgage securities led to a costly bailout of the firm that insured many such securities—American International Group Inc.—some of the federal cash that was sunk into AIG flowed to Deutsche, to cover bearish bets by its hedge-fund clients. Deutsche's actions are a vivid example of potential conflicts on Wall Street—the way big financial firms play both sides of the fence with investors. The issue became more extreme during the mortgage bubble and subsequent bust because of the size of the bets on Wall Street and subsequent losses on Main Street.
Regulators now are grappling with whether the business-as-usual conduct at financial firms merely looks bad in hindsight, or whether there were misrepresentations or other legal issues that need to be further investigated and guarded against in the future. "This is a gray area that we need more investigation into," says Andrew Lo, a finance professor at Massachusetts Institute of Technology and a hedge-fund manager. Deutsche says that helping investors bet either way—either for or against an asset—is part of doing business for a securities firm.
"Some clients sought more exposure to the housing market, while others sought less," a spokesman for Deutsche said. "We served clients whatever their investment objective, but only after being satisfied that they had arrived at their view after thorough consideration."
As for betting against housing with its own money, Deutsche, while acknowledging having made tens of millions of dollars doing that, says that overall, it "maintained a net long position in the housing market and ultimately suffered billions in losses, even after factoring in our hedges and offsetting positions." Deutsche is just one of a number of financial firms whose roles in the mortgage boom and bust are being examined by the U.S. Securities and Exchange Commission, the Justice Department or the Financial Crisis Inquiry Commission set up by Congress.
In mid-July, the SEC reached a $550 million settlement with Goldman Sachs Group Inc. of civil charges that Goldman misled investors in a mortgage security, failing to tell them a bearish hedge fund had helped design the security and was betting against it. Citigroup Inc. last week agreed to pay $75 million to settle SEC charges of understating its subprime exposure in reports to investors. Deutsche says it has been cooperating with a variety of mortgage-related inquiries but hasn't been told it is a target of any investigations. Deutsche recently settled charges by an industry self-regulatory group, the Financial Industry Regulatory Authority, that it misrepresented delinquency data in issuing subprime securities. In agreeing to a $7.5 million penalty, the bank neither admitted nor denied the charges.
Deutsche's disparate dealings with two investor clients in February 2007 illustrate how it played both sides of the mortgage-securities market. That month, a time when the U.S. housing and mortgage markets were beginning to crack, Deutsche was helping put together bond deals backed by subprime mortgages. They included loans originated by NovaStar Financial Inc., a Missouri subprime lender that Deutsche had financed. A promotional flier from NovaStar in 2003 said, "Ignore the Rules and Qualify More Borrowers with our Credit Score Override Program!" As housing boomed, NovaStar thrived.
But on Feb. 20, 2007, NovaStar reported a quarterly loss and said it was tightening the spigot on new loans. It was another piece of evidence the long-rising housing market was headed the other way. That evening, a senior Deutsche trader received an email from a hedge-fund manager with the subject line "Novastar" and the message: "It is like the plague." The Deutsche trader, Greg Lippmann, encouraged the email writer to bet against subprime bonds, telling him "you should get some [courage] and do some shorts," because "these bonds are going much much lower....."
Deutsche, however, continued to market new mortgage-bond deals predicated on the mortgage-securities market staying strong. The very next day, M&T Bank Corp. of Buffalo, N.Y., poured $82 million into a Deutsche deal known as Gemstone VII. Within 10 months, M&T lost 98% of its investment, according to a lawsuit it has filed against Deutsche. By that time, NovaStar was out of the lending business. "Some of our employees were bearish on the housing market," a Deutsche spokesman said, "but they were transparent with their views and spoke at dozens of conferences and client meetings and published more than a dozen research reports which were distributed to thousands of institutional investors." There's no indication Mr. Lippmann was among those at Deutsche encouraging others to buy.
Deutsche is fighting M&T's fraud-and-misrepresentation suit in a New York state court. A Deutsche spokesman described M&T as "an extremely sophisticated investor" and active player in the mortgage market. Deutsche, founded in Berlin in 1870, and occupying a skyscraper at 60 Wall Street in recent years, had a major role in the frothy rise and later crumbling of the U.S. housing market. In 2007, a peak year for production of mortgage deals known as collateralized debt obligations, or CDOs, Deutsche arranged about $42 billion of them, compared with $25 billion by Goldman, according to Thomson Reuters.
Signing off on the deals were lawyers supervised by Robert Khuzami, who ran Deutsche's U.S. legal division. He is now the SEC's enforcement chief and has vowed to pursue any financial wrongdoing by financial firms in areas such as mortgage securities, recusing himself if any matters relate to his old employer. The SEC said Mr. Khuzami declined to comment.
Deutsche analysts also were among the first to flag weaknesses in the market, as early as 2005. In a June 2006 research report, a Deutsche analyst recommended that investors reduce their exposure to subprime mortgage securities. The bank, however, continued to build its mortgage-securities machine. It was a reliable assembly line, beginning with lenders like NovaStar, based in Kansas City, Mo. Deutsche agreed to provide a credit line to NovaStar in 2003, the year the home lender touted its "credit score override program." A co-founder of the lender says that it sought "to underwrite loans with a focus on ensuring the borrower could repay his or her debt."
As U.S. lenders churned out home loans, Deutsche bundled them into mortgage-backed bonds. It assembled these into CDOs, and built other CDOs out of derivatives that served as insurance on the bonds. Deutsche marketed the deals to conservative investors, such as insurers and banks, that had a positive view of the housing market. Meanwhile, for hedge funds or other investors that wanted to bet on a housing downturn, Deutsche in 2005 and 2006 created a half-dozen deals that were collectively known as START. One created in late 2005 was underpinned by about 100 home-mortgage bonds whose ratings were low investment grade. Deutsche put investors on notice that it "may deal in" any mortgage bond in the pool—that is, Deutsche might trade them itself.
Deutsche set up one 2005 START deal partly to facilitate bearish bets by Paulson & Co., the same hedge-fund firm whose role Goldman was accused of insufficiently disclosing, according to people familiar with the matter. Paulson & Co. helped select assets that went into the Deutsche CDO and then bet against the assets, the people said. That was a role similar to the role Paulson played at Goldman. Deutsche, like Goldman, didn't tell investors in its CDO that Paulson had helped pick the assets and was making a bearish bet. A key difference: Goldman told investors that the assets were picked by an independent third party; Deutsche didn't use a third party or give its investors such assurances.
A spokesman for Deutsche said, "Both long and short investors were given the opportunity to select the specific collateral to which they were seeking exposure and mutually agreed on the CDO portfolio." In the complicated START deals, Deutsche agreed to sell investors protection on mortgage securities, and then shielded itself by purchasing protection on those same securities. On two 2005 deals, including the one that helped facilitate Paulson's bets, the provider of the insurance was AIG. For those deals, about $800 million of the federal bailout money given to AIG in 2008 was set aside to be paid to Deutsche as defaults occur. (In all, Deutsche received at least $8.5 billion from AIG, much of it for commercial real-estate deals.)
Conventional wisdom among investors had long held that it was difficult to short housing, that is, bet against it. But a new index called the ABX.HE made this much easier. It was created in January 2006 by Deutsche's Mr. Lippmann and bankers from 15 other big firms. At a September 2006 dinner with hedge-fund clients at a Palm restaurant in New York, Mr. Lippmann said subprime-mortgage bonds were poised to fall. By the end of 2006, Deutsche was using the ABX to make its own bearish housing bets.
The bank's finance chief told investors that as housing weakened in the first quarter of 2007, Deutsche avoided a net loss in part because of "a trading position, which was put on in...late 2006, shorting the ABX index, because our traders felt that the U.S. mortgage market was probably overheating and was potentially going to soften," according to a transcript of the May 2007 earnings conference call. Deutsche's mortgage trading desk assembled other instruments that were tailor-made for betting on housing, either for or against. These were complex CDOs made up of derivatives linked to the performance of mortgage bonds plus some part of the ABX index.
Deutsche took the bearish side of these deals and sought to sell the bullish side of them to U.S. and European investors. The bank says the instruments weren't designed to enable it to short housing. Not all investors who were pitched the bullish side were impressed. "My quick analysis of the portfolio suggests this is the biggest crock of s— I've seen yet!" one London trader who got the pitch responded by email to Deutsche. He added, "I won't be spending any more time on it, but wish you luck in moving some paper." The client later was sent a new portfolio and found it improved, according to what one Deutsche employee told another one.
Then on Feb. 20, 2007, came word of the setbacks at NovaStar, the Kansas City subprime lender. In an email reply to hedge-fund manager Steve Eisman of FrontPoint Partners—the man who had described the worsening situation as "like the plague"—Deutsche's Mr. Lippmann encouraged Mr. Eisman to rev up his bets against mortgage bonds. When Mr. Eisman asked for some recommendations, Mr. Lippmann wrote that he would have another bank employee send some. "On CDOs, we think they are going much much wider," Mr. Lippmann wrote, referring to the already-widening cost of credit protection on mortgage bonds. He said he was having trouble staying "short" housing because of a dwindling pipeline of mortgage products to bet against.
Mr. Eisman's bearish bets were lucrative for his hedge fund, which is owned by Morgan Stanley. During this time, Deutsche continued trying to get other investors to go "long" the housing market—that is, it continued trying to sell them products likely to prosper if housing did. M&T, the bank that agreed during this time to invest in a new Deutsche mortgage deal, alleges in its suit that a week before the purchase, a Deutsche salesman told it by phone that the "underlying structures in these bonds are built to withstand" adverse conditions.
In late 2007, M&T wrote down the value of its $82 million investment to just $1.9 million, according to its suit. Deutsche said documents for the product had clearly warned that the assets in the pool were of poor quality. As NovaStar's troubles mounted, it hired Deutsche in 2007 to help the subprime lender sell its mortgage-servicing operation. In late 2007, NovaStar abandoned home lending altogether. Two months ago, Deutsche's Mr. Lippmann, the trader who had advised the hedge-fund manager to short mortgage bonds while his bank continued to push them, left to help form a hedge fund himself, one aimed at profiting from the mortgage mess.
College Loan Debt: A Big Problem for Borrowers, Lenders and Government
by John Lounsbury - Seeking Alpha
MSN Money and The Wall Street Journal have combined to produce an article detailing some of the problems that exist for those with college loans debt. Among the situations cited is a 41-year old MD with $550,000 outstanding college debt. The debt was much less (about $250,000) when this individual graduated from medical school in 2003, but has ballooned to the present amount through mismanagement.
Another case mentioned is a laid-off factory worker with $120 a week garnished from her $300 a week unemployment check to apply against her son's college loan debt. The son is also unemployed, having lost his $29,000 a year job 8 months ago. A third case describes a college loan debt that has grown from $28,000 to more than $90,000, with monthly payments that were originally $230 now $816.
How do such cases happen? Here is an excerpt from the article:There is an estimated $730 billion in outstanding federal and private student-loan debt, says Mark Kantrowitz of FinAid, a Web site that tracks financial-aid issues -- and only 40% of that debt is actively being repaid. The rest is in default, or in deferment, which means payments and interest are halted, or in forbearance, which means payments are stopped while interest accrues.
College loans are difficult to restructure, as well. One individual was able to renegotiate home mortgage terms but has not been able to do the same with outstanding college loan debt.
While some of the defaulted debt, or that in forbearance, results from financial hardship, it appears that some is also the result of mismanagement by the debtors. One gets the impression that some who borrow for college make no effort to understand the financial details of the loans they assume. This seems to be a familiar story of how individuals simply do not understand basics of personal finance.
Is it any wonder that the value of a college education is now being questioned more than it used to be? Perhaps a basic education in personal finance would help more people make informed decisions about college and how to handle the financing of that endeavor.
Student loans are largely held by SLM Corp (SLM), familiarly called Sallie Mae and Student Loan Corp (STU), a subsidiary of Citigroup (C), with smaller amounts of such loans placed by individual banks. SLM currently trades at $12, down nearly 80% from its high in early 2006. STU is at $25.10, down nearly 90% from its high in April, 2006.
Sallie Mae was originated as a GSE (government sponsored enterprise) in 1972 but completed privatization (as a publicly traded company) in 2004. Student Loan Corporation was founded as a non-government enterprise and remains that today. Approximately 78% of the outstanding loans issued by STU (approximately $17 billion) were government insured against default as of 2007. Sallie Mae holds a much larger amount of government guaranteed debt, $145 billion according to Mark DeCambre in the New York Post.
Both companies lost the opportunity to issue more government backed loans in the future as of March this year, when a bill was passed into law and signed by the president that re-established direct lending to students by the government. The changing nature of the business opportunity has renewed speculation about the sale of both SLM and STU, or of their break-up into spin-offs. Such rumors helped spark a 11% rally in SLM this past week after announcements of increased loan loss provisions had dropped the stock by the same amount the previous week. STU, without any specific news, has rallied even more, up 19% from July 21 and 12% in the past week.
STU is certain to be a possible sale by Citigroup, who owns more than 80% of the company, as the giant bank tries to raise capital to deal with its solvency issues. At the current market price, C's stake in STU is worth more than $400 million.
More Workers Face Pay Cuts, Not Furloughs
by Steven Greenhouse - New York Times
The furloughs that popped up during the recession are being replaced by a highly unusual tactic: actual cuts in pay. Local and state governments, as well as some companies, are squeezing their employees to work the same amount for less money in cost-saving measures that are often described as a last-ditch effort to avoid layoffs.
A new report on Tuesday showed a slight dip in overall wages and salaries in June, caused partly by employees working fewer hours. Though average hourly pay is still higher than when the recession began, the new wage rollbacks feed worries that the economy has weakened and could even be at risk of deflation. That is when the prices of goods and assets fall and people withhold spending as they wait for prices to drop further, a familiar idea to those following the recent housing market.
A period of such slack economic demand produced a lost decade in Japan, and while it is still seen as unlikely here, some policy-making officials at the Federal Reserve recently voiced concern about the possibility because the consequences could be so dire. Pay cuts are appearing most frequently among state and local governments, which are under extraordinary budget pressures and have often already tried furloughs, i.e., docking pay in exchange for time off. Warning that they will have to lay off people otherwise, many governors and mayors are pressing public employee unions to accept a reduction in salary of a few percentage points, without getting days off in exchange.
At the University of Hawaii, professors have accepted a 6.7 percent cut. Albuquerque has trimmed pay for its 6,000 employees by 1.8 percent on average, and New York’s governor, David A. Paterson, has sought a 4 percent wage rollback for most state employees. State troopers in Vermont agreed to a 3 percent cut. In California, teachers in the Capistrano and Pacheco school districts have accepted salary cuts. "We’ve seen pay freezes before in the public sector, but pay cuts are something very new to that sector," said Gary N. Chaison, an industrial relations professor at Clark University. Outsize pension costs and balanced budget requirements are squeezing many states as tax revenue has come up short.
It is impossible to say how many employers have cut workers’ pay, because the government does not keep such statistics. Economists say a modest but growing number of employers have ordered wage cuts, especially in the public sector. In a 2010 survey by the National League of Cities, 51 percent of the cities that responded said they had either cut or frozen salaries of city employees, 22 percent said they had revised union contracts to reduce some pay and benefits, and 19 percent said they had instituted furloughs.
Some businesses are also cutting workers’ pay, often to help stay afloat or to eliminate their losses, although a few have seized on the slack labor market and workers’ weak bargaining power to cut pay and thereby increase their profits and competitiveness. Economists note that wages continued to increase in 2008 after the recession began, even adjusted for inflation. But those wages have been flat for the last 18 months, according to the Bureau of Labor Statistics.
Mr. Chaison says the latest wave of private-sector pay cuts is reminiscent of those in the early 1980s, when many companies — especially those with unionized work forces — cut wages in response to a recession, intensified competition from imports and new low-cost competitors spawned by government-backed deregulation. Now, as then, companies frequently say that compensation for unionized workers, in both wages and benefits, is out of line. For instance, the Westin Hotel in Providence, R.I., after failing to reach a new contract with its main union, has sliced wages 20 percent, saying its previous pay levels were not competitive with those at the city’s many nonunion hotels.
Factory owners sometimes warn that they will close or move jobs to lower-cost locales unless workers agree to a pay cut. In its most recent union contract, General Motors is paying new employees $14 an hour, half the rate it pays its long-term workers. Sub-Zero, which makes refrigerators, freezers and ovens, warned its workers last month that it might close one or more factories in Wisconsin and lay off 500 employees unless they accepted a 20 percent cut in wages and benefits. Management warned that it might transfer those operations to Kentucky or Arizona, saying it needed lower costs because sales were weaker than hoped.
The pain is felt across industries. At the Seattle Symphony, musicians have taken a 5 percent pay cut, while ABF Freight System, a major trucking company, has asked the Teamsters to agree to 15 percent less. The St. Louis Post-Dispatch has lowered pay 6 percent, while Newsday has gotten its staff to accept a 5 to 10 percent pay cut. While most of the pay cuts seem to hit unionized workers, David Lewin, a professor of management at the University of California, Los Angeles, who has written extensively on employee compensation, says some cuts are also quietly taking place among nonunion employers.
Reed Smith, a firm with 1,500 lawyers, has cut salaries for first-year associates in major cities to $130,000 from $160,000. Warren Hospital, a nonunionized facility in Phillipsburg, N.J., ordered pay cuts of 2 to 4 percent because lower Medicaid reimbursements had squeezed the hospital’s finances. Fast-rising pension and health costs are making benefit costs grow more rapidly than wages, some employers say, and cutting wages is often easier than other ways to pare labor costs. But some workers say these cuts are unfair at a time when corporate profits and employee productivity have risen strongly.
Sometimes unions and their workers cooperate with management on pay cuts, hoping to recoup some wage increases when conditions improve. In Madawaska, Me., 460 unionized workers accepted an 8.5 percent wage cut in May to help keep their paper mill in business. "Workers, of course, do not like to have their pay cut, but I think that workers’ major concern now is, ‘Do I have a job?’ " Professor Lewin said. "If the unemployment rate were lower, we’d see a lot more resentment toward pay cuts." But workers sometimes fight back — particularly if an employer doesn’t show signs of distress.
In Albuquerque, where the mayor pushed through pay cuts to bridge a $66 million budget deficit, the largest union of municipal workers is suing, arguing that the mayor’s plan should include furloughs. The mayor, Richard J. Berry, rejected that idea. "You want to keep people employed. You want to preserve public services. And you don’t want to raise taxes," he said. "When you’re trying to lower the cost of government while maintaining services, furloughs don’t do the trick." Albuquerque would have to trim at least 100 jobs without the cuts, he said, which top out at 3.5 percent for employees earning more than $90,000. Those earning under $30,000 will not be affected.
At the Mott’s apple juice and sauce plant in Williamson, N.Y., 30 miles east of Rochester, 300 unionized workers have been on strike since May 23 over management’s demands for a $1.50-an-hour wage cut, a reduction in company 401(k) contributions and higher employee contributions to health insurance. The strikers are seething over management’s demands because the plant has been profitable and Mott’s corporate parent, the Dr Pepper Snapple Group, reported record profits last year. "They keep piling more and more work on us, but they want to pay us less and less," said Michele Morgan, a Mott’s employee. "It’s a slap in the face."
Chris Barnes, a company spokesman, said the Mott’s employees were overpaid, at $21 an hour, given that the average in the area for food manufacturing workers was $14 an hour. The union disputes those figures. "Our only objective," Mr. Barnes said, "was to continue to enhance the competitiveness and flexibility of our operations."
The Long-Term Jobless: Left Behind
by Timothy R. Homan and Zachary Tracer - Business Week
To understand the potential consequences of long-term unemployment, consider the job prospects of Sheldon Fisher and Douglas Lawson. In January, Fisher, 53, was dismissed from a software company in Washington State. Lawson, 34, lost his job in October with a builder in South Carolina. Now the technology industry is bouncing back while construction remains in the dumps, and Washington's jobless rate is 8.9 percent, vs. South Carolina's 10.7 percent. Still, Lawson's prospects may be better than Fisher's.
That's because being jobless for a long time hurts workers in some industries far more than in others. The technology sector is known for such rapid change that those out of work for even a few months can find themselves with out-of-date skills. Construction skills are far less likely to grow stale. "I never forget what I know. … I'm not worried about doing the work once I get it," says Lawson, who has applied for about 30 jobs so far. Fisher, by contrast, is considering leaving information technology altogether, though he says he's not sure what else he's qualified to do. After applying for about 100 jobs in his first half-year out of work, Fisher began to worry that employers might think he was getting rusty. "Then everything after six months just makes it worse," he says.
The average duration of unemployment in the U.S. jumped to a record 35.2 weeks in June, up from 16.5 weeks when the recession began in December 2007, according to the Labor Dept. Today, almost half of unemployed Americans have been out of work for 27 weeks or more (the official definition of long-term unemployment), vs. 30 percent in June 2009.
Industries with highly perishable skill sets include health-care technology, telecommunications, and finance, where regulations have changed dramatically in the past year. The toughest, though, may be information technology. Companies in that sector have cut payrolls for 32 of the last 33 months, through June, for a cumulative loss of some 312,000 jobs, or about 10 percent. In technology, "if you've been out of work for a year or two, you're probably somewhat outdated," says Shami Khorana, president of HCL America, the U.S. arm of New Delhi-based HCL Technologies, which employs about 5,000 workers in the U.S. He plans to hire at least an additional 600 people as the economy improves and anticipates retraining some candidates with obsolete skills.
Unemployed workers in construction, retail, low-level health-care jobs, and teaching are more likely to be attractive to employers once hiring picks up because such jobs don't change as quickly, experts say. "You don't get the sense that residential construction has changed that much in the past decade," says Harry J. Holzer, an economist at Georgetown University and the Urban Institute in Washington. The skills needed to work at a grocery or clothing store—running the cash register, for instance—are "rudimentary," he says.
There are downsides to switching careers, because doing so can push workers into fields where their training isn't valuable, creating a less skilled workforce, says Daniel S. Hamermesh, a former Labor Dept. official who is now an economist at the University of Texas. "It's tremendously difficult [for workers] to decide when the skill is no longer valuable," he says. When employers start hiring, they'll want to see prospective employees who have done more than pump out résumés trying to find a new job. Accenture, for example, will want to see "how the applicants used their time" to stay marketable, says Catherine S. Farley, a Seattle-based managing director at the consulting firm. "Did that person do something to keep their skills fresh?"
99 Weeks Later, Jobless Have Only Desperation
by Michael Luo - New York Times
Facing eviction from her Tennessee apartment after several months of unpaid rent, Alexandra Jarrin packed up whatever she could fit into her two-door coupe recently and drove out of town. Ms. Jarrin, 49, wound up at a motel here [in Brattleboro, VT], putting down $260 she had managed to scrape together from friends and from selling her living room set, enough for a weeklong stay.
It was essentially all the money she had left after her unemployment benefits expired in March. Now she is facing a previously unimaginable situation for a woman who, not that long ago, had a corporate job near New York City and was enrolled in a graduate business school, whose sticker is still emblazoned on her back windshield. "Barring a miracle, I’m going to be in my car," she said.
Ms. Jarrin is part of a hard-luck group of jobless Americans whose members have taken to calling themselves "99ers," because they have exhausted the maximum 99 weeks of unemployment insurance benefits that they can claim. For them, the resolution recently of the lengthy Senate impasse over extending jobless benefits was no balm. The measure renewed two federal programs that extended jobless benefits in this recession beyond the traditional 26 weeks to anywhere from 60 to 99 weeks, depending on the state’s unemployment rate. But many jobless have now exceeded those limits. They are adjusting to a new, harsh reality with no income.
In June, with long-term unemployment at record levels, about 1.4 million people were out of work for 99 weeks or more, according to the Bureau of Labor Statistics. Not all of them received unemployment benefits, but for many of those who did, the modest payments were a lifeline that enabled them to maintain at least a veneer of normalcy, keeping a roof over their heads, putting gas in their cars, paying electric and phone bills.
Without the checks, many like Ms. Jarrin, who lost her job as director of client services at a small technology company in March 2008, are beginning to tumble over the economic cliff. The last vestiges of their former working-class or middle-class lives are gone; it is inescapable now that they are indigent. Ms. Jarrin said she wept as she drove away from her old life last month, wondering if she would ever be able to reclaim it. "At one point, I thought, you know, what if I turned the wheel in my car and wrecked my car?" she said.
Nevertheless, the political appetite to help people like Ms. Jarrin appears limited. Over the last few months, 99ers have tried to organize to press Congress to provide an additional tier of unemployment insurance. But the political potency of fears about the skyrocketing deficit has drowned them out. The notion that unemployment benefits discourage recipients from finding work has also crept into Republican arguments against extensions. As a result, the plight of 99ers was notably absent from the recent debate in the Senate.
Senator Debbie Stabenow, Democrat of Michigan, is now working on a bill to help those in the group, a spokesman, Miguel Ayala, said, but the chances of providing them with additional weeks of benefits seem dim. "It’s going to be extremely hard to pass," said Andrew Stettner, deputy director of the National Employment Law Project. "We barely got 60 votes to keep 99 weeks, so it’s even harder to get more." Other ways of helping the long-term jobless might have a better shot of succeeding, Mr. Stettner said, like a temporary jobs program or assistance for emergency needs.
Ms. Jarrin ping-pongs between resolve and despair. She received her last unemployment check in the third week of March, putting her among the first wave of 99ers. Her two checking accounts now show negative balances (she has overdrafts on both). Her cellphone has been ringing incessantly with calls from the financing company for her car loan. Her vehicle is on the verge of being repossessed. It is a sickening plummet, considering that she was earning $56,000 a year in her old job, enjoyed vacationing in places like Mexico and the Caribbean, and had started business school in 2008 at Iona College.
Ms. Jarrin had scrabbled for her foothold in the middle class. She graduated from college late in life, in 2003, attending classes while working full time. She used to believe that education would be her ticket to prosperity, but is now bitter about what it has gotten her. "I owe $92,000 for an education which is basically worthless," she said. Last year she moved to Brentwood, Tenn., south of Nashville, in search of work. After initially trying to finish her M.B.A. program remotely, she dropped out because of the stress from her sinking finances. She has applied for everything from minimum-wage jobs to director positions.
She should have been evicted from her two-bedroom apartment several months ago, but the process was delayed when flooding gripped middle Tennessee in May. In mid-July, a judge finally gave her 10 days to vacate. Helped by some gas cards donated by a church, she decided to return to this quiet New England town, where she had spent most of her adult life. She figured the health care safety net was better, as well as the job market. She contacted a local shelter but learned there was a waiting list. Welfare is not an option, because she does not have young children. She says none of her three adult sons are in a position to help her.
A friend wired her $200 while she was driving from Tennessee, enabling her to check into a motel along the way and helping to pay for her stay here. But Ms. Jarrin doubts that much more charity is coming. "The only help I’m going to get is from myself," she said. "I’m going to have to take care of me. That has to be through a job." So, in her drab motel room, Ms. Jarrin has been spending her days surfing the Internet, applying for jobs. Lining the shelves underneath the television are her food supplies: rice and noodles that Ms. Jarrin mixes with water in the motel’s ice bucket and heats up in a microwave; peanut butter and jelly; a loaf of white bread.
Ms. Jarrin still has food stamps, which she qualified for in Tennessee. But she is required to report her move, which will cut them off, so she will have to reapply in Vermont. She has been struggling with new obstacles, like what to do when an address is required in online applications. She is worried about what will happen when her cellphone is finally cut off, because then any calls to the number she sent out with her résumés will disappear into a netherworld.
The news, however, has not been all bad. She had her first face-to-face interview in more than a year, for a coordinator position at a nonprofit drop-in center, on Monday. And last Thursday, she got her first miracle, when an old friend from New York sent by overnight mail $300 in cash, enough for another week in purgatory.
U.S. Senate bill to send states money advances
by Lisa Lambert and Richard Cowan - Reuters
A bill to send U.S. states billions of dollars for schools and healthcare advanced in the Senate on Wednesday, bolstering states' hopes for federal help in confronting enormous budget holes. The Senate voted 61-38 to close debate and move the legislation toward a final vote. Republicans attempted to kill the bill, saying it violated U.S. budget rules, but the Senate voted to waive budget rules and allow it to proceed. Democrats treated the final vote, which will likely take place before Thursday evening, as symbolic and proceeded as if the legislation had passed. The legislation would give states $16.1 billion for Medicaid, the healthcare program for the poor, and $10 billion for teaching jobs.
The Senate leaves for its month-long break at the end of the week, and the House of Representatives is already on recess. States may have to wait until the House returns and agrees to the legislation before they see any of the funding. Democratic leaders in the Senate and House have been discussing whether the House should be called back to session to pass whatever jobs bill clears the Senate.
"I think it's going to be very difficult for the House to be away from Washington for five weeks while we have this legislation needing their stamp of approval," Senate Majority Leader Harry Reid told reporters, suggesting that the House may cut its recess short. One aide, who asked not to be identified, said House Speaker Nancy Pelosi and Majority Leader Steny Hoyer on Tuesday discussed that possibility. They concluded that the flow of federal funds under the legislation would not be altered whether the House were to vote soon or in mid-September, the aide said, adding that conversations on the matter continue.
Fiscal conservatives oppose the legislation because of concerns it will add to the deficit and tie states' hands on how to spend funds. States are wary of the teachers' fund, because it requires that the states maintain education spending at 2008 levels, which many cannot afford. Supporters say it is crucial to help states close budget gaps that could total more than $120 billion this year and to avert teacher layoffs.
They say the bill will not add to the deficit because it is paid for by closing tax loopholes, eliminating advance refunds on the earned income tax credit, and ending stimulus funds for food stamps earlier than expected. One tax loophole that would be closed would raise more than $10 billion over a decade by preventing companies from claiming foreign tax credits for income not yet subject to U.S. tax. Another relates to how foreign stock acquisitions are valued for tax purposes. "It saves jobs without adding a dime to the deficit," said Senator Charles Schumer, a Democrat. "We cut in other places to help save the jobs of firefighters and teachers."
A Battle Of Budgets And Elections
More than half of U.S. states counted on receiving the Medicaid money for fiscal 2011. Most states' fiscal years started last month, and they have been scrambling to find spending cuts to keep their budgets balanced -- as is required by all state constitutions except for Vermont -- if the Medicaid money is not approved. States administer Medicaid and receive reimbursements from the federal government. The stimulus plan passed last year increased the reimbursements, but the money runs out in December.
The Senate's move on Wednesday "means Washington, and many other states, will not be forced to make drastic cuts that would have harmed both our citizens and our economic recovery," said the governor of Washington state, Chris Gregoire. The fragile rebound from the economic recession that began in 2007 is first and foremost on voters' minds. With an election battle looming for control of Congress in November, lawmakers are eager to show they are helping the country return to economic health. Federal Reserve Chairman Ben Bernanke, White House economic adviser Christina Romer and many economists see state budget woes as a drag on the recovery.
Controller: $2.19 billion in California bills may go unpaid without budget
by Shane Goldmacher - LA Times
State Controller John Chiang has released a list of the more than $2.19 billion in bills he says the state cannot pay in August without a budget in place. Chiang posted the full list for August on the controller's website. It includes $284 million to community colleges, $130 million in payment due to K-12 schools and nearly $450 million from businesses that have contracts with the state.
The $2.19-billion figure is in addition to the estimated $1.16 billion in bills Chiang could not pay in July with no budget in place. Chiang estimated he can legally pay $15.16 billion of the state's bills this month, even without a budget. But the controller has also warned of a coming cash crunch that could force him to issue IOUs by the end of August to conserve cash to make debt payments and pay other essential bills.
NY state lawmakers finalize $136 billion FY 2011 budget
by Ciara Linnane - Reuters
New York state lawmakers finalized a $136 billion budget for fiscal 2011 late Tuesday, approving a final piece of legislation that will raise about $1 billion through a mix of tax hikes and other measures. However they rejected a controversial tax increase on hedge fund managers who live out of state, fearing an exodus of funds to neighboring Connecticut.
A late-evening 32 to 28 vote by the state Senate ended months of bickering between Republicans and Democrats, who control the legislature, over measures to close a $9.2 billion deficit.
The stalemate had delayed the budget 125 days into the new fiscal year, which began on April 1. Assembly lawmakers approved the budget several weeks ago. Democratic Governor David Paterson welcomed passage of the budget, which he said eliminated the deficit mainly through spending cuts, with no borrowing. The measure now goes to Paterson for his signature.
For the first time in state history, lawmakers have taken action to create a contingency plan in anticipation of a loss of federal revenue, and put spending cuts in place to fill the gap, Paterson said in a statement. Like many states, New York is hoping the federal government will extend Medicaid stimulus funds due to expire at year-end. The contingency plan will cut about $1 billion in spending if the funds do not materialize.
Republicans were critical of the plan. "Today's action also completes one of the latest budgets in state history," Senate Republican Leader Dean Skelos said in a statement. "What did taxpayers get as a result? They got higher spending and more taxes, but not a single initiative to create any new jobs or improve New York's economy." The legislation approved on Tuesday eliminates a sales tax exemption on clothing purchases of less than $110, beginning October 1, to raise an expected $330 million.
Lawmakers also agreed to limit deductions for charitable donations for taxpayers who earn more than $10 million a year. They also approved expanded tax credits for film production companies. The Senate approved a 4 percent cap on local property taxes though the measure still awaits approval by the assembly. But the Senate dropped a controversial proposal, approved by the assembly, to subject the so-called "carried" interest paid to hedge fund managers living out of state to New York income tax rates. The change would have generated an estimated $50 million in revenue.
In recent weeks, Connecticut Governor Jodi Rell has waged a campaign to woo New York hedge funds. "It was too long and more painful than necessary for the legislature in New York to come around on this issue," Tim Selby, president of the New York Hedge Fund Roundtable, said in a statement. "Nevertheless they got to the right result even though it was through peer pressure from Gov. Rell," he said. Paterson pushed parts of the budget through the legislature in June by signing a series of weekly emergency spending bills that lawmakers had to pass to avoid a government shutdown, an unpopular move ahead of November elections.
Treasuries Lack Safety, Liquidity for China: Yu Yongding
by Belinda Cao - Bloomberg
U.S. Treasuries fail to provide safety or liquidity when it comes to managing China’s $2.45 trillion foreign-exchange reserves, said Yu Yongding, a former central bank adviser. "I do not think U.S. Treasuries are safe in the medium-and long-run," Yu, a member of the state-backed Chinese Academy of Social Sciences, wrote yesterday in an e-mailed response to questions. China is unable to sell the securities in a "big way" and a "scary trajectory" of budget deficits and a growing supply of U.S. dollars put their value at risk, he said.
The State Administration of Foreign Exchange, which manages the nation’s reserves, said last month that U.S. government debt has the benefits of "relatively good" safety, liquidity, low trading costs and market capacity. China’s holdings of Treasuries, the largest outside of the U.S., totaled $867.7 billion at the end of May, down from $900.2 billion in April and a record $939.9 billion in July 2009.
To help cool demand for the securities, China needs to curb the growth of its foreign reserves by intervening less in the currency market, Yu said. The People’s Bank of China said June 19 it would let the yuan float with reference to a basket of currencies, ending a two-year-old dollar peg. The yuan has since appreciated 0.8 percent to 6.773 per dollar and analysts surveyed by Bloomberg predict the currency will end the year at 6.67, based on the median estimate. China limits appreciation by buying dollars, fueling its demand for Treasuries.
"China has to depend more on demand and supply in the foreign exchange market for the determination of the yuan exchange rate," Yu wrote. "Only God knows how much value that China has stored in the U.S. government securities will be left in the future when China needs to run down its reserves." The cost of pegging the Chinese currency to the dollar is "intolerably high" and threatens the welfare of Chinese people, Zhang Ming, deputy chief of the International Finance Research Office at the Chinese Academy of Social Sciences, wrote today on the website of China Finance 40 Forum.
"The U.S. government has strong incentives to reduce its real burden of debt through inflation and dollar devaluation," he said. "Whichever way it is, the yuan-recorded market value of Treasuries will fall, causing huge capital losses to China’s central bank."
The dollar has weakened against all 16 major currencies monitored by Bloomberg in the past month, sliding 5.4 percent versus the euro and 4.7 percent against the pound. The Dollar Index, which the ICE futures exchange uses to track the greenback against the currencies of six major U.S. trading partners, is headed for its lowest close since April 15. Premier Wen Jiabao in March urged the U.S. to take "concrete steps" to reassure investors about the safety of dollar assets after President Barack Obama stepped up spending to help end a recession. The White House predicts the U.S. budget deficit will hit a record $1.47 trillion this year, about 10 percent of gross domestic product.
An "appropriate" policy for China would be to allocate its reserves with reference to the weightings of Special Drawing Rights, a unit of account of the International Monetary Fund, Yu said in May. China bought a net 735.2 billion yen ($8.3 billion) of Japanese bonds in May, doubling purchases for this year.
Banks on Europe’s Edge Face $122 Billion Bill
by Bryan Keogh and Kate Haywood - Bloomberg
Banks in Europe’s most indebted nations need to refinance $122 billion of bonds this year, likely paying high interest costs even after receiving a clean bill of health from regulators. Italy’s Intesa Sanpaolo SpA has the most debt coming due at $28 billion, followed by UniCredit SpA with $21 billion, according to data compiled by Bloomberg. Italian banks must refinance a total $69 billion of bonds this year and $157 billion in 2011, while Spanish lenders have $28 billion and $73 billion of debt that needs to be paid.
Banks in so-called peripheral European countries from Greece to Ireland have been largely shut out of debt markets since April amid concern their governments will struggle to cut budget deficits. Banco Santander SA, the countries’ third- biggest debtor, and Banco Bilbao Vizcaya Argentaria SA took advantage of a thaw following the European Union’s stress tests to sell bonds last week, though at relative yields that were as much as double what they paid before the crisis.
"There is still a strong cloud of pessimism hanging over the markets," saidPeter Chatwell, a fixed-income strategist at Credit Agricole CIB in London. "Getting that funding done will be as good a test as the stress tests were." Banco Santander, Spain’s largest bank, which has 14.2 billion euros ($18.5 billion) of bonds maturing this year and 25.8 billion euros in 2011, paid a margin 50 percent higher on July 29 than when it sold debt in February, Bloomberg data show. BBVA, with 5.1 billion euros of notes due by year-end, paid double. Alberte Patino, a spokesman for BBVA in Madrid, declined to comment.
The 24 lenders in the benchmark Stoxx 600 Banks Index that are from Portugal, Italy, Ireland, Greece and Spain have $271 billion of debt to refinance next year and $230 billion in 2012, Bloomberg data show. Elsewhere in credit markets, the extra yield investors demand to own corporate bonds rather than government debt narrowed for a fourth straight week and by the most since December. Global corporate bond spreads fell 6 basis points last week to 177 basis points, or 1.77 percentage points, according to Bank of America Merrill Lynch’s Global Broad Market Corporate index. The gap has declined 19 basis points since the end of June and is up 1 basis point from Dec. 31. Yields fell to 3.72 percent, from 3.96 percent on June 30.
International Business Machines Corp., the world’s biggest computer-services company, may sell three-year notes in a benchmark offering, according to a person familiar with the transaction. The Armonk, New York-based company may issue the debt as soon as today, said the person, who declined to be identified because terms aren’t set. Benchmark offerings are typically at least $500 million. The cost of protecting company debt in the U.S. and Europe fell to the lowest in more than 11 weeks. The Markit CDX North America Investment Grade Index, which investors use to hedge against losses on corporate debt or speculate on creditworthiness, declining 3.76 basis points to a mid-price of 100.63 basis points as of 11:27 a.m. in New York, according to Markit Group Ltd.
That’s the biggest decline since July 13. In London, the Markit iTraxx Europe Index of swaps on 125 companies with investment-grade ratings dropped 4.58 to 100.43. Both indexes, which are at the lowest since May 13, typically fall as investor confidence improves and rise as it deteriorates. Credit-default swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a swap protecting $10 million of bonds and loans.
Bank of Ireland
Bank of Ireland Plc and Allied Irish Banks Plc, the country’s two biggest lenders, have 16.7 billion euros of debt maturing this year, according to data compiled by Bloomberg. No Irish lender has issued a benchmark bond since April. Portuguese banks have 1.4 billion euros of bonds coming due this year and 8.6 billion euros in 2011, while Greek lenders have 1.1 billion euros and 11.4 billion euros. The results of the EU’s stress tests on banks’ financial health on July 23 helped ease investor concern that lenders would suffer losses on sovereign debt holdings. Just 7 of 91 lenders failed, and sentiment was further buoyed three days later when the Basel Committee on Banking Supervision proposed softer capital rules for financial companies worldwide.
"Sentiment is much more positive, even toward some of the more difficult names like the Irish or Spanish banks," said Edward Stevenson, the London-based head of European financial debt at BNP Paribas SA, France’s biggest bank by assets. Bank of America Corp., the biggest U.S. lender, Switzerland’s second-largest bank Credit Suisse Group AG and No. 1 Dutch lender Rabobank Nederland NV used the investor optimism to raise money in Europe’s bond market last week. Banks sold 8.8 billion euros of notes, making it the busiest week since lenders issued 19.6 billion euros of debt in the five days starting July 4, Bloomberg data show.
Banco Santander issued 1.5 billion euros of notes due August 2014 in its first public offering of fixed-rate, senior unsecured debt since Feb. 24. It paid interest of 160 basis points more than the benchmark swap rate, compared with the 105 basis-point margin on its earlier 1 billion-euro March 2015 deal, according to Bloomberg data. The lender’s deal was helped by "a little bit of the locomotive effect," where issues by other banks helped stoke investor appetite, Chief Executive OfficerAlfredo Saenz said at a press conference in Madrid on the day of the sale.
Santander, Spain-based Banco Santander has enough money from debt issues and deposits to repay its maturities through 2012, according to spokesman Peter Grieff. BBVA sold 1.25 billion euros of bonds due August 2015 on July 28 that were priced to yield 170 basis points over swaps, double the spread when it last issued five-year debt. The bank paid a margin of 85 basis points when it issued 1 billion euros of April 2015 notes on April 12, Bloomberg data show. "It’s good for the sector that BBVA got done but it’s too early to say" if weaker banks will be able to raise money before the summer lull, said Anke Richter, a credit research analyst at Conduit Capital Markets Ltd. in London. "Second-tier banks will probably have to wait until September."
Smaller lenders may also be hampered by concern the stress tests weren’t rigorous enough because they didn’t take account of all government bonds held by banks. "Rather than the stress tests being a game-changer, one is left with the nagging feeling that this was another opportunity missed," Andrew Balls, head of European portfolio management at Pacific Investment Management Co., wrote in a July 28 report. European lenders’ "underlying problems are fundamental and long-term in nature," wrote Balls, whose Newport Beach, California-based firm runs the world’s biggest bond fund.
Major lenders from Europe’s peripheral nations have sold $22.4 billion of bonds with lifetimes of 18 months or longer since May, the smallest amount in any three-month period since the aftermath of Lehman Brothers Holdings Inc.’s bankruptcy in September 2008, according to Bloomberg data. For all the improvement in sentiment last week, bonds sold by European banks still lagged their U.S. counterparts in July. European financial-company debt handed investors a 1.48 percent return, compared with 2.37 percent in the U.S., according to Bank of America Merrill Lynch index data. Global government debt returned 0.59 percent, down from 0.83 percent in June.
‘Lingering Sovereign Risk’
"We’re very wary of lingering sovereign risk and are buying debt of banks which aren’t going to be affected by a negative change in sentiment," saidSanjay Joshi, who oversees about $500 million as a money manager at London & Capital Group Ltd. in London. He said he passed on the Banco Santander and BBVA issues. The extra yield investors demand to own European financial- company bonds has climbed 48 basis points to 217 basis points from a 29-month low on April 16, according to Bank of America Merrill Lynch’s EMU Financial Corporate Index. Spanish bank spreads average 333 basis points, 62 percent wider than at the beginning of April. Portuguese lenders’ margins average 495 basis points, 85 percent wider, while Irish financial debt pays a 585 basis-point margin, 35 percent more.
Italian bank spreads are 218 basis points, an increase of 34 percent compared with four months ago. With many frozen out of the bond market, banks in the peripheral countries are relying on the European Central Bank for the bulk of their funding. Spanish lenders, which account for 10.5 percent of assets in the EU financial system, borrowed a record 126.3 billion euros from the Frankfurt-based ECB in June, the most recent Bank of Spain data show. The cash, lent at cheap rates, is "the ultimate methadone," and is prompting banks to "delay their refinancings because they can always get money from the ECB," said Stuart Thomson, who helps manage the equivalent of about $1 billion at Ignis Management in Glasgow.
Italy trapped in slow lane as political crisis deepens
by Ambrose Evans-Pritchard - Telegraph
July car sales have plummeted in Italy, compounding the country’s woes as political crisis threatens months of wrangling and fresh concerns about the safety of Italian debt. Rome said new registrations dropped 26pc from a year earlier, led by a 36pc fall for Fiat. "It is a complete disaster for everybody. The prime minister needs to take charge," said Filippo Pavan Bernacchi, head of the trade lobby Federauto.
Fiat’s chief executive Sergio Marchionne said Italy is the only part of the world where the resurgent company has not made a profit over the last eighteen months. "Italy’s industrial network cannot compete as it is," he said. Mr Marchionne is embroiled in a showdown with Italy’s trade unions, demanding a radical overhaul of working practices before agreeing to fresh investment. "We want to run the plants. There is nothing obscene about that, but here in Italy it seems like we are asking for the moon," he said.
Italy has weathered the crisis of the last three years in good shape, thanks to modest private debt and the firm hand of finance minister Giulio Tremonti. However, political risk is rising as the ruling party of premier Silvio Berlusconi breaks apart over claims of corruption, masonic conspiracies, wire-tap abuses, and attempts to interfere with the courts and free speech. Mr Berlusconi’s attempts to silence his erstwhile ally and chief critic Ginafranco Fini have back-fired badly, leading to revolt that has stripped the government of its parliamentary majority.
This has not had a discernable effect on Italian bond yields but the global markets have shown a tendency over the last three years to rotate from one country to another with sudden bursts of angst over sovereign debt. "I really do think people have been closing their eyes to what may happen in Europe," said Simon Derrick from Bank of New York Mellon. "Our custodial flow data for July shows a steady selling of Italian debt by foreign investors. The last thing anybody wants at this point is political uncertainty," he said. Car sales fell 24pc in Spain and 13pc in France as scrappage schemes are phased out and consumers brace for austerity. The contours of a two-speed recovery in the eurozone are becoming clearer, with Club Med lagging far behind a turbo-charged Germany.
Germany’s KfW-IFO confidence index for Mittelstand firms has surged to 21.1, the highest since reunification in 1991. "There is now a property mini-boom in cities such as Dusseldorf, Munich, and Berlin: people are buying like mad," said Hans Redeker, currency chief at BNP Paribas. As widely predicted, Europe’s scrappage schemes "cannibalised" future sales, leading to a cliff-edge effect that now weighs on economic recovery. "We think Europe’s economy will start rolling over again as we move into September and October, and may even contract in the fourth quarter," said David Owen from Jefferies Fixed Income. "The boost from the inventory cycle is largely behind us and the eurozone needs a much weaker exchange rate-- perhaps $1.10 against the dollar," he said.
Ominously, Ireland said its budget deficit would reach 18.7pc of GDP this year despite wage cuts and 1930s-style austerity policies. While this is partly due to rescue costs for the banks, it is reminder that fiscal retrenchment can itself prove self-defeating unless there is offsetting stimulus from a weaker currency, or looser money, or both. Italy has so far decoupled from the so-called PIGS (Portugal, Ireland, Greece, and Spain) despite a public debt 117pc of GDP, the third largest in the world in absolute terms after Japan and US. French banks alone have $476bn of exposure to Italian debt, according to the Bank for International Settlements.
Investors have switched their focus to Italy’s combined levels of private and public debt. By this measure, it looks almost frugal. The country’s old-fashioned banks have proved reasonably solid. The budget deficit will be 5pc of GDP this year, much lower than France, Spain, Britain or the US. Exactly how Rome has achieved this even though the economy contracted by 5pc during the recession -- more than those four countries -- remains one of the mysteries of this crisis.
However, Italy is clearly trapped with an overvalued exchange rate within EMU. It has lost 30pc in unit labour cost competitiveness against Germany since the exchange rates were fixed in perpetuity in the mid-1990s. This will be extremely hard to claw back without going through the pain of wage deflation. The risk is perma-slump along the lines of Japan.
Ben May from Capital Economics said dismal growth will make it much harder to break out of the debt cycle. "Once interest rates go up again, the debt could start to explode. We think the size of the government’s debts will eventually prompt the markets to turn their sights on Italy and a default is a distinct possibility," he said. The EU authorities and the International Monetary Fund will go to great lengths to avoid such an outcome. We can be sure that they are watching the unfolding the political drama in Rome with close attention.
Finding Swimming Pools with Google Earth
by Daniel Steinvorth - Der Spiegel
Greek Government Hauls in Billions in Back Taxes
In a bid to increase revenues, the Greek authorities are employing all kinds of clever tricks to crack down on tax cheats, including using Google Earth to find undeclared swimming pools. But efforts by the government to liberalize markets could unleash a wave of civil unrest.
There are very few people who can speak passionately about statistics and use words like "logical beauty," "great purity" and "pure poetry" when talking about ordinary numbers. But when Nikolaos Logothetis, 57, expounds on numbers, it sounds like a love poem. "The science of statistics has its own language," says Logothetis, a tall, thin Greek with a carefully trimmed beard and professorial glasses. "We only have to listen attentively to what it has to say, if we want to understand the ills afflicting our country." This is a remarkable statement to make in Greece, which currently has the reputation of being the home of fudged and forged statistics.
It's a sultry July evening in Athens, and Logothetis is sitting in an exclusive restaurant on the city's Kolonaki Square. The mathematician and aesthete became the deputy head of the newly-created, independent Hellenic Statistical Authority (ELSTAT) just a few hours earlier. He has loosened his tie, ordered an after-work beer and, in polished Oxford English, given a short lecture on numbers. Today was his first day of work at the agency. Logothetis is proud of this fresh start and he plans to introduce radical reforms. "In the future, we will only be accountable to the parliament," he says. "There will no longer be directives from the government. We want to finally be able to work as an independent scientific institution."
A Clean Sweep
"Greek statistics" has become something of a running joke in Brussels and Strasbourg. The term stands for tricks, political manipulation and creative accounting. It stands for the entire Greek tragedy, for the numbers-juggling that drove the country to the brink of bankruptcy, and for the statistical pipe dreams of Logothetis' predecessors -- one of whom has already fled abroad. But Logothetis doesn't want to talk about the mistakes of the past. He would rather talk about the future. He wants to be one of the men who get Greece's numbers back in order. He wants to make a clean sweep. "If there is even a hint of political influence," he says, "I'll hand in my notice, I promise you that."
There is apparently a sea change underway in Greece these days, the Mediterranean country where, according to one government official, "virtually everyone cheats, and virtually everyone evades taxes." The Greeks, out of necessity, are about to embark on a kind of cultural revolution. The money that has been pledged to save them from collapse comes with stringent conditions. The so-called troika of the European Union (EU), the International Monetary Fund (IMF) and the European Central Bank (ECB) has been in the country again since Monday of last week.
The three auditors are to decide again if the efforts made to date by the government of Greek Prime Minister George Papandreou have been sufficient to warrant the transfer of an additional €9 billion ($11.7 billion) out of a total bailout package of €110 billion over three years, which the euro zone countries and the IMF have pledged to provide. The Dane Poul Thomsen, the Belgian Servaas Deroose and the German Klaus Masuch have taken up residence in the luxurious Grande Bretagne hotel in Athens. The three Europeans have the Greeks trembling with fear because, during their two-week inspection tour through the ministries and agencies, all doors and books have to be opened to the men in dark suits. "We Greeks have long since lost all sovereignty," says one hotel manager. "They are the real rulers in this country."
Uncovering Fraud on a Grand Scale
In addition to Logothetis, the statistician, there is a second man who stands for a possible fresh start in Athens and the desire for change: Ioannis Kapeleris, the head of Greece's financial crimes squad, the SDOE, which was founded in December to combat tax evasion. Kapeleris, 50, is currently the busiest worker in the Papandreou administration. His workday begins every morning at 7 a.m., in a vast room decorated with Byzantine icons, where three phones continuously ring. This is where he receives his visitors: tired from lack of sleep, smoking, gripping a coffee mug in one hand and wearing a partially unbuttoned shirt.
"Take a look at this," he says, and pulls out a printed Excel table from a pile of documents in front of him. "Here you can see how many cases of tax fraud the Greek state was able to document in the Athens tourist sector in June 2009. Five hundred and six. And do you know how many we found in June 2010? Four thousand, three hundred and forty." Another table lists the names of doctors, who are considered in Greece to be particularly corrupt. "In May we uncovered 4,357 cases of tax evasion among our doctors," says Kapeleris. "In May of last year it was only 24."
Tracking Down Swimming Pools
His staff have become very creative when it comes to tracking down tax offenders: They use police helicopters to fly over Athens' affluent suburbs and make films of homes owned by doctors, lawyers and businesspeople. They use satellite pictures by Google Earth to locate country villas, swimming pools and properties. And these tactics have revealed that the suburbs didn't have 324 swimming pools, as was reported, but rather 16,974.
Tax fraud investigators spent a number of weeks on nightclub parking lots in Athens and noted down the registration numbers of luxury sedans. Their investigation revealed that approximately 6,000 car owners have vehicles worth €100,000, but only reported to the tax authorities that they have an annual income of €10,000. "We are making it increasingly difficult to cheat," says Kapeleris. "And we are making sure that not just the small fish but also the big fish get caught in the net."
The socialist PASOK government has called on the SDOE to drum up at least €1.2 billion in 2010, as outlined in Prime Minister Papandreou's austerity program. In the first six months of this year, however, investigators have already taken in over €1.8 billion in back taxes and fines. An interim report by the IMF acknowledges "impressive improvements" that have been observed in trimming the government's budget -- although this primarily referred to severe cutbacks to salaries and pensions.
But the auditors will most likely continue to exert pressure on Papandreou. Athens urgently needs to curb skyrocketing costs in the Greek health system, liberalize the labor and energy markets and privatize loss-making state-owned companies -- primarily Hellenic Railways, which owes nearly €10 billion, making it the most debt-ridden railway in Europe. Privatizations and cutbacks in the public sector -- in Greece, such measures are guaranteed to lead to conflicts. Over the past week, truck and tank truck drivers protested efforts to liberalize their profession in line with EU regulations.
The sale of coveted truck licenses has, up to now, ensured that they can retire with ample pensions, but now authorities want to do away with these costly concessions and open up the trucking market. Was this a sign of much worse conflicts looming on the horizon? The chaos at Greek filling stations that thousands of tank truck drivers unleashed in the middle of the high season provided merely a small taste of the wave of strikes that is expected to roll across Greece over the coming weeks.
Unpleasant Times Ahead
Kostas Papantoniou, 59, a civil servant and the vice president of the powerful civil servants' union, predicts that the government will face far more unpleasant times. "They say that Greek civil servants are too expensive and too numerous," says Papantoniou, "but that hardly corresponds with reality. Eighty percent of us earn between €700 and €1,400 a month net. Would you call that privileged?"
There is no doubt, however, that permanent positions in the public sector are often awarded very generously, all too often in the wake of elections. Up until last week, nobody could say precisely how many jobs were concerned. Then the government launched a detailed census on the Internet and had teachers, police officers and firefighters fill out an online form, providing for the first time a clear picture of the number of people on state payrolls. Since last Friday, they now know that it is 768,000. The planned cutbacks in salaries and bonuses will hit many of them extremely hard.
Among the angriest civil servants are those who intend to retire this year. They are actually entitled to a one-off payment from the civil servants' retirement fund that they have paid into for decades -- on average €40,000. But to avoid further burdening the budget, the socialist government has temporarily put a stop to these payments. The idea is to ensure that there is the maximum amount of money possible in the public coffers when they are inspected by the IMF and EU auditors.
By delaying these payments, though, the state is surreptitiously accumulating new debts, argues Athens business journalist George Kyrtsos. "While the government is paying its debts abroad on time, domestic payments are simply being postponed," he says. "This can't work in the long run."
For months now, some 4,000 former employees of the recently privatized Olympic Airlines have been waiting for severance payments from the state. The state has also withheld reimbursements of value-added tax for companies. The amazingly reduced government budget that the Papandreou government intends to use to impress the European Union and the IMF could once again be attributed to very Greek and very creative accounting -- and turn out to be yet another example of the notorious "Greek statistics."
Hungary Lays Blame for Fiscal Crisis on Its Central Bank
by Landon Thomas Jr. - New York Times
It’s not easy being a central banker in Europe — especially during the biggest economic crisis in a generation. But Andras Simor, the governor of the Hungarian Central Bank, has it even worse than most. Not only has the new government of Viktor Orban placed the blame on Mr. Simor, among others, for Hungary’s stagnant economy, it has slashed his salary by 75 percent. The Hungarian government has attacked him for holding offshore investments in Cyprus and, insiders say, now may even consider pressing criminal charges in a bid to force him from office.
What those charges might be is unclear, and Mr. Simor says there is no basis for any accusations of wrongdoing. In Brussels, the European Commission is pondering a legal challenge to the policy maker’s pay cut on the basis that it is an unwarranted interference in the operations of the central bank. A spokesperson for the government in Budapest did not respond to questions about the central banker’s standing.
The fight that Mr. Orban has picked with his central bank head — after sweeping into office earlier this year with a populist campaign that brought him an overwhelming parliamentary majority — is unlikely to remain confined to Hungary. It reflects a larger struggle that is expected to play out over the next year or so as most European politicians, following Germany’s lead, seek to impose fiscal discipline on their increasingly unruly citizens.
Mr. Orban is tapping into a deep vein of social resentment in Hungary, where the median wage remains not much higher than it was when the nation broke free from the disintegrating Soviet empire in 1989. His criticisms of foreign banks, speculators and most recently the European Union and the International Monetary Fund have found a ready audience in a country that has experienced five consecutive years of government-imposed austerity. And they could serve as a template for opposition politicians in several other countries, including Greece, Ireland, Portugal and Spain.
Demonizing Mr. Simor and cutting ties with the I.M.F. — which the Orban government did two weeks ago in a dispute over how to pare the deficit — may be crowd-pleasing in Hungary, especially with local elections due this fall. But such an approach also runs the risk of alienating European allies and foreign investors, precipitating the type of speculative run on the forint that brought Hungary to the brink of bankruptcy in 2008.
Indeed, with the government now appearing set to pursue a more expansionary fiscal policy, the odds are growing that it will miss its deficit targets and expand the debt — already at 80 percent of gross domestic product. That could push Hungary into a Greek-style financial crisis early next year when it must repay close to $30 billion — including 2 billion in euros to the I.M.F. that the fund would have covered had it come to an agreement with the Orban administration. "This is a very dangerous course of action," said Peter Rona, an economist in Budapest who argues that without the I.M.F. imprimatur, Hungary’s short-term funding needs and high levels of foreign currency debt increase the risk of a financial crisis. "The mismatch on the Hungarian balance sheet," he added, "is very substantial."
Mr. Orban is the first major European leader to challenge the new orthodoxy of budget cuts and structural reforms that has swept Europe since the onset of the Greek crisis late last year. With the I.M.F. or without, governments in Athens, Dublin, Lisbon and Madrid have enacted ground-breaking austerity programs. But as the Hungarian case is showing, the true test is whether governments can maintain their tightness long enough to reach the deficit target — 3 percent of the nation’s output — set by Europe for those in the euro club.
Since 2006, Hungary has brought its deficit down to about 3.8 percent of economic output, from 9 percent — an impressive policy achievement that has also taken a deep social toll. Unemployment is 11 percent, and retail sales are shrinking. Adding to Hungary’s woes, 1.7 million people in a country of 10 million hold foreign loans that have become increasingly difficult to repay because of the forint’s weakness against the euro and the Swiss franc.
Mr. Orban has won political backing by insisting that enough is enough. He has announced plans to reverse a recent increase in the retirement age, proposed a one-off tax on the country’s banks and trumpeted a mini-stimulus called the Szechenyi Plan in honor of Istvan Szechenyi, a 19th-century reformer who pushed what was then a backward Hungry to modernize and grow.
Mr. Orban says he can meet the I.M.F.’s target of 3.8 percent this year. But next year, when Hungary is supposed to bring its deficit below 3 percent, is another matter. "The big problem is 2011," said Christoph B. Rosenberg, who led the fund in its talks with Hungary. "Given Hungary’s high debt level and its vulnerability to financial flows, it is important that they reduce the deficit from this year’s level."
So far, the markets have been fairly tolerant. Rates at government auctions have increased, and the forint has weakened by about 4 percent, but there has been no panic yet. "Investors think that Hungary and the E.U. will do a deal," said Peter Attard Montalto, a fixed-income analyst at Nomura Holdings. "But we don’t think the E.U. will do a deal without the I.M.F. at the table."
In many respects Mr. Simor, a former chairman of Deloitte & Touche in Hungary, is the perfect foil for Mr. Orban’s government and its nationalist approach. "I think they will go after him," said Gyorgy Lazar, a Hungarian-American investor who writes frequently on Hungarian financial matters. "These guys are from the countryside," he said, of the new administration, as opposed to the "refined intellectual sensibilities of the Budapest elite" that Mr. Simor represents.
Mr. Lazar’s view, one that is shared by the Orban camp, is that Mr. Simor’s high interest rate policy is primarily to blame for Hungary’s current economic woes. "Thousands of businesses have gone bankrupt, industries have suffered," Mr. Lazar said. "He should have reduced interest rates faster." The central bank’s 5.25 percent benchmark rate is among the highest in Europe. But Mr. Simor argues that high rates are still needed to maintain the confidence of the foreign investors that Hungary, with its punishing debts, is so reliant on. In an interview, Mr. Simor would not comment on his tense relationship with Mr. Orban, who he has not yet met since the change in government.
But in the recent release from its monetary council, the bank made clear its disappointment with the breakdown in talks with the I.M.F. and the European Union. "The I.M.F./E.U. umbrella was very important in keeping the confidence of foreign investors," Mr. Simor said. "Giving up this umbrella increases the vulnerability of the Hungarian economy."