"Smallest news & post card stand in New Orleans, 103 Royal Street"
Stoneleigh: As our readers know, we do not provide investment advice. We do not exist to help people make money in the markets, but to help them avoid losing what they have in a deflationary crisis, at a time when almost everyone will lose a great deal. Our position is that being in cash on the sidelines is by far the safest option at this point, and where most people would be better off by far. Those who are still in the markets are playing a very dangerous game. Many of them know this perfectly well, but they can't walk away from the casino. The upside is limited, possibly very limited, and the risks are steadily increasing.
Stock market bubbles (and housing bubbles etc) are ponzi schemes. As with all ponzi schemes, only a few manage to cash out, and the majority are those who do so early. Those who do not cash out become the designated empty bag holders, but that empty bag can look awfully attractive at a market top. Trying to catch the top tick, and wring every last ounce of profit out of a collapsing system, is foolish. Most investors who play that game are likely to lose badly.
They may be convinced that they are clever and quick enough to get out before the rest, but the odds are not good. Also, the rules of the game are likely to be changed along the way, so that one would have to be both right and lucky in order to profit. For instance, shorting is likely to be banned at some point, and speculators demonized. There will be opportunities to make a killing, but many more 'opportunities' to lose your shirt.
Capital preservation is essential in a deflation, and the best way to preserve capital at this point is to be liquid. Cash constitutes uncommitted choices, and in a world of uncertainty, one needs to be flexible. There will be plenty of opportunities over the next few years (both to improve circumstances and avoid disaster) that will only be available to the few who still have the options cash provides. It isn't necessary to have a fortune. Even a small amount of cash can go a long way as deflation causes prices to fall.
Those without any cash, or the means to earn some (in what will be a very difficult earning environment), will be at the mercy of whatever the world has to throw at them. Most of us are accustomed to far more choice and self-determination than most people have had in human history, and there would be nothing harder to lose. Nothing is as addictive as freedom.
The best way to approach a major threat with attendant uncertainty is to minimize the consequences of being wrong. If people follow our suggestions then they will have reduced or eliminated debt, will have cash on hand and will have perhaps some control over the essentials of their own existence. In short they will be far more resilient in a world where many families are brittle, with little ability to weather even minor turbulence.
These measures are actually prudent under most circumstances. If one takes such steps and things do not go as badly wrong as we think they will, what is the downside? There may be some opportunity cost, but the result will not be catastrophic. Alternatively, if one does nothing to prepare, on the assumption that the situation is under control when it is not, then being wrong could easily be an unrecoverable disaster.
The herd is always fully invested at tops and fully liquid at bottoms, meaning that they are never in a position to take advantage of opportunities. They typically buy high and sell low. Naturally insiders do the opposite, behaving as any predator would. They are currently selling vastly more than they are buying, and this should be a very large red flag to anyone who is paying attention. They know the bag they are selling to the public is empty. Financial markets are a very effective mechanism for exploiting the masses and separating greater fools from their money.
People are always asking us about timing. It's no surprise that people should want as clear a picture as possible, especially since we are talking about a very major change in most people's circumstances. As a society we are collectively not used to risk and uncertainty and it is very unsettling. We offer our informed opinion as to when we are likely to see the events we predict unfold, but we do not have a crystal ball and cannot offer an infallible view of the future. Nor can anyone else, so if that is what you expect, any analyst will disappoint you.
Market timing is by its very nature probabilistic. There are always many interpretations of the market's fractal movements, but one can identify more and less probable options by assessing each in comparison with the guidelines for fractal behaviour. The tops of rallies are difficult to call, as corrective patterns are very complex, and can extend into multiple patterns. When a pattern completes, the correction could be over, so it is appropriate to identify a relatively high risk juncture. There are limits to how far rallies can extend, in terms of multiple patterns and extent of retracement.
This rally has extended as a complex multiple pattern, but is nowhere near a retracement limit for a counter-trend move (limits grounded in fibonacci mathematics). In fact the retracement is quite standard. For vastly more detail than we discuss here, I suggest to anyone who may be interested to read through the Elliottwave primer material on Bob Prechter's site. Essentially, what Elliottwave analysis does is to allow people to identify high risk junctures, and margins for error of one interpretation over another.
The rally we are living through has done nothing whatsoever to change the nature of our times. We have lived through the largest credit expansion in human history. Credit expansions create excess claims to underlying real wealth through ponzi finance. When the debt created can no longer be serviced, the bubble will implode and the excess claims will be messily extinguished. This is deflation, and it is inevitable once a bubble has developed. The aftermath of a bubble implosion is generally proportionate to the scale of the excesses that preceded it, hence we can expect the impact to be extremely severe.
Being grounded in positive feedback, deflation builds momentum relatively slowly at first, but later at an increasing pace. When credit contraction reaches a 'critical mass' it can unfold with terrifying speed, and for this reason extreme caution is warranted. It is well possible for the global banking system to seize up in a matter of hours, as it came very close to doing in September 2008. Given the scale of the threat, and how long it can take to extract oneself from an over-leveraged and highly vulnerable position, it is entirely appropriate to convey a sense of urgency. In fact it would be irresponsible of us not to do so.
People ask us when deflation will begin, but it has already begun. It has been underway since at least 2007, when the markets topped and the credit crunch made its first made significant appearance. At this point I published The Resurgence of Risk (the version linked to here is the October 2008 reprint, since the old TOD:Canada archives no longer exist).
I had been warning of a coming credit crunch since October 2005, just about at the point where the housing bubble in the US was topping. These were timely warnings for anyone who was paying attention, although they were treated as the ravings of the lunatic fringe at the time, as is always the case for contrarian views. Unfortunately, timely warnings are never credible at the point when heeding them would do the most good, because they contradict the received wisdom of the bubble years.
We are now seeing a firmly established received wisdom that recovery is underway and that the Fed has saved the day with quantitative easing. Bullishness is at an extreme. The psychology of the market is the opposite of what it was at the March 2009 bottom. This represents a large red flag, as sentiment extremes are major indicators of approaching trend changes. It takes time for a position to be widely accepted and internalized, and the greater the extent to which that has happened, the closer one is to a reversal. I think we are close to one, but it really doesn't matter whether the top is this week, next month, or even next year. It is coming soon enough that evasive action is thoroughly warranted now.
In fact several years ago, when we first began warning people, would have been a better time to act. Those who did are now sitting comfortably liquid on the sidelines with little or (preferably) no leverage. They didn't suffer huge loses in the first phase of the credit crunch, which other less lucky people have been using this rally to recover from (and if the less lucky hang on too long they will see even larger losses once the decline resumes). The prudent early movers can sleep at night because they will not be wiped out in a bubble implosion. They may have forgone a certain amount of profit in the meantime, but they have also avoided an enormous amount of risk.
Those who are addicted to the leverage game are often looking only at the fortunes of Wall Street in their blind enthusiasm for recovery. They are ignoring the on-going trainwreck happening on Main Street. Ordinary people are suffering staggeringly high unemployment and underemployment, and are losing homes and pensions. Mortgage interest resets will continue until 2012, helping to drive sky-high inventory levels that will depress housing prices drastically for years, and have knock-on consequences for individuals and for the banking system (as we have repeatedly pointed out).
Approximately one in seven Americans is on food stamps already. The number one cause of personal bankruptcy in the US, even among people who have health insurance, is healthcare emergencies, as the co-pays are so high. More and more people are falling off the edge all the time. Their plight is ignored higher up the financial food chain, but it cannot be ignored forever. The middle class is dying, and the already poor are being driven into destitution. Eventually the ruined will reach a critical mass, and people who have nothing left to lose, lose it. This is a recipe for a degree of social unrest that will threaten the fabric of society.
There are many actions one can take to lessen the impact of deflation for family, friends and community. The challenge is reaching enough people who are aware to be able to work together with a group rather than in isolation. The effort is absolutely worth it, as those who prepare will be very much better off in a few years time than those who do not. It can be difficult to convince others, however. It certainly strains relationships when people have widely differing views of the future, hence we work to disseminate the information people need to make informed decisions that will allow them to retain their freedom of action. The future belongs to the adaptable.
There will definitely be hard choices to be made, as we have collectively invested so much in a way of life that cannot continue, and extracting oneself from the resulting structural dependencies can be both difficult and time consuming. Trying to live with a foot in two different worlds during the transition to a more resilient life can initially mean all the work of both, without the many of the benefits of either. This is not an easy path to walk. We wish all our readers the very best of luck in walking it, and we intend to remain your traveling companions.
The 'Ponzi scheme' of 'artificial prosperity'
by Nathan Diebenow - Raw Story
The Obama administration's $78 billion cut to US defense spending is a mere "pin-prick" to a behemoth military-industrial complex that must drastically shrink for the good of the republic, a former Reagan administration budget director recently told Raw Story. "It amounts to a failed opportunity to recognize that we are now at a historical inflection point at which the time has arrived for a classic post-war demobilization of the entire military establishment," David Stockman said in an exclusive interview.
"The Cold War is long over," he continued. "The wars of occupation are almost over and were complete failures -- Afghanistan and Iraq. The American empire is done. There are no real seriously armed enemies left in the world that can possibly justify an $800 billion national defense and security establishment, including Homeland Security." Short of that, he suggested, the United States has "reached the point of no return" with its artificial creation of wealth, and will eventually face a sharp economic decline.
Stockman last fall criticized the extension of the Bush tax cuts while the federal government continued to borrow money abroad to pay for its public welfare and warfare programs. His solution to deficit spending -- a huge across-the-board tax increase -- is contrary to the current anti-tax ideology shared among tea party activists as well as fiscal conservatives in the Republican Party.
Stockman, who was appointed by President Ronald Reagan in 1981 to run the Office of Management and Budget, offered two models for the US military's compulsory demobilization: the one after World War I in 1920 and the one after World War II in 1946. Calling today's military spending running at 5.4 percent of GDP "simply an absurd level that begs for radical contraction and surgery," he said that a "reasonable target" to shrink the defense establishment would be 3 percent of GDP by 2015.
What budget cuts?
Republicans, who were elected to a majority in the House of Representatives on promises to cut government spending, promised to cut $100 billion from the budget in their first year. Relatively few have proposed significant decreases in defense spending, and GOP leadership has outright dismissed the possibility. Some prominent members of the House GOP caucus have even suggested the sum of their austerity measures could fall to only $30 billion, if that.
Republicans in Congress have instead championed their success in extending President George W. Bush's tax cuts for the wealthiest Americans. The Congressional Research Service reported (PDF) that extending debased tax rates to the wealthy will add an additional $5.08 trillion to the US deficit over the next 10 years. The Bush-era tax rates that Republicans had set to expire were continued for another two years in a legislative compromise that cleared the way for a series of Democratic legislative victories in Congress. President Obama vowed to press the issue again in 2012.
Among their first actions as the House majority, Republicans also pushed for a repeal of President Obama's health care reform laws, even as the Senate's Democratic majority vowed to block the measure. Repeal of the laws would cost an additional $230 billion, according to the Congressional Budget Office (PDF), and would likely drive the number of uninsured Americans to over 54 million by 2019. But with the US national debt ballooning past $14 trillion in recent days, even a debasement of the military-industrial complex might be too little, too late.
Some analysts have warned the next debt crisis could be municipal bonds, where a $2 trillion market bubble currently exists. One, who correctly predicted the Citigroup credit crunch, even suggested that over 100 US cities may default in the process. But very few, if anyone, in Congress, the National Security Council, the State or Defense Departments have even dared to publicly raise the prospect of reducing the military establishment and its spending to offset the national debt, Stockman said.
"Unless you have a profound change in foreign policy, you're not going to have the possibility of a radical change in defense spending. The later follows from the former," he said. "This is a profound disappointment that there's not even a debate -- a serious debate about dramatic change in our imperialist foreign policy and war-making establishment in this administration -- allegedly the most left-wing administration that we've had in modern time." "I don't have much hope that what needs to be done will be done until it's finally forced on us by a world bond market crisis, which will happen sooner or later," Stockman added.
The 'Ponzi scheme' of 'artificial prosperity'
Stockman, who described himself as a libertarian during a recent interview with Reason.tv, told Raw Story that the economy got into this mess because of the public and private sectors' addiction to "guns and butter Keynesianism," an economic policy that amounts to a Ponzi scheme that has ballooned since 1990. "If we see what's going on carefully, we've reached the final unmasking of the Keynesian illusion, that Keynesianism is really nothing but borrowing, stealing from the future to induce consumption today," he said. "There are no multipliers. Every one of these programs we've had from 'cash for clunkers' to housing purchase credits have disappeared as soon as they expired and simple shifted activities in time by a few months."
Stockman explained that before 1980, it took about $1.50 of new borrowing -- public or private -- to generate $1 of GDP growth. By the mid-1990s, it was $2.50 or $3 of borrowing for a $1 of GDP growth. By 2007, before the big collapse and meltdown finally came, $7 of public and private debt was added to the national balance sheet in order to get $1 of GDP growth. "When you get to the point of $7 of borrowing to get $1 of income, you're obviously on an unsustainable path and pretty close to hitting the wall, which more or less we have," he said.
"So the addicts in Washington are now unfortunately terrified to stop all this borrowing whether it's for guns or butter for fear of the economy will collapse.... That's why we're just at the beginning of solving this massive financial collapse we had in 2008 and not in the process of healthy recovery as some of the pals in the White House or on Capitol Hill or on Wall Street would have you believe."
America's "massive debt-created, artificial prosperity" is unprecedented in history, he continued. The dependence on consumption supported by public and private borrowing, not income, is a new stage for Western Europe as well. A global public debt crisis was inevitable and likely unstoppable, given the political conditions, Stockman added. "We've reached a point of no return. The size of the government. The massive size of the deficits and the national debt that has been created. The precedents that have been established for bailouts and intervention in every sector of the economy. The K Street lobbying system which totally dominates the Congress. All of these are very unhealthy developments.
"And I'm not sure how they are going to be reversed or eliminated," he concluded. "It may be a permanent way of life. Then, if it is, it'll be both a corruption of democracy and a serious weakening of the private capitalistic economy."
Deepening crisis traps America's have-nots
by Ambrose Evans-Pritchard - Telegraph
The US is drifting from a financial crisis to a deeper and more insidious social crisis. Self-congratulation by the US authorities that they have this time avoided a repeat of the 1930s is premature.
There is a telling detail in the US retail chain store data for December. Stephen Lewis from Monument Securities points out that luxury outlets saw an 8.1pc rise from a year ago, but discount stores catering to America’s poorer half rose just 1.2pc. Tiffany’s, Nordstrom, and Saks Fifth Avenue are booming. Sales of Cadillac cars have jumped 35pc, while Porsche’s US sales are up 29pc. Cartier and Louis Vuitton have helped boost the luxury goods stock index by almost 50pc since October. Yet Best Buy, Target, and Walmart have languished.
Such is the blighted fruit of Federal Reserve policy. The Fed no longer even denies that the purpose of its latest blast of bond purchases, or QE2, is to drive up Wall Street, perhaps because it has so signally failed to achieve its other purpose of driving down borrowing costs. Yet surely Ben Bernanke’s `trickle down’ strategy risks corroding America’s ethic of solidarity long before it does much to help America’s poor.
The retail data can be quirky but it fits in with everything else we know. The numbers of people on food stamps have reached 43.2m, an all time-high of 14pc of the population. Recipients receive debit cards – not stamps -- currently worth about $140 a month under President Obama’s stimulus package. The US Conference of Mayors said visits to soup kitchens are up 24pc this year. There are 643,000 people needing shelter each night.
Jobs data released on Friday was again shocking. The only the reason that headline unemployment fell from 9.7pc to 9.4pc was that so many people dropped out of the system altogether. The actual number of jobs contracted by 260,000 to 153,690,000. The "labour participation rate" for working-age men over 20 dropped to 73.6pc, the lowest the since the data series began in 1948. My guess is that this figure exceeds the average for the Great Depression (minus the cruellest year of 1932).
"Corporate America is in a V-shaped recovery," said Robert Reich, a former labour secretary. "That’s great news for investors whose savings are mainly in stocks and bonds, and for executives and Wall Street traders. But most American workers are trapped in an L-shaped recovery." It is no surprise that America’s armed dissident movement has resurfaced.
For a glimpse into this sub-culture, read Time Magazine’s "Locked and Loaded: The Secret World of Extreme Militias". Time’s reporters went underground with the 300-strong `Ohio Defence Force’, an eclectic posse of citizens who spend weekends with M16 assault rifles and an M60 machine gun training to defend their constitutional rights by guerrilla warfare. As it happens, I spent some time with militia groups across the US at the tail end of the recession in the early 1990s. While the rallying cry then was gun control and encroachments on freedom, the movement was at root a primordial scream by blue-collar Americans left behind in the new global dispensation. That grievance is surely worse today.
The long-term unemployed (more than six months) have reached 42pc of the total, twice the peak of the early 1990s. Nothing like this has been seen since the World War Two. The Gini Coefficient used to measure income inequality has risen from the mid-30s to 46.8 over the last quarter century, touching the same extremes reached in the Roaring Twenties just before the Slump. It has also been ratcheting up in Britain and Europe.
Raghuram Rajan, the IMF’s former chief economist, argues that the subprime debt build-up was an attempt – "whether carefully planned or the path of least resistance" – to disguise stagnating incomes and to buy off the poor. "The inevitable bill could be postponed into the future. Cynical as it might seem, easy credit has been used throughout history as a palliative by governments that are unable to address the deeper anxieties of the middle class directly," he said.
Bank failures in the Depression were in part caused by expansion of credit to struggling farmers in response to the US Populist movement. Extreme inequalities are toxic for societies, but there is also a body of scholarship suggesting that they cause depressions as well by upsetting the economic balance. They create a bias towards asset bubbles and overinvestment, while holding down consumption, until the system becomes top-heavy and tips over, as happened in the 1930s.
The switch from brawn to brain in the internet age has obviously pushed up the Gini count, but so has globalization. Multinationals are exploiting "labour arbitrage" by moving plant to low-wage countries, playing off workers in China and the West against each other. The profit share of corporations is at record highs across in America and Europe. More subtly, Asia’s mercantilist powers have flooded the world with excess capacity, holding down their currencies to lock in trade surpluses. The effect is to create a black hole in the global system.
Yes, we can still hope that this is a passing phase until rising wages in Asia restore balance to East and West, but what it if it proves to be permanent, a structural incompatibility of the Confucian model with our own Ricardian trade doctrine? There is no easy solution to creeping depression in America and swathes of the Old World. A Keynesian `New Deal’ of borrowing on the bond markets to build roads, bridges, solar farms, or nuclear power stations to soak up the army of unemployed is not a credible option in our new age of sovereign debt jitters. The fiscal card is played out.
So we limp on, with very large numbers of people in the West trapped on the wrong side of globalization, and nobody doing much about it. Would Franklin Roosevelt have tolerated such a lamentable state of affairs, or would he have ripped up and reshaped the global system until it answered the needs of his citizens?
Why It Could Be Very Hard for Banks to Avoid Ibanez Mortgage Catastrophes
by John Carney - CNBC.com
Although it’s only been a couple of days since the Massachusetts Supreme Court handed down its ruling in the "Ibanez" case, analysts are already announcing that it won’t be as big of a deal as it might seem. I don’t share their confidence.
Recall that in a decision released Friday, the highest court in Massachusetts declared that Wells Fargo and US Bancorp wrongfully foreclosed on two properties whose mortgages were unarguably in default. The court held that Well Fargo and US Bancorp had failed to show that the mortgages had been assigned to them at the time of the foreclosure.
In the Ibanez case—actually, it was two mortgage cases decided at once—the banks could not show that they were entitled to foreclose because in the case of each of the mortgages, there were holes in the chain of title that the banks could not—or did not—close. Although the decision initially will only affect the two foreclosures in question, it’s application by lower courts in Massachusetts will make foreclosures in the Bay State far more difficult and costly for banks. The time it takes to foreclose in Massachusetts is likely to extend beyond the current 11-month period by several more months. Many more attempts at foreclosure in the state will be contested.
Basically, if your bank is foreclosing on your home in Massachusetts, you should be contacting a lawyer and planning to contest the bank’s right to foreclose right now. Foreclosure notices will now become the first step in a lengthy litigation process in Massachusetts. The effect of this case is unlikely to be limited to Massachusetts. Other states will apply their own laws, of course. But the Massachusetts Supreme Court is regarded as one of the the best courts in the US, which means that this decision will be taken as what lawyers call "persuasive precedent" in other states.
The word that is being passed around by very smart research analysts such as Laurie Goodman at Amherst Securities is that the decision is not going to be what Felix Salmon has called a "bank-eating cancer." She argues that while this might mean more paperwork and delays in foreclosure, banks should be able to eventually prove their case and seize the properties when borrowers default on mortgages:One final positive note on the ruling—the court did not say that the lenders could not go back and re-foreclose on these properties. And based on what the lenders have re-documented since the initial actions, the lender should be able to restart and complete the action now, subject to the normal legal delays.
But this might be far more difficult than Goodman thinks. Let’s take the example of the Ibanez mortgage. The case involved a $103,5000 loan on a house in Springfield, Massachusetts made on December 1, 2005. The initial lender, Rose Mortgage, Inc., recorded the mortgage in the county registry of deeds the following day.
Several days later, Rose Mortgage executed an assignment of this mortgage in blank--meaning, they noted that they were assigning the mortgage but left a blank space when it came time to identify to whom the mortgage was being assigned. At some later point, the blank space in the assignment section was stamped with the name of Option One Mortgage Corporation (Option One) as the assignee, and that assignment was recorded in the registry of deeds on June 7, 2006.
As far as the court is concerned, that’s all hunky-dory. Even the fact that Option One executed an assignment in blank in January of 2006—some five months before anyone recorded to assignment to Option One—doesn’t phase the court. What does give the court pause is what happened next, when the mortgage entered the Wall Street securitization assembly-line.
Option One assigned the Springfield mortgage to Lehman Brothers Bank, FSB, which assigned it to Lehman Brothers Holdings Inc. Next the mortgage was assigned to the Structured Asset Securities Corporation (a Lehman subsidiary), which then assigned the mortgage, pooled with approximately 1,220 other mortgage loans, to U.S. Bank, as trustee for the Structured Asset Securities Corporation Mortgage Pass-Through Certificates, Series 2006-Z.
The rub is that US Trust couldn’t show any evidence of these assignments. As soon as Ibanez mortgage entered the securitization assembly line, the assignments stop being duly noted on the mortgage, much less recorded in any property registry offices. The last proper assignment in evidence was the assignment from Rose Mortgage to Option One.
The court goes out of its way to show that it is not being especially picky about who assigns the mortgage or when the assignment is done. US Bank could have proven its ownership of the mortgage by having Option One simply assign the mortgage to US Bank—skipping all those intermediate Lehman steps. But US Bank didn’t do this before it foreclosed, which made the foreclosure invalid.
The solution to this seems easy enough. From now on, banks seeking to foreclose should just make sure that whoever is the last recorded assignee grants a new assignment to the foreclosing entity before the bank takes any action. No doubt this is what Goodman has in mind when she says banks will go back and re-document the assignments.
It might not be so easy. Let’s say you are US Bancorp and you find yourself with a mortgage whose chain of title is incomplete. You took the mortgage from a now bankrupt subsidiary of the now bankrupt Lehman Brothers. Getting someone at Lehman to go through the process of executing the assignment is going to be very difficult. It’s not even clear if anyone at Lehman Brothers has the legal authority to execute an assignment now, while Lehman is bankrupt.
In any case, getting the assignment from Lehman wouldn’t really help you. You’d still have a gap in the chain from Option One to Lehman. It’s probably best to skip over Lehman all together and go directly to Option One to ask for the assignment. But you have a bit of a problem. You didn’t buy the mortgage from Option One. They aren’t under any contractual obligation to you to execute any documents. So when you call, here’s how the conversation goes.
- US Bank dude: "Hey, can I speak to whoever it is who is handling the Ibanez mortgage?"
- Option One guy (after some delay): "No one handles that mortgage. We sold it five years ago to Lehman and closed the file."
- US Bank: "Right. Okay. Well, I need you to find someone who will execute an assignment of the mortgage to me."
- Option One: "First of all, no one who handled that mortgage still works here. You might have heard about the mortgage meltdown, right? Second, we sold it to Lehman, according to the file."
- US Bank: "Right. But I bought it from Lehman."
- Option One: "So get the assignment from Lehman."
- US Bank: "They’re an empty company that is in bankruptcy."
- Option One: "I’ve heard about that. Thanks for the news."
- US Bank: "So I need you to execute the assignment."
- Option One: "First of all, you’re going to have to show me that you bought the loan from Lehman. Second, I need to talk to legal to make sure I can assign a mortgage to someone we never dealt with. Third, how much are you willing to pay me to do all this?"
- US Bank: "Pay you? I already own the mortgage."
- Option One: "The mortgage we sold to Lehman. If Lehman asks for the assignment, we’ll do it as part of that deal. But, as far as I can tell, I don’t owe you anything. If you want an assignment, you’re going to at least be paying the legal bills for the legal opinion that says it’s okay for us to do this."
- US Bank: "You don't have to be an [expletive deleted] about this."
- Option One: "I also don't have to give you an assignment."
By the way, if you do get Option One to assign it to Lehman, you might find yourself trapped. In that case, the mortgage arguably becomes part of the estate of Lehman—subject to the jurisdiction of the bankruptcy court. Sure, eventually, you may be able to prove that you are entitled to the assignment from Lehman. But you’ll be fighting the other creditors, who will argue that you are just one more unsecured creditor in a long line of people who say that Lehman owes them something.
While this example might be specific to loans that went through Lehman, these kind of problems are not likely to be confined to the sizable part of the mortgage market that went through Lehman at one time or another. A great many of the companies involved have entered bankruptcy or changed ownership. When these companies appear in the ownership chain, "re-documenting" the assignments may be all but impossible.
Christopher Whalen: Massachusetts Mortgage Decision Could Kill Top Banks
by Lori Ann LaRocco - CNBC
The bank stress tests are back and you'll sure be hearing the phrase "Too Big To Fail" uttered over and over again. The purpose of this test is to allow the 19 big banks to raise their dividends or repurchase stock. In order to get the approval they must submit their new capital plans to the Federal Reserve by this Friday. It will be a big banking week with concerns about Portugal and on Friday, JP Morgan is set to report is earnings. I decided to speak with Christopher Whalen, Senior Vice President and Managing Director of Institutional Risk Analytics.
LL: Stress tests will be back on the big 19 banks before they can return capital back to shareholders. Which ones do you think will be the first ones to be able to do this?
CW: Depends on degree of regulatory capture. None of the top eight bank holding companies should be able to change dividends this year if we have regulators worthy of the description. Bank of America, Wells Fargo, JPMorgan, US Bancorp still have issues to address with mortgage servicing/securitization mess.
LL: Any concerns of banks failing this test?
CW: No. These tests are not meant to be failed.
LL: If these tests are not designed to truly test the banks, why do them? Is it just a pr measure to put investors at ease? How much credibility is in them?
CW: The stress tests are a marketing exercise by the Fed on behalf of its "clients" the banks. The head of supervision & regulation at the Federal Reserve Bank of New York refers to her large banks as clients. The stress tests have no credibility with Buy Side investors who really follow banks. They are simply a clever way for the Fed/Treasury to convince most investors that the too big to fail banks are solvent.
LL: Across the pond bank concerns continue. What is your outlook? Is Portugal the next to fail?
CW: I think the EU is going to gradually impose "burden sharing" on bond holders and large depositors of banks. They don't have money for subsidies. Ireland will be the test case.
LL: What inning are we in in the banking crisis in Europe?
LL: Last week, the banks were impacted by concerns surrounding the mortgage repurchase risks following the settlement between BAC and the GSEs. How concerned are you?
CW: Not as much as everyone else about the lien/foreclosure issue. Very worried about investor issue. If you don't know Benedict v. Kapner (1925, Louis Brandeis), you need to do some reading.
LL: There is a lot of cash on balance sheets, do you expect any big M&A activity this year?
CW: Yes. Mostly medium size banks and funds buying fixer uppers. Think AmericanWest. Another court decision everyone in the M&A world needs to read is the bankruptcy court decision approving the Sec 363 sale of the bank in that transaction.
LL: How many bank failures?
LL: We are heading into the unofficial kickoff of Q4 earnings season,what is your outlook?
CW: We've seen revenues improving generally in the industry since bloodbath in Q3 2009. Question now is whether credit costs continue to drop or if a flat economy means that credit costs will plateau here. I look for the positive names on our list to continue to improve, but the larger banks will have issues in terms of non-interest expenses for several quarters if not years. BAC expects to peak its ramp in terms of operational capacity to deal with foreclosures and reps & warranties claims Q3 2011.
LL: Who are the big winners?
CW: Investors with cash buying the assets/business of failed banks, companies. Huge opportunity. Almost all of our advisory work is focused on private transactions as opposed to public markets. The banks which are buying these assets are the ones to watch.
LL: Who are the losers?
CW: U.S. taxpayer. "Too Big To Fail" lives and Tim Geithner is spending tax dollars freely to subsidize the large banks.
LL: You are always looking ahead of the headlines, in fact you often predict them. What are you watching right now that others have failed to noticed?
CW: The MA decision is misunderstood. Homeowners are unlikely to win loan forgiveness as the result of errors in recording the lien on their home. But investors in RMBS are facing hundreds of billions of dollars in losses on securities where the note was either not delivered or done so in a haphazard and negligent fashion. These claims could kill some of the top banks. But we should also remember that if the housing market continues to sink as we have predicted, then credit expenses will start to rise again. That is what Wall Street does not expect.
Implications of the Ibanez Case Ruling
by Numerian - Agonist
The Too Big To Fail banks have been waiting with trepidation for a ruling from the Supreme Judicial Court of the State of Massachusetts on the case titled US Bank National Association (as trustee) vs. Antonio Ibanez. They were right to be fearful. The state supreme court has ruled against the banks and upheld a lower court order that nullified foreclosures by US Bancorp and Wells Fargo, on the grounds that neither bank had the legal right under Massachusetts law to foreclose. Today’s ruling has far-reaching consequences for the banks and the housing market in general, as it throws into serious question the legal soundness of millions of mortgages in the US if, as expected, courts in other states come to similar conclusions as the Supreme Judicial Court of Massachusetts.
The Ibanez case tied together two separate but similar foreclosure actions in Massachusetts, the second case being that of Wells Fargo vs. Mark and Tammy LaRace. Both foreclosures took place on the same day, the banks having previously published their intention to foreclose in a local newspaper as required by law. The banks then purchased the properties at prices described by the court as significantly below market value.
About a year after the foreclosures (in autumn of 2008) the banks then applied to the local Land Court for a ruling that in each foreclosure, the bank had full legal right to foreclose as mortgagee, that the bank title to the property was "unclouded" by any other contesting right, and that the bank therefore owned the property in what is legally known as "fee simple" status. These claims were contested by the property owners who had lost their homes in the foreclosure, and the Land Court agreed with the homeowners that the foreclosures had been invalid. Critical to the decision of the Land Court was the fact that both banks admitted that they did not receive assignment of the mortgage to the property until after the foreclosure.
The State Supreme Judicial Court Upholds the Ruling of the Lower Court
The Supreme Judicial Court found that the Land Court made no errors in its judgment for the defendants. Citing the Ibanez case as an example, the justices noted that Antonio Ibanez executed a mortgage in 2005 with Rose Mortgage Inc., which allegedly assigned this mortgage (which gives the proper holder the legal right to foreclose) to Option One Mortgage Co. They in turn assigned it to Lehman Bros. Lehman Bros. supposedly assigned the mortgage to Lehman Bros. Holdings Inc., which packaged it with about 1,000 other mortgages to be sold as a security. These mortgages were supposed to be placed with Structured Asset Securities Corp, set up explicitly for the purpose of protecting the bondholders who bought the securities.
This company was supposed to assign the mortgages to US Bancorp N.A., as trustee. In the event there was need to foreclose on any of the properties, it was the job of US Bancorp to do so, on behalf of the trust and the interest of the bondholders. This is why US Bancorp entered into a foreclosure action against Antonio Ibanez, who clearly had defaulted on his mortgage, and it is why US Bancorp became a plaintiff in front of the Land Court and the Supreme Judicial Court of Massachusetts.
This chain of assignments is important to the case, because all it took for the banks to win was to show up in court with the proper legal documents evidencing the mortgage assignment. They didn’t even have to show up with the original mortgage or the note from the borrower – they just had to have documentation for each link in the chain of assignments. Not only did they not have this, the best they could show was an assignment after the date of the foreclosure, meaning the banks never had assigned the mortgage properly in the first place. This was the basis under which the Land Court ruled against the banks, and which was convincing proof for the state supreme court justices that the foreclosures were never legal.
Carelessness Is a Polite Term for Criminal Recklessness by the Banks
One of the justices who concurred in this decision, Justice Cordry, wrote:[W]hat is surprising about these cases is … the utter carelessness with which the plaintiff banks documented the titles to their assets.
Carelessness is a polite word. The banks have acted with criminal recklessness. In these and similar cases that have cropped up around the country, it is becoming obvious that the big banks involved in securitizing mortgages during the past 15 years purposefully evaded local legal requirements for registering mortgages and accompanying borrower notes with a county recorder of deeds. The banks sold mortgages to other banks without bothering to transfer to the buyer a proper document of assignment evidencing the sale. Mortgages were bundled up into trusts for the purpose of securitizing them to investors, but the trusts were also never given proper legal evidence of the assignment of the mortgages.
Then, when the housing market blew up and banks were forced into pursuing millions of foreclosures, they created the assignments after the fact, used "robo-signers" to submit legal documents to the courts (in one such case the signer had been dead for over five years), falsified notarizations, and in other similar ways perpetrated fraud upon the courts. This is on top of the thousands of documented cases where foreclosures were conducted even though the borrower was not notified in advance, or the borrower was specifically told by the bank to withhold payments in order to qualify for a mortgage modification but then declared in default by the bank, or the bank added thousands of dollars of "late fees" to the borrower’s account, forcing them into default.
Today’s ruling by the Massachusetts supreme court is just one more step in this long judicial argument over foreclosures, but it is consistent with a string of similar rulings from common law courts and bankruptcy judges against the banks. It remains to be seen whether today’s ruling will be appealed by the banks to the US Supreme Court, but this may be highly risky. Real estate law is almost always viewed by the federal courts as the province of state legislatures and courts, so it is hard to overturn a state supreme court on such a matter. Moreover, the banks’ case is exceptionally weak. Banks have been unable in courts anywhere in the US to show up with basic documentation, including a stream of assignments properly executed, that shows they are the holder of the mortgage with a right to foreclosure.
The right of the banks to foreclose on residential property is now being contested in every state. People who have lost their homes in foreclosure are now suing for compensation for their loss, on the grounds the foreclosure was fraudulent. Even more serious than this, investors who bought "mortgage backed securities" are beginning to file claims of fraud against the banks, arguing that these securities were never properly collateralized in the first place. These investors want 100% of their money back, which would lead to claims of trillions of dollars against the big banks.
There are therefore two areas of jeopardy for the big banks. First, investors who bought securities that were supposedly collateralized by mortgages can claim they were victims of fraud, and demand their money back. This means that the big banks will become direct mortgagee not only for the properties in their portfolio now, but for millions more that they must buy back. This could constitute much more than half of all homes/mortgages in the US, of which over 3% are now already in default.
The second problem is that the mortgages in many of these cases may now be deemed legally invalid. This doesn’t mean the homeowner can live for free forever in their home if they default; it just means that the banks have to pursue the defaulting homeowner as it would someone who defaults on an unsecured credit card loan. Credit card defaults are usually absorbed 100% by the banks since there is no collateral to posses and sell. Credit cards therefore carry interest rates as high as 30% p.a., compared to mortgage rates of around 5%, even though the term of a mortgage is much longer. If mortgages were unsecured, they would be priced much closer to 30% p.a. to ensure that the banks made enough money on their mortgage portfolios after taking 100% of the loss on defaults. This would make homeownership virtually unaffordable for any American.
Are You Incredulous Yet?
What is beginning to unfold before our eyes is a situation which can only be comprehended with jaw-dropping incredulity. For at least ten years the large US banks have been selling a product – the residential home mortgage – with a fatal legal flaw that renders it uncollateralized. The product should have been priced like any other unsecured consumer loan – at rates at least triple the actual mortgage rate in the US.
There are something like $6 trillion of mortgages extant in the US, among over 55 million borrowers. Most of these mortgages have been grossly underpriced, and at existing default rates, there is simply not enough equity capital in the banking system – and not enough profit being generated by mortgage portfolios - to absorb current losses. Even if you assume the banks don’t have to take a full 100% loss on a home default, and that some portion of the home sale after bankruptcy will eventually trickle down to the bank as a general creditor, the Too Big To Fail banks are doomed to insolvency.
Dragged into this situation automatically is the federal government. The US Treasury owns Fannie Mae and Freddie Mac, which are already insolvent and must turn to the government for capital infusions every quarter just to cover the losses on their existing home mortgage portfolios. These institutions are now facing much higher loss rates on their own portfolios of trillions of dollars of home mortgages. You may throw into this picture also the Federal Reserve System, which chose to buy over one trillion dollars of mortgage backed securities from the banks in 2008 and 2009, and which is itself technically insolvent if this portfolio turns out to be uncollateralized, as is becoming increasingly likely.
With increasing desperation, banks along with their enablers in Washington are going to try to jerry-rig a way out of this problem. Unfortunately for the banks, ex post facto laws are strictly forbidden by the Constitution, which is now being treated with new-found reverence by the Congress. It may be impossible to construct a law that solves problems like this that already exist. Perhaps the banks will get lucky, and some courts will begin to find in their favor, though that is certainly not the trend at the moment.
Maybe the US Supreme Court will accept the banks’ argument that the securitization process in itself established a valid foreclosure claim even though mortgages were not properly assigned as required by state laws. This, however, would require the Supreme Court to make up a legal doctrine out of the blue (as the banks have done), thereby overturning all state laws and court rulings going back well over 100 years. Only a Supreme Court bought and paid for by bank lobbyists, and willing to prostitute itself publicly to its paymasters, would issue such a ruling.
This means that the likely progression of events – the path we are now on - will lead to a near complete collapse of the housing market, because the big banks and the two government enterprises responsible for supporting the housing market will be fatally crippled wards of the state. The US government itself, including the Federal Reserve, will be equally crippled. Try as you might, you will find no words in the Bible – no phrases applicable to The Flood or to the destruction of whole cities at the hands of a vengeful God – that appropriately capture the financial gravity of this situation. But if we are forced to come up with some metaphor, Financial Armageddon will have to do.
Judges Berate Bank Lawyers in Foreclosures
by John Schwartz - New York Times
With judges looking ever more critically at home foreclosures, they are reaching beyond the bankers to heap some of their most scorching criticism on the lawyers. In numerous opinions, judges have accused lawyers of processing shoddy or even fabricated paperwork in foreclosure actions when representing the banks.
Judge Arthur M. Schack of New York State Supreme Court in Brooklyn has taken aim at an upstate lawyer, Steven J. Baum, referring to one filing as "incredible, outrageous, ludicrous and disingenuous." But New York judges are also trying to take the lead in fixing the mortgage mess by leaning on the lawyers. In November, a judge ordered Mr. Baum’s firm to pay nearly $20,000 in fines and costs related to papers that he said contained numerous "falsities." The judge, Scott Fairgrieve of Nassau County District Court, wrote that "swearing to false statements reflects poorly on the profession as a whole."
More broadly, the courts in New York State, along with Florida, have begun requiring that lawyers in foreclosure cases vouch for the accuracy of the documents they present, which prompted a protest from the New York bar. The requirement, which is being considered by courts in other states, could open lawyers to disciplinary actions that could harm or even end careers.
Stephen Gillers, an expert in legal ethics at New York University, agreed with Judge Fairgrieve that the involvement of lawyers in questionable transactions could damage the overall reputation of the legal profession, "which does not fare well in public opinion" throughout history. "When the consequence of a lawyer plying his trade is the loss of someone’s home, and it turns out there are documents being given to the courts that have no basis in reality, the profession gets a very big black eye," Professor Gillers said.
The issue of vouching for documents will undoubtedly meet resistance by lawyers elsewhere as it has in New York. Anne Reynolds Copps, the chairwoman of the real property law section of the New York State bar, said, "We had a lot of concerns, because it seemed to paint attorneys as being the problem." Lawyers feared they would be responsible for a bank’s mistakes. "They are relying on a client, or the client’s employees, to provide the information on which they are basing the documents," she said.
The role of lawyers is under scrutiny in the 23 states where foreclosures must be reviewed by a court. The situation has become especially heated for high-volume firms whose practices mirror the so-called robo-signing of some financial institutions; in these cases, documents were signed without sufficient examination or proper notarization. In the most publicized example, David J. Stern, a lawyer whose Florida firm has been part of an estimated 20 percent of the foreclosure actions in the state, has been accused of filing sloppy and even fraudulent mortgage paperwork. Major institutions have dropped the firm, which has been the subject of several lawsuits, and 1,200 of the 1,400 people once at the firm are out of work.
The Florida attorney general’s office is conducting a civil investigation of Mr. Stern’s firm and two others. "There’s been no determination" in a court that Mr. Stern or his employees "did wrong things, said Jeffrey Tew, Mr. Stern’s lawyer, adding that the impact was nevertheless devastating. "There are groups in society that everybody likes to hate," Mr. Tew added. "Now foreclosure lawyers are on the list."
Such concerns have, in recent months, brought a sharp focus on activities in New York State, and in particular on the practice of Mr. Baum, a lawyer in Amherst, outside Buffalo. Judges have cited his firm for what they call slipshod work that, in some cases, was followed by the dismissal of foreclosure actions.
One case involved Sunny D. Eng, a former manager of computer systems on Wall Street. He and his wife, who has cancer, stopped paying the mortgage on their Holtsville, N.Y., home after Mr. Eng’s Internet services business foundered. The mortgage was originally held by the HTFC Corporation, but the foreclosure notice came from Wells Fargo, a bank that the Engs had no relationship with. They hired an experienced foreclosure defense lawyer on Long Island, Craig Robins. The court ultimately ruled in favor of Mr. Eng. "You want to call it God, you can call it God," Mr. Eng said. "You want to call it luck, you can call it luck. We just followed the system, and thank God the system worked."
Through a spokesman, Mr. Baum said, "The foreclosure process in New York State is extremely complex and subject to extensive judicial review. We believe this review respects the due process of anyone who challenges a foreclosure. Consumer activists and attorneys representing homeowners have their own agenda in this process, including degrading the legal work we conduct on behalf of our clients by using terms like ’foreclosure mill,’ which I find personally and professionally insulting." He added, "What is important now is that all parties attempt to work together to resolve issues amicably. The barrage of accusations and litigation does little to help the underlying problems."
Cases across the nation like Mr. Eng’s have led New York’s judicial system to take a hard look at the 80,000 pending foreclosures in the state and demand that the paperwork be sound, said the state’s chief judge, Jonathan Lippman. "Knowing what we know, our only option — at least from my perspective — is to turn to the lawyers who are officers of the court and say, ’You’d better go to your clients and find out if these cases are real,’ " he said.
The court devised a two-page affirmation to be signed by lawyers in foreclosure actions saying they had reviewed the documents and had "confirmed the factual accuracy" of any allegations with the clients. Ann Pfau, deputy chief administrative judge for New York State, who has worked directly with the state bar to carry out the plan, said, "We need to know that this is a court process that has some integrity." Judge Pfau said, "If you can’t get good information, you shouldn’t be filing the cases in the first place."
To address some lawyer concerns, the judiciary issued a modified version of the affirmation in November but said that the alterations were minor. In the end, the lawyers are vouching for their filing, Judge Pfau said. "They are absolutely still on the hook." While lawyers are being implicated as part of the problem, they should also be part of the solution, said Stephen P. Younger, the president of the New York State Bar Association, which has not taken an overall position on the foreclosure matter. Foreclosure defense lawyers, he noted, have led court proceedings to throw out flawed cases. "The real problem is that there are thousands and thousands of people who are unrepresented by lawyers," Mr. Younger said.
Downturn's Ugly Trademark: Steep, Lasting Drop in Wages
by Sudeep Reddy - Wall Street Journal
In California, former auto worker Maria Gregg was out of work five months last year before landing a new job—at a nearly 20% pay cut.
In Massachusetts, Kevin Cronan, who lost his $150,000-a-year job as a money manager in early 2009, is now frothing cappuccinos at a Starbucks for $8.85 an hour.
In Wisconsin, Dale Szabo, a former manufacturing manager with two master's degrees, has been searching years for a job comparable to the one he lost in 2003. He's now a school janitor.
They are among the lucky. There are 14.5 million people on the unemployment rolls, including 6.4 million who have been jobless for more than six months. But the decline in their fortunes points to a signature outcome of the long downturn in the labor market. Even at times of high unemployment in the past, wages have been very slow to fall; economists describe them as "sticky." To an extent rarely seen in recessions since the Great Depression, wages for a swath of the labor force this time have taken a sharp and swift fall.
The only other downturn since the Depression to see similarly large wage cuts was the 1981-82 recession. But the latest downturn is already eclipsing that one. Unemployment has stood above 9% for 20 straight months—longer than the early 1980s stretch—and is likely to remain above that level for most of 2011, putting downward pressure on wages. Many laid-off workers who have found new jobs are taking pay cuts or settling for part-time work when they get new ones, sometimes taking jobs far below their skill levels.
Economists had wondered how far this dynamic would go in this recession, and now the numbers are starting to show it: Between 2007 and 2009, more than half the full-time workers who lost jobs that they had held for at least three years and then found new full-time work by early last year reported wage declines, according to the Labor Department. Thirty-six percent reported the new job paid at least 20% less than the one they lost.
The severity of the latest downturn makes it likely that many of the unemployed who get rehired will take wage cuts, and that it will be years, if ever, before many of their wages return to pre-recession levels, says Columbia University labor economist Till von Wachter. "The deeper the recession, the lower the wage you're going to get in the next job and the lower the quality of your next job," he says. While difficult for individual workers, lower wages can make U.S. industries and companies overall more competitive and allow employers to hire more workers than they would otherwise. In the long run, that may make the nation more prosperous.
South Seas Island Resort, which employs about 300 in Captiva, Fla., cut jobs during the downturn, but has now begun adding staff. "Right now I view this as an employer's market," says Rick Hayduk, managing director, who says the resort is attracting senior people at lower salaries than before. "The past 24 months have taken a toll on a lot of individuals," he says. "I think they abandoned their hopes to receive compensation similar to what they did when they lost their jobs. We have been able to reevaluate some of our starting wages." The upshot: The resort will keep labor costs flat this year, even as revenue picks up and the resort selectively adds workers.
Overall, U.S. wages continue to grow, but at a slow pace. Wages and salaries for civilian workers were up 1.5% before adjusting for inflation in the 12 months ended in September, according to the Labor Department's comprehensive Employment Cost Index, which compares wages in the same jobs and doesn't reflect wages of people switching careers. Over the same period, consumer prices rose 1.1%.
Ms. Gregg, 45, the California auto worker, says at least she had a chance to prepare for tougher times. She spent two decades working for New United Motor Manufacturing Inc., a Fremont, Calif., joint venture between General Motors and Toyota, before the plant closed in April. The factory had warned workers seven months earlier that it was closing. "I was preparing myself beforehand and getting all my bills lowered," she says.
She considered pursuing her dream of starting a small business, perhaps an ice-cream parlor. She contemplated going back to school to build on her associate's degrees. But she says that with her income cut from $1,200 a week at the auto plant, where she was a technician, to $450 in unemployment checks, she couldn't afford it, in part because she was supporting her daughter who had just entered college. She recently joined a start-up energy technology firm. The pay is $28 an hour, $6 less than in her prior job, but she jumped at it. Though she's already cut back on travel, eating out and shopping to adjust, she wonders how she might make up the wage gap over time. "I do want to make more money," Ms. Gregg says. "The only way I'm going to get back to that is if I go back to college and get more of an education."
Mr. von Wachter, the Columbia economist, has studied three decades of Social Security data in order to track the paychecks of workers from the 1981-82 recession who experienced sudden mass layoffs. Those workers saw their earnings drop 30% on average compared to similar nondisplaced workers. Even after 15 to 20 years, those workers lagged behind: Their wages were still 20% lower than their counterparts who didn't lose their jobs in the original layoffs, according to his research.
A key part of earnings losses, Mr. von Wachter and his fellow researchers found, comes from the fact that workers accumulated skills over a decade or two that may be outdated and not garner the same wages after a downturn. And then instead of gaining new skills for a higher-paying job, they often take what they can get at a lower wage and stop their job hunts. "Given that the process of recovery can take so long, it's important to make people who were unemployed realize that if they really want to recover they may need to stay in the game for a long time, and perhaps consider a switch in careers," Mr. von Wachter said.
Mr. Szabo, the 53-year-old Wisconsin janitor, switched fields. With a MBA and another master's degree in organizational communications, he says he had worked his way up to training manager in a nearly 26-year career at Briggs & Stratton Corp., a Milwaukee-based engine maker, when he lost his job in a round of layoffs in 2003. The company didn't return calls seeking comment. Mr. Szabo says he keeps an Excel spreadsheet tracking his job search. By early 2004, he says he had applied for 750 jobs. A year later, it topped 1,000. Since then, he says he sent out 1,000 more resumes as he grew less picky about the location and position.
In late 2005, with his severance long exhausted, a friend bet him that he couldn't get one of two openings as a janitor in the Wauwatosa School District, earning $9 an hour. He got the job and has since moved up to a nighttime janitor position, the lone man supervising school buildings in the evenings. In his old job, Mr. Szabo says he earned $48,000 plus overtime—as much as $63,000 in total in 2000. His new job pays $34,000 a year. "It's very hard work. I never dreamed I would be doing it," he says. "But I have to pay the bills."
Mr. Szabo still says he wants to go back to work in manufacturing, in the field of training and development, and continues sending out resumes. "I would love to get back to my field," he says. "Am I prepared to stay where I am? Yes, if that's where God has me. I'm making my $17 an hour and I'm encouraging all my friends who are making zero to keep looking. They may end up with something like what I've got. Seventeen is much better than zero."
Research shows that children of workers who lose jobs and go back to work at lower wages appear to suffer from lower wages, too. In a 2008 study, a group of economists tracked the wages of 60,000 father-child pairs from 1978 to 1999. Children whose fathers went through mass layoffs in the 1982 recession ended up with 9% lower earnings than similar children whose fathers didn't experience the job cuts. The impact was concentrated in children from lower-income families. "When someone at the bottom of the income distribution loses their job, the loss of income is much more likely to involve losing things that matter for the family to sustain itself," says Marianne Page of the University of California, Davis, one of the researchers.
Part of the wage adjustment after a downturn rests on how much workers are willing to give up. After seven years working in regional sales in Southern California for Diebold Inc., a manufacturer of ATMs and security systems, Virginia May says she was earning $30 an hour plus bonuses when she and 800 colleagues lost their jobs in early 2008. She took a seven-month stint with the Census Bureau last year, earning $25 an hour, but struggled to find the same wage anywhere else. Ms. May says she turned down 10 job offers out of 58 interviews. One of them was as an office manager, similar to the job she had at Diebold, paying $10 an hour. "When it comes down to it, they want to offer us peanuts to work," she said last fall.
Ms. May, 63 years old and never unemployed before the latest downturn, runs a group for unemployed professionals in the Los Angeles area. "The first thing we teach all of our members is: 'Don't accept the first offer, always go into negotiation with them,'" she says. "Some of the people are afraid to, because the market is so tough out there." After cashing out half of her $90,000 retirement account to get by, Ms. May had started eyeing part-time jobs and wages at $20 an hour or less. But she pulled through. A few days after Christmas, just as her unemployment benefits ran out, she got a job as an office administrator in California. Her pay, she says, "is more than I expected" and "just a little above what I was making two years ago."
Others, like Mr. Cronan, the Starbucks barista in Massachusetts, take whatever work is available. He lost his job in January 2009 at a Boston money-management company, where he says he earned a $100,000 salary and $50,000 annual bonus in recent years. Mr. Cronan, 40, enrolled in adult-education courses and tried to wait out the downturn as he saw other people with MBAs take entry-level, $40,000-a-year jobs. But once his 19-month severance period ended, Mr. Cronan needed health insurance and decided he couldn't limit his search to only his field. So, in August, he got a job at his local Starbucks—the one he'd visited daily since losing his job—even though he expects to leave once he finds employment in his field.
He says he's now earning $8.85 an hour for about 38 hours a week of work. The Arlington, Mass., resident is continuing his job search with new expectations for how much he'll earn when finance jobs in his specialty, currency, come back. "If I'm offered $75,000, that's a lot more than I'm making now," Mr. Cronan says. "It's a realistic approach. You can't live looking in the rearview mirror."
The Amazing Collapse Of The Working Teen
by Joe Weisenthal - Business Insider
Despite the anemic pace of job creation, December saw a sizable decrease in the headline unemployment rate thanks to a decline in the workforce.
A lot of that discussion focused on folks going into early retirement or giving up the search for jobs, but there's another factor, which is the disappearance of teens in the workforce.
Mike O'Rourke of BTIG has a good breakdown of what this looks like:
In examining the participation data, the most notable decrease in participation has been among Teens (Chart 2). Teen participation has been in a long term decline since it peaked at 59.3% in 1978. In January 2000 it was 52.3%. In December 2007 when the recession started, it was 41.3%. Today, it is 34.3%. As noted earlier, a lower participation rate usually helps push the unemployment rate lower. During this Recession, teen unemployment hit a record of 27.1% and currently stands at 25.4%. This is remarkably high considering the way the participation rate among teens has collapsed. If the participation level of teens today was the same as it was at the start of the Recession, or 41.4%, the Unemployment Rate among teens would be approximately 45%.
The next question is how do these teen participation rates fit into the overall participation and Unemployment? Despite only being 4.5% of the Labor Force at the start of the Recession, they are responsible for nearly a third of the 170 basis point drop in Total Labor Force participation. If teen participation was at December 2007 levels, the Labor Force participation rate would be 50 basis points higher at 64.8%, and the headline Unemployment Rate would be 10.1%. Teens lost approximately 1.56 Million jobs from December 2007 through December 2010, which equals 22% of the 7 million jobs the Household Survey has yet to recover since the Recession started. If teen Labor Force participation held the level of 41.4% from December 2007, there would be 2.6 million unemployed teens. Teens represent just over 3% of employed persons, a record low (the 1973 peak was 8.7%).
As investors monitor the decline in the Unemployment Rate, they have to balance the decline in the Labor Force participation rate. The 50 basis points Teens represent within the 170 basis point drop is a notable influence. One must consider what influence those lost jobs and participants have on the economy. Not to minimize the travails of youth, but teens are generally in a position to fall back on their family or focus more on education. Since the overall participation rate peaked in 2000, there is potential a modest structural shift to lower participation was underway. In the end, the contraction of Labor Force participation is still a negative. Considering the origin of a large portion of the contraction, it may not be as influential on the economy as the headline number indicates.
Spinning Unemployment Figures in a Collapsing Empire
by Paul Craig Roberts - Global Research
The Bureau of Labor Statistics (BLS) reported Friday that the economy gained only 103,000 new jobs in December--not enough to keep up with population growth--but the rate of unemployment (U.3) fell from 9.8% to 9.4%. If you are confused by the report, you are among the many.
In truth, what fell was not the number of unemployed people but the number of unemployed people who are actively looking for work. Those who have become discouraged and have ceased looking for work are not considered to be in the work force and are not counted as unemployed in the U.3 measure. The unemployment rate fell because discouraged workers increased, not because employment rose.
The BLS counts short-term discouraged workers (less than one year) in its U.6 measure of unemployment. That unemployment rate is 16.7%. When statistician John Williams (shadowstats.com) adds the long-term discouraged, the US unemployment rate as of December 2010 was 22.4%.
The question to ask yourself is: why does the media focus on the unemployment measure that does not count any discouraged workers? The answer is that the U.3 measurement only counts 42% of the unemployed and makes the situation appear to be a lot better than it is. Where are the 103,000 new jobs? As I have reported for years, the jobs are in non-tradable domestic services: waitresses and bar tenders, health care and social assistance (primarily ambulatory health care services), and retail and wholesale trade.
Today the United States has only 11,670,000 manufacturing jobs, less than 9% of total jobs. Yet, despite America’s heavy dependence on foreign manufactures and foreign creditors, the idiots in Washington think that they are a superpower standing astride the world like a colossus. John Williams reports that "the level of payroll employment still stands below where it was a decade ago, despite the U.S.population growing by more than 10% in the same period. The structural impairments to U.S. economic activity continue to constrain normal commercial activity, preventing any meaningful recovery in business activity."
Another way of saying this is that American corporations have taken American jobs offshore and given them to the Chinese. So much for big business patriotism. Williams also reports that, unless it is finagled, next month’s BLS benchmark revision of payroll employment data will lower the level of previously reported employment by more than 500,000.
Federal Reserve chairman Ben Bernanke used his testimony before the Senate Budget Committee last Friday to warn that the U.S. government must get its budget deficit under control or "the economic and financial effects would be severe." Here Bernanke is acknowledging that the Federal Reserve cannot indefinitely print money in order to finance wars and bailouts of the mega-rich.
But how is the government to get its budget under control? The U.S. government, regardless of political party or president, is committed to American hegemony over the world. The Congress has just passed the largest military budget in history, and there is no indication that any of America’s wars and military occupations are near an end.
The financial crisis is not over, with more foreclosures and more losses for the financial sector that will result in more taxpayer bailouts for those "too big to fail." John Williams says that the double-dip is already happening, just disguised by faulty statistics, and that the deficit implications are horrendous and are likely to result in hyperinflation as the Federal Reserve will have to monetize the otherwise un-financeable deficits.
The dollar is also in danger, its role as reserve currency undermined by the Federal Reserve’s creation of more and more dollars. Temporarily, the dollar is buttressed by the grief that Wall Street’s sale of fraudulent derivative financial instruments to Europe has caused the euro.
The Republicans will try to destroy Social Security and Medicare in order to pay for wars and bailouts. If Americans are capable of realizing that they are threatened on a much greater level by the Republicans’ evisceration of the social safety net than they are by terrorists, the Republican assault on what they call "the welfare state" will fail.
The fallback target will be private pensions, assuming any survive plunder by the Wall Street investment banks. Pension funds could be required to invest in Treasury debt or they could face a levy. In the Clinton administration, Assistant Secretary of the Treasury Alicia Munnell proposed confiscating 15% of all pension assets on the grounds that they had accumulated tax free. Certainly Washington will steal Americans’ pensions, just as Washington has stolen Americans’ civil liberties, in order to continue the empire’s wars of hegemony.
Increasingly, the rest of the world views America as the single source of its financial and political woes. While the superpower massacres Muslims in the Middle East and Central Asia, people in the rest of the world have learned from WikiLeaks that the U.S. government manipulates, bribes, threatens, and deceives other governments in order to have those governments serve the U.S. government’s interest at the expense of the interests of their own peoples.
The American Imperial Empire rests on puppet governments that are increasingly distrusted and hated by the peoples under their rule. Like the Soviet Union’s Eastern European empire, the American Empire is ruled not directly but through puppet states.
Puppet governments are caught between the empire’s power and the power of the local population. To the extent that Europeans have a moral conscience, they will find America’s foreign policy increasingly repugnant. To the extent that Muslim solidarity grows, the Muslim puppet governments that support America’s and Israel’s massacres of Muslims will find themselves threatened from within.
The American Empire is on the rocks, despite its vast arsenal of nuclear weapons and its control over the foreign and domestic policies of its subservient puppet states in Western and Eastern Europe, the United Kingdom, Canada, Australia, parts of Africa, the Middle East, Japan, Thailand, Indonesia, the Baltic states, Georgia, Kosovo, Mexico, Central America, Columbia, and, no doubt, others.
A country that is the font of war and oppression, whose dominance rests on the weak reed of puppet states, and whose economy is collapsing will not long remain dominant.
'Japan is a nuclear bomb strapped onto the chest of the global economy'
by Kevin Crowley - Bloomberg
Hugh Hendry is a man worried about the future. Although the hedge-fund manager beat more than 80 percent of his peer group rivals in 2010, Hendry laments that he’s part of an oppressed minority -- and likens the threat of hedge-fund regulation to the plight of the Roma migrants expelled from France last summer by President Nicolas Sarkozy.
"Social mood is hardening, changing, deteriorating: We see that not just in hedge funds; we see that in the very polite, previously libertarian societies," says Hendry, dressed in an open-necked gray shirt and light-blue linen jacket at his Eclectica Asset Management LLP in London. "Hedge funds are a minority. Guess who else is a minority? People from overseas." Hendry, gesturing for emphasis, is just getting started on his defense of the downtrodden, Bloomberg Markets magazine reports in its February issue.
"My little French friend Sarkozy, he’s picked on the Roma gypsies, the minorities," he says. "This is the beginning of a movement, which, if left unchecked, has very worrisome implications."
Provocative statements and aggressive positions are Hendry hallmarks. The 41-year-old fund manager says he’s proud to have profited from trading interest-rate options after the near collapse of the European and U.S. banking systems. His chaos play triggered a public spat with European Union lawmaker Poul Nyrup Rasmussen, a former Danish prime minister, who is driving efforts to regulate hedge funds. "Mr. Hendry, you can say farewell," Rasmussen said in a U.K. television debate on the Greek sovereign-debt crisis in March 2010. "We are going to stop your attacks on ordinary people."
The fund manager dismissed Rasmussen as one of Europe’s "champagne socialists" determined to penalize success. "The truth today has become unpalatable, and these jokers don’t want to hear it," Hendry said in a riposte to Rasmussen, who is president of the Party of European Socialists. "They are now afraid because the magnitude of the problem confronting Greece is now greater than these guys and their ability to respond to it."
Hendry’s Eclectica Fund, which bets on broad global macroeconomic indicators, gained the notice of investors in 2008 when it posted a 31.2 percent return, in a year when the Standard & Poor’s 500 Index dropped 38.5 percent. Hendry’s fund was up 9.6 percent for the year to Oct. 31, besting 83 percent of its rivals in the annual Bloomberg Markets ranking of global macro hedge funds. (Hendry’s fund wasn’t big enough to be included in the rankings for mid-sized funds.) As of Nov. 30, 2010, the $233 million Eclectica Fund had climbed 119.3 percent since its inception in 2002.
Now, Hendry is focusing his rhetoric -- and investing strategy -- on a bigger target: China. He’s betting that growth in the world’s No. 2 economy will collapse because of rampant real-estate speculation, sending shock waves through Asia and beyond. The problem, Hendry says, is that China’s gross domestic product growth isn’t matched by wealth creation at home. In his doom-laden scenario, a plunge in Chinese stock prices and property values will be exacerbated by a softening demand for the country’s exports, triggering an extended period of global deflation and slower growth.
Hendry, a combative Scotsman, is betting against China in an unusual way, by snapping up credit-default-swap protection on bonds issued by Japanese industrial companies such as JFE Holdings Inc. and Nippon Steel Corp., which have benefited from China’s construction boom. Hendry is convinced that Japanese banks are selling such protection too cheaply. Nippon Steel CDSs, for example, cost 57.25 basis points on Jan. 7, about a quarter of their high of 215 basis points on Feb. 17, 2009. (A basis point is 0.01 percentage point.)
"I see Japan as a nuclear bomb strapped onto the chest of the global economy," Hendry says. "They’ve got uranium -- which is, they sell credit protection: CDSs. I’m the other side of that." If the Japanese corporate bond CDS spreads widen to equal or surpass their record highs of 2009, Hendry’s fund could rise by as much as 50 percent, he says.
A slump in the price of Japanese bank shares shows that Hendry may be on to something. The Topix Banks Index, which tracks Japanese banks, sank on Nov. 1 to its lowest level since at least 1983, when Bloomberg first tracked the data, as demand for loans dropped in a sluggish economy. The index has trailed the benchmark MSCI World Bank Index since mid-2009. Hendry promoted his downbeat view on China by traveling to that country’s major cities with a video camera in the spring of 2009. His report, in which he pointed out numerous empty skyscrapers, has been viewed nearly 100,000 times on YouTube.com.
Anthony Bolton, the U.K. money manager who started the Fidelity China Special Situations Fund in April 2010, says he isn’t losing any sleep over Hendry’s dire predictions. "I am not sure it is going to be all plain sailing in China," says Bolton, whose fund’s share price climbed 16.3 percent from its inception to Jan. 7. "Hugh Hendry is worried about the bad debts from local governments and bad debts from other areas and the fact that some of the infrastructure spend is going into projects that won’t see a return for many years. These are all challenges, but I don’t think they overweigh the bull points." Bolton says his fund’s performance is driven by underpriced small- and medium-sized Chinese companies that will benefit from a shift toward domestic consumption.
Profiting From Disaster
Hendry has a track record of profiting from disaster with Eclectica, which bets on trends such as currency swings and interest-rate movements. One of Hendry’s major trades in 2010 was to purchase options on interest-rate swaps that bet on the future course of the Bank of England’s benchmark lending rate. The value of those contracts should rise if the market expects that the central bank will keep borrowing costs at or near historic lows.
Those positions helped Eclectica gain 15.3 percent in 2010 through Aug. 31, ranking it No. 8 among 235 global macro funds in that period, according to data compiled by Bloomberg.
Hendry’s interest-rate positions became less attractive near year-end, when the market bet that rate rises were more likely after the U.S. Federal Reserve initiated a second round of quantitative easing and inflation rose in Britain. "It’s not our year; nothing profoundly bad has happened," said Hendry in mid-December, projecting that his total 2010 gain would be about 5 percent.
Hendry isn’t always right. In 2006 and 2007, before the financial crisis, his flagship hedge fund underperformed the HFRX Macro Index, a benchmark of rival funds. In 2009, when funds tracking the S&P 500 returned about 23 percent, Hendry lost 8 percent -- his worst performance since the fund’s inception, although the HFRX Index fell 8.8 percent in the same period.
"In a way, he’s real hedge material," says Jacob Schmidt, CEO and founder of London-based Schmidt Research Partners Ltd. "Hedge-fund material should not be mainstream -- it should be different. That explains his performance. In difficult markets, you’re getting fantastic performance. In good markets, you might get disappointing performance."
The son of a truck-driver father and a mother who worked as a secretary, Hendry was born on the south side of Glasgow, close to the notorious Gorbals public housing district. Hendry planned to escape his poor upbringing by becoming an accountant and studied the subject at the city’s University of Strathclyde. Upon graduation, Hendry spent eight years working as an analyst for Baillie Gifford & Co., an Edinburgh-based pension fund manager. He moved to London in 1998 after getting a job as an equities analyst with Credit Suisse Group AG. A year later, he met Crispin Odey, who ran his own hedge fund in London’s Mayfair neighborhood.
Bucking the Herd
The two made for an odd pair. The pinstripe-wearing Odey went to Harrow School, which counts Winston Churchill among its alumni, and was a graduate of the University of Oxford’s Christ Church College. The state-educated Hendry shuns ties and often wears khakis. Yet, together they found a common avocation: profiting from bucking the herd.
"He taught me how to manage money," Hendry says of Odey. "More than that, he taught me how to misbehave. Misbehavior is all about curiosity, how you invoke and think about change, which is very necessary in the management of money." In 2002, Hendry set up his Eclectica hedge fund as a side business. He parted company with Odey in 2005. "For the last five years, I’ve been working with myself," Hendry says in a September interview. "I don’t think anyone else would choose to work with me."
He drives a G-Wiz electric car to his loft-style office in Bayswater, a district of small shops and cheap tourist hotels 2 miles (3 kilometers) from Mayfair. Hendry turned bearish on the euro following the Irish government’s pledge on Sept. 30, 2008, to guarantee the debt of domestic banks. His fund later took positions correctly anticipating a drop in the euro’s value against rival currencies such as the Australian dollar and the yen.
In March 2009, Hendry tangled at a London debate with Liam Halligan, chief economist at Prosperity Capital Management UK Ltd., who argued that Bank of England pump priming would trigger inflation in Britain. "I know that your head is firmly lodged somewhere," Hendry said, asserting that the U.K. was entering a period of deflation.
Since then, the U.K. consumer price index has remained above the Bank of England’s 2 percent target, supporting Halligan’s view that inflation was on the rise. "Hugh is very smart and is always worth listening to -- even when he turns out to be wrong," Halligan says. Hendry frequently airs his opinions on British TV, where he has tangled with the likes of Nobel economic laureate Joseph Stiglitz and Rasmussen.
In February 2010, Stiglitz predicted on the British Broadcasting Corp.’s Newsnight program that the major European countries would calm market concerns about a Greek default by standing behind the country. "Hello?" Hendry replied. "Can I tell you about the real world?"
A month later, in his televised clash with Rasmussen, Hendry dismissed European lawmakers who want to regulate hedge funds and private equity firms. "Now they have to apportion blame elsewhere," Hendry said. "I am a convenient scapegoat for Greece breaking all of the rules." The euro lost 9 percent in 2010 against a basket of currencies of its major trading partners.
Hendry’s resolute defense of profiteering at a time of crisis still angers Rasmussen. "Hedge fund managers need to look outside that 20th-floor window and see that impact they can have on ordinary people’s lives," he says. "Being allowed to openly speculate on a sovereign state’s weakness only accelerates that weakness." Schmidt says Hendry’s big mouth may scare away potential investors and is one explanation why Hendry now manages about $500 million across three funds -- about half of the money he handled for Odey. "To some extent, the public profile does not help him," Schmidt says, noting that Hendry’s performances on TV can reveal his trading positions.
Hendry’s bets on Japan have a time horizon of between two and five years, indicating that he expects China to crash sometime before 2015. Hendry says investors who have been dazzled by China’s economic growth ignore the country’s problems in creating individual wealth.
Veteran investors in Asia disagree with Hendry’s gloomy analysis. "It may be a painful adjustment, but in the near term there is no danger of an implosion in China," says Marc Faber, the Hong Kong-based investment adviser and fund manager who publishes the Gloom, Boom & Doom report. "If I was negative about China and the credit implosion in China, I would short the Chinese banks."
Hendry says he avoids direct bets on Chinese lenders because of the potential for unlimited losses. He favors trading options in the credit markets where his downside is limited to the premium he pays for holding an option. Hendry says his positions will result in no more than a 15 percent loss for his fund if they go sour. Having ridden Europe’s sovereign-debt crisis in early 2010, Hendry says he won’t be joining the speculators seeking to profit from the euro’s current troubles.
"Because the euro problem is known, the cost of insuring against it is very high," he says. "If I defray into Asia, I think I’m buying something very similar but at 80 to 90 percent less. If it all goes belly up, I’m going to make 50 percent." And if it somehow comes out fine, Hendry will be ready to turn his attention to some other part of the world where the lurch toward chaos offers an outspoken fund manager a chance to make a profit.
94% Of The S&P 500's Performance In 2010 Was From Gains On Just The First Trading Day Of Each Month
by Tyler Durden
And now for today's stunning mutual fund first of the month-day statistic: David Rosenberg notes that "134 points of the 143 points that were racked up in 2010 occurred in the first trading day of each month. That is truly remarkable ? 94% of the entire year boiled down to 12 sessions. And what do you know? 2011 started with a 1.1% pop and has sputtered since."
Has trading for humans only been relegated to just 12 times a year when mutual funds invest their previously month's capital allocation in the stock market? Statistically, the trade is to go long at closing on the last trading session of any given month, hold long through next day's closing, and short the remainder of the month.
From David Rosenberg:One has to really wonder about a stock market (talking about the S&P 500 here) in which 134 points of the 143 points that were racked up in 2010 occurred in the first trading day of each month (see The Trader on page M3 of Barron’s). That is truly remarkable ? 94% of the entire year boiled down to 12 sessions. And what do you know? 2011 started with a 1.1% pop and has sputtered since.
It is truly the nuttiest thing ? the best days last year were the first day of each month (save for June and July) and then after that there were practically no crumbs to nibble on: These are the point changes for the first trading day of each month in 2010, which totals 134 points (as we mentioned above): December +26 points; November +1 point; October + 5 points; September +31 points; August +24 points; July –3 points; June -19 points; May +16 points; April + 9 points; March +11 points; February +15 points; and January +18 points.
Now look at 2011 ? +14 points to kick off the month and year, to close at 1,271.87, and here we are today, after a supposedly ripping ISM and ADP set of numbers, and as of January 7, the S&P 500 is sitting at 1,271.50. Hope you didn’t decide to get in on the second day.
As for bond yields, the nice backup in December, as was the case a year earlier, has set us up again for a 2011 of decent returns. After a bit of a struggle at the onset, we have the yields across the U.S. Treasury curve out to the 5-year maturity (very nice 10 basis points rally there on Friday too), lower now than they were at the end of 2010. The 10-year note yield has also rallied nicely after the opening day selloff. Ignore the masses and stay the course. Bonds still offer decent value with the long Treasury yield now nearly 270 basis points above the S&P 500 dividend yield (you won’t hear that discussed much on Wall Street since broker commissions are driven by stocks, not bonds).
Stress Tests For Banks Will Be Kept Secret
by William Alden - Huffington Post
Wall Street's largest firms will undergo scrutiny by the Federal Reserve in the coming months, as they submit to a new round of "stress tests," designed to gauge their financial health, the Financial Times reports.
Like the earlier set of tests, completed in 2009, these will attempt to determine whether financial companies are able to withstand another crisis. But while the results of the first tests were made public in an effort to reassure taxpayers and investors, the results of the new analysis -- which will also test whether banks are able to increase the dividends they pay to shareholders -- will be kept secret.
For the 19 financial groups under review, this will be the first time since the financial crisis that they have had to be tested simultaneously, the New York Times noted. The banks -- including Citigroup, Bank of America, Goldman Sachs, Wells Fargo and JPMorgan -- have seen regulators limit their ability to pay dividends, in the wake of the historic $700 billion taxpayer bailout.
Of particular concern to the Fed will likely be the banks' ability to weather the recent controversy in mortgage and foreclosure documents. As employees of the nation's biggest banks have admitted to botching, misplacing or even falsifying crucial mortgage paperwork, investors have been pressuring banks to buy back billions of dollars' worth of securities. As banks contend with lawsuits, losses for 11 financial firms could reach $179.2 billion, according to an estimate from Compass Point Research and Trading, in Washington.
Regulators will also attempt to determine whether banks will be able to meet new capital requirements, outlined under last year's Basel III agreement. The accords, designed to encourage regulators to force banks to bolsters their defense against losses, require that banks hold the equivalent of 8.5 percent of their assets in reserves by the end of the decade.
After the first set of stress tests, 10 banks were required to raise $75 billion, a sum that was smaller than many expected. Those tests, hailed by the Treasury, were criticized by others as an exercise in restoring complacency, at a time when the financial system still faced significant challenges.
China's credit bubble on borrowed time as inflation bites
by Ambrose Evans-Pritchard - Telegraph
The Royal Bank of Scotland has advised clients to take out protection against the risk of a sovereign default by China as one of its top trade trades for 2011. This is a new twist.
It warns that the Communist Party will have to puncture the credit bubble before inflation reaches levels that threaten social stability. This in turn may open a can of worms. "Many see China’s monetary tightening as a pre-emptive tap on the brakes, a warning shot across the proverbial economic bows. We see it as a potentially more malevolent reactive day of reckoning," said Tim Ash, the bank’s emerging markets chief.
Officially, inflation was 4.4pc in October, and may reach 5pc in November, but it is to hard find anybody in China who believes it is that low. Vegetables have risen 20pc in a month. The Communist Party learned from Tiananmen in 1989 how surging prices can seed dissent. "Inflation is a redistributive mechanism in favour of the few that can protect living standards, against the large majority who cannot. The political leadership cannot, will not, take risks in that regard," said Mr Ash.
RBS recommends credit default swaps on China’s five-year debt. This is not a forecast that China will default. It is insurance against the "fat tail risk" of a hard landing, with ramifications across Asia. The Politburo said on Friday that China would move from "relatively loose" money to a "prudent" policy next year, a recognition that credit rationing, price controls, and other forms of Medieval restraint are not enough. The question is whether Beijing has already left it too late.
Diana Choyleva from Lombard Street Research said the money supply rose at a 40pc rate in 2009 and the first half of 2010 as Beijing stoked an epic credit boom to keep uber-growth alive, but the costs of this policy now outweigh the benefits. The economy is entering the ugly quadrant of cycle – stagflation – where credit-pumping leaks into speculation and price spirals, even as growth slows. Citigroup’s Minggao Shen said it now takes a rise of ¥1.84 in the M2 money supply to generate just one yuan of GDP growth, up from ¥1.30 earlier this decade.
The froth is going into property. Experts argue heatedly over whether or not China has managed to outdo America’s subprime bubble, or even match the Tokyo frenzy of late 1980s. The IMF straddles the two. It concluded in a report last week that there was no nationwide bubble but that home prices in Shenzen, Shanghai, Beijing, and Nanjing seem "increasingly disconnected from fundamentals". Prices are 22 times disposable income in Beijing, and 18 times in Shenzen, compared to eight in Tokyo. The US bubble peaked at 6.4 and has since dropped 4.7. The price-to-rent ratio in China’s eastern cities has risen by over 200pc since 2004.
The IMF said land sales make up 30pc of local government revenue in Beijing. This has echoes of Ireland where "fair weather" property taxes disguised the erosion of state finances. Ms Choyleva said China drew a false conclusion from the global credit crisis that their top-down economy trumps the free market, failing to see that the events of 2008-2009 did equally great damage to them – though of a different kind. It closed the door on mercantilist export strategies that depend on cheap loans, a cheap currency, and the willingness of the West to tolerate predatory trade.
China is trying to keep the game going as if nothing has changed, but cannot do so. It dares not raise rates fast enough to let air out of the bubble because this would expose the bad debts of the banking system. The regime is stymied. "The Chinese growth machine is likely to continue to function in the minds of people long after it has no visible means of support. China’s potential growth rate could well halve to 5pc in this decade," she said.
As it happens, Fitch Ratings has just done a study with Oxford Economics on what would happen if China does indeed slow to under 5pc next year, tantamount to a recession for China. The risk is clearly there. Fitch said private credit has grown to 148pc of GDP, compared to a median of 41pc for emerging markets. It said the true scale of loans to local governments and state entities has been disguised.
The result of such a hard landing would be a 20pc fall in global commodity prices, a 100 basis point widening of spreads on emerging market debt, a 25pc fall in Asian bourses, a fall in the growth in emerging Asia by 2.6 percentage points, with a risk that toxic politics could make matters much worse. It is sobering that even a slight cooling of China’s credit growth led to economic contraction in Malaysia and Thailand in the third quarter, and sharp slowdowns across Asia. Japan’s economy will almost certainly contract this quarter.
Albert Edwards from Societe General said the OECD’s leading indicators are signalling a "downturn" for Asia’s big five (Japan, Korea, China, India, and Indonesia). The China indicator composed by Beijing’s National Bureau of Statistics has fallen almost as far as it did at the onset of the 2008 crash. "I remain convinced we are witnessing a bubble of epic proportions which will burst – catching investors as unawares as the bursting of the Asian bubbles of the mid-1990s. Ignore these indicators at your peril," he said.
In a sense, inflation is a crude way of curbing China’s export surpluses and therefore of resolving a key trade imbalance that lay behind the global credit crisis. If China continues to stoke inflation – and blaming the US Federal Reserve for its own errors help – there will no longer be any need for a yuan revaluation against the dollar, and the US Congress can shelve its sanctions law.
On a recent visit to a chemical plant in Suzhou, I was told by the English manager that wage bonuses for staff will average nine months pay this year. This is what it costs to keep skilled workers. His own contract is fixed in sterling, which has crashed against the yuan over the last two years. "It is a sobering experience," he said.
China may have hit the "Lewis turning point", named after the Nobel economist Arthur Lewis from St Lucia. It is the moment for each catch-up economy when the supply of cheap labour from the countryside dries up, leading to a surge in industrial wages. That reserve army of 120m Chinese migrants everybody was so worried about four years ago has already dwindled to 25m. China’s problem is that this is happening just as the aging crisis starts to bite. The number of workers will decline in absolute terms within four years. The society will then tip into precipitous demographic decline. Unlike Japan, it will become old before it is has built a cushion of wealth.
If there is a hard-landing in 2011, China’s reserves of $2.6 trillion – or over $3 trillion if counted fully – will not help much. Professor Michael Pettis from Beijing University says the money cannot be used internally in the economy. While this fund does offer China external protection, Mr Pettis notes wryly that the only other times in the last century when one country accumulated reserves equal to 5pc to 6pc of global GDP was US in the 1920s, and Japan in the 1980s. We know how both episodes ended.
The sons of Mao insist that they have studied the Japanese debacle closely and will not repeat the error. And I can sell you an ocean-front property in Chengdu.
Chinese Reserves Set for $2.8 Trillion, to Spur 'Intense Tightening'
by Paul Panckhurst, Zheng Lifei and Jay Wang - Bloomberg
China’s foreign-exchange reserves probably rose 4 percent to $2.76 trillion in the fourth quarter, adding to pressure on the central bank to drain cash from the economy and allow the yuan to strengthen. The world’s largest currency holdings jumped $112 billion after a $194 billion gain in the third quarter, according to the median estimate in a Bloomberg survey of nine economists before the central bank releases the data this week. Reserves probably climbed $361 billion for the year, compared with $453 billion in 2009.
People’s Bank of China Governor Zhou Xiaochuan ordered lenders to increase funds on deposit at the authority six times in 2010, as the yuan’s interest-rate advantage over the dollar attracted capital that stoked inflation. The yuan may gain the most among currencies in the so-called BRIC nations, rising 5.3 percent by year-end, compared with a 1 percent drop for Brazil’s real, a 0.3 percent increase for Russia’s ruble and 4.5 percent advance for India’s rupee, according to Bloomberg surveys of strategists.
"We will probably see a round of pretty intense tightening in the first half," said Ren Xianfang, an economist in Beijing for Lexington, Massachusetts-based research company IHS Global Insight. "The yuan’s appreciation in 2011, particularly in the first half, should be faster than last year." The reserves, which exceeded $1 trillion in 2006 and $2 trillion in 2009, will reach $3 trillion by June 30, according to UBS AG estimates. A weaker euro has eroded the value of China’s European debt holdings and is slowing the pace of growth. Hong Kong’s holdings stood at $268.7 billion, Singapore’s at $225.8 billion and Thailand’s at $172.1 billion, government data released Jan. 7 show.
Premier Wen Jiabao is seeking to sustain the economy’s growth to create millions of jobs each year, while preventing rising prices for homes and food from fueling social unrest. Benchmark borrowing costs for Chinese banks have risen to a two- year high, fuelling an 13 percent decline in the benchmark Shanghai Composite Index of stocks in the past 12 months.
While a stronger currency and higher rates may help tame inflation, they also risk attracting capital from abroad. In November, consumer prices rose 5.1 percent from a year earlier, the most in 28 months, food costs jumped 11.7 percent and property prices gained 7.7 percent, government data show.
The cost of insuring the government’s dollar debt for five years climbed 6 basis points on Jan. 7 to 75, up from a 2 1/2- year low of 52 basis points on Oct. 13, according to CMA prices. Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent if the government fails to adhere to debt agreements.
The yield on the 3.77 percent yuan government bond due in December 2020 advanced 3 basis points, or 0.03 percentage point, to 3.85 percent today, data compiled by Bloomberg show. The extra yield investors demand to hold the debt rather than similar maturity U.S. Treasuries has dropped to 53 basis points from 101 on Dec. 1. China’s 2.75 percent one-year deposit rate is a record 1.955 percentage points more than that of the U.S., the highest in at least 14 years, after two increases last quarter.
The yuan appreciated 2.9 percent versus the dollar since a two-year peg was relaxed in June, and non-deliverable forwards show traders are betting on a 2.6 percent increase in the coming 12 months. The currency hit 6.5896 per dollar on Dec. 31, the strongest level since 1993. The yuan slid 0.58 percent to 6.6280 per dollar last week and last traded at 6.6347.
The State Administration of Foreign Exchange said Dec. 31 it was expanding a program to let exporters keep revenue overseas, easing pressure for appreciation. On Jan. 6, SAFE said it would step up monitoring of cross-border capital flows. A less-than-forecast December trade surplus, announced by customs today, may help efforts to rein in supplies of cash. The excess of $13.1 billion compared with the $20.8 billion median estimate in a Bloomberg News survey of 20 economists.
The government’s purchases of foreign exchange from exporters results in extra yuan being pumped into the financial system, money that the central bank drains away by selling bills or raising reserve requirements Officials will use differentiated reserve ratios to improve liquidity management, Governor Zhou said in an interview published by China Finance magazine on Jan. 4. The system involves setting separate requirements for lenders according to their balance sheets.
"The risk of a widening interest-rate gap attracting hot money inflows may be part of the reason behind the central bank’s inclination to use the reserve ratio tool more frequently than interest rates," said Wen Pengyong, an economist at Essence Securities Co., a Shenzhen-based brokerage. Reserve requirements for the biggest banks, such as Industrial & Commercial Bank of China Ltd., stand at 18.5 percent. UBS and Citigroup Inc. expect the ratio to pass 20 percent this year.
China will keep raising interest rates this year even at the risk of attracting more capital because of the threat of inflation, according to Standard Chartered Plc and IHS Global. The central bank may raise the one-year deposit rate to 3.5 percent by year-end, according to the median estimate in a Bloomberg News survey of 13 economists last month. The one-year interest-rate swap, the fixed cost needed to receive the floating seven-day repo rate, dropped two basis points today to 3.17 percent, according to data compiled by Bloomberg. It has climbed from last year’s low of 1.97 percent on Aug. 12.
The seven-day repurchase rate, which measures interbank funding availability, averaged 2.75 percent in the fourth quarter, the highest level since the third quarter of 2008. The rate plunged to 2.38 percent today from 6.34 percent on Dec. 31 as a year-end financing crunch eased. "The increase in the foreign-exchange reserves will pile pressure on the government to allow faster currency gains," said Liu Li-Gang, a Hong Kong-based economist at Australia and New Zealand Banking Group Ltd., who previously worked at the Hong Kong Monetary Authority and the World Bank.
Rising wages will burst China’s bubble
by Peter Tasker - Financial Times
Who has survived the global credit crisis in the best shape? As Zhou Enlai is reputed to have said about the impact of the French Revolution, it is still too early to judge. The snap verdict that China is the big winner and the US and rest of the old Group of Seven big losers is already looking questionable. True, China has continued to register turbo-charged growth while many of the debt-laden economies of the west have struggled. No surprise, then, that a tsunami of financial capital has surged eastwards, or that European politicians are scrabbling for trade deals, despite China’s extraordinarily aggressive posture over the Nobel peace prize and other diplomatic issues.
The financial markets, however, have taken a rather different view. The Shanghai market is at less than half its all-time high, significantly underperforming the other three members of the Bric group. More surprising, since the start of the US subprime crisis in August 2007, Shanghai’s total return in dollars has been beaten by the American S&P500, the UK’s FTSE 100, and even the Japanese Topix. The message is clear. The China story that has been sold so skilfully all over the world is simply another version of the “new era” thinking that has characterised every investment mania from the South Sea bubble to the dotcom frenzy.
After the extended period of disappointing performance, Chinese shares no longer look so expensive in terms of the current price to earnings ratio. But this may be deceptive. On the cyclically adjusted “Shiller PE” – which uses a 10-year average of earnings – the China market is even now almost as expensive as the US stock market was in 1929. In other words, the current level of Chinese earnings is high and probably unsustainable.
There are good grounds for concern about the future. A significant increase in the profit share of national income, as we have seen in China this century, implies a significant decrease in the labour share – meaning that wages fail to keep up with economic growth. The other side of this is apparent in the gross domestic product numbers – a decline in the contribution of consumption and a ballooning dependence on investment. The longer these trends continue, the greater the ultimate reversal.
We’ve seen this movie before – 40 years ago, to be exact. In the 1960s Japan was achieving year upon year of double-digit GDP growth, fuelled by government-directed investment into infrastructure projects such as the bullet-train network and the build-up of heavy industry. Throughout this period, workers were flooding into the cities from the countryside, depressing wages and setting off a virtuous cycle of rising profitability and rising investment.
In the mid-1950s, Japanese labour had taken 60 per cent of total value added. In the miracle years this ratio fell to 50 per cent, then started a V-shaped recovery in 1970 as the labour market tightened. Ten years later it had soared to a plateau of 68 per cent. These gains had to be fought for. In the 1970s, Japan’s now dormant union movement was in its heyday. Profit margins were squeezed, and in real terms the stock market went nowhere for a decade.
Can workers grab a bigger share of the economic pie before the urbanisation process is complete? In Japan they did. In 1970 Japan’s urbanisation ratio (the proportion of urban population to total population) was still just 53 per cent. Currently the Chinese urbanisation ratio is 45 per cent, roughly where Japan was in 1964. However, Chinese statistics are notoriously unreliable. The floating population of unregistered urban migrants is estimated at between 50m and 140m people. So China’s true urbanisation ratio may already be close to Japan’s in 1970.
If China were to follow Japan, the next stage would be labour strife and inflation. The best way to avoid that outcome would be a radical tightening of the current super-easy monetary policy. But that would risk a serious slowdown and probably necessitate a large revaluation of the renminbi – both anathema to Beijing. Meanwhile, China’s reliance on a cheap currency is helping to fuel a trade war, in the words of the Brazilian finance minister. There is no good way out of the corner into which China has painted itself. Rebalancing the economy is absolutely necessary. It is also a long-term project fraught with risks for China’s rulers – and for investors who have bought the story of inevitable western decline and unstoppable Chinese ascent.
Trade war looming, warns Brazil
by Jonathan Wheatley and Joe Leahy - Financial Times
Brazil has warned that the world is on course for a full-blown "trade war" as it stepped up its rhetoric against exchange rate manipulation. Guido Mantega, finance minister, told the Financial Times that Brazil was preparing new measures to prevent further appreciation of its currency, the real, and would raise the issue of exchange-rate manipulation at the World Trade Organisation and other global bodies. He said the US and China were among the worst offenders.
"This is a currency war that is turning into a trade war," Mr Mantega said in his first exclusive interview since Dilma Rousseff, Brazil’s new president, took office on January 1. His comments follow interventions in currency markets by Brazil, Chile and Peru last week and recent sharp rises in the Australian dollar, the Swiss franc and other currencies amid an exodus of investment from the sluggish economies of the US and Europe. The actions have renewed interest in how to manage destabilising flows of speculative money, with the International Monetary Fund suggesting last week that the world needed rules to govern the use of capital controls.
Mr Mantega, finance minister since 2006, coined the term "currency war" in September before launching controls on foreign portfolio investments in Brazil aimed at stemming an increase of 39 per cent in the real against the dollar over the past two years. He said that most of Brazil’s measures last year were directed at the spot market but the focus had switched to the futures markets, which he said were now behind the upward pressure on the currency. On Thursday, Brazil’s central bank launched a surprise measure to curb short selling of the dollar against the real by onshore banks. "You can expect more measures on the futures market," he said.
He said currency manipulation would be on the G20 agenda this year. Brazil would also lobby to have the WTO define exchange-rate manipulation as a form of veiled export subsidy. Any attempt to change WTO rules to incorporate exchange rates would be difficult, however, as China could be expected to veto it, analysts said. Mr Mantega said that Brazil’s trade with the US had slipped from an annual surplus of about $15bn (£9.6bn) in Brazil’s favour to a deficit of $6bn since the US began trying to reflate its economy through loose monetary policy. He said China’s undervalued currency was also distorting world trade. "We have excellent trade relations with China ... But there are some problems ... Of course we would like to see a revaluation of the renminbi."
'Europe Needs Growth to Prevent a Collapse of the Euro'
by Peter Müller - Spiegel
Europe, says star economist Nouriel Roubini, needs to take immediate action to shore up the euro. In an interview with SPIEGEL, Roubini said Germany must provide more money to defend the common currency and allow the European Central Bank to loosen monetary policy. Otherwise, disaster could be looming.
SPIEGEL: Mr. Roubini, when you recently acquired a new penthouse in Manhattan for $5.5 million observers on both sides of the Atlantic hailed it as a sign: The man who predicted the financial crisis had regained confidence in the US housing market and in the US economy.
Roubini: There's a bit of good news -- and a lot of bad news. In 2011, the US economy will likely grow by 2.7 percent. That's a robust rate of growth. The risk of a second slump has dropped considerably. The US Federal Reserve's policy of buying government bonds and the middle-class tax benefits of the Obama administration are already having an effect. That's the good news.
SPIEGEL: And the bad news?
Roubini: The persisting housing crisis, the implications of this on the financial condition of banks and, above all, the high public debt and deficit, both at the federal and state levels. The US is in a dilemma. In the medium term, there is no getting around budget consolidation, otherwise the country will be threatened by a debt crisis such as Europe is currently experiencing. However, given the weak recovery so far, the US must do all it can to boost economic growth.
SPIEGEL: Tax cuts for the super rich, which are part of President Barack Obama's tax package, are hardly going to create additional growth.
Roubini: And that's the heart of the problem. The plan is a complete waste of money. It's going to increase the deficit without doing anything to kick-start the economy. And, unfortunately, I don't see any chance of this fiscal stalemate changing significantly before the presidential elections in 2012. The White House and the Republican majority in Congress block each other's proposals, and there is no such thing as bipartisan crisis management in the US. I'm sure that the public debt of the US will eventually make the markets very nervous in the next few years.
SPIEGEL: Although the situation is actually better in the euro area, the euro is the target of attacks and not the dollar.
Roubini: The condition of the over-indebted states on the periphery of the euro area is similar to that of the US federal states, from California to Illinois. But there are also clear differences: Even if California were to go bankrupt, nobody would think that the US monetary union would collapse because of this. The debt problems that Greece and Ireland are currently experiencing, could, in contrast, actually lead to a collapse of the euro area. What's more, the US can always finance its debt by printing more money. Greece and Ireland are dependent on the European Central Bank, the ECB, to relax its monetary policy against the will of Germany. There is simply more discordance than agreement in the euro area.
SPIEGEL: Americans and Germans differ widely in their views on how to make the economy pick up again. The US is trying to boost the economy with tax cuts and by having the Fed buy government bonds, while Germany wants to stringently cut expenditures.
Roubini: The cost-cutting measures, the ECB's tight monetary policy, the current high value of the euro -- that's all fine for Germany and the heart of the EU. But what's good for Germany is by no measure good for the countries on the periphery of the EU. The economic output of Greece, Ireland and Spain is shrinking, and there is hardly any growth in Portugal and Italy. To get these countries back on track for recovery the ECB should do what the Fed is doing and increase the money in circulation to stimulate growth.
SPIEGEL: The public debt of member states such as Greece or Portugal is what caused the euro crisis in the first place. Why should Germany now backtrack on its cost-cutting strategy?
Roubini: Europe needs growth to prevent a disorderly collapse of the euro area. The stringent cost-cutting measures that the EU and the International Monetary Fund are imposing on countries such as Greece and Ireland are, in principle, the right way to get a handle on their debt. However, these measures also strangle an economy. Higher taxes mean people have less money to spend. If the government cuts spending it cannot make investments to stimulate growth. This creates huge difficulties for the governments concerned: If people cannot see the light at the end of the tunnel they will start to withdraw their support for reforms. In the interests of Europe as a whole, Germany should do all it can to bolster growth -- at home and in Europe. Germany should, therefore, postpone its austerity strategy.
SPIEGEL: Last year the German economy grew by 4 percent, due primarily to exports. The US and France harshly criticize Germany for this and say that Germany should reduce its trade surplus. Should Germany be punished because its companies are so competitive?
Roubini: The German growth model will not work in the medium term, not for Germany, nor for Europe. Germany's economy relies too heavily on exports. At the beginning of the financial crisis the German slump was higher than in the US, where the crisis originated. Even if domestic demand is now gathering pace, Germany must do more, such as liberalize the service sector and stimulate consumption. And this would kill two birds with one stone: it would reduce Germany's dependence on exports and cut its trade surplus, which causes other parts of Europe to slide further into the red.
SPIEGEL: In essence, you are accusing Germany of acting selfishly, to the detriment of its European partners. This criticism was voiced loudly in the past few weeks when Germany insisted on private-sector creditors participating in the future crisis mechanism for the euro area. Was this justified?
Roubini: First off, the participation of private-sector creditors is right, in principle. But the Germans have made the crisis worse with their idea and their timing. I have worked on debt restructuring for a number of years and have not been able to identify any really workable proposals from Germany for helping countries such as Greece and Portugal to emerge from the debt trap. If you don't mind me saying so, the idea of an international insolvency law is absurd, as orderly restructuring of sovereign debt doesn't require a new legal framework.
SPIEGEL: Why shouldn't government bonds include clauses in the future that regulate a procedure for the worst case scenario, in which private-sector creditors have to accept losses?
Roubini: Let's take the example of Greece. In the best case, i.e. according to their current austerity plan, Greece's public debt will still be at 160 percent of GDP in two years. Who is going to lend the country new money in 2013 if they know that they will definitely face losses if the country goes bankrupt? Greece will have to restructure its debt in any case.
SPIEGEL: The permanent crisis mechanism agreed by the euro states for 2013 at their summit this December requires the participation of private-sector creditors.
Roubini: What the euro countries decide for 2013 is completely inconsequential. Forget 2013! The important thing is what will happen in the next three months in Portugal, Spain, Italy, and France. I can't fathom how the EU member states can hold a summit entirely preoccupied with what will happen after the present rescue package runs out, without once mentioning what they intend to do now to help Portugal and Spain.
SPIEGEL: But the summit did, at least, signal a willingness to increase the size of the euro backstop fund currently worth 750 billion.
Roubini: Europe must make more money available to defend its currency and sovereign states under stress. Which tools it uses to do this is of secondary importance. Of course, the EU can continue to rely on the ECB to do its dirty work and buy up the government bonds of distressed states. But it would be better to drive a proactive strategy and increase the bail-out funds, introduce euro bonds, or even set up a European monetary fund. All solutions have one thing in common: the German taxpayers' money will be used to stop the debt crisis in other countries. In Germany's place, I would opt for increasing the bail-out package
SPIEGEL: which is already insufficient if Spain needs help too.
Roubini: The fact alone that everybody knows this increases the risk of a run on Spanish banks. If the rescue package isn't increased soon the ECB will have to buy Spanish government bonds. The German taxpayers will ultimately have to foot the bill for this, too, as the ECB will need more capital.
SPIEGEL: The Germans are fed up with being the biggest payer among the Europeans. Could they avoid the burden of the bankrupt countries by splitting up the euro area into a north euro and a south euro?
Roubini: No. There has never been a monetary union with only weak members. It would be more likely for Portugal, Italy, Spain or Greece to revert to their national currencies. The debt problems of the weak countries would increase if the monetary union is split up. The weaker countries would have to continue paying back the majority of their debt in hard euros while their new national currencies sharply depreciate. And they would be very hard-pressed to do so. This would trigger a financial crisis and default for sure and German creditors would incur big losses.
SPIEGEL: This is also why going back to the deutsche mark is not an option.
Roubini: This would force the weaker states to devalue their currency, and they would also have problems repaying their debts in German marks. Greece and Portugal are already unable to pay back their debts within the monetary union, and they certainly wouldn't be able to if the monetary union collapsed.
SPIEGEL: If splitting up the euro area or withdrawing from the monetary union is not feasible, is stronger integration the solution? Does the euro area need a common economic government?
Roubini: What it comes down to is a deal: If the Germans agree to relax the ECB's monetary policy and provide more money to defend the euro and the weaker states, then they should, in return, get regulations that automatically punish countries flouting budget rules. Overly indebted states would then have to accept a loss of their autonomy in fiscal issues. This would be a hairy deal but could avoid the collapse of the euro area.
SPIEGEL: And the premiums on German government bonds have recently risen.
Roubini: I can understand the Germans' concerns, that using their fiscal discipline to backstop and bailout the weaker periphery members could eventually reduce Germany's creditworthiness and ratings. Therefore, any additional bailout funds for the periphery should come with strict rules to enforce fisal discipline. There is fiscal discipline in Germany, so there is no risk of a default by Germany.
SPIEGEL: The euro area's problems and the relaxed monetary policy of the US are causing large inflows of capital into emerging countries. Is this the beginning of the next dangerous bubble?
Roubini: The interest rates in the developed economies are at zero percent, and there are concerns about the stability of their currencies. Emerging countries such as Brazil are consequentially being flooded with cash. And this capital seeks investment options even in places where there aren't any good opportunities. It's difficult for emerging countries to stem this tide of capital. If they let their currency rise in value they loose their competitiveness.
SPIEGEL: The Chinese yuan, in particular, is causing strife. The US is accusing China of keeping its currency artificially low in order to reap the benefits in its export markets. This could lead to a currency war.
Roubini: I wouldn't call it a war, but there is tension. To even out global growth a little better there is no other option than to weaken the dollar and increase the value of the yuan. Nobody would call on China to increase its currency by 20 percent in one go. But the 2 percent that the Chinese have brought themselves to implement in the past few months is not enough. A midpoint -- at around 6 percent per year like in the 2005-2008 period -- would satisfy all sides.
SPIEGEL: Given the fact that not everybody can afford an apartment in Manhattan like you, what would be your advice to investors? Are commodity securities a good investment in view of the rising oil and gold prices?
Roubini: My advice is simple: diversify! Don't buy anything that's overpriced! The global economy is on the right path, but there are risks along the way. Growth in the euro area is still dependent on that of the US. Policy mistakes in China or in emerging countries could strangle growth. On top of that, we have oil price levels which will soon no longer be viable for industry. North Korea and Iran still represent dangerous trouble spots. 2011 is set to be a risky year for investors even if the global economic outlook is improving.
EMU debt crisis edges ever closer to the core
by Ambrose Evans-Pritchard - Telegraph
The eurozone's debt crisis is once again in danger of spiralling out of control after yields on Portuguese debt spiked to a post-EMU high and contagion hit Spain and Belgium.
The European Central Bank (ECB) intervened heavily in the markets, buying Greek, Irish and Portuguese bonds to drive down yields again, but has yet to broaden its emergency purchases to a fresh set of countries. Germany's Bundesbank is vehemently opposed to policy "creep" that involves the ECB in fiscal rescues by the backdoor. The bank's refusal to be drawn further has left Belgium fending for itself as an escalating constitutional crisis pushes yields on its 10-year bonds to a post-euro record of 4.27pc. The country has not had a government since Flemish separatists emerged as the biggest party in elections seven months ago.
Stephen Jen, chief economist at Blue Gold Capital and a former IMF official, said Greece, Ireland and Portugal are already "insolvent". Refusal to face up to reality draws out agony, with a "cancerous" effect on the whole eurozone. Mr Jen said the bail-outs themselves - done in the in the name of "saving the euro" - are causing the crisis to spread ever wider by contaminating stronger states instead of separating the balance sheets of good from bad, as would be normal in a debt clean-up operation.
The danger is that this will infect Europe's core, threatening the AAA ratings of France, Germany and others. If the EU's bail-out fund is enlarged by a further €250bn (£208bn) to €700bn, "one or more" of the AAA states may be downgraded, "most likely" France. "We see a further escalation of the debt crisis. There is no silver bullet because the underlying problems are 'knotted'," he said.
In Belgium, King Albert II asked caretaker ministers to push through a special austerity budget to reassure markets after the latest set of coalition talks broke down, chiefly over the scale of subsidies from the Dutch-speaking North to the poorer francophone Walloons. Didier Reynders, the finance minister, called for emergency powers to drive through reforms and cut the budget deficit below 4pc of GDP, deemed a step too far for now.
Fears Belgium may break up have thrown a fresh spotlight on its public debt, expected to reach 110pc of GDP by the mid-decade although offset by large private savings. Belgian banks are heavily invested on the EMU periphery with $54bn (£35bn) of exposure to Ireland alone, led by KBC and Dexia.
Spain also came under fresh pressure. Bond yields flirted with a post-EMU high at 5.58pc on fears that Madrid will struggle to find buyers at a crucial debt auction on Thursday, despite pledges by China that it would stand behind Iberian debt. Antonio Pacual Garcia from Barclays Capital said Chinese assurances may "help at the margin" but will do little to change the ugly debt dynamics of the EMU periphery.
Barclays has called for a radical shift in policy by the EU authorities to break out of the impasse, proposing "unlimited funding" for the EU's €440bn bail-out fund (EFSF) to reassure markets that it can cope with Spain if necessary. The interest rate charged on rescue packages should be slashed to allow EMU debtors to claw their way out of their traps. The fund is currently charging Ireland 5.7pc for rescue loans – which were arguably forced upon it – even though the EU raised the money at an average 2.59pc. The punitive rate has caused bitterness in Ireland.
"We think the EFSF should charge its own average funding cost, or even below it, offering an interest rates subsidy," said Frank Engels, Barclays' Europe economist. "This should be done under IMF-style conditionality to prevent moral hazard." Mr Engels said the European Investment Bank should buttress the policy with €30bn of spending on infrastructure projects to underpin growth in the debt-stricken states.
Portuguese leaders continued to insist on Monday that their country does not need a rescue, but markets now think an EU-IMF loan package is inevitable after leaks in the German press revealed that Berlin – some say Frankfurt – is pushing the country to act.
David Owen, from Jefferies Fixed Income, said Portugal's reluctance to take this bitter medicine is entirely understandable since such packages have driven the bond yields even higher for Ireland and Greece, precisely because the punitive rates trap countries in debt-deflation and do nothing to reduce the likelihood of default in end. "The mere fact of asking for money makes matters worse," he said. This is a grave indictment of EU strategy.
ECB intervenes as debt crisis deepens
by David Oakley, Gerrit Wiesmann and Peter Wise - Financial Times
The European Central Bank intervened to prop up the eurozone bond markets on Monday as political leaders and bankers warned the debt crisis was deepening amid fears Portugal was edging closer to an international bail-out. Although European Union officials denied they were talking about a bail-out for Portugal, the ECB had to buy the country’s government bonds to stop the market selling off steeply before important debt auctions in Lisbon on Wednesday.
Investor attention is also turning towards Belgium, which has the third highest public debt-to-GDP ratio in the eurozone. The king of Belgium asked the country’s caretaker prime minister to draw up a tighter budget for 2011 than the one already agreed with the EU to ease market concerns over his country’s debt.
Alan Wilde, head of fixed income and currency at Baring Asset Management, said: "The crisis is reaching another key phase with debt auctions this week. It seems unlikely that Portugal can avoid a bail-out." Portugal’s cost of borrowing jumped to 7.18 per cent for 10-year debt, close to euro-era highs at one point before intervention by the ECB saw yields fall back to close at 7.01 per cent. This is significant as officials in Lisbon have admitted that yields above 7 per cent are unsustainable.
The euro fell to four-month lows against the dollar, sterling and the yen, and a key gauge of sentiment among eurozone banks that measures the cost to insure debt rose to the highest levels since March 2009. Increasing worries about the eurozone prompted Josef Ackermann, Deutsche Bank chief executive, to call on eurozone governments to use the debt crisis as an opportunity to lead the bloc towards greater economic integration.
"The time has come to deepen economic and currency union," Germany’s most influential banker said in a speech in Berlin late on Monday. "For this renewed push towards integration we need strong political leadership." In Brussels, Amadeau Altafaj-Tardio, the EU spokesman for economic and monetary issues, referring to a potential Portuguese bail-out, said: "There is no discussion to this effect. And none is envisaged at this stage."
In Portugal, political rhetoric in campaigning for Lisbon’s presidential election on January 23 is adding to pressures on the government, with the main opposition party calling on José Sócrates, the prime minister, to resign if he has to ask the international community for help. The centre-right Social Democrats (PSD) had earlier backed his deficit-cutting measures. Pedro Passos Coelho, the PSD leader, said Mr Sócrates would be responsible for a "serious political failure" if Portugal had to ask for outside help and would "no longer be in a position to govern".
In a further blow to Mr Sócrates, António Bagão Félix, a respected former finance minister and rightwing politician, said on Monday that it was no longer a question of "if" Portugal would have to turn to the European financial stability facility, the EU bail-out fund, for help, but "when". The cost to the country of high bond yields was increasing every day, he said. "The situation is unsustainable."
EU officials have expressed concern over the potential adverse impact on investors of the heated rhetoric leading up to the presidential election, in which Aníbal Cavaco Silva, the candidate supported by the PSD, is expected to be re-elected for a second five-year term. But Mr Passos Coelho, who has given his party a strong lead in national opinion polls, said it was necessary to "turn the page" and elect a new government with better policies to create jobs and stimulate economic growth. The PSD has grown increasingly critical of Mr Sócrates’s handling of the debt crisis, accusing him of "merely pretending" to cut government spending.
UK house prices lost more than £2,000 on average in December
by Amy Wilson - Telegraph
Homeowners were hit by a much bigger than expected fall in house prices in December and are likely to face more pain in this year as economic uncertainty deters buyers, Halifax said on Monday. Prices fell 1.3pc, an average of more than £2,000 to £163,435, between November and December, Halifax said – far more than the 0.4pc economists had forecast and contributing to a 0.9pc fall in the last quarter of 2010.
House prices were 3.4pc lower than in December 2009, the Halifax's latest figures showed. In the three months to December, prices were 1.6pc lower than the previous year, and Halifax said prices were likely to keep falling in 2011. "We expect limited movement in house prices during 2011 but with the risks on the downside," said Martin Ellis, housing economist at Halifax. "Uncertainty about the economy, weak earnings growth and higher taxes could put some downward pressure on demand." Regions which are harder hit by government spending cuts will see more change in house prices this year, Halifax predicted.
The problems in the housing market would be further exacerbated if the Bank of England decides to raise interest rates in the face of rising inflation, economists warned. However, with recent economic data showing the UK's construction and services sectors shrank at the end of last year, suggesting a slowdown in Britain's recovery, Mr Ellis said he expected rates to remain very low for "some time". "This will continue to support a favourable affordability position for those entering the market and limit financial pressure on existing homeowners to sell," he said.
Separately, housebuilder Persimmon said it expects prices to be largely unchanged this year. "We are looking at generally fairly flat pricing this year," Michael Farley, chief executive, said in a Bloomberg News interview. "The mortgage issue is still the critical issue for the industry as a whole." Persimmon said profit for 2010 will be at the "top end" of analysts forecasts, which range from £75m to £96m, after increasing the average selling price by 6pc during the year, and a 4.5pc rise in completions to 9,384 houses.
Mortgage payments are now far lower than at the top of the market, because of low interest rates and stricter borrowing criteria. Average payments for new mortage customers have fallen from a peak of 48pc of average disposable earnings in the middle of 2007, down to 29pc in the last quarter of 2010. That is below the average over the last 25 years of 37pc of average disposable earnings, Halifax said.
Portugal Finance Minister sees no need for bailout
by Axel Bugge - Reuters
Portugal has no plans to seek a bailout from the EU and IMF, and the government is doing everything possible to avoid doing so, Finance Minister Fernando Teixeira dos Santos said. "We are seeking to avoid this possibility," Teixeira dos Santos told TSF radio when asked about a possible rescue. Portugal is widely seen by economists as the country that is most likely to follow Greece and Ireland in seeking outside help with its finances to take it out of the firing line of the widening euro zone debt crisis.
Late on Tuesday, a Bank of Portugal board member was quoted as saying the country would leave behind its crisis more easily if it sought foreign financing. But Teixeira dos Santos said the country was capable of continuing without a bailout, adding that the average interest rates it is still paying on its debt are relatively low, with only a small proportion being serviced at current higher borrowing costs. "We are doing our work. Clearly Europe is not doing its work to guarantee stability of the euro," he added.
Teixeira dos Santos said he could not confirm that China had bought bonds directly from Portugal. But he added that he was confident that Wednesday's auction of up to 1.25 billion euros of five and 10-year bonds would go well. Prime Minister Jose Socrates and Teixeira dos Santos were due to hold a press conference at 0930 GMT but the minister would not say what it was about when asked.
Rumour of €80 billion bail-out to squeeze Portugese bonds
by Ben Harrington and Rowena Mason - Telegraph
Portuguese bond yields are expected to come under further pressure today, after the country's president was forced to deny the need for a €80bn (£66bn) bail-out. Aníbal Cavaco Silva, the Portuguese president, said he had no intention of asking the International Monetary Fund (IMF) or Europe for financial help. The comments came after Germany's Der Spiegel magazine and senior eurozone sources claimed that Germany and France will push Portugal to tap the rescue fund set up for European countries facing debt problems.
Mr Cavaco Silva told Portugal's Público newspaper that he was "surprised" a German magazine is publishing news of such importance to a European Union member state without the issue being discussed by the EU authorities. Still, Portugal's finances appear to be coming under fresh scrutiny over whether it will have to take financial help from the EU and the IMF. Europe is anxious to stop the sovereign debt crisis from spreading across the eurozone, having already bailed out Ireland and Greece.
On Friday, yields on Portugal's 10-year bonds rose to all-time highs above 7pc, dragging down European stock markets. Investors are also concerned about euro bond auctions due to take place this week. Economists say a key question for Portugal is how long it can sustain the high yield levels, and the auction will be an important gauge of that. Newswire reports suggested that some preliminary discussions have taken place on the possibility of giving Portugal help if financing costs on markets become too high.
Although no formal talks have started, one source told Reuters: "France and Germany have indicated in the context of the eurogroup that Portugal should apply for help sooner rather than later." Finland and the Netherlands were also reported to believe Portugal should seek financial help. Asked to estimate the possible size of a rescue programme for Portugal, a source said: "More than €50bn and less than €100bn, say between €60bn and €80bn, but this is off the cuff, because we don't know the needs of the Portuguese banking sector." Ireland and Greece repeatedly denied that they were seeking a bail-out before they accepted €85bn and €110bn in aid respectively.
The dam breaks in Portugal
by Ambrose Evans-Pritchard - Telegraph
Those of us chained by journalistic destiny to the eternal EMU crisis remember the exact moment when Ireland succumbed. Premier Brian Cowen was still insisting that his government was fully funded for months to come and had no need whatsoever for an EU-IMF loan package when the central bank put a swift stop to the charade. The moment that Governor Patrick Hohonan said he “absolutely” expected his country to accept a loan package worth “tens of billion”, it was over.
So I had a sense of deja vu this morning when Teodora Cardoso, the Adminstradora of the Banco de Portugal, blurted out in a conference that her country should turn to the IMF. “It would be easier if we had external support because the adjustment would be less abrupt: if we leave it to the markets it may be brutal,” she said. (My loose translation). Here is the Portuguese version from Economico for Lusophiles: “É mais fácil se tivermos um apoio externo, desde logo porque isso permite que o ajustamento não seja tão abrupto, mas feito sozinho, para os mercados acreditarem nele, teria que ser brutal. Com o apoio de uma dessas instituições (FMI ou Fundo Europeu) poderá ser menos abrupto”.
Meanwhile, Publico reports that “technical talks” are going on behind the scenes with the EU authorities and the IMF, with a plan likely to be in place by next week. This feels exactly like the final days – or hours – before Ireland gave in. Evidently, there is a split at the central bank. Governor Carlos Costa still insists that a rescue can be avoided. “I have said it, and I will say it again: the Portuguese are solving their problems and have the ability to solve their problems themselves,” he said.
Well, Dr Costa, if you cannot hold your own board together, do you expect us to believe this? The current rule of thumb in the markets is that when yields on 10-year bonds rise above 7pc – they reached 7.24pc yesterday before ECB gunners fired off a whiff of grapeshot – the situation becomes untenable, especially for economies that are contracting. Portugal’s central bank has just released its forecast for 2011, predicting that GDP will contract 1.3pc. Think about this. Interest costs on total public/private debt of 325pc of GDP are rising on a shrinking economy. The debt dynamics are deathly.
Finance minister Fernando Texeira dos Santos this morning sounded like a man who has just been flattened by a Panzer. “We are doing our job. Clearly, Europe is not doing its job to defend the stability of the euro,” he said. Diabo, Sehnor.
I cannot see what Portugal gains at this point from dragging out the agony, though I can quite understand why the ruling Socialists prefer to delude themselves a little longer. Any recourse to the IMF would shatter all that remains of their credibility. Let me be clear, there is no shame or necessary stigma to an IMF package, and the Fund is a much cuddlier institution than it was last time Portugal needed help. Nor let it ever be forgotten that Portugal is to a great extent the victim of EMU’s unworkable structure. However, the political reality is that any bail-out would be viewed by Portugal’s people as a disgrace and a humiliation.
As for Germany and France, what do they think will be gained by using press leaks to set in motion a chain of events that forces Portugal to take a loan package? Did they not learn from Ireland’s forced rescue that deployment of the EFSF bail-out fund offered no defence whatsoever against further contagion, failed to bring down Irish spreads, and merely drew closer attention to the fact the EU rescue machinery is too small and dysfunctional to cope with the berg beneath the protruding ice?
As Wolfgang Munchau wrote in the FT on Monday, the essential problem is that Spain and other Club Med states cannot both deflate to regain lost competitiveness within EMU and at the same grow fast enough to control debt dynamics. They can do one or the other, but not both at the same time. The EU strategy is simply unworkable. It relies on hope and a prayer, and the misguided believe that the North-South imbalances are “self-correcting” to pinch from Wolfgang’s excellent column once again.
All we can do is stand back and watch in pain as the Euro-Hegelians ruin one country after another. My sympathies to the Portuguese people who are not to blame for the foolish illusions of their governing elites. And remember, Cara Nação, this bail-out is not for you: it is for European banks exposed to Portuguese debt, just as the Irish and Greek bail-outs were in reality rescues for German, French, Belgian, Dutch, British, and Spanish lenders that ran amok during the credit bubble. But you pay.
Italy 'Unfairly Punished' as EU Debt Crisis Proxy
by Anchalee Worrachate - Bloomberg
Italy, whose 10-year bond yields are near their highest in two years, may be a safer investment than its peers as the nation’s banks dodge the woes plaguing lenders in the euro region’s most indebted nations.
"Italian bonds are unfairly punished," said Frances Hudson, who helps oversee about $220 billion as head of global thematic strategy at Standard Life Investments in Edinburgh. "It doesn’t have the same structural problems that other peripheral countries have, and yet they are sold off because they are seen as a proxy to those bonds. From that perspective, their yields are attractive."
Italy, which has the euro region’s second-largest debt burden, has fared better than its neighbors since Greece’s near- default last year drove up borrowing costs. Unlike Spain and Ireland, Italy’s economic growth wasn’t fueled by a housing and borrowing boom, and its banks haven’t had government bailouts. The country’s 10-year bonds yield 4.8 percent, after jumping by a percentage point in the past three months. Investors lost 0.7 percent, including reinvested interest, on Italian debt last year. That beat Greek securities, which lost 20 percent, as well as the bonds of Portugal, Ireland and Spain.
"Italy has a relatively high savings rate and domestic investors reinvest those savings into Italian bonds," said Stuart Thomson, who helps manage $110 billion at Ignis Investment Management in Glasgow. "We are very cautious still about peripheral bonds, but we are willing to take risk through an exposure to Italian securities."
Italian household debt was the equivalent of 44 percent of gross domestic product in 2009, less than half the level of Spain and Portugal, according to Bloomberg calculation based on Bank of Italy and Istat data. Thomson said he’s been getting rid of Belgian bonds and Portuguese securities, while maintaining Ignis’s Italian holdings at a level that matches the index it uses to measure performance. The fund has a so-called underweight position in Spanish bonds, he said.
Investors pay less in the credit-default swap market to insure A+ rated Italian debt against default than they do to protect Spanish securities, which are rated two levels higher at AA by Standard & Poor’s Corp. About 46 percent of Italy’s debt is in the hands of foreign investors, according to UniCredit SpA, compared with as much as 80 percent of Portugal’s borrowing. Ireland relies on non- domestic buyers to buy as much as 85 percent of its bonds, according to NCB Stockbrokers in Dublin.
‘Constructive on Italy’
"We are constructive on Italy and see value in Italian government bonds," said Oliver Eichmann, a portfolio manager at DWS Investment GmbH in Frankfurt, Germany’s biggest mutual fund manager. "The economic situation in Italy is OK, and we find its short-dated bonds attractive given yields are high and the country is unlikely to need help."
Italian two-year yields of 2.7 percent are 183 basis points higher than their German counterparts, up from less than 80 in October and compared with an average of just 36 in 2009. Italian business confidence rose for a third month in December to the highest in almost three years as executives shared consumers’ optimism about the economic recovery, according to an ISAE report on Dec. 30. Italy is the only high- deficit country in the euro region to avoid a credit rating downgrade since the sovereign crisis erupted at the end of 2009.
Italy’s primary budget deficit, or the budget balance less interest payments, will turn into a surplus equivalent to 0.5 percent of GDP this year, compared with a shortfall of 0.5 percent in 2010, according to forecasts released by the employer association Confindustria on Dec. 16.
Economists foretell of U.S. decline, China's ascension
by Mark Felsenthal - Reuters
To hear a number of prominent economists tell it, it doesn't look good for the U.S. economy, not this year, not in 10 years. Leading thinkers in the dismal science speaking at an annual convention offered varying visions of U.S. economic decline, in the short, medium and long term. This year, the recovery may bog down as government stimulus measures dry up.
In the long run, the United States must face up to inevitably being overtaken by China as the world's largest economy. And it may have missed a chance to rein in its largest financial institutions, many of whom remain too big to fail and are getting bigger. On the one hand, Harvard's Martin Feldstein said he believes the outlook for U.S. economic growth in 2011 is less sanguine than many believe.
First, the boost to growth from government spending will be drying up this year, he said. Renewal of expiring tax cuts is no more than a decision not to raise taxes, and the impact of one-year payroll tax cut is likely modest, he said. "There's really not much help coming from fiscal policy in the year ahead," he said. Woes from the dire situations of state and local governments may actually be a drag on growth, he said.
Growth got a lift from a lower saving rate in 2010, but that probably will not last this year as households worried about an uncertain future return to paring back debt and socking more away, Feldstein added. Discouraging declines in home values mean there is less to save from, he said. "People are worried, so there's a strong reason for precautionary saving," he said.
The Race Is On
On the other hand, there is the race with China and the dynamic Asian economies, including India. Most estimates put the size of the Chinese economy on par with the United States by the early 2020s, said Dale Jorgenson, also of Harvard. Jorgenson sees Asian emerging markets as the most dynamic in the world, eclipsing other emerging market contenders such as Brazil and Russia with steady growth over the next decade. "The rise of developing Asia is going to accompany slower world economic growth," he said.
The United States will need to come to terms with the fact that its prevalence in the world is fated to come to an end, Jorgenson said. This will be difficult for many Americans to swallow and the United States should brace for social unrest amid blame over who was responsible for squandering global primacy, he said.
MIT's Simon Johnson put it more bluntly, saying the damage from the financial crisis and its aftermath have dealt U.S. prominence a permanent blow. "The age of American predominance is over," he told a panel. "The (Chinese) Yuan will be the world's reserve currency within two decades." Johnson said he believes the United States has failed to learn its lesson from the financial crisis and continues to implicitly back its largest financial institutions. "I'm concerned about the excessive power of the largest global banks," he said. "Who are the government-sponsored enterprises now? It's the six biggest bank holding companies."
To be sure, Raghuram Rajan, a former IMF chief economist now with the University of Chicago's Booth School of Business, could still envision an ongoing U.S. leadership role. Nothing proceeds in a straight line, he said, and there are many pitfalls along the way even for dynamic Asian economies. "I would say the age of American dominance may be nearing an end. But America as the biggest mover will be in place for a long time," he said.
$2.6 Billion to Cover Bad Loans: It’s a Start
by Gretchen Morgenson - New York Times
Bank investors cheered the announcement last week that Bank of America would pay $2.6 billion to buy back mortgages it had improperly sold during the housing bubble to Fannie Mae and Freddie Mac, the beleaguered mortgage finance giants. It seemed a sweet deal for the bank, whose Countrywide Home Loans unit had peddled tens of billions of dollars in risky loans to the taxpayer-owned companies.
While it is unfortunate that the Bank of America deal won’t recoup much for taxpayers, the resolution could have one important benefit. It might just open the door to a much-needed reckoning of the liabilities created by questionable mortgage practices at the nation’s largest banks. These institutions have not yet made a full and realistic accounting of their liabilities.
It seems clear, after all, that Bank of America will not be the only institution forced to buy back billions of dollars’ worth of loans because it did not meet the lending standards promised to buyers. Costs associated with foreclosure improprieties that have come to light in courts across the country — robosigners, forged legal documents — are also likely to be substantial.
But you’ll find precious little clarity on these liabilities in the financial statements of Bank of America, Citigroup, JPMorgan Chase and Wells Fargo. The amounts that these banks, the nation’s four largest, have reserved for possible mortgage repurchases — about $10 billion as of the third quarter of 2010 — is microscopic when compared with the more than $5 trillion in mortgage securities issued from 2005 through 2007.
For some investors, this is the accounting equivalent of whistling past the graveyard. And they are demanding that the audit committees of the banks’ boards step up their scrutiny of these institutions’ practices.
Last Thursday, officials overseeing 11 large public pension funds that own shares in the big four banks sent a letter to the directors who head each board’s audit committee. The investors are asking that the audit committees conduct in-depth and independent reviews of all the internal controls related to the banks’ mortgage operations. Once the review has been completed — by a different accounting firm from the one currently signing off on the bank’s books — the investors want the audit committees to report their findings to shareholders.
John C. Liu, the New York City comptroller and overseer of five city pension funds, instigated the campaign to focus the banks’ audit committees on mortgage problems. "There is a fundamental problem in the banks’ procedures that endangers not just homeowners, but shareholders, and local economies," he said in a statement on Thursday. "Given the risks involved, only a swift and unbiased audit can reassure shareholders that the pension funds of 700,000 working and retired New Yorkers are in safe hands."
Joining him in signing the letters were the heads of the Connecticut Retirement Plans, the Illinois State Board of Investment and its State Universities Retirement System, the North Carolina Retirement System, the Oregon State Treasury and the New York State Common Retirement Fund. Together, the funds own $5.6 billion of stock in the top four banks and oversee $430 billion in assets.
The New York City pension funds have also put forward a shareholder proposal asking for an independent audit of the top four banks’ mortgage operations. Mr. Liu hopes that the proposal will be put to a stockholder vote at the banks’ annual meetings this year. It is unclear whether the proposal will be subject to such a vote. Citigroup doesn’t want it considered and has already asked the Securities and Exchange Commission to allow it to exclude the proposal from matters to be voted on at its coming meeting. The other banks will probably follow suit.
An official at JPMorgan Chase declined to comment on the shareholders’ request for an independent audit of its mortgage operations. Officials at Bank of America, Citigroup and Wells Fargo said that they were reviewing the letter but that they had confidence in their internal controls and audit committees’ vigilance. The Bank of America spokesman added that it had hired external auditors to review its foreclosure processes, which led it to enhance its practices.
But Robert L. Christensen, an authority on financial services accounting, says it is high time that investors — and regulators, for that matter — scrutinize the banks’ auditing processes. "I believe there is an avalanche of liabilities that has not been recorded in their reserves," Mr. Christensen said. "They say it’s not estimable, but the question is, are they really accounting for it properly and are regulators pushing them hard enough to do it?"
He thinks they haven’t. Mr. Christensen, a certified public accountant who spent 24 years as an auditor at Arthur Andersen, is a senior adviser to Natoma Partners, a forensic accounting and litigation consulting firm. He says the banks have understated the liabilities for possible loan repurchases that they were supposed to have recorded in recent years. Under accounting rules, when a bank sells a loan or a pool of them to investors, the gain on that sale is supposed to be reduced by an amount reflecting the possibility that some loans will have to be bought back later. These amounts are estimates.
It wasn’t until 2009 that banks began to discuss in their filings the reserves they had set aside for these potential liabilities. Mr. Christensen said reserves should have been set aside much earlier, given that the banks selling these loans were in position to know that underwriting standards were slipping and that forced buybacks could rise. "Where were these banks’ internal controls?" Mr. Christensen asked. "Somebody inside knew that they were lowering their underwriting standards. They should have had processes that told them if these loans ever go bad, they will be put back because we are not meeting our representations and warranties."
Banks are beginning to disclose more about their reserves in this area, but investors deserve far more, Mr. Christensen said. Regulators seem to agree. Last October, the S.E.C. sent letters to chief financial officers of public companies reminding them of their obligation to disclose the potential pitfalls in their mortgage operations. For example, the letter tells them to detail the risks associated with potentially higher loan repurchase requests and defects in the loan securitization process.
Mr. Christensen welcomes the regulatory interest, especially because the banks have set aside so little to repurchase loans sold to investors other than Fannie and Freddie. "They still haven’t taken any significant reserves for private-label deals, which were very large and probably contained lower-quality loans," he said.
For example, JPMorgan Chase said in its third-quarter 2010 filings that it had set aside $3.3 billion in reserves for potential loan repurchases. But most of this applies to the roughly $380 billion of loans sold to Fannie and Freddie from 2005 through 2008, the bank said. Reserves to cover any potential putbacks from purchasers of the $450 billion in private-label securitizations the bank sold during that period are unspecified. They are included in a bucket designated for litigation costs, which consisted of $5.2 billion in the third quarter.
The bank said that because repurchase demands from private-label buyers had been limited thus far, it is tough to estimate future requests. Analysts in JPMorgan Chase’s own research unit published a report last fall stating that possible mortgage repurchase liabilities for the overall banking industry ranged from a best case of $20 billion to a worst case of $90 billion.
It is unclear whether regulators or auditors will require the banks to increase reserves for the questionable loans they sold to private investors. The banks say investors will have a tough time proving the buybacks are warrented. Still, it is becoming more obvious by the day that these reserves are probably too low. "There may be a reluctance to challenge the banks because of the overall fragility of the financial system," Mr. Christensen speculated. "But I don’t think it’s a good thing to mix politics and accounting. That’s not a legitimate reason not to enforce the rules."
Lehman's Repo-105 Auditors in U.K. Lose Shield From U.S. Accounting Probe
by Jesse Hamilton - Bloomberg
U.S. inspectors blocked from examining whether British auditors of Lehman Brothers Holdings Inc. improperly cleared questionable accounting will get access to the books under an agreement set to be announced today. Authorities in the U.S. and U.K. have settled a jurisdictional dispute that since 2008 has prevented the U.S. Public Company Accounting Oversight Board from reviewing British auditors of U.S. companies, according to a person familiar with the agreement and documents obtained by Bloomberg News.
The U.K. unit of Ernst & Young LLP was largely responsible for reviewing Lehman’s so-called Repo 105 transactions, allegedly used to conceal billions of dollars in debt before the firm collapsed in 2008, according to a report last year by Lehman’s bankruptcy examiner. The accounting board "was unable to carry out inspections in the United Kingdom -- as well as the rest of the European Union -- due to obstacles raised by the European Commission and European Union audit regulators," Rhonda Schnare, the board’s director of international affairs, said in an interview.
The PCAOB, which was established in 2002 by the Sarbanes- Oxley Act to oversee auditors of companies with U.S.-registered securities wherever they do business, has been barred by Switzerland and China, in addition to the EU. The new cooperative agreement with the U.K. re-opens one of the world’s major financial centers to joint inspections. Because earlier U.S. law wouldn’t allow inspectors to share documentation with their non-U.S. counterparts, the talks to open EU borders were hampered until the Dodd-Frank Act, passed in July, permitted the exchange.
In September, the European Commission authorized EU nations to "enter into bilateral agreements" with U.S. regulators of auditors. The commission is working with EU members and the PCAOB, "trying to solve any outstanding issues," Chantal Hughes, a commission spokeswoman, said in an e-mail. Mary Schapiro, chairman of the U.S. Securities and Exchange Commission that authorizes and oversees PCAOB work said in a Dec. 6 speech that she was looking forward to securing deals with the countries "that will allow those inspections to go forward." The U.K. allowed the PCAOB to examine Ernst & Young’s work in London in 2006. It shut down inspections when the European Commission closed the door in 2008.
While federal authorities haven’t taken action against Ernst & Young for its Lehman work, New York Attorney General Andrew Cuomo sued the audit firm last month, alleging it participated in a "major accounting fraud" by helping Lehman mask its condition. The state aims to recover more than $150 million Ernst & Young charged the firm from 2001 to 2008. Lehman’s Repo 105s were short-term asset sales that included repurchase agreements, which helped the company raise quick cash. The Lehman bankruptcy examiner’s report said the transactions were booked as true sales. The report described three consecutive quarters in which Lehman’s repo transactions totaled $38.6 billion, $49.1 billion and $50.4 billion.
"We stand by the audit opinions issued by Ernst & Young relating to the financial statements of Lehman Brothers," said Sarah Jurado, a spokeswoman for Ernst & Young in the U.K., in an e-mail. "Ernst & Young is cooperating fully with the regulatory authorities in the U.K. and the U.S., including the PCAOB and SEC, on this matter." Ernst & Young has said previously that Lehman’s bankruptcy wasn’t brought on by accounting problems.
Other companies that have filed financial reports audited by the Ernst & Young’s U.K. affiliate, according to information it files with the PCAOB, include BP Plc, Virgin Media Inc., Aviva Plc, Intercontinental Hotels Group Plc and GLG Partners Inc., a hedge fund founded as a unit of Lehman. The jurisdictional dispute means that average investors may be unaware that U.S. officials aren’t watching people who audit major portions of global companies including International Business Machines Corp., Coca-Cola Co., General Motors Co., Chevron Corp. and Exxon Mobil Corp., said Lynn E. Turner, a former chief accountant at the SEC. "The work of their auditors may not have been examined by the PCAOB," he said. Colleen Brennan, a PCAOB spokeswoman, said the board is "acutely aware" that investors haven’t been protected by the regulator in such cases.
While China cites sovereignty in its denial of U.S. inspections, EU officials have said they prefer that U.S. authorities rely on the work of European watchdogs. "The EU does not view joint inspections as the final goal of international cooperation," Hughes said. The PCAOB, under U.S. law, doesn’t have the option of accepting other countries’ inspection work. In October, the PCAOB said new requests to audit U.S. public companies from firms operating in blocked jurisdictions will be subject to board hearings and may be delayed.
While U.S. inspectors were denied access to Ernst & Young in London, the U.K.’s Financial Reporting Council’s Audit Inspection Unit reviewed the auditor annually. The U.K. regulators said in their 2008-2009 report that the firm generally maintained good or acceptable standards, while citing weaknesses in "the identification of significant risks."
In June, the FRC’s Accountancy and Actuarial Discipline Board said it had begun an investigation of Ernst & Young’s auditing of Lehman Brothers International Europe -- specifically "the use and accounting treatment of transactions known as ‘Repo 105s’ and ‘Repo 108s.’" In October, the U.K. disciplinary board announced another investigation, examining the auditor’s conduct in preparing a report to the U.K.’s bank regulator on Lehman’s 2007 compliance with rules governing the protection of clients’ money.
Texas revenue estimate puts shortfall at $27 billion
by Kate Alexander - Statesman
Texas is expected to collect $72.2 billion in taxes, fees and other general revenue during the 2012-13 budget, down from the $87 billion used in the current two-year budget, Comptroller Susan Combs announced Monday. That puts the shortfall at $27 billion given that maintaining services would run $99 billion for biennium.
Collections for the current budget will come in $4.3 billion less than budgeted, Combs’ estimate dictates how much the Legislature will have to spend in the upcoming budget on education, prisons, health and human services and a slew of other state functions. Even with the $9.4 billion rainy day fund, the state would still not have enough to maintain services at their current levels, which would run $99 billion according to agency budget requests.
The Fed’s QE2 Traders, Buying Bonds by the Billions
by Graham Bowley - New York Times
Deep inside the Federal Reserve Bank of New York, the $600 billion man is fast at work.
In a spare, government-issue office in Lower Manhattan, behind a bank of cubicles and a scruffy copy machine, Josh Frost and a band of market specialists are making the Fed’s ultimate Wall Street trade. They are buying hundreds of billions of dollars of United States Treasury securities on the open market in a controversial attempt to keep interest rates low and, in the process, revive the economy.
To critics, it is a Hail Mary play — an admission that the economy’s persistent weakness has all but exhausted the central bank’s powers and tested the limits of its policy making. Around the world, some warn the unusual strategy will weaken the dollar and lead to crippling inflation. But inside the Operations Room, on the ninth floor of the New York Fed’s fortresslike headquarters, there is no time for second-guessing. Here the second round of what is known as quantitative easing — QE2, as it is called on Wall Street — is being put into practice almost daily by the central bank’s powerful New York arm.
Each morning Mr. Frost and his team face a formidable task: they must try to buy Treasuries at the best possible price from the savviest bond traders in the business. The smallest miscalculation, a few one-hundredths of a percentage point here or there, could unsettle the markets and cost taxpayers dearly. It could also embolden critics at home and abroad who say QE2 represents a dangerous expansion of the Fed’s role in the markets. "We are looking to get the best price we can for the taxpayer," said Mr. Frost, a buttoned-down 34-year-old in a striped suit and rimless glasses.
Whether Mr. Frost will reach that goal is uncertain. What is sure is that market interest rates have risen, rather than fallen, since the Fed embarked on the program in November. That is the opposite of what was supposed to happen, although rates might have been even higher without the Fed program. Mr. Frost’s task is to avoid paying top dollar for bonds that could be worth less when the Fed tries to sell them one day.
Louis V. Crandall, the chief economist at the research firm Wrightson ICAP, said Wall Street bond traders were driving hard bargains. The Fed has tipped its hand by laying out which Treasuries it intends to buy and when, giving the bond houses an edge. "A buyer of $100 billion a month is always going to be paying top prices," Mr. Crandall said of the Fed. "You can’t be a known buyer of $100 billion a month and get a good price."
Nevertheless, Mr. Frost and his team have been praised on Wall Street for creating a simple, transparent program. Neither the Fed nor Wall Street wants any surprises. The central bank is even disclosing the prices at which it buys. Mr. Frost and his team work out of a small, beige corner office with arched windows that used to be a library. There, at about 10:15 most workday mornings, one of them pushes a button on a computer. Across Wall Street, three musical notes — an F, an E and a D — sound on trading terminals, alerting traders that the Fed is in the market.
On one recent Tuesday morning, what Mr. Frost and his five young colleagues did over a 45-minute period might have unsettled even a seasoned Wall Street hand: they bought $7.8 billion of Treasuries. Mr. Frost and his team drew up the daily schedule for what the Fed calls its Large-Scale Asset Purchase program. And that program is, by any measure, large scale: through next June, these traders will buy roughly $75 billion of Treasuries a month — on top of another $30 billion it is reinvesting in Treasuries from its mortgage-related holdings.
But depending on daily market conditions, Mr. Frost can decide not to buy certain bonds if they are already in short supply. As offers to sell Treasuries flash on a bank of trading screens, a computer algorithm works out which ones to accept. The computer compares the offers from Wall Street against market prices and the Fed’s own calculation of what constitutes a "fair value" price. The real work is done by three traders who are referred to during the operation as trader one, trader two and trader three. They sit at a long table against the wall, tapping at seven screens.
On one recent morning, trader one was Tiffany Wilding, 26. While she reviewed the stream of offers and then the prices finally accepted by the algorithm, trader two, Blake Gwinn, 29, double-checked her decisions and trader three, James White, 29, made a duplicate of everything in case the computers crashed. All the while, Mr. Frost stood behind his colleagues, ready to intervene — and even cancel the Fed’s purchases — at any sign of trouble. They have their work cut out, trying to outwit the 18 investment firms that deal directly with the Fed. These so-called primary dealers — the Goldmans and Morgans of the world — employ some of the sharpest minds on Wall Street.
Mr. Frost — a Rutgers math grad who has worked at the Fed for 12 years, lives in the Borough Hall area of Brooklyn and takes the subway each day to work — is fairly well known within the dealer community. He and his team talk to the big banks most days. The job carries great responsibility and is prominent within the Fed. But outside the Fed he and his colleagues are still seen more as staid central bankers doing a job, bankers say, not necessarily Wall Street hotshots likely to be snapped up by the likes of Goldman Sachs.
When devising the program, Mr. Frost and his team decided to focus most on buying Treasury notes with an average maturity of five to six years. That is because the yields on these notes have the biggest impact on interest rates for mortgage holders, consumers and companies issuing debt, and on banks’ decisions to lend to businesses. Over the weeks and months of the program, his purchases should drive up the prices of these securities — because they will be in greater demand — and consequently push down their yields.
The trouble is, though yields fell sharply between August and November as the markets anticipated the new program, they have risen since it was formally announced in November, leaving many in the markets puzzled about the value of the Fed’s bond-buying program. Mr. Frost, and his boss, Brian P. Sack, insist the program has succeeded. Mr. Sack, 40, joined the Fed 18 months ago to run the entire markets group. He has a Ph.D. from M.I.T. and worked most recently for a Washington consulting firm. In 2004, he wrote a paper with Ben S. Bernanke, the future chairman of the Federal Reserve, and another economist about unconventional measures for stimulating the economy in extraordinary times — just like large-scale purchases of Treasuries.
"We didn’t know then that the Fed would be putting it to the test," he said. He said the Obama administration’s $858 billion tax compromise with Congressional Republicans in December complicated the macroeconomic picture. But the biggest reason for the rise in interest rates was probably that the economy was, at last, growing faster. And that’s good news. "Rates have risen for the reasons we were hoping for: investors are more optimistic about the recovery," said Mr. Sack. "It is a good sign."
'One poor harvest away from chaos'
by Geoffrey Lean - Telegraph
'Within a decade," promised the top representative of the world's mightiest country, "no man, woman or child will go to bed hungry."
Dr Henry Kissinger, at the height of his powers as US Secretary of State, was speaking to the landmark 1974 World Food Conference. Since then, the number of hungry people worldwide has almost exactly doubled: from 460 million to 925 million. And this week the airwaves have been full of warnings that the formidable figure could be about to increase further, as a new food crisis takes hold. Some experts warned that the world could be on the verge of a "nightmare scenario" of cut?throat competition for the control of shrinking supplies.
The cause of such alarm? On Wednesday, the Food and Agriculture Organisation (FAO) reported that global food prices had hit a record high and were likely to go on rising, entering what Abdolreza Abbassian, its senior grains economist, called "danger territory". That is bad enough for Britain, adding to the inflationary pressures from the soaring cost of oil and other commodities, not to mention the VAT increase. But for the world's poor, who have to spend 80 per cent of their income on food, it could be catastrophic.
Robert Zoellick, president of the World Bank, warns that the rising prices are "a threat to global growth and social stability", and Nicolas Sarkozy has identified them as a priority for the G20, which he chairs this year. Already they are higher than in 2008, when they drove the tally of the malnourished briefly above a billion for the first time in history, and caused riots in countries as far apart as Indonesia, Cameroon and Mexico. That ended nearly two decades during which the number of hungry people had stayed the same, while the world population grew by 1.2 billion, so that the proportion of an increasing humanity without enough to eat steadily fell.
But the crisis of two years ago, and the one that may be unfolding now, are polar opposites of the one behind the World Food Conference. Then, bad harvests had produced a real shortage. Now, we have bumper crops: the past three years have produced the biggest harvests ever. The issue is not one of supply, but of demand.
The mushrooming middle classes of India and China helped cause the 2008 price hike by eating more meat, which, in turn, mops up grain: it can take, for example, 8lb of cereals to produce one of beef. And cars contributed as well as cows. Biofuels transferred over 100 million tons of cereals from plates to petrol tanks: to fill a 4 x 4 tank requires enough grain to feed a poor person for a year. Speculation, too, helped drive prices up.
The same factors are at work again, though fortunately the hungry are not yet as badly hit. This is partly because the price of rice, which feeds almost half of humanity, has remained relatively stable; and partly because it is mainly the higher-quality wheat and maize – eaten by the better off – that has got much more expensive. But things remain volatile, since the world has heavily run down its grain stocks over the past decade, and much of what remains is in China, which does not readily release them even when prices are high. So the present abrupt rises have been brought about by a harvest that is only 1.4 per cent down on last year, and prices remain unusually hostage to the weather.
So if it is all so precarious at times of bumper harvests, what will happen if – or rather, when – we get a really bad one? That is what is worrying Lester Brown, president of the Washingtion-based Earth Policy Institute, whom I first met at the 1974 conference. A former champion tomato-grower – then an enthusiast for the Green Revolution, now a leading prophet of danger and one of the first to forecast the present situation – he is publishing a book on the issue on Wednesday. "The reality," he says, "is that the world is only one poor harvest away from chaos. We are so close to the edge that politically destabilising food prices could come at any time."
Imagine, he says, if last year's Moscow heatwave – which sent average temperatures 14F above normal, and contributed to this year's smaller harvest – next hit Chicago and the Midwestern bread basket. The US harvest could slump by 40 per cent, sending prices "off the chart" and cause "the global economy to start to unravel". As the climate changes, such extremes are likely to be more common. Back in 1974, Kissinger spoke of the "thin edge between hope and hunger". A generation on, it is time to take it seriously.