"Angelus siren on roof of Evans building,Washington, D.C."
Every day at noon, Get Behind the Government and Pray for Victory
Ilargi: Yes, Fukushima has been lifted to Level 7 on the International Nuclear Event Scale. The promotion, long overdue, places it in a class where until now only Chernobyl resided. But that does not mean, though I'm sure we'll get to hear that a lot, that Stoneleigh was wrong when she said Fukushima is no Chernobyl. For one thing, the differences in respective reactor designs make the accidents hard to compare. For another, even if it's now classified as Level 7, the amount of radiation released at Fukushima is still only 10% of what Chernobyl unleashed into the atmosphere. Which is not to downplay the event: it is set to haunt Japan, and perhaps its neighbors, for many generations to come.
In the financial world, the end of QE2 (and no QE3 for a long time) is now understood as being all but certain. PIMCO's Bill Gross' decision to move from Treasuries into cash (re: deflation) is stealing the headlines, but there's more to come from many angles. If the Fed doesn't purchase US sovereign debt any longer (it bought 70% at one point), who will (and can) take its place? And what will be the consequences if no-one stands up to do it? TAE staff writer Ashvin thinks perhaps Gross, who's known for knowing many things before others do, is playing a predatory game, with the Fed as the background puppeteer:
Every so often, and more often than not, a rumor emerges in the blogosphere about a significant development, seemingly adverse to the interests of the U.S. federal government, being manufactured by the government to further solidify their control over the masses. Sometimes these rumors are plainly absurd on their surface, and sometimes they are just too perfect to be true. The nature of these "psy-ops" is that they are nearly impossible to verify with any direct evidence until well after the fact, so we must rely on indirect logical analysis and a bit of intuition.
Personally, I always find it curious when a piece of news that pops up into the public domain just doesn't seem to fit in with the systemic realities that I otherwise perceive. It could be that I am simply taking these realities for granted and it is time to re-evaluate them, but it could be that they don't fit because they were never intended to. A report last month from Zero Hedge showed that PIMCO had reduced the Treasury exposure of its Total Return Fund (TRF) from 18% to 0%, and a more recent report has shown that it actually has a net short position on Treasuries. .
Pimco is the world's largest bond fund, and its manager Bill Gross has been quite vocal over the last two years about the U.S. Treasury's massive and unsustainable deficits. He was so vocal about it that he decided to load up on Treasuries and make a killing from February of 2009 until July of last year, with only a few brief respites in between. That's just the type of person Bill Gross is - he's a shark wading in the deep blue waters of Wall Street, and, like most other ones, he's an "insider trader".
He went on a Treasury-buying binge in February 2009, just in time to fully ride the coat tails of the Fed's QE operations that commenced in March and monetized $300B in long-term Treasury debt. . No one in the public domain knew about the existence of this program in February, or the extent to which it would be carried out. It's not about economic fundamentals and it's certainly not about principles or "what's right", it's only about money and, specifically, lots and lots of money.
Now, the TRF is net short Treasuries and many people are convinced that its short position is, in fact, nothing short of a prediction by Gross that the Treasury market will soon collapse. Indeed, he seems to be at least betting that rates will increase significantly in the short-term. Perhaps that is true or perhaps he is making a bad bet, but perhaps we should also be wary of such plainly advertised convictions. After all, the insider "beltway" encompassing Wall Street and Washington has two lanes running in both directions.
If the Fed has a hidden agenda, then it would not hesitate to use Gross and his bond fund to pursue it, and if there's any institution with a hidden agenda, it's the Fed. At the beginning of 2009, the prospect of the Fed launching operations to monetize the federal debt was a radical one, unexpected by all but the most well-connected money managers.
By this time, QE has been going on for so long and with such force that it has become a standard routine. It has even gotten to the point where mainstream publications, such as the Wall Street Journal , are accusing the Fed of directly influencing the eruption of bloody revolutions in foreign countries. The Fed needs to maintain integrity in the U.S. Treasury market above all else , but it is also needs to maintain a semblance of integrity in its own house.
It's in the process of walking a delicate tightrope, and the rope it struggles to walk has increasing amounts of slack. With additional QE to supplement the MBS prepayment re-investments and QE2 operations, both of which are currently winding down, the Fed risks stoking the fires of social and political chaos which constantly threaten to consume it. This dynamic is the result of primary dealer banks selling newly issued Treasury coupons to the Fed at scheduled times and walking the profits down the beltway into equity and commodity markets. The Fed must now fear that further hot money speculation in commodities will make gas and certain foods unaffordable for not only the poor Tunisian people, but for the average American energy guzzler as well.
Without additional QE, however, the Fed loses all control of U.S. asset markets, and, by proxy, asset markets the world over. So what it really needs is a sort of timeout, in which it can engage in an immature display of wild-eyed frustration, erratically flailing its hands up in the air, shouting, "We're Done!". Then, it can sit back and watch fear set in the eyes of investors worldwide, as they realize that no more QE means no more over-valued equity and commodity markets. And no more of those means no more towers of leveraged capital producing unspeakable returns 24/7, day in and day out. Instead, all of that imaginary capital will be squashed down into a dime-sized pancake and will return nothing but the foul odor of putridly stale losses.
It is at that point when senior editors at the Wall Street Journal will abandon their offices and go running to the Fed with their guts in hand, furiously apologizing in one breath and then begging for more QE in the next.
"You see, Mr. Bernanke, our subscribers have been calling en masse to cancel over-priced yearly subscriptions as their investment capital continues to get wiped out in the stock, commodity and real estate markets. For Christ's sake, man, we need your help!"
The systemic fear generated from crumbling markets worldwide will first serve to attract scared capital into the Treasury market, as it still remains the only place to go for people with sums of money that won't fit under any mattress. Besides, the only real difference between the U.S. dollar and short-term Treasury bills or notes is that the latter could potentially give you a fixed income over their duration. The fear will then serve to further justify Treasury asset purchase operations by the Fed, the ongoing sociopolitical destruction in the Middle East be damned. So how does Pimco and Bill Gross fit into all of these deceptive monetary tactics? Well, the fact that TRF currently holds a record 38% of its assets in dollar-denominated cash is a telling one. .
Every investor knows that the best and quickest way to make money is to own something that virtually no one else does, right before it gets hot and takes off towards the moon and the stars. An unexpected end to QE operations will send the dollar soaring, and as mentioned before, all asset markets plunging except for the U.S. Treasury market. Bill Gross may have dumped all of his Treasury exposure for now, but has any other major financial institution or money manager followed his suit? Has the Fed announced any plans to sell its Treasury holdings back into the primary or secondary markets?
Of course not. These institutions are not worried about rates surging outside of their control anytime soon, and will be glad to make a few extra bucks from higher interest payments (paid by taxpayers) before the "rush to safety" really gets underway. I suspect that, by that time, there would have been a significant reversal in the Treasury holdings of TRF and the superficial justifications for the investment decisions of the omniscient Bill Gross. Perhaps he will continue to have minimal exposure to U.S. Treasuries throughout the year, as a partial hedge to his fund's enormous cash holdings, but that certainly should not be taken as an absolute bet against the Treasury market.
Gross is merely a beltway insider with a purpose, which happens to coincide with the purpose of every other insider and elite - to preserve the dollar-based financial system. He is the magician's assistant, distracting the audience in the front with a short-con while the magician sets up the long-con behind him. The bad cop who beats the suspect over the head and tells him he has one last minute to confess before the entire case is blown wide open, followed by the good cop who enters the room and promises they will go easy on the suspect and recommend leniency to the judge, as long as he just tells them where all the money is hidden. Once again, it is not about enforcing the law or finding justice, it's only about using deception to drive all of that money out of its hole and into their hands.
Besides, did anyone really think that the world's biggest bond fund was about to unconditionally give up on the world's biggest bond market (which just so happens to support every other U.S. bond market, and foreign ones as well)? Personally, I think Bill Gross is going to continue doing what he does best - speaking in half-truths and pretending like he cares about day-to-day developments in the U.S. fiscal situation, while carting his millions in compensation to undisclosed personal bank accounts around the world. That is one financial shark who cannot survive outside of the deep waters, and his next feast of flesh will be no less filling than the last.
Bill Gross Is Now Short US Debt, Hikes Cash To $73 Billion, An All Time Record
by Tyler Durden - Zero Hedge
A month ago, Zero Hedge first reported that Bill Gross had taken the stunning decision to bring his Treasury exposure from 12% to 0%: a move which many interpreted as just business, and not personal: after all Pimco had previously telegraphed its disgust with US paper, and was merely mitigating its exposure.
This time, in another Zero Hedge first, we discover that it is no longer business for Bill - it has now become personal (and with an attendant cost of carry). In March, Pimco's flagship Total Return Fund (TRF) has now taken an active short position in US government debt: -3% on a Market Value basis (or $7.1 billion), and a whopping -18% on a Duration Weighted Exposure basis.
And confirming just what PIMCO thinks of US-related paper is the fact that the world's largest "bond" fund now has cash, at a stunning $73 billion, or 31% of all assets, as its largest asset class on both a relative and absolute basis. We repeat: cash is more than PIMCO's holdings of Treasurys and Mortgage securities ($66 billion) combined. To paraphrase: in March PIMCO was dumping everything related to US rates (see chart below).
This is the first net short position that PIMCO has had in Government-related debt since the Great Financial Crisis of 2008, and going positive in February of 2009 only after it became clear that the Fed would commence monetizing US debt one month later. This is the closest that Gross has come to making a political statement and is now without doubt putting his money where his mouth is.
The only event that could possibly derail Gross' thinking is a huge market crash forcing a rush to Treasury safety. Alas, as has been made all too clear recently, US debt is no longer the safe haven it once was. Which begs the question: when will the TRF break out a "gold" asset holdings line item.
And another side effect of the firm's scramble away from debt and into cash is that the effective duration of TRF is now down to 3.6: only the second lowest since the 3.38 posted in December of 2008... when the world was on the verge of ending.
That Bill Gross is willing to risk a surge in redemptions (after all who would be wiling to pay PIMCO to manage a third of their assets in the form of supposedly devaluating cash) in order to make a statement about the credibility of the US government, and specifically the viability of its IOUs, is easily the only thing that the US government has to consider when evaluating the prospects for funding trillions and trillions of US deficits at "acceptable" rates in the absence of further quantitative easing by the Chairman.
If Gross is indeed right, something very wicked this way comes.
What Is The Low Trading Volume Telling Us?
by Michael Santoli - Barron’s
All the chatter about the market's low volume is beginning to get rather loud.
Yes, it's been slow. The 10-day moving average of New York Stock Exchange composite volume last week dipped to levels on par with the typical turnover of the year 2007, notes technical strategist John Roque of WJB Capital. The 12-month moving average of NYSE volume has declined to levels last seen in 2004, according to a recent report by Jeffrey Kleintop of LPL Financial Research. In the middle third of most days, the toughest job for traders is to ignore all the snoring.
This has given market participants a convenient "Yeah, but…" retort to anyone noting that stocks are challenging their bull-market highs, that most smaller-cap indexes are already there, and that the breadth of the market—rising stocks versus falling ones—is sitting at peak levels.
Louise Yamada, the longtime technical analyst now running her own research firm, last week invoked a standard market tenet attributed to her. "Volume," she wrote, "is the weapon of the bull, historically, and is generally essential to push the market higher." This is but one reason Yamada says her "antennae are up for signs of any further weakening technical evidence suggesting more than a consolidation ahead." In other words, volume and other stats on the back of the market's bubblegum card are raising suspicion without yet handing up an indictment.
It's true that, all else being equal, brisker volume lends more credence to a market move. Still, all else is almost never equal, and the understandable craving for more robust share volume is not based on any ironclad historical relationship to share prices.
Jeff deGraaf of Renaissance Macro Research, studied prior low-volume rallies of recent decades and notes that the late 1998 surge came on below-average volume, and that volume also was unimpressive in the 2003 rebound. "We do not believe that volume over the last two weeks is an ample excuse to stay away from equities," he says. "In fact, when volume begins to pick up meaningfully…it's often close to a cyclical [market] peak in need of a consolidation," or a sideways-to-down rest period.
This is what happened as volume rebounded in early 2004 and multiple times during the months that followed the 1987 crash and recovery. It should be noted, too, that investors' sense of what "normal" volume levels look like has been inflated, in part by the enormous order flow of the crisis meltdown and subsequent rebound. A three-billion-share day in NYSE stocks, now considered uneventful, would have been cheered as a feeding frenzy just a few years ago.
Other factors that seem to be dampening activity include the relatively slow flow of new money into traditional equity funds, and the dismantling of large banks' proprietary-trading desks in response to new regulations, which has removed some unknowable amount of leveraged, high-energy trading action. Animal spirits, too, have migrated to markets other than stocks. Have you heard that commodities, such as oil and gold and silver, have been on a tear? So have the legions of traders flocking to chase them.
Even as stock volume has ebbed, the business in options has been heavy. CBOE Holdings reported that last month that average daily volume across all products rose 3% versus the total a year earlier, including a 16% rise in index-options turnover and a 25% gain in options on exchange-traded funds. And instruments tied to the CBOE Volatility Index, or VIX, set a record, despite a steady drop in the market's observed volatility.
Speaking of the slow-drip ebbing of volatility, this is another major factor holding back volume. Higher volume usually accompanies spikes in market jumpiness, especially today when the black-box, arbitrage-oriented "high frequency traders" are the marginal providers of volume on a daily basis. These firms take the other side of urgent order flow and feast on volatile moves. Calm markets leave less for them to do.
Adding it all up, the dearth of volume is understandable, yet without a clear implication for the market's direction. It's yet another way that the market feels like it's in the low-volume, Fed-medicated, range-trading, easy-corporate-credit, buyout-happy days of the middle part of the last decade. One thing is for sure, however: With the market looking impressive but a bit overbought, with investor sentiment inching toward excessive cheer and with compressed volatility dragging down option prices, the opportunity to hedge stock holdings with cheap options is ripe.
by John Hussman - Hussman Funds
Market participants widely assume that they are relatively "safe" to take speculative risk through mid-year, on the belief that the Fed's policy of quantitative easing will be sustained through the end of June. But looking at the monetary data, it is not clear that the Fed's statement "by the end of the second quarter" means "precisely until the end of the second quarter."
We can evaluate the pace of QE2 in two ways. One is by looking directly at the monetary base. QE2 transactions expand the Fed's balance sheet, increasing its assets (Treasury debt) and simultaneously increasing its liabilities (currency and bank reserves). So we can measure the progress of QE2 by calculating the change in the monetary base since QE2 was initiated.
- Monetary Base 11/03/10: $1985.1 billion
- Monetary Base 04/06/11: $2490.3 billion
- QE2 completed based on change in Monetary Base: $505.2 billion
A second way to evaluate the pace of QE2 is to go directly to the information on "permanent open market operations" (POMO) conducted by the Federal Reserve Bank of New York. However, the POMO figures also include reinvestment of principal repayments from mortgage-backed securities. So a portion of these transactions do not change the monetary base - they simply exchange mortgage-backed assets with Treasury securities. The cumulative par amount accepted by NY FRB from 11/04/10 through 04/07/11 is $523.2 billion
A $600 billion addition to the monetary base from QE2 would leave the Fed with only about $94.8 billion of QE2 transactions remaining. Alternatively, the targeted size of the Fed's SOMA (System Open Market Account) portfolio is $2600 billion at the end of QE2 (this is the primary repository of assets backing the monetary base, the remainder representing the Maiden Lane portfolios and about $11 billion in gold). As of April 6, the SOMA portfolio was already at $2421 billion. This would leave a larger $179 billion remaining to QE2, putting the program about 70% complete. The average pace of Fed purchases since February has been about $5.5 billion per business day, with about $4.7 billion adding to the monetary base, on average (the rest representing mortgage principal reinvestments). That leaves QE2 somewhere between 20 to 38 business days from completion.
The next FOMC meeting is on April 26-27. While there has been some debate on whether the Fed might decide at that meeting to terminate the policy of QE2 early, that debate is actually moot. By the time the Fed meets later this month, QE2 will already be at least 85% complete.
Economy Faces Test With End Of QE2, Rising Oil Prices, Debt Limit Fight
by William Alden - Huffington Post
Recent fears of weakening economic growth have been tied to broad trends: falling home prices, the high unemployment rate and the tendency of rising energy prices to make Americans spend less money. But going forward, economists' concerns center on a few crucial policy decisions, which in the coming months will help determine the nation's -- and the world's -- economic health.
The U.S. government is scheduled to reach its debt limit by mid-May, at which point the Treasury Department will resort to emergency measures to avert default if that ceiling is not raised. The Federal Reserve, meanwhile, will be finishing its $600 billion asset-purchase program, ending one of the economy's major support systems. As policymakers gradually rein in stimulus measures, some experts fear the world's economies are still too weak to survive without that boost.
"There are a number of forces that are restraining economic growth. That puts the Fed into a position where they're more likely to be cautious and careful going forward," said Kevin Logan, chief U.S. economist for HSBC. "After all, this is one grand experiment," he added.
The so-called quantitative easing program, in which the Fed has been buying U.S. government debt from big banks in an effort to lower interest rates and augment the flow of money through the economy, is scheduled to end in late June. To some extent, that policy appears to have succeeded: Interest rates have sat at rock-bottom lows and the stock market has enjoyed a rally. Since the Fed announced the move last fall, the Standard & Poor's 500 stock index has risen by 12 percent. The Dow Jones Industrial Average has climbed 11 percent.
That growth has come in spite of weak economic fundamentals. As stock markets have surged, home prices have fallen. The unemployment rate remains near 9 percent. Oil prices have reached a level not seen since 2008, when a summer of record-high prices helped drag the economy further into recession. Gas prices at the pump are approaching $4 a gallon, reducing many Americans' driving and raising fears that further increases could seriously impair the nation's economic growth.
When the Fed stops buying, it's not clear how the markets or the broader economy will respond. Since quantitative easing began last fall, 70 percent of annualized U.S. debt issuance has been bought by the Fed, according to Bill Gross, a founder and co-chief investment officer of Pimco, who runs the world's biggest bond fund. Declining demand for U.S. debt could cause bond prices to fall and interest rates to rise, a scenario that could challenge economic growth still further.
"That remains a very big question, once the Federal Reserve is no longer a buyer," said Bernard Baumohl, chief global economist of the Economic Outlook Group. "After the second quarter, assuming that there is no other quantitative easing, we can expect to see yields on Treasury securities move higher, and with it other loans -- mortgages, car loans -- will begin to move up."
In effect, higher interest rates would challenge the progress that the Fed program has made. But not all economists see that scenario playing out. Some foresee rates staying low or even falling -- which isn't necessarily a sign of strength. In that case, low rates could be an indication of broader economic weakness, as investors leave risky assets and turn toward the safety of Treasury bonds.
Moreover, the most important concern isn't that demand for U.S. debt will fall off, said Logan, the HSBC chief economist. Rather, he said, it's that the weak fundamentals of the economy will finally express themselves in markets without the crutch of government support. "It's not necessarily the flow, but it's the long-term outlook that sets the price," Logan said.
The economy, in any case, will be missing a major source of support. As broader strains -- energy prices, home prices, unemployment -- continue to weigh on markets, some economists fear that a move away from stimulative policies may be premature.
But global leaders appear to be moving in that direction. The European Central Bank raised its benchmark interest rate by a quarter of a percentage point last week, citing concerns of inflation. Such tightening is designed to stem the flow of money through the economy, as borrowing becomes more expensive. It was the first time the bank has increased rates since 2008. "The ECB made a mistake," said Gus Faucher, director of macroeconomics at Moody's Analytics. "There's the potential there for a double-dip European recession, given tighter monetary policy, and given the debt problems there." Added Faucher: "That could rebound on the U.S."
All of this uncertainty isn't helped by the gridlock in Congress, which nearly caused the federal government to shut down Friday night. In the past weeks, a fierce clash of wills in the upper echelons of U.S. political power has stalled progress on legislating a budget. That stalemate has shown no signs of fading. Treasury Secretary Tim Geithner delivered the May debt-limit deadline last week in testimony before a Senate subcommittee. The government needs to borrow to pay for its existing debt and other obligations; if the government can't issue any more debt, it risks entering default.
A missed debt payment, which could come as soon as July if the limit is not raised, could trash the nation's credit rating, raise borrowing costs for the government and all of its citizens and infect global markets with panic. It could set off a crisis worse than the one the nation is still recovering from, Geithner said. Economists tend to agree. "If the debt ceiling were not passed, the consequences could be horrific," said Nariman Behravesh, chief economist at IHS Global Insight, a financial and economic analysis firm.
The coming months will be decisive. As the debt ceiling debate will likely be contentious, investors will keep a close eye on interest rates in the wake of quantitative easing. And as fighting continues in the Middle East, sustaining fears of an oil supply disruption, energy prices will likely continue to rise. "Oil prices are still the wild card," Behravesh said. "That's probably the single biggest risk right now."
The End of QE2: Major Policy Shift Ahead
by John Mauldin - Frontlinethoughts
This week’s Outside the Box is from my friend David Galland, an interview he did for The Casey Report, and it represents a philosophical train of thought more in line with Austrian economics and libertarianism than my own. But if we only read what we already think, then how do we learn? It is only when your ideas are challenged and you must determine why the other guys are wrong and you are right, that you can either become more firm in your beliefs, or change. And much of what David says in this interview resonates. (I wrote about the end of QE2 a few weeks ago.)
The guys at Casey are natural resources, commodities, and precious metals investors. Yet David argues that cash might be the wise thing now, after pounding the table for years on gold. He believes that the end of QE2 will be more important and dramatic than most think. That it is coming to an end I have no doubt, so it is important to think about what the effects, if any, will be. There are those who argue that we can live without it now. I argued (and still do) that we should have never had it. The unintended consequences are the ones I worry about. We just don’t know. It was a crazy experiment, with no understanding of what would really happen. But hoping for the best is not a strategy, so let’s think about it. David provides us with some different ways to look at the process.
The Casey Report's David Galland Interviewed by Louis James, Editor, International Speculator
Editor’s Note: David Galland, Casey Research partner and managing editor of The Casey Report, sees a major shift in Federal Reserve policy ahead and has advice on how to invest accordingly. Time is short, so we’ve asked David to share his thoughts with us.
L: David, in recent editorials you’ve warned of what could be an important shift in Fed policy – can you fill us in?
David: Sure. The purpose of The Casey Report is to keep subscribers well positioned in powerful, long-term trends – the kind of trend that will keep giving and giving. The trend in precious metals – gold and silver – which we’ve been heavily recommending for ten years is a good example. The overarching goal of The Casey Report is first and foremost to identify those critical larger trends and then closely monitor them until they play out – which is another way of saying that we aren’t big about market timing or jumping in and out of trades. I mention this to set the context for the coming shift in Fed policy.
L: And that context is?
David: That the shift, and it is imminent, will not change the larger trend, but it has the potential to be quite disruptive over the short term.
David: In terms of the larger trends, the fundamentals that have caused so much pain and economic woe over the last ten years or so remain intact. If anything, they’ve gotten worse. We’ve gotten currency debasement, not just in the U.S., but especially in the U.S. dollar, which is not just any currency, but the world’s reserve currency.
We’ve got a truly mind-boggling expansion of the reach of government into all aspects of society and the economy, with all that that implies in terms of regulation, taxation, controls over investments and finance, impact on personal liberty, and so forth. By recognizing this destructive trend for what it is, investors can position themselves to avoid the worst, and to profit by betting on things like the continuing debasement of the dollar.
So that’s the big picture. There is growing evidence that in the next month or two, we will head into a very dangerous period. The Fed has been extremely supportive of the U.S. government’s insane spending, polluting its own balance sheet by buying up toxic loans by the hundreds of billions and by pumping enormous quantities of cash into the money supply. You don’t have to look very hard to understand why we have seen some small recovery in the economy, much of which has been driven by the financial sector that has been the recipient of so much largess – it was bought and paid for by the government, working hand in glove with the Fed.
But there is about to be a fundamental change in this arrangement. It appears that the Fed has decided that it’s time to take a step back from its monetization – or quantitative easing (QE), as they now term it – in the hopes that the market will step in to fill the large gap it will leave. They can’t know how that’s going to work out, but if they don’t stop pumping money into the economy, they never will know if the quantitative easing has worked.
Based on a lot of statements from a number of the voting members of the Federal Open Market Committee, the change just ahead is that they are serious about stopping QE in June. As they won’t wait until the last minute to confirm the end of their Treasury buying, I would expect their intentions to be made clear following their end-of-April meeting, the full minutes of which should be released in early May.
L: To be clear, do you mean no QE3, or that they cancel the portion of QE2 they haven’t spent yet?
David: They may leave themselves a bit of wiggle room by holding back some of the funds slated to be spent as part of QE2, in the hopes of demonstrating a high level of confidence in their decision to stop the monetization. That would also give them a bit of powder to use should the need suddenly arise, without exceeding the mandate of QE2. The important point is that I am increasingly sure they won’t just roll out QE3, and that will have consequences.
L: Are you saying, no QE3 at all?
David: No. I think there will be a QE3, but it won’t materialize until after a relatively lengthy period during which the Fed stands aside in order to give the market the opportunity to adapt and adjust to their exit from the Treasury auctions. In other words, once they stop, I wouldn’t anticipate them jumping right back in at the first sign of trouble – say, if the stock market crashes. In time, however, as the ponderous problems weighing on the economy come back to the fore and return the economy to its knees, the Fed will be forced to reinstitute the monetization, though they will likely try to come up with a moniker other than quantitative easing to describe it.
L: You’re as cheerful as Doug. Why are you so sure there will be a QE3?
David: Because the problems that made the economy stumble in 2008 have not been solved. As I said before, most have gotten worse. Have the impossible levels of sovereign debt and trillions in unresolved bad mortgages embedded in the balance sheets of Fannie, Freddie, the Zombie Banks and even the Fed been resolved? Hardly. Is there any real sign coming out of Washington that the deficits will be substantively tackled? You don’t have to be as active a skeptic as I to understand that the deepest spending cuts being discussed don’t even scratch the surface of the $1.5 to $2 trillion deficit. As for the $60 trillion or so in debt and unfunded obligations, forget about it.
The U.S. government and the governments of most large nation-states are fundamentally bankrupt. In time, they will have to default on their obligations. While there will be some overt defaults, I expect most of them to follow the path of least resistance, which is to try to inflate the problem away. And that means QE3. For now, however, the Fed will claim victory over the economic crisis and follow suit with many other central banks – switching to a less accommodative monetary policy.
L: They’ve done their job and now it’s time for back-slapping and cigars.
David: If you look at a chart of the dollar, you’ll see that it has been bumping along the bottom recently. Logically, if the Fed stops monetizing the Treasury’s spending, we should see a rebound in the dollar. The big traders – the big institutional money out there – are going to use the change in Fed policy as a clear signal that it’s safe to get back in the U.S. dollar.
It would be wrong to underestimate the amount of money that needs to find a home, and the liquidity advantages offered by the U.S. Treasury market. If the river of money redirects into Treasuries, it could – at least for a time – offset the Fed’s exit and push the dollar up, maybe significantly so. And if the dollar comes roaring back, commodities, including gold and silver, would likely take a fairly hard hit.
Again, this is a short-term view. The longer-term trend for the precious metals is absolutely intact, because the fundamentals are entrenched – namely that the sovereign debt and spending is out of control, and politically uncontrollable.
L: Let’s talk about that for a moment. These people – the big money – are financial types. Bankers. They know about all the bad debt they have, even if the ever-so-convenient new reporting rules allow them to keep some of their problems off the books. They must know that a so-called jobless recovery is not a recovery. They are well aware of all sorts of dirt they don’t discuss in public – how could they be stupid enough to let the Fed convince them the economy is healthy when their own information tells them it isn’t?
David: First off, "they" are not one guy. They are a lot of people with a lot of different perspectives and a lot of different objectives. Right now, for example, people look at the lack of yields in bonds and the potential for inflation in bonds, so they’ve been easing back on bonds and getting into equities more, in the hope of generating some kind of return. If you’re a fund manager or a large institutional trader, you’re not paid to sit on your hands. You’ve got to "do something," even though there are times – and I think this is one of those times – when doing nothing is exactly the right thing to do. So, I wouldn’t say they are being stupid–
L: Doug would: "An unwitting tendency toward self-destruction."
David: Yes, he would – but these guys are not stupid; it's rather that they’ve made their own calculations and concluded that U.S. equities are still safe – a position that is supported by the very low levels of volatility. Even the troubled financials have seen strong gains of late, even though nothing has been fixed. Of course, if you look under the hood, you find they’ve benefited substantially from the cheap money and rigged deals the government has orchestrated to bail them out.
While no one can say when the shift out of equities and back into Treasuries and lower-risk assets will begin, in my view the Fed’s exit from quantitative easing sets the stage for that to happen. After that, it will just be a matter of time before traders are going to wake up and decide equities are not safe, and they’ll start leaving in droves.
Remember, however, that the stock market and the economy are by nature very complex systems. There are so many variables, you just can’t know which variable is going to rule the day at any given time. But given the importance of the Fed’s intervention and the government spending that has helped engender, its policy shift is certainly a variable to keep an eye on.
L: I find the capacity of bankrupt financial companies to defy gravity truly amazing. Disbelief sustained for such lengths of time makes me dizzy.
David: You’re not alone. The vast ocean of bad debt out there is just as big as ever. Everything I hear from people in the financial industry is that the banks’ debt profiles are not getting any better. People are not getting on top of their debts. They are not paying down their mortgages. Default rates are still astronomical…
L: How could it be otherwise? Unemployment is still high.
David: Unemployment is still stubbornly very high, though if you buy into the government’s figures, it is moving steadily in the right direction. Of course, the government has no reservations about jiggering the data to suit itself. That makes it important – if you want to get a more realistic picture – to look at the topic from different angles. One telling statistic is unemployment as a percentage of the employable population, which screens out many of the government’s self-serving adjustments to its official figures. Looked at that way, you can see that unemployment is continuing to rise, even though the government is reporting that it’s falling markedly.
L: No! You can’t be suggesting good old Uncle Sam would lie to us…
David: You could say we have another deficit, one in government accountability. Clearly, it’s very politically important that unemployment be perceived as declining, therefore, voilà, it is.
L: "Alas, Bartleby." Okay, let’s back up a bit to the debasement of the dollar. You mentioned that as a given, almost in passing, but there are a lot of people who don’t see it. Inflation is low, Uncle Sam assures us, so the dollar has not been debased. Q.E.D.
David: Well, anyone who can see beyond the tip of their nose can see that inflation is going up. Just pull up a chart of the CRB Index for commodities – the real stuff required for life – and one can see it has been on a steep upwards trajectory. Inflation is very much here and alive.
L: John Williams’ Shadow Stats chart shows inflation at nearly 10%, while the Bureau of Labor Statistics is reporting 2.1%. But even Williams’ statistics don’t report real inflation; they just report what it would be if the government reported inflation the way it used to, before it started "improving" its reporting in the 1980s. It’s still an incomplete view, because the government’s original reporting was flawed to begin with.
David: Right. And one of those flaws is the way they weigh housing. It plays a big, big role in CPI, and in 2008 housing was dealt, if not a death blow, at least a blow that put it in the hospital. And it will be there for a very long time, because government policies encouraged bad decisions on the part of both lenders and borrowers. This has left trillions of dollars of bad debt hanging out there. The retracement of housing prices, as a component of official CPI, pulls the official inflation figures down, even though those figures don’t sync up with the actual cost of living. Of course, a low CPI gives the government cover for continuing to monetize its debt. Inflation problem? What inflation problem?
L: The net of this for inflation is that the crushing of the housing sector makes the CPI drop, making it look like life is getting cheaper, whereas the reality is that people’s hard-earned wealth put into real property has taken a beating at the same time as the things they consume on a daily basis cost more. Life has gotten a lot more expensive even as savings have been wiped out. Not good.
David: Right. And the government is trying to get people to ignore the signs of inflation, saying everything is all right. But recently, several Fed governors have been saying outright that there is a problem and that they need to cool off the money creation and start dealing with inflation. This is why I think there isn’t going to be an immediate QE3.
L: So, what happens next?
David: Consider Japan as an example of an advanced economy that has been struggling to deal with the aftereffects of a collapsed bubble in real estate and stocks for many years – well before the recent earthquake. If you look at what happened when they did their equivalent of QE after the initial stock market crash, the spending stimulated a fairly significant recovery in Japanese equities, taking the market back up about halfway to the bubble’s top; but the rally didn’t last.
Once the Japanese government put an end to its quantitative easing, the Nikkei plummeted. The government resisted reinstating quantitative easing for two years before throwing in the towel and once again cranking up the money engines in an attempt to break the economy out of the doldrums. The long-term result is a Nikkei still well below the crash level (even before the earthquake), and all the spending has caused Japanese government debt to rise to 200% of GDP. While no two situations are identical, I think the U.S. is following a very similar script.
L: If the Fed decided to hold off on QE3, do you think it could take as long as two years for them to feel forced back to it, forced to do something?
David: It could. It would depend on how sharp the downtick is. There are so many factors at work here that it’s really unknowable at this point. Nearer-term, all the signals are that the Fed will hold off on QE3 at their next meeting. And, as I have tried to make clear, that will have consequences – for equities, for the dollar, for the commodities sector.
L: Can you give those readers not familiar with The Casey Report some reason to believe your crystal-ball gazing? What’s your track record with these sorts of predictions?
David: Well before the current financial storm hit, we were forecasting that the Fed would begin monetizing the government’s debt, and we were writing about a credit crisis leading to a currency crisis, which is exactly what’s happened. We absolutely nailed it, and our subscribers made a lot of money on some of our recommendations – and safeguarded a lot of their wealth with others.
L: That’s true, though back then, before The Casey Report separated out the big-picture writing from the International Speculator our portfolio did take a temporary beating – along with everything else at the end of 2008.
David: Yes, but everything we said about the debasement of the dollar and its consequences for gold was borne out. Further, we made a bold move, counseling people to go a third in gold and gold-related assets, a third in cash, and a third in other assets that could do well in an economic crisis. Subscribers who actually followed this allocation suffered very little in 2008.
L: Isn’t it a bit contradictory to recommend that people keep 33% of their wealth in cash, if you think the dollar is being destroyed?
David: The dollar is being destroyed, as one can see by how much gold, oil, wheat, cotton or any other number of things one can buy with it. However, while it’s not dropping day to day and the markets remain extremely volatile, cash is not a bad thing to hold – especially in relatively safer currencies, like the Canadian dollar and the Norwegian krone. So, again, the big trends remain intact. Our question now is what’s going to happen next, in the short term. And in that context, the Fed’s switch in policy is a big deal. When you go from the Fed showing up every week and buying Treasuries, to the Fed stepping back and saying "No more," it can send major shock waves through the economy.
L: So, if the Fed does what you think it will, by June, how do readers invest accordingly?
David: [Laughs] This may not be a popular answer, but I think the correct answer is that the best thing you can do in the near term is to increase your cash position. I would be very cautious about moving into any other asset class at this point, including gold.
L: You wound me.
David: I know. Listen, if you own high-quality gold stocks, such as those you recommend in the International Speculator – companies that have the goods and can weather the coming storm – you can certainly just ride right through what’s coming. But if you’re not quite confident enough to avoid panic selling in a correction, or if you have some mutts in your portfolio that haven’t performed and you’re not sure why you own them, I’d get rid of them fairly quickly.
Remember: the time line on the Fed’s decision is quite near-term. That doesn’t necessarily mean there would be an immediate stock market crash, but it certainly would have an effect on the commodities sector. On the other hand, as I’ve said, markets are complex. Saudi Arabia could go up in flames, sending oil and gold both way up. So I’m not telling anyone to get out of the markets. There’s no way to predict such events – but what we do feel confident about predicting is that the Fed will not roll right into QE3.
L: Agreed. And if you’re wrong, having cash to deploy into new opportunities won’t be a bad thing. Anything else?
David: If you’re of a mind to play in the currency markets, you could take a leverage bet on the dollar rising against competitive currencies. But right now, personally, I’m inclined to do nothing, except maybe to lighten up on some investments and go to cash. That sets you up for the real play. If I’m right, and commodities – including precious metals – sell off, and mining stocks sell off even more, there will be some fantastic opportunities to take advantage of. The people who are paying attention will be able to clean up.
L: Now you’re singing my song: short-term cash, and get your shopping list ready.
David: That’s the way I see it.
L: Okay then, thanks for your predictions – I look forward to seeing how they bear out.
Obama to Put Taxes on the Table
by Carol E. Lee and Damian Paletta - Wall Street Journal
President Barack Obama will lay out his plan for reducing the nation's deficit Wednesday, belatedly entering a fight over the nation's long-term financial future. But in addition to suggesting cuts—the current focus of debate—the White House looks set to aim its firepower on a more divisive topic: taxes.
In a speech Wednesday, Mr. Obama will propose cuts to entitlement programs, including Medicare and Medicaid, and changes to Social Security, a discussion he has largely left to Democrats and Republicans in Congress. He also will call for tax increases for people making over $250,000 a year, a proposal contained in his 2012 budget, and changing parts of the tax code he thinks benefit the wealthy. "Every corner of the federal government has to be looked at here," David Plouffe, a senior White House adviser, said Sunday in one of multiple television appearances. "Revenues are going to have to be part of this," he said, referring to tax increases.
Until now, Mr. Obama has been largely absent from the raging debate over the long-term deficit. The White House has done little with the recommendations of its own bipartisan deficit commission. And Mr. Obama's 2012 budget didn't offer many new ideas for tackling entitlement spending, among the biggest long-term drains on the federal budget. The president stayed out of the long-term deficit debate in an apparent effort to see whether Republicans would move first in offering long-term deficit-reduction ideas—something House Budget Committee Chairman Paul Ryan did with an ambitious plan last week to trim spending now and in the future.
The White House move caught Democrats in Congress off guard, according to aides, and details of the president's proposals were sketchy. Mr. Plouffe said the president will name a dollar amount for deficit reduction, although the White House wouldn't provide specifics. Introducing taxes into the discussion has the potential to complicate the resolution of coming budget fights, specifically the need to raise the debt ceiling, a move needed to prevent the U.S. defaulting on its debt.
The administration's push comes less than two days after Mr. Obama and congressional leaders reached a deal to fund the government for the next six months that would cut $39 billion in spending. Administration officials say they have long been working on a comprehensive plan to tackle the country's debt, but waited so as not to complicate budget negotiations that almost shut down the government.
Rep. Eric Cantor of Virginia, the No. 2 Republican in the House, said in an interview that Mr. Obama had already passed up an opportunity to show seriousness about deficit reduction with his 2012 budget. "Instead of returning back to the age-old playbook of raising taxes so that spending can continue, I think maybe the White House ought to take a look at what we're talking about…which is to cut spending as well as to reform these entitlement programs."
Mr. Cantor called the debate over top personal-income-tax rates "settled" by last year's elections and the subsequent tax deal. "It was then that we all agreed it wouldn't be a good thing if we want to see job creation for taxes to go up," he said.
The plan released last week by Mr. Ryan (R., Wis.), would make permanent the tax cuts approved under President George W. Bush, close loopholes and lower tax rates. It also envisions essentially privatizing Medicare and cutting Medicaid spending by turning the program over to states to administer. The GOP plan cuts $6.2 trillion over 10 years. Mr. Obama's budget forecast a $1 trillion cut over the same period.
The cuts Mr. Obama will propose Wednesday to Medicare will differ from the Republican plan. Mr. Plouffe said only that the White House supports the Ryan provisions that preserve Medicare savings already in the health law. On Social Security, Mr. Plouffe said Mr. Obama is willing to work with Congress on a long-term plan, but offered no further details.
About a month ago, senior Democrats in Congress appealed to the White House to get involved in a separate set of bipartisan deficit-reduction talks led by a group of senators known as the Gang of Six. The Democrats wanted the White House to influence the talks before they became too focused on spending cuts. A Democrat involved in that appeal said White House help hasn't been forthcoming.
On Monday, Sens. Mark Warner (D., Va.) and Saxby Chambliss (R., Ga.), who are leading the Gang of Six effort, plan to brief 500 business leaders and others at the Rotary Club of Atlanta about their effort. The group is close to finalizing a proposal that would cut the deficit by $4 trillion over 10 years.
The White House is trying to portray Democrats as the champions of the middle class. After days of commenting little on the Ryan budget, Mr. Plouffe said there are parts of it the White House agrees with, but he rejected one element of the proposal as a $1 trillion tax break for Americans making over $250,000 a year. In his speech Wednesday, Mr. Obama will use himself as an example to make the case for raising taxes on the wealthy, while preserving those for the middle class. "People like him, as he'll say, who've been very fortunate in life, have the ability to pay a little bit more," Mr. Plouffe said.
Eliminating the Bush tax cuts for the highest earners, however, will only put a small dent in the projected deficit.
Republicans contend that raising top rates would hurt small businesses and cut into cash that might otherwise turn into consumer spending. Mr. Ryan said on NBC's "Meet the Press" Sunday that "If you go down the tax increase path you're sacrificing the economy." The White House will stress what Mr. Plouffe called "smart" deficit reduction, meaning a plan that avoids cuts to administration priorities such as spending on education and infrastructure.
If the tax fight reignites, the White House could be setting itself on a collision course with Republicans on the debt ceiling, a fight with more serious consequences for financial markets. The U.S. Treasury issues debt to fund the country's obligations, including interest payments. But Congress sets the limit, or ceiling—currently at $14.294 trillion—and the country has roughly $14.2 trillion in debt outstanding. The Treasury wants the ceiling raised now, believing the country could potentially default on its debt July 8.
Many GOP lawmakers refuse to increase the ceiling under any circumstances, while others plan to use the vote as leverage to get deficit-reduction measures. Mr. Plouffe signaled the White House is open to attaching deficit-reduction measures to a bill.
Eurozone ship is on the course that was set for it: heading for the rocks
by Roger Bootle - Telegraph
Two events last week saw the crisis in the eurozone deepen - the Portuguese bail-out and the ECB's interest rate increase. But much more is brewing.
Everyone is now focused on government debt as the nub of the problem. And the numbers are shocking. The debt to GDP ratio is over 140pc in Greece. Indeed, it is all but impossible for Greece to adjust through fiscal austerity. It is caught in a debt trap from which the only escapes are inflation (which is impossible if you are still in the euro), default, or being bailed out.
As with most things "euro", the bail-outs provided to Greece and Ireland – and now on offer to Portugal – aren't quite what they seem. They are high interest loans. If this is any sort of remedy, it is for a different malady.
The peripheral countries' fundamental problem is not illiquidity but insolvency. At some point, Greece will have to default on its debts or be the beneficiary of an outright gift from its creditors – or leave the euro.
And the debt problem is pretty serious elsewhere too. In Italy, the debt to GDP ratio is about 120pc. Italy has not really featured in the crisis so far, partly because its government debt is largely held by Italians. Yet if confidence in the Italian government's ability to service its debt were to crumble, then its people and institutions would not sit there passively out of a sense of public duty.
Debt is one facet of the euro's crisis. There are three others.
- The first is competitiveness. Since the formation of the euro, German unit labour costs have barely risen, but in the peripheral countries they have surged ahead – by about 30pc in Greece, Spain and Portugal. The result is that the peripheral countries are uncompetitive both inside and outside the eurozone, thereby shutting off strong exports as a route to recovery.
- The second factor is the property market. In Ireland and Spain, house prices were driven up in a major property bubble. Although prices have since fallen a long way, the prospect is for further large drops.
- The third factor is the weakness of the banks. Interestingly, some of the most serious problems lurk in that paragon of financial orthodoxy, Germany, where the state-owned regional banks have taken on oodles of dodgy assets.
The euro is supposedly cemented by unshakeable political will. Yet not only has the eurozone failed to establish workable union-wide political institutions, but the political situation in member countries has turned ugly. Portugal and Belgium are without governments. Opposition to austerity is building in Greece and Ireland. President Sarkozy of France faces an uphill battle to be re-elected, not least against a revived, and euro-sceptic, National Front. In Germany, after recent electoral losses, Angela Merkel is in a weak position.
Even so, the medicine being dished out to the afflicted countries is a dose of German austerity. The idea is that fiscal deficits can be reduced by expenditure cuts and tax rises while competitiveness can be restored through reducing costs and prices. But given the multi-faceted nature of the euro's problems, this mixture of depression and deflation is extremely dangerous. Because it reduces aggregate demand, fiscal austerity will intensify the downward pressures on house prices and undermine the quality of banks' assets.
Admittedly, if costs and prices fall, then competitiveness can gradually be regained. But falling prices increase the real value of debt – both public and private – and make the debt crisis worse. Most of this mess was envisaged by the critics of monetary union when the single currency was established but the euro-elite just ploughed on. The single currency was going to bring convergence between member countries. In fact, several members have diverged.
It was going to lead to an upsurge of growth. In fact, there has been no improvement in underlying economic performance and the eurozone has been clobbered by the global financial crisis. The private sector was assumed to be well behaved and the banks sober and responsible. In fact, the euro led to a mega-property boom which has left an already shaky banking system distinctly vulnerable.
What the eurozone needs now is sustained, strong economic growth. Yet this is a realistic prospect only for Germany and its immediate satellites. By contrast, the peripheral countries face years of depression. Predictably, the remedy offered by the politicians is an alphabet soup of support mechanisms, all beginning with the magical letter E, and more of the balm that supposedly overcomes all ills, namely political will.
In other words: don't panic; it will be all right on the night.
It won't. The eurozone is heading for the rocks.
Spain will be next for a bail-out by the EU
by Wolfgang Münchau - Financial Times
European politicians have every incentive to postpone crisis resolution indefinitely, as I argued last week. In the meantime, the debt of several peripheral eurozone countries continues to build up. On Wednesday, Portugal finally accepted the inevitable and applied for a financial rescue. European officials quickly pronounced that this would be the last rescue ever. Everyone in Brussels fell over themselves to argue Spain would be safe.
On Thursday, the European Central Bank raised its main refinance rate by a quarter point to 1.25 per cent. This was a well-flagged move, but more are likely to follow. I expect the ECB’s main policy interest rate to rise to 2 per cent by the end of this year and to 3 per cent in 2013. This trajectory, while consistent with the ECB’s inflation target, will have negative consequences for Spain in particular. Apart from the direct impact on economic growth, higher interest rates will hit the Spanish real estate market. Almost all Spanish mortgages are based on the one-year Euribor money market rate, which is now close to 2 per cent, and rising.
Spain had an extreme property bubble before the crisis, and unlike in the US and Ireland, prices have so far fallen only moderately. According to data from Bank of International Settlements, real house prices in Spain – price per square metre adjusted by the personal consumption deflators – rose by 106 per cent from the beginning of monetary union and to the peak in June 2007. They have since come off by 18 per cent as of end-2010. Calculations such as these are sensitive to the starting date, but Spanish real prices were relatively flat throughout the 1990s, so this is a relatively safe starting point.
Where will it stop? I would expect all of that increase to be reversed. The total peak-to-trough fall would be more than 50 per cent, and prices would have to fall by another 40 per cent fall from today’s level. Is that a reasonable assumption? In the US, real house prices stagnated for most of the 20th century. Increased demand, through immigration for example, should not affect the price level, as long as supply can adjust.
The situation is different in countries with natural or artificial supply constraints, like the UK. But in terms of supply conditions Spain is more similar to the US. I have yet to hear an intelligent reason why Spanish real house prices should be any higher today that they were 10 years ago, and indeed why they should keep on rising.
The most important housing market statistic in Spain is the number of vacant properties, about 1m, which means that the market will suffer from oversupply for several years. This will be the driver of further price declines. Given the stress in the system – recession, high unemployment, a weak financial sector, higher oil prices and rising interest rates – one might even expect house prices to overshoot below the horizontal trend line.
Falling house prices and rising mortgage payments are bound to push up the still moderate delinquency rates and the number of foreclosures. This will affect the balance sheet of the cajas, the Spanish savings banks. The balance sheets carry all property loans and mortgages at cost. As default rates rise, the savings bank system will need to be recapitalised to cover the losses. The Spanish government implausibly estimates the recapitalisation need to be below €20bn, while other estimates put the number at between €50bn and €100bn. The assets most at risk are loans to the construction and real estate sector – €439bn as of end-2010. Spanish banks also have about €100bn in exposures to Portugal, a further source of risk.
The good news is that even under a worst-case scenario, Spain would still be solvent. The Spanish public sector debt-to-GDP ratio was 62 per cent as of end-2010. Ernst & Young, in its latest eurozone forecast, projects the debt-to-GDP ratio to increase to 72 per cent by 2015 – still below the levels of both Germany and France.
But the Spanish private sector debt-to-GDP ratio is 170 per cent. The current account deficit peaked at 10 per cent of GDP in 2008, but remains unsustainably high, with projected rates of more than 3 per cent until 2015. This means that Spain will continue to accumulate net foreign debt. The country’s net international investment position – the difference between external financial assets and external liabilities – was minus €926bn at the end of 2010, according to the Bank of Spain, or almost 90 per cent of GDP.
If my hunch on the Spanish property market proves correct, I would expect the Spanish banking sector to need more capital than is currently estimated. It is hard to say how much because we are well outside the scope of forecasting models. When prices drop so fast, there will be much endogenous pressure that no stress test could ever capture.
The mix of high external indebtedness, the fragility of the financial sector and the probability of further declines in asset prices increase the probability of a funding squeeze at some point. And that means that Spain will be the next country to seek financial assistance from the EU and the International Monetary Fund. As for the large number of official statements that Spain is safe, I think they are merely a metric of the complacency that has characterised the European crisis from the start.
Britain, Netherlands vow legal action as Iceland's voters reject refund
by Richard Connor -dpa, Reuters
Britain and the Netherlands have promised to take legal action against Iceland after the country's electorate opposed a deal to repay banking debts. The Icelandic government says it remains prepared to refund the money.
The British and Dutch governments on Sunday warned of legal action after Icelandic voters rejected a plan to repay both countries for losses sustained in a banking collapse. In a referendum Saturday, some 60 percent of the Icelandic electorate opposed the negotiated deal to refund 3.9 billion euros ($5.6 billion) in losses incurred following the collapse of the online bank Icesave.
"This is not good for Iceland, nor for the Netherlands," said Dutch Finance Minister Jan Kees de Jager. "The time for negotiation is over." "It now looks like this process will end up in the courts," Danny Alexander, British Chief Secretary to the Treasury, told BBC television. Despite the rejection, Iceland's government attempted to reassure Britain and the Netherlands on Sunday that there were sufficient funds repay the debt.
Reykjavik saddled with bank bill
Both countries' governments reimbursed investors who lost money with the bank when it collapsed in 2008, and both claim Iceland should pick up the tab. The court route is likely to prove much costlier for Iceland. Reykjavik hopes most of the debt can still be repaid by the bankrupt estate of Landsbanki, the company that operated Icesave, which is due to make some repayments later this year. "The Icelandic state has absolutely no problem in repaying its debts," Icelandic Finance Minister Steingrimur Sigfusson told a press conference.
"Iceland's reserves are more than enough to cover all the payments in the coming years," he added. The matter could now be settled by the court of the European Free Trade Association, the body responsible for overseeing Iceland's trade links with the European Union. Sigfusson said Iceland would cooperate legally to find a "rapid solution," but that the procedure could take time. "My estimate is that the process will take a year, a year and a half at least," said Sigfusson.
Counting the cost to individuals
With 70 percent of ballots counted on Sunday, the "no" vote led with 57.7 percent against a "yes" vote of 42.3 percent. The no campaign emphasized throughout the campaign that the deal would cost each of the island's 320,000 citizens 12,000 euros - before interest.
In spite of the defeat, the center-left coalition government declared in a statement that it would not resign. "The government will emphasize maintaining economic and financial stability in Iceland and continuing along the path of reconstruction which it began following the economic collapse of 2008," the statement read. Prime Minister Johanna Sigurdardottir has said the result was a "shock" for parliament, which approved the deal by a 70 percent majority. Acceptance of the negotiated refund has been seen as crucial for the country's hopes of joining the European Union.
UK disposable income falls to lowest since 1921
by Rupert Neate - Telegraph
British household budgets face their biggest squeeze in 90 years, according to a leading economic consultancy.
The Centre for Economics and Business Research (CEBR) said soaring inflation coupled with low pay rises means household peacetime disposable income is at its lowest since 1921.
Rising food, clothing and energy prices mean the average British family will have £910 less to spend this year than they did in 2009. The CEBR calculates that household disposable income will fall by 2pc this year, more than double last year's fall of 0.8pc and the biggest drop since the savage 1919 to 1921 post-First World War recession.
It forecasts inflation will average 3.9pc in 2011, its highest since 1992, as January's increase in VAT from 17.5pc to 20pc and the rising cost of oil and other commodities continue to drive up prices. At the same time, salaries will rise just 1.9pc as unemployment remains high and the public sector makes cut-backs.
Douglas Williams, chief executive of the CEBR, said: "The virtually unprecedented peacetime squeeze on real household incomes, combined with [our] more realistic forecasts for exports and investment growth means that GDP growth will be subdued for the next two or three years."
Japan quake's economic impact worse than first feared
by Rie Ishiguro and Shinji Kitamura - Reuters
The economic damage from Japan's massive earthquake and tsunami last month is likely to be worse than first thought as power shortages curtail factory output and disrupt supply chains, the country's economics minister warned on Tuesday. The more sober assessment came as Japan raised the severity of its nuclear crisis at the Fukushima Daiichi nuclear plant to a level 7 from 5, putting it on par with the Chernobyl nuclear disaster in 1986.
The Bank of Japan governor said the economy was in a "severe state," while central bankers were uncertain when efforts to rebuild the tsunami-ravaged northeast would boost growth, according to minutes from a meeting held three days after a record earthquake struck Japan on March 11. The government and main opposition party have agreed to a spending package to get some reconstruction work started, but setting a large additional budget will be difficult due to Japan's heavy debt burden.
"After a natural disaster, people tend to refrain from spending and you get a sense that factory output will shrink," Economics Minister Kaoru Yosano told reporters after a cabinet meeting. "In some areas, the impact could be very big."
Japan is facing its worst crisis since World War Two after a 9.0 magnitude earthquake and a tsunami towering more than 10 meters battered its northeast coast, leaving nearly 28,000 dead or missing and rocking the world's third-largest economy. The government estimates the material damage alone could top $300 billion, making it by far the world's costliest natural disaster.
Finance Minister Yoshihiko Noda said on Tuesday that he would explain the Japanese government's efforts on post-quake reconstruction and the nuclear crisis at a Group of 20 meeting in Washington on April 15. Measuring the impact on consumer sentiment, factory production and the supply chain is proving more difficult, but as the crisis drags on at the nuclear power plant, the damage to the economy looks to be more severe. "We were in recession already," said Takuji Okubo, chief economist for Japan at Societe Generale. "This time it will take longer for industrial production to rebound, because just-in-time delivery systems have become even more complicated."
Japan's economy is likely to grow 1 percent this year, down from 2 percent growth forecast before the earthquake, as private consumption slows to a halt, Okubo said. The economy could then accelerate to 3.9 percent growth next year, he said. Shortages of key components, including semiconductors, point to the possibility of deeper and longer-running output disruptions from Japan that could also hobble factories elsewhere in the world which rely on Japanese parts.
Major Japanese automakers are grappling with complications caused by parts factories that have been shuttered or are running with limited power. Toyota Motor Corp on Monday warned that the uncertain supply of parts from Japan could threaten its output of vehicles through July. "Our economy is in a severe state," BOJ Governor Masaaki Shirakawa told lawmakers on Tuesday.
Many BOJ members said power supply constraints are likely to impact the economy on top of the damage from the quake, minutes from a March 14 meeting showed. The BOJ loosened policy at that meeting by doubling its asset-purchase program to 10 trillion yen ($118 billion). At its latest policy meeting last week, the BOJ launched an ultra-cheap loan scheme for banks in the area devastated by the quake, and has signaled its readiness to ease monetary policy further if damage from the quake threatens Japan's return to a moderate recovery.
Japan is set to compile an extra budget worth about 4 trillion yen, focusing on removing debris, building temporary housing and restoring infrastructure such as schools. Japan plans to allocate 1 trillion yen to stem job losses and help the unemployed, the Nikkei business daily reported on Tuesday. This is likely to be the first of several spending packages, but cabinet ministers, including the finance minister, have said that Japan, which has a huge public debt already twice the size of its $5 trillion economy, should avoid new bond issuance.
Lending at regional banks rose 1.1 percent year-on-year in March, up from a 0.8 percent rise in February, which may reflect an increase in demand for funding after the quake, a Bank of Japan official told reporters. Outstanding commercial paper held by banks rose 0.2 percent in March, marking the first rise since September 2008, also likely reflecting the impact of the quake, the official said.
Japan nuclear disaster tops scale
by Matt Smith - CNN
Japan declared the crisis at the Fukushima Daiichi nuclear power plant a top-scale event on the international system for rating nuclear accidents Tuesday, putting it on par with the 1986 Chernobyl disaster.
The decision to bump the accident up to level 7 on the International Nuclear Event Scale came after a review of the amount of radiation released in the month since the accident, said Hidehiko Nishiyama, chief spokesman, Japan's Nuclear and Industrial Safety Agency. The Fukushima Daiichi accident is now at the top of that scale and two notches higher than the rating Japanese officials assigned to it previously.
"Right at this moment, we are still trying to control this accident, and the nuclear reactors are not stable yet," Nishiyama said. "We are dealing with all our might and resources and try to minimize the impact of the radiation to the people around this nuclear plant."
Tetsunari Iida, a former nuclear engineer-turned-industry critic, told CNN the declaration has no immediate practical impact on the crisis. But it's a sign that Japanese regulators have rethought their earlier assessments of the disaster, said Iida, who now runs an alternative energy think-tank in Tokyo. The announcement comes a day after Japan ordered new evacuations for towns around the plant, including some outside the 20- and 30-km danger zones drawn in the early days of the accident.
But both Nishiyama and Chief Cabinet Secretary Yukio Edano, the Japanese government's leading spokesman on the crisis, tried to draw distinctions between their crisis and Soviet experience at Chernobyl. "The change in the level reminds us the accident is very big," Edano said. "I apologize to the residents of the area, the people of Japan and the international community." But he added, "What's different here from the Chernobyl accident is that we have not yet seen a direct impact on the health of the people as a result of the nuclear accident. The accident itself is big, but we will make, as our first priority, our utmost effort to avoid any health impact on the people."
Scientists believe the amount of radiation released is only a tenth of what was released at Chernobyl, Nishiyama said. But the levels for radioactive iodine and cesium that have been spewed into the air, water and soil around the plant are in the tens of trillions of bequerels -- 15 times higher than the threshold for a top-scale event, according to figures released by the safety agency Tuesday morning.
Nishiyama said the designation was made "provisionally," and that a final level won't be set until the disaster is over and a more detailed investigation has been conducted. The previous event level of 5, equal to the 1979 accident at Three Mile Island in Pennsylvania, was also a provisional designation.
Three Mile Island involved a partial meltdown of the radioactive core of one reactor, with only a limited release of radioactivity, according to the U.S. Nuclear Regulatory Commission. At Chernobyl, an explosion and fire at a nuclear power plant in the former Soviet Union resulted in the permanent evacuation of a 30-km (19-mile) radius around the plant. There were 32 deaths among plant workers and firefighters, mostly due to radiation exposure, and the International Atomic Energy Agency estimates another 4,000 will die of related cancers.
Japan ordered people living within 20 km of the plant to evacuate after the accident began March 11. A few days later, it told people living another 10 km out to stay inside their homes. Monday, it warned that many of those remaining inside the 20-30 km belt would need to leave -- and so would residents of several other towns outside the existing danger zone, Edano said.
"This policy does not require immediate evacuation right away, but we take the long-term perspective, considering the long-term effect of radiation on your health," Edano told reporters.
Evacuation orders have so far covered about 85,000 people inside the 20-kilometer (12.4-mile) zone, while another 62,000 within 30 kilometers have been told to stay inside, Fukushima prefecture officials told CNN. Japan's government said it had no estimate of the number of people who would be covered by the new directives.
The move was triggered by the discovery of low levels of radiation that could give residents a dose of more than 20 millisieverts per year -- a tiny fraction of what would cause immediate radiation sickness, but more than seven times the amount a typical resident of a western industrialized country receives from background sources in a year. Long-term exposures to those levels of radiation could increase the risk of cancer, and the presence of cesium isotopes that have half-lives of up to 30 years means that radioactivity could linger for some time.
Edano said Monday that Japanese should "be ready for the possibility that things may turn for the worse." About an hour after he spoke, a fresh earthquake rattled the country, forcing workers to evacuate the plant and knocking out power to the three damaged reactors for about 40 minutes, the plant's owner, the Tokyo Electric Power Company, reported.
The magnitude 6.6 tremor came a month to the day after the magnitude 9 quake and tsunami that knocked out the plant's cooling systems, and followed a magnitude 7.1 aftershock Thursday night. But neither the 6.6 quake nor any of the smaller ones that rippled across the region Monday night and Tuesday inflicted any more damage to the plant, Tokyo Electric officials told reporters.
Tuesday morning, a fire broke out in a battery storage building in a water discharge area of reactors 1-4 at Fukushima Daiichi, Tokyo Electric said. The fire was out a few hours later and the company said it caused no radiation emissions and no effect on cooling systems. The cause was not immediately known, the company said.
More quakes rattle northeastern Japan
by CNN Wire Staff
A fresh round of tremors, including one with a magnitude of 6.3, shook northern Japan on Tuesday afternoon, the Japan Meteorological Agency reported. The quake was centered in Fukushima Prefecture, near Japan's Pacific coast and about 64 kilometers (40 miles) southwest of the crippled Fukushima Daiichi nuclear power plant. Workers retreated to earthquake-resistant shelters during the event, but there was no loss of power at the plant, the Tokyo Electric Power Company told CNN.
It followed a magnitude-6.4 quake Tuesday morning that killed at least six people when it triggered a landslide in Iwaki, north of Tokyo. The earlier quake buried three homes, the Iwaki fire department said. Three people were rescued and hospitalized, and fire officials were working to rescue an unknown number of others believed to be trapped, the department said.
The quake struck at about 8:08 a.m. Tuesday (7:08 p.m. Monday ET), according to the U.S. Geological Survey. It had a depth of about 13 kilometers (8 miles) and was centered about 77 miles east-southeast of Tokyo. Monday night, one person was killed in Iwaki and several others were trapped when a powerful 6.6-magnitude earthquake triggered landslides there, the fire department said. It happened exactly one month after the country's devastating 9.0-magnitude quake and tsunami.
Since the March 11 disaster, there have been more than 400 aftershocks of magnitude 6.0 or greater. The earlier quake was centered about 100 miles (164 kilometers) northeast of Tokyo and about 30 miles (50 kilometers) southwest of the nuclear facility, according to the U.S. Geological Survey. The landslides in Iwaki buried three houses. Police in Fukushima Prefecture initially reported that four people were trapped. The Iwaki Fire Department later said more than four people were trapped, but the exact number was unclear.
Nuclear engineer Arnie Gundersen demonstrates how Fukushima's fuel rods melted and shattered
by Fairewinds Associates
Japan Expected To Extend Evacuation Zone Over 18 Miles
by Shinichi Saoshiro and Chisa Fujioka - Reuters
Japan said on Monday it may extend some parts of an evacuation zone around its crippled nuclear plant if tests show high radiation outside the area, imposed after an earthquake and tsunami sparked the worst nuclear crisis since Chernobyl. Japan has steadfastly refused to extend its 20 km (12 mile) evacuation zone, despite international concerns over radiation spreading from the six damaged nuclear reactors in Fukushima which engineers are still struggling to bring under control a month after they were wrecked by the 15-meter tsunami.
Chief Cabinet Secretary Yukio Edano said the existing area was sufficient as the risk of an accident was now lower. But the government might extend the evacuation zone if tests show high levels of accumulated radiation in specific areas, he said. The Asahi newspaper said evacuations may extend 30 km out from the plant. "This won't be based on a radius zone-type (evacuation)...from the perspective of accumulated radiation, we need appropriate steps to ensure safety," Edano told reporters.
Japanese Prime Minister Naoto Kan told parliament last month that widening the area would force 130,000 people to move in addition to 70,000 already displaced. Residents of one village, Iitate which is 40 km from the Fukushima Daiichi plant, have been told to prepare for evacuation because of prolonged exposure to radiation, a local official told Reuters by phone. The village has a population of 5,000.
The International Atomic Energy Agency has urged Japan to extend the zone and countries like the United States and Australia have advised citizens to stay 80 km away from the plant. The Japan Times said authorities would soon forcibly close the 20 km zone, stopping people returning to their shattered homes to pick through the rubble for belongings. The president of Tokyo Electric Power Co (TEPCO), which operates the plant, plans to visit the area on Monday, the first by Masatake Shimizu since the March 11 disaster.
Shimizu has all but disappeared from public view apart from a brief apology shortly after the crisis began and has spent some of the time since in hospital. Fukushima Governor Yuhei Sato was quoted by media as saying he would refuse to meet Shimizu during his visit. Sato has criticized the evacuation policy, saying residents in a 20-30 km radius were initially told to stay indoors and then advised to evacuate voluntarily. "Residents in the 20-30 km radius were really confused about what to do." Sato told NHK television on Sunday.
Engineers at the damaged Daiichi plant north of Tokyo said they were no closer to restoring the plant's cooling system which is critical if overheated fuel rods are to be cooled and the six reactors brought under control. In a desperate move to cool highly radioactive fuel rods, operator Tokyo Electric Power Co (TEPCO) has pumped water onto reactors, some of which have experienced partial meltdown. But the strategy has hindered moves to restore the plant's internal cooling system, critical to end the crisis, as engineers have had to focus how to store 60,000 tons of contaminated water.
Engineers have been forced to pump low-level radioactive water, left by the tsunami, back into the sea in order to free up storage capacity for highly contaminated water from reactors. China and South Korea have both criticized Japan for pumping radioactive water into the sea, with Seoul calling it incompetent, reflecting growing international unease over the month-long atomic disaster and the spread of radiation. TEPCO hopes to stop pumping radioactive water into the ocean on Monday, days later than planned. Engineers are also pumping nitrogen into reactors to counter a build-up of hydrogen and prevent another explosion sending more radiation into the air, but they say the risk of such a dramatic event has lowered significantly since March 11.
The triple disaster is the worst to hit Japan since World War Two after a 9.0 magnitude earthquake and a huge tsunami battered its northeast coast, leaving nearly 28,000 dead or missing and rocking the world's third-largest economy. Concern at Japan's inability contain its nuclear crisis is mounting with Kan's ruling party suffering embarrassing losses in local elections on Sunday. Voters vented their anger at the government's handling of the nuclear and humanitarian crisis, with Kan's ruling Democratic Party of Japan losing nearly 70 seats in local elections.
The unpopular Kan was already under pressure to step down before March 11, but analysts say he is unlikely to be forced out during the crisis, set to drag on for months. "The great disaster was a double tragedy for Japan. The first tragedy was the catastrophe caused by the earthquake, tsunami and the nuclear accident. The other misfortune was that the disaster resulted in prolonging Prime Minister Kan's time in office," Sankei newspaper said in an editorial on Monday.
McDonald’s Wage For Nuclear Job Shows Some Japan Towns May Fade
by John Brinsley and Aki Ito - Bloomberg
A week before becoming ground zero for the world’s biggest nuclear crisis since 1986, the Fukushima Dai-Ichi plant offered $11 an hour for full-time maintenance work in an area of Japan that was lagging even before last month’s earthquake and tsunami struck.
The wage, the same as McDonald’s Corp. (MCD) pays for part-time work in Tokyo, shows the scale of the northern Tohoku region’s economic blight and indicates towns may never recover from the disaster. Almost 28,000 people are dead or missing and 160,000 are homeless in Tohoku, where 25 percent of the population is 65 or older and job seekers outnumber jobs by two-to-one.
Once the rescue and clean-up is over, Prime Minister Naoto Kan’s government will have to decide whether to rebuild homes, roads and businesses or relocate tens of thousands of people. The challenge: structure investment plans to bring private job creation, beyond the short-term bump from public works.
"To put it very crudely, there won’t be a lot of people left in these communities," Takayoshi Igarashi, Kan’s special adviser on addressing population decline and rural decay, said in an interview. "Old people will pass away and the young will surely leave for Tokyo. The government now faces this awful choice of whether to invest in rebuilding these areas or leaving them behind."
Successive governments and Tokyo Electric Power Co. have poured money into the building of bridges, roads and soccer stadiums in places like the Fukushima town of Ohkuma, which has failed to revive the economies in the northeast, said Daniel Aldrich, author of ‘Site Fights: Divisive Facilities and Civil Society in Japan and the West.’ The problem with these "empty box projects" is that they temporarily create construction jobs that evaporate when the work is done, he said.
The 9-magnitude quake and waves as high as 15 meters (49 feet) damaged or destroyed more than 200,000 buildings and leveled entire towns in Japan’s northeast. Sony Corp. (6758), Toyota Motor Corp. (7203) and Sapporo Holdings Ltd. (2501) are among the companies that have shut down factories from damage that the government estimates is as high as 25 trillion yen ($295 billion).
Igarashi said Japan will need "at least" 20 trillion yen to rebuild the area. If residents who have been evacuated from near the nuclear power plant can’t return, the amount of spending needed "will be exponentially larger," he said.
The disaster struck an economy already mired in its second decade of stagnation and deflation. Japan’s national debt is twice the size of gross domestic product, the result of soaring welfare costs and falling revenue. The benchmark Nikkei 225 (NKY) Stock Average has fallen 6.4 percent since March 10, the day before the catastrophe struck.
Tohoku’s six prefectures, with a population of about 9 million, have an average per capita income of 2.6 million yen, 15 percent less than the national figure. In the northernmost prefecture of Aomori, the population fell 4.4 percent between 2005 and 2010, the second-biggest drop in the country, as young Japanese left to find work in the bigger cities.
Radiation from the Fukushima complex about 220 kilometers (137 miles) north of Tokyo has contaminated vegetables and seafood in Tohoku, which depends on agriculture, fishing and manufacturing. Shipments of milk and spinach have been restricted in the area that accounts for more than a quarter of Japan’s production of rice. Radioactive iodine, cesium and cobalt have been found in the sea nearby. Chief Cabinet Secretary Yukio Edano said April 1 the evacuation of residents near the plant may be "long-term."
"The biggest problem is the nuclear one," said Itsunori Onodera, a lawmaker with the opposition Liberal Democratic Party, whose hometown of Kesennuma was ravaged by the tsunami. "If the area of nuclear contamination spreads, people won’t live there and there’ll be no reconstruction." Most of the region’s jobs don’t require academic degrees or advanced training, Aldrich said. Executives who work in the region come from Tokyo and go home on weekends and some towns that in the 1980s had several schools have consolidated to one.
Three of the prefectures -- Miyagi, Iwate and Fukushima -- account for 99 percent of the casualties from the disaster. In Kesennuma, which had a pre-quake population of 74,000, 2,172 people are dead or missing and 11,211 are in evacuation centers, according to the city’s Web site.
The ruling Democratic Party of Japan and the opposition have pledged to cooperate in funding the recovery and the administration is considering setting up a reconstruction agency to oversee the rebuilding effort. Kan said the first spending package to cope with relief and reconstruction will be compiled this month, without giving details. He promised that farmers will be repaid for their losses, and vowed "full-scale restoration" of the area.
Edano said April 7 that an initial spending package could be as much as 4 trillion yen. The opposition Liberal Democratic Party has called for a 5 trillion yen effort, about $5 billion more than South Korea’s 1997 bailout package.
The disaster has also created an opportunity to rebuild some parts of Tohoku, experts say. The first priority will be housing for those who lost their homes, said Itsuki Nakabayashi, an engineering professor at Tokyo Metropolitan University who specializes in disaster recovery and mitigation. After that, the government should consider tax cuts and other incentives to lure businesses to the region, he said. A new international airport at Sendai, and better road and telecommunication links are measures experts say will help to rejuvenate the region.
‘More Attractive Tohoku’
"Here’s a tremendous opportunity to create a more attractive Tohoku, one that moves away from the concrete state," said Robert Mason, an expert in environmental policy at Temple University in Philadelphia who has lived in Japan and studied its suburban sprawl. "What’s required is a measured approach of ‘What should we rebuild, where should we rebuild?’"
Kan’s DPJ in 2009 defeated the LDP, which governed Japan almost without interruption in the postwar era in part by railing against the LDP’s support for public works projects that benefited the construction industry. Rebuilding Tohoku with a view toward sustainability could be a way for Kan to make good on his campaign pledge "From concrete to people."
"Unless you build new and long-term industries there, the kids are going to leave," Aldrich said. "The long-term problem is that many of the incentives provided have been these infrastructure projects and they haven’t been thinking about how to revive these economies."
Japan's Lost Money: Safes, Cash Wash Up On Shores After Tsunami
by Tomoko A. Hosaka - Huffington Post
In this photo taken on April 7, 2011, a police office cleans cashboxes after they collected those from damaged houses at a police station in tsunami-hit Ofunato city, Iwate Prefecture, Japan. Safes were washing up along the tsunami-battered coast, and police were trying to find their owners, a unique problem in the country where many people, especially the elderly, still stash their cash at home.
There are no cars inside the parking garage at Ofunato police headquarters. Instead, hundreds of dented metal safes, swept out of homes and businesses by last month's tsunami, crowd the long rectangular building. Any one could hold someone's life savings.
Safes are washing up along the tsunami-battered coast, and police are trying to find their owners – a unique problem in a country where many people, especially the elderly, still stash their cash at home. By one estimate, some $350 billion worth of yen doesn't circulate. There's even a term for this hidden money in Japanese: "tansu yokin." Or literally, "wardrobe savings."
So the massive post-tsunami cleanup under way along hundreds of miles (kilometers) of Japan's ravaged northeastern coast involves the delicate business of separating junk from valuables. As workers and residents pick through the wreckage, they are increasingly stumbling upon cash and locked safes. One month after the March 11 tsunami devastated Ofunato and other nearby cities, police departments already stretched thin now face the growing task of managing lost wealth.
"At first we put all the safes in the station," said Noriyoshi Goto, head of the Ofunato Police Department's financial affairs department, which is in charge of lost-and-found items. "But then there were too many, so we had to move them." Goto couldn't specify how many safes his department has collected so far, saying only that there were "several hundreds" with more coming in every day. Identifying the owners of lost safes is hard enough. But it's nearly impossible when it comes to wads of cash being found in envelopes, unmarked bags, boxes and furniture.
Yasuo Kimura, 67, considers himself one of the lucky ones. The tsunami swallowed and gutted his home in Onagawa, about 50 miles (75 kilometers) south of Ofunato. He escaped with his 90-year-old father and the clothes on his back. But he still has money in the bank. That's not the case for many of his longtime friends and acquaintances, said Kimura, a former bank employee. "I spent my career trying to convince them to deposit their money in a bank," he said, staring out at his flattened city. "They always thought it was safer to keep it at home."
The number of safes that have turned up in Ofunato alone is a reflection of the area's population: In Iwate prefecture, where this Pacific fishing town is located, nearly 30 percent of the population is over 65. Many of them keep money at home out of habit and convenience, said Koetsu Saiki of the Miyagi Prefectural Police's financial affairs department. This practice is likely compounded by persistently low interest rates, leaving little financial incentive for depositing money in a bank.
As in Iwate, local police stations in Miyagi are reporting "very high numbers" of safes and cash being turned in. "It's just how people have operated their entire lives," he said. "When they need money, they'd rather have their money close by. It's not necessarily that they don't trust banks. But there are a lot of people who don't feel comfortable using ATMs, especially the elderly." A 2008 report by Japan's central bank estimated that more than a third of 10,000-yen ($118) bank notes issued don't actually circulate. That amounts to some 30 trillion yen, or $354 billion at current exchange rates, ferreted away.
The government has estimated that the cost of the earthquake and tsunami could reach $309 billion, making it the world's most expensive natural disaster on record. The figure includes direct losses from damaged houses, roads and utilities. But it doesn't take into account individual losses from home-held cash washed away by the powerful waves. With more than 25,000 people believed to have died in the tsunami, many safes could to go unclaimed. Under Japanese law, authorities must store found items for three months. If the owner does not appear within that time, the finder is entitled to the item, unless it contains personal identification such as an address book.
If neither owner nor finder claims it, the government takes possession. But all those who survived and are seeking to retrieve savings will need to offer proof. That proof could include opening the safe and providing identification that matches any documents inside, said Akihiro Ito, a spokesman for the disaster response unit in Kesennuma, among the worst-hit cities in Miyagi prefecture.
Cold, hard cash is more complicated. "Even if we receive 50,000 yen ($589) in cash, and someone comes in saying they've lost 50,000 yen, it's nearly impossible to prove exactly whose money we actually have," Saiki of Miyagi's police force said. Only 10 to 15 percent of valuables found in the tsunami rubble have been returned so far, officials in Miyagi and Iwate prefectures said last week.
Instead of waiting, police in Iwate are considering a more proactive measure. Individual stations will likely start opening safes to try to identify their owners, said Kiyoto Fujii, a spokesman for the prefectural police. And the safes are likely to keep on coming. "There's probably a lot of valuables still left in the rubble, including safes," Fujii said. "We are expecting and preparing for that."
US watchdogs to sue executives of failed banks
by Suzanne Kapner and Paul J Davies - Financial Times
US regulators are expected to file up to 100 lawsuits against executives and directors of failed banks in the next two years, as they seek to hold people accountable for management failings and recover billions of dollars, industry experts said.
The Federal Deposit Insurance Corporation is only now beginning to step up its efforts to make an example of overly aggressive executives or inattentive directors of the 348 banks that have failed since 2008. The FDIC says the failures have cost its insurance fund $59bn. However, analysis by Nera Economic Consulting of material on the FDIC’s website suggests it has lost $80bn.
Insurers who write policies known as D&O, which are held by directors and officers to protect them in the event of a bank failure, are likely to be liable for much of the money the FDIC aims to recover. Many have tightened up their terms, making it difficult for the 884 banks that remain on the group’s watch list to renew cover.
The FDIC has authorised the filing of suits against 158 directors in total seeking more than $3.5bn. But of those, it has brought only six cases so far against 44 officials totalling $1.5bn, with the lion’s share of recoveries, about $900m, expected to come from Washington Mutual, the failed lender acquired by Wells Fargo.
"We’re still very early in the process in terms of the claims that we will be bringing," said Richard Osterman, the FDIC’s deputy general counsel. "There are still a lot of failed banks that we are investigating." Most of the FDIC’s suits have been filed in the first months of this year. Bank failures have continued with another 26 shutting their doors by the end of March, after 157 failures in 2010.
Ned Kirk, a partner at Clyde & Co in New York, said the FDIC was expected to pursue claims against a similar proportion of bank directors and officers as it did after the savings and loan crisis of the 1980s when it sued 24 per cent of the 1,813 lenders it seized.
Any money recovered from D&O policies will cover only a fraction of the cost of bank failures as claims first go to pay the legal costs of policyholders. In the savings and loan crisis the FDIC recovered only $4.1bn in D&O claims, a tiny slice of the $103bn bank failures drained from its insurance fund, said Nera.
Ex-Federal Reserve chief Paul Volcker says breaking up Wall Street banks 'almost impossible'
by Richard Blackden - Telegraph
Paul Volcker, the former head of the Federal Reserve and a driving force behind financial reform in the US, has said that the task of splitting up Wall Street banks now seems "almost impossible".
"I don't like these banks being as big as they are," Mr Volcker told a conference at Bretton Woods in New Hampshire on Sunday night. But "to break them up to the point where the remaining units would be small enough so you wouldn't worry about their failure seems almost impossible," he said.
The concern about the effectiveness of the reform of Wall Street since the crisis from Mr Volcker, who was chairman of the Fed for almost a decade from 1979 and, more recently, an adviser to President Barack Obama, comes as the Independent Banking Commission (ICB) today delivered its report on the future structure of British banks. Regulators in the world's financial capitals are wrestling with how to make the financial system safer without prompting banks to leave for jurisdictions where regulation is lighter.
The former Fed chairman's concern over the failure to protect taxpayers and the wider economy from the potential failure of large banks was echoed by George Soros, the billionaire financier and philanthropist. "I certainly consider they haven't addressed the problem correctly," Mr Soros said. "The whole issue of living wills and resolution authorities is not convincing."
While the UK government has until September to consider the recommendations from today's report from the ICB, US regulators have until July to turn last year's financial reform act known as Dodd-Frank into actual rules for the financial services industry. Mr Soros said that authorities had not produced tough enough regulation to ensure that there won't be a need for governments to exercise the implicit guarantee that they would again bail out the financial system in a future crisis.
Mr Volcker and Mr Soros were among about 400 people who gathered over the weekend in Bretton Woods, where the monetary system that dominated in the 30 years after World War Two was created in July 1944, to discuss how economic thinking has and should respond to the most recent financial crisis.
Why aren’t the honest bankers demanding prosecutions of their dishonest rivals?
by Bill Black - Benzinga
This is the second column in a series responding to Stephen Moore’s central assaults on regulation and the prosecution of the elite white-collar criminals who cause our recurrent, intensifying financial crises. Last week’s column addressed his claim in a recent Wall Street Journal column that all government employees, including the regulatory cops on the beat, are "takers" destroying America.
This column addresses Moore’s even more vehement criticism of efforts to prosecute elite white-collar criminals in an earlier column decrying the Sarbanes-Oxley Act’s criminal provisions: "White-Collar Witch Hunt: Why do Republicans so easily accept Neobolshevism as a cost of doing business?" [American Spectator September 2005] This column illustrates one of the reasons why elite criminals are able to loot "their" banks with impunity – they have a lobby of exceptionally influential shills. Moore, for example, is the Wall Street Journal’s senior economics writer.
Somehow, prominent conservatives have become "bleeding hearts" for the most wealthy, powerful, arrogant, and destructive white-collar criminals in the world. Criminology research has demonstrated the importance of "neutralization." Criminals don’t like to think of themselves as criminals and their actions as criminal. They have to override their societal inhibitions on criminality to commit their crimes.
When prominent individuals like Moore call their actions lawful and demonize the regulatory cops on the beat and the prosecutors it becomes more likely that CEOs will successfully neutralize their inhibitions and commit fraud. People like Moore have never studied white-collar crime, have no knowledge of white-collar criminology, do not understand control fraud, and do not understand sophisticated financial fraud mechanisms.
They show no awareness of the economics literature on accounting control fraud, particularly George Akerlof & Paul Romer’s famous 1993 article – "Looting: the Economic Underworld of Bankruptcy for Profit." People like Moore not only spur neutralization, they actively campaign to minimize the destructiveness of elite white-collar crime and to deny the regulators and the prosecutors the resources to prosecute the criminals.
My favorite in this genre was authored by Professor John S. Baker, Jr. and published by Heritage on October 4, 2004, The Sociological Origins of White Collar Crime Baker concludes his article with this passage:"The origin of the "white-collar crime" concept derives from a socialist, anti-business viewpoint that defines the term by the class of those it stigmatizes. In coining the phrase, Sutherland initiated a political movement within the legal system. This meddling in the law perverts the justice system into a mere tool for achieving narrow political ends. As the movement expands today, those who champion it would be wise to recall its origins. For those origins reflect contemporary misuses made of criminal law–the criminalization of productive social and economic conduct, not because of its wrongful nature but, ultimately, because of fidelity to a long-discredited class-based view of society."
We "stigmatize" criminals precisely to increase the difficulty potential criminals face in neutralizing restraints against engaging in crime. Stigmatization is an important restraint reducing crime. Indeed, it is likely that stigmatization can be most effective in reducing crime in the context of elite white-collar criminals because such individuals have more valuable reputations that can be harmed by stigma. A violent street criminal may find a reputation for violence useful.
Sutherland’s research demonstrated that elite white-collar criminals were often able to violate the law with impunity. The corporation they controlled might pay a fine, but the CEO was typically not sanctioned when the corporation violated the law – even when the violations were repeated and egregious. Class proved, empirically, to be a powerful predictor of criminal prosecutions, convictions, and sentencing.
Sutherland correctly sought to stigmatize elite white-collar criminals and to get policy-makers, academics, and the criminal justice system to view their crimes as important. Sutherland’s partial success in doing so is what enrages people like Moore and Baker. By the way, in order to publish his famous book on white-collar crime, Professor Sutherland was forced to delete his tables setting forth the violations of law by many of America’s top corporations – even though it was all public record information.
The censorship had the ironic effect of demonstrating the accuracy of Sutherland’s observation that class mattered when it came to how we framed and responded to fraud by elite criminals. What aspect of holding fraudulent CEOs criminally responsible for their crimes is "socialist", "anti-business", or "neo-Bolshevism"? Baker claims that "class" has long been discredited as an important variable. Baker is not a social scientist and he is flat out wrong about class.
There are literally thousands of empirical studies demonstrating the explanatory power of class in a host of settings. Baker is also flat out wrong empirically in claiming that white-collar prosecutions target "productive social and economic conduct." White-collar prosecutions of elites are overwhelmingly based on fraud. Fraud is one of the most destructive of all social and economic conduct. Consider six forms of economic injury caused by accounting control fraud.
The essence of fraud is convincing the victim to trust the perpetrator – and then betraying that trust. The result is that fraud, particularly by elites, is the most destructive acid for eroding trust. Research in economics, political science, psychology, and sociology concurs on the enormous value that trust provides in each of these settings. We have all attended conferences that provided the participants with bottled water. If we knew that one bottle in a hundred were contaminated how many of us would drink our bottle? This dynamic explains why hundreds of markets collapsed during the events leading to the Great Recession – bankers no longer trusted other bankers’ representations as to asset quality. Accounting control fraud can cause systemic risk by eroding trust.
When bubbles hyper-inflate they can cause catastrophic economic damage and systemic risk. Accounting control fraud can hyper-inflate bubbles. The first two ingredients in the recipe for lenders engaged in accounting control fraud (extreme growth though lending to uncreditworthy borrowers) have the effect of right-shifting the demand curve. Because particular assets are superior devices for accounting fraud and because accounting frauds will tend to cluster in industries in which entry is easier and regulation and supervision are weak, accounting frauds tend to cluster in particular industries and regions. Accounting control frauds drove the Southwest bubble in commercial real estate during the S&L debacle and the U.S. residential real estate bubble in the current crisis. Hyper-inflated bubbles cause catastrophic losses to lenders and (late) owners, trigger severe recessions, and misallocate credit and assets (causing real economic losses).
Misallocation of credit and human talent
Even when accounting control fraud does not lead to a hyper-inflated bubble, it misallocates credit and human and non-human capital. Accounting control fraud substantially inflates individual asset values. Individuals with strong science and mathematics skills – critical shortages in our real economy – are wasted in making models designed to inflate asset values by fraudulently ignoring or minimizing risk. Accounting control fraud commonly produces reverse Pareto optimality – the borrower and the lender on a liar’s loan made in 2006 and 2007 typically suffered losses while the unfaithful agents become wealthy by betraying their principals and customers. (It is important to recall that it was the lenders and their agents who normally prompted by false statements in liar’s loans.) Fraud makes markets profoundly inefficient.
"Private market discipline" becomes perverse under accounting control fraud. Capital is allocated in abundance, at progressively lower spreads (despite massively increased risk), to fraudulent firms and professionals. In this form of Gresham’s dynamic, bad ethics drives good ethics out of the marketplace. Note that once, for example, a significant number of appraisers are suborned by the fraudulent lenders to inflate appraised value it is more likely that such appraisers will go on to commit other frauds during their career. If cheaters prosper, then honest businesses are placed at a crippling competitive disadvantage. Effective regulation and prosecution is essential to make it possible for honest firms to compete.
"Echo" fraud epidemics
Fraud begets fraud. Or to put it in criminology terminology – accounting control fraud is criminogenic. Fraudulent lenders created perverse incentives that produced endemic fraud (often by generating Gresham’s dynamics) in other fields. Fraudulent lenders making liar’s loans, for example, created overwhelming financial incentives they knew would lead their loan officers and loan brokers to engage in pervasive fraud. Indeed, fraudulent lenders embraced liar’s loans because they facilitated endemic fraud by eviscerating underwriting.
Accounting control fraud also leads to the spontaneous generation of criminal profit opportunities, causing opportunistic fraud. Liar’s loans, for example, generated a host of fraudulent entrepreneurs offering illicit opportunities to use someone else’s credit score to secure a loan. (Austrian school economists should recognize this dynamic.) Undesired frauds arising from control fraud
Lenders engaged in accounting control fraud must suborn or render ineffective their underwriting and internal and external controls. They also select, praise, enrich, and promote the most unethical officers. The real "tone at the top" of a control fraud is pro-fraud – often overlaid with a cynical propaganda campaign extolling the Dear Leader’ astonishing virtues. The result is that the firm environment is criminogenic. Some officers may loot the firm through private schemes, e.g., embezzlement at Charles Keating’s Lincoln Savings and self-dealing at Enron. White-collar crime prosecutions are overwhelmingly taken against frauds. There is nothing economically productive about fraud. When Heritage and the Wall Street Journal feature odes to elite frauds they are fertilizing the seeds of the destruction of capitalism and its replacement by crony capitalism.
Moore’s article has the same tone and themes as Baker’s complaints against prosecuting elite white-collar criminals. "[T]he anti-capitalist left … [is] using the criminal law for the endgame purpose of striking down the productive class in American that they so envy and despise…."
Moore decries the passage of "Sarbanes-Oxley and other such laws criminalizing economic behavior…." He claims that prosecuting CEOs leading control frauds will harm shareholders – which he plainly sees as prohibiting criminal liability for corporate officers. Moore’s complaints about SOX are confusing because Sarbanes-Oxley does not criminalize honest "economic behavior." "Economic behavior" is not privileged. It can be honest or dishonest.
Only honest economic behavior is potentially productive. Even honest economic behavior may prove unproductive or cause severe negative externalities. Dishonest economic behavior can benefit shareholders. A firm that gains a competitive advantage over its market rivals through fraud will be more profitable and should have a higher share price. That increased profit and share price is bad for the world. It creates a Gresham’s dynamic and misallocates capital. It may also maim and kill if the competitive advantage arises from selling harmful products to consumers or firms.
Moore eventually explains that what disturbs him most about white-collar prosecutions is that the CEO of a publicly traded company can be prosecuted for accounting fraud. SEC rules require that registrants comply with GAAP, so material accounting fraud constitutes securities fraud (a felony). Criminologists have long pointed out that accounting is the "weapon of choice" for financial firms. Moore objects to prosecuting the most destructive property crimes committed by elite white-collar criminals.
Accounting control fraud drove the second phase of the S&L debacle. The first phase was interest rate risk and ultimately led to roughly $25 billion in losses. The Enron-era frauds prosecuted by the federal government were accounting control frauds. The current crisis was driven by the accounting control frauds – the largest nonprime lenders, Fannie, and Freddie. The officers that were prosecuted during the S&L debacle and the Enron-era frauds were not members of the "productive class."
No one destroyed more wealth, for purposes of personal greed, than these fraudulent elites. Their crimes and the harm they caused, however, pale in comparison to the accounting control frauds that drove the current crisis. That makes it all the more astonishing that not a single fraudulent senior officer at the major nonprime lenders, Fannie, or Freddie has been convicted. The shills for elite white-collar criminals have swept the field.
The administration they constantly deride as socialist has continued the Bush administration’s policy of de facto decriminalization of accounting control fraud. Moore and Baker have, once more, proven Sutherland correct – we treat elite white-collar criminals in a way that bears no relationship to street criminals. We now bail them out after they loot and cause "their" banks to fail and change the accounting rules at their demand to hide their losses.
We even invite them repeatedly to the White House to advise us on what policies we should follow. The anti-regulators got their wish – they took the regulatory cops off the beat. The banking regulatory agencies ceased making criminal referrals, the SEC ceased bringing even their wimpy consent actions against the massive accounting control frauds, and the Justice Department ceased prosecuting the accounting control frauds during the run up to the crisis. The results were multiple echo epidemics of fraud, a hyper-inflated bubble, and the Great Recession.
If Baker and Moore think these fraudulent CEOs constitute the "productive class" – then capitalism was killed by the producers. The financial frauds, however, were not productive. They were weapons of mass financial destruction. Their fraudulent CEOs were motivated by the most banal of motivations that every major religion warns against – unlimited greed, ego, and a radical lack of empathy for their victims. The most pathetic figures in the crisis, however, are not the CEOs but their shills. Why aren’t the honest bankers leading the charge to prosecute their fraudulent rivals?
The Wall Street Mind: Anxious...
by John Gapper - New Yorker
Now they’re getting paid … But where will the next big paydays come from?
Stage 1 (left), Stage 2 (right)
(Photo: Joerg Klaus/Bransch)
Two and a half years after the crash, Wall Street ought to be feeling pleased with itself. It lost billions of dollars, devastating the world’s economy in the process, the federal government had to put up $700 billion of taxpayers’ money to prevent an even worse disaster, and otherwise reasonable politicians began using epithets like “fat cats” and “robber barons” for the first time in decades. And yet now the financiers are firmly back in business. Bonuses are flowing again—JPMorgan Chase CEO Jamie Dimon got a 51 percent raise in 2010, to $23 million—and Bernie Madoff is the only chief executive to end up in jail. It’s almost as if nothing had happened.
“No one has laid a glove on them,” says Janet Tavakoli, a derivatives expert. “There was massive fraud, and nothing was done. If you are a banker, you are slapping high fives at the moment.” Michael Mayo, an analyst at Crédit Lyonnais Securities, adds, “Wall Street is back, to a far greater degree than many people, including me, would have expected during the crash. Investment banks are alive and kicking.”
Nonetheless, despite all the reasons for celebration, the mood inside many banks is downbeat, even paranoid. Bankers, while not exactly overly sensitive to others’ perceptions of them (hence the goal of “fuck-you money”), still find it a shock to be so publicly despised. More important, many fear that the twenty-year bull run that led up to the crash, when bonuses, debt, and leverage all grew to what turned out to be unsustainable levels, may turn out to be a golden age that will never return. Wall Street feels not only loathed but also fearful.
Even if investment banks find new ways to make money after the previous methods ended in a crash and scandal—their age-old pattern of behavior—many wonder if any newfangled proposition can rival mortgage securitization. It just made so much money. “We always seem to find the next thing; that’s part of our DNA. But nothing else feels as large as that. It was just so enormous,” says one executive.
There is a deeper worry: that the only way banks can make the megaprofits they need to support their vast staffs and infrastructure is in operations that are at best opaque and impossible for outsiders to understand and at worst unethical and possibly illegal. Wall Street’s history is that, at the peak of bubbles, sensing that the end is coming and the profit opportunity disappearing, it degenerates into shocking behavior.
That was the story of the Internet initial-public-offering boom of the late nineties, which culminated in Eliot Spitzer’s uncovering the research scandal as attorney general of New York. It was even more the case with the mortgage bubble. Banks were able to make huge profits because the market was extremely opaque. That allowed them to charge investors big fees compared with a fraction of a cent on public-stock-exchange trades. Ultimately, it also provided cover for the unscrupulous.
“I am charitable enough to say that 80 percent of the time, banks try to identify clients’ needs and innovate in a healthy fashion to meet them,” says one executive. “Then there is fraud, an activity that ought to be illegal if people were smart enough to write laws that made sense. Do you admit to your boss that your business no longer makes sense, or do you start to cheat? Or, as your margins decline, do you raise the leverage to make up for that? It’s insidious.”
This spring has brought a coda with the trial of Raj Rajaratnam, the founder of the Galleon Group hedge fund, on charges of insider trading. Rajaratnam denies the charges, but the jury in lower Manhattan was played long, damning wiretaps of his conversations with two former McKinsey & Company partners, Anil Kumar and Rajat Gupta. Kumar says Rajaratnam paid him $500,000 a year for information.
Gupta actually used to run the management consultancy—about as respectable a job as exists—yet he has been accused by the Securities and Exchange Commission of leaking tidbits to Rajaratnam while on the board of directors of both Goldman Sachs and Procter & Gamble. Whatever the outcome, the trial at the very least raises the question: Is this how members of elite financial circles actually operate?
Lloyd Blankfein, the former trader who is now chairman and chief executive of Goldman, testified at the Galleon trial against Rajaratnam. Goldman had had its reputation tarnished by how it behaved during the credit boom, having paid a $550 million fine to settle SEC charges that it misled investors in its Abacus collateralized-debt-obligation deals.
“I see much less boastful pride than there used to be,” says one top executive at a Wall Street firm. “I wouldn’t call it humility, just shame. I am astonished by how many senior people I meet who are ashamed of their own institutions. They are still a bit paralyzed by the shock of realizing how much of their profits came from unsavory practices.”
Stage 3 (left), Stage 4 (right)
(Photo: Joerg Klaus/Bransch)
Of course, pushing the edge of savory was always part of the allure of Wall Street; it’s what made it badass. The popular image of Wall Street, in the eponymous film and Tom Wolfe’s The Bonfire of the Vanities, was never about rectitude, but it was glamorous. It can be fun to be considered rich, powerful, and ruthless, to understand how things really work. Fabrice Tourre, the former Goldman mortgage-bond trader who still faces SEC charges, e-mailed Marine Serres, his “super?smart French girl in London,” that he’d been told by his boss “that business is totally dead and the poor little subprime borrowers will not last so long!!!”
But there was always a way to justify the greed, some faith in the necessity of the larger system. As Tourre put it, “Anyway, not feeling too guilty about this, the real purpose of my job is to make capital markets more efficient and ultimately provide the U.S. consumer with more efficient ways to leverage and finance himself, so there is a humble, noble, and ethical reason for my job ;).”
That explanation began to seem a bit unconvincing, even to bankers, as reality played out over the last three years. Some wonder openly if the profits and bonuses of the mortgage boom were as fanciful as Madoff’s Ponzi scheme—a temporarily self-reinforcing bubble that was bound to end in massive losses. “Lots of the money the banks reported they were making was really an illusion,” says Tavakoli.
One Wall Street executive (few of whom would be quoted by name) admits that it is harder to attract recruits out of business school. “It is hard for people coming out of school now to get a job, so any job is a good one. But there is less enthusiasm and less of a feeling that this is a hot place to be. There is definitely a stigma,” he says.
Each year, Ray Soifer, a veteran bank analyst, monitors what percentage of Harvard M.B.A. graduates choose careers on Wall Street. The figure peaked at a record 41 percent in 2008, just before the crash, and then dropped to 28 percent in 2009. It recovered slightly last year to just over 31 percent. Instead, interest has increased in other professional services, such as consultancy. Engineers and mathematicians are choosing the Internet as a possible route to great fortune over investment banks’ derivatives operations.
This reflects not only ethical qualms but also doubts about the future of the business. “Most people are fairly pessimistic,” says Terry Smith, chief executive of Tullett Prebon, a Wall Street bond brokerage. “When you look back at the last 25 years, there was an extraordinary wave of deregulation and an upsurge in pay. You had the slaying of inflation and then a dot-com bubble that rolled into a credit bubble. People are still getting paid, but they know they are in the last-chance saloon and it won’t be so easy now.”
One could argue that Wall Street has been the last-chance saloon for decades now. The abolition of fixed commissions on bond and equity brokering in 1975 ended the era of partners in white-shoe firms’ being able to live comfortably in a protected industry that could support ranks of traders, brokers, and analysts. Since then, Wall Street’s challenge has been to run fast enough to outpace a relentless squeeze on its old business.
In theory, this should have reduced profits at each investment bank. In practice, it had the opposite effect. The underlying returns fell: Even at the height of the mortgage boom, return on assets (a measure of the margins on each deal) in securities firms was less than a third of the level in 1968, according to figures from Deloitte Consulting. Yet profits and bonuses soared.
Wall Street managed to escape destruction through a wave of mergers (helped by the abolition of the Glass-Steagall Act, which separated banking and securities, in 1999), a rapid increase in leverage and debt, and an astonishing ability to ferret out new ways of making money, from initial public offerings of Internet companies to mortgage securitization. As it did, Wall Street bonuses exploded and the industry loomed ever larger in the New York economy. The securities industry contributed 20 percent of state-tax revenues before the crash.
The banks that survived 2008 didn’t even do so badly in the aftermath. Helped by Treasury and Federal Reserve support in the form of very low interest rates and asset guarantees, Wall Street made profits of $61 billion in 2009 and paid $22.5 billion in bonuses.
Then, in 2010, profits dropped by half,to $27 billion, and the mood is correspondingly deflated. It’s still awaiting (and lobbying fiercely against) a wave of new regulations, both from the central bankers who meet in Basel and from Congress, in the form of the Dodd-Frank bill. The latter passed last year but includes a huge number of new rules that are yet to be drafted in detail by regulators such as the SEC.
“A large number of people cannot get on with their lives and their careers until we know what the rules of the game will be,” says John Coffee, a professor at Columbia Law School. “If you are a bank executive trying to plan for the future, you are not sure of precisely what you will be allowed to do. It is like a giant gin-rummy game where you don’t know which cards to pick up or put down.”
“Trading volumes are pretty low, and equity financings are hard. You add all that up, and you have an anemic top line,” says one private-equity executive. “At the same time, there are new rules bubbling out of Congress and the Basel Committee, and no one knows exactly what they’ll mean. There is going to be a lot of fighting over them and some unpleasant surprises.”
In some ways, Wall Street has fought a strong rearguard action by resisting reforms that would break up “too big to fail” institutions. Although the Volcker Rule has forced some to sell their proprietary trading desks, they remain mostly intact. The new Republican majority in the House of Representatives is trying to squeeze SEC funding and block Elizabeth Warren, the activist Harvard professor, from being confirmed as director of the new Consumer Financial Protection Bureau that she’s been running.
But behind these headline-grabbing events, there is a much bigger threat from the more technical-sounding reforms to derivatives trading contained in Dodd-Frank. These could submit the banks’ largest and juiciest businesses—their bond and derivatives operations that have operated off public exchanges, which makes it easier to charge investors more for each transaction—to public exchanges. There, prices can get forced down by the fact that they are easily compared and transparent. “The 1987 stock-market crash was a walk in the park compared with the credit-?market meltdown. It had almost no impact whatsoever, whereas 2008 almost caused the end of the world. The over-the-counter credit markets are so much bigger and more important than the equity markets to large banks,” says Smith.
Whatever happens with any new regulation, there’s the bigger problem that maybe the entire economy, particularly in the U.S., isn’t getting any healthier. Bill Gross, the head of Pimco, the largest U.S. bond manager, recently sold all $150 billion in Treasury bonds he held in Pimco’s Total Return Fund, because of concerns about who would buy Treasuries when the Fed stops doing so to keep interest rates low.
Last month, financier Carl Icahn returned $1.76 billion in cash to investors in his fund, explaining in a letter to them that “while we are not forecasting renewed market dislocation, this possibility cannot be dismissed.” Since then, the uprisings have spread in the Middle East and Japan has experienced one disaster after another.
It’s going to be next to impossible to replace bonds and derivatives as all-you-can-eat revenue buffets for investment banks. At the 2007 peak, for example, Goldman Sachs was making four times as much from trading and principal investments as from its traditional investment-banking businesses such as mergers and acquisitions and equity underwriting. The entire shape of its business had altered since its IPO in 1999.
So what’s going to get the appetite going again? Bankers point hopefully to the $2 trillion of cash on U.S. corporations’ balance sheets. “Companies are sitting on enormous pools of cash, so eventually they have to do something with it,” says one. In fact, there are already signs of their doing so: AT&T’s $39 billion acquisition of TMobile USA this week with $20 billion in financing from JPMorgan Chase cheered a lot of M&A bankers.
Investment bankers can also hope for an IPO revival, probably thanks to tech firms. There were an average of 530 IPOs annually in the U.S. during the nineties, but the figure fell to 61 in 2009, according to accounting firm Grant Thornton. Facebook’s IPO is expected next year—other Internet companies such as LinkedIn have already filed to go public. Both Goldman Sachs and JPMorgan have been trying to crack Silicon Valley by investing in companies such as Twitter and Facebook through private markets on which pre-IPO shares now trade.
That blew up in Goldman’s face when it offered to raise $1.5 billion for Facebook with a private placement of shares. Goldman had to close the offer to its U.S. clients, probably under SEC pressure, when the plan became known. Goldman had already upset some by charging hedge-fund-like fees: 4 percent up front and 5 percent of any profits. Jim Clark, a Silicon Valley investor, dismissed it to Bloomberg Markets as “just another way for them to make money from their clients.”
The arrangement was reminiscent of the way in which banks made money by selling shares on behalf of tech companies during the first dot-com bubble. They not only got paid by technology companies for underwriting their IPOs but also could allocate shares to clients who were most likely to give them other business. “There is a mind-set on Wall Street of wanting to gouge fees wherever they can,” says Tavakoli.
Even if the banks pull off such gouging and invade the territory of Silicon Valley’s venture-capital funds, it is unlikely to make up for what they have lost. “They might take stakes in Facebook and clip the ticket several times with banking and investment fees, but the underlying opportunity is still smaller than the mortgage market. Everyone’s got a mortgage,” says one banker.
Which is probably why Wall Street hasn’t entirely given up on mortgages. Many bankers are hoping to play a bigger role in housing finance as the Obama administration tries to rein in Fannie Mae and Freddie Mac, the government-sponsored entities. “The reform of Fannie and Freddie is an enormous opportunity. It is the last brick in the Berlin Wall of official intervention in housing finance,” says one executive.
That may be true in theory, but Wall Street’s record in mortgage securitization is not going to encourage either borrowers or regulators to trust it in the future. Any efforts by Wall Street to offer “innovative” products related to mortgages and housing will be scrutinized very closely by Warren and other financial regulators.
The cynical view: “Leverage pushed up returns and encouraged excessive risk-taking, and then the government bailed everyone out, so why won’t it happen again next time?” asks one financier. “A lot of people think it’ll take time for us to figure out what to binge on next, but we’ll find something.” After all, as former TARP cop Neil Barofsky pointed out in an op-ed on his way out the door, ratings agencies assume that many banks today are just too big to fail and include that in their calculations.
In the meantime, many bankers are looking for a way out. Those who can will move to hedge funds and private-equity firms or to boutique banks such as Evercore and Greenhill that lack the costs, complexities, and regulatory headaches of the big banks.
Banking’s future is in reality not on Park Avenue at all but in emerging markets—especially Brazil, China, and India, where Goldman has been focusing attention. Banks need not scramble to find new revenues there because traditional activities are still flourishing. While the number of IPOs in the U.S. has been falling, for example, there are plenty in Asia. In 2009, the Chinese IPO market was four times the size of those in the U.S. and Europe combined.
Big banks are shifting staff to India and China. “When I started in Asia fifteen years ago, my friends teased me mercilessly for giving up a proper career for this emerging-markets lark,” says Euan Rellie, the New York–based 43-year-old British co-founder of BDA, a boutique bank serving China and Asia. “Asia used to be all young adventurers and spivvy entrepreneurs, but that’s changed. Now everyone tells me, ‘You’re lucky to be exposed to India and China.’?”
The shift out of what people used to think of as Wall Street—the big investment banks—into hedge funds and emerging markets could be viewed as simply its latest evolution: Wall Street now means something else, but it still has a future. “The alternative investment world is prospering. There is huge demand for all kinds of derivatives and options and ?exchange-traded funds in every flavor,” says one money manager.
The problem for New York is that a lot of that future lies in other cities. The name on the door may still be Goldman Sachs and JPMorgan, but the bonuses will be paid to residents of Shanghai, Rio de Janeiro, and Mumbai. New York used to worry about London taking over its crown, but that isn’t the big threat now. Deutsche Börse’s bid to acquire the New York Stock Exchange is only an attempt to counterbalance a far bigger shift to the East.
“A lot of friends of my age on Wall Street got a bloody rude shock in the downturn. It was quite profound, and I think that it altered the way they think about the future,” says Rellie. “They realized the old model of the big integrated banks was threatened in a way it never had been before, and they had a very strong sense of not wanting to be there anymore.”