Ilargi: It's time for thank you's. First of all of course to Stoneleigh, who’s been a driving force all along, and who's had a remarkable year for herself, gaining here and shedding there, and coming out a different person. We will set up a section of economical primers soon, and you will find out how accurate my dear friend Stoneleigh’s been all the time, if you didn’t know that yet.
And to all of our readers, and commenters, and most of all our sponsors, without whom there would be no Automatic Earth. We limp along on small donations, but at least we still do. And we are grateful for the space and time you gracefully give us. To Rod and Paul and their better halves, and my MTL crew of O'Meara and Burnett, we've had quite a journey so far.
To the folks who send me articles lately, which makes it all so much more do-able, and which allows me to look at least a little bit beyond out present confines, and to develop an idea of what to do better still in 2009.
To fervent supporters like Sharon Astyk, g-d bless you girl, and Jim Kunstler, and some but not all at the Oil Drum, Karl Denninger, Michael Panzner, and all the others who link to and talk about us, many of whom do so in languages I haven't yet mastered. Big in Kazakhstan, Turkey and Poland, that sort of idea. I’m sure I forget many in the spur of the moment; please forgive me, it's not for lack of appreciation.
I know the format here rubs some people the wrong way, the use of whole articles vs snippets, fair use and all that, but I have felt for ages that it is imperative that people have a place where they can read all that is relative to the day's events. If there is a news organization, or an individual writer, who protests against the format, I will gladly stand aside, not post them and get my news elsewhere. Meanwhile, my take is that there is no time to lose when it comes to informing people.
The reason there is an Automatic Earth is first and foremost that there is no more time to waste. We have managed to save a lot of you a lot of money, for instance by telling you to get the hell out of the stock markets. The flipside of that is that we have undoubtedly saved you -combined- millions of dollars, whereas our Christmas fundraiser so far is stuck well below $10.000. There is something wrong in that. The way I see it is that we are in this together, that donating some of what this site has saved you will allow others to do the same. But I also do understand how people more and more start being afraid for their own situation.
You guys just think about it. Without your contributions, there is no Automatic Earth.
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Going into 2009, as you can see in the news below, the losses in the markets are as unprecedented as they are devastating. Just in one year: 35% for the Dow Jones, 52% for Amsterdam, 65% for Shanghai and 72% in Moscow. And that’s just stocks. As Marc Faber noted a few days ago, $30 trillion was lost in stock exchanges globally in 2008, and MarketOracle added that combined losses in commodities, stocks, bonds, real estate were likely greater than $60 trillion. And, mind you, there's still people talking about imminent hyperinflation. Confusion reigns with a vengeance.
Money is vanishing from our economies like there's no tomorrow. Problem is, there will still be a tomorrow. Every Day is Tomorrow. We will wake up on January 1. The only question is: what will it look like, that world over there, in that new timeframe?
We at the Automatic Earth have an idea what it will look like. Just like we did when a year ago we started this. I am still waiting for someone to tell me which prediction I gave over the past year was wrong. I know that sounds bloated and all, but I'd like to be proven wrong at least one time.
In the meantime, please be good to those around you, cut them some extra slack, you will need their presence in your life much more than you ever have. We will be normal people again, dependent on each other, like our ancestors always were. Love the ones you're with. I send you all my love, hoping we've made a difference in the past year, and hoping we'll be able to do so in 2009 as well. The world a year from now will be very different from what you see today, that much is evident.
2008 US loan issuance falls 55 percent
U.S. loan issuance in 2008 tumbled 55 percent to $764 billion, the lowest volume since 1994, as the global credit crunch choked off lending to American businesses, according to data from Reuters Loan Pricing Corp. Loan issuance was down from $1.69 trillion in 2007 as banks focused on repairing balance sheets damaged by mortgage losses and had little interest in underwriting riskier deals, RLPC reported on Tuesday. Investment-grade loans fell to $319 billion, down 52 percent from 2007's 658 billion, while leveraged loan issuance slid to $294 billion, down 57 percent from $689 billion in 2007, RLPC said.
JPMorgan was lead arranger for U.S. loans in 2008, with $198.5 billion, or 26 percent market share, followed by Bank of America, with $137.4 billion, or 18 percent market share, and Citigroup, with $116 billion, or 15 percent market share. Lending will likely remain anemic in 2009, according to an RLPC quarterly survey of loan market participants. Nearly 54 percent of respondents said their lending will be limited to key relationships. Institutional loans were especially hard hit as collateralized loan obligations disappeared from the market. Loans purchased by institutional investors slid to $69.6 billion, down 84 percent from 2007's $425.8 billion.
Loans backing leveraged buyouts, a key source of loan growth for the past several years, were down by 80 percent to just $41.3 billion from $209.9 billion. Much of the loan slump came in the second half of the year, after Bear Stearns collapsed and Washington Mutual Inc was seized by regulators, sending convulsions through the financial system. As banks scrambled to limit risk, bridge or temporary loans became the only viable funding source for many companies. A $14.5 billion one-year bridge loan backing Verizon Wireless' acquisition of Alltel Corp was the largest deal of the year in the loan market, according to RLPC.
Japan Economy May Shrink 12.1 Percent, Barclays Says
Japan's economy will probably shrink at an annual 12.1 percent pace this quarter, the sharpest drop since 1974, as exports collapse, Barclays Capital said. Gross domestic product in the three months ending tomorrow will fall at almost three times the 4.1 percent rate previously predicted, said Kyohei Morita, chief Japan economist at Barclays in Tokyo, after reports last week showed industrial production and exports posted the biggest declines on record in November. "Given the speed and the length of the contraction, this recession could be the most severe in the postwar era," Morita said. "We expect negative growth will continue for a fifth straight quarter to the April-June period of 2009."
Plunging sales of cars and electronics are forcing companies from Toyota Motor Corp. to Panasonic Corp. to idle plants and fire workers. The Nikkei 225 Stock Average tumbled a record 42 percent this year, eclipsing a 39 percent slide in 1990 that helped trigger a decade of economic stagnation and deflation. A 12.1 percent annualized contraction would be the steepest since the first quarter of 1974, when the oil shock caused the economy to shrink 13.1 percent, according to Barclays. Japanese government bonds completed the best year since 2002, with the yield on the benchmark 10-year bond falling 3.5 basis points to 1.165 percent, the lowest in more than five years, at the close in Tokyo today.
Panasonic Electric Works Co., a Panasonic subsidiary, said this week that it plans to shut three factories and eliminate 1,000 jobs by the year ending March 2011. Aeon Co., Japan's largest supermarket operator, will cut spending on stores at home and slow expansion in China. Production plummeted 8.1 percent in November from October, the most since comparable data were first kept 55 years ago. Companies surveyed said they planned to reduce output a further 8 percent this month and 2.1 percent in January. Exports slid an unprecedented 26.7 percent last month from a year earlier. The numbers were "shocking," Morita said. "Exports are dropping at a very rapid pace and capital investment also is fizzling." The data prompted other economists to revise their GDP projections. Bank of America Corp. now predicts an annualized 6.5 percent contraction from a 2.7 percent drop previously estimated.
"External demand has vanished all of a sudden," Tomoko Fujii, head of Japan economics and strategy at Bank of America in Tokyo. "Almost every industrialized nation is in a recession. Even in China, growth is slowing sharply." Japan Research Institute went even further, foreseeing a 14.1 percent drop. "I couldn't believe my eyes when I calculated the figures," said Takuto Murase, a Tokyo-based economist at the researcher, which is owned by Sumitomo Mitsui Financial Group Inc. "This could be the worst contraction in the postwar era." The most severe financial crisis since the Great Depression is spreading from industrialized nations to developing markets including Asia, the destination for about half of Japan's exports. Consumers at home are unlikely to pick up the slack, with household confidence at a record low and job prospects worsening. "This is the toughest climate I've seen," said Aeon Chief Financial Officer Masaaki Toyoshima, who began working for the retailer in 1974. "It's looking tougher by the month."
Deflation may return next year as the recession deepens, the yen extends its gains and companies restrain wages to protect profits, the Economist Intelligence Unit wrote in a report published today. Consumer-price inflation eased the most in a decade in November as prices of oil and other commodities slumped. "Many parts of the economy are already suffering from deflation," the London-based EIU said. "The poor outlook for the economy will continue to restrict companies' pricing power, and real wages are forecast to continue falling in 2009." Policy makers have little scope to respond. The Bank of Japan has already cut its benchmark interest rate to 0.1 percent and started buying short-term corporate debt.
Any extra spending by the government risks swelling the public debt, which is already the world's largest at more than 170 percent of GDP. Prime Minister Taro Aso has yet to get parliamentary approval for plans to spend about 10 trillion yen ($111 billion) to support households and the unemployed. Aso, whose approval rating fell 10 points to 21 percent in a Nikkei newspaper survey published this week, has to call a general election by September. "Given that Aso is struggling to show his political leadership, the fiscal policy that could influence Japan's economy will be the U.S.'s and China's, not be Japan's," Morita said. "Even once Japan eventually recovers, the economy will still depend on exports."
China's share index ends year down 65%, losing $3 trillion
China’s stock market became the worst major performing index in the world for 2008, ending the year down 65 per cent. The annual drop, triggered by a broadening global economic malaise that has punctured China’s unprecedented economic boom, was the biggest in the index’s 18-year history, wiping out nearly $3 trillion in market value — not far off the total value of the country's $3.4 trillion annual gross domestic product. Shanghai’s benchmark composite Index dropped 0.66 per cent today to end the year at 1,820.8 points. The index had glanced an annual low of 1,664 points in late October, down from a 2007 record peak of 6,124 points.
Other Asia-Pacific markets also ended the year sharply lower today. Australian shares posted a 41 per cent loss with the S&P/ASX 200 index ending the year at 3,722.3. Japan’s Nikkei average ended 2008 down 42 per cent — the worst in its 58-year history. New Zealand’s benchmark NZX 50 index slipped 33 per cent for the year to end at 2,715.71. In early trading European shares rose today. The London stock exchange closes for the year at 1230 GMT while Euronext’s Paris, Amsterdam and Brussels bourses are set to close half an hour later. The FTSEurofirst 300 index of top European shares is predicted to show a 45 per cent slide this year.
Russian Stock Index Down 72%; Gazprom Tumbles
A 72 percent drop in the RTS Index made Russia the worst index among the world’s 20 biggest equity markets this year and gave investors in the country their biggest losses since Russia defaulted on its debt 10 years ago. OAO Gazprom dropped from being the world’s third-biggest company to 47th, and other stocks slumped amid falling oil prices, capital flight following the August war with Georgia and forced selling by investors and billionaires who faced margin calls from banks and brokers. "The uninspiring performance of the Russian equity market was driven by the deteriorating global macroeconomic environment, but it was Russia-specific factors that drove the substantial underperformance," UBS AG strategists including Dmitry Vinogradov wrote in a year-end report Dec. 23. "Russia has been hit by a triple whammy."
Prime Minister Vladimir Putin, who vacated the presidency in May for Dmitry Medvedev, ordered an investigation of steel and coal producer OAO Mechel, which contributed to an 85 percent drop in its shares this year. The government also reopened an investigation into a flood at potash producer OAO Uralkali, helping that stock fall 71 percent in 2008. Investment banks Renaissance Capital and UralSib Financial Corp. both predicted a year ago that the RTS would rise to 3,000 by today; instead the index tumbled to 631.89 at today’s close of trading, or little more than one-fifth of that level. Both banks later changed their recommendation, saying investors should buy bonds rather than only stocks in 2009. The ruble fell 16 percent against the dollar this year, the currency’s worst annual performance since 1999, after the central bank began a series of small devaluations as the country’s foreign reserves, the world’s third-biggest, lost more than a quarter of their value, prompting Standard & Poor’s to downgrade Russia for the first time since 1999.
Trading was light today on the Micex Stock Exchange, Russia’s biggest by volume, with only 17.7 million shares of Gazprom changing hands in regular trading, compared with an average of 69 million over the last six months. The 30-stock Micex Index rose 0.3 percent to 619.53 in shortened trading today. Trading was halted in the Micex more than 30 times this fall, helping send Russian trading volume to London, according to Micex’s Chief Executive Officer Alexei Rybnikov. Gazprom passed General Electric Co. and China Mobile Ltd. in May to become the world’s third-biggest company by market value as its chairman at the time, Dmitry Medvedev, became Russia’s third president. Gazprom’s value has since fallen from about $360 billion to $86 billion. Deputy Chief Executive Officer Alexander Medvedev said in an interview last year that investors would value the company at $1 trillion as soon as 2014.
Record stock market falls in 2008
Shanghai was one of the worst-performing markets, ending 65% lower - its biggest annual drop. Major western markets have also seen steep falls during the year due to the impact of the global credit crisis. Britain's FTSE 100 is set for its worst year on record, having lost more than 30%, while Paris and Frankfurt have seen similar falls. "If there's any optimism, it's on the basis that stock markets recover in recessions," said Justin Urquhart Stewart, at Seven Investment Management in London. "Last year we were so optimistic, that we were fooling ourselves. It's now gone too far the other way. We've discounted a huge amount of bad news," he said.
While Paris and London are still trading, in Germany, Frankfurt's market has already closed for the year. The Dax-30 ended 2008 down 40%, which was the index's second-worst annual performance in its 20-year history. The index had risen 22% in 2007. Technology firm Infineon was the Dax's biggest loser in 2008, down 88.1%, followed by Commerzbank, down 74.7%. "I believe that we will have a lot of problems next year and much deeper prices than this year. But where we will be at the end of the year, absolutely no clue," said Dirk Mueller of MWB Fairtrading.
Shanghai's fall wiped nearly $3 trillion (£2.1 trillion) off share values. Shanghai soared more than 300% in 2006 and 2007. Japanese shares also suffered their biggest yearly decline, with the Nikkei dropping 42% as world's second-largest economy slid into recession. As a meltdown of the US housing market led to a global slump in consumer spending and industrial production, foreign firms withdrew investments from Asia to repay debts back home. In many cases, markets that had benefited most during the previous bull-run were the worst affected as it ended.
As demand in overseas markets slowed, Asia's export-driven economies were hard hit. In Hong Kong, which is in recession, the Hang Seng index closed the year 48% lower. This was its second-biggest drop to date and its worst since the global oil shock of the early 1970s. India's main index in Mumbai has more than halved. "It was ferocious, it was an unprecedented move down. The domino effect was so quick and so swift," said Lucinda Chan of Macquarie Securities in Sydney. A surging yen added to the woes of Japan's biggest exporters such as Toyota and Sony, while political upheaval hit Thailand's market. "No one saw an end to the bull run," said Kirby Daley, at Newedge Group in Hong Kong. "What many failed to see was an endgame to the leveraged world we were living in and an endgame to the consumption-driven economy that the world had become."
Whether the stock markets fall further in 2009 is a matter of debate. Many investment strategists have written off any chance of a major rebound in at least the first six months of the new year, when company earnings could prove especially bleak. How China's economy shapes up will also be closely watched. Fourth quarter growth in 2008 is already forecast to drop to as low as 2% from nearly 12% in 2007. "China's economy is obviously at a turning point. There are too many uncertainties, and past huge losses have made investors increasingly cautious," said Cheng Weiqing, at Citic Securities in Beijing. Asia's fortunes could depend greatly on the mood of consumers, especially in the US, where their appetite for cars, electronics and other goods has been the driver of regional growth.
Commodity markets in worst annual fall
Oil and gold fell on Wednesday in the final trading hours of 2008 as investors reflected on the worst year for commodity markets since modern records began. The Reuters-Jefferies CRB index, which began life in 1956, was on track for a fall of just under 40 per cent in 2008, a record annual decline. The S&P GSCI index, the most widely followed benchmark for commodity investors was on course for a drop of just over 50 per cent, underperforming global stock markets which have delivered total returns of minus 42 per cent, according to the FTSE All World equities index. A year of extra-ordinary highs and lows for commodities, new price records were establised for crude oil, petrol, gold, platinum, copper, aluminium, tin and lead as the bull market which had lasted six years reached its zenith. However, with only a few rare exceptions such as gold, virtually all commodity markets ended the year in a disorderly retreat as the worldwide financial crisis provoked by the credit crunch dragged the global economy into recession.
The credit crunch also had a more direct impact on commodity markets as investment banks radically limited the availability of credit to hedge funds which forced them to reduce long positions (bets that prices would keep rising). Two of the most important ideas which had supported the bull market for commodities withered in 2008. The hope that commodity markets were experiencing a once-in-a-lifetime upswing, described by analysts as a "supercycle", due to rising demand from emerging markets, particularly China, to cope with massive expansions in urbanisation and infrastructure spending, was dealt a fatal blow as the credit crisis spread its paralysing grip on activity in both advanced and developing countries. The idea that China might "decouple" from the rest of the global economy also proved false. Decoupling implied that the Chinese economy would prove immune from the global economic downturn as strong demand for raw materials from China’s interior regions would continue to bolster metals and energy prices.
Crude oil prices, which recorded both record highs and multi-year lows in 2008 have weighed heavily on the performance of commodity indices this year. The benchmark for US crude prices, Nymex West Texas Intermediate, which touched the $100 a barrel mark for the first time in the first session of 2008, marking a historic moment for financial markets, climbed to a record $147.27 a barrel in July, prompting talk that oil might hit the $200 level before the end of the year. Motorists in the US and Europe saw retail prices for petrol rise to record levels in the summer. Angry accusations that hedge funds were responsible for driving prices higher sparked debate among US lawmakers in Congress over the need to curb the influence of speculators in energy markets. High prices did eventually supress consumption, however, particularly in the US, and towards the the end of 2008, it was clear that global oil demand was set for its first annual decline in a quarter of a century. The rapid deterioration in the outlook for oil demand combined with massive deleveraging by hedge funds after the implosion of Lehman Brothers, the US investment bank, in September, led to a dramatic decline in crude prices in the second half of the year.
WTI has sunk 74.3 per cent since hitting the all-time high in early July, its steepest peak to trough decline, leaving crude oil on course for a record annual decline this year, down 60.6 per cent. On Wednesday, Nymex February West Texas Intermediate fell $1.23 to $37.80 a barrel after touching a low of $37.75, while ICE February Brent lost $1.15 at $39.00 a barrel.However, the unprecented volatility of crude oil prices this year was just one of many remarkable performances in commodity markets in 2008. Gold was one of only a few commodities to end the year higher than last December. Over the whole of 2008, gold has risen 3.7 per cent, ending the year above the $850 mark which was the previous record for spot bullion prices stretching back to 1981. Gold hit a record $1,030.80 in mid-March but could only manage to close above the $1,000 mark on one session this year.
The upswing in interest in gold this year was dramatically illustrated by the fact that mints around the world ran out of popular gold coins and small bars as investors flocked to the gold market seeking a safe haven, bullion’s traditional role in times of trouble. The collapse of Lehman Brothers in September led to widespread concerns about counterparty risk and also sparked unprecedented levels of demand for physical gold. Holdings in gold exchange traded funds rose to record levels this year, reflecting investors desire for a haven from the turbulence which was affecting other asset classes, such as equities and property. On Wednesday, gold slipped to $864 a troy ounce, moving in a relatively narrow range between a low of $865.70 and a high of $873.85, after ending trading in New York on Tuesday at $872.55 Platinum traded at $904.50 a troy ounce on Wednesday, down 1.1 per cent on the day and down 40.5 per cent this year. Platinum soared to a record $2,290 a troy ounce in March amid concerns that power supply problems would affect mine output in South Africa, the world’s largest producer.
However, those concerns about supply tightness were eventually overwhelmed by fears about the outlook for demand as new car sales around the world plunged. (More than half of global platinum output is consumerd by the automotive sector as the precious metal is a key component in autocatalysts). Base metals have been hit hard this year by concerns over the impact of the global economic downturn on demand with copper down 56 per cent this year after reaching a high of $8,930 a tonne in July. Base metals producers have been reducing output and cutting capacity in an effort to stabilise their markets but with little impact on prices. Aluminium has sunk 37.8 per cent this year, with weak demand conditions reflected in massive increases in stocks on the light metal held in London Metal Exchange warehouses.
UK insolvencies to hit record level in 2009, warns KPMG
The number of people being declared insolvent next year is expected to climb to its highest level since records began almost 50 years ago, experts have warned. KPMG said numbers would surpass 150,000 next year as people struggled to meet the rising cost of living. If the prediction proved to be correct, it would be the highest level since The Insolvency Service figures began in 1960. The forecast includes people being declared bankrupt and the less stringent Individual Voluntary Arrangements (IVAs), which allow borrowers to agree a repayment plan with their creditors.
The average person entering into an IVA over the past year owed £47,000 and planned to pay just 38 per cent of this sum, equivalent to £18,200 per borrower, according to KPMG. But while the average IVA debtor owed £47,800, KPMG estimates that more than 2,500 people entered into IVAs with debts exceeding £100,000 this year. Mark Sands, director of personal insolvency at KPMG, said: "This high average level of debt clearly indicates that too many people have borrowings that they have no realistic hope of repaying. Any excessive spending over Christmas and at the New Year sales, especially where goods are paid for on credit, risks tipping even more consumers over the edge."
The forecast also includes Debt Relief Orders being introduced by the Government in April, which will allow those with debts of less than £15,000 and minimal assets to write off their debts without entering into a full blown bankruptcy. KPMG also predicted that 37,000 people used the IVA procedure to write off a portion of their debts while 67,000 people were declared bankrupt, taking total personal insolvencies to around 104,000 this year. Figures from the Insolvency Service are expected to be published in February. Its last figures disclosed that almost 300 people a day were declared insolvent during the three months to the end of September. It said the number of individual insolvencies rose to 27,087 in England and Wales in the third quarter – an 8.8 per cent increase on the previous three months.
The Breakdown of the World Money Machine
"What an awful year. And 2009 doesn’t look like it’s going to be any better." Our neighbor, Pierre, was describing the state of the agricultural industry in Europe...and, indirectly, why he couldn’t pay the rent. He leases some land from us at a price of about $150 per acre. He’s now far behind on his rent payments. Elizabeth had asked for a meeting to try to collect. Your editor sat off to the side, listening. "Of course, I’d like to pay," Pierre explained. "And I’m sorry I’m so far behind. But this is just a terrible time for us. I have to feed the cows. That’s the first priority. I have to feed them...and buy medicines and fertilizers...even though nobody is buying them. The meter turns over pretty fast – even though I’m not going anywhere. I’m not a meat producer. I’m a breeder. We’ve been breeding Limousine cattle here for more than a hundred years. These cows can trace their ancestry better than most people. But when farm prices fall, people stop investing in the quality of their herds.
"Normally, I sell about 20 top breeding bulls per year. This year, I’ve sold 5. There are many people who want to buy, but they don’t have any money. They don’t have any money because they can’t get good prices for their cows...and can’t get credit from the bank. So they don’t buy my bulls...so I can’t pay you." "Well, the publishing business is no picnic either," Elizabeth replied. "Your customers don’t have any money...you don’t have any money...and now I don’t have any money either," she added with a laugh. We wondered how many conversations like this were taking place all over the world. The world’s money machine has broken down. Yesterday, the Dow fell 31 points. Oil rose to $40. The dollar held steady at $1.40 to the euro. Gold rose $4 – giving it a nice gain of about 6% for the year.
Everything else is losing money. This will go down in history as the worst year for investors of all time. Oil, copper, and most financial stocks are down 2/3 from their highs. Stock markets generally are down 40% to 60% all over the world. Housing markets are down in most places too – with prices in Britain and America off about 20%. Bloomberg reports that holiday sales were so bad it will "force store closings, bankruptcies." And USA Today reports that global trade is expected to shrink by 2% in ‘09, after rising at nearly 10% per year for the last decade. Smoot? Hawley? Who needs those knuckleheads? Global trade is collapsing without trade barriers. Because Americans aren’t buying.
And here, we can trace the breakdown in the entire world money machine...from the pistons that don’t fire to the crankshaft that doesn’t turn. Like the farming business in France, one man doesn’t have any money...so the next man is a little short...and so on all up and down the line. And here, for the benefit of new readers, we offer a simple schema of the machinery of the Bubble Epoch: Americans bought stuff from the Chinese. The Chinese printed up yuan to buy dollars from Chinese merchants. Then, the nice Chinese financial authorities lent the money back to America. What else could they do with it? So, you see, everyone had plenty of money. And the more Americans bought...the more money they had to spend. And the more they spent, the more the Chinese had to lend!
Of course, it didn’t take a genius to see that a system that depended on people buying things they didn’t need with money they didn’t really have couldn’t last long. In the event, it lasted longer than we expected. But still, not forever. It broke down under the strain of its own absurdity. But wait a minute. How come all of a sudden Americans don’t have any money? Won’t anyone lend any money to them? And why not? Oh dear reader, throw us a bone! The financial authorities are clumsily turning screws and tightening valves. They think they can fix the machine by simply getting more credit into consumers’ hands. But this machine is not that simple. In fact, it’s not a machine at all...but a living, organic thing. It has emotions as well as a brain. It is capable of self-delusion, deceit, corruption, wishful thinking, and extravagance.
Investors, businessmen, householders and consumers are all now reacting to the madness of the Bubble Epoch. They lent, spent, speculated and borrowed wildly – as if there were no tomorrow. Now, every day is tomorrow. And they’re afraid. After the sub-prime bubble popped, all the bubble delusions began to fall from their eyes. While once they looked through the glass rosily, not they look darkly: Wall Street was not making them rich, after all – it was ripping them off! Houses didn’t go up forever – sometimes they went down! Things didn’t get better and better all the time; often, they got worse! Prominent analysts and economists often have no idea what they’re talking about! Alan Greenspan wasn’t such a genius after all!
Suddenly, they looked at their balance sheets and realized that they were in danger. Investors have lost half their money in 2008. Homeowners have lost about $4 trillion in America alone. They read the news. They talk. They know the whole thing is imploding. How are they going to pay their bills? How are they going to keep up their standards of living? How are they going to be able to retire? Instinctively, reflexively, they cut back their spending. And when the pistons stop pumping, the drive shaft stops spinning, and the wheels stop turning. Americans don’t go to the stores, the stores don’t order more stuff, the ships don’t bring more stuff, the Chinese merchants don’t make money, the Chinese central bank doesn’t have to buy it from them, and then the Chinese have less money to lend back to Americans – who aren’t borrowing in any case.
The machine is busted. It can’t be fixed. "The Undeniable Shift to Keynes" , begins a piece in the Financial Times . Why the shift? Because Friedman has let us down. The Fed kept the supply of money and credit fairly constant, just as it was supposed to. Then, when credit got tight, it cut rates...all the way down to zero, just as it was supposed to. Did that solve the problem? Nope. Because the economy is not a simple machine. It’s a complex, organic system. It cannot be controlled. It can only be survived. Tolerated. Enjoyed. Let’s imagine that the Fed’s key lending rate was zero all year long. Even so, if you’d borrowed money directly from the Fed and used it to buy stocks, your rate of return would be about MINUS 50%. Or suppose you bought a house with a zero-interest mortgage? Your rate of return would be about MINUS 20%. Or, it could have been worse. You might have invested your money with Bernie Madoff, in which case your rate of return would be MINUS 100%.
What business...what investment...what durable consumer item is worth borrowing for under those conditions? Not many. Besides, once the Fed gives away money at zero interest, what more can it do? Well, it still has some tricks up its sleeve, but its main monetary tool is worthless. It can’t cut rates further. So, it turns to another great economist – Keynes. Instead of colluding to fix the price of money, Keynes said governments should make up for the lack of private spending with public spending. That is, instead of allowing consumers to use their resources as they wished, politicians should divert resources to their own pet projects. In its idealized form, if the private sector found no use for a working man, for example, the feds should put him to work on some socially-useful project – such as building a bridge or picking up trash.
Of course, if there are idle hands in an economy it’s because the feds have already distorted it. Typically, various government rules and safety nets make it difficult to adjust the price of labor downwards. So, when prices fall, labor rates become disproportionately high. Who’s going to pay a man $25 to make a gadget that sells for $15? No one. That is what causes unemployment. But rather than allow labor prices to fall, Keynes came up with a trick. Government should spend money, thus causing inflation. The rising prices will make labor seem relatively affordable again.
But like all the tricks and quick-fixes in economics, Keynesianism causes more problems than it solves. Governments rarely have any genuine savings. So, in order to spend, they either have to take money away from other spenders ...or print it up. If they take it from other uses, the net gain, in theory, is zero. In practice, it is much less than zero, since most government spending is wasted. If it prints up the money, on the other hand, the inflationary effect is much greater...and ultimately ruinous. As we shall see...as the reckoning continues.
German Finance Minister Warns Against New "Growth Bubble"
German Finance Minister Peer Steinbrueck has warned against cutting interest rates to spur the country's economy, a move he insists would lead to a hazardous "growth bubble" in Germany. In an interview with news agency AFP, Steinbrueck said he recognized the need to stimulate Europe's largest economy, but that cutting rates and thereby boosting spending and debt levels was the wrong move. "On the one hand we need to boost the economy, on the other hand we must make sure that a policy of cheap money does not lead to a new growth bubble founded on credit, as happened after Sept. 11, 2001," Steinbrueck said. "It is therefore important that the focus, at least in Germany, be on sustainable investments in infrastructure and less on consumer spending financed by debt," he told AFP. "This is also an argument against hasty tax cuts," he added.
With global money markets taking a battering in recent months and consumers reining in their spending on fears of future instability, central banks around the world have taken to reducing borrowing costs to motivate shoppers into parting with their cash. Germany released an economic stimulus package in November aimed at spurring growth, but Chancellor Angela Merkel's government has come under pressure to do more to ease the economic strain on Germany. Merkel's cabinet is to meet January 5 to discuss a second stimulus package, but Steinbrueck insists there will be no place in the second plan for tax cuts.
"What we do must be intelligent, be fair to future generations and reap future benefits," he said. "Making temporary cuts in value added tax (VAT), for example, fulfils none of these criteria." Steinbrueck told the Passauer Neue Presse daily that reducing Germans' health insurance contributions would be more effective in putting money into consumers' pockets because half of all households already paid zero income tax. The second package is likely to help the struggling German auto industry and as well as untangle significant infrastructure projects caught up in red tape, the finance minister said.
Parallel to Steinbrueck's calls for refraining from increasing consumer debt levels, the European Union's executive approved Tuesday a German initiative to stave off recession by offering firms over 15 billion euros ($21.3 billion) in low-interest loans. The plan is aimed at protecting the "real" -- non-financial -- economy from recession. It was the first such package to be approved under the European Commission's revised system. The package consists of a loan fund of up to 15 billion euros for companies which have difficulties in borrowing money due to the global financial squeeze. The maximum low-interest loan any one firm can receive from the scheme is 50 million euros, with companies whose turnover is greater than 500 million euros per year excluded.
The plan also includes a separate program capped at 500,000 euros per company for emergency grants to firms operating on the local or national level. Both programs are short-term and were drawn up in line with the Commission's recently revised rules on state aid, the Commission said in a statement. In recent months, the Commission has dealt with a slew of state-aid cases as EU member states have rushed to protect their financial sectors in the global financial storm. The pressure has been so great that the Brussels executive has revised its own state-aid rules to make it easier to deal with the crisis.
Stop the Presses…
The Internet has overtaken newspapers as a source of national and international news. That’s the axiomatic conclusion of a new survey from the Pew Research Center for the People & the Press that proves irrevocably what anyone with even a passing interest in the news business has known for some time now.
Of the 1,489 adults surveyed by Pew, 40 percent identified the Internet as their primary source for national and international news. Thirty-five percent identified newspapers and 70 percent identified television. And that’s not all that surprising, is it?Indeed, given the big news stories of 2008–the presidential election, the econalypse–it’s surprising the Internet didn’t skew even higher in the survey results simply because of people monitoring the presidential campaign or monomaniacally tracking the stock market’s plunge into the abyss.
Of course, it will continue to skew higher in the years to come, and markedly so as the ink-and-paper generation declines and the keyboard-and-browser generation continues to rise. But it will be the newspapers driving that change because often, it’s their original reporting that we find ourselves reading on the Web. As one commenter noted over at News.com, "Newspapers are the assignment desks for broadcast and Web media outlets. Who is going to perform the basic grunt work of journalism after the newspapers are gone?"
Paulson says U.S. lacked tools to tackle crisis: report
Outgoing U.S. Treasury Secretary Henry Paulson said the U.S. government had to battle the financial crisis without the tools needed to do the job effectively, the Financial Times newspaper reported on Wednesday. Paulson also said any future regulatory overhaul needed to ensure that financial system infrastructure could allow for the failure of large institutions. In one of his last interviews before leaving office, Paulson said, "We've done all this without all of the authorities that a major nation like the U.S. needs."
He said even after Congress in October approved the $700 billion troubled asset relief program, the U.S. still lacked tools such as an adequate special bankruptcy regime for non-bank financial firms. "We're dealing with something that is really historic and we haven't had a playbook," he said. "The reason it has been difficult is first of all, these excesses have been building up for many, many years. Secondly, we had a hopelessly outdated global architecture and regulatory authorities...in the U.S.," the newspaper quoted him as saying.
Paulson said any regulatory overhaul should emphasize "better and more effective" regulation and needed to make sure that infrastructures and powers were robust enough to allow large institutions to fail. "The organizations (financial firms) cannot be too big or too interconnected to fail," he said. Paulson said he was surprised by the ferocity of the crisis but believed he grasped from August how severe it was as problems at home funding companies Fannie Mae and Freddie Mac threatened to coalesce with a dangerous September results season for financial institutions.
"If you asked me six months ago... if I was surprised by the magnitude of the challenge, the answer is 'yes'," he said. "But we have been for some time in the frustrating situation of understanding much more than the public or even the Congress understood in terms of the magnitude of what we are facing." Asked what the past year has been like personally, he said: "It has been unusually intense." He said the U.S. Treasury had been going "all out" since July. Paulson praised his successors, saying "They have got a great team and they don't need advice. I really believe that."
Fighting the Last Depression: The Fed's Policy Errors
The government is fighting the current recession as if it were the Great Depression of the 1930s. This reflects a serious misinterpretation of reality, and one that will most likely persist beyond Inauguration Day. President-elect Obama's appointment of Berkeley Professor Christina D. Romer as Chairwoman of the Council of Economic Advisors is consistent with this orientation, as she is an expert on the Great Depression and may lend support to the unwarranted focus on the Depression. Indeed, Romer has supported the Fed's current monetary policy because she sees parallels with earlier financial panics.
From this anti-Depression policy has come a stream of costly policy errors that could ultimately prolong the current recession. The Fed's December 16th decision to drop the target federal-funds rate to a record low of zero to 0.25% is but the most recent of these. With rates already effectively trading near zero despite the Fed's previous target of 1%, the decision does not actually change rates, but only sends a negative message about the state of the economy. That worsens confidence. And now the target rate has nowhere else to go, so the Fed will have to resort to new means to increase liquidity — a painful irony since liquidity is not even the problem.
It is true that the Great Depression of the 1930s was a crisis of liquidity. Stocks plunged, banks went under, and the value of assets disintegrated. Our current policies would have been appropriate in the Great Depression, but they are not appropriate now. Liquidity problems are not the source of our current financial and economic woes. Incredibly, excess reserves of depository institutions have increased from under $2 billion in August to a record $774 billion in mid-December, according to the Federal Reserve's December 18 release. But the banks have not taken advantage of this liquidity to increase their lending. Why not? Because what we have is not a crisis of liquidity but rather a crisis of confidence.
With tremendous excess reserves, it is obviously not the case that banks are not lending money because they do not have the money to loan. Instead, they are afraid that other institutions, including even other banks, will not pay it back. The banks do not have confidence in each other. Businesses, also, are not inclined to borrow money and take risks. Further, consumers are not spending because they are afraid they could lose their jobs. By continuing to throw money at the banks, the government is on the road to prolong the recession and effect massive inflation when confidence is restored and the economy then has too much liquidity. By making money available to the banks essentially for free, the Fed does not guarantee that the banks will loan out the money to businesses. There is no motivation to lend money at low rates when capital preservation (i.e., lack of confidence) is still a leading issue.
Rates may be low, but the banks are not going to offer these rates to the individuals and industries that can make most productive use of them — at least not until confidence returns. Far from being helpful, the Treasury worsened the situation by increasing the liquidity of the financial sector through its bailout. However, the greatly enhanced lending capacity of depository institutions has not yet reached the money supply, as evidenced by the tremendous level of excess reserves. When it does, the Fed will find it difficult indeed to summon the political will, or find the ability, to soak up all this excess liquidity. Recessions ordinarily lead to deflation or disinflation, which increases the real value of assets and acts to end the recession by fostering spending. This natural and necessary corrective mechanism will be thwarted by inflation as soon as we begin to get out of the recession. That is the danger of treating a crisis of confidence as a crisis of liquidity.
Lawrence H. Officer is Professor of Economics at the University of Illinois at Chicago ; Ari J. Officer has completed a Master of Science degree in Financial Mathematics at Stanford University.
US Consumer Confidence Falls To All Time Low
Consumer confidence hit an all-time low in December, according to the private research firm known as The Conference Board. The exceptionally bleak outlook comes in the face of an economy mired in recession, rising layoffs, the loss of trillions in home and stock equity, and one of the worst holiday shopping seasons in the past 40 years. The Conference Board's Consumer Confidence Index slipped to 38 in December, lower than the expected 45. November's reading was revised down to 44.7, a moderate increase from October.
Swiftly deteriorating economic conditions in the last three months of 2008 are behind the record low number, Conference Board Research Center director Lynn Franco said in the press release. "The overall economic outlook remains quite dismal for the first half of 2009, and only a modest recovery is expected in the second half," she said in a statement. Franco notes that the present situation index, a sub-index which reflects consumer sentiment about current business conditions and employment prospects, plunged to 29.4 in December from 42.3 in November. These levels are still higher than the 1981-82 recession, but are near the levels seen in the wake of the 1990-1991 recession.
The expectations index, which is sub-index that measures overall consumer sentiments toward the short-term future economic situation "continues to hover at historical lows" Franco said. However, she added that the index appears to be moderating. Both the present situation and expectations indices "bear careful watching over the next several months to see if they are starting to show signs of approaching a bottom," Franco said. The survey is based on a sample of 5,000 households in the United States.
Consumers believe that conditions in December grew "substantially worse" than in November, the survey showed. 46 percent of those surveyed categorized business conditions as "bad," up from 40.6 percent in November. At the same time, only 7.7 percent view business conditions as "good," down from 10.1 percent last month. Declines in the labor market, with over 500,000 jobs lost in November alone, were also reflected in the survey. 42 percent of consumers said that jobs are "hard to get," up from 37.1 percent in November. Those claiming jobs are "plentiful" slipped from 8.7 percent last month to a mere 6.2 percent. In addition, consumers see little improvement in business conditions over the next six months. The numbers reflect an increasingly polarized consumer base, with consumers either growing more negative or more positive.
While in November only 28.3 percent expected conditions to worsen in the short-term, that number rose to 32.8 percent in December. Conversely, more consumers expect improvement - 13.4 percent - then the 11.4 percent that saw brighter skies ahead in November. In terms of the labor market over the six month, 41 percent of consumers now expect fewer jobs, higher than the 33.7 percent last month. However, there were slightly more optimists, with 9.7 percent anticipating the situation to improve, up from 9.2 percent in November. Employment situation aside, consumers agreed that incomes will likely not increase. Only 12.7 percent of those surveyed expecting an increase in the next six months, down from 13.7 percent last month.
SEC Study Defends Fair-Value Accounting Rule
The Securities and Exchange Commission yesterday rejected calls by banks to suspend an accounting rule blamed for exacerbating the financial crisis, saying the "fair- value" standard should instead be improved. "Fair-value accounting did not appear to play a meaningful role in the bank failures that occurred in 2008," the regulator said in a statement. The SEC study, ordered by Congress, recommends changing accounting for so-called impaired securities and giving companies more guidance on determining the value of investments in inactive markets.
Banks including Citigroup say the rule, which requires companies to record assets every quarter to reflect market value, fails when buyers shun assets such as subprime mortgages. Proponents, including the Financial Accounting Standards Board, say it adds to transparency and gives investors information about companies. The study "will be a useful source of information and guidance not only to policymakers in Congress but also to independent standard-setters," SEC Chairman Christopher Cox said in the statement. Congress gave the SEC 90 days to study fair-value rules when lawmakers passed the $700 billion federal financial rescue package in October.
New SEC Rule on Reserves May Benefit Oil, Natural-Gas Producers
A new U.S. Securities and Exchange Commission rule may make oil and natural-gas producers more attractive to investors by letting them declare reserves that have yet to be confirmed, according to the head of an Illinois- based energy research and consulting firm. The new rule, approved by the commission yesterday and effective in January 2010, allows producers to include probable and possible reserves that reflect new technologies in their reporting, according to a statement from the commission. The value of the reserves will be based on average oil and gas prices over the previous 12 months, rather than at year’s end. The actual wording of the new rule wasn’t disclosed.
"This change by the SEC is, undoubtedly, a boost to oil majors," said Gianna Bern, president of Flossmoor, Illinois- based Brookshire Advisory & Research Inc. "By including probable and possible reserves, the opportunity exists to re-evaluate and increase reserves." The new rule was adopted as producers such as Exxon Mobil Corp. and Chevron Corp. find it more difficult and costly to replenish crude-oil reserves with a decline in easily accessible deposits. The rule still is subject to review before the SEC can publish it, said John Heine, a spokesman for the commission. Heine said he couldn’t provide further details before the rule is published in final form.
The oil industry in June supported a proposal to value oil reserves based on average pricing. Reserves reporting for 2008 will be based on year-end prices. "That’s the one issue out there that industry has had the most agreement on, because there have been wild aberrations in some years between a one-day snapshot price and average pricing for the year," said Mike Wysatta, business development manager for Houston-based Ryder Scott Petroleum Consultants, which evaluates oil and gas properties. Oil producers would benefit from use of average pricing this year. Oil futures traded on the New York Mercantile Exchange, averaged about $100 a barrel so far this year, more than twice the current price of about $39.
Among the companies that the new pricing reports would help are Exco Resources Inc., Chesapeake Energy Corp., Pioneer Natural Resources Co. and Berry Petroleum Co., Pritchard Capital Partners said in a report today. Bern said the expanded definition of reserves also benefits national oil companies such as Petroleos de Venezuela SA and Petroleo Brasiliero SA, which also report on an SEC basis. Karen Matusic, a spokeswoman for the American Petroleum Institute, an industry group, declined to comment on the new rule, saying the group had yet to see the full text.
How Madoff Is Burning the SEC
A 1992 probe should have raised red flags when new tips came in about Madoff. Now critics question the agency's ability to act as a watchdog. Bernard L. Madoff operated on the edge for years. But an early encounter with the Securities & Exchange Commission (SEC) didn't raise red flags about the financier now accused of running a massive fraud. It's the type of missed opportunity that's further eroding investor confidence and prompting Congress to explore regulatory reforms. The SEC's interest in Madoff goes back to at least 1992. That year the federal watchdog sanctioned three small firms raising money exclusively for Madoff. After investigating a confidential tip that one of the money managers was promising annual returns of up to 20 percent, the SEC shut them all down for selling unregistered shares. (Under federal rules any firm that sells securities to a US investor must file certain documents first.)
Madoff, whose books were examined soon after by the SEC, was never sued by the regulator. But as part of a settlement, the firms, which neither admitted nor denied liability, had to repay investors. That forced Madoff to return the money they raised for him, some $454 million (€322 million). "Somehow, he got it done over a weekend," says a person familiar with the firms. It's not clear whether Madoff was already developing what authorities claim may be the biggest financial fraud ever—an alleged scam that collected money from new investors to pay off earlier ones. But that's just the sort of shenanigans regulators initially suspected they had uncovered in the 1992 probe: a Ponzi scheme perpetrated by the three firms. When investigators learned the money had been funneled to a Wall Street titan, Madoff, they became less concerned about outright fraud. After all, Madoff, a former chairman of the Nasdaq stock market, was a pioneer in electronic trading.
The Madoff connection "was a good thing" for the firms, says a person close to the SEC investigation. "Nothing improper was found (in Madoff's books)." In hindsight, the episode should have been remembered a decade later when regulators started receiving anonymous tips about potential improprieties at Madoff's operations; but the resulting inquiries yielded nothing significant. That they did not raises serious questions about the SEC's ability to combat and prevent fraud. "The commission doesn't seem to have pursued its enforcement mandate with enough vigor," says noted SEC historian Joel Seligman, president of the University of Rochester. Congress will hold hearings in January to discuss why the SEC failed to uncover the Madoff mess. Critics say the SEC doesn't have the manpower or the systems to provide the necessary oversight. "The SEC needs more staffing in both its enforcement and examination divisions," says Ron Geffner, a former SEC staff attorney, now a lawyer at Sadis & Goldberg. "It needs to enact a process in which recidivists are reviewed with greater scrutiny."
Madoff and the SEC declined to comment. The 1992 investigation centered on Avellino & Bienes, a tiny New York accounting firm run by Frank Avellino and Michael Bienes. According to court filings, the duo started raising money from clients, friends, and relatives 30 years earlier, handing the cash over to Madoff to invest. By 1984, Avellino and Bienes had ditched their accounting practice altogether to focus exclusively on finding investors for Madoff. Avellino and Bienes didn't return calls. The firm had its own "feeders," associates who rounded up cash that eventually made its way to Madoff. In 1989 accountants Steven Mendelow and Edward Glantz, whose office was on the same floor as Avellino & Bienes in a Manhattan office building, joined the game. According to the SEC's complaint, Mendelow and Glantz collected $89 million for Avellino & Bienes. Glantz's son Richard later started raising money as well. The party ended in 1992 when the SEC demanded in a settlement that the firms close up shop, reimburse $454 million to 3,200 investors, and pay a collective $875,000 fine. Edward Glantz has since passed away. Mendelow couldn't be reached.
Within a year or two of the SEC investigation, Madoff was accepting money from at least one player who didn't register shares with the SEC, according to a person familiar with the operation. In an effort to rebuild his investment practice after the probe, Madoff also dropped his minimum account size from $1 million to $50,000 for at least one feeder fund. As a result, less affluent investors gained entrée to Madoff's operation. That's one reason it's not just wealthy investors and institutions who are ensnared by the current scandal. Rather than viewing Madoff as a scofflaw, regulators called on him for his expertise. Edwin Nordlinger, an SEC staffer involved in the Avellino & Bienes investigation, recalls accompanying a new SEC commissioner on a visit in the late '90s with Madoff, who schooled the regulator on over-the-counter markets. Arthur Levitt, chairman of the SEC from 1993-2001, has said publicly he consulted with Madoff during his tenure. Says Nordlinger: "Madoff was considered an expert."
Which Airlines Will Disappear in 2009?
Yes, fuel prices are down, but so is passenger travel, so any new bankruptcies could prove fatal. The airline industry should be entering 2009 with a nice tailwind. Airlines spent most of the past year cutting routes, and employees and tacking on a welter of fees to counter record high fuel prices. Then they lucked out when the cost of jet fuel plunged by two-thirds as 2008 wound down. But operating expenses aren't the only thing that has dropped: Passenger traffic tumbled 10.6% in November, according to Boyd Group, an Evergreen (Colo.) consultant, prompting carriers to slash fares to fill empty seats. Now, with both business and leisure travel in North America expected to fall as much as 15% this year, the industry may face another round of bankruptcies. Unlike the last spate of failures in the mid-2000s, not every airline may survive. In previous downturns, carriers often used Chapter 11 as a reset button that let them emerge from bankruptcy even stronger by shedding debt and other obligations, such as pensions.
To play it safe, big carriers such as American Airlines and US Airways have raised fresh cash. But many airlines have hocked most of their assets, leaving them little to borrow against. "At this point, bankruptcy is liquidation," says Roger E. King, an airline analyst at institutional research firm CreditSights. For now, the International Air Transport Assn. expects North American carriers to eke out a $300 million profit in 2009 thanks to capacity cuts and the plunge in fuel costs. That would be a big turnaround from estimated losses of nearly $4 billion in 2008. But a sharp drop in passenger traffic could be enough to put some airlines under. In a Dec. 2 conference call with analysts, executives at General Electric's GE Capital, one of the world's largest lessors of aircraft, said its "base case" for 2009 calls for a 1% to 2% drop in global traffic, which could result in the liquidation of one major global carrier. If traffic dips 3% worldwide—the IATA expects a 3.6% falloff—a second major airline could liquidate, the GE executives warned. Some airline officials say that scenario isn't farfetched.
"You're going to see a massive amount of restructuring in the industry because it is ill-equipped for financial hardship," says Gary C. Kelly, CEO of Southwest Airlines. "The industry has very stretched balance sheets." The majority of Asian and European carriers should have the wherewithal to weather the recession, except for some startup carriers in India and Italy's state-owned airline, Alitalia, which filed for bankruptcy protection last August. While North American carriers are well ahead of their overseas rivals in pruning capacity, their balance sheets are much weaker. The U.S. industry is still dragging around $95 billion in debt, as much as the rest of the world's carriers combined. Industry experts say the biggest jolt could be felt by discount carriers like AirTran Airways and JetBlue Airways, which can't downsize as easily as big airlines can.
Two majors that could feel the squeeze are US Airways and Air Canada, which lost $1.7 billion and $244 million, respectively, in the first nine months of 2008. The collapse of fuel prices could make them profitable in 2009, but Vaughn Cordle, CEO of AirlineForecasts, an Arlington (Va.) research firm, says they could be in the red again if traffic plummets. US Airways' woes stem from its inability to integrate operations fully with those of America West Airlines, with which it merged in 2005. As a result, US Airways remains saddled with high costs. Cordle says its cost per average seat mile is still above 8¢ before fuel costs, vs. 6.8¢ for Delta Air Lines. And with much of its assets already pledged to creditors, the Tempe (Ariz.) carrier doesn't have much borrowing power left. US Airways says a $950 million refinancing in October helped boost its cash position by $370 million and notes that the new passenger fees are generating $400 million in high-margin revenues. Even if demand falls 10%, says US Airways President J. Scott Kirby, "this could be the most profitable year in the history of the industry."
Air Canada's wounds are somewhat self-inflicted. When the Montreal-based carrier reorganized under bankruptcy in 2004, it created a new parent, ACE Aviation Holdings, to oversee its operations. At the prodding of Cerberus Capital Management and other hedge funds that bought the stock during the bankruptcy, Air Canada spun off its maintenance unit, frequent-flier program, and a regional airline subsidiary to unlock the value of these assets. While ACE shareholders have seen their stakes rise 265% since 2004, some analysts fear the moves have stripped too much from Air Canada. Now the carrier must come up with $481 million in pension funds in 2009 and can't draw on the cash flow of those spun-off operations. Small wonder Air Canada's A shares have tumbled 87% in the past year, to around $1.30. A spokesman notes that credit markets have been supportive: In December the carrier got $330 million in loans from GE Capital and two banks. If Air Canada were to hit the skids, analysts believe a big European carrier would swoop in to buy at least some of its assets. In the U.S., however, foreign carriers are barred from taking majority ownership of an airline. That means U.S. carriers can only hope oil prices stay low—and passengers return.
Fed aims to buy $500 billion in MBS by mid-year
The U.S. Federal Reserve on Tuesday moved forward aggressively with an effort to drive down mortgage costs, setting a goal of buying $500 billion in mortgage-backed securities by mid-2009. The central bank said it would start buying the securities in early January under a program announced last month. When it announced the program, mortgage rates dropped in anticipation of the purchases. Still, some analysts on Tuesday expressed surprise with how vigorously the Fed was pledging to act and the news propped up prices for MBS in very thin trade.
"When they are buying along the lines of $80 billion to $100 billion a month, if they're going to do it in six months, they have to buy everything they can get their hands on," said Kevin Cavin, a mortgage strategist at FTN Financial in Chicago. "It will push up prices and tighten spreads and push down primary mortgage rates," he said. The Fed selected investment managers BlackRock, Goldman Sachs Asset Management, PIMCO, and Wellington Management to implement the programme. The mortgage-buying program is part of a sustained government effort to help the United States withstand a severe credit crunch and deep housing downturn that have tipped the economy into recession and damaged activity around the globe.
Earlier this month, the Fed cut benchmark U.S. interest rates close to zero and signalled that it was turning more heavily to unconventional measures to spur the economy. On Tuesday, it said it would increase the money supply to make the MBS purchases, effectively easing monetary policy further. The program only covers securities issued by government-sponsored mortgage enterprises Fannie Mae and Freddie Mac and government loan financer Ginnie Mae. When it announced the programme on November 25, the Fed also said it would buy up to $100 billion in debt issued by Fannie Mae, Freddie Mac and the Federal Home Loan Banks, and after its meeting on interest rates on December 15-16 it said it could press even more heavily into mortgage markets.
"The goal of the programme is to provide support to mortgage and housing markets and to foster improved conditions in the financial markets generally," the Fed said in a statement on Tuesday. The central bank said it would adjust the pace of its purchases based on changing market conditions and the impact of the programme. The initiative is aimed at reducing the cost of credit and increasing its availability, which authorities hope will support housing markets and foster improved financial conditions generally. Investment managers are needed because of the size and complexity of the program, the Fed said. Investor appetite for debt issued by Fannie Mae and Freddie Mac had dried up since the government seized control of both companies in September.
Fed Selects Four Firms to Manage MBS Purchase Plan
The Federal Reserve chose BlackRock Inc., Goldman Sachs Asset Management, Pacific Investment Management Co. and Wellington Management Co. to manage a $500 billion purchase of mortgage-backed securities it plans to complete by June. "They picked the crème de la creme of the money managers," said Art Frank, head of mortgage-bond research at Deutsche Bank AG in New York. "By doing $500 billion by June, no question they’re doing their best to try to hold down mortgage rates."
The collapse of U.S. mortgage finance last year led to the worst credit crisis in seven decades and triggered write downs and losses at financial institutions exceeding $1 trillion. The central bank has expanded credit by $1.3 trillion over the past year through programs extending liquidity to banks, bond dealers and other financial institutions. The Fed plans to create money to purchase the bonds, boosting bank reserves. Only fixed-rate agency mortgage-backed securities guaranteed by Fannie Mae, Freddie Mac and Ginnie Mae will be eligible for purchase, the central bank said in a statement released in Washington today. The purchases, to start early in January, will include securities with maturities of 30, 20, and 15 years, and will exclude riskier securities such as interest- only bonds, the Fed said.
The Fed’s program is intended to lower rates by reducing the supply of outstanding agency mortgage bonds, boosting their prices and thus lowering their yields. Lower yields in turn reduce the interest rates banks need to charge on new mortgages to ensure profitable sales of the securities. "It looks like they’re really going to ramp this up and it’s going to be done very quickly," said Credit Suisse analyst Mahesh Swaminathan. Thirty-year mortgage rates could fall to an average 4.75 percent, he said, and "this is going to take it down sooner rather than later."
The average rate on a typical U.S. fixed-rate mortgage fell to 5.22 percent early yesterday, the lowest since 2005, from as high as 6.46 percent in October, according to Bankrate.com data. The Treasury also bought $49.7 billion of the companies’ home- loan securities from September through last month. "The investment managers will be required to purchase securities frequently and to disclose the Federal Reserve as principal," the central bank said. "Each investment manager will be required to implement ethical walls that appropriately segregate the investment management team" that implements the Fed’s purchases from advisory and proprietary trading teams, the Fed said.
The central bank said risk on the securities would be "minimal" and "mitigated by the conservative, buy-and-hold investment strategy" of the program. Fed officials announced the program Nov. 25 and said the action was taken to "reduce the cost and increase the availability of credit for the purchase of houses." The government hasn’t stemmed the decline in housing even after channeling $172 billion in new capital to banks. The Fed has provided $535 billion in loans to banks as of Dec. 24. Slumping sales and tight credit helped push home prices in 20 major U.S. cities a record 18 percent lower in the 12 months to October, according to the S&P/Case-Shiller index released today.
How will history view the year 2008?
Will this year be remembered as the year of the credit crisis or the brief panic? What were you doing on September 15? "No idea" is the likely reply. That question is only easy to answer for a few memorable dates, like 9/11. And older people will remember what they were doing when the first man set foot on the moon. Or when president John Kennedy was assassinated in Dallas. It was on 15 September 2008 that the global investment bank Lehman Brothers was declared bankrupt. The rumble in the distance suddenly changed from one moment to the next into a raging storm on the doorstep. The US undertook the greatest nationalisation in its history, various countries followed suit, and next year the west can definitely expect a recession of unique magnitude - certainly since the last World War. But to remember the fifteenth of September, something is lacking: physical, visible drama. History will supply the background in time.
The British tabloids successfully spread the story of the suicides in New York around the world in the months after the 1929 stock market crash; boring files of bankruptcy cases would not have communicated the feeling of panic and human suffering. The suicide stories were not accurate, but they were gripping and tangible. Now we are not only lacking an image to engrave on our memories, but also a term, a label. There is talk of the ‘credit crisis’, a rather dull and ordinary name for what happened. Most likely, we shall have to wait until we can better envisage what happened and understand the consequences before we can label it. The name of the Great Depression was also invented later. What are we witnessing now? Economists are talking about a period of excessively low interest, which lasted too long. Cheap money opened the way for huge debts and financial innovations that hid the normal banking risks. Governments withdrew from supervision, and an ideologically tinted faith in the free market allowed the system to spin out of control without any alarms going off. And then the construction collapsed. Economists are being heavily criticised.
As the Boston Globe wrote reprovingly in its Christmas issue: "An entire field of experts dedicated to studying the behavior of markets failed to anticipate what may prove to be the biggest economic collapse of our lifetime." The irritation is understandable, but not entirely fair. Over the past few decades, leading economists popped up more and more as the true interpreters of society. But society came to consider them more than behavioural scientists but rather as universal visionaries. Almost a year ago at the World Economic Forum in Davos, the well-known speculator, philanthropist and political commentator George Soros said that something else was going on alongside too much credit and too low interest rates. It was the manifestation of a radical rearrangement of the world economy, "with the relative decline of the US and the rise of China and other developing countries."
This seems plausible. The credit crisis is not so much the result of far too many debts and far too much money being lent out, but of adjusting too late to a changing world. America with all its debts did not solve the problem of China – the surpluses – but denied its own problem, being unable to tighten its belt. The credit crisis is in this interpretation only the symptom, not the cause. How shall we look back on 2008? That depends on how this crisis ends. The rapidly expanding state support for entire branches of industry will lead sooner or later to protectionism and political tension. Western governments are taking the correct measures at the moment – at least, for those who have learned from the lessons of the Great Depression. But because the lessons are only being learned now, no one can foresee what the consequences will be: an interest rate of practically zero and keep printing dollars - the latest proposal - could produce miracles, but could also end badly. Perhaps countries like China and Germany will become so insecure that they may search for the safe option and not play the game properly. This is difficult to work out or to manipulate in models. And economists who try to do so are no longer believed. In other words, no one knows how 2008 will be remembered. Will it be the Great Shift, the Hard Landing? Or just the credit crisis, the Brief Panic.
Ilargi: Uh, yeah, if you just ignore the ones who get it right all the time, you can say all forecasters got it wrong. Simply as pie.
2008 was the year forecasters got it all wrong
Oil to soar to $200 US a barrel. This is a good time to buy stocks. A lot of things economic took a battering in 2008 -- from stock markets to autos to consumer confidence -- but the list wouldn't be complete without adding the pride of professional economic forecasters. With commodities soaring in the first half of the year and plunging in the second, Wall Street financial giants collapsing, the Detroit Three teetering and the world heading into recession -- all surprises -- 2008 may be remembered as the year nobody got right. "I would say this has been the most difficult (to forecast) of the last 10 years at least,'' says Dale Orr of IHS Global Insight, perhaps Canada's leading forecasting firm. "It's partly because we haven't seen anything quite like the U.S. financial turmoil before.''
To be fair, the past year has been anything but typical. The year began with a bang in Canada with the creation of over 46,000 jobs in January and commodity prices continuing their upward ascent to stratospheric levels. When CIBC chief economist Jeff Rubin made his prediction of $200-a-barrel oil in April, oil was on its way to a record high $147 US and the forecast of $200 US by 2012 seemed a gross undershoot. Not so much now with oil struggling to remain above $40, although he has time on his side. Perhaps even Prime Minister Stephen Harper, an economist himself, can be excused for thinking on Oct. 7 that having lost one-third its value in a mere few months, the Toronto Stock Exchange was a good place to hunt for bargains. If Canadians had heeded his advice, however, they'd likely be 13 per cent poorer now. Rubin and Harper are in good company.
With few exceptions -- including former Bank of Canada deputy governor Bill White and Harvard University's Ken Rogoff -- the vast majority of economists saw 2008 as a bumpy year, but not the catastrophe it has turned out to be. Coming off a modest 2.7 per cent growth in real gross domestic product in 2007, Global Insight had projected this year's GDP increase would be 2.4 per cent, about the middle of most major forecasts. The Bank of Montreal was slightly more pessimistic at 2.2 per cent, and TD Bank was decidedly gloomy at 1.9 per cent. The Conference Board saw the economy actually improving in 2008 to 2.8 per cent growth. The Bank of Canada was more prescient with a 1.8 per cent growth figure, but it had the benefit of a few more weeks of real data to look at before it made its call on Jan. 24. In actual fact, the economy is likely to grow by a mere 0.6 or 0.7 per cent this year when all the numbers are in.
The downside miss is the worst for Global Insight since it began issuing its Canadian forecasts in 1993. Those few who saw the U.S. bottom falling off "look like geniuses now,'' admits Glen Hodgson, chief economist with the Conference Board. The economic models just couldn't account for what happened, he said. "We've seen periods where interests rates were very high, but we've never seen a situation where people went to the bank and were told, 'I'm sorry, your credit line is no longer available,"' he explains. "Never before have we seen the Big Three all cancel leasing. This was a totally new shock.'' Another logic-defying event was the behaviour of commodity prices, particularly oil soaring to $147 US in July, then collapsing as quickly as it rose. Critics would argue that economists are paid to predict surprises, and in a sense they do. Along with their base projections -- the ones that are published -- many economists also project worst-case scenarios and these were closer to the mark.
TD Bank chief economist Don Drummond says his bank has been predicting trouble from America's artificial housing market for the past three years and had underestimated growth the two previous years when the subprime collapse did not occur. In 2008, the surprise was that when the reckoning came, it was quick and hard. "We've had the same story back to 2005, that U.S. housing would pull back and create a pullback in U.S. consumption . . . and that would pull down commodity prices, but we certainly messed up on the lag,'' he said. Economists shouldn't be viewed as seers, adds Douglas Porter of BMO Capital Markets. While the U.S. and Canadian economies were coming in weaker through most of the year, it was the mid-September failure of Lehman Brothers -- or rather the fact the investment firm was not rescued like others had been -- that really sent stock markets plummeting and once again froze up credit markets.
"I would love to be able to go back and see how (the forecasts) would have turned out if the U.S. had not let Lehman Brothers go under,'' Porter wondered. Another problem with forecasting, says Orr, is that economists use models based on predictable, historic effects, such as the downward impact on housing starts if interest rates rise. But that depends on the historic relationships remaining somewhat predictable. When surprises happen, the models sometime break down. "We always go wrong at the turning points, we're slow at forecasting recession and the same thing on the upside, we will under forecast strong growth,'' Orr says.
That's why economics is often called the "dismal science,'' he adds, or something worse.
Money flows out of hedge funds at record rate
Investors pulled a net $32bn from hedge funds last month, making 2008 the first year in their recorded history that the funds have had significant outflows and ending the industry’s 18 years of asset growth. Money has been taken out of funds following every strategy, even those – such as macro funds – which were showing returns, according to data from fund trackers Hedge Fund Research. The funds enjoyed net inflows for the first part of the year, even as the financial crisis hit and traditional mutual funds began to show outflows. However, in September a tide of redemptions began, according to TrimTabs, another fund tracker.
Conrad Gann, chief operating officer of TrimTabs, said: “We estimate outflows in November were $32bn, and there is an additional pipeline of redemptions that have not been filled, there could be $80bn [of redemptions] in December. “There are $57bn of redemptions that we know are in, that are not reflected yet,” he said. Mr Gann said it was difficult to estimate outflows for coming months because hedge funds had different redemption cycles. In recent months funds have also tried to halt outflows by limiting or suspending investor withdrawals. This means that data on outflows, which reflect actual repayments to investors, understates the true picture. Some funds, such as Chicago-based Grosvenor Capital, have split their assets into liquid and non-liquid baskets, which has made it harder for investors to get their money back immediately.
This is the first year since at least 1990 that hedge funds have seen a drop in assets. The combination of performance losses and investor redemptions pushed industry assets down by $500m during the year, to $1,500bn at the end of October, according to HFR. Hedge funds lost an average of 19 per cent in the 11 months to the end of November, it said. That loss easily eclipses the 1.5 per cent lost in 2002, the only previous annual loss since records began in 1990. In the 11 months to November, Standard & Poor’s 500 index lost 37 per cent. The funds had outflows of $43bn for the 10 months to the end of October, according to HFR. With TrimTabs’ estimate of further significant redemptions for November and December, the funds will show outflows of more than $100bn for the full year. In 1994, the only previous time they had outflows, the figure was $1m.
GMAC Rescue a Poor Roadmap
There were plenty of poorly handled bailouts in 2008, but the GMAC rescue might go down as the year's most haphazard. Any time the government intervenes in a private company, the wider market benefits if it can be done in a clear and consistent manner. Once the government's guiding principles for rescues can be more easily discerned, investors find it easier to factor potential government action into prices for other institutions that might need help. After weeks of doubt about its viability GMAC, majority-owned by Cerberus Capital Management, appears temporarily stabilized. It received a $5 billion preference-share investment from the Treasury. But lifting the cloud hanging over GMAC has created others elsewhere.The Federal Reserve's actions regarding GMAC have been particularly hard to follow. GMAC originally planned to take actions that would raise capital to a level sufficient to get the Fed's approval for it to become a bank-holding company. The main initiative was to ask bondholders to swap some of their debt for new paper, including preferred shares. However, GMAC had to extend the exchange deadline several times. On Dec. 10, GMAC said participation in the debt exchange fell short of the targeted 75% and it wouldn't be able to raise the $30 billion in regulatory capital required by the Fed.
Ominously, GMAC added: "The Federal Reserve has informed GMAC that if GMAC is unable to meet these capital requirements, it will not approve GMAC's application to become a bank-holding company." GMAC still hasn't publicized the final results of the debt exchange, which closed on Dec. 26. But the Fed went ahead and granted bank-holding-company status anyway on Dec. 24. One reason the Fed gave for doing this was "successful efforts of management of GMAC to raise capital." The central bank gave no numbers showing what the level of GMAC's capital actually is.
Another unfortunate result of that GMAC scramble is the apparent formation of two classes of bondholders. There are those who took part in the exchange and made concessions. And there are those who didn't participate -- perhaps expecting the government to cave -- who appear to have avoided any pain for now. As a result, bondholders facing similar situations in the future might feel emboldened to hold out and make the taxpayer cough up instead. Clearly, one important factor behind these events was the decision by the Bush administration to bail out General Motors and Chrysler on Dec. 19. Since GMAC finances a large share of GM's sales, it made sense for bondholders to bet on a GMAC rescue following soon after.
The GMAC bailout also raises the thorny question about whether such moves can lead the government to influence management in a way that might serve political ends -- but also hurt the business over the long term. For example, Tuesday, the day after getting TARP money, GMAC said it was going to start lending again to less-creditworthy borrowers. The company says it is doing that because it has expanded access to funding as a bank. Some might suggest the influence of a government keen to expand credit provision in the economy. If the incoming Obama administration is looking for bailout templates, the GMAC example is one to avoid.
GMAC's $6 billion deal shows why automakers need to head for Chapter 11
The US automaker bailout is skidding down a slippery slope. To rescue General Motors, the Treasury has now ponied up $6bn to prop up its finance affiliate, GMAC. But for GMAC to crank up its lending, the Fed may have to take a liberal view of its capital levels. There are other disquieting signs the Treasury and Fed are not totally in accord, which may further damage their credibility. The Fed imposed tough conditions on GMAC last week when it approved its application to become a bank holding company, giving it access to oodles of government lending facilities. It required the company to scrape together about $30bn of equity in order to be "well capitalised" and to cut Cerberus’s and GM’s ownership stakes sharply over time.
But the Treasury seems to be pushing in the opposite direction - $1bn of the funds it has siphoned from the Troubled Asset Relief Programme has been lent to GM so that the carmaker can participate in an upcoming rights offering by GMAC. That will actually increase GM's stake. Of course, there are several reasons the Treasury may have taken this route. The government is already purchasing $5bn of preferred stock and warrants with the balance of the funds; by lending to GM rather than buying GMAC common stock directly, it gets a higher position in the pecking order if the automaker goes bankrupt. More worrying is the possibility that this $6bn is the first of many trips to the well.
After all, GMAC is still losing money - it has haemorrhaged almost $7.5bn since the start of 2007 - and isn’t overflowing with capital. It had $9bn at the end of September, is raising $2bn from shareholders – including the rights offering – and now has the $5bn in Tarp money. It just concluded a debt for debt-and-preferred exchange offer, the deadline for which it had to extend several times. It says enough bondholders swapped their debt for it to meet the Fed’s capital requirement, but that doesn’t leave it with a huge amount of excess cash to leverage into new loans, or act as a buffer against future losses. If GMAC’s woes end up threatening to pull the US taxpayer ever-deeper into Detroit’s mire, it’s just one more reason the government should stand firm come March and force the automakers to restructure under the auspices of Chapter 11.
GM Aims To Drive Sales With Incentives
No longer teetering on the brink of bankruptcy, General Motors is tackling its next financial challenge: convincing people to buy cars again. GM's financing arm, GMAC, detailed plans to increase lending to a broader range of car buyers yesterday, just hours after the Treasury Department said it would invest $6 billion to stabilize the troubled company. Meanwhile, the automaker announced that it would offer financing as low as zero percent for up to five years on select new cars and trucks in a year-end push to lift sales. Some vehicles will have cash rebates of as much as $4,250.
The announcements come as GM attempts to battle a severe slump in sales. That slump -- sales dropped by 41 percent in November -- has been blamed on a host of factors, including the country's economic downturn and consumer fears about buying brands that the ailing U.S. automakers might soon be forced to eliminate. Consumers interested in buying cars often have had difficulty obtaining necessary loans because of the credit crunch.
Yesterday, GMAC said it would try to make those purchases easier by offering financing to customers with credit scores above 620, ending a policy announced in October of lending only to customers with credit scores above 700. The change expands eligibility for GMAC loans from about 60 percent of the adult population to about 80 percent, based on the distribution of credit scores. The announcement also marked an attempt by GMAC to demonstrate that the investment from the government would help the broader economy. Other recipients of government investments, mostly banks, have declined to provide such detailed accounts of how they would increase lending.
"The actions of the federal government to support GMAC are having an immediate and meaningful effect on our ability to provide credit to automotive customers," GMAC President Bill Muir said in a statement. As the economy improves, GM said in a separate statement, the company would consider returning to the leasing business. Automakers have scaled back their leasing programs because the practice became too expensive, thanks to the plummeting resale value of gas-guzzling trucks and sport-utility vehicles. GM stock jumped about 6 percent to close at $3.80 yesterday.
"Little things like this help," said Michael Martin, owner of two Virginia dealerships and a board member of the National Automobile Dealers Association. "I'm not saying this will be fixed overnight, but this is a step forward for us." Indeed, the automaker still faces a host of challenges. In accepting as much as $13.4 billion in emergency aid from the government earlier this month, GM agreed to undertake what could prove to be a painful corporate restructuring. Plus, the market for automobiles is expected to remain tough. Many analysts say consumers won't be buying vehicles at normal levels until 2010.
Chrysler, the other recipient of the Treasury Department's bailout, has concentrated on saving its cash. Yesterday, the company said it had canceled its annual reward meeting for top dealers for the first time in decades. The meeting had included an all-expenses paid trip to Mexico in March. "It was a decision made by the dealer council and our leadership together in fall," said Chrysler spokesman Stuart Schorr. "Based on a shared recognition of the difficult market conditions and challenges the company faces, both sides thought it was prudent not to have the meeting." Ford, which currently is financially stable without federal aid, unveiled technology yesterday that can parallel-park Lincoln MKS sedans and crossovers with the touch of a button -- without a driver touching the steering wheel.
GM, GMAC ease lending rules to entice car buyers
General Motors Corp and its GMAC funding affiliate launched programs on Tuesday to lure U.S. car and truck buyers back into showrooms, as the nation's largest automaker tries to revive its sagging fortunes. GMAC modified its credit criteria so that it could lend to a wider range of potential customers, two-and-a-half months after significantly curbing lending. Meanwhile, GM is offering zero-percent financing on several vehicles, and rates no higher than 5.9 percent on more than three dozen 2008 and 2009 models. The offer expires on January 5. Many eligible vehicles also carry cash discounts of $500 to $4,250.
The changes came a day after the U.S. Treasury Department agreed to take a $5 billion stake in GMAC, and lend GM as much as $1 billion to support GMAC, in an effort to help ensure that both survive. "The bottom line is much better access to funding," said Mark LaNeve, GM's vice president for North American sales, on a conference call with reporters. GMAC will now extend loans to retail customers with credit scores of 621 or higher, eliminating a restriction that required a score of 700. Many analysts consider borrowers with a credit score of 620 or lower to be "subprime." The median U.S. credit score is 723, according to Fair Isaac Corp's myFICO unit.
GMAC has traditionally provided the bulk of financing for GM retail customers, and also financing that dealers rely on to carry vehicle inventory. But it has struggled under the weight of $7.9 billion of losses in the 15 months ending September 30, largely tied to soured mortgages in its Residential Capital LLC unit. Sales at GM had plunged 41 percent in November in part because many customers could not obtain financing from GMAC. LaNeve said GMAC may now be able to fund 75 to 80 percent of new GM vehicle purchases, up from 40 percent since October. The Treasury Department agreed to buy $5 billion of senior preferred equity in GMAC. It is lending GM up to $1 billion to let the automaker take part in a rights offering to support GMAC's reorganization as a bank holding company, which won Federal Reserve approval on December 24.
GMAC is owned by GM and private equity firm Cerberus Capital Management LP. The government financing will result in both reducing their ownership stakes. GMAC is the latest non-bank financial company to qualify for help under the Treasury Department's $700 billion Troubled Asset Relief Program. Unlike many lenders that received TARP funds, GMAC said it will use its money to provide affordable credit to consumers. The $6 billion of financing is in addition to a potential $17.4 billion that the government committed on December 19 to help GM and smaller rival Chrysler LLC avoid possible bankruptcy. Cerberus also owns a majority of Chrysler.
"Federal aid to GMAC suggests the government is probably now so financially entangled in the GM complex that a Chapter 7 liquidation of (GM's auto operations) seems highly unlikely," JPMorgan analyst Himanshu Patel wrote. GM's zero-percent financing is limited to buyers of the slow-selling sport-utility vehicles Chevrolet TrailBlazer and GMC Envoy, and three Saab models. Rivals such as Toyota Motor Corp and Nissan Motor Co have offered similar financing on some vehicles. LaNeve said GM's December sales were up "considerably" from November, and that the automaker might return to auto leasing, credited with supporting sales industrywide from 2000 until about 2006.
U.S. auto sales have plunged to 25-year lows. Analysts do not expect them to recover substantially before 2010. GM shares rose 20 cents or 5.6 percent to close at $3.80 on the New York Stock Exchange on Tuesday. The cost of insuring $10 million of GMAC debt against default for five years fell to $1.4 million upfront plus $500,000 annually, according to Phoenix Partners Group, compared with $2.15 million upfront on Monday. Credit default swaps for Ford Motor Co's finance arm also declined. GM's deeply distressed 8.375 percent bonds maturing in 2033 rose 1.8 cents on the dollar to 16.8 cents, yielding 49.9 percent to maturity, according to bond pricing service Trace.
Bailout Trims Cerberus's GMAC Stake
The government bailouts of GMAC LLC and Chrysler LLC represent a dramatic, and perhaps ironic, turn of events for Cerberus Capital Management. The private-equity firm's boss, Stephen Feinberg, had pitched his firm's investments in the struggling companies partly as a patriotic duty. Now it is the U.S. government coming to Cerberus's aid, and Cerberus will essentially lose control of GMAC in the process. Cerberus and dozens of co-investors paid $7.4 billion in 2006 for a 51% stake in GMAC. The stake became one of the New York firm's biggest headaches, and Cerberus could have suffered a huge loss and damage to its reputation had the Treasury Department not committed $6 billion to stabilize GMAC. The Treasury's $5 billion preferred stake will pay an 8% dividend, putting the government in line ahead of Cerberus's common-equity holdings.
Cerberus and General Motors Corp. are contributing $2 billion of new equity to GMAC, suggesting that the value of existing equity stakes in the lender will be diluted. The Treasury Department will loan $1 billion to GM, but not Cerberus, to pay for the new GMAC equity. To avoid being classified as a bank holding company, which would put Cerberus under direct government supervision, the private-equity firm will reduce its ownership to no more than 14.9% in voting shares and 33% of total equity. Cerberus plans to distribute pieces of its current GMAC stake directly to the co-investors.
Cerberus also will stop providing consulting services to GMAC, and the two companies no longer will share executives. And GMAC will reconstitute its board, reducing the number of members affiliated with GM and Cerberus and adding a government-appointed member. Another complication for GMAC is that Chairman J. Ezra Merkin's Ascot Partners fund invested $1.8 billion with Bernard Madoff, who has been accused of running a $50 billion Ponzi scheme. Mr. Merkin is a longtime partner of Cerberus and a friend of Mr. Feinberg. Mr. Merkin's lawyer didn't respond to requests for comment. A GMAC spokeswoman declined to comment.
GMAC and Chrysler, of which Cerberus is the majority owner, aren't the private-equity firm's only troubled investments. Earlier this month, the firm suspended withdrawal requests from investors after suffering sizable losses in October and November from a wrong-way bet on the fixed-income markets. The firm's flagship $4 billion fund was down 15.8% as of Nov. 30. Cerberus spent $5.7 million on lobbying through Sept. 30, according to the Center for Responsive Politics. Of that total, $4.7 million was on behalf of Chrysler. Last year, Cerberus spent roughly $3 million on lobbying.
For GMAC, ResCap, a Merry Christmas; But a Happy New Year?
GMAC Financial Services announced the day before Christmas that its application to become a bank holding company had been approved by the Federal Reserve. GMAC Bank also said it had received approval from the Utah Department of Financial Institutions to convert to a state bank. "As a bank holding company, GMAC will have expanded opportunities for funding and access to capital, which will provide increased flexibility and stability," the company said in a press release. "Today’s announcement marks a key turning point in GMAC’s history," said GMAC CEO Alvaro de Molina. "As a bank holding company, GMAC will be competitively positioned for the long-term to provide financing to auto and mortgage consumers and businesses such as automotive dealers."
GMAC’s previously announced separate private debt exchange offers and cash tender offers were subject to the approval of the bank holding company application. The offers expired Friday at 11:59 p.m. EST, and GMAC has made no announcement whether the final stipulation of the approval had been completed. General Motors Corp. (GM: 3.80 0.00%) shares spiked 19 percent to $3.87 early Friday after the announcement earlier in the week. If finalized, the transition to a bank holding company will also open the door for GMAC to the U.S. Treasury Department’s TARP funds, the first leg of which was depleted by Treasury secretary Henry Paulson’s hefty Christmas gift to failing automakers GM and Chrysler Holding LLC–little stocking stuffers to the tunes of $9.4 billion and $4 billion, respectively. Talk of an additional $4 billion injection into GM suggests Paulson will have to go to Congress to plead the case for the release of the last $350 billion installment of TARP funds.
"While the purpose of [the TARP] and the enabling legislation is to stabilize our financial sector, the authority allows us to take this action," Paulson said of the automaker bailout. "Absent Congressional action, no other authorities existed to stave off a disorderly bankruptcy of one or more auto companies." It has been said by various lawmakers including House speaker Nancy Pelosi, D-Calif., House Financial Services Committee chairman Barney Frank, D-Mass. and Federal Deposit Insurance Corp. chairwoman Sheila Bair that additional TARP funds should not be granted without some sort of result for struggling homeowners. It is unclear now whether an injection into the GMAC bank holding company–and its mortgage finance business Residential Capital LLC–will be considered sufficient aid for homeowners.
Bankruptcy had appeared on the horizon for GMAC and its giant mortgage lending arm ResCap in recent weeks as investors had thus far balked at a $38 billion debt exchange needed to raise sufficient capital for the ailing financial giant to become a federally-chartered bank holding company. Analysts at Moody’s Investors Services have surmised that ResCap’s future is likely in doubt, regardless of GMAC’s access to TARP funding by becoming a bank holding company.
GMAC Says ResCap Will Continue to Originate Mortgages
GMAC LLC’s mortgage-lending unit will continue to make home loans after the company receives a promised $6 billion federal bailout. "We will continue to originate mortgage products that can move in the secondary market," GMAC spokeswoman Gina Proia said in an e-mail, referring to a lender’s ability to sell loans to securities investors. "We are in a more stable position to conduct servicing operations." Residential Capital LLC, GMAC’s home loan unit, wrote $46.3 billion in mortgages in the first nine months of 2008, making it the seventh-largest U.S. mortgage lender, according to Guy Cecala, publisher of Bethesda, Maryland-based Inside Mortgage Finance. ResCap is also the sixth-largest among U.S. mortgage servicers, which collect monthly payments from borrowers.
GMAC, the Detroit-based lender owned by General Motors Corp. and Cerberus Capital Management LLC, ran short of cash after losing $7.9 billion over five quarters, mostly from defaults on subprime mortgages originated by ResCap. GMAC applied to become a bank holding company so it could gain access to the Treasury Department’s Troubled Asset Relief Program. Subprime mortgages were available to borrowers with bad or incomplete credit histories. ResCap isn’t making new subprime mortgage loans, Proia said. The $6 billion in federal funding for GMAC is in addition to the $13.4 billion that the Treasury Department agreed earlier this month to lend to GM and Chrysler LLC, also a unit of Cerberus, a New York-based buyout firm.
"The auto side of the business is getting all the attention," Cecala said. "Their mortgage lending has been flying under the radar and they are probably happier that way. The strategy got them a government rescue." More than 100 mortgage companies have closed, been bought or suspended operations since the beginning of 2007, including Countrywide Financial Corp., the biggest U.S. mortgage lender last year. "My question is this: if Countrywide had stayed around till now, would we be bailing it out?" said Joseph Mason, a securities professor at Louisiana State University in Baton Rouge who previously worked at the Treasury’s Office of the Comptroller of the Currency. "This is where we give back-door access to Treasury funds for private equity firms" such as Cerberus.
Reviving GM has become a priority for U.S. policy makers because of concern that a bankruptcy would deepen the year-old recession by putting millions of people out of work. ResCap’s $1.2 billion of 6.375 percent notes due in June 2010 rose 0.5 cents on the dollar to 20.5 cents at 4 p.m. New York time, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. The debt yields 164 percent. U.S. Representative Scott Garrett, a New Jersey Republican, criticized the timing of the bailout, which was announced at 8:24 p.m. New York time yesterday. "It’s par for the course for this administration, doing this in the dead of night," Garrett said. "It’s not good, nor is it acceptable that they aren’t more forthcoming with the media or members of Congress about specifics on exactly what they’re doing."
UK house prices will not be leaping ahead for many years to come
2009 will bring more price falls and less lending, writes Economics editor Edmund Conway. The year that is now drawing to a close ought to have been the easiest 12 months to predict for the property market in a long time. By late 2007 the market was already starting to slide. In the US, prices were plunging at the fastest rate on record – showing that even in less overvalued markets property values could suddenly fall. The securitisation market had seized up, removing the very foundations from the mortgage market and stifling the availability of finance even for those with decent credit records. Northern Rock, once the UK's most active mortgage lender, had effectively collapsed, removing another support for lending. In hindsight, it is hardly surprising that by November 2008 the annual rate of house price inflation had dropped to –14pc, worse even than during the last housing crash in the early 1990s.
However, this time last year, the vast majority of housing economists were predicting that prices would, at worst, fall by only 5pc or so in 2008. The moral of the story is that, as Mervyn King the Governor of the Bank of England has repeatedly warned, house prices are near impossible to predict. That said, there are some relatively safe predictions one can make about the coming year. The main one is that prices will continue to fall at a fair whip for the majority of the year. Of all the investment markets, the slowest to react to any kind of measures – whether it be changes in interest rates or other more radical schemes to either support or dampen prices – is housing. So while there is a chance buyers could return to the market and start propping up prices, this is very unlikely to happen before the end of the year. Indeed, John Varley, the chief executive of Barclays, has predicted that house prices will fall by about 15pc again next year, taking their total top-to-bottom fall to 30pc. Standard & Poor's said that with houses in the UK still overvalued, prices will have to fall by a further 20pc, taking the total decline to almost 35pc.
Both of these predictions, which are increasingly looking like middle-of-the-road assessments, chime with the warning from Bank policy-maker David Blanchflower, who said earlier this year that house prices could lose as much of a third of their value. Others, including the Council of Mortgage Lenders (CML), one of the chief institutions which produced bizarrely optimistic house price forecasts for 2008, have now effectively thrown in the towel and abandoned making firm house price predictions this year. Whether this is because of their lack of confidence about their forecasts or their embarrassment about the state of the market is another question. The property market's problem is twofold. On the one hand, the economy is sliding with such violence into a recession that consumers are extremely reluctant to spend. The rise in unemployment is also increasing the number of households being forced to "panic sell" as they lose their jobs and cannot meet their mortgage commitments. Add to this the fact that house prices were already notoriously overvalued, and there is no surprise that the demand side of the housing equation has simply dropped off the radar.
Against such a backdrop it is hardly surprising that the CML expects that next year's net mortgage lending will drop into negative territory for the first time. But while many may think it good news that Britain's vastly over-indebted public is, en masse, paying back more than they take out in home loans, the dive in activity is worrying. There is no doubt that Britons need to cut the amount they owe. However, the key question revolves around the speed with which they do this. A sharp correction in mortgage lending activity would have a dismal effect on the financial system and broader economy, causing a chain reaction of further losses and redundancies and possibly ensuring that Britain suffers recession. The issue is that not only is the mortgage market seeing a sudden dip in the appetite from prospective homebuyers, but it also has its own ingrained problems which are disrupting supply. As Sir James Crosby's report on mortgages showed earlier this year, the collapse of the securitisation markets has left banks facing serious – and potentially fatal – holes in their balance sheets.
Their consequent reluctance to lend has manifested itself in higher mortgage rates and fees, meaning that even those with money to spend on property bargains have been deflected from doing so. Rarely before has the housing market had to suffer such a dramatic fall in both supply and demand. The first six months of the year are likely to see demand slide further as unemployment rises. However, there is some chance that the supply of mortgages improves during that period. Having cut borrowing costs to 2pc, the Bank of England looks likely to reduce rates even further in the first few months of the year, possibly taking them to near zero. The effect will be to make mortgages cheaper than they have been for many years – even if, as seems likely, they are offered at a premium to the base rate. Much depends, however, on whether the lenders make good on their promise to increase the availability of mortgages to borrowers. When Royal Bank of Scotland, HBOS and Lloyds TSB accepted an infusion of public cash in October, they agreed to increase the availability of mortgages to 2007 levels, but neither the banks nor the Government have elaborated on what this will mean for the mortgage market.
Indeed, mortgage availability, at least in terms of the number of products on offer and their cost, has deteriorated since. As a result, the Government is mulling new, more dramatic plans to boost lending, including entering the market itself. To say the fate of the housing market in 2009 depends on the success of these measures is not quite right. Indeed, even if they are more successful than even the optimists believe, the likelihood of a further 10pc or greater fall in prices in 2009 is already "baked into the cake". However, the prospects for the property market thereafter remain in the balance. If the Government can successfully increase mortgage availability, while near-zero interest rates encourage more homebuyer demand, it could mean a return to a rather more healthy – if not booming – housing market by 2010. Be warned, however, that prices are not likely to start leaping ahead for many years after that.
Britain braces for rash of retail profit warnings
The City is bracing for a rash of retail profit warnings next week and fears a fresh run of bad news from Marks & Spencer. Analysts said that a late burst of discount-driven spending had failed to rescue like-for-like sales and further eroded profit margins. M&S is expected to announce a profit warning when it reports third-quarter performance a week from today. Like-for-like sales are said to be down by as much as 15 per cent. Freddie George, at Seymour Pierce, the investment bank and stockbroker, said: "As with last year, we believe the trading statement will disappoint, 2009-10 profits will be downgraded and the 2008-09 dividend will inevitably be cut. The debt covenants are now becoming an issue." Sir Stuart Rose, M&S's executive chairman, said last month that he would attempt to maintain the dividend at the group's half-year results. But the group's commitment to trim its approximate £3 billion debt means that, in the face of the slump in sterling and torrid trading conditions, it was likely to have to slash the payment.
Concern was also mounting last night over Debenhams's £1 billion debt. Yesterday the department store chain's debt was trading at only 58p in the pound. It also updates the City with trading news next week. Debenhams, Britain's largest department store group, will seek to reassure investors on its debt. It is not expected to breach its covenants in the next six months but there are concerns that its facilities may be reduced because its banks include HBOS and Lloyds TSB, which are set to merge. The group's net debt stood at £994 million on August 30, it revealed last month. Its senior debt was trading at 58p in the pound, down from 76p on October 1, reflecting heightened anxiety over its trading performance and a wider pessimism on debt markets. Measures to reduce debt will be on the agenda when the Debenhams board meets but it is not thought to be considering a fresh equity injection.
In the first half of the year Debenhams attempted to whittle down its debt by offering dividends in shares rather than cash and by cutting its capital expenditure to £90 million. Analysts have said that fashion retailers appear to be the next sector likely to suffer after the furniture and DIY sectors were ravaged by a combination of declining consumer confidence and the housing slump. As well as battling against the consumer slowdown, clothing retailers have been particularly exposed to the slump in sterling's value. M&S, which is Britain's biggest clothes retailer by volume, imports an estimated 75 per cent of its clothes. USC, the designer fashion shop owned by Sir Tom Hunter's West Coast Capital, went into administration on Monday, following The Officers Club. Adams, the children's clothing chain, is on the brink of calling in administrators.
The Times disclosed this month that Peter Simon, the entrepreneur behind Monsoon Accessorize, wrote to the group's suppliers telling them they would need to give leeway in terms of profit margins and payment terms because of the depreciation of the pound. Separately, Asda last night cast light on the last-minute rush to the shops before Christmas when it said that December 23 was its busiest-ever day's trading. The number of shoppers going into stores rose sharply, by 12.5 per cent in the week beginning December 22, according to footfall figures released by Experian. Anita Manan, a senior analyst at Experian Business Strategies, said: "This recent surge in shoppers to the high street may be short-lived as reality kicks in for consumers who will face the first credit card bill of the year, together with job insecurities and recession worries impacting confidence, which may force consumers to tighten their purse strings."
Close tax havens and make super-rich pay for the crunch, says UK's biggest union
Britain's biggest union, Unite, is calling for a crackdown on tax havens, which it claims rob the Treasury of £33bn a year. As Britain faces a bleak new year with public finances under increasing strain, Unite is urging prime minister Gordon Brown to make the "culprits" of the credit crunch pay their fair share of tax. The union cites figures published by analysts Tax Research UK, which suggest that Britain's top companies avoid paying £25bn in tax a year through the use of tax havens. In addition, a conservative estimate suggests that wealthy individuals - those earning over £200,000 a year - avoid a further £8bn in tax.
"A commitment to make 2009 the year Labour gets tough on the tax havens would be met with delight by hard-working families," said Unite joint general secretary Derek Simpson. "For years, super-rich individuals and corporations have undermined the UK's tax revenues and without decisive intervention from the government those same people would have destroyed our economy. Thanks to them, our jobs and homes are at risk." There has been growing disquiet over the use of tax havens - financial "boltholes" that allow companies to pay little or no tax. Britain joined France and Germany in pledging to get tough on tax havens and draw up punitive measures for uncooperative countries at an OECD summit in Paris, although Brown has been accused of standing in the way of a crackdown.
According to Tax Research UK, the top 100 companies have reduced their tax payments by 5% over the past five years. The union is calling on the government to force financial institutions to close down their structured finance operations, repatriate offshore profits and make them subject to UK tax, and close down private banking advice departments that help to exploit tax loopholes. Clawing back just one year's tax would have been enough to pay for the government's £20bn fiscal stimulus package, the union noted. "The taxes these corporations and super-rich individuals avoid could go a long way to boosting the UK economy during these tough times," Simpson said.
"The government must close the loopholes that allow the super-rich to avoid paying their fair share of tax. It is also time for the banks to close down their private banking advice sections." Barack Obama, the incoming US president, has added to the pressure for further scrutiny on tax havens, commenting: "We need to crack down on individuals and businesses that abuse our tax laws so that those who work hard and play by the rules aren't disadvantaged."
Discounts Fail to Save Retailers' Holiday
Heavy discounting by retailers in the days after Christmas didn't prevent the industry from turning in its worst holiday-season performance since at least 1970, and the situation isn't likely to improve before spring at the earliest. That is the view of the International Council of Shopping Centers, which said that, based on its estimate that sales in the week ended Saturday fell 1.8% below year-earlier levels, it now expects same-store sales in December to decline by at least 1%. The numbers are compiled by the shopping-center group and Goldman Sachs Group Inc.
The outlook for many retailers, however, is even worse. Excluding the results of discount giant Wal-Mart Stores Inc., which has been outperforming its rivals, sales at stores open at least a year -- a key barometer of retail performance -- could fall as much as 8% below year-earlier levels, according to Michael P. Niemira, chief economist at the shopping-center group. The ICSC expects December same-store sales to decline by 11%, 10% and 8% at J.C. Penney Co., Kohl's Corp. and Target Corp. respectively, compared with an increase of 3% at Wal-Mart.The industry's poor performance in December follows an even more dismal November, when same-store sales at retailers tracked by the ICSC fell 2.7%, the biggest monthly drop since the group began recording year-to-year changes in sales in 1970.
In an interview, Mr. Niemira said he expects the tough environment to continue for at least the next three months. January, in particular, will be rocky, he said. "The first half of the month is dominated by gift-card redemptions and to the extent that less [gift cards] were purchased, we expect it will dampen sales in first the half of January." A new projection of gift-card sales from TowerGroup has them falling 12% to $61 billion through Dec. 22, the biggest decline since stores began issuing the cards a decade ago, as shoppers opted to buy gifts at big discounts instead.
The ICSC's Mr. Niemira doesn't expect any improvement in February, which is typically a low-volume month. "If one is looking for some kind of fundamental change, you won't see that before spring," Mr. Niemira said. "About March is when you can look for potentially some improvement, not dramatic, but not the kind of contraction we see currently." By then, he said, more concrete plans on a financial-stimulus package may emerge from Congress that might provide "an element of optimism." Standard & Poor's also issued a grim outlook on Tuesday, saying: "With the economy in a recession and consumers in turmoil due to sharp declines in discretionary incomes and rising unemployment, we see 'stay-away-from-stores' behavior continuing well into 2009."
Japan auto sales plunge as young lose interest
To get around the city, Yutaka Makino hops on his skateboard or rides commuter trains. Does he dream of the day when he has his own car? Not a chance. Like many Japanese of his generation, the 28-year-old musician and part-time maintenance worker says owning a car is more trouble than it's worth, especially in a congested city where monthly parking runs as much as 30,000 yen ($330), and gas costs $3.50 a gallon (about 100 yen a liter). That kind of thinking — which automakers here have dubbed "kuruma banare," or "demotorization" — is a U-turn from earlier generations of Japanese who viewed car ownership as a status symbol. The trend is worrying Japan's auto executives, who fear the nation's love affair with the auto may be coming to an end. "Young people's interest is shifting from cars to communication tools like personal computers, mobile phones and services," said Yoichiro Ichimaru, who oversees domestic sales at Toyota.
The Japan Automobile Manufacturers Association predicts auto sales in Japan will fall to 4.86 million in 2009 — the first time below 5 million in more than three decades. This year, sales are projected at 5.11 million, the worst since 1980. Vehicle sales peaked at 7.78 million vehicles in 1990 during the nation's heyday "bubble" economy. After that burst, Japan was mired in a decade-long slowdown, which squelched consumer spending and sent car sales on a decline. A surge in gas prices, which has subsided in recent weeks, also eroded sales. "The changes in individuals' values on cars came cumulatively over time," said Nissan Chief Operating Officer Toshiyuki Shiga. "The change in young people's attitude toward cars didn't happen overnight. So we have to keep convincing them cars are great." In an effort to do just that, Nissan Motor Co. has dealerships featuring colorful accessories for cars meant to appeal to Japanese women's alleged penchant for "cute" things, and signed major league star Ichiro for splashy TV ads for a new sporty model, among other efforts.
Toyota, the nation's biggest car maker, has hosted test-drive events, taken part in fashion shows and even developed its own suburban shopping mall that houses a dealership to reach out to buyers. About half the autos produced in Japan are sold in Japan, while the other half are exported. But the U.S. market — where more profitable models like light trucks tend to be popular — is more lucrative. Still, this nation's disenchantment with cars is cause for concern. Americans, after all, are expected to start buying cars again — eventually — partly because of the inadequacy of mass transit there. It's a different story in Japan's cities where streets are clogged but trains are efficient. The domestic market also is shrinking due to a drop in population. Makino, the young man who plays what he calls "organic folk music," is typical of the new breed who scoffs at the sportscar-idolizing culture of the older generation. He and his friends see cars as nothing more than a tool, much like a vacuum cleaner, not a reflection of their identity, tastes or income level. Makino's father own a car, but he has never owned one. And he doesn't know a Honda Fit from a Toyota Vitz.
"I don't believe that having more things enriches you," Makino said in a recent interview at his apartment, sitting among shelves of wooden crates. "If you stay happy in your soul then you can be happy without money." Companies like Toyota and Honda Motor Co., along with the electronics giants like Sony Corp. and Panasonic Corp., are the mainstays of the world's second-largest economy, and a hollowing out of manufacturing would be lethal. Manufacturing makes up a fifth of Japan's economy in gross domestic product. But it makes up 90 percent of its exports, and any faltering in that sector would send debilitating ripple effects throughout Japan. And that's likely to further depress auto sales in Japan. Unlike other industrialized nations, Japan lacks other sectors to drive its economy such as financials and services. Consumer spending makes up about 60 percent of Japan's GDP. The damage to this nation's economy would be devastating if the auto industry fails to turn itself around because so many jobs will be affected — not only directly at the plants but related ones such as auto-parts makers, distributors and other jobs, including electronics companies that make batteries and other products for the auto industry.
Already, automakers here have shed thousands of jobs at plants, which had been producing cars for export to the U.S. and other overseas markets with a bigger thirst for autos. Toyota is projecting its first operating loss in 70 years. Some dealers are taking extraordinary steps to attract domestic customers. Motoharu Ishii has turned his Honda dealership into a special shop for dog-owners. Bigger dogs can't travel in Japanese trains, and so pet owners may be among the last holdouts in car ownership. He helps them fit their vehicles with cages, offers discount coupons at dog runs, and has a fuzzy mat ready for visiting pets — in the same way some dealers prepare play areas for children. "We want out customers to stay even a bit longer in our showroom," he said, adding that although sales haven't shot up he has managed to prevent drastic drops. "The last thing you want is a deserted showroom. If it looks busy, it makes it easier for people to drop by."
Gazprom Says Ukraine May Disrupt Gas Supply to Europe
OAO Gazprom, supplier of a quarter of Europe’s gas, warned customers that Ukraine may disrupt supplies by siphoning fuel from transit pipelines should Russia’s gas exporter stop deliveries tomorrow morning. NAK Naftogaz Ukrainy, Ukraine’s state-run energy company, notified Gazprom that it couldn’t guarantee shipments to Europe if the Russian company halts supplies tomorrow, Gazprom Deputy Chief Executive Officer Alexander Medvedev told reporters in Moscow today. "Ukraine’s position can only be described as blackmail," said Medvedev, who was flanked by Gazprom’s spokesman, Sergei Kupriyanov. Naftogaz spokesmen weren’t immediately available to comment.
Gazprom said shipments to Ukraine could be halted at 10 a.m. Moscow time tomorrow should the sides fail to sign a supply contract, echoing a similar cut in 2006. Ukraine’s government ordered two state banks yesterday to lend as much as $2 billion to clear debts for November and December supplies, which Gazprom says must be paid along with penalties before a new deal is sealed. Naftogaz transferred $1.52 billion to RosUkrEnergo AG, the Swiss-based trader that imports the gas from Russia, Valentyn Zemlyanskyi, a spokesman for the Ukrainian energy company, said earlier today. RosUkrEnergo, half-owned by Gazprom, received the funds, Medvedev said. "We shall transfer the rest of the amount after we and Gazprom check everything and recalculate penalties," Zemlyanskyi said. Ukrainian President Viktor Yushchenko hailed the order to transfer the funds yesterday, saying "all the obstacles" to a deal for 2009 had been removed.
Prior to Gazprom’s announcement that Naftogaz refused to guarantee transit, Ukraine and Gazprom had pledged to ensure supplies of gas to Europe. Some consumers, including in Hungary and Italy, registered shortfalls in shipments when Gazprom shut off deliveries to Ukraine in January 2006 for just over two days. "Only a further significant deterioration in Gazprom’s relationship with Ukraine could lead to complete disruption to gas deliveries to Europe," Alexander Burgansky and Irina Elinevskaya, analysts with Moscow-based investment bank Renaissance Capital, said in a note to investors before Medvedev’s comments. Officials of E.ON AG and RWE AG, Germany’s two largest utilities, both said this week they didn’t expect the dispute to affect their markets. GasTerra BV, a gas-trading venture between the Dutch state, Royal Dutch Shell Plc and Exxon Mobil Corp., also won’t be affected by any Russian move to halt supplies because it sources the fuel by the same route, spokesman Ben Warner said.
Oleksandr Shlapak, first deputy head of Yushchenko’s office, said Ukraine reiterated that it would ensure stable transit of the fuel from Russia to the European Union. The former Soviet state "has enough resources to secure domestic natural-gas supply," he said in an e-mailed statement. The chances of the signing an agreement have deteriorated from 50-50 yesterday, Medvedev said. Gazprom made a "super- discounted" offer on the price for supplies to Ukraine next year, Medvedev told reporters, declining to name the price. Gazprom offered to pay Ukraine gas transit fees for 2009 ahead of schedule to enable Ukraine to pay its outstanding obligations, Kupriyanov said yesterday. Transit fees to Ukraine will amount to about $2.3 billion to $2.4 billion this year, he said.
The Russian company has a transit contract that runs through 2010 and revising it "isn’t an option," Medvedev said in an interview today. Ukraine made a "ridiculous" proposal to raise the transit fees to match the increase in fuel prices that the Russian company is seeking. Last month, Ukraine received approval for a two-year, $16.4 billion International Monetary Fund loan to help support its banking system and widening current-account deficit. The country, like other emerging markets, has been shaken by a lack of credit, a weakening currency and plunging demand for its products because of the global financial crisis.
Australian, New Zealand Dollars Complete Worst Year on Record
The Australian and New Zealand dollars fell, capping their biggest annual declines on record, as prices slid for commodities the nations export and investors dumped higher-yielding assets amid a worldwide economic slump. The currencies in 2008 reached their highest levels against the U.S. dollar in more than 20 years before sliding in tandem with commodities, which account for more than half the countries’ exports. Oil prices fell yesterday, contributing to the steepest annual drop in raw-materials costs in more than half a century, after a report showed U.S. consumers are the most pessimistic they’ve been in at least 41 years. "Commodity prices are off a bit after the weak consumer sentiment data in the U.S. refocused the market on the global slump," said Adam Carr, a senior economist at ICAP Australia Ltd. in Sydney.
Australia’s currency fell to 69.20 U.S. cents as of 5:14 p.m. in Sydney, from 69.37 cents late yesterday in Asia. The currency, which touched a 25-year high of 98.49 cents on July 16, is down 21 percent from end-2007. It was at 62.53 yen today, a 36 percent drop for the year. New Zealand’s dollar traded at 57.93 U.S. cents from 58.01 cents yesterday, and has tumbled 24 percent this year. The currency touched a 23-year high of 82.13 cents on March 14. It bought 52.30 yen from 52.26 yesterday and 86.63 late last year. The Aussie, as Australia’s currency is known, may decline to as low as 65 U.S. cents in the first half of 2009 before rebounding to 70 cents by the end of June, Carr said. The Australian dollar extended declines after a report showed lending to Australian consumers and businesses cooled in November, suggesting further slowing in an economy that last quarter expanded at the weakest pace in eight years.
The South Pacific nations’ currencies may decline in 2009 as policy makers continue to reduce borrowing costs to boost their economies. Benchmark interest rates are 4.25 percent in Australia and 5 percent in New Zealand, compared with 0.1 percent in Japan and as low as zero in the U.S., attracting investors to the South Pacific nations’ higher-yielding assets. Australian government bonds surged this year as the Reserve Bank of Australia lowered borrowing costs by three percentage points in the final four months of the year. The RBA’s overnight cash target stood at 6.75 percent a year ago and was raised to a 12-year high of 7.25 percent in March. Federal government bonds returned 16.7 percent this year, their best performance since 1995, according to Merrill Lynch & Co. indexes. That compares with 10.1 percent for U.S. Treasuries.
The yield on the benchmark Australian 10-year bond fell two basis points today to 3.99 percent, down from 6.27 percent a year ago, according to data compiled by Bloomberg. The price of the 5.25 percent note maturing in March 2019 rose 0.174, or A$1.74 per A$1,000 face amount, to 110.441, A basis point is 0.01 percentage point. Traders are betting that the Reserve Bank of Australia will lower rates an additional 1.2 percentage points over the next 12 months, while New Zealand’s central bank will cut a further 1.14 percentage points from its benchmark, according to separate Credit Suisse indexes based on overnight swaps trading. The South Pacific currencies tumbled this year as the Reuters/Jefferies CRB Index of 19 raw materials dropped 39 percent in the past 12 months, the most since the measure was introduced in 1957. Prices for coal and oil, Australia’s biggest and fourth-biggest export earners, fell from records in the past six months as a seizure in global credit markets tipped the world into recession.
The weekly index for thermal coal prices at Australia’s Newcastle, a benchmark for Asia, has dropped 60 percent since reaching a record on July 4 and was $77.50 a ton in the week ended Dec. 19, according to the globalCOAL NEWC Index. World prices of butter, milk and cheese, which make up a fifth of New Zealand’s exports, plunged 53 percent from record highs reached 13 months ago. Auckland-based Fonterra Cooperative Group Ltd., the world’s largest dairy exporter, yesterday said it may have to cut payouts to the nation’s farmers as prices and demand soften. The RBA cited "the deterioration in the global growth outlook, declines in commodity prices and general unwinding of leveraged positions," as weakening the Australian dollar in its Statement on Monetary Policy in November. "Some investors appear to have exited Australian dollar positions as a proxy for unwinding positions in other less liquid markets, including emerging market currencies."
The Australian dollar dropped to a 5 1/2 year low of 60.10 U.S. cents in October this year, prompting the Reserve Bank of Australia to make net purchases of its own currency in October and November to provide liquidity in "disorderly conditions." The last time the bank was a net buyer of the currency was 2001.
The so-called Aussie may recover in 2009 to 79 U.S. cents, wrote Sydney-based John Kyriakopoulos, head of currency strategy at National Australia Bank Ltd., in a research note on Dec. 17. His forecast was the most bullish of 41 firms surveyed by Bloomberg News. The average forecast is for the currency to reach a low of 62 cents in the first quarter before recovering to 66 cents by the end of 2009. New Zealand’s dollar, nicknamed the Kiwi, will bottom at 52 U.S. cents in the second quarter and recover to 55 cents by the end of the year, according to the average forecast of 39 institutions polled by Bloomberg News. Prime Minister John Key said he thought the nation’s currency "would print with a 4 in front of it at some point against the U.S. dollar," on Television New Zealand’s Agenda program Dec. 7. "My personal view is it will go lower," he said after the kiwi closed that week trading at 53.11 U.S. cents.
Another Big Bank Failure: More Likely Than Not to Occur
Countrywide was forced into a fire sale vs. bankruptcy situation. It was totally insolvent and reeked of non-performing, illiquid and depreciating assets. Merrill Lynch was forced into a fire sale vs bankruptcy situation. It was totally insolvent and reeked of non-performing, illiquid and depreciating assets. Bank of America bought both of these companies. Hmmmm. Look at its share price and balance sheet. Where do we think all of those reeking assets ended up? Bear Stearns was forced into a fire sale vs. bankruptcy situation. It was totally insolvent and reeked of non-performing, illiquid and depreciating assets. Washington Mutual was forced into a fire sale vs bankruptcy situation. It was totally insolvent and reeked of non-performing, illiquid and depreciating assets.
JP Morgan bought both of these companies. Hmmmm. Look at its share price and balance sheet. Where do we think all of those reeking assets ended up? The government virtually nationalizes Citibank, one of (used to be, anyway) the world's largest banks. Goldman falls in price by ~75%, Morgan Stanley likewise. They are both forced to become commercial banks. Morgan decides to play the retail banking game, but Goldman appears to remain obstinate. I think they are still punch drunk from drinking their own (we're the best on the Street) Kool Aid.
I stated in the past, they have a very high share price correlation to their brethren (most of which no longer exist) and they still have some of the most illiquid and dangerous assets on their books. Yes, they have delevered significantly over the last few quarters, but a forensic glance shows that this delivering was achieved by selling the more liquid and marketable stuff, thus actually increasing the concentrations of the stuff that made them need to delever in the first place. Now, this is a judgment call by management, and I will not argue with it. I am sure they are loathe to sell depreciating assets in a down market when they probably feel the market will turn in the near to medium term.
I look at it this way though. They wrote leveraged products on overvalued underlyings at the top of one of the most effervescent bubbles in modern history. Now the bubble has popped, and reality is hastily approaching. Many companies from the previous year would have been much better off (actually, would still be in business), if they bit the bullet and sold at a loss today in lieu of waiting tomorrow when their assets for sale are definitively worth less than the aggregate debt used to finance them. That is the danger of 30x leverage, and that is the danger with what's left with these banks. We don't know what the leverage ratio is for these banks. Although many (example Goldman and Citi) have taken their leverage down considerably - we really don't know from what level it is truly coming from. Almost all of the off balance sheet vehicle, specifically the SIV's, use significant leverage. The reporting on them is murky at best, non-existent for the most part.
Make no mistake, there is exposure to economic risk from these entities. Thus, as Goldman delevers by selling a few things that it probably should keep, it amasses greater concentrations of the things most likely to kill it. Think of a woman that sheds lots of water (marketable assets) to lose weight to impress beauty judges (short sighted shareholders, shorter sighted regulators, and the sell side game), thereby building up dangerous levels of toxicity within her system. Now, the woman looks a lot better from the outside, and may even win a trophy, but the poisons within are now undiluted and potentially killing her. The pretty woman that walks down the aisle very well may collapse (like so many of her sisters from last year), and I get the feeling that if she does, everyone will act surprised.
"Won't the government help us?" Many of my lesser aware associates are still of the mindset that the government will pull us out of this one. I am put in mind of those who blindly follow religion without bothering to once wonder exactly how all of those miracles may actually work. I believe it is a lot easier for government to allow us to go down the path to recession than it is to work our way out of it. Recession is natural and normal anyway, and needs to happen. The kicker is that we had a wildly voracious up-cycle that ridiculed both the fundamentals and fiscal prudence - this lasted for about six and a half years. We have seen roughly one and half years of carnage. Methinks that we have roughly three to six years more of this to go, or 12 to 18 months of a hyper accelerated, extremely destructive downward plunge - one that would have 2008 something the optimists would end up wishing for. The only variable is the velocity of the descent. It is guaranteed, a given, that mother equilibrium will insist upon returning to her pre-bubble ways, and potentially then some.
I rant ad nauseum because I find myself returning back to the big money center banks mentioned above. As you all know, I shorted all of the names mentioned above heavily backed by some rather comprehensive fundamental and forensic research, and am still short most of those that are still in business. The trades were roughly six months to a year in duration, and although proved to be very, very profitable (several scoring more than 100 point hits) had a significant amount of volatility introduced that produced some nasty drawdowns. These drawdowns came from bear market rallies that were sparked by the "Won't the government help us?" mentality. As stated earlier, recession is a natural and inevitable occurrence that needs to happen, just as much so as economic boom times. The dead banks will have to die. It's just a matter of whether we get it over quickly and allow the Phoenix to rise from its ashes to start anew, or we drag this out in a form of macro-economic water torture.
Remember, mortgage banks were dropping like flies. Bear Stearns collapsed over the weekend. The Fed backstopped investment banks by allowing unprecedented borrowing from the Fed discount window, accepting as collateral practically anything, stocks, private labeled MBS, baseball cards, manure and fertilizer (Okay, I was joking about the baseball cards). This allowed the market to rally from the March lows that was put in by the Bear Stearns collapse. After all, the government has unlimited resources and they have pretty much stated that they will not allow a large investment bank to fail. Six months later, a large investment banks fails in the form of Lehman Brothers. What happened? The government said it wasn't their fault. They had no viable buyer. What happened to the government sanctioned liquidity? What did Lehman and Bear have on their books that the other ex-I banks don't? The short answer is nothing. They had higher concentrations o mortgage related assets.
That may sound bad given the occurrences of the past year, but it trust me, it sounds worse than it is. This was not a real estate or mortgage crisis, but an asset securitization crisis born from the punch drunk giddiness to be had when lenders and their cronies have access to nigh unlimited balance sheets and liquidity, and very limited recourse and responsibility for their actions. Thus, any asset that was normally lent against, was most likely abusively lent against under this scenario. Real assets and mortgages were simply the first to pop, starting with subprime, and as we have already seen, definitely not ending there.
As a matter of opinion, it is quite probable that the other asset classes that have bore witness to the lending abuses very well may be hit harder than real estate and mortgages - if not on an individual basis, then definitely on an aggregate basis. This is where Goldman, Morgan, HSBC, et. al. will see real pain. This is why Goldman's level 3 assets are actually increasing as they delever. Think private equity, think leveraged loans, think venture capital. Just think... Do you really think the government can prevent another big bank failure? It will happen sooner or later, but looking at the current condition and prospects, it appears to be more likely to happen than not.
Only full disclosure of toxic debts will get the West moving again
It has been a year of financial explosions. The commercial pillars holding up the Western world - banking prudence and sound credit - have been smashed to smithereens The "advanced" nations are now flirting with economic collapse. The emerging economies have also suffered "collateral damage" – the West's "sub-prime" debt bombs now threatening the stability of global commerce. The developed world is on course to contract by 1.1pc during 2009. That will hurt. The emerging markets are also set to slow – their growth falling to 3.1pc – as China and India feel the impact of lower Western demand.
But 2010 could be even worse – unless policymakers can piece the global economy back together. And the prevailing policy response –soft bail-outs, ultra-low interest rates and unfettered government spending – not only won't work, but will compound this crisis. So how should Western governments respond? How can we escape this credit crunch, and prevent it being repeated? As the Bank of England Governor Mervyn King said last month, "getting the banks lending normally again . . . is more important than anything else". After piling into risky assets for years, the Western banks now refuse to lend to millions of credit-worthy firms and households. That's jammed the wheels of finance, making fears of recession self-fulfilling.
The money markets are locked because the banks don't trust each other. Even they don't know how much toxic debt is out there – and which bank could be the next to fall. That's why the spread between the London Inter-bank Offered Rate and overnight interest rate swaps of the same maturity remains so wide – and wider in the UK, now, than either the States or the eurozone. The crucial inter-bank market will remain frozen until the banks are forced, under threat of prosecution, to reveal the true extent of their sub-prime liabilities. Such "full disclosure" won't be easy – involving the exploration of millions of complex derivative contracts, often across borders – but it simply must be done.
America's first serious reaction to "sub-prime" was the Troubled Assets Relief Programme – buying up hundreds of billions of dollars of dodgy loans the banks didn't want any more. When that didn't work, the US asked banks to forfeit some share capital in return for government cash, as in the UK. But that's failing too – as shown by sky-high Libor rates. So, as a matter of urgency, the West must copy the hard-headed Swedes – who, in the early 1990s, insisted nationalised banks write down the full extent of their non-performing loans before more public money is spent on recapitalisation. Only then – once the sub-prime losses are fully-exposed – can securities markets clear and the inter-bank market reboot.
The UK/US approach of piling public sector debts on top of private sector debts prevents this vital purging process. Until it happens the global economy will continue to slide. But the big Western economies remain in self-denial, repeating the mistakes made by the Japanese. We're creating our very own "zombie banks" – technically alive, but commercially dead due to the weight of their toxic debts. A Western "lost decade" now looms. So we need Swedish-style full disclosure. Nothing else will break the deadlock and get us out of this fix. Western politicians – and commentators – need to stand up to the powerful money men and administer the necessary medicine. Instead, all our leaders do is slash interest rates, print money and rack up public debt. History will judge them harshly.
After full disclosure, how do we prevent such a crisis happening again? Firstly, the "white collar" crimes which drove this sub-prime debacle – at mortgage lenders, investment banks and ratings agencies – need to be severely punished. People who did bad things must go to jail. I'm against regulatory overkill, but recognise a strong framework of rules is needed. We need to acknowledge that too much leverage is even more dangerous than too little. Western central banks need to regain powers, weakened in the 1980s and 1990s, to impose "reserve asset requirements", so reining in bank lending.
Above all, we need to re-introduce the Glass-Steagall Act of 1933. This legislation – the centre-piece of America's response to the 1929 Wall Street crash – was copied across the Western world. Glass-Steagall prevented commercial banks – which take in deposits and service ordinary firms and households – from engaging in the high-risk speculative activities undertaken by investment banks. In the early 1990s – after huge lobbying by Wall Street, and lots of ridiculous talk about "freedom" – the legislation was repealed. No other single action has done more to cause this crisis. The money men have, so far, managed to close down any talk about restoring Glass-Steagall. But that debate must now take place. That's why Glass-Steagall will be the subject of my first column of 2009.
Clay Kingdoms
Here at The Daily Reckoning , we turn to Shakespeare for a more poetic view of the financial collapse: "Let Rome in Tiber melt, and the wide arch Of the ranged empire fall!" So said Marc Antony as he drew the Queen of the Nile into his embrace. This is another way to look at the crisis of ‘08. You begin by noticing that it is centered in just two countries – Britain and America. Not coincidentally, those two countries are the twin capitals of the world’s only surviving empire, an empire built on a foundation of industry, technology and trade...but lately richly redecorated in an elaborate rococo style of modern debt and finance.
Beginning in the 19th century, factories in England and New England transformed the value of a working man. Instead of being equal to his counterpart in China or India – as he had been for a thousand years – he suddenly was superior; he could produce more. By the 21st century, the average day laborer in Britain and America earned 10 to 20 times more than his confrere in Asia. Of course, the English speakers had rivals. They were challenged by other Europeans...and the Japanese. All learned that the same machines that produced wealth could destroy it even faster. The Germans were particularly tenacious competitors. By 1910, their factory output was greater than that of the UK. By 1940, they were trying to blow up England’s factories. But England and America ganged up against them. In a couple costly wars in the first half of the 20th century, the Teuton threat was finally crushed.
By 1945, The Anglo-American empire had only one challenger still standing – the Union of Soviet Socialist Republics. Militarily, the USSR was a real menace. But commercially, it was no more than a comic footnote in economic history. At first, the weakness in the Soviet’s system was not obvious ... especially not to economists. The figures – put out by the USSR – showed rapid growth. But nobody flew to Moscow to buy the latest fashions nor bragged about his Soviet auto. Nor did people hasten to open accounts in Russian banks or seek heart transplants in Soviet hospitals. The Soviets had managed to create a rare thing – a value-subtracting economy. They took valuable raw materials out of the ground and turned them into worthless finished products. If he had a choice, no one would buy soviet-made goods. Every sale made the seller poorer. And the longer this went on, the poorer the Russians got. Finally, the whole system caved in – in 1989, leaving the Anglo-Americans masters of earth, sky and the seven seas.
This next era, 1989-2007, was remarkably pleasing to almost everyone. Even former enemies rushed to stock the empire’s shelves and lend it money.
Overstretched, over-indebted and over-there... it had military bases all over the world. No swallow could fall nowhere in the world without it being captured and interrogated by the Pentagon or its proxies. Back in the homeland, the imperial race went a little mad. People spent too much money...distracted themselves with bread and circuses...and flattered themselves with delusions of mediocrity. It seemed perfectly normal to them that they consumed while the foreigners produced...and that they spent what the foreigners saved. Central banks encouraged the plebes to consume; the more they consumed, the poorer they got, but as long as they had someone else’s money to spend, they didn’t complain. The imperial youth studied gender sensitivity at school; rivals studied engineering. And as for the foreigners themselves, like gigolos complimenting an aging heiress, they barely suppressed a snicker: "Your hair is beautiful," they remarked. "Have another drink of sherry." And while the poor woman admired herself in the mirror, they rewrote her will.
Soon, competitors had more modern factories, more savings, better-trained workers – as well as lower costs. Then, the empire turned to a colossal conceit; that it could make its way in the world by financing things, rather than making them. Gradually, the Anglo Americans developed a value-subtracting society too – financing, derivatizing, borrowing, flipping, consuming – all at the expense of real production. Russians recognized the symptoms: the leadership was largely delusional, industrial capacity was largely archaic and dysfunctional, and the working class was largely broke. The old Bolsheviks recognized the rot too. What the Romans called "consuetude fraudium" became business as usual...in the Soviet Union...and then in England and America.
By 2006, practically every transaction was tainted with swindle. Banks sold each other packages of scammy debt, composed of mortgage contracts on houses sold to people who couldn’t afford them, fraudulently rated Triple A by the rating agencies, based on quack formulae invented by Nobel-prizing winning economists. This took place in a party atmosphere created by central bankers, who had put something in the water; they spiked the entire economy by under-pricing credit and then urged consumers to drink up, by buying SUVs (Fed governor Tier, 2002) and using sub-prime loans (Fed chairman Greenspan, 2005). The Russians would recognize the next stage too. After the collapse, the ruins are liquidated, picked over, and parceled out to the politically well-connected. "Kingdoms are of clay," said Antony, before killing himself.
Ilargi: Last night, I though Thoreau’s Civil Disobedience might be good a a sole post. But then all the news came in. Still, in the vein of much of what we’ve talked about here, henry still stands out as a beacon in a pitch back night.
And it all comes down to the same question of the legitimacy of a government, as I’ve posed amy times, as Jim Kunstler did last week, and as Thoreau did so much better so long ago. I don’t wnat to incite anyhting at all, but I do find it grossly irresponsible not to think and write about these issues.
Ideal Governance Is The Lack Thereof
I heartily accept the motto,—”That government is best which governs least”; and I should like to see it acted up to more rapidly and systematically. Carried out, it finally amounts to this, which also I believe—”That government is best which governs not at all”; and when men are prepared for it, that will be the kind of government which they will have. Government is at best but an expedient; but most governments are usually, and all governments are sometimes, inexpedient. The objections which have been brought against a standing army, and they are many and weighty, and deserve to prevail, may also at last be brought against a standing government. The standing army is only an arm of the standing government. The government itself, which is only the mode which the people have chosen to execute their will , is equally liable to be abused and perverted before the people can act through it. Witness the present Mexican war, the work of comparatively a few individuals using the standing government as their tool; for in the outset, the people would not have consented to this measure.
This American government—what is it but a tradition, though a recent one, endeavoring to transmit itself unimpaired to posterity, but each instant losing some of its integrity? It has not the vitality and force of a single living man; for a single man can bend it to his will. It is a sort of wooden gun to the people themselves. But it is not the less necessary for this; for the people must have some complicated machinery or other, and hear its din, to satisfy that idea of government which they have. Governments show thus how successfully men can be imposed upon, even impose on themselves, for their own advantage. It is excellent, we must all allow. Yet this government never of itself furthered any enterprise, but by the alacrity with which it got out of its way. It does not keep the country free.
It does not settle the West. It does not educate. The character inherent in the American people has done all that has been accomplished; and it would have done somewhat more, if the government had not sometimes got in its way. For government is an expedient, by which men would fain succeed in letting one another alone; and, as has been said, when it is most expedient, the governed are most let alone by it. Trade and commerce, if they were not made of india-rubber, would never manage to bounce over obstacles which legislators are continually putting in their way; and if one were to judge these men wholly by the effects of their actions and not partly by their intentions, they would deserve to be classed and punished with those mischievious persons who put obstructions on the railroads.
But, to speak practically and as a citizen, unlike those who call themselves no-government men, I ask for, not at once no government, but at once a better government. Let every man make known what kind of government would command his respect, and that will be one step toward obtaining it. After all, the practical reason why, when the power is once in the hands of the people, a majority are permitted, and for a long period continue, to rule is not because they are most likely to be in the right, nor because this seems fairest to the minority, but because they are physically the strongest. But government in which the majority rule in all cases can not be based on justice, even as far as men understand it. Can there not be a government in which the majorities do not virtually decide right and wrong, but conscience?—in which majorities decide only those questions to which the rule of expediency is applicable? Must the citizen ever for a moment, or in the least degree, resign his conscience to the legislator? Why has every man a conscience then? I think that we should be men first, and subjects afterward. It is not desirable to cultivate a respect for the law, so much as for the right.
The only obligation which I have a right to assume is to do at any time what I think right. It is truly enough said that a corporation has no conscience; but a corporation of conscientious men is a corporation with a conscience. Law never made men a whit more just; and, by means of their respect for it, even the well-disposed are daily made the agents of injustice. A common and natural result of an undue respect for the law is, that you may see a file of soldiers, colonel, captain, corporal, privates, powder-monkeys, and all, marching in admirable order over hill and dale to the wars, against their wills, ay, against their common sense and consciences, which makes it very steep marching indeed, and produces a palpitation of the heart. They have no doubt that it is a damnable business in which they are concerned; they are all peaceably inclined. Now, what are they? Men at all? or small movable forts and magazines, at the service of some unscrupulous man in power? Visit the Navy Yard, and behold a marine, such a man as an American government can make, or such as it can make a man with its black arts—a mere shadow and reminiscence of humanity, a man laid out alive and standing, and already, as one may say, buried under arms with funeral accompaniment, though it may be,—“Not a drum was heard, not a funeral note,The mass of men serve the state thus, not as men mainly, but as machines, with their bodies. They are the standing army, and the militia, jailers, constables, posse comitatus, etc. In most cases there is no free exercise whatever of the judgment or of the moral sense; but they put themselves on a level with wood and earth and stones; and wooden men can perhaps be manufactured that will serve the purpose as well. Such command no more respect than men of straw or a lump of dirt. They have the same sort of worth only as horses and dogs. Yet such as these even are commonly esteemed good citizens. Others—as most legislators, politicians, lawyers, ministers, and office-holders—serve the state chiefly with their heads; and, as they rarely make any moral distinctions, they are as likely to serve the devil, without intending it, as God. A very few—as heroes, patriots, martyrs, reformers in the great sense, and men—serve the state with their consciences also, and so necessarily resist it for the most part; and they are commonly treated as enemies by it. A wise man will only be useful as a man, and will not submit to be “clay,” and “stop a hole to keep the wind away,” but leave that office to his dust at least:—
As his corse to the rampart we hurried;
Not a soldier discharged his farewell shot
O’er the grave where our hero was buried.”“I am too high-born to be propertied,He who gives himself entirely to his fellow men appears to them useless and selfish; but he who gives himself partially to them is pronounced a benefactor and philanthropist. How does it become a man to behave toward the American government today? I answer, that he cannot without disgrace be associated with it. I cannot for an instant recognize that political organization as my government which is the slave’s government also. All men recognize the right of revolution; that is, the right to refuse allegiance to, and to resist, the government, when its tyranny or its inefficiency are great and unendurable. But almost all say that such is not the case now. But such was the case, they think, in the Revolution of ‘75. If one were to tell me that this was a bad government because it taxed certain foreign commodities brought to its ports, it is most probable that I should not make an ado about it, for I can do without them.
To be a second at control,
Or useful serving-man and instrument
To any sovereign state throughout the world.”
All machines have their friction; and possibly this does enough good to counter-balance the evil. At any rate, it is a great evil to make a stir about it. But when the friction comes to have its machine, and oppression and robbery are organized, I say, let us not have such a machine any longer. In other words, when a sixth of the population of a nation which has undertaken to be the refuge of liberty are slaves, and a whole country is unjustly overrun and conquered by a foreign army, and subjected to military law, I think that it is not too soon for honest men to rebel and revolutionize. What makes this duty the more urgent is that fact that the country so overrun is not our own, but ours is the invading army.
