Sunday, February 3, 2008

Debt Rattle, February 3 2008

Ilargi: On this Sunday, we do some longer background articles, and we look around the globe a little: the UK, Canada (our own homestead), and, because it's unknown and surprising, we open with the financial meltdown in Iceland. Because, as we have said time and again: this credit crunch will come at you from many different directions, all mutually reinforcing. Positive debt feedback.

In Europe, we should all be very afraid of what's about to come down -soon- in Iceland, Ireland, Spain, and probably most of all, the UK. And don't be surprised if another country there, Greece or Italy perhaps, crashes first. The only EU members that still look relatively strong are the usual ones, the large and prudent exporters Germany and The Netherlands, maybe France. But above all, watch the UK.

Is Iceland headed for meltdown?

A Northern Rock style crisis is threatening Iceland's entire banking system, writes Iain Dey

For those residents of Reykjavik who live close to the city's small airport, disturbed sleep patterns have become the norm. Iceland's capital city now hosts one of the largest collections of private jets found anywhere in the world, used to whisk its new ruling elite of billionaire businessmen to visit their operations around the globe. The roar of Learjet engines has become such a frequent annoyance that the local MP is now lobbying for flight restrictions so his constituents can sleep easy again.

Reykjavik, it should be noted, is about the size of Scunthorpe, with a population of about 200,000. The busy flight schedule from its airport speaks of Iceland's rapid economic expansion of recent years, which has seen it colonise a substantial chunk of UK business.

Baugur, the Icelandic investment group, owns much of Britain's high street, with an empire stretching from House of Fraser and Whittard of Chelsea to the Iceland food store chain. Landsbanki, the banking group, now has a firm foothold in the City, having bought stockbrokers Teather & Greenwood and Bridgewell. It has also built a huge UK internet savings business, branded IceSave. Bakkavor, the food group, owns the fruit supplier Geest, along with a number of other specialist food businesses. The list goes on and on.

But there are increasing fears that Iceland's entrepreneurs will soon be brought back to earth with a bump. The financial system that has bankrolled Iceland's rapid growth is under suspicion.
Based on prices quoted in the credit markets, international investors reckon Kaupthing, Iceland's biggest bank, is about seven times more likely to default than the typical European bank. Moody's, the credit rating agency, last week placed the entire Icelandic banking sector on review for a possible downgrade. Standard & Poor's has warned that the major institutions - Kaupthing, Glitnir and Landsbanki - are facing tough times.

Results published by the key players in Iceland's financial sector last week helped alleviate fears that the country is on the cusp of a Northern Rock-style bank funding crisis. But analysts reckon that, thanks to a series of cross-shareholdings across the Icelandic economy, it would not take much for the whole country's financial system to go into meltdown. "The Icelandic banking sector is a classic example of plucky ambition or unrestraint, depending on one's attitude to risk," said a research note from the consultancy Markit last week. "The credit markets have certainly taken the latter view in recent months."

U.S. debt service load higher now than days of double-digit interest rates
David Rosenberg, chief North American economist at Merrill Lynch, outlines the madness ultra-low interest rates in the early 2000's did to U.S. consumers. The federal funds target rate bottomed at 1% in the summer of 2003, the lowest in a generation.

Mr. Rosenberg, calculates the debt-service-to-income-ratio — interest and principal payments siphoned from after-tax earnings — has now soared to a near-record of 14.3%. That means 14.3¢ of every after-tax dollar of income earned goes to debt service. The aggregate household debt-to-income ratio soared to 138% in the third quarter of 2007 from 101% at the end of 2001, an increase equal to all of the last 40 years combined. 

“We have taken out so much debt as a society to finance a consumption boom and asset boom...that total interest payments are a bigger drag today than they were 25 years ago when the prime and conventional mortgage rate were both north of 16%,” Mr. Rosenberg said in a research note. “This is rather unbelievable.”

Americans have basically used debt as income. “The consumer sector added an average of US$1-trillion per year from 2001 to 2006,” Mr. Rosenberg said. "So who needed a pay rise, or a job for that matter? This was akin to a 10% wage increase per year or about a US$10,000 supplement per household.”

It is Mr. Rosenberg’s contention of course that the consumer has nothing left to give, even if rates come down sharply. He simply has to rebuild his balance sheet and drag his personal savings rate back into postive territory from -0.5% now. It will take years before the consumer could embark on a new spending cycle.

Monoline Update: Are the Rating Agencies Moving the Goalposts?
We have been skeptical about the possibility of a private-sector rescue of the troubled bond insurers. Nevertheless, both the Wall Street Journal and the Financial Times reported progress on discussions to shore up Ambac, the number two insurer, and that efforts were underway to assist the smaller fry. From the Financial Times:
US and European banks are joining forces to try to solve the crisis among US bond insurers that could exacerbate the impact of the credit squeeze.

One group, including Citigroup and Barclays, is examining options for supporting Ambac Financial, the bond insurer. Separate teams are working with other bond insurers, according to people close to the process.

Note that the worst outcome for Wall Street isn't that the insurers are downgraded; it's that they spend money trying to salvage them up and they nevertheless lose their AAAs later. What we find surprising is that Wall Street is willing to stump up cash, worse, at least some equity funding, at a time when money is tight and more writeoffs are likely. And this is also taking place despite the fact that the majority of Wall Street analysts who have taken a look at the bond insurers are putting out even bigger loss estimates than Bill Ackman, the head of Pershing Square who has been saying that the monoline business model is unworkable since 2002.

What gives? Two things: the investment banks' assumptions and the rating agencies actions. A mere patching of the leaks at the bond guarantors is not a sensible move unless you have a very optimistic set of assumptions. If you believe that the economic downturn is only a two-quarter event and that a rising economy will take pressure off the insurers, investing would be attractive.
Ilargi: That’s exactly what I said yesterday: ”When all is said and done, all of these rescue missions depend on one little fantasy: that the credit crisis won’t get worse than it is today. If it does get worse, all bets are off, and all rescue attempts will fail.”
The problem, of course, is that the bond insurer troubles are driven primarily by the housing market. The last housing recession, which started in 1989, lasted 15 quarters and had less unsold home inventory (as a percentage of outstanding) than we have now. Even if you date the start of this housing slump at end of second quarter 2007, we have a long way to go. Thus the idea that this charade can be kept gong beyond two or three quarters is highly questionable. Or is it? The mistake is believing, as we perhaps have too much, that the rating agency saber rattling means they have the will to downgrade. They don't. The very last thing they want to do is be accused of causing The End of the Financial World as We Know It.

Even thought anyone who has looked at these companies in a serious way knows the AAA ratings for MBIA and Ambac are a sham, they are coming to resemble guys on death row that it takes 20 years to execute. The rating agencies, while threatening that downgrades are imminent, keep allowing the timetable for fundraising to be extended. According to the Wall Street Journal:
Moody's prepared investors for bond-insurer downgrades in a research note Thursday and subsequent investor call Friday.

Some firms "may be unable to restore financial strength to levels consistent with a Aaa rating," the firm wrote. Moody's is likely to make decisions on downgrades this month, it said, possibly sooner in the month for insurers having trouble raising capital.
While this sounds like the heat is on, the reality is more nuanced. If the rating agencies believe serious negotiations are underway for specific firms, the decisions on downgrades "this month' probably means that they have until at least the end of February. [..]Also note that despite the continuing deterioration in the credit markets, the rating agencies have not increased the required fundraising for the bond insurers. That seems highly inconsistent with recent developments, most notably S&P saying that it will either downgrade or put on review $534 billion of debt, and estimated that this move could increase bank and investment bank losses from $130 billion to $265 billion. Pray tell me how this has no impact on MBIA and Ambac? This confirms that Moody's and S&P will take advantage of any route open to them to avoid downgrading the insurers

Fitch Places $139 Billion of Subprime RMBS on Negative Watch, Cites ‘Walk Aways’
Fitch Ratings said late Friday that it had placed $139 billion of subprime RMBS on Watch Negative, the result of increased loss expecations. The rating agency said it now expected cumulative losses for the 2006 and early 2007 subprime vintages to range from 21 to 26 percent.

That loss estimate is by far the largest of the three rating agencies. Both Standard & Poor’s and Moody’s Investors Service have in recent weeks updated their loss expectations; S&P said it expected cumulative losses on the 2006 vintage to approach 19 percent, while Moody’s estimated total losses at 14 to 18 percent. Fitch’s move affects 2,972 rated classes, it said, and comes as the rating agency has enhanced its default and loss model. A review is expected to be complete by the end of February.

It’s worth noting some of the language in Fitch’s press statement — because it’s the first time any of the rating agencies have lended credence to the idea that borrowers are walking away from their homes [emphasis added]:

In Fitch’s opinion the contraction in the mortgage markets has contributed to an acceleration and deepening of home price declines, and has eliminated the option to sell or refinance a home to avoid foreclosure for many borrowers. Additionally, the apparent willingness of borrowers to ‘walk away’ from mortgage debt has contributed to extraordinarily high levels of early default, which is particularly noticeable in the 2007 vintage mortgages. As Fitch has described in recent research reports, this behavior appears to be largely attributable to the use of high risk mortgage products such as ‘piggy-back’ second liens and stated-income documentation programs, which in many instances were poorly underwritten and susceptible to borrower/broker fraud.

UK: The return of negative equity: Thousands at risk of owing more on homes than they are worth
Thousands of families are at risk of plunging into negative equity if house prices fall by even a small amount, experts warned yesterday.

Those who took out huge mortgages while property prices were soaring have been left exposed by the market downturn.
Credit ratings agency Experian have drawn up a map showing which areas of the country are most at risk from a fall in prices.
It found that in some parts of Britain, the average mortgage debt is more than 90 per cent of local property prices.
This leaves owners vulnerable to negative equity - where the amount owed on the home is more than it is worth.

Andrew Burrell, chief UK economist at Experian, said: "There have been concerns about over-extension in the mortgage market after many years of rapid growth and these data give a very strong indication of the weak points across the UK.
"The highest loan-to-value areas are likely to be those most vulnerable to house price falls, as they will see negative equity emerge more rapidly.

UK: Why the global crisis is about to hit home hard
The international financial crisis has, for most of us, been a spectator sport so far. It's like watching a well-made American TV series about global capitalism, where each instalment brings a fantastic new turn of events as banks lose billions and crazy characters emerge, such as dealer Jerome Kerviel, who blew £3.6 billion on financial derivative bets for the French bank Société Générale. A lot of City traders were feeling their collars after that episode.

In the States, where they take their drama seriously, the FBI has been called in to investigate the subprime mortgage scams and the vehicles used by the banks to keep their losses - and gains - off their books. In fact, the lawsuits are piling up so fast on Wall Street there is a shortage of lawyers to handle them. The city of Cleveland alone has 21 lawsuits outstanding against leading banks such as Goldman Sachs and Morgan Stanley.

For most of us in Britain, this has been a compelling drama, but nothing really to do with us. Talk of Libor (the London interbank offered rate), monolines and credit default swaps goes over our heads. Part of an exotic world far from the real economy, let alone our salaries.

Until now. For, what has become clear in the past week or so is that this is not just about US mortgages, or turbulence in the international derivatives market, but a systemic crisis of the global economy. And we can't escape it. Last week, the Financial Services Authority said a million subprime mortgage holders in Britain were facing ruin. Britain is about to rediscover the meaning of negative equity as the property bubble deflates and exposes all those dodgy mortgages from the likes of, well, Northern Rock. The banks are refusing to lend on the old throwaway terms, and the number of new mortgages approved fell to a 10-year low last month.

This might explain why no new bidders have entered the race for the Rock before tomorrow's deadline, despite the government effectively guaranteeing a £50 billion loan of our money. That none of the big banks is prepared to take on Northern Wreck speaks volumes. Gordon Brown seems determined to hand those billions over to self-publicist Richard Branson, who didn't have a banking licence when he made his initial bid.

Stiglitz: Central banks need to act pre-emptively, not reactively
If we know the price of cream and the price of skim milk, we can figure out the price of milk with 1% cream, 2% cream, or 4% cream. There might be some money in repackaging, but not the billions that banks made by slicing and dicing sub-prime mortgages into packages whose value was much greater than their contents.
It seemed too good to be true -– and it was. Worse, banks failed to understand the first principle of risk management: diversification only works when risks are not correlated, and macro-shocks (such as those that affect housing prices or borrowers’ ability to repay) affect the probability of default for all mortgages. 

I argued at Davos that central bankers also got it wrong by misjudging the threat of a downturn and failing to provide sufficient regulation. They waited too long to take action. Because it normally takes a year or more for the full effects of monetary policy to be felt, central banks need to act preemptively, not reactively. Worse, the US Federal Reserve and its previous chairman, Alan Greenspan, may have helped create the problem, encouraging households to take on risky variable-rate mortgages by reassuring those who worried about a housing bubble that there was at most a little “froth” in the market.

Normally, a Davos audience would rally to the support of the central bankers. This time, a vote at the end of the session supported my view by a margin of three to one. Even the plea of one of central banker that “no one could have predicted the problems” moved few in the audience -– perhaps because several people sitting there had, like me, explicitly warned about the impending problem in previous years. The only thing we got wrong was how bad banks’ lending practices were, how non-transparent banks really were, and how inadequate their risk management systems were.

It was interesting to see the different cultural attitudes to the crisis on display. In Japan, the CEO of a major bank would have apologised to his employees and his country, and would have refused his pension and bonus so that those who suffered as a result of corporate failures could share the money. He would have resigned. In America, the only questions are whether a board will force a CEO to leave and, if so, how big his severance package will be. When I asked one CEO whether there was any discussion of returning their bonuses, the response was not just no, but an aggressive defence of the bonus system. 

Ilargi: Read the piece below and decide for yourself whether the website Financial Sense should be renamed Financial Nonsense. Governments should use your tax money to buy out bankrupt banks, at a loss (of course?!). Who would that be good for? You? Or the people at Financial Nonsense who are invested in that part of the failed system?

The Bank Of International Settlements (BIS) Has Set The Tone
We have argued that the governments and central banks in the U.S. and Europe, and possibly places like; Japan, Australia, and Canada, will need to buy debt and/or take over bankrupt banks and financial companies.  Of course the debt that they buy will be worth less than they pay for it and the companies they take over will be bankrupt, but a lot of the losses can be recovered with a return of confidence in the markets and a new wave of capital from government sponsors.

The taxpayers will foot the bill, some of which will be recovered with a return of confidence and rationality in the markets and with punishing of the fraudsters who caused the problems in the first place.

We know that if the government throws good money into this as they did in the U.S. Savings and Loan crisis; they will want a body count of jailed mortgage brokers, appraisers, escrow agents, and possibly bankers and other types who engaged in various types of fraud while creating and marketing what appear to be clearly fraudulent loans and securities.

Ilargi: HA HA HA HA HA HA. Geez, almost forgot about the Terry Schiavo act in Canadian ABCP. It really once was worth $40 billion, but apparently not anymore: it’s now $30 billion. Yeah, well, in your dreams! Just as long as there’s a moratorium on selling it, and no-one can mark it to market. The committee is now down to its, what, 10th(?) “self-imposed” deadline? This gives a whole new meaning to the term “deadline”.

BlackRock to oversee ABCP assets: sources
The job of overseeing almost $30-billion of assets after the Crawford Committee's restructuring of the stricken non-bank asset backed commercial paper market will go to U.S. financial services giant BlackRock Inc., sources said. There had been speculation that the task would go to Coventree Inc., the biggest manager of the paper before the market melted down, but Coventree said Friday its proposal wasn't accepted by the committee.

BlackRock is the world's fifth-largest asset management company, and aside from running mutual funds, it has a big business overseeing assets for other companies. In this case, BlackRock will be asked to oversee a complex portfolio of assets that includes about $27-billion of derivatives. The assets were originally backing almost two dozen ABCP trusts, but have now all been rolled together to back new bonds that are expected to trade freely once the restructuring is completed.

The committee is working toward a self-imposed March 31 deadline for finishing the restructuring of the market, which froze up in August on concern that the assets backing the ABCP were infected with subprime mortgages. While that proved to be largely false, the damage was done as investors stopped buying and big players in the market have been searching for a solution ever since. Coventree said Friday that it likely will seek an “orderly windup” after losing the contest to run the assets, given that all its business lines have basically been shut down.

Ilargi: I have ranted against the BCE buy-out for a long time. It’s the worst of the worst: first, funds from a major pension fund will be thrown at the wolves; their partners are US -far too- private equity funds. Second: the entire proposed deal is based on enormous leverage. If memory serves, Ontario Teachers would throw in $4 billion, while $7 billion of BCE’s own money would be used (!!!) , and the whole deal would cost some $51 billion. Between Teachers and the equity fund, the purchase funding hardly exceeds 10% of the cost. Pension funds need to stay out of these deals. Mind you, the Financial Post, which published the article below, was jubilant about the deal not so long ago.

Canada: BCE and bad governance
The BCE Inc. affair is the intersection of Canadian cronyism and shareholder abuse. The telecoms giant has drifted for years and last year managers and directors endorsed a leveraged buyout deal, then lobbied shareholders to approve it. Embedded in the deal were provisions which would make certain managers, and directors (or their firms) obscenely wealthy. The deal was lousy and the market is starting to understand it and much speculation is that the takeover is on the ropes.

As my friend, money guru Stephen Jarislowsky said at the time: "We have private equity coming in who will clean up things and flog it back out for a profit. Why doesn't the board and management do this themselves? Aren't they supposed to know more about the company? Then why would someone pay them millions?"
Of course, making profits on this situation is far from guaranteed. And a leveraged buyout in a debt crisis atmosphere is not very smart, plus there were better alternatives that shareholders were not asked to examine. So here are the roadblocks:
  • BCE will go from an investment grade credit and public company to a private company with junk-bond status. Proposed privatization involves $7 billion of its own cash and $28 billion in borrowed funds plus the rape of Canadian bondholders, who are now fighting an oppression case in court.
  • BCE control will be shared between the Ontario Teachers Pension Plan and American private equity funds but there are complaints this transgresses restrictions on pension fund ownership and on foreign ownership of telecoms.
  • The buyout was unethical: it contained $500 million in collateral benefits accruing to managers and directors (or their firms) in the form of options; retention bonuses and a carried interest of 6 to 8% of the company if certain performances are achieved. Four of the BCE directors who voted for the deal worked for firms that will make windfalls in fees such as Tony Fell from RBC Dominion, Ed Lumley, BMO Capital and two others with banks or law firms.

Fortunately, there are two flies in the ointment: BCE’s bondholders are fighting in court to try and establish the same legal protections as American bondholders enjoyed from BCE.

"Instead of treating an important stakeholder group fairly...the 1976 and 1996 bondholders were the victim of a gotcha approach," lawyer Mark Meland told a Quebec court in his closing arguments this week on behalf of bondholders.

Then there is Brent Fullard who proposed a brilliant restructuring that was ignored by BCE’s board. So he and others have taken up the cause to the CRTC which must approve the leveraged buyout of BCE.
(Canada’s securities regulators dropped the ball by deferring to shareholder approval of the BCE buyout, with disclosure about bonuses, even though the “menu” excluded Fullard’s perfectly reasonable and shareholder-rich proposal.)

Globalised China has two glaring needs
In not much more than two decades, globalisation has changed China from basket case to economic power, but has left its present-day leaders with two glaring needs. One is to protect its industrial base, which has raised the expectations of so many millions of its people, from those same global winds of change as the credit crunch turns them into more of a gale.

The second is to employ its savings to project its influence and allow it to become more than a low-cost base for other nations' manufacturers. Both needs met neatly when BHP announced its bid for Rio Tinto. With profit margins wafer thin in much of its manufacturing industry, China's companies fear the rises in raw material costs, for which its own insatiable demand is partly responsible.

In one sense, which company moved in to try to stop the takeover was not important. Most heavy industrial companies with the financial muscle for major purchases abroad remained state-controlled, with majority shares held by the State-owned Assets Supervision and Administration Commission (SASAC), the world's richest quango. But Chinalco, the world's fourth-largest aluminium company, has been on a buying spree in recent years and already has interests in Australia, Africa and South-East Asia. "Rio Tinto is an international multi-metal mining company, which fits with our development goals," said Lu Youqing, its vice-president.

The stake it is buying in Rio Tinto is already the biggest single foreign purchase by a Chinese company, and while it follows in a path well-trodden by other resource-seekers, particularly the state oil and gas firms, its increased ambition is a clue to another concern of the Communist Party. It is currently fighting further international demands to strengthen its currency as its trade surpluses and foreign exchange reserves - to say nothing of its inflation rates - grow ever higher, while at the same time preventing too fast a slowdown in the economy as exports to debt-ridden America fall.

Soaking up some of those reserves in foreign purchases takes some of the pressure off - and, finally, establishes China's industrialists, and not just its hundreds of millions of workers, as players on the world stage.

Judge won't let homeowners buy loans
A Maryland homeowner lost her bid Friday to force American Home Mortgage Investment Corp. to let homeowners pay off their mortgages at the bargain-basement prices at which they're sold to institutional investors at bankruptcy auctions. Judge Christopher Sontchi of the U.S. Bankruptcy Court in Wilmington, Del., said there was no legal reason why homeowners shouldn't be allowed to participate in bankruptcy auctions at which hedge funds and other big investors buy mortgages for as little as 50 percent of their face value. But he said it isn't his job to look out for the interests of consumers in a bankruptcy case.

"I'm not sure that I have to consider giving the consumers a fair shake at bidding on their own loans," Sontchi said, turning down a request from homeowner Paula Rush to let her bid in a Feb. 26 auction of 424 American Home mortgages. The face value of those mortgages, which are sold in pools, is $152 million.

The collapse of the subprime mortgage market last year threw dozens of mortgage lenders into bankruptcy, triggering the transfer of billions of dollars in mortgages at bankruptcy auctions. In several cases around the country, homeowners have complained that the transfer made it difficult for them to identify who owned their loans and who they should negotiate workouts with.

American Home, one of the country's biggest mortgage lenders, collapsed into bankruptcy last year and is going out of business. Rush, who lives in Churchville, Md., has been fighting the company since before the bankruptcy, alleging she was duped into an expensive mortgage and denied her legal right to get out of it. American Home won't tell her who now owns her loan, but says it was sold to an investor as part of a big pool of mortgages.

At bankruptcy auctions, mortgage lenders sell loans in big packages. Last year, for example, American Home sold a $1.6 billion package of mortgages at prices ranging from 54 percent to 91 percent of the outstanding balance of the loans. Rush, in court papers, argued that if big investors get to buy mortgages at such heavily discounted rates, homeowners should be granted that privilege too. If homeowners were allowed to participate at such auctions, she said, they would easily be able to arrange the financing to pay off their loans. "At 50 cents on the dollar, anyone would buy out their loan," she said in an interview Friday.

Ilargi: The credit card industry has a word for people who pay off their balance every month. That words is ”deadbeats”. Now it seems they will get rid of the deadbeats, and hold on only to those who can’t afford to pay off the debt, but “carry” the balance further, thus getting into the higher interest rates that come with doing so. Yeah, what a wonderful world this could be.

Prudent customers risk losing credit cards
Credit card customers who pay off their balance each month are as much risk from being cut off by their lender as those that have lost control of their spiralling debts. Credit checking agencies say banks are beginning to weed out customers with faultless borrowing histories because they can make little profit on them. It comes as credit card company Egg was accused of withdrawing cards from some of its most responsible customers as part of a cull of those said to have a "higher than acceptable risk profile".

The lender, part of US investment bank Citigroup, wrote to 161,000 customers - 7% of its total base - last week to warn them their cards would be withdrawn in 35 days. They can still repay balances over time. Many Egg customers who caught up in the clamp down claim they are "risk free" customers who have never breached their credit limit and who pay off their balance each month. Gillian Cox, an Egg customer from Farnham, Surrey, said she was "absolutely furious" to learn that her credit card had been cancelled in what she described as an "unbelievable arbitrary action".

She said she her husband were retired with no mortgage and no debts and "always paid the balance off in full each month". Trevor Smith, from Nottingham, who also pays of his balance each month has also had his card cancelled. "It's disgusting that they are making out its just the bad ones who are being dropped," Smith said. "Fair enough if that's what they want to do, but don't send a really upsetting letter that makes it sound like we have a bad credit history all of a sudden. Good riddance... if that's how they treat people."

One industry insider said that as businesses credit card providers had a right to ditch customers who do not generate income. "In the last two years more and more customers have been paying off their credit card debt and that means less interest charges and other fees for the provider," the source said. "Maintaining a customers account costs money - it's hardly surprising that they want to lose some of those people."

Chancellor cedes to Bank over rescues
Alistair Darling, chancellor, on Wednesday bowed to Bank of England pressure to allow it to carry out limited covert bank rescue operations, as part of a wide-ranging package of measures to avert another Northern Rock crisis.

The move is a sop to Mervyn King, the newly reappointed Bank governor, who claimed a secret aid package to Northern Rock last summer might have saved the business without the humiliating public run on the bank.

Mr Darling proposes legislating to allow the Bank covertly to provide emergency liquidity support for a “short period”, but his consultation paper is dripping with scepticism about whether this would work in practice. “There is a strong possibility that such lending could quickly become public knowledge,” the paper says. It warns that a leak of a Bank intervention – as happened with Northern Rock – could “prove a greater risk than a timely, but planned announcement to the market”.

Mr Darling told the Financial Times last October that the days of the Bank doing deals in “smoke-filled rooms” were over, adding: “I think the system is just far more open than it was.”
Government insiders also point out that Northern Rock needed, and still needs, long-term public support of more than £25bn and that keeping such a rescue secret would have been out of the question.

UK banks could be tapped for billions
UK banks face having to put billions of pounds into a revamped scheme to compensate savers in a banking collapse, as part of a wide shake-up of the sector after the Northern Rock debacle.

Alistair Darling, chancellor, will on Tuesday launch a three-month consultation on legislation to control the damage of a future banking crisis, including an idea that banks fund upfront the depositor compensation scheme.
The idea is unpopular with banks and Mr Darling will admit there are “significant disadvantages” in forcing them to pay into a compensation pot when capital is tight. “This is a very significant IOU the government is handing to the banking sector,” one banking executive said.

MPs on the Treasury select committee insist banks should pre-fund the scheme, preferably in economic good times, to reassure savers and provide instant money if a bank goes under. One alternative would be to retain the “pay as you go” approach, where the scheme is funded by loans in the event of a crisis and later repaid by banks . Another would be to make banks partially pre-fund the scheme.

Mr Darling’s paper launches a consultation on whether the current level of saver compensation – 100 per cent of the first £35,000 – should be extended to £50,000 or even £100,000. The banks want to keep the figure at £35,000, covering an estimated 97 per cent of savers. But the chancellor has an open mind, arguing that the 3 per cent of remaining savers hold roughly 50 per cent of all bank deposits.

Northern Rock spectre looms large in revamp
In Wednesday’s 155-page document on reforming banking regulation, Northern Rock is mentioned just three times. But it is obvious the spectre of the stricken Newcastle lender, the subject of the first run on a British bank since Victorian times, looms large over the proposals.

Wednesday’s suggested reforms will go some way to creating a number of the backstops that would have prevented the Northern Rock crisis, or at least neutralised its impact. But an important question hung over the blueprint from Wednesday: have the authorities been so seared by those scenes that they have made the mistake of fighting the last war – not the next? Take the recommendation to hand greater powers to the Financial Services Authority to prevent a bank failure in the first place by strengthening its supervision.

By ensuring better stress testing in key areas such as liquidity and allowing it to demand information quickly from banks, this type of supervision could have raised earlier questions about the business plan of Northern Rock. Its heavy reliance on wholesale funding and aggressive growth in the first part of 2007 would have raised alarm bells.
The second safety net – Wednesday’s plan to give the Bank of England wider powers to provide covert emergency funding to rescue stricken banks – also appears to have been framed with Northern Rock squarely in mind.

Yet if the bank was the inspiration, it would not in practice have been a beneficiary. While covert borrowing could theoretically have helped the bank by preventing the spectacle of thousands of worried savers rushing to withdraw funds, both the size of the institution and the depth of its problems would have rendered such an approach unfeasible. What if, even after those two backstops, a bank fails in future?

Housing Meltdown
Why home prices could drop 25% more on average before the market finally hits bottom

As Washington policymakers struggle to keep the U.S. out of recession, the swirling confusion over the housing market is making their job a lot tougher. Will American consumers keep shopping or be forced to pull back? Will banks lend freely or be hamstrung by mortgage defaults? What are the best policy options right now? Those and other important questions simply can't be answered without a good idea of whether home prices will rise, flatten out, or keep dropping.

Some experts have begun to suggest that a bottom is in sight. Pali Research analyst Stephen East wrote in a research note to his firm's clients on Jan. 25 that "the sun is not shining very brightly, but at least the worst of the storm has likely passed." With optimism budding, Standard & Poor's beaten-down index of homebuilder stocks soared 49% from Jan. 15 through Jan. 29.

But it's considerably more likely that the storm is still gathering force. On Jan. 30 the government said annual economic growth slowed to just 0.6% in the fourth quarter as home construction plunged at a 24% annual rate. The Standard & Poor's/Case-Shiller 20-city home price index fell 7.7% in November from the year before, the biggest decline since the index was created in 2000.

And that could be just the start. Brace yourself: Home prices could sink an additional 25% over the next two or three years, returning values to their 2000 levels in inflation-adjusted terms. That's even with the Federal Reserve's half-percentage-point rate cut on Jan. 30. While a 25% decline is unprecedented in modern times, some economists are beginning to talk about it. "We now see potential for another 25% to 30% downside over the next two years," says David A. Rosenberg, North American economist for Merrill Lynch, who until recently had expected a much smaller slide.

Shocking though it might seem, a decline of 25% from here would merely reverse the market's spectacular appreciation during the boom. It would put the national price level right back on its long-term growth trend line, a surprisingly modest 0.4% a year after inflation. There's a recent model for this kind of return to normalcy after the bursting of a financial bubble. The stock market decline that began in 2000 erased most of the gains of the boom of the second half of the 1990s, leaving investors with ordinary-sized returns. "A down market is getting baked into expectations," says Chris Flanagan, head of research in JPMorgan Chase's (JPM) asset-backed securities group. "People say: I'm not buying until prices are lower.'" He predicts prices will fall about 25%, bottoming in 2010

Canadian economy beginning to show the strain
Manufacturing and forestry may already be in recession: economist

Canada's manufacturing and forestry sectors may already be in recession and the U.S. slowdown and spike in the Canadian dollar are beginning to have a greater impact on the broader economy, with the mining and wholesale trades contributing to weaker economic growth in November, new figures show.

Canadian gross domestic product (GDP) slowed to 0.1% in November from 0.2% in October, resulting in an annualized growth rate of 2.7%, Statistics Canada figures showed yesterday. The pace of growth is not expected to pick up anytime soon, with the Bank of Canada predicting growth of 1.8% in 2008.

"It's clear that Canada's economy is not immune to the weakness south of the border and the strong Canadian dollar," Sal Guatieri, senior economist at BMO Capital Markets, said.
The agricultural and forestry industry took the biggest hit in November, declining 0.4% for an annualized contraction of 3.8%.

"There's really no sign of a recovery in forestry products," Mr. Guatieri said, adding growth in one of that industry's main markets, the housing sector, was also slowing. Mining growth fell 0.4% in the month and was down 0.7% on the year. Manufacturing activity declined by 0.3% in November, but remained slightly higher over the year at 0.2%.

US Housing Slowdown Results in Major Furniture Liquidations
Liquidation World Inc. today announces a number of new major furniture liquidations being offered throughout its stores in Canada. The recent and dramatic changes to the US housing market, precipitated by the sub-prime mortgage crisis, have impacted a number of major US furniture vendors.

Maurice Chelli, SVP Merchandising said: "The US housing slowdown has had ripple effects in the furniture sector. As a result we have recently acquired several million dollars worth of furniture inventories and we are continuing to see new opportunities almost on a daily basis. The result is a wide array of high quality furniture being liquidated throughout our Canadian outlets.

While these same economic factors are causing price deflation in the North American furniture market in general, the sheer volume of deals has put us in the position of being able to choose the deals that deliver the best value to our customers. In one recent example, we sold more than a million dollars worth of living room furniture for less than $500,000.00. For the value-driven Canadian consumer, there has never been a better opportunity to purchase household furniture."


souperman2 said...

Great rattle - I always value the big picture perspective as the $hit is happening everywhere. Money keeps seeking flight to safety only to hear the door being knocked down and having to flee again.

Feeling a little guilty as I just found out the family who bought our 5000 sq' house last year have not been able to sell their other house yet (6000sq' by the way. they are

They are now paying 2 huge mortgs. and he, a realestate agent is not sell anything lately. These folks are royally $crewed but I can.t take responsiblity.

The whole Western Oregon RE market is locking up, retail is tanking, I am seeing more and more vacant retail space and the regional business magazine does a huge piece on "Yes all this is bad but Commercial Construction is really booming so thats good. Yea!!!

What disconnect. They can not even add 1+1.

Unknown said...

The musical version.


The exceptionalists that control US and UK banking need to be lined up for the guillotine.

The IMF policies they forced on developing nations should also be used in the US and UK.

Now they want the kinder and gentler version? LOL. 


Unknown said...

Interesting discussion.

Ilargi said...


As is obvious by now, we down here see not even a remote possibility for inflation, so we agree with Karl on that one. But the ensuing blabber about drilling in the GOM? I don't feel like going back ten years and doing that all over again. Yeah, the liberals....

Unknown said...

I thought the comment regarding the export of labor to Chindia resulting in high oil prices was a valuable insight, because that is one of the main drivers of world demand.

Our politics are very different, but it is quite possible to be a environmentalist and true conservative.

The export of labor isn't necessarily based on cost, but on cost effectiveness.

The cost effectiveness of US labor was destroyed by the failure of the education system, quota systems instead of meritocracy and massive degradation of ethics by neo liberals and neo cons.

Anonymous said...

I think the cost effectiveness of American labor was also destroyed by a government tax policy subsidizing corporate off-shoring and the effect of a “reserve currency” too.

What about adding government Military Keynesianism spending to that list? Chalmers Johnson wrote the following referring to 1990, almost two decades ago; can there be any other competitive American industry (and workers) left by now?

By 1990, the value of the weapons, equipment, and factories devoted to the Department of Defense was 83% of the value of all plants and equipment in American manufacturing. From 1947 to 1990, the combined U.S. military budgets amounted to $8.7 trillion.
"According to the U.S. Department of Defense, during the four decades from 1947 through 1987 it used (in 1982 dollars) $7.62 trillion in capital resources. In 1985, the Department of Commerce estimated the value of the nation's plant and equipment, and infrastructure, at just over $7.29 trillion. In other words, the amount spent over that period could have doubled the American capital stock or modernized and replaced its existing stock."”
Going Bankrupt
Why the Debt Crisis Is Now the Greatest Threat to the American Republic


Unknown said...

Perhaps the spending on military production confirms the lack of cost competitiveness at a given quality level.

It puts money into the hands of workers and the system in general like anything else would and can be operated on a cost plus basis behind the national security argument.

Right now the military is being mis used in the interest of third parties, but it might one day come in handy when push comes to shove.

Anonymous said...

a very imformative site

my questions:

what if all of the financial manipulation that is now being decried was the only viable option to maintain the economies of the countries involved?

for example america's population is 300mil with 70% of gdp from consumer spending. how can the u.s continue its present standard of living under that circumstance?

i truly hope someone will attempt to answer those questions

thanks, dave

Ilargi said...


We ran the Chalmers Johnson piece when it came out, and I highlighted the exact same paragraph that you did. To be honest, I still have a very hard time wrapping my mind around that, and I think many more people should look at that for an hour or so, and try to figure out what that means for the American economy, its politics, and the future of both the country and its citizens.

For it puts the bankruptcy of that economy in a shrill and chilling light, and at the same time assures there is no way forward from here other than with that very military industrial complex. Not only has the US become a completely unproductive society when it comes to its own domestic needs, it has also lost the capacity, as well as the financial structure, to turn around and start taking care of itself. There is nothing left but the machinery of war. No, it's not all Greenspan's doing, but he finished off the job of gutting and liquidating the American economy superbly.

And now there's an apparatus in place, both politically and economically, that looks far too much and far too eerily like the one Herman Göring designed 75 years ago from his offices in Berlin. There's only one way left to go.

Anonymous said...

At the risk if making Pollyanna utterances, in response to this:

By 1990, the value of the weapons, equipment, and factories devoted to the Department of Defense was 83% of the value of all plants and equipment in American manufacturing.

I think the main resistance to joining the two world wars was from business feeling that money would be lost retooling for war, yet the once the die was cast:) packets were made. Moving from a war ecconomy was cast in stone no matter how much lolly was made. The trouble here is moving from a war time economy in relatively peaceful times back to a consumer oriented one. Likely will take a bit of the Hard Times to do that but if the world can take it that is where i would expect the US to go.

Ilargi said...

what if all of the financial manipulation that is now being decried was the only viable option to maintain the economies of the countries involved?

then it failed, obviously, hence it was not the only viable option

for example america's population is 300mil with 70% of gdp from consumer spending. how can the u.s continue its present standard of living under that circumstance?

it can't, equally obviously

Dave, I'm not sure I understand what you're asking. I'm not so sure there's been attempts to maintain the economies of the countries involved in the manipulation. Why does everyone see the world that way, while they recognize that their politicians can't be trusted not to sell their own grandma's?

I think people are much too easily fooled by their inner desires for benevolent masters. What the masters like to maintain is that illusion, not the economies.

Anonymous said...

Hey there! Musashi

Ilargi said...

The trouble here is moving from a war time economy in relatively peaceful times back to a consumer oriented one. Likely will take a bit of the Hard Times to do that but if the world can take it that is where i would expect the US to go.

CR, the US is preparing for war, not trying to get out of it. A country that has 83%, and more by now likely, tied up in its arms, in relatively peaceful times, what does that make you think of?

Me, I thought of Göring.

Anonymous said...

This is by Naomi Klein (The Shock Doctrine). I am not sure if George Bush’s USA is the Israeli model or the reverse.

“Israel's economy isn't booming despite the political chaos that devours the headlines but because of it. This phase of development dates back to the mid-90s, when the country was in the vanguard of the information revolution - the most tech-dependent economy in the world. After the dotcom bubble burst in 2000, Israel's economy was devastated, facing its worst year since 1953. Then came 9/11, and suddenly new profit vistas opened up for any company that claimed it could spot terrorists in crowds, seal borders from attack, and extract confessions from closed-mouthed prisoners.

Within three years, large parts of Israel's tech economy had been radically repurposed. Put in Friedmanesque terms, Israel went from inventing the networking tools of the "flat world" to selling fences to an apartheid planet. Many of the country's most successful entrepreneurs are using Israel's status as a fortressed state, surrounded by furious enemies, as a kind of 24-hour-a-day showroom, a living example of how to enjoy relative safety amid constant war. And the reason Israel is now enjoying supergrowth is that those companies are busily exporting that model to the world.”
--How war was turned into a brand


Anonymous said...

ilargi thanks for the reply

i dont believe the bush/cheney regime was put in place to ruin the middle class or wreck america's economy for the benefit of the rich. that meme is quite popular on various poitical websites

the end of the cold war has resulted in the competition of all countries for the same limited amount of capital, markets and natural resources. the old rules of capitalism and free open markets economies no longer apply. if they ever really did

what is workable today may/will not work tomorrow as the global scenario is in constant flux

again thanks for responding


Farmerod said...

My department recently had an afternoon meeting with a couple of our company's VP's. Before Christmas, 40% of our first line managers were given packages, a quarter of our staff was re-assigned to another department and our director still has not been replaced. To the VPs' credit, they told us what was on the mind of the executive: ABCP (although he actually thought they might get it all back and then some!), increasing pension costs due to falling interest rates and stock market declines and, for the first time in years, falling revenue.

Our business is sensitive to dicretionary spending and oil prices. With everything else going on in the world politically, economically, financially and ecologically, it absolutely seems like a no-brainer to accelerate the transition to a livelihod with some sort of future.

But, aside from myself, I can count on one hand the people in my organization who have similar thoughts, even when I suggest certain sources of information that, perhaps, they aren't likely to read on TV...

Good for me. The longer others live the illusion, the more time I have to build my liferaft.

Anonymous said...

ilargi it makes me think that if that is a dead certainty then the US is Dead in the water! A country that can not subdue Iraq or Afghanistan and let's not bring in the Hezbola that would be too embarrassing, is not a credible threat.

To fight a ground war of any real substance they need more than arms they would need to bring back the draft, how real is that? As far as going nuclear there would be no winner there except Gaia and possibly the rapture crew if they happen to be right.

No, I think they will bluster and whine and back off. I don't think we can get them to do the right thing and rid the planet of its pests:)

Oh, Goring on morphine is a nice choice but personally I would go for Goebbels on Valium ... you know Cheney.

Unknown said...

Howdy CR.

PS. Same methodology, opposite party.

The Lizard said...
This comment has been removed by the author.
Anonymous said...

I keep thinking about that manufacturing statistic too ...

Ilargi said "Not only has the US become a completely unproductive society when it comes to its own domestic needs, it has also lost the capacity, as well as the financial structure, to turn around and start taking care of itself. There is nothing left but the machinery of war."

Here is another way to spin it.

Those parts of the economy pegged to the dollar are being/have been liquidated, leaving very little self-sufficiency, non-military industry, or financial structure that can survive the coming meltdowns.

But most nations have plenty of stuff off the books too. Informal economies are always a big sector, albeit hard to tell how big a sector. Our bonds of loyalty to family are debts but not dollar-denominated debts. Our social capital are assets, but not dollar denominated assets. As everything but the machineries of war are gutted out of the formal-economy, more and more of the actual self-sufficiency and non-war production will shift to informal economy. It will be a pale reflection of the luxurious lifestyles of the last few decades, but it isn't going to be Haiti-like either. Even without financial assets and structures, or much domestic manufacturing, Americans can still keep things lurching along (at a much poorer level) on our tenuous social webs.

Dollars will be for use in the formal economy, while social debt will be the medium of exchange of the informal economies. We may not get "hyper"-inflation unless things get really bad, but the informal economy serves as a floor to the formal economy. If the formal economy fails spectacularly enough, the informal economy will prop it up.