Saturday, November 15, 2008

Debt Rattle, November 15 2008: One Dollar One Vote

Harris & Ewing Thrifty 1913.
Boy Scouts, postal savings; Scouts depositing.

Ilargi: The G20 negotiations this weekend will produce nothing but empty resolutions and tons of embarrassing footage of twistedly smiling old men in surprisingly ill-fitting suits eating caviar and truffles. Their interests are way too diverse and divided.

Europe is subject to a virtually unlimited number of highly divergent and often contradictory forces. What is good for one goose is not for any two ganders. Further rate cuts seem an inevitable necessity in the eyes of most European policy makers, but they will leave certain EU members, even if they do not yet use the Euro, strongly vulnerable to "sovereign" attacks. We've seen huge rate hikes in Iceland and Hungary, and for countries like Greece, Turkey, Portugal, Latvia and Italy similar hikes may be the only path towards protecting their domestic markets.

The situation surrounding the G20 negotiations is very similar to what happens within OPEC. All sorts of agreements will be reached and made public, but they are increasingly meaningless and void, hollowed out by the sheer desperation that is developing on the respective home fronts. OPEC members all understand perfectly well that production cuts are probably the only way to stop the breakneck-speed fall in prices.

But for many, it is impossible to make that the top item on their agenda's. Budget deficits are rising as fast as prices fall, and they have only one way out: producing more, not less. They need all the income they can get their hands on, and are more than willing to risk disputes with other member states. The troubles on the Kuwait stock exchange this week should stand out as a bright red warning beacon to all.

Differences among the G20 participants are even an order of magnitude greater than those within OPEC. There are powerful players, like the EU and Russia, who seem willing to accept additional and stricter regulations in international banking and finance. There are parties like China, Brazil, India, and perhaps Japan, who primarily seek to come away from the meetings with increasing powers. And then there is the US, which doesn't feel like giving away one inch of the power and the freedom that the existing system provides it with.

Trying to hold on to what you got, trying to save the system as is, has been the sole US policy since the credit dams started bursting last year. In view of the fact that the policy has an exactly null and zero chance of succeeding, one might wonder why the country clings to it tooth and nail. A look at what the American political system has grown into could offer quite an insightful explanation.

Over the past 25 years, coinciding with Reagan’s push for less government and the continuation of that idea by subsequent administrations, a fourth branch of government has blossomed with a vengeance. Once again, as is the case with so much of what transpires in Washington, it is completely illegal and unconstitutional. By law, there are three branches of government, and three only: judiciary, legislative and executive. The added limb, the fourth branch, is formed by armies of corporate lobbyists. Since they operate mostly out of sight of the media and the public at large, their influence on policy making and -executing is hugely underestimated.

In exchange for the support of Congressmen and Senators for the corporations on whose pay-rolls they appear, the lobbyists offer the people’s representatives help in understanding difficult issues, and framing policy decisions based on the information they provide. When you see that the unwinding of Lehman Brothers, and all its interests, assets, liabilities and operations, which have tentacles deeply embedded inside financial institutions all over the planet, will take over ten years, you get a good picture of what it is decision makers and legislators are up against. The trimming down of government, exemplified by the outsourcing of many former Washington operations to private companies, often makes it impossible to get expert advice from neutral sources. There is no other help available.

These developments have made it inevitable that many of Washington’s official policies are being defined, and often even written, word for word, by parties that have very explicit interests in shaping policy in a way that benefits their employers. Yes, that is exactly what Mussolini and his crew had in mind when they defined corporate fascism, and it's somewhat odd that this aspect of 21st century American politics invites and receives so little attention. It may be obvious that the actors themselves would rather not be in the limelight, since they know full well what the legal status of their machinations is, but it's much less obvious why the media leave it all alone. Well, that is, if we forget for a second who owns those media.

Still, understanding how American policies are crafted, it becomes much easier to see why there is such an emphasis on rescuing corporations, especially financials, that everybody can see, and with their eyes closed, are beyond salvation, deeply bankrupt, and certain to fail eventually. And why it can all happen at the cost of ordinary citizens. The One Man One Vote principle may arguably have died long ago, the rise of the fourth branch of government has been the fatal stake through the heart of democracy. One Dollar One Vote rules today.

What will be decided in the G20 negotiations will to a very large extent carry the seal and stamp of the same corporate fourth branch of government: Wall Street banks will not accept laws and regulations that threaten their place in the sun. They will keep resisting, at home and abroad, until they no longer can. That fatal moment will come when they are forced, one way or the other, to reveal what lies in their vaults, and what losses they have incurred. It may not be so long anymore: the high-profile fight between JPMorgan and Freddie Mac may be a first indication that cracks are forming.

Citigroup: another 35,000 to be fired? Another big hit to the stock?
Vikram Pandi, the CEO of Citigroup, does not seem to be good at very much, but he is starting to get the hang of firing people. According to Reuters, "Citigroup Inc plans to shed about 10 percent of its global workforce, a person familiar with the matter said Friday."

Maybe Pandit is responding to pressure he is facing to keep his own job. Citi's shares are below $10 for the first time in over a decade and have fallen much more than those of the other major US money center banks. Wall St. still fears another year of write-offs as the big financial firm faces trouble with its portfolio of consumer debt , heavy with credit card customers who are defaulting in greater numbers as the economy worsens.

Pandit's greatest sin may be that he has not done any deal to spread his risks, broaden the bank's businesses, and transform the company. Several of his peer companies have done deals like Bank of America's purchase of Merrill Lynch which brings in more deposits and an investment banking and money management unit.

At this stage there is nothing Pandit can do. He has let the problems at the bank go too far. The economy is failing at too fast a rate. Citi's troubled balance sheet is almost certainly getting more troubled. It is not a bad bet that Citi ends up the way AIG has. If so, investors could lose another 80% or 90% of their money.

Ilargi: One of the best analyses I've seen in quite a while.

Back to the Bad Old Days: Systemic Risk, Contagion and Trade Finance
Back in the old days (pre-1980s), the term systemic risk did not refer to contagion of illiquidity within the financial sector alone. Back then, when the real economy was much more important than low margin, unglamorous banking, it was understood that the really scary systemic risk was the risk of contagion of illiquidity from the financial sector to the real economy of trade in real goods and real services.

If you think of it, every single non-cash commercial transaction requires the intermediation of banks on behalf of – at the very least – the buyer and the seller. If you lengthen the supply chain to producers, exporters and importers and allow for agents along the way, the chain of banks involved becomes quite long and complex.

When central bankers back in the old days argued that banks were “special” – and therefore demanded higher capital, strict limits on leverage, tight constraints on business activity, and superior integrity of management – it was because they appreciated the harm that a bank failure would have in undermining the supply chain for business in the real economy for real people causing real joblessness and real hunger if any bank along the chain should be unable to perform.

As the “specialness” of banks eroded with the decline of the real economy (and the migration globally of many of those real jobs making real goods and providing real added-value services to real people), the nature of systemic risk was adjusted to become self-referencing to the financial elite. Central bankers of the current generation only understand systemic risk as referring to contagion of illiquidity among financial institutions. They and we all are about to learn the lessons of the past anew.

We are now starting to see the contagion effects of the current liquidity crisis feed through to the real economy. We are about to go back to the bad old days. Whether the zombie banks are kept on life support by the central banks and taxpayers of the world is highly relevant to whether the zombie bank executives pay themselves outsize bonuses and their zombie shareholders outsize dividends with taxpayer money. It appears sadly irrelevant to whether the banks perform their function of intermediating credit and commercial transactions in the real economy along the supply chain. The bailout cash and executive and shareholder priorities do not seem to reach so far.

The recent 93 percent collapse of the obscure Baltic Dry Index – an index of the cost of chartering bulk cargo vessels for goods like ore, cotton, grain or similar dry tonnage – has caused a bit of a stir among the financial cognoscenti. What is less discussed amidst the alarm is the reason for the collapse of the index – the collapse of trade credit based on the venerable letter of credit.

Letters of credit have financed trade for over 400 years. They are considered one of the more stable and secure means of finance as the cargo is secures the credit extended to import it. The letter of credit irrevocably advises an exporter and his bank that payment will be made by the importer's issuing bank if the proper documentation confirming a shipment is presented. This was seen as low risk as the issuing bank could seize and sell the cargo if its client defaulted after payment was made. Like so much else in this topsy turvy financial crisis, however, the verities of the ages have been discarded in favour of new and unpleasant realities.

The combination of the global interbank lending freeze with the collapse of the speculative, leveraged commodity price bubble have undermined both the confidence of banks in the ability of a far-flung peer bank to pay an obligation when due and confidence in the value of the dry cargo as security for the credit if liquidated on default. The result is that those with goods to export and those with goods to import, no matter how worthy and well capitalised, are left standing quayside without bank finance for trade.

Adding to the difficulties, letters of credit are so short term that they become an easy target for scaling back credit as liquidity tightens around bank operations globally. Longer term “assets” – like mortgage-back securities, CDOs and CDSs – can’t be easily renegotiated, and banks are loathe to default to one another on them because of cross-default provisions. Short term credit like trade finance can be cut with the flick of an executive wrist.

Further adding to the difficulties, many bulk cargoes are financed in dollars. Non-US banks have been progressively starved of dollar credit because US banks hoarded it as the funding crisis intensified. Recent currency swaps between central banks should be seen in this light, noting the allocation of Federal Reserve dollar liquidity to key trading partners Brazil, Mexico, South Korea and Singapore in particular.

Fixing this problem shouldn't be left to the Fed. They aren't going to make it a priority. Indeed, their determination to accelerate the payment of interest on reserves and then to raise that rate to match the Fed Funds target rate indicates that the Fed are more likely to constrain trade finance liquidity rather than improve it. Furthermore, the Fed may be highly selective in its allocation of dollar liquidity abroad, prejudicing the economic prospects of a large part of the world that is either indifferent or hostile to the continuation of American dollar hegemony.

If cargo trade stops, a whole lot of supply chain disruption starts. If the ore doesn’t go to the refinery, there is no plate steel. If the plate steel doesn’t get shipped, there is nothing to fabricate into components. If there are no components, there is nothing to assemble in the factory. If the factory closes the assembly line, there are no finished goods. If there are no finished goods, there is nothing to restock the shelves of the shops. If there is nothing in the shops, the consumers don’t buy. If the consumers don’t buy, there is no Christmas.

Everyone along the supply chain should worry about their jobs. Many will lose their jobs sooner rather than later.

If cargo trade stops, the wheat doesn’t get exported. If the wheat doesn’t get exported, the mill has nothing to grind into flour. If there is no flour, the bakeries and food processors can’t produce bread and pasta and other foods. If there are no foods shipped from the bakeries and factories, there are no foods in the shops. If there are no foods in the shops, people go hungry. If people go hungry their children go hungry. When children go hungry, people riot and governments fall.

Everyone along the supply chain should worry about their children going hungry.

When that happens, everyone in governments should worry about the riots.

Controlling access to trade finance determines who loses their jobs, whose children go hungry, who riots, which governments fall. Without dedicated focus on the issue of trade finance and liquidity from those in the emerging world most interested in sustaining the growth of recent years, little progress can be expected.Trade finance is rapidly communicating the stress on bank liquidity to the real economy. It presents a systemic risk much more frightening than the collapsing value of bits of paper traded electronically in London and New York. It could collapse the employment, the well being and the political stability of most of the world’s population.

The World Trade Organisation hosted a meeting on trade credit in Washington Wednesday to highlight the rapid and accelerating deterioration in trade finance as an urgent priority for public policy. I look at the precipitous collapse of the Baltic Dry Index and I wish them Godspeed.

Treasury attacked over $700 billion bail-out
A senior US Treasury official came under attack on Friday as critics of the $700bn bail-out from the left and the right questioned whether the Bush administration had deceived members of Congress over how the funds would be used. Congressional leaders, including Chuck Schumer, a Democratic senator, and Spencer Bachus, a Republican congressman, applauded a Treasury move this week to scrap plans to purchase troubled securities in favour of direct capital injections into financial institutions.

But at a hearing on Friday, Dennis Kucinich, a liberal Democrat, and Darrell Issa, a conservative Republican, lashed out at Neel Kashkari, the Treasury official in charge of the bail-out, for ignoring “congressional intent”. The criticism pointed to deeper unease about the Treasury’s handling of the rescue among rank-and-file legislators, which could make it more difficult for the administration to secure approval from Congress for the final $350bn of funds that it is expected to seek.

“I want to know whether Congress was lied to or whether there was a team all along that had an alternate idea of how the money was spent,” Mr Issa said, before demanding to know the “time and date” Hank Paulson, Treasury secretary, had decided to abandon his initial plan. Mr Kashkari said the legislation authorising the $700bn bail-out had been designed to give the Treasury broad flexibility to adapt its strategies. At the same time, he said, as the bail-out was being negotiated in Congress, “credit markets were deteriorating much more quickly than we had expected”.

He also defended the Treasury against claims that it was not doing enough to immediately help homeowners at risk of foreclosure, arguing that “every American” would benefit from stability in the financial system. Separately, the Federal Deposit Insurance Corporation on Friday released the details of a new plan to refinance mortgage loans for 1.6m US households, costing the government an estimated $24.4bn. The FDIC had been discussing this proposal with the Treasury for several weeks, but the talks broke down since Bush administration officials were reluctant to fund it through the $700bn financial rescue package.

The Treasury announced its own plan this week for a more systematic modification of loans held by Fannie Mae and Freddie Mac. The Federal Housing Finance Agency, which regulates the two mortgage giants, participated in the rollout of the plan, but the FDIC did not, exposing its rift with the Treasury over this aspect of US housing policy. Some lawmakers have expressed concern that, because Treasury will not be buying mortgage securities as planned, it will have less power to modify home loans on a large scale.

Economists lock horns over bailout for automakers
A bail-out for the automobile industry being pushed by Democrats would assist companies that shouldn’t be getting aid, open the door to other undeserving applicants and stretch the limits of government, according to several prominent economists and financial experts. The federal government should stick to rescuing large, interconnected financial institutions whose collapse could reverberate throughout the economy, these observers told Financial Week.

The impact of the failure of General Motors and other car manufacturers, they explained, would be less far-reaching than that of big financial institutions. Struggling auto makers should instead consider filing for Chapter 11 bankruptcy reorganization, as airlines such as United and Continental have done. “I’m a very strong left-leaning Democrat, but I can’t support what they’re trying to do,” said Peter Bernstein, a financial consultant, economic historian and editor of the Economics & Portfolio Strategy newsletter. “Bailing out the auto industry would be a turning point that would send the message, ‘If you’re running a company that’s in trouble, take a shot at getting federal aid.’”

William Isaac, former chairman of the Federal Deposit Insurance Corp. under President Reagan, expressed similar concerns. “I don’t know where it stops,” said Mr. Isaac, chairman of consultancy Secura Group. “If you help GM, do you help Ford? If you help Ford, what about a large retailer like Wal-Mart? What about the phone companies?” “Sounds like it’s a slippery slope, doesn’t it?” added Yale University economist Robert Shiller.

However, another prominent economist expressed a contrary view, arguing that the auto industry is a special case. “Chapter 11 bankruptcy would be more devastating to car manufacturers than to airlines because owning a car is a multiyear thing, and consumers might not want to take a chance on the warranty,” said Simon Johnson, an economics professor at the Massachusetts Institute of Technology. Lending support to Mr. Johnson’s view, a CNW Marketing Research survey of new car buyers earlier this year found that 80% would avoid a bankrupt auto maker.

Mr. Johnson, who was chief economist at the International Monetary Fund, acknowledged that aiding the auto industry “could open the door to everyone, and that is a danger.” After assisting car manufacturers, the government should try to draw the line, while remaining open-minded to the special circumstances of other applicants, he said. While Mr. Johnson said he wasn’t sure to what extent a GM collapse would threaten the rest of the economy, a Deutsche Bank analyst said it would pose a significant risk.

Without federal assistance, “we believe that GM’s collapse would be inevitable, and that it would precipitate systemic risk that would be difficult to overcome for automakers, suppliers, retailers and sectors of the U.S. economy,” analyst Rod Lache wrote in a note to clients, according to the Wall Street Journal. But Mr. Isaac, the former FDIC chairman, said he believed a Chapter 11 bankruptcy would actually make GM “more viable by forcing a day of reckoning” that would involve concessions among workers, creditors, shareholders and others. Without it, GM “will be back again” for more aid six months after a bailout, he said.

The House is due to vote this week on a plan pushed by Democratic leaders to give the auto industry $25 billion in loans, in addition to the $25 billion in low-interest loans already approved by Congress. The initial aid was to retool factories to make more fuel-efficient vehicles. The legislation would give the government authority to use the $700 billion rescue fund for car makers and not just financial institutions. President-elect Barack Obama pressed President George W. Bush last week for more funding for the auto industry.

Republicans, including the president, have reacted coolly to the notion of an auto industry rescue, and Treasury Secretary Henry Paulson said last week that the bail-out legislation should be limited to financial institutions. GM reported last week that October sales fell to their lowest seasonally adjusted rate since 1982 and that it is going through $2.3 billion a month in cash, up from $1 billion earlier this year. Last Tuesday, GM shares sank to their lowest level in 65 years.

Among the financial companies that may be eligible for federal assistance are large insurers, the lending arms of car manufacturers and bond insurers. American Express, which last week got federal approval to become a bank holding company, is seeking $3.5 billion in aid, according to the Wall Street Journal. Treasury Secretary Henry Paulson said last week that the government may also try to ease strains in the markets for student loans, credit card debt and auto purchases.

Many bankers are watching warily as the rescue spreads. “Our members are concerned that there might not be enough money available for financial institutions who need it,” said Peter Garuccio, a spokesman for the American Bankers Association, which represents thousands of banks of various types. Congress split its $700 billion allotment into two equal parts. Treasury has set aside $250 billion of the first half to buy stakes in banks and committed last week to insurer American International Group.

The deadline to apply for federal aid was Nov. 14. The long line of companies seeking aid now includes even boat dealers, whose trade group is asking whether boat-financing companies are eligible for federal aid to help dealers stock their showrooms. “Should lending continue to contract for the marine sector, the U.S. boating industry will face severe short- and long-term challenges,” the National Marine Manufacturers Association said in a Nov. 12 letter to Mr. Paulson.

Gordon Brown warns US: saving car giants will ruin us all
In a veiled warning to the next American President, Gordon Brown described protectionism as the “road to ruin” yesterday as international tensions surfaced at the start of the G20 summit in Washington. As world leaders assembled for dinner at the White House last night at the start of the two-day meeting, the backdrop was one of plunging sales and surging unemployment. The New York stock market dropped 350 points after official data showed that US retail sales had fallen by 2.8 per cent in October, the biggest slide for 16 years.

The mood was darkened further with confirmation that the eurozone was now in the grip of recession for the first time since the creation of the single currency in 1999. The news will add impetus to calls for internationally co-ordinated tax cuts, public infrastructure projects and other measures to stave off a severe global recession. Although some measures to reform international financial oversight are set to be agreed at the G20 meeting this weekend, no substantial deals are expected before the inauguration of Barack Obama in January.

Mr Brown was already risking confrontation with the President-elect in barely coded criticism of a planned measure to bail out America’s ailing carmakers, a plan Mr Obama supports. “I do think it is really important that we send out a signal today that protectionism would be the road to ruin,” the Prime Minister said, in a speech to the Council of Foreign Relations in New York. “If we get into a situation where countries made decisions irrespective of what happened anywhere else, then we will see the same problems of other times. The dividing line here is between an open society capable of trading round the world, against a protectionist response that happened in the 1930s and is totally unacceptable.”

The EU said that it was ready to take action against the US at the World Trade Organisation if aid for the stricken US car industry was judged by the European Commission as illegal under international rules. The US Congress approved a $25 billion (£17 billion) aid package for American carmakers in September, although no timetable was fixed for payments to be made. Republicans on Capitol Hill oppose plans championed by Nancy Pelosi, the Democratic Speaker of the House, to use taxpayers’ money to rescue the big three car companies, General Motors, Ford and Chrysler. The industry employs about three million people across the country, and iconic of the American Dream. Wall Street is scared that should the aid be delayed, General Motors, which gave warning last week that it would run out of money by Christmas, will go bust.

Concerns over the deal helped to drive down stocks already hit by worse than expected retail figures. Yesterday’s economic numbers also showed that car sales fell by 34 per cent in the past three months, as Americans grew more fearful of losing their jobs and banks slashed overdraft and credit card limits. Consumer spending has a critical role in the US, accounting for two thirds of economic growth. Fears that the US unemployment rate was set to breach 7 per cent by Christmas grew after Citigroup, the world’s biggest bank, said that it was laying off 10,000 workers. The figures were grim on the other side of the Atlantic, too. Official figures showed that the 15-nation eurozone economy shrank by 0.2 per cent in the past quarter, on the heels of a similar drop in the previous three months. Fears grew that the contraction was set to accelerate sharply in the present quarter.

Germany was among the hardest-hit countries, with its economy shrinking a hefty 0.5 per cent in the third quarter after a 0.4 per cent drop in the three months before that. Italy suffered a similar 0.5 per cent cent contraction, its worst slump for a decade, while Spanish GDP dropped for the first time since 1993. The Irish Republic and Denmark are also now gripped by recession. In a surprise development, the French economy continued to expand in the third quarter — albeit with a meagre growth of 0.1 per cent — defying predictions of a far worse outcome.

So far, eurozone economies — which account for 16 per cent of world output and about 319 million people — have not seen unemployment rise rapidly but the EU estimates that it will increase steadily over coming months. It is also expected that the European Central Bank will be forced to cut interest rates to boost demand; some economists think that the bank will reduce the cost of borrowing by a full percentage point from 3.25 per cent in the coming weeks.

Differing agendas

United States The US is scared of new, onerous regulation and is urging European countries to respect free-market principles on the basis that long-term state intervention will damage economic growth. But US policy on bailing out troubled industries is split: Barack Obama, the President-elect, wants to use federal funds to rescue American car companies; many Republicans do not.
Britain Gordon Brown has a long list. To start with, he wants “co-ordinated fiscal stimulus packages” — which means getting countries to increase public spending to create new jobs and offer tax rebates to families. He wants the IMF to create a council of experts to monitor the markets for danger signs — his much-vaunted early-warning system — and the IMF’s coffers to be boosted by cash-rich states such as Saudi Arabia and China. He is also calling for a clean-up of the banking system, including a network of regulators to scrutinise the world’s biggest banks.
France President Sarkozy is also pushing for cross-border regulation, meaning he wants to control French banks even when they are operating outside French borders. He sees the crisis as an opportunity to depose the US dollar as the king of currencies, and replace it with the euro. Mr Sarkozy would also like an overhaul of the world financial architecture, including making rating agencies more regulated and forcing accounting standards to be the same worldwide.
Germany The Germans are deeply suspicious of secretive hedge funds, which control about $2.5 trillion worth of assets and whose activities are not regulated. They blame the hedge funds for market volatility and driving down shares by short-selling. Angela Merkel, the Chancellor, also backs greater powers for the IMF to oversee international companies, revised rules for rating agencies and making it harder to hide risks off company balance sheets.
Russia President Medvedev wants more say in the IMF, so he is teaming up with Mr Sarkozy to back President Bush into a corner. He wants alternatives to the IMF as lenders of last resort and is willing to contribute to the cost of the new agencies. Russia has also pressed for international budgetary and economic rules to prevent any further crises
China China wants to press the West for a bigger role in global financial bodies such as the IMF but at the same time it has been trying to lower Western expectations that it will join in global actions. It cites as reasons its own economic problems and limited resources as a developing country.
Brazil and other developing nations These want changes to the voting structure at the IMF and the World Bank’s to give them more of a voice.

GM Collapse Could Cost U.S. Taxpayers Up to $200 Billion, More Than Rescue
General Motors Corp., burning through cash as sales slump, would cost the government as much as $200 billion should the biggest U.S. automaker be forced to liquidate, a forecasting firm estimated. A GM collapse would mean "more aid to specific states like Michigan, Ohio, and Indiana, and more money into unemployment and extended benefits," Nariman Behravesh, chief economist at IHS Global Insight Inc. in Lexington, Massachusetts, said yesterday in an interview.

Behravesh's projection of $100 billion to $200 billion in costs dwarfs the $25 billion industry bailout plan that will be debated in Congress next week to prop up Detroit-based GM, Ford Motor Co. and Chrysler LLC. The drain on taxpayers from a rescue or a GM failure is a central issue for U.S. lawmakers. Included in the Global Insight estimate, which Behravesh supplied to Bloomberg News, are the anticipated costs for existing programs, such as unemployment insurance, and new measures that the economist said would be needed to revive economic growth after millions of auto-related job losses.

A GM shutdown would wipe out jobs among suppliers as well as at the automaker itself, pushing the U.S. unemployment rate next year to 9.5 percent, compared with current projections of as high as 8.5 percent, Behravesh said. GM said Nov. 7 it may not have enough operating cash by year's end, and would be "significantly short" of its needs by June unless it adds capital or the U.S. auto market recovers from its worst sales year since 1991. GM had $16.2 billion on hand as of Sept. 30, down from $21 billion at the end of June, and needs $11 billion to pay its monthly bills.

While some investors including Wilbur Ross say a GM bankruptcy would be a "real mess" that would end in liquidation, others such as hedge-fund manager William Ackman say there is no need for taxpayer funds and that GM should reorganize in court. "A bankruptcy wouldn't address our immediate liquidity concerns," said Renee Rashid-Merem, a GM spokeswoman. "It's not an option for GM because it creates more problems than it solves."

The Center for Automotive Research projects that federal, state and local governments would lose $108.1 billion in taxes over three years in the event of a 50 percent reduction in U.S. automaker operations. Job losses would total 2.5 million from an automaker failure in 2009, including 1.4 million people in industries not directly tied to manufacturing, the Ann Arbor, Michigan-based group said in a report on Nov. 4, three days before GM disclosed its cash drain.

"The government has real costs it would have to foot" in a liquidation, said Bob Brusca, president of Fact & Opinion Economics in New York and a former chief of international markets at the New York Federal Reserve. "They don't get those income taxes any more from the workers, they don't get the taxes from the corporation, they don't get local loss of taxes," Brusca said in an interview. States pay an average of $279 a week for unemployment benefits for 26 weeks, according to Jennifer Kaplan, a U.S. Labor Department economist. The payments can last as long as 39 weeks in some states including Ohio, where the jobless rate was 7.2 percent in September. The federal government also might "be on the hook for the pension benefits and health benefits" for workers thrown out of their jobs in an automaker collapse, said Dana Johnson, chief economist with Comerica Inc. in Dallas.

GM climbed 6 cents to $3.01 yesterday on the New York Stock Exchange. The shares have tumbled 88 percent this year. The 15 percent slump in U.S. auto sales this year through October is overwhelming years of cost-cutting efforts at GM. The company has eliminated 46,000 U.S. jobs since 2004, when it last posted an annual profit. Payroll cuts and plant closures at Ford and Chrysler have added to the erosion of auto jobs in states such as Ohio, home to assembly plants for all three companies and behind only Michigan in auto-industry employment.

The state may exhaust its unemployment trust fund by the end of December and is seeking a $500 million line of credit from the U.S. Department of Labor, said Brian Harter, spokesman for the Ohio Department of Job and Family Services. "The health of the heartland of America would be devastated" should GM stop operations along with many suppliers, former Michigan Governor Jim Buchanan, a Democrat, said yesterday in an interview. "The loss of revenue to the federal government and the states would be horrendous." The fallout wouldn't be that dire should GM manage to keep operating while in bankruptcy protection, said George Eads, a senior consultant at economic business and consulting firm CRA International Inc. "It would be a big tragedy, but not like some estimates," he said.

GM, suppliers: Trapeze artists with no net
General Motors and its suppliers are performing a death-defying trapeze act. And suppliers’ insurance companies are rolling up the net. If GM files for Chapter 11 reorganization, it will drag its suppliers down, too. On the other hand, suppliers are in a position to drive the automaker into bankruptcy. GM owes its suppliers $3 billion to $7 billion for parts in any given month, according to calculations by Automotive News.

Say nervous suppliers were to demand that GM pay cash on delivery for parts. If GM had to pay out even $3 billion tomorrow, its operating cash would drop below the $14 billion level it says is necessary to run the business on a day-to-day basis. Asked if he is seeking shorter payment terms from the Detroit 3, Gregg Sherrill, CEO of Tenneco Inc., of Lake Forest, Ill., said “We don’t think that’s the right way to go. You start doing that and pretty soon you push everyone over the cliff.”

On Nov. 8, two top GM executives—Bo Andersson, group vice president for purchasing, and COO Fritz Henderson—held a conference call to reassure its 325 largest suppliers, says a supplier executive. Mr. Andersson has stepped up his meetings with individual suppliers as conditions have worsened. A GM bankruptcy could devastate a supply base left fragile from declining production volumes, higher raw material prices and tight credit.

“We have a lot of exposure to the Detroit 3,” said Charles Hageman, vice president of the Forging Industry Association in Cleveland. “It they went out of business they would take a lot of our members’ revenue with them.” Marc Santucci, president of consulting firm Elm International Inc., of East Lansing, Mich., disputes the theory that supplier ranks would tumble if one of the Detroit 3 melt down—with a few notable exceptions, including American Axle & Manufacturing Holdings Inc., Delphi Corp. and Visteon Corp.

Most other companies, he said, have enough nonautomotive business, or are nimble enough, to weather the storm. Those well diversified by region, customer and product lines include Johnson Controls Inc., Denso International America Inc. and Robert Bosch LLC. But survival assumes that suppliers get paid for the work they have delivered. Many have large obligations from buying tools, certifying parts and prototyping expenses. If they can’t recover their debts, they could be toast.

The most immediate risk comes from the banking community, said turnaround expert John Groustra of Conway MacKenzie & Dunleavy, of suburban Detroit. He said banks would halt lending if a bankruptcy were imminent. “If they stop lending, it would bankrupt most suppliers. It’s doomsday.”

Meanwhile, some suppliers that bought credit protection for their deliveries have had their insurance canceled. “My client got whacked by Euler Hermes ACI,” said Scott Eisenberg, managing partner with investment banking firm Amherst Partners LLC, of suburban Detroit. He said Euler Hermes, a Paris unit of insurer Allianz, canceled its trade credit insurance as the client, an injection molder supplying mostly Asian companies, came under pressure from higher-priced raw materials and falling volumes. Rick Ostopowicz, a spokesman for Euler Hermes, said, “Buyers with riskier grades have their coverage severely reduced or canceled.”

Great Britain’s Financial Times newspaper reported today that Euler Hermes and two other large European credit insurers, which together control more than 80 percent of the world’s credit insurance market, are refusing to write policies for suppliers trading with GM or Ford Motor Co.

'Dumbest People' Industry Image May Cost GM CEO Wagoner His Job
Rick Wagoner's 31-year career may fall victim to the mistakes of the industry and his own, even if General Motors Corp. survives.
The GM chief executive officer unleashed scrutiny of his record after asking for a government bailout to keep the Detroit automaker in business. Now, his departure may be a necessary condition of any federal rescue, business leaders and lawmakers say. "Management needs to be replaced," said Robert Crandall, former chairman and CEO of American Airlines parent AMR Corp. "The fact is that the management as a whole has had lots of opportunities to fix this. They haven't."

Wagoner has run the world's largest automaker for the past eight years, presiding over $73 billion in losses beginning in 2005. He already endured a fight with dissident shareholders and several failed turnarounds and may argue he knows the company better than most who could take his job. The 55-year-old executive joined GM in 1977, as U.S. automakers were fending off Japanese competitors who recognized the need a decade earlier to build fuel-efficient vehicles. While U.S. auto sales broke records during Wagoner's years as CEO, the three major producers -- Ford Motor Co., Chrysler LLC and GM -- battled against high labor costs from pension and retiree health care obligations.

"There's the feeling that next to financial services, automotive execs are the dumbest people in the world," said Thomas Stallkamp, a former Chrysler president who worked at the car company when it received emergency government loans in 1980. "There are probably some symbolic moves that somebody's going to ask for." The federal government insisted on replacing the CEOs of American International Group Inc., Fannie Mae and Freddie Mac when they received aid. Lawmakers including Senator Sherrod Brown, an Ohio Democrat, said some executives may have to go before GM and the other U.S. automakers receive $25 billion in new government loans. "It's pretty clear that management has made some pretty bad decisions over the last 20 years," Brown said, adding that changing management is something that Congress must "think seriously about."

Wagoner won't offer to resign, he told Automotive News this week. "It's not clear to me what purpose would be served," he said. "Our job is to make sure we have the best management team to run GM." He wasn't available for comment. "Nothing has changed relative to the GM board's support for the GM management team," the company said in an e-mailed statement. The automaker, which may lose its title as the biggest to Toyota Motor Corp. at the end of the year, has dropped almost six percentage points of U.S. market share during Wagoner's tenure, falling to 22 percent as of Sept. 30. GM stock, at a six-decade low, has sunk 95 percent under the 6-foot-4-inch, Wilmington, Delaware-born executive.

"It's hard to imagine how a management team that has presided over this sort of decline would instill confidence that they can manage their way out of it," said Charles Elson, director of the Weinberg Center for Corporate Governance at the University of Delaware. Still, Wagoner has shown staying power, weathering the losses and activist investor Kirk Kerkorian's 2006 push for an alliance with Renault SA and Nissan Motor Co., Elson said. A case can be made that Wagoner shouldn't be blamed for GM's travails, he said, because it has been hamstrung by the costs of providing health care to 1 million employees and dependents, an issue that should have been handled by the government. As CEO, the former Duke University basketball player and Harvard University MBA early on bet against gasoline-electric hybrid vehicles, focusing research on hydrogen technology. GM offered its first full-scale hybrids in 2007, a decade after Toyota introduced the Prius.

He kept GM focused on trucks and sport-utility vehicles, only to press for development of the Volt plug-in electric car when gasoline prices soared. Truck and SUV sales are down 16 percent since 2004. Wagoner used the purchase of South Korea's Daewoo Motor Co. to expand GM's overseas sales 51 percent to 5.5 million cars and trucks by 2007. He wrung concessions from labor unions last year, including cutting wages in half for new hires and offloading retiree health care to a union-run trust by 2010. "We believe that we were well along to fundamentally restructuring our business before the current financial crisis, in terms of product quality, productivity, energy solutions and costs," Tony Cervone, a GM spokesman, said. "That strategy will be what leads us to success in the future."

Finding the right person willing to take the job may extend Wagoner's longevity. Firing management will cause more trouble than it solves if a new team has to relearn the issues and deal with federal overseers new to the car market, Stallkamp said. "You can't parachute in a bunch of people that don't know anything about it," said Stallkamp, 62, now a partner at the buyout firm Ripplewood Holdings LLC. He said he "has a lot of respect" for many executives at the automakers and wasn't referring to any one person. President-elect Barack Obama is pushing for Congress to approve as much as $50 billion for the automakers and appoint a czar or board to oversee them, people familiar with the matter said yesterday.

Stallkamp recalled fighting with a government board that wanted to delay investments in light trucks and minivans during the Chrysler bailout. Chrysler CEO Lee Iacocca pressed for them and the family-friendly vans turned out to be one of the automaker's 1980s successes. Wagoner's situation differs from Iacocca's, and the other Big Three auto leaders, because of his three-decade GM employment. Ford CEO Alan Mulally took up his post in 2006 after a career at Boeing Co. Robert Nardelli became Chrysler's CEO in 2007 after running Home Depot Inc. Iacocca, known as a product innovator responsible for the Ford Mustang, was brought in to help fix Chrysler in 1978. He lobbied Congress for a bailout, and in January 1980 $1.5 billion in federally guaranteed loans was signed into law. Chrysler repaid them three years later. "Lee Iacocca had a clear plan to return that company to profitability," said Peter Morici, a business professor at the University of Maryland. "These guys do not."

Senator Charles Grassley, an Iowa Republican, said in a letter yesterday to the three auto leaders that they should follow Iacocca's example and cut their own pay. Iacocca took a $1 yearly salary and his executives as much as 10 percent less after the bailout, according to the letter. The bailout for automakers faces opposition from Republicans, including House Minority Leader John Boehner and Senator Richard Shelby from Alabama who sits on the Senate Banking Committee. The Bush administration also opposes using any of the $700 billion financial-rescue package to aid automakers.
Wagoner, the CEOs of Ford and Chrysler, and the United Auto Workers president have been invited to testify at a Nov. 19 hearing before the House Financial Services Committee.

In several bailouts, the government has required top executives to leave when it takes financial control of companies. Treasury Secretary Henry Paulson replaced Fannie Mae CEO Daniel Mudd and Freddie Mac's Richard Syron when he put the two mortgage-finance companies into government conservatorship in September. AIG chief Robert Willumstad left after the Fed took control the same month. In 1984, federal regulators replaced the board chairman and CEO of Continental Illinois National Bank and Trust Co. after taking an 80 percent ownership stake. The chairman of Lockheed Aircraft Corp., now part of Lockheed Martin Corp., kept his job when the defense contractor won $250 million in federal loan guarantees in 1971, even after offering to resign.

"The management is more interested in Lockheed's survival than in any jobs, and that starts with me," Lockheed Chairman Daniel Haughtontold Time magazine. Aid to the automakers must come with conditions that reduce their U.S. production costs to match or beat those of Toyota, said Crandall, who managed a unionized workforce as American Airlines CEO from 1985 to 1998. Toyota generated pretax profit of $922 per vehicle on North American sales in 2007, while GM lost $729, according a June report by New York-based consulting firm Oliver Wyman. "If we don't impose conditions that we honestly believe will make GM successful, then we're just kidding ourselves," said Crandall, who last owned an American car 10 years ago and now drives a Toyota. "Their costs are simply out of whack and the quality isn't up to snuff."

Russia and EU attempt to outflank US on G20 global finance revolution
Russia and the EU agreed today to pile pressure on President Bush to accept far-reaching changes to the global financial system at the G-20 summit in Washington. Dmitri Medvedev, the Russian President, said that Russia's ideas were almost identical to those put forward by Nicolas Sarkozy, the French President, on behalf of the EU.

Both men have talked of the need for fundamental changes to post-war institutions such as the International Monetary Fund to take better account of the developing economic powers of the world, while President Bush has appeared reluctant to make major alterations. In a sign that they are prepared to sideline the outgoing US president, Mr Medvedev backed the call from President Sarkozy for a follow-up summit in February once Barack Obama has taken over.

Mr Sarkozy said after a one-day EU/Russia summit in Nice that he welcomed the meeting of minds with President Medvedev, which came despite lingering disagreements over Russia's invasion of Georgia. "Russia's financial, technical and economic proposals are of singular quality and they are very close to the European proposals," Mr Sarkozy said. "I am delighted to know that there is a determination on behalf of the Russian Federation to ensure that something strong comes out of the Washington summit. This should not be a summit held without any positive outcome."

Mindful that the combined pressure of Russia and the EU will be seen as a concerted effort to force President Bush to make deeper changes than he wants to, Mr Sarkozy added: "I do not say this in a spirit of aggressiveness to anybody but this crisis is very serious and we have to change things on a long-lasting basis." President Medvedev said: "The positions that I have and Nicolas has pretty much coincide. We need an appropriate, adequate response, not just a list of decarations, not just hand-shaking, not just photos."

Looking beyond the remaining weeks of the presidency of Mr Bush, he added: "We need a plan of action. We need to insist on having a fully-fledged agenda and reaching very serious decisions. The positions of Russia and the EU on overcoming the global economic crisis are very close. "We are not going to create a new Bretton Woods in Washington but we need to make a very serious step in this direction and I am very supportive of the idea of holding another summit after Washington without any serious delays."

FDIC clashes with US Treasury on anti-foreclosure plan
A top U.S. banking regulator unveiled a plan on Friday to prevent about 1.5 million foreclosures, breaking ranks with the Bush administration by demanding bailout funds be diverted from banks to consumers. The Federal Deposit Insurance Corp said the plan would modify millions of delinquent mortgages and the government would reward participating lenders by sharing the cost of defaults on restructured loans.

The dispute over housing policy during the administration's final weeks spilled into the public as a the President George W. Bush administration renewed its opposition to using money from the $700 billion bailout fund to support such a foreclosure-prevention program. "The FDIC proposal at the end of the day is a spending proposal," Treasury Interim Assistant Secretary Neel Kashkari told a Congressional hearing on Friday. Kashkari said the Troubled Assets Relief Program (TARP), which the Treasury controls, was designed for making investments in the financial system, not giving aid.

FDIC Chairman Sheila Bair spent weeks lobbying Bush administration officials to fund her plan through TARP before announcing the initiative. "I have never seen anything like this," said John Douglas, a former FDIC general counsel who is now a partner at law firm Paul Hastings Janofsky & Walker. "This is extremely unusual for an agency to get out in front of the administration like this."

Viewed narrowly, Bair's responsibility is to protect the solvency of the nation's bank insurance fund -- the pot of money that is used to protect depositors if a bank fails. Bair is taking an uncommonly broad view of her role and has become a consumer crusader through the housing crisis. Douglas said that Bair does not have the power to unilaterally implement the foreclosure plan but that her approach is gaining currency. "She certainly has a lot of cover from Democrats and even some Republicans," he said.

Kashkari said Treasury Secretary Henry Paulson thinks the FDIC proposal "is a very interesting idea" and urged Congress to consider drafting legislation to create such a program. The White House said it is carefully reviewing the FDIC plan, but that it has to think about its potential cost. The FDIC said its plan would cost the government about $24.4 billion, which could be paid from the TARP. Most of the money from an initial disbursement in that program has been injected as capital into banks.

The FDIC issued the proposal two days after Paulson publicly dismissed the idea. Leading Democratic lawmakers have rallied behind Bair, a Republican, and have even pushed for her to have a place in Democratic president-elect Barack Obama's administration. The FDIC pushed forward with its plan, posting it on the agency's Web site on Friday morning ( "Although foreclosures are costly to lenders, borrowers and communities, the pace of loan modifications continues to be extremely slow," the FDIC said.

Still, Douglas said, Bair's bold plan might obscure the fact that modifying mortgages is a complicated business. Litton Loan Servicing, one of the nation's largest servicers for subrime loans, has found that more than one in four home loans that go into foreclosure have already been abandoned by the borrower. "Many times these homeowners did not respond to loan modification offers and have simply walked away from their homes," Larry Litton, Jr., the company's president, told a Congressional panel on Friday.

"This sort of approach can create all sorts of incentives for people to change their behavior and look at their mortgages differently," Douglas said of Bair's proposal. Eligible borrowers would include those who have missed at least two monthly payments on loans for homes they live in. Lenders would be expected to lower those borrowers' monthly payments to about 31 percent of the borrowers' monthly income. The plan is modeled on the FDIC's program to modify distressed mortgages at failed lender IndyMac Bancorp Inc, which the agency seized in July.

The federal government has laid out a number of plans in recent months to try to help distressed homeowners, the latest of which came earlier this week. On Monday, the federal overseer of mortgage giants Fannie Mae and Freddie Mac said the companies' struggling borrowers can apply to have their mortgage payments lowered to 38 percent of their income. The FDIC has said those industry-led efforts have not gone far enough, and that $24 billion in federal money should be spent on the mortgage guarantee program.

Paulson's 'Chump' Kashkari May Ruin Christmas, Congressman Says
On Capitol Hill today, Neel Kashkari became the "chump" who stole Christmas. Kashkari, who oversees the Treasury's $700 billion financial rescue plan, came under fire at a congressional hearing, notably by Maryland Democrat Elijah Cummings. Cummings was angry about reports American International Group Inc., which got an expanded $150 billion government bailout this week, is setting aside $503 million in compensation for executives.

"I'm just wondering how you feel about an AIG giving $503 million worth of bonuses on the one hand, and accepting $154 billion from hard-working taxpayers," Cummings asked Kashkari. "What really bothers me is all these other people who are lining up. They say, well, is Kashkari a chump?" Kashkari, who was selected by Treasury Secretary Henry Paulson as interim head of the Troubled Asset Relief Program, told the panel that he was "outraged" when he first read the reports. Then he learned AIG has set aside the money to eliminate an incentive to leave the insurer, he said. "I'm not defending it," he said.

Cummings went further, saying Kashkari's decisions will determine whether consumers will have a happy holiday. "Every decision that you make you think about those folks who are losing their jobs and who are in pain and who are not going to have a decent Christmas," Cummings said. "They're going to probably be sitting under the Christmas tree with no presents." Cummings didn't seem to be in a hurry to have Kashkari leave the job, asking him whether he'd stay on to manage TARP for the next administration. Kashkari responded that he'd be "honored" to be asked to serve, with the caveat that "I'd have to ask my wife."

Dennis Kucinich, chairman of a House Oversight and Government Reform subcommittee, repeatedly interrupted the Treasury official during the more than two-hour session, criticizing Paulson's decision this week to abandon the TARP's original intent of purchasing toxic mortgage assets from financial firms. Paulson two days ago said he was shifting the focus of the program to relieve pressures on consumer credit. The reversal came with two months left before the end of the Bush administration and the inauguration of President-elect Barack Obama.

"The secretary just essentially took some scissors and cut it out and threw it away," Kucinich said. "Maybe this is some kind of game to some people in the administration. They're on their way out of office and they just feel they can do whatever they want." The Treasury has committed $290 billion of the $350 billion already allocated through capital injections to banks and AIG. The four attending members of the House Oversight and Government Reform Committee's subcommittee on domestic policy accused Treasury of picking "winners and losers" by giving loans to healthy banks to use in buying smaller ones.

"All of a sudden, the Treasury sent a signal to the banks: 'Forget about it. We're going to give you the money you want and you do what you want with it,"' Kucinich said. Kashkari, 35, said his department isn't in charge of bank oversight, and that financial regulators are working to ensure participating firms use capital to increase lending. Even as they accused his department of not paying enough attention to homeowners struggling to avoid foreclosure, members of the panel acknowledged that Kashkari was taking heat for the Treasury as a whole.

"I guess you sort of got a taste of how Mel Gibson felt in the last scenes of `Braveheart,"' California Republican Brian Bilbray said, referring to when Gibson gets strung up on a rack. "You're probably the best spokesman the administration has. You've come across with more credibility than anyone else that I've heard."

Freddie, JPMorgan in Dispute Over Bad WaMu Loans
Freddie Mac and JPMorgan Chase & Co. are in a dispute over bad mortgages sold by Washington Mutual Inc. that may strip JPMorgan of millions of dollars in fees. JPMorgan, which took over Washington Mutual's assets after the thrift collapsed, told Freddie it won't buy back mortgages sold by WaMu that failed to match promises made about their quality, McLean, Virginia-based Freddie said today in a regulatory filing.

Freddie, the mortgage-finance company seeking $13.8 billion of capital from U.S. taxpayers, in turn told JPMorgan that it won't permit the bank to keep the thrift's mortgage servicing contracts "unless it assumes the Washington Mutual repurchase obligations," according to the filing. Freddie, competitor Fannie Mae, insurers, banks, and bond investors have been seeking to enforce contracts that would shift more of the losses from a surge in U.S. foreclosures to the lenders that originally made the loans or to others that provided assurances about their creditworthiness.

Under Freddie's agreements with banks, the company can seize contracts to service, or manage, outstanding loans for several reasons, including a failure by the servicing bank to repurchase mortgages. Servicers collect mortgage payments and pass them on to other companies and bond investors for a fee that's typically 0.25 percent a year. WaMu, the fifth-largest mortgage servicer at the time of its collapse, reported its contracts to service $441 billion of loans for third parties were worth $6.2 billion on June 30, according to a July statement. Servicing for Freddie, Fannie and government agencies accounted for $252 billion of the loans.

Thomas Kelly, a spokesman for New York-based JPMorgan, which acquired Seattle-based Wamu's assets and branches in September as the savings and loan became the largest U.S. banking company to fail, declined to comment. JPMorgan is the third-largest servicer, according to newsletter National Mortgage News. Loan repurchases by sellers to Freddie almost tripled during the first nine months of this year to $1.2 billion and the company may lose more than $1.3 billion because of outstanding "servicing-related obligations" including for buybacks at Lehman Brothers Holdings Inc. and IndyMac Bancorp., according to the filing. Lenders sometimes agree to cover Freddie's losses instead of repurchasing loans, the filing said.

"Next year will bring more of these sorts of disputes to light as the stakes get larger and patterns of bad originations standards in 2006-2007 become clearer," Jim Vogel, the head of agency debt research at FTN Financial Group in Memphis, Tennessee, wrote in an e-mail today. Ambac Financial Group Inc., the New York-based bond insurer, sued JPMorgan's EMC Mortgage Corp. on Nov. 5 over representations made about loans backing mortgage securities. JPMorgan bought EMC Mortgage along with the collapsed Bear Stearns Cos. in March.

Freddie, which today reported a record quarterly loss of $25.3 billion, and Washington-based Fannie own or guarantee more than 40 percent of the almost $11 billion of outstanding U.S. home loans. The government seized the firms in September amid growing losses and promised to inject $100 billion in capital into each, to protect buyers of their debt and mortgage bonds. Lehman filed for bankruptcy protection in September and IndyMac was taken over by bank regulators in July.

Fannie's "backlog of unfulfilled loan repurchase and reimbursement requests" has been burgeoning, in part because "many servicers have been slower to comply with our requests due to financial difficulties and liquidity constraints they are experiencing," according to a Nov. 10 filing. As far as Fannie knew on Nov. 7, JPMorgan hadn't "yet indicated" to Federal Deposit Insurance Corp. whether it planned to permanently assume the WaMu's servicing contracts, which were held at the company's bank unit, the filing said.

Lehman's bankruptcy '10 times more complicated than Enron'
The administration of the London-based arm of Lehman Brothers will be "at least 10 times" more complicated than the European side of the Enron bankruptcy in 2001, according to the team of accountants at PricewaterhouseCoopers which has worked on both transactions.

The administrators, led by Tony Lomas, said yesterday at a press conference on the Lehman situation that there are more than $1 trillion of positions to unwind as part of the administration process, which is likely to take several years and go through court proceedings with some parties as they try to decide what is owed to whom, where the assets are, and secure those funds or securities for the creditors. Only about $5bn of asset realisations have been made so far after more than two months. "We have got a long way to go," said Mr Lomas.

Part of the complication is due to UK bankruptcy law, as opposed to its US equivalent. While the US arm of Lehman was able to continue to trade for several days while under bankruptcy protection, the European arm, based in London, had all its trades frozen, leaving a big web of in-limbo assets and payments. The complexity of the trades and inter-relationships between different Lehman businesses also makes the unwinding more difficult. About $1bn is held up in the company's German business, for example. The problem is especially acute for some creditors such as hedge funds, which are already being battered by the market and facing mass redemptions as well as trading losses.

The PWC partner Mike Jervis, who is also working on the situation, said that about 100 of Lehman's creditors have told PWC they face serious financial challenges due to Lehman's insolvency. The comments came at a press conference given after the PWC team met creditors at a semi-public event at O2 in London, within sight of the Lehman building at nearby Canary Wharf. The creditors had arrived around 11am, although the meeting had to be delayed due to the high attendance. About 1,000 creditors stood out in the huge space that is the O2, partly by their sheer number and partly due to their grey suits as they queued to enter the venue in an otherwise almost empty venue aside from a few families.

Some looked resigned, some nervously made and took calls on their mobile phones before entering. PWC public relations executives hovered near the queue in an apparent attempt to stop press – who were banned from the meeting – from talking to possibly disgruntled creditors as they queued. Three hours later the creditors flooded out in a big horde, still looking subdued, with some joking with one another as they walked towards the Jubilee line station for the rides back to Canary Wharf, the City and Mayfair.

Unlike meetings in the US, where creditors have regularly vented their anger, the London affair was much more polite. While there is undoubtedly anger among those owed money by the defunct bank, it was "kept as inner frustration" in a very British way, according to Raj Jansari, a lawyer for Dresdner, who attended the meeting. "It was very civil. Questions were asked, questions were answered," said Mr Jansari. The most noteworthy point made in the meeting was "how extremely complicated and long this is going to be to unwind," he said.

Among points was a vote among creditors for a committee representing them, the results of which will be known next week. But another point is clear: there will be no refund of all the owed money as fees are levied, the positions are unwound and assets are revalued. "The creditors will lose money," said Mr Lomas. PWC is yet to formally set its own fees as administrator, but those are running around $4m a week. The accountant also has to pay about 1,100 Lehman employees to stay on and use their unique knowledge of trades and the Lehman systems to help it unwind positions.

It will be paying them equivalent salaries to those they would have earned in 2007 – at the height of the financial boom that preceded the credit crunch – and will also pay some of them more as it seeks to retain them. the total cost will be about $8m a month, they said. "This will be an expensive process."

4 US insurers seek to buy thrifts to be eligible for bailout
Four insurance companies on Friday asked the government to allow them to buy thrifts so they can qualify to receive federal money under the financial rescue program. Hartford Financial Services Group Inc., Genworth Financial Inc., Lincoln National Corp. and Aegon NV, a Dutch company that owns U.S. insurer Transamerica, each asked the Office of Thrift Supervision for permission to acquire an existing savings and loan.

The deadline for filing applications was Friday. The Treasury Department agency said it received submissions from those four firms to become thrift holding companies by acquiring savings and loans. Insurers that own thrifts, which are federally regulated, are eligible to apply for a piece of the $250 billion the government is spending to buy shares in banks and other financial companies. Thrifts differ from banks in that, by law, they must have at least 65 percent of their lending in consumer loans such as mortgages.

Hartford Financial said it expects to be eligible for between $1.1 billion and $3.4 billion in government bailout money. The Hartford, Conn.-based company said it had agreed to buy Federal Trust Bank for about $10 million and to inject an undisclosed amount of new capital into the federally chartered savings bank. Federal Trust Bank, now owned by Sanford, Fla.-based Federal Trust Corp., operates 11 branches in Florida.

Richmond, Va.-based Genworth Financial applied to acquire Inter Savings Bank, a thrift based in Minneapolis, according to the thrift agency. Philadelphia-based Lincoln National is looking to buy Newton County Loan & Savings, based in Goodland, Ind., while Transamerica is seeking to acquire Suburban Federal Savings Bank of Crofton, Md. Insurance companies are mostly regulated at the state level, but insurers that become thrift holding companies are under federal supervision and thereby qualify for the government bailout money. At least two dozen insurers currently own thrifts.

Many insurers have been struggling. Hartford and Lincoln were among several companies analysts identified this week as likely needing to raise capital and facing the possibility of ratings downgrades. "It wasn't just the banks and other institutions that were buying the subprime mortgage packages," said Tony Plath, a finance professor at the University of North Carolina at Charlotte. "It was the insurance industry that bought a lot of that -- which is why they are now backpedaling to write all that stuff off their balance sheets."

Plath said insurance companies are "holding their hand out to Treasury for money because they don't have any capital left to write it off against." A number of property-casualty insurers have said they aren't interested in participating in the bailout program. The industry appears to be split between life insurers, some of whom have previously expressed interest in participating in the program, and property-casualty companies.

In a letter last month to Treasury Secretary Henry Paulson, Chubb Corp., a major property-casualty insurer, said "we do not believe that allowing property and casualty insurance companies to participate in the (Treasury program) is consistent with the stated purpose" of the law creating it. That purpose is "to restore liquidity and stability" to the U.S. financial system, Chubb noted in the letter.

Nearly a million British buy-to-let properties are standing empty
The credit crisis is set to take the number of vacant properties in the UK past 1m next year and tax incentives for renovation work are needed to spark a change in thinking. Almost 1m homes are standing empty across the United Kingdom, and the vast majority – more than four out of every five – are believed to be owned by private landlords.

An empty home could just as easily be a rundown terrace house in an urban back street as a luxury newbuild apartment in a city centre filled with identical blocks. It might be empty because a glut of rental property means no tenants, or because vandalism, or simple disrepair, has made it unlettable. Some landlords might be actively trying to sell, or planning refurbishment, while many have simply given up on their empty properties. Whatever the reason, the Empty Homes Agency (EHA) believes that a staggering 85pc of empty homes in this country belong to landlords.

The campaigning charity plans to use this year's National Week of Action on Empty Homes, which runs from November 24 to 28, to highlight how individuals can help to reduce the number. Earlier this month Halifax, the mortgage provider, put out figures showing that the number of privately owned properties in England standing empty for more than six months had fallen gradually over recent years. However, David Ireland, chief executive of the EHA, says that the figures date from April 2007, just before the supply of city centre flats passed saturation point, and before the credit crunch and falling prices made it less attractive for developers and landlords to renovate empty homes.

The EHA claims that there are more than 762,000 empty residential properties in England. Based on earlier figures, about 650,000 of these are believed to be owned by private landlords, and almost half of these are thought to have been empty for more than six months. The charity estimates that there are at least another 77,000 empty residential properties in Scotland, plus 50,000 each in Wales and Northern Ireland. Mr Ireland predicts that the total number will pass 1m in the next year. "The situation is getting worse," he says. "Even these figures were compiled in October 2007, before the property downturn led to a rise in repossessions. We're at the beginning of a trend of rising empty homes, which is what we have seen at the beginning of other recessions."

The National Landlords Association (NLA) questions how many owners of empty homes are "true" landlords. "There is a difference between empty properties owned by landlords and those owned by speculators," says Elizabeth Brogan of the NLA. "Genuine landlords want a property occupied. It costs money to keep it empty. Most homes are only empty for a short while, and there is usually a valid reason. It could be between tenants, for example." However, Mr Ireland says that, whatever the definition, landlords have a huge role to play in bringing down the number of empty homes. "If you don't want the worries of being a landlord, housing associations and local authorities are always looking for empty homes. They offer various schemes, such as private-sector leasing, which will take over your property for several years," he says.

Landlords with dilapidated properties should investigate local authority grant and loan schemes, which help with the cost of repairs and refurbishment. Although local authorities are not obliged to use their housing budget to deal with empty homes, some will work in conjunction with private landlords. The No Use Empty initiative, for example – a partnership between Kent County Council and four East Kent District Councils, Dover, Shepway, Swale and Thanet – has rescued almost 500 empty properties since it was launched in 2005.

It offers interest-free loans to existing landlords or prospective purchasers to renovate empty properties. "This amounts to £25,000 for each unit of accommodation proposed for the renovated building, up to a maximum of £175,000 per project," says Mike Thompson, the empty property officer for Thanet District Council, which is renovating properties in Margate and Ramsgate. When renovation is complete, the owner is free to let or sell the property. The loan is paid back as a proportion of the rent, or at the point of sale. However, some local authority grants will require you to let your home to the authority or a housing association for a set term, usually between three and five years.

Another option is to find out about housing co-operatives in your area. These are not-for-profit organisations set up to help those in need of housing, and may take on residential properties that require refurbishment to bring them up to rental standard. Local councils will have details, or you can search online for "housing co-operative" and the relevant town or city. This option is particularly suitable for landlords who lack the resources to do the work themselves. The co-operative will carry out the work, and rent the property on a licence, usually allowing the landlord one month's notice to reclaim it. The monthly rental figure will usually be lower than a market rent, depending on local demand, and subject to deductions for repair work. Housing co-operatives generally cover council tax and water rates.

"When you reclaim the property, it will have been improved and maintained," Mr Ireland says. "Tenants tend to be responsible people who are employed, but on a low income. They are not vulnerable, so won't be prioritised for social housing, but are a group badly served by the current housing market." The EHA and Halifax are calling on the Government to reduce the rate of value added tax payable on renovations. Building work on an empty home attracts full VAT at 17.5pc, unless the property has been vacant for more than three years, when a reduced rate of 5pc applies. A property has to be vacant for more than 10 years to attract a zero rate. "The 17.5pc VAT rate is a huge financial disincentive to refurbish empty properties," Mr Ireland says.

Although empty and unfurnished properties are exempt from council tax for six months, and are allowed a 10pc "empty discount" after this period, landlords with empty properties lose out, not only because they receive no rent but also because their neglected investment depreciates in value. "Investors with an empty property should also inform their insurers as soon as it becomes vacant, or they could have difficulties claiming and be refused further cover," says Nigel Hughes of Stephen Lower Insurance Services, the buy-to-let insurer. "Most policies have clauses that accept there will be breaks in occupancy, and usually allow 30 days. The problem is large breaks. We would probably wait until the renewal date to increase premiums, but excesses might increase midterm if a claim had to be made."

Some insurers will cover an empty property only if it is inspected regularly. Extra security measures, including boarding-up and draining the water system to reduce the risk of burst pipes, may be required. In theory, there should be no empty homes at all. Under Empty Dwelling Management Orders (EDMOs) introduced in April 2006, local authorities can seize a property if it is left empty for more than six months. If the owner wishes to reclaim it, they must go to a Residential Property Tribunal to argue for the order to be withdrawn.

However, EDMOs are complex and lengthy, and so far only a few hundred have started. About 20 went as far as the "interim order" stage before owners stepped in and reclaimed properties, and only three have resulted in a final order. "The EDMO legislation has not resulted in thousands of empty properties being seized, as was first anticipated," Mr Ireland says. "But where it has been enforced it has acted as a lever to encourage landlords to take responsibility for the empty properties they own."

Landlords who need to keep an empty property safe from vandals and squatters while it awaits refurbishment could consider using a property guardian. The system, a cheaper option than employing a security guard, typically uses young people who are prepared to move into empty buildings with basic facilities and act as passive guards to deter squatters and intruders. They pay the property guardian company a low rent, and the company also charges the landlord a weekly sum. "One of the reasons why people use us is that we can get people into a property at 24 hours' notice," says Paul Cook, who founded the property guardians Ambika in 1988. The business started out working with the Crown Estate in Regent's Park, now a slice of central London prime estate, but then plagued with squatters.

Property guardians, such as Ambika ( and Camelot (, operate not only in residential properties but also, for example, in former care homes, libraries and office blocks. Guardians will move into a property regardless of its physical condition – as long as it meets health and safety requirements. The company will install temporary kitchens and bathrooms if required. Tenants live at properties on a licence, which gives security but not residency rights and allows landlords to reclaim the properties at short notice – usually a month.

Most of Ambika's guardians are male Australians, New Zealanders and South Africans. A strict vetting procedure is in place; each individual must hold a security guard licence from the Security Industry Authority, and new guardians will be taken on only if they are personally introduced by an existing guardian. Ambika charges clients from £40 a week for property guardian cover – a substantial saving on full-scale security guards and cameras.

Middle class face jobs disaster, warns Bank of England
The middle classes are facing a "white collar recession" of falling living standards and unemployment as the economy suffers its worst year since 1980, the Bank of England has warned. Mervyn King, the Bank's governor, said the economy would shrink by 2 per cent next year, with the downturn hitting those working in the managerial, services and financial sectors. He said "the world had changed" in the wake of the global financial crisis and that "people should be concerned" about the difficult times ahead.

Analysts warned that whereas in the recessions of the early 1980s and 1990s, when manufacturing and manual workers were the hardest hit, the recession of 2009 would impact particularly badly on households dependant on the "white collar" professions. This time around, the recession has its roots in the financial services, with thousands of jobs already having been cut from investment banks and other financial services companies.
Goldman Sachs, the most prestige of all investment banks, has started to cut 10 per cent of its 32,5000 global workforce, while rivals UBS, Cititgroup and Morgan Stanley have also wielded the axe to their London offices.. Richard Snook, of the Centre for Economics and Business Research, which tracks City jobs, predicted that 28,000 wholesale financial services jobs would go in London over the next year. "Goldman is just the tip of the iceberg," he said.

There are already signs that the recession has spread from the City to hit a host of other white collar professions, many of which have enjoyed a period of unprecedented growth over the last decade. Estate agents, mortgage brokers and other people working in the housing industry have lost jobs in their thousands, while the media sector has also been hit hard. Earlier this week cable group Virgin Media, which said it was axing about 2,200 British jobs by 2012 and about 1,300 jobs are scheduled to disappear at Yell, the company behind the Yellow Pages directories, over the coming year. GlaxoSmithKline, the UK's biggest drugs group, unveiled plans to close its factory at Dartford, with some 620 jobs to go by 2013.

Ruth Lea, economic advisor to the Arbuthnot Banking Group, said: "The truth is the early 1980s recession was overwhelming a manufacturing recession. Many people in London did not know the misery that was hitting swathes of the country. "But this time around we don't have those manufacturing jobs any more. There are now proportionately far more middle class jobs than there were back then. And many of those will be affected. The metropolitan areas, especially affluent areas of London, will feel this recession far more acutely than in previous periods of economic contraction."

In his stark update on the state of the nation's finances yesterday, Mr King said the Bank may have to cut interest rates to an all time low of below 2 per cent to revive the economy. He even indicated that the Bank was prepared to cut rates to 0 per cent - to "whatever level is necessary".
Delivering the Bank's Quarterly Inflation Report, Mr King radically revised its prediction of economic growth of 0.5 per cent next year to warn that economy would shrink by 2 per cent in 2009, wiping £25 billion off the country's output. "We're moving into very difficult times and people should be concerned," he said, adding it was "very likely" that the UK economy was already in recession. According to Capital Economics, a contraction of 2 per cent in the economy would mean unemployment rising by another 1 million from its current 11 year high of 1.82 million, house prices falling by 13 per cent and High Street spending slumping by £16 billion, with middle class families reluctant to spend on all but the most essential items.

If the Bank's worse-than-expected forecast is correct, this would be the first time in any calendar year that the economy has shrunk by 2 per cent since 1980 - a year that saw the start of the bitter recession overseen by the then Chancellor Geoffrey Howe when inflation ran out of control and unemployment shot through 2 million. The Bank also warned that deflation - a sustained period of falling prices - could return to the economy for the first time since 1947. This would force policy makers to slash interest rates again following this month's 1.5 percentage point cut that brought base rates down to a 53-year low of 3 per cent. If they fall below 2 per cent they will be at their lowest level for more than 300 years.

Mr King admitted it was very difficult to make accurate forecasts because of the "exceptional and difficult times" that has seen the financial world in turmoil since the collapse of Lehman Brothers in September. However, he denied he had been too slow to act over the summer. He also cautioned that any forecasts would have to be changed if Alistair Darling, the Chancellor, announced changes to Government spending in the Pre-Budget Report, which - it was announced yesterday - will take place on Monday, November 24, . Professor Peter Spencer, economic advisor to the think tank The Item Club, said: "Minus 2 per cent feels really quite rough, baring in mind normality is at least plus 2.5 per cent. You will see an increase in redundancies and everything follows with that. It's all grief for the man and woman in the street. It's a matter of keeping your head down and trying to hold on to your job – a new phenomenon for anyone under the age of 35."

The recession of the 1990s saw economic output fall by 2 per cent between the summer of 1990 and the summer of 1991. The Bank of England's forecast warned that the slump in 2009 could match this 12-month period over a calendar year - or even be worse, with output falling by as much as 3 per cent at the most pessimistic end of its predictions. The Bank's report also made clear yesterday that the rising level of unemployment would lower the standard of living for everyone – not just those losing their job. "Falling unemployment is likely to amplify the slowdown . . . reducing household income both directly, as the number of those in work declines, and by weakening employees bargaining positioning." Gordon Brown acknowledged that Britain may no longer be in the best position to cope with the slump. "We're in tough times," he said at Prime Ministers Question Time. He said that the Government would double spending on a "rapid response" unit to help people find work.

Alongside a prediction about the economy slumping, the Bank also forecast that inflation – which has hit 5.2 per cent – would fall very sharply next year, with prices likely to be rising by no more than 1 per cent on an annual basis in 2010. The Bank's target is 2 per cent. While this entails food, gas, petrol and energy prices tumbling, Mr King warned there was a real risk of deflation rearing its dangerous head. This has not happened since 1947, and helped destroy the Japanese economy during the 1980s. Paul Dales at Capital Economics said: "To get any sales you – be you a factory or a retailer – cut your prices as far as you can. But once consumers see prices falling they wait until they go and buy a television, for example. It then turns into vicious, deflationary spiral."

To avoid this happening policy makers at the Bank are likely to slash interest rates much further. Many economists now predict they could fall below 2 per cent – which has never happened since records began in 1694. While this would benefit some mortgage holders, it would be a blow for savers. Mr King also said that while he thought lower rates would help home owners, there was little he could do to force lenders to push down credit card rates or new mortgage rates. "I don't think it is easy for the Bank of England or anyone else to tell the banks precisely what pricing structure should be," he said.

UK house price recovery 'could take ten years'
Homeowners will have to wait a decade before property prices return to 2007 levels, a leading estate agent said yesterday. Average house prices are tumbling at a rate of £78 a day and are set to fall in total by 16 per cent this year and 11 per cent by the end of 2009, according to a forecast from Savills. This will bring the average value down from £182,080 in December 2007 to £136,123.

The London-based agent does not expect the market to show signs of recovery for another two years, with a full rebound to 2007 levels not likely until at least 2018. It cautioned that only buyers with adequate cash will be able to take advantage of cheaper prices in the meantime, because of the lack of availability of mortgage deals. The proportion of cash buyers is set to grow from 25 per cent today to up to 40 per cent by the end of next year, as investors and owner-occupiers who built up equity during times of strong growth use their spare resources to take advantage of better-value properties during the downturn.

Meanwhile, first-time buyers will continue to be frozen out of the market until they have managed to save sufficient capital, because of the ongoing mortgage drought for those who do not have a substantial deposit. They are now having to save an average £16,720 to get on the ladder, according to the Council of Mortgage Lenders. Homeowners with big mortgages face similar difficulties because new loans are almost unavailable for those without a large equity stake in the home that they wish to sell. Lucian Cook, director of research at Savills, said: “There will be a bigger differential between the haves and have-nots. The recovery will start with investment from people with equity. First-time buyers will have to spend longer saving up their deposits and will be behind the curve when prices do start to pick up.”

Savills said it had revised its forecast downwards because of the severity of the mortgage drought. In November last year, it had forecast that prices would grow by 3 per cent in 2008. Since then, the mortgage market had dried up, causing bigger than expected price falls as buyers struggled to finance their purchases. The housing market has come to a virtual standstill over recent weeks with lenders growing increasingly cautious. Home sales plunged to a new low last month, while Nationwide, Britain's biggest building society, reported that its net mortgage lending had fallen by 70 per cent over the past six months. Estate agents in England and Wales sold an average of only 10.9 properties per firm in the 12 weeks to the beginning of November, according to the Royal Institution of Chartered Surveyors.

Savills said it expects prices to “bump around the bottom” during 2010 before gaining momentum in 2011. It added that prime property in Central London would see the sharpest total falls because of its dependence on the City. Prime properties worth £1 million are falling in value by £493 a day. Total declines from peak to trough in the capital are expected to reach 30 per cent, but could be as much as 35 per cent if City job losses exceed expectations, Savills said. The Centre for Economics and Business Research estimates that 62,000 city workers are expected to lose their jobs in the next two years.

However, prices in London and the South East are expected to recover earlier than elsewhere, with predictions of a return to the peak by 2014. London rental values are forecast to fall by 7 per cent as a result of falling demand from City workers. Mr Cook said: “Twenty-five per cent falls in house prices will rapidly restore affordability and this, combined with the prospect of cuts in interest rates, will progressively cause the cost of mortgage finance to fall and will set the platform for recovery. The outlook for the economy and continued constraints on accessibility to mortgage finance indicates that this recovery will not gain momentum until 2011.”

Savills said it expected the Bank of England base rate to fall to 2 per cent in 2009 before rising to 2.4 per cent in 2010 and hitting 4.4 per cent in 2012. Mortgage rates have remained stubbornly high relative to the Bank of England base rate, even after two cuts of 0.5 and 1.5 percentage points in September and October, as lenders keep their margins high above base rate to shore up their balance sheets. The number of mortgages on the market fell by 15 per cent this week after the latest rate cut, according to

Barclays fails to win compromise with Middle East investors
The Middle East investors planning to buy almost one third of Barclays have refused to reduce their return on the deal, in a move which is set to lead to a head-on collision between the high street bank and its existing shareholders. Sources close to the negotiations said the group from Qatar and Abu Dhabi would not agree to any change to their contract, which will see them invest £5.8bn in Barclays for a 31pc stake. Other shareholders have complained the move is "effective change of control".

Barclays was last night still trying to find a way to reconcile its UK shareholders with the Gulf group, made up of the Qatar Investment Authority (QIA), Challenger, a vehicle owned by Qatar's royal family, and Sheikh Mansour Bin Zayed Al Nahyan, a member of the Abu Dhabi royal family.
But sources said Barclays was having little success. Marcus Agius, Barclays' chairman, will meet large shareholders at the Association of British Insurers but few expect him to come armed with an new offer. Time has almost run out for Barclays to break the deadlock and strike new terms for the £7bn fund raising that was demanded by the Financial Services Authority as part of the banking industry-wide recapitalisation programme in early October.

Barclays plans to hold a vote on the fund raising on November 24 and would need to publish a new circular if the terms are amended. That means Barclays has only a couple of days to strike a new deal. The bank could delay the shareholder vote if it was confident that allowing more time could lead to a compromise. However, sources said the chances of a change were very remote. One shareholder said: "We are utterly hacked off but there is not a Plan B". Shareholders can block the fund raising if 25.1pc vote against it. Legal & General, which owns 4.8pc, and Aviva, which owns 1pc, have led a rebellion against the current deal.

Several others are likely to join the camp. A large shareholder said the group wanted to cast a "substantial protest vote" while knowing they could not marshal enough support to vote the deal down. Corporate governance advisory body RREV recommended investors abstain, to register their protest at the lack of pre-emption rights, which traditionally give existing shareholders first refusal on any fund-raising. Some shareholders have considered voting down the deal with the Middle Eastern group and forcing Barclays to return to the Government for public funding. But most believe that option is not viable because the Treasury would be likely to offer far less attractive terms than was given to Royal Bank of Scotland, HBOS and Lloyds on October 13.

Barclays is frustrated with its UK shareholders because while they have complained about the generous terms given to the Middle Eastern investors, they have not offered to stump up £7bn instead. Of the £4.5bn fund raising Barclays did in June, UK shareholders took up their right to clawback only 18pc. The rest was taken up by a group of strategic investors including QIA and Challenger. The UK shareholders believe Barclays has reneged on its promise on October 13 that a new equity raising "will be structured so as to give existing shareholders full rights of participation". Barclays offered £1.5bn of "mandatorily convertible notes" (MCNs) to existing shareholders, and they took up £1.25bn. The rest of the £7bn of new capital was only offered to the Gulf investors.

Europe is unravelling but the ECB still doesn't quite get it
Outlook: One by one, Europe's economies are tumbling into recession. Ireland went first, to be followed on Thursday by Germany. Yesterday, Italy joined the party – or should that be w ake? – with the effect that the eurozone as a whole also plunged into a technical recession, recording its second successive quarter of negative GDP growth. To the list you can add Spain and, of course, Britain, both of which have revealed negative third-quarter numbers and are certain to double up in the fourth quarter. Of the major European Union economies, only France reported a positive GDP figure for the three months to the end of September, but that may be a statistical oddity, buoyed as the French were by unexpectedly resilient – and almost certainly temporary – consumer spending.

What is most striking about the latest data is the speed with which the decline in the European economy has gathered pace over the past few months. It would be tempting to pin the date the slowdown became a slump to 15 September, the day the US Treasury Secretary Hank Paulson pulled the plug on Lehman Brothers, but, in fact, the latest updates from companies across the economy suggest trading had already gone seriously awry several weeks before then.

Still, as recently as the late summer, business leaders, politicians and the rest were talking up their chances of avoiding recession, or at least offering reassurances that we were in for the briefest of downturns. Was this wishful thinking that then distracted central bankers from focusing on the downside risks to inflation sooner than they did? Mervyn King, the Governor of the Bank of England, resolutely rejects the suggestion that the Monetary Policy Committee was too slow to react to the threat of recession. But the European Central Bank, which has consistently been more hawkish on inflation, despite price rises in the eurozone being more muted this year than in Britain, is arguably even more culpable. How else is one to read the fact that the base rate here is now lower than in the euro area for the first time since the single currency's launch?

Jean-Claude Trichet, the ECB's governor, still seems remarkably calm given the economic storm into which Europe is now sailing. Speaking yesterday, M. Trichet did not even address such woes, instead dwelling on his pride about the extent to which central bankers have co-ordinated their response to the credit crunch. There are some good reasons why the ECB should feel more relaxed about the eurozone's prospects. The latest forecasts from the IMF and the OECD share the assessment that the downturn in the region next year will be less marked than in either the US or the UK. That reflects the area's exposure to housing markets and personal indebtedness where, with one or two exceptions, bubbles have not developed to anything like the extent seen in America and Britain.

Even so, the outlook is bleak. Europe ought, in theory, soon to be enjoying stronger exports given that both sterling and the euro have both tumbled against the dollar in recent months. But the theory only holds good on the assumption that someone out there in the rest of the world has money to spend importing European goods. If that is the case, perhaps they would like to start shouting about it, if only to give this part of the world some hope of a slightly less depressing Christmas.

Nor is there any prospect of Europe's banks emerging from the gloom anytime soon. Indeed, the eurozone's leading banks now seem to be playing catch-up with their counterparts elsewhere on the credit crisis, with, for example, ING of Holland and Hypo Real Estate of Germany announcing awful figures this week. Even the supposedly credit crunch-immune Spanish banks are now raising capital, with Santander in the middle of a rights issue.

No wonder eurozone leaders joining the G20 sessions in Washington today are as keen to see a global fiscal response to the recession as their opposite numbers here and in the US. But just as Mr King has fired a warning shot across the British Government's bows – any reflationary package in the pre-Budget report must be accompanied by a medium-term strategy for a more balanced budget, he says – so too will M. Trichet be demanding prudence. The ECB will almost certainly cut interest rates further in the coming months, but its governor is in no mood to give up on his hawkish instincts. It may be some time before Britain's base rate moves above the eurozone level once more.

Court-ordered closure halts slide on Kuwait Stock Exchange
Reporting from Beirut -- Investors in Kuwait found a solution Thursday to tumbling share prices: Get a court to shut down the stock market. A judge in the oil-rich Persian Gulf kingdom, acting on a lawsuit brought by individual investors, ordered the country's stock market closed to protect small investors from further declines in their portfolios.

Stock markets in the Middle East have tumbled along with others around the globe as oil prices have plunged and the financial contagion sparked by the U.S. mortgage crisis has continued to spread worldwide. The main Kuwaiti stock index is down 44% since June. On Thursday, bankers from around the Arab world convened in Lebanon to discuss the crisis and the Kuwaiti government announced the creation of a multibillion-dollar fund to bail out ailing financial institutions.

Although traders at the Kuwait Stock Exchange cheered and howled with delight after learning that the market would be closed after less than an hour of trading, the court order was strongly criticized in other quarters. "It is like fighting mosquitoes with a machine gun," said Haitham Abo Shady, managing director of Dubai Financial Brokerage, which is based in the United Arab Emirates. "This will only increase the panic among investors and is going against all the rules of free trade."

Last month a group of Kuwaiti investors demonstrated in front of government offices, demanding that the government intervene to stop the bleeding. Individual investors also sued the government, naming the prime minister and the head of the stock exchange as defendants and demanding that "trade be halted till measures are taken to check losses at the exchange," according to the official Kuwait News Agency. The plaintiffs blamed the government for mismanaging the crisis.

Judge Najib al-Majed granted the request for a suspension of trading, which is to remain in place until at least Monday, when the court will review its decision. Kuwait's judiciary is far more independent than those of other Persian Gulf countries. The Cabinet vowed to appeal the decision. Kuwaiti Finance Minister Mustafa Shimali called it dangerous, the news agency reported. "We respect the court ruling and as a government we only have to implement it," he said, but added: "The consequences of this ruling would be dire."

U.S. and other markets have rules in place to automatically suspend trading if stocks swing too wildly. But finance experts said they had never heard of an exchange shutting down at the behest of battered investors. "It's kind of a bizarre thing to do," Yale finance professor Matthew Spiegel said. "Closing the exchange doesn't erase the losses. As soon as you open back up, it's going down the same amount."

Ilargi: "The IMF did not give us any condition different from our economic stabilization program,"

Nice try, but we already knew weeks ago what the conditions are: a total take-over of the economy, including the central bank.

Pakistan Agrees to $7.6 Billion IMF Bailout Program
Pakistan agreed to a $7.6 billion bailout loan plan with the International Monetary Fund, to help the south Asian country avert defaulting on its debt with the first such program in four years. The loan "will be used for the balance of payments and to build our foreign reserves," Shaukat Tarin, the finance adviser to the prime minister, said today at a televised news conference in Karachi. The IMF will give the loan in installments over 23 months at interest rate of 3.5 percent to 4.5 percent, he said.

Pakistan was forced to seek funds from the IMF after its foreign-exchange reserves shrank 75 percent in the past year to $3.5 billion last week, the equivalent of one month's imports, and a group of donor nations declined to provide funds. "The IMF did not give us any condition different from our economic stabilization program," Tarin said. "The IMF counseled us to increase the key interest rate to curb inflation," he said.

The State Bank of Pakistan, the nation's central bank, increased its benchmark interest rate by 2 percentage points, the most in more than a decade, to 15 percent on Nov. 12, citing inflation that reached a 30-year high in October.

Poverty, Pension Fears Drive Japan's Elderly Citizens to Crime
More senior citizens are picking pockets and shoplifting in Japan to cope with cuts in government welfare spending and rising health-care costs in a fast-ageing society. Criminal offences by people 65 or older doubled to 48,605 in the five years to 2008, the most since police began compiling national statistics in 1978, a Ministry of Justice report said. Theft is the most common crime of senior citizens, many of whom face declining health, low incomes and a sense of isolation, the report said. Elderly crime may increase in parallel with poverty rates as Japan enters another recession and the budget deficit makes it harder for the government to provide a safety net for people on the fringes of society.

"The elderly are turning to shoplifting as an increasing number of them lack assets and children to depend on," Masahiro Yamada, a sociology professor at Chuo University in Tokyo and an author of books on income disparity in Japan, said in an interview yesterday. "We won't see the decline of elderly crimes as long as the income gap continues to rise." Crime rates among the elderly are rising as the overall rate for Japan has fallen for five consecutive years after peaking in 2002. Over 60s accounted for 18.9 percent of all crimes last year compared with 3.1 percent in 1978, with shoplifting accounting for 80 percent of the total, the report said. The trend has captivated Japan's media, which include regular accounts of the latest thief or pickpocket as well as undercover footage of people shoplifting food in convenience stores and supermarkets.

Coverage intensified after a 79-year-old woman slashed two women with a knife near a Tokyo railway station in August. She wanted police to take care of her after she ran away from a shelter for the homeless, Kyodo English News reported at the time. "Elderly crime is a serious problem that our society must shoulder in the years to come," the government report said. "With baby boomers becoming elderly within five years, we have reached a state where we must make a fundamental review of anti- crime measures in a fast-ageing society." About a fifth of Japanese are 65 or older, almost twice the proportion in the U.S. and three times China's rate. That figure will double to more than 40 percent by 2050, according to the National Institute of Population and Social Security Research. There will be twice as many elderly Japanese as there are children within five years.

The government aims to cut 220 billion yen ($2.3 billion) from social welfare spending in each of the five years starting 2006 as it seeks to balance the budget by 2011. As part of this plan, the government introduced a new health insurance system that would raise premiums for some elderly patients. The initiative has stirred anxiety about pensions and health care, and Japan's economic situation is doing little to help. Industrial production tumbled for a third quarter in September as retail sales dropped for the first time in 14 months and household spending fell for a seventh month. Japan's economy is at risk of deteriorating further as the global financial turmoil slows growth worldwide, Bank of Japan board member Seiji Nakamura said yesterday.

The number of households on welfare reached 1.1 million last year, an increase of 300,000 since 2001, according to the latest figures from the Ministry of Health, Labor and Welfare. Japan ranks behind the U.S. at fourth-worst among 30 developed countries in terms of the number of people living on less than half the country's median income, according to a report by the Organization for Economic Cooperation and Development last month. "Some elderly, particularly men who lost their wives, even turn to crimes to be put in jail so they can be fed three times a day," Yamada said.
Still, Japan's weakening economy is not the only cause of elderly crime, Yamada said. The current generation of seniors grew up in the confusion of the aftermath of World War II, when crime rates in Japan were at their highest, he said. "They don't feel guilty because they were the generation who recorded the highest youth crime rates when they were young."

Can Smoot-Hawley return in a wholly different guise?
Chinese stock markets have bucked the trend in the rest of the world by posting a decent day yesterday and a great day today.  Yesterday the SSE Composite rose 0.8%, and today it rose another 3.7% to close at 1928.  I don’t think the rally was caused by good economic news – today’s data release showed October’s industrial production up a surprisingly low 8.2% year on year, although yesterday’s retail sales were in line with fairly high expectations, of which more later – so much as good technical news, or rather a rumor that has caused a certain amount of “technical” excitement.  According to an article in today’s Economic Observer, one of the local papers I read regularly:
An anonymous policy recommendation calling for an RMB 600-800 billion fund to buy up mainland stocks in the event of a market crash has made its way onto the desk of top banking officials.  The report, which included three pages of discussion and a two-page list of target shares, was first sent using an anonymous internal email account to a mailing list at the Research Center of International Finance (RCIF), under the Chinese Academy of Social Sciences, on October 30. It was later submitted to top banking officials as policy advice, the EO learned.

It suggested the government use such a fund to unconditionally buy shares in 50 heavyweight firms listed on the Shenzhen and Shanghai exchanges if the Shanghai index hit 1,500 points. The RCIF's director Yu Yongding confirmed the authenticity of the report. According to a researcher at the Center, the report was well received by the financial industry, and the Center had so far received much feedback. Banking officials had long considered establishing such a fund, he added.  According to the report, in extreme cases, the stock market might drop between 800 and 1,000 points, when rescue measures from the government would be meaningless. To effectively prevent panic selling, the government should take action if the index approached 1,500 points, it suggested.
By its estimate, RMB 930 billion would be needed to buy all circulating shares if the index reached 1,500. But, it added, buying one third of the total circulation would be sufficient to bolster the market, which would cost RMB 300 to 400 billion. Based on these calculations, the report then suggested that the government establish an RMB 600 to 800-billion stabilization fund. 

For nearly a year there has been talk of using stock market stabilization funds to halt the collapse of share prices.  Chinese regulators, to their credit I think, have pretty steadfastly rejected the rumors and denied they had any intention of doing so.  Officially they have argued that this kind of intervention would seriously set back the development of the stock market as an efficient allocator of capital, and unofficially a lot of people have worried about the opportunities for manipulation and conflicts of interest. 
I have no idea if the most recent proposal is likely to have more traction, but Chinese investors certainly seem to be “buying” the rumor.  Whether they subsequently sell the fact we will have to wait and see.  By the way, as a total aside, for those who are skeptical about how modern our modern financial experiences really are, I found the following quote in the first dialogue of Jose de la Vega’s 1688 classic work on the Amsterdam Stock Exchange, Confusion de Confusiones, “The expectation of an event creates a much deeper impression on the exchange than the event itself.”  This I guess is the 17th century version of Wall Street’s “Buy the rumor, sell the fact".
As for other news, yesterday the authorities released retail sales figures, which although not a perfect proxy, are often used as an indicator for domestic consumption.  The numbers were surprising, at least to me (Bloomberg says that it was equal to the median expectation among the economists it surveyed).  Retail sales rose 22.0% in October, down somewhat from September’s 23.2% but still close to its fastest pace in nine years – July’s 23.3%.
I expected retail sales growth to be much lower than that.  Certainly the economy is not acting like it is experiencing a consumption boom.  Today the authorities released industrial output numbers for October and they were much worse than anyone expected – the lowest since 2001.  According to an article in today’s South China Morning Post:
Mainland’s industrial output slumped to a seven-year last month as manufacturers throttled back production in response to weakness in the domestic property market and an unfolding slowdown in export demand. Growth in factory output slowed to 8.2 per cent in the year to October from September’s reading of 11.4 per cent, the National Bureau of Statistics said on Thursday.
“It’s a horrible-looking figure. It’s a shock figure,” said Ben Simpfendorfer, an economist at Royal Bank of Scotland in Hong Kong.  Zhang Shiyuan with Southwest Securities in Beijing called the outcome terrible. Economists polled by Reuters had forecast a rise of 11.3 per cent.

 Some of the other numbers were really grim.  Power use was actually lower in October than it was last year – the first time this has happened since the 1997 Asian crisis – and iron and steel production was down sharply.  But I am having trouble putting all this together.  Industrial output is slowing considerably, it seems.  But domestic demand is still very strong and the trade surplus is at a record.  And yet as far as I can tell inventories are rising.  This doesn’t add up.  Perhaps there are significant lags in some of the data and we are still seeing the delayed effects of Olympics spending, but if output continues slowing and demand continues growing and the trade surplus keeps rising, either inventories are collapsing, the numbers are lying, or I am going to have re-jigger my understanding of how these things work.
One last point, and as an explanation of the title of this entry, the world is agonizing over the possibility of a return of protectionism, especially US protectionism, with innumerable references to the notorious Smoot Hawley Tariff Act June 17, 1930.  As the US department of State website says, “To this day, the phrase “Smoot-Hawley” remains a watchword for the perils of protectionism.”  However as often happens by a too-facile re-reading of history, we may be looking for an exact repeat of history rather than see the new way it sneaks up on us.
To get a quick review Smoot Hawley let me reprint the Wikipedia entry:
Smoot-Hawley was an attempt by the Republican Party to deal with the problem of overcapacity that plagued the U.S. economy in the 1910s and 1920s, which was the result of extremely-high-throughput, continuous-flow mass production and, in agriculture, the widespread efficiency gains brought on by the use of farm tractors.  Although rated capacity had increased tremendously, actual output, income, and expenditure had not.  Under the direction of Senator Reed Smoot of Utah, the party drafted the Fordney-McCumber tariff act in 1921 with an eye to increasing domestic firms' market share. Weakening labor markets in 1927 and 1928 prompted Smoot to propose yet another round of tariff hikes.

 The important thing to remember about Smoot-Hawley may be not so much its provenance but rather than underlying conditions that led to it.  The US was at that time, remember, running massive current account surpluses.  In 1929 it exported 75% more to Europe than it imported.  Deficit countries financed their trade deficits in part by running down gold reserves (Keynes complained that the US was accumulating “all the bullion in the world”) and in some cases partly by capital exports from the US (although, consistent with rising gold reserves, the US was a net capital importer).
When first the stock market crash and later the banking crisis caused a collapse in US financing and in global demand, the US trade surplus also collapsed – with exports to Europe dropping by nearly 70% over the next three years.  It was in this context that Smoot-Hawley was passed in 1930.
Just as the end of the liquidity cycle in the 1930s caused a collapse in the export sector of the world’s leading current-account-surplus country, it seems to me that much of the brunt of the global adjustment in the current crisis is likely to be absorbed once again by today’s current-account-surplus countries.  If the global problem is likely to be a drop in demand, it is countries with too little demand who will adjust more than countries with too much demand.  And if their exports drop quickly, for the obvious domestic politics reasons there may be significant pressure for current-account-surplus countries to engineer moves to support their export industries.  Since most of them lack large domestic markets, the result isn’t likely to be direct import tariffs.  It is more likely to be various permutations of competitive devaluations (which were also quite common during the 1930s).
In that context it is worth considering a note by Credit Suisse in their November 12 Emerging Markets Economics Daily:
PBoC Zhou Xiaochuan hinted yesterday that China could depreciate its currency. Answering a journalist’s question during the BIS meetings in San Paolo, Brazil, Zhou said that he would not rule out any options to help ease the pain of exporters. The Chinese currency started depreciating against USD since 1 July 2008.  While there is clear demand from the local exporters for a weaker RMB amid the economic downturn with a stronger USD against other major currencies, we think the RMB can only manage a small depreciation against USD and a small appreciation against other major currencies under international pressure.

Yesterday Xinhua, in a very brief piece, noted that “China's State Council said on Wednesday the country would raise export rebates for more than 3,700 items from next month to further boost the export sector.”  Raising export subsidies, raising import tariffs, and depreciating the currency all have the same trade effect.  They are ways of boosting domestic growth by boosting exports.  But as we learned in the 1930s, countries cannot all export their way to growth unless they also collectively act to boost imports. 
While everyone watches fairly closely and with dread to see if the US re-enacts new versions of Smoot-Hawley by attempting to resolve declines in domestic demand via beggar-thy-neighbor trade polices, the real threat may come from somewhere else.  Current-account-surplus countries may, just as they did in the 1930s, find themselves under immense pressure to support their export sectors.  Already we are seeing this in China, and I suspect a lot of other Asian exporters are also casting at ways to boost their own export industries.
One of the things the participants in the upcoming G20 meeting Washington should watch very closely is export subsidies and currency policies aimed at boosting exports.  US imports must decline as a share of global demand, for reasons that have been widely discussed and widely accepted, and because of this, unlike in previous crises in the past two decades, the world won’t all be able to export its way out of this crisis.

UBS runs questionable operations in Canada, too
A senior Swiss banker who was charged two days ago by United States prosecutors with dispatching bankers to help rich Americans evade taxes also oversaw a covert team in Canada that funnelled as much as $5.6-billion offshore, The Globe and Mail has learned. Raoul Weil, former head of wealth management for Swiss financial giant UBS, has been accused by the U.S. Department of Justice of equipping a team of bankers with encrypted computers and countersurveillance training in an effort to conceal $20-billion from the Internal Revenue Service.

Internal UBS records, as well as interviews with former UBS officials, show Mr. Weil was in charge of a similar operation in Canada. A team of a dozen or so bankers, known internally in UBS's Zurich and Geneva offices as the “Canada Desk,” made several trips a year to UBS-sponsored events, such as chamber orchestra concerts, and encouraged the country's wealthy elites to move their money to Switzerland. UBS operates a legitimate, licensed Canadian subsidiary, which manages the multimillion-dollar portfolios of many well-to-do clients, but officials from the subsidiary say the members of the Canada Desk never set foot in its offices in Toronto, Montreal, Calgary and Vancouver.

There is so much secrecy surrounding the Canada Desk, which has been led by a Zurich-based banker named Edith Roellin, that many former directors said they had never heard of the group. “It was not talked about. It was never mentioned. I didn't really even know they existed,” said Fred Ladly, a former director of the Canadian subsidiary's wealth-management division for about 10 years. “I think I could say this for all the other members. If I knew something like that was going on, I'd quit.”

Another former official of the licensed business said the subsidiary kept a “distance” from Ms. Roellin and her team. “From a compliance and governance perspective, UBS Canada did not participate nor know of those assets,” said the former official, who declined to be named. Although their dealings in Canada are discreet, Ms. Roellin and her team appear to do significantly better business than UBS's licensed operation. Internal bank balance sheets obtained through the investigations in the United States show that as of October, 2005, the Canada Desk managed $5.6-billion. The licensed business held less than half that – $2.6-billion. The bank declined to make Ms. Roellin available for an interview, and she did not respond to an e-mail request for comment.

Despite the highly publicized indictment of Mr. Weil, which made the front page of The Wall Street Journal, as well as the arrest of several UBS bankers in countries such as Brazil, the Canadian operation has received little scrutiny from law-enforcement officials. The Canada Revenue Agency has refused to say whether it has launched an investigation. Records released in the United States show that the bank itself was aware it was on shaky legal ground every time Ms. Roellin and her team touched down at a Canadian airport.

One UBS slideshow, which was released through a U.S. Senate hearing and dated 2003-2005, warns: “It is not permissible for non-Canadians [sic] banks outside of Canada to seek out banking relationships with Canadian residents while the residents are in Canada.” That law is a provision of the Bank Act that Parliament passed more than two decades ago to clamp down on foreign bankers – so-called suitcase bankers – attempting to skirt domestic regulations. As the law stands, a banker who does not work for a licensed subsidiary or branch is not supposed to be in Canada doing business.

“That would be illegal” said Robert MacIntosh, a former president of the Canadian Bankers Association, when he was told about UBS's dual operations. “That's what happens over time. People bend around the rules and forget what the rules were in the first place.” Some of the bank's defenders argue that Ms. Roellin and her team aren't in violation of the law because UBS has a licensed operation in Canada. However, each UBS Canada official interviewed by The Globe disavowed the conduct of Ms. Roellin and the Canada Desk. UBS declined to explain why it issued an internal warning about that provision of the Bank Act, but continued to send Swiss bankers to Canada. “I don't think it makes sense that we go into this thing,” UBS spokesman Serge Steiner said when asked about the contradiction between the bank's internal warning and Ms. Roellin's regular trips to Toronto. “We can't go now and discuss every and each detail on several documents.”

Canada's banking regulator, the Office of the Superintendent of Financial Institutions, is responsible for enforcing the law, but in the past three years it hasn't handed out any formal notices of violation. A spokesman for the regulator said the normal practice is to issue an informal notice, which he said is usually sufficient to get offenders to stop. The agency declined to say how many informal notices it has issued. No former management executives of UBS's Canadian subsidiary reached by The Globe would speak on the record, but several said there were legitimate reasons why a Canadian would prefer a Swiss UBS banker over someone from the Canadian branches. One former official highlighted the service culture and reputation of Swiss bankers. The former officials also pointed to the expansive pool of mutual funds available through the Swiss offices, which dwarf the securities products available in Canada.

Professor Reuven Avi-Yonah, an international tax expert at the University of Michigan and a member of the board of editors of the Canadian Tax Journal, dismissed those explanations. If enhanced service was the main reason for parking savings in Switzerland, UBS could implement similar service at its Canadian branches, Prof. Avi-Yonah said. As for mutual-fund options, no one from the Canada Desk is registered with the country's securities commissions, which means it's illegal for them to market securities during their trips. “By and large, the main reason is bank secrecy and to hide income from Revenue Canada,” Prof. Avi-Yonah said. “When UBS sends their own Swiss people into Canada to solicit the funds that's basically what they're promising.”

Shareholders Pay as Barclays, UniCredit Raise Capital
Shareholder rights in Europe may be the next casualty of the global financial crisis. Barclays Plc plans to raise capital without giving existing investors first call on new stock. Credit Suisse Group AG did so last month. UniCredit SpA made what's become an unprofitable proposition to all shareholders, and offered a different deal to some, including Libya's central bank. All three are wooing big investors with securities paying as much as 14 percent interest.

The banks argue that so-called rights offerings are too slow and too risky in a falling market. Stockholders are concerned the new approach may become common practice, diluting their voting rights and claims on future profits. Barclays managers met today in London with investors threatening to put up a fight at a Nov. 24 shareholders meeting. UniCredit investors approved the capital increase today in Rome. "If you waive pre-emption, it damages the relationship with shareholders," said Colin Melvin, chief executive officer of Hermes Equity Ownership Services Ltd., which manages about 35 billion pounds ($52 billion) for BT Pension Scheme and 205 other institutional clients.

The issue is important to funds such as Hermes because they hold shares for decades and count on those rights to maintain positions that could be at risk if a large stake is sold to a new investor, Melvin said. Without pre-emption, "companies' shares are traded as if they were in a casino, and that's just wrong," Melvin said. European corporate law and securities rules typically require companies to offer existing shareholders a first crack at new stock, unlike in the U.S. Sales can take the form of rights offers, which entitle shareholders to buy new stock, often at a discount, or to sell their allotment on to someone else. Companies must get investor approval to bypass common shareholders in most cases.

Barclays, Britain's second-biggest bank by market value, unveiled plans on Oct. 31 to sell 5.8 billion pounds of convertible notes and preferred shares paying as much as 14 percent annual interest to funds in Abu Dhabi and Qatar. It sold an additional 1.25 billion pounds of convertible notes to money managers, without allowing ordinary shareholders to take part. Shareholders want the bank to change the terms of the transaction to let them participate too, said Robert Talbut, who helps manage $31 billion of assets, including 9.1 million Barclays shares, at Royal London Asset Management. "There is widespread dissatisfaction with the terms of the deal, and there is pressure for the company to think again," Talbut said.

The U.K. bank has failed to convince the Middle East funds to renegotiate the deal to appease other investors, two people familiar with the matter said today. They declined to be identified because the discussions are confidential. Barclays is in "constructive" talks with shareholders, spokesman Alistair Smith said. He declined to comment on today's meeting in London or on whether there are discussions with Qatar and Abu Dhabi. Banks are seeking alternatives to tapping existing investors partly because of tepid demand from shareholders burned by plunging stock values. What's more, selling stock in rights offers can take weeks. Companies need to hold a vote, provide investors with an offer document and give shareholders time to assess the investment.

"What we wanted to achieve was raising all the capital that we had agreed to raise simultaneously," Barclays CEO John Varley said in a Nov. 3 internal e-mail obtained by Bloomberg News. "So the words at the top of our mind were: size, speed, certainty." The experience of U.K. banks that had rights offers this year "is not something that inspires confidence," he wrote. HBOS Plc, the U.K.'s largest mortgage lender, in July held the European rights offer with the largest value of unsold stock this decade, with shareholders claiming only 8 percent of its 4 billion-pound sale. New investors and underwriters of the transaction bought the rest. The offer lasted more than 11 weeks as HBOS shares plunged 43 percent. HBOS is being bought by Lloyds TSB Group Plc.

In August, Bradford & Bingley Plc, the biggest U.K. lender to landlords, raised 400 million pounds in its third attempt at a rights offer in as many months. Investors ordered just 28 percent of the shares on offer, leaving underwriters to buy the rest. The lender was seized by the government on Sept. 29. Where shareholders have participated more fully, they've been burned. Royal Bank of Scotland Group Plc in June raised the entire 12.3 billion pounds it sought, selling shares at 200 pence apiece. The stock now trades at 56.2 pence. Credit Suisse, Switzerland's second-biggest bank, is paying interest of 11 percent on $4.7 billion of securities sold to investors including Qatar. It bypassed existing shareholders by selling a combination of bonds that investors must swap into stock and some treasury shares.

"We thought that speed was essential," said Andres Luther, a spokesman for Credit Suisse in Zurich. The bank had already gotten shareholder approval to go that route, he said. Not all banks agree. On Nov. 10, Spain's Banco Santander SA said it plans to raise 7.2 billion euros from shareholders. The bank, named for the town where it's based, said in a statement on its Web site that enabling shareholders to participate "provides them with the biggest benefit." Milan-based UniCredit hedged its bets. At the same time the bank offered shareholders the option of buying 3 billion euros of stock at 3.083 euros a share, it lined up a selection of new and existing shareholders to buy any leftover stock under different terms to secure their commitment. The stock now trades at about 2 euros.

Buyers will get bonds that convert into shares and pay 4.5 percentage points more than the six-month euro interbank offered rate, or Euribor. That's 8.8 percent based on today's Euribor of 4.29 percent. They'll get more if UniCredit's dividend yield is higher than 8 percent. The Central Bank of Libya and Munich-based Allianz SE, Europe's second-biggest insurer, are among the investors that have ordered about 60 percent of the stock, according to UniCredit's underwriter Mediobanca SpA. New investors, who weren't identified, have committed to buying the rest of the securities. The offering is planned for later this year.

At today's UniCredit meeting in Rome, Giammario Fiorentini, a shareholder, criticized the securities sale, saying investors aren't been treated equally. What's more, "this may serve as a model for others," he said. UniCredit may not have had a choice, according to Wolfram Mrowetz, CEO of fund manager Alisei SIM in Milan. "Favoring some investors is the only way to raise cash and help restore credibility in the company," said Mrowetz, who sold his UniCredit shares at around 5 euros. UniCredit CEO Alessandro Profumo confirmed the rights offer terms at the Rome meeting. The price was fixed in October to prevent speculation on the stock, and to give certainty on the dilution, he said. He said the convertible bonds aren't suitable for ordinary shareholders because they won't be traded.

"Bypassing pre-emptive rights damages stocks and creates a dangerous precedent," said Arturo Albano, who works in Milan for Deminor, an adviser to investors in closely held and publicly listed companies. The Bloomberg Europe Banks Index rose 0.4 percent today in London, leaving it down 13.5 percent for the week. Credit Suisse rose 3.7 percent to 32.68 Swiss francs in Zurich trading, Barclays gained 0.9 percent to 159.1 pence in London and UniCredit added 2.2 percent to 1.99 euros in Milan. The price paid to line up quick financing is steep both for the banks and their investors. Barclays turned to Abu Dhabi and Qatar to avoid participating in the U.K. government's rescue plan for the banking industry, whose conditions include capping executive salaries and banning dividends. Barclays shares have fallen 22 percent since Oct. 30, the day before the announcement.

"Barclays's alternative avenue to government or shareholder money is very, very expensive," said Adrian Darley, who helps oversee $1.6 billion at Resolution Asset Management in London, and is a Barclays shareholder. Paul Myners, who last month was appointed as minister in charge of the City of London financial district, is leading a review by the Treasury and the U.K. financial regulator into whether the timetable governing rights offers can be sped up. Myners, a former chairman of retailer Marks & Spencer Group Plc, said in a 2005 report that pre-emption was "universally considered to be an unnecessarily lengthy and cumbersome process."

Still, he supported the use of rights offers. In the U.S. pre-emption rights were used as early as the 1800s. Their decline began in the 1930s as states competed against each other to attract companies for incorporation. "They prevent transfers of ownership to new shareholders from occurring without the prior agreement of existing shareholders," Myners wrote. "Ownership confers voting rights as well as claims on the earnings and valuation of a company." Matthew Robertson, who helps oversee 4 billion euros at SG Asset Management in London and is a UniCredit shareholder, said that as confidence returns, ordinary shareholders will be more willing to invest. "It's good for shareholders to have the first call on new equity capital," he said.

Is this Canada's 'last hurrah?'
Analysts doubt country can weather economic storm much longer

As the U.S. economy continues its downward spiral, economists are warning that the relative strength Canada has shown so far will likely be the "last hurrah." Any remaining hopes that the fallout from the collapse of the U.S. housing market could somehow be contained grew dimmer yesterday. Another volley of dismal economic news cast doubt on recent efforts to shore up battered credit markets and revive consumer and business confidence, just as world leaders gathered at an emergency summit in Washington.

Topping the list of bad news yesterday was a record 2.8 per cent plunge in U.S. retail sales in October as consumers, concerned about their jobs, dramatically curbed their spending. In another sign that retailers should brace for a tough holiday shopping season, another closely watched indicator, the Reuters/University Michigan survey of U.S. consumer sentiment, remained near a 28-year low despite rising slightly in November. U.S. consumer fears are already being borne out in that country's job market. The parade of layoffs continued yesterday as Sun Microsystems Inc. said it plans to cut as many as 6,000 jobs as sales of its server computers plunge.

Those job cuts come on top of other major layoffs announced recently across financial services, the auto industry and other sectors, and appear to augur badly for the U.S. jobless rate, which hit a 14-year high of 6.5 per cent in October. Evidence mounted this week that the U.S. contagion is spreading quickly to other parts of the world. The European Union said yesterday that the 15 countries that use the euro are officially in recession, after their economies shrank for the second straight quarter. The news came a day after the Organization for Economic Co-operation and Development said its members, representing the world's developed economies, appear to be in recession.

"Financial markets remain under severe strain," U.S. Federal Reserve chair Ben Bernanke said yesterday. So far, at least, Canada appears to be weathering the storm better than most. "We're certainly going into it in a lot better shape than we've gone into the prior two serious recessions, in the early 1990s and the early 1980s," said Douglas Porter, deputy chief economist at BMO Capital Markets. He pointed to strong government balance sheets, "relatively healthy" corporate balance sheets, a strong banking sector and financial markets that "are closer to functioning normally than in most other economies."

But "despite all those positives, the fact of the matter is that we still export a huge portion of our output to the U.S., and we cannot escape the pull on the U.S. economy completely – there's just no way," Porter said. "We've certainly hung in there better than the U.S. economy right up to and including October, but I think the weakness in the U.S. is just so pervasive, as shown by the October retail sales results, that it will seep into the Canadian economy more broadly." A TD Economics research note echoed those concerns yesterday, calling recent upbeat indicators "Canada's last hurrah."

"Given the data that has come out of the U.S. in the last few weeks, this strength is not likely to hold up through the last quarter of the year," economist James Marple wrote. In a troubling sign that Canada's housing market is softening, the Canadian Real Estate Association reported yesterday that the number of homes sold through the Multiple Listing Service plunged 14 per cent in October to the weakest level since July 2002. The drop suggests "a major downshift in consumer psychology," CREA chief economist Gregory Klump said.

Canadian housing slump deepens as prices drop most in 26 years
In the six weeks since Vicky and Mike Plover put their house in Kelowna, B.C., on the market, a so-called healthy housing correction has been turned by a crumbling economy into the worst decline in a generation. House prices in the B.C. Interior region tumbled by 11.2 per cent last month from the previous October, the sharpest decline in the province and even worse than the national drop, which was the worst year-over-year monthly tumble in 26 years.

Ms. Plover said she remains confident the home will sell but realizes the economy is now working against her and her husband. “Unfortunately, we were a bit late [to put the house up for sale],” Ms. Plover said Friday morning before her realtor hosted an open house, with another set for Sunday. “It's definitely tougher than it was six months ago. And the economy this fall has made a huge difference.” The Plovers have lived in their four-bedroom, 1,940-square-foot house for 18 years.

They now plan to move into something smaller. Their situation is playing out in other markets across the country as the housing slump that started with a correction in overheated prices in Western Canada becomes more pervasive as the outlook for jobs and economic growth weakens. Nationally, the average price of a resale home in October fell the most, percentage-wise, since August, 1982, sinking 10 per cent from the year before to $281,133, the Canadian Real Estate Association (CREA) says. It was the fifth consecutive month with year-over-year price declines.

Unit sales fell by 27 per cent from October, 2007, declining sharply in every province except Newfoundland and Labrador and the Northwest Territories. Month-over-month sales fell by 14 per cent, the largest drop since June, 1994. “We declared early this year that the housing boom was over, and these figures on the surface would suggest the bust has begun,” Douglas Porter, deputy chief economist at BMO Nesbitt Burns Inc., said in an interview. The slowdown in home sales hit more than three-quarters of Canada's housing markets last month, including the five most active: Toronto, Montreal, Vancouver, Calgary and Edmonton.

Fewer sales in Toronto were responsible for nearly one-third of the drop in sales across the country. In Toronto, Canada's largest housing market, sales fell by 35 per cent year-over-year in October, and prices by 10.5 per cent. Other hard-hit parts of Ontario included the cottage country regions of Muskoka, Haliburton and Bancroft. The housing market downturn in Ontario, and to a lesser extent in Quebec, is worrisome because it reflects weakening economic fundamentals rather than the sharp price increases that took place in the West, Mr. Porter said.

“In some cities things did get overheated last year, and the correction was what got the ball rolling in terms of lower prices, especially in places such as Calgary, Edmonton and to a lesser extent in Vancouver. But I think more broadly what we're seeing now is a weakening economy starting to make itself heard in the housing market, and that's the bigger story for the next year,” he said. In the past six weeks the Toronto market appears to have slowed dramatically as buyers become plagued by indecision, said Chander Chaddah, real estate agent at Sutton Group Associates Realty Inc.

“It's definitely taking longer for houses to sell. What you're basically seeing is the decision that people are making is not to do anything,” he said. The depth of the decline in home prices is a worry for buyers, particularly those with low down payments who don't want to find themselves owing more on their mortgages than their homes are worth if the downturn continues. Job security is also is also on people's minds as layoffs spread from the auto and forestry industries into the financial, media and technology sectors.

One set of prospective buyers have returned to a home in Toronto's Bloor West Village area so many times, they've probably spent more waking hours there in the past week and a half than the property owners have, Mr. Chaddah said. He currently has three houses listed on the market for less than $450,000 apiece. Each is drawing about one showing every two or three days, a trickle of the interest shown just months ago, he said. Even the curiosity seekers who frequented open houses appear to be staying home, with two recent events luring about ten people each instead of the throngs that used to show up.

The lack of interest means many sellers likely won't bother with price reductions, but instead let their listings expire after 60 days and wait until a better time of year to relist, he said. “It wouldn't surprise me if people are saying, ‘If it's going to take me a couple of months to sell my place, I'm not interested in having the house on the market over the holidays. Why not wait until the early spring?'” he said.

One month's numbers don't make a trend, and before drawing conclusions Mr. Porter said he'd like to see the data for the fourth quarter as a whole. “Having said that, there's little doubt that the market continues to weaken markedly. We're basically seeing a one-way move since the start of the year, a steady stream of double-digit declines in sales and a slow grind down in prices. It's tough to see that bigger trend turning around any time soon.”

Citigroup, Wachovia and Sheila Bair is smarter than all of us
In the middle of the Citigroup/Wachovia thing I wrote a post which I circulated amongst friends but do not remember posting.  It was a little hot. As speculation that Citigroup is insolvent is now widespread (see Felix for a recent example), I thought I might just post it.  Sorry dear readers to not give it you when it was more relevant:
Is Citigroup going under? Is Sheila Bair's erratic behaviour really her trying to save Citi? 

Readers will know that I think pretty lowly of the head of the FDIC. Maybe I am wrong.  I have been puzzling this weekend – trying to work out what is going on using the assumption that all is part of a grand and competently executed strategy. And the result was unsettling. The best hypothesis I came to is that Citigroup is going down and that Sheila Bair is trying to save it.

Sheila Bair – as readers will remember – forced Wachovia to sell itself in three days whilst other parties had not had anything like enough time to complete due diligence. She – unilaterally and incorrectly – told the world that this deal could not be done without government assistance. She unilaterally decided to issue a guarantee that on a pool of $312 billion of Wachovia assets Citigroup could not lose more than $42 billion. She made that decision even though Wells Fargo was telling her that all they required was more time to do due diligence.

Given that Wells Fargo was willing to acquire Wachovia at no-cost to taxpayers that looks like a very bad decision indeed. But this is the post assuming that Sheila Bair is smarter than all of us.

And so we need to understand the significance of that guarantee. The significance is as follows: Once Citi owns $312 billion in assets on which they can only lose $42 billion the remaining pool must be worth $270 billion. That $270 billion is guaranteed by the US Government – as the FDIC is a full faith and credit organisation. Citigroup can put that $270 billion (plus the $42 billion in non-guaranteed assets) in a pool and repo it – and as Treasuries yield very little they will wind up paying well under a percent of interest. The Sheila Bair decision was equivalent to a cash injection into Citigroup of 270 billion because the repo-market will turn government guaranteed loans into cash.

That cash injection is almost 40 percent of the size of the whole bailout package and it was given to Citigroup by Sheila Bair without congressional oversight. We got all stroppy at giving Paulson that sort of unilateral powers – but – hey – we are prepared to forget that Sheila Bair already has them. Anyway – Citigroup buying Wachovia reliquefies Citigroup. Big time. Citigroup almost certainly knows this. Sheila Bair – if she is smart – knows this. That is why it is so important for Citigroup to complete the deal.

Now Wells Fargo have come to destroy the party. They are prepared to buy Wachovia without any government guarantee. The FDIC should be cheering as this removes all cost to the taxpayer – but Sheila Bair stands behind the decision to sell Wachovia to Citigroup.

Citigroup isn't looking to sue Wachovia for a break-up fee. They are looking to enforce specific performance on Wachovia. They are not interested in a $20 billion break-up fee – that does not save them. That is just too small. They are interested – critically interested – in the net $270 billion in guaranteed assets because that is the equivalent of $270 billion in cash – enough to save Citigroup from destruction.

Specific performance is very hard to enforce as numerous blogs have pointed out – here and here for example. But in this case it is necessary. Sheila Bair is smarter than I thought and she knows it too. So I withdraw my demand that Sheila Bair resign – on the basis that it is probable that Sheila Bair knows more than me and she deemed it necessary to inject $270 billion in cash into Citigroup to stop their imminent failure. Of course if this thesis is wrong Sheila should just save me the trouble of issuing a correction and resign forthwith.

China Can't Let Crisis End Reform, Central Bank Says
China can't let the global credit crisis derail financial reforms that have benefited the public and helped the nation's banks weather the turmoil, said Yi Gang, vice governor of the People's Bank of China. "Although there have been doubts in the market on whether China's financial reforms should continue after this crisis led to massive government bailouts and nationalization of financial institutions, China's bank reforms can't backtrack," Yi said at a conference in Beijing today.

The worst financial crisis since the Great Depression has caused about $966 billion of writedowns and credit losses among financial institutions worldwide, according to data compiled by Bloomberg. The U.S. Treasury has initiated a $700 billion rescue plan to shore up distressed financial institutions. "The U.S. and Europe may need to rethink financial innovations that exceed real economy needs and have pushed risks beyond control," said Zhao Xijun, a finance professor at Renmin University in Beijing. "China's financial services are under- developed by comparison, so we need to push ahead with reforms."

Banks in China sold shares, accepted foreign strategic investors and enhanced risk management over the past three years to avoid repeating the bad-loans crisis earlier this decade, when the government spent $650 billion rescuing them. Limited buying of subprime debt has helped the banks avoid bigger losses. "State-bank reform has been a success, benefiting people and greatly enhancing financial services," Yi said. "China's banks may have taken an unimaginable shock from this financial tsunami if they hadn't completed shareholding reforms."

Reforms based on market principles must continue to help shield banks from future risks during economic cycles, Yi said today. Banks will also be "tested" when the nation's currency gradually become convertible and when interest rates are further liberalized, he added. "The economic downturn has already started, and banks must be well prepared," Yi said. China's economy expanded at the slowest pace in five years between July and September as the global crisis trimmed exports and industrial production and may send developed economies into recession. China announced a $586 billion economic stimulus package on Nov. 9 and also relaxed monetary policy to spur growth.

"China's banks are on the right tracks and they have learn a lot about risk management over the past few years, so such reforms should move forward," said Renmin University's Zhao. The central bank has cut interest rates three times since September, lending weight to the coordinated emergency reductions by the Federal Reserve and five other monetary authorities on Oct. 8. President Hu Jintao is in Washington today with leaders from the Group of 20 nations to discuss how to counter the financial crisis.

Before Saving the US
The nature of the current global financial crisis is the biggest debt crisis in America’s history. The issuer of the world’s reserve currency, the US has been borrowing for quite a long time without any limit. America’s trade, international payment and fiscal deficits have existed for over 40 years (a fiscal dividend once occurred during Clinton’s administration but deficit soon returned).

Statistics show that America’s internal and external debt exceeds $60 trillion, over 400% of the country’s annual GDP of a bit over $14 trillion. Of that total, family debt (including mortgages), financial and non-financial firms’ debt, and municipal and national debt come to about $15 trillion, $17 trillion, $22 trillion, $3.5 trillion, and $11 trillion, respectively, though it is hard to tell how these debts have been split up among foreign governments, financial firms, companies, and individuals. To relieve the crisis, the US must repay its debts, and to do that it needs to live a more frugal life instead of asking others to continue lending it the money to maintain its over-consumption.

The first thing the government needs to do is reduce spending and the deficit. Correspondingly, the US needs to cut military disbursement, stop its global expansion and the robbing of oil resources from other countries. Companies should also become thrifty and avoid highly leveraged operation. Families and individuals should stop anticipating their income to buy houses and travel globally. Instead, they should warmly welcome foreigners to travel to and spend money in the US.          

But if the US must ask China to buy some portion of its national debt, what kind of conditions and principles should China we raise? The principle should be the same as the basic principle upheld by the US and IMF when “saving” other countries in crisis: cut fiscal disbursement and both the government and the people should save money. Besides that, there are six points:

• first, the US should cancel the limits on high-tech exports to China, and allow China to acquire advanced technology and high-tech companies from the US;
• secondly, the US needs to open its financial system to Chinese financial institutions, allowing all Chinese financial firms to open branches and develop business in the US;
• third, the US should not prevent Europe from canceling the ban against selling weapons to China;
• fourth, the US should stop selling military weapons to Taiwan;
• fifth, the US should loosen its limits on numbers of Chinese tourists and allow them to travel freely to the US; and
• sixth, the US should never restrain China’s exports to the US and force RMB appreciation in the name of domestic protectionism and employment pressure.

If the US should refuse to agree to the six principals, that only means it doesn’t really need China to save its market and buy its national debt. Then China’s choice is quite simple: rationally adjust the structure of its foreign exchange reserve assets and avoid the risk of the US national debt according to market rules.

What is worth special attention is that the prerequisite for China’s purchase of US national debt is that China has enough foreign currency to meet the exchange demand when hot money is flowing out in large scale. Otherwise China will have to sell US debt to relieve its lack of foreign exchange currency, which will lead to sharp depreciation of China’s dollar assets. What is even worse, China may immediately suffer a financial crisis led by the lack of foreign currency.

So if the US wants China to help save its market, the US government and the IMF must admit China’s right to manage its foreign exchange independently. Once large scale hot money outflows occurs, China has the right to take effective measures to restrain the speed and amount of hot money outflow, and the US and IMF can’t blame China for it. This is the most important prerequisite, even more important than the six principles mentioned above. If the US can’t agree to it, China may trap itself when saving the US. When exchange crisis happens in China, who can promise the US and the IMF won’t hit China when it’s down?

China Should Buy Gold for Reserves, Association Says
China, the second-biggest overseas holder of U.S. Treasuries, should increase its bullion holding to diversify its reserves because the dollar may decline, the country's gold association said. "China should have at least several thousand tons of gold in its reserves, five to six times the officially announced 600 tons," Hou Huimin, vice chairman of the China Gold Association said by phone from Beijing. The group represents producers, traders and retailers.

The U.S. budget deficit climbed to a record in October, and some investors are betting the dollar may weaken as the Treasury would need to sell more debt to finance its $700 billion financial-rescue package. Gold has tumbled 29 percent from its March record. " There's no doubt that gold would be attractive, as U.S. debt is likely to swell," said Kenichiro Ikezawa, who oversees about $3 billion as a fund manager at Daiwa SB Investments Ltd. in Tokyo. "In the long term, both the dollar and Treasuries will probably weaken. It's possible that China will buy more gold, though the country is likely to do so gradually."

China has the world's biggest foreign-exchange reserves at $1.9 trillion, according to data compiled by Bloomberg. It is also the largest overseas holder of Treasuries after Japan. China's demand for gold jumped 23 percent in 2007, making it the world's second-largest consumer. The Asian nation may buy more gold for its reserves on concern the $700 billion U.S. bank bailout will cause declines in the dollar and Treasuries, the Standard newspaper in Hong Kong reported today, citing an unidentified person.

Zijin Mining Group Co., China's largest gold producer, and rivals Shandong Gold Mining Co. and Zhongjin Gold Corp. jumped by their daily limit of 10 percent in Shanghai trading. Zijin rose to 3.87 yuan at the 3 p.m. close, the highest in a month. Shandong Gold gained to 38.13 yuan, and Zhongjin Gold climbed to 29.34 yuan. "Chinese gold stocks are probably rising on the speculation that China may buy more bullion," said Wayne Fung, a Hong Kong-based analyst at China Everbright Securities Ltd. "It won't surprise me if China goes ahead as it's not the first time the rumor has emerged in the market."

Some Asian central banks may seek to build up gold holdings a little as the percentage in their reserves is rather low, said Dominic Schnider, commodities analyst at UBS Wealth Management Research. "But I don't think they will go into the market and destroy the balance and push it to ridiculous prices," he said. Gold more than doubled in the past six years and reached a record $1,032.70 an ounce March 17 as the dollar slumped and oil advanced, increasing concern inflation would accelerate. In the past eight months, the precious metal has plunged about 30 percent as the dollar rallied, oil collapsed and the global credit crisis pushed the world toward a recession. The U.S. dollar index advanced to a 30-month high yesterday.

"The dollar has gone up and gold come down so if you want to diversify it's a decent time to do so," Larry Kantor, head of research at Barclays Capital, said in Singapore. If countries want to shift into gold from currencies, "they will do it over a very long period." The U.S. budget deficit climbed to an all-time high of $237.2 billion in October, spurred by the purchase of stakes in some of the nation's largest banks, according to Treasury Department data released yesterday in Washington. The Treasury this month said it will more than triple its planned debt sales this quarter to help finance this year's budget shortfall. The government needs to raise money not only for the package, but also to pay for its bailouts of mortgage companies Fannie Mae and Freddie Mac.

How likely is a sterling crisis or: is London really Reykjavik-on-Thames?
Willem Buiter

With the pound sterling dropping like a stone against most other currencies and long-term interest rates on UK sovereign debt beginning to edge up, this is a good time to revisit a suggestion I made earlier on a number of occasions (e.g. here, here and here), that there is a non-trivial risk of the UK becoming the next Iceland.

The risk of a triple crisis - a banking crisis, a currency crisis and a sovereign debt default crisis - is always there for countries that are afflicted with the inconsistent quartet identified by Anne Sibert and myself in our work on Iceland: (1) a small country with (2) a large internationally exposed banking sector, (3) a currency that is not a global reserve currency and (4) limited fiscal capacity.

The argument is simple. First consider the case where the banking sector is fundamentally solvent, in the sense that its assets, if held to maturity, would cover its liabilities. Iceland’s banks were supposed to have been in that position, although I have seen no verifiable information on the quality of the three formerly internationally active banks. There is no such thing as a safe bank, even if the bank is sound. Without an explicit or implicit government guarantee, there is always the risk of a bank run (a withdrawal of deposits or a refusal to renew maturing credit and to roll over maturing debt) or a sudden market seizure or ’strike’ in the markets for the bank’s assets bringing down a fundamentally sound bank.

To prevent a fundamentally sound bank succumbing to a deposit run or to asset market illiquidity, the central bank has to be able to act as lender of last resort, providing funding liquidity and as market maker of last resort, providing market liquidity to liquidity-constrained banks.

If the country has an internationally active banking and financial sector and if its foreign currency liabilities have a shorter maturity than its foreign currency assets, and especially if these foreign currency assets have become illiquid, the central bank has to be able to act as foreign currency lender of last resort and market maker of last resort if it is to be able to guarantee the survival of the banking sector when faced with a deposit run and/or illiquid markets for its assets.

The central bank of Iceland could be an effective lender of last resort in Icelandic krona, as it can print the stuff in unlimited quantities. It can be a lender of last resort and market maker of last resort in other currencies only to a limited extend - limited by the fact that the Icelandic krona is not a global reserve currency and by the fiscal spare capacity of the Icelandic sovereign.

If Iceland had been a member of the euro area, its central bank would have been part of the Eurosystem - the euro area central bank consisting of the ECB and the (currently 15) national central banks of the euro area member states. The euro is the junior of the two global reserve currencies. First is the US dollar, with around 64 percent of global official foreign exchange reserves held in US dollars. The euro’s share is around 27 percent. After the euro, there is nothing. Sterling’s share of 4.7 percent (at the overly flattering strong sterling exchange rate of late 2007) reflects its minor-league legacy reserve currency status. The Japanese yen and Swiss franc are completely irrelevant as global reserve currencies.

Clearly if a country has a major-league global reserve currency as its national currency, two consequences follow. First, it is likely to be able to borrow abroad using instruments denominated in its own currency rather than in that of the currency of the lender or some other global reserve currency - they are less affected by ‘original sin’ - in the currency-denomination-of-external-debt sense of the expression. Second, it will be possible for both private parties and for official parties like the central bank, to arrange access to foreign exchange (through swaps with other central banks, credit lines etc.) more easily and on better terms than are available to private parties, central banks and other official agents not blessed with a global reserve currency of their own.

As a member of the euro area, it would have been much easier and cheaper for Iceland to defend itself against speculative attacks on its banks - provided the banks and its government were indeed solvent and perceived to be so. With the krona, not only could solvent banks be brought down, even a solvent but illiquid (in foreign exchange) government could be brought down by a sufficiently large speculative attack on the banks, the currency and the public debt.

Of course, even with the euro, the banks could not have been saved by the Icelandic authorities if the banks were fundamentally unsound and if the government did not have the fiscal strength to recapitalise the banks. Under current circumstances, if the government injects capital into a bank to compensate for past and anticipated future losses, it may not achieve a risk-adjusted expected rate of return on this investment equal to its borrowing cost. The difference will have to be recouped through higher future primary surpluses, that is, higher future government budget surpluses excluding interest payments. If there is doubt in the markets about the ability or willingness of current and/or future governments to raise future taxes or cut future spending to generate the required increase in future primary surpluses, the default risk premium on the public debt will rise. We are seeing such increased default risk premia even for the most credit-worthy sovereigns, including the German government, the US government and the UK government. On Friday October 10, 2008, the spreads on 5 year sovereign CDS were 0.456% for the UK, 0.33% for the USA ad 0.265% for Germany, well above their post-war historical averages. On October 28, 2008, Bloomberg wrote:

“Credit-default swaps on [U.S.] Treasuries have risen nearly 40 percent since TARP was signed into law Oct. 3, and are now about the same as Mexican and Thai government debt before the credit markets began to seize up in June 2007.”

By bailing out the banks, and other bits of the financial system, the authorities reduce bank default risk but by increasing sovereign default risk. As long as there is sufficient fiscal spare capacity (the technical, economic and political prerequisites are met for raising future taxes and/or cutting future public spending by a sufficient amount to service the additional public debt and maintain long-run government solvency).

Iceland’s government did not have the fiscal resources to bail out its banks. All three internationally active banks were put into receivership. The domestic bits then were bought by the government out of the receivership. The Icelandic krona collapsed and is no longer internationally convertible: exchange rate restrictions have been imposed. It is an open issue whether Iceland will default on some of its sovereign debt obligations as well.

How and to what degree is this relevant to the UK? Iceland is a tiny country (about 300,000 people - the size of the city of Coventry). The UK has a population of over 61 million. Nevertheless, the UK is a small open economy for economic purposes: it is a price taker in the markets for its imports and exports and in global financial markets. Its share of world GDP in 2007 was 3.3% (at PPP exchange rates - somewhat higher at market exchange rates). Its currency is no longer a serious world reserve currency.

The UK banking sector’s balance sheet is about half the size of the Icelandic banking sector as a share of annual GDP: just under 450% at the end of 2007 as compared to Iceland’s almost 900%. Switzerland, another vulnerable country (small, no currency with global reserve currency status , large banking sector relative to GDP and limited central government fiscal capacity) has a banking sector balance sheet of just over 650% of annual GDP. With UK annual GDP around £1.5 trillion, that gives us a banking sector balance sheet of well over £ 6 trillion.

The first Chart below shows the size of the balance of the UK banking sector. This includes the Bank of England. If we exclude the Bank of England, the latest observation on the balance sheet of the banking sector and a percentage of annual GDP would still be around 420 percent. The deleveraging of the banking sector, visible at the very end of the sample period, has much further to go. The Chart also shows that foreign currency assets and liabilities of the banking sector are very evenly matched - the two lines are almost indistinguishable. Both now are just below 250% of GDP. I don’t have any data on the degree of mismatch by individual currency. Just the aggregate foreign currency exposure is shown.

While there is no net foreign exchange exposure of the banking system in the UK, banks are banks. The foreign currency liabilities of the banking system are therefore likely to have shorter maturities than the foreign currency assets. The foreign currency assets are also likely to be less liquid than the liabilities. I don’t have information on the maturity and liquidity composition of foreign currency assets and liabilities to confirm or refute this presumption. Let me just say that Iceland’s banks were brought down despite an aggregate match between foreign currency assets and foreign liabilities.

Chart 1


Source: Office for National Statistics

Not only are the UK banks rather large relative to the size of the economy, the gross external assets and liabilities of the British economy are also hefty - about the same size relative to UK GDP as the total assets of the banking sector (there is no deep reason for this coincidence). Chart 2 below shows the gross external asset and liability position and the net foreign investment position of the UK. While not in the Iceland league (Iceland had gross foreign assets and liabilities of around 800 percent of annual GDP at the end of 2007) the UK, with gross foreign assets and liabilities of well over 400 percent of annual GDP does look like a highly leveraged entity - like an investment bank or a hedge fund. By contrast, gross external assets and liabilities of the US straddle 100 percent of annual GDP.

Chart 2


Source: Office for National Statistics

Foreign currency illiquidity risk for the UK banks and authorities

Assume for the sake of argument that the UK’s banks are sound. Most of them obviously are not, which is why so many of them have had capital injected into them by the government, and why all of them benefit from explicit government guarantees on new bank debt issuance and implicit government guarantees that the government will come to their assistance should they be at risk of insolvency. With foreign currency assets of longer maturity and less liquid than foreign liabilities, the banks and the country would still be vulnerable to a foreign currency run on the banks (a refusal to renew foreign currency credit) or a seizing up of the markets in which the banks’ foreign currency assets are traded. The Bank of England’s foreign currency reserves are puny and the government’s foreign currency reserves are small - around US$43 billion, pocket change, really.

No doubt the Bank of England would be able to arrange swaps, credit lines or overdraft facilities with the systemically important central banks - the Fed, the ECB and the Bank of Japan. Given sound banks and sound fiscal fundamentals, it should be possible for the UK to defend the banking sector against runs or market strikes. There would, however, be a cost involved - the cost faced by any issuer of a currency that is not a global reserve currency and who therefore either has to insure ex-ante against the possibility of running short of global reserve currencies, or risk getting clobbered on the terms of an emergency currency swap or similar arrangement cobbled together when the enemies are already scaling the ramparts.

This cost of insuring against foreign currency illiquidity risk will make the City of London less competitive as a global financial center than rivals based in global reserve currency jurisdictions. It provides another strong argument for the UK adopting the euro and for the Bank of England becoming part of the Eurosystem as soon as the other EU member states will let it.

The reason the costly handicap of a minor-league currency does not appear to have harmed the UK in the past is the same as the reason why I have not made the argument in the past. Before the current financial crisis, no-one could conceive of a world in which a financial crisis would start in the global financial heartland - Wall Street and the City of London - rather than in some developing country or emerging market, would paralyze most systemically important wholesale financial markets and lead to the government nationalising much of the north Atlantic region’s banking and wider financial system and underwriting or guaranteeing the rest. Well, most of the world now knows that this is the way things can be. If it retains sterling, the City of London will put itself at a competitive disadvantage (for those who remember then-Chancellor Brown’s Five Tests for euro area membership, this means that the fourth of these tests now has been met also).

Sovereign default risk for the UK

Even if the UK had the euro as its currency, its banks would still have been at risk if they were unsound (their assets, even if held to maturity, would not cover their financial obligations). In this case, bank insolvency would result unless the British authorities were both able and willing to bail them out. I assume in what follows that the government is willing to bail out the banks. The evidence thus far supports this.

Northern Rock and (rump) Bradford and Bingley were nationalised. The SLS allows all banks to swap illiquid asset-backed securities for Treasury Bills. For reasons that cannot be understood by ordinary mortals, the Treasury Bills lent/swapped by the SLS don’t count as public debt (something to do with Treasury bills with less than one year remaining maturity not being part of the public debt for some accounting and accountability purposes - don’t ask). The Bank of England is accepting a wider range of private securities as collateral at the discount window and in repos. The state has a 60 percent ownership stake in RBS and roughly 40 percent ownership stakes in HBOS and Lloyds-TSB. The government has made up to £25o billion available to guarantee new issuance of bank debt. The state stands behind the formal £50,000 deposit guarantee for bank retail deposits.

The key question is, can the government meet all these fiscal commitments, whether firm or flaccid, unconditional or contingent and explicit or implicit ? Does it have the resources, now and in the future, to issue the additional debt required to meet the growing volume of up-front obligations it has taken on?

To be solvent, the face value of the government’s net financial obligations has to be no larger than the present discounted value of current and future primary government surpluses (government surpluses excluding net interest and other investment income). The government argues that its net debt position is strong, with a net debt to annual GDP ratio still just below forty percent. That statistic is a prime example of lies, damned lies and government statistics.

The 40 percent excludes such old sins as the debt incurred through the PFI (private finance initiatives). This will be brought into the total soon. It also does not yet include the net debt of Northern Rock and Bradford and Bingley. It also excludes the debt of RBS, where the government owns a majority stake and the debt of Lloyds-TSB and HBOS, where the government has a controlling minority stake. Under normal accounting practices, the debt of all three banks will have to be counted as public debt in the future.

Three large UK banks, HSBC, Barclays and Abbey (Santander) have not yet taken the King’s shilling - they are attempting to meet the capital raising targets they agreed with the government from sources other than the government. All three banks are, however, heavily exposed to emerging markets (Santander mainly in Latin America, HSBC in Asia, the Americas, Europe, the Middle East, and Africa and Barclays in Europe, Africa and Asia). This has been a source of strength until recently, compared to their competitors who were mainly exposed to the USA and Western Europe. However, with all emerging markets now severely affected by the financial crisis (both directly and through trade links with Western Europe and the USA), what was a source of strength is become a further source of weakness. The likelihood that some or all of the banks that have not yet received capital injections from the government will do so in the not too distant future is rising steadily.

It is not at all far-fetched to hold the view that the British government has effectively guaranteed the balance sheets of the entire UK banking sector. Let’s value this conservatively at 400 percent of annual GDP, some £ 6 trillion. The value of this guarantee depends on the likelihood it will be called upon, and on the amount of money the government would have to come up with if the guarantee is called. Both numbers are highly uncertain and any guestimate is bound to be subjective. The expected payments under the guarantee are, in my view, hardly likely to be less than £300 bn (on top of any money already paid out), some 20 percent of annual GDP. It could be much higher. With a recession of unknown depth and duration looming, there is a material risk that the government would have to come up with a multiple of the £300 bn just mentioned.

Of course, the value of the assets acquired by the government as shareholder has to be set against the explicit and implicit liabilities it has taken on. I would like to see a valuation of the equity stakes of the government that does not benefit from the recent scandalous relaxation of fair-value accounting and reporting that was forced upon the IASB. I don’t believe any valuation that relies on managerial discretion. With the regulatory constraints likely to be imposed on banks in the future, and the lower returns associated with banking-as-a-public utility, the government may well be getting rather poor financial returns on its investment in the banks. While that does not mean the government should not have made the capital injections - the systemic externalities associated with the failure of large banks don’t show up in the share price - it does mean that the immediate fiscal burden of the capital injections is likely to be only partially offset by future dividends and (re-)privatisation receipts.

In addition to the debt that has been and will be issued to finance asset purchases by the government, there are the future debt issuance associated with the large cyclical and structural government deficits that will be a feature of the coming recession. If GDP falls peak-to-trough by, say 3.5 percent and recovers only slowly, we could have a seven percent of GDP or higher government deficit for 2009 and 2010. Together with the explicit or implicit fiscal commitments made to safeguard the British banking system, the numbers are likely to spook the markets.

With the true net public debt to GDP ratio probably already well above 100 percent of GDP and rising, and with massive public sector deficits, partly cyclical and partly structural, about to materialise, the markets will question the fiscal-financial sustainability of the government’s programme with increasing vehemence. The CDS spreads on UK public debt will start rising. The notion that, except for currency, there may not be a safe sterling-denominated asset may come as a shock. But the same is true in the US. In 2009, the US government will have to sell (gross) at least $ 2 trillion worth of government debt (the sum of the Federal deficit plus asset purchases plus refinancing of maturing debt). The largest such figure ever in the past was $550 billion. In the US too, the markets will have to learn to do without a US dollar financial instrument that is free of default risk.

The fiscal dire straits the UK government are in limits their capacity to engage in a discretionary fiscal stimulus to boost domestic demand. For it to be meaningful, a debt or money-financed stimulus of at least one percent of GDP and more likely two percent of GDP is called for. But if the market takes fright and believes that the government will not raise future taxes or cut future public spending by the amounts required to safeguard government solvency despite greater current borrowing, it will add higher default risk premia to the longer-dated UK sovereign debt instruments.

Such mistrust in the temporary nature of a fiscal stimulus would not be irrational. After its first term in office, the government have thrown fiscal restraint to the wind and have engaged in a steady increase in public spending as a share of GDP which has been only partly matched by an increase in the tax burden as a share of GDP. Rising debt and deficits and a fondness for fiscal and accounting gimmicks designed to hide the increase in the debt burden have undermined public confidence in the fiscal rectitude of the government. With enough mistrust, the interest rates will rise by enough to crowd out completely the stimulus to private demand provided by the tax cut or public spending increase. Lack of confidence in the government’s fiscal sustainability would also undermine confidence in sterling. In the worst case, we could see a run on the banks, on the public debt and on sterling all at the same time. This is not the most likely outcome yet, in my view. But it is a distinct possibility.

Could the government monetise the deficits instead (i.e. sell gilts to the bank of England)? The Bank would only be willing to buy such debt (either directly or indirectly in the secondary markets) if it was consistent with its interpretation of its price stability mandate. The Bank appears to believe that short rates may have to go down quite a bit further if it is not to undershoot the inflation target by the end of next year. It may also view the monetisation of gilt issuance as consistent with its mandate.

If there is a conflict between the Bank of England and the government, the government could invoke the Treasury’s Reserve Powers. This is a clause in the Bank of England Act that allows the government to take back the power to set rates from the Bank of England, under exceptional and emergency conditions. It has never been invoked.

If the deficits get monetised, there will not be the upward pressure on real interest rates that would result from debt financing. But the markets may fear the long-term inflationary consequences of the monetary financing, especially if it were to be done by the government after invoking the Treasury’s Reserve Powers. So long nominal rates would be likely to rise if monetisation of the government’s deficits were chosen. Monetisation of deficits would also weaken sterling further.

All may still end up well (cyclically adjusted well, that is). But the piling of fiscal commitment on fiscal commitment by the government is not a risk-free option. The British government has limited fiscal spare capacity. Among the larger European countries, the UK government’s exposure, formal or implicit, to its banking sector is by far the highest. Switzerland, Denmark and Sweden are in a similar pickle, with the banking sector solvency gap threatening to become larger than the fiscal spare capacity of the state.

The British government should go easy on the discretionary fiscal stimulus it applies, lest it risk a triple bank, sterling and public debt crisis. Better to first let the Bank of England use the 300 basis points worth of Bank Rate cuts that it still can play with. Even better to combine rate cuts with measures to directly target the disfunctionalities in the interbank market, such as government guarantees for (cross-border) interbank lending.

The UK shares with the United States of America the predicament that unfavourable fiscal circumstances make the wisdom of a significant fiscal stimulus questionable. In the US as in the UK the twin deficits (government and current account) severely constrain the government’s fiscal elbow room. Both countries need all the help they can get from fiscal stimuli abroad, in China, in Germany and in the Gulf. Beggars can’t be choosers.

Letter from Iceland: A pig trying to balance on a mouse’s back
Think of Ireland. Rotate it 90 degrees clockwise, make it a third bigger and hang it like a pendant from the Arctic Circle. Crack open the earth’s crust below to release limitless supplies of geothermal steam, then fill its territorial waters, all 200 miles of them, with an abundance of cod.

Give it a population of 300,000, about the same as Coventry, 70 per cent of them in the cities of Reykjavik and Akureyri. Ensure they are all related and give the majority the ability to trace their ancestry back to the times of settlement, more than a thousand years earlier. Endow these people with industry and ambition. Give them their own language – all but unchanged for a millennium – a literary tradition, three national newspapers, two television channels, free universal healthcare and education and close to zero unemployment. Give this country a consistently high ranking in the world standard-of-living charts and you have the Iceland of the recent past. Not a bad place, all in all.

Now allow this country’s banks – virtually unregulated – to borrow more than 10 times their country’s gross domestic product from the international wholesale money markets. Watch as a Graf Zeppelin of debt propels its self-styled “Viking Raiders” across the world’s financial stage, accumulating companies like gamblers hoarding chips. Then sit on the sidelines as the airship flies home and explodes, showering its blazing wreckage over this once proud, yet tiny, nation. There you see the Iceland of today – the victim of an economic 9/11 and one of the very few places in the world where the words “financial meltdown” can be used without fear of exaggeration.

There is no daytime TV in Iceland. Parents are at work and children at school, so the test card, that feature of a bygone age, is the only thing aired. For the transmitters to be switched on in mid-afternoon and a sombre-looking Geir Haarde, the prime minister, to appear behind a desk, a national flag at his side, it had to be serious – and it was. The country was on the verge of bankruptcy; the government was taking control of the banks and was going to assume far-reaching powers to secure the safety of the nation and its savers.

As I watched, I felt a detached sympathy for those poor people living on a blighted island – until it dawned on me that I was one of them. Recent events had savaged my net worth by 60 per cent and pushed up my cost of living by more than 20 per cent. Iceland’s plight was mine, too. What I failed to appreciate at the time was the emotion of this unprecedented television address, particularly in the way it finished:

“Fellow countrymen ... If there was ever a time when the Icelandic nation needed to stand together and show fortitude in the face of adversity, then this is the moment. I urge you all to guard that which is most important in the life of every one of us, to protect those values which will survive the storm now beginning. I urge families to talk together and not to allow anxiety to get the upper hand, even though the outlook is grim for many. We need to explain to our children that the world is not on the edge of a precipice, and we all need to find an inner courage to look to the future ... Thus with Icelandic optimism, fortitude and solidarity as weapons, we will ride out the storm. “God bless Iceland.”

Edda, my partner, was in tears on the sofa beside me.

A drive across town later that afternoon, October 6, at first gave grounds for comfort. The roads were as full as usual for the Reykjavik rush-hour – a half-hour build-up of traffic. Aircraft flew in and out of the downtown airport, students made their way home from schools and universities – note the plural – while visitors went to hospitals and fitness fiends to sports clubs. Reykjavik showed all the outward appearances of carrying on. But a different picture began to emerge from the hourly news bulletins on the car radio. The Icelandic krona’s freeze in the capital markets had now spilled over into the day-to-day transactions of Icelanders abroad. Holidaymakers and business travellers venturing “til Útlanda”, as it is called, found their credit cards refused, and those wishing to buy foreign currency could not find willing sellers, aside from one or two who limited their purchases to €200.

Trust in the banks had evaporated and people were trying to find a safe haven for their cash. One man had waited for six hours in a bank while his life savings, more than £1m in kronur (at IKr200 to the pound), were counted out in cash in front of him. “I feel like an innocent man dragged from his bed, put in a barrel and hurled over Gullfoss!” wrote one journalist that morning. “We have been brought down by a handful of men who bet our nation’s wealth, fame and prosperity on a throw of the dice.” Gullfoss is one of Iceland’s tourist attractions – a majestic 100ft waterfall. On collecting our daughter from her handball practice, I learnt the news that her club could not obtain the foreign currency it needed to release their new team shirts from customs. The city’s myriad sports teams rely on local sponsors and our daughter also brought the news that this source of funding for her team was likely to dry up in the months to come.

Later that evening, Skype, our communications lifeline, would not renew our credits with an Icelandic credit card. E-mails began to arrive from friends overseas, alarmed by news reports and asking if we were all right. But all this was trivial compared with the financial distress, in some cases ruin, that now faces a significant proportion of the population. Easy access to 100 per cent mortgages has seen a change to the traditional pattern of young Icelanders living with their parents until their mid-twenties. The suburbs of Reykjavik have grown by a third in the past decade, most of it housing for first-time buyers. Whole new neighbourhoods have emerged. New streets house young couples, many with children, most with two cars in the drive and furnished with the best that Ikea can provide. All bought with 100 per cent loans, many in foreign currencies.

Iceland is the only country in the world that indexes its loans in addition to charging interest. This means that when Icelanders borrow IKr1,000 from the bank and inflation increases by 5 per cent, the bank increases their debt to IKr1,050 at the end of the year. A great deal for the bank and fine for you, too – so long as the property’s value and your salary are increasing by inflation and more. The majority of Icelandic mortgages are based on this punitive system and with inflation running at nearly 20 per cent, they will see their IKr1,000 loan turn into a IKr1,200 loan. The interest burden will increase proportionally. This is bad enough, but when coupled with falling house prices, it means that many face a particularly savage variety of negative equity. The impact on highly geared borrowers, which in practice means most Icelanders, would be hard enough even with two incomes, but with unemployment set to soar, many households are going to go under.

A recent first-time buyer, a woman in her late twenties, said: “I took a 100 per cent loan to buy an apartment. I placed my savings in Kaupthing’s money market account, because it promised high interest rates, and my pensions in Kaupthing’s Vista 1 at the prospect of becoming a millionaire retiree. Both of these funds were based on stock investments and I knew that they were risky – but I took the bait and the risk. Now most of this money, if not all, is lost.”

Icelanders are by nature frugal people. It was one of the few countries in the world, perhaps the only one, that had a pension system that could meet the needs of its ageing population. But in recent years, many older people have been persuaded by the banks to invest their savings in high-yielding money-market accounts. As a result of the collapse of the banking system, many of these accounts have seen huge write-downs and some are now worth less than half of their previous values. The additional money people had put aside to top up their pensions has been hard hit.

Bjork, Iceland’s ambassadress of cool, summed it up in The Times on October 28: “Young families are threatened with losing their houses and elderly people their pensions. This is catastrophic. There is also a lot of anger. The six biggest venture capitalists in Iceland are being booed in public places and on TV and radio shows; furious voices insist that they sell all their belongings and give the proceeds to the nation. Gigantic loans, it has been revealed, were taken out abroad by a few individuals and without the full knowledge of the Icelandic people. Now the nation seems to be responsible for having to pay them back.”

A homemade banner, made of sheets, hangs over the main motorway in Reykjavik, tied to the railings of a bridge. “Stondum Saman!” it cries out. “Let us stand together!” It’s the new rallying cry of a beleaguered nation.

Icelanders have seen their economy swell and shrink from time to time over the centuries, and always handled it calmly. Perhaps their heritage in fishing and agriculture enabled them to meet good years and bad with equanimity. Now they must cope equally well with an attack of economic bulimia. To understand what makes this crisis – kreppa, as it is known here – so unlike any other, a little history is needed.

For Icelanders, the golden years were the early years, shortly after the land was settled in the ninth century. The Viking tradition, the Althing – the legislative assembly dating to 930 – and the literary canon of Sagas and Eddas are the nation’s cultural bedrock. But after that, Iceland almost disappears from the history books. While the agricultural revolution, the Renaissance, the industrial revolution came and went, while the fine cities of Europe were being built, while artists from Michelangelo to Mozart were pouring forth their creations, while the great inventions and discoveries were being invented and discovered, Icelanders were hunkering down in their turf houses, meeting the hardest challenge of all – survival.

They survived plague, famine, earthquakes and volcanoes. There were times when some even considered abandoning the island. But they stayed on. They stayed and survived. Icelanders will tell you that only the fittest survived, but that is only half the story, because survival requires another key attribute: stubbornness. And Icelanders have it in spades. It is a national trait, and they view it not as a weakness but as a virtue. It comes from experiencing hardship and enduring it. It means finding satisfaction in a simple task done well and sticking to it; finding comfort and solace in family and kinship and being bound by those familial bonds and duties. And perhaps most important of all, it means believing in the independence of the individual as part of the fabric of nationhood, and fighting for that independence. Put simply, the country has values.

And this is what sets this catastrophe apart from the earthquakes and plagues of former years. This is a man-made disaster and worse still, one made by a small group of Icelanders who set off to conquer the financial world, only to return defeated and humiliated. The country is on the verge of bankruptcy and, even more important for those of Viking stock, its international reputation is in tatters. It hurts.

Picture a pig trying to balance on a mouse’s back and you’ll get some idea of the scale of the problem. In a mere seven years since bank deregulation and privatisation, Iceland’s financial institutions had managed to rack up $75bn of foreign debt. In his address to the nation, Haarde put the problem in perspective by referring to the $700bn financial rescue package in America: “The huge measures introduced by the US authorities to rescue their banking system represent just under 5 per cent of the US GDP. The total economic debt of the Icelandic banks, however, is many times the GDP of Iceland.”

And here is the nub. Iceland’s banks borrowed more than $250,000 for every man, woman and child in Iceland, and placed an impossible burden on the modest reserves of the central bank in the event of default. And default they have. Voices of caution – there were many in Iceland – were drowned out by a media that became fixated on the nation’s emergence from drab pupa to gaudy butterfly. Yet, Icelanders’ opinions were divided. For some, the success of their Viking Raiders, buying up the British high street, one even acquiring that most treasured bauble of all, a Premier League football club, marked the arrival of a golden era. The transformation of Reykjavik from a quiet, provincial fishing port to a brash financial centre had been as swift as it was complete, and with the musicians Bjork and Sigur Ros and Danish-Icelandic artist Ólafur Eliasson attracting global audiences, cultural prestige went hand in hand with financial success. Icelanders could hold their heads high before the rest of the world.

Hallgrimur Helgason, well-known for his novel 101 Reykjavik, said in a letter to the nation in a Sunday newspaper on October 26: “Deep down inside we idolised these titans, these money pop-stars. Awestruck we watched their adventures and admired them when they supported the arts and charities. We never had clever businessmen, not for a thousand years, not to mention men who had won battles in other countries...” For others, the growth was too rapid, the change too extreme. Many became uncomfortable with the excesses of the Viking Raiders. The liveried private jets, the Elton John parties, the residences in St Moritz, New York and London and the yachts in St Tropez – all flaunted in Sed og Heyrt, Iceland’s equivalent of Hello! magazine – were not, and this is important, they were not Icelandic. There was a strong undertow of public opinion that felt that all this ostentatious celebration of lavish lifestyles and excess was causing the nation to disconnect from its thousand-year heritage. In his letter to the nation, Hallgrimur continued: “This was all about the building of personal image rather than the building of anything tangible for the good of our nation and its people. Icelanders living abroad failed to recognise their own country when they came home.”

What international sympathy there was for Iceland’s plight evaporated with the dark realisation that the downfall of Iceland’s three main banks – Landsbanki, Kaupthing and Glitnir – brought with it the potential loss of £8bn for half a million savers in northern Europe, the bulk of whom were British. The shrill media response in the UK was reported extensively in Iceland. The British government’s use of anti-terror legislation to freeze the assets of Landsbanki pushed Iceland’s banking system into the abyss. It was a move viewed in Iceland as hateful and unnecessary. A few days later the one remaining viable bank, Kaupthing, went under. Then Landsbanki was placed on a British Treasury list of groups subjected to financial sanctions, along with al-Qaeda and the Taliban. A copy of the UK government webpage appeared in Icelandic papers and a new website,, was launched. A picture on it shows a young girl with a placard that reads: “I am not a terrorist, Mr Brown.”

At this time of year, the most-watched TV show in Iceland is Saturday night’s Spaugstofan, which translates literally as The Spoof Room. It’s a hit-or-miss affair, but events of the past few weeks have provided the writers with a rich seam of source material. A recent episode featured a well-worked lampoon of the film Titanic, entitled Icetanic, with Geir Haarde and the chairman of the governors of the central bank, David Oddsson, standing on the bridge of “the economy that could not sink”. A sketch shows Gordon Brown throwing Icelanders off a life raft. “Get back in the water where you belong, you terrorist bastard!” he shouts as he throws another one overboard.

When I tried to explain Iceland’s plight to a friend in the UK who works in banking, I received short shrift. “You must have gone troppo, Robert! They may not have dressed up in burkas and strapped several kilos of Semtex around their waists. But to go into the high street, persuade charities, pensioners, local authorities to deposit money and then disappear, having trousered nigh on £8bn is, even by City standards, bad. Financial terrorism, grand larceny, call it what you will, but the government had to act and act quickly to stop funds leaving the country.” Troppo can hardly apply one degree south of the Arctic Circle, but if its northern equivalent is to go polar, then evidently I have.

Fear, outrage, jealousy and guilt have mingled to form a volatile cocktail of emotions as the blame game has started, and Icelanders attempt to come to terms with it all. They are divided between those who blame the Viking Raiders and those who blame successive governments and central banks for allowing them to behave the way they did. There have been demonstrations, previously almost unheard of in Iceland, in which families have marched on the parliament buildings, stringing up an effigy of Oddsson along the way.

Of the various Viking Raiders, only one, Jon Ásgeir, of Baugur fame, has had the guts to turn up and face the music on a TV chat show. But any temporary benevolence towards him evaporated when it emerged that he had arrived back in Iceland with high-street billionaire Sir Philip Green in tow. Together they proposed to buy Baugur’s debt, reported at the time as £2bn, thereby acquiring the group’s UK retail assets, including House of Fraser and Hamleys at a significant discount that would involve massive debt writeoffs.

One of the most telling images was the departure of Jon Ásgeir’s private jet on news that the government had nationalised Glitnir Bank (in which his investment vehicle Stodir was a leading shareholder), wiping out his shareholding and rattling the debt-burdened house of cards that is his Baugur business empire. Painted black and as sleek as a Stealth bomber, the aircraft was photographed taxiing from its hangar by Morgunbladid, a daily newspaper. Like the last helicopter out of Saigon, the departure of Ásgeir’s jet symbolised the end of an era, the last act of Iceland’s debt-fuelled spending spree.

Bjorgolfur Thor and his father Bjorgolfur Gudmundsson have, to date, disappeared from the radar. Together they own a majority stake in Landsbanki, and Gudmundsson owns West Ham United football club. Their jets have also flown the coop. Downtown, beside the harbour, construction work on a landmark project underwritten by them, the National Concert Hall, is expected to stop any day now. Like Hallgrimskirkja, the striking cathedral that presides over Reykjavik and that took more than 40 years to complete thanks to a lack of finance, the concert hall might need a change in the country’s fortunes before it can be completed.

The government has announced that it will carry out a thorough investigation into what happened and determine who is to blame. It will be called “The White Book”, and “leave no stone unturned in getting to the truth”. It will not be a slender volume. We live now in a foreign-currency lockdown, and although the government has assured everyone that there are sufficient reserves to buy essentials such as oil, grain and medical supplies for the winter, such assurances only serve to create a further sense of unease in a people who have learnt to take such commodities for granted.

There is some encouraging news. The International Monetary Fund is putting the finishing touches to a $2bn bailout package and this is likely to lead to a further $4bn from a consortium of Nordic central banks. These funds will come with stringent conditions that will impose external financial controls and impinge heavily on Iceland’s hard-won sovereign independence. But they should inject some much-needed confidence into the currency and into an embattled people.

There is an Icelandic expression: “We started with two empty hands.” Whoever coined it could not have expected that it would still be so pertinent in 2008, as the nation begins the process of rebuilding its economy and that thing it covets most of all, its reputation. It is going to be a long, hard struggle.

The 'Miracle of Macau' faces stark reality
In a park at the heart of old Macau, three men in their 20s, wearing tracksuits and expressions of great concentration, juggle plastic cocktail shakers in a baffling flurry of patterns. When they clatter to the floor, the trio scream abuse at each other. It is an uncomfortably tense time in Macau. All three men have dropped out of university to seize a dream job behind a bar in one of the casinos: but not only is their act far from perfect, the construction of the bar they hoped to work in has stopped.

Standing in a sea of silent building sites, Macau has become the lates, probably glitziest, victim of the credit crunch. The work that ground to a halt last week was on sections five and six of a huge casino development for which the Las Vegas Sands Corporation run by Sheldon Adelson, the casino billionaire, had borrowed heavily. Funding problems mean the future of the complex is in the balance. The dread sweeping through Macau and its once irrepressible investors is that the gambling town's woes do not begin and end with Mr Adelson's financial problems. He may have allowed the creation of a “Vegas of the East” to snowball into a vast, unfundable mess, but there are many others who have bought into the same vision, and have the vast, half-finished building sites along Macau's reclaimed seafront to show for it. In a worst-case scenario, say analysts, Mr Adelson's miseries are just an early symptom of worse carnage to come.

Behind the warnings of the pessimists are serious questions about Macau's future revenues. Income from gaming has grown nearly 30 per cent in the past year, but did so while Macau wallowed in a golden era of liberal travel rules, roaring economic growth and soaring wage packages that has now abruptly ended. At the official level there are clear signs that confidence is slipping. Edmond Ho, the chief executive of Macau, used his annual address last week to declare that the Government would take over any bankrupt casino. Analysts in Hong Kong said the comments suggest that the authorities have come to view the casinos like Wall Street banks, as edifices on the brink of implosion.

Like everyone in Macau, the would-be cocktail waiters practising in the park do not know what will happen next. The real clues are, for good, practical reasons, impossible to read. In the public gaming rooms of the big casinos, the gambling fever from which Macau visitors suffer so acutely still seems to grip its victims. Even the slot machines, never dominant in Macau, still have their devoted feeders. But it is not these noisy, blaring dens that built the Macau “miracle”. The real money is moving around behind the closed doors of the VIP rooms, whose occupants represent 80 per cent of Macau's gaming income. Macau's future turns on what is happening at its invisible tables.

Many believe that after its astonishing growth over the past four years, Macau will now behave as a straight proxy for mainland Chinese consumer sentiment. The chief threat in the current conditions, say analysts, arises because Macau's development tracked the general market excitement about Chinese economic growth. American and domestic investors and casino operators were mesmerised by a mouth-watering array of numbers. 100 million Chinese live within a three-hour drive of Macau, and, judged the developers, they all know the odds of rolling a nine at Sic Bo, one of the most popular casino tables among Chinese.

Steve Wynn's Macau casino and hotel makes about five times the quarterly operating income of his Las Vegas flagship, but with less than a quarter of the hotel rooms. In one corner of that property is a branch of Louis Vuitton which, until last month, raked in more money than any of the brand's concessions anywhere else in the world. But as sub-prime calamity has morphed into the threat of global recession, the neighbouring province is reportedly seeing factory closures at the rate of 20 per day. Tens of thousands of workers are being laid off, and even if they were never Macau's target audience, the VIP gaming tables will soon be losing the custom of the factory's senior management.

On top of this, travelling restrictions imposed by Beijing in the autumn are about to hit the high-roller market hard: mainland visitors will be limited to just six visits per year. Alas, the development of Macau has proceeded as if everyone in China would be free to satisfy a universal gambling itch. Looming menacingly over the entire Macau story is the single critical figure of 1.4. That is the number of nights, on average, spent by visitors to Macau. The tens of billions invested in Macau, especially by the likes of Mr Adelson and the other Las Vegas operators who arrived when the monopoly of Stanley Ho, the local gambling kingpin, was broken in 2002, assume that the critical number of nights stayed will reach 3.5.

Luring Chinese men to the gambling tables is no great challenge, even in a downturn. But persuading them to bring the family and stay for a week could be a ruinous challenge.


Anonymous said...

We are the Paulson
you will be liquidated
lower your rates and surrender your equity
your pensions will be adapted to service us
Resistance is unbecoming.

Anonymous said...

The history of Jekyll
is forbidden, why?

Because, dummy,
when we can remove man from
himself, his family, other men,
there is no loyalty,
but loyalty to the Paulson,
no love, but love for Ben Bernanke.
All competing pleasures,
we will dilute and monetize.
In our world, there will only be Victory and self-abasement, everything else, we will destroy.

Anonymous said...

sorry about that, it was not my intention to make stupid comments,
it just sort of happened.

But if they dont come up with a cunning plan to rescue the global economy at this meeting, then what?

will we even have a christmas
this year? its looking pretty grim...

Greenpa said...

Ha! See, Ilargi is WRONG - and according to the Washington Post, no less! "World Leaders Agree to Sweeping Economic Plan"

Of course- it does go on: "The leaders' statement spoke of broad principles, leaving the details to be worked out before another summit meeting"

Details, shmetails! All is swell!

Hey, look you gotta take your humor where you can find it, these days.

Anonymous said...

The theory and practice
of the Paulson

the paulsy

refers to the man,
remains strong with the dark side,
and the mob, the interests of
the oligarchical collective
of supra-national power-structures throughout the financial, industrial and intellectual elite.

Paulson and Bernanke both serve
the money interests,
though there might be
some local disagreement
in intent and randomness
in execution.

Big Brother Ben Bernanke
and Papa Paulson,
both innocent, not deeply involved
in the architecture of this final liquidation.

Obama belongs to them now,
probably always has,
this force has long since
reached a critical mass
of people and influence
holding the vital positions
for controlling this master Swap,
now set in motion.

I like to call it
cryptocratic supra-national
plutocracy, or oligarchical collectivism.

the Growth of cattle, world population,
probably stagnates around 2010
at 6,92 billion,
by means of tragically unforeseen widespread starvation,
and so less productive assets must be liquidated, or culled,
in the most expedient manner available,
both in accordance with the depletion of available resources,
and the marginal gains of an added worker-unit
in relation to the biosphere-stabilization quotient.

Anonymous said...

The story about Iceland and the cultural/heritage ache that this collapse if causing is interesting. They talk about their values- stubborness, stoicism, independence. Hurts to be sold out-- sounds like by 6 individuals.

The article says that the boom was not "Icelandic"- more about individual image (glitz) than care of nation/community.

I live in the US near the Canadian border and we have a very large Icelandic community (Swedes, Norwegians, and Finns too). There are still some who speak Icelandic. I see those quaint values in the people here-- some think these rural hicks are out of touch and behind the times. Here's hoping some of those stoic, community oriented values carry us through in this region. I'm certain that is why we have all these blue counties where these immigrants live (although it has been over 100 years since they immigrated here.)

Thanks Ilargi.

. said...

Wow, can I bitchslap these two?

Alex Ortolani and Mike Ramsey

The GM implosion will cost $100 to $200B, bailout is only $25B ... but they never address the fact that THE BAILOUT WON'T WORK.

People get paid to write that crap. I write crap some times. Where's my check?

Thomas Eicher said...

Here's a rather cutesy story from NPR on another aspect of international trade--a shipping container shortage.

A Strange Shortage Illustrates The Global Economy

by Chana Joffe-Walt

North Dakota farmer Bob Sinner's problem was shipping containers — he couldn't find enough.

If anyone needs more proof that we're all part of a global economy, picture this: A young woman in Philadelphia is trying to decide on a rug for her new home, a mother in Japan is buying groceries for her kids, and a grain farmer in North Dakota is facing a strange and serious shortage. They might be scattered around the globe, but they are all connected.

The North Dakota farmer, Bob Sinner, says he is suddenly getting more business than ever from overseas. But just as he was gearing up to sell more wheat and soybeans abroad, he discovered he couldn't find enough shipping containers — the big, colorful steel boxes seen on ships and trains.

The mystery of those missing containers reveals the interdependence of producers, consumers and economies around the world. [more]

Anonymous said...

My guess is we will start to see spot shortages develop as the system starts to crack.Stockpile NOW.

I am set fairly well now,except I just put another on the"will show up soon"family list....think like 500 lb more of everything.
I am trying to finish the dental work,extra new glasses.

When you understand whats on the way, its easy to figure out what to do to start "hardening "a place.More sleeping spots,more beans&rice,TP,matches...Think ,another permanent house guest...and its easy...

Other things...home school stuff...I have a good library,but not that good...

I try not to think too hard about the rape of my country.At some point,there might be actions one might take,but as it is,and take names...Remember everything.Forget,and forgive nothing.

My goaal this week was to see for how little money,I could come up with medicinal ,and culinary plants &seed for the garden.To my delight,several places were having their"get rid of it"sales,and I made out like a bandit...ommorw most goes in the ground,in a protected area...such is my life now...Prep prep prep.


Anonymous said...

Paulson's bailout money. which is overseen by Neel Kashkari, the Treasury official in charge of the bail-out, a 35 yr old guy. $700 billion, since when does a 35 yr old man (through life experiences) know how to manage $700 Billion? Seems like he keeps throwing money at places that don't need it. because it's not helping anything. but if the money had gone down to the people or simply payoff everyones credit cards , student loans, car loans etc. eventually the people would turn around and run up their credit as high or higher in a few years.
but then again that would encourage people to never payoff debt, because the treasury would bail them out. mis-management of money is rewarded with a bailout of money from the treasury (as approved by congress to be passed down to generations of taxpayers via tax increases), to allow continued mis-management of money.

oh, wait that just happened didn't it?
AIG, Freddie Mac, Fannie Mae.

I don't think these treasury clowns (and I am being nice) really know what they are doing. I am not saying I could do better, but I'd at least be consulting a panel of economists as to what the hell i should do.

is this rocket science? or am i being too naive? I know it's a very complex subject. I am not into finance or macro economics but good gosh. I sincerely think some people in charge are completely out of touch with this real world.

robert h.

Anonymous said...

Great opening there!

I really enjoy your efforts here; top notch!

Re: "twistedly smiling old men in surprisingly ill-fitting suits eating caviar and truffles." ROTFLMAO!!!!

Greenpa said...

Snuffy: "My guess is we will start to see spot shortages develop as the system starts to crack.Stockpile NOW."

I can't remember where I saw this- maybe here?, but it keeps echoing around in my cranium.

"In a panic, he who panics first, panics best."

A very scary statement, all around... but...

Stoneleigh said...

Ilargi and I added some comments to Garth Turner's recent thread. There's a particularly interesting comment (#49) on the trader culture by a poster who calls himself nonplused. My long comment is near the bottom (#74).

By the way, all Canadians here should read Garth Turner's blog Greater Fool to follow what's going on with Canadian real estate.

Anonymous said...

Waiting for Godot...

Paulson caught lying, Bush caught lying, millions to lose jobs, Baltic Dry Index shot, no goods to market, reserves running low, hunger imminent, more attacks on Pakistan with drone bombers, Bank execs making billions, Kashkari caught lying, Bernanke caught lying, Barney Frank caught lying, Civil Rights denied to 1/10 of the US population, know, Depression looms, starvation looms...

They (the American people) do not move.

Why? TV, Mcdonalds, Walmart, Video Games, Heroin, OxyContin, Southern Baptism, Nascar, Gated Communities, Fruit Loops, Reefer, Coors, American Idol, Desperate Housewives, Dancing with the Stars, NFL, NBA, CBS, Fox...

They do not move.

bluemarble said...


Your explanation of credit default swaps in the comment on Garth Turner's blog is crystal clear. I've been walking around with a vague understanding but all the finacial jargon has prevented me from fully understanding the mechanism. Thanks!

Farmerod said...


I though #49's comment was fascinating too. I'm glad you and Ilargi post there; it raises the apparent intelligence average dramatically. More importantly, it hopefully keeps some people from following some of the silly advice that is often posted there. It's too funny that Mrs Garth is in the TAE camp.

I put a short comment there myself (as did IntoControl, I see). As for some "Stephen from Toronto" guy, he's posting articles that he's read here and calling them TAE's. I think he's figured out blogging etiquette. It's one thing to be an unpaid mercenary blogwhore; it's another to be an annoying unpaid mercenary blogwhore, which can only reflect poorly on TAE.

Ilargi said...


I was hoping Garth would do the etiquette bit.

scandia said...

I am in need of the " etiquette bit". What is it?

el gallinazo said...

Great comment, Stoneleigh. Particularly as a former science teacher, I'm always amazed at how clearly you can explain things.

Regarding CDS's,

I was thinking about taking out a life insurance policy on my neighbor and then shooting him, but then someone told me it was illegal. Do you think they would enforce it?

Anonymous said...

To paraphrase GWB, "You're doing a heck of a job, Hankie..."

Anonymous said...

Scandia, me too on that etiquette thing. The only thing I can figure is that ilargi read this :

So sitting in front of the fire tonight I told my wife about our little squirrel chats here. And she surprised me. She’s backing Ilargi.

Written by Garth not quite correctly. I found it complimentary to ilargi but from his wife's point of view I think Garth would be sleeping in the spare room for a bit. Could be wrong though might be some other incomprehensible matter entirely, maybe we find out maybe we don't. Sweet mysteries of life...etc:)