Thursday, February 19, 2009

February 19 2009: Is home ownership 'a good thing'?

Alexander Gardner Mister President February 5, 1865
Abraham Lincoln, seated, holding spectacles and a pencil

Ilargi: Willem Buiter, who asks if home loans in the US are the biggest racket since Al Capone, touches on a number of points I've often made here: the homeownership and mortgage industries in the US —and beyond— are the -by far- largest swindle ever perpetrated upon the people. The best part of the swindle is that people are fooled into thinking that's they benefit from it. At the start of the current US housing bubble, both Bush and Greenspan repeatedly held speeches touting the blessings of the American Dream, encouraging every citizen and their pet parrots to go out and get a loan. What Buiter fails to see is that there is another element to all this, the most important one: a government subsidized mortgage industry hugely drives up prices, and therefore transfers trillions of dollars from borrowers to lenders.

A second point Buiter misses is the proliferation of the trade in mortgage backed securities that was enabled by the 'innovative instruments' Greenspan so deeply believed in. It allowed lenders to raise their leverage to fantastical levels, and since the loans were no longer in their books, nobody noticed. It is much more reminiscent of Charles Ponzi than of Al Capone. Capone could only have dreamed of a racket as big and perverted as this. Obama's Stability Plan completely overlooks one essential component, and it probably does so deliberately. That is, what happens when home prices keep on plummeting?

If they do, all parties, from Fannie and Freddie to the banks and other lenders, as well as the underwater borrowers, will have to come back to the well of public funding. The plan sets a limit for eligibility at a loan-to-value ratio of 105%. That is, if you owe $315.000 but your home is worth $300.000, you don't get a thing. Going forward, pieces are certain to keep falling for a long time to come, and millions of homeowners will owe more than the 105% ratio on their properties. Hence, the foreclosure rate will keep surging. And then it's back to the well.

The one party most hit by this process is not the borrowers, but the lenders. If you provide underwater borrowers with a few thousand dollars in cash, and/or a lower property assessment or lower interest percentage on their loan, they will still be back in the same position as before when prices drop. Meanwhile, though, the banks have continued cash flow for a few more months or years. But homes that lose 50% of their value will return to the lenders anyway, either because people walk away or because they are foreclosed upon. Meanwhile, the banks face writedown after writedown.

The Obama plan talks about stabilizing home prices. That’s either a sham or a dream. Prices won't stabilize for a long time, and when they do it won't be anywhere near today's levels. There are many who agree with me that home prices must keep falling. Most of them point to figures such as 3 times annual income to "find" a reasonable price for a home. While that may seem reasonable, and has undoubtedly been so at times, in the years forward it will not apply. First of all because we will see a profound downward oscillation in prices. Because of the heights reached in the past decade(s), prices will fall through the bottom of the trendline, and violently too. Secondly, incomes will drop off a cliff, so you have to ask: 3 times what? The US, if recent monthly job losses are any indication, will lose over 6 million jobs this year. This little fact, along with others, will further increase the downward pressure on prices.

Having said that, i want to return to some things I’ve said before. Why is 3 times income a reasonable price for a home? Shouldn't the prices perhaps be exclusively set by the cost of building a home? If 3 times income were "normal", consider that prices have become easily 3 times the cost of building the home. So most homes cost 1 time annual income to build. And that’s just the start. A mortgage of the elevated value will cost 3-4 times its notional value to be paid off in full. Thus instead of living in a home paid off at 1 time annual income, buyers will need 10-12 times annual income to own a home free and clear. All this is money that disappears from communities, and into the vaults of big faceless banks. It's little wonder that communities and individuals have an ever harder time establishing a decent level of services and decent living standards, health care, education, water treatment etc.

Why do we accept so easily that speculation is a good thing when it comes to our basic needs? It will come back to haunt us in a very aggressive way. Now that the speculators, banks and developers can no longer rely on housing for their gambling incomes, they will turn to other basic necessities, none of which are shielded from the so-called free market. Thus, as incomes drop and deflation expands its rule over the earth, prices for food, water and energy will be set by "free" markets.

And increasingly, more and more of us will be priced out of these markets. There is no better way to make money in the years to come than in food and water. People can and must purchase less of all sorts of discretionary items, but they will do and pay anything to eat and drink, until they can no longer afford to. Which means that's where the profits are. Al Capone would be licking his chops.

Washington now bails out banks for trillions of dollars, Fannie and Freddie for hundreds of billions, the economies of states and municipalities for hundreds of billions, carmakers for $130 billion and homeowners directly for $100 billion. Moreover, it's evident for anyone with one life synapsis that much more will be needed along the same lines in the near future.

If we would stop handing money to the banks, which are insolvent anyway, take the troubled mortgages they hold or have sold to Fannie and Freddie, who would also receive not one additional penny, and give them to the communities, who can negotiate with the occupants about a reasonable rent that would allow them to remain on the premises (perhaps the Obama 31%-38% of income?!), providing the communities with income, we do away with the need for all these bail-outs. In one fell swoop.

The reason we don't rests at the top of the pyramid: the banks. Because they demand to be paid ad infinitum, and they have the political power to do so, we need to bail out all the links in the housing chain, the banks, the GSE's, the communities and the homeowners. Not only is that crazy, it's also certain to fail. And then we're back to Charles Ponzi, and Al Capone is but a little wimp.

A situation such as the one I’m painting here will eventually and inevitably come to fruition. But our political and societal structures will not let it, not voluntarily. And that will unnecessarily raise the suffering to levels we do not even dare to fear. Free market capitalism is dead, and I don't say that because I have communist sympathies. I just look around me and see that no society can exist that allows too many of its citizens to fall into utter misery. What killed our capitalist system is the inclusion of basic human needs in an economic system based on speculative games. If you set up an economy that propagates gambling with basic human necessities, you will of necessity end up gambling away the lives of the people who depend for their survival on those necessities. Our societies have played these games beyond our borders, in Africa and Asia, for hundreds of years. And now, because the system dies of it cannot grow, it's our turn.

Home loans in the US: the biggest racket since Al Capone?
The Obama administration today unveiled the 'Homeowner Affordability and Stability Plan' - measures to help financially challenged homeowners to avoid foreclosures. The program has three key components. The first is $75 bn of Federal government money to subsidise the modification of home loans (I believe $50bn of this was already in Treasury Secretary Geithner’s earlier announcements on the Financial Stability Plan). The Federal government is also making an additional $200 bn of capital available to Fannie Mae and Freddie Mac, so they can expand their mortgage lending and guarantee activities. The second is to "Institute Clear and Consistent Guidelines for Loan Modifications": a standardized framework for dealing with troubled mortgages. The third is an overhaul of bankruptcy laws to allow judges to force the writedown of principal on mortgages for bankrupt homeowners or to force lenders to reduce mortgage rates.

Are there too many foreclosures?  What determines the socially optimal number of foreclosures?  Foreclosure is the taking by the creditor of the collateral offered for a loan, following a default on the loan by the borrower, and the sale of that collateral by the creditor so he can recover what is due to him. We have foreclosures because there is collateral and because there is uncertainty about the future financial circumstances of the borrower. We cannot eliminate all uncertainty about the future financial circumstances of the borrower. Still, there are several ways to eliminate foreclosures altogether.

The first would be to forbid offering residential real estate as collateral (or at any rate to forbid the offer of an owner-occupied home as collateral for a loan).  Home loans (in the sense of loans to purchase a home with) could be unsecured, or secured against other assets. Alternatively, households would have to save up the full purchase price of the property. Finally, you could stipulate that a mortgage could only be given with 100 percent mortgage protection insurance attached - covering all contingencies (death, disability, ill-health) that might impair the ability of the mortgage borrower to service the mortgage. This eliminates foreclosures but would also seriously reduce home ownership. So let’s try something else.

What are the costs of foreclosure? Who bears them?  Are the private costs smaller than the social costs? Foreclosure is a step in a well-understood contractual arrangement - a change of title happens: the house that was mine is now under the control of the mortgage lender who can sell the property to recover the sum owed to him.  As it happens, foreclosure eats up a lot of real resources: time, lawyers’ fees, bailiffs, other legal fees, surveyors’ fees, etc.  This is a real resource cost, not the redistribution of property rights. It has been estimated at between $50,000 and $80,000 per foreclosure. The transaction costs associated with foreclosure are outrageous. It clearly makes mortgage lending a less profitable attractive activity to engage in and reduces the size of the mortgage market.  It makes sense, from a social efficiency point of view, to make foreclosure cheaper and easier. This could be achieved most easily by strengthening the rights of the creditor (the mortgage lender) vis-à-vis those of the debtor (the mortgage borrower). The proposals that I have seen, however, all want to make foreclosure more difficult, by entrenching the owner-occupier more securely in the family home.

Another cost often attributed to foreclosure is ‘neighbourhood blight’, that is, negative externalities associated with foreclosures and the associated repossessions and evictions. The value of neighbours’ properties goes down and pretty soon the weeds are growing through the cracks in the pavement, homes are boarded up and the entire neighbourhood risk going down the snytgard. This argument makes no sense and appears to be an example of confusing association (or correlation) with causation. What is likely to have a stronger negative effect on the value of neighbouring properties: an owner-occupier who can no longer afford the mortgage he has taken on, or the forced sale of his property to someone who can afford it? The answer seems pretty clear.

Declining, blighted neighbourhoods are likely to be found in regions that are in economic decline, like parts of the American Mid-West. In such regions, there are likely to be more existing homeowners who lose their job or become worse off for other reasons and who as a result cannot keep up with their mortgage payments and face foreclosure, than there are would-be home owners ready to take on a mortgage and buy a home. So rising foreclosures are likely to be followed by periods during which more properties stand empty, inviting vandalism or use as a crack den. The neighbours try to move away from such toxic properties and the blight spreads. The fundamental driver of all this is, however, the economic decline of the region. Foreclosures do not cause neighbouring property values to fall.  Both foreclosures and declining property values are driven by broader economic conditions.

One reason foreclosures are so politically sensitive is that they are associated with the dispossession of owner-occupiers and the eviction of families. Distraught parents standing on the stoop of what used to be the family home, clutching a few meagre belongings. Crying children. There is even a sub-conscious association of foreclosures with homelessness. Foreclosures don’t just involve owner-occupiers, however. Buy-to-let owners have mortgages also. But let’s leave that aside. The reason that foreclosures involving owner-occupiers are an issue has to be either that (even after allowing for the transaction costs of foreclosure), the value of the home that is lost to the owner-occupier is greater than the value of the home to the bank and/or that there are serious distributional or poverty issues associated with foreclosure.

There may be something to the first of these points. To most people, a home is more than a hotel room. It becomes part of what you are - it gets under your skin. I am quite willing to believe that. I don’t, however, believe that this emotional attachment to the place you live in is identified with owner-occupancy. Until I was 21 years old, my parents always lived in rented accommodation. We spent 14 years in the same rented place in Brussels. It was very important to me - it was our ‘home’ - and even now I often remember it. I also remember quite well the (rented) house we lived in for two years in Luxembourg. I was eight when we left; I cried my eyes out, in part because I really loved that house.  Are we going to give tenants special rights and financial assistance because the place they rent is worth more to them than it is to their landlord?

If foreclosure leads to poverty, that poverty may be of concern to and a responsibility of the state, but only because it is poverty, not because it is poverty due to a specific event or cause - foreclosure. I believe a civilised, compassionate society tries to eliminate poverty. It does not have a special policy for eliminating poverty suffered by former owner-occupiers who have lost their homes because of foreclosure. Homelessness is a curse. But it is a curse regardless of whether homelessness is suffered as a result of an owner-occupier and her family experiencing foreclosure and eviction, as a result of a tenant being evicted by his landlord, as a result of divorce or mental illness, or as a result of a natural disaster or a war. In addition, only a small fraction of foreclosures leads to homelessness. Most victims of foreclosures manage to find cheaper accommodation.

Is home ownership ‘a good thing’?

Why do politicians of all political colours and parties get their knickers so twisted about people losing their homes? In the case of the Tories in the UK and the Republicans in the US, the answer is obvious. Both parties believe that home owners are conservative. Not it the sense that people who are inherently conservative are more likely to become homeowners (although they may believe that as well). This is not a selection story but an osmosis story. Home ownership makes people more conservative.  So both Tories and Republicans do everything they can to encourage home ownership. But so do (New) Labour in the UK and the Democrats in the US, so it’s no longer a left-right thing.

The one argument for encouraging home ownership that makes sense is that owner-occupiers look better after their property and its immediate surroundings than would a tenant. This is a simple principal-agent story where it is costly for the principal (the owner) to monitor the care and attention the agent (the tenant) bestows on his property. Add some neighbourhood externalities (I don’t want to live next door to a place where they don’t mow the lawn or paint the exterior of the house), and you have an argument for encouraging owner-occupancy, say by subsidising it.

But a subsidy for owner-occupancy is something completely different from subsidising borrowing using residential real estate as collateral. If they exist, the benefits from owner-occupancy are there regardless of whether the owner-occupier has a mortgage or not. It doesn’t matter whether she borrowed to buy the house, paid in cash, stole it, inherited it from her parents, or built it with sweat equity on land won in a raffle. The US does not encourage owner-occupancy directly, say by paying each head of household who is an owner-occupier, a given amount of cash each year. Instead it encourages and subsidises a particular form of borrowing, regardless of what that borrowing is spent on. Funds, after all, are fungible. I can withdraw equity from my house by taking out a first or second mortgage against it, or by increasing the size of an existing mortgage, and spend the proceeds on Cuban cigars.

All this is rather insane. Through the deductibility of mortgage interest from taxable income, the US tax payer gives vast subsidies to borrowing secured against a particular type of collateral - residential real estate. What so special about this borrowing and this collateral? Fortunately, the UK has abolished this boondoggle. In the US, other forms of preferential treatment for home ownership are piled on top of the mortgage interest-deductibility. Over half the stock of home loans, and virtually all new home lending in the US are heavily subsidized by the lending and guarantees of Fannie Mae, Freddie Mac, Ginnie Mae and assorted aller smaller government agencies. The direct interventions of the Fed and the Treasury in the market for residential mortgage-backed securities, announced as part of the credit-easing policies of the FEd represent further quasi-fiscal subsidies to housing finance. 

This is on top of the creation by the Fed of at least a dozen facilities that accept RMBS as collateral for Fed loans in the earlier stages of the financial crisis. All these quasi-fiscal interventions by the GSEs and the Fed are deeply non-transparent as regards the magnitude of the subsidies involved. They also evade the normal scrutiny and accountability to Congress that is associated with explicit subsidies by the Treasury. The only priviliged treatment of residential housing that makes a modicum of sense from the perspective of encouraging owner-occupancy (as opposed to borrowing to fund whatever expenditures using residential housing as collateral), is the ability to postpone capital gains taxation on the sale of one’s principal residence, and to have one capital-gains-tax-free realisation during one’s lifetime (taken generally when people size down on retirement or when the kids have flown from the nest).

The extreme fiscal largesse bestowed on residential housing, directly and indirectly through mortgage interest deductibility, has led to a massive misallocation of investment in the US.  There has been overinvestment in the private residential housing stock and underinvestment in just about every other form of fixed capital: infrastructure, public amenities of all kinds (sports facilities, public recreational facilities, parks etc.), commercial structures, plant and equipment. It is time to correct the distorted incentives that are at the root of this misallocation. The easiest way to do this, in the current tax system, is to end the deductibility of mortgage interest in the personal income tax, close down Fannie and Freddie and end the role of the US government in the provision of residential mortgages. A focused social housing program is of course a legitimate activity of the Federal government. It should be on-budget, that is, fiscal rather than quasi-fiscal.

The Obama administration is going to ease the burden on existing financially challenged mortgage borrowers. As much as $75 bn will be used to compensate the lenders - the banks or to bribe them into accepting easier financing terms for financially stressed borrowers. That’s nice. It will, of course, encourage moral hazard.  People who have mortgages that have become too large for them to service and who have not bothered to purchase the right kind of mortgage protection insurance are getting ex-post free mortgage protection insurance from the tax payer. It will encourage future reckless borrowing by would-be home-owners with residential ambitions larger than their wallets. It is tax on the prudent to subsidize the imprudent. It is both inefficient and unfair. Fannie and Freddie will expand their lending and guarantees thanks to the additional capital provided by the Treasury.

A simpler, standardised framework for dealing with troubled mortgages would be welcome, as it could reduce the cost of foreclosures and also the cost of voluntary renegotiations of the terms of the mortgage contract between borrowers and lenders. It is especially important that an end be put to those complex securitisations of residential mortgages that make it effectively impossible to renegotiate individual mortgages that are bundled with thousands of other mortgages and God knows what else down seven layers deep in some CDO. I would favour simplifying the procedures for foreclosure to reduce their cost. Increasing creditor rights, limiting the grounds for appeals by the borrower and other measures speeding up the foreclosure process would make mortgage lending a more profitable and attractive activity, and would also make lenders willing to consider application by more risky borrowers.

Modifying bankruptcy laws to allow judges to force the writedown of mortgages looks like a prime example of populist pandering and insider or incumbent protection. It will hurt future mortgage borrowers. Those who already have their home loans will like it. Those who won’t be able to get a home loan in the future because of these measures will probably blame the banks rather than the politicians that brought in these inane laws. Especially when judges are elected, as they often are in the US, I hate to think of the political shenanigans that will be the inevitable outcome of greater judicial discretion in forcing lenders to accept writedowns of their loans. Judges in the kinds of courts that deal with distressed mortgage lending are unlikely to have invested in a Ph.D. in Law and Economics. They are likely to be lawyers - full stop - and not very good lawyers at that (is ‘not very good lawyers’ an oxymoron?). They know nothing about markets and incentives, valuation and credit risk. They will make future mortgage lending much riskier and much more costly for the lender. Only the best risks will be able to get loans.

The quasi-socialised, opaque system of residential mortgage financing in the US is wasteful and distortionary to a degree that is truly staggering. How can this grotesquely distortionary and deeply unfair system be killed off when so many undeserving over-indebted homeowners who also happen to be marginal voters, so many politically well-connected interest groups and so many influential politicians all have their snouts in the trough? It is clear that the Obama administration far from using the opportunity sent by the crisis to cut the mortgage monster down to size, is instead feeding it and beefing it up further. The fiscal and quasi-fiscal costs of this massive subsidization of residential mortgages will become apparent during the years to come, as mortgage related government expenditures rise and revenues fail to materialise. But that will be then – sometime in the future. This is now. And now always wins. Myopia, opportunistic behaviour and insider protection: welcome to US home financing policy.

U.S. Jobless Benefit Rolls Reach Record 4.99 Million
The number of Americans collecting unemployment benefits jumped to 4.99 million two weeks ago, breaking a record for a fourth straight time, signaling the job market is still deteriorating. Total benefit rolls surged by 170,000 in the week ended Feb. 7, the Labor Department reported today in Washington. First-time applications for unemployment benefits were unchanged at 627,000 last week, higher than economists projected. General Motors Corp. and Chrysler LLC this week announced an additional 50,000 workers would be cut from payrolls as crumbling demand for autos deepens a recession now in its second year. President Barack Obama is counting on the $787 billion stimulus plan he signed into law this week to create or save 3.5 million jobs and stem the slump in spending.

"This is a really rotten labor market," Roger Kubarych, chief U.S. economist at UniCredit Global Research in New York, said in an interview with Bloomberg Television. "We’re going to have an unemployment rate that grazes 9 percent." Treasuries were lower, driving up yields. The benchmark 10- year note yielded 2.8 percent as of 8:37 a.m. in New York, up 4 basis points from yesterday. Stock-index futures were higher. Prices paid to U.S. producers rose in January for the first time in six months as fuel costs climbed, another Labor report showed. The 0.8 percent increase in wholesale costs was higher than forecast and followed a 1.9 percent decline in December. Over the last 12 months, producer prices fell 1 percent, the biggest year-over-year decline since 2006.

Economists forecast claims would fall to 620,000 from a previously reported 623,000, according to the median forecast of 39 estimates in a Bloomberg News survey. Projections ranged from 590,000 to 660,000. The four-week moving average of claims, a less volatile measure, rose to 619,000 last week, the highest level since November 1982, from 608,500 the previous week. The unemployment rate among people eligible for benefits, which tends to track the U.S. jobless rate, climbed to 3.7 percent in the week ended Feb. 7, from 3.6 percent a week earlier. Thirty-two states and territories had an increase in new claims for the week ended Feb. 7, while 21 reported a decrease.

U.S. companies in January sacked 598,000 workers, the most since December 1974, the Labor Department said Feb. 6. The U.S. has lost 3.6 million jobs since the recession began in December 2007. The jobless rate climbed last month to a 16-year high of 7.6 percent. The world’s largest economy will contract 2 percent this year, according to projections in a Bloomberg News survey taken Feb. 2 to Feb. 10. The drop was a half percentage point more than estimated in January. The unemployment rate may climb to 8.8 percent this year, according to the poll. GM, the largest U.S. automaker, will cut about 47,000 more jobs worldwide as it sheds brands and seeks as much as $16.6 billion in new loans to avoid bankruptcy, the Detroit-based automaker said this week. Chrysler, propped up like GM with federal assistance, said it’s seeking $5 billion more from the government and will shed 3,000 more positions.

"We have continued to see an unprecedented decline in the automotive sector," Chrysler Chief Executive Officer Robert Nardelli said in a briefing with reporters. "The focus of this company for the last two years and going forward is going to be to right-size for the marketplace and the realities of the economy." The reductions are reverberating through the industry. Goodyear Tire & Rubber Co., the largest U.S. tiremaker, yesterday said it posted a fourth-quarter net loss of $330 million and plans to cut almost 5,000 jobs. The Akron, Ohio-based company said it eliminated 4,000 jobs and imposed a salary freeze in the second half of last year.

Treasuries Tumble as Fed Signals U.S. Debt Purchases on Hold
Treasuries fell as the Federal Reserve signaled it’s not going to purchase U.S. securities to lower consumer borrowing costs any time soon. Thirty-year bonds, which had been little changed for much of the day, plunged after the minutes of the Fed’s Jan. 27-28 policy meeting showed officials will wait before buying Treasuries. The government tomorrow will announce the size of next week’s auctions of two-, five-, and seven-year notes. The likely total is $97 billion, according to Wrightson ICAP LLC. "Why wait?" said Michael Franzese, head of government bond trading for Standard Chartered in New York. "Why not take the pressure off the market by saying it’s imminent, or by saying it will be within a target range?"

Yields on 30-year bonds rose seven basis points, or 0.07 percentage point, to 3.55 percent at 4:52 p.m. in New York, according to BGCantor Market Data. The 3.5 percent security due in February 2039 dropped 1 9/32, or $12.81 per $1,000 face amount, to 99 3/32. Two-year note yields climbed 10 basis points, the most since Dec. 5, to 0.95 percent. Benchmark 10-year note yields increased 10 basis points to 2.75 percent. Fed policy makers introduced a long-term U.S. inflation estimate, with most officials aiming to anchor public expectations at a 2 percent rate. Officials also downgraded their forecasts for growth this year, seeing a deeper contraction as the credit crunch tightens, the Fed said in minutes released today of the Federal Open Market Committee meeting Jan. 27-28.

At the meeting, Fed officials discussed the purchase of longer-term Treasuries but decided it would "only modestly improve" credit markets, according to the minutes. Following through on programs to buy mortgage-backed securities and agency debt was likely to be "more effective," the minutes said. "It’s an issue the Fed is still wrestling with," said William Hornbarger, a fixed-income strategist at Wachovia Securities in St. Louis. "The big issue is: how will they do this? That’s what they are wrestling with -- what are the logistics, how would it work?" The government will sell $41 billion in two-year notes, $31 billion in five-year notes and $25 billion in seven-year notes next week, Wrightson ICAP forecast. The Jersey City, New Jersey- based firm specializes in government finance. The record for a two-year auction is the $40 billion sold Jan. 27. The five-year record is $30 billion, set Jan. 29, and the seven-year record is $9.8 billion in 1993, the year the note was discontinued. The Treasury sold a record $67 billion in notes and bonds last week.

"The market is going to have to digest a huge dose of Treasuries for a while," said Jack Bauer, a managing director who helps oversee more than $4 billion in debt in Fairport, New York, for Manning & Napier Advisors Inc. "These numbers are so big it’s hard to get your arms around them." Treasuries lost 2.1 percent so far in 2009, according to Merrill Lynch & Co.’s U.S. Treasury Master index, on speculation investors will demand higher yields to lend to the government. President Barack Obama pledged $275 billion to a program to bring down mortgage rates and curb foreclosures. Treasury notes remained lower after a Fed report showed U.S. industrial production fell in January for the sixth time in seven months. Builders broke ground last month on the fewest houses since records on the data began in 1959, a Commerce Department report showed.

The U.S. economy is contracting at a "disturbing pace" and gross domestic product will fall "markedly" through June, Federal Reserve Bank of Chicago President Charles Evans said in the text of a speech in Rockford, Illinois. Corporate debt issued by companies like Freddie Mac, the mortgage-finance company under U.S. government control, and Roche Holding AG vied for investors’ attention. Freddie sold $10 billion in three-year notes maturing in March 23, 2012. Roche, Switzerland’s biggest drugmaker by sales, plans to sell $16 billion to finance its acquisition of Genentech Inc., according to a person familiar with the transaction.

The difference between rates on 10-year notes and Treasury Inflation Protected Securities, or TIPS, which reflects the outlook among traders for consumer prices, narrowed to 1.15 percentage points from last week’s high of 1.43 percentage points. The figure has averaged 1.70 percentage points for the past year. Demand for Treasuries from China "remains quite strong," Fed Chairman Ben S. Bernanke said in response to a question after a speech in Washington. China, the world’s biggest holder of U.S. government debt, increased its Treasury holdings 46 percent in 2008 to $696.2 billion, according to Treasury data. China bought $218.6 billion of U.S. government debt last year, more than is held by any country except Japan and the U.K.

Federal Reserve Bank of Cleveland President Sandra Pianalto said the central bank’s new $1 trillion program to prop up markets for auto loans and other debt will make a "big difference" in strengthening the U.S. economy. The Term Asset- Backed Securities Loan Facility, known as the TALF, is likely to start operating "within the next few weeks," Pianalto said in a speech in Columbus, Ohio.

With the US deficit soaring, Treasuries aren't a great safe-haven investment
Based on the cost of fiscal stimulus and the recently announced bank bail-out, the US federal government's debt to GDP ratio is heading much higher. By 2011, it may even equal Hungary's current ratio, which skyrocketed due to profligate spending and remnants of centrally planned waste. This suggests the credit quality of currently top-rated US Treasury debt may trend down more toward the quality of Hungary's government debt, which is nearer the bottom of the investment-grade pecking order. That's not a complete disaster. But it means treasury bonds won't really be a safe-haven investment either.

Assuming deficit projections by the Congressional Budget Office (CBO) for the 2009 and 2010 fiscal years are right, and adding in the costs of the stimulus package, the bank rescue plan and borrowing costs, US public debt would rise from 41pc of GDP in September 2008 to about 70pc of GDP in September 2011 - roughly in line with Hungary's December 2008 ratio. After 2011, the US debt-to-GDP ratio is expected to decline again. The CBO projects deficits of less than 2pc of GDP after 2012, and the capital injected into the banking system under the government's bailout plans should start to produce some returns for taxpayers around that time.

There are considerable downside risks. The CBO projections are based on optimistic assumptions: that growth averages 4pc annually between 2011-14, that the Bush tax cuts and Alternative Minimum Tax relief all expire in December 2010, and that discretionary spending increases only in line with inflation after 2010. The falling debt scenario also assumes that none of the expenditures under the stimulus plan migrate into annual spending after 2010. Should the recession deepen, or persist beyond the end of 2010, higher budget deficits could become entrenched. Finally, the projection assumes US interest rates remain low. With treasury-bond maturities now averaging only 48 months, higher interest rates would rapidly feed into higher borrowing costs and budget deficits. "No European government has done anything as bone-headed as we have," said Hungarian Prime Minister Ferenc Gyurcsany of his country's fiscal policy in May 2006. By 2012, US policymakers may be echoing him.

Fear about 'insolvent' banks jacks up counterparty risk
Financial counterparty risk is back up to where it was when Bear Stearns ran into trouble, according to an index that tracks prices of credit default swaps on the 14 dealers that account for the vast majority of derivatives trading. The Counterparty Risk Index shows that prices of five-year contracts that insure investors against bond defaults by Bank of America, Citigroup, Goldman Sachs, J.P. Morgan, Merrill Lynch and Morgan Stanley along with eight foreign firms reached 207 basis points today—slightly more than right before Bear was acquired by J.P. Morgan in March 2008.

The index has been trading in a range between 150 and 190 basis points for most of the past several months. The index, which is maintained by Credit Derivatives Research of Walnut Creek, Calif., is still well below its historical peak of 283 bps on October 10, around the time that AIG and Lehman Brothers failed. But in a statement released today, Tim Backshall, CDR’s chief strategist, said the recent climb back over 200 indicates that counterparty risk "has risen dramatically." He attributed that climb to investors’ dismay over the Financial Stability Plan unveiled last week by Treasury Secretary Timothy Geithner, or as Mr. Backshall put it, "the dysphoria surrounding Geithner’s vagaries."

Mr. Backshall said that counterparty risk was likely to remain high. He pointed out that the stress tests that the stability plan requires of large U.S. banks—along with the mortgage modifications included in the Obama administration’s housing plan—have created further uncertainty over the value of mortgage-backed securities. The rise in the 14 dealers’ CDS prices, he continued, coupled with the recent weakness in their equity prices reflect "the market’s strong view that many of our major global financial institutions are technically insolvent no matter what government plans are put in place."

Swiss finance minister: UBS case not the end for banking secrecy
The Swiss government today mounted a last-ditch campaign to reassert the country's hallowed reputation for banking secrecy after UBS agreed to let the names of up to 300 of its rich US clients be handed over to the American authorities. The country's biggest bank, under a settlement on tax fraud charges with the US Department of Justice (DoJ) and Securities & Exchange Commission (SEC), will pay $780m (£547m) in a move that could herald a global clampdown on tax evasion. Under the deal, the Swiss financial services authority, Finma, will hand over the names of between 250 and 300 clients among UBS's estimated 20,000 US private banking customers.

The bulk of these are alleged to have secreted up to $20bn of assets through sham and offshore accounts, costing the federal tax authorities at least $300m. Today, as Swiss media and lawyers slammed the deal as a "capitulation" and a "true catastrophe," the country's finance minister, Hans-Rudolf Merz, insisted banking secrecy was intact. "It is evident there has been tax fraud but bank secrecy will stay," he told journalists, helping to send UBS shares up more than 5% in New York. The federal government agreed to let Finma hand over the names at an emergency cabinet meeting on Wednesday night. Swiss banking secrecy has been under sustained attack from governments determined to stamp out tax evasion costing them up to $100bn.

Gordon Brown has embarked on a mini-EU tour, ahead of the G20 summit he will chair in London on April 2, to drum up support for the clamp-down, which is being co-ordinated globally among tax authorities through the OECD. He has identified Switzerland — excluded from a recent top-level OECD meeting — as a serious culprit. Peer Steinbrueck, the German finance minister, has urged the OECD to add Switzerland to its backlist for non-cooperation. This currently extends to Andorra, Liechtenstein and Monaco. The Germans have stepped up their onslaught on tax evasion after the former head of the country's postal operator, Deutsche Post, was sentenced to two years on probation for secreting up to €10m in Liechtenstein trust accounts. Klaus Zumwinkel was also fined €1m.

Overnight John DiCicco, acting DoJ assistant attorney-general, said of the UBS case: "The veil of secrecy has finally been pulled aside and we will continue to aggressively pursue those who shirk their federal tax obligations or assist others in doing so." The US tax fraud case against UBS has already seen the heads of several executives roll. Peter Kurer, its chairman, has said the bank "sincerely regrets the compliance failures in its US cross-border business" and "we accept full responsibility for these improper activities."But he added that UBS, the biggest European casualty of the financial crisis, with multi-billion losses and writedowns of toxic assets, remains committed to client confidentiality, adding that this was "never designed to protect fraudulent acts."

U.S. Sues UBS Seeking 52,000 More Swiss Account Customer Names
The U.S. government sued UBS AG, Switzerland’s largest bank, to try to force disclosure of the identities of as many as 52,000 American customers who allegedly hid their secret Swiss accounts from U.S. tax authorities. U.S. customers had 32,940 secret accounts containing cash and 20,877 accounts holding securities, according to the Justice Department lawsuit filed today in federal court in Miami. U.S. customers failed to report and pay U.S. taxes on income earned in those accounts, which held about $14.8 billion in assets during the middle of this decade, according to the court filing.

"At a time when millions of Americans are losing their jobs, their homes and their health care, it is appalling that more than 50,000 of the wealthiest among us have actively sought to evade their civic and legal duty to pay taxes," John A. DiCicco, acting assistant attorney general in the Justice Department’s tax division, said in a statement. The lawsuit came a day after UBS agreed to pay $780 million and disclose the names of about 250 account holders to avoid U.S. prosecution on a charge that it helped thousands of wealthy Americans evade taxes. The U.S. and Zurich-based UBS disagreed over how many account holders the bank must disclose to the Internal Revenue Service, agreeing to resolve it in court.

With today’s lawsuit, the U.S. asked a federal judge to enforce its so-called John Doe summonses. On July 1, a federal judge in Miami approved an IRS summons seeking information on thousands of UBS accounts owned or controlled by U.S. citizens. Negotiations between the U.S., Switzerland and UBS have been at a standstill since then, according to a Justice Department filing. UBS said in a statement that it expected today’s filing. "UBS believes it has substantial defenses" to the U.S. attempt to enforce the summonses and will "vigorously contest" the case, the bank said in the statement. The bank’s objections are based on U.S. laws, Swiss financial privacy laws, and a 2001 agreement between UBS and the IRRS, according to the statement. The Justice Department accused UBS of conspiring to defraud the U.S. by helping 17,000 Americans hide accounts from the Internal Revenue Service. The U.S. will drop the charge in 18 months if the bank reforms its practices, helps prosecutors and makes payments

Goldman warns on commodity returns
Goldman Sachs, Wall Street’s largest commodities dealer, yesterday told clients to bet on falling returns from commodities, including crude oil, warning that the shape of the futures curve will trigger further losses to investors in the asset class. The shape of the futures curve is crucial to the profitability of commodities indices. In addition to the spot return, commodity index investors obtain a separate return – the roll yield – as they roll trades over each month, just before the futures contract expires.

That return is positive when futures prices are lower than the prevailing front-month price – a backward-dated market – and negative when futures prices are higher – a contango market. "While we remain long-term bullish on direct commodity investments, it is this large cost of holding  the position [rolling] that drives our underweight recommendation on direct commodity investments," Goldman Sachs said. The contango in many markets has widened to record levels, causing hefty losses due to the roll even with stable spot prices.

Auto bailout tab could top $130 billion
GM and Chrysler say they need $21.6 billion more in loans. But that won't be enough to save Detroit. Here's a rundown of all the auto bailout proposals. General Motors and Chrysler LLC asked the government Tuesday for $21.6 billion in additional loans, but the final cost of a bailout of the auto industry could be significantly higher. The two struggling auto giants have already received a total of $17.4 billion in loans. If they get the new loans they want, the price tag of the bailout would climb to $39 billion.

What's more, $7.5 billion in loans have already been approved for the financing arms of GM and Chrysler. Congress also approved funding last year for $25 billion in loans to help automakers convert their plants to produce more fuel efficient cars. But dealers and suppliers are also asking for federal aid. And consumers may eventually get further incentives from the government to buy new cars. All told, it could take up to $130 billion to save Detroit. Here's a breakdown of the rest of the money that might be needed.
  • Loan guarantees requested by auto parts suppliers: $18.5 billion. The trade groups for parts suppliers are asking loan guarantees for the amount they're owed by domestic automakers. They are also seeking guarantees other types of commercial loans and help so General Motors (GM, Fortune 500) and Chrysler pay their suppliers more quickly.
  • Loan guarantees being requested by auto dealers: $5 billion to $20 billion. This is still in the works. But the National Automobile Dealers Association is working on a request for federal loan guarantees to make sure they can get the cash they need to finance their inventories. NADA vice president and general counsel Andrew Koblenz said the range is likely to be in the $5 billion to $20 billion range.
  • Line of credit being requested by Ford: $9 billion. Ford Motor (F, Fortune 500) continues to insist that it shouldn't need federal help, primarily because it locked up financing years before the credit markets dried up. But in December, the automaker asked Congress to approve a $9 billion line of credit for the company in case sales were worse than expected or a rival's bankruptcy caused widespread failures in its own supplier or dealership base. Since that request, car sales have plunged further and forecasts for 2009 have grown increasingly bleak.
  • Tax credit for "Cash for Clunkers" program: $16 billion. There are a couple of different proposals floating around Capitol Hill to have the federal government give buyers of new, fuel-efficient vehicles a tax credit of up to $10,000 if they turn in an old, fuel-inefficient vehicle to be scrapped. One version of the proposal, which would have been available for 1.6 million buyers, was briefly included in the economic stimulus package before it was stripped out. But stand-alone versions of the bill are still alive in Congress, and they have support of both the auto industry and environmentalists.
  • Allowing car buyers to deduct interest on auto loans: $9 billion. This proposal from Sen. Barbara Mikulski, D-Md., easily passed the Senate during debate on the stimulus bill. But it was stripped out of the final version, leaving a far more modest tax credit that allows buyers to deduct only the sales and excise tax they pay on a new car purchase.

Auto dealers and automakers were strong supporters of making interest deductible as a way to spur demand. How to pay for it If the Obama administration decides to move ahead with additional loans for GM and Chrysler, some think it may wrap all the various proposals into one auto bailout bill. Still, there are questions about where future funding will come from. Much of the money for Detroit so far has come from the Troubled Asset Relief Program, the $700 bailout of the nation's financial system approved last fall. But much, if not all, of the additional money will probably have to be approved by Congress, rather than just Treasury. That could prove to be an easier sell in this Congress though.

The House passed a $34 billion bailout for GM, Chrysler and Ford last December but it failed to win approval from enough Republicans in the Senate. But the Democratic majority of both houses has grown significantly since then. So it is likely that a similar bailout measure would find the 60 votes needed to advance in the Senate, assuming all Democrats support it as they did the recently passed stimulus bill. The automakers' strongest argument for getting the help to get the industry back on its feet is that it could cost the government far more if they fail.

GM and Chrysler both included estimates in viability plans submitted to the Treasury Tuesday about how much they would need to fund their operations if they went through a bankruptcy reorganization. GM said it could cost up to $100 billion in loans over two years, while Chrysler estimated it would cost between $20 billion and $25 billion. Both companies said that if they went bankrupt, they would be forced to halt operations and liquidate if they did not receive the loans. And if they were to go out of business, lost federal tax revenue would reach into the hundreds of billions of dollars, according to company estimates.

Experts agreed that a bankruptcy at either company would be far more expensive for taxpayers than the amount of money they are asking for. "There would be nothing standard about a bankruptcy filing at GM," said Michigan bankruptcy attorney Douglas Bernstein. "You don't normally have the government as your lender. And I don't think anybody has been through a bankruptcy of this magnitude."

GM: Unrealistic Expectations
It's avoided bankruptcy so far, but are GM's sales expectations realistic enough to bring the struggling automaker back to profitability? As promised, General Motors (GM) and Chrysler delivered their turnaround plans to the Treasury Dept. on Tuesday, Feb. 17. While both companies have slashed costs, both say they need more government cash and concessions from the union or their creditors to survive the downturn. GM got another $4 billion from Treasury on Tuesday, completing a government commitment made in December to give the automaker $13.4 billion. But GM says that given the weaker economy and declining auto market, the company still could need as much as $30 billion in total. Chrysler has asked for $5 billion on top of the $4 billion it has borrowed from the government.

It will be up to Treasury to decide if the two companies' plans go far enough to prove that they are viable and will be able to pay the money back. There is risk that GM can't get all of the concessions it needs and that sales won't rebound fast enough to build revenue. In GM's case, the company still has to convince its bondholders and the United Auto Workers to reduce future debts. The car market will also need to revive in the next couple of years to the levels that both automakers have forecast. And there's still a lot of work to be done. GM has two major issues that need to be resolved. First, the company has to negotiate with its bondholders to drop its unsecured debt burden from $27 billion to about $9 billion. Second, GM owes the UAW $20 billion to start a union-led trust fund to manage retiree health care.

GM wants to give the UAW half in cash and half in stock. But like bondholders, the UAW has balked. GM Chairman and Chief Executive Officer G. Richard Wagoner Jr., said the company is making good progress on both fronts. But GM could not strike a deal before the proposal to Treasury was due. Getting both parties to reduce GM's long-term debts will be vital to ensuring the company's viability. The automaker has more than $60 billion in debt between its creditors and the union. "What has weighed on us more than anything," Wagoner said, "is that we have a huge debt burden. We had to raise money to pay $103 billion in post-retirement benefits over the last 15 years."

Wagoner said GM's cost cuts will make it profitable in a car market of 11.5 million to 12 million cars, about 1 million fewer vehicles than the company said it needed in December before it cut more jobs. If all goes according to plan, GM could return to profitability within 24 months, Wagoner said. "Supporting GM's viability is a sound investment for U.S. taxpayers and one that will be paid back," Wagoner said. GM has an offer on the table to a committee representing its bondholders, which the legal and financial advisors have endorsed if GM makes a few changes that they want. GM and the bondholders representatives will kick their proposals back and forth, but they are getting closer. It will be up to the bondholders to examine GM's turnaround plan and agree to the terms of the offer to get a deal done.

GM said it also has a deal to reduce its labor costs with the UAW, but the company wouldn't give details until UAW President Ron Gettelfinger took it to his members for a ratification vote. But if Chrysler's deal with the UAW is an indicator—and the union usually treats all three automakers somewhat equally—GM should be able to cut its remaining $20 billion in cash obligation to the union's health-care trust by 50% and give the rest in stock. Chrysler said that the UAW agreed tentatively to swap half of its $10 billion in health-care funding obligations for equity if Chrysler can successfully get banks and other debtholders holding $6.9 billion in debt to take two-thirds of that in equity such as preferred stock.

GM is in a similar pickle. The bondholders will want to see that GM's deal with the UAW goes far enough. And the UAW wants to make sure that their concessions are going to make Wall Street investors whole. So both companies will have a job of shuttle diplomacy to get both deals done. GM needs to make further cuts to its labor costs to satisfy the original qualifications set in place by the Bush Administration. Right now, GM's costs are $77 an hour versus $48 an hour including benefits at foreign-owned plants in the U.S. But about $18 an hour goes to retirees. A source close to GM's planning says the company wanted wage and benefits concessions from the union. The UAW already agreed that new hires will make $14 an hour in wages compared with $28 for veteran workers. The source said that GM was also trying to cut wages and health-care benefits for veteran workers. That complicated talks.

GM also wants to get more flexible work rules in the plants and to cut the number of skilled tradesmen, like electricians and plumbers, who make more than $30 an hour. GM's Wagoner wouldn't give details, except to say that "We came into this with very ambitious targets. This will take a big bite out of our labor costs." GM did say it will close five more factories globally on top of the nine that the company has already announced. A total of 47,000 jobs have been eliminated worldwide this year. There's another possible pitfall for GM. The company said its pension plan was significantly underfunded at the end of 2008. The company could have to plow more cash into the pension plan in 2012 or 2013 if the stock market doesn't rebound. That could further hit GM's balance sheet. Chrysler said it reached agreement with the United Auto Workers on work rules and wage concessions that meet the criteria of Treasury, putting its employees at parity with U.S. workers assembling vehicles for foreign automakers like Toyota and Honda.

Perhaps the biggest wild card for GM, Chrysler, and Ford, which has not asked for government assistance, is how low auto sales will remain and for how long. Chrysler, perhaps to shock legislators and Treasury into funding the restructuring plan, projects sales this year of 10.1 million units, and a moribund average selling rate for the industry of 10.8 million units between 2010 and 2012. GM thinks it will be much higher, ranging between 11.5 million vehicles and 14.3 million vehicles in 2010 and from 14.5 million to 17.5 million in 2012. If sales are on the high end of GM's plan, the company would pay back its government debt by 2014. If sales stay on the low side of GM's projections, the company would still owe Uncle Sam $30 billion in 2014.

GM's plan has a rosier sales outlook that Chrysler's. Jeremy Anwyl, CEO of, a Web site tracking auto sales pricing and data, says it's safer to use GM's lower sales estimates. He thinks sales will be in the range of 12 million to 13 million vehicles in the U.S. over the next couple of years. But in a few more years, 16 million cars and trucks isn't a crazy idea, he says. "Everyone wants to know if they will be back for more, and that depends on auto sales," Anwyl says. "I have to believe that 15 million or more is the industry's average."

If the government doesn't support the two companies they both could end up in bankruptcy. GM executives maintain that bankruptcy is their last option and could result in liquidation. In its report to Treasury, the company says that bankruptcy would cost the government more in loan support since banks are doing very little debtor-in-possession financing for bankrupt companies. GM says a quick bankruptcy, or a prepackaged bankruptcy in which terms are agreed with the union and creditors before filing with the court, would require $36 billion in government funding. On the long end, a traditional Chapter 11 bankruptcy would require between $71 billion and $86 billion in government loans.

Chrysler's bankruptcy plan says it would need $24 billion in debtor-in-possession financing from the government. Without it, the company would face a 24-month-long liquidation. Chrysler estimates the cost of the loan program to be $65 per tax filer, with the expectation that the loans can be repaid. Liquidation, with the resulting unemployment, lost tax revenues, and the government assuming pension liabilities would be $1,200 per tax filer, the automaker estimates. Chrysler's plan calls for the company to stay independent but in an alliance with Italian automaker Fiat, which would share vehicle platforms, engines, and technology with Chrysler in exchange for 35% of the company and the possibility that it could acquire an additional 20% at a later date.

But Chrysler also outlined enormous savings that could be gained from a consolidation of Chrysler with another automaker. It does not name General Motors as the other company, but the two companies talked at length last year about merging. One source at GM said the company does not have much interest in merging with Chrysler and that talks didn't get very far last year before GM realized that the costs outweighed the benefits. Chrysler has too many problems, and GM has a lot of work to do. One of its big issues is winding down four of its eight brands. GM will spin Saab into a separate independent company. Saturn will effectively be closed after 2011, and Hummer will be shuttered if a buyer isn't found soon. GM has set aside money to pay dealers for their investment in the euthanized brands. Pontiac will just be a niche player selling a couple of sports cars in Buick-GMC showrooms.

That will allow GM to drop down to 36 nameplates from 48. With fewer mouths to feed, GM says it could be competitive spending just $6.5 billion a year on new vehicles. The company spent as much as $8 billion in recent years. But going forward, Chevrolet, Cadillac, Buick, and GMC will get all of the funding. "GM has to continue on its very recent path of building cars people like," says Roger Martin, dean of the University of Toronto's Rotman School of Management. "The entire product portfolio has to look that way."

Europe Cool to GM's Aid Push
European governments reacted coolly Wednesday to General Motors Corp.'s request for financial support for GM-owned car makers in their countries, despite growing concerns over job losses. The governments of Germany and the U.K., home to GM's big Opel and Vauxhall brands, said they were seeking detailed talks with GM on the topic. Sweden gave a flat refusal to further underwrite GM's Saab unit. GM's bid underscores the global effects of recession on multinational manufacturers. European governments would like to preserve thousands of GM-related jobs in Europe but are wary of setting a precedent for other, locally owned industry groups to exploit. While Europeans have opened the door to bank nationalization to prevent financial collapse, they are steering clear of putting money into the manufacturing sector.

"I'm very disappointed in GM," Swedish Minister for Enterprise and Energy Maud Olofsson told a news conference in Stockholm Wednesday. "We're not prepared to risk the taxpayers' money," she said, adding that Saab has been unprofitable since GM took control in 2000. Separately, GM's Zurich-based European division on Wednesday indicated that it is open to selling a stake or forming a strategic alliance with a partner for GM's units in Europe. "If it makes sense for the sustainable success of GM Europe and Opel, management is also willing to negotiate partnerships and shareholdings by third parties," said the company and labor representatives in a joint statement. GM Europe wouldn't elaborate or indicate whether any such talks were under way or even being considered.

GM for now is trying to line up $6 billion in financial support from five countries by March 31, including Germany, the U.K., Sweden, Thailand and Canada. In a revamped restructuring plan submitted to the U.S. Treasury on Tuesday, GM said it needs help from abroad in addition to $16.6 billion in U.S. government assistance coming on top of the $13.4 billion in loans the company has received since December. GM is targeting $1.2 billion in savings from its European operations. The company said 26,000 of its 47,000 planned job cuts would come from outside the U.S. It also warned of the possible closure or spinoff of European plants in "high-cost locations." Labor representatives at Opel have been appealing to German federal and state governments to consider nationalizing Opel to preserve its 26,000 jobs. Some also have suggested creating one car-making group out of all of GM's current units.

German Finance Minister Peer Steinbrück told reporters Wednesday that Berlin now has to enter talks with GM about the fate of Opel, which also provides work for outside suppliers. Mr. Steinbrück, who said he is a "skeptic" when it comes to nationalization, called on GM to provide a clear concept for future operations, saying the company has a duty to furnish details. He declined to say whether liquidity guarantees would be an option for the government. The U.K. government said in a statement Wednesday it wants to "discuss the implications of the plan" with GM. GM employs about 5,000 people in the U.K., most of them at its Vauxhall unit. GM's U.K. unit estimates suppliers and others employ five people for every staff job at the firm. A Swedish trade union estimates that there are about 15,000 Saab and Saab-related jobs at stake in Sweden: 4,000 Saab employees and about 11,000 subcontractors and suppliers to the company.

Oppenheimer’s Whitney Resigns to Start Her Own Firm
Oppenheimer & Co. analyst Meredith Whitney, who gained fame by correctly predicting a decline in U.S. bank shares and a dividend cut by Citigroup Inc., resigned to start her own advisory firm. Whitney, 39, departs today, John Parks, Oppenheimer’s director of research, said in an interview. The New York-based analyst will open a firm that will carry her name, Parks said.

Whitney in late October 2007 predicted that Citigroup would have to cut its dividend, which the bank did in January 2008, slashing it by 41 percent. At the time, her recommendation triggered the steepest tumble in Citigroup shares since September 2002. "No one had the moxie to put in print what I put in print," Whitney said in an interview at the time. The KBW Bank Index dropped 50 percent last year, including a 77 percent decline for Citigroup, which she has rated "underperform" since October 2007. "The financials are going to be on life support for at least 18 months if not 36 months," Whitney said in an interview with CNBC on Dec. 10. "It’s beyond the banks, it’s beyond the investment banks. The biggest issue for the United States is the health of the U.S. consumer."

Whitney was named one of Fortune’s Top 50 Most Powerful Women in 2008. The same year, she was a runner-up in the banking category of Institutional Investor magazine’s annual ranking of research analysts. In 1993, Whitney began her career as a research analyst, initially covering the oil and gas industry, according to Oppenheimer’s Web site. By 1995 she switched to covering the finance industry. "We will miss having her here on staff, but it’s very amicable," Parks said. "It’s a solo venture and we wish her the very best." A call and e-mail to Whitney for comment weren’t immediately returned. Whitney graduated with honors from Brown University in Providence, Rhode Island. She is married to John "Bradshaw" Layfield, a World Wrestling Entertainment Inc. champion.

Freddie Mac Sells $10 Billion of Debt in Biggest Sale
Freddie Mac, the mortgage-finance company under government control, raised $10 billion selling three-year reference notes in its largest debt offering. "Frankly, I was surprised it got this big," Peter Federico, the McLean, Virginia-based company’s treasurer, said in a telephone interview today. Investors offered to buy 30 percent more debt than was sold, he said. The notes, which mature March 23, 2012, were priced to yield 2.247 percent, or 88 basis points more than three-year Treasuries, the company said today in a statement. A basis point is 0.01 percentage point. The yield is lower relative to benchmarks than in Freddie’s last sale of similar-maturity debt.

Investors have shown increased interest in so-called agency debt -- mainly the borrowing of Freddie, competitor Fannie Mae and the Federal Home Loan Bank system -- "right from the beginning of the year," Federico said. The reasons include an overall improvement in the debt markets, reduced concern that government-guaranteed bank debt would "crowd out" agency debt and a Federal Reserve program to purchase as much as $100 billion of the securities, he said. "A lot of pent up demand globally for agency and government-related paper" amid a slowdown in sales of U.S.- guaranteed bank bonds translated into a strong appetite for the Freddie debt sale, Tom Lewis, head of the U.S. investment-grade debt syndicate at New York-based Morgan Stanley, one of the underwriters, said in a telephone interview today. "There’s just a lot of excess cash in the system that wants to get placed in safe hands," he said.

The average spread on Freddie’s outstanding three-year debt has narrowed from a record of 177 basis points on Nov. 20 to 30 basis points as 4:30 p.m. today in New York, according to data compiled by Bloomberg. Banks and financial companies have sold $153.6 billion of bonds backed by Federal Deposit Insurance Corp since they began using the program Nov. 25, Bloomberg data show. Congress created Freddie and Fannie to provide market stability and expand homeownership by increasing mortgage financing. The U.S. took control of the companies in September as losses threatened to further roil the housing market. The government agreed to inject as much as $200 billion of capital to protect investors in their debt and mortgage bonds, a pledge increased to $400 billion today.

That announcement created a "little extra" interest in the sale among investors, Federico said. Bond buyers expressed interest in more than $10 billion of the debt by late yesterday, after the company announced the offering in the morning, according to Drew Ertman, head of Morgan Stanley’s financial- institutions debt coverage. JPMorgan Chase & Co., Morgan Stanley and UBS AG managed the sale, the company said. Freddie’s reference notes are its largest type of debt issue, with a minimum size of $3 billion. About 75 percent of the debt went to U.S. investors, high in comparison to recent years, according to Ertman.

"But it’s very consistent with what we’ve seen over the last six months, where the U.S. domestic investor who probably understands the conversatorship status better than foreign investors have really been supporting the market in a big way," he said in a telephone interview. In June, Freddie Mac sold three-year notes at a spread of 103 basis points more than two-year government notes, the benchmark the company cited before the Treasury restarted sales of its own three-year debt in November.

Obama offers carrots for mortgage firms
The same mortgage lenders that candidate Barack Obama accused last year of causing the housing mess would get a windfall from President Obama's government under his foreclosure rescue program. The $75 billion plan announced Wednesday has the potential to be far more effective than past federal efforts to help struggling homeowners lower their mortgage payments and stay in their homes. But for that to happen, investors in complex mortgage securities have to agree to participate — something the government has so far failed miserably to persuade them to do. That's where the goodies for the much-maligned industry come in.

Companies would get $1,000 for agreeing to give a strapped homeowner a lower monthly payment instead of foreclosing — more if the borrower hasn't yet fallen behind on what they owe. They can get up to another $3,000 over the next three years. And they get government insurance to cover part of the money they might lose if the homeowner ultimately defaults on the house anyway. Last October in Reno, Nev., Obama vowed, "I won't let banks and lenders off the hook when it was their greed and irresponsibility that got us into this mess." But the outlines of his plan were an acknowledgment that he will need cooperation from firms that collect mortgage payments — known as loan servicers — if he intends to reach his goal of preventing up to 9 million foreclosures.

"The truth is that at the end of the day, loan modification remains voluntary, so the servicers need to see it as sufficient incentive to participate," said Andrew Jakabovics of the Center for American Progress, who has worked with Obama's team on housing issues. Still, Jakabovics called some of the payments an "unnecessary windfall" that is "overly generous" — particularly since avoiding a costly foreclosure is a financial imperative for mortgage servicers anyway. "You still have the very serious question of what kind of incentives you're providing for what's essentially bad behavior," said David C. John, an analyst at the conservative Heritage Foundation.

Even tough mortgage industry critics concede, however, that such enticements are necessary to get companies to step up and help homeowners, given the legal and financial challenges that modifying home loans can pose. "It's just what needs to happen, wherever the blame lies" for the housing mess, said Debbie Goldstein, the executive vice president of the Center for Responsible Lending, a consumer group. The plan also abandons an aspect of the Democratic-written foreclosure rescue program enacted last year that proved anathema to mortgage holders: requiring that they take a loss up front before the government would help renegotiate a loan. The program failed miserably, helping fewer than 40 homeowners compared to the 400,000 promised.

Under Obama's new plan, mortgage holders only have to take a hit on the interest payments they receive each month, and would in most cases be made whole by the government for the value of their loans. "It's a veritable garden full of carrots," said Howard Glaser, a mortgage industry consultant who served in the Clinton administration. A key element would loosen lending rules at government home loan giants Fannie Mae and Freddie Mac to let as many as 5 million homeowners who owe more than their homes are worth refinance to bring down their monthly payments. But that's little comfort to many borrowers in places like Arizona, California, Nevada and Florida — they owe far too much to qualify.

The plan "seems to offer little help to borrowers whose loan exceeds their property value by more than 5 percent," John Courson, chief executive of the Mortgage Bankers Association, said in a statement. The plan beefs up the role of Fannie and Freddie, which were seized by federal regulators last year, allowing them to hold an additional $50 billion each in mortgage investments. The plan isn't all about sweeteners for mortgage holders. Obama's plan also requires that any financial institution benefiting from the $700 billion Wall Street bailout develop plans to help homeowners avoid foreclosures. Those rules apply to the largest banks, which are also the largest holders of home loans.

Yet some doubt that even those new rules will prod financial players that have so far been unwilling to help homeowners to do so now. "It maintains a voluntary system of compliance," said John Taylor, chief executive of the National Community Reinvestment Coalition, a consumer group. "The investors and banks have shown great hesitancy in voluntarily participating in these mortgage programs." Many Democrats and housing analysts believe that the only true way to force mortgage holders to help strapped borrowers is to give judges power to modify bankrupt homeowners' loans, cutting the total they owe and their monthly payments. Obama is backing that move as part of his housing plan, although it will be up to Congress to work out the details.

Meanwhile, housing specialists say the mortgage industry will be slow to act on the new incentives Obama has laid out for helping homeowners — if they end up working. "It's going to be a long, slow process because these mortgages have to be redone one by one," the Heritage Foundation's John said. "You can't just snap your fingers and solve this one."

Obama’s $75 Billion Foreclosure Plan Spells Relief for Bankers
President Barack Obama offered $75 billion of relief yesterday to homeowners facing foreclosure. He also gave bankers a reprieve.
Some lenders, including New York-based JPMorgan Chase & Co., have worried that proposed "cramdown" legislation giving judges the power to modify mortgages of those who file for bankruptcy would increase the number of filings. Obama, who said yesterday he supports a cramdown law, signaled that it would only be a last resort for struggling borrowers. "Allowing cramdowns is a bad idea," said Andrew Sandler, a partner in the Washington office of law firm Skadden, Arps, Slate, Meagher & Flom LLP, whose clients include mortgage companies. "Obama’s program has the potential to reduce the number of bankruptcies. The fewer loans that go to bankruptcy and are subject to cramdowns the better."

Lenders that have large amounts of other types of consumer loans, such as home equity and credit cards, could suffer further losses because bankruptcy judges are likely to wipe out that debt, Paul Miller, analyst at Friedman, Billings, Ramsey Group Inc., said in a Jan. 26 research note. "That’s what scares a lot of people, especially anybody that has second liens," he said in an interview yesterday. "The mortgage industry does not want cramdowns because it’s going to open up a Pandora’s box." The foreclosure plan is part of a broader $275 billion proposal announced by Obama. The $75 billion would reduce monthly payments for borrowers, help homeowners with loans owned or backed by Fannie Mae and Freddie Mac to refinance at lower rates, and provide incentives to the industry. The government committed to buy up to $200 billion of preferred stock in each of the two housing lenders, twice as much as previously pledged.

JPMorgan Chase Chief Executive Officer Jamie Dimon said in an interview that modification in bankruptcy will be "the last resort, not the first resort." He called Obama’s plan an "elegant" way for homeowners to have recourse if they’re unable to change loan terms by any other means. JPMorgan held $352.4 billion in consumer loans on its books in the retail bank at the end of the fourth quarter. Obama’s support for changing the bankruptcy rules is intended to help "borrowers who have run out of options," according to a White House fact sheet released yesterday. "My administration will continue to support reforming our bankruptcy rules so that we allow judges to reduce home mortgages on primary residences to their fair-market value -- as long as borrowers pay their debts under a court-ordered plan," Obama said yesterday in Mesa, Arizona.

The bankruptcy change has come under criticism from investors and analysts who say modifying loan terms would add more instability to the market for debt packaged into securities. "Cramdowns encourage more people to consider bankruptcy," said Andrew Harding, who helps manage $20 billion as chief investment officer for fixed income at Allegiant Asset Management in Cleveland. "It might sound good to the politicians, but it’s certainly not something that behooves the securitized market." Mortgage securities that are rated AAA were sold with the expectation they would be the last to suffer losses, said Gerard Cassidy, a banking analyst at RBC Capital Markets in Portland, Maine. Once those securities take losses, their value will have to be marked down, he said.

Lenders may also pass on higher rates to consumers as risk increases, said David Olson, president of Wholesale Access Mortgage Research, a research firm based in Columbia, Maryland, and a former Freddie Mac economist. "You are saying that contracts can be broken, which is a dangerous concept," he said. U.S. foreclosures reached 274,399 in January, the 10th straight month in which more than a quarter-million filings were processed, according to RealtyTrac Inc., the Irvine, California- based provider of real estate data. Last year, more than 2.3 million homeowners faced foreclosure proceedings, an 81 percent increase from 2007, and analysts say that number may soar to as many as 10 million in coming years. The Obama plan would cut mortgage payments for as many as 9 million struggling homeowners and work with banks to reduce payments to 31 percent of a borrower’s monthly income.

"The refinancing pieces of the plan open up a new tool or opportunity for many consumers across America who really didn’t have refinancing as a viable option before," said Mike Heid, co- president of Wells Fargo Home Mortgage in Des Moines, Iowa. "It’s a very comprehensive, very thoughtful plan that will go a long way towards helping stabilize housing in America." Bank of America Corp. and Citigroup Inc. said in statements they supported the government’s initiative. Citigroup, which has taken $45 billion in government funding and a $301 billion backstop on assets, said in January it supported giving bankruptcy judges the ability to alter loan terms. In a Feb. 11 hearing before the U.S. House Financial Services Committee, chief executives of seven large banks said that while they supported modifying loans, they didn’t share Citigroup’s view that bankruptcy courts should have the leeway to change payments.

Mortgage Bailout: Time to Vent
I listened carefully to Obama's announcement of the new mortgage bailout program - and some venting is required. It's the only way to prevent too much misplaced aggravation on this hump day.
  • First, Mr. President, don't insult my intelligence by telling me that paying for my neighbor's mortgage will benefit me by propping up the value of my home: My tax money will be wasted in propping up my neighbor's home value, so I'm paying for the propping up of my own. This isn't exactly pennies from heaven.
  • Second, Mr. President, as to the "cram-down" provision you're proposing: Under current law, the portion of a mortgage carved out as an unsecured claim gets repaid in part under the plan of reorganization. Under your proposal, the unsecured portion of the mortgage gets wiped out.  Furthermore, under current law, mortgages are crammed down to the market value of the collateral; once you daisy-chain your plans, mortgages will be crammed down to 80% of the value of the collateral, thus rewarding stupidity with fresh equity forced out of taxpayers' pockets. So much for the new era of transparency in the White House.
  • Third, Mr. President, if you're going to force TARP money onto banks in service of a "too big to fail" thesis, and then you tell those banks how much they can pay their officers, and how they must administer their mortgage assets, and whom they should lend to, and how much they should lend - you have effectively nationalized these banks. In this new era of transparency, I'm waiting with bated breath for the politically unsavory announcement that you have in fact nationalized our banking system.

If this is indeed the new age of transparency, Mr. President, start by telling it the way it is: You're going to fund the greed and foolishness of banks and borrowers alike with the money of prudent citizens.  Perhaps you're going to do this because that's where your moral and political compass is taking you; but you are also doing it because you're the government and you can. I may not like your "compass," but at least I'd know where you stand. Please don't tell me, however, that you're taking money out of my pocket for my own good.

Obama threads a mortgage needle
In office 30 days and President Obama has already devised a stimulus package, a bank bailout, and now a mortgage rescue. Like Franklin D. Roosevelt, he has put government's shoulder into a falling economy. But also like FDR, he says he would end any program that doesn't work. For his mortgage scheme, he may want to keep his hand on the plug. The $225-billion plan aims to help millions of homeowners either on the cliff of foreclosure or living in houses worth less than the mortgage. The real purpose, though, isn't a long-term social program but to put a floor under a housing market in a downward spiral.

If prices stabilize, then a value can be put on the bundles of mortgages held as securities by wobbly banks. Banks in turn will start lending again. The credit crunch will decrunch. If lending and the economy revive in coming months, this taxpayer subsidy will be justified. Mr. Obama also claims the plan will keep all home values from sliding by $6,000 from current trends. If either promise doesn't hold up and the wave of foreclosures continues, the president needs to "do what works" and rethink his bailout. At a practical level, the plan may be too limited or risky to arrest a housing slump that has yet to fall to its prebubble prices in most regions. For starters, it applies only to those living in their primary residences. About 40 percent of purchases during the bubble were by investors who aren't eligible for this bailout. And people with "jumbo loans" – generally in higher priced homes – also are not eligible.

It's also not clear yet if the plan applies to second mortgages – often done by different lenders – or to people who lied about their incomes in applying for a mortgage.
The plan is also largely voluntary on the part of banks and relies mainly on government handouts to encourage refinancing of troubled loans. This wisely honors the private contract that is a mortgage but there's no assurance banks will rush to save homeowners on the edge. Many banks may prefer to wait for interest rates to rise rather than take on low-rate mortgages. And recent refinancing done under government guidance has shown high rates of repeat defaults. The only blunt tool Obama offers is to ask Congress to allow bankruptcy judges to readjust mortgages. But causing such uncertainty for banks would likely end up raising interest rates for all new homebuyers, hurting the market.

Perhaps for all these reasons, Obama is unable to offer an estimate on the number of foreclosures the plan will prevent. The plan also lacks permanent relief. Its low interest rates last only five years. By then those rates will go up. Even with a healthy economy, many homeowners may not be able to afford the higher rates.
Fundamentally this latest attempt to prop up "the American dream" of owning a home shows the difficulty of meddling in such a diverse and huge private market. The housing bubble was caused in large part by federal rules and subsidies that made it too easy for people to take on mortgages they shouldn't and for investors to believe prices would always rise under government's paternal eye. To pull the plug on this rescue plan if it doesn't work would at least be a reminder that government can't always get it right.

Some Americans, Underwater but Ineligible, Are Riled Up
President Barack Obama's new foreclosure-prevention plan is already sparking outrage from some Americans who won't qualify for federal aid -- and from those who resent having to foot the bill for those who do. "What do you expect from the government?" said David Newton, 46 years old, proprietor of DJN Management LLC, which owns 232 rental apartments in the Atlanta area. "The government isn't out there to help people who obey the law and follow the rules." Mr. Obama "told everybody, 'I'm going to spread wealth around,' and that's what he's going to do," Mr. Newton said. The housing plan, which President Obama outlined Wednesday in Phoenix, will allow homeowners who have little or no equity to refinance their homes, something that has been nearly impossible to do under current rules. It also establishes standards for government-subsidized loan modifications for borrowers in subprime loans and endorses a provision that would allow bankruptcy judges to reduce the principal on primary residences.

While real-estate professionals applauded the refinance provisions, which the White House says could help four million to five million homeowners, lots of borrowers wouldn't be eligible. For example, the refinance provision is limited to borrowers whose mortgages are owned or securitized by Fannie Mae or Freddie Mac, the government-backed mortgage companies. That essentially shuts out wealthy borrowers who would like to refinance but can't because they own expensive homes financed with so-called jumbo mortgages, which are too large to be owned by Fannie Mae and Freddie Mac. Steve Rosenberg, a 44-year-old institutional stock broker in Chicago, has been trying to refinance his $815,000 option adjustable-rate mortgage for months. But his bank is requiring him to put an additional $150,000 of equity into his home, something he is reluctant to do because his income has been cut in half over the past year. For jumbo borrowers, he said, the government's message is, "You're on your own." Mr. Rosenberg saw little consolation in the president's initiative. "The only recourse I will have is a bankruptcy judge."

Congress has endorsed a provision that would allow bankruptcy judges to modify all types of loans. The White House's proposal would limit such write-downs to existing mortgages under Fannie Mae and Freddie Mac loan limits. Some borrowers in hard-hit markets say they also are excluded. That is because the foreclosure-mitigation plan allows borrowers with little or no equity to refinance a first mortgage for up to 105% of the property's current market value. For some affluent borrowers heavily underwater in markets like California, that isn't enough. "We can afford to make our payments, so no one is going to help us," said Jill Wong, who has watched the value of her Modesto, Calif., home drop to around $350,000, from the $605,000 she paid four years ago. That wiped out her 20% down payment and has left her with a mortgage that has a 125% loan-to-value ratio.

Ms. Wong said she is considering walking away from her current residence since she doesn't expect that the home will ever recover its value. "What's to stop me?" she said. "Years ago you would have thought it was immoral." The housing measures have also upset a range of homeowners who say they shouldn't have to subsidize those who bought more than they could afford. "We've lived a conservative life," said Tim O'Brien, 61, a retired CPA from Los Angeles. "We've paid our house off and saved our money, so you kind of find yourself on this issue not agreeing with everything." Mr. O'Brien believes that Mr. Obama's approach will prove inflationary -- a hardship for those, like him, on fixed incomes. "It's kind of like they've chosen the bloc they want to support with the packages and we're going to end up paying for a lot of it through the losses we've suffered in the market and through inflation over the next 10-15 years," he said as he worked on a project restoring an 80-year-old, two-masted wooden schooner.

The White House says even those who don't benefit directly could benefit indirectly if the effort boosts the housing market and lifts the economy. Brenda Gilchrist said she feels like she is being punished twice, first by watching foreclosures depress the value of her three-bedroom condominium in Santa Rosa, Calif., and now by subsidizing borrowers who bought more than they could afford. The price of her condo has fallen to the mid-$300,000 range, down so far from the $510,000 that she and her husband paid for it four years ago that their 20% in equity is gone. She said they decided to buy a less expensive home even though they had qualified for a $1 million loan. "We said, 'Absolutely, no way.' We chose to buy within our means," said Ms. Gilchrist, a 39-year-old managing partner of a human-resources firm. "The 'good guys' are getting a raw deal," she said.

Jim Stoll, 67, of Stafford, Va., said tax cuts would be more equitable. "I look at all the spending in this bill, and I don't see it going to the normal taxpayer," said Mr. Stoll, who spent 26 years in the Marine Corps and an additional 16 in civil service. "If they have to spend money, then it would be easier to put it in consumers' pockets and let them do with it what they will," he said. Others are skeptical that the plan will work. "Twelve months down the road they're going to say, 'We're going to need to throw another $50 billion at the problem,' " said Mr. Newton, the Atlanta property owner. "They should just foreclose on the properties, auction them off on the courthouse steps and see who buys them.

The Risk from Underwater Homeowners
Obama's $75 billion mortgage rescue plan doesn't address the danger that more homeowners whose equity has evaporated might just walk away. The Obama Administration's $75 billion homeowner-rescue plan offers a lot of help to people in imminent danger of losing their homes. It does far less for those who are deep underwater on their mortgages but have the wherewithal to keep making their monthly payments. And that could be a problem—not only for those homeowners themselves, but for the banking system and the economy in general. Here's the dilemma: Many homeowners owe more on their mortgages than their homes are worth, and—rightly or wrongly—increasing numbers of them may decide to give up and mail in the keys. The taboo against reneging on debts already shows signs of fading in hard-hit markets like Phoenix and Las Vegas. More abandonments would increase losses for lenders while damaging the vitality of neighborhoods.

There's not much in the Homeowner Affordability and Stability Plan announced on Feb. 18 to deal with this looming problem. Provisions to reduce monthly loan payments for homeowners who are struggling don't prevent these so-called "voluntary foreclosures," since in many cases the payments already are affordable. The most effective way to keep underwater homeowners from walking away en masse would be a big writedown of the principal they owe. That would give them positive equity in their homes—or at least the hope for it once prices begin creeping upward again—and with it, a reason to stay put. Although the Obama plan permits principal writedowns—and even pays off up to $5,000 of principal for homeowners who remain current on their payments—they aren't required, or even central to the proposal. Writing down mortgage debt on houses that are underwater could total $1 trillion or more. The value of underwater homes could be as much as $700 billion below the mortgage values, according to financial analysts and informal government estimates. Keep in mind, though, that this is not an actual expense because no dollars would change hands: The debt holders would simply be bringing their valuations in line with the reality that many of the loans are destined to be defaulted on. And banks would recoup even less if the homes are allowed to go into foreclosure unnecessarily than they would have in a writedown, because the owners will stop paying entirely. What's more, vacant houses are subject to vandalism that further erodes their value, and foreclosures drag down the value of neighboring properties.

For some of the roughly 10 million underwater homeowners, especially those with spotty credit records, the temptation is great to walk away. "It's just common sense," says Yale University economist John Geanakoplos. He takes pains to say he's not defending the behavior, but adds, "If your house is worth much less than the loan, you're pretty sure you'll never really own it. You'll just go rent somewhere. The only bad thing is the mark on your credit rating, which for these people wasn't too good in the first place." Even for those who want to keep their homes at the moment, reducing monthly payments without addressing negative equity may just postpone the inevitable. "The reality is, people lose jobs, especially in a recession. People get transferred, people have to move at some point," says Sean O'Toole, founder and CEO of, which tracks California foreclosures. "By lowering payments and not principal balance, you're guaranteeing the extension of this crisis for years to come." How big is the risk that many more Americans will give up and walk away from their homes, figuring that paying the mortgage every month is throwing good money after bad? A widely cited study by the Federal Reserve Bank of Boston found, seemingly reassuringly, that only about 6% of people who were underwater on their mortgages in the 1991 regional housing slump eventually faced foreclosure.

But Yale's Geanakoplos says the danger is much greater this time. Housing prices have fallen more, and many more of the loans were made to people with bad credit. His research using more recent data finds that default rates skyrocket when subprime or option adjustable-rate mortgage borrowers owe more than their houses are worth. The default rate is about nine times as high for people who are way underwater as for people with substantial equity in their homes, all else equal, Geanakoplos found. Lowering the amount that people owe on their homes would obviously help the homeowners. What's surprising is that it might even benefit the people who bought their loans, bundled into mortgage-backed securities. How could that be? Because the values of those securities have already plunged—in some cases to as little as 25¢ per dollar of face value—in the expectation of massive foreclosures. If big writedowns managed to keep more people in their homes, it could actually enhance the value of those mortgage-backed securities.

There is one potential obstacle to big principal adjustments that the Obama plan doesn't address: litigation over writedowns by investors who bought stakes in the vast number of mortgages that have been securitized. A minority of the "pooling and servicing" agreements governing securitized loans explicitly restrict modifications. Even in cases where modifications aren't banned, servicers say they worry about getting sued anyway for abrogating unwritten responsibilities to investors. Indeed, on Dec. 1, William Frey, a private investor in mortgage-backed securities, filed a lawsuit in New York State Supreme Court alleging that the proposed modification of some 400,000 home loans originally underwritten by the defunct lender Countrywide Financial is illegal. Many in the industry expected the Administration's proposal to include a "safe harbor" protecting servicers against lawsuits where loan modifications benefit investors as a whole more than foreclosure would. But while Congress is contemplating such protections, the Obama plan doesn't—and one Democratic Senate aide says Administration officials have been distinctly cool to the idea.

Is there an argument against massive writedowns of principal for underwater homeowners? Sure: It rewards the person who put no money down, and it does nothing for the next-door neighbor who put 20% or 30% down and still has equity. "I don't think you're going to find any sympathy for that," says Guy Cecala, publisher of Inside Mortgage Finance, an industry newsletter. Trouble is, trying to treat those two neighbors equally could have unintended harmful consequences for the neighborhood if the family that's underwater simply walks away. Ultimately, strong resistance to principal writedowns in the industry—whether from legal concerns, because banks can't absorb the paper losses, or because it sets a worrisome precedent for other borrowers—means implementing such a program would involve "a major time delay," a senior Administration official says. "If you're going to try to prevent the foreclosures now, you can't go that way."

The Obama Administration missed another opportunity to help underwater homeowners when it limited the assistance it is offering homeowners who are current on their mortgage payments. In a step in the right direction, the Obama plan allows Fannie Mae and Freddie Mac to finance new, more affordable mortgages even if homeowners owe more than the current standard of 75% to 80% of their home's current value. But for unexplained reasons, there's a cap on eligibility. Fannie and Freddie still won't be allowed to help with refinancings if the loan-to-value ratio exceeds 105% (e.g., the loan is $210,000 and the house is worth $200,000). Putting a cap on eligibility for refis cuts out many of the people who most need a break and doesn't appear to make any sense from the government's viewpoint either, says Christopher Mayer, a Columbia University economist who has helped devise homeowner-rescue plans. Throwing open eligibility for cheaper loans to anyone who currently has a loan owned or guaranteed by Fannie and Freddie would lower default rates and thus the ultimate cost to the agencies and taxpayers, says Mayer. He adds, "I don't understand why they did this."

Moreover, "private-label" mortgages that lack Fannie or Freddie's backing—particularly in California and the Northeast, where home prices are higher and subprime mortgages more common—aren't eligible for Fannie and Freddie refis at all. "Where the markets have been hardest hit on the coasts, where private mortgages are the biggest, this program won't really help," says a fixed-income portfolio manager for a major mutual-fund management firm. The senior Administration official said the 105% cap seemed advisable in part because re-default rates tend to rise with high loan-to-value ratios. And the government excluded private-label loans from the refinancing program because it little or no authority to dictate rate changes where government-affiliated entities don't provide guarantees. Obama's plan is broader and stronger than Hope for Homeowners, the unwieldy, mostly voluntary program passed by Congress last summer. On the other hand, that's not saying a lot. Hope for Homeowners has refinanced a microscopic 25 mortgage loans so far. Even a thousandfold improvement over that would still constitute failure for the Obama Administration. That's why this plan may require some changes in the months ahead.

Modifying Mortgages Can Be Tricky
When her brother could no longer help support her, Luzetta Reeves asked her small mortgage company to cut her monthly payments. It did — by 11 percent — making it possible for her to afford her house here on her modest fixed income. In Miami, Jeffrey Mitchell saw his family income drop just as real estate taxes and insurance premiums increased, making his monthly mortgage payments crushing. He got a lower interest rate, too. But with the added fees and penalties, his monthly payment remained the same. He is now back in foreclosure. As the Obama administration steps up efforts to help troubled homeowners modify their mortgages, it might consider the experiences of these two South Florida borrowers and their mortgage companies, one small, one large.

National statistics on mortgage modifications suggest that what happened to Ms. Reeves, a disabled 54-year-old, and Mr. Mitchell, a 42-year-old union representative, is fairly typical. The nation’s 14 largest banks reported that more than half of the loans they modified last year were delinquent again after just six months, according to the federal bank regulator, the comptroller of the currency. But several small mortgage companies like the one that helped Ms. Reeves, which have been pursuing modifications longer, say that less than 25 percent of their modified loans became delinquent again. "It’s becoming more and more clear to us that if you do real modifications the default rate is significantly lower," said Tom Miller, the attorney general of Iowa, who has led a group of state officials pushing the industry to modify more loans. "They shouldn’t be called modifications if people pay more or approximately the same."

Two years into the foreclosure crisis, many borrowers say they still have trouble reaching anyone at their bank or mortgage company to discuss loan modifications. Banks and investors absorb huge losses in foreclosures, but some mortgage companies may view foreclosure as more profitable and expedient than modifications because they can levy extra fees and they do not have to wait to see if a homeowner will continue to make payments. Bankers counter that they pursue options that minimize losses, but add that it is often hard to reach delinquent borrowers because many hide from their creditors. While both arguments appear to have merit, reports by analysts at Credit Suisse and a law professor, Alan M. White, show that when mortgages are renegotiated, borrowers often face higher monthly payments or balloon payments at the end of the term.

Rod Dubitsky, a mortgage analyst at Credit Suisse, found that modifications that result in lower payments tended to re-default at half the rate as plans under which payments were higher or remained roughly the same. The performance of individual companies varies greatly. Some, like Wells Fargo, one of the nation’s largest servicers of home loans, have modified few loans as a percentage of their delinquent mortgages, said Mr. White, an assistant professor of law at Valparaiso University. Other companies like Ocwen Financial and Litton Loan Servicing, a subsidiary of Goldman Sachs, have modified a big portion of their delinquent loans, according to Credit Suisse. (The studies cover only loans packaged into securities, not those held on the books of banks.) In the case of Ms. Reeves, Ocwen cut the interest rate to 5.6 percent, from 8.9 percent, lowering her payments by $125, to $1,027. Officials at the company said the reduction would cost less than seizing and selling Ms. Reeves’s modest two-bedroom house near Dolphin Stadium.

"Ocwen was very patient with me, and they really worked with me," said Ms. Reeves, who has back problems and breast cancer. The company said its modifications were not acts of charity but were based on calculations of whether changing loan terms was in the best interests of investors. Using home price data, estimates of legal costs and the time it takes to foreclose, the company determines how much it will recover in foreclosure. It compares that with estimates of what borrowers can afford based on income, family size and expenses. "Our biggest hurdle is reaching out and talking to people," said Margery A. Rotundo, Ocwen’s senior vice president for residential loss mitigation. "If a borrower has a desire and the ability to stay in the home, we can help them." Ms. Rotundo said the company’s decades-long experience with borrowers with blemished credit histories informed its approach.

Ocwen, which is based in West Palm Beach, Fla., modified half of the delinquent loans it resolved last year. It foreclosed on a third, and most of the rest were sold before foreclosure for less than what was owed on them. But many more people appear to have the experience of Mr. Mitchell, the other Florida borrower. Mr. Mitchell bought his Miami home four years ago for $282,000. In 2007, his wife had to work less to care for a sick child, and the family was hit with higher tax bills and insurance premiums, raising monthly payments to $2,700 from $2,200. When Mr. Mitchell told Wells Fargo he could not keep up, he said, "It fell on deaf ears for a while." Wells Fargo ultimately cut Mr. Mitchell’s interest rate to 6.1 percent, from 6.5 percent. But it added fees, back payments and penalties to his principal, raising it above $300,000. His payments were virtually unchanged, and he was asked to make a $5,000 payment to get out of foreclosure. He fell behind again right away. His house, he estimates, is worth only $199,000.

"The arrangements they come up with are not really in your best interest," he said. "You feel like you’re trapped." Analysts say it is hard to know exactly why different mortgage companies handle delinquent loans so differently. Smaller companies like Ocwen that are under more financial pressure and have more experience in dealing with higher-cost loans have been most aggressive in lowering payments, said Mr. Dubitsky, the Credit Suisse analyst. Big banks like Wells Fargo, which would need to be retooled to emphasize modifications over foreclosures, appear to favor modifications that do not lower payments or debts very much. A spokesman for the comptroller, Bryan Hubbard, said that many banks began focusing on lowering monthly payments last year and that it would be premature to say they had not done enough to help borrowers. Lowering payments is becoming more important as the economy weakens, Mr. Dubitsky said, because more borrowers are likely to lose jobs or encounter expenses they cannot afford. "If the borrower is spending every last dollar on their debt," he said, "that leaves them vulnerable to unexpected expenses."

Mortgage Plan Effect May Be Limited, Analysts Say
The effect of Obama administration’s housing plan on home-loan bonds and borrowers will be limited by restrictions on which mortgages are eligible, according to Bank of America Corp. analysts. The plan, announced yesterday, includes government payments to lenders such as bond investors, mortgage servicers and borrowers either before or after loans are reworked. It also will loosen Fannie Mae and Freddie Mac rules to allow more borrowers to refinance into lower payments, including some who owe more than their homes are worth. Only about 50 percent to 60 percent of securitized prime jumbo or Alt-A loans meet the loan-modification standards requiring borrowers to live in mortgaged properties and owe no more than Fannie and Freddie’s loan limits, according to a report yesterday by Bank of America strategists including Akiva Dickstein and Vipul Jain. The refinancing plan will be limited by a standard preventing homeowners from qualifying if they owe more than 105 percent of their homes’ value, they said.

"Borrowers who do not qualify due to loan size can of course still have their loans modified by their servicers, but without the government incentives," the New York-based analysts wrote. The refinancing plan "does little to help underwater borrowers," they added. Jumbo loans are larger than Fannie and Freddie, the government-chartered mortgage companies under federal control, can buy or guarantee, currently $417,000 in most areas and as much as $729,000. Alt-A loans went to borrowers who wanted atypical terms such as proof-of-income waivers, investment- property collateral or delayed principal repayment, without enough positive compensating attributes.

About $1.2 trillion of bonds backed by prime-jumbo or Alt-A mortgages, when including so-called option adjustable-rate loans, are outstanding, according to Memphis, Tennessee-based FTN Financial data. The total amount of U.S. home-mortgage debt is $10.5 trillion, according to Federal Reserve data. The refinancing plan covers loans already guaranteed or directly owned by Washington-based Fannie or McLean, Virginia- based Freddie, which help finance $5.3 trillion of residential debt. The U.S. housing market lost $3.3 trillion in value last year and almost one in six owners with mortgages owed more than their homes’ worth, according to a Feb. 3 report from After a record boom, home prices are down 25 percent on average since mid-2006 amid a tightening of lending standards and an economic recession, an S&P/Case-Shiller index shows.

Mortgage-bond analysts at Credit Suisse Group and Barclays Capital Inc. joined the Bank of America strategists in saying the refinancing plan lacked enough detail to predict how many more borrowers will replace their loans because of the program. "If anything, the announcement of the new program created more questions than it answered," the New York-based Barclays analysts led by Ajay Rajadhyaksha wrote in a report today. "This suggests to us the details for the plan are still being worked out." The plan will probably help four to five million homeowners refinance as the administration predicts, the analysts said, though the equation will be affected by details including whether Fannie and Freddie will waive fees for borrowers with little or no home equity and how the companies will be directed to deal with borrowers who currently have mortgage insurance.

Fannie and Freddie typically must have borrowers or lenders buy mortgage insurance on loans with less than 20 percent down payments or home equity. For loans without mortgage insurance now, the companies will probably be allowed to break their normal rules under powers granted to their regulator by a law passed last year, Laurie Goodman, an analyst in New York at Amherst Securities Group LP, said in an interview yesterday. About 9 percent to 11 percent of loans backing Freddie mortgage securities issued in 2006 and 2007 with the most-common coupons exceed 105 percent of the homes’ value, making them ineligible for the refinancing under the standard for how much "underwater" borrowers can be, the Credit Suisse analysts in New York including Mahesh Swaminathan wrote in a report today.

Mortgage-bond holders who paid more than face value for the debt may incur losses if refinancing means the securities are repaid faster than expected, cutting the value of the premium coupons on the bonds. More than 95 percent of Fannie or Freddie- guaranteed fixed-rate mortgage securities are trading above face value, according to Bloomberg data. While the Bank of America analysts said about 90 percent of subprime mortgages underlying securities will be eligible for the loan-modification plan, the Barclays analysts wrote that payment reductions for the borrowers might not be enough to significantly reduce their defaults because they "typically have poor spending habits and high" non-mortgage debt burdens. Overall, the modification program, which the administration predicted will cover three to four million loans, will have a "meaningful and beneficial effect" on home prices by cutting prime-mortgage defaults, the Barclays analysts said.

California Foreclosure Center Shows Obama Challenge
It has taken Susan Erb just three years to see the value of her Merced, California, home plunge by more than half to $350,000. Next month, her mortgage payment jumps 20 percent to $3,321 and she knows she can’t afford it. Her bank won’t rework the loan unless she stops paying altogether.
"Now I know how people feel when I go knocking on their door," said Erb, 53, a real estate agent who works for a company that notifies residents in foreclosed properties that they must vacate. "I’m in their shoes."

Merced, the epicenter of the U.S. foreclosure crisis, demonstrates the steep challenges President Barack Obama will face in trying to stem defaults. One in 59 housing units in the Merced metropolitan area received a foreclosure filing in January, the highest rate in the U.S., according to RealtyTrac Inc., an Irvine, California-based seller of default data. For- sale signs are everywhere and a building boom fueled by subprime mortgages has been brought to a standstill. Just 16 construction permits were issued last year. In 2005, there were 1,427. "We’re ground zero," said Merced Mayor Ellie Wooten, 75. The city, population 81,000, had an unemployment rate of 15.5 percent in December, "and it’s going to get worse," she said.

Obama unveiled a series of measures in Arizona to reduce record home foreclosures and halt the erosion of property values. As many as 9 million people can restructure or refinance their mortgages under the proposal. The program will use $75 billion to bring down interest rates and encourage loan modifications, the White House said in a statement. The Treasury Department will double the amount of stock purchases of Fannie Mae and Freddie Mac to as much as $200 billion of each company. Obama said he supported revised U.S. bankruptcy rules that would let judges reduce mortgages on primary residences to fair- market value, as long as borrowers pay their debts under a court- ordered plan. His proposal will use government funds to match reductions lenders make in interest payments and lower borrowers’ payments to 31 percent of their monthly income.

Treasury will share the cost when lenders reduce monthly payments by forgiving a portion of the borrower’s mortgage balance, the government said. The program may help as many as 4 million borrowers, and the average borrower’s home value could be stabilized against a price decline of up to $6,000. Banks accepting help from the government’s financial-system bailout must adopt loan modifications, the administration said. The measures come amid a worsening economy and plunging home values that have put 17.6 percent of mortgage holders underwater, or owing more than their property is worth, Seattle-based said Feb. 3. Modifying loans and reducing principal may not be enough to keep people in their homes and fix the housing market, said Ethan Harris, co-head of U.S. economics research for Barclays Capital Inc. in New York, in an interview.

"There’s a chunk of these loans that are unsustainable, where people have gotten divorced or lost their jobs, or the loans were way beyond the borrowers’ capability to pay in the first place," said Harris. "A lot of the loans were not designed to be repaid, they were designed to be refinanced. That works only when housing prices are going up." The "sheer volume of bad loans" is also a challenge, said Harris. "Getting the process going is very tough to do with such volume, even when it’s in everybody’s best interests." U.S. homeowners lost an estimated $3.3 trillion in house value last year, real estate valuation service Zillow said. In California, the state with the most foreclosure filings, the share of underwater owners will rise to a third of all mortgage holders by the end of the year, according to data provider First American LoanPerformance of Santa Ana, California.

Merced, located about 110 miles southeast of San Francisco in California’s agricultural Central Valley, became a housing boom town in the early part of the decade as buyers with subprime loans sought affordable property within commuting distance of Bay Area job centers, said Jeff Michael of the University of the Pacific’s Eberhardt School of Business in Stockton. Median home prices in Merced rose from $150,000 in January 2002 to a peak $382,750 in December 2005, according to MDA DataQuick, a San Diego-based property research firm. In December 2008, the median stood at $120,500, down 52 percent from a year earlier, as four out of five resales involved properties that had been foreclosed on in the prior 12 months.

"There were a lot of young families and first-time buyers with not a particularly high income, so it was perfect ground for subprime lending," said Michael, who directs the school’s business forecasting center. "You had people streaming in from the Bay Area. This was their chance to get in." Many of the people coming to town were immigrants priced out of other parts of California. About 17 percent of Merced’s population is of Laotian descent and 52 percent is Hispanic, city spokesman Mike Conway said. Homebuilders constructed subdivisions to the north, west and east of the downtown, and today "no area is untouched" by the foreclosure crisis, said Brad Grant, city finance director. Merced’s general fund revenue, mostly from property and sales taxes, will drop 12 percent to $38.6 million for the fiscal year ending June 30, and will probably decline a further 7 percent next year, Grant said. The city won’t fill 35 jobs and department managers are to cut budgets by 12 percent.

Bankrupt retailers including Mervyn’s LLC, Circuit City Stores Inc. and Linens ‘n Things Inc. have cut almost 200 jobs in town, and Quebecor Inc. may close its Merced printing plant and fire about 100 workers, Wooten said. Rina Serrano, 35, an after-school program supervisor for the Merced County Office of Education, may lose her job next year due to budget cuts. The value of her house, built by Calabasas, California-based Ryland Group Inc. in the Bellevue Ranch development, fell by at least a third since she purchased it in 2007. Her husband’s cabinetmaking business is down by half. "Nobody has given us any options, but my feeling is there should be some assistance," said Serrano, 35, a mother of four. The couple took out a 30-year fixed loan and aren’t behind on payments but they are underwater by about $70,000. Speculators helped drive up Merced prices during the boom, said Greg Parle, co-owner of the Branding Iron steak house on Main Street, not far from a historic courthouse built in 1875, three years after the city was established.

"We had a tremendous wave of Bay Area people coming through, and they were rolling houses," Parle said. "You couldn’t touch a two-bedroom condo for less than $600,000 there. But you could buy a three-bedroom house for $250,000 here." The Obama plan probably can’t help Merced residents Bountay and Khamtanh Rattanavongsa, who walked away from their adjustable-rate home loan last year and were foreclosed upon after monthly payments jumped to $3,500 from $1,800. They’re now renting a Bellevue Ranch house constructed by Kimball Hill Homes, the Rolling Meadows, Illinois-based homebuilder that filed for Chapter 11 bankruptcy protection in December. Across the street, wooden frames of partially built two-story homes, with no windows or doors, are clustered in a former cattle pasture. Khamtanh, 63, a retired school aide, came to the U.S. from Laos in 1978 with her husband, 60, who works as a custodian. Their son lives with them and helps pay the $1,500 rent. "I loved my house, I never thought I’d lose it," Rattanavongsa said. "Now I have no credit. I’ve got nothing."

Southern California home prices fall 40% in one year to 2002 levels
Southern California home prices continued their decline in January, falling to 2002 price levels, a real estate research firm reported today. The January median sales price for all Southern California homes fell to $250,000, a 40% drop from the same month a year prior, according to San Diego based MDA DataQuick. The falling prices were again driven by sales of foreclosed properties, which comprised nearly 60% of all homes sold in the region. Consequently, the lowest median sales prices were reported in San Bernardino County ($162,000) and Riverside County ($195,000), where foreclosures have been rampant.

Los Angeles County's median sales price of $300,000 was down 35% from January 2008, while Orange County's median sales price fell 29% to $370,000. San Diego's median of $280,000 was down 35% from a year ago, Ventura County's median fell 30% to $335,000. The low prices are now attracting buyers in some areas. DataQuick reported record January sales totals in Perris, Temecula, Victorville and Fontana in the Inland Empire. Palmdale in Los Angeles County posted a record total in January, and record January sales totals also were achieved in Chula Vista and Lemon Grove in San Diego County and Oxnard in Ventura County, DataQuick reported.

"We can only assume that many first-time buyers, investors and others buying in these areas have concluded it's not worth trying to time the price-bottom perfectly," said DataQuick president John Walsh, "They're happy to lock in substantial discounts relative to the peak." According to DataQuick, the typical monthly mortgage payment that Southern California buyers committed themselves to paying was $1,081 last month, down from $1,239 the previous month, and down from $1,940 a year ago. Adjusted for inflation, current payments are 51% below typical payments in the spring of 1989, the peak of the prior real estate cycle. They are 59.9% below the current cycle's peak in June 2006.

Bank of America, American Express May Suffer as Credit Card Defaults Set Record
Credit-card defaults may rise beyond 10 percent this year, breaking records and wiping out more than half of annual profit for lenders including Bank of America Corp. and JPMorgan Chase & Co., analysts said. Loan failures are about to surpass a previous high of 7.53 percent as people losing jobs amid the U.S. recession can’t repay debt, according to Fitch Ratings. The defaults may peak at 10 percent to 11 percent of loans by yearend under a stress scenario, Goldman Sachs Group Inc. analyst Brian Foran said yesterday in an e-mail, reducing 2009 earnings for issuers including an almost 40 percent cut for American Express Co.

"The challenge is getting past the intensifying credit problems that will probably stay pretty rotten over the next six months or longer," said John Williams, an analyst at Macquarie Capital in New York, who rates American Express and Discover Financial Services "underperform." Banks that already got cash from the U.S. Treasury after losses tied to mortgage securities may have to add billions to reserves for credit-card defaults, straining capital levels further. They are cutting credit lines, raising interest rates and scaling back on mail solicitations to brace for future losses. Citigroup Inc., Bank of America, JPMorgan, American Express, Capital One Financial Corp. and Discover are the biggest card lenders.

Charge-offs, or loans that banks deem uncollectible, reached 7.5 percent in December, according to Fitch Ratings analyst Cynthia Ullrich. The record of 7.53 percent was in 2005 after a change in bankruptcy law spurred a wave of filings, according to Fitch, which tracks a quarter of the $964 billion in U.S. credit card receivables. Unemployment worsened in January, rising to 7.6 percent, the highest rate since 1992. "This is going to be an awful year for the credit card industry," Bank of America Chief Executive Officer Kenneth Lewis told lawmakers this month. "The more optimistic views are unemployment at 8 or 8.5 percent, and that would cause very high loss rates in the credit-card portfolios."

The rise in losses may outpace unemployment as credit-card debt from the past two years is defaulting more than older vintages, Goldman Sachs’s Foran said in a Jan. 26 note. Assuming a U.S. unemployment rate of 9 percent by yearend, 2009 profit for Bank of America, JPMorgan and Capital One may be cut by more than half, he said. Discover’s earnings may be totally wiped out, while American Express profits may be 38 percent lower. Citigroup posted a net loss in 2008, obviating a percentage comparison. Charge-offs may reach the "mid-teens" in a worst-case scenario, Moody’s Investors Service analysts led by William Black said in a Feb. 4 note. Issuers would have to bolster their securities to prevent them from hitting early payment-triggers and lower-rated securities could be downgraded, Moody’s said.

Sustained defaults at 10 percent could force a major issuer to seek a rescue or sell its credit-card division, said David Robertson, president of the Nilson Report, the Carpinteria, California-based trade newsletter. "There’s never been a lender of that scale in this predicament," Robertson said in an interview. "Portfolios that have been required to sell themselves to a lender because they’ve gone underwater have been far smaller." Samuel Wang of Citigroup and Joanna Lambert of American Express, both based in New York, declined to comment, as did Betty Riess of Charlotte, North Carolina-based Bank of America, and Leslie Sutton of Riverwoods, Illinois-based Discover. Tatiana Stead of McLean, Virginia-based Capital One didn’t returns calls or an e-mail.

Paul Hartwick of JPMorgan Chase said in an e-mail that the firm was "concerned" about charge-offs, which may rise from 5.29 percent in the fourth quarter to 8 percent by yearend, excluding the September acquisition of Washington Mutual Inc.’s card unit. Chase has about 168 million cards issued. Citigroup, the largest credit-card company by managed loans, said profit in its global card unit plunged 96 percent in 2008 to $166 million from $4.67 billion a year earlier. Credit losses in the unit rose 53 percent to $5.92 billion and the company more than doubled loss reserves to $3.55 billion. Bank of America, the second-largest credit-card lender, said its card services unit’s profit declined 85 percent to $521 million last year from $3.59 billion in 2007. Charge-offs rose to $11.4 billion from $8.2 billion the year earlier as 6.18 percent of accounts failed, from 4.79 percent in 2007.

American Express, whose net income slipped 34 percent to $2.63 billion in 2008, blamed rising defaults on having a bigger percentage of small business customers who failed to make payments, Chief Financial Officer Dan Henry said last month. The company also has more cardholders in California and Florida, states especially hard hit by the housing bust, he said. "We expected to see deterioration in the sector," Ullrich said. "This is the worst I’ve seen in my career." The so-called private-label card industry, whose cards are typically only used at a single retailer, had defaults of 10.51 percent in January, according to Fitch, 44 percent higher than a year earlier. These cardholders often have poorer credit histories and choose to pay off other cards first. Citigroup announced plans last month to sell its private- label credit-card unit as soon as the market permits, and shunted the unit into a new division with other "non-core" businesses including consumer-finance and life insurance. The bank plans to keep its Citigroup-branded credit-card business, which will be folded into regular banking operations.

General Electric Co., the largest private-label card issuer, said in September it will keep the business after failing to find a buyer since putting it up for sale in late 2007. The unit has about $30 billion in assets and operates cards for retailers including Wal-Mart Stores Inc. and J.C. Penney Co. American Express and Discover, the last major standalone credit-card lenders, became bank holding companies last year to gain greater access to federal funds and consumer deposits. American Express got $3.39 billion from the U.S. Treasury rescue fund and Capital One received $3.6 billion. The market for bonds backed by credit-card payments, once a major source of funding for lenders including American Express, froze in October after investors demanded wider spreads on new debt. Companies issued $76 billion in securities last year, down from $95 billion in 2007, and may sell as little as $10 billion in debt this year, according to Moody’s.
Rules that limit ways issuers can raise fees to customers may also squeeze lenders.

The Federal Reserve and other regulators adopted changes in December that take effect in July 2010, and lawmakers may pass similar legislation that accelerate reforms. The companies sent out the fewest direct mail credit-card offers to Americans last year since at least 2000, when Mintel Comperemedia began tracking the data, the market research firm said this month. Lenders sent out 5.4 billion of the letters, down about 26 percent from 2007. "Issuers have historically been their own worst enemy," said Robertson. "They find themselves in a situation where they need to do what bankers are supposed to do, which is protect the bottom line and make sure they’re not making irrational loans."

The Decline of California
They still think they can tax their way out of this one.

If you thought Washington's stimulus debate was depressing, take a look at the long-running budget spectacle in California. The Golden State's deficit has reached $42 billion, Governor Arnold Schwarzenegger is threatening to furlough 20,000 state workers (go ahead, make our day), and as we went to press yesterday Democrats who control the legislature had blocked lawmakers from leaving until they finally get a deal. It's sad to watch. The Golden State -- which a decade ago was the booming technology capital of the world -- has been done in by two decades of chronic overspending, overregulating and a hyperprogressive tax code that exaggerates the impact on state revenues of economic boom and bust.

Total state expenditures have grown to $145 billion in 2008 from $104 billion in 2003 and California now has the worst credit rating in the nation -- worse even than Louisiana's. It also has the nation's fourth highest unemployment rate of 9.3% (after Michigan, Rhode Island and South Carolina) and the second highest home foreclosure rate (after Nevada). Roughly 1.4 million more nonimmigrant Americans have left California than entered over the last decade, according to the American Legislative Exchange Council. California is suffering more than most states from the housing bust, but its politicians also showed less spending restraint during the boom.

To close the current deficit, the pols in Sacramento are nearing a deal that cuts spending by $15 billion and raises $14.2 billion in higher taxes on income, sales, gasoline and cars. Six years ago Mr. Schwarzenegger helped depose Governor Gray Davis by calling him "Car-taxula." Now he's agreed to double the same tax. Mr. Schwarzenegger has won at least some concessions from Democrats, who run the most liberal legislature this side of Trenton. The budget deal contains a handful of useful tax breaks for job creation and the first public union workplace reforms in a decade; it also creates a new rainy day fund. These taxpayer victories wouldn't have been possible if Republicans in the legislature hadn't held out for them.

But the plan is still far short of the radical tax and spending surgery the state needs. It's loaded with short-term gimmicks -- such as $5 billion of borrowing from future lottery receipts and nearly $10 billion in one-time federal stimulus cash. Even proponents concede the plan doesn't balance spending and revenues 18 months from now. The tax increases will continue to chase even more productive people out of the state. For at least two years, the sales tax would rise by one percentage point to 8.25% and the income tax by 0.3% to a top marginal rate of 10.56%. These will both be the highest statewide rates in the nation.

Do these taxes hurt business? Ask Hollywood. Film makers are threatening to flee to avoid the state's high costs, so to keep them in Southern California the deal offers $500 million in tax breaks for producers. Rich liberals like Rob Reiner, who love higher taxes on other people, get a sweetheart tax break and everyone else pays more. Mr. Schwarzenegger is finally getting a constitutional state spending cap that will be on the ballot in the next election, but even that is flawed. This cap would limit spending hikes in any year to a rolling average of the percentage increase of the past 10 years. Nice idea, except that if Californians vote yes, the higher income and sales taxes automatically kick in for three more years.

So to get a modicum of spending restraint, the voters have to agree to tax themselves by $25 billion more for three additional years. Californians can be forgiven if they say "no deal." The tragedy of this gamesmanship is that the political class still won't address the root cause of its financial problems, which is that the state is becoming less economically competitive. California businesses and high-income families already pay a surtax for locating inside the state. The new budget deal raises that tax toll higher still. It's no surprise that most CEOs we talk to, many of whom live in California, say they'd be foolish to build another plant in the state. California's budget crisis is the inevitable result of runaway liberal governance, and the state's voters will keep paying for it until they reduce their tax burden and adopt more radical spending controls.

Ilargi: A Republican governor who has his entire party against him finally will get a deal that cuts $700 million in corporate taxes while the citizens see their taxes, already the highest in the country, rise even more. Something doesn't add up.

California Senate, Assembly Reach Deal, Send Budget to Schwarzenegger
A Republican California state legislator on Thursday morning backed a plan to close the state's $42 billion budget deficit through steep cuts and new taxes. He provided the final vote needed to approve the budget, signaling the end of a 15-week partisan conflict that has battered an already-crippled state economy. State Sen. Abel Maldonado, who had voted against the budget Wednesday morning, changed his vote to an "aye" on the plan after state leaders met his demands that certain state-government reforms be added to the proposal and that the plan be stripped of a gas-tax increase. The state Senate passed the budget around 6 a.m. Thursday, and the assembly followed suit shortly afterward.

Mr. Maldonado's vote swing came after five days of legislative sessions that ended every day in an impasse for lack of the additional Republican vote needed make up the two-thirds majority that is required to pass a budget or tax increase in California. "I don't like the budget; I don't like the revenue increases," Mr. Maldonado said Wednesday night, "but I don't want California to fall off the cliff." Mr. Maldonado was heavily lobbied over the past week by the budget plan's creators, Gov. Arnold Schwarzenegger and state legislative leaders from both parties. With Mr. Maldonado on board, state senators began voting before 4 a.m. Thursday and finished more than two hours later. They expressed relief as the marathon budget session ended. Some even applauded. "This morning represents the longest state senate session in history, 45-and-a-half hours," said Darrell Steinberg, the Democratic state senate leader. "Given the end result, I think it was worth every long hour."

Along with Mr. Maldonado, two other Republican senators and three GOP assembly members were expected to break party lines to join Democratic lawmakers, who were expected to unanimously back the budget package. Mr. Schwarzenegger would likely sign the budget by the weekend, opening the way for officials to restart construction projects and send tax refunds that had been delayed to keep the state from running out of cash. The budget calls for California to generate up to $13 billion in revenue by raising sales taxes one percentage point and adding a surcharge on state income taxes, among other steps. One feature represents a remarkable capitulation for Mr. Schwarzenegger: an increase in the vehicle-license fee from 0.65% to 1.15%. The governor won his post in 2003 after campaigning to cut back the so-called car tax, which he did soon after taking office.

The proposal calls for the state to slash $15 billion in spending, including $8.6 billion from education. To save $1.4 billion from payroll costs, the government will eliminate two state holidays, change overtime rules and furlough workers at least one day a month. The remaining deficit was to be closed mostly through borrowing or with money from a federal-stimulus package. The spending plan also includes $700 million in tax breaks for large corporations. Voters later this year will have to approve some aspects of the plan, such as a spending cap. The proposed budget outlines spending for the next 17 months. Some of the taxes and cuts will go into effect almost immediately, while others will begin July 1. The original budget proposal -- a set of nearly 30 bills -- was hammered out in closed-door negotiations by Gov. Schwarzenegger and the four majority and minority legislative leaders.

The changes made after negotiations with Mr. Maldonado include measures calling for the state to hold open primary elections and to stop pay raises for lawmakers in years the state faces a budget shortfall. Both reforms would have to be approved by voters, however. Legislative leaders also agreed to strip out the gas-tax increase. "We really needed to reform the way we do business in California," Mr. Maldonado said, "and if we have good reforms in place, hopefully we'll never be in this situation again." With the budget proposal close to passing, Mr. Schwarzenegger must now turn his attention to revitalizing a state economy slammed by the housing-market crash, the national recession and growing unemployment. He must also repair frayed relationships with legislators, with whom he had earlier success in what he called a "post-partisan" era -- an era that collapsed along with the economy and the budget impasse.

The budget approval seemed doubtful many times through an extraordinary five days of legislative sessions. Lawmakers entered their chambers at 8:30 p.m. Saturday, only to adjourn 24 hours later without a vote after it became clear that only two of the needed three Republicans in the state senate had committed to approving the spending plan with the Democratic majority. Mr. Steinberg, the state senate leader, pushed the vote to Monday, then to Tuesday and finally started the vote just before 1 a.m. Wednesday morning. He vowed to force his colleagues to remain in the statehouse until they passed a budget. "Bring a toothbrush," he said the night before. While the senate was at an impasse, the assembly was poised all along to pass the spending plan with bipartisan support, leaving Mr. Schwarzenegger and senate leaders to scramble for the final senate vote. But Republican senators continued to hold out against voting for a spending plan that raised taxes.

On Wednesday night, Mr. Schwarzenegger and Democratic lawmakers finally persuaded 41-year-old Mr. Maldonado, a broccoli-and-cauliflower farmer from Santa Maria, to become the 27th and final 'aye' vote needed to pass the proposal in exchange for the concessions. Even before it passed, the budget drew almost universal criticism in California, which, with 37 million residents and a gross state product of $1.6 trillion, is the nation's most-populous state and is the equivalent of the world's eighth-largest economy by some measures. "Certain elements of this [budget] will exacerbate future challenges, rather than minimize them, and will make it harder for California to have a healthy economy," said Jean Ross, executive director of the nonpartisan California Budget Project. Labor unions blasted the compensation cutbacks. Taxpayers associations decried new levies in one of the country's highest-taxed states. And economists said the cuts and taxes will exacerbate the woes of a state facing rising unemployment and foreclosure rates.

Even lawmakers and other government leaders said they despised much of the budget, calling it a flawed compromise. But with the state nearly out of cash, legislators said they needed to pass a spending plan immediately so the state wouldn't have to issue IOUs for tax refunds and other payments. Though dissatisfied with the approved budget, weary lawmakers expressed relief that the often-testy three-month impasse was near its end. The struggle began in early November, when Mr. Schwarzenegger declared a fiscal emergency after it became clear that the recession was shrinking the state's tax revenues. But he and state lawmakers got tangled in a three-way clash over ways to balance a budget projected to have a $42 billion shortfall by July 2010. Democratic legislators wanted new taxes and moderate cuts, Republican lawmakers wanted deep cuts and no new taxes, while the moderate Republican governor wanted a combination of the two approaches.

The state bled cash as the stalemate dragged on. With the state projected to run out of cash in February, state leaders froze funding for $18 billion in public-works projects and delayed $3 billion in tax refunds, welfare checks and other payments. The governor this month implemented furloughs and began the process for laying off 10,000 workers over several months. Meanwhile, Standard and Poor's Corp. cut the California's credit rating to the lowest among 50 states. Shut out of Wall Street, the state treasurer looked for creative funding alternatives, eventually negotiating an unprecedented deal to sell $200 million in bonds to a municipal agency. The stalemate even threatened to cost California a chunk of the $26 billion it was expected to receive from the federal stimulus package President Barack Obama signed Tuesday. U.S. Sen. Barbara Boxer met Wednesday with state legislators, warning them that California could lose $5.8 billion in stimulus money if it did not balance its budget soon.

Canada Slips on Oil's Slide
Last summer, when the price of oil neared $150 a barrel, Terrance Coles's family earth-removal business in this energy boomtown was pulling in revenue of more than $200,000 a month. These days, Mr. Coles, who abandoned a failing seafood business in Newfoundland to join the oil rush here, is out of work, sleeping at the home of a cousin. The Canadian economy, like Mr. Coles, has been blindsided by plummeting oil prices. The nation has ratcheted up its dependence on oil revenue, more than doubling its crude-oil exports over the past four years. Now, the oil bust is pushing it into a deeper recession than many economists had expected.

On Thursday, President Barack Obama will visit Ottawa in his first trip abroad as president. Because Canada has become the biggest supplier of crude oil to the U.S., energy policy is expected to be high on the agenda in his meeting with Canadian Prime Minister Stephen Harper. Economic problems in the U.S. have always been keenly felt in Canada. But until last fall, Canada looked positioned to weather the storm better than its southern neighbor. Low corporate and consumer debt levels, no subprime-mortgage crisis, and surpluses in the federal budget and trade balance placed it on sounder footing. Economists expected slower growth but no recession.

The ills infecting this northeastern Alberta town, which sits atop the world's second-largest oil reserve behind Saudi Arabia, are now spreading across broad swaths of the Canadian economy. In recent months, oil companies have shelved investment plans worth close to 50 billion Canadian dollars (US$39.8 billion), according to the Oil Sands Developers Group, an industry association. "This is going to have a big impact right across Canada," says Ryan Kubik, the chief financial officer of Canadian Oil Sands Ltd., the largest investor in a consortium of oil companies called Syncrude Canada Ltd. "These are huge dollars not being spent." Oil-patch spending has a big multiplier effect, and boosted sectors such as construction and heavy equipment at a time when the nation's manufacturing industry was steadily shedding jobs. "Most of Canada doesn't identify itself with oil," says Jacques Marcil, an economist with the Canada West Foundation, a Calgary think tank. "But without really realizing it, it now relies on it."

 President Obama has been under pressure from environmentalists not to veer from campaign pledges to reduce U.S. oil consumption and to tackle the problem of climate change. The oil patch here in Alberta, known as oil sands, produces crude oil from a tarlike substance called bitumen in a process that emits more greenhouse gases than conventional drilling. To be sure, oil prices aren't Canada's only economic problem. Deep troubles in the U.S. auto industry have crippled manufacturing in southern Ontario, home to many auto plants and parts makers. The U.S. housing bust has hit the timber industry, once one of Canada's biggest businesses. Canadian forestry exports have fallen by a quarter from two years ago, and now amount to about one-fifth of energy exports.

The weaker demand for all Canadian exports, particularly from the U.S., tipped Canada's trade balance into deficit in December for the first time since the mid-1970s.
In January, unemployment rose by 129,000, the biggest one-month increase in years, pushing the jobless rate to 7.2%. Economists now expect the Canadian economy to contract by about 1.1% this year, a downward revision of earlier forecasts of 1.8% growth. To confront the downturn, the Canadian government last month unveiled a stimulus plan expected to cost C$39 billion over two years, producing a federal budget deficit for the first time in more than a decade.

The oil patch around Fort McMurray and two other patches nearby cover an area of boreal forest about the size of Florida. The fields account for 1.3 million barrels of crude oil a day, more than half of Canada's total production. Canada's crude-oil exports, in dollar terms, now rival those of its automotive sector, centered in Ontario, the traditional backbone of its manufacturing sector. The existence of bitumen around Fort McMurray has been known since at least the 19th century. Early last century, prospectors tried to market it for paving roads. In the late 1960s and early 1970s, Canadian oil companies, led by those now called Suncor Energy Inc. and Syncrude, began developing open-pit mines to extract it. Yet despite the huge scale of the reserve, the global energy sector paid relatively little notice due to the high cost of producing petroleum from the sands. With the price of oil dropping to as low as $10.72 a barrel in 1998, the investment wasn't worthwhile. Then the game changed.

Advances in technology, including improvements in extracting bitumen using steam, made the process more efficient. The availability of easy credit fueled ever bigger investments. The Iraq war, coupled with the unpredictability of Hugo Chávez's Venezuela, made reserves in a politically stable country like Canada more attractive. And as the global economy boomed, the price of oil soared, more than covering the costs of production. Major oil companies from around the world, along with big Canadian firms, poured money into the oil sands. Annual spending, including both new construction and the expenses to operate the huge sites, nearly quintupled to a planned $34.6 billion in 2008, from $7 billion in 2003, according to the Oil Sands Developers Group. Those flows contributed to a stronger Canadian dollar, which in turn crimped manufacturing exports by making them more expensive to the U.S. and other countries.

Since 2000, the Canadian economy "has evolved from the manufacturing sector of Ontario to the oil fields of Alberta," says Jeffrey Rubin, chief economist with CIBC World Markets, in Toronto. The stronger Canadian dollar "only accelerated the de-industrialization of Canada -- it fed on itself." The westward shift in economic power is also evident in the country's "equalization" program, which requires richer provinces to subsidize poorer ones to ensure a relative equality in public services across the country. Ontario, traditionally the economic engine of the country, for the first time in memory will soon receive more assistance from the program than it pays into it. Alberta, home to about 75% of the oil sector, now pays more into the program, on a per capita basis, than any other province. The boom in the oil patch created tens of thousands of jobs. Unemployed workers flooded into Alberta from the economically ailing Atlantic provinces.

Mr. Coles, who is 56 years old, and his two sons gave up their family seafood business in Newfoundland six years ago and headed for Fort McMurray. Mr. Coles began driving trucks for oil companies, and eventually he and his sons started a business removing dirt for them. As the oil sector boomed, the business thrived. His two sons bought new pickup trucks and snowmobiles. One splurged on a Corvette. Over the past decade, the population of the town, nicknamed "Fort McMoney," doubled to 66,000. Because of traffic snarls, it begin building a five-lane bridge over the Athabasca River, next to two existing bridges. Early each morning, long lines of pickup trucks would form at the two Tim Horton's doughnut shops, a popular Canadian chain. The wait could last an hour. Blair Macnab, 44, moved with his family 400 miles from Valleyview, Alberta, to take over a tire and auto repair business. He more than doubled the staff to 21 workers, but he still needed his crew to work late into evenings.

Home prices soared, rivaling those in Toronto. Few single-family homes were available for less than about $500,000. Average wages were among the highest in the country. Mark Plewes, 43, moved 2,200 miles from his home in Barrie, Ontario, to install phone and Internet service in new homes. Regular telecommunications work is scarce in Ontario. So he works for three weeks straight in Fort McMurray, returns to his wife and three kids for a week, then commutes back -- a pattern followed by thousands of other migrants. Last fall, as economic problems multiplied in the U.S. and elsewhere in Canada, Alberta's oil-and-gas industry briefly remained a bright spot. Then the bottom dropped out of the oil market, as the global downturn suppressed demand. Tightening credit compounded the problem. Almost overnight, oil companies started postponing investment plans.

For Mr. Coles, the timing couldn't have been worse. After tensions with his sons forced him out of the family excavation business, he began working in October for a large construction company in town, driving a truck hauling bitumen. In November, Petro-Canada Oil Sands Inc., a Canadian oil company, announced it was delaying investment on the site where Mr. Coles was working. He was laid off, along with hundreds of others. He's had no luck finding another job. "They're not hiring now," said Mr. Coles one recent evening, nursing a beer at a bar catering to Newfoundlanders. Like many others from the hard-luck province, Mr. Coles is considering moving back. "It's been rough." Mr. Macnab says his tire shop began feeling the effects a few weeks ago. He told his staff recently they'd have to work fewer hours. Instead of buying new tools and other things needed around the shop, they're repairing what they have. In the past few months, thieves have broken in three times, on one occasion stealing 80 tires, he says.

"All of a sudden the conversation changed" from talk about big paychecks to talk about break-ins, he said one recent afternoon at his shop. "We're hearing more about these shady things now." Mr. Plewes, the telecom worker, says he is doing about half as many installations a day as in the fall, due to the slowdown in housing construction. Two members of the nine-person team recently were laid off. Rick George, the chief executive of Calgary-based Suncor, which in January postponed site-expansion work worth C$14 billion, estimates that 35,000 temporary workers employed around the Fort McMurray oil sands will be reduced to fewer than 10,000 by the end of the year. Given how frenetic the boom was, he says, "we needed a correction. What we didn't need is a collapse in the banking system and the world economy to get it."

Many workers are now returning home to the four provinces on the Atlantic coast, taking their chances there. Close to 12,000 a year left that area for the oil sands in 2006 and 2007; migration shrank to 1,700 last year, and now appears shifting the other way, according to the Atlantic Provinces Economic Council. For the first time in years, some vacant houses are languishing on the market in Fort McMurray. "What's difficult to get across to Canadians is that when the economy slows enough to [result in] a $37 barrel of oil, everybody suffers," Alberta Premier Ed Stelmach said last month. On Wednesday, U.S. benchmark crude closed at $34.62 a barrel on the New York Mercantile Exchange. In their meeting in Ottawa on Thursday, President Obama and Prime Minister Harper will discuss energy issues. Given the size of the oil patch around Fort McMurray, it is expected to be critical to the Canadian and U.S. economies for years to come.

But environmental concerns about the oil sands are likely to complicate matters. The traditional method of extracting the bitumen from the dirt involves large open-pit mines that scar the land. Removing the bitumen and turning it into oil requires lots of energy and water, producing three times the greenhouse gas of conventional oil drilling. Messrs. Obama and Harper are expected to search for common ground on the environmental issues, weighing the economic benefits of the oil sands against its environmental costs. Both sides have signaled interest in a so-called cap-and-trade emissions system, where companies can buy and sell permits for the greenhouse gases they emit. Many oil executives predict prices to rebound before the end of the year, which would reignite expansion plans. But that might not be soon enough for Mr. Plewes, the telecom worker, who says the slowdown in Fort McMurray makes it less worthwhile for him to be away from his family in Ontario.
"Ontario doesn't look any better right now," he says. "But the chances are very good I'm moving back."

Euro Strengthens on Speculation Germany May Act to Counter Regional Crisis
The euro rose from near the lowest level against the dollar in three months on speculation German Chancellor Angela Merkel will signal Europe’s largest economy plans to help ease financial turmoil in the region. The 16-nation currency gained for the first time in four days as Goldman Sachs Group Inc. said the euro will rebound to $1.35 on the outlook for a European bailout. The dollar and yen tumbled more than 2 percent versus the Norwegian krone, Swedish krona and Australian dollar as demand for the greenback as a haven diminished. "The euro suffered in the last few days as the market was concerned about western Europe’s exposure to eastern European countries," said Meg Browne, a currency strategist at Brown Brothers Harriman & Co. in New York. "Now the Europeans are working on a solution. Euro-positive sentiment can carry on."

Europe’s currency rose as much as 1.6 percent to $1.2754, its biggest intraday gain in almost two weeks, before trading at $1.2742 at 9:18 a.m. in New York. It touched $1.2513 yesterday, the lowest level since Nov. 21. Europe’s currency increased 1.5 percent to 119.23 yen from 117.50 today. The dollar rose above 94 yen for the first time since Jan. 7, gaining momentum after breaking the 100-day moving average. It traded at 94.27 yen, compared with 93.79 yesterday. Poland’s zloty strengthened 2.3 percent to 4.6692 per euro and Czech’s koruna advanced 1.2 percent to 28.61 on the outlook for German aid. The koruna touched 29.68 on Feb. 17, the weakest level since October 2005, and the zloty declined as Moody’s Investors Service said it may cut the ratings of several banks with units in eastern Europe that are coming under "downward pressure."

The euro tumbled 1.7 percent against the dollar two days ago as the Moody’s report raised concern financial turmoil in eastern Europe may slow growth in the countries that use the currency. German Finance Minister Peer Steinbrueck told reporters yesterday in Berlin that "we would show our ability to act" should countries in the euro region face problems and speculation on a potential breakup of the euro region "is absolutely absurd." Merkel’s Cabinet approved yesterday draft legislation allowing the state to take over lender Hypo Real Estate Holding AG, paving the way for the first German bank nationalization since the 1930s. Merkel will hold a joint press conference with European Commission President Jose Barroso today in Berlin.

"Germany is finally waking up to the reality that if they want to preserve that project which is the euro, then they’ll have to open up their own purse strings and help their neighbors," said Geoffrey Yu, a strategist in London at UBS AG, the world’s second-biggest foreign-exchange trader. "That helped to lift the euro after its recent underperformance." Investors should buy the euro because the EU may bail out member states in financial difficulties, reducing the chance of countries leaving the single currency, Goldman Sachs said. There is "reduced Economic and Monetary Union breakup probability," analysts led by Thomas Stolper in London said in a note today.

The German government also plans changes to insolvency rules that would improve chances of rescuing troubled banks and non-financial companies, the Financial Times Deutschland reported, citing government officials it didn’t name. The U.S. dollar fell 3.1 percent to 6.8324 kroner and dropped 2.4 percent to 8.5730 Swedish kronar on speculation efforts by policy makers’ efforts to revive growth may reduce demand for the dollar as a haven. The Bank of Japan said it will buy corporate bonds for the first time, widening its asset-purchase program to prevent a shortage of credit from deepening the recession. The ICE’s Dollar Index, which tracks the U.S. currency versus the euro, yen, pound, Canadian dollar, Swedish krona and Swiss franc, fell 1.1 percent to 87.321 today.

The eurozone needs a government bond market
by George Soros

The euro suffers from certain structural deficiencies; it has a central bank but it does not have a central treasury and the supervision of the banking system is left to national authorities. These defects are increasingly making their influence felt, aggravating the financial crisis. The process began in earnest after the failure of Lehman Brothers when, on October 12 , the European finance ministers found it necessary to reassure the public that no other systemically important financial institution would be allowed to fail. In the absence of a central treasury, the task fell to the national authorities. This arrangement created an immediate and severe financial crisis in new European Union member states that have not yet joined the euro and eventually it also heightened tensions within the eurozone. Most of the credit in the new member states is provided by eurozone banks and most household debt is denominated in foreign currencies. As the eurozone banks sought the protection of their home countries by repatriating their capital, east European currencies and bond markets came under pressure, their economies sagged and the ability of households to service their debts diminished. Banks with large exposure to eastern Europe found their balance sheets impaired.

The capacity of individual member states to protect their banks came into question and the interest rate spread between different government bonds began to widen alarmingly. Moreover, national regulators, in their efforts to protect their banks, were unwittingly engaging in beggar-thy-neighbour policies. All this is contributing to internal tensions. At the same time, the unfolding financial crisis has convincingly demonstrated the advantages of a common currency. Without it, some members of the eurozone might have found themselves in the same difficulties as the countries of eastern Europe. As it is, Greece is hurting less than Denmark, although its fundamentals are much worse. The euro may be under stress but it is here to stay.

The weaker members will certainly cling to it; if there is any danger, it comes from its strongest member, Germany. Germany is at odds with most of the world in its attitude to the current financial crisis but it is easy to understand why. It has been traumatised by its history during the 1930s when runaway inflation in the Weimar republic led to the rise of Hitler. While the rest of the world recognises that the way to counteract the collapse of credit is by expanding the monetary base, Germany remains opposed to any policy that might carry the seeds of eventual inflation. Moreover, while Germany has been a steadfast supporter of European integration, it is understandably reluctant to become the deep pocket that finances bail-outs in the eurozone.

Yet the situation cries out for institutional reform and Germany would benefit from it just as much as the others. Creating a eurozone government bond market would bring immediate benefits in addition to correcting a structural deficiency. For one thing, it would lend credence to the rescue of the banking system and allow additional support to the newer and more vulnerable members of the EU. For another, it would serve as a financing mechanism for co-ordinated counter-cyclical fiscal policies. Properly structured, it would relieve Germany’s anxiety about other countries picking its pocket. The eurozone bond and bill markets would complement but not replace the existing government bond markets of individual states. They would be under the control of eurozone finance ministers. The regulation of the financial system would then be put in the hands of the European Central Bank while the task of guaranteeing and, when necessary, rescuing financial institutions would fall to the finance ministers. This would produce a unified and well supported financial system within the eurozone. Even the UK, which is struggling with an oversized and undercapitalised banking system, may be tempted to join.

Eurozone bonds could be used to assist the new EU member countries that do not yet belong to the eurozone. They could also serve to increase the lending capacity of the EU beyond the current mandates of the European Investment Bank and European Bank for Reconstruction and Development. The EU could then finance investment programmes that combine a counter-cyclical function with important European objectives such as an electricity grid, a network of gas and oil pipelines, alternative energy investments and employment-creating public works in Ukraine. All these investments would help break Russia’s stranglehold over Europe. The objection that they would take too long to serve a counter-cyclical purpose can be rejected on the grounds that the recession is also liable to last a long time.

Two thorny issues would need to be resolved – one is the allocation of the debt burden among member states and the other is the relative voting power of the different eurozone finance ministers. The existing precedents, namely the EU’s budget and the composition of the ECB, would be considered unfair and unacceptable by Germany. But many member states will balk at agreeing to a solution that changes the balance of power within the EU. Nevertheless some concessions would have to be made to bring Germany on board. Usually it takes a crisis to bring about a compromise but the crisis is now brewing and the sooner it is resolved the better.

EU Concerned as Countries Violate Deficit Rules
The European Commission on Wednesday released reports on the economic health of 17 member states. A number of them are in violation of the bloc's budget deficit rules. Brussels, though, is likely to show flexibility. The reports issued by the European Commission on Wednesday will hardly come as a surprise. In 2008, France, Greece, Spain, Ireland, Latvia and Malta were all in violation of bloc rules calling for budget deficits to remain lower than 3 percent of gross domestic product. Now, though, Brussels has to figure out what to do about it. The Commission will likely show a certain degree of tolerance given the expensive economic stimulus packages passed by a number of member states.

"The Commission will use the full flexibility imbedded in (EU rules) when considering the next steps under the excessive deficit procedure in the weeks to come," said Economic and Monetary Affairs Commissioner Joaquín Almunia in a statement on Wednesday. While Almunia was careful to emphasize that the stability pact was crucial for sound EU finances "once the recession is over and growth resumes," the report made it clear that, for the six countries now in violation, lower budget deficits might be a ways off. Ireland, in particular, is expected to emerge from 2009 with a bloated deficit shortfall equivalent to 9.5 percent of GDP. The report forecast a 5.8 percent deficit for Spain and 4.4 percent for France.

The report did not provide a forecast for Germany, but Berlin expects its deficit for 2009 to only slightly exceed the 3 percent cutoff, if at all. Many had been expecting an increased number of violations of European budget deficit rules given the strength of the current economic downturn. Country's across the 27-member EU have passed hefty bank bailout bills and expensive economic stimulus plans. So far, no changes have been made to the budgetary rules, sometimes referred to as the "Maastricht Criteria," but deadlines set for countries to come back into compliance will likely be looser than they have been in the past. European budget rules are primarily aimed at keeping the euro -- the common currency used by 16 EU member states -- stable.

In recent years, the euro has done well against the dollar, soaring to almost $1.60 per euro last summer. Recently, though, it has been dragged down as a number of national economies in Europe -- along with the European economy as a whole -- have gone into recession. More trouble may be on the horizon. A number of countries in Europe, including some euro-zone economies, are struggling to meet their debt obligations. Confidence in the region could be further eroded as countries in eastern and southeastern Europe continue to be battered by the financial crisis. Many governments across the region have taken steps this week to defend their currencies against precipitous falls. On Wednesday, Almunia said that the Commission was watching developments across the EU.

"I am concerned about the volatility of the exchange rate in EU countries with floating regimes," he said, referring to those currencies not yet pegged to the euro. "I am also concerned by the possibility that some public statements have accelerated this evolution." In all, the European Commission issued reports on the economic health of 17 member states on Wednesday. "We are going through a very serious crisis that is taking its toll on public finances," Almunia said in a statement. He did, however, sound a positive note, saying that he still expects the European economy to show some recovery in 2010. The report is an annual assessment. It has attracted more attention than usual given the dire state of finances in many EU member states.

EU fights plan to ring-fence British banks' toxic assets
The government's multi-billion pound insurance scheme to ring-fence British banks' toxic assets and reboot lending to the recession-hit economy has run into a wall of opposition in the EU, the Guardian has learned. The European commission and several leading EU countries are understood to have objected that the UK proposals are a serious threat to competition and to the much-prized single market. The commission is due to publish final guidance on how to treat their toxic or impaired assets next Wednesday. It is understood to be insisting that the UK Treasury impose a hefty premium on the banks benefiting from the insurance. Royal Bank of Scotland, soon to be 70% owned by the British taxpayer, is the guinea pig for the scheme which is regarded as vital in ring-fencing an estimated £150bn of toxic assets on its balance sheet.

Details of the scheme are yet to be finalised, but there are expectations of a government announcement when RBS publishes its 2008 figures - expected to show a £28bn loss - next Thursday . Analysts at Credit Suisse have assumed that RBS and other banks signing up to the insurance scheme would pay an annual fee of 3% and might not have to pay in the first year of what might be a three- to five-year arrangement. The government has made it clear that RBS would not have to find the cash - which would indicate annual payments of £4.5bn - but could pay in other ways. The Credit Suisse analysts suggest that RBS, which has received £20bn of government funds, could pay using deferred tax assets or issue subordinated debt or other bonds to prevent the government's stake from rising any higher. RBS shares closed last night at 18.1p down 12.5%.

Brussels is also determined to force Britain to shrink the business of its state-owned or semi-nationalised banks through restructuring schemes as the eventual price for approving the scheme. Last autumn Neelie Kroes, the EU competition commissioner, and colleagues imposed at least 10 conditions, including stiff charges and a ban on dividends, for sanctioning the government's £250bn bank recapitalisation scheme. Kroes's department is now taking the same approach in negotiations with Whitehall. Brussels is also considering forcing France to raise the 6% premium on its €6bn (£5.3bn) loans to its two biggest carmakers. Renault and PSA Peugeot Citroën.

Britain has been at the forefront of EU countries pressing for early approval on how to define, evaluate and treat toxic assets said to amount trillions of euros in Europe. Other countries urging a rapid solution in the run-up to an emergency EU summit in Brussels on 1 March are Holland, whose biggest bank ING declared a €3.7bn loss in the final quarter of 2008 yesterday, and Germany, where the cabinet approved legislation to take banks under full state control. Britain pressed to be allowed to go ahead with its scheme at last week's meeting of EU finance ministers.

Subsequent talks at the EU's economic and financial committee, chaired by senior commission officials and embracing senior treasury officials from all 27 countries, have failed to resolve serious differences, according to insiders. Countries whose banks are less exposed to toxic assets are mounting the fiercest resistance to the insurance schemes, they added. The Treasury has yet to submit its proposed insurance scheme, amid suggestions that it is waiting for the commission to issue its final guidance next week. It said yesterday: "The government has worked very closely with the EU commission on support for financial institutions in the UK and will continue to do so. There will be further announcements relating to the detail of the asset protection scheme by the end of the month."

Zoellick urges EU to help east Europe
Robert Zoellick, World Bank president, has called for European Union-led co-ordinated global support for the economies of central and eastern Europe, even as divisions emerge in the EU over handling the crisis. Speaking to the Financial Times amid turmoil in central and east European markets yesterday, Mr Zoellick said the bank was trying to work with the International Monetary Fund and other multilateral institutions to help the region but needed more backing from Brussels.

"It’s got to have support from the European governments," he said. "It’s 20 years after Europe was united in 1989 – what a tragedy if you allow Europe to split again." Mr Zoellick’s appeal came as he outlined the World Bank’s ambition to restore some health to trade finance in time for the G20 summit of leading and emerging economies in April. He hoped the World Bank, governments and banks could come together to finance a $25bn facility for trade finance, where the bank would accept the most risky part of the loans.

Mr Zoellick’s comments follow calls for region-wide international action made recently by Austria, the west European country with the greatest exposure to eastern Europe, Hungary and some other east European states. But the European Commission said that while it was co-operating with the World Bank and other partners, it preferred a country-by-country approach. Joaquín Almunia, EU monetary affairs commissioner, said the commission felt it would be inappropriate to devise one solution for the region’s problems because the countries fell into different categories, with some being EU members and some not.

Mr Almunia also warned east European leaders in countries with floating exchange rates not to make public statements about their currencies, for fear of making markets more nervous. He mentioned no one in particular, but Donald Tusk, Poland’s premier, took the unusual step on Tuesday of saying his government might defend the zloty if it fell to five against the euro. Mr Almunia said: "I am concerned about the volatility of exchange rates in countries with floating currency regimes. I’m concerned that some public statements have accelerated this evolution. I would ask all the authorities to be careful when they make public statements, because the markets are very nervous and sometimes they don’t understand very well some of the statements."

However, east European leaders reinforced their calls for stronger EU-led region-wide action. Andrius Kubilius, Lithuania’s premier, told the FT: "It would be good to see a more co-ordinated approach from the EU authorities." Ferenc Gyurcsany, Hungary’s leader, urged central and east European government to jointly support Austria’s proposals for an EU bank package.

Ukraine must be rescued from tragi-comedy for Europe's sake
Ukraine is degenerating into tragi-comedy. The president and premier are at daggers drawn. The finance minister has resigned in disgust, no longer willing to serve as a "political pawn" in a government that tears up its agreements. The IMF has stormed off, refusing to disburse the next tranche of its $16.4bn (£11.5bn) rescue loan. Kiev's leaders are winking at Russia, hoping that this sort of geo-strategic blackmail will force the West to open its purse strings. Meanwhile gross domestic product has contracted by 20pc over the last year, apparently worse than early Bolshevism or the Stalin famine. It would be tempting to leave this misgoverned country to its fate. That would be an error.

If Ukraine defaults on its foreign debt – or lets its private companies default on their dollar and euro loans – it will lead to near instant contagion through much of Eastern Europe. The currency pegs of the Baltics and Balkan are already under strain. Romania needs an IMF bail-out. Poland's zloty is being used as a proxy instrument by hedge funds to bet against the whole region, causing mayhem in the process. What we are seeing is a vicious circle where falling currencies are ratcheting up the real burden of East Europe's $1.74 trillion foreign debt, which in turn leads to more capital flight. Some $400bn must be rolled over this year – an impossible challenge.

Unless this poisonous dynamic is stopped by outside help from the IMF, the European Central Bank, and the leading political powers of the EU, we risk a full-fledged meltdown. This will not remain on the East side of the old Warsaw Pact/Nato line. West Europe's banks are an integral part of the lending debacle. It was they that provided all this debt in euros, dollars, and Swiss francs. In the case of Austria, Sweden, and perhaps Switzerland and Belgium, their exposure puts the broader banking system at risk. This cannot be allowed to run its course. The European Central Bank is going to have to put a clothes peg over its nose and use its printing powers to rescue the region. If it resists for ideological reasons, history will hold its governors to account.

EU mulls action as Ukraine crumble triggers contagion fears for Europe
Europe's institutions are scrambling for ways to prevent financial contagion from Ukraine and the rest of Eastern Europe from setting off a full-blown banking crisis in Austria, with risks of systemic contagion across the eurozone. Joaquin Almunia, EU's economic commissioner, said Brussels is ready to co-ordinate a pan-EU response to contain the crisis before matters get out of hand. "I share with the Austrian authorities their concern about the situation of these economies. Everybody shares their concern about the risks involved. We are extremely concerned about the difficulties with the Ukrainian government," he said. West European banks have lent roughly $1.6 trillion (£1.13 trillion) to the region, led by Austrian, Swedish, Italian, Greek, Belgian, and Swiss banks. Almost $400bn must be rolled over this year in hostile markets. Lithuania's president Andrius Kubilius echoed the warnings on Wednesday.

"We are worried about what can happen in Ukraine and Russia. The collapse of one of these markets would have a very negative impact. It would be good to see a more co-ordinated approach," he told the Financial Times. Ukraine's travails appear to be snowballing out of control after the central bank said the economy contracted 20pc in January year-on-year, with a dramatic 34pc slide in industrial production. Valery Lytvytsky, the bank's top adviser, said the collapse is the worst in recorded Ukrainian history, exceeding the darkest days after the Bolshevik revolution. The currency has fallen 40pc since the crisis began, a crippling blow to companies with large debts in dollars or euros. Three banks have failed.

Credit default swaps measuring risk on Ukraine's state debt rose to panic levels of 3,500 on rumours of imminent default following the refusal of the International Monetary Fund to disburse the second tranche of its $16.4bn rescue package. The IMF said the government had failed to rein in public spending as agreed. Premier Yulia Tymoshenko insisted there was no danger of default. "I would like to tell the whole country that the state is paying all its credits," she said. She appeared unrepentant over the loss of her finance minister, Viktor Pynzenyk, who resigned this week saying he was no longer willing to serve as a political pawn. "Not all government officials are capable of working in difficult circumstances.

The weakest ones abandon the battlefield," she said, in comments bordering on political farce. Neil Shearing from Capital Economics said Eastern Europe as a whole is likely to contract by 5pc to 10pc this year. "It's pretty grim and it creates the risk of a retreat into populism," he said. The political risks in Ukraine are huge. The country has a large Russian minority, much of it living in oblasts near Russia's frontier, creating an open door for the Kremlin to intervene if the crisis leads to civil disorder. Lars Christensen from Danske Bank said ex-Soviet bloc had been a casualty of the blanket extension of guarantees to banks across Western Europe. "East Europe's governments are not strong enough to offer such guarantees for their own banks. This has increased relative risk." he said. The European Bank for Reconstruction and Development said it is mulling $500m in aid to boost Ukraine's banks, but first the country has to restore credibility. "We see an urgent need for conducive, comprehensive actions by the Ukrainian authorities," EBRD chief Thomas Mirow said.

UK overshoots borrowing target
The public finances took a sharp turn for the worse in the crucial month of January as the recession and credit crisis hit corporate and personal tax revenues, making it almost impossible for the government to meet its borrowing target made in late November. In his autumn pre-Budget report, Alistair Darling, chancellor of the exchequer, forecast government borrowing of £77.6bn in the 2008-09 financial year, a sharp deterioration on the £35bn outturn for 2007-08. But in the 12 months to the end of January 2009, tax revenues have been so weak that borrowing has already exceeded the pre-Budget report forecast and reached £79.3bn. For the past two months, the degree to which the government’s finances have been in deficit over the most recent year of data has deteriorated by £10bn a month. With the public finances falling much more deeply into the red than the Treasury expected, its forecast for a deficit of £118bn or 8 per cent of national income now appears all but impossible to meet.

The consensus among independent forecasters, who have tended to be slow at realising the depth of public borrowing, is for the deficit to reach almost £130bn in 2008-09 with no improvement in 2010-11. Sterling showed little reaction to the public finances data, instead rallying strongly against the dollar and the yen as it continued to track the fortunes of UK financial stocks. As banking stocks rallied, the pound rose 1.2 per cent to $1.4384 against the dollar and gained 1.1 per cent to Y134.72 against the yen. The pound eased 0.1 per cent to £0.8828 against the euro, however. January’s public finance figures are the most important of the year because they include the proceeds from self-assessment of income tax, financial sector profits and January bonuses. All three were weak this year leading to the worst January public sector net borrowing in the month since 1994-95, a year that preceded the introduction of self-assessment in 1996-97.

Because January is such an important month for tax revenues, public sector net borrowing still showed a surplus in the month of £3.3bn, but that was down from £13.9bn in January 2008. Financial markets had expected a much bigger surplus of £7bn. The main cause of the government needing to borrow more than expected is weak tax revenue. Total receipts in the first 10 months of the financial year are £10bn lower than in the same period of 2007-08, while the chancellor’s forecast for the entire year is a drop of only £2bn. Value added tax is lower, as expected, because of the temporary reduction from 17.5 per cent to 15 per cent. The big problems, however, are in income tax and corporation tax revenues where lower profits and bonuses have hit receipts hard. Income tax revenue in January was £1bn lower than a year ago, while corporation tax was down £2.4bn.

In the official figures, the Office for National Statistics also announced it had decided that such is the government’s control over the Lloyds Banking Group that it would classify the company as a public corporation, joining Royal Bank of Scotland, Northern Rock and Bradford & Bingley as British banks with this status. But because statisticians did not have time to work through all the implications of the move, the ONS only partially reflected the changes in the figures for government financing and debt. This led to the incomplete outcome where the cash borrowed by government to finance the recapitalisation of RBS and Lloyds no longer counted in the monthly totals for government financing requirements, but the liabilities of the banks also do not yet appear on the government’s books. Once these liabilities are counted as public sector debt, it will cause the official level of net public debt to explode, potentially close to 150 per cent of national income, a figure economists believe is an exaggeration of the true reflection of taxpayers’ debts. But underlying public sector net debt is also likely to jump well above the projection of a 57 per cent of national income peak in the November pre-Budget report, a figure that at the time was seen already as placing a large burden on future generations.

Government stakes in RBS and Lloyds could add £1.5 trillion to UK national debt
The Government's stakes in Royal Bank of Scotland and Lloyds could add an extra £1.5 trillion to Britain's national debt, the equivalent of 100pc of gross domestic product (GDP), the Office for National Statistics said on Thursday. National debt is already at levels not seen since the late 1970's, hitting £703.4bn in January or 47.8pc of GDP, according to the ONS figures. ONS is calculating that the figure will raise to between £1 trillion and £1.5 trillion, or 70-100pc of GDP, once the banks' liabilities are transferred to the public sector balance sheet in due course. The public finances are being badly hit by the recession, as the Government raises spending at a time when tax receipts are diminishing. January is usually a good month for tax receipts, enabling the Government to pay back some of its borrowing.

However, last month the Government paid back just £3.3bn, compared with £13.9bn in the same month last year, as companies and individuals paid less tax on shrinking incomes. This was the lowest January surplus since 1995. The Government is also being forced pay out more in jobless benefits as unemployment rises during the recession, further exacerbating the problem. Government borrowing for the financial year to date now stands at £67.2bn, almost three times more than the £23.1bn of borrowing at the same point last year. Howard Archer, chief economist at IHS Global Insight, said: "The public finances for January are terrible, coming in even worse than feared. January always sees a surplus on the public finances at is a bumper month for tax receipts.

"Unfortunately though, bumper hardly describes the tax receipts for this January as they have been decimated by sharply contracting economic activity, declining profitability, rising unemployment, reduced bonus payments, December's VAT cut and substantially weakened housing market activity and prices." Economists said the ONS figures made Alistair Darling's projections for £118bn of borrowing in 2009/10 look unrealistic. "Spending will rise sharply over the coming months as unemployment surges, while the deep contraction in activity will continue to reduce tax revenues," said Andrew Goodwin, senior economic adviser to the Ernst & Young ITEM Club. "We expect the Chancellor to be forced to make significant upward revisions to his borrowing projections when he presents the Budget. ITEM expects Public Sector Net Borrowing to rise above £130bn in 2009/10."

UK tax-take to reveal depth of crisis
A dramatic deterioration in the public finances is expected to be revealed on Thursday morning as official figures show extremely weak tax revenues in the crucial month of January and lay bare the cost of the government’s capital injections into Britain’s banks. The Treasury is bracing for investor disappointment given expectations for a cash surplus of £16bn for January, only £9bn worse than the bumper receipts in the same month last year. But the government injected £17bn of capital into the Lloyds Banking Group alone last month, making those market predictions far too optimistic.

Stripping out one-off hits to the public purse, government revenues are also likely to be hit hard in January, since it is the month when income tax is traditionally boosted by bankers’ bonuses and corporation tax receives the fruits of financial sector profits. All of these tax receipts will reflect the credit crisis and the recession for the first time on Thursday. In the last few months of 2008, tax revenues started to fall dramatically below forecasts and the deterioration has been so rapid that the January figure for public sector net borrowing runs the risk of showing no surplus for the first time since comparable statistics were published in 1993.

Much of the distress in government financing stems from the banking crisis that has decimated profitability in the sector, which contributed 25 per cent of corporate tax revenues in recent years. But the partial nationalisation of some banks will also make a big difference to the government’s books. The Office for National Statistics is engaged in a process of assessing how much of the liabilities of these banks be counted as government debt. It has already decided that the Royal Bank of Scotland, Northern Rock and Bradford & Bingley are, in effect, public corporations because the government has significant control over their operations. It is likely to make a similar determination on Lloyds Banking Group in the near future.

When a bank goes on the government’s books all the liabilities count as public sector net debt, but complex accounting rules require the ONS only to net-off the banks’ most liquid assets. The result is that the headline level of public sector net debt is set to rise close to 250 per cent of national income – or £3,750bn – in coming months. Neither the Treasury nor outside experts believe this figure accurately reflects what British taxpayers really owe.

The Institute for Fiscal Studies has said in its Green Budget: "The focus for fiscal policy should be whether the public sector expects to make a profit or loss once these positions have been unwound." Ministers have yet to make an estimate of the likely ultimate liabilities but officials recognise it will not be zero. Goldman Sachs estimates the cost will be close to 8 per cent of national income – £120bn – while thinking within the International Monetary Fund suggests 13 per cent – just short of £200bn.

Sterling weakness does little to help exports
The weakness of the pound has so far done little to boost exports and manufacturers are reporting the lowest level of new orders in 17 years, the CBI said on Wednesday. The CBI's latest industrial trends survey showed that export orders continued to fall in February as global demand for goods slid, and a balance of -56pc of firms said that overall order book levels were below normal levels, up from -48pc in January. That represents the weakest demand for UK goods since January 1992. The balance represents the difference between the percentage of manufacturers reporting an increase and those reporting a decrease. The exports balance fell to -49pc this month from -39pc in January, the weakest since November 2001. It had been hoped that the depreciation of sterling, which has fallen by about 27pc against the dollar and 15pc against the euro over the past year, would provide a stimulus to exports by improving UK competitiveness. However, because the UK's key export markets, including the US and Europe, are also suffering from the global downturn, demand for goods there is also diminishing.

The figures from the CBI supported anecdotal evidence from the Bank of England's regional agents, also published yesterday, which showed that weaker overseas demand was more than offsetting the pound's weakness. "UK manufacturers continue to suffer as the recession worsens, and their order books have weakened further this month. The weak pound has made UK exports more competitive, but this advantage has been outweighed by falling global demand," said John Cridland, deputy director general at the CBI. "Moves to get credit flowing around the economy must bear fruit soon if job losses and further damage to the sector are to be mitigated." The majority of manufacturers were downbeat about the short-term future, with 56pc expecting their order books to shrink in the next three months, and just 12pc expecting them to rise. The survey also showed that manufacturing firms expect to lower the prices they charge in the domestic market over the next three months, evidence that inflationary pressures are receding as demand falls. Howard Archer, chief economist at IHS Global Insight said it was an indication that "substantially contracting demand and activity is biting hard into manufacturers' pricing power".

Asian container ports see alarming drop in throughput
Asian container ports are bracing themselves for a grim year ahead as they report alarming drops in volumes in January. Box throughput at Singapore, the world’s largest container port took a 19% dive in January this year to 2m teu compared to 2.4m teu for the first month of 2008.  Singapore’s sharp drop in volumes in particular reflect the collapse in the Asia- Europe trade where it is a key relay port transhipping exports from surrounding countries to Europe and the Middle East. The picture for world’s third busiest boxport, Hong Kong was even bleaker. 

Hong Kong, saw January throughput plunge 23% in January to 1.6m teu. Its flagship Kwai Tsing Terminals moved 1.2m teu, down 19% from the same month last year.  "We think February throughput remains challenging. Suspension of trade services, especially Asia-Europe, seems to have not ended at all as announcements had been accelerating. Lay-up had increased from 300,000 teu in first half of January to about 800,000 teu in the first week of February," said Daiwa Institute of Research analyst Geoffrey Cheng. 

At Malaysia’s largest port, Port Klang, the picture was not much better. Port Klang Authority general manager Lim Thean Shiang told local press that the port had seen a 16% drop in volumes in the first month of the year compared to January 2008.  A 10% drop in throughput was projected by Port Klang for 2009 as whole, having handled 7.8m teu last year.  The engine of world trade, China saw a very similar drop in throughput in January for its coastal container ports.  China’s Ministry of Transport said throughput of the country’s coastal ports has fallen for three consecutive months on a month-on-month term. China coastal ports handled 8.2m teu in January, down 15% from the same month last year and 10% from December. 

The country’s third largest port, Shenzhen, saw throughput fall by 18% to 1.5m teu in the first month of this year. The proportion of empty boxes at east Shenzhen’s Yantian port district has risen from 60% to 80%, according to the city government. Xiamen port, located in east China along the Taiwan Strait, is another port recorded double-digit decrease in January. The port handled 382,500 teu, down 10% from the same month last year.  The southern neighbour of Shanghai, Ningbo port, recorded a 9% drop in volume, to 798,000 teu. Ports that are so far immune from the downward movement are Qingdao and Dalian ports in northeastern China. Qingdao managed to move 852,000 teu while Dalian lifted 385,000 teu, up 2% and 6% respectively from the same month last year. 

Industry analysts said the dividing trends might due to the different types of cargoes being shipped through north and south Chinese ports. In tradition, provinces in the north mainly export machineries and raw materials while the southern provinces depend heavily on light industry and consumer products such as garment, toys and shoes which usually react quickly to economic downturn. The picture was equally grim for one of Southeast Asia largest exporters with the country’s trade minister Mari Pangestu forecast that its exports could fall by at least 20% this year. "Based on container flow for January-February, exports volume this year may decline by between 20%-30%. Non-oil and gas exports are expected to fall," Ms Pangestu said at the weekend. Exact throughput figures were not given. Much of Indonesia’s exports are transhipped via Singapore.

Russia braced for more challenges
Russia's transition from a centrally-planned economy to free market capitalism has not been smooth, and the global downturn is providing yet another challenge with jobs being lost and wage payments being delayed. President Medvedev recently indicated that he was not overly worried. "Our financial and economic situation is absolutely stable," he says, "We amended the budget - it's a budget with a budget deficit." "Nevertheless. using money from the reserve fund we'll be able to cover all our spending, including social spending and get through the most complicated period of the financial crisis."

The gap between what the government spends and what it earns - its budget deficit - is expected to rise sharply in 2009 to around $60bn (£42bn). Moscow's revenues are sharply down because the the price of oil has plummeted due to a drop in global demand. Oil prices are more than $100 a barrel below their peak in July 2008, whilst the rouble is now more than 50% below its record levels against the US dollar reached at the beginning of August. Russia's central bank has spent more than $200bn defending its currency, opting to devalue gradually by widening the rouble's trading band, instead of making a single big devaluation. "All the commodity currencies have devalued and the rouble is a laggard here," says Alexei Moisseev at Renaissance Capital.

"There is a real chance it will help, it is a real alternative to a big one-off devaluation." Butfund manager James Fenkner at Red Star Fund Management in Moscow, says the government should stop wasting precious reserves trying to prop up the rouble on the international money markets. "What the government needs to do is recognise it cannot hold back the tide," he says. "The oil price has come down dramatically but the rouble has not. The central bank has lost an enormous amount of foreign reserves and letting the rouble drop would address some of the imbalances," he maintains. In Vladivostock on the Pacific coast, Russian car importers demonstrated against tariffs on vehicles they bring in from Japan. Although a devalued rouble makes imported goods more expensive. Mr Fenker points out that the Russian people have already been paying a heavy price for the government's economic policies.

In the last six months, industrial production in Russia has plunged by 20%. Yegor Gaidar became prime minister just after the Soviet regime fell and is considered to be the architect of the modern Russian market economy. "The Russian economy is strongly dependent on the level of the oil price, gas price and metal prices," he says. He adds that after the crisis of 1998 the government created significant quantities of foreign currency reserves and is optimistic that Russia is well prepared to deal with its current problems. "When you have recessions in the world you have recoveries. That means commodity prices recover too," he says.

President Dmitri Medvedev has replaced four of the country's regional governors in a move thought to signal the Kremlin's concern that the economic slump could lead to social unrest. A senior aide to the president, Vladislav Surkov, said the global crisis had accentuated the evaluation of the governors' performance. President Medvedev had warned that he would not tolerate slackers or slovenliness. "We aren't going to close eyes on flaws in work and, simply speaking, ineptness, sloppiness and carelessness of some officials," Mr Medvedev told state television.

With electricity prices rising by 21% and heating 14%, and people being laid off or being told to take unpaid leave, there is concern that the social unrest experienced in Vladivostok could spread to Moscow. One commentator noted that although the latest budget will result in a deficit this year, there has not been any cut in the cost of funding the police or interior troops. That perhaps, is the clearest indication that the economical situation is not going to improve in the near future.

Bank of Japan to buy $11 billion in corporate bonds
The Bank of Japan on Thursday stepped up measures to help embattled companies weather the credit crisis, unveiling plans to buy up to Y1,000bn ($10.7bn) in corporate bonds and extend its purchases of other assets in an acknowledgement that Japan’s economic downturn would last longer than it had initially expected. The BoJ said it would buy corporate bonds rated A and higher from financial institutions as well as extend its programme to buy commercial paper and provide unlimited collateral-backed loans to financial institutions, but kept its key policy rate unchanged at 0.1 per cent. "Economic conditions have deteriorated significantly and are likely to continue deteriorating for the time being," the BoJ said in a statement, adding that Japan was likely to see prices falling by the spring. Although the central bank continues to predict that the Japanese economy will start recovering from the latter half of fiscal 2009, "uncertainty is high," it said.

The gloomy assessment follows the release of data earlier this week showing the Japanese economy was in its worst downturn in 35 years. Gross domestic product contracted sharply in the third quarter, by a seasonally adjusted 3.3 per cent, as export demand evaporated. However, the Japanese government has been paralysed by political instability following the sudden resignation of the finance minister on Tuesday, which has hardened the political opposition’s stance against passage of the 2009 budget. The central bank’s move, which was widely anticipated, failed to ease concerns about the outlook for the Japanese economy. "There were no surprises," said Masaaki Kanno, chief economist at JP Morgan in Tokyo. The BoJ’s moves have had somewhat of an impact, "but this is not going to solve [companies’] credit problems," he said.

The latest measures come on the heels of the BoJ’s decision to buy a total of up to Y3,000bn in commercial paper by the end of the fiscal year, increase its purchases of government bonds and accept corporate bonds issued by real estate investment trusts as collateral for loans to financial institutions. The central bank has also re-introduced a stock purchase programme under which it will buy up to Y1,000bn in shares held by financial institutions. Analysts, including the central bank’s own chief economist, expect the Japanese economy to suffer another large decline in the current quarter, prompting calls for the BoJ to do more to support the economy. "We fear that Japanese policymakers will continue to do too little, too late," said Julian Jessop, chief international economist at Capital Economics.

China Feasts on Miners as 'Bank of Last Resort'
Wuhan Iron & Steel Group and Jiangsu Shagang Group Co., China’s third- and fifth-largest steelmakers, are shopping for iron ore mining stakes in Australia and Brazil, executives said in interviews. "We are evaluating and selecting" candidates in Australia and Brazil, said Shen Wenrong, Jiangsu-based Shagang’s chairman. "Going overseas is the government policy, so I believe we will get financing from Chinese banks." Wuhan spokesman Bai Fang said his company is "looking for opportunities" amid lower acquisition costs for iron ore assets in Australia and "won’t rule out other countries." The world’s top metal user, China has agreed to acquire $22 billion worth of commodity assets this year after a 70 percent drop in metals and oil since July ended a six-year boom in raw materials. With U.S. and Australian banks still hesitant to lend, Rio Tinto Group and OZ Minerals Ltd., laboring under combined debt of $40 billion, agreed this month to sell stakes to Aluminum Corp. of China and China Minmetals Corp., respectively.

"China has turned out to be the bank of last resort," said Glyn Lawcock, head of resources research at UBS AG in Sydney. "China is a net importer of copper, bauxite, alumina, nickel, zircon, uranium. China is looking for ways to secure supply of these raw materials." China, whose $1.95 trillion in currency reserves are the world’s largest, plans to spend more foreign exchange on imports and acquisitions. The State Administration for Foreign Exchange said today it will make it easier for companies to purchase foreign-exchange for their overseas investments. Commodity acquisitions by China would put increasing amounts of the world’s raw materials under control of their biggest consumer and may allow it to influence prices. The investment by Aluminum Corp., or Chinalco as the state-owned entity is known, into Rio may bolster China’s bargaining power to set iron ore prices, China Iron and Steel Association said. China’s plan to boost the economy with 4 trillion ($585 billion) yuan in spending on roads, bridges and other infrastructure has pushed up prices for steel and iron ore by as much as 37 percent and the cost of shipping commodities has more than doubled.

The nation may set up an oil fund using part of the reserves to help companies buy fields abroad, according to a statement this week by the China National Petroleum Corp., the country’s biggest oil producer. China this week agreed to provide $25 billion of loans to Russia in return for oil supplies for the next 20 years. Australia already has signaled concern that China is buying strategic assets on the cheap. Treasurer Wayne Swan last week tightened takeover laws when Chinalco announced its investment in London-based Rio Tinto, the world’s third-largest mining company. Swan has the power to reject both that deal and Minmetals’ proposition with Melbourne-based OZ Minerals on national interest grounds. When Peter Costello was Australia’s treasurer in 2001, he blocked Royal Dutch Shell Plc’s bid for Woodside Petroleum Ltd. In 2004, Minmetals failed to reach an accord to buy Noranda Inc. amid objections from Canadian politicians.

China’s acquisition hunt is happening as the government ponders where to invest its currency reserves, which increased 27 percent in the past year to about 29 percent of the world’s total. The country already owns $696.2 billion in Treasuries, about 12 percent of the U.S.’s outstanding marketable debt and has been stung by losses of more than $5 billion on $10.5 billion invested in Blackstone Group LP and Morgan Stanley in New York and TPG Inc. in Fort Worth, Texas, since mid-2007. "China has burnt its hands in the past buying liquid assets like Blackstone, but here they have the chance to buy tangible, useful assets," said Professor Liu Baocheng at the University of International Business & Economics in Beijing. "There’s no point putting money in the bank or in deposits with low returns."

China consumes over a third of the world’s aluminum output, a quarter of its copper production, almost a tenth of its oil and it accounts for more than half of the trading in iron ore. Last year, China bought $211 billion worth of iron ore, refined copper, crude oil and alumina. The deals by Chinalco and Minmetals, both based in Beijing and controlled by the state, come amid difficulties that Australian mining companies face in borrowing A$26 billion to fund for new projects, as detailed in a September UBS report. Chinalco agreed on Feb. 12 to spend $19.5 billion to acquire debt and stakes in Rio Tinto’s mines in Australia, Indonesia, the U.S. and Chile. Rio was forced to seek a deal from its biggest shareholder to help reduce $38.9 billion of debt largely incurred from its 2007 acquisition of Alcan Inc. Rio’s high-level of debt was one of the reasons why BHP Billiton Ltd. abandoned its $66 billion hostile bid for Rio in November. Chinalco will increase its stake in Rio to 18 percent should it convert the debt.

Minmetals on Feb. 16 said it will take over OZ Minerals for A$2.6 billion ($1.7 billion) and assume debt of A$1.2 billion. In addition to Wuhan and Shagang, Zijin Mining Group Co., China’s largest bullion producer, may spend as much as 20 billion yuan on acquisitions, Chen Jinghe, chairman of the Fujian-based company, said Nov. 11. Yanzhou Coal Mining Co. said on Dec. 5 that it is looking at deals, following an Australian Financial Review report that the Shandong-based company wanted to buy Felix Resources Ltd. in Australia for more than A$3 billion. Fortescue Metals Group Ltd., Australia’s third-largest iron ore exporter, surged 12 percent today after it said it held investment talks with China Investment Corp., the nation’s sovereign wealth fund, and Anglo American Plc. Talks are "preliminary and incomplete", the Perth-based company said. China Investment may bring in Baosteel Group Corp. and China Shenhua Energy Co. as partners to invest in Fortescue, the South China Morning Post said Nov. 17, citing people it didn’t identify.

Excluding the $22 billion of spending this year, Chinese companies last year bought stakes or control of Australian iron ore producers Midwest Corp. and Murchison Metals Ltd. and metals explorer Abra Mining Ltd. In August, China Shenhua Energy Co., the world’s largest coal producer by value, won a coal exploration license in Australia for A$300 million. "I would’ve thought there is probably many billions of dollars still to come because China does have enormous financial firepower," said Peter Arden, an analyst in Melbourne at Ord Minnett Ltd., an affiliate of JPMorgan Chase & Co. "We will see some more chunky deals being done."

China Stock Gains to End as Profit Drops
China’s stocks rally, having turned the Shanghai Composite Index into the world’s best performer this year, will falter as profits are "non-existent," said Andy Xie, former chief Asian economist at Morgan Stanley. The Shanghai measure has gained 22 percent this year, the most among 90 global stock gauges tracked by Bloomberg. The index is valued at 17.4 times earnings, the most expensive among the so-called BRIC markets of Brazil, Russia, India and China. The rally will run out of steam as "profits are non- existent and valuations are still expensive," Xie, who is now an independent economist, said in an interview yesterday. He correctly predicted in April 2007 that China’s stock market was a "bubble" and would burst.

The Shanghai Composite peaked on Oct. 16 that year and tumbled more than 70 percent to its trough on Nov. 4, 2008, as the nation’s exports shrank and economic growth slowed. China’s economy may grow 6.7 percent this year, the weakest pace since 1990, dragged down by a slowdown in the first half, Barclays Capital said in a note today. Investors opened 427,460 new accounts to trade stocks last week, according to data posted on the Web site of China Securities Depository & Clearing Corp. yesterday, almost double the number in the previous week and the most since the five days to March 28. The rally has fueled concern that companies are using loans to speculate in stocks after new lending rose by a record 1.62 trillion yuan ($236 billion) in January as part of a government drive to boost the world’s third-largest economy.

As much as 660 billion yuan of new lending may have been converted by companies into term deposits or used to buy equities, Li Huiyong, Shanghai-based analyst at Shenyin Wanguo, said in a phone interview this week. "It’s a rampant practice," said Xie. "Here you are borrowing at 1.5 percent and the stock market rises, so you put your money into stocks and hope to get out after making 20 percent." The nation’s 3-month deposit rate stands at 1.71 percent, after the central bank cut interest rates five times in 2008 to stimulate growth. Chinese banks have the ability to monitor how loans given to companies are used, making it unlikely that credit is funneled into the stock market, Industrial & Commercial Bank of China Ltd. and Shanghai Pudong Development Bank Co. said yesterday.

Bailed-Out Banks Charge Highest Fees in FDIC Sales
Citigroup Inc. and Bank of America Corp., recipients of $90 billion in bailout funds from American taxpayers, are charging financial companies three times more to sell bonds under a U.S.-backed rescue program than government- controlled Fannie Mae and Freddie Mac pay to issue notes with similar maturities. Since the Federal Deposit Insurance Corp. started guaranteeing debt in November, banks have charged clients, including themselves, more than $375 million in fees on $154 billion of deals in the U.S., according to data compiled by Bloomberg. Pittsburgh-based PNC Financial Services Group Inc., which received $7.6 billion from the U.S. Treasury, paid Citigroup and JPMorgan Chase & Co. 30 basis points, or $6 million, in December to sell FDIC-backed notes due in three-and- a-half years. A month later, JPMorgan and two other banks charged Freddie Mac 7.5 basis points for a similar offering.

"The fact that you have U.S. government support in the form of the FDIC guarantee, there should be a reduction in fees," said Sean Egan, president of bond ratings firm Egan Jones Ratings Co. in Haverford, Pennsylvania. "The best proxy for fees would be Fannie and Freddie, and if anything, it should be a bit less than that." As the financial crisis reduces income from mergers and acquisitions, equity sales and securities trading, bankers are looking for revenue anywhere they can find it. While fees on FDIC-backed securities sales are less than half of the average 57 basis points on all maturities of U.S. investment-grade bonds, government-guaranteed issues account for 46 percent of the corporate debt and equity offerings in the U.S. since Nov. 25, Bloomberg data show.

The underwriters, which include New York-based Citigroup and Bank of America in Charlotte, North Carolina, are now under pressure from lawmakers to explain why they’re paying themselves and other bailed out banks tens of millions of dollars to manage government-guaranteed bond offerings after receiving more than $145 billion of financial aid from taxpayers. At a hearing of the House Financial Services Committee last week, Democratic Congresswoman Maxine Waters of California criticized the banks for paying themselves to underwrite FDIC- backed bonds rather than hire more smaller firms, including those owned by women and minorities, to sell the debt. "When they have an opportunity to have these small firms do the underwriting on these bonds, they’re hogging it all to themselves," Waters, 70, said in an interview. "We have been wrestling with major Wall Street firms and banks about opening up opportunities to women and minorities. This is clearly the taxpayers’ money that we are allowing them to use."

According to people familiar with the matter, banks prefer to hire their own sales forces to sell their bonds because it is the most efficient way to unload billions of dollars of debt. They say that paying themselves to do so is little more than an accounting exercise, regardless of how much the fee is. They also say they make an effort to hire minority-owned firms to sell their offerings, often giving them 1 percent of the deal. About two-thirds of the FDIC-backed bonds sold since November -- more than $100 billion -- have been underwritten by the same banks that are issuing debt, including Citigroup and New York-based Goldman Sachs Group Inc. Fees on those sales total about $290 million, according to Bloomberg data. "We have to pay the underwriters to raise that money," Citigroup Chief Executive Officer Vikram Pandit, 52, told Waters at the hearing, acknowledging that some of those payments were made to Citigroup.

Bank of America, which at $33.2 billion is the biggest issuer of government-guaranteed debt, paid itself and 10 co- managers 30 basis points to sell $8.35 billion of FDIC-backed bonds on Jan. 27, according to a filing with the U.S. Securities and Exchange Commission. The bank handled 93 percent of the bonds and collected at least $23.3 million in fees on the deal. HSBC Holdings Plc in London, New York-based JPMorgan and six other banks were given $501 million of bonds to distribute, or about 6 percent of the deal, and four minority-owned brokers received $83.5 million of bonds, or 1 percent of the total, according to the filing. Citigroup, which has issued $19.6 billion of the notes, putting it third behind General Electric Capital Corp., paid itself and 12 co-managers $24 million, or 30 basis points, to underwrite the sale of $8 billion of bonds on Jan. 23 and Jan. 27, according to a securities filing. Citigroup distributed the bulk of the debt and paid itself at least $19.9 million in fees.

GE Capital, the second-biggest issuer of FDIC-backed notes and the financing arm of Fairfield, Connecticut-based General Electric Co., paid underwriters the lowest rates to sell FDIC- backed debt, ranging from 4.5 basis points for 1.5-year notes to 17.5 basis points on $5.5 billion of 3.4-year securities, Bloomberg data show. The rates are about the same as investment banks charged AAA rated GE Capital to sell debt with a similar maturity before the FDIC guarantee. At the high end, fees on top-rated FDIC-backed notes sold by Cleveland-based KeyCorp and New York Community Bank were 30 basis points. In December, KeyCorp, which received $2.5 billion from the Treasury, paid $750,000 to Barclays Plc to underwrite a $250 million sale of floating-rate notes due three years later, Bloomberg data show. Banks led by Citigroup charged New York Community Bank $1.5 million on a $512 million offering on Dec. 12 of three-year fixed-rate debt.

That’s the same basis-point fee Mexico, rated seven steps lower at the third-lowest investment grade, paid in December to sell $2 billion of 10-year notes and more than three times as much as the 8.75 basis points that speculative-grade-rated Turkey was charged in September to sell $1.5 billion of debt due in 2019, Bloomberg data show. Underwriters charge higher fees to sell riskier debt and longer maturities, indicating the banks see FDIC-backed notes and Mexico’s bonds as bearing similar risk. Government-backed Fannie Mae and Freddie Mac typically pay fees of less than 10 basis points on notes due in two or three years. Investment banks say they are charging higher fees for FDIC- backed notes than for agency and sovereign debt in part because the security was a new product and because they were unsure how it would fare with investors.

The fees may be justified because investors see risk in holding bank debt even with government guarantees, said Walter Mix, a former commissioner of the California Department of Financial Institutions. The FDIC has closed 38 banks since the beginning of last year and real estate markets continue to deteriorate, Mix said, making it difficult to sell the bonds. "It’s a perceived risk-premium because of all the uncertainty that’s surrounding this situation," said Mix, who’s now a managing director at Secura Group of LECG, a consulting firm in Los Angeles. The FDIC’s decision to back corporate bonds was based on the need to ensure investors that the "full faith and credit of the United States" was behind the debt, John Dugan, head of the Comptroller of the Currency, said at the time. In the two months following the September bankruptcy of Lehman Brothers Holdings Inc., credit markets froze and yields over benchmark rates on bank debt almost doubled to a record 725 basis points on Oct. 10, triple the average spread on the riskiest bonds in June 2007.

Bank debt spreads have since narrowed to 649 basis points still more than double the 270 basis points a year ago, according to Merrill Lynch & Co.’s U.S. Corporates, Banks index. Under the initial guidelines, financial companies have until the end of June to sell debt, and the FDIC will guarantee the notes through June 2012. The agency, which established the program to help banks refinance debt maturing this year, said it is considering extending the guarantee’s duration. "If it weren’t for the government backing, I’m not sure if any of these banks would be able to sell commercial paper," said Sung Won-Sohn, a former chief economist at Wells Fargo & Co. and now a professor of economics and finance at California State University Channel Islands in Camarillo, California.

Madoff Loss Spawned in 'Bargain With Devil' at Cerberus Bank
Two of Japan’s eight nationwide banks are braced for $2.6 billion in losses after investments by U.S. private equity groups, which the Obama administration is counting on to help bail out the U.S. financial system. The lenders took on increased risks under foreign ownership. Aozora Bank Ltd., acquired in 2003 by Cerberus Capital Management LP, reported reverses on subprime mortgages, GMAC LLC shares and Bernard Madoff’s fund. Shinsei Bank Ltd., bought in 2000 by private investors including billionaire J. Christopher Flowers, had losses on a stake in Germany’s Hypo Real Estate Holding AG. "Aozora and Shinsei were managed like many banks in America, investing in derivatives and other toxic assets," said Neil Katkov, head of Asia research at Boston-based Celent LLC. "It was a bargain with the devil."

Buyout firms including Cerberus and J.C. Flowers & Co. are stumbling with investments from Japan to Germany as their acquisitions are battered by the credit crisis and the deepest recession since the early 1980s. As many as 50 percent of companies owned by private-equity firms may default by 2011, according to a study of 328 holdings by Boston Consulting Group. The failures are affecting a cross section of the global economy. Mervyn’s LLC, Lyondell Chemical Co. and Linens ‘n Things Inc. -- all controlled by buyout firms -- have filed for bankruptcy. Cerberus received U.S. government aid for Chrysler LLC and GMAC, the lender affiliated with General Motors Corp.

U.S. Treasury Secretary Timothy Geithner last week urged that private investors take on a role in rescuing financial institutions, and regulators eased rules to promote private takeovers of banks. Carlyle Group LP, the world’s second-largest buyout firm behind Blackstone Group LP, has lined up $1 billion to invest in banks, according to people familiar with the matter. In Japan, Flowers co-led a group of international investors to buy Shinsei for 121 billion yen ($1.3 billion). The new owners invested the bank’s money in Hypo Real Estate, the German property lender battling to avoid insolvency. That’s contributed to Shinsei forecasting a 48 billion yen loss this financial year. Flowers said in an interview that the bank invested abroad too much, yet its overall record with his fund is very profitable.

After Cerberus gained control of Aozora, Japan’s eighth- largest nationwide lender, the bank switched its focus from making domestic loans to investing overseas. Last week, it forecast a 196 billion yen deficit for this financial year and ousted Chief Executive Officer Federico Sacasa. The Japanese government injected 12.8 trillion yen to rescue the two banks from an earlier crisis that led to their nationalization a decade ago. "It’s outrageous they were investing taxpayers’ money, our money, in those risky assets," said Kristine Li, a Tokyo-based analyst at KBC Securities who no longer rates Aozora. "Aozora was chasing only short-term gains."
Cerberus doesn’t influence Aozora’s investment decisions, said Tim Price, a partner at the New York-based firm. The fund owned 50.02 percent of the bank, Aozora said on Dec. 5.

"Management runs the company on a day-to-day basis, and the independent board of directors gives strategic direction," he said. "The people on the board that Cerberus has nominated are there because they are highly qualified." Sacasa was one of four foreign directors who resigned from Aozora’s board Feb. 10 as it predicted a loss in the year through March 31, 2009. Aozora fell 75 percent last year, the biggest drop among 84 stocks in the Topix Banks Index. Standard & Poor’s and Moody’s Investors Service last week cut Aozora’s credit ratings to the third-lowest investment grade, citing eroding earnings and asset quality.
Masaaki Harada, a spokesman for Tokyo-based Aozora, declined to comment on the bank’s future. Japan’s government sought foreign investors after it started taking over insolvent lenders in 1998. The banks were saddled with 72 trillion yen of bad loans tied to a property bubble that burst in the early 1990s.

U.S. private-equity firms including Cerberus, Ripplewood Holdings LLC and Lone Star Funds, as well as billionaire Wilbur L. Ross, were among those who bought banks that received public funds. Ross and Lone Star have since sold their controlling stakes. Aozora -- Japanese for "blue skies" -- emerged in 2001 from the ashes of failed lender Nippon Credit Bank Ltd., which was nationalized as the government injected 12.4 trillion yen in capital into the industry over five years. Forced mergers cut the number of nationwide lenders to eight from more than 20. The Japanese government spent 4.9 trillion yen rescuing Aozora Bank since the late 1990s as it bought back bad loans and assets and boosted its capital. Cerberus lost a bid to buy the bank in 2000 as the government sold 49 percent to Softbank Corp., a Tokyo-based Internet investor. Cerberus built up a 12 percent stake and returned in 2003 with an offer for Softbank’s shares.

The takeover provoked opposition from investors, politicians and senior management. Hiroshi Maruyama, then Aozora’s president, said in 2002 that investment funds weren’t welcome buyers. Such resistance reflects a clash of cultures. "Western investors are driven by profit, return on investment and the economic interests of their shareholders," said Thomas Barrack, a former Aozora director and investor who heads Colony Capital LLC., the Los Angeles private-equity firm that has invested $39 billion worldwide. Japanese banks are concerned about their duty to borrowers and the welfare of those companies’ employees, he said.
In April 2003, former U.S. Vice President Dan Quayle, chairman of Cerberus Global Investments, rallied support in Tokyo for the Aozora bid. "We’re going to make this bank operate profitably, and we are going to make sure that we do it the Japanese way," Quayle told the Financial Times that month. He didn’t respond to e- mails or calls seeking comment for this story.

Cerberus closed the deal four months later, paying 101.1 billion yen. At the time, Aozora owed the government 355 billion yen from the bailout. Nine new directors were appointed to Aozora’s 13-seat board in May 2004, joining Quayle and Chairman Edward Harshfield. Cerberus-appointed directors failed to understand Japan’s banking industry and didn’t trust Japanese managers because of concerns they would pour money into failed domestic companies, a person familiar with the board’s discussions said. Harshfield signaled a strategy change a month after he took charge in September 2003, telling the Nikkei newspaper he’d allocate as much as 20 percent of assets for overseas investments, including securities backed by U.S. and U.K. loans. The bank needed to look beyond Japan because domestic lending yielded low profits, Harshfield told the paper. The Bank of Japan kept its key overnight lending rate near zero for more than five years from March 2001.

Results initially improved. Profit more than doubled to 81.5 billion yen in the three years to March 31, 2007. Securities holdings, including collateralized debt obligations, almost doubled to 1.9 trillion yen in the period, according to the bank’s financial reports. CDOs bundle bonds or loans, or both, from a variety of issuers. Income from investments rose to 42 percent of earnings, from 13 percent, during the same three years, the reports show. Loans and other interest paying assets dropped to 39 percent from 73 percent, even as total lending expanded. Loans in Japan to manufacturers fell 24 percent to 335.9 billion yen.
Aozora shareholders led by Cerberus raised 351 billion yen by selling 37 percent of the bank in a 2006 initial public offering. Aozora’s fortunes tumbled when the credit crisis erupted in mid-2007.

The bank lost 45.4 billion yen on CDOs in the year through March 2008, cutting net income to 5.9 billion yen, according to earnings statements. In the first nine months of this financial year, Aozora posted a loss of 109.4 billion yen, including soured hedge fund bets and loans to bankrupt Lehman Brothers Holdings Inc. It also lost 11.7 billion yen on investments related to Madoff, the New York fund manager charged with fraud, the bank said this month. Among Aozora’s most damaging overseas forays was its purchase of 3.2 percent of GMAC, General Motors’ consumer finance unit, for $500 million. The bank was part of a group led by Cerberus that in April 2006 agreed to buy a controlling interest. By the time the transaction was completed in November of that year, GMAC’s home loan unit, Residential Capital LLC, was getting stung by rising delinquencies on subprime mortgages. Aozora has since written off 97 percent of the investment, according to third-quarter earnings released Feb. 10.

Last December, GMAC received a $6 billion lifeline from the U.S. Treasury. "At the time, being invited into that consortium, which included Citigroup, seemed like a very interesting opportunity," Sacasa said in an interview last May. The Cerberus connection let Aozora "play well above our weight," he said. Sacasa, 58, declined to comment for this story. James Fiorillo, managing principal at private equity advisory firm Ottoman Capital Japan, called Aozora the "best deal" among Japanese banks. The stock trades for less than a third of its book value, making it the cheapest one in the Topix Bank Index. That’s "ludicrously low," Fiorillo said. "Aozora is going to survive." The shares have gained 25 percent to 104 yen this year, making the company the best performer in the index. Aozora and Shinsei aren’t the only Japanese lenders to be burned by investments abroad. Mizuho Financial Group Inc., the nation’s second-biggest bank, with 25 times more assets than Aozora, lost $8 billion on securities tied to U.S. mortgages, more than any other Asian lender.

Aozora’s focus on overseas investments led Kimikazu Noumi to quit as chairman in May 2008 after 15 months in the job, according to two people familiar with the decision who declined to be identified, citing confidentiality. Noumi, 64, had sought to return Aozora to its roots as a wholesale lender, the people said. Noumi declined to be interviewed for this story. On Feb. 10, Deputy President Brian Prince, 45, replaced Sacasa as CEO. Prince, who helped clear up $20 billion of bad loans at Shinsei from 2000 to 2003, plans to return Aozora to Japanese lending. "We should get out of the hedge fund business because these industries are going down," he said in a telephone interview. "We’re going to focus on our core business in Japan." Aozora still owed the government 227.6 billion yen in November, according to financial reports. Japan’s three largest banks, including Mitsubishi UFJ Financial Group Inc. and Sumitomo Mitsui Financial Group Inc., finished repayments in 2006.

Some investors have already cut their losses, including Belluna Co., a Tokyo-based mail order company that held about 250 million yen of Aozora shares on March 31 last year, according to Bloomberg data. "There was little sign that the stock would climb, so we sold them at a loss," said company spokesman Nobuaki Nakanishi. "We lost a few hundred million yen on Aozora." Aozora may struggle to survive in its current form, said Masaru Hamasaki, a Tokyo-based strategist at Toyota Asset Management Co. The company’s actively managed funds don’t own Aozora shares, he said. "They can’t win at home and there’s no surety they can overseas," Hamasaki said. "Aozora’s days as a bank may be over."

Bonds: What's Behind the Bounce in Corporates?
Warren Buffett's investment in Tiffany and other factors are helping lift prices for corporate bonds. Even as equity indexes retested their November 2008 lows on Feb. 17, the bond market was telling a different story. Spreads between the composite yield on investment-grade corporate bonds and U.S. Treasury bonds of comparable maturity narrowed to their tightest levels since the beginning of the new year, indicating that investors have regained some appetite for corporate bonds even as equities resumed their slide. That's a far cry from the oft-heard remark last fall that if stocks were priced for an impending recession, corporate bonds were being priced for a depression. Corporate bond yields, or the interest rate that bondholders earn, have dropped dramatically over the past three months, which means corporate bond prices have been rising. After reaching nearly 600 basis points in early December, the spread over Treasuries had narrowed to 470 basis points as of Feb. 17.

One reason for what Tom Murphy, manager of the Diversified Bond Fund at RiverSource Investments in Minneapolis, calls a "decoupling of equity and bond markets" recently is the absence of the forced selling by hedge and mutual funds that made both stock and debt investors skittish at the end of 2008. "Now people are doing a more rational analysis of the risk/reward [comparison] and can still get comfortable with that even as the equity market trades down to its lows," he says. "We need to continue to make progress. I'm not naive enough to think that if equities continue to test the lows, that the corporate debt market" can stay immune to stocks' downdraft. Billionaire investor Warren Buffett's investment in Tiffany debt has also helped stoke more confidence in corporate bonds. On Feb. 12, subsidiaries of Buffett's company, Berkshire Hathaway (BRKA) bought $250 million of Tiffany's 10.00% Series A-2009 and Series B-2009 Senior Notes due in February of 2017 and 2019, respectively. Murphy sees the investment as consistent with Buffett's purchasing preferred shares of companies after the Lehman Bros. collapse last September in order to have stakes higher up in the capital structure. "It's a high-profile example of people [looking at] the debt vs. equity trade-off at relative valuations and deciding they'd rather own the debt," he says.

Companies are returning to the credit markets— if not in a torrent, at least in a steady stream. On Feb. 17, DuPont sold $900 million of debt in a two-part sale, comprised of $400 million of six-year notes priced at a 4.75% yield and $500 million of 10-year notes priced at a yield of 5.75%. Both tranches were done at yields 313 basis points over comparable Treasuries, according to IFR, a Thomson Reuters service. The same day, Honeywell sold $600 million of 3.875% Senior Notes due 2014 and $900 million of 5.0% Senior Notes due 2019. Roche Holdings' offering on Feb. 18 was the biggest by far: a six-part sale in the private placement market worth a total of $16 billion, of which $13 billion has a maturity of two years or more. "Cisco [Systems] was the first one to put some size in there, and now everybody is following suit," says Bill Larkin, portfolio manager of fixed income at Cabot Money Management in Salem, Mass. What helped Cisco sell $4.0 billion of five- and 10-year notes on Feb. 9 for relatively small premiums over Treasuries was the fact that it's one of very few technology companies the market expects to weather the recession and continue to generate strong cash flow, he says.

Cisco had to agree to pay buyers of $2 billion in 10-year notes a coupon of 4.95%, roughly 200 basis points above the 10-year Treasury bond. That's quite reasonable, compared with the 550-basis point premium to Treasuries the company would have had to pay two months earlier to attract buyers, says Larkin. As much as corporate debt spreads have narrowed in the past two months, they are still wide by historically standards, having been less than 100 basis points before the credit crunch began in 2007. Once the economy stabilizes and conditions start to improve, there will be lots of room for further tightening of spreads, says Murphy at RiverSource. It's prudent for underwriters to offer new issues at a nice discount relative to the prices at which existing bonds are trading in the secondary market in order to ensure sufficient participation so the deal will be oversubscribed, says Manny Labrinos, a corporate bond portfolio manager at Nuveen Asset Management in Chicago. "It's similar to the IPO market where you want to price it so it trades up rather than down" once it hits the secondary market, he says. Total returns on investment-grade corporate bonds between Dec. 1 and Feb. 17 are 8.9%, as measured by Barclays U.S. Investment Grade Corporate Bond Index.

However encouraging the rally in corporate bonds since early December, the positive returns are being generated less by the fundamentals of an improving economic outlook than by confidence engendered by special programs guaranteeing certain kinds of debt introduced first by the Federal Reserve and more recently by the U.S. Treasury Dept., according to Mike Brandes, senior fixed-income strategist at Smith Barney, a division of Citigroup. "There's an extraordinary appetite for investment-grade paper, partly triggered" by the Fed's promise to purchase $100 billion of government agency debt and $500 billion of agency mortgage-backed securities and the FDIC's Temporary Liquidity Guarantee Program (TLGP), he says. Indeed, the TLGP contributed 14 bond offerings worth $39.7 billion, or over 31% of the 94 deals worth a total of $127.1 billion with maturity greater than 18 months done this year through Feb. 17 by investment-grade U.S. companies, according to Dealogic, a research firm in New York. One benefit the larger-size debt issues has had is to boost liquidity of those bonds when they start to trade in the secondary market, which can bolster confidence in the corporate bond market.

Labrinos at Nuveen sees liquidity in high-quality investment-grade bonds improving and is now a much smaller concern among bond investors than it was a few months ago. The larger size of bond offerings has made the major Wall Street firms more willing to make a market in certain issues that they don't own but that clients are requesting since they're confident they'll be able to easily buy back bonds to cover short positions if needed without having to pay a premium. The key question investors should be asking is whether a bond has already priced in ratings downgrades that are likely to happen, says Labrinos. "If you're holding a single-A bond already trading at spreads reflective of triple B bonds and you think it's going to get downgraded to triple B and stay there," you'll be willing to buy it at the current price, he says. It all comes down to what rating you think the bond will ultimately settle at once this tough credit cycle ends. For his part, RiverSource's Murphy is relying less on the rating agencies and more on his own models to determine companies' credit quality. Ultimately, the current thaw in the corporate market remains limited to the companies on the upper rungs of the ratings ladder. The fact that more than $100 billion of investment-grade bonds have been issued so far this year demonstrates that access to the capital markets for high-quality non-cyclical companies is improving, but that doesn't mean that low-triple B cyclical companies will be able to get a bond offering done in the next three to six months, says Murphy. "The market's not there yet," he says. For now, bond investors appear content to nibble at the offerings of higher-quality names.


Anonymous said...

Hi Ilargi:!
As usual, too many informative links to be able to make comment on all.

I'll make one ...
What training do our elective representative have in finance?

Here is a hint from a quote of one of your links.
Judges in the kinds of courts that deal with distressed mortgage lending are unlikely to have invested in a Ph.D. in Law and Economics. They are likely to be lawyers - full stop - and not very good lawyers at that (is ‘not very good lawyers’ an oxymoron?). They know nothing about markets and incentives, valuation and credit risk.

My training did not include finance and as a result I got blindsided.
Our politicians are also getting blindsided.

Anonymous said...

-I just look around me and see that no society can exist that allows too many of its citizens to fall into utter misery.

With enough military and political force such states can exist. Think Zimbabwe, Congo, Sudan, Central African Republic, swathes of West Africa. There are plenty of countries in latin america and Asia (I'm thinking Myanmanr, N.Korea) where the vast majority are consigned to a life of poverty and misery.

What compounds the problem in the West is that people have a really high standard of living and are used to being entitled in the last 60-70 years. It's normal to have Social Security, Medicare, Unemployment benefits etc. If the whole ponzi scheme crashes, than the sense of loss is what will trigger the trouble.

Another point I'd make is that Australia, NZ, UK had far greater housing booms without the presence of GSE's I believe like Fannie and Freddie. So why did they have much bigger booms compared to the US and in a higher interest rate environment?

We trash the banks, but the people working in banks are not inherently evil people. They have kids, family, relatives. They hurt too when the economy does badly. IMO the banks/ corporations have surpassed human ability to control them. We created them to serve us but we have ended up in their control. As Jay Hanson put it, the sole purpose of a corporate machine is to ingest the earth's natural resources in and churn out garbage. A bank is a machine, in that it modifies the behaviour of otherwise decent people.

Society has unleashed these monsters. We have become addicted to the illusion they portray of an ever better life. In the meanwhile we are chasing a mirage in the desert and we're quickly running out of water.

Anonymous said...

Some items of note in the news:
Everyone Get in Line
The Looming Collapse of European Banking
See also:
Deleted from web! European banks may need 16.3 trillion pound bail-out, EC document warns

Frank said...

Gary North is not someone you want to cite. He's been a professional fear monger for 30+ years, and some of the stuff he put out about y2k was either deliberate distortion or demonstration of such cluelessness as to render his opinion worthless.

Greenpa said...

jal- "What training do our elective representative have in finance?"

um. what? And exactly what good, to anyone, is "training in finance"? The trained put us here; don't understand how, or how to get out.

Seriously. Please don't inflict an "economist" or MBA's theories on me. They're as clueless as it's possible to be.

Now- if only we could get our elected officials to understand that.

EBrown said...

I am of the opinion that there's a good chance US financial institutions would have found ways to create credit and fuel the housing boom without the GSEs or lax oversight from the Fed. Your citation of Australia, NZ, etc that managed to blow even larger housing bubbles without GSE equivalents only adds another arrow to my quiver. I think once a mania takes hold and it becomes "accepted" knowledge that housing only goes up or that the internet will usher in a new economy there is little the government can actually do to turn the herd. If you haven't already read it Steve Keen's post on The Cavaliers of Credit is a superb post over at He lays out the mechanism for how credit is truly the dog that wags the fiat money tail, not vice versa. In the western world credit is mostly, though by no means exclusively, originated in the private markets. Now that credit is contracting we have a long way to go in the deflation game and there is actually little that national governements can do to alter the course of things. They could provide basic services (on a voluntary basis I would hope) such as food, water, and shelter for a few dollars a day per person so that millions don't slip through the cracks, but that doesn't look too likely to be done.

Anonymous said...

@EBrown - good point, yet I believe you missed Keen's most important observation:

"Given their proclivity to lend as much as is possible, the only real constraint on bank lending is the public’s willingness to go into debt. In the model economy shown here, that willingness directly relates to the perceived possibilities for profitable investment...there is an additional reason why the public will take on debt: the perception of possibilities for private gain from leveraged speculation on asset prices."

In other words, forget the Fed, Fannie/Freddie, etc. It all comes down to ***lenders successfully creating an appetite for debt***, whether credit is sold as education (student loans), pleasure (HELOC driven luxury purchases [cars, kitchens], vacations, etc) or asset appreciation/speculation (home mortgages - non-conforming AltA, subprime, etc).

To the extent that the gov't encouraged the latter, perhaps future regulations will recognize that banking is a utility, and separate this function from all other forms of free-market risk/reward lending/investing activities.

Anonymous said...

@ Ebrown

Indeed manias once they take root are exceptionally difficult to stop. One of the books mentioned on TAE is MEMOIRS
AND THE MADNESS OF CROWDS written in 1852!! I will quote the preface,

"Money, again, has often been a cause of the delusion of multitudes. Sober nations have all at once become desperate gamblers, and risked almost their existence upon the turn of a piece
of paper."

It goes on,

"Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one."

Read the extraordinary story of the Scottish John Law of the Mississippi bubble fame. He was quite a decent chap but his idea caught on so rapidly in Paris and with such enthusiasm that it became a bubble and eventually burst causing him to lose his entire fortune and nearly bankrupt France!!

Humanity has been in bubble situations many times before and survived and prospered even more!! Every bubble in history has burst but has been followed by renewed growth, but I do not think we've ever had such a global bubble and such a complex and interconnected world.And the specter of peak everything haunts us as well.

Anonymous said...

Greenpa said...
um. what? And exactly what good, to anyone, is "training in finance"? The trained put us here; don't understand how, or how to get out.

Seriously. Please don't inflict an "economist" or MBA's theories on me. They're as clueless as it's possible to be.

heheh ... I Agree ... My training is happening here and now. It never happened in a school.

Maybe the BLOGS will train a new generation.
However, its too late for that generation to do any good in the present financial situation that we find ourselves having to solve.

It really is, "The blind leading the blind", situation.

Anonymous said...

When I was a kid, my brother and I would play a game of chicken by taking turns blowing up a one penny balloon.

The last one to blow into the balloon and not have it explode won.

It was very dramatic towards the end and always seemed to startle both of us, even though we were anticipating the Inevitable.

Having gotten bored with the power and spectacle of a one penny balloon reaching it's Ultimate Limit, we decided to up the ante one day and go with a nickle balloon.

This balloon, despite being five times the money, was in fact five times the diameter of the penny one. We were just kids and did not realize it was more like 25 times the bang as the small balloon.Its power increased by the square, a concept our young minds were unfamiliar with to that point.

It took us Much longer to get it to the breaking point, we were hyperventilating and exhausted by the time it was huge but neither of us would back down.

Well, to wrap it up, it finally burst when my brother gave it that one last huff.

The force and sound of it were so great that it:
(a) somehow managed to split his forehead open (a few stitches)
(b) gave him two black eyes and
(c) almost broke one of his ear drums.(it took a week or so for him to turn when you called his name)

The sound was so loud the neighbors called the cops thinking it was a shotgun going off in the house.

IMHO, the U.S economy is like that nickle balloon (times a million or so) with all the top players taking turns giving it another blow.

Anonymous said...

ilargi says:

"All this is money that disappears from communities, and into the vaults of big faceless banks."

Isn't the vault the place where money goes "hssss", when it contacts bad bets, and disappears?

Ilargi said...

Anon 8:14

I like that analogy.

Anon 8:31

It was that way way before the betting started for real. That's how we got the Hamptons. But you're right today it is like that.

bluebird said...

Anon 8:14 - That is the best analogy I have ever read. I hope your brother didn't suffer any any lasting effects into adulthood.

Somehow, I think it will be like that when the bubble we are in today, finally bursts. It will be heard around the world.

Anonymous said...

Gary North is mentioning something published in UK.
EU think tank has already wanred about European banks and their debts exceeding GDPs of their countires, then came EU COmmission report.

Anonymous said...

Europe's goose is cooked, when will the dish be served is the question...
European banking on borrowed time

Note:North not only one who missed the dletion in article after publication:
Deleted from web! European banks may need 16.3 trillion pound bail-out, EC document warns

Starcade said...

Understand that the entire concept of owning a home being that good a thing is based on Alger's American Dream that working hard actually means something in this country.

You are about to find out what happens when the masses find that not to be true.

AR said...

Hi Ilargi,

I've been reading your commentary for a few months, following Stoneleigh's cross-posts at Daily Kos. Thanks for telling it like it is. Community autonomy of housing is a great idea, in keeping with the relocalization theme propounded elsewhere.

I'd appreciate it if you could suggest how much (%) I should offer Wells Fargo on a short sale of a house that is about to be foreclosed. I figure that I may as well spend my nestegg doing good works now, before TSHTF and hyperinflation makes it impossible. I'm helping a family keep their home. (Mine is paid off already.) I read in the Business Week article How Banks Are Worsening the Foreclosure Crisis: "Foreclosure proceedings typically cost banks about 50% of a property's value. That's assuming the home can be resold -- not a certainty when empty houses multiply in a neighborhood." Since real estate values are still collapsing, I figure less than 50% is fair. The neighborhood is one that was targeted for predatory loans.

Wyote said...

From Warren Peace:

Older, Wiser Bunny: “Alright everybody, sit down and let’s get to work.”

Bunny Winthrop: (aside to a friend): “It gets a bit old doesn’t it? The whole pledge thing. “roots and shoots for all” what a lie. I’ve heard of bunnies running out of shoots.”

Bunny Blinky: “Its shoots and leaves Win, shoots and leaves. But yeah, I’ve heard that too. Hey, what’s up after lessens?"

Winthrop: “Might go downtown, maybe dance a bit, you know, shake the tail.”

Blinky: “Right. I’m for home and some action there. Are you staying for the economist lecture?”

Winthrop: “You mean the one on Disclosure?"

Blinky: “It’s Foreclosure, dude."

Winthrop: “Right, whatever. When I saw that guy’s picture, I wasn’t even sure he was a bunny. Somethin’ strange about the ears.”

Blinky: "Yeah, well I heard he can tell us how to stay in our burrows. The Mrs. is worried about that, so I guess I’ll go."

Winthrop: “I’d rather play, Blinky, but take notes for me, would ya?”

OW Bunny: “Would the two bunnies in the back please sit down so we can get started? Thank you. Now, we can begin this morning’s discussion on analog vs. digital TV and it’s importance to societal harmony..”

Anonymous said...

Stoneleigh, Ilargi,
I have Canadian friends who are planning trips to the US. The US dollar has been strengthening. Do you think that the Canadian dollar value may increase or should they buy USD now.

BTW... Ilargi....another excellent intro.

Anonymous said...

+1 Wyote

Very bunny! I can tell you have a rabbit sense of humor.

"Shouldn't the prices perhaps be exclusively set by the cost of building a home?"

Nope, not at all.

One can take the same, exactly identical, home and put it in two completely different neighborhoods.

In the "good" neighborhood, lots of people will want to live there. In the "bad" neighborhood, few will.

One can try to figure out how to make all neighborhoods equal. I believe it's been tried and it failed miserably.

Alan said...

How much should a home cost? 1 times income? 3 times income?

Around here construction costs are around $150 a square foot. Median incomes are around 50K. If we use the 1 times income rule, and assume free land, our average buyer gets a nice 333 square foot house.

If we use the 3 times rule, again with free land, we get a 1000 square foot house.

With some reasonably priced land and using the 3 times rule, a nice 650 square foot house. I owned one of those back in the 80's. Quite nice. House was built in the 30's.

Of course, there are places in the world where nobody pays more then 10% of their income for housing. Around here we would have to find ways to build places a lot cheaper then we do now to come close to that.

Anonymous said...

Premier of Alberta Ed Stelmach(tarsands country) said "... that would be giving money to the gansters that started this recession". This during a set to in the house the other day, haggling with the opposition, something to do with cap and trade on carbon credits. I don't know who he thought the gangsters are, could he mean banks/wall street etc? It was a heat of the moment comment for sure.

To add to the ranks of the semi-alert politicians? I disagree with most what Stelmach says, however interestingly he was not the 'chosen one' to run my province, he is some farmer or farmer's son from the Andrew area of Alberta, a virtual nobody on the Alberta political scene who won when the leadership rules caught Dinning (annointed successor)in an accidental no-win. So maybe, just maybe, Stelmach is just exactly who he seems to be, a careful, close-minded, inarticulate, unimaginative and deeply conservative small town boy. No hooks. Not too bright though.

Anyways it was an interesting comment and if he means wall/street banks it shows he is not totally dead. So what will be his response to unfolding events? Alberta is positioned extremely well, relatively, to any spot on the globe, over near and long terms.

Anonymous said...

@ jal : Bankuptcy judges are not elected, and have lots of experience in distressed mortgages. They wouldn't need a Ph.D. in Law and Economics. Presumably they woiuld apply standards set by Congress, which could incorporate market, incentive, valuation, and risk factors.

I'm not saying this should be done, but if it were it would not be done by incompetent, elected judges.

Anonymous said...

Wow, that's a very interesting photo of Abraham Lincoln, America's 16th president. The homeless people around my area look better kempt than he did back in 1865.

Anonymous said...

"Free market capitalism is dead, and I don't say that because I have communist sympathies. I just look around me and see that no society can exist that allows too many of its citizens to fall into utter misery. What killed our capitalist system is the inclusion of basic human needs in an economic system based on speculative games."

Really? Really?

There is nothing free market about the current system.Dean Baker even admitted so(

The foundation of the system we have now was laid by the progressives and the temple that rests on that foundation was FDR's New Deal.

Illargi, please be intellectually honest and don't call the system "free market." For those how doubt the truth of that please read a bit on free markets by economists like Mises, Hayek, Hazlitt, and others.

Anonymous said...

Ilargi must be asking a rhetorical question. Americans have always, except perhaps the very first Puritans for the first years, dreamed of speculative profits from real estate. The inflation of real estate values. The dream of inflation was later transferred into every other asset class imaginable. Inflation of asset prices, values in the parlance, could be said to be the American dream.

I don't think America can exist without that dream. In a way that is what Americans rebel against when they hear the word socialism. I don't think they think of it in those terms but anything that cannot be capitalized and inflated is bad. It's socialist. That's how I think about it and I find it a pretty handy way to conceive of it.

Bigelow said...

Difference of opinion Swampfox…the foundation of the system we have now was twisted by Reagan’s ‘Morning in America’, Bush Sr., Clinton and Bush Jr. Free Markets are expedient mythology.

Anonymous said...

The foundation of the system we have now was laid by the progressives and the temple that rests on that foundation was FDR's New Deal.

Dude, they've been dismantling the New Deal for decades. What we have now is the predictable result of class warfare against the poor and middle class.

How freepers keep confusing socialism with fascism mystifies me. It can only be faith-based ideology.

There sure is no such thing as a free market and there never was. It's rigged in favor of the big players, not the little players.

Sure wish we could have saved capitalism from itself again this time. But ain't no 'traitors to their class' in power any more.

Anonymous said...

Some particular thoughts on housing in America.

First of all, the trained craftsperson/artisan relies on the ultra-wealthy for their lively hood: second and third homes--no matter how repulsive in terms of over the top opulence-- provide a means for those in the building trades to make a living. Some of us--I am an European trained and guild elected master carver--entered these trades because we felt an affinity for beauty and quality. And to work honestly with our hands, striving to reach the rarified skill of a Veit Stoss of Grinling Gibbons. In other words, for the love of the art and the lineage. Lately work has been extremely sparse; the very wealthy with their half- built home projects on hold, presumably waiting for better days. For the independent craftsperson this wait often means the difference between business survival or going under.

When work is abundant the life of a self-employed artisan is both exhilarating and terrifying. Exhilarating to wake up in the morning, turn your favorite music on and work at something you truly enjoy. One of the great joys is the simple act of seeking to improve and further hone your skills. It is a lifelong quest--the journey is the destination as the saying goes. But terrifying in the sense that deadlines can be smothering beyond belief. And also terrifying if a client does not like your work, in which case you probably will not get paid. And even if the work is a spectacular success, artisans often have to wait a excruciatingly long time to receive pay. Some of the wealthiest clients are the slowest paying.

Very few walk the free market high-wire like self-employed artists. Many high-end shops with hundreds of thousands of dollars worth of machinery and equipment bought on credit will simply cease to exist. These shops are simply auctioned off, much to the delight of weekend tool collectors everywhere. Those who survive are extremely lean and with very low overhead. Sometimes it feels like one is in a very lonely desert, with no water anywhere to be found. Fortunately, it does not take a lot to keep one or two people gainfully occupied with work.

Art galleries also suck on the tit of the wealthy. And many of them are out of business. Even in towns like Sante Fe, Taos and Aspen.

How all of this eventually plays out is beyond my comprehension. I do know for those lonely souls plying a trade or painting a canvass there will be no helping hands offered. But then again, when was that ever the case. Many times in the past the phone does not ring for months and then suddenly there is so much work that seven days a week and twelve hours a day is the life for months on end.

I have a real sense that the long hour days are over, or at least for a good long time. A hand carved Art Nouveau fire surround is the last thing anyone needs in times like these. In fact, who really needs anything at all when it comes to luxury items.

As far as self-employed artisans, many will cease to exist in terms of occupation. These are dark days for painters, sculptors and others involved in the high-end building trades and arts. Many of us knew we were committing economic suicide when we initially answered the call of our occupational yearning. But many of us also believed the implorations of Joseph Cambell when he wrote to follow your bliss or risk dying a slow day-by-day death of the spirit. The writings of Cambell will have to provide the consolation for those of us in our fifties who are currently unable to afford health insurance as we wait for the next job to ring.

I do realize I was a selfish bastard when I chose this occupation so many years ago. I am sure my son would have prefered an accountant, lawyer or some other conventional field of employment for his father. He could never understand how someone like me, who made beautiful things for unbeliavibly oppulent houses, could suffer such dire economic moments in his life. Fortunately, he learned from my example and now he is another mouse on the wheel, around and around chasing the American dream. I am sure after I take my final breath under some desolate highway bridge more than one person will wag a told you so castigation at my very limited service.

So believe me, I do understand the disdain for the wealthy; however, I also realize there will be collateral damage when their ship sinks.

Anonymous said...

"I don't think America can exist without that dream."

Indeed. As reflected and said best in the movie Oh Brother, Where art thou?:

"You ain't no kind of man if you ain't got land." - Delmar O'Donnell

Anonymous said...

"We thought you was a toad"
--Oh Brother, Where art thou?

Anonymous said...

Dismantling the New Deal? Parts of the banking regulations were dismantled, but what else has been seriously dismantled?
Social Security? Nope.
Farm subsidies? Nope.
Arcane tax laws creating 3rd party health care? Nope.

Should I continue?

As for the socialism vs. fascism thing. FDRs moves in the 1930s certainly resembled fascism more than anything else. Again, the Austrian school recognizes this:

tooearly said...

you neednt worry about how banks will fair with this latest "save-the-poor-under-water-homeowner scam"
Take the much-vaunted $50 billion program designed to renegotiate mortgages downward for “troubled homeowners.”

From Hudson "Upon closer examination it turns out that the real beneficiaries are the giant leading banks such as Citibank and Bank of America that have made the bad loans. The Treasury will take on the bad debt that banks are stuck with, and will permit mortgagees to renegotiate their monthly payment down to 38 per cent of their income. But rather than the banks taking the loss as they should do for over-lending, the Treasury itself will make up the difference – and pay it to the banks so that they will be able to get what they hoped to get. The hapless mortgage-burdened family stuck in their negative-equity home turns out to be merely a passive vehicle for the Treasury to pass debt relief on to the commercial banks.

Few news stories have made this clear, but the Financial Times spelled the details buried in small print. It added that the Treasury has not yet decided whether to write down the debt principal for the estimated 15 million families with negative equity (and perhaps 30 million by this time next year as property prices continue to plunge). No doubt a similar deal will be made: For every $100,000 of write-down in debt owed by over-mortgaged homeowners, the bank will receive $100,000 from the Treasury. Government debt will rise by $100,000, and the process will continue until the Treasury has transferred $50,000,000 to the banks that made the reckless loans.

Anonymous said...

So.... long time reader, and of TOD.

My wife wants a nest. A house of her own (that the bank will really own). Sadly, our marriage hasn't been without issues, and this is shaking up to be a pretty big one. She claims I'll never commit. I just REALLY don't like the current market. Right now, we could "afford" (debt-to-eyeballs) a nice 2/3 bedroom house in a not horrible part of town, in the 80-90k range.

Considering this is the midwest, winters are bone chilling cold, and all of the houses in our price range in the area, seem to be built in 1890-1910. Insulation values are laughable. Heating bill for a coworker in similar housing is $800 a month in winter.

For another 50-60k, that I don't think we could get approval for... especially not in this credit market, we could get a house built in the 50's. Built in garage, basement storage, insulation, wiring that isn't prehistoric, etc.

Any idea what timeframes might be for those 150k houses to drop into the 80-90k range, or hopefully... even lower.

My wife doesn't care for economic news/finance news.... says thats "My Job" yet doesn't seem to want to hear any bad news... doesn't want to hear anything other than "Yeah, lets go buy that house"

Sadly, I may be running out of time. Hopefully things get bad enough fast enough for reality to sink in for her.

The whole $8000 tax credit seems to be against me as well, but at least that would cover me for the first 10% of losses.

(Will someone PLEASE make the DOW drop a thousand points or so next week so that FINALLY we get some real "OMG!" gloom and doom on the mainstream news? Or maybe some accurate numbers on teacher layoffs with all the new budget cuts in the media?)

Unknown said...

Everyone should own their home otherwise you're no more than a serf living somewhere at the leisure of the owner class. Unfortunately that is the situation we have now too, getting a house in exchange for a life of indentured servitude to the bank.

Anonymous said...

investment tips: I'm all for caps. It's one of the things I happen to have a surplus on and apparently, we are short on them everywhere else...


Anonymous said...

Off in the weeds.........Ownership of land, title to it, is conferred by government. This is a foundational issue universally ignored by all but it is of particular interest in regard to Libertarians.

In point of fact there is no ownership of land without government. There can be occupation of it or possession of it but the Indians didn't own any land in North America. No tribal people anywhere ever owned land in a legal sense

Except for exercising eminent domain government here does not expropriate title, but it could. The do if taxes on it are not paid. The purest expression that ownership is granted by government.

In the beginning when civilizations started the king owned the land and could give title of it to others. Later governments owned the land and confirmed title.

Followed to logical conclusion Libertarian ideal would make land ownership a matter of possession, by force if necessary.

scandia said...

Just heard on CBC radio a poll result that 62% of Cdns believe the economy will turn around this year. Also believe out leadership will solve our problems.
Re anon with wife who wants a strong friend. Go to the mirror and practice saying, " I love you. No I am not going to buy a house at this time." Say it over and over again. If she wants a house more than you its best to face/accept her decision.No doubt many relationships are in crisis when the white picket fence fantasy doesn't materialize.Adding to the burden of debt will not enable you and your wife to address the issues you refer to.

~J~ said...

@ Anon 1.32, thanks for the beautiful post. fwiw, even after reading your woes, I wish I'd followed my OWN dreams rather than playing the American dream game.
wishing you the best~

el gallinazo said...

Anon 5:18

Last time I owned a house was in 1982, when I lost it to the ex in a bitter divorce. That was 27 years ago. While I have had multi-year live together relationships since then, I have never remarried. Your post makes me rationally exuberant about that course.

Before you buy a house, you should practice catching falling knives with your bare hands. Perhaps you can get your wife to assist you in this matter. If you buy a house now, you will surely lose it within the next three years, probably sooner. I&S predict with great confidence (and their predictions are invariably correct if one disregards exact timing), that domestic housing will trough out at 10-20% of peak nominal prices. I&S make it quite clear that you should rent unless you can buy a house free and clear of debt. They have been over this many times. Check the primers on the home page. No one can explain things more clearly than Stoneleigh - she is a master teacher.

The only reason one may consider buying a house now is if you have the money to buy it clear and the energy to convert it to a proper "doomstead," efficient and off the grid. The extra time for preparation might compensate for the higher pricing relative to down the road. Anything else is suicidal. Properly insulating existing houses is not huge unless they have plaster and lath walls.

I Kahn O'Clast said...

I love this blog and am an avid reader of it. But today's commentary was a bit off the mark. The price of a home cannot only reflect the cost of building it (as a toaster might) but must also reflect the value of the land (a scarce resource in many places, particularly where it offers additional value in proximity to work, desirable community, or other features that provide people joy (oceans, wilderness, what have you).

And this additional value must also reflect the likelihood of more scarcity of same in the future as well as some forecast for higher building costs in future given that it is something to be lived in for decades at a time.

Yes, houses depreciate and need to be maintained and recent prices have been out of whack. But to say they should only reflect the cost of building is so very off the mark, you threaten to lose credibility.

Unknown said...

For those how [sic] doubt the truth of that please read a bit on free markets by economists like Mises, Hayek, Hazlitt, and others.

The Road to Serfdom was right - collectivism leads to tyranny. Too bad the other options lead to tyranny, as well. Man is man, and regardless of the system the powerful will seek the means to subjugate the rest, one way or another.

And please don't try to blame today's ills on FDR. Not to say FDR was right or good, but that short-sighted decisions based on greed over the past three decades have had much more to do with the current mess than the mistakes of the 30's.

el gallinazo said...

I think the PPT will make itself obvious shoring of the equities market today.

Submit your advice said...

a. don't buy the house, that's madness

b. would you settle for a 500 pt drop in the dow? I figure it'll go there and then languish around 6800 or so til the late spring layoffs hit hard (teachers at end of school year, and lots of other public employees), which will knock it down into the 5000's, after which we get that big giant sucker rally, in which people will get a final chance to get out of their mutual funds in the retirement plans, so at least they get something out of it. You'll know when the time is right because every article you see will be about "it's time to start putting even more money into you plan." Turn to cash and walk away.

Anyway, now that dow went below 7400 low and S&P went below 800, and there appeared to be no support or technical buy order bounce off of those levels (is it my imagination or is there a lot less program trading these days?), I'd be curious to see Stoneleigh's feelings about the next few months in equities.

Anonymous said...

@anon: 12:47 AM. That was well written. Thanks for posting that.

"Too bad the other options lead to tyranny, as well. Man is man, and regardless of the system the powerful will seek the means to subjugate the rest, one way or another."

That's why we have the enshrined right to have guns. All political power starts from the barrel of a gun, as one of the worst tyrants and mass murders in history (Mao) noted.

And why all tyrants want to take them away.

On a different note, here's something for those facing foreclosure:
Homeowners' rallying cry: Produce the note

"Kathy Lovelace lost her job and was about to lose her house, too. But then she made a seemingly simple request of the bank: Show me the original mortgage paperwork.

And just like that, the foreclosure proceedings came to a standstill.

Lovelace and other homeowners around the country are managing to stave off foreclosure by employing a strategy that goes to the heart of the whole nationwide mess.

This should be interesting.

Stoneleigh said...


I'd appreciate it if you could suggest how much (%) I should offer Wells Fargo on a short sale of a house that is about to be foreclosed. I figure that I may as well spend my nestegg doing good works now, before TSHTF and hyperinflation makes it impossible. I'm helping a family keep their home. (Mine is paid off already.) I read in the Business Week article How Banks Are Worsening the Foreclosure Crisis: "Foreclosure proceedings typically cost banks about 50% of a property's value. That's assuming the home can be resold -- not a certainty when empty houses multiply in a neighborhood." Since real estate values are still collapsing, I figure less than 50% is fair. The neighborhood is one that was targeted for predatory loans.

That's very noble of you, but it's something to think long and hard about. For starters, your money isn't about to be inflated out of existence - it's about to become more valuable thanks to deflation. The money you would spend now would buy an awful lot more house later when property prices have come down.

Would you own the other house outright and let the family live there as tenants? Are they close friends or family? Is the place physically close to where you live yourself? Helping others who are in trouble by pooling resources can be a great thing to do if you can afford it, if you are close to the people in question, and if it allows you to keep the pool of resources relatively close by.

However, this isn't the time to take risks if you aren't quite secure yourself, and that means more than having your own home paid off. It means having thought through your vulnerabilities and how you might address the needs of yourself and those who live with you. It means having a supply of cash and cash equivalents under your own control, and having some control over the essentials of your own existence. If you can get yourself into such a position then you will be very well prepared indeed to help others down the line.

Anonymous said...

We're not in a bear market anymore folks. We're in a scare market now! Hold on to your hats.

Anonymous said...

Anonymous @ 5:18am

You aren't listening to your wife. She doesn't necessarily want a house RIGHT NOW, she wants you to COMMIT to buying a house. So commit then. Open a savings account and tell her that you both will start saving for the house you WANT because you will never be happy in a house you DON'T want or CAN'T AFFORD. Once she sees the quality of the house you CAN buy going up because of saving and dropping home prices she will be content to wait and work toward buying your dream home.

Stoneleigh said...

Anon @1:32,

Some of us--I am an European trained and guild elected master carver--entered these trades because we felt an affinity for beauty and quality. And to work honestly with our hands, striving to reach the rarified skill of a Veit Stoss of Grinling Gibbons. In other words, for the love of the art and the lineage.

There a lot to be said for the pursuit of beauty and craftsmanship, although as you say, it doesn't necessarily lead to stable employment. I would probably spend a great deal more of my time in similar pursuits if I really felt had the choice, but for now I need to write (and do the tasks I am being paid for). I'm hoping to do a lot of spinning, knitting, crocheting, sewing, weaving etc once what I do now is no longer possible.

When work is abundant the life of a self-employed artisan is both exhilarating and terrifying. Exhilarating to wake up in the morning, turn your favorite music on and work at something you truly enjoy. One of the great joys is the simple act of seeking to improve and further hone your skills. It is a lifelong quest--the journey is the destination as the saying goes.

Beautifully put.

I have a real sense that the long hour days are over, or at least for a good long time. A hand carved Art Nouveau fire surround is the last thing anyone needs in times like these. In fact, who really needs anything at all when it comes to luxury items.

Actually, the ultra rich will probably develop an even greater taste for the very fine things in life, as they did in the Great Depression. There will be far fewer of them though, so finding someone to buy your wares will be much harder. You may need to be even more up market.

In a depression people can sell the basics to ordinary people (those who still have enough money not be be among the destitute), sell very high end luxury goods to the exceptionally wealthy, or produce cheap entertainment and other forms of escapism. (Sadly, people will drink to escape their reality even if they and their families can't afford to eat.) There will be very few depression-proof, or even depression-resistant forms of employment though. Most artists will be very poor.

But many of us also believed the implorations of Joseph Cambell when he wrote to follow your bliss or risk dying a slow day-by-day death of the spirit.

Again, beautifully put.

I do realize I was a selfish bastard when I chose this occupation so many years ago....

....Fortunately, he learned from my example and now he is another mouse on the wheel, around and around chasing the American dream.

How sad. You will have something wonderful to look back on, but the rat race has little to offer the young except perpetual debt slavery.

I am sure after I take my final breath under some desolate highway bridge more than one person will wag a told you so castigation at my very limited service.

I won't be one of them. Beauty is a worthy goal, whether or not it earns you a living. I wish I had an opportunity to see your work.

Zaphod said...


I've owned rent houses and I've owned houses that I've rented at a loss to friends and family.

Those that rent to family are a source of friction, as even once you accept that you're willing to take a loss it's hard not to negotiate the degree of that loss. Let's say you say "pay for upkeep", but does that include new carpet in 5 years, half a new roof in 10, or a new HVAC in 15? How about damage versus wear and tear -- who decides? Who handles lawn care? What if you later need to sell -- what friction does that cause?

For friends or strangers its even worse. For a couple of years we had extra cash, and rented a property at a heavy loss (1/3 of value) as a charity. In three years we got the house back with no normal upkeep inside or out and $15,000 in damages (pets ruined the carpet despite a "no pets" rule, walls and doors had holes, appliances were all broken (stove, oven, microwave, dishwasher), fireplace glass doors were broken, ceiling fans had blades broken off, 4 windows were broken, fence gate was torn off, etc.)

Renters are not like homeowners in thought or deed, and subsidized renters are more like denizens of the projects, and they typically take more effort and cost you money as well.

I'm painting with a broad brush, and YMMV, but I would at least charge enough rent to cover the taxes, insurance, upkeep, repairs (including future ones like roofing), and get a damage deposit plus some return on your investment. If you want to give them the house, that's your business, but no way would I ever own one and rent it for free to a non-family member.

Stoneleigh said...

Someone asked me my current view of the market. I think we're looking at a developing spike low driven by fear. We should see some apocalyptic headlines over the next month or so as a result, as the fear that drives the market lower will also be all over the media. Fear is extremely catching. My best guess is that the market will end up somewhere in the (low?) 6000s, before rebounding in a large sucker rally.

The rally could last several months and should be accompanied by considerable optimism by its end. I can imagine people patting Obama and his team on the back for saving the world, just before the next phase of the decline sets in. And that next phase should carry the market down much further than anything we've seen so far. By the end of 2010 I'd be surprised if the DJIA was still over 1000.

Anonymous said...

Dr doom expects the index to reach 11,000 by the end of the year. That means a rise of some 40% at todays number of 7900.

I'd like that but I'm not holding my breath.

Stoneleigh said...


I've owned rent houses and I've owned houses that I've rented at a loss to friends and family.

I've had a similar experience to yours. The house I got back (that I'd been renting at a loss to a friend) was in terrible shape and cost me a lot of money to fix up before I could sell it. This was quite some time ago, when it was much easier to sell properties. Now it would be worse. There are tenants in the world who write their phone messages on the walls in crayon.

Good tenants can be hard to find, but when you do find them it can be a really good experience if you avoid the pitfalls. I wouldn't want to be a landlord now when the pitfalls are loomign so large, but ironically I'm happy to share my own place. When you live communally you're all in it together and everyone is equal.

When you're a landlord it's either a business or a favour to someone with perhaps a business element. If it's a business decision then its the wrong one when property prices are about to fall off a cliff. If it's part business and part friendship or charity then it's very risky. The business aspect won't work out and that could put a huge strain on the friendship. Any kind of loss-sharing arrangement is likely to be fraught with problems, and the other part may well resent being expected to share losses at all if they have less than you do. Living communally takes the business element out of it completely, and I prefer it that way.

From the point of view of a prospective tenant, if you are a good tenant you will be highly valued by your landlord. I have one friend who works as a builder and who makes a point of improving every home he rents. He'll always have a roof over his head as anyone would be happy to rent to someone so responsible and thoughtful. His rent never goes up because landlords want so much to keep him there looking after their property.

In general, renting is paying someone else a fee to take the property price risk for you. It's a great deal for renters right now and a lousy deal for owners. Ownership is only a good idea when either property prices are set to rise or you have enough to pay for the property outright in any case, and it's the sort of place you wouldn't mind being stuck for a long time.

Stoneleigh said...


Dr doom expects the index to reach 11,000 by the end of the year. That means a rise of some 40% at todays number of 7900.

A rise of 40% is quite possible for a major rally. In fact counter-trend moves can commonly retrace over 60% of the preceding decline, and less commonly can retrace up to nearly 80%. In this case that would mean retracing a large percentage of the decline from over 14,000 to wherever the Dow ends up at the end of this phase of the decline.

I don't think we'll see the index up there by the end of the year though. We my see it in the summer, but I think the rally will be over by late summer and the market will probably crash again this autumn. By the end of the year I think it will be much lower. As always, rallies represent an opportunity to cash out at an advantageous rate before the decline begins again.

Anonymous said...

Anon. @1:32,

I think you chose the better path.

The most unhappy and shallow people I've ever met are those who chose careers based on the money they thought they would earn.

Do not feel responsible for the path your child has taken. He may have chosen his present path if you had been an accountant. Also, his life is not over. Ultimately, your example might be an inspiration to your son.

Yes, and I think none amongst us will escape suffering.

Be happy ...

Anonymous said...

Anon 1:32 am

Thanks, again for your post from an artist's viewpoint. (I assume you are the one who posted the quote by Robert Henri the other day.) I am also a Joseph Campbell fan, and recently read "The Hero's Journey" by Phil Cousineau. Campbell lived from 1904-1988. In his later life, he made some brilliant comments about how economics destroyed culture, mythology, and society (especially in the US). He would enjoy watching our current crisis unfold, as he looked at everything from the view of the big picture.
IMO we're on a trajectory that can't be changed right now. How gloomy we choose to be about it is up to each of us. In that regard, I think that you, artist, will do well, because you will continue to find beauty around you no matter what. It is a given that there is suffering in life, as there always has been and always will be, and most likely we will all see suffering far beyond anything we've ever know in our pasts.
Yesterday, I saw a raven doing tumbles in the air in a mountain canyon before resuming flight about 30 feet above the ground. That's what life is all about.


Anonymous said...

Is home ownership a good thing? No offense man, and I love your blog. I read it every day. And look, all your points are well taken, but I just can't agree with your main thesis. It is clear to me that you have probably forgotten more about economics than I ever knew, but it seems like - to me - that it wasn't necessary to be a an economics genius to avoid getting screwed in all this.

In 1998 I took a look around and saw that money was piling up in real estate, and that credit was getting really loose so I bought my first house. By 2003 I owned 5 houses, and started selling them while buying a few more, and then selling them as well. Long story short, I made a shitload of money on all that that easy credit, and then got the hell out. Having been born at the end of the baby boom - 1958 - I learned to expect that everything would turn to shit in fairly short order - story of my life - so I was nervous as hell the whole time.

Yes, it is true that anytime you stack up a great big pile of money for whatever reason, the pigs, the sharks, and the sheep will cluster around along with everyone else.

BUT - and this is a big but - if it weren't for the (few) real estate investments I made in my life - made possible only through the stunning magic of easy credit - I would be so financially screwed beyond recognition right now that I would be a walking punchline to a very bad joke. I came from dirt-poor, and not very well educated people, and I am damned glad that real estate + easy credit made my life what it is today.

I own my house outright, and I'm sitting on a shitpot full of cash money - enough to last the rest of my life or at least as long as the dollar stands. Nothing I ever did - no matter how goddamned hard I worked, or how smart I played the game, could have done this for me. Everything else that I ever touched has turned to shit, hopefully not because I touched it, but fuck, it if that's the case then I'm sorry - joking.

Surely I'm not the only one. Many of us who can read, and can also think, saw this shit coming and cashed out in early 2006, right? Right?

Greenpa said...

Anon 1:32; outstanding contribution to the discussion.

Extreme wealth is frequently cited as necessary for "real civilization"; both needed to fund our huge projects, and needed to support art.

I really wonder, though. My own preferred model for living is closer to Thoreau's philosopher's cabin, and Gandhi's simple community. I'm happy here, and I do think others can be- though it requires some education, and a well developed resistance to advertising aimed wholly at generating discontent.

Philosophers certainly can/do appreciate beauty. What would you think of a model where you moved from one cabin to another- and they fed, housed, and cared for you while you created something for them?

Nope, you'd never make enough money to buy yourself a Bentley; but the cabin dwellers would never have one, either.

Could you, and other artists/artisans be interested in that sort of life?

Ilargi said...

”I Kahn O'Clast said...
I love this blog and am an avid reader of it. But today's commentary was a bit off the mark. The price of a home cannot only reflect the cost of building it (as a toaster might) but must also reflect the value of the land (a scarce resource in many places, particularly where it offers additional value in proximity to work, desirable community, or other features that provide people joy (oceans, wilderness, what have you).

The land has its own value, which has nothing to do with teh house, no matter that at times they can be part of the same deal. The rest are subjective preferences that are not shared by everybody. Moreover, that’s not what I was talking about. Which is the added "value" generated by a) the financial system and b) the government's meddling where it should not (since it drives prices up).

And this additional value must also reflect the likelihood of more scarcity of same in the future as well as some forecast for higher building costs in future given that it is something to be lived in for decades at a time.

A home price must reflect future building costs? And what would those be? Got tea leaves? Why would they be higher?

Yes, houses depreciate and need to be maintained and recent prices have been out of whack. But to say they should only reflect the cost of building is so very off the mark, you threaten to lose credibility.”

I’ll gladly take that risk.

Anonymous said...


Thankyou for your insightful Market projections. I always look forward to your comments they are very enlightening.

Bigelow said...

A guess 754.37 looks to be the near term low on the S&P. Now for that sucker rally...

Anonymous said...

"By the end of 2010 I'd be surprised if the DJIA was still over 1000."

Stoneleigh your message comes through very clear and striking. Thanks for your honesty.

My husband and I made our way into the middle class about 12 years ago. I realized yesterday that we are poorer than we've been in many years. The edges are tighter-- we've lost about 30% of our income over the past year. For the first time in about 12 years I feel poorer. I'm sure I am a barometer of many middle class families.

I know what is coming is worse and this is just a taste. So I think I'll invest in some piano lessons for our little daughter-- music seems as good an investment as any...

Nate H said...

Ilargi:What killed our capitalist system is the inclusion of basic human needs in an economic system based on speculative games.

This is well said. IF we are going to have the speculative games, they should be outside and separate from basic needs. But if all we had were basic needs, some charismatic hominid somewhere would want some speculative games instituted. History repeating, etc.

Anonymous said...

“Follow my logic here - I'll put it up as bullet points:
• October 2007 the Dow closed at 14,066.01
• Since it's now 2009 and the Minneapolis Fed's inflation calculator has been updated, we can see that in order to just stay even with inflation, the Dow would need to be at 14,820.13 today.
• Which means: When we cross 7,410.065 this morning, on an inflation-adjusted basis the...


Come on! Do I have to do all the thinking about this stuff? The way I got it figured is this: At some point more than just ol' George is gonna figure out that half their retirement dream has collapsed in the past year and a half.”
George Ure, UrbanSurvival

Sandor said...

Thank you to Ilargi, Stoneleigh, and the comments. This blog has really opened me up in a big way. I am doing my best to pass it on to those near and dear to me.

We live in a profoundly strange world, in which alternate parallel realities of perception exist side by side. This thread helped remind me how even such basic values as "home ownership" are based on unspoken assumptions about collective organization. And how important it is that we learn to dream for ourselves.

Stoneleigh said...

Anon @1:37,

BUT - and this is a big but - if it weren't for the (few) real estate investments I made in my life - made possible only through the stunning magic of easy credit - I would be so financially screwed beyond recognition right now that I would be a walking punchline to a very bad joke. I came from dirt-poor, and not very well educated people, and I am damned glad that real estate + easy credit made my life what it is today.

The financial benefits of home ownership, as with any asset class, are largely a matter of timing. When society stands at the beginning of a huge credit expansion, buying anything and everything on credit is a winning strategy. Inflation eats away the value of the debt and you end up vastly better off IF you get out before things get ugly. Most people hang on too long and lose all their gains.

During expansionary times, you want to be an owner in order to benefit from asset appreciation, and if you rent you will lose out relatively speaking. However, during an epic property price collapse the opposite is true. Owners will lose far more than renters. Renters who manage to look after their liquid assets, and not lose them in a bank holiday or stock market crash, will have enough liquidity to buy any property they want later on.

Of course a home is about far more than financial benefits, but there's no point thinking in terms of those other benefits if you have to overreach yourself so far financially to achieve them that you will lose the home anyway. If you can afford a home outright and can still cover other preparedness-for-severe-economic-disruption bases then by all means do so. If you can make it a homestead then so much the better. You will lose money, but you will have the other benefits of ownership and should be able to keep them.

Most people are far more over-reached financially than they realize. Mortgage payments that seem reasonable now will not seem so if you lose your job and cannot find another in an era of exceptionally high unemployment. They won't seem reasonable if interest rates skyrocket, as they eventually will in the coming (but not imminent) bond market dislocation. If you have to move to where the work is and cannot sell, then being tied to a property won't look like a good idea either.

Stoneleigh said...

The over-pricing in housing went so far that the under-pricing to follow will be quite something to see. For a while most homes will probably be worth less than the cost of the raw materials it took to build them, as much of the suburban over-build was an exercise in negative added value. Of course there are always local variations, but on average housing prices should fall at least 90%. Owning an 'asset' with that kind of future, especially if it was purchased on margin (ie with borrowed money), is something one should think long and hard about.

Eric_Olson said...

Remember that "real estate" has two components: land + improvements. Improvements rarely go up in value on their own. Land does, in large part due to aggregate demand and the locational benefits of a particular site. Aggregate demand in an urban region grows (and declines) with income and population growth (and decline). Almost everybody in a metropolitan region is a land speculator, but chief among them are the landed elite, the media, and local political actors. They constitute the Growth Machine whose reason for being is to elevate land values. The classic paper on this is:

Anonymous said...

AR - I admire your charitable aspirations but don't forget that no good deed goes unpunished.