Friday, April 24, 2009

April 24 2009 1: Fool's Gold for Fair Value

Edwin Rosskam Fair Value January 1938
Interior of workers' shack. Porta de Tierra, San Juan, Puerto Rico

Ilargi: Barry Ritholtz today writes The Elusive Housing "Fair Value", a proper warning on the future of US home values, with proper-looking arguments. But, like the vast majority of writers do who come from the financial world, he misses out on the major, and in the end only, underlying reason why home prices will -have to- keep on falling: there is no credit left in the system.

Where does that blind spot come from? Perhaps it's the fact that it would force these people to contemplate a direct threat to their own livelihood, which might not survive a real downfall. Nevertheless, the factors Ritholtz mentions all originate in disappearing credit, though we need to question whether unemployment has anything to do with the fair value of homes in the first place.

I’ll keep on repeating that in my view fair value in the end can only be determined by the cost of building a home, but I realize that one can still be -too- hard to swallow for many who've been versed in the ideas behind "the markets".

What should be easier to wrap their minds around is that US home prices would have been much lower already today if not for the trillions pumped into banks and other lenders, as well as- and most of all- if there wouldn't be a government that buys, with taxpayer's money, the risk of mortgage loans -and securities- from lenders through its semi-agencies Fannie and Freddie. That is to say, home prices are still way above anything resembling true fair value because the American public at large guarantees any losses on loans for homes bought at artificially elevated prices.

Hence, it is the American people themselves, poor as they are getting, who keep home prices much higher than they should be if "fair value" were to be calculated in a "fair" way, and who keep banks and lenders in the housing business. Which in turn means that those who take out a loan to buy a home these days (not a smart idea, let's be clear about it!), pay far more than they otherwise would, simply and only because their own tax money is used to keep prices high. The main beneficiaries of this price warp? Why, the banks, of course. Yes, I've said it before: this is as perverted as it gets.

But even this ultimate scam won't hold, and the reason for that is what I started out with: there is no credit left in the system. All the government can do is to artificially prop up the system, and that can necessarily only be temporary. Then Fannie and Freddie will collapse, the taxpayer will be on the hook for trillions more in losses, and home prices will fall till they are at least 80% below their peak. Existing homes will then sell for less than it cost to build them, and new construction will be virtually non-existent.

Still, even for those who choose to keep on insisting that a home is worth what the market says it is, or in other words what a fool will give for it, it doesn’t make any difference anymore, does it? There are no more fools left with money. Or credit. Or gold. No more fool’s gold.

PS: In the headlines today:
  • South Korean economy shrinks 4.3 percent in 1st quarter (Forbes)
  • South Korea Economy Avoids Recession, Grows 0.1% (Wall Street Journal)

The Elusive Housing "Fair Value"
Over the past few years, I have frequently referred to US housing as over priced and over valued by traditional metrics. These include:
  • Median Income vs Median Home Price
  • Ownership Costs vs Renting Costs
  • Market Value of Housing as a percentage of GDP
  • Housing Inventory Supply vs Sales Rates
During the Housing boom and credit bubble, prices moved several standard deviations away from the norm to extremely over bought, over valued levels. As prices have come down, these metrics are getting closer to typical levels. They remain elevated, but no longer outrageously so, as they revert back to historic means. Those who are now calling a housing bottom (despite having done so for years) are finding comfort in this mean reversion. They shouldn’t — and for three reasons.

The first is that asset classes which become wildly over-priced do not merely revert to the mean — they tend to carom straight through the mean, eventually becoming significantly under-valued. You see, if you only spend time above the mean trend line, and never below it, well then, that cannot possibly be the "mean" — the line down the middle.

Second, we know the recession plus a glut of foreclosed homes creates a "self-reinforcing cycle." Job losses and income decreases lead to more distressed sales, with prices especially pressured. Falling prices make put mortgage holders underwater — holding homes worth less than the mortgage. This leads to walkaways, jingle mail, and even more foreclosures. All of this adds up to an even greater excess supply of homes for sale. More supply equals lower prices. The entire vicious cycle continues.

But the third issue is the biggest one of all. Its something we touched upon previously in NAR Housing Affordability Index is Worthless. None of the factors outside of price and interest rates are constructive to home sales. Outside of the $8,000 buyers tax credit, all of the rest of the factors impacting sales are deeply in the red:
  1. Employment: Job losses and unemployment data remain at deep recession levels;
  2. Down Payments: Surprisingly few buyers have a cash down payment of 20%. Unless we go back to LTV of 90 and 100%, that reduces the pool of qualified mortgage applicants.
  3. Debt servicing: Many mortgage applicant do not qualify in terms of 25% of monthly gross income available to pay for Mortgage Principle and Interest. This is a function of the prior debt binge — credit card, HELOC and auto.
  4. Credit: Lots of potential buyers damaged their FICO credit scores in the last round of leverage;
  5. Non-purchase costs: have risen dramatically. The biggest being local property taxes, and energy. The silver lining is energy prices are more reasoanble lately, and thanks tot he recession, maintenance and repair costs (especially labor) are the cheapest they have been in years.
All of these factors only go to buying a house. The bottom line: An increasing number of families no longer qualify for a standard conforming mortgage. We are still no way near a bottom in housing . . .

Fannie Mae Creates Housing Mirage With Bum Loans
Give money away. That was a solution to the housing crisis mortgage giant Fannie Mae hit on last year. Faced with growing numbers of homeowners unable to make mortgage payments, Fannie decided to fund loans to borrowers that were instant losers. The point was to buy time. Even though those loans resulted in a $453 million loss, they helped keep troubled homeowners from defaulting. That meant Fannie for now didn’t have to make good on loan guarantees that may have cost it as much as $2.4 billion. The big game of kick the can strikes at a deep-seated fear among many investors -- that banks and others faced with mounting housing losses are finding all manner of dubious ways to push a day of reckoning into the future.

If that’s the case, any improvement in the housing outlook might be a mirage obscuring even greater pressures building in the financial system. That would eventually counter better-than- expected first-quarter results from many banks. Investor angst was made worse by the knowledge that the government is leaning hard on banks to modify troubled loans any way they can. Prevent foreclosures and worry about the consequences later is the mantra of the day. In a perverse way, there is some logic to such maneuvers. Today’s troubled borrower may be in better shape if given time to wait for fractured markets to heal. Or, if today’s losses can’t be cured, the company facing them may be better able to deal with them at a less-stressed future date.

Still, that’s a big gamble. Markets may not rebound as quickly as some investors expect, meaning time might not heal the wounds of borrowers who can’t meet payments today. That would leave them in even worse shape in the future. And by failing to deal with problems now, financial institutions may cause them to grow even bigger. That’s sure to lead to nasty surprises down the road at individual banks. It also promises to lengthen the economic slump by preventing markets from finding natural bottoms that allow excess inventory to be sold.
Fannie’s program shows how potentially big losses are still festering within the system, unbeknownst to investors. Known as the “HomeSaver Advance” plan, Fannie used the program to provide “foreclosure prevention assistance to distressed borrowers,” according to its 2008 securities filing.

The plan entailed Fannie funding loans to help distressed borrowers get current on their mortgage payments. Fannie said there were about 71,000 advances made in 2008 with an average value of $6,500. Fannie funded $462 million in such loans during 2008. The company tells investors in notes to its financial statements, though, what it thinks the loans are actually worth. Based on market prices, Fannie said the loans had a value of just $8 million. That’s right, the loans, which are in many cases just months old, were worth 1.7 cents on the dollar.
In a footnote, Fannie said there were several reasons for the huge markdown. Among them: the loans aren’t secured by any collateral; and they are second loans, or liens, that serve as catch-up payments for borrowers who can’t pay their primary debt. This is reminiscent of the piggyback loans given out during the housing bubble to home buyers unable to come up with the usual 20 percent down needed to buy a house. Deals like those led to big losses.

Granted, the HomeSaver Advance program isn’t a general loan modification program. It’s targeted at people who were current on payments and due to a big event like a divorce or loss of a job fell behind. The loans are meant to get them over that hump. Still, these borrowers are probably at greater risk of future financial problems. And if Fannie wasn’t able to get them current, it could face even bigger losses. Because it has guaranteed the mortgages, Fannie would have to repurchase them at their full value in the event of a default. After doing that, Fannie would have to work the mortgage out, likely selling the home, to recoup value. Because of the housing crunch, such recovery values slumped during 2008. Fannie’s loss on such repurchases rose to 56 percent by year’s end from 40 percent at the start of 2008, its filing shows. For the year, the loss averaged 49 percent.

Based on this average loss, and using an average mortgage value of $175,000, Fannie would face a loss of about $2.4 billion if it had to repurchase the 71,000 loans covered by the HomeSaver program. Not to mention that having to process 71,000 additional foreclosures might further depress real estate prices, driving Fannie’s recovery rates even lower. Be that as it may, Fannie’s sobering writedown of these loans shows that even it knows the program may be an exercise in futility. The likelihood is many of these loans will go bad anyway. The housing market will have to deal with that one day. In the meantime, Fannie is simply burning taxpayer dollars to create a housing smoke-screen.

Wall Street’s 1929 Scams Return in Geithner Plan
What would Ferdinand Pecora do? Thirty-seven years after his death, the name of this former assistant district attorney from New York suddenly is on a lot of politicians’ lips. Starting in 1933, as counsel to the Senate Banking and Currency Committee, the Sicilian-born Pecora led a yearlong series of sensational hearings into the causes of the 1929 stock-market crash. The Wall Street scandals he unearthed spurred the creation of the Securities and Exchange Commission and the passage of the Glass-Steagall Act, which separated commercial and investment banking until its repeal in 1999.

Now, House Speaker Nancy Pelosi says she will push for the deepest congressional inquiry into Wall Street’s abuses since the 1930s, using Pecora’s investigation as a model. Before Congress proceeds, though, there’s one thing its members should do: Read the Pecora Commission’s 1934 report. Some of the abusive practices Pecora chronicled are similar to the machinations at the heart of the Treasury Department’s plan to revive the nation’s hobbled financial-services industry. To see how, let’s look at a 1920s-era scheme called a pool, which in those days was a common device for manipulating prices on the New York Stock Exchange.

A pool referred to an agreement between several people, usually more than three, to actively trade in a single security. The purpose, the Pecora Commission wrote, was "to raise the price of a security by concerted activity on the part of the pool members," enabling them "to unload their holdings at a profit upon the public attracted by the activity or by information disseminated about the stock." Some bankers claimed there was a difference between "beneficent" and "nefarious" pools. The good kind supposedly helped stabilize market prices, while the bad kind let swindlers make a quick buck. Pecora didn’t buy the distinction. Either way, these were not free, uncontrolled markets. "In all cases fictitious activity is intentionally created, and the purchaser is deceived by an appearance of genuine demand for the security," the commission’s report said. "Motive furnishes no justification for the employment of manipulative devices."

Compare that with Treasury Secretary Timothy Geithner’s latest proposal to help financial institutions remove unwanted loans and mortgage-backed securities from their balance sheets. Under the Treasury’s Public-Private Investment Program, the size of which could hit $1 trillion, the government plans to invest side-by-side with private investors who place bids on toxic assets that have plummeted in value. Those buyers, lured by federal loans and guarantees, might include affiliates of the same struggling banks and insurance companies the program is designed to assist. The Treasury program’s goal is to drive up prices and stimulate trading, so the financial institutions can minimize their losses and replenish their capital. Should the prices later collapse, taxpayers could end up with the vast majority of any losses.

As with an old-fashioned pool, one of the public-private program’s biggest vulnerabilities is that it invites collusion. That was one of the points made in a report this week by the Troubled Asset Relief Program’s inspector general. "In both the Legacy Loans Program and the Legacy Securities Program, the significant government-financed leverage presents a great incentive for collusion between the buyer and seller of the asset, or the buyer and other buyers, whereby, once again, the taxpayer takes a significant loss while others profit," the report said. One example from the report: Say a bank and a private- equity firm both agree that a group of the bank’s loans is worth $600 million. The private-equity firm, however, agrees to overpay for the loans and bid $840 million at auction. The private-equity firm invests $60 million, which the government matches with $60 million of TARP money, and which is leveraged by a $720 million loan guaranteed by the Federal Deposit Insurance Corp.

After the auction, the bank secretly pays the investor a $120 million kickback, or half the difference between the auction price and the real value. Even if the private-equity firm’s $60 million investment is wiped out, it still would get a $60 million profit because of the kickback. Meanwhile, the bank would make a $120 million profit, at taxpayer expense. "Of course, in practice, the collusive scheme would be far more complex and would likely involve a series of affiliates and offsetting transactions, but the principle would be the same," the inspector general’s report said. Similar collusion could occur in the program for mortgage- backed securities. Fund managers might agree to overpay for each other’s holdings, leaving taxpayers to bear the losses. So far, the report said, the Treasury Department hasn’t set up the systems it needs to ensure proper oversight, such as basic conflict-of-interest rules or disclosure requirements for the private-equity firms’ owners.

The main premise of Geithner’s plan is that the banks’ toxic assets are now priced at artificially low levels. As the federal bailout program’s Congressional Oversight Panel wrote in an April 7 report, "Treasury has not explained its assumption that the proper values for these assets are their book values," rather than the prices unsubsidized investors would pay for them. If Treasury’s premise proves false, we may end up looking back on the Public-Private Investment Program as an elaborate pump-and-dump game. Only this time, unlike with the pools that sucked in gullible investors during the 1920s, the big losers would be taxpayers -- who never had the choice of not playing. It’s hard to imagine that Pecora would think any of this is a good idea.

China's dollar dump plan to be G7 focus
While foreign exchange is unlikely to be the subject of bold public pronouncements when the world's most powerful finance ministers and central bankers meet Friday in Washington, China's call for the replacement of the U.S. dollar as the world's leading reserve currency is likely to be a hot topic behind closed doors, currency strategists said. Namely, foreign-exchange traders will be looking for any clues to discussions with Chinese officials as policy makers around the world attempt to piece together the implications of remarks by China central bank governor Zhou Xiauchuan in March for the eventual replacement of the U.S. dollar as the world's main currency with special drawing rights, the quasi-currency issued by the International Monetary fund.

The implication of such a policy would be a weaker dollar, as central banks move to diversify away from the world's largest reserve currency. And that's something that makes a number of policy makers, including officials from the 16-nation euro zone, nervous, analysts said. The prospect of a substantially weaker dollar is unwelcome to policy makers in the euro zone, Japan or other countries worried about their own exports. The main thrust of China's message is that it wants to diversify holdings of foreign exchange reserves in a way that more closely mimics the make-up of SDRs, said Simon Derrick, currency strategist at Bank of New York Mellon. That means going from reserve holdings that stand at more than 60% dollars to around 44%. For the euro, holdings would rise to around 34% from 31%.

"You've got to read between the lines all the time," said Stephen Gallo, head of market analysis at Schneider Foreign Exchange. Over the long run, euro-zone officials are going to be more worried about the prospect of a higher euro rather than a weaker euro, he said. "All these policy makers are worried about a snap back (to lower levels) by the dollar" as the United States ramps up borrowing, said Gallo. With export powerhouse Germany and the rest of the euro-zone laid low by a collapse in global demand, a rise in the euro would be unwelcome. Jitters over such changes may explain European Central Bank President Jean-Claude Trichet's reiteration last weekend of his support for the U.S. government's "strong dollar policy," Derrick said. Trichet's remarks appeared to be aimed at reminding U.S. officials of the need to follow a fiscally prudent path, he said.

G7 finance ministers and central bankers meet Friday afternoon in Washington ahead of this weekend's meetings of representatives of the International Monetary Fund. The bigger G20 group of policy makers, which includes China, is scheduled to meet later in the day. The G7 includes the United States, Japan, Germany, Great Britain, France, Italy and Canada. Reuters this week reported that an unidentified G7 source said Trichet and European Economic and Monetary Affairs Commissioner Joaquin Almunia would ask Chinese representatives about the SDR statements at the G20 meeting. With that in mind, currency traders will be picking over remarks by Trichet, Almunia and other officials for clues, Derrick said. But news reports indicate G7 officials don't expect the meeting to produce any major language changes when it comes to currency markets.

Euro-zone officials have little to complain about with the single currency trading near $1.30 versus the dollar, while the greenback has gained ground versus the Japanese yen since plunging below 90 yen last winter. The British pound, which drew the ire of French and other euro-zone officials, remains fragile but is well off its winter lows. The joint statement issued by the G7 at the February meeting of central bankers and finance ministers in Rome warned that "excess volatility and disorderly movements in exchange rates have adverse implications for economic and financial stability." Policy makers pledged to watch markets closely and "cooperate as appropriate."

Banks May Struggle to Raise Money After Stress Tests as Bad Assets Triple
U.S. banks that get preliminary results today of U.S. government stress tests may struggle to raise money after bad assets at the biggest lenders almost tripled on average in the past year. Pittsburgh-based PNC Financial Services Group Inc. saw nonperforming assets -- those no longer accruing interest -- jump more than fivefold in the first quarter from a year earlier. They more than quadrupled at U.S. Bancorp in Minneapolis. At 13 of the largest U.S. banks, bad assets increased 169 percent on average from a year ago, according to first-quarter data compiled by Bloomberg. The tests on the 19 largest banks are expected to focus in part on loan quality as a measure of health.

The lenders, which may need to raise $1 trillion in capital to cushion losses according to an April 23 KBW Inc. report, may have a hard time convincing investors to give them cash. "We’re really hesitant to put money into financials," said Douglas Ciocca, a managing director at Renaissance Financial Corp. in Leawood, Kansas, which has $1.6 billion under management. "The ambiguity is still engulfing the opportunity." The preliminary results will be disseminated to representatives of the firms by Federal Reserve officials in a number of meetings at central bank offices today, according to a person familiar with the matter. The Fed is set to release the methodology for the exams to the public today.

The Obama administration may ask banks that need more capital to disclose how they plan to get additional funds when the government releases final results on May 4. Loan defaults as of the end of last year were at the highest levels since 1992, data from the Federal Reserve Bank of St. Louis show, and could climb higher as the U.S. economy weakens. The number of people staying on jobless-benefit rolls rose by 93,000 to 6.14 million in the week ended April 11, the 12th straight week the figure has set a record, the Labor Department said. Commercial loans in default or foreclosure jumped 43 percent in the first quarter to $65.9 billion from $46 billion at year-end, according to New York-based research firm Real Capital Analytics Inc. Property values have fallen at least 30 percent since their 2007 peak.

Even if banks say their capital levels are adequate, the government could require them to raise more money, JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon said April 16 during the firm’s earnings conference call. "I don’t know what we need to do because it may not be solely up to us," Dimon, 53, said in response to a question about whether the firm was planning to issue new equity. "I don’t think we need it." New York-based JPMorgan’s nonperforming assets grew 185 percent in the past year to $14.7 billion, or 0.7 percent of the firm’s total. Bank of America Corp., based in Charlotte, North Carolina, said bad assets increased 229 percent to $25.7 billion. Problem assets at New York-based Citigroup Inc. rose 128 percent to $27.4 billion, and San Francisco-based Wells Fargo & Co.’s jumped 180 percent to $12.6 billion.

Goldman Sachs Group Inc. raised $5 billion in an equity offering last week to repay government rescue funds. The New York-based company didn’t disclose comparable nonperforming asset data. Investors and analysts have been debating which lenders may require help absorbing losses without full knowledge of how institutions will be judged. U.S. banks have reported more than $550 billion in writedowns, losses and credit provisions since 2007, according to Bloomberg data. Losses at both Citigroup and Wachovia Corp., which was acquired by Wells Fargo, have exceeded $100 billion. Banks have raised more than $400 billion from private investors and the government to guard against loan losses as mortgage defaults surged. PNC, which reported first-quarter profit of $530 million on April 23, said the increase in nonperforming assets was linked to economic conditions as well as the firm’s acquisition of Cleveland-based National City Corp. at the end of 2008.

"We’re comfortable with the balance sheet as it is," PNC Chief Executive Officer James Rohr said in an interview yesterday, adding that the bank isn’t worried about capital adequacy because it is mostly funded through customer deposits. "The economy is going to continue to get tougher" and "in this kind of environment you do continue to add to reserves just to be conservative," he said. As banks grapple with increases in bad loans, many are closely watching unemployment and other economic data to get a sense for how many more losses the industry may have to take, said Seamus McMahon, a financial services consultant who works with Booz & Co. in New York. "We’re still not out of the woods in terms of how much worse this gets," he said.

Fed's Bear Stearns Losses Dominated by Commercial, Residential Real Estate
The Federal Reserve released its most detailed breakdown to date on the types of assets it accepted from Bear Stearns Cos. a year ago and the cause of losses on the portfolio. The biggest losses in the $25.7 billion portfolio of Bear Stearns assets as of the end of last year came from commercial and residential mortgages, according to a report released by the Fed in Washington today. The central bank agreed in March 2008 to buy the assets so JPMorgan Chase & Co. would acquire Bear Stearns and avert the investment bank’s bankruptcy. Today’s report follows pressure by lawmakers on the central bank to identify the collateral for its record extension of credit, along with a lawsuit by Bloomberg News in November. Fed Chairman Ben S. Bernanke has pledged to boost disclosure, assigning Vice Chairman Donald Kohn to lead the effort.

The Fed wrote down the value of former Bear Stearns commercial-mortgage holdings by 28 percent to $5.6 billion and residential loans by 38 percent to $937 million as of Dec. 31, the central bank said today. Properties in California and Florida accounted for 45 percent of outstanding principal of the residential mortgages. "It’s just the tip of the iceberg when it comes to losses in the commercial real estate market," said Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ Ltd. in New York. Lenders "were over-optimistic about tenant occupancy rates and rents," he said. The emergency action to prevent the collapse of Bear Stearns started the Fed on an unprecedented path, which has led the central bank to more than double the size of its balance sheet.

Bernanke has overseen an expansion of its efforts to include financing corporate debt, lending to securities dealers and the commitment to buy hundreds of billions of dollars of mortgage securities and Treasuries. The Fed has declined to identify the collateral it accepts under a number of its programs, prompting lawmakers to call for increased transparency. The Senate voted 96-2 earlier this month to urge greater disclosure by the Fed, including on the collateral taken on in the bailouts of Bear Stearns and American International Group Inc. Today’s releases from the Fed also included information on its holdings of assets accepted from AIG, which reflect less of a change because of the shorter period that the central bank has owned the portfolios. The AIG rescue dated from September.

Maiden Lane II LLC, formed to buy residential mortgage- backed securities from AIG, included subprime-loan assets valued at $10.8 billion and "Alt-A" or adjustable-rate loans valued at $5.23 billion as of Dec. 31. Maiden Lane III LLC was formed to buy from AIG collateralized debt obligations linked with residential and commercial mortgage securities. One-third of the $26.7 billion of CDOs in the portfolio have ratings below investment grade, the Fed report showed today. AIG said last month that Societe Generale of France and Deutsche Bank AG of Germany led a group of 20 foreign and U.S. banks that received $22.4 billion in collateral payments after the Fed’s rescue. Also in September, the Fed declined to rescue Lehman Brothers Holdings Inc., saying the firm lacked acceptable collateral for it to justify extraordinary aid.

The Bear Stearns holdings show new detail on the type of assets that JPMorgan didn’t want to accept as part of its takeover of Bear Stearns. The total amount of losses on the Bear Stearns holdings was previously disclosed by the Fed in January. The Fed said its commercial-mortgage loans had principal of $8.5 billion at the end of December, compared with the "fair value" assessment of $5.6 billion, indicating an assumption that about 35 percent of the debt won’t be paid back. One company, which the Fed didn’t identify, represented 48 percent of the total principal balance of the commercial mortgage loans in the portfolio. The residential loans had principal of $1.7 billion, compared with the fair-value amount of $937 million, for an anticipated loss of 44 percent.

The Fed issued a $28.8 billion, 10-year loan to a new unit, called Maiden Lane LLC, formed to buy the portfolio. JPMorgan is taking the first loss through a $1.15 billion loan, which would be wiped out by unrealized losses already. Unrealized losses on the Fed’s loan total $3.4 billion, the central bank said. Maiden Lane paid $54.1 million in "professional fees" to firms including BlackRock Inc., which is managing the portfolio. The amount also includes payments to State Street Bank and Trust Co. for administrative services and to the Fed’s auditor, Deloitte & Touche LLP. The Fed wrote down the value of performing loans by about one-third and of nonperforming loans, or those more than 60 days past due, by two-thirds. That left the fair value of the loans at a total of $6.5 billion. About 9.3 percent of the commercial mortgages and 23 percent of the residential mortgages were nonperforming, the Fed said. The audited financial statement of Maiden Lane LLC reflects the fair value of assets as of Dec. 31. Today’s report was part of a release of 2008 financial statements of the Fed’s 12 district banks.

Subprime Loans, Corporate-Style, Will Fuel Defaults
The loans went to borrowers who might never before have been allowed to borrow. When they found repayment difficult, they were permitted to refinance their loans, generating fees for the lenders and postponing the ultimate reckoning. Then the credit markets turned and both the borrowers and lenders were in deep trouble. So it went with the subprime mortgage crisis. And so it is now going with corporate loans and bonds. It appears that defaults on leveraged loans and corporate bonds will soon rise to levels not seen since the Great Depression. If that does happen, a wave of corporate bankruptcies will deal another blow to the American economy, and present the Obama administration with more painful decisions about possible bailouts — bailouts that could be made directly or indirectly by persuading bailed-out banks to make loans that might not seem wise to the bankers.

One reason for the rise in defaults is that this is a severe recession. But it is not the principal one. Junk, circa 2009, is the worst junk ever. Calculations by Moody’s Investors Service show that as of the beginning of April, a record 27 percent of speculative-grade debt issuers had a rating on their senior debt ranging from Caa down to C. These are the lowest rungs of credit quality — rungs that once rendered a borrower ineligible for a loan. The default rate on leveraged loans and speculative grade bonds is rising rapidly. "We expect the default rate to get to the range of 14 percent by the end of the year," said Kenneth Emery, a senior vice president of Moody’s. That compares to peak default rates of 10 to 12 percent during the last two recessions, in 1991 and 2001. That could turn out to be an optimistic forecast. Edward I. Altman, a finance professor at New York University, says he thinks the rate will probably be in the range of 13 to 15 percent, but could go as high as 19 percent this year. If the recession continues into 2010, he fears that year could see a comparable default rate.

Martin S. Fridson, a veteran high-yield analyst who now runs his own research firm, FridsonVision, looked back at the 1991 default rates for various quality high-yield bonds. Since there are many more low-quality bonds now, he says equivalent default rates would produce an overall rate of 24 percent — twice the old peak. How did we get into this mess? The story is remarkably similar to the tale of subprime mortgages. Lenders who were making money by putting the loans into pools became more and more eager to make loans, and less and less concerned about their quality. The way the loan securitization market developed, the most profitable loans to make were those rated B or even B-minus, levels of debt below the old standard for most junk bonds. There was a market for some Caa paper, even though such loans historically often landed in default.

Borrowers who ran into problems could refinance their debt, creating new rounds of fees for the banks making the loans and obscuring the problems with credit. And with the economy booming, there were not that many problems anyway. The secret to all this was the collateralized loan obligation, or C.L.O. As with mortgage securities, the rating agency models figured that 70 percent of the money that went into financing single-B rated loans could be financed with AAA-rated paper. As time went on, the big banks making the leveraged loans became more and more competitive, figuring the secret to profits was in making the loans and securitizing them — not necessarily getting them paid back. It was financial alchemy, but the AAA-rated paper was popular with buyers like banks and insurance companies, whose capital rules treated such securities as virtually risk-free. They wanted more such paper, and the big banks obliged.

"C.L.O.’s bought about two-thirds of corporate loans from 2004 to 2007," said David Preston, a structured products analyst at Wachovia Securities. But there are now no new C.L.O.’s being created, and many of the old ones may soon be barred from reinvesting repayments in new loans — in part because so many existing loans are being downgraded by the rating agencies. David M. Rubenstein, the founder of the Carlyle Group, a major private equity firm that was borrowing a lot of the money, now gives speeches recalling how JPMorgan and Citigroup bid against each other for the privilege of lending to him. First they cut the interest rate they were asking. Then they raised the amount they would lend, reducing the equity investment Carlyle needed to make an acquisition.

But that was not all. At the height of the lending mania in early 2007, the banks were offering "covenant-lite" loans, meaning that they would not go into default just because the borrower ran into financial problems that caused it to fail to meet some covenant, perhaps requiring a minimum level of earnings. And the banks offered what was called "toggle-PIK," which gave the borrower the option to pay the interest by increasing the amount owed, rather than by putting up cash.

If a company can default only by not paying the interest, and it is not required to pay the interest in cash, defaults are unlikely, at least until the PIK period ends or the company is unable to meet some other obligation. The loans were the corporate equivalent of the now-notorious pay-option mortgage loans, where the borrower could choose to pay only a fraction of the interest, adding the rest to the amount he owed. It all sounds absurd now. But at the time, any bank that refused to lower standards on mortgage loans or on corporate loans risked plunging profits as all the business went to competitors. That might not have happened if regulators had been willing to step in, as some of them wanted to do.

But Alan Greenspan, the chairman of the Federal Reserve when the credit party grew delirious, was the dominant regulator. He saw no need to interfere with markets. It might have been different if he had understood markets and the flaws that were leading to disaster. Instead, he worshipped markets. Defaults are now rising because of the recession, but the news could get even worse. Unlike most mortgages, leveraged loans and junk bonds are not scheduled to be gradually paid off over the life of the loan. Instead, they come due and must be refinanced. Moody’s reports that leveraged companies need to refinance $26 billion in loans this year, $44 billion in 2010 and $120 billion in 2011. If credit markets remain tight, we could see lots of defaults even among companies that are doing well enough to make their interest payments.

"If they are not around," asked Mr. Preston, speaking of the C.L.O.’s, "where is the demand to buy loans going to come from?" When the subprime mortgage crisis burst into public view in 2007, government officials were slow to understand that the problem was much broader than the mortgage market. As it happens, the mortgage problem helped to bring on a recession, which is making the coming crisis in corporate loans — not to mention in commercial real estate loans — that much worse. The financial engineers seemed very clever at the time. They created a lending boom that appeared to increase economic growth and general prosperity. Few paid much attention to how the clever products could blow up if things went wrong. Now that they are exploding, there are no easy solutions.

Clash looms over US mortgage aid
With house prices in some parts of the US down 40 per cent in the past two years – and with many parts of the country still experiencing falls – stabilising the housing market has become a top priority for the US government. The losses on houses have not just hit homeowners – the banks and investors that lent people money for mortgages have taken huge hits. The losses have swept around the world, reflecting the fact that billions of dollars of securities that were sold were backed by US mortgage payments. Parts of the mortgage-backed securities market have been further hit amid fears that government actions aimed at keeping people in their homes will force investors to take bigger losses than they expected.

Now, bond investors are gearing up for a clash with banks – and potentially the government – over current proposals that they say might end up favouring banks holding riskier mortgages over those owning supposedly safer investments. Investors are escalating lobbying efforts to change parts of policies aimed at reducing foreclosures, on the grounds that measures discriminate against them. Many of these investors say they are willing to take losses, but they want those banks that lent people money that was supposed to get hit first – second lien mortgages – actually to be hit first. "We are willing to take losses to facilitate economically sound debt restructurings for troubled homeowners, but the second lien holders are not," said Ralph Deloisio, head of structured finance at Natixis, a large money management company. "They stand against a better solution for the borrowers, taxpayers, and markets."

Pension fund managers and life insurance groups are preparing to meet senators in Washington next week to urge them to oppose the introduction of the "servicer safe harbour", a law that would shield mortgage servicers from legal action by investors owning securities backed by the mortgages. Investors are particularly concerned that the inability to challenge mortgage servicers’ actions will lead servicers to modify people’s first mortgages – which back the securities owned by the investors – and leave intact people’s second mortgages and other home equity loans, which are supposed to be paid back only after first mortgages. These second lien loans are largely owned by banks, which also own the mortgage servicers. The "servicer safe harbour" would allow servicers to prioritise investors that are supposed to take losses first, and thus help banks avoid billions of dollars of losses which would instead be taken by investors.

"The largest servicers are also the largest holders of second mortgages and home equity lines of credit," said Laurie Goodman, analyst at Amherst Securities. "We do not want to suggest that abuses will occur; it’s just that the stage appears to have been perfectly set up for such." Bank of America, Wells Fargo, JPMorgan Chase and Citibank between them own more than $400bn of second lien mortgages. JPMorgan and Citi declined to comment and the others were unavailable. The investor efforts are split into two broad groups. One is particularly focused on pension funds and insurance companies – traditional investors that manage investments for ordinary Americans. Bill Frey, head of Greenwich Financial Services, said up to 10 pension funds and insurers might attend meetings next week with senators, which he is organising. Mr Frey is suing Countrywide, now owned by Bank of America, over mortgage modifications.

Another group, which includes hedge funds such as Fortress Investment, has hired Patton Boggs, a legal firm, to argue its case in Washington, according to people involved. Some large investors want to avoid a clash with the government as they seek to work with the it on plans to buy toxic assets. Also, some investors believe a servicer safe harbour might work, as long as it came alongside requirements that second lien holders took losses before first lien holders. Andrew McCormick, head of structured products at T Rowe Price, one of the biggest US money managers, said regulatory uncertainty in the mortgage sector was keeping investors away, pushing up the costs of new mortgages. "The potential abrogation of contracts could be a test for the markets. If done carefully it could reassure investors. If done in a way that favours one group over another, it could have a tremendous negative impact on the securitisation market."

Bank of America’s Lewis May Face SEC Probe on Merrill
Bank of America Corp. Chief Executive Officer Kenneth D. Lewis may face scrutiny by the U.S. Securities and Exchange Commission for failing to disclose mounting losses at Merrill Lynch & Co. because of pressure from federal regulators to complete the takeover. "We have been actively reviewing the disclosure surrounding the merger between Bank of America and Merrill Lynch," said agency spokesman John Nester. "The issues identified in New York Attorney General Andrew Cuomo’s letter are part of our review." Cuomo revealed in a letter yesterday to Congress and federal regulators that Lewis testified in December that then- Treasury Secretary Henry Paulson may have threatened to remove the bank’s management and directors if the lender tried to back out of buying Merrill.

Lewis said he was instructed by federal officials not to disclose Merrill’s losses, his desire to back out of the merger or the intervention of regulators, according to Cuomo. Former SEC Chairman Harvey Pitt said he has "no doubt" the agency will investigate. Lewis was obligated to make full disclosure to shareholders even with the regulators’ pressure, Pitt said in a Bloomberg Television interview. "At least he could have demonstrated he was acting at the request of an official of the U.S. government," Pitt said. The allegations in Cuomo’s letter suggest Paulson and other policy makers may have resorted to breaking securities laws to protect a fragile financial system, according to Peter Sorrentino, a senior portfolio manager at Cincinnati-based Huntington Asset Advisors, which has about $13.3 billion under management and doesn’t own stock in Charlotte, North Carolina- based Bank of America.

"Everyone involved knew that was a clear violation, that’s material non-public information, so basically we just closed the rule book during the crisis and said we don’t care, we need to keep the lights on, and we’ll deal with that manana," Sorrentino said. "Logic went out the window and they were just acting out of fear," he said. It was "completely panic mode." Both Paulson and Federal Reserve Chairman Ben S. Bernanke said they hadn’t advised Lewis to conceal Merrill’s mounting losses from his shareholders. "Questions of Bank of America’s disclosures were left up to Bank of America," Paulson said in statements e-mailed by a spokesperson. "Secretary Paulson does not take exception with the Attorney General’s characterization of his conversation with Ken Lewis. His prediction of what could happen to Lewis and the Board was his language, but based on what he knew to be the Fed’s strong opposition to Bank of America attempting to renounce the deal."

Lewis testified for four hours in Cuomo’s New York offices on Feb. 26 as part of an investigation by Cuomo of $3.6 billion in bonuses paid at Merrill just before it merged with the bank. Cuomo’s letter was based on Lewis’s recollections of a Dec. 21 conversation with Paulson. Cuomo, in his letter to SEC Chairman Mary Schapiro and members of Congress, said the SEC "appears to have been kept in the dark" about talks between Bank of America and the Fed and Treasury. Cuomo’s letter didn’t dissuade critics who want the 62- year-old Lewis ousted from the bank’s board at next week’s annual shareholders meeting in Charlotte. "Mr. Lewis and the board owe their fiduciary obligation to the corporation and shareholders, not to the regulators who reportedly pressed them to close the deal," Michael Garland, research director at CtW Investment Group, said in an e-mailed statement.

Lewis had little choice but to follow the Fed’s direction, Hugh McColl Jr., Lewis’s predecessor as Bank of America’s CEO, said in a telephone interview yesterday. "Anyone who has ever run a big national bank knows that when the Fed tells you to do something, you will do it," McColl said. "It’s an order." Scott Silvestri, a spokesman for Bank of America, defended the Merrill deal in a telephone interview yesterday. "We believe we acted legally and appropriately with regard to the Merrill Lynch transaction," he said. Lewis and the board of the biggest U.S. bank by assets are under fire for not telling shareholders that New York-based Merrill’s fourth-quarter loss was spiraling toward $15.8 billion before they voted to approve the deal in December. Shareholders are set to cast ballots on April 29 whether to re-elect directors including Lewis and split his roles as chairman and CEO. Some investors are calling for Lewis, CEO since 2001, to resign after a 76 percent decline in Bank of America shares over the past year. The stock, which closed at $8.90 yesterday on the New York Stock Exchange, sold for as little as $2.53 in February.

Schapiro said earlier this month that the SEC is already reviewing whether Bank of America violated the law by not disclosing to shareholders that Merrill Lynch employees were set to receive year-end bonuses that totaled $3.62 billion. Former SEC Chairman Christopher Cox, who led the agency at the time of Lewis’s discussion with regulators, declined to comment. John Coffee, a securities law professor at Columbia University Law School in New York, said Lewis’s testimony to Cuomo’s office puts the SEC in a "very difficult" position. "They are under some pressure to bring action against Lewis if they feel that Lewis was withholding material information," Coffee said. Companies can’t argue that it’s in "the national interest" to "withhold material facts from your shareholders," he said.

Lewis testified that he asked Bernanke to "put something in writing" regarding the U.S. government’s plan to support Bank of America’s acquisition in view of Merrill’s mounting losses. After Bernanke said he would consider the idea, Paulson called Lewis. He said, according to Lewis, "First it would be so watered down, it wouldn’t be as strong as what we were going to say to you verbally, and secondly, this would be a disclosable event and we do not want a disclosable event." Attached to Cuomo’s letter was a Dec. 22 e-mail from Lewis to his board. "I just talked with Hank Paulson," the e-mail reads. "He said that there was no way the Federal Reserve and the Treasury could send us a letter of any substance without public disclosure which, of course, we do not want." Paulson said in his statements that his discussions with Lewis "centered on the Fed lawyers’ opinion that the merger contract was binding, and the U.S. Treasury’s commitment to ensuring that no systemically important financial institution would be allowed to fail."

"No one at the Federal Reserve advised Ken Lewis or Bank of America on any questions of disclosure," said Michelle Smith, a Fed spokeswoman. "It has long been the Federal Reserve’s view that questions of this nature are best addressed by individual institutions and their legal counsel, as they are in a position to understand clearly their obligations and responsibilities," said Fed spokeswoman Smith. Senate Banking Committee Chairman Christopher Dodd and other congressional leaders said they would respond to Cuomo’s letter. "We had suspected there was some behind the scenes work to get Bank of America to buy Merrill," said Steven Adamske, spokesman for House Financial Services Chairman Barney Frank. "It does show the federal government needs to have greater tools to wind down non-bank institutions."

Investors move against mortgage securities bill
Bond investors are lobbying hard to change federal policies aimed at reducing foreclosures in the US, saying the measures discriminate against holders of top-rated securities backed by mortgages. The investors are set to meet senators next week. The next step could be legal action against the US government if the law is passed, on the basis that it could violate the Fifth Amendment, which blocks abuses of state interference in legal procedures. "Serious investors are committing significant resources to this issue," said Eric Brenner, partner at Boies Schiller and Flexner, which is advising investors that hold mortgage-backed securities.

"They are really troubled that government action could prevent enforcement of their contracts and are considering the potential for legal action to protect their property rights." The plans, introduced by Barack Obama, US president, last month to try to stem the surge in foreclosures, could go before Congress next month. The difficulty in changing terms on mortgages – particularly those that have been repackaged into securities and sliced into tranches owned by investors around the world – has angered advocates for homeowners. High levels of foreclosures and forced sales are a factor in depressing house prices.

Investors owning securities backed by people’s main mortgages say banks owning riskier mortgages – so-called second lien – could use the legislation to avoid billions of dollars of losses.
These second-lien loans are mostly owned by banks, which also own the mortgage servicers. A "servicer safe harbour" in the legislation would shield servicers from legal action if they changed the terms on people’s mortgages, many of which back securities. Investors say this would allow servicers to prioritise the banks that own them, and whose risky mortgages are supposed to take losses first. This could help banks avoid billions of dollars of losses that would instead be suffered by investors. The proposals have the backing of large banks, such as Bank of America, JPMorgan Chase and Wells Fargo. The fight by investors potentially pits some of the biggest buyers of bonds against banks and the government.

Summers Caught a-Snoozin’
Americans may be struggling to pay their credit card debt. But for Larry Summers, President Obama’s chief economic adviser, the issue is apparently a snooze. Mr. Summers was caught dozing in a Roosevelt Room meeting this afternoon as Mr. Obama addressed credit card industry officials, according to a White House pool report. Mr. Summers "appeared to be nodding off near the beginning’’ of Mr. Obama’s remarks, the report said. It went on "And then he DID nod off, doing the head on the hand and then head falling off the hand thing.’’

The photographers had a field day at what would otherwise have been just another White House photo op with officials seated around a table. All the other officials in the room, including Treasury Secretary Timothy F. Geithner; senior adviser Valerie Jarrett; chief of staff Rahm Emanuel; Christina Romer, head of the Council of Economic Advisers, and Gene Sperling, counselor to Mr. Geithner, seemed to be fully awake. Of course, with a worldwide economic recession to help manage, Mr. Summers has not been getting a lot of sleep since joining the Obama White House; aides say he is known to host midnight telephone conference calls.

Who killed Chrysler?
The survival of Chrysler as an independent company is looking increasingly unlikely. The fundamentals of its business structure - unappealing passenger cars, dismal quality, little technology, minimal international operations - are scary enough. Meanwhile, continuous rounds of layoffs have hollowed out the company, starving it of the basic resources it needs to engineer, manufacture and market automobiles. One executive described Chrysler as looking like an imposing castle from the outside, but actually being empty once you got beyond the front door.

Now debt-holders are balking at government demands to take a haircut, car sales show no signs of improving, and the government's May 1 deadline for demonstrating viability is fast approaching. Having escaped bankruptcy in the late '70s and again in the early '90s, Chrysler appears to have run out of options. Fiat, once held out as Chrysler's last hope, no longer needs to go through the trouble of a formal takeover. It could easily cherry-pick the company's assets in a liquidation. It would cost the Italian automaker a few bucks more, but it would be a lot cheaper in the long run. So what happened to Chrysler?

While General Motors has been on a slippery slope for 40 years, the roots of Chrysler's decline are more recent. At the time of its merger with Daimler in 1998, it was the hottest company in Detroit. With its dream team of engineers, designers, and marketers, Chrysler had created a high-profit lineup of minivans, pickup trucks and Jeeps. At one point, its CEO, Robert J. Eaton, was fantasizing about 20% market share and 8% profit margins. Mixing in Daimler's technical resources, global reach, and the always-tantalizing benefits of synergy should have created a Chrysler recipe for success. But the Germans hamstrung their new American unit more than they helped it. Their formal business structure clashed with Chrysler's more freewheeling ways and promised resources took a long time to make their way from Stuttgart to Auburn Hills.

And Chrysler made plenty of mistakes on its own. The dream team disbanded, engineering costs skyrocketed and an ill-conceived efficiency program hurt vehicle quality and customer appeal. In retrospect, the fatal blow was struck when then-CEO Dieter Zetsche tried to stretch the product development budget by churning out more new models with less money. It sounded like black magic -- and as it turned out -- it was. What Chrysler produced were half a dozen derivative models with eye-catching but cheesy styling, bargain-basement interiors and the worst quality in Detroit. Customers caught on quickly. This year, sales of many models are just one-third of what they were just a year ago:
  • 3,186 copies of the square-cornered Jeep Commander, derided as the box that the smaller Grand Cherokee came in, sold in the first quarter, compared with 9,648 a year ago.
  • The smaller, clunkier and even more angular Jeep Compass performed even more poorly, with 3,147 sold in the first quarter versus 10,400 in the same 2008 period.
  • Looking like an extra from a "Transformers" movie, the Jeep-based Dodge Nitro has lit very few fires. Exactly 5,218 have found buyers this year, as against 15,355 last year.
A special place in the Chrysler Hall of Shame should be reserved for the executive who green-lighted the Sebring sedan. Designed to compete against the Toyota Camry and the Honda Accord, the Sebring became a total flop in the midsize segment by trying to combine the virtues of a higher "command seating" position with traditional four door styling. The awkward design satisfied no one. Chrysler managed to sell 30,411 Sebrings in the first three months of last year but just 5, 636 this year. Instead of 20% market share, Chrysler has notched just 11.2% of U.S. sales in 2009. And of course its profit margin is less than zero.

With that kind of product lineup, why would Fiat want to rush in to save the company? The redesigned Jeep Grand Cherokee looks promising, but its arrival in dealer showrooms is many months away. A new Chrysler 300C is on the way, too, but its day may have come and gone. Designs that really turn heads rarely have legs. Fiat would be far better off bidding for Chrysler's viable pieces after the lights are turned off: the Jeep Grand Cherokee and Wrangler; Chrysler and Dodge minivans, and Dodge trucks. After it buys the cars and trucks, it may want to acquire the valuable Saturn network from General Motors to have some dealers through which to sell them. And then Chrysler can join American Motors, Studebaker-Packard and all the other departed in the automotive graveyard.

Auditors: Nearly 25% of US Companies May Not Be Going Concerns
The auditors of nearly one-quarter of publicly traded companies feel that the companies may not live out the year. Auditors have become increasingly doubtful about their clients' ability to continue as going concerns, according to the most recent report on the subject by Audit Analytics, which has tracked the number of such going-concern opinions this decade in a recently released report. With calendar year-end 2008 filings still coming in to the Securities and Exchange Commission, the research firm estimates there will be 3,589 going-concern opinions eventually filed for 2008 annual reports, an increase of 9% compared to last year's total of 3,293 going-concern opinions.

Audit Analytics made this prediction based on a compilation of regulatory filings made as of late March for 2008 10-Ks. Its data suggests auditors' going-concern doubts were more commonplace compared to the previous year. If the firm's estimate is correct, the number of auditors' documented worries about their clients' viability will reach the highest level this decade. In 2001, 19.2% of companies noted their auditors' going-concern uncertainty. But only 15% had those qualifications in 2003, according to the Audit Analytics report. For 2007 10-Ks, that number rose to 20.9%, reflecting the highest number of going-concern doubts since 2000. Now the total could reach 23.4% percent, the firm's researchers say.

The audit profession has been predicting a surge in the number of going-concern doubts since last fall, when auditors were on the verge of beginning their annual reviews for calendar year-end companies amid the rough economy. Last month, on the heels of General Motors revealing its auditors' going-concern doubts, Grant Thornton CEO Ed Nussbaum told there will be "an unprecedented number of going-concern footnote disclosures and clarification from the auditors" forthcoming. Auditors must consider several factors during their annual client reviews that may signal that a company won't be in existence 12 months from now. Among them: negative recurring operating losses, working capital deficiencies, loan defaults, unlikely prospects for more financing, and work stoppages. Auditors also consider such external issues as legal proceedings and the loss of a key customer or supplier.

Auditors' going-concern evaluations don't stop there. If they have doubts about a company's future, they tend to confer with their client's management and review the company's plans for overcoming the problems noted and decide whether those plans can likely keep the company in business. If they still aren't satisfied, then the auditors will explain why they have "substantial doubt" about the company's ability to stay a going concern in an opinion filed with the company's 10-K. In late March, when Audit Analytics compiled the data, only 10,895 auditor opinions had been filed for year-end 2008 with the SEC. That means that Audit Analytics' forecast could be off, since the data doesn't account for about 5,000 10-Ks that were still due. Still left to be collected was data from smaller companies, late filers, and foreign filers. But it's likely that companies that have missed the SEC's filing deadlines are dealing with financial issues, possibly involving discussions over a going-concern qualification with their auditors, suggests Don Whalen, research director at Audit Analytics.

To be sure, what the findings mean has yet to be determined . Still unclear is whether audit firms are being more conservative in their forecasts because regulators have indicated they will keep a close watch on going-concern opinions. Or is it a fact that a higher number of companies have a seriously uncertain financial future? "I'm not really sure what's driving this," Whalen says. "Obviously, there's a lot of economic pressure right now with the credit crunch and the dearth in consumer spending. At the same time, it might be that ... auditors are being a little more cautious in their assumptions." Accounting firms have been criticized for not reliably raising going-concern red flags for investors before their clients file for bankruptcy protection. Past academic studies have found audit firms have made going-concern qualifications for just over half of the companies that eventually go bankrupt, according to Joseph Carcello, a University of Tennessee professor.

Last fall, in a practice alert, the Public Company Accounting Oversight Board warned auditors that companies' ability to stay viable during the economic downturn would likely slide — effectively putting audit firms on notice that this would be at least one area high on the radar of PCAOB inspectors in the coming year. Further, the board is revising its going-concern rules to align them more with those of the Financial Accounting Standards Board. Audit Analytics hasn't analyzed whether certain kinds of firms were more likely to issue going-concern opinions than others. Whalen noted, however, that smaller audit firms as well as larger ones have expressed doubts about their clients' viability. "The smaller audit firms are not shying away," he says.

Credit-Card Shocks Anger More Borrowers
Michael Burkholder, who has had a Bank of America credit card for the better part of the last decade, said his jaw dropped recently when the interest rate on his card nearly tripled to 14.99% from 5.5%. The 41-year-old Laurel, Md., resident insists that he always pays his bills on time and that while he typically carries a balance, he has made it a practice the last two decades to pay well over the minimum amount due on his accounts. When he called to complain, a customer-service representative told him the bank would lower the new rate to 7.9% for six months and that he should call back at a later time for another decrease. He asked why the bank jacked up his rate for what he believes was no apparent reason and was told it was necessary to offset losses from the growing numbers of low-performing or default accounts.

"It was just incredible to me that they would do that like that," he said. "I said it sounds like they're spreading the wealth and the rep said, 'Yep, that's what's happening.'" Welcome to today's credit-card world, where interest rates and fees can go up, and credit limits and rewards benefits can go down, seemingly at the drop of a hat and with little notice to borrowers - a situation that has consumers fuming and politicians taking notice. The House already has taken action on a bill that would limit the most egregious credit-card abuses and President Barack Obama on Thursday met with credit-card issuers to address outrage from borrowers over practices that consumer advocates say are unfair. The Pew Charitable Trusts, in calling for a policy of Safe Credit Card Standards this week, said that 100% of cards allowed the issuer to get paid back in a manner which, according to the Federal Reserve, "is likely to cause substantial monetary damage to consumers," said Nick Bourke, a manager at the institution.

"These products can have dangerous qualities," Bourke said. "The costs can go up in unpredictable and nontransparent ways. Consumers are finding that they're paying hundreds or even thousands of dollars per year more than the upfront price tag would indicate." Bank of America spokeswoman Betty Riess, like her colleagues at other big banks, stressed that customers are informed of changes and that the rules are plainly listed - in the fine prints. The recent rate increases, she said, are mostly tied to the dire economic conditions that have crippled credit everywhere. "Our costs for providing credit have significantly increased," she said. That aside, she added, it is not unusual for Bank of America to periodically review the credit risk for individual accounts and reprice their rates accordingly. "That's been an ongoing practice," she said, again echoing her counterparts at other large banks with similar routines.

Customers like Burkholder who had accounts charging interest rates below 10% and holding balances were told this month that their average percentage rates, or APR, would be elevated by June to low- to mid-teens rates. "We are raising rates on a small portion of the (bank's lending) portfolio that is underpriced relative to current market conditions," Riess said. Other banks are making similar moves: In February, Citigroup Inc. (C) increased its rates on one of its most popular cards, the Platinum Select, to 8.75% from 7.74%. It also raised rates on the MTVU card, targeted to a younger generation, to 14.24% from 12.24%. In all, Citigroup is raising rates - though banks like to refer to it as "repricing" rates - on an estimated 20% of its Citi-branded consumer credit-card business in the U.S. Those customers, it claims, haven't seen rate increases for at least two years and in many cases three years. "We are carrying out this repricing in order to continue lending in this environment," said spokesman Samuel Wang.

Capital One also increased rates to new customers on 15 different cards in February. The Platinum Prestige card jumped to 11.9% from 7.15%. Its No-Hassle card leapt to 13.9% from 8.15% to new customers, according to In December, American Express boosted interest rates by two to three percentage points on "segments of our portfolio across the board," said spokeswoman Marina Hoffmann. Like Bank of America and Citigroup, the changes were made "in response to challenges in the economic environment and the increasing costs of doing business," she said. "These are not charitable organizations," said Bill Hardekopf of "If they're hurting on one end they're going to make up for it on the other." But, he added, customers don't have to put up with it. They can opt out, which mostly means they lose charging privileges and have to pay off outstanding debt. There are some exceptions, such as at Citigroup, which allows customers to continue to charge at their prior interest rate until the card expires and privileges are yanked.

Fees are on the upswing too. Beginning June 1, Bank of American will raise its balance transfer fee to 4% from 3%, the industry's long-held standard cut. For a $10,000 transfer, the fee goes to $400 from $300. "That's a big change," Hardekopf said. "That's added to your transfer balance and then you're paying interest on that too." Meanwhile, banks are lowering limits on credit cards and home-equity lines on what many maintain is a case-by-case basis. Rewards programs also are getting whacked. The Discover card, for example, used to award new customers 12,000 bonus flight miles after their first purchase. Now customers can receive 1,000 bonus miles each month they've made a purchase for the first year. Some Citigroup cards no longer redeem 20,000 points for a domestic flight valued at $400. It's now 40,000 points. "No matter how you get the points, you have to now use twice as many -- and that's a big change," Hardekopf said.

Making matters worse for consumers is the domino effect many of these rate and limit changes have had on creditworthiness. As a rule, consumers are warned that their credit scores will be hurt if an outstanding balance on an account exceeds 30% of the limit, called the "credit utilization ratio." If a card issuer, for example, lowers the limit on a $10,000 account to $5,000 and there's already a $3,000 balance on the account, the debt-to-credit limit, or utilization ratio, has surged to 60% from 30% overnight and you didn't charge a thing. In most cases that will significantly drag down a borrower's FICO score, the widely used measure of creditworthiness developed by Fair Isaac Corp. It's worse if the account has been closed by the creditor. "That's been one of the insidious things about the banks," said Ben Woolsey, director of marketing and consumer research at "As they're controlling their risk, they're lowering the credit scores of millions of Americans.

"I don't think it's malicious, but it's kind of capricious," said Woolsey, adding that these practices could lead to a mass exodus of customers. "Their primary interest is self interest. They're just not concerned with the collateral damage." For their part, the banks said they find themselves between a rock and a hard place given the tough economy, particularly with job losses mounting and home values falling. "We're trying to strike a balance of managing credit risk on our end and giving the customer the ability to spend," Bank of America's Riess said. "Our objective is to work with our customers."

Slump Creates Lack of Mobility for Americans
Stranded by the nationwide slump in housing and jobs, fewer Americans are moving, the Census Bureau said Wednesday. The bureau found that the number of people who changed residences declined to 35.2 million from March 2007 to March 2008, the lowest number since 1962, when the nation had 120 million fewer people. Experts said the lack of mobility was of concern on two fronts. It suggests that Americans were unable or unwilling to follow any job opportunities that may have existed around the country, as they have in the past. And the lack of movement itself, they said, could have an impact on the economy, reducing the economic activity generated by moves. Joseph S. Tracy, research director of the Federal Reserve Bank of New York, said the lack of mobility meant less income for movers and the people they employ and less spending on renovation and on durable goods like appliances.

But, Dr. Tracy said, the most troubling prospect is that people were no longer able to relocate for work. "The thing that would be of deeper concern is if job-related moves are getting suppressed and workers are not getting re-sorted to the jobs that best use their skills," he said. "As the labor market started to improve, if mobility stays low, you can worry about the allocation of workers." How long will the downturn in mobility last? Michael J. Hicks, director of the Center for Business and Economic Research at Ball State University in Indiana, said, "I think it will be well into next year before we see any growth in migration, and that still may be optimistic." "If the stock market rebounds before the housing market, we might see a scramble for retirement housing," Professor Hicks added.

The American Moving and Storage Association said the number of people changing residences had been dropping for four years and fell 17.7 percent from 2007 to 2008. The first quarter of 2009 is likely to be even worse, the trade group said. "We saw a standstill in new home construction, so there was no domino effect from people moving," John Bisney, a spokesman, said. "People are a little nervous about getting a mortgage. And the recession is so broad-based it’s not as if you can pull up stakes and move to a part of the country that’s growing." Jed Smith, a research director for the National Association of Realtors, said that on average it took a homeowner 10.5 months to sell a house in 2008 compared with 8.9 months in 2007. "Generally speaking, people move based on the economy," Dr. Smith said, "and obviously the economy in 2008 was mediocre to bad. That would tend to have a negative impact on people’s desire, ability or need to move."

In its report Wednesday, the Census Bureau said that Americans’ mobility rate, which has been declining for decades, fell to 11.9 percent in 2008, down from 13.2 percent the year before and setting a post-World War II record low. Moves between states dropped the most, to half the rate recorded at the beginning of this decade. In addition, immigration from overseas was the lowest in more than a decade, which experts attributed to the lack of jobs. Over all, movers were more likely than nonmovers to be unemployed, renters, poor and black. For decades, several trends have driven a decline in American wanderlust. Home ownership rates have risen, and owners are typically less likely to move than renters. Two-earner families have become more common, and finding employment for both spouses in a new location can be challenging. Americans’ median age has been climbing, and it is younger people who usually move most often.

"It does show that the U.S. population, often thought of as the most mobile in the developed world, seems to have been stopped dead in its tracks due a confluence of constraints posed by a tough economic spell," said William H. Frey, a demographer with the Brookings Institution. Dr. Frey predicted that the foreclosure crisis might spur more local mobility, within or between counties, as families shift to rented quarters or move in with relatives. Robin Camacho, a Las Vegas real estate agent, expressed surprise at the census mobility figures, given the high foreclosure rates in her city. "If people are losing their homes and tenants are being forced to vacate," Ms. Camacho said, "then this just doesn’t jibe with what I intuitively think. I see people moving constantly because they have no choice."

Patrick Bonnema, sales manager for Anderson Brothers Moving and Storage in Chicago, said local residential moves were "down drastically over the last six months." "I’m not surprised this has happened," Mr. Bonnema said. "Look at the economy, look at the banking industry, look at the credit industry. People can’t move, what are they going to do? Their homes are now worth less than what they originally paid, and they don’t want to take a loss." Those surveyed by the census said they moved for housing, family and job reasons, in that order. Suburbs gained 2.2 million movers while major cities lost 2 million. Immigrants, though, appeared less likely to settle in the suburbs in 2008, compared with recent years. "The housing crunch and its impact on employment in construction, plus the demise of sub-prime lending, gave immigrants fewer opportunities for living and working in the suburbs than in the immediately preceding years," Dr. Frey said. The influx of 1.1 million overseas foreigners was the lowest since the 780,000 in 1995. Among movers, the South recorded the largest net gain, but the gain was the smallest in five years.

ECB Demands Data on Asset-Backed Bonds as Collateral
The European Central Bank, facing potential losses on asset-backed bonds held as collateral for loans, will require banks to provide more details about the debt, two people familiar with the matter said. Banks have used asset-backed bonds -- notes secured by mortgages and credit card bills -- more than any other type of debt to obtain 676 billion euros ($883 billion) of loans from the ECB, according to central bank data. Bank officials are planning to tighten rules as Standard & Poor’s says credit- rating downgrades are "rising sharply" amid Europe’s deepest economic slump in 13 years. "The ECB needs to know more about the asset-backed bonds it’s taking from banks as collateral because this debt is vulnerable to severe losses in the credit crunch," said James Zanesi, a Munich-based analyst at UniCredit SpA, Italy’s biggest lender.

Financial companies will have to provide details of each underlying mortgage or loan they package into the debt, said the people, who declined to be identified before the plan is announced. Banks would provide the information to S&P, Moody’s Investors Service and Fitch Ratings, the people said. Raphael Anspach, a spokesman for the ECB in Frankfurt, declined to comment. Bank officials may complete the rules by the end of the year, the people said. The Federal Reserve doesn’t require the same level of information for securities it accepts as collateral for loans to commercial banks, according to the Fed’s Web site. U.S. authorities committed $12.8 trillion to bail out the financial system and cut interest rates to zero to 0.25 percent. The ECB’s main rate is 1.25 percent.

Policy makers in Europe tightened rules twice this year. Since February, the central bank has charged financial institutions more to borrow by reducing the amount it lends against some assets to 88 percent of the collateral from 98 percent. Last month, the ECB started demanding asset-backed securities be rated AAA. "The ECB needs to know more about the credit quality of the underlying collateral to help it avoid losses," said Willem Buiter, a professor at the London School of Economics who was a member of the Bank of England’s Monetary Policy Committee from 1997 to 2000. The ECB also may require that banks disclose the additional details to investors to encourage trading in the bonds, said the people. Sales of asset-backed securities shrank to 5.2 billion euros this year, from 45.4 billion euros in the same period of 2008 and 167 billion euros a year earlier, according to data compiled by Milan-based UniCredit.

To obtain credit from the ECB, banks will have to provide information about individual loans such as the value of the property backing a mortgage, how the property was assessed, details on cash flow and whether the borrower is in arrears, the people said. Ian Linnell, head of European structured finance at Fitch in London, said the company has been working with the ECB on its collateral eligibility rules, while declining to give details. Daniel Piels, a London-based spokesman for Moody’s, declined to comment on the talks, as did Mark Tierney, a spokesman for S&P. The ECB’s requirements come after European Union lawmakers passed this week the region’s first direct regulation of credit rating companies, which were blamed for ignoring risks that led to the financial crisis.

The ECB held 442 billion euros of asset-backed bonds at the end of last year, or 28 percent of all collateral the bank has accepted since it expanded lending in August 2007 as the subprime mortgage crisis took hold, according to central bank data published April 22. European financial companies have reported $384 billion of credit-related losses and writedowns since the start of 2007. The ECB asked euro-region central banks last month to set aside 5.7 billion euros to cover potential losses on asset- backed debt after five lenders, including a Lehman Brothers Holdings Inc. unit, defaulted. Rating downgrades on asset-backed debt are increasing, according to S&P. Last year, the New York-based company cut 17.8 percent of its 9,320 ratings of the bonds, almost eight times the proportion in 2007, S&P said Jan. 27.

Credit quality is deteriorating because Europe’s economy shrank 1.6 percent in the fourth quarter, the most in at least 13 years and faster than economists estimated, the European Union said April 7. "The market has been crying out for this data for ages," said Harpreet Parhar, a credit analyst in London at Calyon, the securities unit of Paris-based Credit Agricole SA "It needs it if it’s to restore faith."

U.K. Shrinks Most Since Thatcher Era Dawned in 1979
The U.K. economy shrank more than economists forecast in the first quarter in the biggest contraction since Margaret Thatcher came to power in 1979. Gross domestic product fell 1.9 percent from the final three months of 2008 as manufacturing and business services posted record declines, the Office for National Statistics said today in London. The median prediction in a Bloomberg News survey was 1.5 percent. On the year, GDP slumped 4.1 percent. The recession, which may turn out to be the worst since the 1930s, prompted Prime Minister Gordon Brown’s government to say this week that the budget deficit may swell to a record and is casting doubt on Britain’s credit rating. The Bank of England nevertheless argues the slump may be easing as they print money to stave off deflation and keep rates at a record low.

"It’s shockingly bad," said Alan Clarke, an economist at BNP Paribas SA in London. "People still aren’t pessimistic enough. This casts shadows over any green shoots of recovery. This recession will be more prolonged than people expect." The pound was little changed against the euro and the dollar after the figures were released and traded at $1.4607 at 11:17 a.m. in London. The U.K. is the first Group of Seven nation to report first quarter GDP data. Leaders from the G-7 meet in Washington today as unemployment, deflation and toxic bank assets still stand in the way of a rebound from the global recession. Reports today gave a mixed picture about the health of Europe’s economy. Spanish unemployment rose to a decade-high of 17.4 percent, while Germany’s Ifo business confidence index rose for the first time in 11 months.

U.K. business services and finance shrank 1.8 percent, the most since records for the category began in 1983. Manufacturing contracted 6.2 percent, the most since at least 1948, the statistics office said. The worsening recession may see Britain’s economy shrink by the most since 1931 this year, the London-based Centre for Economics and Business Research said today, forecasting a 4.5 percent annual contraction. This is the first time GDP has contracted by more than 1 percent for two consecutive quarters since modern records began after World War II. GDP declined 1.6 percent in the fourth quarter of 2008. "The best we can say is that the pace of economic decline may slow in the coming months," said John Cridland, deputy- director general at the Confederation of British Industry. "Given that unemployment will continue rising sharply, even if businesses begin to see the rate of decline in activity starting to ease, consumers are likely to feel anxious."

The economy last shrank by more in the third quarter of 1979. Labour Prime Minister James Callaghan began that year by saying he wouldn’t declare a state of emergency and denying that the country had been left in chaos because of rampant strikes. Margaret Thatcher replaced him as the nation’s first female premier after the Conservative Party won the election in May. Brown must hold an election by June 3 next year. His ruling Labour party trails the opposition Conservatives in opinion polls, lagging by 19 percent in a BPIX poll published April 19. Chancellor of the Exchequer Alistair Darling predicted in his April 22 budget that the economy will contract about 3.5 percent this year, and rebound with a 1.25 percent expansion in 2010. That’s at odds with the International Monetary Fund, which predicts a GDP drop of 0.4 percent next year after shrinking 4.1 percent in 2009.

Britain’s "balance sheet is deteriorating rapidly, due to a combination of weakening revenues and the accumulation of sizeable assets and contingent liabilities as a result of successive bank bailouts," analysts at Moody’s including Arnaud Mares in London wrote in a report yesterday. "The government is taking risks with public finances." Brown told reporters today that he’s satisfied Britain will retain its top sovereign credit rating. He has spent 1.4 trillion pounds ($2.1 trillion) bailing out British banks crippled by the crisis, pushing this year’s budget deficit to 12.4 percent of GDP, the highest of any Group of 20 nation. Darling this week offered motorists a 2,000-pound ($2,928) payment to trade in old cars for new ones to stem job losses at manufacturers. Auto sales slid 31 percent in March.

Lloyds Banking Group Plc, which has received billions of pounds of state guarantees, said yesterday it will cut 985 jobs. Michael Page International Plc, the U.K.’s second-largest recruitment company, said April 7 first-quarter profit slumped 32 percent as the pace of layoffs increased. U.K. unemployment rose in March to the highest level since Brown’s Labour Party came to power in 1997 as the recession forced companies to cut jobs. Retail sales still climbed 0.3 percent in March, the statistics office said in a separate report today. Economists predicted a 0.3 percent drop, according to the median of 26 forecasts in a Bloomberg News survey. Debenhams Plc, the U.K.’s second-biggest department story company, said yesterday that sales rose and profit margins increase. Bank of England policy makers said there are signs the pace of economic contraction may be moderating, minutes of their April 9 meeting show. The bank is spending 75 billion pounds to buy bonds with newly created money after it cut the key interest rate to 0.5 percent, the lowest since it was founded in 1694.

Spanish Jobless Rate Rises to 10-Year High of 17.4%
Spain’s unemployment rate rose to 17.4 percent in the first quarter, more than double the European Union average, as the global recession ravages an economy that was once one of the region’s strongest performers. The number of unemployed jumped by 802,800 to 4.01 million, more even than in Germany, which has twice Spain’s population. It was the biggest quarterly increase in unemployment since the National Statistics Institute began the survey in 1976. The jobless rate rose from 13.9 percent in the fourth quarter. Spain is at the forefront of Europe’s economic crisis and accounts for more than half the increase in euro-region joblessness. The collapse of the country’s housing boom, which allowed economic growth to outpace the EU for more than a decade, has triggered the deepest recession in half a century. Consumer prices are declining, fueling deflation risks, and the government effort to spend its way out of the slump prompted Standard & Poor’s to cut Spain’s credit rating in January.

"It certainly seems to suggest it’s going to head way over 20 percent this year," said Ben May, economist at Capital Economics in London. "We currently think GDP will contract by about 5 percent and I think that probably supports that." That forecast is even grimmer than the International Monetary Fund’s projections released on April 22 that predict the economy will contract 3 percent this year and Spanish joblessness would reach 19.3 percent, compared with 11.5 percent in the euro area. The government of Jose Luis Rodriguez Zapatero has adopted some 50 billion euros ($66 billion) in stimulus measures, aimed at curbing the contraction and stemming job losses. Zapatero this month replaced Finance Minister Pedro Solbes, who said that Spain couldn’t afford further stimulus measures, and replaced him with Elena Salgado, who has said that more government spending may be possible.

The government is considering extending unemployment benefits, Salgado said today in Madrid. "It’s the greatest quarterly decline in employment since the start of the unemployment survey in 1976," she said at a press conference. "The first quarter of 2009 is going to be the worst quarter in terms of the decline in employment." So far, there are few signs that the government’s efforts are helping to ease the slump. Industrial production plunged an annual 22 percent in February and consumer prices fell in March from a year earlier for the first time on record. Retail sales have fallen for 12 straight months. Zapatero, who was elected to a second, four-year term in March 2008, has seen his popularity decline as the economic slump deepens.

The opposition Peoples Party would receive 42.3 percent of the vote in European elections in June to 37.9 percent for Zapatero’s Socialists, according to a poll by Sigma Dos, published in newspaper El Mundo on April 12. Sigma Dos interviewed 900 people between April 3 and 8. The stimulus spending and falling tax receipts caused by higher unemployment will further strain Spain’s budget gap, which the European Commission forecasts will more than double the EU’s limit of 3 percent of GDP this year. The Bank of Spain forecasts the deficit will swell to 8.3 percent of output. Salgado said today that the government would bring its deficit in line with the 3 percent limit by 2012, as demanded by the European Commission demanded.

South Korean economy shrinks 4.3% in 1st quarter
South Korea's economy contracted 4.3 percent in the first quarter of 2009 from the same period last year, as manufacturing and exports slumped amid the global downturn, the Bank of Korea announced Friday. That marks the second straight quarter that South Korea's economy grew smaller. Gross domestic product shrank 3.4 percent in the fourth quarter of 2008 in the first year-on-year contraction in a decade. Still, the economy managed to grow marginally in the first quarter compared with the fourth, on the back of government stimulus efforts, suggesting that conditions may be improving. South Korea is battling its worst downturn since the Asian economic crisis of 1997-98 as exports and industrial production have wilted in the face of slowing global demand.

Both the government and central bank forecast that Asia's fourth-largest economy will contract on an annual basis in 2009 for the first time since 1998. The government has responded to the slump and rising unemployment by offering stimulus programs, including a 28.9 trillion won, or $21.6 billion, supplementary budget announced last month. The Bank of Korea, meanwhile, has slashed its benchmark interest rate six times since October to a record low 2 percent to spur growth. Manufacturing and exports both slumped during the first quarter, which covers the three months ended March 31. Manufacturing contracted 13.5 percent while exports shrank 14.1 percent. The economy, however, grew 0.1 percent in the first quarter from the final three months of last year, when GDP shrank 5.1 percent.

Lim Ji-won, economist at JP Morgan in Seoul, said that the quarter-on-quarter gain was mostly due to the "public sector's role," adding that the government's attempt to boost the economy was paying off. The government "actually frontloaded 2009 fiscal spending in the first half and mostly in the first quarter," she said. The 0.1 percent growth figure equates to an annualized expansion of 0.2 percent, she said. The central bank does not provide an annualized number. She also said that though manufacturing continued to suffer quarter on quarter, the drop had eased. "The pace of contraction has decreased quite significantly," she said. South Korea's economy grew 2.2 percent in 2008, the worst performance since an annual contraction of 6.9 percent in 1998. Both the government and central bank are forecasting the economy will contract on an annual basis in 2009, though expect it will rebound and grow again in 2010.

South Korea Economy Avoids Recession, Grows 0.1%
South Korea's central bank said Friday the country's economy averted a recession in the first quarter of this year on unprecedented interest-rate cuts and government spending. Gross domestic product rose a seasonally adjusted 0.1% in the January-March period from the fourth quarter of 2008, when the economy shrank 5.1% from the earlier quarter, the Bank of Korea said. Some economists had forecast the economy would continue to contract in the first quarter, slipping into its first recession in more than a decade. Asia's fourth-largest economy shrank 4.3% in the first quarter from the same period in 2008, after contracting 3.4% on year in the final quarter of last year, the BOK said.

The first-quarter performance was in line with the median 0.1% on-quarter growth -- and 4.5% on-year decline -- forecast by economists polled by Dow Jones Newswires. The first-quarter results, however, came below the BOK's initial estimate. The central bank had said early this month GDP likely grew a seasonally adjusted 0.2% on quarter but shrank 4.2% on year. For all of 2009, the export-dependent economy is expected to contract 2.4% after growing 2.2% in 2008, the BOK said. The government has unveiled a series of measures to boost the economy, including a 28.9 trillion won ($21.3 billion) stimulus package announced last month. Earlier this month, the central bank kept its benchmark interest rate unchanged at an all-time low of 2.00% for a second straight month amid some signs the economy is improving. The BOK had slashed its base rate by 3.25 percentage points since October to prop up the $1 trillion economy.

10 Countries in Deep Trouble
While the collapsing U.S. housing market may be at the root of the global economic recession, the downturn's effects are being felt hardest overseas. Take Iceland, for instance. Its biggest banks failed, its economy may shrink 10 percent this year, its government fell, its central banker was sacked, the country was bailed out with a $2.1 billion IMF loan, and 7,000 people (in a country of 300,000) took to the streets in protest. Which countries have the greatest chances of being the next stories of failure? U.S.News looked at some countries that are currently facing severe economic disruption that endangers their standards of living, attractiveness to foreign investors, and political stability.

First, we examined what Moody's Investors Service and Standard & Poor's had to say about them. These firms rate the risk of sovereign bonds, securities that finance the debt of a country. Many of the countries we identified have poor bond ratings or ratings under review for a downgrade, showing that these governments are perceived as being at greater risk of defaulting on their debt. Second, we looked at what global markets think about a country's debt, based on data from Markit. The financial information company provides daily pricing on credit-default swaps, contracts between two parties that provide a kind of insurance on corporate and government debt. Analysis was also supplied by credit-rating organization AM Best. It ranks countries into five tiers based on the risk to insurers posed by the countries' economic, political, and financial systems. Using these analyses, here are five countries in deep trouble and five worth keeping an eye on.

Five Countries in Deep Trouble
Mexico. Thousands of would-be tourists from America and elsewhere had to cancel spring break trips to Mexico due to ongoing violence related to the drug trade. Mexico was the second country recently identified by the U.S. Joint Forces Command as possibly poised for a "rapid and sudden" collapse. Mexico's "politicians, police, and judicial infrastructure are all under sustained assault and pressure by criminal gangs and drug cartels," says the report. The violence and tourism decline could not come at a worse time. Economists predict a 3.3 percent contraction of the Mexican economy this year. The poor economic growth means that the government is getting strapped for funds. In April, it asked the International Monetary Fund for a $47 billion loan. While credit-rating agencies don't expect Mexico's debt to grow riskier soon, and the risk of its sovereign derivatives has not skyrocketed like some other countries on this list, serious problems still remain for the Mexican economy. The country depends on the United States to consume its exports and pay Mexican immigrants who send money back home. If the U.S. recession deepens, Mexicans will feel the pain as much as Americans.

Pakistan. The country has already almost gone bankrupt once in the past six months. In October, only an emergency $10 billion in support from the World Bank, the Asian Development Bank, and others prevented Pakistan from defaulting on its debt. During that crisis, the cost of insurance on Pakistan's debt exploded. Even though the situation has calmed since then, investors are not getting comfortable with Pakistan. It still costs $2.2 million a year to insure $10 million of Pakistan's sovereign bonds. The economic situation isn't all bad. The Asia Development Bank recently predicted that Pakistan's economy will grow 4 percent in the next fiscal year beginning in July, compared to 2.5 percent growth estimated this year. But the wild card that could change everything is the country's political situation. Pakistan is one of the most unstable countries in the world. On April 13, White House counterterrorism consultant David Kilcullen said that a political collapse in Pakistan could come within months. A 2008 report from the U.S. Joint Forces Command identified Pakistan as a country at risk of a "rapid and sudden collapse," one that would create a devastating security problem for the world. The report says that "the collapse of a state usually comes as a surprise." Anyone banking their money on Pakistan's economic growth might not know what hit them.

Ukraine. While Iceland may have suffered the worst financial collapse of the global recession, Ukraine has also received a dubious honor: It had the priciest sovereign credit-default swaps for the first quarter of the year. It currently costs about $3.9 million to insure $10 million of Ukrainian five-year sovereign bonds. A year ago it cost just under $3,000. S&P rates them CCC--the seventh-best (out of eleven) rating, indicating that Ukraine is vulnerable to nonpayment. As the government tries to solve the crisis, Ukrainians are getting squeezed. Kiev, one of the oldest capitals in Europe, has had to shut down free clinics, schools, and increase public transportation costs in order to close a deficit. The Institute for Economic Research and Consulting is forecasting a GDP contraction of 12 percent. The Ukrainian stock market has fallen 25 percent so far this year. The Ukrainian currency, the hyrvnia, is also plummeting, falling 35 percent against the dollar in the last six months. The Ukrainian government's efforts to shore up the currency, including setting a floor for which the hryvnia can be traded, have so far been in vain.

Venezuela.Hugo Chavez has inextricably tied the Venezuelan economy to oil, and that didn't look so bad before the financial crisis. Oil profits helped deliver massive economic growth, so much that 4.8 percent growth in 2008 was seen as a disappointment. But with oil prices having plunged due to the global slowdown, the fortunes for Chavez's strategy have changed. Many economists are predicting negative growth for Venezuela this year, such as the 4 percent drop predicted by Morgan Stanley. From June to September, the cost for an investor to buy insurance against Venezuela's debt almost doubled. Right now, to protect $10 million in Venezuelan sovereign bonds against default, an investor would need to spend $1.8 million each year. S&P gives Venezuela's sovereign bonds a BB rating, meaning Venezuela faces "major ongoing uncertainties" that could lead to "inadequate capacity" to meet its obligations. S&P also has a negative outlook for the bond rating, meaning it could decline in the next six months to two years.

Argentina. The Argentine economy is notorious for its boom and busts. The country last defaulted on its debt in 2002, but enjoyed economic improvements through most of this decade. During that last financial crisis, citizens staged protests known as cacerolazos, which means "banging of pots and pans," but the demonstrations resulted in broken windows and fires. Argentina has not seen that kind of violence stemming from the current financial crisis yet, but foreign investors are worried the economy is back to "bust" mode. CMS Datavision ranks Argentina as having the third most expensive credit derivatives in the world. Right now, Markit composite prices show an annual cost of $3.2 million for an investor to buy protection against $10 million of Argentina's sovereign debt. Moody's rates Argentina's sovereign bonds as B3, meaning a high, speculative credit risk, and S&P as B-, meaning that more bad economic news for Argentina could lead to default. The Organization for Economic Cooperation and Development gives Argentina a seven, its riskiest classification rating.

Five Countries to Keep An Eye On
Latvia. Iceland isn't the only country that's seen massive protests against economic hardship. In January, a 10,000-strong demonstration in Latvia's capital, Riga, turned into a riot. Tremendous economic growth since the end of the Cold War earned Latvia its place as one of the "Baltic Tigers." GDP growth was 11.2 percent in 2006, for instance. But Latvia's Ministry of Finance forecasts a 14.9 percent drop in GDP this year. Latvia is getting a $7.5 billion emergency loan from the IMF, but the organization is sitting on part of the money because of the Latvian government's failures thus far to reform its budget. The past two years have seen the cost of Latvia's credit default swaps increase over one-hundred fold. Moody's rates Latvia's bonds as Baa1, or "moderate" credit risks, and projects that they could become riskier bets in the medium term.

Croatia. The country's beaches on the Adriatic Sea draw so many visitors that tourism is almost 20 percent of the country's GDP. But since the recession is taking a bite out of travelers' pocketbooks, Croatia's economy is getting bitten as well. The government forecasts unemployment could rise as high as 12 percent this year. And a recent poll found that 78 percent of Croatians think the country is going in a bad direction, with unemployment cited as the primary reason. All this bad economic news might be one of the reasons S&P projects a possible rating decline for Croatia's BBB-rated bonds. The BBB rating means that Croatia does not have payment problems yet, but are in a position where their ability to pay for debt could be easily weakened.

Kazakhstan. While the Central Asian nation's GDP has grown in recent years, Kazakhstan has two problems that have created the potential for economic disaster: a reliance on foreign lending and a reliance on oil. Kazakhstan holds 3.2 percent of world's oil reserves. But the soaring oil prices that have boosted Kazakhstan's economy are no more, and investors have pulled money out of Kazakhstan in response. The cost of buying protection against Kazakhstan's debt has skyrocketed about 75 percent during the past year. The cost is back up to a peak reached in October, and it currently costs $875,000 a year to insure $10 million of Kazakhstan's debt. S&P has a negative outlook on Kazakhstan's BBB-rated sovereign bonds, meaning they could get riskier in the next six months to two years.

Vietnam. Unlike many of the other countries on this list, Vietnam has had some good news recently. The Asian Development Bank forecasted Vietnam's economic growth at 4.5 percent for the next year, the highest in Southeast Asia. Yet the country just registered its slowest economic growth in a decade. A survey found that 46 percent of Vietnamese were afraid of unemployment in January, up from 9 percent in September. Both Moody's and S&P have a negative outlook for Vietnam's sovereign bonds. The price of its sovereign derivatives has almost doubled in the past year. Vietnam falls into the riskiest of the five tiers as rated by AM Best. In particular, the firm identifies Vietnam's financial system, plagued by "relatively poor infrastructure and cumbersome bureaucracy," as "very high" risk.

Belarus. Minsk, the capital of Belarus, was mostly destroyed during World War II and much of the city was rebuilt in the form of hulking, utilitarian, Soviet-style buildings. Belarus also retains a heavy Soviet influence in its financial system--all but one of the country's 31 banks is controlled by the state, according to AM Best. Because of Belarus's failure to reform its financial system, the firm gives the country its highest score for financial risk. Even though Belarus scores relatively well for political stability, that economic rating is enough to push it into the riskiest of the report's classifications. Belarus's problems aren't just speculative. Although its economy is still growing, the IMF expects it will expand 1.4 percent this year, compared to 10 percent last year.The country's government has also been approved for a $2.46 billion IMF loan. But the IMF now forecasts that the country will need a further $10.7 billion in 2009. Still, other experts disagree about just how fragile Belarus's economy is. Its bonds are rated as B1 from Moody's, meaning high credit risk but also at the top of the pack of the high-risk countries.

"Banker to the poor" gives New York women a boost
Nobel Peace Prize winner Muhammad Yunus, known as the "banker to the poor" for making small loans in impoverished countries, is now doing business in the center of capitalism -- New York City. In the past year the first U.S. branch of his Grameen Bank has lent $1.5 million, ranging from a few hundred dollars to a few thousand dollars, to nearly 600 women with small business plans in the city's borough of Queens. People around the country are struggling to repay mortgages and credit card debts, but Grameen America says its loan repayment rate is more than 99 percent. "While other banks are collapsing, this one remains strong," Yunus told reporters at a street fair, where about 100 Grameen America borrowers sold wares ranging from food and flowers to clothes and jewelry.

"Microcredit has been one area the crisis has not impacted. The crisis has not touched it, still it is robust as ever," said Yunus, who started Grameen Bank in Bangladesh in 1983. Zemia Shoffner received a loan of $2,000 in January from Grameen America, which she used to take a baking class to expand her catering expertise and drum up more business. "I have been running my business for about three years now and (the course) meant a lot because it makes me more marketable," Shoffner told Reuters, noting her bad credit meant she could not get a traditional bank loan. "This has really allowed me to live my dream. I had another job and I wasn't really happy, so now I really have the freedom to pursue my passion. It means everything," she said.

In Bangladesh Grameen Bank has lent nearly $8 billion, in increments of a few dollars to a few thousand, to millions of poor borrowers -- almost all women -- to run small businesses. Bangladeshi economist Yunus and his Grameen Bank were awarded the Nobel Peace Prize in 2006. Karen Giral, 20, who is pregnant with her second child and lives in Elmhurst, Queens, has paid off her first loan of $600 and now has a second loan of $1,000. She has used the money to build her business selling Avon products. "It was a really big help because to save up that much money is ... hard," said Giral, who heard about Grameen America from her mother.

In addition to America, the Grameen Bank operates in Kosovo, Turkey, Zambia, Costa Rica, Guatemala and Indonesia. Microfinance institutions around the world say they are struggling to raise funds for loans. But Grameen Bank in Bangladesh -- where 98 percent of loans are repaid -- uses deposits to finance loans. Grameen America now operates by lending out money gathered through donations and money from payments on existing loans. The bank is applying for a U.S. credit union license to generate the deposits it needs to make more loans. "Microcredit cannot depend on small donations. This is a business, it should be run like a business," Yunus said.

U.S. President Barack Obama recently announced the creation of a $100 million microfinance growth fund for small lenders in the Western Hemisphere to allow them to continue making loans despite the global recession. "$100 million is a very small amount to start. Grameen Bank in Bangladesh lends more than $100 million a month," said Yunus, adding that it was a welcome "first step." In Queens, Grameen America borrowers must have two forms of identification and a tax return to show their financial situation. They also must open up a bank account that requires them to deposit $2 a week, on top of repaying their loan, to foster a habit of saving.

Leslie Kane, vice president of finance and strategy for Grameen America, said reducing poverty through microfinance banking is not just for developing economies. "Many Americans say, 'Oh we don't have poverty in the United States.' But we do, just like every country around the world we need to focus on microcredit," she said. For Yoly Castillo, 37, a Colombian immigrant who lives in College Point, Queens, a $1,000 loan from Grameen America not only helped her start a clothing business seven months ago but also inspired her to study business administration at college. "This business has made me open up my horizons, it's amazing," said Castillo, who also works part-time as a medical biller and pays back $22 a week on her loan. "I never expected this of myself ... . It has given me so much strength."


Anonymous said...

How refreshing that even the guitarist get it.

Even?!...and how about those whose second language is English?

Remember now, modern man does not live by bread alone, he also needs stocks and bonds!

Lets see if the 'economists' here get this ... here is something about a guitarist during times we have seen and seemingly seeing once again.

-Nagasaki the sailor man-

Chaos said...

Since we have a video lead off, just thought I'd mention the video posted over at Denninger's site...pretty catchy tune, with some appropriate visual effects.

Brian M said...

repeat posted from this morning's comments

Todd beat me to answering you about where that discussion was here on TAE, but let me also say that I posted my essay on the Value of Despair to day on my blog at

pdh1953 said...

Brian -- thanks much. I thanked Todd on other comment thread. Now, I will go read your essay.

Unknown said...

The South Korean economic growth rate measurement (changing the typical measurement comparison from annual -down 4.3% - to quarterly - up 0.1%) is something I've started to notice creeping in all over the reporting of financial news. Car sales and house sales and housing starts in my area are often getting spun this way - "It's up 5% from last month (oh, and down 39% compared to the same month last year)". Better than historic lows is not a good thing...

Soon the unemployment rate will be reported this way. "This month, employment rate rose 0.5%, as only 600,000 jobs were lost, an improvement over last month", or something like that. It makes even less sense to report employment this way than GDP, but I wouldn't put it past the media in their fierce spinning attempts.

Anonymous said...

The Grameen bank concept generates loans based on actual deposits.

This is almost the opposite of the fractional reserve banking concept.

This is closer to 'full reserve banking'.

No credit left in the system is the logical end result of fractional reserve banking. The leveraging and compound interest itself insure this outcome.

At it's core fractional reserve banking is a Ponzi.

Grameen America is not, it can going on indefinitely.

"The Market" as hoisted up in America as god's-gift-to-the-world is nothing but a perverted Ponzi, always was.

Ahimsa said...

"In the Nick of Time or Too Late?"
by Michael C. Ruppert"I wrote a pretty good book and was the subject of what I suspect is going to be a pretty good movie: Collapse that can soften the end result of all this. I haven't seen any of the movie yet. But was all this work by so many people in the nick of time or too late? I am beginning to think we'll look back and say the former.

Honest John said...

Anom @ 12:34

Thanks for the post on Django...great documentary...

Gravity said...

He who knows not how to
dissimulate cannot mark to malice.

Ahimsa said...

"Mexico City Closes Museums to Stop Flu Outbreak" wonder what Adios a Babilonia would say about this ...

Gravity said...
This comment has been removed by the author.
Gravity said...

A variant of the H1N1 virus supposedly caused the 1918 influenza epidemic that killed an estimated 50 million people worldwide.

If this becomes a serious outbreak,
it may cause a general scare, making people avoid exposure in public spaces, thus collapsing consumer spending even further.

Penn said...
This comment has been removed by the author.
Penn said...


Doom and Gloom Dad said...

“in the end only, underlying reason why home prices will -have to- keep on falling: there is no credit left in the system”
What rubbish. After many times of restraint I am pushed to express a very different viewpoint on the whole mess. In this particular instance, I maintain there is no shortage of credit in the system. If the banks thought there was a chance that people could continue to pay for mortgages they would extend them. You can blame bankers for many things but to blame them for not extending loans – for houses, credit cards, businesses – when there will be very little prospect for payback? You see, you are concerned with the middle class, in your words “poor as they are getting”, these people you consider to be “the American people themselves”. I read your blog with great interest as it does a wonderful job of giving a view of what is actually going on, but I do not buy at all your underlying analysis. You ask for contributions on the basis of the asset protection provided by that view. Don't you see? Your attention is on those who have assets. The very words “middle class” should alert you to the possibility that there are others involved and I don't mean the various levels of “upper class”. One who comes close to getting it is Robert Reich in “America’s middle classes are no longer coping”. ( If you shift your economic focus just a little lower than where he has set his, you will see those for whom “are no longer coping” moves into the past tense.
(A personal note on my situation: You could say that I have no assets or that what I have is “sunk” in 9 acres in an out-of-the-way place in Hawaii which I work to bring into sustainability so my kids will have a place to retreat to if needed.)

Anonymous said...

Chaos, thanks for the mention of Denninger, but now about the anon what said:

How refreshing that even the guitarist get it.

Maybe I guess I owe him an apology. Times they not only are times-a-changing but now, even before, already we are there.

Anonymous said...

Your attention is on those who have assets.

Well I dunno, but being warned not to go into debt seems to me as much directed at them as got nothing than at them that have.

Chaos said...

Anybody notice that the US News piece was only concerned with which countries to invest (or not invest) in? I guess human suffering doesn't enter the picture...

Doom and Gloom Dad said...

“Your attention is on those who have assets.
Well I dunno, but being warned not to go into debt seems to me as much directed at them as got nothing than at them that have. “
You guys still don't get it. First, for many I refer to it would be “not to go into DEEPER debt.” For many others, there is no option of going into debt and for those who do have that option the alternatives can be pretty desparate.

Anonymous said...


Someone else says it it "Mark to Snark", who is right?

VK said...

Hey it's not only Ilargi that cracks up at Darling. The times online compares him to Mr. Bean.

Those crazy brits, what a laugh they must be having ;-)

"Bad economics, timing and politics: but a good impression of Mr Bean

Alistair Darling has saved the economy. Unfortunately the economy he has saved is the wrong one. In true Mr Bean fashion, yesterday’s Budget saved the economies of Switzerland, Luxembourg, Jersey, Hong Kong and other low-tax jurisdictions (polite society no longer describes them as tax havens), which only three weeks ago his boss Gordon Brown had boasted of closing down.

As for the British economy, one can only sigh in disbelief. To cram so much bad news and so many policy blunders into an hour-long speech was quite an achievement, matched only by David Cameron, who managed in just 15 minutes to prove that Britain under the Tories would fare even worse."

Erin Winthrope said...
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rapier said...

Noland is hanging his hat on the viability of the Government Finance Bubble.

The unfolding refi boom has the potential to significantly impact systemic reflation. For one, millions of households will be reducing their monthly mortgage payments. Many with adjustable-rate, shorter-term, or various “exotic” mortgages now have an opportunity to stretch things out to 30 years at quite favorable rates. While certainly a fraction of previous inflated levels, there will be meaningful equity extraction used to pay down higher cost debt and, perhaps even, buy things (weekly retail sales trends have stabilized). There is also the dynamic where holders of millions of old mortgages will receive early repayment in a process that works to reliquefy segments of the MBS marketplace. And I’ll assume that the GSE’s will increase their holdings of new MBS, perhaps creating a significant impetus for system reflation. At the minimum, Fannie, Freddie, and the FHA will be stamping their (I mean the taxpayers’) guarantee on hundreds of billions of MBS, creating more “money-like” debt instruments out of Wall Street’s previous “private-label” variety of (discredited) mortgage security.

It’s my view that the markets generally lead the economy – not vice-versa. If this stock market rally is sustained, I would expect the summer home selling season to surprise on the upside in many locations. When some semblance of confidence returns to housing markets, I would not be surprised to see some pent up demand positively impact auto sales. Anecdotally, it appears consumer Credit conditions are beginning to loosen – even in auto finance.

If we step back and ponder the unprecedented scope of today’s global fiscal and monetary stimulus, we shouldn’t be all that surprised by the fledgling reflationary forces observable both at home and abroad. I have labeled emerging dynamics the “Government Finance Bubble.” There is mounting evidence that this Bubble is developing critical mass and should be taken seriously."

Who am I to argue? I discounted him in 03. I just wonder if they can flate the real economy, this time, enough, however much that is? Stocks are easy to flate. His bond rates and spread numbers are something else again.

ccpo said...

Re: Korea
Purely anecdotal, but I live there. Korea has a pop. density of nearly 400/sq. km. On an off day, it's busy. Korea is one of those countries where you can go to a convenience store, buy a beer, and drink it at a table outside on the sidewalk. As the weather warms, there are people out all the time. Even in the wee hours, it's not unusual for some areas to remain relatively busy.

I live in one of the higher income suburbs of Seoul. It's dead compared to the past. The malls are walkable rather than like being a ball in a pinball machine. Traffic is better at all hours (relative to the hour in question).

If this economy is growing, I'm Admiral Yi Sun Shin.