Washington DC. 1st U.S. Volunteer Infantry. Hancock's Veteran Corps on F Street
Ilargi: Bankers on Wall Street and London’s City are to be paid salaries, fees and bonuses of close to $100 billion, for 'work' that has cost the two countries’ taxpayers well north of $1 trillion.
It's important to note that the bankers are no longer responsible for their own actions. Since all banks involved are now de facto owned by their respective governments, the responsibility for the pay-outs rests squarely on the shoulders of the Treasury secretaries Paulson and Darling, their bosses, Bush and Brown, and the houses of representatives.
US and UK citizens should send a very clear message to their elected representatives that if this is not halted immediately, they will, all of them, be indicted for fraud and other criminal acts. The people’s money cannot be used to spend on multi-million dollar compensation packages for the same guys and dolls whose gross incompetence and blatant greed has already cost the people a true fortune.
It might be good to warn these representatives that being dragged into court is quite likely to be their best-case scenario. Beyond that, there are pitchforks. If the nations’ legal systems are unable or unwilling to apply the full extent of the law to these bizarre acts of highway robbery, the legitimacy of the judiciary branch of government will find itself in the same grave danger that the the legislative and executive branches have now been in for quite some time.
If the people lose faith in the principle that their rights are secured by the laws of the land, then there is no longer a democracy. As long as they are provided with sufficient bread and circuses, a situation such as this can linger for a while. Today, however, the bread is disappearing from the table, and a circus alone will not stem the tide.
Spain, Argentina, Pakistan, Ecuador, Ukraine, Hungary, Serbia, Latvia, Estonia, Lithuania, Romania, Bulgaria, Turkey and Switzerland are today all teetering dangerously close to various brinks, while there are undoubtedly dozens of basket cases hiding in the shadows, behind the veils of reassuring PR.
The people of Iceland, until a few weeks ago one of the richest countries in the world, no longer have access to the money in their bank accounts. That should be a warning sign for everyone, wherever you live. No matter how much money you have in the bank, if you can’t get to it, you can be poor from one day to the next.
And when the first of the long list of troubled countries start collapsing economically, we are all smart enough to realize that there will be mobs in the streets and runs on the banks.
What we see unfold before our eyes is not an economic crisis. It is something much bigger.
Wall Street banks in $70 billion staff payout
Pay and bonus deals are equivalent to 10% of the US government bail-out package. Financial workers at Wall Street's top banks are to receive pay deals worth more than $70bn (£40bn), or 10% of the US government bail-out package, a substantial proportion of which is expected to be paid in discretionary bonuses, for their work so far this year - despite plunging the global financial system into its worst crisis since the 1929 stock market crash, the Guardian has learned.
Staff at six banks including Goldman Sachs and Citigroup are in line to pick up the payouts despite being the beneficiaries of a $700bn bail-out from the US government that has already prompted criticism. The government's cash has been poured in on the condition that excessive executive pay would be curbed.
Pay plans for bankers have been disclosed in recent corporate statements. Pressure on the US firms to review preparations for annual bonuses increased yesterday when Germany's Deutsche Bank said many of its leading traders would join Josef Ackermann, its chief executive, in waiving millions of euros in annual payouts.
The sums that continue to be spent by Wall Street firms on payroll, payoffs and, most controversially, bonuses appear to bear no relation to the losses incurred by investors in the banks. Shares in Citigroup and Goldman Sachs have declined by more than 45% since the start of the year. Merrill Lynch and Morgan Stanley have fallen by more than 60%. JP MorganChase fell 6.4% and Lehman Brothers has collapsed.
At one point last week the Morgan Stanley $10.7bn pay pot for the year to date was greater than the entire stock market value of the business. In effect, staff, on receiving their remuneration, could club together and buy the bank.
In the first nine months of the year Citigroup, which employs thousands of staff in the UK, accrued $25.9bn for salaries and bonuses, an increase on the previous year of 4%. Earlier this week the bank accepted a $25bn investment by the US government as part of its bail-out plan.
At Goldman Sachs the figure was $11.4bn, Morgan Stanley $10.73bn, JP Morgan $6.53bn and Merrill Lynch $11.7bn. At Merrill, which was on the point of going bust last month before being taken over by Bank of America, the total accrued in the last quarter grew 76% to $3.49bn. At Morgan Stanley, the amount put aside for staff compensation also grew in the last quarter to the end of August by 3% to $3.7bn.
Days before it collapsed into bankruptcy protection a month ago Lehman Brothers revealed $6.12bn of staff pay plans in its corporate filings. These payouts, the bank insisted, were justified despite net revenue collapsing from $14.9bn to a net outgoing of $64m.
None of the banks the Guardian contacted wished to comment on the record about their pay plans. But behind the scenes, one source said: "For a normal person the salaries are very high and the bonuses seem even higher. But in this world you get a top bonus for top performance, a medium bonus for mediocre performance and a much smaller bonus if you don't do so well."
Many critics of investment banks have questioned why firms continue to siphon off billions of dollars of bank earnings into bonus pools rather than using the funds to shore up the capital position of the crisis-stricken institutions. One source said: "That's a fair question - and it may well be that by the end of the year the banks start review the situation."
Much of the anger about investment banking bonuses has focused on boardroom executives such as former Lehman boss Dick Fuld, who was paid $485m in salary, bonuses and options between 2000 and 2007.
Last year Merrill Lynch's chairman Stan O'Neal retired after announcing losses of $8bn, taking a final pay deal worth $161m. Citigroup boss Chuck Prince left last year with a $38m in bonuses, shares and options after multibillion-dollar write-downs. In Britain, Bob Diamond, Barclays president, is one of the few investment bankers whose pay is public. Last year he received a salary of £250,000, but his total pay, including bonuses, reached £36m.
City of London bankers' £16 billion bonus bonanza
City bankers have not lost a penny of their multimillion-pound bonus packages so far, despite the credit crunch which has caused the worst financial crisis in 80 years, new figures show.
Official statistics reveal that, in the financial year to April, City workers took home £16bn, almost exactly the same as in 2007. The period covers the Northern Rock nationalisation and the UK employees hit by the Bear Stearns implosion. During the period, banks across the world were forced to make huge writedowns on investments linked to US subprime mortgages.
Bonus payments in the UK financial sector have more than trebled in just over five years, from £5bn in 2003, according to the Office for National Statistics (ONS). This is shared among just over one million employees in the sector, but that is heavily skewed towards the high-powered executives, who are routinely handed seven-figure packages.
Last year, Bob Diamond, the president and head of investment banking at Barclays whose base salary was £250,000, was paid £18m after bonuses and options were taken into account. The remuneration figures were released only days after Gordon Brown vowed to wage war on the "irresponsible" bonus culture that had helped cause the financial crisis gripping Britain. Financial sector payments made up about two-thirds of the bonuses across the entire British economy. Total bonus payments last year hit £28bn, which has doubled over the past eight years.
Last night politicians and union officials said it was deeply concerning that such large bonuses were still being paid even when the financial markets were clearly deteriorating. Vince Cable, the Liberal Democrat Treasury spokesman, said: "It is deeply alarming that, after what has happened in financial markets, no lessons have been learnt. The bonus culture was deeply destabilising and contributed to the crisis."
Derek Simpson, the joint general secretary for the Unite trade union, added: "This is evidence that the City bonus system is rotten to the core. These bankers are being rewarded for failures which have had devastating consequences for our economy." He called on the authorities to tackle the problem head on, saying: "It is time for the Government and the Financial Services Authority to get really tough and stamp out the bonus culture in the City."
Yesterday provided some slight relief for the battered UK markets. The week had seen staggering losses across the globe, with London's blue chip index slumping to its lowest point in five years as fears of a worldwide recession intensified. Yesterday the FTSE 100 rose 2 per cent with investor confidence returning in the banks as well as the oil companies, after the oil price bounced back to more than $70 a barrel.
The mining companies continued to suffer as metal prices fell further on fears of slowing demand from China. It was further hit by hedge funds forced into selling to cover losses elsewhere. There was bad news for the French bank Caisse d'Epargne, however, which admitted shock losses of €600m (£470m) from derivatives trading. The inflation-busting bonus numbers emerged on the day that Josef Ackermann, chief executive of Germany's biggest financial services group, Deutsche Bank, pledged to relinquish his bonus, which would have run into "millions of euros".
He told the German newspaper Bild am Sonntag: "I told the Deutsche Bank supervisory board that I am renouncing my bonus in this difficult year in favour of hard-working staff that need the money more than I do." The three other senior board members agreed, who received a combined payment of £4.3m.
Mr Cable welcomed the move and called on the financial services sector in the UK to take a page out of Mr Ackermann's book. He said that, as banks' remuneration committees prepare to decide next year's bonuses, "until regulation is put in place it would be good to see some self-restraint from those who work in the financial services".
The Government's official bonus numbers are compiled from those paid during bonus season – the period from December 2007 to April 2008. The latest figures show no decline in rewards, despite the City being at least six months into the credit crunch when the payments started. The issue of bonuses has become a huge political issue this year, with investors furious over bankers taking rewards in a year that many banks have declined or even collapsed.
Following the Government's £37bn rescue package for Royal Bank of Scotland, HBOS and Lloyds TSB this month, the Prime Minister said he wanted to "bring an end to rewards for failure". He said: "The guiding idea is fair reward for hard work, effort and enterprise, not incentives for irresponsibility or excessive risk-taking for which the rest of us have paid."
A critical problem of the bonuses, as highlighted by Mr Brown and Mr Cable, was their promotion of huge risks for a short-term gain. Bonuses should be paid in shares, which could not be sold for several years to track the performance of a company over the long term, Mr Cable added.
The FSA, the City watchdog, has begun to scrutinise the issue of bonuses, and sent a letter to bank chief executives, calling for bonuses to be aligned with "sound risk-management practices and controls". So far the FSA is yet to impose regulations, but said it would demand more regulatory capital for those that do not heed its warning on risk.
No Bonus for Deutsche Bank Boss Ackermann
Josef Ackermann, head of Germany's biggest bank, said he would not accept bonuses this year, forgoing the potential for millions in personal income.
The German Social Democrats have never been shy of a little populism. In 2002, it was then-Chancellor Gerhard Schröder who made his opposition to the impending US invasion of Iraq a major plank in his re-election campaign. SPD head Franz Müntefering followed in 2005 with his oft-repeated labelling of private-equity investors as "locusts" on German businesses.
Finance Minister Peer Steinbrück's insertion of a clause in Germany's €500 billion bank bailout bill calling for managers from those banks in need of public help to accept a reduced salary of just €500,000 per year fits right in. But now, it seems that Steinbrück has been one-upped in the populism department -- by none other than Deutsche Bank CEO Josef Ackermann. On Thursday Ackermann told the German tabloid Bild that he would forgo his annual bonus this year out of solidarity with Deutsche Bank employees lower down on the ladder.
"I have told the supervisory board that in this difficult year I will waive my bonus -- for the good of deserving workers who need the money more than I do," Ackermann told the paper. In 2007, the Deutsche Bank head earned over €12 million worth of bonuses. It is unclear how high Ackermann's bonus would have been this year, but he said it was "a few million."
Deutsche Bank says it has lost in the neighborhood of $10 billion as a result of the credit crisis since the beginning of 2007.
At a Thursday management meeting in Frankfurt, Ackermann also said Deutsche Bank would not take advantage of help offered by the €500 billion German bailout package that passed through both houses of German parliament on Friday.
The SPD on Friday seemed unhappy with Ackermann's attempt to portray himself as a man of the people. SPD parliamentary floor leader Peter Struck called Ackermann's offer "pure showmanship." Struck made his comments just before Germany's lower house of parliament, the Bundestag, voted to approve the gigantic bailout package. He went on to say "the arrogance of the bankers has to come to an end once and for all. These gentlemen acted as if they were playing a giant game of Monopoly."
Despite the widespread disgust with the financial calamity brought on by dubious investments and high-risk trading, it seems doubtful that Finance Minister Steinbrück's plan to require bank managers receiving state help to accept a salary of no more than €500,000 per year will gain traction.
Frankfurt law professor Theodor Baums told SPIEGEL ONLINE that "no one can require a manager with a valid contract to reduce his salary to €500,000 per year." But then, when it comes to populism, real-world effects are perhaps secondary. Ackermann, for his part, certainly won't go hungry as a result of his offer. His base salary in 2007 was €1.2 million.
Britain faces deflation for first time since 1960
Britain will slump into deflation next year for the first time in half a century, experts have warned. For the first time since 1960, the cost of living will start to shrink next year, in a worrying parallel of the Japanese "disease" of the 1990s, according to new research. The news comes amid growing speculation that the Bank of England will soon be forced to cut borrowing costs to 2pc or below, taking them to their lowest level since it was founded in 1694.
The Monetary Policy Committee last week unexpectedly cut rates by a half percentage point to 4.5pc in the face of the financial crisis. However, there is also growing evidence that inflation, which has risen above 5pc in recent months, is set for a dramatic fall. The Retail Price Index – the most comprehensive measure of UK high street prices, will drop at an almost unprecedented rate to -2pc by the second half of next year, according to new research from Fathom Consulting.
It said the fall was largely due to the drop in mortgage costs and house prices, which together form a large part of the RPI. However, lower food and energy prices would also play an important role. Since modern comparable records began in 1956, the RPI has dropped into negative territory only once, in the late 1950s and early 1960s, but it only dropped as far as a rate of -0.5pc.
Andrew Brigden, economist at Fathom Consulting, said: "This does have worrying implications – particularly if it heralded a general period of deflation. The risk is we have a rerun of Japan because you simply can't [cut interest rates] to below zero." Japan suffered almost a decade of deflation and falling economic growth in the 1990s after its debt-fuelled economic bubble burst with painful consequences. Despite cutting official interest rates to zero and pumping cash into the economy, the Bank of Japan was unable to pull prices back up into positive territory for years. However, Fathom predicts RPI will drop below zero for only a few months.
Whereas high inflation tends to encourage borrowing, deflation encourages saving and, as a result, discourages companies from investing and spending today what they could save for tomorrow. Fathom's prediction is based on the assumption that the Bank of England cuts interest rates to 2pc within a year.
Although markets anticipate borrowing costs falling to only 3.5pc, a growing cohort of economists think it will be forced into taking more drastic action. Mr Brigden said if oil prices came back below $70 a barrel and house prices fall at an even faster rate, the level of RPI inflation could fall as low as -3pc and remain in negative territory for a year.
Although Fathom does not expect the Consumer Price Index – the measure targeted by the Bank's MPC – to drop into negative territory, Prof Peter Spencer, of the Ernst & Young Item Club, said such an eventuality was not out of the question. "This time next year we're looking at all of these huge increases in bills coming out of the index, and then potentially falling," he said. "CPI will go viciously negative – it's looking increasingly likely that it drops below target. It could easily go into negative territory, along with RPI."
Amid Pressing Problems, Threat of Deflation Looms
Policy makers navigating the U.S. through the global credit crisis may have a new concern on the horizon for 2009: deflation.
The risk of deflation -- generally falling prices across the economy, beyond volatile energy and food costs -- remains slim. But the financial shock and a faltering economy can set the stage for a deflationary environment. Federal Reserve officials view broad-based deflation as unlikely but possible. Federal Reserve Bank of San Francisco President Janet Yellen said in a speech this week that the plunge in oil prices along with slackening demand for labor and goods should "push inflation down to, and possibly even below, rates that I consider consistent with price stability."
Fed officials generally consider price stability to be an inflation rate between 1.5% and 2%. Their preferred measure of core inflation, which excludes food and energy, stands above 2% now, and is expected to remain above that mark as price increases from earlier this year advance through the product pipeline. The economic slowdown and declining commodity prices have eased the nation's consumer inflation rate, which surged to 5.6% over the summer. Annual inflation in the U.S. is likely to turn negative for at least several months next year, on declining energy and food prices.
With the unemployment rate rising rapidly and capital markets in turmoil, "pretty much everything points toward deflation," said Paul Ashworth, chief U.S. economist at Capital Economics. "The only thing you can hope is that the prompt action of policy makers can maybe head this off first." The Japanese economy in the 1990s and the U.S. during the 1930s illustrate how deflation can choke a weak economy and spiral out of control. A sagging economy exerts downward pressure on prices because of weak demand for labor and goods.
Broad-based declines -- particularly in a credit crisis, which can push asset prices down sharply -- can also force down wages, preventing consumers and, therefore, companies from paying their debts. Falling prices also encourage businesses and consumers to save rather than spend, because money would be worth more after prices decline. The restrained spending, in turn, hurts the economy even more.
Federal Reserve Chairman Ben Bernanke, in a speech as a Fed governor in 2002, said deflation in the U.S. is "highly unlikely" but added, "I would be imprudent to rule out the possibility altogether." The reason, he said at the time, was the Fed "has sufficient policy instruments to ensure that any deflation that might occur would be both mild and brief." The government has taken extraordinary measures in recent months to stem the credit crisis and further action is expected to keep the economy from becoming too weak to benefit from monetary and fiscal stimulus.
"You know stimulus is coming," said Vincent Reinhart, former director of the Fed's monetary affairs division. "The appetite of a new president and new Congress for a prolonged economic slump is zero." The risk of deflation was among the factors leading the Fed to keep interest rates at only 1% earlier this decade, when its preferred inflation measure also was around 1%. The Fed's target rate now is 1.5% and some economists expect the central bank to lower it further in coming months.
Fed policy makers can raise short-term interest rates to fight rising prices, as they did into the early 1980s. But they can only cut rates to zero to fight deflation. After that, other policy options come into play. Deflation concerns in 2002 and 2003 led Fed officials to consider alternative measures to stimulate the economy. Their initial option came from the Fed's 1940s playbook: buying Treasuries to force down long-term yields, leading consumers and businesses to spend instead of save. In normal circumstances, effectively pumping money into the economy would support growth and spur inflation over time. Today's credit crisis has pushed Treasury yields lower already as investors seek less-risky assets.
Mr. Reinhart, among the officials leading the Fed's deflation studies earlier this decade, said the Fed now has other tools. This month, Congress gave the central bank permission to start paying interest on reserves held by commercial banks. That gives the Fed more latitude to expand its balance sheet, which it can use to pump more reserves into the banking system.
In 2003, the Fed signaled its willingness to keep interest rates down at 1% for a "considerable period." That communication helped support the economy by pushing market rates down. Today, Fed officials are facing criticism for keeping interest rates too low for too long this decade, worsening the housing boom. However, "if the economy is under duress," Mr. Reinhart says, "too long doesn't look that long at all."
Sudden business collapses likely in frozen markets
Some large, perfectly healthy British companies could be at risk of sudden collapse if lending markets are not unfrozen soon, the Association of Corporate Treasurers has warned. Richard Raeburn, chief executive of the ACT, the professional body for those dealing with treasury, risk and corporate finance, said his organisation was concerned that solvent companies could be vulnerable as they struggled to borrow at a time when their existing bank refinancings were due for renewal.
Under normal credit conditions companies rely for their short-term funding needs on uncommitted funding from their banks. Larger companies also tap the commercial paper markets. But such markets are virtually closed due to an absence of confidence in corporate risk. Uncommitted bank funding is scarce, and expensive if available.
"We are obviously in very difficult territory," Mr Raeburn told the Financial Times at an ACT conference on working capital management. "It feels almost like the lull before the storm in which any particularly turbulent waters could actually swamp a company that hasn't been able to manage its refinancing in a way that avoids excessive concentration of maturities."
Mr Raeburn suggested that the Bank of England consider resurrecting a form of financing popular until the 1980s called "acceptance-based financing". Such financing took the form of "eligible bills", issued by a company after acceptance by the company's bank and backed by the Bank if England. This created a flow of funds direct to the company.
Mr Raeburn said this type of corporate funding was one way of unblocking the system and "getting funding to where it is needed". Writing in today's Financial Times, Mr Raeburn says: "Corporate Britain needs cash to flow from where it should not be - at the central bank - to where it should be, refinancing corporates. Absent further radical action, it is quite possible we will witness the unexpected collapse of a solvent but illiquid corporate."
Is Switzerland the next Iceland?
In an extraordinary move for a nation proud of its financial prudence and stability, Switzerland was forced to take emergency measures yesterday to shore up its two biggest lenders to prevent a collapse in confidence in the country's banking system.
The state will inject SFr6bn (£3.1bn) into UBS, its biggest bank, in return for a 9.3 per cent stake, and will allow UBS to unload $54bn (£31bn) of toxic assets, including sub-prime mortgages and Alt-A securities, into a fund controlled by the central bank.
Credit Suisse, the No 2 Swiss lender, obeyed instructions from the central bank by raising about SFr10bn from investors in the market, including the Qatar Investment Authority, which is already a big shareholder and is a major stakeholder in Barclays. The fundraising, which allows Credit Suisse to meet tough new Swiss capital rules, represented about 12 per cent of the bank's existing equity.
Switzerland had to act to underpin confidence in its prized banking system after Britain, the US and others announced massive capital injections into their major lenders. Without doing likewise, the Swiss banks would have been left exposed to market jitters and speculation. The country of 7.5 million people houses SFr3.46trn of bank deposits, almost seven times its gross national product. That is less than Iceland, whose deposits are nine times GDP, but much higher than the UK where deposits are close to double GDP.
"It's clear that we have a confidence problem," Philipp Hildebrand, the Swiss National Bank's vice president, said. "It is notably the two large banks that are affected." The woes of its banks, and UBS in particular, have rocked Switzerland, where the financial sector accounts for almost 15 per cent of output. The government said it did not intend to hold the stake in UBS for many years and hoped to sell it to private investors soon. It will impose changes in corporate governance and risk controls in return for the state's support.
The capital increase will lift UBS's tier one capital ratio to 11.5 per cent by the end of the year from 10.4 per cent. After its fundraising, Credit Suisse's tier one ratio would have been 13.7 per cent at the end of September, compared with the 10.8 per cent the bank reported.
The Swiss government also said it would follow other European governments by increasing its depositor protection scheme from the current SFr30,000 level. It stressed that the country's other banks were generally sound. UBS said the government's measures should help it reverse withdrawals of client assets. Wealthy clients have been taking money out of the bank's core wealth management business because of a stream of writedowns at the investment banking division, which expanded into structured credit just before the market imploded in the summer of 2007.
Net outflows of SFr49.3bn hit the wealth management business in the third quarter, while the global asset management division leaked SFr34.4bn. The withdrawals increased as the financial crisis worsened in September after the bankruptcy of Lehman Brothers in the US. UBS recorded a small net profit of SFr296m for the third quarter, though it was helped by benefits from the reduced value of its own debt and tax gains.
UBS said its biggest need was to reduce its exposure to illiquid assets, whose plunging value has caused massive losses and shattered confidence in the bank, and that the central bank's fund would help it get back to running its business as normal. The investment bank made new writedowns and losses of $4.4bn on top of $42bn of writedowns since the start of the credit crunch.
"All European governments intervened and this left the Swiss banks at a competitive disadvantage," Dirk Becker at Kepler, the brokerage, told Reuters. "The Swiss have recapitalised their banks and made them the best capitalised banks in the world." Credit Suisse saw strong inflows at its wealth management business of about SFr14bn in the quarter but made a net loss of about SFr1.3bn due to new writedowns.
The government also said that if refinancing problems emerged, it would guarantee banks' new short- and medium-term interbank liabilities and money market transactions. The move would follow a key step announced by the UK as part of its rescue package for the sector. Shares in the two banks rose after the rescue package was announced but fell at the end of the session in line with the wider market after gloomy employment numbers from the US increased fears about the world economy. Credit Suisse drop-ped 0.9 per cent to SFr45.5 while UBS lost 4.9 per cent, closing at SFr19.09.
Like other governments, Switzerland has acted to try to stop the financial crisis wreaking havoc on the wider economy. With banks refusing to lend to each other, the cost and lack of credit for small businesses and corporations threatens to turn the economic downturn into a punishing recession. "This package of measures will contribute to the lasting strengthening of the Swiss financial system," the government said. "The resulting stabilisation is beneficial for overall economic development in Switzerland and is in the interests of the economy as a whole."
With even the mighty Swiss banking system needing government support, it will come as little surprise that a swathe of emerging market economies are suddenly looking fragile. Ukraine emerged yesterday as the winner of the title "the next Iceland", with the International Monetary Fund offering the former Soviet republic up to $14bn (£8bn) to shore up its financial system.
An IMF delegation landed in the country on Wednesday to try to stabilise the country's battered banking sector and ailing currency, hit hard by the global financial crisis. The central bank was forced to impose restrictions on deposit withdrawals and lending after panicked savers rushed to empty their accounts, draining the banking system of more than $1.3bn. The authorities also had to rescue two key banks and battle a sharp fall in the currency as the stock market plunged.
Ukraine emerged as the biggest crisis after Hungary agreed to borrow up to €5bn from the European Central Bank. Capital Economics warned that there were risks for a swathe of emerging European economies in the Baltics and the Balkans, including Lithuania and Latvia. Their problem is that they have been living beyond their means by borrowing to finance increases in their standard of living. Jitters spread to Asia yesterday after Standard & Poor's, the credit rating agency, warned that Korean banks would struggle to repay their debt.
Ukraine, Hungary and Serbia in emergency talks with IMF
Ukraine, Hungary, and Serbia are all in emergency talks with the International Monetary Fund, raising fears that an exodus of foreign investors will set off a systemic crisis across Eastern Europe. A team of IMF trouble-shooters rushed to Kiev on Wednesay to draw up a possible standby loan to help Ukraine stabilize its bank after a panic run on deposits this month.
The outlook has darkened since President Viktor Yushchenko dissolved parliament in a dispute that threatens to anger the country's Russian minority. Kiev and Moscow are at loggerheads over the Sevastopol base used by Russia's Black Sea fleet. Foreign investment has largely dried up, leaving it unclear whether banks with large debts in dollars and euros will be able to roll over short-term loans. The government has already seized Prominvestbank, suspending payments to creditors. The authorities have frozen all time deposits.
The plunge in steel and grain prices over recent weeks has made matters worse, hitting two of the country's key exports. Zaporizhtal, MML Steel, and Donsetsk Steel are all slashing output. "The global credit crisis is spreading to the most leveraged economies in the world," said Danske Bank. "Iceland was the canary. It was the first to need a helping hand from the IMF, but all countries that have had asset bubbles and rely on foreign funding are vulnerable," said Lars Christensen, the bank's East Europe expert.
The credit default swaps (CDS) for Argentina, Pakistan, and Ecuador are flashing warnings of insolvency, while the Baltic States, Romania, Bulgaria, and Turkey are at risk as it becomes harder to finance current account deficits. "This is turning serious," said Hans Redeker, currency chief at BNP Paribas.
"Countries in Eastern Europe have been living beyond means for years and now they face a full-blown credit crunch. They are going to have to cut back on imports and that will push the eurozone deeper into recession," he said. "We think the next phase will be an attack on the currency pegs in the Baltics and Bulgaria," he said.
Hungary may soon become the first EU state to need an IMF bail-out since Britain's loan in 1976. Premier Ferenc Gyurcsany said he was in close talks with the fund but viewed financial aid as a "last resort." The forint plummeted 5pc yesterday as panic swept the Budapest markets, inflicting more pain on those with large debts in Swiss francs and euros. More than 80pc of mortgages issued over the last two years have been in foreign curencies. Borrowers have been lured by low rates, ignoring the exchange risk.
Raiffeisen Bank, Volksbank, and Bayerische Landesbank, have all ordered their Hungarian subsidiaries to stop lending in foreign currencies in recent days. Ukraine's currency fell to a record low last week, forcing the central bank to intervene. Fitch Ratings said Ukraine's red-hot credit growth of 74pc last year had led to overheating, leaving the banks vulnerable as the boom deflates. The current account deficit is expected to reach 7pc of GDP next year.
Commerzbank said the escalating political crisis in Ukraine was manageable in the boom years when foreign funds were pouring in. "Those days are long gone," it said.
Bleak Economic Outlook for Spain
The collapse in housing and construction has combined with the global financial crisis to create one of Spain's worst periods in decades.
When Romanian-born Ion Lacureanu migrated to Spain five years ago, he found himself in one the fastest-growing countries in the European Union. Spain's booming job market and average annual economic growth of 3 percent were the envy of the region. Soon the 38-year-old Lacureanu was flourishing as a self-employed construction worker in Valladolid, a city of 320,000. He earned €2,200 ($2,975) a month and had so much work he had to hire other workers to help him out.
He doesn't have to hire anyone anymore. "For the past six months I've just worked three or four days a month, and I've earned no more than [$473]," says Lacureanu. "There is almost no work." Spain's decade-long construction boom began to run out of steam last year, and now the global financial crisis is drying up the international funding that financed the country's huge infrastructure investments.
Antonio Argandoña, professor of economics at Barcelona's IESE business school, says the construction industry, which spurred gross domestic product growth in the last decade, is going to stall for the next five to seven years. That in turn will spark unemployment and drag down investment and consumer spending.
Making matters worse, the European Union also has cut back on its financial support for Spain, since the EU now has to shift subsidies to newer members in Eastern Europe. "We are in danger of a general economic collapse," says Argandoña. "We'll see negative growth within this year…This is a long and deep crisis." During the second quarter of 2008, Spain's GDP increased just 1.8 percent from the same period a year earlier, the lowest growth rate in more than a decade. The International Monetary Fund now forecasts GDP growth this year of just 1.4 percent, and a 2 percent decline in 2009.
The collapse in housing and construction has mingled with the global financial crisis to create one of Spain's worst periods in decades. The Ibex 35, the benchmark index of the Madrid stock market, is down more than 38 percent since January. Although Spanish commercial banks have less exposure to toxic loans than other countries, on Oct. 13 Spanish Prime Minister Jose Luís Rodríguez Zapatero drafted a $136 billion plan to help Spain's banks amid the global financial crisis. Until now, they have largely fared better than rivals in some other European countries, especially surging Santander, which has moved quickly in recent weeks to snap up weaker banks in Britain and the U.S.
Earlier this month, the government approved a $41 billion fund -- which may be extended to $68 billion -- to buy high-quality assets from banks, and raised bank deposit insurance from €20,000 to €100,000 in order to boost confidence. These bold actions, though, may not be enough to stave off a deep downturn. The IMF recently forecast that Spain will enter a recession in 2009 -- its first since 1993 -- and said it "will be harder-hit than other European countries."
The Spanish government's National Institute of Employment has already revealed that unemployment rate reached 11.3 percent in September, the highest level since 1997. The country probably will have more than 3 million people out of work by the middle of next year, and "we'll continue to be the top European country in terms of unemployment," says Rafael Pampillón, professor of economic environment and analysis of countries at Madrid's Instituto de Empresa business school. "Until the market buys all the houses [that have been built] -- and this will take two or three years -- employment won't grow again."
The housing bust already is spilling over to other industries such as furniture and home appliances, says Argandoña. Elías Muñoz, 55, owner of a small furniture store in Granollers, a city 20 miles north of Barcelona, says furniture sales in Spain have dwindled because of the crisis and the "huge lack of confidence." Thanks to business generated from his Web site, Muñoz has so far been able to offset the weakness in demand.
Other industrial and service sectors also are feeling the pinch. September sales of new cars declined more than 30 percent from the same month a year ago. Seat, a Spanish unit of Germany's Volkswagen, and other major automakers including General Motors and Ford are struggling to avoid layoffs in Spain.
Hotels and restaurants are being hit by lower consumer confidence and slackening tourism. Manuel Díaz-Obregón, 33, director of the Don Fadrique restaurant in downtown Seville, sees the recession at work every day. "About a year ago we used to serve 40 lunches a day, and now we serve just 30 or so," he says. "People think twice before ordering and look more at the price."
The textile industry, too, has been widely affected. Already under enormous competitive pressure from Asia and Eastern Europe (the industry lost 61,000 jobs between 2003 and 2007), it may now see further losses due to Spain's domestic downturn. Case in point: Unión General de Trabajadores, a major Spanish trade union, announced on Oct. 8 that textile company Grupo Sáez Merino, owner of Spanish brand icons such as Lois Jeans, is about to shut its operations down and lay off its 350 employees. An employee who declined to be identified said, "The company is closing down, and nobody is allowed to give any kind of information about it."
Like immmigrant Ion Lacureanu, hundreds of thousands of Spanish baby boomers are now on the brink of losing their jobs. "Things have turned out pretty bad. I don't know how this is going to be fixed," Lacureanu says. Pampillón argues that greater liberalization of labor markets would give companies more incentives to hire people, while further privatizations of state companies could bolster growth. But "the solution is not easy," he adds. "The crisis will continue."
Sarkozy to press Bush over global finance reform
French President Nicolas Sarkozy called for change in the global financial system before crisis talks with US counterpart George W. Bush outside Washington on Saturday, amid more gloomy economic news. Bush was to host Sarkozy, who is armed with a mandate from his EU colleagues to push for an overhaul of the financial system, and European Commission chief Jose Manuel Barroso at his Camp David retreat in Maryland.
But the White House preemptively warned that the talks will yield no new policy proposals, nor a date or location for a world summit that the French leader hopes will generate sweeping reforms.
Sarkozy and Canadian Prime Minister Stephen Harper have called for an international summit by the end of 2008 to coordinate an urgent response to the worst financial crisis since the Great Depression. "We need to reflect on the stakes, how we arrived here, who is responsible, and what happened," Sarkozy told a summit of French-speaking nations in Canada late Friday. "And we must draw lessons from it. The world must change," he said.
Fallout from the crisis grew Friday as fresh job losses were blamed on the turmoil and bank chiefs faced a backlash, while stocks closed a tumultuous week with more wild swings. In the United States, key data showed construction starts on building new homes slumped an additional 6.3 percent in September to the lowest level since the recession in 1991. The annualized rate of 817,000 was down 31.1 percent from a year ago in the latest evidence of the bursting of the housing bubble that has ravaged the US economy and led to the global financial crisis. Unemployment has grown across Europe and the United States, with key sectors such as car-makers badly hit. Analysts forecast worsening economic conditions in most advanced economies.
The finance industry's reputation took a new blow in France where Caisse d'Epargne bank said it lost about 600 million euros (800 million dollars) in a trading "incident." A company official told AFP that a group finance director had been sacked over the loss. Swiss newspapers on Saturday angrily called on former top managers of banking giant UBS to return bonuses after the bank had to be rescued by the state this week. "Mr. Ospel, pay back your bonus! Now! Immediately!" screamed the front page of tabloid Blick, referring to former UBS chairman Marcel Ospel, who was forced to resign this year over billions in losses in the US subprime mortgage crisis.
The headline reflected widespread public anger in Europe and the United States about the massive bailout of troubled banks, whose bosses have pocketed millions in bonuses in recent years. Christian Levrat, leader of Switzerland's Socialist Party told a newspaper Saturday he plans to lodge a civil complaint against Ospel. In South Korea , Finance Minister Kang Man-Soo is expected to announce on Sunday an extra 30 billion dollars to help banks, businesses and the currency market, South Korea's Yonhap news agency said. Asia's fourth-largest economy has been hit by devastating currency falls and the departure of foreign investors from the local stock market. Pakistan's central bank moved to inject liquidity into the country's struggling financial system by cutting the amount of cash commercial banks must hold in reserve.
In Germany, Europe's biggest economy, banks will discuss Monday whether to jointly demand state aid under a brand new 480-billion-euro rescue plan to streamline what could be a chaotic process, Focus magazine said. Belgian Prime Minister Yves Leterme said his government is also working on a plan to soften the effects of the financial crisis on the nation's economy. "We are a hair's breadth away from a serious economic crisis," he told Le Soir in an interview published Saturday.
Meanwhile the Saudi stock market, the largest in the Arab world, which uniquely opens its trading week on a Saturday, ended the first day down 5.23 percent, shedding some of last week's gains. The latest fall followed modest Friday losses on Wall Street as US investors remained cautious about whether the hundreds of billions of dollars being injected into banks by US and European governments will be enough to stabilise the markets. However most global stock markets were firm on Friday after wild swings in the past week as some analysts said there was evidence of a "bottom" from the market meltdown of the past few weeks.
So long, suckers. Millionaire hedge fund boss thanks 'idiot' traders and retires at 37
The boss of a successful US hedge fund has quit the industry with an extraordinary farewell letter dismissing his rivals as over-privileged "idiots" and thanking "stupid" traders for making him rich. Andrew Lahde's $80m Los Angeles-based firm Lahde Capital Management in Los Angeles made a huge return last year by betting against subprime mortgages.
Yesterday the 37-year-old told his clients that he had hated the business and had only been in it for the money. And after declaring he would no longer manage money for other people, because he had enough of his own, Lahde said that instead he intended to repair his stress-damaged health; he made it clear he would not miss the financial world.
"The low-hanging fruit, ie idiots whose parents paid for prep school, Yale and then the Harvard MBA, was there for the taking," he wrote. "These people who were (often) truly not worthy of the education they received (or supposedly received) rose to the top of companies such as AIG, Bear Stearns and Lehman Brothers and all levels of our government," he said.
"All of this behaviour supporting the aristocracy only ended up making it easier for me to find people stupid enough to take the other side of my trades. God bless America." Lahde became one of the biggest names in the investment industry when one of his funds produced a return of 866% last year, largely by forecasting the US home loans industry would collapse.
In his farewell letter, which concluded with an appeal for the legalisation of marijuana, Lahde said he was happy with his rewards and did not envy those who had made even more money. "I will let others try to amass nine, 10 or 11 figure net worths. Meanwhile, their lives suck," he wrote, citing a life of back-to-back business appointments relieved only by a two-week annual holiday in which financiers are still "glued to their Blackberries".
Lahde's retirement came amid an implosion among the hedge fund industry - some 350 of the funds have liquidated this year, according to Hedge Fund Research. His final words of advice? "Throw the Blackberry away and enjoy life."
Banks borrow record $437.5 billion per day from Fed
Financial institutions ran to their lender of last resort for record amounts of cash in the latest week, under extreme pressure from the worst global financial crisis in a generation, Federal Reserve data showed on Thursday.
Banks and dealers' overall direct borrowings from the Fed averaged a record $437.53 billion per day in the week ended October 15, topping the previous week's $420.16 billion per day. Some analysts are concerned that banks' dependence on Fed lending might become long term and difficult to change. "The banking system is going to become addicted to this very cheap money. Unwinding it will be very difficult," said Howard Simons, strategist with Bianco Research in Chicago.
"We have effectively allowed the central banks to disintermediate the banking system. Why would I want to borrow from you if I could do it with the central bank, because they can always print it up and say 'here'...and they are in the business now of making sure I stay in business," Simons said.
Primary credit discount window borrowings averaged a record $99.66 billion per day in the latest week, up from $75.0 billion per day the previous week. Primary dealer and other broker dealer borrowings were $133.87 billion as of October 15, versus $122.94 billion on October 8.
"Other credit extensions", mostly reflecting loans to insurer AIG, were $82.86 billion as of October 15, versus $70.30 billion as of October 8. The Fed's lending to banks to enable them to purchase asset-backed commercial paper from money market mutual funds was $122.76 billion as of October 15, versus $139.48 billion on October 8.
Proceeds from the U.S. Treasury's sales of Treasury bills in the Fed's supplementary financing account, which are helping to fund the Fed's support of financial institutions, were $499.13 billion as of October 15, versus $459.25 billion as of October 8.
Weekly Leading Index Growth at 33-Year Low
A measure of future economic growth in the United States fell to its worst level in 6 years and its annualized growth rate had its biggest weekly decline in almost four decades to hit a fresh 33-year low, a search group said on Friday.
The Economic Cycle Research Institute, a New York-based independent forecasting group, said its Weekly Leading Index fell to 117.0 in the week to Oct. 10, down from 120.6 in the previous period. It is at its lowest level since Oct. 25, 2002, when it stood at 117.0.
The index's annualized growth rate slid from a downwardly revised minus 14.8 percent to negative 17.1 percent, its lowest since Jan 31, 1975, when it was minus 17.9 percent, according to ECRI data.
"With its biggest weekly plunge in 37 years WLI growth has dived to a new 33-year low. This data objectively shows that financial market turmoil is rapidly worsening an already-grim recessionary outlook," said Lakshman Achuthan, managing director at ECRI. ECRI data showed the index fell due to unfavorable moves in all components except for jobless claims.
The £2 trillion craziness that swept the globe
Let's be generous here. Perhaps history will prove that the events of this week were all a clever plot by the world's leaders to deter an alien invasion.
How else to comprehend the £2 trillion of craziness that swept the globe – the sort of financial caper that would have had the little green men scurrying for their spacecraft, sharpish. It started, in Britain, with a twist on a popular TV programme. Call it "Darling's Den" – the Chancellor's lair to which quivering bank chiefs were hauled last weekend.
With Treasury and Financial Services Authority officials applying the thumbscrews, the bankers were shown just how much capital they needed to raise. If they had thought they might get away with offering the taxpayer, say, a 10pc stake for a £5bn cash injection, the heads of Royal Bank of Scotland, HBOS and Lloyds TSB were swiftly disillusioned. In what Lloyds boss Eric Daniels described as "bullet-proofing the banks against any downturn", the trio were told they needed to pump in £37bn among them to improve their capital ratios.
When the news broke on Monday, there was only one word for it. New Labour was poised to do what Old Labour had never dared and partially "nationalise" three high-street banks serving more than 40m customers – on top of the two existing state dependants, Northern Rock and Bradford & Bingley. It was a simple question of arithmetic. Unless the trio can raise tens of billions from their own investors – a tall order, if ever, in the current crisis-torn markets – the taxpayer will wind up with a near-60pc stake in RBS and up to 43.5pc in the planned Lloyds/HBOS combo.
There was a price for tapping the taxpayer too – the scalps of Sir Fred Goodwin and Sir Tom McKillop, respectively the chief executive and chairman of RBS, and of Andy Hornby and Lord Stevenson, their counterparts at HBOS. David Freud, the former UBS banker now advising the Government on welfare reform, characterised the taxpayer-funded bail-out as "not really nationalisation. It's extra capital with punishment." Long-term, the Government does not want to own banks. But while it does, the kicking it gives them – over such things as bonuses and lending criteria – will change the face of the industry. Not least if Lord "Red Adair" Turner, the FSA chairman, gets his way.
One issue became increasingly contentious as the week wore on: the Government's plan to compel banks that took its preference shares to suspend dividends for up to five years – a diktat, as it turned out, from Brussels. Investors responded by dumping high-yielding bank shares, threatening Lloyds' tie-up with HBOS. Recapitalising the banks was the final piece in Flush Gordon's cistern-bursting £500bn bail-out plan. He also earmarked £250bn of Government guarantees to coerce banks into lending to each other again and £200bn of emergency funding from the Bank of England's gushers.
Lampooned over here for his tardy response to the crisis, the PM suddenly found himself a hero abroad as US Treasury Secretary Hank Paulson copied the Brit blueprint. He set aside $250bn (£145bn) from his $850bn rescue stash to recapitalise nine American banks. They include such bastions of capitalism as Goldman Sachs and Morgan Stanley – and Paulson made no secret of his misgivings. "Government owing a stake in any private US company is objectionable to most Americans – me included," he said. "Yet the alternative of leaving businesses and consumers without access to financing is totally unacceptable."
Europe followed suit, with six countries setting aside €1,500bn (£1,170bn) to save its banks. Both Germany's €500bn bail-out and France's €360bn lifebelt carried the UK imprimatur of addressing banks' capital positions. Tot it all up and the world's leaders – acting in concert after last weekend's G7 meeting – had thrown more than £2 trillion at the problem. And, for almost two days, the markets roared their approval as politicians sought to put the banking crisis behind them.
Having tanked 21pc the previous week, the FTSE-100 leapt 8.26pc on Monday and a further 3.23pc on Tuesday to stand at 4,394.21 – moves mirrored on all major markets, excepting minor wobbles in Russia and Spain. By Tuesday night, however, the US Dow Jones was signalling the big-dipper to come. Having bounced 11.1pc on Monday, the Dow surged to a 500 point advance on Tuesday before beating a hasty retreat to close down 0.82pc. Increasingly febrile markets had shifted their focus from the banks to the world economy.
Traders were now in a right sweat over the looming global slump – their panic over the pain required to pay back a £2 trillion bail-out bill exacerbated by more specific concerns. Who, they wondered, is on the hook for $360bn of default insurance arising from the toxic dump at Lehman Brothers? What is the $2 trillion hedge fund industry sitting on? And will insurance companies become the next major casualties? So began the rollercoaster. By Wednesday, data was coming thick and fast. None of it was pretty.
On this side of the Atlantic, Bank of England Monetary Policy Committee member Andrew Sentance had already warned that "the risks of a bigger and more sustained downturn" were increasing. The UK unemployment figures – a lagging indicator of economic health – confirmed that. They showed the jobless total rising at the fastest rate for 17 years. Abroad, evidence that the crisis on Wall Street had extended to Main Street came with September's 1.2pc fall in US retail sales – far worse than the 0.7pc drop expected. Meanwhile San Francisco Federal Reserve Bank president, Janet Yellen, dared to utter the dreaded "R" word.
Recession fears swept the market, puncturing the commodity bubble on the rational grounds that if the global economy goes into reverse, demand for raw materials and manufactured goods plummets. Even China, the engine of world growth was beginning to splutter, according to Rio Tinto chief executive Tom Albanese. "China is not completely insulated from OECD recession," he warned.
Meanwhile, the contagion was spreading to Eastern Europe, with Ukraine, Hungary and Serbia all in emergency talks with the International Monetary Fund, while victims of Iceland's meltdown continued to emerge in unlikely corners. Oxford University became the latest institution to admit that £30m of its money was submerged somewhere in Iceland's Blue Lagoon. The markets took their cue. The FTSE plunged 7.16pc, only slightly more than Germany's DAX index and France's CAC. And the Dow dived 7.87pc to below 9,000. A day later, the markets were out of step again, the FTSE tanking a further 5.35pc, while the Dow climbed 4.68pc after an 800-point gyration. Its higher close, analysts said, was brought about by oil falling to just above $66.
In Europe, Switzerland's proud banking nation was forced to provide a Sfr60bn (£31bn) lifeline to UBS, while traders drove UK insurance companies shares up to 20pc lower on fears that their solvency ratios were going the same way as falling equity markets. Hedge funds became a bigger worry still, with London's Gradient Capital the latest on the slide.
Howard Wheeldon, senior strategist at BGC Partners, summed up the antsy atmosphere: "Market sentiment is now being completely driven by fear," he said. By yesterday, the panic had subsidied – for now. The FTSE bounced by 5.2pc to end the week at 4063.01 points – ahead of last week's 3932.06 close. Those two figures scarcely tell the story. What, you wonder, could possibly top this week's dramas? An alien invasion perhaps.
US automakers want merger deal, but financing may be holding it up
Chrysler owner Cerberus Capital Management and General Motors Corp. are working as hard as they can to get a deal to merge the two automakers, but financing is the issue keeping them apart, a person familiar with the talks told the Free Press. But the private equity firm is “willing to put in cash to any deal that makes sense,” another source said.
A merger is seen as Cerberus’ preferred solution for Chrysler, where U.S. sales have dropped 25% so far this year, the people said. But financing a deal such as this can be complicated and could involve money flowing either way. When Cerberus acquired majority control of Chrysler from Daimler last year, the $7.4-billion deal included then-DaimlerChrysler spending money to get rid of its U.S. unit.
Because neither Cerberus nor GM is making public statements about the talks, it’s hard to definitively say how things are going. What is clear is that a number of scenarios -- including a laundry list of automakers and possible equity stakes -- are floating around Detroit about the future of the auto industry and Chrysler in particular. GM hopes to have a deal by the end of the month, the Wall Street Journal reported Thursday.
It noted that J.P. Morgan Chase, a key lender to both automakers, favors a deal. Citing people briefed on the talks, the paper said a deal is far from settled. The turmoil in the U.S. auto industry could have historic ramifications. Industry sales in the United States are down almost 13%; GM’s sales are down nearly 18%. Chrysler’s supposed kitty of cash could be useful for GM.
GM, which lost $18.8 billion in the first half of the year and has been burning through at least $1 billion a month, is believed to have enough cash to make it through the rest of 2008, but several analysts worry the company will not have enough for 2009. Barclays Capital analyst Brian Johnson, in a note to investors, said GM is about $2 billion short of what it needs to make it through 2009 -- even with help from the government and drawing down an additional $3.5 billion on its credit line.
As a privately owned company, Chrysler’s finances are less clear, but all signs point to trouble. The automaker has seen the biggest sales decline in Detroit, and it has indicated that its automotive and financial arm lost $509 million in the first quarter of the year. It has said it had $11.7 billion in cash on hand at the end of June, and that it had earned $1.1 billion before interest, taxes, depreciation, amortization and before restructuring charges during the first half of 2008. Chrysler had identified $1 billion in noncore assets to be sold to raise money and has said about half of that has occurred.
“People have been talking about the $11 billion that Chrysler supposedly had at the end of June. I think Chrysler needs that money just to maintain its operations as well,” said Aaron Bragman, an analyst with Global Insight. “If that cash is going to be used by GM to further its own operations, that means they’re going to shut down Chrysler.” There could be other partners for Chrysler, perhaps Renault-Nissan. An executive with Renault reportedly said earlier this month that the automaker might be interested in Chrysler.
Chrysler and Nissan already have an agreement to build some specific vehicles for each other. Similarly, Chrysler is building minivans for Volkswagen. “For a foreign automaker, there is value in Chrysler in its domestic capacity, in its domestic brands and dealership network,” Bragman said. Some see Italian automaker Fiat as a dark horse candidate to acquire Chrysler, noting it has the means and motivation to make such a deal work.
In August, Tom LaSorda, a Chrysler president and vice chairman, confirmed that the Auburn Hills automaker had talked with Fiat, but he declined to say over what. “At this stage, there are no formal discussions going on,” he said back then. Chrysler Chief Executive Officer Bob Nardelli has also said a Chinese automaker might be interested in buying Chrysler. “It depends on who has a hoard of cash in this economy because they’re not going to get a lot of debt out there,” Nardelli told the Automotive News.
Tightening Credit Complicates Bankruptcies
Credit has gotten so tight in recent weeks that companies contemplating a bankruptcy filing can't find the cash needed to get through the process. This multibillion-dollar corner of the lending market -- debtor-in-possession and exit financing -- has been rocked by General Electric Co.'s recent, undisclosed decision to largely halt lending to companies in bankruptcy-court protection or near it, said several bankruptcy lawyers and financial advisers. GE is one of the world's largest such lenders, last year doing $1.75 billion in restructuring loans.
Debtor-in-possession, or DIP, financing is essential for the lawyers, layoffs and other restructuring necessary for a company's rebirth. Exit financing is used when a company "exits" reorganization. Banks have been eager to take part in this market because the loans are the first to be paid back and command high interest rates. Without the lending lines, companies that would normally survive bankruptcy will have to quickly sell assets. Potential buyers may not be able to borrow either, meaning companies could be forced to liquidate immediately instead of working out their problems. That could cost tens of thousands of jobs across the economy.
GE Capital, meanwhile, has told numerous potential borrowers that it is out of the DIP and exit-lending business until at least next year, said these people. GE Capital spokesman Ned Reynolds said, "We're still open" and the company is living up to its existing commitments. GE executives said last month that demand for DIP financing may jump to as high as $12 billion this year. But market volatility has limited GE's role in DIP financing. "We have to be very selective right now," said Mr. Reynolds. Pricing deals is difficult, he said, as the cost of funding changes from the time a deal is proposed until when it closes.
"It is a struggle, a real struggle to find DIP financing," said Jonathan Henes, bankruptcy attorney at Kirkland & Ellis LLP in New York. "In the old days, like early 2007, the banks would do an origination and syndication model, where hedge funds and [loan funds] would gobble up those loans, but they don't have the capital. They are out."
Data provider Dealogic estimates lenders provided $24.24 billion on 40 restructuring deals in 2008, a 38% increase from the $17.59 billion on 18 deals in 2007. Major banks do much of the work, with GE typically among the top five or 10 lenders each year. Despite the tight credit markets, DIP lending is up this year because of the overall increase in bankruptcy filings since 2007. Little has been done in the past few weeks.
Interest rates for bankruptcy financing have doubled to the London interbank offered rate plus 5% to 7% or higher, compared with Libor plus 2.5% last year, said Mr. Henes and others. "When I think of GE Capital and where their expertise lies, DIP financing is front and center," said Scott Davis, an analyst at Morgan Stanley. "If they are backing away from DIP financing, that would be a big surprise."
Several companies are trying to raise DIP financing in case they need to file for bankruptcy reorganization, but have struggled to find any takers, said bankruptcy observers. These people said one such company is Pilgrim's Pride Corp. of Texas, which is the country's largest poultry producer by sales and has about 50,000 employees. Pilgrim's Pride spokesman Gary Rhodes declined to comment on whether the company is seeking DIP lending.
Henry Miller, chairman of the investment-banking boutique Miller Buckfire & Co., said the number of lenders willing to do DIP financing "has shrunk in recent months from 30-plus in the heydays of 2006-07 to maybe five or six now." He cited Wells Fargo & Co., Bank of America Corp. and Ableco, a division of Cerberus Capital Management LP, as among the few still interested in DIP financing.
"There is very little liquidity out there. It means bankruptcy has gotten harder. So, what does a company do? Good question. You can try to muddle by, but it's really not a good situation," said Barry Ridings, co-chairman of the investment-banking unit at Lazard Ltd
The Hedge Fund Apocalypse
Billionaire investor Warren Buffett wants his fellow Americans to buy stocks, but the Greenwich, Conn., set couldn't take his advice if they wanted to. As investors scream for their money back, hedge fund managers are as paralyzed as the rest of Wall Street.
Hedge fund assets shrank by $210 billion in the third quarter, hit by volatility, higher borrowing costs and $31 billion in redemptions after a wave of investor panic. The carnage is the worst in the industry's history, surpassing the jolts in 1998, 2002 and 2005, according to Chicago's Hedge Fund Research, which has tracked fund assets and performance since 1990. Funds are scrambling to meet the withdrawal requests, helping to push the major stock averages down in the last few days, and many won't be able to continue in business.
So far this year, 350 funds have closed shop, but that doesn't count the third quarter, when most of the bloodletting has taken place. Ken Heinz, the president of Hedge Fund Research, says he wouldn't be surprised to see 1100 funds liquidate this year. That would be three times greater than in 1998, when $4 billion Long-Term Capital Management had to be rescued. "We've never seen it happen in this magnitude," Heinz said.
The research firm's hedge fund composite index dropped 8.8% in the third quarter and is down more than 10% for the year. The quarter's performance matched the decline in the Standard & Poor's 500. But year-to-date, the decline in hedge funds is far less severe than the rout in the index, which is down 35% since January. That should be enough to encourage money into funds instead of out of them--indeed many previously closed funds have reopened to new investment. But investor confidence has shriveled in the face of a highly correlated market with no safe havens.
Investors suffering sharp declines in their holdings and margin calls are redeeming investments where they can. And hedge funds that were not in a bad position going into September are preying on the funds they are trying to liquidate. The turmoil hasn't spared the industry's brightest stars. Ken Griffen's Citadel Investment Group reported 26% to 30% declines in two of its funds for the quarter and had to go out on the defensive after a spate of rumors about performance for the group overall sent the spreads on credit default swaps in Citadel soaring.
"We have never backed down when faced with a challenge, and this time will be no exception," Griffen said in a letter to clients in which he expressed regret for not anticipating the severity of the credit crisis. Highland Capital Management in Dallas is closing two of its funds, with combined $1.5 billion under management, after losses. Perry Capital cut 20 to 30 jobs and is turning its focus away from stocks to credit-related trading strategies, where it sees more opportunities.
Other fund managers have sent apologetic letters to investors. "We clearly underestimated several things, most importantly the tsunami of redemptions that are being delivered to hedge funds as investors line up to get our of these funds as well as record outflows from equity mutual funds," said Jeffrey Gendell, general partner of Tontine Associates, in an Oct. 1 letter. Total industry capital at quarter end was $1.72 trillion, down from $1.93 trillion in June.
Withdrawals entirely offset the capital inflows into hedge funds during the first half of 2008, bringing year-to-date net capital flows to a decline of $2.5 billion. Last year, inflows into hedge funds reached a record $194 billion. Funds of funds did poorly as well, falling 9.7% for the third quarter and 11.8% for the year, and investors withdrew $13.3 billion in the last three months, according to Hedge Fund Research.
This year could be the first negative year for the industry since 2002, when the average hedge fund lost 1.45%. September was the cruelest month, with average declines of 5.5%, the second worst single month for the industry, according to Hedge Fund Research, behind the 8.7% average loss in August 1998. Since peaking last October, hedge funds have lost 11.5%--mostly because of performance--an amount that surpasses the losses in 1998, which was about the time of the collapse of Long-Term Capital Management.
Financial Crisis Provides Fertile Ground for Boom in Lawsuits
Nothing makes lawyers more popular than bad times. It seems like just a few months ago — because it was — that trial lawyers, those advocates who take on companies on behalf of investors, customers or even other businesses, had a wretched reputation. Three of the best known of those lawyers, William S. Lerach, Melvyn I. Weiss and Richard F. Scruggs, had all pleaded guilty to crimes. Defense lawyers were gleeful.
But the pendulum has shifted again, much as in the years after the collapse of Enron and WorldCom. Accusations of executive excess, accounting fraud and lack of disclosure are far more credible now, since bad bets on real estate and securities linked to home loans have caused some of the biggest and most prestigious financial firms in the country — Lehman Brothers, the American International Group, Fannie Mae, Freddie Mac — to collapse, sell parts of themselves at fire-sale prices or suffer outright government takeovers. A legal argument rarely used in investor lawsuits is tempting: res ipsa loquitur, or the thing speaks for itself.
“There’s clearly going to be an erosion in the presumption that these senior-ranking executives should be given the benefit of the doubt,” said John P. Coffey, a partner at Bernstein Litowitz Berger & Grossmann, adding that as a result of regulators’ investigations and angry former employees, there is also more information available to plaintiffs about questionable conduct. “There’s clearly going to be an effect there; judges are human.”
So are investors, who are angry. Individual shareholders as well as big companies want someone else to pay for their losses on investments in everything from basic stocks to exotic swaps. And lawyers are emboldened in their claims by the huge losses and obvious errors in judgment at companies that, until recently, confidently asserted their immunity to market turbulence.
Investors’ lawyers can point at statements and actions by regulators to bolster their claims. In a suit filed in mid-September by Fannie Mae shareholders, the plaintiffs blamed a government plan to buy shares of the company and then take it over for helping to depress the company’s stock price. The lawsuit names Merrill Lynch, Citigroup, Morgan Stanley and others as defendants, accusing them of making false statements about Fannie Mae’s financial condition.
“The more you think about it, there’re so many different ways that so many different people could be responsible for this,” said H. Adam Prussin, a partner at Pomerantz Haudek Block Grossman & Gross, referring to losses suffered in this financial crisis. His firm is representing Fannie Mae investors. “There are the lenders who screwed up in the first place, there are the people who bought these things from the lenders and then didn’t account correctly for them.”
A recent report by the law firm Fulbright & Jaworski found that more than one-third of lawyers working internally for companies expected to see more litigation in 2009. Lawyers at the biggest companies were more likely to expect a boom in lawsuits, according to the study. One factor contributing to litigation is the rapid availability of information about corporate mistakes and losses, which in the past might have taken longer to circulate among investors, said Michael Young, a partner at Willkie Farr & Gallagher in New York.
“What’s really going on here is a type of accounting that is capturing changes in value and making them public much faster than anything we’ve seen before,” Mr. Young said. Armed with such data, shareholders have charged the courthouse steps, claiming that companies failed to disclose their vulnerability to declines in the real estate market, often through holdings of securities backed by home loans. Even companies that have suffered huge losses may still be worth pursuing because of their liability insurance.
“You can’t get blood from a stone,” said Joseph A. Grundfest, a former commissioner of the Securities and Exchange Commission who now teaches at Stanford Law School. “But you sure can get money from the insurance company that covered the stone.” There are other deep pockets, even in the current economic climate.
When confronted by bankruptcy filings or government takeovers, the lawsuits name every possible defendant involved in a stock offering — the underwriters, the rating agencies and individual executives — but not the issuing company itself. That way, they avoid the problem of fighting with other creditors in bankruptcy or the question of whether they can sue the government.
In the case brought by Fannie shareholders, for example, Fannie itself is not a defendant. A suit filed last month by investors who bought Freddie Mac shares names only Goldman Sachs, JPMorgan Chase and Citigroup. The suit claims that the investment firms, which underwrote a Freddie Mac stock offering, did not disclose the company’s “massive exposure to mortgage-related losses.” (JPMorgan Chase did not underwrite the offering itself but it acquired Bear Sterns, which did).
Events have moved quickly enough that some lawyers have found that their lawsuits may have been filed too early, before the biggest losses and consequently before the biggest damage claims were possible. “The plaintiffs’ firm will try to amend the existing complaint in order to allege subprime losses,” said Stephen Froot, a partner at Boies Schiller & Flexner. So lawyers might argue, for example, that falling stock prices over the last few months are related to a claim made much earlier.
It remains to be seen how receptive judges will be to efforts to add to complaints. Judge John E. Sprizzo of Federal District Court in Manhattan in July rejected an attempt to add new claims to a complaint filed by shareholders of the American International Group in 2004. “The proposed amendments concern different time periods, different divisions of the company, different management, different alleged objectives, different disclosures and different shareholders,” Judge Sprizzo wrote.
One difference between this and previous waves of litigation is the greater number of companies that have been hurt by the continuing credit squeeze and subprime mortgage collapse and that are willing to sue individually, not as part of a shareholder class action and often not under securities laws. These cases may be the most significant, lawyers said, because they could force courts to decide what a big, sophisticated investor must show to support a claim that it was duped.
Almost three weeks ago, MBIA filed a lawsuit against Countrywide Financial, accusing the company of lying about the quality of mortgage-backed securities that MBIA essentially guaranteed. MBIA has paid more than $459 million on those guarantees as mortgage defaults become more frequent and the value of the securities fall.
“Although there were supposed to have been prudent underwriting standards, it turned out that all the borrower needed was a heartbeat to get a loan,” said Michael B. Carlinsky, a partner at Quinn Emanuel Urquhart Oliver & Hedges, which is representing MBIA. His firm also represents two units of Fifth Third Bancorp that sued the Transamerica Insurance Company and Clark Consulting after losing $323 million on complex investments the insurer oversaw. Fifth Third had invested more than $600 million indirectly in a hedge fund that turned out to be heavily exposed to fluctuations in the residential real estate market.
Such potential litigation on behalf of big companies is so attractive that lawyers at even a few white-shoe law firms, which hardly ever sue a financial firm out of fear of alienating a potential client, now say they may change that policy on behalf of clients that have lost hundreds of millions of dollars. (Of course, none of these lawyers would say this on the record.) One major reason that more lawsuits have not yet been filed is the difficulty some of these companies face in figuring out how much money they have lost in markets that have yet to settle.
“Until the market determines what these instruments are worth, no one knows what claims they have,” said Stephen P. Younger, a partner at Patterson Belknap Webb & Tyler in New York. There is another reason some public companies may be waiting to go to court. They may not want to disclose just how big their losses are or reveal something else in a court document that could, in turn, attract a shareholder suit.
AIG Fraud Case: Using the Market to Set Jail Terms
In coming weeks, five former insurance executives, including General Reinsurance ex-CEO Ronald Ferguson, are due to appear in federal court in Hartford. There, U.S. District Judge Christopher F. Droney will sentence them for their role in a sham transaction to boost the loss reserves of American International Group (AIG).
When the deal was disclosed in 2005, prosecutors contend, it caused AIG's share price to drop 6% to 15%. Because of that, the defendants, who were convicted of fraud in February, could go to prison for life. While the case involves events that seem far removed from the present financial crisis, it highlights an issue that's sure to be front and center if prosecutors seek retribution for the market losses of recent weeks. Under federal guidelines, the base-level sentence for someone convicted of securities fraud is zero to six months.
But a variety of factors can increase time behind bars—including the size of shareholder losses, the number of victims, and whether a defendant is an officer or director at a public company. In reaction to the implosion of Enron, WorldCom, and other scandals that cost investors billions, lawmakers sharply raised the potential penalties in 2003. Now, instead of a few years in prison, fraud that results in stock losses exceeding $400 million could earn a defendant a life term.
Given the size of losses related to the subprime meltdown, prosecutors may be able to threaten alleged culprits with lifetime incarceration. Reid H. Weingarten, a Washington attorney representing Elizabeth Monrad, the convicted former Gen Re CFO, argues that "this puts unhealthy leverage in prosecutors' hands to extract unfair plea deals." Going for the maximum sentence "may be popular in these chaotic times," he says, "but it usually has absolutely no relationship to the severity of the wrongdoing." Indeed judges in some recent securities-fraud cases have found guideline sentences draconian and have meted out far less time, especially when the crime did not imperil a giant company.
In the case of AIG, the insurer's stock fell to 61.92 from 71.49 in the month following its disclosure of the Gen Re transaction and a subsequent probe by then New York Attorney General Eliot Spitzer. (Since then, AIG shares have dropped below 3 because of unrelated subprime losses that forced a massive government bailout.) Attorneys for the five defendants argue that a host of factors caused AIG's stock to swoon three years ago, including the forced departure of AIG chief Maurice "Hank" Greenberg. The defendants—including AIG's former head of reinsurance, Christian Milton—plan to appeal their convictions.
For sentencing, a lot rides on the complex and controversial discipline of determining market loss. Both sides retained financial experts to determine how much shareholder harm could be directly tied to the fraudulent inflation of AIG's loss reserves. The defendants say that amount was zero, which means under the guidelines they would face a year or two at most in prison. Prosecutors, seeking life, contend losses were as high as $1.4 billion.
Such disparate conclusions are not uncommon, defense lawyers say. This points to the exercise as more art than science. "In the end, you're making a lot of sort of crude assumptions," says David Topol, a Washington attorney who monitors shareholder lawsuits for insurers. "When you get an enormous disparity, somebody's clearly wrong."
Canada Consumer Confidence Drops to 26-Year Low
Canadian consumer confidence is at its lowest level since 1982 this month as more families expect their financial situation will deteriorate, according to a survey by the Conference Board of Canada. The board's consumer confidence index fell 11.9 points from the month before to 73.9, the Ottawa-based group said today.
The share of consumers who anticipated their finances worsening over the next six months rose to 17 percent, an increase of 4.3 percentage points from September. Also, 17 percent of respondents said they were worse off than six months ago, an increase of 2.5 percentage points.
The Bank of Canada unexpectedly cut its key rate to 2.5 percent from 3 percent on Oct. 8 as part of a coordinated bid by policy makers across the globe to ease the worst financial crisis since the Great Depression. BMO Capital Markets Chief Economist Sherry Cooper predicts the Canadian economy will sink into a recession caused by tumbling demand from the U.S.
The Conference Board survey showed a 5.5 percentage point decrease in the proportion of respondents who said they expect the labor market to improve over the next six months. A third of respondents said there would be fewer jobs. The telephone survey of more than 2,000 people was taken from Oct. 2-8. The Conference Board poll is accurate within 2.19 percentage points, 19 times out of 20.
Canada rule change marks shift from mark-to-market accounting
Canadian banks and other financial institutions will be able to postpone taking profit hits from plunging financial assets on their books under emergency new accounting rules designed to bring Canada in line with recent changes in the United States and Europe.
The Accounting Standards Board said Friday it has initiated amendments that will allow companies to shift financial assets out of accounting categories that require changes in fair value to be recognized in net income immediately. The move away from so-called fair value or mark-to-market accounting is designed to make sure that Canadian rules are consistent with both international and U.S. standards, which have been changed to help financial companies better cope with the global market meltdown, the AcSB said in a news release.
AcSB chairman Paul Cherry sought to counter concerns raised by institutional investors and other parties that the changes would allow companies to conceal damage from investors. “It must be stressed that assets will remain subject to impairment testing and the amendments involve extensive disclosure requirements” he said. “Transparency will remain for investors.”
Mark-to-market rules require financial institutions to place a value on many of their holdings on the last day of each financial quarter. However, in period of great market turmoil such as the present, the values can fluctuate wildly, and lead to large writeoffs and losses, even if the companies plan to hold the securities until their value rises again.
A number of major Canadian financial companies, including Sun Life Financial Inc., Manulife Financial Corp. and GreatWest Lifeco, for example, have disclosed that they expect to take charges on hundreds of millions of dollars in bonds and other securities issued by troubled or failed U.S. companies, such as Washington Mutual Inc. of Seattle, American International Group Inc. and. failed New York investment bank, Lehman Bros. Holdings Inc.
Manulife chief executive officer Dominic D'Alessandro complained last month that the mark-to-market accounting rules are exacerbating the financial crisis and have exaggerated the tendency toward greed and short-term thinking in the financial system.
Senior bankers such as Royal Bank of Canada CEO Gordon Nixon and Rick Waugh, his counterpart at Bank of Nova Scotia, also have blamed these rules for prolonging and worsening the global financial crisis, arguing that they have led to a higher degree of hard-to-predict writedowns at the world's banks.
German Industry Wants a Bailout Too
With the real economy beginning to show signs of strain, industrial leaders in Germany say Berlin should do what it can to limit the pain. Global markets on Thursday continued their freefall.
If the world's stock markets were human, they would all be diagnosed with bipolar disorder and immediately put on a strict regimen of antipsychotics. All major indexes across the globe fell off a cliff last week, only to recover rapidly on news of bank bailout plans in Europe designed to jumpstart the financial markets. On Tuesday and Wednesday of this week, the markets plunged once again. Now, many are calling for further treatment. This time though, the remedy should not be on multi-billion euro bank bailouts, rather it is the real economy that needs a panacea.
Jürgen Thumann, president of the Federation of German Industries (BDI), said on Thursday that the German government needs to take action to lessen the real economic effects of the financial crisis as much as possible. "Under no circumstances should the government reduce its level of investing," he told the Berlin daily Tagesspiegel. "Rather, investments should be sped up and increased. Infrastructure should be upgraded in partnership with private companies."
Thomas Straubhaar, director of the Hamburg Institute of International Economics, went even a step further, calling for the government to put together an economic stimulus package not unlike that undertaken by the US government in the spring. "Every taxpayer should get a check from the government this year," he told the Hamburger Abendblatt.
The concerns about the real economy are valid. German Economics Minister Michael Glos on Thursday is set to lower the country's growth forecasts for 2009 to just 0.2 percent from 1.2 percent, according to SPIEGEL sources. Furthermore, despite markets reacting positively on Monday to a number of European bailout plans put together over the weekend -- including Germany's €500 billion package, set for parliamentary approval later this week or early next -- Thursday saw a continuation of the drops seen on Wednesday.
The Japanese index Nikkei tumbled by 11.41 percent in Thursday trading while the main South Korean index shed 9.25 percent. The market losses mirrored the US Dow Jones index's Wednesday loss of almost 8 percent. The markets were reacting to, among other economic uncertainties, the news that US consumers were much less willing to spend money than expected, with retail sales falling 1.2 percent in September. Germany's DAX at midday on Thursday was managing to hold relatively steady, down 1.75 percent on the day.
"This is the end of the beginning," Marino Valensise, head of investment for Baring Asset Management in Hong Kong, told Reuters. "We are going from a situation in which the banks were the main actors in the crisis to a situation where the real economies will be next." US Federal Reserve Chairman Ben Bernanke likewise warned on Wednesday that the numerous packages established around the world to shore up the credit markets likely won't have an immediate positive effect on the economy.
European Union leaders, meeting in Brussels on Wednesday and Thursday, are set to begin looking into ways to avoid a deep recession and help the real economy get back on its feet, according to a draft version of the final statement obtained by Reuters. "The European Council underlines its determination to take the necessary steps to react to the slowdown in demand and the contraction in investment and in particular to support European industry," the document said according to Reuters.
The European Central Bank (ECB) has already agreed to provide up to €30 billion worth of cheap loans to small businesses in need of cash. But even as concerns have begun to shift toward the real economy, waves from the financial crisis continue to wash over Europe. The ECB announced on Thursday that it would provide Hungary with up to €5 billion ($6.83 billion) to help the country out with liquidity shortages.
Switzerland's two largest banks, UBS and Credit Suisse Group, will also get some much needed cash injections, the banks announced on Thursday. UBS is set to receive 6 billion francs (€3.88 billion) from the Swiss government, with Bern ending up with a 9.3 percent stake in the bank. Credit Suisse raised an additional 10 billion francs (€6.48 billion) from investors including the Qatar Investment Authority.
The European Union has also set its sights on holding a global finance summit in November. Chancellor Angela Merkel and British Prime Minister Gordon Brown called for the meeting at the beginning of the EU summit on Wednesday and said that, in addition to countries belonging to the G-8, China, India and other major world economies should also attend.
The goal of the meeting would be to establish a new, worldwide system of financial rules to preclude another financial system meltdown in the future. French President Nicolas Sarkozy referred to the idea as a "Bretton Woods II," a reference to the 1944 conference in which leading global economies agreed on a new finance structure. Brown said the world needs an early warning system for the global economy.
Many have mentioned the International Monetary Fund as perhaps taking over a more regulatory role in the future. IMF President Dominique Strauss-Kahn has mentioned his willingness to take on the task, and a deputy of his told the Financial Times Deutschland on Thursday that the IMF is ready. "I welcome the fact that the capacities and the role of the IMF are appreciated to such a high degree," Jaime Caruana, director of the Monetary and Capital Markets Department, told the paper. "We are open to further responsibilities relating to controlling and monitoring financial stability."
Before that happens, though, the world's economic leaders may have some more work to do, according to Japanese Prime Minister Taro Aso. Commenting on the renewed plunge of his country's stock market, he said "the markets are selling off stocks because investors still think the steps by US authorities are not sufficient."
Math mistake sees hundreds of Dallas teachers laid off
The Dallas, Texas, school district laid off hundreds of teachers Thursday to avoid a projected $84 million deficit. "Today is a day of tremendous sadness throughout the district," Dallas Independent School District Superintendent Michael Hinojosa said in a written statement.
"These teachers and counselors are people who devoted themselves to helping Dallas students, and we will do everything within our power to help them find new jobs." The district laid off 375 teachers and 40 counselors and assistant principals Thursday, and transferred 460 teachers to other schools within the district.
The deficit was caused by a massive miscalculation in the budget, CNN affiliate WFAA-TV reported. Children, one crying, crowded Thursday around Mary Crose, a music teacher at San Jacinto Elementary School. "I've had them since they were in kindergarten," she told The Dallas Morning News, as she wrapped her arms around two of the children. "We've been through a lot at our school, and it's going to be so hard. We need the prayers and support of everyone in Dallas." "Why do you have to leave?" a girl wailed, through her tears.
"I've been looking at some of the notes they've already written," Crose said, unfolding several pieces of notebook paper. A pink heart had been drawn on one. Words were scrawled on others in crayon. "My kids are going to lose out because I'm a very good teacher, and so they're going to lose out because they won't have me," a tearful Sandy Keaton, a second-grade teacher at San Jacinto Elementary, told WFAA.
The 375 teachers represent about 3 percent of the district's more than 11,500 teachers. Last week, 152 employees -- including clerks, office managers and teacher assistants -- voluntarily left their jobs, the district said. On September 29, 62 central staff members lost their jobs. Voluntarily resignations and transfers spared 88 jobs, WFAA reported.
The district estimates that the job cuts and unfilled vacancies will save $30 million. An additional $38 million will be saved by cutting various programs throughout the district. The Dallas Independent School District is the nation's 12th largest, with more than 160,000 students. "The children are going to suffer," Karina Colon, a prekindergarten bilingual teacher at San Jacinto Elementary, told The Dallas Morning News. Colon kept her job, but was crying for her colleagues. "I should feel happy," she said.
The Dallas Independent School District will hold a job fair Tuesday for all employees who were given notice. More than 110 employers will attend the fair, which was put together by the district, the United Way and the Dallas Regional Chamber.
Hurting the real economy
It is about as far as you can get from the woes of Wall Street:the mucky business of digging ore out of the ground, shipping it across the oceans and turning it into steel, the feedstock of industry. So the recent slump in raw-material prices and the decline in shipping costs indicate just how far-reaching the consequences of the global financial crisis will be for the real economy.
Since the early summer the price of steel has fallen by 20-70% and the key rate for bulk shipping of commodities is down by more than four-fifths. There are even stories of grain cargoes piling up in ports in the Americas. Their buyers’ letters of credit have not been honoured, because of a lack of confidence in the banks that underwrite them. At least one Australian producer has had the same problem with iron ore shipments to China. And shipowners are having trouble raising finance for new vessels.
The most spectacular reflection of falling activity has been the Baltic Dry Index (BDI), which traces prices for shipping bulk cargoes such as iron ore from producers such as Brazil and Australia to markets in America, Europe and China. The index has plunged by 85% after hitting a record high of 11,793 points in late May. It is a leading indicator of international trade and, by extension, of economic activity. In the past couple of years the index has been driven up by the boom in China, as that economy sucks in raw materials in bulk-carrying ships and pumps out finished products, which are exported in vessels.
The weakness is because of the slowing of world demand and the arrival of new capacity following the recent boom in shipbuilding. There are also signs of slowing demand for the container ships that take China’s manufactured goods to Western markets. The latest forecasts show growth in container demand falling from 15% a year to barely 5%.
Steel prices have also been falling fast from record highs. In America the price of coil steel, used to make cars and white goods, has fallen by 20% since May. The price of steel billets, which are traded on the London Metal Exchange, has tumbled by 70% since May. Steelmakers, including ArcelorMittal, the industry leader, and Russian and Chinese firms, are moving to cut production.
Although China’s iron ore imports in the first nine months of the year were up by 22% on 2007, there are fears among Australian mining firms that the cuts in Chinese steel production could presage a pause in China’s boom. Mount Gibson, an Australian producer, has given warning that stockpiles of ore are piling up in China. Iron-ore prices on the spot market have fallen by roughly half this year, to $100 a tonne or less. The prices of copper, nickel and zinc have also fallen by half or more this year, and aluminium is down by a third. Those drops, in turn, have battered the share prices of mining companies.
BHP Billiton and Rio Tinto, two giants that are big exporters of iron ore from Australia to China, say that they will not be too badly hit by falling demand. They do expect rivals with higher costs to rein in their output. To some extent, that is already happening. Ferrexpo, a Ukrainian iron-ore producer, has said it will postpone a decision about whether to expand. Rio Tinto itself has reduced output at one Chinese aluminium mill.
Alcoa, a big American aluminium firm which reported a sharp fall in profits this month, has shut a smelter in America and says it will halve its planned investments next year. Other firms have scrapped planned nickel and zinc mines.
Nonetheless, the bigger mining firms are far from despair. Alberto Calderon of BHP points out that the Baltic Dry Index is extremely volatile; in his view, it is not a good indicator of the long-term prospects of the mining industry. He expects the Chinese economy to keep growing by 6-9% a year for the next five years. Rio Tinto is even more sanguine: it does not foresee China’s growth falling below 8%. Tom Albanese, its boss, says the Chinese economy is merely “pausing for breath”.
Both firms point out that some metals, such as copper, are still in short supply, and that the credit crunch will only make it harder to finance new mines. By delaying expansions and squeezing marginal producers, it might actually sow the seeds for a recovery in metals prices sooner than most analysts expect. At any rate, BHP is still keen to buy Rio Tinto—an indication, presumably, that it still thinks raw materials is a good business to be in
Empires Built on Debt Start to Crumble
Are the Russian oligarchs going bust? In the current global financial crisis, perhaps no community of the superaffluent has fallen as hard, or as fast, as the brash Kremlin-connected insiders whose wealth was tied up in the overlapping bubbles of the Russian stock market, commodity prices and easy credit.
Already, Russia’s richest man, Oleg V. Deripaska, the nuclear physicist turned post-Soviet corporate raider, has ceded more than a billion dollars in assets to jittery creditors as his aluminum-to-automobile empire reels. “Half the Russians could fall off the Forbes list” by next year, Maxim V. Kashulinsky, the editor of the Russian edition of the magazine, said in an interview. Those most in favor with the Kremlin — who expanded fastest and ran up the largest debts — are most at risk now as borrowing costs soar.
Most of the ultrawealthy have large stakes in the mining and petroleum behemoths of the Russian economy, stakes gained through the legally questionable privatizations of the 1990s. A decade later, company ownership has still not spread to a broad shareholder base as in the West. Without a broad base of potential customers, the stock market here has tanked even faster than exchanges in the United States.
In America, toxic mortgage-backed securities sank mighty investment banks. In Russia, it is the empires of the oligarchs and the loans they took out from Western banks, using shares in their companies as collateral, that are at risk. In a number of cases the value of shares pledged by Russia’s rich has fallen below the value of the loans, an ominous sign for the market here, where the benchmark RTS index is already down 71 percent from its peak in May.
Western banks are not immune. Their exposure to oligarch debt came into focus last week when the Russian central bank reported that, all told, Russian companies have to repay $47.5 billion to foreign creditors by the end of this year, and $160 billion by the end of 2009. If banks require businesses to sell shares to repay these loans, “the Russian stock market could come down like a house of cards,” Michael Kavanagh, a mining sector analyst at Uralsib bank, said. “This could be a game changer for a lot of very, very large players,” Rory MacFarquhar, an economist at Goldman Sachs in Moscow, added. “The ground is shifting under them.”
Not all of Russia’s rich are hurting. Their yachts, jets and London mansions are not yet up for sale. For instance, Roman A. Abramovich, the owner of the Chelsea Football Club in London, has not sold his 377-foot yacht, Pelorus. Or the 282-foot Ecstasea, his other yacht.
In the 1998 financial crisis, ordinary Russians lost savings in a devaluation of the ruble. This time is different. The wide middle class that emerged under the former president and now prime minister, Vladimir V. Putin, and the oil boom has yet to feel the financial turmoil, because few own stocks. That could change depending on how badly the economy is hurt by falling commodity prices and the flight of an estimated $74 billion in foreign investment since Aug. 1.
Estimates of the oligarch’s losses are necessarily rough. Bloomberg News calculated the richest 25 Russians on the Forbes list lost a collective $230 billion since the market peak, based on declines in value of publicly traded companies and analysts’ estimates of private company losses. That would make their collective loss over five months four times greater than the total wealth of Warren E. Buffett. The oligarchs’ remaining assets, based on this estimate, would be worth about $140 billion.
In a more narrow sampling, Forbes magazine on Sept. 22 estimated that the loss for 10 oligarchs whose wealth was primarily in public companies totaled $42.75 billion, or 34.1 percent of their estimated worth on Jan. 1. Vladimir S. Lisin, the steel magnate, led the list with a loss of $11.21 billion on declining share value at his company, Novolipetsk Steel.
Spokesmen for Mr. Deripaska and Mr. Abramovich brushed off estimates based on gyrating stock prices as misleading, noting that the paper gains at the market peak were just as provisional as the losses today. But the Moscow office of UniCredit, the Italian bank, said Mr. Deripaska; Mikhail M. Fridman, a partner in a conglomerate with telecoms, oil assets and grocery stores; and Vladimir P. Yevtushenkov, who owns a cellphone company, real estate and retail businesses, are at risk from overstretched credit backed by tumbling shares.
UniCredit, with liquidity problems of its own, has turned to Libyan government investors for a cash infusion. Mr. Deripaska, who, like Mr. Abramovich, was an orphan and a driven young man, achieved unimaginable wealth in the chaos of the immediate post-Soviet period, seizing on the windfall profits of the commodity boom to begin a global expansion. He built his empire on debt. Mr. Deripaska and Mr. Lisin, the steel tycoon, are seeking bailout loans from the state for an undetermined amount. The government has set aside $50 billion from its rainy day fund, made up of oil revenue, to aid struggling businesses.
The rules under Mr. Putin as understood by all players after the incarceration of Mikhail B. Khodorkovsky in 2003, suggest a strict quid pro quo of government largess in exchange for fealty and payments to Kremlin pet projects.
Mr. Deripaska has been on both ends. In 2007, the owner of Russneft, one of the country’s largest private oil companies, said he would sell his business to Mr. Deripaska, seen as closer to authorities, but added in an open letter that the sale was not voluntary. “They made an offer to leave the oil business,” the owner, Mikhail S. Gutseriev, said. “To make me more amenable, they tightened the screws.” Mr. Gutseriev fled into exile and is believed to be living in London. Expansion of his empire, however, put Mr. Deripaska at risk now that markets are falling.
Last month, Mr. Deripaska shed his investment in Magna International, the Canadian auto parts maker, to a bank that financed the $1.54 billion purchase. Mr. Deripaska’s conglomerate, Basic Element, said it did not have a liquidity crisis but sold the stake to finance other projects. Last week, Mr. Deripaska divested himself of his 9.9 percent stake in the German construction company Hochtief. He refinanced his holding in Strabag, an Austrian construction company, through a 500-billion-euro loan from Raiffeisen Bank, staving off a possible seizure by Deutsche Bank.
“This is global,” said one Moscow banker of the crisis, who did not want his name used in remarks critical of the business practices of his Russian clients. “Home rules don’t apply.” In April, Mr. Deripaska bought a 25 percent stake in Norilsk Nickel, a once-coveted company whose stock has turned poisonous for the Russian oligarchy. Norilsk stock tumbled on falling nickel prices and rumors that the owners were dumping shares to repay loans.
In the latest sign unlikely to help build investor trust in Russian corporations, some rich Russians have apparently taken to using their board control of publicly traded companies to siphon off money to bail out unrelated personal projects. For instance, Sibir Energy, a Siberian oil company, spent $274 million on a Moscow hotel this week. The seller? The oligarch Shalva Chigirinsky, who is also the principal Russian shareholder in Sibir. Similarly, Norilsk has bought 25 percent of a natural gas field owned by a Norilsk shareholder, Vladimir O. Potanin, the metals and mining oligarch.
In a deal typical of the high-wire finance of the oligarchy in the boom, for his stake in Norilsk, Mr. Deripaska paid $8.5 billion in shares in his aluminum company and $4.5 billion in cash, drawn on credit from Western banks, including Goldman Sachs and Morgan Stanley. The stake in Norilsk is worth about $2.34 billion today, less than the loan amount.
Konstantin A. Panin, a spokesman for Basic Element, said the company’s diversity would help it pull through the financial crisis and swooning commodity prices. “There are, however, no companies that have not been affected by the global crisis,” he said. “We believe that this crisis will only make us stronger, because we know how to stay competitive and will be there for our partners and customers when everything settles down.” Until that happens, the Moscow business elite are on edge.
Just last week, they gathered for an anticrisis pep talk from a man who knows: Rudy Giuliani, the former New York mayor. As waiters drifted silently about, balancing trays of caviar canapés, a string quartet played Tchaikovsky and bankers traded market collapse rumors. The evening was sponsored by Mr. Fridman’s Alfa-Bank to honor Intel with a foreign investors award. Mr. Giuliani suggested that Russia and the United States cooperate on financial stabilization, despite their differences. “We don’t want it to affect the bottom line,” he said.
Meanwhile, a banker eyed the passing caviar trays and with a sigh lamented he had not brought a carry-out bag. (The Alfa Group partners have lost at least $12.1 billion, Bloomberg News estimates.) Not all of the Moscow business world is worrying about tomorrow’s meal, however. Mikhail D. Prokhorov, the youthful mining tycoon, seemed washed up earlier this year after selling his shares in Norilsk to Mr. Deripaska. Now, he is sitting on $4.5 billion from a syndicated loan from Goldman Sachs, Morgan Stanley and other Western banks.
Speculation has swirled about how Mr. Prokhorov might occupy his early retirement after the Norilsk sale. One pet project is a lifestyle magazine for the Russian rich, titled Snob. On the cover of the October issue is a man crumbled on the floor, covering his face with his hands, as if in sorrow.
Panic at Iceland's Banking Counters
With the collapse of its banking system, Iceland's economic miracle is finished. The country now faces the real threat of bankruptcy.
The day doesn't start off well for Hanna Hrefnudottir. The interior designer has arrived early to stand in line in front of Glitnir Bank in downtown Reykjavic, and she's the first person to make her way to the teller counter. She pleas, she begs and she fights. It does no good. She isn't able to withdraw any cash. "Not a single krona," she says. The 43-year-old wanted to withdraw 500,000 Icelandic krona -- a sum worth about €4,000 just 2 months ago -- from her private savings account and another $60,000 from her dollar account. "I want to take my money home," she says. "I don't believe a single word the government is telling us anymore. We just get false information."
For years the designer saved money, for her four children and her business. She decided to put her money in normal savings accounts with conservative, government-stipulated interest rates. She wanted nothing to do with risky investments. She wanted to stay on the safe side, and now this. Last Monday, Icelandic Prime Minister Geir Haarde spoke for the first time in a televised address to the nation about the possibility the country could go bankrupt, and Hrefnudottir reacted immediately. Since then she has tried every day to fetch her money. One day the bank paid out $1,000, and on another she even managed to get $19,000. But on some days, like today, she goes home empty-handed.
No one knows for sure what the coming days will bring. All the tricks, like moving savings to the accounts of other family members or going to tellers at different banks, have ceased to work. That won't keep Hanna Hrefnudottir from returning tomorrow. And the day after -- for as long as it takes to get all of her money out of the bank and safely to her home. Miming the shape of a large box, she begins to describe the large and secure safe she has in her house. Neither the threat of thieves nor fire makes her fret. "Anything is safer than the bank," she says.
With the financial crisis reaching epic proportions, the atmosphere in Iceland, with its 320,000 residents, ranges at the moment from tense to outright panic. The government has nationalized the country's three biggest banks -- first Landesbanki and Glitnir, and on Thursday it surprisingly swallowed banking sector leader Kaupthing. For many, that move dashed any remaining hope people had had of escaping this crisis unscathed. Kaupthing had been considered a comparatively solid bank that had been successful with its audacious buying spree throughout half of Europe.
Using dubious financing tricks, bank executives snapped up one financial institution, retail chain and supermarket after the other. Those deals, however, relied on "debt investments," says consultant Pall Pallsson. The bank was only able to continue as long as it could secure liquidity to refinance its loans, which it did by taking advantage of the seemingly endless availability of foreign credit and obscure capital flows -- it was a pyramid scheme.
When the financial crash struck the United States and Europe, the scheme collapsed. Foreign banks no longer wanted to finance suspicious debt. Prime Minister Haarde sought to assuage fears by saying that Iceland's banks hadn't been taking any more risks than those of other countries. The problem, he said, is that, three banks in Iceland largely "account for the country's entire financial system."
Today, the country faces the real threat of state bankruptcy. Foreigners who had been lured with campaigns advertising time deposit interest rates of 6.1 percent (an investment you could "trust in the long term") now fear their private investments will be lost. And Germans who conduct online banking through Kaupthing are currently unable to access their money. Company owners fear they will lose access to liquidity and home owners are worried about their financing plans.
Meanwhile, the Icelandic krona is in freefall and nobody can say what its actual exchange rate is. Inflation has surged to 14 percent. Interest rates on loans have risen to a dramatic 15 percent. People are losing their jobs, fear is spreading as well as depression. On top of all that, the Icelanders now have to swallow the bitter pill of accepting billions in loans from Russia.
Landsbanki wants to sack 500 of its 1,500 workers, Glitner 400 and Kaupthing as many as 1,000.
Other companies are also starting to fire staff. Construction and home improvement store Husasmidjan -- one of Iceland's top 30 companies with its annual sales of €220 million -- will have little choice but to "cut costs," says CEO Stein Logi Björnsson. The company is expected to announce the loss of 200 jobs. "We just have no idea what's going to happen," says Baastyan Bajer, 29. His wife, Ilona Najdek, had just returned from the bank teller counter without any luck. They wanted to exchange the 500,000 krona they have saved up into euros, despite the horrendous exchange rate.
The young Polish couple moved to Iceland just a few years ago. For a year, they deposited all of their money at the bank, but now they need it. Ilona is in her late stages of pregnancy and the couple say they "no longer have enough money to pay their bills." The bank has refused to wire money to Ilona's accounts back in Poland, and at the moment, the maximum she can withdraw is €360, not a cent more. "I have no idea how we are supposed to go on," says Najdek. "Maybe we'll have to go back home and have our child in Poland."
Iceland's economic miracle was wrecked by a new generation of financial market jugglers who took advantage of the new spirit of optimism in the country's burgeoning financial center. The sky seemed the limit after the country's banks were privatized just 10 years ago. For consultant Pallsson, 54, it was a bit like when the Vikings set off 1,000 years ago from Iceland to conquer the world and plunder its riches. "The island was too small for them back then, too. There were no dreams left for them to fulfil here," he says.
Pallsson knows what he's talking about. He studied industrial engineering and, for years, was also involved in the financial markets, freely investing venture capital in hi-tech firms and telecommunications companies. When the IT bubble burst, he lost everything, "including my home." He had to start over again and focused entirely on low-risk equity stakes. "In the end, the global players in banking succumbed to an uncontrollable addiction to gambling," he says. "It's the same with any rush." But now everyone is stuck footing the bill for the bailout.
The showroom of Hekla, Reykjavic's largest car dealer, is filled with shining VW and Audi sedans. But few are looking at the cars. Sales have recently fallen by 60 percent. "The first things to stop are home construction and car sales," says CEO Knutur Hauksson. He looks a lot less unhappy than the situation perhaps warrants: He has to purchase his vehicles in euros from Germany, and his costs are spiraling out of control. "The krona is currently down 75 percent, but prices have only risen by 30 percent," says Hauksson. "All we can do is wait and see."
As Banks Are Rescued, Will the World's Hungry Be Overlooked?
A dramatic increase in food prices over the last year has pushed nearly a billion people to the brink of starvation. The international aid organization Oxfam warns in a new report that the global financial crisis could exacerbate the situation.
As markets plunge around the world and rich countries become increasingly preoccupied with the global financial crisis, 923 million around the world are going hungry waiting for their own multibillion dollar rescue plan. According to a new study released on Thursday by the international aid organization Oxfam, the world hunger crisis threatens to slip entirely under the radar as developed countries grow more and more obsessed with the turmoil in financial markets. "At the same time when billions of dollars are being allocated to address the financial crisis, it seems as if the world hunger crisis has been totally forgotten," said Marita Wiggerthale, an expert with Oxfam Germany told SPIEGEL ONLINE.
Last May, the prospects for fighting world hunger looked much brighter. At a conference held in Rome, industrialized nations pledged $12.3 billion to help combat the problem. So far, though, only $1 billion has been paid out. To put these figures in perspective, German Chancellor Angela Merkel that would commit up to €500 billion ($669 billion) to help bailout German banks and financial institutions.
A stark increase in food prices over the last year is putting an ever larger portion of the globe at risk for starvation. Over the last 14 months, for example, the price of rice has gone up 66 percent in Bangladesh while the price of wheat has doubled in Senegal and quadrupled in Somalia. "Since families in developing countries spend almost two-thirds of their income on food, even a small increase in prices can push the poorest of the poor toward starvation," said Wiggerthale.
And while "one might think that millions of farmers in poor countries would be benefiting from the recent climb in prices, but that's not happening." The reason, said Wiggerthale, is that farmers are consumers as well as producers of commodities. At the same time that food prices have risen, the cost of seed and fertilizer has also nearly tripled. That's why in countries such as Zambia and Malawi, the poverty rate is rising twice as fast in the countryside as in cities.
The United Nations estimates it would require between $25 billion and $40 billion to effectively respond to the world hunger crisis. The measures taken so far, according to Oxfam, are "totally inadequate." Still, not everyone is feeling the squeeze from soaring food prices. Several big multinational corporations linked to agriculture are having banner years. Nestle's revenues were up nine percent in the first half of 2008, while sales at British supermarket giant Tesco climbed 10 percent. The biggest winner of all might be agribusiness giant Monsanto: Its profits for the first quarter amounted to $3.6 billion, a 26 percent spike over last year.
The mystery of the missing opium
It's a mystery that has got British law enforcement officials and others across the planet scratching their heads. Put bluntly, enough heroin to supply the world's demand for years has simply disappeared.
The United Nations Office on Drugs and Crime (UNODC) describes the situation as "a time bomb for public health and global security".
This week's Map of the Week comes courtesy of the UNODC. It shows their latest estimate of opium production in Afghanistan - another bumper year.
A crop of 7,700 tonnes will produce around 1,100 tonnes of heroin - it basically works on a 7:1 ratio.The mystery is that the global demand for heroin is less than half that. In other words, Afghanistan only needs to produce 3,500 tonnes to satisfy every known heroin user on the planet.
Look at the graph, though.
For the past three years, production has been running at almost twice the level of global demand.The numbers just don't add up. There are two credible theories.
Theory 1: A large and undocumented market has opened up in countries which don't want to admit the problem. Russia has long been in denial over the scale of its heroin problem and the same may be true in emerging drug markets like Iran, Turkmenistan and Kazakhstan.
The Iranians are certainly increasingly anxious about the opium fields on their doorstep. Border guards and police have been involved in deadly shoot-outs with smugglers with experts suggesting that there are now a million heroin users in Iran. But the over-supply is so great that it is hard to conceive of it all disappearing in to the blood-streams of new addicts in Tehran and Ashgabat.
Theory 2: Vast quantities of heroin and morphine are being stockpiled. Antonio Maria Costa, head of the UNODC is convinced that is the only explanation. In a recent bulletin he issues an urgent order: 'Find the missing opium.' "As a priority, intelligence services need to examine who holds this surplus, where it may go, and for what purpose" he says. "We know little about these stockpiles of drugs, besides that they are not in the hands of farmers."
Further credibility is given to the stockpiling theory in that 'farm-gate' prices for opium remain pretty stable at about $70 per kilo. So where are the thousands of tonnes of drugs that the UNODC describe as a "time bomb"?
Well a clue, perhaps, comes from a senior law enforcement official who told me that British undercover teams in Afghanistan are reporting seizures of "enormous quantities of precursors". Precursors are the chemicals required to turn base opium into heroin.The intelligence suggests that, rather than export opium to established drug laboratories in, for example, eastern Turkey, smugglers are processing the crop in Afghanistan.
The likelihood is that vast quantities of heroin are being warehoused somewhere close to the fields where the opium grows. But there is another mystery surrounding the heroin market at the moment. If the international drug cartels are so awash with product that they are prepared to risk hiding billions of dollars worth, why are there shortages on some British streets?
That is the peculiar state of affairs revealed in Drugscope's recent trends survey.
"Some areas are experiencing outright shortages or shortages of good quality heroin. The quality of street heroin had dropped in 12 of the 20 town and cities surveyed, with five areas - Penzance, Cardiff, north London, Luton and Birmingham - noticing a shortage of the drug on the streets" the report says. The field-work, conducted in July and August, finds shortages had typically been in place for two months - a longer stretch than is usual in a market well known for its peaks and troughs.
The Serious Organised Crime Agency (SOCA) believes the heroin shortage in some parts of the country could have been sparked by a rise in the price of UK wholesale heroin. "Current intelligence suggests that some criminal groups are having difficulty getting hold of what they perceive to be good quality heroin."
One theory is that smugglers are using new routes, increasingly distributing heroin through East Africa.The switch in tactics may have led to a temporary pause in supply which is being felt in the UK.
But very few would claim the shortages are the result of police activity. The Drugscope survey concludes that "street level drug enforcement had little long-term impact on illegal drug markets." At best, operations only disrupt the flow of drugs for a few days or weeks and merely displace drug use and drug dealing for a short time.
One serious anxiety is that the economic downturn will herald a new wave of drug misuse.The recession in the 80s coincided with the British heroin epidemic. In the US it was crack cocaine. It is not just that people turn to drugs to blot out the misery of a downturn. If the crisis pushes up unemployment, it is likely that, deprived of a legitimate way to make a living, some may turn to an illegitimate source.
Perhaps a global downturn is what the drug cartels, with their huge stockpiles of heroin, have been waiting for.
Since posting this article the Serious Organised Crime Agency has been in touch.
SOCA has a number of undercover operatives in southern Afghanistan. They tell me this: "Whilst the cultivation and production of opium in Afghanistan is in decline, intelligence suggests there is considerable stockpiling of narcotics by Afghan criminal networks in order to control prices in the growing markets in Russia, China and within the local region."
I also understand that Nato's top operations commander is calling for more aggressive tactics against the opium trade in Afghanistan. US General John Craddock will tell Defence Ministers gathering in Budapest that troops should focus on "high-end" targets like drug dealers and laboratories. Some Nato ministers, however, are concerned that any crackdown would prompt a violent backlash against allied troops.
Bernanke Is Fighting the Last War
'Everything works much better when wrong decisions are punished and good decisions make you rich.'
On Aug. 9, 2007, central banks around the world first intervened to stanch what has become a massive credit crunch. Since then, the Federal Reserve and the Treasury have taken a series of increasingly drastic emergency actions to get lending flowing again. The central bank has lent out hundreds of billions of dollars, accepted collateral that in the past it would never have touched, and opened direct lending to institutions that have never had that privilege. The Treasury has deployed billions more. And yet, "Nothing," Anna Schwartz says, "seems to have quieted the fears of either the investors in the securities markets or the lenders and would-be borrowers in the credit market."
The credit markets remain frozen, the stock market continues to get hammered, and deep recession now seems a certainty -- if not a reality already. Most people now living have never seen a credit crunch like the one we are currently enduring. Ms. Schwartz, 92 years old, is one of the exceptions. She's not only old enough to remember the period from 1929 to 1933, she may know more about monetary history and banking than anyone alive. She co-authored, with Milton Friedman, "A Monetary History of the United States" (1963). It's the definitive account of how misguided monetary policy turned the stock-market crash of 1929 into the Great Depression.
Since 1941, Ms. Schwartz has reported for work at the National Bureau of Economic Research in New York, where we met Thursday morning for an interview. She is currently using a wheelchair after a recent fall and laments her "many infirmities," but those are all physical; her mind is as sharp as ever. She speaks with passion and just a hint of resignation about the current financial situation. And looking at how the authorities have handled it so far, she doesn't like what she sees.
Federal Reserve Chairman Ben Bernanke has called the 888-page "Monetary History" "the leading and most persuasive explanation of the worst economic disaster in American history." Ms. Schwartz thinks that our central bankers and our Treasury Department are getting it wrong again.
To understand why, one first has to understand the nature of the current "credit market disturbance," as Ms. Schwartz delicately calls it. We now hear almost every day that banks will not lend to each other, or will do so only at punitive interest rates. Credit spreads -- the difference between what it costs the government to borrow and what private-sector borrowers must pay -- are at historic highs.
This is not due to a lack of money available to lend, Ms. Schwartz says, but to a lack of faith in the ability of borrowers to repay their debts. "The Fed," she argues, "has gone about as if the problem is a shortage of liquidity. That is not the basic problem. The basic problem for the markets is that [uncertainty] that the balance sheets of financial firms are credible."
So even though the Fed has flooded the credit markets with cash, spreads haven't budged because banks don't know who is still solvent and who is not. This uncertainty, says Ms. Schwartz, is "the basic problem in the credit market. Lending freezes up when lenders are uncertain that would-be borrowers have the resources to repay them. So to assume that the whole problem is inadequate liquidity bypasses the real issue."
In the 1930s, as Ms. Schwartz and Mr. Friedman argued in "A Monetary History," the country and the Federal Reserve were faced with a liquidity crisis in the banking sector. As banks failed, depositors became alarmed that they'd lose their money if their bank, too, failed. So bank runs began, and these became self-reinforcing: "If the borrowers hadn't withdrawn cash, they [the banks] would have been in good shape. But the Fed just sat by and did nothing, so bank after bank failed. And that only motivated depositors to withdraw funds from banks that were not in distress," deepening the crisis and causing still more failures.
But "that's not what's going on in the market now," Ms. Schwartz says. Today, the banks have a problem on the asset side of their ledgers -- "all these exotic securities that the market does not know how to value." "Why are they 'toxic'?" Ms. Schwartz asks. "They're toxic because you cannot sell them, you don't know what they're worth, your balance sheet is not credible and the whole market freezes up. We don't know whom to lend to because we don't know who is sound. So if you could get rid of them, that would be an improvement." The only way to "get rid of them" is to sell them, which is why Ms. Schwartz thought that Treasury Secretary Hank Paulson's original proposal to buy these assets from the banks was "a step in the right direction."
The problem with that idea was, and is, how to price "toxic" assets that nobody wants. And lurking beneath that problem is another, stickier problem: If they are priced at current market levels, selling them would be a recipe for instant insolvency at many institutions. The fears that are locking up the credit markets would be realized, and a number of banks would probably fail. Ms. Schwartz won't say so, but this is the dirty little secret that led Secretary Paulson to shift from buying bank assets to recapitalizing them directly, as the Treasury did this week. But in doing so, he's shifted from trying to save the banking system to trying to save banks. These are not, Ms. Schwartz argues, the same thing. In fact, by keeping otherwise insolvent banks afloat, the Federal Reserve and the Treasury have actually prolonged the crisis. "They should not be recapitalizing firms that should be shut down."
Rather, "firms that made wrong decisions should fail," she says bluntly. "You shouldn't rescue them. And once that's established as a principle, I think the market recognizes that it makes sense. Everything works much better when wrong decisions are punished and good decisions make you rich." The trouble is, "that's not the way the world has been going in recent years." Instead, we've been hearing for most of the past year about "systemic risk" -- the notion that allowing one firm to fail will cause a cascade that will take down otherwise healthy companies in its wake.
Ms. Schwartz doesn't buy it. "It's very easy when you're a market participant," she notes with a smile, "to claim that you shouldn't shut down a firm that's in really bad straits because everybody else who has lent to it will be injured. Well, if they lent to a firm that they knew was pretty rocky, that's their responsibility. And if they have to be denied repayment of their loans, well, they wished it on themselves. The [government] doesn't have to save them, just as it didn't save the stockholders and the employees of Bear Stearns. Why should they be worried about the creditors? Creditors are no more worthy of being rescued than ordinary people, who are really innocent of what's been going on."
It takes real guts to let a large, powerful institution go down. But the alternative -- the current credit freeze -- is worse, Ms. Schwartz argues. "I think if you have some principles and know what you're doing, the market responds. They see that you have some structure to your actions, that it isn't just ad hoc -- you'll do this today but you'll do something different tomorrow. And the market respects people in supervisory positions who seem to be on top of what's going on. So I think if you're tough about firms that have invested unwisely, the market won't blame you.
They'll say, 'Well, yeah, it's your fault. You did this. Nobody else told you to do it. Why should we be saving you at this point if you're stuck with assets you can't sell and liabilities you can't pay off?'" But when the authorities finally got around to letting Lehman Brothers fail, it had saved so many others already that the markets didn't know how to react. Instead of looking principled, the authorities looked erratic and inconstant.
How did we get into this mess in the first place? As in the 1920s, the current "disturbance" started with a "mania." But manias always have a cause. "If you investigate individually the manias that the market has so dubbed over the years, in every case, it was expansive monetary policy that generated the boom in an asset.
"The particular asset varied from one boom to another. But the basic underlying propagator was too-easy monetary policy and too-low interest rates that induced ordinary people to say, well, it's so cheap to acquire whatever is the object of desire in an asset boom, and go ahead and acquire that object. And then of course if monetary policy tightens, the boom collapses."
The house-price boom began with the very low interest rates in the early years of this decade under former Fed Chairman Alan Greenspan. "Now, Alan Greenspan has issued an epilogue to his memoir, 'Time of Turbulence,' and it's about what's going on in the credit market," Ms. Schwartz says. "And he says, 'Well, it's true that monetary policy was expansive. But there was nothing that a central bank could do in those circumstances.
The market would have been very much displeased, if the Fed had tightened and crushed the boom. They would have felt that it wasn't just the boom in the assets that was being terminated.'" In other words, Mr. Greenspan "absolves himself. There was no way you could really terminate the boom because you'd be doing collateral damage to areas of the economy that you don't really want to damage."
Ms Schwartz adds, gently, "I don't think that that's an adequate kind of response to those who argue that absent accommodative monetary policy, you would not have had this asset-price boom." Policies based on such thinking only lead to a more damaging bust when the mania ends, as they all do. "In general, it's easier for a central bank to be accommodative, to be loose, to be promoting conditions that make everybody feel that things are going well."
Fed Chairman Ben Bernanke, of all people, should understand this, Ms. Schwartz says. In 2002, Mr. Bernanke, then a Federal Reserve Board governor, said in a speech in honor of Mr. Friedman's 90th birthday, "I would like to say to Milton and Anna: Regarding the Great Depression. You're right, we did it. We're very sorry. But thanks to you, we won't do it again."
"This was [his] claim to be worthy of running the Fed," she says. He was "familiar with history. He knew what had been done." But perhaps this is actually Mr. Bernanke's biggest problem. Today's crisis isn't a replay of the problem in the 1930s, but our central bankers have responded by using the tools they should have used then. They are fighting the last war. The result, she argues, has been failure. "I don't see that they've achieved what they should have been trying to achieve. So my verdict on this present Fed leadership is that they have not really done their job."