St. Louis, Missouri newsboy, 6 years old, been working for a year
Ilargi: The number 1 concern in today's economy, both in the US and everywhere else, is not the availability of credit, as anyone would like to have you believe. The biggest concern is trust, and there’s even a lot less of it available than there is of credit.
No matter how much of your money now sits in bankers’ vaults, and how much more will be send on its way there, it will not expand credit in any substantial sense. The reason of course is the paper that also sits in the same vaults, spreading its toxic contagion to everything around it.
And there's another aspect of trust that is about to rear its head: the trust of the people in their governments. There is so far no signal that the incoming new US government has placed rebuilding trust in the top spot of its agenda. They are focused, as are all governments around the world, on rebuilding credit. That will prove to be a grave mistake.
Without trust, no significant part of taxpayer money will ever be used even just to lend it back to the same taxpayer, with interest. And that in turn means that the financial situation of the taxpayer will continue to deteriorate, and pick up speed doing so, until the public’s trust in its own leaders will start vanishing.
People may have some initial faith in bail-outs, after all, they trust their leaders to know what they do, but there is a point beyond which they will stop believing. They are smart enough to see that the $3 trillion worldwide in hand-outs for financial corporations have done nothing to restore neither trust nor credit. On the contrary, things get worse fast, and the only answer they see coming from their governments is more of the same, with added interest rate cuts that destroy their savings.
In Spain, unemployment rates are expected to soon rise to 15%-20%, and not to stop there. Numbers like that are a blunt threat to a society. No country can afford to pay adequate benefits for 1 in 4 of their citizens, and no country is stable that sees such a large part of its people fall into destitute poverty.
The news from China is getting bleaker by the day. If we assume that any growth level under 8% will destabilize the Chinese economy, because of massive migration from the land to the cities, combined with people’s expectations of a better life, and we see warnings of a growth level as low as 5% in 2009-2010, we can predict 100 or 200 million people rising up. Add the enormous increases in pollution across the country, and you have a recipe for a powder keg. Beijing may throw half a trillion dollars at its banking system today, a huge amount for an economy of that size, but just like in the West, it’ll disappear into the black holes of losses already incurred.
In short, no government thus far has shown the courage to do what must be done. Big money and big politics are too closely linked, and all politicians use public funds to try and save their banker friends and donors. And not only that: they allow the same friends to keep operating without revealing what losses they have suffered. For many banks, mortgage lenders and carmakers, just to name a few large industries, such forced revelations would mean game over. By repeating to themselves, each other, and the public, that the world would come to an end if ever the losses were publicly recognized, they are spreading the most expensive lie in history: that bankrupt corporations are in fact going concerns.
This can't last. The center cannot hold. Not in Spain, not in China, not in Britain, nor in Portugal, Australia, Ireland, Hungary or Greece. And neither can it in the US. And people like Larry Summers or Robert Rubin are seated much too close to the center to be in any position to expose the financial world’s dirty laundry. Nouriel Roubini is fast losing his claim to fame by calling guys like them the right people at the right place and time. That is ludicrous.
In all aspects of our societies we demand and expect independent assessments of what has gone wrong in issues of national interest. In this case, we all let Tony Soprano's books by audited by his own accountants. People won't continue to buy into that. They don't trust it, and rightfully so.
If trust in not rebuilt, whether between governments and the people they represent, or between bankers, no amount of taxpayer money can do a single thing to restore credit, and a hard rain is going to fall on all of us.
China Announces $586 billion Economic Stimulus
China announced a 4 trillion yuan ($586 billion) stimulus plan to spur expansion in the world's fourth-largest economy, helping sustain global growth as the U.S., Europe and Japan teeter on the brink of recession. The funds, equivalent to almost a fifth of China's $3.3 trillion gross domestic product last year, will be used by the end of 2010, the Beijing-based State Council said today on its Web site. China will adopt a "pro-active fiscal policy" and pursue a "moderately loose" monetary policy, it said.
China is taking steps to bolster its economy less than a week before Premier Wen Jiabao goes to Washington for talks with global leaders on ways to alleviate the world's biggest financial crisis since the Great Depression. People's Bank of China Governor Zhou Xiaochuan said yesterday boosting domestic demand is the best way China can help stabilize the economy. "The downside risks to economic growth are significantly greater now than just a few months ago," said Ma Jun, chief China economist at Deutsche Bank AG in Hong Kong. "China needs an aggressive fiscal stimulus package."
The spending announced today, of which 100 billion yuan is earmarked for this quarter, will cover low-rent housing, infrastructure in the rural areas, as well as roads, railways and airports, the State Council said. The government will also allow tax deductions for purchases of fixed assets such as machinery to stimulate investment, a move that will reduce companies' costs by an estimated 120 billion yuan.
Wen is trying to stop China's economic slowdown from deepening as exports wane, manufacturing contracts and a property slump undermines domestic demand. The central bank has already cut interest rates three times in two months, reducing the one-year lending rate to 6.66 percent. Manufacturing contracted by the most since at least 2004 in October and export orders dropped to their lowest, according to CLSA Asia Pacific Markets. Home sales have plunged in major cities including Beijing and the stockpile of unsold new vehicles was at a four-year high in September.
China's economy may grow 7.5 percent or less, the slowest pace in nearly two decades, in 2009, according to UBS AG and Credit Suisse AG. Last year, the expansion was 11.9 percent. "The golden years have shuddered to a dramatic halt," said Stephen Green, head of China research at Standard Chartered Bank Plc in Shanghai.
Global crisis threatens China's income gains
Short of food and running low on cash, a group of men huddled under a bridge in Beijing and waited for someone, anyone, to come by and offer them work, any work. The global economic slowdown is taking a toll on China and threatens to swell its ranks of the unemployed, undoing impressive income gains made in recent years and undermining the ‘harmonious society' that the government prizes above all else. Hit especially hard are the rural migrants who have long streamed into cities to build office towers, clean streets and staff factories.
Under the bridge in southwest Beijing, an area where construction managers would hire crews in better times, Ren, a day labourer in his 40s, contemplated giving up and returning to his patch of farmland in Hebei province. “This is the worst I've ever seen it. Normally I can get a job in a few days, but I've been out here a month already,” he said. Whether Ren goes back or not, he and an estimated 130 million rural migrants like him are not legally registered as living in the cities where they work and so do not show up in official employment statistics. But evidence is mounting that their prospects have turned bleak in the space of just a few months. The government, which bases its quest for social stability on economic strength, has responded with tax breaks, interest rate cuts, big spending projects and pledges to do more.
The suddenness with which China's economy has lost momentum is Beijing's immediate concern. Annual growth in the third quarter sank to 9 per cent, well down from its scorching 11.9-per-cent pace in all of last year, putting the country on track for its first single-digit expansion since 2002. The extreme ravages of the global financial crisis have raised the spectre of a further slowdown to 8 per cent – enough to be flirting with recession in Chinese terms. Most countries would salivate at such growth, but for China it is a tipping point: anything less, experts say, and the economy cannot create enough jobs to keep up with the mass of people – at least 15 million – entering the labour market every year.
“If economic growth fell below 8 per cent there would be tension, social tension, complaints and job losses,” Chen Xingdong, chief economist at BNP Paribas in Beijing, said. “You can understand why the Chinese government seems to have become desperate about delivering all kinds of stimulus measures,” he added. A small taste of exactly what the government wants to avoid came last month in the southern city of Dongguan, an exporting hub near Hong Kong. About 1,000 labourers protested outside a toy factory, demanding unpaid wages after the firm, battered by the downturn overseas, closed its doors. In Wenzhou, an export powerhouse in the east, about 20 per cent of workers have lost their jobs, prompting an exodus to the countryside, local press recently reported. “We must be crystal clear that without a certain pace of economic growth, there will be difficulties with employment,” Premier Wen Jiabao warned in the latest issue of the Communist Party's ideological journal, Seeking Truth. “Factors damaging social stability will grow,” he wrote.
Pain has spread throughout China, not just its export sector. Industrial production slumped in September to its weakest annual growth in six years, and real estate development has slowed as prices have faltered. Business managers have started to cut staff, a pair of recent surveys showed. Just last year, companies complained that China's surging economy had led to labour shortages and forced wages higher. But workers' newfound bargaining power may have been short-lived. Groups of men sat dejectedly on the curb as they came to the end of another day of waiting in vain for work at a job market in a south Beijing parking lot. “I've been here for three weeks and not seen one boss come past. It used to be bosses everywhere,” said Xiao Wu, 38, who worked on building sites in the capital for the past five years. Mr. Wu's oily hair and blood-shot eyes bore testimony to the 20 nights he said he had slept in a railway station, splashing water from a public restroom sink on his face to wash every morning.
“I'd go back to my hometown but I don't even have the money for the train ticket,” Mr. Wu, from the central province of Henan, said. Migrant labourers have little in the way of a cushion to fall back on when they lose a job. “Their social protection is quite low and their jobs tend to be less formal, often with no legal framework, so they are more susceptible to shocks,” Du Yang, a labour economist at the Chinese Academy of Social Sciences, said. Under China's social security system, citizens can collect welfare payments only in the city where they hold a hukou, or household registration permit, usually their birthplace. That means the vast majority of rural migrants have no coverage. China has begun to beef up its social security system, but with tax revenues plummeting as the economy slows, big improvements for migrants are off the table for now. The farms they left behind in search of better lives are their only safety net.
“Most have land in the countryside, so they could always go back to that,” said Wang Xiaolu, deputy director of the National Economic Research Institute, a think-tank in Beijing. “If they've been in cities for a long time, they might find it tough to readjust to the countryside. Conditions are more difficult and income is lower,” he said. The average farmer's income was 4,140 yuan ($605 U.S.) last year, less than one-third the urban average. Many of the thousands of sometimes deadly protests that erupt across China every year have their roots in rural discontent over economic hardship. Remittances from migrant labourers have been among the best ways of transferring wealth to the countryside, making the loss of urban jobs all the more worrying for a government that sees easing the city-farm imbalance as critical for social peace.
White-collar workers are also feeling the sting from the weak economy, if not in quite the same way as migrant labourers. Employees at CITIC Securities and Haitong Securities will take pay cuts of up to 30 per cent as the brokerages try to shave costs without laying off staff, according to company sources who spoke on the condition of anonymity. At an official job centre in Beijing, Huo Yong, an electrician, sat in front of a screen listing job advertisements, noting down one offer for 1,500 yuan a month. “If you have skills like mine, you should do fine,” he said. “But see that salary? Speak to the boss in person and I am sure he would say it is lower.” China has pinned its hopes on domestic demand filling in for sagging exports. That will be hard to achieve if pay packets are being slimmed. “Consumption is definitely going to be affected, because income will be affected,” said Chen Xingdong of BNP Paribas. “By the first quarter of next year, we should be able to see quite a dramatic slowdown in retail sales.”
Curiously, the one economic gauge that few expect to deteriorate is the unemployment rate. China's urban jobless rate was 4.0 per cent at the end of September, utterly unchanged over the past 12 months. The problem is that it measures only legal urban residents who actually report they are out of work and register for unemployment benefits. It excludes the tens of millions of migrants labouring in cities. Economists think China's real jobless rate could be twice as high as the government's figure. Trouble in the months ahead may, officially at least, go unreported. “The trend is clear. Unemployment is rising. That's for sure, but by how much, we don't know,” Chen Xingdong said. “And if the official statistics do show the unemployment rate going up strongly, then the economy would really be in big trouble.”
Spain unemployment rate on its way to 25%
Unemployment in Spain is surging ahead of job losses in other EU countries and there are fears it could hit depression-like rates above 20 per cent as 14 years of economic boom give way to a protracted slump. Spain's economy, fourth largest in the euro zone, will suffer its first recession since 1993 this year, likely contract until 2011 and not generate jobs until 2012, analysts say. Already in just over a year, Spain has gone from creating over a third of new jobs in the European Union to destroying more than France, Britain and Italy put together.
During October, 193,000 people, or 6,214 a day, registered jobless in Spain, stretching dole lines around city blocks. Total unemployed reached a 12-year high of 2.8 million out of a workforce of just 20 million. By contrast in the much bigger U.S. workforce, average weekly jobless claims remained steady, and they fell by 26,000 in the euro zone's biggest economy, Germany, in October. Most analysts do not yet expect Spanish unemployment, now up to 11.9 per cent from 8 per cent in 2007, to exceed a peak of 23 per cent reached in 1996 when an economic crisis helped topple Spain's last Socialist government.
But economics professor Santiago Nino-Becerra is among those who say it could rise above the 25.2 per cent rate reached in the United States during the depths of the Great Depression. "This crisis is systemic, it's similar to the 1929 crash," said Nino-Becerra of Barcelona's Ramon Llull University. "By 2011, one in every four people could be out of work." In a self-perpetuating cycle, the collapse of housing and credit booms is pushing firms and families into default, crushing consumer spending, and stoking layoffs.
It remains to be seen if Spanish banks' high provisions are enough to avoid capital problems and government rescues in 2009 when non-performing loans will rise sharply, a senior Bank of Spain official recently told Reuters. "The worry now is this ends up in depression like 1929," said professor Antoni Espasa of Madrid's Carlos III University. Construction workers make up the bulk of the 770,000 new unemployed in the past 12 months but the bloated service sector is now haemorrhaging tens of thousands of jobs each week. "There is horrible momentum behind this and we're going to have to completely purge not only residential construction but all sectors," said professor Emilio Ontiveros at Madrid's Autonomous University, who saw 16 per cent unemployment in 2009.
The purge is well under way, based on the number of technicians, engineers and business managers standing in the dawn cold each morning outside the Ronda de Atocha employment office in Madrid. Yosvany Hurtado, a 39-year-old computer technician, was laid off last week at a U.S. firm and had been waiting since 5 a.m. to avoid 9-hour queues later in the day. "They lost a bank contract, that was it," he said. Felipe, a former manufacturing firm manager who did not give his surname, was despondent. "There is no work. Even for a job that pays 1,000 euros there are 300 or 400 applicants," the 59-year-old said.
Spain's deepening crisis lies in long dependence on foreign capital to expand construction, real estate and service sectors and create millions of low-skilled jobs. Spain failed to use its golden years to boost weak secondary education and diversify into value-added sectors. It was the only OECD country where productivity fell between 1991 and 2005. With economies across Europe slowing if not shrinking, the chances of Spain's jobless finding work elsewhere in the European Union are limited, analysts say.
Starved of foreign cash and chained to the euro currency and European Central Bank interest rates, Spain has few ways to raise competitiveness other than increased unemployment that will depress wages. Credit Suisse says Spain must cut wages 20 per cent to regain competitiveness and could even be forced to leave the euro. To avoid social upheaval, Prime Minister Jose Luis Rodriguez Zapatero has rolled out a 38 billion euros stimulus package, up to 400 million euros in mortgage aid for the unemployed and incentives for jobless immigrants to return home.
World Bank Report Paints Bleak Picture for Australia
Australia's economy may be hit harder than expected as the global economic slowdown spreads to emerging markets that are among the nation's key trading partners, Treasurer Wayne Swan said, citing a World Bank report. The report, shown to finance ministers and central bank heads meeting in Brazil, shows the crisis that began in advanced economies is spreading to the developing world. That threatens Australia's extensive trade with countries in Asia and elsewhere, Swan said in comments to journalists e-mailed to Bloomberg News by his office in Canberra.
"We had already factored in a slowing of Australian growth and world growth," Swan said. "It appears from this World Bank report that the slowing in growth will be more dramatic than many had thought previously." Last week, the government slashed its forecast budget surplus by 75 percent, saying the slowest economic growth in eight years will erode tax revenue. On Nov. 6, the International Monetary Fund approved a $15.7 billion loan to Hungary to shore up an economy it said was among the first emerging markets to be ravaged by the financial crisis.
"Finance has been drying up for the emerging world," said Shane Oliver, senior economist at AMP Capital Investors in Sydney. "Most of Australia's exports go to Asia, and if those economies are slowing down more than expected it'll cut into demand for our exports." Swan spoke to journalists after the first day of a meeting in Sao Paulo of ministers and bank governors of the so-called Group of 20 industrialized and developing nations, a prelude to the G-20 leaders' meeting on Nov. 15 in Washington.
The summit is exploring the impact of the global financial crisis on the world's developing economies. Separately, European Union leaders completed proposals during the week for tighter worldwide financial regulation, which they plan to take to the Washington summit. "It is very clear that in the past month or so emerging economies have entered a dangerous new zone," Swan said. "That is the description of the World Bank in their report." Swan told journalists a consensus was emerging among G-20 ministers of the need for coordinated action to stimulate national economies, a further loosening of monetary policy and "fundamental" reform of the international financial architecture.
Australia's central bank has cut the benchmark interest rate by 2 percentage points since September, the most aggressive round of reductions since the economy was in recession in 1991. House prices dropped in the third quarter by the most since 1978 and retail sales in September had their biggest fall in three years. The International Monetary Fund forecasts 1.8 percent growth for Australia's economy in fiscal 2009, Swan said last week. "While the global financial crisis is causing a global recession, Australia is expected to continue to record modest growth and compares favorably with most other advanced economies," he said in an e-mailed statement.
Italy next to bail out banks
The Italian government is this weekend working on plans to pump as much as €20 billion (£16 billion) into its biggest banks and could take large shareholdings in some institutions. Unicredit, Intesa Sanpaolo, Banca Popolare and Banca Monte dei Paschi di Siena (BMPS) will all be offered the chance to join the scheme, along with the rest of Italy’s largest banking groups.
Under the plan, to be unveiled this week, the government will buy bonds that can be converted into equity at the agreement of both parties. The investments will help the banks raise their Tier 1 capital ratios to 8% or higher. The banks are expected to be charged interest rates of between 7% and 9% for the bonds – substantially less than the 12% Britain’s banks are charged for state-backed preference shares.
Unicredit and Intesa Sanpaolo are both due to publish third-quarter results this week. BMPS has been under pressure since it bought rival Antonveneta for €9 billion. Italy joins a growing list of European countries to put forward a bank bailout scheme on substantially better terms than the British government’s scheme. Germany’s scheme, which was used by Commerzbank last week, is being investigated by the European Commission, which fears it may breach the rules on state aid.
The banks just don't get it - they're lucky to be alive
"No, you can't". These are unfashionable words at the moment – and nowhere more so than in the banking industry. While politicians were hoping for an outbreak of economic optimism after Thursday's reduction in interest rates, our High Street bank managers were having none of it. Nearly 24 hours after the Bank of England slashed the official price of money by a record-breaking 1.5 percentage points, only three of the 88 major lenders had said they would pass it on to their borrowers. In fact, only 30 of them had got around to sharing the proceeds of last month's half-point rate cut.
The fact they were much quicker to cut interest rates for many savers only served to rub in the message: No, you can't have a cheaper mortgage. No, you can't get a fairer rate on your savings. No, you can't expect us to go without large profits and bonuses. Change is for wimps. Well, let's see about that. In scenes that would have been unthinkable only two months ago, the Chancellor of the Exchequer summoned the industry's leaders to Downing Street on Friday and promptly pistol-whipped them into submission. Treasury officials were said to have waved press cuttings in their faces, pointing out that the word "banker" had become a popular term of abuse – and not just in rhyming slang. Out they meekly trotted, finally ready to cut their standard variable rate on most mortgages by the same 1.5 percentage points suggested by the Bank of England.
Uncomfortable as it is to watch this public tarring and feathering, it is important to remember whose fault it is. The banks just don't get it. Their economic world changed this autumn (just as the political landscape arguably has now done so too). Yet many senior figures in the City continue to behave as if it were a temporary aberration; a regular swing in the banking cycle rather than a violent snapping of the rope. Only weeks before, these same money men had been on their knees (quite literally, in some cases) begging for help. Having over extended their once-cautious institutions in the name of short-term profit, they were staring into the abyss. Since we could not afford to plunge into a financial dark age, we agreed to hand over £500 billion of taxpayers money (£2 trillion globally) in exchange for an understanding that the bankers' behaviour would change. Nationalisation was not our choice; it was the only alternative to calamity.
What happens now is not about right versus left or the rights and wrongs of capitalism; it is about the survival of capitalism. If the public is going to continue to have faith in the merits of the market, it needs to be convinced that justice prevails. The least we can expect therefore is for bank executives to behave with the same awareness of the bigger picture that we extended to them. Passing on interest rate cuts is only one part of this new deal, but it is symbolically important. With the state yanking hard on one of only two levers it has to stop the economy derailing (the other being tax and spending policy) it does not expect the lever to snap off in its hand. To be told that the lever has broken because bank executives want to keep their short-term profitability up is a grave insult to every taxpayer who contributed to that £500 billion rescue.
This morality tale might seem oversimplified. What about the fact that Libor, the inter-bank lending rate, remains high, the banks say. What about the need to repair our balance sheets? What about paying dividends to pension funds? What about the 90 per cent of mortgages which are not on standard variable rate interest? It is true that bank executives remain in an acutely difficult spot. The rate at which they are able to raise money in the wholesale financial markets did not fall as fast as the Bank of England moved its official rates. The rate for three month lending between banks dropped on Friday from 5.56 per cent to 4.50 per cent – still way above normal levels, given a base rate of just 3 per cent. Anyone raising money in the market at 4.5 per cent and lending it to a customer with an existing tracker rate mortgage (now at, say, 3.8 per cent) is making a significant loss.
Worse still, several banks have been raising fresh capital at far higher rates. Barclays, for instance, went to the Middle East for help last week and received new money at a cost approaching 14 per cent in certain cases. They had the choice of taking the Treasury's shilling, but valued their independence too highly (the cynical view is that it allowed them to carry on paying large bonuses to investment bankers.) Another reason this money is so expensive is that many of those with funds to invest still regard banks as a risky proposition. Equally, at a time when many households and companies face an increased risk of going bust, it is fair for banks to argue that they need to charge us a higher price for taking on that risk when lending us money.
All these points are true, but don't let the small print bamboozle you. They miss the fundamental point that banks now have the explicit backing of the state. The cost might be higher than they would like it to be, but for now this source of support is immensely valuable. Instead, what this is really about is the level of profitability that banks and their shareholders can expect in return, especially during these exceptional times. Of course we need to encourage bankers to return to profitability and independence in the long term, but, given what they have just gone through, most shareholders ought to be glad their banks are still alive. Their more immediate goal ought to be to keep the economy from contracting any faster than it is already. This, at least, is the one thing we all have an interest in.
Which brings us to the final argument wheeled out by those who seek to defend the behaviour of banks last week: if excessive lending and cheap debt is what got us into this mess in the first place, how can it make sense to force banks to carry on offering cheap mortgages now? Surely we can't ask them to curb excessive lending and keep cutting the price of lending? Once again, there is a grain of truth in this argument. The road back to normal economic growth will have to involve less dependence on debt. But the pace of change is vitally important: if banks swing too fast in the other direction and cut off all affordable lending to the economy, the consequences would be disastrous. We need to wean ourselves off gradually and carefully.
As I've argued here before, it is also vital that savers are properly looked after. This is partly so as not to punish the prudent while we reward the reckless, but it is also in the interests of banks to attract new, more stable sources of capital. Just as it is dangerous not to pass on the full effect of interest rate cuts to borrowers, there is a danger in being too swift to pass on the pain to savers. In fact, you can expect this to be the next battleground. An imminent government report on mortgages will almost certainly encourage banks to increase their reliance on savings deposits. Neither of these of two prescriptions bode well for short-term bank profits, but there is a lot more at stake that simply funding next year's dividend or bonus pot.
UK carmakers plead for aid
Britain’s beleaguered carmakers are to ask Lord Mandelson, the business secretary, for a package of measures to help boost demand and safeguard manufacturing jobs. They want ministers to scrap plans to raise vehicle excise duty and will ask for subsidies for companies that renew old corporate fleets. Alistair Darling, the chancellor, has separately been asked by industry leaders to throw his weight behind a €40 billion (£30 billion) package of loans being prepared in Brussels.
Car companies are being hammered by a fall in sales. New-car registrations dipped 23% in October, with sales for the year now forecast to be 2.15m vehicles, down from last year’s 2.4m. Most UK carmakers have laid off staff, cut back working hours and are planning long shutdowns over Christmas. “It is the worst we have ever seen,” said David Smith, chief executive of Jaguar Land Rover. “And it has been a sudden and sharp drop. After Lehman Brothers collapsed, we saw a rapid fall-off,” he said. Smith is one of a group of industry leaders seeking a meeting within the next 10 days with Mandelson, Geoff Hoon, the transport secretary, and Treasury ministers.
Excise duties on larger cars are to be increased in April. The increase will also apply to some secondhand cars. Paul Everitt, chief executive of the Society of Motor Manufacturers and Traders (SMMT), said a reprieve on the duty increases would help consumer confidence. “It would send out the right signal – and it is also the right thing to do for the government because, as we have explained to them before, the increases as framed do little to help the environment.” Smith urged the government to adopt a German scheme that gave incentives to companies to encourage them to renew old fleets. Subsidies are available for those who want to get rid of vehicles that are more than eight years old. “Not only would it help stimulate demand but it would get more fuel-efficient cars on the road,” said Smith.
The SMMT has written to Darling asking him to support a proposed €40 billion loan package from the European Investment Bank, which will be discussed on December 2. It would make cheap loans to carmakers to help pay for the development of low-emission vehicles. A similar programme has been made available in America. Detroit is likely to receive more direct assistance. GM, Ford and Chrysler have begun talks about a “bridge” loan from Washington that would ease their immediate cash problems. Ford and GM said last week they burned through about $7 billion (£4.5 billion) each in the last quarter, with GM warning it did not have enough reserves to last it through next year.
Emerging Economies Pledge Stimulus to Fight Slump
Finance ministers from emerging economies said they will take new measures to tackle the global economic slowdown at a meeting of the Group of 20 nations in Sao Paulo yesterday. Brazil, Russia, India and China, the so-called BRIC nations, plan coordinated measures to increase trade and capital flows between their economies, Russian Finance Minister Alexei Kudrin said in an interview, and China today announced a $586 billion stimulus plan to spur growth in the world's fourth largest economy. Mexican Deputy Finance Minister Alejandro Werner said slower growth and lower commodity prices justify cutting interest rates.
The ministers are meeting amid mounting evidence the financial crisis pushing the world's biggest industrialized economies into recession is also dragging down growth in Asia and Latin America. India, Russia and Brazil have already injected funds into commercial banks and South Korea last week unveiled a 14 trillion won ($10.8 billion) fiscal stimulus plan. "This is a global crisis and demands global solutions," Brazilian President Luiz Inacio Lula da Silva told delegates yesterday. "The participation of the developing world is essential."
Finance ministers and central bankers from the G-20 are laying the groundwork for a Nov. 15 heads-of-state summit in Washington. The ministers' meeting ends today. "Finance ministers of BRIC countries have worked out measures for the near future," Kudrin said. "We have agreed that we can jointly increase trade and capital flows. The major thing is that we are prepared to coordinate." The International Monetary Fund is forecasting that the U.K., Japan, the euro region and the U.K. economies will all contract next year in their first simultaneous recession since the Second World War. With slower growth damping inflationary pressures, central banks are likely to cut borrowing costs further, Canadian Finance Minister Jim Flaherty said.
"There are ongoing conversations about who plans to do what, when" on interest rates, Flaherty said. "I expect that these discussions will lead to some degree of coordinated action." Canada's central bank joined the Fed, the European Central Bank and the Bank of England in an unprecedented coordinated interest rate cut on Oct. 8 after the collapse of Lehman Brothers Holdings Inc. sent credit markets into seizure. The Reserve Bank of India on Nov. 1 lowered its main interest rate for the second time in two weeks while China cut its key interest rate for the third time in two months on Oct. 29.
"We are closely watching the development of the financial crisis and the situation regarding global activity," Zhou Xiaochuan, governor of the People's Bank of China, said yesterday. "If China can maintain domestic demand, it's helpful for global stability." China's State Council said today the government will spend 4 trillion yuan by the end of 2010 as part of its stimulus plans, according to a statement on its Web site. Calls from the IMF and U.K. Prime Minister Gordon Brown for coordinated fiscal stimulus will probably fail to win backing from the group because some countries are concerned about increasing public spending, Flaherty said. "Ideally that would be so -- it's just not likely to happen," Flaherty said. "Some countries feel that they are more constrained than others." China's willingness to stimulate its economy may play an important role in supporting world growth, Flaherty said.
China's economy grew at the slowest pace in five years in the three months through September as export orders shrank and industrial production waned. "Chinese authorities talked about having a strong fiscal expansion," World Bank President Robert Zoellick said in a briefing yesterday. "China is in a very good position." Companies from Paris to Mexico City are feeling the heat as credit dries up. PSA Peugeot Citroen is cutting staff in China, Mexican homebuilder Consorcio Ara SAB's middle-class clients are struggling to raise home-loans and Brazilian aircraft maker, Empresa Brasileira de Aeronautica SA, slashed its 2009 forecast for deliveries by a quarter. "Clearly, a lower interest rate would be very favorable to stimulate aggregate demand and to lessen the impact of the international crisis," said Mexico's Werner, a former central bank economist.
Ilargi: Two notes here:
1/ The October job loss number will also be revised upward, they always are, and
2/ We are talking about well more than 3 million jobs lost on an annual basis, and there is zero reason to expect the trend to be broken, or indeed not to pick up speed
US sheds over half a million jobs in two months
Employment in the United States fell by a bigger-than-expected 240,000 in October, while September's fall was revised up massively to 284,000, meaning the world's biggest economy has shed over half a million jobs in the past two months alone. The figures highlight the difficult economic situation President-elect Barack Obama will inherit when he assumes office in January as the numbers show unemployment has risen to a higher rate than during the recession of the early part of this decade after the dotcom bust.
"We have entered the phase of serious recession conditions. Unfortunately we will encounter more of this going forward," said Richard Dekaser, economist at National City Corp in Cleveland, Ohio. Payrolls have fallen for the past 10 months in a row and a total of 1.2 million jobs have so far been lost this year. September's job losses were the worst since November 2001 in the aftermath of 9/11. The labour department also said that the jobless rates in America rose to a higher than expected 6.5% from 6.1% in September, the worst rate since March 1994.
The revision to September's figure was unusually large - the labour department last month estimated the loss of jobs at 159,000. August's number was also revised up, to 127,000 from the 73,000 previously reported. Markets took fright at the numbers with the dollar falling further against the yen while US stock futures fell back, dragging the FTSE 100 lower in its wake. Interest rate futures moved to price in another big interest rate cut from the Federal Reserve which last month reduced borrowing costs to just 1%.
"This report highlights the intensifying downside risks for economic activity and suggests that further policy stimulus is necessary," said James Knightley, economist at ING Financial Markets. "We look for an additional 50bp Fed rate cut in December and the Presidential transition team to be looking at stepping up the pace on the implementation of a second fiscal package."
British banks defy Gordon Brown over new interest rate cut
High Street banks have told Alistair Darling they will not pass on any further interest rate cuts to consumers and businesses. The banks have warned the chancellor they are “not charities”. They said they could not afford further to reduce mortgage payments and interest rates to businesses if, as expected, the Bank of England continued to cut rates as the economy fell deeper into recession.
The tough line from the banks will anger taxpayers, coming just a month after the government injected £37 billion into Royal Bank of Scotland (RBS), HBOS and Lloyds TSB to protect them from the credit crunch. Northern Rock and Bradford & Bingley have already been rescued by the taxpayer. Most main banks have responded to the 1.5 percentage point cut made by the Bank of England on Thursday. The only two big lenders not to have trimmed their rates are HSBC and Barclays, which both avoided the Treasury-backed bailout. Bankers, who were summoned to a meeting at the Treasury on Friday morning, have told Darling that these latest cuts, which took bank rates to a 54-year low at 3%, represented a “line in the sand”.
“Base rates are now so low that our margins are desperately small,” said one bank executive. “This point was made quite clear to the chancellor by several of the executives — we are not charities.” During the meeting, which was attended by executives of eight major banks, it is understood Darling indicated that the three part-nationalised banks — RBS, HBOS and Lloyds TSB — would be placed under greater pressure to pass on any cuts. When told that banks might not pass on Thursday’s rate cut to their customers, Darling said he would consider “prescriptive” measures to force the banks to do so.
“It was a difficult meeting,” said one banking source. “Right at the start the chancellor’s people thrust unflattering newspaper headlines under the executives’ noses.” A Treasury spokeswoman described the chancellor as “firm” with the banks at Friday’s meeting. “They all agreed to pass on all, or at least nearly all, of the rate cut to their customers.” Interest rates are expected to fall below 2% next year. Some City economists believe there is a good chance of a pre-Christmas cut of one percentage point. The bankers also repeated their concerns that Libor — the rate at which banks lend to one another and which broadly determines their ability to lend to mortgage-holders — remains substantially higher than the Bank of England base rate.
However, the three-month Libor rate fell by 1.07 percentage points to close at 4.5% on Friday, the biggest fall since 1992. Vince Cable, the Liberal Democrats’ Treasury spokesman, said: “The banks cannot be allowed to hold the consumer to ransom like this, especially now Libor is falling. If base rates fall, mortgage lenders must pass this on to their customers.” Treasury officials confirmed yesterday that the chancellor’s pre-budget report, due this month, could include tax help for families and small businesses. The Centre for Economics and Business Research, a consultancy, is calling for a cut in Vat from 17.5% to 12.5% until the end of 2009, to help prevent a deep recession.
Though Brown has won plaudits for his handling of the crisis, an ICM poll for The Sunday Telegraph today gives the Conservatives a healthy 13-point lead. The Tories are on 43%, Labour 30% and the Liberal Democrats 18%. Meanwhile, two former chief executives of Bank of Scotland and RBS are trying to stage a boardroom coup in which they replace the board of HBOS and sabotage the bank’s proposed £12 billion merger with Lloyds TSB. Sir Peter Burt and Sir George Mathewson wrote to Lord Stevenson, HBOS’s chairman, claiming that the Treasury’s plan to inject money into the banking sector meant the merger was “no longer necessary”. It also emerged last night that Lloyds TSB is providing financial support to HBOS through a £10 billion loan facility, in a covert agreement between the two banks.
AIG's Plan D
After nearly eight weeks of questions, the world is likely to get some answers Monday about exactly what's going on with American International Group, the official insurance company of the United States. The bedragged stock of American International Group surged 12.3% Friday after reports emerged that the government and the insurer are in talks to renegotiate the draconian terms of the $85.0 billion bridge loan that kept the company afloat in September and to discuss another massive taxpayer investment in the form of preferred shares, according to TradeTheNews.com.
Nick Ashooh, a spokesman for AIG, did not deny the reports and told Forbes.com, "We continue to evaluate other potential options for addressing our financial issues" specifically in regard to the onerous 14.0% interest rate on AIG's bridge loan. It's clear that government intends to soften its grip on AIG to try to enable the insurer -- in which the Federal Reserve has a 79.9% stake as a result of its extraordinary action to rescue the company -- to return to health. Reports that it is trying to act before Monday's third-quarter earnings announcement is an ominous sign that the pending news is not good and that resulting downgrades by credit ratings agencies, are likely. If AIG or its subsidiaries get dinged, they may have to post additional collateral for various deals and may have troubled writing new business.
Drastic on-the-fly measures have become business as usual for American International Group. Since the September bailout, the government has tossed AIG two additional tax-payer funded credit lines. Some of this money is being used to replace borrowings under the original $85.0 billion bridge loan, but it is hard to see when the cash spigot will be turned off. This is because the plan for AIG to pare down its businesses and use the proceeds of asset sales to pay back its borrowings appears increasingly unlikely, leaving taxpayers on the hook for the long haul.
Chief Executive Edward Liddy said divestitures would be an "open and transparent process" and that deals might be announced as soon as September. As of Friday, no disposals have been reported. The garage sale hasn't been much of a success so far, in part because AIG isn't under immediate pressure to sell now that it has the Fed's cash. But the longer it remains on life support, the more the risk that the value of the company's businesses will deteriorate, given the global financial crisis. "We recognize that the environment has gotten more difficult, but we have additional flexibility with two credit facilities and the quality of our businesses," said Ashooh. "There's a lot of activity but this process will play out over months."
The insurer's determination to avoid fire sales may be futile. For one thing, the likely buyers are competing companies -- who might benefit more from letting the situation drag on and attempting to grab clients and employees who desert AIG. Potential acquirers with a less Machiavellian bent can still be conservative about when and how much they bid, knowing the the firm has to sell some of its assets at some point.
Fed capitulates: the central bank is broken
Or perhaps better, the entire banking system is broken. For it appears that the US Federal Reserve has given up on the idea of easing stress on interbank and wholesale lending and is resigned to being the central bank-come-market-maker of last, first and every resort. For some time now there’s been a debate about the direction of the Fed’s policy. Would we see target rates come down further? Quantitative easing? Massive T-Bill issuance in the open market?
From the Fed yesterday:The Federal Reserve Board on Wednesday announced that it will alter the formulas used to determine the interest rates paid to depository institutions on required reserve balances and excess reserve balances.Previously, the rate on required reserve balances had been set at the average target federal funds rate established by the Federal Open Market Committee (FOMC) over a reserves maintenance period minus 10 basis points. The rate on excess balances had been set as the lowest federal funds rate target in effect during a reserve maintenance period minus 35 basis points. Under the new formulas, the rate on required reserve balances will be set equal to the average target federal funds rate over the reserve maintenance period.
The rate on excess balances will be set equal to the lowest FOMC target rate in effect during the reserve maintenance period. These changes will become effective for the maintenance periods beginning Thursday, November 6. The Board judged that these changes would help foster trading in the funds market at rates closer to the FOMC’s target federal funds rate.
Why do such a thing? Michael Cloherty at Bank of America points out in a research note this morning that the move will cripple the Fed Funds market - that is, interbank lending:The Fed is going to pay target flat for excess reserves rather than target less 35bps. This is likely to sharply reduce flows in the funds market. There is a staggering amount of excess reserves in the banking system– a normal level of reserves held at the Fed is $7.5bn, where last Wed there was $420bn. With that many excess reserves, funds should trade soft. Now, rather than lend to another bank at a sub-target rate, we should just see banks leave the $ in their account at the Fed. Volumes in the Fed funds market are likely to drop dramatically.
What that means is that the effective is likely to remain below target, and with volumes down, the effective will be even more volatle (unusual trades will have a larger impact on the average). This will make Fed funds futures contract even harder to trade.
The Fed isn’t supposed to work this way. The Fed is supposed to have a control over the monetary system; by which it can manipulate the rates at which banks lend to each other, and the rate at which banks lend to the economy. And yet the Fed has cut rates - slashed them. Its target now stands at 1 per cent. It, and other central banks, have flooded the system with liquidity through a smorgasbord of different open market operations. Banks though, still aren’t lending to the economy. And they are still keeping huge sums in reserve. (They don’t have anywhere else safe to put their cash.) Ben Bernanke knows this scenario. It’s not been admitted yet, but it’s looking very much like a liquidity trap. Rates on T-bills are already precipitously close to zero. Paul Krugman wrote in September (emphasis ours):You still see people saying, in effect, “never mind the zero interest rate, why not just print more money?” Actually, the Bank of Japan tried that, under the name “quantitative easing;” basically, the money just piled up in bank vaults. To see why, think of it this way: once T-bills have a near-zero interest rate, cash becomes a competitive store of value, even if it doesn’t have any other advantages. As a result, monetary base and T-bills - the two sides of the Fed’s balance sheet - become perfect substitutes. In that case, if the Fed expands its balance sheet, it’s basically taking away with one hand what it’s giving with the other: more monetary base is out there, but less short-term debt, and since these things are perfect substitutes, there’s no market impact. That’s why the liquidity trap makes conventional monetary policy impotent.
How impotent? Consider the numbers: the Fed has an $800bn balance sheet to operate in a $50 trillion credit market. The only thing that gives it power is its ability to create monetary base, and in a liquidity trap, that power is useless.
Krugman’s point then was that Bernanke had come up with a third-way alternative to escape a liquidity trap, but that the alternative was, in practice, failing.
That alternative being a quantitative-easing type expansion of the balance sheet, but not to buy T-bills, but other assets - mortgage securities, for example. A Bernanke Twist.
In 1961, the Fed launched the first - formally, only - “Operation Twist”. The idea was that the Fed would use its powers in open market operations to target asset prices: specifically, to flatten the yield curve. The Fed operated directly in the long term Treasuries market in an effort to depress long-term borrowing costs (and thus stimulate economic growth) while simultaneously seeking to prop the dollar by supporting shorter term rates. Krugman again:I guess the Fed had to try the “Bernanke twist.” And it did - the old Fed balance sheet, in which T-bills were the vast bulk of assets, is no more. But the effects have been disappointing, especially weighed against the risk, which I know is making Fed officials very nervous.
Bernanke though, now doesn’t look like he is giving up on the twist, as Krugman thought the advent of the TARP signalled. Indeed, the realisation seems to be, that as now a mere $800bn player in a $50 trillion market, the Fed needs more ammunition. Brad DeLong writes:…the natural answer appears to be open-market operations working not on the liquidity premium but on the risk premium–Operation Twist on a Pan-Galactic scale.
How to fund that? You could issue T-bills. But as Brad Setser points out fundamental changes in the T-bill buyer market make that a risky proposition.
So you could just admit you were in a liquidity trap and use all those excess bank reserves to your advantage instead. As Cloherty writes at BoA:If the Fed is going to pay target, it suggests that they may scrap the SFP bill program (there is less need to drain reserves to try to keep funds above the target). If that happens, that is $630bn of outstanding SFP bills that are no longer needed. Any reduction in SFP bills would likely be replaced by regular Tbills. But this means much less need for larger auction sizes out the curve-fewer SFP bills means fewer 2yr and 5yr notes.
The Fed’s move last night is the first big signal, then, that it will pursue a policy of quantitative easing. At its core, the Bernanke Twist is a direct effort to try and support prices; to stop destructive debt deflation. We are in uncharted territory though. The Fed is not just trying to game the market in US government debt. It’s trying to support the entire asset-backed debt market. Which is particularly risky when the the Fed is effectively supporting those prices by positioning itself as a risk sump. No wonder, as Krugman says, Fed officials are “nervous”. This is an all-out gamble.
It isn’t clear just how much the Fed will need to throw into that system to actually prop it: so far, the Fed’s balance sheet alone has not been enough. The TARP doesn’t look like it has enough either. Consider the fact that total capital raised by the banking system is actually less than total writedowns taken to date. There’s a big danger here for the Fed: that it is trying to catch a falling knife. The Fed is risking things it’s never risked before. That’s not to say we’re in apocalyptic territory at all; consider the firepower the Fed has behind it. It is though, to use a hackneyed, but apt phrase, paradigm shifting.
In Japan, where quantitative easing failed, the central bank’s balance sheet swelled to a size equivalent to 30 per cent of GDP. The Fed’s balance sheet is currently equivalent to 12 per cent of GDP. Where we go from here then very much depends on how severe you see this crisis relative to Japan.
More Pain to Come, Even if He's Perfect
This is one hell of a way to win. Barack Obama owes his victory in large measure to the prospect of the longest and deepest economic downturn in a quarter-century and perhaps since the Great Depression. If he performs well, he could become a great president. If he flubs it, he could get the same reception as Jimmy Carter. In the crassest political terms, it was good luck to have the financial crisis hit so close to the election. But Obama's lucky streak will end in a hurry if he can't find a way out of this mess.
He will also have to manage expectations: Even if he does everything perfectly, we probably won't turn the corner for 18 months, and the downturn could last far longer than that. The first task facing President-elect Obama, after eight years of misguided economic policies, will be to begin the recovery -- or at least forestall a further decline. It won't be easy. Some 1.2 million jobs have already been shed this year, and some three-quarters of a million Americans are about to exhaust their limited unemployment-insurance benefits. By October, only 32 percent of unemployed Americans were receiving unemployment checks. To make matters worse, when Americans lose their jobs, they typically lose their health insurance, too. Meanwhile, 3.8 million homes are under foreclosure, and states are facing massive revenue shortfalls; without assistance, they will have to cut spending, plunging the economy deeper into recession.
So some steps are obvious: assistance to homeowners and bankruptcy reform; extending unemployment insurance; and making up for the gap in state revenue. The United States also has an infrastructure deficit, not just a fiscal and trade deficit, which means that spending more on infrastructure (such as public transport and technology -- especially of the green variety) will stimulate the economy in the short term and help us be more competitive in the long run. But then matters start to get trickier. The economy obviously needs a direct shot in the arm, but the 44th president needs to be careful about the design of the stimulus he proposes.
That's because President Bush will bequeath him a national debt -- $10.5 trillion and rising -- that has almost doubled since he took office, even before you factor in the full costs of the financial bailout and the Medicare prescription benefit, as well as the price tag for providing for the hundreds of thousands of returning Iraq war veterans. To his credit, Obama knows much of this. During the campaign, he argued against cutting taxes on upper-income Americans, who have done so well in recent years. In addition to repealing the 2001-03 tax cuts for the wealthiest, Obama should also consider taxing dividends and capital gains at the same rate as ordinary income: It would reduce the deficit, have few short-term adverse effects on an already reeling economy and make the tax code more fair.
After all, why should speculators -- whether on oil, food or real estate -- be taxed less than those who work long hours to make a living? Another major problem Obama has to tackle is growing inequality in this country. Some of these trends will take decades to reverse, but ensuring that no Americans are denied a college education because they can't afford it, providing adequate funding for public primary and secondary schools and so forth would be a good beginning Obama has also promised to wind down the war in Iraq. Spending a fraction of the war's cost -- my estimate places the total at $3 trillion for our entire economy -- on investments within the United States would help reduce the deficit and boost economic growth at home.
While the federal deficit looms over the Obama administration's economic deliberations, we must be careful not to let it block bold action. Sometimes, we're wiser to pay now rather than later. Borrowing for high-yielding investments (not just Wall Street bailouts) is common sense. The decisions not to reinforce the levees in New Orleans or upgrade the bridges in Minneapolis were penny-wise, pound-foolish blunders that we lived to regret. The root of so many of our problems is the reeling financial sector. The plan cooked up by Bush and his Treasury secretary, Henry M. Paulson Jr., isn't likely to work, or work well enough. So Obama's team will have to wade in. Already, the banks have been talking about using taxpayers' money for dividends, bonuses and acquiring other banks, rather than doing more lending, which was clearly what Congress had in mind for the $700 billion.
U.S. taxpayers got a raw deal, compared to the terms won by other governments (such as Great Britain) or by the legendary investor Warren Buffett, who provided capital to the best capitalized investment bank, Paulson's own Goldman Sachs. Want further proof that Washington got a lousy deal? Look at how the markets reacted. The share prices of the bailed-out banks shot up, showing that investors expected net profits to rise substantially. The U.S. financial sector, once the emblem of our economic success, has failed us. Financial markets are supposed to allocate capital and manage risk; instead, they squandered capital and created risk. Even more galling, the banks' chiefs raked in private rewards totally out of whack with what scant good they were doing for the wider society.
So Obama will have to push for major changes, in both regulations and the overall systems of carrots and sticks, to restore confidence, spur lending and ensure that our financial markets do what they are supposed to do. This may require, for instance, restricting some of the special benefits (such as easy-to-get Federal Reserve loans) granted to the banks in recent months only to well-behaved institutions that actually lend more and use publicly provided funds responsibly. And it means that the financial sector should not only fully repay the bailout funds it has received but also give taxpayers a return commensurate with the risks the country has undertaken. If that means taxing the banks, so be it. Wall Street would demand no less if it were doling out its own money.
Obama will also need to deal with some vast inefficiencies in our economy if we are to prevent further erosions in our standard of living. Some U.S. sectors are global leaders, such as our world-beating universities and the high-tech firms that thrive on the ideas hatched in our ivory towers. Others are embarrassing, such as health care, where Americans spend far more than citizens in many other industrialized countries and get underwhelming results. We need a bold approach here, reforming not just the way we provide medicine but also thinking more broadly about health. That means doing more about diseases associated with alcohol, drugs, tobacco and obesity, which have increasingly come to symbolize American over-consumption.
Similarly, we should think more broadly about the bang we get for our buck in international affairs. Our current military expenditures are a serious drain; we could get more security for far less money if we didn't waste so much on weapons systems that don't work or are designed to fight enemies that don't exist. (Think the Air Force's multibillion-dollar program for a new deep-strike bomber that would be completely useless against terrorists.) Moreover, we might be the richest country in the world, but we have been among the stingiest of the advanced industrial countries when it comes to fighting global poverty and disease.
We devote only 0.16 percent of our world-leading GDP to foreign aid, among the lowest rates in the developed world. If we make the World Bank and the International Monetary Fund more democratic, we will lose some voting power, but we will gain tremendously in "soft power," or global influence. Obama is also inheriting a climate crisis. The United States and China have been racing to see which nation will contribute most to the greenhouse gases that cause global warming. It looks as though China will win in absolute terms, but on a per capita basis, America takes the smoggy cake. We cannot save the planet without a global agreement, and we cannot get such an agreement without massive reductions in U.S. emissions. This transition could have upsides beyond the environmental ones.
A carbon tax -- or the auctioning of emissions permits -- could generate huge revenues; some of those could be used to help Americans adjust to the new "green economy," while the rest could be used to reduce the deficit or lower taxes on workers. But we really have little choice here: Europe and other global players are likely to slap a carbon tax on U.S. goods if we don't deal with the issue at home. Their firms will not tolerate giving U.S. firms a competitive advantage simply because we refuse to bear our responsibility for the global environment.
We may be witnessing the birth of a new economic model. We have been treating two of the world's scarcest resources, air and water, as if they were actually free. No wonder we have paid so little attention to resource-saving innovations. Perversely, the U.S. tax code has actually been subsidizing the production of the very fossil fuels that contribute to global warming. We have been pursuing a policy that amounts to "Drain America first." It has made us even more dependent on oil imports -- a stunningly short-sighted plan. And in the rare cases when we have turned to renewable sources of fuel, we have done so in a manner driven by special interests, not by common sense.
Subsidies to corn-based ethanol, for instance, offer little if any benefit to the environment; such handouts have been justified in the name of helping out an infant industry that will stand on its own feet if given a good start. But ethanol is an infant that has refused to grow up. The new economic model will require changes in the ways and places where we live and work. There will be some losers (including the oil industry, which has done jarringly well in recent years), but there will be even more winners. In so many ways, the United States has reached a low point. Picking ourselves up off the ground is itself no mean achievement. But I hope that our new president will do even more for us than that.
Why not hyperinflation?
I'll try and explain why I believe a deflationary debt unwind is now underway, and why I believe it will be many years before we should start worrying about inflation again. In fact, by the time inflation becomes a legitimate concern, I expect the vast majority of people will find it as outrageous to worry about inflation then as found it outrageous last year when I made deflation one of my Five Themes for 2008. The disconnect at work today that makes it difficult to envision a life without inflation is almost entirely grounded in a failure to see that credit expansion, by necessity, must have two sides; a credit production mechanism, and a debt acceptance recipient. We have as much of the former as the world has ever seen, but none of the latter.
Going back to 1934, whenever the Federal Reserve has made credit available the world has accepted it. While it is true, as those anticipating hyperinflation argue, the Fed and global central banks are making record amounts of credit available, that is only one side of the credit equation. The assumption is that this record-breaking credit expansion means risk assets (stocks, commodities, etc.) will all skyrocket and the U.S. dollar will get destroyed. But what hyperinflationists fail to realize is that for an inflation (of either the tame or hyper variety) to take place, one must have both the means (credit from the fed and banks) and the motive (the desire to take on more debt) for credit expansion. For over a year now we have had record amounts of the former, but none of the latter.
Additionally, in order for hyperinflation to even be a remote possibility here there would have to be at least one economy that is both, stronger than the weakest.S. economic downturn, and larger in size that the state of Ohio's or even California's economy. Ironically, while smaller emerging markets could potentially find themselves facing a Zimbabwe-esque hyperinflation, that would only make the U.S. dollar and U.S. debt more attractive and secure. Emerging markets are at this point the only place where it seems a possibility that credit could find a willing home and debt an eager taker, but even that is not a certainty. It is more likely that the creeping protectionism that is developing, as countries begin to wake up to the fact that the global system is too big to save, results in a more severe credit contraction globally.
But so what? What if I am wrong about this? What, if anything, is at stake? One the most remarkable things to me is how the American people have been sold on accepting, even preferring, inflation over deflation. It is truly amazing that government and central banking bureaucrats could successfully instill the belief that lower prices for assets are bad. The reality is that lower prices are only bad for artificially-constructed economies. Deflation is necessary to restore market and economic stability. It is not without pain. But inflation, even mild inflation, is like an intoxicant that slowly destroys the body over time even as its narcotic properties mask the pain. By comparison, hyperinflation is ruinous. How ruinous?
Consider this passage from Adam Fergusson's book, "When Money Dies: The nightmare of the Weimar collapse": "In hyperinflation, a kilo of potatoes was worth, to some, more than the family silver; a side of pork more than the grand piano. A prostitute in the family was better than an infant corpse; theft was preferable to starvation; warmth was finer than honour, clothing more essential than democracy, food more needed than freedom."
This is important to understand. The argument against deflation and inflation is both academic and political. Present economic elites benefit from inflation and suffer terribly in deflation. Therefore there is great incentive for the small minority, the 2-3% of wealthy who control the vast majority of assets in this country, to continue to press government and the Fed to maintain the present course of inflation over deflation. But as Fergusson illustrates, hyperinflation is another matter. Just as the Federal Reserve and Chairman Ben Bernanke maintain they will do everything in their power to prevent deflation, then the American people, as patriots, should be equally insistent on doing everything in their power to prevent hyperinflation.
Rahm Emanuel Says Auto Industry Essential Part of U.S. Economy
Rahm Emanuel, President-elect Barack Obama's chief of staff, called the auto industry ``essential'' to the U.S. economy, without specifically endorsing a proposal to use some of the $700 billion financial-rescue fund to aid automakers. ``The auto industry is an essential part of our economy,'' Emmanuel said on ABC's ``This Week.'' Lawmakers should speed up the availability and automakers should tap $25 billion in government loans for retooling the industry, he said.
In addition, there are ``other authorities'' that can be used now and Obama ``has asked his economic team to look at different options of what it takes to help bridge the auto industry so they are a part of not only a revived economy, but part of an energy policy going forward.'' Emanuel didn't directly respond to whether Obama endorses a proposal by House Speaker Nancy Pelosi and Senate Majority Leader Harry Reid to use some of the $700 billion approved to stabilize the financial services industry to aid automakers.
General Motors Corp. is seeking U.S. aid to avoid collapse. On Nov. 7 it said it may not have enough cash to keep operating this year and will be ``significantly short'' by the end of June unless the auto market improves or it adds capital. GM's outlook and Ford Motor Co.'s $7.7 billion cash burn added urgency to automakers' pleas for government help after a quarter in which U.S. industrywide sales plunged 18 percent.
Ford will survive, CEO says
Despite burning through $16 billion in cash during the first nine months of the year and watching its credit rating knocked another notch into junk territory, Ford Motor Co. CEO Alan Mulally on Friday insisted that the company's reserves of $29.6 billion in cash and credit would be enough to survive until 2010. "With the assumptions we have in place, we believe we have sufficient liquidity to make it through this downturn," Mulally told the Free Press, after the automaker disclosed that it had burned through $7.7 billion during the third quarter and would launch yet another cost-cutting effort.
That includes slashing white-collar pay and benefit costs by 10% by the end of January, which Mulally said would result in involuntary layoffs and other cuts. The company also will eliminate merit pay and bonuses next year. "This was very tough for everybody," Mulally said. "We decided together, with the situation we are in on cash, it's just so important to conserve all cash, and so we made the tough decisions to forego those for now." Ford now has $18.9 billion in cash and $10.7 billion in credit to survive until 2010 -- a year that Mulally and other automotive executives have been eyeing like a finish line.
Mulally said he hopes that the economy will begin rebounding then, just as Ford's stable of new fuel-efficient cars from Europe begins arriving in U.S. showrooms. The automaker by then also will realize the full savings of its historic labor contract with the UAW, which removes billions in health care liabilities from its balance sheet. While Ford's position that it has enough money might not clearly support its efforts to get Congress to put emergency funds in place for the auto industry, Mulally said that having federal loans available is critical for the teetering industry and the economy. "If the economy really degraded further, and more rapidly, it could really overwhelm everybody, everybody in the United States," Mulally said.
The Center for Automotive Research in Ann Arbor estimates that the industry directly or indirectly supports 3 million jobs, which could be at risk if the automakers fail. Despite Ford's insistence that it has enough money to make a comeback, however, Moody's Investors Service on Friday downgraded its credit rating. Moody's cited several serious risks to the company's turnaround plan and characterized the situation as delicate. "The problem is that despite Ford's building its plan on reasonably conservative expectations ... things could easily be worse than the company plans," Bruce Clark, Moody's senior vice president, said in a statement.
During the third quarter, Ford posted a net loss of $129 million, or 6 cents a share. While that is better than the $380 million, or 19 cents a share, Ford lost during the same period a year ago, the overall performance belied Ford's worse-than-expected operating results and cash burn. Ford's revenue during the period declined to $32.1 billion in the third quarter, down $9 billion from a year ago, as consumers worried about the weakening economy dramatically curtailed spending on cars and trucks. The company's operating loss for the quarter, which excludes special one-time items, was $2.98 billion, or $1.31 per share. It's worse than the $2.1 billion, or 93 cents per share, in losses that Wall Street analysts forecast. Ford's bottom-line result was buoyed only by special items, which included a $2-billion gain from shifting retiree health care costs to a UAW-run trust fund established under last year's collective bargaining agreement and approved by the federal courts in August.
Most critically, Ford's cash burn intensified dramatically. Ford burned through $7.7 billion in cash in three months, or $2.6 billion a month. While many considered that alarming, Mulally assured journalists that the cash burn would slow down during the last three months of the year. "It will be less," said Mulally, who outlined a cost-cutting plan to provide Ford with another $14 billion to $17 billion in cash through 2010. Despite that, Wall Street seemed taken aback by the cash disclosure. Patrick Archambault of Goldman, Sachs & Co. still said Ford's "cash burn is troubling." For the first nine months of the year, Ford burned through $15.8 billion in cash. Its year-to-date net loss, which takes into account a variety of noncash assets and liabilities, is $8.7 billion.
Ford's troubles remain largely concentrated in its North American business unit for the United States, Canada and Mexico, which posted a pretax loss of $2.6 billion during the third quarter, compared with a loss of $1 billion a year ago. That means Ford's North American employees will continue to endure changes. The Dearborn-based automaker, which turned 105 years old this year, has been trying to restructure its operations to return to profitability since 2006, when it posted a record $12.6-billion loss. The automaker narrowed its losses to $2.7 billion in 2007. Since 2005, Ford's North American operations have closed seven assembly and parts plants and shed 55,500 salaried and hourly workers.
At the end of September, 80,200 workers remained in Ford's North American operations, a 41% reduction from 2005, when the automaker employed nearly 136,000 workers. Of Ford's remaining workers, 22,600 are salaried workers while 57,600 are hourly workers. Independent experts give Ford a lot of credit for making progress in its cost-cutting and product revival efforts. Several say Ford has a fighting chance at long-term viability if it can survive this downturn. This year, Consumer Reports concluded that "nearly all Fords are average or above." The respected magazine even lauded Ford for catching up to foreign automakers and continuing "to pull away from the rest of Detroit."
Despite that, Ford knows it must stabilize or reverse its sales slide in order to succeed. Through October, Ford's sales were down 18.6%, while the overall market was down a lesser 14.6%. In the near-term, Ford is bringing several critical vehicles to market that might help. That includes the all-new 2009 Ford F-150 pickup, which is part of the company's best-selling F-Series lineup and a longtime source of profitability for Ford. The automaker also is to launch a redesigned Ford Fusion midsize car early next year. Ford has said the four-cylinder engine versions of that vehicle will deliver better fuel economy than the Toyota Camry and Honda Accord. "We have a good plan. We're making progress on our plan," Mulally said. "We're on our way."
Reid, Pelosi Urge Treasury to Extend Aid to Automakers
With the nation's automotive industry hemorrhaging cash, congressional leaders called on the Bush administration yesterday to offer government assistance to the car companies as part of the Treasury Department's $700 billion emergency rescue program. The call came one day after General Motors, the nation's largest auto manufacturer, announced another multibillion dollar loss for the third quarter and said it was running out of money fast. Ford, the second-biggest car company, also reported heavy losses. Unless the government steps in, analysts warned, GM could face bankruptcy, endangering the livelihoods of about 100,000 North American autoworkers and hundreds of thousands of others whose jobs depend on the industry.
In a letter to Treasury Secretary Henry M. Paulson Jr., House Speaker Nancy Pelosi (D-Calif.) and Senate Majority Leader Harry M. Reid (D-Nev.) asked Paulson to "review the feasibility . . . of providing temporary assistance to the automobile industry during the current financial crisis." The letter notes that Congress granted Paulson broad discretion to use the bailout money to "restore financial market stability. A healthy automobile manufacturing sector is essential to the restoration of financial market security," the letter continues, as well as to "the overall health of our economy, and the livelihood of the automobile sector's workforce."
If the request is granted, it would expand the federal government's role in private enterprise far beyond the financial sector. Critics have warned that a bailout of GM would attract a long line of other companies to Washington to argue that their survival, too, is critical to the economic health of the country. The move would push the Bush administration to decide winners and losers in yet another huge sector of the economy, and it would force President-elect Barack Obama to manage a complex restructuring of the ailing automotive industry. The Treasury has so far declined to assist the automakers, which have been devastated by the twin shocks of a collapsing credit market and the sharpest drop in auto sales in more than two decades. But as the news from Detroit has grown increasingly grim, lawmakers from both parties, Michigan officials, auto industry executives and labor leaders have stepped up their campaign for federal aid.
A plan is in the works at the Treasury to use bailout money to take ownership stakes in a wide array of companies beyond the banking sector. But Treasury officials have indicated that participants in its recapitalization program must be financial firms subject to federal regulation. That means GMAC, GM's auto financing arm, may be eligible for quick help, but GM itself may not. The rescue legislation gives Paulson authority to consider the automakers for future programs, such as auctions to purchase troubled assets. But the Treasury has yet to establish rules for those programs, which means such help could be months away. Treasury officials declined yesterday to comment directly on the request from Reid and Pelosi. "We continue to work on a strategy that most effectively deploys the remaining funds to strengthen the financial system and get lending going again," Treasury spokeswoman Jennifer Zuccarelli said.
In recent days, top auto industry executives have been making the rounds in Washington, trying to shake loose federal cash from a variety of sources. And there are strong indications that Democrats, newly empowered in Tuesday's election, are inclined to oblige. Obama and other key Democrats vowed during the campaign to support as much as $50 billion in low-interest loans for the car companies. On Friday, during his first news conference since his election as president, Obama spoke at length about the "hardship" the industry faces and referred to the auto industry as "the backbone of American manufacturing."
Obama's team of economic advisers includes Michigan Gov. Jennifer Granholm (D) and former Michigan congressman David Bonior, who is considered a strong candidate for Labor secretary. With Granholm on stage with him Friday, Obama said his transition team is already working on "policy options to help the auto industry adjust, weather the financial crisis and succeed in producing fuel-efficient cars," either under existing law or through the passage of "additional legislation." In the meantime, however, the automakers have gotten little but sympathy. Congress recently voted to fund a $25 billion low-interest loan package intended to help the car companies retool their factories to produce fuel-efficient vehicles that meet tough new emissions standards.
But that money has been hung up by red tape. Obama and other Democrats have discussed providing another $25 billion in loans, bringing the total federal aid to $50 billion. But unless the Bush administration agrees to work on an economic stimulus package when Congress returns to Washington later this month, that money would have to wait until at least January. Analysts fear the firms may not be able to hold on that long. GM and Ford posted big losses Friday as they continued to pay out more in salaries and other expenses than they are taking in from sales. GM said it would cut spending and sell some product lines but nonetheless expects to "fall significantly short" of the cash it needs to operate next year. The failure of GM or one of the other Detroit automakers could wipe out 2.5 million jobs and $125 billion in personal income in the first 12 months, according to a report released this week by the Center for Automotive Research.
This is not unfamiliar territory for the auto industry. In 1979, Chrysler nearly went bankrupt and lobbied the government for assistance. A $1.2 billion loan, coupled with deep executive pay cuts and major union concessions, helped turn the troubled company around. Under Lee Iacocca, Chrysler invented its iconic minivan, popularized the SUV and repaid the loan in four years. The government even made money off the deal. Asked Friday whether future assistance could mirror the Chrysler bailout, GM executives told investors that they consider the Treasury program a more modern means to solving the crisis.
In their letter to Paulson, Reid and Pelosi wrote that Friday's earnings reports "only reaffirm the need for urgent action." If the Treasury does decide to assist the auto industry, they wrote, its chief executives should be subject to the same "limits on executive compensation" as other participants in the program and should be required to give the government equity stakes in their firms "to provide taxpayers a return on their investment upon the industry's recovery." Spokesmen for Ford and GM issued statements thanking the lawmakers for their request. "We appreciate Congress recognizes the urgency to help the auto industry weather this troubled economic period," GM spokesman Greg Martin said. "We hope Congress and the administration can work together to provide immediate aid."
General Motors Aims to Raise Stake in China Venture
General Motors Corp., the biggest overseas automaker in China, is in talks with a local partner to increase its stake in a venture that produces vans and light trucks under the Wuling brand. The U.S. automaker is seeking to buy additional shares in SAIC-GM-Wuling Automobile Co., Hu Maoyuan, chairman of SAIC Motor Corp., said yesterday in an interview in Tianjin. SAIC is the majority shareholder of the venture with 50.1 percent, GM owns 34 percent and Liuzhou Wuling Motors Co. holds the rest.
GM is seeking to boost market share in the world's fastest- growing major economy, where the venture based in southern Guangxi province accounts for about half its local sales. GM said last week that it may not have enough cash to keep operating this year after reporting a $4.2 billion third-quarter operating loss. "Given the lobbying power of both SAIC and GM, the American carmaker will sooner or later get more shares," Ricon Xia, an analyst with Daiwa Associate Holdings Ltd. in Shanghai, said today. "This venture is a vital part of GM's China operation." Henry Wong, GM's Shanghai-based spokesman, declined to comment, saying all business discussions with its partners are confidential and the company has nothing to announce. SAIC's Hu didn't provide any details or disclose how large a stake Detroit-based General Motors is seeking. "GM and our partner in Guangxi are still discussing how to settle the share transfer," Hu said. "We won't give up any of our stake."
Combined first-half losses at GM, Ford Motor Co. and Chrysler LLC, the three largest U.S. automakers, totaled $28.6 billion. The companies are seeking $50 billion in federal loans to help them weather the worst market in 25 years. New vehicles sold at a seasonally adjusted annual rate of 10.6 million in October, the lowest since 1983. A U.S. rescue package for the so-called Big Three is likely before President George W. Bush leaves office in January, Dennis Virag, president of Automotive Consulting Group in Ann Arbor, told Bloomberg Television last week. Democratic congressional leaders have urged U.S. Treasury Secretary Henry Paulson to provide temporary aid to the U.S. auto industry from funds available in a $700 billion rescue bill passed last month.
"A healthy automobile manufacturing sector is essential to the restoration of financial market stability, the overall health of our economy, and the livelihood of the automobile sector's workforce," House Speaker Nancy Pelosi and Senate Majority Leader Harry Reid said in the letter to Paulson today. GM sold 1.03 million vehicles in China last year, about 11 percent of its global total. The company is the biggest overseas automaker in the country in terms of total sales. Combined nine- month vehicle sales at its Chinese ventures rose 9.3 percent to 785,144, according to Bloomberg calculations. "The current financial situation may actually help GM push forward the deal," Daiwa's Xia said. "Especially given the Chinese government's willingness to help the U.S. fend off the financial crisis that has also hit GM heavily."
Obama raises a long-neglected concept: sacrifice
One word, nestled amid the eloquence of Barack Obama’s victory speech, lingered long after the cheers subsided. Sacrifice. It’s a word too long absent from the political discourse, one that speaks to the change that Obama claims his presidency will represent. We cannot fix our finances without it. We can’t address our foreign oil dependence without it. We can’t repair our broken health care system without it. We can’t simply shop our way through the crisis, and we can no longer afford to delude ourselves into thinking we can. Tuesday’s election was about many things, but fundamentally it was about the economy.
On the cusp of Obama’s victory, the stock market rose more than on any previous Election Day, but a day later it turned in its worst post-election drop. The Obama presidency faces the worst stock, bond and commodity markets in three decades. Even strong performers such as oil companies are now facing the prospect of weaker earnings because of lower commodity prices. Employers nationwide eliminated more than three-quarters of a million jobs so far this year, and economists are predicting that the latest report today will show that unemployment has climbed to 6.3 percent, the highest since 1994. Manufacturing jobs have disappeared at their fastest rate in 26 years, as the credit crunch and shrinking global economy undermined exports.
Last month, bankruptcy filings topped 100,000 for the first time since Congress changed the law three years ago to make filing more difficult. Retailers are bracing for an ugly Christmas. All of those disturbing numbers come against a backdrop of stagnant wages and rising health care costs for most Americans. Obama faces a nation hungry for fiscal direction. In all likelihood, Congress will return for a lame-duck session to discuss a stimulus plan.
A broad stimulus, aimed not at putting single checks in people’s hands but at addressing the underlying economic problems of unemployment, battered credit and foreclosures, is probably needed. But it must come with the assurance that fiscal restraint will follow. We entered this crisis in a precarious position because our federal deficit had ballooned under the borrow-and-spend policies of the past eight years. That makes it more difficult to deal with the crisis we now face, because it limits our financial flexibility.
No stimulus, no bailout, no amount of hope and soaring rhetoric can succeed if it’s not accompanied by fiscal responsibility.
Taxes must rise
At some point, higher taxes are inevitable to bring the deficit back in line, and Obama’s plan to limit the increases to the rich aren’t likely to be enough. That is the sort of sacrifice we must make to resolve the crisis. The economy is too precarious to endure tax increases to stabilize our finances right now, and some of the ambitious programs outlined on the campaign trail will have to be sacrificed to fiscal prudence. We must make sacrifices at the personal level, too, by reducing our use of credit and curtailing our spending, building our savings so that we are better prepared.
This is a crisis spawned, in large part, by our own delusion. We wanted to believe in ever-rising stocks, in a shop-till-the-terrorists-are-defeated foreign policy and homes that were worth whatever our mortgage broker told us. For eight years, our government borrowed to pay for wars, tax cuts and prescription drugs, while we borrowed to pay for HDTVs, iPhones and Xboxes. Buy now, pay later wasn’t just a sales pitch, it was fiscal policy. Later is now. To fix our economy we first must change our views of debt and savings. That will take sacrifice, the one word from the president-elect’s speech that we must hear before all others. Sacrifice, after all, is the prefix for change.
The Obama Agenda
Tuesday, Nov. 4, 2008, is a date that will live in fame (the opposite of infamy) forever. If the election of our first African-American president didn’t stir you, if it didn’t leave you teary-eyed and proud of your country, there’s something wrong with you. But will the election also mark a turning point in the actual substance of policy? Can Barack Obama really usher in a new era of progressive policies? Yes, he can.
Right now, many commentators are urging Mr. Obama to think small. Some make the case on political grounds: America, they say, is still a conservative country, and voters will punish Democrats if they move to the left. Others say that the financial and economic crisis leaves no room for action on, say, health care reform. Let’s hope that Mr. Obama has the good sense to ignore this advice.
About the political argument: Anyone who doubts that we’ve had a major political realignment should look at what’s happened to Congress. After the 2004 election, there were many declarations that we’d entered a long-term, perhaps permanent era of Republican dominance. Since then, Democrats have won back-to-back victories, picking up at least 12 Senate seats and more than 50 House seats. They now have bigger majorities in both houses than the G.O.P. ever achieved in its 12-year reign. Bear in mind, also, that this year’s presidential election was a clear referendum on political philosophies — and the progressive philosophy won.
Maybe the best way to highlight the importance of that fact is to contrast this year’s campaign with what happened four years ago. In 2004, President Bush concealed his real agenda. He basically ran as the nation’s defender against gay married terrorists, leaving even his supporters nonplussed when he announced, soon after the election was over, that his first priority was Social Security privatization. That wasn’t what people thought they had been voting for, and the privatization campaign quickly devolved from juggernaut to farce.
This year, however, Mr. Obama ran on a platform of guaranteed health care and tax breaks for the middle class, paid for with higher taxes on the affluent. John McCain denounced his opponent as a socialist and a “redistributor,” but America voted for him anyway. That’s a real mandate. What about the argument that the economic crisis will make a progressive agenda unaffordable? Well, there’s no question that fighting the crisis will cost a lot of money. Rescuing the financial system will probably require large outlays beyond the funds already disbursed. And on top of that, we badly need a program of increased government spending to support output and employment. Could next year’s federal budget deficit reach $1 trillion? Yes.
But standard textbook economics says that it’s O.K., in fact appropriate, to run temporary deficits in the face of a depressed economy. Meanwhile, one or two years of red ink, while it would add modestly to future federal interest expenses, shouldn’t stand in the way of a health care plan that, even if quickly enacted into law, probably wouldn’t take effect until 2011. Beyond that, the response to the economic crisis is, in itself, a chance to advance the progressive agenda. Now, the Obama administration shouldn’t emulate the Bush administration’s habit of turning anything and everything into an argument for its preferred policies. (Recession? The economy needs help — let’s cut taxes on rich people! Recovery? Tax cuts for rich people work — let’s do some more!)
But it would be fair for the new administration to point out how conservative ideology, the belief that greed is always good, helped create this crisis. What F.D.R. said in his second inaugural address — “We have always known that heedless self-interest was bad morals; we know now that it is bad economics” — has never rung truer. And right now happens to be one of those times when the converse is also true, and good morals are good economics. Helping the neediest in a time of crisis, through expanded health and unemployment benefits, is the morally right thing to do; it’s also a far more effective form of economic stimulus than cutting the capital gains tax.
Providing aid to beleaguered state and local governments, so that they can sustain essential public services, is important for those who depend on those services; it’s also a way to avoid job losses and limit the depth of the economy’s slump. So a serious progressive agenda — call it a new New Deal — isn’t just economically possible, it’s exactly what the economy needs. The bottom line, then, is that Barack Obama shouldn’t listen to the people trying to scare him into being a do-nothing president. He has the political mandate; he has good economics on his side. You might say that the only thing he has to fear is fear itself.
Despite crisis, Merrill Lynch still lobbying
Brokerage giant Merrill Lynch, a victim of the financial crisis, is merging with Bank of America and expects to share in the $25 billion the Treasury Department is spending to help the merged bank. Despite its crumbling financial foundation and organizational upheaval, one thing at Merrill hasn't changing: It has continued to lobby the federal government, including on the $700 billion financial rescue package that provided the money for the government investments in Merrill and other major banks.
President-elect Barack Obama and members of Congress have blamed lobbying by the financial industry in part for the current financial crisis. Last month, Obama said the crisis developed "when speculators gamed the system, regulators looked the other way, and lobbyists bought their way into our government." Jeff Peck, a lobbyist whose clients include Merrill Lynch, says financial companies will "take their lumps" before a skeptical Congress but have a right to lobby Washington policymakers. Merrill Lynch hired the firm April 1 and paid it $160,000 through September to lobby Congress on a "blueprint for regulatory and mortgage reform," the firm's disclosure reports say. Merrill Lynch has spent $4.6 million in lobbying in the first nine months of the year, records show.
"When you have this kind of scrutiny and this kind of seismic change happening … everyone wants to make sure they're part of the process that affects their business," Peck said. Bank of America also has no plans to quit lobbying, spokesman Scott Silvestri said. "We continue to talk to Congress and regulators about issues of interest and concern to our company," Silvestri said. Lobbyists play a key role in keeping lawmakers and government decision-makers informed about how their decisions affect the lobbyists' clients, says Scott Talbott of the Financial Services Roundtable, a group representing large banks, insurance companies and other financial institutions.
"Lobbyists provide information, and that role is more important than ever right now," Talbott says. "You have a very complicated industry, and we're trying to find the best solutions. … Now is not the time to be cutting back on information flow." Banks and other financial firms lobbied Congress for the financial rescue package, but the idea for direct government investment in financial institutions came from the Treasury Department. The American Bankers Association wrote to Treasury Secretary Henry Paulson last week to complain that healthy banks without toxic debt on their books were being pressured to take part. "This is not a program the banking industry sought," wrote Ed Yingling, CEO of the bankers' group. He said some banks are worried that being coerced into taking government money will make them appear to be financially weak and that the government may decide to restrict dividend payments to shareholders.
Unlike the banks, in which the government is buying minority stakes, the feds completely took over Fannie Mae and Freddie Mac, the giant home mortgage financing companies brought down by the foreclosure crisis. Fannie Mae and Freddie Mac spent $14.3 million on lobbying before the government halted it in September after taking over the companies at a cost of as much as $200 billion. Lobbying by Fannie and Freddie has been bipartisan. Freddie Mac's internal lobbyists included Kirsten Johnson-Obey, the daughter-in-law of House Appropriations Committee Chairman Dave Obey, D-Wis. Fannie Mae paid $115,000 in lobbying fees this year to a lobbying firm headed by Steve Farber, the co-chairman of the host committee for Democratic Party convention held in August in Denver.
On the Republican side, Freddie Mac paid $260,000 this year to Timmons & Co. — a lobbying firm founded by Bill Timmons, who worked in the Nixon and Ford administrations and was a top campaign aide or adviser to every presidential candidate since Richard Nixon. Kathleen Day of the Center for Responsible Lending says financial companies' clout should be on the decline because their mistakes led to the current crisis. "It shouldn't be the industry getting its way all the time," Day said. "Look where that got us."
California Budget Deficit Balloons to $11.2 Billion
California Governor Arnold Schwarzenegger said his state's finances have deteriorated so rapidly that a budget he signed just six weeks ago has already fallen into a $11.2 billion deficit and taxes must be raised. Schwarzenegger ordered lawmakers into a special session to consider ways to close the gap. He proposed increasing the sales tax by 1.5 percentage points for three years as well as raising oil severance and alcoholic beverage taxes and motor vehicle fees. In all, taxes and fees would increase $4.7 billion while spending is cut $4.5 billion. "We have a dramatic situation here and it will take dramatic solutions to solve it," Schwarzenegger, a 61-year-old Republican, told reporters in Sacramento. "We must stop the bleeding."
California has been hard hit by the housing-market rout and the worst financial crisis on Wall Street since the Great Depression. The state leads the nation in foreclosures and its unemployment rate reached 7.7 percent last month, the fourth highest in the country. Double-digit declines in stock markets have sapped tax revenue from income and capital gains. Schwarzenegger said this shortfall differs from those in years past, when he resisted tax increases to solve what he said were problems caused by overspending. "It is now a revenue problem, rather than a spending problem," he said. The Standard & Poor's 500, down 39 percent in 2008, slumped 19 percent in October alone. The Dow Jones Industrial Average dropped 35 percent this year. The declines have erased more than $9.5 trillion from the value of stocks worldwide.
Schwarzenegger's proposal also would expand sales and use taxes to include appliance and furniture repair, vehicle repairs, golf greens' fees, amusement park admissions, sporting event tickets and veterinarian services. Statewide sales taxes would increase to 8.75 percent from 7.25 for three years. The proposal would add a 9.9 percent per barrel severance tax on oil drilled in this state. The proposal would also add 5 cents for every alcoholic mixed-drink, beer and glass of wine sold in the state. He warned that if lawmakers don't take action soon, the state would run out of money in February and might be unable to pay some bills, including payroll. The budget gap has grown from $3 billion the state estimated when it sold $5 billion of short-term notes Oct. 16. That deficit figure was based on tax revenue projections through September and didn't anticipate projected shortfalls in October.
The state was supposed to sell another $2 billion of notes this month. That sale has now been shelved, budget director Mike Genest said. "Now with the announcement of this size of a deficit, I can't imagine us being able to borrow until the Legislature gives us the solutions we need to get back on an even keel," Genest said. California Treasurer Bill Lockyer said he will postpone any bond offering backed by the state's general fund until lawmakers agree on how to solve the problem. "Current financial market conditions are not favorable, and with our state budget assumptions in flux during the special session, securities disclosure requirements would make it difficult or impossible to access the credit market," Lockyer said in a statement. "Investors will want to see how the state addresses the budget imbalance before lending to us at reasonable rates."
By ordering a special session now, Schwarzenegger is gambling that Republican lawmakers who are stepping down because of term limits or who were defeated during the Nov. 4 general election might be willing to approve the tax increase before a new class of lawmakers takes office on Dec. 1. California requires a two-thirds legislative majority to raise taxes, a requirement that has hobbled proposals to increase revenue because of steadfast resistance from Republican lawmakers. Schwarzenegger said he was optimistic that fellow members of his party would see the need to boost taxes, given the slumping stock market and economic slowdown. "No one wants to raise taxes, but we have an obligation to fully fund public education and to fund infrastructure and to make progress in health care," said Senate President pro Tem- Elect Darrell Steinberg, who will take over the leadership job Dec. 1.
Schwarzenegger today also proposed a 90-day stay on home foreclosures to help distressed homeowners and stem escalating defaults. Under the measure, lenders would be exempt from the stay if they can prove they have set up a program to help troubled homeowners modify their loans. The number of California homes in foreclosure totaled 79,511 in the third quarter, said San Diego-based real estate research firm MDA DataQuick. That was more than triple the year- earlier number, and the highest since MDA DataQuick began tracking trustee deeds in 1988. Schwarzenegger signed a $143 billion budget Sept. 23, a record 85 days past the start of the fiscal year, following a standoff with lawmakers over how to close a $15 billion deficit caused when the housing-market rout erased thousands of jobs and weighed on residents' incomes. Democrats wanted to raise taxes, which Republicans opposed.
Lawmakers ultimately agreed to cut $8 billion in spending, doubling penalties charged to companies that underestimate taxes owed the state, suspending the net operating loss deduction companies can claim when they don't report a profit and temporarily cutting in half the tax credit for research and development. California, the biggest borrower in the municipal-bond market, has $51.9 billion in general-obligation debt outstanding. The state is rated A+ by Fitch Ratings and Standard & Poor's, the fifth-highest rankings, and a comparable A1 by Moody's Investors Service.
Stunned Icelanders Struggle After Economy’s Fall
The collapse came so fast it seemed unreal, impossible. One woman here compared it to being hit by a train. Another said she felt as if she were watching it through a window. Another said, “It feels like you’ve been put in a prison, and you don’t know what you did wrong.” This country, as modern and sophisticated as it is geographically isolated, still seems to be in shock. But if the events of last month — the failure of Iceland’s banks; the plummeting of its currency; the first wave of layoffs; the loss of reputation abroad — felt like a bad dream, Iceland has now awakened to find that it is all coming true.
It is not as if Reykjavik, where about two-thirds of the country’s 300,000 people live, is filled with bread lines or homeless shanties or looters smashing store windows. But this city, until recently the center of one of the world’s fastest economic booms, is now the unhappy site of one of its great crashes. It is impossible to meet anyone here who has not been profoundly affected by the financial crisis. Overnight, people lost their savings. Prices are soaring. Once-crowded restaurants are almost empty. Banks are rationing foreign currency, and companies are finding it dauntingly difficult to do business abroad.
Inflation is at 16 percent and rising. People have stopped traveling overseas. The local currency, the krona, was 65 to the dollar a year ago; now it is 130. Companies are slashing salaries, reducing workers’ hours and, in some instances, embarking on mass layoffs. “No country has ever crashed as quickly and as badly in peacetime,” said Jon Danielsson, an economist with the London School of Economics. The loss goes beyond the personal, shattering a proud country’s sense of itself. “Years ago, I would say that I was Icelandic and people might say, ‘Oh, where’s that?’ ” said Katrin Runolfsdottir, 49, who was fired from her secretarial job on Oct. 31.
“That was fine. But now there’s this image of us being overspenders, thieves.” Aldis Nordfjord, a 53-year-old architect, also lost her job last month. So did all 44 of her co-workers — everyone in the company except its owners. As many as 75 percent of Iceland’s private-sector architects have probably been fired in the past few weeks, she said. In a strange way, she said, it is comforting to be one in a crowd. “Everyone is in the same situation,” she said. “If you can imagine, if only 10 out of 40 people had been fired, it would have been different; you would have felt, ‘Why me? Why not him?’
”Until last spring, Iceland’s economy seemed white-hot. It had the fourth-highest gross domestic product per capita in the world. Unemployment hovered between 0 and 1 percent (while forecasts for next spring are as high as 10 percent). A 2007 United Nations report measuring life expectancy, real per-capita income and educational levels identified Iceland as the world’s best country in which to live. Emboldened by the strong krona, once-frugal Icelanders took regular shopping weekends in Europe, bought fancy cars and built bigger houses paid for with low-interest loans in foreign currencies.
Like the Vikings of old, Icelandic bankers were roaming the world and aggressively seizing business, pumping debt into a soufflé of a system. The banks are the ones that cannot repay tens of billions of dollars in foreign debt, and “they’re the ones who ruined our reputation,” said Adalheidur Hedinsdottir, who runs a small chain of coffee shops called Kaffitar and sells coffee wholesale to stores. There was so much work, employers had to import workers from abroad. Ms. Nordfjord, the architect, worked so much overtime last year that she doubled her salary. She was featured on a Swedish radio program as an expert on Iceland’s extraordinary building boom.
Two months ago, her company canceled all overtime. Two weeks ago, it acknowledged that work was slowing. But it promised that there would be enough to last through next summer. The next day, everyone was herded into a conference room and fired. Employers are hurting just as much as employees. Ms. Hedinsdottir has laid off seven part-time employees, cut full-time workers’ hours and raised prices. The Kaffitar branch on Reykjavik’s central shopping street was perhaps half full; in normal times, it would have been bursting at its seams.
While business is dwindling, costs are soaring. When the government took over the country’s failing banks in October, Ms. Hedinsdottir’s latest shipment of coffee — more than 109,000 pounds — was already on the water, en route from Nicaragua. She had the money to pay for it, but because the crisis made foreign banks leery of doing business with Iceland, she said, she was unable to convert enough cash into foreign currency. “They were calling me every day and asking me what the situation was, and they got really nervous,” Ms. Hedinsdottir said of her creditors. They got so nervous that they sent the coffee to a warehouse in Hamburg, Germany, where it now sits while she tries to find the foreign currency to pay for it.
Her fixed costs are no longer fixed. Five years ago, the company built a new factory, borrowing the 120 million kronur — about $1.5 million — in foreign currencies. But the currency’s fall has increased her debt to 200 million kronur. This summer, her monthly payments were 2.5 million kronur; now they may be double that — the equivalent of $38,500 in Iceland’s debased currency. “My financial manager is talking to the banks every day, and we don’t know how much we’re supposed to pay,” Ms. Hedinsdottir said. In a recent survey, one-third of Icelanders said they would consider emigrating. Foreigners are already abandoning Iceland.
Anthony Restivo, an American who worked this fall for a potato farm in eastern Iceland and was heading home, said all of the farm’s foreign workers abruptly left last month because their salaries had fallen so much. One man arrived from Poland, he said, then realized how little the krona was worth and went home the next day. At the Kringlan shopping center on the edge of Reykjavik, Hronn Helgadottir, who works at the Aveda beauty store, said she could no longer afford to travel abroad. But the previous weekend, she said, she and her husband had gone for a last trip to Amsterdam, a holiday they had paid for months ago, when the krona was still strong.
They ate as cheaply as they could and bought nothing. “It was strange to stand in a store and look at a bag or a pair of shoes and see that they cost 100,000 kronur, when last year they cost only 40,000,” she said. In Kopavogur, a suburb of Reykjavik, Ms. Runolfsdottir, the recently fired secretary, said she had worried for some time that Iceland would collapse under the weight of inflated expectations. “If you drive through Reykjavik, you see all these new houses, and I’ve been thinking for the longest time, ‘Where are we going to get people to live in all these homes?’” she said. The real estate firm that used to employ Ms. Runolfsdottir built about 800 houses two years ago, she said; only 40 percent have been sold.
By Icelandic law, Ms. Runolfsdottir and other fired employees have three months before they have to leave their jobs. At the end of that period, she will start drawing unemployment benefits. Meanwhile, her husband’s modest investment in several now-failed Icelandic banks is worthless. “They were encouraging us to buy shares in their firms until the last minute,” she said. She feels angry at the government, which in her view has mishandled everything, and angry at the banks that have tarnished Iceland’s reputation. And while she has every sympathy with the hundreds of thousands of foreign depositors who may have lost their money, she wonders why the Icelandic government — and, in essence, the Icelandic people — should have to suffer more than they already have.
“We didn’t ask anyone to put their money in the banks,” she said. “These are private companies and private banks, and they went abroad and did business there.” Despite all this, Icelanders are naturally optimistic, a trait born, perhaps, of living in one of the world’s most punishing landscapes and depending for so much of their history on the fickle fishing industry. The weak krona will make exports more attractive, they point out. Also, Iceland has a highly educated, young and flexible population, and has triumphed after hardship before.
Ragna Sara Jonsdottir, who runs a small business consultancy, said she had met for the first time with other businesses in her office building. “We sat down and said, ‘We all have ideas, and we can help each other through difficult times,’ ” she said. But she said she was just as shocked as everyone else by the suddenness, and the severity, of the downturn. When the prime minister, Geir H. Haarde, addressed the nation at the beginning of October, she said, her 6-year-old daughter asked her to explain what he had said. She answered that there was a crisis, but that the prime minister had not told the country how the government planned to address it. Her daughter said, “Maybe he didn’t know what to say.”
Tough Times Strain Colleges Rich and Poor
Arizona State University, anticipating at least $25 million in budget cuts this fiscal year — on top of the $30 million already cut — is ending its contracts with as many as 200 adjunct instructors. Boston University, Cornell and Brown have announced selective hiring freezes. And Tufts University, which for the last two years has, proudly, been one of the few colleges in the nation that could afford to be need-blind — that is, to admit the best-qualified applicants and meet their full financial need — may not be able to maintain that generosity for next year’s incoming class.
This fall, Tufts suspended new capital projects and budgeted more for financial aid. But with the market downturn, and the likelihood that more applicants will need bigger aid packages, need-blind admissions may go by the wayside.“The target of being need-blind is our highest priority,” said Lawrence S. Bacow, president of Tufts. “But with what’s happening in the larger economy, we expect that the incoming class is going to be needier. That’s the real uncertainty.”
Tough economic times have come to public and private universities alike, and rich or poor, they are figuring out how to respond. Many are announcing hiring freezes, postponing construction projects or putting off planned capital campaigns. With endowment values and charitable gifts likely to decline, the process of setting next year’s tuition low enough to keep students coming, but high enough to support operations, is trickier than ever. Dozens of college presidents, especially at wealthy institutions, have sent letters and e-mail to students and their families describing their financial situation and belt-tightening plans.
At Williams College, for example, President Morton Owen Schapiro wrote that with last year’s negative return on the endowment and the worsening situation since June, some renovation and facilities spending would be reduced and nonessential openings left unfilled. Many students, increasingly conscious of costs, are flocking to their state universities; at Binghamton University, part of the New York State university system, applications were up 50 percent this fall. But with this year’s state budget problems, tuition increases at public universities may be especially steep. Some public universities have already announced midyear tuition increases.
With endowment values shrinking, variable-rate debt costs rising and states cutting their financing, colleges face challenges on multiple fronts, said Molly Corbett Broad, president of the American Council on Education. “There’s no evidence of a complete meltdown,” Ms. Broad said, “but the problems are serious enough that higher education is going to need help from the government.” And as in other sectors, she said, some financially shaky institutions will most likely be seeking mergers. Nationwide, retrenchment announcements are coming fast and furious, as state after state reduces education financing.
The University of Florida, which eliminated 430 faculty and staff positions this year, was told recently to cut next year’s budget by 10 percent, probably requiring more layoffs. Financing for the University of Massachusetts system was cut $24.6 million for the current fiscal year. On Thursday, Gov. Arnold Schwarzenegger of California proposed a midyear budget cut of $65.5 million for the University of California system — on top of the $48 million reduction already in the budget.
“Budget cuts mean that campuses won’t be able to fill faculty vacancies, that the student-faculty ratio rises, that students have lecturers instead of tenured professors,” said Mark G. Yudof, president of the California system. “Higher education is very labor intensive. We may be getting to the point where there will have to be some basic change in the model.” Private colleges, too, are tightening their belts — turning down thermostats, scrapping plans for new gardens or quads, reducing faculty raises. But many are also increasing their pool of financial aid.
Vassar College will give out $1 million more in financial aid this year than originally budgeted, even though the endowment, which provides a third of its operating budget, dropped to $765 million at the end of September, down $80 million from late June. President Catharine Bond Hill of Vassar said the college would reduce its operating costs, but remain need-blind. Many institutions with small endowments, however, will probably become more need-sensitive than usual this year, quietly offering places to fewer students who need large aid packages.
At Dickinson College in Pennsylvania, Robert J. Massa, the vice president for enrollment and student life, said that about 200 applicants last year might have been accepted if they had not needed so much financial help, but that that number might rise to 250 this year. Dickinson’s endowment was $280 million in mid-October, Mr. Massa said, down from $350 million in June. And while more than three quarters of the college’s operating budget comes from student fees, some endowment revenue will have to be replaced.
“Here’s the rub,” Mr. Massa said. “I really don’t think that colleges can afford to increase their tuition price at higher than inflation this year. I don’t think the public will stand for it. What we’ve done in higher education is let our dreams and aspirations dictate our cost structure.” Most colleges will have a better sense next month of how many students are struggling, when second-semester tuition bills come due.
Paola Aguilar, a sophomore at Shenandoah University in Winchester, Va., is worrying about whether she can afford to return next year. “My mom became a Realtor last year to try to earn more money, but that didn’t help,” Ms. Aguilar said. “I’ve talked to the people here, and they’ve helped me out a little more for next semester, but as of right now, if I don’t get more help, I’ll have to leave next year and go somewhere cheaper, near home.” Tracy Fitzsimmons, Shenandoah’s president, said she began hearing about students’ financial anxieties in mid-September.
“They’d tell me they were thinking they might have to move off campus next semester and stay three to a bedroom, or give up the meal plan and just eat one meal a day,” Ms. Fitzsimmons said. Shenandoah has started an emergency grant fund for students, increased its loan program and prepared to stretch out spring tuition payments for hard-pressed families. Economic uncertainty touches every facet of higher education. “We are planning to begin a capital campaign of $150-185 million,” said Karen R. Lawrence, president of Sarah Lawrence College. “We will still do that. We’re not compromising our ambitions, but the timing will be a little bit deferred.”
At the wealthiest institutions, endowment revenue usually covers about a third of operating costs, and most colleges and universities spend a percentage of their endowment, based on its average value over the previous three years, helping to smooth out economic ups and downs. In recent years, with tuition rising faster than inflation, college affordability has become a significant issue. And with the sharp growth of endowments in recent years — Harvard’s hit $36.9 billion this summer — some politicians, notably Senator Charles E. Grassley, Republican of Iowa, have pushed for a requirement that colleges spend 5 percent of their endowments. Many of the wealthiest institutions responded by expanding financial aid last year, with dozens of them replacing loans with grants.
This fall, more universities are taking steps to increase affordability. Benedictine University, a Roman Catholic institution in Illinois, is freezing tuition; Vanderbilt University will replace loans with grants; Boston University has expanded scholarships for students who graduated from Boston public schools; and the University of Toledo announced free tuition for needy, high-performing graduates of Ohio’s six largest public school systems. Presidents of many expensive private colleges are wondering how much more tuition pressure families can bear.
“I wouldn’t deny that a tuition freeze has occurred to me, but we can’t afford heroic gestures,” said Sandy Ungar, president of Goucher College in Baltimore. Given the current climate, some say, colleges need to re-examine all of their economic assumptions. “Several years ago, we started thinking about sustainability in environmental terms,” said Dick Celeste, the president of Colorado College. “Now we need to be thinking about sustainability in economic terms.”
The economy lost 651,000 jobs in three months. Auto sales have collapsed, and retail sales have "fallen off a cliff." And there is at this point little indication that Credit Availability will normalize anytime soon for household, corporate or municipal borrowers. While the extraordinary efforts by the Fed and global central bankers have loosened the clogged up inter-bank lending market, risk markets remain hopelessly paralyzed. The unfolding collapse of the leveraged speculating community continues to overhanging the marketplace. Securitization markets are still essentially closed for business.
We can continue to analyze developments in the context of two overarching themes: First, there is the implosion of contemporary "Wall Street finance." Second, the bursting of the Credit Bubble has initiated what will be an arduous and protracted economic adjustment. Each week provides additional confirmation of the interplay between the breakdown of Wall Street risk intermediation and the bursting of the U.S. Bubble Economy. This process has gained overwhelming momentum.
I know some analysts are anticipating an eventual return to "normalcy." The thought is that it is only a matter of time before "shock and awe" policymaking and Trillions of newly created liquidity entice investors and speculators back into risk assets. This view is too optimistic, and history offers an especially poor guide in this respect. By and large, the unprecedented growth in Federal Reserve and global central bank balance sheets is (scarcely) accommodating de-leveraging. Between the hedge funds, global "proprietary trading" and other leveraged speculators, it is not unreasonable to contemplate an overhang of (prospective forced and deliberate sales) of upwards of $10 Trillion.
It's popular to label Federal Reserve operations as a massive effort to "print money." Yet it is important to recognize that, at least to this point, the expansion of the Fed assets ("Fed Credit") is counterbalanced by the collapsing balance sheets of leveraged financial operators. The inflationary effects - the increased purchasing power created by the expansion of Credit - occurred back when the original loan was made, securitized, and leveraged by, say, a hedge fund. Today's ballooning central bank holdings (and TARP spending) may very well stem financial system implosion. This is, however, a far cry from engendering a meaningful increase in either the market's appetite for risk assets or the expansion of new system Credit in the real economy.
I don't want to imply that unprecedented monetary policy measures aren't having an impact. Overnight lending rates (Libor) were quoted at 0.33% today, down from a spike to almost 7.00% in late September. And at 2.29%, three-month Libor has dropped from early October's 4.82%. Other measures of systemic risk and liquidity premiums (including the 2- and 10-year dollar swap spreads) have dropped dramatically over the past month.
The problem is that the "unclogging" of inter-bank and "money" markets has had little effect on the Pricing and Availability of Credit for the vast majority of borrowers operating throughout the real economy. After ending September at about 650, junk bond spreads have surged to 950 bps. Investment-grade bond spreads are also higher today than at the end of the third quarter. Benchmark MBS spreads have changed little, while Jumbo mortgage borrowing rates remain elevated. Risk premiums for municipal borrowings have been reduced only somewhat from extreme levels. Unsound borrowers everywhere have little hope of borrowing anywhere.
There are complaints out of Washington that, despite oodles of bailout funding, the banks are refusing to lend. Well, total bank Credit has expanded $575bn over the past 10 weeks, or 32% annualized. Importantly, the asset-backed securities (ABS), collateralized debt obligation (CDO), and securitization markets generally remain closed for new business. The heart of the matter is not so much that banks are refusing to extend Credit but that the entire mechanism of Wall Street risk intermediation has collapsed. After ballooning into multi-Trillion dollar avenues for Credit expansion, intermediation through the ABS and CDO markets is basically over.
The convertible bond market has also badly malfunctioned, along with the "private-label" MBS marketplace. Wall Street's "auction-rate securities" has ceased as a mechanism for Credit expansion, along with myriad other avenues for securitization. And, importantly, derivatives markets, having evolved into an essential element of contemporary risk intermediation and Credit expansion, have suffered a devastating crisis of confidence. Scores of leveraged strategies are no longer viable. Indeed, Monetary Processes essential for funding broad cross-sections of the economy have completely broken down.
Even if banks had a desire to make the same types of risky loans Wall Street financed throughout the boom (which they clearly don't), it is difficult to envisage how bank Credit could today adequately compensate for the interrelated collapses in Wall Street risk intermediation and leveraged speculation. And unlike previous crises, no amount of rate cutting, liquidity injections, or policymaker jawboning will revive leveraged speculation. That historic Bubble and mania has burst, and it is now only a matter of waiting to dissect the devastation wrought by the unfolding run on the industry. A typical Federal Reserve-induced return to risk-taking in the Credit markets will be stymied for some time to come by an unrivaled inventory of debt instruments overhanging the markets.
The critical issue then becomes how the system can generate sufficient new Credit to keep our asset markets and Bubble economy from completely imploding. Well, we can assume at this point that the Fed will continue to accommodate de-leveraging through the ballooning of its balance sheet. At the same time, the federal government will soon be running Trillion dollar annual deficits. GSE balance sheets will likely commence a period of aggressive expansion. And, importantly, the banking system will have no alternative than to expand rapidly. At this point, timid banks equate to a Bubble Economy spiraling into depression.
If the markets cooperate, perhaps over the coming months the now breakneck economic contraction will somewhat stabilize. I fear, however, that current dynamics are setting the stage for yet another stage of this vicious crisis. Some analysts believe - and certainly it is the Fed's intention - for ultra-low interest rates to assist in the recapitalization of the banking system. The early 1990's provides a nice example: aggressive rate cuts and a steep yield curve provided a backdrop for troubled banks to quietly convalesce by raising cheap deposits and sitting on a safe portfolio of longer-term government debt securities. Why can't a similar operation bail the banks out of their current predicament?
One should note the stark contrasts between today's environment and that from the early nineties. First of all, 10-year government yields averaged about 7.8% in the three years 1990 through '92. Bond markets back then were commencing a historic bull run and, strangely enough, the price of government debt ran higher in the face of huge deficits. There are reasons these days to fear an emergent bond bear. Second, from the Fed's "flow of funds" report, we know that "Total Net Borrowing and Lending in Credit Markets" averaged $770 billion annually during the '90-'92 period. "Total Net Borrowing..." last year approached a staggering $4.40 TN. The important point is that today's Bubble Economy Dynamics were not in play in the early nineties. Sustaining the system required a fraction of today's Credit creation, thus there was little prevailing pressure on the banks back then to lend amid their "convalescing."
Indeed, banking system impairment and resulting Fed policymaking engendered the emergence of Wall Street finance in the early nineties - from the Wall Street firms, the GSEs, securitizations, derivatives and leveraged speculation. All were more than happy to take up the slack in bank Credit creation - signficantly helping to reflate both the banking system and the overall economy in the process.
With the Bursting of the Bubble in Wall Street Finance, the banking system will today have no alternative than to lend and expand Credit aggressively. The banks provide the only hope for reflation, and there will be no room for nineties-style risk-free government carry trades. Instead, it will now be the banking system's role to take up enormous systemic Credit slack and rapidly expand its portfolio of risk assets. Especially at this precarious stage of the Credit cycle, the banking system's predicament ensures the ongoing need for hugely expensive government funded industry recapitalizations.
In today's interest rate and market environment, massive government deficits don't worry the bond market. I view the marketplace as quite complacent when it comes to the scope of unfolding Treasury and agency debt issuance. Actually, the Treasury, the GSEs and the banking system have in concert succumbed to Debt Trap Dynamics. With Wall Street risk intermediation now out of the equation, the system is down to four principal sources of "money" creation - the Fed, Treasury, GSEs and the Banks. It's that old "inflate or die" dilemma that's already smothered Wall Street finance.
The good news is these sources of Credit creation do today retain the capacity to somewhat stabilize financial and economic systems. The bad news is that going forward all four must expand aggressively - in collaboration - to forestall acute systemic crisis. All four must expand aggressively to bolster a highly maladjusted economic system, in the process sustaining confidence in the value of their liabilities. At some point, one would expect a crisis of confidence with respect to the quality of these Credit instruments. And, you know, the way things have unfolded, Murphy's Law would only seem to dictate a destabilizing jump in market yields.