Fort McAllister on the Ogeechee River near Savannah, Georgia
Ilargi: I’ll do some commenting where the articles are, and open with a song.
"Hard Times Come Again No More" was written by Irish/American Stephen C. Foster in 1854. The Irish potato famine took place from the mid 1840's to mid 1850's. The song was hugely popular around the time of the Civil War, on both sides of the Atlantic. Ironically, the potato blight is thought to have been imported to Ireland from the US, while many of the surviving people traveled in the opposite direction.
This is a version by Kate and Anna McGarrigle, Kate's son Rufus Wainwright, Emmylou Harris, Mary Black and others.
Hard Times Come Again No More
Let us pause in life's pleasures and count its many tears,
While we all sup sorrow with the poor;
There's a song that will linger forever in our ears;
Oh Hard times come again no more.
Tis the song, the sigh of the weary,While we seek mirth and beauty and music light and gay,
Hard Times, hard times, come again no more
Many days you have lingered around my cabin door;
Oh hard times come again no more.
There are frail forms fainting at the door;
Though their voices are silent, their pleading looks will say
Oh hard times come again no more.
There's a pale drooping maiden who toils her life away,
With a worn heart whose better days are o'er:
Though her voice would be singing, 'tis sighing all the day,
Oh hard times come again no more.
Tis a sigh that is wafted across the troubled wave,
Tis a wail that is heard upon the shore
Tis a dirge that is murmured around the lowly grave
Oh hard times come again no more.
US Retail Sales Plummet
Price-slashing failed to rescue a bleak holiday season for beleaguered retailers, as sales plunged across most categories on shrinking consumer spending, according to new data released Thursday. Despite a flurry of last-minute shoppers lured by the deep discounts, total retail sales, excluding automobiles, fell over the year-earlier period by 5.5% in November and 8% in December through Christmas Eve, according to MasterCard Inc.'s SpendingPulse unit. When gasoline sales are excluded, the fall in overall retail sales is more modest: a 2.5% drop in November and a 4% decline in December. A 40% drop in gasoline prices over the year-earlier period contributed to the sharp decline in total sales.
But considering individual sectors, "This will go down as the one of the worst holiday sales seasons on record," said Mary Delk, a director in the retail practice at consulting firm Deloitte LLP. "Retailers went from 'Ho-ho' to 'Uh-oh' to 'Oh-no.'" The holiday retail-sales decline was much worse than the already-dire picture painted by industry forecasts, which had predicted sales ranging from a 1% drop to a more optimistic increase of 2.2%. Luxury goods, once considered immune from economic turmoil, were hardest hit, with sales falling 21.2%, compared with a jump of 7.5% a year ago, when the economy had just begun to sputter. Including jewelry sales, the luxury sector plunged by a whopping 34.5%. During the same period last year, overall retail sales rose a modest 2.4%, helped by late-season discounting that enticed procrastinating shoppers. But this year, after a moderate uptick in shopping activity boosted by steep promotions the Friday after Thanksgiving, shoppers closed their wallets and reopened them only cautiously, worried by job losses, a sinking stock market and a recession climbing into its second year.
"There has been a major contraction in consumer spending," Michael McNamara, vice president of research and analysis for MasterCard Advisors, said in an interview yesterday. This spells a bitter disappointment for companies that had hoped the holidays would offset a year when sales have been sliding steadily, draining profits and, in many instances, undermining the ability to pay down debt. The industry already has seen a parade of retailers entering bankruptcy proceedings, such as Circuit City Stores Inc., and liquidating, including Mervyn's LLC and Linens 'N Things Inc. The weak holiday sales mean more chains are likely to follow suit next year. To be sure, there was a glimmer of positive economic news this week as well, as the Labor Department released figures showing inflation-adjusted consumer spending inched up slightly in November as gas prices fell steeply. The personal savings rate also climbed in November. Socking away more in the bank leaves less for splurging at the mall. "It's all about restoring confidence in the buying climate and declining prices help to bring us there, but we're not there yet," said Michael Niemira, chief economist at the International Council of Shopping Centers.
At a Los Angeles Anthropologie store on Christmas Eve, even a clearance table at the apparel and home-goods store didn't tempt Gloria Langstaff, 60 years old. "We're spending less," said the librarian from Missoula, Mont., who is visiting Los Angeles on an annual holiday trip. The trip itself was a cutback from last year, when the family went to the Dominican Republic. A final burst of spending retailers hoped for last weekend never came. Shopper traffic fell 27% compared with the same time last year, while sales declined 5.3%, according to ShopperTrak RCT Corp., which tracks sales in retail outlets nationwide. Bad weather on both coasts combined with economic factors to slow sales, the company said. Few retailers were counting on the holidays being robust when they placed conservative orders for merchandise last summer. Most worried that high gas prices and the continuing housing slump would cause another lackluster year. But even that conservative approach wasn't enough when the bottom fell out of the stock market in September. By October, retail sales were declining faster than expected amid the steady drumbeat of bad economic news.
No retail sector was spared. Among the biggest losers were electronics and appliances, which fell a combined 26.7% versus a 2.7% gain last year. Women's apparel slid 22.7% compared with a 2.4% drop a year ago. E-commerce showed the most resilience, with online sales falling just 2%. But it was still a disappointment compared with last year when online sales posted a 22.4% gain in the period. In addition to sales at stores and online, SpendingPulse tracks spending at restaurants and on gift cards, though retailers don't book revenue from card sales until they are redeemed. Its data are based on sales activity in the MasterCard payments network with estimates for all other payment forms, including cash and checks. At the Prudential Center mall in downtown Boston on Christmas Eve, Stephen Sweigart and Paul Heffernan were perusing sale items and refused to buy anything for less than half off. Mr. Sweigart said he wasn't spending as much on family this year, and was making donations to charity in lieu of gifts due to the recession.
"It makes unwrapping presents a lot faster, and we spent less money. It's a win-win," he said. Glen Senk, chief executive officer of clothing and home accessories retailer Urban Outfitters Inc., said he's been struck by the extent of retail price cuts over the past several months. Mr. Senk says he's not planning any unusual post-Christmas price cuts. The season's dismal results have left stores with mountains of inventory to clear, prompting many to move up their typical January clearance sales to this weekend to help salvage what they can of the season. Luxury retailer Neiman Marcus Group Inc.'s namesake department-store chain posted its online after-Christmas sale on Tuesday, with the message: "Savings so good, we couldn't wait!" and offered 40% off already reduced merchandise. Two weeks ago, Neiman's reported its net profit dropped 84% for its fiscal first quarter as affluent shoppers cut way back on discretionary purchases.
J.C. Penney Co. is offering free wake-up calls to rouse department-store shoppers at 5:30 a.m. Friday. From the time the store opens until 1 p.m., the stores will offer 100 "doorbuster" deals, twice as many as last year, including 50% off Ralph Lauren-designed American Living sportswear line, 70% off gold and sterling-silver jewelry and juniors holiday sweaters for $9.99. Limited Brands Inc. is moving the start date of semiannual sales at its Victoria's Secret and Bath & Body Works stores to the end of December from January, according to a spokeswoman. Both chains are already offering the semiannual sale prices online.
Retailers were stung by a shorter holiday-shopping season this year -- just 27 days between Thanksgiving and Christmas in 2008 compared with 32 in 2007. But some are holding out hope that the calendar will improve post-Christmas sales. This year, a complete weekend falls between Christmas and New Year's Eve. "What we lose between Thanksgiving and Christmas, we think we gain between Christmas and New Year's," said Jeff Maynard, the head of marketing at Circuit City, which has been advertising Blu-Ray discs for $12.99 this week and unveiled a fresh round of post-Christmas sales Thursday. Circuit City, which is operating under Chapter 11 bankruptcy-court protection, needs the extra sales. An attorney for the company told a judge this week that holiday sales were down 50%, nearly twice what the chain had expected.
The post-Christmas lift retailers are now hoping for may be hampered by shoppers who took advantage of early discounts and snapped up merchandise for themselves. In a survey by the International Council of Shopping Centers and Goldman Sachs Group, 20% of consumers said they took advantage of bargains and bought for themselves. Michelle Culang, 26, a doctoral student at City University of New York, stopped by Macy's Herald Square store in Manhattan before Christmas because the store was having a big sale on pillows. "Once I saw the prices I bought more than I would have," said Ms. Culang, who spent $130 on a satin-sheet set and two extra-firm pillows for $29.99 each, marked down from $100. Retailers soon may face yet another blow. In recent years, they have seen a big lift in post-Christmas sales as shoppers coming back to stores to redeem gift cards often spent more than the card amount to buy full-price merchandise. But Deloitte's holiday consumer survey earlier this week found that shoppers expected to spend only $151 on gift cards this season, a 24% drop from last year.
Japan's Industrial Output Drops Most On Record
Japan's industrial output posted its biggest drop on record in November while consumption and employment worsened, the government said Friday, showing how rapidly the global economic slump is aggravating the recession of the country's export-dependent economy. The pace of increase in Japan's consumer-product inflation also had its sharpest slowdown in November since spring 1981 as food and energy costs dropped worldwide. Although milder price gains are generally beneficial for consumers, November's unusually rapid cooling in inflation rather stoked fears of deflation re-emerging to thwart Japan's economic activities.
Friday's data are likely to pile more pressure on Japanese policy-makers to do more to support an economy that analysts expect will contract for the third straight quarter in the October-December period. The economy needs help from policymakers because exports on which Japan relies heavily for growth are crumbling as the global economy deteriorates, analysts said. "Demand is rapidly receding across the world, and Japan is bearing the brunt of it," said Takeshi Minami, chief economist at Norinchukin Research Institute. The Bank of Japan "will probably face more calls for further monetary easing," to lower its rock-bottom 0.1% interest rate, he said. The government may also seek additional stimulus steps even though it has just compiled a record ¥88.548 trillion budget for the next fiscal year starting in April to shore up growth.
"We're facing an economic and financial crisis of abnormal proportion," Economy Minister Kaoru Yosano said at a news conference. "Against such an abnormal situation, we must to do what we have to, even if it requires us to divert from our [fiscal-reform] principles." Data from the Ministry of Trade, Economy and Industry showed that output at Japanese mines and factories dropped 8.1% in November from the previous month. The reading was the worst since the government began releasing comparable data in February 1953, the ministry said. It also marked the second straight month of decline following October's 3.1% fall. Economists polled by Dow Jones had expected a 6.7% drop.
Major Japanese exporters like makers of cars, general machinery and electronic parts and devices scaled back their production as exports logged a record 26.7% year-to-year fall in November. "Big manufacturers are being forced to cut their production, meaning that it is unavoidable that smaller ones will go out of business" in the coming months, said Norio Miyagawa, economist at Shinko Research Institute. Manufacturers surveyed also expect their production to fall 8% in December. If their forecast materializes, output could register the largest on-quarter drop of 11.1% in the October-December period, a trade ministry official said. For January, manufacturers, which generate most of Japan's industrial goods, predicted a 2.1% decrease.
Separate data issued by the Ministry of Internal Affairs and Communications showed how weakness in Japan's key growth driver -- big manufacturers -- is affecting the country's broader economy. Household spending dropped an inflation-adjusted 0.5% year-to-year in November for the ninth consecutive month of decline. The jobless rate rose by 0.2 percentage point to 3.9% in November. Given the poor state of carmakers, "employment conditions will get much worse ahead, with an unemployment rate possibly rising to 5% next year," said Taro Saito, senior economist at NLI Research Institute. Retail sales, not adjusted for price changes, fell 0.9% in November from a year earlier in what was its third straight month of decrease, the trade ministry said.
Japan's core consumer price index rose 1% in November from a year earlier. The rate of climb in the core index -- which excludes volatile fresh food prices -- was sharply lower than October's 1.9% increase. If one-off factors -- such as the fading effect of a 1997 sales-tax rate increase -- are excluded, the easing of inflation last month was the most pronounced since April 1981. Analysts said it will only be a matter of time before the CPI gets into negative territory, given tumbling prices of natural resources world-wide and Japan's sagging demand. And "it's quite possible for us to see a decline [year-to-year] of more than 2% around next summer depending on crude oil prices, exchange rates and the cost of food items," said Yoshiki Shinke, senior economist at Dai-ichi Life Research Institute.
Japanese auto production marks its worst drop in at least 40 years
Japan's production of cars, trucks and buses marked its steepest drop in at least four decades in November, an industry group said Thursday, as the fallout from the U.S. slowdown crimped auto demand. Vehicle production in Japan, home to Toyota Motor Corp. and other major automakers, plunged 20.4 per cent in November compared to the same month a year ago to 854,171 vehicles, the Japan Automobile Manufacturers Association said. That marked the second straight month of on-year declines and the percentage slide was the biggest since the group began compiling such data in 1967, it said.
Production of passenger cars decreased 20.3 per cent in November from the previous year to 737,797 vehicles, while production of trucks here declined 20.9 per cent for the month to 106,170. Japanese automakers, which also include Honda Motor Co., Nissan Motor Co. and several other manufacturers, have been hammered by the dwindling of demand in the United States, the world's biggest auto market. But signs are growing the fallout is so serious domestic sales are getting drastically damaged as well. Auto executives have expressed dismay at the fall in Japanese sales.
Japanese plants are being idled to reduce production, and thousands of assembly line workers have lost their jobs in recent weeks. "Even if we are doing our utmost, the global crisis is coming at us like a tidal wave," Teruyuki Minoura, president of Daihatsu Motor Co., a Toyota affiliate, told reporters Thursday. Earlier this month, the automobile association said it expected demand in Japan will dive next year to its lowest in about three decades. Sales of new autos are expected to stand at 4.86 million in 2009, down 4.9 per cent from what it's projecting for this year at 5.11 million, the group said. New vehicle sales in Japan have never dipped below the five million mark since 1980. They reached 7.78 million in 1990, during this heyday "bubble" economy.
One Last Super Bubble
Like the sorcerer’s apprentice, Federal Reserve Chairman Ben Bernanke and his predecessor Alan Greenspan have unleashed a series of ever-larger asset bubbles they cannot control. Now the Fed’s decision to cut interest rates to between zero and 0.25%, coupled with a promise to keep them there for an extended period, and the threat to conduct even more unconventional operations in the longer-dated Treasury market risks the biggest bubble of all, this time in U.S. government debt. Bubble mania is no accident. It is the direct consequence of the Fed’s asymmetric response to shifts in asset prices. Pressed to “lean against the wind” and adopt counter-cyclical interest rate and credit policies in the asset market, senior Fed policymakers have repeatedly demurred.
Led by Messrs. Bernanke and Greenspan, officials have argued it is too hard and subjective to identify bubbles until afterwards, and not the Fed’s job to second-guess asset allocation decisions of professional investors. Even if bubbles could be identified, they argue, pricking them would require swinging rate rises that would inflict widespread damage on the rest of the economy. Far less damaging to allow asset markets to follow their natural cycle and stand by to cut interest rates sharply, supply liquidity and contain the fallout when the bubble bursts. But the Fed’s asymmetric policy response to rising and falling asset prices (colloquially known as the “Greenspan/Bernanke put”) directly led to much of the excessive risk-taking which has humbled the financial system over the last eighteen months.
More importantly, the Fed’s decision to respond to the collapse of the technology and stock market bubble by lowering rates to 1% and holding them there for an extended period is now widely accepted as a mistake that contributed to the bond bubble and subsequent housing market boom in the middle of the decade. If the low-rate strategy was a mistake, it was a conscious one. In testimony to the U.K. Parliament last year, former Bank of England Governor Eddie George admitted the bank had deliberately sought to stimulate the housing market and house prices to support consumption during the downturn. Greenspan, Bernanke and Co. seem to have adopted a similar approach in the United States. The real mistake, however, was not creating one bubble to offset the collapse of another, but believing they could control what they had wrought.
When the Fed did eventually start to raise short-term interest rates in 2004, long rates remained stubbornly low for a year, and then rose much more slowly than anticipated, a development the puzzled Fed chairman and his able assistant Dr. Bernanke described as “the Great Conundrum”. Even as rates eventually rose, the alchemy of securitization ensured the real cost of credit remained far too low until the subprime bubble finally burst in late 2007. The second mistake is a basic design flaw in the Fed’s “risk-management” approach to setting monetary policy. Risk management is a nice idea, but not terribly useful. As engineer will explain, risk management involves trade offs and is not cost-free. The Fed has struggled to formulate a response to “low probability, high impact” events such as the threat of deflation in the early 2000s. Its response has been to cut rates aggressively to ward off the danger of extreme downside events, a strategy officials liken to taking out an insurance policy.
That’s fine, but when these low risk events have not in fact occurred, as was never statistically likely, the resulting policy settings have proved far too loose, and the central bank much too slow to change it. Concentrating on theoretical but small risks such as deflation has too often blinded the Fed to much larger risks near at hand of bubbles and asset inflation. Even as officials recognize policy has played a role stimulating an endless series of bubbles, the Fed finds itself trapped with no way out. Following the collapse of much of the modern banking system, the risk of pernicious deflation is now very real—more so than in the early 2000s. So like the sorcerer’s apprentice, the Fed has cranked up the Great Bubble Machine for what policymakers hope will be one final time. The Fed’s “unconventional” monetary strategy comes in four parts:
- Cutting interest rates to near-zero to lower the cost of borrowing.
- Injecting short-term liquidity into the financial system in the form of bank reserves (quantitative easing).
- Trying to pull down yields on longer-dated Treasury bonds through a combination of the jawbone (promising to keep short rates low for an extended period) and the threat to intervene in the market directly by buying longer-dated paper.
- Trying to reduce credit spreads above the Treasury yield for other borrowers, and increase the quantity of credit available, by buying mortgage-backed agency bonds for its own account, and financing other market participants to buy securities backed by other consumer credits, auto loans and student loans.
Most attention has focused on the zero-rate policy and quantitative easing at the short end of the curve. But the real significance lies in the unconventional operations targeting Treasury yields and eventually credit spreads at the long end. Operations at the short end are designed to bolster the banking system and restart lending. But the Fed knows the banking system is not large enough to replace the much more important sources of credit from securities markets. Operations at the long end are designed to get bond finance and securitized credit flowing. Short-end interest rates and quantitative operations are significant because they help shape the whole term structure of interest rates embedded in the curve.
The strategy has already succeeded in halving yields from over 4% in mid October to just 2.25% now. By convincing investors interest rates will remain ultra low for a long period, the Fed has made them willing to lend to the U.S. government for up to ten years for what is a paltry return. There are two risks. First, the massive rise in bond prices and compression of yields has come in the secondary market. The U.S. Treasury has not yet succeeded in placing much of its massively expanded debt and new requirements for next year at such low levels. But given the panic-driven demand for default-free assets, officials should not have too much difficulty. The bigger one is that the Fed is misleading investors into the biggest bubble of all time. Mr. Bernanke is making what learned economists call a “time-inconsistent” promise to hold interest rates at ultra low levels for an extended period.
The problem is that if the unconventional monetary policy works, and the economy picks up, the Fed will come under pressure to “normalize” rates and reduce excess liquidity to prevent a rise in inflation. The resulting rate rises will inflict massive losses on anyone who bought bonds at today 2.25% rate. Bizarrely, Bernanke and Co are in fact inviting investors to bet the policy will fail, the economy will remain mired in slump for a long period, deflation will occur and interest rates will remain on the floor, as Japan’s have done since the 1990s. Buyers of real estate and subprime securities have recently been lampooned for foolishly overpaying at the top of the market. Bernanke and Co are gambling memories will prove short and investors will prove just as eager to pay top prices for long-term government and private debt even though the downside is large. Let us have one last bubble, and when it collapses, we promise not to do any more in future…honest.
Ilargi: Great piece by Byron King on a question I have posed her before. How exactly is a government racking up debt that only your grandchildren might be able to pay (big question mark), not a Ponzi scheme? The key component, from where I’m sitting, is the need for a constant and unending influx of new investors. Today, GM shares are up, not because they have changed anything in their cars, or have found financiers, but because GMAC, their in-house lender, has become a bank-holding company. That's right GM will now be stealthily funded through TARP, on yop of the billions they already got. But like, GM, GMAC is broke! How can you let them become a bank and get their bankrupt fingers on taxpayer's money?
The Day the Earth Went Broke
What if you woke up one day and there was a flying saucer sitting in the middle of Central Park? It would change your view of the world, if not the universe, right? At least that's the idea behind the newly released remake of the classic 1951 film The Day the Earth Stood Still. And what if you went to bed one night and thought that you had money on account in a fine silk stocking firm? What if you believed that you and your family were well provided for? What if you were sure that you had made all the right choices and done all the prudent things? You saved your money. You placed it with a reputable outfit. You were in the bluest of blue chips. And you woke up the next morning and it was all gone? Poof. Vanished. You're broke! It would change your world, right? Maybe your life would fall off a cliff. Your standard of living would crater.
Well, this is exactly what happened to a lot of people a few days ago. These unfortunate souls invested their funds with Bernard Madoff's firm in New York. Apparently, Madoff (pronounced "made off") was running what The New York Times said "may be the largest Ponzi scheme in history." He may have wiped out as much as $50 billion of other people's money. $50 billion. No typo. For about 48 years, Madoff took in people's money and claimed to invest it through his proprietary "split-strike conversion." What's that? Actually, I've never heard of it. It's some sort of investment hocus-pocus that promises something for nothing. But Madoff always claimed he was making solid returns, in good times and bad, of 8-12% per year. Like clockwork. Such a deal.
Madoff's investment firm was not for just anybody. You had to be somebody to be part of this firm. You had to be invited to invest with Madoff. So at fine country clubs up and down the East Coast, people would politely mention that "I invest my money with Madoff." And other people would say, "Oh? Can I invest with Madoff too?" Then maybe they would get a discrete solicitation in the mail offering the opportunity to open a modest account. Maybe. Or maybe they wouldn't get that solicitation. And the people who were rejected wanted to know why. "So how come my money is no good with Madoff?" they would ask. And thus did the cachet grow. People wanted in. "Hey, tell me how I can invest with this guy?" was the topic at many a dinner of lobster Newburg or veal a l'Oscar. Over the years, thousands of people, firms, businesses, charities, pensions, hedge funds and even government entities placed money with Madoff. And Madoff took it. With pleasure.
It was all a swindle. Madoff was taking in the new money and paying it out to the previous investors. He had no real system of investing. Madoff just dabbled in the markets, making some money here and losing it there. He lived well. He owned a yacht. He attended fancy parties. He was a patron of the arts and charity. He contributed generously to politicians in the Democratic Party (Hillary Clinton, Chuck Schumer and Charles Rangel, among others, in recent federal campaign filings). He was polite and distinguished. He was a counselor to many a family, always good for wise advice about how to make the next right move in life.
Indeed, Madoff pretended for decades that things were all right. But things weren't all right. Madoff and his firm just took money from one group of people and paid it to others. He sent out elaborate statements, documenting how well people's accounts were doing. Yet in the process, Madoff lost billions of dollars. The funds vanished into money heaven. And Madoff did it all under the noses of auditors, lawyers, accountants, tax agencies, the Securities and Exchange Commission (SEC) and a host of other pretend regulators. In short, Madoff is a financial psychopath. He's a money-murderer. He is to money management what Ted Bundy was to unsuspecting young women.
Along the way, a few people raised suspicions. They said things like, "No one can deliver those kinds of results year after year. It's impossible." But many other people didn't want to believe anything was wrong. The final whistle didn't blow until Madoff's sons turned him in to the FBI last week. (The sons claimed that they "knew nothing" about the scam.) And according to press reports, Madoff confessed everything to the FBI arresting agent, saying, "There is no innocent explanation." Many of Madoff's clients are from the Jewish community. That was Madoff's heritage, and thus did Jews form much of the clientele that Madoff cultivated. According to The Wall Street Journal, some Jewish investors called Mr. Madoff "the Jewish bond" because of his solid and predictable returns.
Now with Madoff's demise, there is an entire swath of Jewish "old money" gone down the tubes. There are personal wipeouts that will devastate entire extended families. The legacy economy of many trust fund families is wrecked. A lot of country club bills, condo dues and school tuition statements are about to go unpaid. This will impact communities from Boston to Palm Beach and even overseas as far away as Buenos Aires and Johannesburg. That is, for some overseas Jewish families, Madoff held the "safe" money, the strategic reserve for when it was time to pack the bags and move away. (An old African expression comes to mind: "When the Jews leave, it's time to leave. When the Portuguese leave, it's too late to leave.")
Some charities are hitting the rocks too, totally wiped out by Madoff. There are several hedge funds going down like the Titanic, with one fund losing nearly $1.8 billion. Just in Geneva, Switzerland, a number of banks reportedly may be out of $4 billion invested with Madoff. French bank BNP Paribas is said to be on the hook. Japan's Nomura Holdings, which markets Madoff's funds, also has been swept up in the financial wipeout. HSBC is taking a serious hit. Kingate Management of Bermuda has reportedly invested part of its $2.8 billion fund with Madoff.
So it makes me wonder. How bad is it out there? How many other Ponzi schemes are there besides Madoff's? How many more financial psychopaths are ginning up fake account statements? How many little old ladies are there out there who think they have money in an account, but it's all just some big scam? How many more bad banks? How many bad brokerage houses? How many more bad companies with bad stock? How many more bad government entities with bad finances and worse bonds? How many bad pension funds? It drives home the point of wondering whom you can trust. And how bad is it with even the U.S. government? Do you really trust government statistics, like the one for the rate of inflation or unemployment? And how about the numbers in the national budget accounts? We're spending how much? Does money even have any meaning to the people who have the power to appropriate it? Our whole national accounting process has turned into an intergenerational Ponzi scheme.
Really, our $10 trillion national debt is not enough? We are looking at trillion-dollar deficits in just the next year or two. How long can it last? And whom can you believe in any position of authority? So Bernard Madoff had a "system" for investing? And Ben Bernanke has a "system" for managing the monetary policy of the country, right? Hank Paulson has a "system" for managing the Treasury accounts? And Congress and the president G.W. Bush, and after him B.H. Obama have a "system" for spending the nation's limited wealth on important things, yes?
How do you know that you don't own a big fat piece of nothing? It's why I believe you need to own some real gold and silver. I've said it before, and I'll say it again: You need to own some gold and silver in addition to whatever else you own on account. Just do it! Go out and buy some. Today. When all else fails, if you have the precious metals, you still have something you can hold in your hand. And when someone comes along with that great deal that looks just too good to turn down steady returns forever, with minimal risk: Remember what happened with Madoff. He was a pillar of the Jewish community. "Such a nice man." Now his fraud has collapsed like the temple around the ears of Samson. Let me mix my Old and New Testaments on this one and quote Matthew 10:36, "A man's foes shall be they of his own household."
Bank regulators forced accounting board to ease fair-value rules
Comments at FASB meeting show regulators refused to adjust capital reserve requirements to reflect banks’ complaints that accounting exaggerates their losses. SEC pressure led FASB to make “emergency” change in accounting rules instead. Bank regulators, acting partly through the Securities and Exchange Commission, pressured the Financial Accounting Standards Board to ease its fair-value rules, according to comments made during a board meeting on Dec. 15. At the meeting, FASB member Lawrence Smith reported that in his consultations with bank regulators over the board’s rules for valuing troubled financial instruments held by banks, the regulators, whom Mr. Smith did not identify, refused to change their capital reserve requirements to take into account complaints that fair-value accounting exaggerated banks’ losses.
Mr. Smith indicated that the regulators insisted that FASB change its rules instead. On Dec. 19, the board agreed to propose easing its rules by letting banks and other holders of securitized investment products such as mortgage-backed securities take into account expected cash flows even when they were classified as available for sale when testing them for impairment. The current rule allows such treatment only if they are classified as held to maturity. “I was particularly frustrated discussing with banking regulators their apparent unwillingness to consider changes to regulatory capital based upon disclosures that we might consider putting into financial statements,” said Mr. Smith, noting that the regulators instead peg their regulatory capital to accounting standards that FASB has in place right now. “It seems to me they have it in their wherewithal to do something other than that.” A spokeswoman for the Federal Reserve, the lead bank regulator, failed to respond to a request for comment. A spokesman for the SEC, which oversees FASB, declined comment.
While FASB took into account the views of investors, banks and others, the views of regulators are widely considered more influential in this case, since the banking industry is under intense pressure to raise more capital at a time when more lending is expected to help ease the recession. “The board was under tremendous political pressure” to ease its rules, said Pat Finnegan, director of financial reporting policy for the CFA Institute Centre for Financial Market Integrity. Still, board member Thomas Linsmeier was clearly uncomfortable with the change. “I don’t understand why we would be necessarily addressing impairment in this isolated instance,” Mr. Linsmeier said during the meeting, disputing the view that the board’s fair-value rules have exaggerated banks’ losses.
Mr. Linsmeier went on to describe the “emergency” decision to propose such a rule change because of the concerns SEC Chairman Christopher Cox expressed about fair value at a speech earlier this month in Washington at the annual conference of the American Institute of Certified Public Accountants. “I think we’re talking about this because Chairman Cox suggested at the AICPA meeting last week that the SEC sees fair value as an area we should be looking at,” said Mr. Linsmeier. “I am greatly concerned that the reason we’re getting pressure to do this is the preparer community doesn’t want to recognize losses.” While Mr. Linsmeier said that he was was willing to vote in favor of moving forward on the proposal, by seeking public comments on it, he said he would be looking to see whether those comments showed the change was justified before he voted in favor of making the proposal a rule.
“Are there really economic circumstances that are being accounted for improperly?” he asked. “I remain skeptical.” Based on their comments at the meeting, others on the five-member board, including board chairman Robert Herz and member Leslie Seidman, shared Mr. Linsmeier’s discomfort with the change. Mr. Herz, for example, said he didn’t see much value in debating different bases for deciding how to impair assets in the first place. “I think all this impairment stuff is voodoo,” said Mr. Herz. In contrast, Mr. Smith seemed more willing to change the rules based on the banking industry’s complaints about fair value. In any case, they agreed to limit the public comment period for the rule to 10 days, a much shorter period than normal. With the proposal issued on Dec. 19, such a comment period would enable the board to vote to make the proposal a rule whose effective date would be Dec. 31, in time to reduce banks’ fourth-quarter losses.
Ilargi: "...the most chilling warning yet on the scale of the looming slump"Huh? I must have missed something, but perhaps British readers can set me straight: How bad exactly was the UK 5 years ago? Buried the corpses yet? Know what I'm thinking? That lost of Brits today wish they were back at Christmas 2003, before they all bought their overpriced hovels.
Recession will 'set British economy back five years'
The 2009 recession could be so severe it sets Britain's economy back five years, according to the most chilling warning yet on the scale of the looming slump. Households must not rule out the prospect that the UK's economy shrinks by between 5 per cent and 10 per cent next year if the financial crisis sets off an even more vicious cycle of cutbacks, according to the Centre for Economics and Business Research. The warning comes only days after the Office for National Statistics announced that gross domestic product contracted by 0.6 per cent in the third quarter - worse than it previously estimated and the weakest quarterly figure since the early 1990s recession.
Although Alistair Darling indicated in the pre-Budget report that the slump would be less severe than in the early 1990s, a growing majority of economists are now warning that the scale of the downturn could be almost unprecedented. Capital Economics and Bank of America have predicted that the economy will shrink next year by the biggest amount since 1947 - one of the worst recessions Britain has ever experienced, following Second World War demobilisation and one of the coldest winters on record. However, Ben Read of the CEBR warned that the scale of the recession could be even more severe. "It is easy to see that things could be even worse," he said. "Despite the public declarations by the Government that the banks ought to be lending more, it is clear that the primary concern of many of our largest banks is to shore up their balance sheets and, for those on the end of government bail-outs, to pay back their Treasury paymasters.
"With few incentives for banks to behave otherwise, credit availability to businesses may become even worse during 2009. At the same time, businesses are already starting to become entrenched in a deflationary mindset where investment budgets are curtailed not only because budgets are tight, but also because prices are falling." With companies facing major pressure on their balance sheets, they look likely to slash their investment budgets, in so doing cutting staff numbrs and wage bills next year. If this combines with a sudden sharp increase in the rate at which consumers save rather than spend, the result could be that a major chunk of UK economic output is lost, he said.
"If this deleveraging scenario occurs, a contraction of between five and ten per cent could be on the cards, setting the United Kingdom economy back by five years," he said. Although such an outcome is less likely if the Bank of England slashes rates even further in the coming months. The Bank is expected to reduce borrowing costs beneath 2 per cent next month for the first time in its 314-year history, and many suspect it could reduce them to zero before the summer. Economists also fear that house prices, which have fallen by around 15 per cent already this year, could drop a further 15 per cent or 20 per cent next year as the number of redundancies climbs further.
Ilargi: One thing I never see mentioned in all the talk of banks "having" to lend out the money they receive from the government (and this plays everywhere, not just in the US) is nevertheless crucial in the discussion. There are further losses and writedowns for all banks, and massive ones, right around the corner. Just wait for the final 2008 books they'll soon need to produce. Ergo: they need all the cash they can get their hands on.
Ironically, if governments want money to reach companies and individuals, they're going to have to bypass the banks, or it won't happen. And once you bypass banks, it will become glaringly clear that you didn't need the banks in the first place. Well, good riddance. Let governments guarantee people's deposits, and give them access to their money through post-offices, or supermarkets, or some other channel.
Everyone tries to forget about the toxic assets in the bank vaults, as if they will go away if you ignore them. But toxic matter tends to brew, fester and contaminate everything around it. Which means the policies adapted thus far don't just not help one inch, they make matters worse. And by the time we figure that one out, we'll all be a lot poorer. And we'll still have to deal with the toxic stuff, which by then will be our responsibility, since our governments are buying it all at insanely high prices.
Banks Told: Lend More, Save More
Federal regulators are sending a mixed message to the nation's banks: Lend more to boost the economy, but at the same time, build up capital to protect against losses. Publicly, officials are pushing banks to make loans, tweaking them for taking government money while they tighten lending standards and turn away borrowers with less than perfect credit records. Privately though, some bankers say regulators are urging them to build capital cushions that are considerably thicker than what is officially required to be classified as a healthy institution. Other banks are being forced to set aside more money to protect against losses on loans normally considered safe. Regulators themselves are under criticism for failing to prevent reckless lending practices that fueled the credit crisis. Now, with bank profits plunging and troubled loans soaring, federal regulators say the tough talk will help gird the industry for even more pressure amid a potentially deep recession.
So far this year, 25 banks have failed and regulators are worried that at least another 200 banks may be at risk of collapsing. But bankers complain that the U.S. government is sending a mixed message, especially to the roughly 200 institutions that analysts estimate are receiving taxpayer capital through the Treasury Department's Troubled Asset Relief Program, or TARP. "It's so incongruous when the four regulators publish a joint press release imploring banks to lend and saying they should do their duty under their charter, when at the same time the regulatory field forces are bludgeoning community banks to death," said Camden Fine, chief executive of the Independent Community Bankers of America. The trade group represents many small financial institutions.
"There are some institutions across the country that are going to feel this contradictory sense of pressures from those in the government who want them to lend more and those who want them to build capital," said J. Downey Bridgwater, CEO of Sterling Bancshares Inc. He said regulators haven't been pressuring the Houston bank, but he says other bankers are feeling squeezed. Federal officials say they are trying to walk a fine line between fending off more bank failures and encouraging banks to lend to borrowers who deserve credit. "We've been trying to strike a balance with our examiners for some time, and I think they are striking the right balance," Federal Deposit Insurance Corp. Chairman Sheila Bair said last week.
Since TARP was proposed in late September as a $700 billion bailout fund, Treasury Secretary Henry Paulson and other government officials have touted it as a way to jumpstart lending, which has slowed at many banks that are trying to reduce risk and conserve capital. But there are few signs that TARP is coaxing many banks to lend more. Frustrated lawmakers have threatened to withhold the remaining $350 billion of unallocated TARP funds until there is proof that banks are using the capital for new loans. Democrats want to legally require banks to lend at least some of the money. That is much easier said than done, according to bankers nationwide. One reason: They are being hounded by regulators to sock away even more capital, which essentially means they have less money to lend.
For example, banks generally are required to hold 6% of their assets as so-called "Tier 1" capital and 10% of assets as "core" capital. But federal examiners recently have been informally boosting those thresholds, according to bankers and other industry experts. "At the moment, for many banks, eight [percent] is the new six and 12 is the new 10," said Eugene A. Ludwig, former head of the Office of the Comptroller of the Currency, which oversees many U.S. banks. Mr. Ludwig is now CEO of Promontory Financial Group, a financial-services consulting firm. OCC spokesman Robert Garsson said: "Regulatory capital requirements are only minimums. Each bank's situation is different, so the amount of capital actually held at individual banks will vary depending upon such factors as the bank's risk profile and its ability to raise capital when needed. And of course, well-capitalized banks are in a stronger position to weather the increased losses from a recession."
Bank executives were reluctant to speak publicly about their interactions with regulators, but they privately grumbled about the dueling pressures. Regulators "aren't using their old standards now" when it comes to capital levels, said the CEO of a large U.S. bank. In addition, the OCC is pushing banks harder to classify more loans as troubled, a designation that forces institutions to set aside additional funds to cover potential defaults. Regulators are criticizing loans where there are signs that a borrower may run into trouble in the future. In good times, a loan wouldn't receive that classification until the borrower actually falls behind on payments. At some banks that regulators regard as troubled, government officials have been reluctant to approve TARP infusions unless the banks agree to bring their Tier 1 ratios up to 8%, said Pat Doyle, co-head of the financial institutions group at law firm Arnold & Porter LLP.
The message is more subtle at relatively healthy banks, said Mr. Doyle, whose firm advises banks that have sought TARP funds. He said regulators are telling such banks, "We think it would be prudent as a risk-management tool to increase your capital just in case the waves break." Regulators also have been warning banks to guard against loosening credit too much now that the Federal Reserve has cut interest rates to near zero. After the Sept. 11, 2001, terrorist attacks, the Fed repeatedly cut its benchmark rate and inadvertently helped inflate the housing bubble. "They are very, very aware of that and are going to be watching that very closely," said Edward J. Wehmer, CEO of Wintrust Financial Corp., a Lake Forest, Ill., banking company with nearly $10 billion in assets. Mr. Wehmer met with federal and state regulators last week. "They're really worried about people doing things they shouldn't be doing," he said.
Ilargi: I thought it might be good to point out these two articles below. Both are Bloomberg, and the same author, Xe Xie, is involved in both. Their message is not the same, though. How and why there's been a "Better-Than-Forecast U.S. Consumer Spending", I don’t know, not with US retail visits down 24% pre-Christmas. Suspicious. Looks like someone is -once again- making up some of the numbers?! There may be small fluctuations in the USD-Euro exchange, but the trend lately has been clear: to put it mildly, it doesn't exactly look like the US government and the Fed are going out of their way to boost the value of their currency.
As for the yen, the Japanese has kept it -too- low for many years, and they have now lost control of it with other economies joining them in deflation. An interest rate of 0.1% leaves no room to wiggle, and exports are down 26% in the past year, in an economy that fully depends on those exports. Moreover, they see their foreign reserves lose value quickly. But for now, the yen trend will remain higher, until it reaches some sort of "natural" -read: non manipulated— exchange rate. Still, with everybody, US, China, Russia, wanting their currencies down, volatility is riding the rooftops with Santa, and trends can reverse overnight. Japan reports dismal numbers today, but none of the others will come with rosy figures either.
Dollar Advances on Better-Than-Forecast U.S. Consumer Spending
The dollar strengthened against the euro after U.S. consumer spending and orders for durable goods were higher than economists’ forecasts. The euro touched a record high versus the pound as an industry report said yesterday U.K. house prices may fall about 10 percent next year. Russia’s ruble traded near its lowest level against the dollar in almost three years after it was devalued for the third time in a week. "The downside risk for the dollar is limited," said Masafumi Yamamoto, head of foreign-exchange strategy for Japan at Royal Bank of Scotland Group Plc in Tokyo. "The market has already priced in the deterioration of the economic outlook in the U.S."
The dollar advanced after stocks in the U.S. gained for the first time in three days yesterday following the Commerce Department’s report showing consumer spending in the U.S. fell 0.6 percent in November, a smaller decline than the 0.7 percent drop economists forecast in a Bloomberg survey, as cheaper gasoline left Americans with more cash. The pound traded at 95.14 pence per euro and earlier touched 96.52, the weakest level since the 15-nation currency’s 1999 debut, after a Royal Institution of Chartered Surveyors report on the U.K. housing market strengthened the case for further interest-rate cuts. The pound was little changed at $1.4724. Russia’s ruble slipped for a second day to 28.6868 against the dollar and was little changed at 40.1816 versus the euro after the central bank allowed the currency to slide. Crude oil fell below $36 a barrel, dimming Russia’s economic growth outlook.
Concerns over an extended global recession have helped Japan’s currency gain 23 percent against the euro and 22 percent versus the dollar this year as Japanese investors sold higher- yielding assets and repatriated overseas earnings. The euro may slide against the yen and dollar in the first quarter of 2009, said Kimihiko Tomita, head of foreign exchange in Tokyo at State Street Bank & Trust Co., a unit of the world’s largest money manager for institutions. "I am relatively bearish on the euro since their fiscal and monetary policies have been behind the curve," he said, forecasting that the currency may fall to $1.24 and 120 yen by March. The dollar dropped last week to the lowest level in almost three months versus the euro as the Federal Reserve cut the overnight target rate to a range of zero to 0.25 percent from 1 percent and said it may keep rates low for "some time."
The Bank of Japan lowered its key lending rate on Dec. 19 to 0.1 and said it would buy commercial paper and more government bonds to pump cash into the economy. The European Central Bank’s benchmark is at 2.5 percent. The U.S. currency will rebound as investors seek dollar funding and other economies match the Fed’s interest-rate cuts, according to Benedikt Germanier, a currency strategist at UBS AG in Stamford, Connecticut. "What will turn it around is the ongoing demand for a safe, liquid store of wealth into next year," Germanier said in an interview on Bloomberg Television. "Demand for a store of wealth and global rate convergence will put the dollar in a relatively good position again." U.S. consumer spending rose for the first time in six months after accounting for inflation, the Commerce Department said yesterday in Washington. First-time unemployment benefit claims jumped to 586,000, and durable-goods orders declined less than anticipated, other reports showed.
Yen May Rise Further as U.S. Jobless Claims Boost Haven Appeal
The yen may extend its gain versus the dollar after U.S. jobless claims reached a 26-year high, increasing the currency’s haven appeal. The euro advanced closer to parity versus the pound yesterday as an industry report showed U.K. house prices may fall about 10 percent next year. Russia’s ruble slid to its lowest level against the dollar in almost two years after it was devalued for the third time in a week. "We think the yen will continue strengthening, especially versus the dollar," said Fabian Eliasson, vice president of currency sales at Mizuho Corporate Bank Ltd. in New York. "The economic data out of the U.S. continues to deteriorate. It’s going to be a tough start for 2009."
The yen traded at 90.40 per dollar at 6 a.m. in Tokyo, after increasing 0.6 percent yesterday and reaching a 13-year high of 87.14 on Dec. 17. Japan’s currency will strengthen to the mid-80s in the first quarter, according to Eliasson. The yen was little changed at 126.59 versus the euro. The euro traded at $1.4002 following an increase of 0.5 percent. The pound dropped 0.5 percent to 95.05 pence per euro as a report from the Royal Institution of Chartered Surveyors also said U.K. house prices may drop as much as 30 percent from their highest point, strengthening the case for further interest-rate cuts. Sterling touched 95.57 per euro on Dec. 18, the weakest level since the 15-nation currency’s 1999 debut. The pound dropped 0.2 percent to $1.4689.
Russia’s ruble slid 0.9 percent to 28.7018 against the dollar and 1.4 percent to 40.1507 versus the euro after the central bank allowed the currency to slide. Crude oil fell below $36 a barrel, dimming the outlook for economic growth. The yen increased 0.5 percent to 38.12 versus the Brazilian real and 0.7 percent to 12.7253 versus Norway’s krone on speculation investors will unwind trades in which they get funds in a country with low borrowing costs and buy assets where returns are higher. Japan’s 0.1 percent target lending rate compares with 13.75 percent in Brazil and 3 percent in Norway. Japan’s currency gained 29 percent against the euro and 23 percent versus the dollar this year as the global recession and a seizure in credit markets prompted Japanese investors to avoid higher-yielding assets and repatriate overseas earnings.
The yen will weaken versus the 15-nation European currency early next year as Japanese investors resume buying higher- yielding assets overseas, according to Marc Chandler, global head of currency strategy at Brown Brothers Harriman & Co. in New York, who said the euro may rally to 130. "I am on the long side of the euro-yen," he said. "In the first quarter next year, there will be renewed outflows from Japanese investors." The dollar fell last week to the lowest level in almost three months versus the euro as the Federal Reserve cut the overnight target rate to a range of zero to 0.25 percent from 1 percent and said it may keep rates low for "some time."
Initial jobless claims increased to 586,000, the most since November 1982, from a revised 556,000 the prior week, the U.S. Labor Department said yesterday. The four-week moving average of claims, a less volatile measure, also was at the highest level since 1982. The ICE’s Dollar Index, which tracks the greenback against the euro, the yen, the pound, the Canadian dollar, the Swiss franc and Sweden’s krona, traded at 81.214 yesterday, compared with 88.463 on Nov. 21, the highest since April 2006. The U.S. currency will rebound as investors seek dollar funding and other economies match the Fed’s interest-rate cuts, according to Benedikt Germanier, a currency strategist at UBS AG in Stamford, Connecticut. "What will turn it around is the ongoing demand for a safe, liquid store of wealth into next year," Germanier said in an interview on Bloomberg Television. "Demand for a store of wealth and global rate convergence will put the dollar in a relatively good position again."
Ruble Falls to Record Low Versus Euro as Russia Weakens Defense
The ruble fell to a record low against the euro as Russia's central bank extended six weeks of devaluation to compensate for falling oil prices. The ruble fell 1.4 percent to 40.8160 per euro at 11:36 a.m. in Moscow, the lowest since the European currency was introduced in 1999. It declined 1 percent to 29.0045 against the dollar, a four-year low, capping a 20 percent drop since early August. Russia's reserves, the world's third largest, have fallen by a quarter since August to $451 billion as the central bank sought to prop up the currency and export revenue decline with falling crude prices. Standard & Poor's cut Russia's credit rating this month for the first time in nine years to BBB on concern the country is wasting its foreign currency reserves defending the currency.
"The central bank tries to devalue the ruble as fast as it only can without attracting too much unwelcome attention of the speculators, many of whom are on vacation now," said Evgeny Nadorshin, a senior economist at Trust Investment Bank in Moscow. "The less speculations the more reserves the central bank keeps for itself in the short term." The currency has weakened 15 percent against the dollar and 12 percent against the euro this year as oil, the nation's biggest exporter earner, lost 62 percent and the global credit crisis prompted investors to pull out of emerging markets. Russia's RTS stock index has dropped 72 percent this year compared with a 56 percent decline in MSCI's emerging-market index.
Bank Rossii allowed the ruble to fall more than 1 percent against its target basket of dollars and euros for the fourth time in a week and the 11th time since Nov. 11, according to a central bank official who declined to be identified. The currency lost 1.2 percent against the basket, which is 55 percent dollars and 45 percent euros, to 34.3191. Barclays Capital says Russia's economy will sink into a recession next year as the price of Urals crude, the country's main export blend of oil, tumbles from a record high in July. Urals has fallen 77 percent since then to $32.34 a barrel, less than half the $70 Russia needs to balance its budget next year. With oil at "very low levels" Bank Rossii "prefers more safety in case it goes even lower," according to Nadorshin. Industrial production shrank the most last month since 1998, when the country defaulted on $40 billion of domestic debt and the ruble plunged more than 70 percent against the dollar.
Russia unveils list of strategic enterprises
Russia has unveiled a list of strategic enterprises entitled to preferential government support in the economic crisis but said the list was not complete and did not guarantee the receipt of the financial help. The cabinet published the list made of 295 companies from various industries and compiled by a government commission for increasing sustainability of the economic development on its Web site late on Thursday. Moscow has pledged over $200 billion to stave off the crisis, which has already seen companies cut jobs, salaries and investment plans, forced consolidation in Russia’s 1,000-plus banking sector and prompted a rise in corporate debt defaults. ”The inclusion of a company in the list does not guarantee the receipt of the financial support,” the government said in a statement on its web site.
”The main objective...is supporting their stability using not only credit instruments but other measures,” it said adding the measures included restructuring tax arrears, altering tariff policy and granting government orders. ”Besides, if it is needed, the government will (act to) minimise negative social and economic consequences of the closure of these enterprises,” the government said. Among others, the list includes oil pipeline monopoly Transneft, Russian Railways, flag carrier Aeroflot, gas export monopoly Gazprom, the largest oil producer Rosneft, No.2 mobile operator Vimpelcom, Norilsk Nickel, the world’s biggest producer of nickel and palladium, and others. However, the list lacks some major companies key for their industries, such as Russia’s largest silver miner Polymetal or oilfield services firm Integra, while some companies are mentioned twice. ”The list...is not complete and may be modified by resolution of the commission,” the government said.
Vietnam devalues currency
Vietnam devalued its currency by 3 percent Thursday, spurred by falling inflation and the weakest annual economic growth in nine years. The central bank set the dong midpoint at 16,989 per dollar Thursday, from 16,494 on Wednesday after a two-day cabinet meeting in which Prime Minister Nguyen Tan Dung said gross domestic product had grown 6.23 percent this year. That is the slowest pace since 1999, when growth was at 4.77 percent. Last year Vietnam was a darling of the investment community, with 8.5 percent expansion. After a domestic overheating crisis earlier this year, and faced with the global slowdown, the government has cut its growth forecast to 6.5 percent.
Next year will be worse, Dung predicted. "The year 2009 will be tougher than 2008, as we will be faced with a strong impact from the global economic downturn," a government statement quoted Dung as telling the cabinet in Ho Chi Minh City. The government forecasts growth of 6 percent to 6.5 percent in 2009, but the International Monetary Fund expects growth to slump to 5 percent. "The central bank's decision to let the dong fall 3 percent against the dollar is wise, as it eases pressure on the country's foreign currency reserves and stimulates exports in 2009," said Tong Minh Tuan, an economist at Bao Viet Securities. "Moreover, this shows that the central bank is moving in a way that investors expected. That will help boost confidence."
Vietnam's stocks fell 0.61 percent Thursday. The index has tumbled 67 percent so far this year and ranks among the worst performers in Asia. Vietnamese consumer prices have risen 19.89 percent in December, well below the government's forecast of 22 percent, while average inflation for the year has been 22.97 percent, the government statistics office said Thursday. December was the 14th consecutive month of double-digit inflation, but the figure has eased for three consecutive months. Earlier in the year, in response to soaring inflation and a widening trade deficit, the government imposed three interest rate increases and strict measures to curb credit growth. But Hanoi has reversed policy since the global credit crunch started turning into a worldwide economic slowdown.
The State Bank of Vietnam, the central bank, has cut rates five times since late October, unwinding most of the earlier tightening, and has reduced banks' compulsory reserve ratio, which has effectively flooded the financial system with money. Dung has said that promoting exports is a priority, and the government has announced plans for a $6 billion economic stimulus package. But foreign portfolio investment has fallen, while export revenues have also slowed in Vietnam's major markets, and the dong has come under pressure to slip.
Dark clouds hover over Goldman Sachs Group
Goldman Sachs Group has come under selling pressure recently after JPMorgan slashed the company's 2009 earnings forecast from $7.00 per share to $6.25 per share. JPMorgan believes that write-downs are likely to persist through the first half of 2009. What's more, the brokerage firm introduced a 2009 year-end target of $95 for GS. Goldman Sachs remains a global leader in mergers and acquisitions advice and securities underwriting, offering a variety of investment banking and asset management services to corporate and government clients, as well as institutional and individual investors. It owns Goldman Sachs Execution & Clearing, one of the largest market makers on the New York Stock Exchange, and is also a leading market maker for fixed income products, currencies, and commodities.
Technically speaking, the shares of GS have dropped more than 64% since the start of 2008. In fact, the security has been in a steady downtrend since reaching a peak in October 2007 at $250.70, resulting in a loss of nearly 70%. The equity is currently encountering resistance at its 10-week moving average, which GS has not closed a session above since the beginning of August. Additional resistance lies overhead at the 80 level -- a round-number level that has capped the equity since the beginning of November. Another key element to the stock’s backdrop that needs to be examined is its sentiment backdrop. As contrarians, we are looking for sentiment that runs counter to a security’s technical trend as a sign of a potential bullish or bearish play. Extreme optimism on a down-trending stock indicates that the shares may succumb to additional selling pressure as the remaining bulls could unload their long positions in the face of the stock’s weakness. On the other hand, extreme pessimism on an up-trending stock indicates that there is still potential sideline money available, which could move in and push the shares higher.
One important sentiment indicator is the Schaeffer’s put/call open interest ratio (SOIR). This ratio compares put open interest against call open interest among options that expire in less than three months, allowing a clearer picture of the sentiment among short-term options speculators. A reading above 1.0 indicates that put open interest outnumbers call open interest. For GS, the SOIR stands at 0.74, as call open interest outnumbers put open interest. However, on a historical basis, this ratio is actually lower than all the readings taken during the past year. In other words, short-term options speculators have not been more optimistically aligned toward the stock at any other time, indicating that hopes are riding high for the shares to break out. Another sentiment indicator that should be reviewed is analyst rankings, as shifts in the various ratings can cause shifts in buying or selling pressure. Zacks reports that GS has earned five “buy” or better ratings and seven “holds.” While the reading has a somewhat bearish slant, there is still room for additional downgrades should the security fail to overcome technical resistance.
Meanwhile, the average 12-month price target shows that expectations for GS are still relatively high. The price-target estimate for the security stands at $112.36, according to Thomson Financial. This lofty reading implies that analysts are expecting the shares to rally more than 45% from their December 22 closing price. Any price-target cuts from this smitten group could push the shares lower. Elsewhere, we find that short sellers have taken an interest in the shares. Short interest can be a useful sentiment indicator, since it measures the level of investor pessimism toward a given stock. Specifically, short interest is created when an investor sells shares of a stock that he or she has borrowed from a broker, but does not own outright. Since the beginning of October, the number of GS shares sold short has nearly doubled to 14.5 million shares.
This accumulation of bearish bets accounts for more than 3.7% of the company’s total float. Should the bears continue to sell short the shares of GS, the stock could be pulled lower by the activity. Overall, traders should keep a close watch on the stock’s 80 level and resistance at its 10-week moving average. A rejection at this level could spell trouble for the shares. With most of the sentiment reading lingering in the bulls’ camp on this underperforming stock, we could see selling take over as disappointed investors sell the equity and go looking for greener opportunities.
Foreign Banks Ask China to Delay New Tax on Interest
A group of foreign banks in China has asked the Chinese government to delay a recently imposed tax on interest paid on money borrowed from overseas, arguing that the tax would exacerbate the impact of the global financial crisis. The request concerns a new withholding tax on interest payments on all loans to banks in China from overseas lenders. The tax, which is retroactive to Jan. 1 2008, is expected to disproportionately affect the Chinese operations of foreign banks, which are more likely to borrow from overseas sources, such as their parent companies. Chinese banks typically have large deposit bases, so are less reliant on borrowing from overseas. A petition signed by 36 foreign banks, and seen by Dow Jones Newswires Friday, describes the tax as an excessive burden on foreign lenders operating in China. The petition was signed Dec. 23 and addressed to China's State Council, its banking regulator, its central bank and the Ministry of Finance.
The new tax is technically directed at the offshore lenders, saying they must pay tax on the interest they earn on loans made to banks in China, according to a statement from the State Administration of Taxation. The statement was dated Nov. 24, but only posted on the administration's Web site Dec. 12. However, the China-based entity is responsible for paying the tax on the lender's behalf, the statement said. Under China's corporate income tax regulations, the withholding tax will be broadly charged at 10%, but with a lower rate of 7% for lenders from places with which China has a tax treaty, such as Hong Kong.
The petition was backed by banks including the local units of HSBC Holdings PLC, Standard Chartered PLC, and Bank of East Asia Ltd. Officials at those three banks didn't immediately respond to requests for comment. The foreign banks have asked that they only be required to pay the withholding tax on interest payments that occur after Dec. 4 while Beijing reviews the petition, and that any back-payment be put on hold.
A cover letter for the petition from accounting firm Ernst & Young said the measure, together with recent changes to the banks' business tax, could roughly add an additional 1 billion yuan ($146.4 million) to the banking sector's tax bill this year. "As far as an independent bank is concerned, this could be the difference between surviving the financial crisis or not," said the accounting firm in the letter addressed to the tax bureau. People familiar with the situation said Ernst & Young has taken a leading role in the lobbying effort. Ernst & Young wasn't immediately available for comment. The petition said that because Hong Kong has been the main source of offshore funding for China-based banks, the withholding tax could reduce the liquidity flow between the mainland and Hong Kong. "It will therefore have a huge impact on Hong Kong's financial market," it said.
China first introduced the withholding tax in mid-1997 as part of corporate income tax regulations, but intense lobbying by foreign banks gained them an exemption by the end of that year. However, China's new corporate income tax, which took effect from Jan. 1 this year, again included the withholding tax, this time extending it to include Chinese state banks. Banks initially assumed the 1997 exemption -- which technically only delayed the tax until further study -- continued to apply under the new tax law.
7 of the year's worst financial ideas
The financial crisis of 2008 was full of surprises. Among the most stupefying were the tales of the complicated instruments that people thought were a good idea during the bull market. More such examples will surely emerge as gallons of toxic waste slosh out of banks and hedge funds in 2009. While waiting for the full inventory, here are seven we hope we won't see again.
- PIK toggles
These debt features were popular in 2007 - but it wasn't until 2008 that toggles started to get flicked. "PIK" stands for payment-in-kind, and means issuers can substitute more bonds for actual cash interest payments whenever they want. Sometimes the "rate" goes up when the toggle is switched. That is cold comfort when it becomes apparent that the bonds are not worth anything like face value because the company is going to the wall - the high probability of which, it should be noted, was why the issuer put in a PIK toggle in the first place.
Retail investors in Asia snapped up minibonds early in 2008, attracted by the fact that these instruments, supposedly backed by a lineup of "safe" banks, had a higher yield than normal and were available in small amounts. The catch? They were not bonds at all, but derivative products, some of which had Lehman Brothers as a counterparty. Investors were effectively paying for Lehman to insure its own portfolio. When Lehman cracked, so did thousands of nest eggs.
- Contingent value rights
CVRs help fudge the fact that a buyer and a seller cannot agree on price. The buyer simply gives the seller a CVR, or an option on the spoils if the buyer's investment does well. Kohlberg Kravis Roberts used a twist on the theme when it de-listed its European arm, giving shareholders new U.S.-listed stock and a CVR. There are two things wrong with these devices: Either they cripple issuers when payday arrives, or they prove virtually worthless, thanks to reams of small print. Too clever by half.
The accumulator - known waggishly as the "I-kill-you-later" - is a device used to hedge cross-currency transactions. It limits the amount of profit the holder can make, but not the losses. That makes it cheap - and dumb. Citic Pacific lost $2 billion on accumulators when the Australian dollar fell hard. The normally staid conglomerate had not just hedged but had made a giant speculative bet. Citic Pacific was effectively taken over by its Chinese parent Citic - the ultimate slap on the behind.
- Cash-settled options
These options, which pay out in cash rather than actual shares, are not new, or necessarily bad. But in Germany they became a battering ram for corporate raiders. Schaeffler, a ball-bearing manufacturer, used cash-settled options to seize control of Continental, an auto parts maker. These options do not need to be disclosed in Germany - even though the holder can, in practice, easily get the underlying shares. Germany has not outlawed this practice. But the fact that Schaeffler is now buried under a mountain of debt should discourage imitators.
- Debt accordions
These provisions in some loans let the issuer expand them later - like an accordion - to let in new investors. During the crunch, subordinated investors in a couple of leveraged companies got a grim ultimatum: Slide into the accordion on the company's senior debt and take a big haircut, or end up with peanuts if the company goes bust. Senior lenders, meanwhile, faced the prospect of fighting for scraps with the newcomers if things really went wrong. Accordion facilities are thus as painful to the pocket as their musical counterparts are to the ear.
- Ponzi schemes
Take money from Peter. Wait a bit, then take money from Paul. Use Paul's money to pay back Peter, proclaim your stupendous rate of return, rinse and repeat. The Ponzi scheme, named after the 1920s scam artist Charles Ponzi, reached new heights in 2008 with the discovery of $50 billion in alleged fraud by the financier Bernard Madoff, who somehow duped the world's biggest and most conservative investment banks. This kind of fraud is unlikely to die out in 2009. But the epithet itself might. Investors will now be looking out for the "Madoff scheme" instead.
In This Picturesque Village, the Rent Hasn't Been Raised Since 1520
Every day, retired florist Rita Wunderle prays for the souls of bankers. Despite daily headlines about banker-fueled economic crisis and an alleged $50 billion Ponzi scheme, her 145 neighbors pray, too. Mrs. Wunderle lives in the Fuggerei, a Roman Catholic housing settlement for the poor that Jakob Fugger "The Rich" built in this southern German city nearly 500 years ago. Praying for Mr. Fugger and his descendants to enter the Pearly Gates is a condition for living here, at an annual rent of 1 Rhein guilder, the same as in 1520. In today's money, that's 88 euro cents, or about $1.23.
Jakob the Rich was Wall Street long before it existed. He minted coins for the Vatican, bankrolled the Holy Roman Empire and helped steer Europe's spice trade in the early 16th century to become one of the wealthiest and most powerful financiers in history. He left more than seven tons of gold to his successors -- and a good deed. Much of the Fugger business empire crumbled over the next 150 years, battered by wars and soured credits. But the walled Fuggerei, with its picturesque lanes and seven gates in the heart of this onetime European banking capital, still stands. As in medieval times, the Fuggerei enclave is locked at night. Residents take turns manning the gatehouse to open up for late stragglers and fine them (between 50 cents and a euro, depending on the hour). They promise to say three prayers -- the Lord's Prayer, Hail Mary and the Apostles' Creed -- each day to boost the celestial ambitions of the Fuggers. To remind them, the family built a church inside the entrance gate. "I don't exactly have the best thoughts when it comes to bankers," says Mrs. Wunderle. She came to the Fuggerei with her husband last year after a bank told them they had to leave their rented home and flower shop because of a change in ownership. The Fuggers, though, are an exception for whom she says she prays heartily, though not on her knees.
"Lots of people have bad knees here," explains Mrs. Wunderle, 71 years old. "Sometimes I forget to pray. But some days I pray extra if there's nothing good on television," says 74-year-old Barbara Jerger. She arrived at the Fuggerei nearly a decade ago, having left Romania in 1990 and having worked in Germany for a time as a cleaning lady. Every 500- to 700-square-foot apartment has its own entrance leading to a lane or a courtyard, giving it the feel of a house. The buildings are pretty, the architecture elaborate. The handles on the iron doorbells have different shapes such as a cloverleaf and a pine cone -- a holdover from when there was less lighting and residents needed help at night to recognize their doors. Many of the residents are widows without savings. They say their meager pensions wouldn't get them through the month if they had to pay several hundred euros in rent. Getting an apartment in the Fuggerei five years ago, after having two heart attacks, was like "winning the lottery," says 66-year-old Maria Mayer, who is divorced.
Jakob the Rich hailed from a weaver-turned-merchant family that was already wealthy by the time he was born in 1459. He built an even bigger fortune running a silver-mining operation and a major trade route to Venice. He also turned to investment banking and was wildly successful, securing the Vatican as a client and financing a trade expedition to India. By the early 16th century, he had become the chief financial backer of the Habsburg family, whose members sat on thrones across Europe. He bankrolled the election of Spain's King Charles V as Emperor of the Holy Roman Empire in 1519. The connections were good for business. The wheeler-dealer from once-sleepy Augsburg was reputed to be the richest man in Europe. Financial success brought Jakob the Rich critics, not the least of them Martin Luther, the Protestant reformer. Luther pointedly asked whether it was God's will that so much wealth and influence be concentrated in one person. At the time, many people believed that simply charging interest constituted immoral "usury."
So around 1520, the controversial banker set up a charitable trust in the name of Augsburg's local St. Ulrich. Jakob Fugger allocated a bit more than 10,000 guilders in start-up money -- a sliver of his fortune -- to build a settlement for the indigent. Within a few years, 52 houses with 106 apartment units had been constructed. A steady stream of out-of-luck painters, printers and other laborers began passing through the Fuggerei's gates with their families. Franz Mozart, a bricklayer and the great-grandfather of the composer Wolfgang Amadeus Mozart, lived here in the late 17th century. The Fuggers still own several castles and other businesses, including a residual stake in a small private bank that carries the family name. But they aren't nearly as rich as they once were. After reaching its zenith in the mid-16th century, the Fugger banking empire was undermined by wars and the repeated bankruptcies of the Spanish state.
The charitable trust, however, has been careful in its investments. Most revenue for the upkeep of the Fuggerei comes from old forestry holdings, which became a staple investment for the Fuggers in the late 17th century after they got burned on higher-yielding but riskier financing ventures. Over the past 200 years, the trust's annual returns after inflation have ranged from 2% in a good year to 0.5% in a bad year, estimates Wolf-Dietrich Graf von Hundt, the administrator. The trust also has a few local real-estate holdings but no exposure to U.S. subprime mortgages, Icelandic savings accounts or New York investment funds that have undone other charities.
Renovations are slow. Some apartments still don't have central heating or showers. But there was enough money to repair the Fuggerei after marauding Swedish troops and their horses took up temporary residence in the 17th century, and after Allied bombing raids damaged most of the buildings in World War II. The lesson isn't lost on Alexander Fugger-Babenhausen, a descendant of Jakob the Rich. He expects soon to replace his father -- Prince Hubertus Fugger-Babenhausen -- on the Fuggerei trust's board. The 27-year-old Harvard graduate recently returned to Augsburg after stints in London with Morgan Stanley and private-equity firm TPG. He says he lost a small bundle on Washington Mutual shares along the way. The recent financial meltdown has been "a good reality check," says the younger Mr. Fugger-Babenhausen, over buttered pretzels at his family's hilltop castle, itself burned and pillaged over the centuries. "I'm not thinking I can reinvent the wheel."
Germans take the credit for crisis jokes
Turbulent economic times have led to comedians flooding the market with jokes capturing the zeitgeist of the credit crunch. German satirists are different: they claim they saw it all coming and have been lampooning the banking system for years. "We have frequently made a lot of the crisis in capitalism," Leo Fischer the editor-in-chief of Titanic, the best-known German satirical magazine, said yesterday. As early as April this year, five months before the global crisis intensified in mid-September with the collapse of Lehman Brothers, Titanicwas joking about worthless share options, suicidal bankers and bank robbers finding nothing worth stealing. Back in 2006, Titanic portrayed the capitalist system as a rabid dog, offering tips on how to control it. Achim Frenz, director of Frankfurt's Museum of Comic Art, says only the scale of the crisis had taken German joke-writers aback. Mr Frenz, who repeatedly explains to foreigners that Germans do have a sense of humour, says satirists have to be ahead of the curve. "It is their job to put the finger in the wound so it hurts - and say that it will create problems."
Like financial markets, joke production has become global since the collapse of Lehman Brothers. The internet is full of examples: "What do you call a Lehman banker? Waiter!" "What is the capital of Iceland? About five euros." "What is the difference between a banker and a pizza? A pizza can feed a family." Finding a distinctly German strand of wit is harder. Titanic is one exception. Its January 2009 edition has a deliberately controversial cover picture of Hitler headlined: "How we will master the crisis." The crisis has not been a big theme on the Schmidt & Pocher television comedy show broadcast by ARD, the public broadcaster, although co-host Harald Schmidt last week joked of Christmas returning to its Christian roots with "ever more families celebrating again in the stable." Other German humour-mongers, however, fit the pattern. Achim Greser - half of the "Greser & Lenz" partnership that produces cartoons for the Frankfurter Allgemeine Zeitung - says his style is "basically pessimistic . . . so in that respect you could perhaps claim we saw it all in advance." One example would be a 2001 cartoon of a father berating his son who wants to become banker, insisting he get a "proper education" in the arts world. Next month, an exhibition of Greser & Lenz cartoons opens at Frankfurt's comic arts museum. It has been entitled "Hooray, the crisis is over!" Note to readers: the title is a joke.
GM Gets Another Boost as GMAC Bank Approval Helps Preserve Loan Access
General Motors Corp., days from receiving its first installment of at least $9.4 billion in U.S. aid, won another victory with the Federal Reserve’s approval of lender GMAC LLC’s bid to become a bank holding company. GMAC’s shift to a bank eases the threat of a default that threatened to dry up credit for GM dealers who used the company to finance about three-quarters of their inventory. GMAC also handled loans for about 35 percent of GM’s 2007 retail buyers. "This has a positive impact on GM and also the auto market," Tatsuya Mizuno, director of Fitch Ratings in Tokyo, said today in a Bloomberg Television interview. "The problem is how they can prepare for next-generation vehicles, to restore their competitiveness."
The Fed used emergency powers on Dec. 24 to grant GMAC’s bank conversion, citing turmoil in financial markets and the potential impact on Detroit-based GM as the biggest U.S. automaker taps emergency federal loans to stay in business. That decision was the second lift for GM in less than a week, after President George W. Bush said Dec. 19 that GM and Cerberus Capital Management LP’s Chrysler LLC were eligible for U.S. aid to help them avoid running out of cash by early next year, threatening a collapse that would cost millions of jobs. GM is due an initial $4 billion in loans by Dec. 29, and $5.4 billion more by Jan. 16. That second payment will come before the inauguration of President-elect Barack Obama, who will inherit responsibility for Bush’s rescue effort next month as GM and Chrysler craft permanent survival plans by March 31. Chrysler will get $4 billion.
GM, which owns 49 percent of GMAC, and Cerberus, which leads the group holding the rest, will give up control of the Detroit-based lender to comply with federal rules on who can own banks. Converting GMAC to a bank "would benefit the public by strengthening GMAC’s ability to fund the purchases of vehicles manufactured by GM," the Fed said in its order. GMAC was shut out of credit markets this year after piling up $7.9 billion in losses dating from the middle of 2007. "We’re clearly very pleased," said GMAC spokeswoman Gina Proia. "We think this is a significant positive step in GMAC’s history." GM spokesman Greg Martin said the automaker was pleased, while Cerberus spokesman Peter Duda declined to comment. GM gained 25 cents, or 8.3 percent, to $3.25 on Dec. 24 in New York Stock Exchange composite trading. The shares have plummeted 87 percent this year, worst among the 30 companies on the Dow Jones Industrial Average.
GM owned all of GMAC until it sold a 51 percent stake in 2006 to a group led by Cerberus, the New York-based private equity firm. As part of the Fed agreement, GM will reduce its ownership in GMAC to less than 10 percent and transfer what remains to an independent trust, which will dispose of the stakes within three years. Cerberus funds that hold GMAC stakes will distribute them to their investors, the Fed said. Cerberus’s voting control will be cut to less than 15 percent, or 33 percent of GMAC’s total equity. None of the recipients will have more than 5 percent of the votes or 7.5 percent of the total equity. The Fed also required Cerberus to sever ties between its people and GMAC. GMAC has been unable to raise cash by selling bonds backed by auto loans since May. The gap, or spread, on auto asset- backed debt relative to benchmark interest rates has soared to record highs as concerns mount that cash-strapped households won’t be able to pay bills.
Fed approval of GMAC as a bank "is a big relief for GM dealers," said Martin Nesmith, a member of GM’s National Dealer Council, who has three outlets in Georgia selling Chevrolets, Buicks and Pontiacs. GMAC cut financing for consumers by about 90 percent and banks aren’t taking up the slack, NeSmith said. He has said previously that a GMAC default might wipe out as many as 40 percent of GM’s dealers. GM’s U.S. sales tumbled 22 percent this year through November, which the automaker blamed in part on buyers’ dwindling access to credit.
Ilargi: Take the last sentence of this article, and then think of Naomi Klein’s Shock Doctrine: "One lesson that I have clearly learned," said Mr. Paulson, sitting beneath his Chinese watercolor. "You don’t get dramatic change, or reform, or action unless there is a crisis."
Dollar Shift: Chinese Pockets Filled as Americans’ Emptied
In March 2005, a low-key Princeton economist who had become a Federal Reserve governor coined a novel theory to explain the growing tendency of Americans to borrow from foreigners, particularly the Chinese, to finance their heavy spending. The problem, he said, was not that Americans spend too much, but that foreigners save too much. The Chinese have piled up so much excess savings that they lend money to the United States at low rates, underwriting American consumption. This colossal credit cycle could not last forever, he said. But in a global economy, the transfer of Chinese money to America was a market phenomenon that would take years, even a decade, to work itself out. For now, he said, "we probably have little choice except to be patient."
Today, the dependence of the United States on Chinese money looks less benign. And the economist who proposed the theory, Ben S. Bernanke, is dealing with the consequences, having been promoted to chairman of the Fed in 2006, as these cross-border money flows were reaching stratospheric levels. In the past decade, China has invested upward of $1 trillion, mostly earnings from manufacturing exports, into American government bonds and government-backed mortgage debt. That has lowered interest rates and helped fuel a historic consumption binge and housing bubble in the United States. China, some economists say, lulled American consumers, and their leaders, into complacency about their spendthrift ways.
"This was a blinking red light," said Kenneth S. Rogoff, a professor of economics at Harvard and a former chief economist at the International Monetary Fund. "We should have reacted to it." In hindsight, many economists say, the United States should have recognized that borrowing from abroad for consumption and deficit spending at home was not a formula for economic success. Even as that weakness is becoming more widely recognized, however, the United States is likely to be more addicted than ever to foreign creditors to finance record government spending to revive the broken economy. To be sure, there were few ready remedies. Some critics argue that the United States could have pushed Beijing harder to abandon its policy of keeping the value of its currency weak — a policy that made its exports less expensive and helped turn it into the world’s leading manufacturing power.
If China had allowed its currency to float according to market demand in the past decade, its export growth probably would have moderated. And it would not have acquired the same vast hoard of dollars to invest abroad. Others say the Federal Reserve and the Treasury Department should have seen the Chinese lending for what it was: a giant stimulus to the American economy, not unlike interest rate cuts by the Fed. These critics say the Fed under Alan Greenspan contributed to the creation of the housing bubble by leaving interest rates too low for too long, even as Chinese investment further stoked an easy-money economy. The Fed should have cut interest rates less in the middle of this decade, they say, and started raising them sooner, to help reduce speculation in real estate.
Today, with the wreckage around him, Mr. Bernanke said he regretted that more was not done to regulate financial institutions and mortgage providers, which might have prevented the flood of investment, including that from China, from being so badly used. But the Fed’s role in regulation is limited to banks. And stricter regulation by itself would not have been enough, he insisted. "Achieving a better balance of international capital flows early on could have significantly reduced the risks to the financial system," Mr. Bernanke said in an interview in his office overlooking the Washington Mall. "However," he continued, "this could only have been done through international cooperation, not by the United States alone. The problem was recognized, but sufficient international cooperation was not forthcoming."
The inaction was because of a range of factors, political and economic. By the yardsticks that appeared to matter most — prosperity and growth — the relationship between China and the United States also seemed to be paying off for both countries. Neither had a strong incentive to break an addiction: China to strong export growth and financial stability; the United States to cheap imports and low-cost foreign loans. In Washington, China was treated as a threat by some people, but mostly because it lured away manufacturing jobs. Others argued that China’s heavy lending to this country was risky because Chinese leaders could decide to withdraw money at a moment’s notice, creating a panicky run on the dollar. Mr. Bernanke viewed such international investment flows through a different lens. He argued that Chinese invested savings abroad because consumers in China did not have enough confidence to spend. Changing that situation would take years, and did not amount to a pressing problem for the Americans.
"The global savings glut story did us a collective disservice," said Edwin M. Truman, a former Fed and Treasury official. "It created the idea that the world was doing it to us and we couldn’t do anything about it." But Mr. Bernanke’s theory fit the prevailing hands-off, pro-market ideology of recent years. Mr. Greenspan and the Bush administration treated the record American trade deficit and heavy foreign borrowing as an abstract threat, not an urgent problem. Mr. Bernanke, after he took charge of the Fed, warned that the imbalances between the countries were growing more serious. By then, however, it was too late to do much about them. And the White House still regarded imbalances as an arcane subject best left to economists.
By itself, money from China is not a bad thing. As American officials like to note, it speaks to the attractiveness of the United States as a destination for foreign investment. In the 19th century, the United States built its railroads with capital borrowed from the British. In the past decade, China arguably enabled an American boom. Low-cost Chinese goods helped keep a lid on inflation, while the flood of Chinese investment helped the government finance mortgages and a public debt of close to $11 trillion. But Americans did not use the lower-cost money afforded by Chinese investment to build a 21st-century equivalent of the railroads. Instead, the government engaged in a costly war in Iraq, and consumers used loose credit to buy sport utility vehicles and larger homes.
Banks and investors, eagerly seeking higher interest rates in this easy-money environment, created risky new securities like collateralized debt obligations. "Nobody wanted to get off this drug," said Senator Lindsey Graham, the South Carolina Republican who pushed legislation to punish China by imposing stiff tariffs. "Their drug was an endless line of customers for made-in-China products. Our drug was the Chinese products and cash." Mr. Graham said he understood the addiction: he was speaking by phone from a Wal-Mart store in Anderson, S.C., where he was Christmas shopping in aisles lined with items from China.
The United States has been here before. In the 1980s, it ran heavy trade deficits with Japan, which recycled some of its trading profits into American government bonds. At that time, the deficits were viewed as a grave threat to America’s economic might. Action took the form of a 1985 agreement known as the Plaza Accord. The world’s major economies intervened in currency markets to drive down the value of the dollar and drive up the Japanese yen. The arrangement did slow the growth of the trade deficit for a time. But economists blamed the sharp revaluation of the Japanese yen for halting Japan’s rapid growth. The lesson of the Plaza Accord was not lost on China, which at that time was just emerging as an export power. China tied itself even more tightly to the United States than did Japan. In 1995, it devalued its currency and set a firm exchange rate of roughly 8.3 to the dollar, a level that remained fixed for a decade.
During the Asian financial crisis of 1997-98, China clung firmly to its currency policy, earning praise from the Clinton administration for helping check the spiral of devaluation sweeping Asia. Its low wages attracted hundreds of billions of dollars in foreign investment. By the early part of this decade, the United States was importing huge amounts of Chinese-made goods — toys, shoes, flat-screen televisions and auto parts — while selling much less to China in return. "For consumers, this was a net benefit because of the availability of cheaper goods," said Laurence H. Meyer, a former Fed governor. "There’s no question that China put downward pressure on inflation rates." But in classical economics, that trade gap could not have persisted for long without bankrupting the American economy. Except that China recycled its trade profits right back into the United States.
It did so to protect its own interests. China kept its banks under tight state control and its currency on a short leash to ensure financial stability. It required companies and individuals to save in the state-run banking system most foreign currency — primarily dollars — that they earned from foreign trade and investment. As foreign trade surged, this hoard of dollars became enormous. In 2000, the reserves were less than $200 billion; today they are about $2 trillion. Chinese leaders chose to park the bulk of that in safe securities backed by the American government, including Treasury bonds and the debt of Fannie Mae and Freddie Mac, which had implicit government backing. This not only allowed the United States to continue to finance its trade deficit, but, by creating greater demand for United States securities, it also helped push interest rates below where they would otherwise have been. For years, China’s government was eager to buy American debt at yields many in the private sector felt were too low.
This financial and trade embrace between the United States and China grew so tight that Niall Ferguson, a financial historian, has dubbed the two countries Chimerica. Being attached at the hip was not entirely comfortable for either side, though for widely differing reasons. In the United States, more people worried about cheap Chinese goods than cheap Chinese loans. By 2003, China’s trade surplus with the United States was ballooning, and lawmakers in Congress were restive. Senator Graham and Senator Charles E. Schumer, Democrat of New York, introduced a bill threatening to impose a 27 percent duty on Chinese goods. "We had a moment where we caught everyone’s attention: the White House and China," Mr. Graham recalled. At the People’s Bank of China, the central bank, a consensus was also emerging in late 2004: China should break its tight link to the dollar, which would make its exports more expensive. Yu Yongding, a leading economic adviser, pressed the case. The American trade and budget deficits were not sustainable, he warned.
China was wrong to keep its currency artificially depressed and depend too much on selling cheap goods. Proponents of revaluation in China argued that the country’s currency policies denied the fruits of prosperity to Chinese consumers. Beijing was investing their savings in low-yielding American government securities. And with a weak currency, they said, Chinese could not afford many imported goods. The central bank’s English-speaking governor, Zhou Xiaochuan, was among those who favored a sizable revaluation. But when Beijing acted to amend its currency policy in 2005, under heavy pressure from Congress and the White House, it moved cautiously. The renminbi was allowed to climb only 2 percent. The Communist Party opted for only incremental adjustments to its economic model after a decade of fast growth. Little changed: China’s exports kept soaring and investment poured into steel mills and garment factories.
But American officials eased the pressure. They decided to put more emphasis on urging Chinese consumers to spend more of their savings, which they hoped would eventually bring the two economies into better balance. On a tour of China, John W. Snow, the Treasury secretary at the time, even urged the Chinese to start using credit cards. China kicked off its own campaign to encourage domestic consumption, which it hoped would provide a new source. But Chinese save with the same zeal that, until recently, Americans spent. Shorn of the social safety net of the old Communist state, they squirrel away money to pay for hospital visits, housing or retirement. This accounts for the savings glut identified by Mr. Bernanke. Privately, Chinese officials confided to visiting Americans that the effort was not achieving much. "It is sometimes hard to change successful models," said Robert B. Zoellick, who negotiated with the Chinese as a deputy secretary of state. "It is prototypically American to say, ‘This worked well, but now you’ve got to change it.’ "
In Washington, some critics say too little was done. A former Treasury official, Timothy D. Adams, tried to get the I.M.F. to act as a watchdog for currency manipulation by China, which would have subjected Beijing to more global pressure. Yet when Mr. Snow was succeeded as Treasury secretary by Henry M. Paulson Jr. in 2006, the I.M.F. was sidelined, according to several officials, and Mr. Paulson took command of China policy. He was not shy about his credentials. As an investment banker with Goldman Sachs, Mr. Paulson made 70 trips to China. In his office hangs a watercolor depicting the hometown of Zhu Rongji, a forceful former prime minister. "I pushed very hard on currency because I believed it was important for China to get to a market-determined currency," Mr. Paulson said in an interview. But he conceded he did not get what he wanted.
In late 2006, Mr. Paulson invited Mr. Bernanke to accompany him to Beijing. Mr. Bernanke used the occasion to deliver a blunt speech to the Chinese Academy of Social Sciences, in which he advised the Chinese to reorient their economy and revalue their currency. At the last minute, however, Mr. Bernanke deleted a reference to the exchange rate being an "effective subsidy" for Chinese exports, out of fear that it could be used as a pretext for a trade lawsuit against China. Critics detected a pattern. They noted that in its twice-yearly reports to Congress about trading partners, the Treasury Department had never branded China a currency manipulator. "We’re tiptoeing around, desperately trying not to irritate or offend the Chinese," said Thea M. Lee, public policy director of the A.F.L.-C.I.O. "But to get concrete results, you have to be confrontational."
For China, too, this crisis has been a time of reckoning. Americans are buying fewer Chinese DVD players and microwave ovens. Trade is collapsing, and thousands of workers are losing their jobs. Chinese leaders are terrified of social unrest. Having allowed the renminbi to rise a little after 2005, the Chinese government is now under intense pressure domestically to reverse course and depreciate it. China’s fortunes remain tethered to those of the United States. And the reverse is equally true. In a glassed-in room in a nondescript office building in Washington, the Treasury conducts nearly daily auctions of billions of dollars’ worth of government bonds. An old Army helmet sits on a shelf: as a lark, Treasury officials have been known to strap it on while they monitor incoming bids. For the past five years, China has been one of the most prolific bidders. It holds $652 billion in Treasury debt, up from $459 billion a year ago. Add in its Fannie Mae bonds and other holdings, and analysts figure China owns $1 of every $10 of America’s public debt.
The Treasury is conducting more auctions than ever to finance its $700 billion bailout of the banks. Still more will be needed to pay for the incoming Obama administration’s stimulus package. The United States, economists say, will depend on the Chinese to keep buying that debt, perpetuating the American habit. Even so, Mr. Paulson said he viewed the debate over global imbalances as hopelessly academic. He expressed doubt that Mr. Bernanke or anyone else could have solved the problem as it was germinating. "One lesson that I have clearly learned," said Mr. Paulson, sitting beneath his Chinese watercolor. "You don’t get dramatic change, or reform, or action unless there is a crisis."
World faces "total" financial meltdown: Bank of Spain chief
The governor of the Bank of Spain on Sunday issued a bleak assessment of the economic crisis, warning that the world faced a "total" financial meltdown unseen since the Great Depression. "The lack of confidence is total," Miguel Angel Fernandez Ordonez said in an interview with Spain's El Pais daily. "The inter-bank (lending) market is not functioning and this is generating vicious cycles: consumers are not consuming, businessmen are not taking on workers, investors are not investing and the banks are not lending. "There is an almost total paralysis from which no-one is escaping," he said, adding that any recovery -- pencilled in by optimists for the end of 2009 and the start of 2010 -- could be delayed if confidence is not restored.
Ordonez recognised that falling oil prices and lower taxes could kick-start a faster-than-anticipated recovery, but warned that a deepening cycle of falling consumer demand, rising unemployment and an ongoing lending squeeze could not be ruled out. "This is the worst financial crisis since the Great Depression" of 1929, he added. Ordonez said the European Central Bank, of which he is a governing council member, would cut interest rates in January if inflation expectations went much below two percent. "If, among other variables, we observe that inflation expectations go much below two percent, it's logical that we will lower rates."
Regarding the dire situation in the United States, Ordonez said he backed the decision by the US Federal Reserve to cut interest rates almost to zero in the face of profound deflation fears. Central banks are seeking to jumpstart movements on crucial interbank money markets that froze after the US market for high-risk, or subprime mortgages collapsed in mid 2007, and locked tighter after the US investment bank Lehman Brothers declared bankruptcy in mid September. Interbank markets are a key link in the chain which provides credit to businesses and households.
Canada’s governments to back ABCP deal with $4.45 billion
The federal government, in conjunction with three provinces and other parties, will provide a total of $4.45 billion in financial backstops to rescue a restructuring plan for a massive slice of this country's commercial paper market. An investor committee responsible for restructuring $32 billion worth of non-bank asset-backed commercial paper revealed those key details last night, nearly one week after Ottawa struck a deal with Ontario, Quebec and Alberta to prop up the problem-plagued retooling.
The exact amount of the "senior funding facility" was not disclosed at that time. The investor committee initially told Ottawa that it needed $9.5 billion in further guarantees to salvage the restructuring after foreign banks threatened to walk away from the deal. The committee now says that Ottawa and the provinces, together with certain participants in the restructuring, will provide $4.45 billion of additional margin facilities to support its restructuring plan. That means margin facilities for the plan now total $17.82 billion.
"We are obviously delighted with this support from the governments of Canada, Quebec, Ontario and Alberta as well as from the asset providers and the Canadian banks. We are equally pleased to have crossed a major hurdle in completing the restructuring plan," said Purdy Crawford, chair of the investors committee, in a release. "... As a result of these latest developments, we can begin the process of completing this restructuring with the posting of documents today." Next steps will occur in early January when the committee seeks court approval of the closing process, which could finally mark the end of its 16-month restructuring ordeal.
Canadian non-bank ABCP, a type of short-term commercial debt, has been in crisis since seizing up in August 2007. The market experienced a dearth of buyers over worries that American subprime mortgages were among the assets backing the securities. The investor committee drafted a restructuring plan last winter that proposes to convert the short-term securities into longer-term investments with maturities of up to nine years. While the bulk of the frozen notes is held by big institutional investors, about 2,000 retail investors are also affected by the restructuring plan, known as the Montreal Accord. The retail group represents about $400 million or 1 per cent of the total ABCP outstanding. Most of them have struck separate bailout deals with their brokers, but getting their money back hinges on the completion of the main restructuring.
Boxing Day Bailout Blast: madness sweeps nation
Where have all the capitalists gone, and if there's a new system governing corporate North America, I want to be part of it with a bailout of my own sinking pension plan. My RRSP statements show me down about 38% and I don't have to look far to find others in my shoes. So where's our bailout? Why don't we get money to replace lost savings under this new corporate mantra of bailoutism, which seems to be replacing capitalism? The lineup to the office of Jim Flaherty, the Finance Minister, resembles the soup line at the local mission, only the have-nots are replaced with the must-haves. Everyone from bankers to brokers, auto magnates, pension-fund managers and forestry tycoons are tripping over themselves in a bid to get their form of government largesse. Think of it as the Boxing Day Bailout Blast, Canada's newest pastime.
The latest to the taxpayer trough is the Pan-Canadian Investors Committee, which at press time appears to have snookered the federal, Quebec, Ontario and Alberta governments for a credit line worth $3.5-billion to backstop the frozen $32-billion asset-backed commercial-paper market. That's much less than the $9.5-billion first sought, but certainly not chump change. Let's call this what it really is, a bailout of the principal players in this saga-- National Bank of Canada, Caisse de depot et placement du Quebec, Canaccord Capital Corp. and the country's credit unions. They are the organizations that will be hurt the most if this market fails. But don't kid yourself, the neatly coined legal-immunity releases that go with this stinky deal mean the government financing effectively backstops a litigation bailout of Canada's investment dealers and financial institutions, which manufactured and sold investments they didn't understand -- or perhaps did, but didn't disclose details -- to unsuspecting investors.
We'll never know, though, because the court-sanctioned legal-immunity trump card means no one, except investors, will be held financially accountable for the making of this investment cesspool. This saga isn't over. We'll see in 2010, when this recession is expected to end and the moratorium on collateral calls by foreign financial institutions on the loans supporting the paper terminates. That's when we will find out if this ABCP pig still has wings and whether or not governments have had their pockets picked by foreign banks for billions in taxpayers' money. Then there is the U. S. financial system, where the government is propping up the likes of AIG Inc., Fannie Mae and Freddie Macand investing billions more in others. In Canada, the bailouts in our financial system are more subtle and come mainly in the form of "liquidity measures." The federal government, through Canada Mortgage and Housing Corp., has plans to buy as much as $75-billion in mortgages from banks. Ottawa is also guaranteeing $200-billion of new borrowing by banks in international markets, albeit for a fee.
I won't even begin to discuss the automakers, which have been running around like Chicken Little claiming Armageddon if they don't get their $4-billion booty from federal-government coffers. Now there's the forestry industry, which wants a $600-million handout. Who is next, Santa Claus and his elves or Robin Hood? It's Keynesian madness run amok. Won't someone stand up and be a capitalist for at least 10 minutes? In the 1930s, U. S. businessmen jumped off buildings when things got bad, which I'll grant you is harsh, but it places the blame where it lies. In 2009, they go cap-in-hand to government to atone for their business-decision-making sins, and our politicians are dumb enough to absolve them. In the rush for taxpayer cash, we are ignoring the system we have in place to deal with overcapacity in the marketplace and inefficient, bloated companies that make bad decisions. It is called insolvency and restructuring -- known in Canada as CCAA and in the United States as Chapter 11, names that refer to the underlying laws behind them.
They work well fixing broken businesses, allowing them to shed debt, recapitalize, restructure and return to the marketplace, albeit often in a shrunken form, but healthier. More important -- the ABCP anomaly aside -- government isn't traditionally called upon to provide the kick-start money to get the company moving again. That comes from capitalists looking for profit, not politicians looking for votes. Rather than let commercial nature takes its course and administer a dose of sour medicine to the failing health of some current industries and businesses, politicians have elected to solve the wounds with taxpayers' money. Meanwhile, average Canadians don't get their pension nests feathered because governments are too busy spending our money bailing out so-called capitalists and greedy executives whose questionable decisions got us into this mess in the first place.
Think 2008 was bad? Just wait, economists say
It's going to get worse. As bad as the past few months were, even the rosiest of economic forecasts shows on average that Canadians will get poorer in 2009 and many – perhaps as many as 200,000 additional workers – will lose their jobs as the economic recession deepens. The economic tsunami that was well below the surface as 2008 began hit Canada's shores with a crash in the fall and is only now washing deeper inshore, swallowing an economy that once appeared impregnable – having withstood both the Asian financial crisis a decade ago and the 9/11 fallout in the United States. Prime Minister Stephen Harper described it best in a recent television interview in which he perhaps tellingly did not reject out of hand the possibility of a depression – a deep economic downturn in which output shrinks by 10 per cent or more. "I've never seen such uncertainty ... I'm very worried about the Canadian economy," he said, before explaining that governments had learned survival lessons from the 1930s depression that they are applying to the current situation.
But as Merrill Lynch's Canadian chief economist David Wolf put it: "Given the events of the past few months how can you rule anything out? Even us bears have been surprised at just how aggressively things have unravelled." A key lesson of the Great Depression – and a reason economists believe the damage can be contained shy of D-terrain – is that governments must not sit idly by as the cancer spreads. The U.S., Europe, China and others have already stepped to the plate with Ruthian stimulus packages worth trillions of dollars in total, and Harper has suggested spending measures in the $20-billion range are being prepared for the Jan. 27 budget, at a price of a huge deficit. As well, Ottawa and Ontario announced last Saturday that $4 billion will go into jump-starting the battered Canadian auto sector, with more likely to come as part of a North American industry restructuring.
The measures aren't necessarily going to be popular with Canadians, although they are likely a minimum condition for preventing a Liberal-NDP coalition, with the backing of the Bloc Quebecois, from seeking to dump the government once Parliament resumes in late January. A Canadian Press Harris/Decima poll conducted in mid-month found only 39 per cent support for stimulus spending if it means Ottawa will go into deficit. For policy makers, the deficit ship has long since sailed. Even sober-minded economists don't see much to shout about in keeping government books in the black if it means the rest of the country sinks. If everyone else is too scared to spend their last dime, governments had better, they reason. "Unfortunately it's necessary. Things could be very ugly if policy makers don't step in to support the economy, in certain cases specific industries," said Bank of Montreal deputy chief economist Douglas Porter.
"It still going to be the weakest year since `91," agreed Dale Orr, managing director of IHS Global Insight. "The second half will be better than the first, thank goodness, but we'll need another year after that before we're back to the economy returning to potential." Orr's analysis is shared almost universally among private sector economists, who have been busily revising even their bleakest forecasts in the past few weeks. Last week, the Bank of Nova Scotia set the standard for low with a projection that the economy would shrink 1.2 per cent in 2009. A day later the Bank of Montreal did it one notch better at minus 1.3 per cent. The shocker, however, is that most expect a seldom considered statistic called nominal gross domestic product – which measures the value of what the country produces – to become headline news next year as the wealth-effect of high commodity prices over the last six years gets reversed big time with oil in the tank and prices of minerals, grains, coal and other commodities also in decline.
Many are expecting nominal GDP to shrink by as much as three per cent in 2009, bringing lower corporate profits, lower government revenues and most importantly, lower wages for Canadians. "That's a shrinking of the economic pie the likes of which we really haven't seen for generations," said Wolf. The latest projections also predict Canada's unemployment rate will rise to about eight per cent, from the current 6.3 per cent, resulting in something Canadians also haven't seen in a generation, outright job losses of 200,000 from the recession's peak to trough. While the jobless rise in 2009 will hurt, it's still a far cry from the last two recessions. Unemployment hit 13 per cent in the 1980-81 decline, when industrial North America – mainly the steel and auto sectors – went through a painful restructuring. In the early 1990s the recession hurt real estate and retail sectors and pushed the jobless rate to 10 per cent. How do we get ourselves out of this mess? A recovery is coming, economists say, and it's likely from a combination of several factors.
Surely some good must come from the trillions of dollars being poured into the economy from governments around the world, they figure. The other bright spot – although it's cold comfort to Canada's oilpatch – comes from cheap oil, which will cut business costs and leave more money in the pockets of consumers around the world. And then there's that fickle measure called consumer confidence, which has been dining on despair for months and sits at its lowest level in more than a quarter century. Orr believes much of the loss of trust and confidence among investors and consumers stems from global markets' stomach-churning bungee jump since mid-September.
In Canada, the stock market has lost more than 40 per cent of its value since a mid-June record high, wiping out hundreds of billions of dollars of stock value and squeezing the investments of Canadians held in pension plans, stocks and mutual funds. That has made people feel poorer and tighten their wallets and companies from cutting investments and expansion plans. "Everybody is gloom and doom now, but things could turn around quickly," Orr says. "Everybody is now waiting for conformation we're at the bottom and if you can get a week or two of really strong markets, there will be a piling on phenomenon and people won't be able to wait to get back in." But he hurries to add, it might not be wise to bank on it happening in 2009.
Get Ready for a Lost Decade
That statement is a bit of a false promise, since there was only one Great Depression, and many, many steps were taken and not taken, with no chance to rerun the experiment over and over to figure out what worked, or would have worked, and what didn't. Letting hundreds of banks collapse, destroying savings and confidence, is one mistake we won't make again. But many want to insist, without evidence, that more government spending would have ended the depression. That's the direction the Obama administration is taking.
Others say government did not do enough to restore business confidence, or did too much to damage it, piling on taxes, regulation and labor unions. This at least is firmer ground. Plenty of evidence from history shows that actions hostile to business tend to be related to an absence of prosperity. But more important than these talismanic assurances about what we've learned from the Great Depression is the mistake in assuming that, even if we had a coherent view of what should be done, coherent polices would therefore be implemented. This has little relation to how policy is made in a democracy.
Policy is always bad to a degree, but long periods of prosperity tend to be self-reinforcing since powerful interests are born with the means and motive to preserve the status quo. That status quo may really be a contributor to prosperity, such as regulatory restraint and moderate tax rates. That status quo may in some respects be ill-advised, such as excessive subsidy to housing debt. But once prosperity blows up, the quasi-virtuous policy circle becomes an unvirtuous one as new interest groups come to the fore to exploit an appetite, previously weak, to impose their costly or vindictive wish lists. And even well-meaning policy gets twisted and rendered incoherent.
It's already happening to our banking bailout. If injecting government capital to improve confidence in banks was a good idea, it did nothing to improve the banks' own confidence in their borrowers. Yet now that banks have government capital, they're being pressed to lend to politically favored constituents regardless of their own judgment about whether the borrower is good for the money. Or take the gathering auto bailout: Taxpayer dollars are being thrown at Detroit auto makers to make them "viable," even as Congress imposes new fuel-mileage mandates requiring them to incur tens of billions in costs unlikely to be recouped from their customers -- the definition of "nonviable."
Mr. Obama's troops palpitate with excitement at the prospect of $1 trillion in "stimulus," though any net benefit to the economy likely will be incidental. Al Gore has thrown out the window any unpopular carbon taxes in favor of direct subsidies to his green energy investments. He sees the moment for what it is -- alarm about global warming has degenerated into a pretext. Billions will be diverted from useful purposes to create "green jobs" that deliver no meaningful impact on climate or the accumulation of atmospheric carbon.
Large "confidence" costs were always destined to flow from the extreme steps being taken, even if advisable, to prop up the economy. The federal government's alternating takeovers and bailouts of companies are inherently destabilizing and create massive uncertainty in investors and businesses. The Fed's shocking steps to print money and acquire every kind of private asset and, soon perhaps, washing machines and Chevy Tahoes, may in retrospect be seen as just the right medicine. At the moment, no rational investor or business manager looks upon such doings with confidence in our economic future.
On top of it all, the Madoff scandal is peculiarly demoralizing in ways that may make its impact greater than the sum of its parts. Our point here is that the bad policy vicious circle probably has a long way to run. While it's still possible to entertain wild hopes about an Obama administration, such hopes are partly self-liquidating on closer inspection -- they exist in the first place only because Mr. Obama has given us so little to go on, except campaign boilerplate. Bottom line: Politics is in charge -- in a way that makes a lost decade of subpar prosperity more likely than not.
Look in a mirror
Europeans are blaming Americans for the credit meltdown. But who was more irresponsible first?
Players of the financial crisis whodunit game are unanimous: The culprit is the United States. The least savoury features of American-style jungle capitalism-outlandish executive pay, endless deregulation, incomprehensible financial instruments, feral greed and reckless leverage-overwhelmed the forces of restrained, decent commercialism elsewhere and plunged much of the developed world into recession. Certainly that's the way Europeans see it. The French think the crisis is an American conspiracy targeted against them, perhaps George W. Bush's payback for their refusal to support the Iraq war. The Germans are angry that their industrial export machine, mightier than China's, has been thrown into reverse. The Italians feel they are being punished for their sensible penchant for avoiding household debt and the stock market casino. "The U.S. must take its responsibility in this situation," European Commission spokesman Johannes Laitenberger said last October. And if you believe that, we've got some UBS shares we'd like to sell you.
Okay, the Europeans have a point, sort of. The fuse that ignited the financial crisis, it could be argued, was lit by decaying U.S. subprime mortgages. But other bombs went off around the world. So why are the Europeans getting away with wagging their fingers at the Americans? Don't forget that the first victims of the credit and liquidity crunches were European. In September, 2007, six months before Bear Stearns was eradicated from Wall Street, the United Kingdom's Northern Rock narrowly avoided collapse after the credit lines (rather than deposits) it relied on for financing in recent years started to dry up. Emergency loans from the Bank of England and a guarantee on savings by the British Treasury halted a run on the bank. Still, the Rock had to be nationalized in February, 2008.
The world should also have paid more attention to the plight of UBS, the Swiss bank, investment dealer and wealth management giant. In the middle part of the decade, UBS plowed more than $100 billion (all currency in U.S. dollars) into U.S. asset-backed securities, including mortgage-based ones. The rot in UBS's portfolio was flagged when it issued a profit warning in August, 2007, more than a year before Lehman Brothers went bankrupt.
Investors fled UBS, and by the end of 2007, it had probably the highest leverage ratio of any major bank in the world, with assets amounting to 53 times its total equity. It was an accident waiting to happen. Since mid-2007, UBS has written off more than $40 billion in dud investments. The Swiss are lucky that it hasn't gone the way of Northern Rock. UBS's $1.7 trillion in assets are equivalent to four times Switzerland's annual GDP. Simply put, the bank would be too big to save.
UBS isn't the only European bank with crazy levels of leverage. U.S. banks had an assets-to-equity ratio of about 20 just before last autumn's stock market collapse. The European banks? Try 30 or higher. One trouble with leverage is that it magnifies losses during bad years just as it pumps up returns in good ones. It's a miracle that the list of rescued European lenders-including Northern Rock, Bradford & Bingley, Fortis and Glitnir-isn't twice as long. Nor can the Europeans claim they took more precautions in their housing markets. Burst real estate bubbles have tipped the U.K., Ireland and Spain into deep recession. In Ireland, the per capita house construction rate during the boom years, propelled by government tax incentives, was an incredible 20 times the U.K.'s rate.
Having engineered their financial mess largely on their own, the Europeans could make it even worse because the Eurozone-the 15 countries that share the euro currency-are moving at different speeds. The finance ministers of the weaker countries, including Spain, Ireland and Italy, would sell their grandmothers for lower interest rates. But everyone suspects the European Central Bank takes its orders from inflation-fearing German officials. Last summer, the ECB was still raising rates. True, rates have come down since then, but they aren't low enough for the basket cases. A few enlightened Europeans know they are not blameless. In November, German president Horst Köhler told a financial services conference in Frankfurt that "too many of you ignored the multiple warnings and preferred to play along." In another speech, he called the global finance industry "a monster." There is little doubt he was including European banks. Hypocrisy is alive and well in Europe. Köhler was just rude enough to point it out.
Broad Probe Into Madoff Fund
The Securities and Exchange Commission is casting a wide net as it investigates the apparent $50 billion fraud allegedly committed by Bernard Madoff, and it continues to look into whether Mr. Madoff's family had any connection to wrongdoing, according to a person familiar with the probe. Mr. Madoff's two sons have said they knew nothing about any fraud until their father confessed to them earlier this month. Other family members have also denied knowledge. Investigators have been combing the books of Mr. Madoff's securities firm and interviewing witnesses to unravel how he conducted the alleged fraud and avoided detection for decades. Authorities are still working to determine how much money was lost.
Because of the size of Mr. Madoff's money-management business, some have speculated that he had help in orchestrating what he described as a Ponzi scheme. Investigators haven't ruled out any possible involvement by family members, the person familiar with the probe said. Mr. Madoff's brother and niece held positions at the firm as of this month, and his wife earlier did. No one other than Mr. Madoff has been charged with any wrongdoing. The three-person accounting firm that audited Mr. Madoff's books has been subpoenaed for information. A longtime Madoff employee, Frank DiPascali, has been questioned and was described by investigators as having been "evasive" in his answers. Mr. DiPascali's lawyer has declined to comment on Mr. DiPascali's role at the firm.
Mr. Madoff was arrested Dec. 11 and now is confined to his home. He used his investment-advisory business's exclusivity and consistent returns over the years to draw investors. The foundation of Nobel Prize-winner Elie Wiesel confirmed this week that it invested $15.3 million or "substantially all" of its assets with Mr. Madoff. Some investors were brought into the Madoff funds by feeder funds that attracted investors from around the world. Authorities are interested in what these feeder funds told their clients about how their money was being invested and whether the feeder funds did what they said they would, said the person familiar with the probe. No one involved with feeder funds has been charged with any wrongdoing in relation to the Madoff probe. At a hearing Wednesday in New York state court, J. Ezra Merkin, who runs funds that put money with Mr. Madoff, was enjoined from concealing or destroying any documents related to Mr. Madoff. Mr. Merkin has not been charged with wrongdoing.
The injunction was entered as part of a suit by New York University, which claims Mr. Merkin turned over his investment responsibilities to Mr. Madoff's funds and lost $24 million of NYU's money. Andrew Levander, counsel to Mr. Merkin, said the court's order, which expires Jan. 6, will have no impact on previously announced plans to wind down Ariel Fund Ltd., a partnership of Mr. Merkin and Fortis bank into which NYU put its money. "Mr. Merkin remains committed to obtaining for shareholders the best results possible in the wake of the terrible fraud committed by Bernard Madoff," Mr. Levander said. The publicity surrounding the Madoff scandal has sparked a half-dozen SEC investigations into other alleged Ponzi schemes, the person familiar with the probe said. Investors are taking closer note of red flags such as promised returns that seem too good to be true, and some are bringing their concerns to the SEC, this person said.
Madoff Scam Will Hit the Feds Too
Regarding your editorial "To Catch a Thief" (Dec 18): One of the biggest losers overlooked in Bernard Madoff's alleged $50 billion Ponzi scheme will be the U.S. government. Assuming Mr. Madoff's compounded returns over the last five years have been 12%, investors have paid up to $9.4 billion in income taxes on these phantom earnings. Many of these taxpayers are eligible to recover a good percentage of this amount in the form of tax rebates.
The remaining principal amount of realized losses (approximately $24 billion) will result in an additional recouping of up to $10 billion in future tax write-offs against earnings. These figures suggest a total government net tax loss of almost $20 billion. The government should help fund an immediate shareholder settlement of at least 60% of the investor's net principal investment in exchange for complete legal and tax absolution including Securities and Exchange Commission and other government agency liability related to this investment.
The government would then become the sole beneficiary of the fund's assets and claims and all investors would realize a swift and fair resolution against the fraud. The government would also be in a better position than the courts to collect investor profits that exceeded principal investments. Having the government stand behind the integrity of the U.S. financial market is a show of good faith world-wide. In addition, the money advanced by the settlement would be a spur to the economy and place a number of individual lives and charitable foundations in order.
State Lotteries Show Big Declines
The sour economy is striking the one source of government financing that had been widely regarded as recession-proof: lotteries. Across the U.S., many state lotteries are reporting hefty declines, with ticket sales down nearly 10% in California and more than 4% in Texas over the past few months. In good years, these lotteries have turned over more than $1 billion apiece to education programs, the most common lottery beneficiaries. Lottery officials have long praised their games as low-cost entertainment that grow even more appealing to players when the economy turns down. But lottery sales nationwide fell about $215 million, or nearly 2%, from July through September compared with the same stretch in 2007, according to La Fleur's magazine, which tracks the lottery business.
The decline in lottery sales "is an unusual phenomenon," said John W. Kindt, a gambling critic and business professor at the University of Illinois. A big proportion of lottery tickets are bought by people with gambling problems who are likely to play more in bad economic times, he said, even as intermittent players cut back. Lottery-ticket sales, which include the big multistate jackpot games such as Mega Millions as well as the instant games known as scratchers, have dipped only once since 1992. That was in fiscal 1998, when they edged down less than 1%, according to the Census Bureau. Otherwise, revenue has marched steadily upward. In the most recent fiscal year, which for most states ended June 30, national lottery sales rose more than $1 billion to $52.7 billion, La Fleur's reported.
In past recessions, players continued to buy tickets, but not this time, said Jack Boehm, director of the Colorado Lottery. "Now they are thinking, 'My retirement is gone, I might lose my job, I'd better start putting money away' -- that means fewer dollars for lottery tickets." In Colorado, sales since July have dropped almost $5 million, or 2.3%, compared with the same period last year. The decline has hit even the usually resilient scratch-off games, Mr. Boehm said, and at the current pace the state's lottery will sell 5% fewer tickets this fiscal year than last year -- a $25 million drop-off. Lottery officials cite other reasons for weak sales, including a lack of big jackpots in multistate games and increased competition from other lotteries and casinos for gamblers' dollars. Natural disasters hurt sales in the Midwest and along the Gulf Coast, while Hurricane Ike knocked out thousands of retailers in Houston, where a quarter of Texas Lottery tickets are sold, said Robert E. Heith, spokesman for the Texas Lottery Commission.
At focus groups held for the commission earlier this year, about half the players said the poor economy had prompted them to cut back on lottery purchases. Die-hard players -- those who bought tickets in the previous month -- reported small cutbacks. But 27% of less-frequent players, those who bought tickets some time in the past year, reported declines of 81% to 100% in their lottery purchases, Mr. Heith said. Maude S. Woods, a postal worker from Arlington, Texas, said she and colleagues stop by a Dairy Mart every day to play the lottery, but that she is spending a lot less than she used to -- no more than $10 a day. Everybody is worried about the economy, she said, "and I don't have that much extra money left to use." But Jose Torres, a disabled forklift driver who lives nearby, said that if anything, the recession has prompted him to spend a little more, maybe $2 a day instead of $1. "We need the money -- we're broke," he said.
In some states, lottery officials are warning programs that benefited from lottery sales that they will be receiving less money. Massachusetts, which uses much of its lottery funds to aid cities and towns, expects net proceeds to drop to $863 million from $913 million last fiscal year. In Bridgewater, 25 miles south of Boston, that aid accounts for about 10% of town revenue, and a cut this year would probably require closing a library or a center for senior citizens, said Paul Sullivan, the municipal administrator. Some lotteries are counting on Christmas stocking-stuffer tickets to boost sales. Others are dreaming up new games to spur interest among buyers. And lottery officials across the U.S. are hoping for a big new jackpot for Powerball, which is tweaking its rules and adding a major new participant, Florida.
Terri LaFleur, publisher of LaFleur's magazine, said she expects "a lot of legislative scrutiny for the expansion of lottery games, such as video lottery terminals, in 2009, as states face severe budget crunches." Not every lottery plans big changes. "We're going to continue doing what we've been doing," said Sally Lunsford, spokeswoman for the Kansas Lottery, which has seen weekly sales fall about 4.5% compared with a year ago. "Kansans are pretty conservative in general," she said. "If they can buy gas or lottery tickets, bread or lottery tickets, they'll probably choose gas and bread. And we certainly support that choice."
New York Times November ad revenue falls 20 percent
The New York Times Co's November advertising revenue fell 20 percent, the company said on Wednesday, illustrating how the financial crisis is aggravating dizzying revenue declines at U.S. newspapers. Ad revenue at the publisher's New York Times Media Group, which includes the Times newspaper, fell 21.2 percent from a year earlier because of a drop in real estate and jobs classified advertising. Studio entertainment, automotive, book and financial services ads also were weak, the Times said in a statement. The New England unit, which includes The Boston Globe newspaper, as well as the group representing its other U.S. papers, also fell. Total company revenue fell 13.9 percent.
Most publicly traded newspaper publishers release monthly numbers because Wall Street scrutinizes them for sometimes minute changes, and their stocks often can rise or fall by significant amounts as a result. For the Times, the numbers are important because it is trying to meet its 2009 debt obligations and reduce borrowing. At the same time, it is trying to save money as the newspaper business worsens. Privately held Tribune Co earlier this month filed for bankruptcy and Journal Register Co has filed a forbearance agreement with its lenders as it restructures. AH Belo Corp and McClatchy Co have amended their debt terms with lenders to avoid edging closer to violating their agreements.
The Times is considering selling some of its properties, but has not yet said which ones. Internet ad revenue, long a source of hope among newspaper publishers battered by falling print ad sales and circulation, dropped 4 percent in the news media group. That reflects a decline in online jobs and real estate ads. For the first 11 months of the year, Internet ad revenue in the news media group is up 10.9 percent compared with the same period a year earlier.
Volumes to slow as Japan switches from paper
Thin trading volumes over the festive period in Japan are likely to get even thinner from Christmas Day as stocks making up about 7 per cent of the MSCI Japan index are suspended, potentially adding to volatility in the markets. The shift to electronic share certificates from paper means companies must eliminate fractional shares (those worth less than one share) if they have them. Some 14 companies, including heavyweights such as NTT, Mizuho Financial Group, Sumitomo Mitsui Financial Group, JR East and Dentsu, have decided to conduct stock splits to eliminate their fractional shares, which means that they will be suspended from trading between December 25 and December 30. Trading will resume on January 5 after the New Year holiday.“The issue the buy side will face is that this might increase the volatility as there will be very few people trading and this will create hedging problems for clients who are unable to trade,” one trader said. “The whole process is not very encouraging in these markets, given the already thin liquidity.”
Another trader said that should there be big news in the financial industry during the suspension, there could be more focus on big names that are trading such as Mitsubishi UFJ Financial. The futures market may also be affected, said Tomochika Kitaoka, an equity strategist at Mizuho Securities. Japan will shift to electronic share certificates on January 5, and many households have been sifting through their cupboards for stock certificates. Hitoshi Tada, Nomura’s chief executive of the domestic retail division, said that in the build-up to the shift this year, a mountain of stock certificates had been collected in the head office in Tokyo’s Nihonbashi district, including those of companies that do not exist any more, some dating back to the Meiji period (1868-1912.) Preparation for the switch has been largely completed and it is possible the collection of these previously ignored stock certificates has helped to increase the number of new accounts opened at Japanese brokerages.
Nomura’s data shows the number of new accounts opened at Nomura branches rose more than 30 per cent in October compared with the three months ended September this year. This timing however, does coincide with the recent bottom in the Nikkei 225 around the end of October, when it fell to 7,162, down 53 per cent for the year. It is now 8,723. Nomura said that the shift to electronic share certificates, also known as dematerialisation, will help prevent loss, theft and counterfeiting of share ownership, while simplifying the process of handing over ownership. Listed companies will benefit from reduced costs of printing and stamp duty. One of the long-term aims of creating electronic trading certificates is to reduce settlement of trades, which is currently the trading day plus three days (T+3.). However, Neil Katkov, senior vice president at financial services consultant Celent in Tokyo, warns that more work needs to be done to improve the trading system. “Faster clearing cycles are not easy to achieve unless all parts of the chain have the technology and processes to support it.”
Friedman Would Be Roiled as Chicago Disciples Rue Repudiation
John Cochrane was steaming as word of U.S. Treasury Secretary Henry Paulson’s plan to buy $700 billion in troubled mortgage assets rippled across the University of Chicago in September. Cochrane had been teaching at the bastion of free-market economics for 14 years and this struck at everything that he -- and the school -- stood for. "We all wandered the hallway thinking, How could this possibly make sense?" says Cochrane, 51, recalling his incredulity at Paulson’s attempt to prop up the mortgage industry and the banks that had precipitated the housing market’s boom and bust. During a lunch held on a balcony with a view of Rockefeller Memorial Chapel, Cochrane, son-in-law of Chicago efficient-market theorist Eugene Fama, and some colleagues made their stand. They wrote a petition attacking Paulson’s proposal, sent it to economists nationwide and collected 230 signatures. Republican Senator Richard Shelby of Alabama waved the document as he scorned the rescue. When Congress rejected it on Sept. 29, Cochrane fired off congratulatory e-mails.
The victory was short-lived. Lawmakers approved the plan four days later, swayed by what Cochrane calls a pinata of pork-barrel amendments. "We should have a recession," Cochrane said in November, speaking to students and investors in a conference room that looks out on Lake Michigan. "People who spend their lives pounding nails in Nevada need something else to do." At the University of Chicago, once ascendant free-market acolytes are finding themselves in an unusual role: They’re battling a wave of government intervention more sweeping than any since the Great Depression as the U.S. struggles with the worst recession in seven decades. By the end of November, the government had committed $8.5 trillion, or more than half the value of everything produced in the country in 2007, to save the financial system. The European Union had ponied up more than $3 trillion to guarantee bank loans and provide capital to lenders. And China had unveiled a $586 billion stimulus plan and its biggest interest-rate cut in 11 years. The intrusion is anathema to the so-called Chicago School of economics and its patriarch, the late Milton Friedman.
For half a century, Chicago’s hands-off principles have permeated financial thinking and shaped global markets, earning the university 10 Nobel Memorial Prizes in Economic Sciences starting in 1969, more than double the four each won by Columbia University, Harvard University, Princeton University and the University of California, Berkeley. Chicago’s laissez-faire imprint underpins everything from U.S. President Ronald Reagan’s 1981 tax cuts and the fall of communism that decade to quantitative investment strategies. In 1972, Friedman helped persuade U.S. Treasury Secretary George Shultz, former dean of Chicago’s business school, to approve the first financial futures contracts in foreign currencies. Such derivatives grew more complex after Chicago economists created the mathematical formulas to price them, helping spawn a $683 trillion market that’s proved to be a root of today’s financial system breakdown. On Dec. 16, the U.S. Federal Reserve cut its target lending rate to as low as zero for the first time and said it will buy mortgage- backed securities.
Friedman, who died in 2006 at age 94, defined the Chicago School in 1974 as he spoke to a board of trustees dinner. "‘Chicago’ stands for a belief in the efficacy of the free market as a means of organizing resources, for skepticism about government intervention into economic affairs," he said. Friedman was explaining a movement that had taken hold in the U.S. and was percolating in Europe and South America. "By the mid-1970s, there was a whole generation in government and academia who’d trained at Chicago or places influenced by it," says Ross Emmett, a Michigan State University professor who’s written three books on the school. Today, 10 percent of Chicago undergraduates study economics. Alumni of Chicago’s graduate business school, now called the Booth School of Business, run states and companies. Jon Corzine, the former chief executive officer of Goldman, Sachs & Co. who earned his MBA in 1973, is governor of New Jersey. Peter Peterson, who graduated with an MBA in 1951, co-founded Blackstone Group LP, the world’s largest private equity firm. David Booth, a 1971 MBA graduate for whom the school is now named, donated $300 million in November, the largest endowment given to the university.
Booth, who founded Dimensional Fund Advisors Inc., bases his funds on Fama’s theory that a market digests information affecting prices so well that even professional investors can’t outsmart it for long. Even with his U.S. Micro Cap Portfolio fund down 40 percent in 2008 through Dec. 22, Booth says quantitative investing is less vulnerable during a slump than stock picking that relies on human judgment. "This supports our theory in that predicting the market is even more difficult than we expected," he says. Unlike Booth, 62, much of the academic world is reassessing Chicago School hallmarks. That’s true even in the limestone buildings on the 211-acre (85-hectare) Hyde Park campus in which professors teach Friedman’s theories. On Oct. 14, about 250 students and professors debated an administration-backed plan for a $200 million research center to be named for Friedman. The protesters argued that the institute would enshrine policies that have brought economies near collapse. "When Friedman’s Platonic ideas of free-market virtues are put into practice, they have too often generated a systemic orgy of competitive greed -- whose remedies, ironically, entail countermeasures of nationalization," Marshall Sahlins, an emeritus professor of anthropology, said during the debate, speaking in a room adorned with murals of female students parading through the campus in medieval gowns. Sahlins, 77, noted a few weeks later socialist and capitalist countries alike are regulating or nationalizing financial institutions in a rebuff to Friedman.
Off campus, the global meltdown is stirring anti-Chicago economists, who were voices in the wilderness during decades of lax government oversight of markets. Joseph Stiglitz, who won one of Columbia’s economics Nobels, says the approach of Friedman and his followers helped cause today’s turmoil. "The Chicago School bears the blame for providing a seeming intellectual foundation for the idea that markets are self- adjusting and the best role for government is to do nothing," says Stiglitz, 65, who received his Nobel in 2001. University of Texas economist James Galbraith says Friedman’s ideology has run its course. He says hands-off policies were convenient for American capitalists after World War II as they vied with government-favored labor unions at home and Soviet expansion overseas. "The inability of Friedman’s successors to say anything useful about what’s happening in financial markets today means their influence is finished," he says. Instead, Galbraith, 56, says policy-makers are rediscovering the ideas of his father, Harvard professor John Kenneth Galbraith, and economist John Maynard Keynes of the University of Cambridge. Keynes, who died in 1946, argued that governments should spend to combat the unemployment that free markets tolerate. Galbraith, who died in 2006, rejected mathematical models and technical analyses as divorced from reality.
Barack Obama, who will referee the laissez-faire versus free- market debate as U.S. president, has pledged the largest spending on infrastructure since the 1950s to save or create 3 million jobs. Obama, 47, has deep roots on the university’s campus in Hyde Park, a middle-class enclave 7 miles south of downtown Chicago. His Victorian house is a five-minute walk from the school’s northern edge. He taught constitutional law there for 12 years, stepping down when he was elected to the U.S. Senate in 2004. Obama tapped fellow Chicago professor Austan Goolsbee as staff director of his President’s Economic Recovery Advisory Board, which will propose ways to revive growth. Goolsbee, 39, who was Obama’s chief economist during the campaign, has taught at the business school since 1995. Goolsbee says Obama’s top priority is to prevent the crisis from spiraling into a depression. Yet he insists Obama won’t overregulate. "If the president-elect were not a ‘University of Chicago Democrat,’ then the natural response would be to just try to turn back the clock to what was there before," he says. "Because Obama comes out of a framework where the market is not the enemy, there’s a possibility we can create new institutions to guard against excess without going back to what was wrong in the old regime."
Goolsbee supports bigger capital requirements for banks and other institutions that can borrow from the Federal Reserve, and wants expanded monitoring of hedge fund firms and ratings companies. Derivatives may need to be traded through clearinghouses, like those used in Chicago wheat pits, which act as counterparties for each trade and can suspend traders with insufficient collateral. "Getting us out of the hole we’re in, promoting oversight and making investments so the economy can grow doesn’t make you anti- market," Goolsbee says. "It’s totally pro-market." Already, some of the university’s top economists have abandoned hard-line Friedmanism for the middle ground. Douglas Diamond, a finance professor at Chicago since 1979, declined to sign Cochrane’s petition damning Paulson’s bailout. Diamond says he knew the Sept. 29 vote against the rescue would spur investors to pull assets from banks. He says governments have no choice but to provide safety nets for banks and tougher oversight. "The vote was the beginning of people believing crazy stuff, like the U.S. might find it politically expedient to let its financial system go," Diamond, 55, says. Robert Lucas, a Chicago economist who won a Nobel in 1995 for a theory that argued against governments trying to fine-tune consumer demand, says deregulation may have gone too far.
Depression-era laws that separated commercial and investment banks helped depositors decide if they wanted secure accounts or riskier investments. Today, without these distinctions, people can’t be sure if their investments, or those of their customers, are safe. "I’m changing my views on bank regulation every week," Lucas, 71, says. "It was an area I saw as under control. Now I don’t believe that." Lucas says he voted for Obama, the only Democrat besides Bill Clinton he’d supported in 44 years. He concluded the candidate was comfortable talking with professional economists. He describes Goolsbee, whom he has met in faculty workshops, as a serious scholar. Chicago students seem less concerned about the debate swirling through their campus than with finding -- or keeping -- a job. Milos Dedovic, an emigre from Serbia, is studying for his MBA at night. He works for Continental AG, Europe’s second-largest auto parts maker, managing sales of transmission control modules to General Motors Corp. Dedovic, 38, says his MBA will help make him secure even if he loses his job. "If the economy is spiraling down, you get survival of the fittest, where skills and accreditation matter even more," he says.
The university got its start in 1892 as a haven for researchers, not would-be managers. William Rainey Harper, a Bible scholar who taught at Yale, attracted oil magnate John D. Rockefeller as his benefactor. Harper broke with then prevailing Ivy League practices by hiring Jews, finance professor Fama says. By 1946, Chicago was luring stars such as Enrico Fermi, father of the self-sustaining nuclear reaction. Friedman’s parents were Jews who emigrated from what’s now Ukraine. When he joined the faculty in 1946, he allied with Friedrich Hayek, a London School of Economics professor who later transferred to Chicago. They sought to discredit Keynes, who argued that deficits in government budgets could revive demand in recessions. They viewed rising government power as a step toward left-wing totalitarianism and wanted to stop it, says Philip Mirowski, a University of Notre Dame economist. Friedman challenged Keynesian orthodoxy with work that culminated in a Nobel Prize in 1976. He argued that consumers decide how much to save based on earnings prospects throughout their lifetimes, not on short-term government efforts to manipulate demand. Friedman demonstrated that inflation and unemployment may rise in tandem and that governments cause inflation by printing too much money. Lucas, the 1995 Nobel laureate, recalls Friedman convincing him in a 90-minute undergraduate class in 1960 that labor was subject to the same economic laws as other commodities. Friedman argued that minimum wage laws, which Lucas saw as humanitarian, harm workers by reducing demand for their services. "I never thought I could change my mind like that," Lucas says.
Deirdre McCloskey, now an economist at the University of Illinois, Chicago, remembers laughing with fellow Harvard undergraduates in 1963 at Friedman’s claim that free markets allocate resources better than governments. She says Harvard-trained bureaucrats enjoyed prestige following World War II. She switched her support to Friedman after the Vietnam War destroyed her faith that such bureaucrats knew what they were doing. Friedman, who stood 5 feet 3 inches (160 centimeters), was a fierce debater, McCloskey recalls. "He always asks, persistently, ‘How do you know?’" McCloskey, now 66, wrote in the Eastern Economic Review in 2003. "It’s a terrifying question, because most of the time we can’t say." Friedman was chief economic adviser to Republican presidential candidate Barry Goldwater in 1964. He began attracting nonacademic audiences with a Newsweek magazine column that ran from 1966 to ’84. When Reagan was governor of California, Friedman campaigned with him in 1973 for limits to property taxes that had fueled government growth in the state.
In 1975, Friedman traveled to Chile and met dictator Augusto Pinochet, who’d seized power two years earlier in a coup in which thousands died, including Socialist President Salvador Allende. Pinochet practiced "shock therapy," including monetary controls, to tame inflation. Friedman’s friend Alan Walters, later an adviser to British Prime Minister Margaret Thatcher, went to Chile to monitor what he viewed as laboratory-like conditions for shock therapy, says Andy Beckett in "Pinochet in Piccadilly" (Faber & Faber, 2002).
Walters, 82, taught at the London School of Economics and at Johns Hopkins University in Baltimore, later serving as vice chairman of AIG Trading Group Inc. He was fascinated by "the Chicago boys" who trained in Hyde Park and became advisers to post-Soviet governments in Eastern Europe after serving in Chile. Students reacted differently. After the coup, a generation of Latin Americans refused to study at Chicago, says James Heckman, 64, an economist at the university who won a Nobel in 2000. McCloskey, who taught in the Chicago economics department for 12 years starting in 1968, says several professors played bigger roles than Friedman in Chile. His opposition to training economists for Shah Mohammed Reza Pahlavi of Iran shows he didn’t coddle dictators, she says. McCloskey still trusts Friedman’s teachings. "The big event of the last 20 years is the success of free markets in India and China," says McCloskey via telephone from South Africa, where she’s a visiting professor at the University of the Free State in Bloemfontein. "This is more important than any financial crisis and makes it really hard to argue for a return to central planning." In 1977, Friedman reached the then mandatory retirement age of 65 and left for the Hoover Institution at Stanford University. While wrapping up his Hyde Park career, he reviewed the early research of professors Fischer Black and Myron Scholes, who gave Chicago theories a bigger and more direct role in financial markets. The pair provided a foundation for trading call options on stocks by creating a formula to link the value of the options to share price and volatility, time remaining on the option and interest rates.
The Black-Scholes model helped spark the global derivatives market. At the time, Fama was positing that securities prices reflect the collective wisdom of all participants. This "efficient market" theory helped make him the No. 1 scholarly business writer, with 250,828 downloads of academic papers as of Dec. 22, according to Social Science Research Network. Fama’s theory helped pave the way for the recent economic crisis by sanctioning limited government, Notre Dame’s Mirowski says. "Fama taught that no human being knows enough to understand how resources should be allocated," he says. "All you can do is let the market have greater and greater ability to repackage information and risk. The result is, people bought mortgage-backed securities with no idea whether borrowers could repay." Fama, 69, who favors casual shirts and chinos on campus, joined the Chicago faculty in 1963. When he opened his financial theory class on Sept. 29, the day Congress voted down Paulson’s bailout, he placed efficient-market equations from his 1976 textbook on an overhead projector. Fama says he never denied the possibility of unexpected events even though he’d spent a lifetime showing that markets effectively digest information. He was stunned that American International Group Inc., once the world’s largest insurer, sold $441 billion in unhedged and undercapitalized insurance on securitized debt, much of it tied to mortgage values. "No one expected a player like AIG to take a long position and not hedge themselves," Fama says. He says the government may have been able to stabilize the U.S. financial system at a lower cost by letting AIG collapse.
Bailing out Detroit automakers will simply postpone their demise as they reel from expenses promised for employee retirement plans, he says. Cochrane, who circulated the anti-rescue petition, says a rash of bailouts will expand government and kill entrepreneurship. "People don’t notice businesses that didn’t start," he says. Cochrane says he was encouraged by the Fed’s Dec. 16 rate cut and its plan to buy mortgage-backed securities, saying these moves will help unfreeze capital markets. "This is exactly the right thing for a central bank to be doing in the midst of a credit crunch," he says. Fama and Cochrane have more in common than their outlooks. Cochrane is married to Fama’s daughter Elizabeth, a finance Ph.D. who writes fiction for young adults. Their families have dinner together twice a week; on campus, their offices adjoin. Cochrane’s has a photo of himself in a glider in which he competes. He says he felt vindicated in November when Paulson abandoned the idea of buying mortgage assets. He advocates patience as markets rebuild themselves. In the future, people who originate securities will retain a higher percentage of the debt, understand risks better and earn smaller profits, he says. For now, he says, when a U.S. bank fails, a hedge fund in Denmark may bear the brunt, which is an improvement from the Depression era, when neighborhoods surrounding a bank were devastated. "That’s risk being spread all around the world," he says. Cochrane says he now represents a minority viewpoint among Chicago’s business faculty. He says Diamond, who declined to sign the petition, holds a majority view, which posits financial institutions must be rescued and regulated.
Diamond began studying bank failures when he was a doctoral student at Yale in the 1970s. The 1963 book that Friedman wrote with Anna Schwartz, "A Monetary History of the United States, 1867- 1960," provided the foundation. A copy, held together by Scotch tape, sits on Diamond’s desk, even though he concluded at Yale that a main premise was wrong. Diamond rejects Friedman’s view that banks failed in the 1930s because the U.S. money supply contracted as panicky Americans started hoarding cash and the Fed reacted too slowly. Diamond sees the money supply as less significant than Friedman did. Banks failed, he says, because their assets weren’t readily converted into the cash that depositors were demanding. During the 1980s, Diamond’s research was similar to that of Fed Chairman Ben S. Bernanke, 55, whom he calls a good friend. The two postulated that because bankers accumulate experience in assessing risk, they play a key role in the economy. In the past decade, bankers failed to properly grasp risk because of a "witch’s brew" of mistakes, Diamond says. Former Fed Chairman Alan Greenspan’s 1 percent interest rate in 2003 -- a 45-year low -- flooded Wall Street with so much cash that banks could increase profits with short-term borrowing to service long-term liabilities, Diamond says. The mismatch grew more dangerous as Greenspan resisted regulation of off-balance-sheet structured investment vehicles, which banks used to circumvent capital requirements.
Reagan’s $4.5 billion rescue of Continental Illinois National Bank & Trust Co. in 1984 convinced bankers that bailouts would come if things turned bad, Diamond says. By 2007, a quarter of assets held by big U.S. investment banks came from short-term borrowing, up from 12 percent three years earlier. Goolsbee describes the plan Obama is formulating -- tax relief for workers, investment in technology and infrastructure and more oversight of financial markets -- as pragmatic and data-driven. He says Friedman would approve of Obama’s determination to keep policy making rooted in the economic methodologies developed at Chicago. The University of Texas’s Galbraith compares Obama to pragmatic philosopher John Dewey, whose ideas sparked educational reform in the 20th century. While on the Chicago faculty in 1896, Dewey started the school that the Obama and Goolsbee children attend. With his inauguration on Jan. 20, Obama faces a real-life experiment in organizing financial markets amid turmoil few presidents have navigated. His success will be measured partly by how he uses the University of Chicago as an intellectual anchor -- and whether he can meld its free-market heritage with today’s nonstop intervention to bring order to uncharted times.
Rising Seas, Severe Drought, Could Come in Decades
The United States could suffer the effects of abrupt climate changes within decades--sooner than some previously thought--says a new government report. It contends that seas could rise rapidly if melting of polar ice continues to outrun recent projections, and that an ongoing drought in the U.S. west could be the start of permanent drying for the region. Commissioned by the U.S. Climate Change Science Program, the report was authored by experts from the U.S. Geological Survey, Columbia University's Lamont-Doherty Earth Observatory and other leading institutions. It was released at this week's meeting of the American Geophysical Union.
Many scientists are now raising the possibility that abrupt, catastrophic switches in natural systems may punctuate the steady rise in global temperatures now underway. However, the likelihood and timing of such "tipping points," where large systems move into radically new states, has been controversial. The new report synthesizes the latest published evidence on four specific threats for the 21st century. It uses studies not available to the Intergovernmental Panel on Climate Change (IPCC), whose widely cited 2007 report explored similar questions. "This is the most up to date, as it includes research that came out after IPCC assembled its data," said Edward Cook, a climatologist at Lamont-Doherty and a lead author of the new study.
The researchers say the IPCC's maximum estimate of two feet of sea level rise by 2100 may be exceeded, because new data shows that melting of polar ice sheets is accelerating. Among other things, there is now good evidence that the Antarctic ice cap is losing overall mass. At the time of the IPCC report, scientists were uncertain whether collapses of ice shelves into the ocean off the western Antarctica were being offset by snow accumulation in the continent's interior. But one coauthor, remote-sensing specialist Eric Rignot of the Jet Propulsion Laboratory, told a press conference at the meeting: "There is a new consensus that Antarctica is losing mass." Seaward flow of ice from Greenland is also accelerating. However, projections of how far sea levels might rise are "highly uncertain," says the report, as researchers cannot say whether such losses will continue at the same rates.
In the interior United States, a widespread drought that began in the Southwest about 6 years ago could be the leading edge of a new climate regime for a wider region. Cook, who heads Lamont's Tree Ring Lab, says that periodic droughts over the past 1,000 years have been driven by natural cycles in air circulation, and that these cycles appear to be made more intense and persistent by warming. Among the new research cited is a 2007 Science paper by Lamont climate modeler Richard Seager, showing how changes in temperature over the Pacific have driven large-scale droughts across western North America. "We have no smoking gun saying that humans are causing the current changes. But the past is a cautionary tale," Cook told the press conference. "What this tells us is that the system has the ability to lock into periods of profound, long-lasting aridity. And there is the suggestion that these changes are related to warmer climate." Cook added: "If the system tips over, that would have catastrophic effects no human activities and populations over wide areas."
The panel said two other systemic changes seem less imminent, but are still of concern. Vast quantities of methane, a potent greenhouse gas, have long been locked up in ocean sediments, wetlands and permafrost. These could be destabilized by climate change, leading to blowouts of gas, and thus even more abrupt temperature shifts. The panel said blowouts appear unlikely in the next 100 years--but that steady emissions could double, especially in the north, as land and water warm up. The panel also looked at the continuous circulation of the Atlantic Ocean, which sends warm water northward and cold water southward, controlling the climate of western Europe and beyond. Some scientists say this circulation could collapse if enough northern ice melts and dilutes the salty water. The panel found this scenario unlikely in the short term, but warned that the circulation's strength might decline 25% to 30% by 2100. "Abrupt climate change presents potential risks for society that are poorly understood," the researchers write. [There is an] urgent need for committed and sustained monitoring of those components [that] are particularly vulnerable." The report, Synthesis and Assessment Product 3.4: Abrupt Climate Change, is at: http://www.climatescience.gov/Library/sap/sap3-4/final-report/default.htm.