Texas Company, Benning Service Station, Washington, DC
Ilargi: 2009 will be the year credit disappears. That, more than any other single factor, is what will determine our economic futures. It will get very ugly, because our economies, even our entire societies, run on credit. There is no replacement.
Governments and central banks are trying to pump your money into the existing banking system, ostensibly with the idea that a credit flow can be (re-) started that way. The idea is so ridiculous that we have to wonder about the intentions behind the policies. To restart credit, they would have to go through any channels BUT the banking system. The reason is simple: the banks are bankrupt, with losses on their books that are many times larger than any sum that has been, will be or even could be handed out to them from the public coffer.
For the man in the street, things won't get better if existing banks are bailed out or nationalized. They get worse, much worse. A government that buys a bank outright, also buys the -so far mostly unrecognized- losses. A government that merely pumps money into a bank will see that money evaporate on the hot plate of yet-to-be-revealed losses.
The loss of credit that will be the prime characteristic of the financial world in 2009 marks a watershed moment in our societies, which will have to scramble to find a new model for survival, for getting things from A to B, and to simply feed their citizens. The credit system that we have lived in for the past decades is gone and will not come back in our lifetimes. The losses, when they are revealed, and they will have to be, no matter how much the ruling classes resist this, are simply too big. What is at risk in the derivatives trade alone is more than all the money on the planet.
Societies and their governments can do some things to mitigate the damage, to minimize the suffering. But none are doing them to date. First, private and small business deposits in banks must be guaranteed. Then, the banks must be folded, along with their losses, which mainly consist of bets gone bad. In order to make this work, governments must set an example of frugality that needs to be adapted by all citizens. The Keynesian overspending that rules the day is a recipe for making the disaster much bigger than it already is. And following Keynes without demanding that the books are opened and losses revealed, is nothing short of criminal behavior.
Then, what needs most attention is what people need most: basic necessities. Water treatment and sewage systems are the most important barrier between a society and widespread disease. They will become, in relative terms, much more expensive for everyone. Forced rationing may have to be applied.
Every level of government needs to look long and hard at where the food for its people comes from. If it is possible to feed everyone of your citizens, action needs to be taken to make sure that self-sufficiency is established. A national government will be mostly useless in these things, you need smaller entities to be efficient. Increasingly empowering lower levels of government has another advantage: it’s much easier for everyone to track where their money is going.
You see, I can write all this, and much more, and know that every word I write is true. But I don't think any of it will be done while there is still time. What I see around me, what governments are doing, is that one-trick pony kind of thing: trying to resurrect the dead with money that doesn't belong to them. Before we can begin a reorganization of our societies, the present political and financial ruling classes will have to fall. And that will only happen after an amount of suffering so overpowering it makes me shudder. Few of those with power, political, economic, will give that up voluntarily, And few of us will volunteer to do with less. Until we run headfirst into the wall, we will deny the existence of the wall.
But first, 2009. No more loans, not for cars and homes, not for business lines and letters of credit, and increasingly not for governments, who'll be attempting to sell their bonds in an ever more overcrowded marketplace. International bond markets will be but a faint shadow of their former selves. And so will trade, in all its aspects. Of course it’s hard to predict exactly what will emerge from the end of credit. What is easy to see is that it will indeed end.
Formerly soaring global trade suddenly comes to a halt
The unstoppable force has stopped. With economies in the United States, Europe and Japan slowing simultaneously, the World Bank says that global trade will shrink next year by more than 2%. That will mark the first time in more than a quarter century that the seemingly inexorable tide of globalization will be in retreat. "Trade tends to be extra responsive to changes in income. When the world economy contracts, trade contracts even more rapidly," says economic historian Douglas Irwin of Dartmouth College.
The trade slump is both symptom and cause of the current global economic distress. For the U.S. economy, which just a few months ago was getting almost all of its forward momentum from net exports, "Trade will be a substantial drag on … growth," Ian Shepherdson, chief economist of High Frequency Economics, told clients in a recent research note. Compounding the recessionary gloom, trade is being choked by the credit crunch, which is drying up routine export financing. Entering 2009, the open trading system that has delivered low-cost goods to American consumers while lifting tens of millions of people in developing countries out of poverty faces the danger of protectionism in countries such as China, Russia, France and, potentially, the U.S.
Trade's turnaround has been abrupt. As recently as 2006, global trade was surging at an annual rate of nearly 10%. This year, the total volume is still expected to grow more than 6% to about $14 trillion. But, with the Economist Intelligence Unit forecasting 29 national economies will shrink next year, demand will slump for products worldwide. "Everything is down significantly, across the board in all sectors," says Peter Keller, president of the North American operations of NYK Line, a 123-year-old Japanese shipping company. "The trenches are ugly." Until recently, trade was virtually the sole bright spot in the U.S. economy, with net exports responsible for most second-quarter growth. But the global slowdown is taking its toll. In October, U.S. goods exports fell for the third-consecutive month to $120.8 billion, almost 14% below July's level. And there are signs that new orders are melting amid the economic tumult.
After 70 consecutive months of expansion, the Institute for Supply Management export index released Dec. 1 showed falling orders in both November and October. A few weeks ago, Keller's ships were mostly full, thanks to orders placed months ago. Then, business tanked. Now there are mounting worries about retailers' plans for post-holiday orders. NYK announced last week that it would defer plans to purchase 60 ships as it seeks to trim capacity. Trade's rise and fall can be traced on the Baltic Dry index, a measure of shipping demand. The index more than quadrupled from the end of 2005 through May of this year, reaching a high of 11,793 on May 20. Since then, as demand for container vessels and cargo ships evaporated, it has dropped an astonishing 94%.
It's not just slumping demand that explains traders' woes. Exporters are finding it difficult to obtain the letters of credit and insurance needed to ship goods between countries. "The subprime crisis has resulted in a liquidity crunch and, hence, bank finance for trade has decreased," said an October report from Celent, a financial consultancy. Latin American exporters were the first to feel the chill, in September. In countries such as Brazil, companies found they couldn't obtain financing from New York banks that were feverishly reducing their credit exposure amid the worsening crisis. Some of the affected trade even involved cases in which the International Finance Corp., the private sector arm of the World Bank, had signed contracts to provide the trade financing. The deals fell through because the money wasn't available from the U.S. banks, according to Hans Timmer, lead economist for the World Bank's global trends unit.
Since then, the problem has spread to other top emerging markets, such as India, according to the World Bank. Even companies in the U.S. and Europe shipping to customers in emerging markets face difficulties. Today's more volatile environment has prompted many companies to move away from so-called open-account or pay-on-delivery trade to the use of letters of credit, in which banks guarantee a customer's payment. But even as demand for such bank guarantees has surged, the supply has been pinched by the overall credit crunch. "Now even for corporations with long relationships, trust is not there anymore. … It's affecting almost everyone," says Axel Pierron, Paris-based senior vice president at Celent. Long a financial backwater, trade finance is drawing increased attention from policymakers: The U.S. Treasury and the Chinese government agreed earlier this month to jointly make available $20 billion to facilitate their companies' sales to emerging markets. That move followed a $3 billion initiative announced last month by the International Finance Corp.
"There's been an aggressive intensification of the crisis over the past five or six weeks. Especially in emerging markets, credit is just drying up," says Harvard University's Kenneth Rogoff, former chief economist for the International Monetary Fund. The frozen trade credit market is attracting new financial players, Pierron says. A handful of hedge funds, seeing prospects for attractive investment returns elsewhere vanishing, are considering getting involved in trade finance, he says. Last month, at the Washington summit on financial markets and the world economy, leaders of the Group of 20 nations promised to refrain from erecting new barriers to trade or investment for the next 12 months. Left unsaid was what would happen in the 13th month. The last thing the already enfeebled global economy needs is a trade war.
Many industry representatives are apprehensive about the new year. With unemployment rising, the new Democratic-controlled Congress is expected to be less amenable to new trade agreements than was its predecessor. Public Citizen's Global Trade Watch says the ranks of trade liberalization opponents had a net gain of 28 votes in the House and six in the Senate, figures business community representatives, such as the National Foreign Trade Council, dispute. Still, there is little argument over the fact that enthusiasm for further trade expansion along the lines of the agreements pursued by both parties in recent years is at low ebb. A trio of bilateral trade deals with Colombia, Panama and South Korea, continue to idle in Congress. And the Doha Round of global trade talks sputtered to a halt this month when WTO Director General Pascal Lamy opted not to convene a last-ditch negotiating session in Geneva.
The U.S. recession — the economy is shrinking in the fourth quarter by an estimated 4% to 6% — provides a potentially receptive environment for anti-trade measures. "As time goes on and the jobless rate goes up everywhere, we will see a growing trend toward protectionism," says Sung Won Sohn, an economist at California State University. The Doha Round's failure also means countries will be free to impose tariffs that could shrink global trade volumes by $728 billion to $1.7 trillion, according to a new report by the International Food Policy Research Institute. Countries typically apply lower tariffs than are permitted by the last global trade agreement, the Uruguay Round. They could legally increase them at any time. Other arguments will come into play.
Already one prominent U.S. economist, Dani Rodrik, has pointed out on his blog that the Obama administration's planned economic stimulus would pack a greater punch if the U.S. raised import tariffs to make sure the money is spent here and not on goods from abroad. A $1 trillion shot of economic adrenaline, for example, would boost gross domestic product by $1.8 trillion, assuming consumers spent 20 cents of every dollar on imports. If tariffs, by raising the price of imported goods, encouraged them to buy only made-in-the-USA goods, the economic gains would rise to $2.8 trillion. But Rodrik also says a coordinated international effort to stimulate spending would be a better option than raising tariffs, which would invite retaliation by other countries and risk a 1930s-style trade war.
The last time the U.S. faced a severe recession, the early 1980s, it imposed import limits to protect the domestic auto, steel and textiles industries. Will a similar pattern unfold next year? Not necessarily, Irwin says. The dollar was strong in the early '80s, so there was more pressure on domestic companies from foreign products. And U.S. manufacturers were not as globalized as they are today, with cross-border ownership stakes and supply chains that span the globe. "Globalization has really defused a lot of protectionist pressures. Stopping trade at the border won't help as it did in the '80s," he said. "Things might be different this time."
Tokyo Stocks End 2008 With 42% Loss
Japanese shares ended 1.3% higher and other Asian markets finished mixed on Tuesday, as a disastrous 2008 began to wind down. The Nikkei ended the half-day session up at 8,859.56 in Tokyo, taking gains to a fourth straight session. But the benchmark tallied losses of 42.1% for the year, succumbing to the combined effect of the global financial crisis, recession in developed countries, declining consumer demand and a steep appreciation in the yen against other major currencies. Andrew Sullivan, a sales trader at Main First Securities, said there was "no real catalyst" for the advance, which was aided by "the normal things of window-dressing, covering [short sales], closing positions and squaring things up for the end of the year."
Tokyo markets, closed for the rest of the week, will reopen Monday. The broad Topix index gained 0.5% Friday to 859.24, but lost 41.8% of its value during the tumultuous year, when scores of stocks lost more than half their market capitalization as corporations cut their earnings forecasts. The Australian share market shrugged off a negative lead from Wall Street to end 0.9% higher, on extremely light trading volumes, after energy stocks rose and fund managers closed positions that bet on stocks to fall. The benchmark S&P/ASX 200 index closed up 1% at 3654.2 after rallying from a lackluster start as Asian markets improved throughout the day.
"With 1.4 billion Australian dollars ($1 billion) worth of shares traded through the market, it's been a woeful, woeful day," a senior trader at a large investment bank said. Traders are expecting the market to stay quiet for the rest of the week, barring worse-than-expected U.S. consumer confidence data for December, due later Tuesday. In Hong Kong, the Hang Seng Index slipped 0.7% to 14,325.50. China's Shanghai Composite fell 1% to 1,832.91, continuing slides in the previous six sessions. Top shareholders in PCCW Ltd., Hong Kong's dominant fixed-line telephone operator, proposed raising their offer to take the company private, although analysts were skeptical the buyout would succeed. Shares were suspended Tuesday.
New Zealand's NZX 50 index ended the day little changed at 2,678.22 and South Korea's Kospi added 0.8% to 1,126.65. Singapore's Straits Times Index slipped 0.5% to 1,771.62 while Taiwan's Taiex closed 3.9% higher at 4,589.04 Analysts say Taiwan's rally was driven by local investors, especially retail investors, who hoped the higher-than-expected fund repatriation from September-November will boost the bourse after the New Year holidays. "I don't think the strong gains will continue for long, as economic data around the globe are still dreadful...Also, retail investors usually buy on news and sell as soon as the news fades," said Henry Miao, a trader at Hua Nan Securities.
Case/Shiller: October Home Prices in 20 U.S. Cities Fall 18% From Year Ago
Home prices in 20 U.S. cities declined at the fastest rate on record, depressed by mounting foreclosures and slumping sales. The S&P/Case-Shiller index declined 18 percent in the 12 months to October, more than forecast, after dropping 17.4 percent in September. The gauge has fallen every month since January 2007, and year-over-year records began in 2001. The financial market meltdown that’s reverberated around the globe has prompted banks to curb lending, signaling the housing slump will persist for a fourth year in 2009. Falling property values have eroded household wealth, causing consumers to pare spending and deepening what is projected to be the longest recession in the postwar period.
"As 2008 comes to an end, the housing market is left in a weaker state than at the beginning of the year," Michelle Meyer, an economist at Barclays Capital Inc. in New York, said before the report. "Uncertainty remains high given the unprecedented nature of the recession." Economists forecast the 20-city index would fall 17.9 percent from a year earlier, according to the median of 21 estimates in a Bloomberg News survey. Projections ranged from declines of 17 percent to 18.4 percent. Compared with a year earlier, all areas in the 20-city survey showed a decrease in prices in October, led by a 33 percent drop in Phoenix and a 32 percent decline in Las Vegas. "The bear market continues," David Blitzer, chairman of the index committee at S&P, said in a statement. The declines in Atlanta, Seattle and Portland surpassed 10 percent for the first time, he said.
Robert Shiller, chief economist at MacroMarkets LLC and a professor at Yale University, and Karl Case, an economics professor at Wellesley College, created the home-price index based on research from the 1980s. The 20-city index is down 23 percent from its 2006 peak. Fourteen of the 20 metropolitan areas showed record declines in the year ended in October. Home prices decreased 2.2 in October from the prior month after declining 1.8 percent in September, the report showed. The figures aren’t adjusted for seasonal effects so economists prefer to focus on year-over-year changes instead of month-to- month. Six cities, including Atlanta, Charlotte, Detroit, Minneapolis, Tampa and Washington, had the largest one-month drop on record.
Other housing reports this month have shown property values are deteriorating even faster as foreclosures climb. Home resales, which account for about 90 percent of the market, dropped in November and median-home prices fell 13 percent from a year earlier, the most since records began in 1968, the National Association of Realtors said last week. Foreclosures and short sales accounted for 45 percent of last month’s total, the agents’ group also said. The share of mortgages delinquent by 30 days or more and those already in foreclosure rose to all-time highs in the third quarter, the Mortgage Bankers Association said Dec. 5.
Declines in home construction have subtracted from economic growth since the first quarter of 2006. Weak housing construction is likely to remain a drag on the economy until sales and prices improve. Lennar Corp., a U.S. home construction company that builds in 14 states, reported its seventh straight quarterly loss on Dec. 18. "Frankly, we’re in the midst of a downward spiral and the momentum is building," Chief Executive Officer Stuart Miller said on a conference call with analysts.
For Big Oil, December 31 is a Day of Reckoning
Most of us are elated with gasoline prices, especially those driving to see relatives. We are down on the Chesapeake shore, and filled up the mini-van for $1.49 a gallon. But if you are a petro-state or an oil company, these aren’t happy times. If you are in oil, you’ve probably got whiplash. Last summer, customers were paying you up to a whopping $147 a barrel for your oil, and though few except perhaps Arjun Murti over at Goldman Sachs thought those prices would stick around, it was equally so that almost no one expected to be paid as little as $32 a barrel just a few months later (and $36 last Friday). Russia, Venezuela, Iran and most of the rest of the oil producing states simply cannot balance their budgets. But, focusing for now on oil companies big and small, matters are about to get worse. As others are pointing out, that will become clear in just a few days — on Dec. 31 to be precise. One might call it the day of reckoning. The Wall Street Journal’s Ben Casselman was ahead of the pack in writing about this.
But what these reports aren’t pointing out is that, if projections are anywhere near correct, this isn’t a one-year matter. The companies may be in for trouble for at least the next couple of years. (After alarming the skittish market in the summer by forecasting $200-a-barrel oil, Goldman Sachs is now predicting average $45-a-barrel oil next year. The World Bank expects an average of $75 a barrel oil over the next two years.) Here’s why: It’s the price of oil on Dec. 31 that all oil companies — at least those that sell shares to the public — must use as a measuring stick of just just how much in the way of proven oil and gas reserves they own. The most important factor in this calibration is how much it costs a company to drill a barrel of oil in, say, Canada, or the Gulf of Mexico. If they cannot drill that barrel economically at $40 a barrel (presuming that’s about the price the day after tomorrow), it must be stricken from the books. Along with that number, the companies report their so-called "reserve replacement" — to what degree they managed to replenish the oil and natural gas they drilled during the year.
Those numbers must be reported to the Securities and Exchange Commission on a company’s 10-K statement. That’s where the trouble begins: When the companies go public with their reports in February and March, Wall Street will use the numbers to help calculate how much their share price is worth; and banks and venture capitalists will do the same to determine whether to lend to oil drillers in this tight financial environment, and if so at what interest rate. Lee Fuller, vice president of government relations for the Independent Petroleum Association of America, says that credit is the key issue for the independent producers whom he represents. "To the degree you are getting credit, you are getting it [as a function of] your resource base," Fuller said in an interview. When that base is much lower, he said, "you are vulnerable to someone coming in and taking you over." An Exxon spokesman said the company declines to comment. But credit isn’t going to be an issue for Exxon and most of the other Big Oil companies — Exxon for example has more than $36 billion in cash on hand. Rather, for the half-dozen mega-majors, the issue is going to be justifying their share price to Wall Street when a chief component of their asset base has dropped considerably.
Even for 2007 — when oil ended the year at about $95 a barrel — the struggle for some of the companies to replace reserves was already apparent. By the SEC rules, Exxon replaced just 76% of its reserves (though by its own internal methods it said it replaced 101%). Chevron replaced just 10%-15% of the oil and gas it drilled. BP said it replaced more than 100%. But at $35 or $40 a barrel, those percentages are going to be far lower. Stay tuned for some news-spinning from Big Oil’s public relations arms in the coming weeks and months. The companies’ share prices have already been pummeled this year by Wall Street. Some say that a focus on reserve reports is something for "unsavvy investors" and commentators — "the resources are still there for a price," said this fellow calling others unsavvy.
That view is correct to a point — Dec. 31 is an arbitrary date to judge one’s reserves. But it’s a narrowly drawn view, concentrating only on the presence of fossil fuels in the ground. It ignores that oil and gas is becoming far harder and more expensive to drill; it’s situated in smaller and smaller reservoirs, requiring the drilling of more and more wells to produce the same volume of oil; and it’s largely controlled by petro-states that, even if low oil prices drive petro-states to be friendlier toward international oil companies, are still likely to demand far tougher terms than they did, say, in the 1990s. In short, company reserves are becoming smaller, and the focus on reserves reporting is demonstrably relevant. Some good news for the companies is that the SEC is going to change the reporting rule starting in 2010 — companies will be able to use an average of the annual price rather than the year-end price. But that’s a slender reed of hope if trends and oil forecasts for an average $40-$60 a-barrel oil next year are accurate. According to inflationdata.com, the average oil price in 2007 was $66.40; so far this year, it’s about $98. So that if the current trajectory holds, the price on which the companies will report their 2009 reserves will be relatively low, too.
Fallout begins after dismal holiday season
The fallout from the horrific holiday season for retailers has begun, with the operator of an online toy seller filing for bankruptcy protection and more stores expected to do the same -- meaning more empty storefronts and fewer brands on store shelves. A rash of store closings, which some experts predict will be the most in 35 years, is likely to cut across areas from electronics to apparel, shrinking the industry and leading to fewer niche players and suppliers. The most dramatic pullback in consumer spending in decades could transform the retail landscape, as thousands of stores and whole malls close down. And analysts expect prolonged woes in the industry as the dramatic changes in shopping behavior could linger for another two or three years amid worries about the deteriorating economy and rising layoffs. "You are going to see a substantial retrenchment in the retail industry," said Rick Chesley, partner in the global bankruptcy and restructuring group at international law firm Paul Hastings. "The downturn has been catastrophic."
A number of stores couldn't even make it to Christmas. Circuit City Stores Inc. filed for bankruptcy protection last month. It plans to keep operating, but toy seller KB Toys, which filed for bankruptcy earlier this month, is liquidating its stores and will shut down. The survival prospects for many more stores are dimming as more sales data comes in about the crucial holiday shopping season, which can account for up to 40 percent of a retailer's annual profit. Holiday sales fell from 2 percent to 4 percent compared to a year ago, according to SpendingPulse, a division of MasterCard Advisors. Excluding gas and car sales, they dropped between 5.5 percent and 8 percent from Nov. 1 through Dec. 24, as key categories from luxury to electronics posted double-digit sales declines. Sales of electronics and appliances fell almost 27 percent, for example. ShopperTrak RCT Corp. which tracks retail sales and customer traffic at more than 50,000 outlets, said Monday that it now expects foot traffic to be down 16 percent and sales to decline 2.3 percent for the November and December period.
The retail casualties, which were first among home furnishing stores and then many apparel stores over the past year or so, are expected to cut across all sectors as shoppers have slashed their spending on nonessentials, from TVs to jewelry. About 160,000 stores will have closed this year and 200,000 more could shutter next year, said Burt P. Flickinger III, managing director of consulting firm Strategic Resource Group. That would be the industry's biggest contraction in 35 years. In March and April of next year, Flickinger expects 2,000 to 3,000 malls to shutter. AlixPartners LLP, a turnaround consulting firm, predicts that 25.8 percent of 182 major retailers it tracks are either facing major financial distress or will face a significant risk of filing for bankruptcy in either next year or 2010 -- the highest level in the 10 years that the firm has been compiling the figures. That compares with the 4 percent to 7 percent that it predicted would face financial woes in the previous two years.
Among the most vulnerable are retailers that have debt coming due soon and had relied on solid holiday sales to generate cash, said Matthew Katz, managing director in the firm's retail performance improvement practice. But he said he's also watching merchants whose debt is not due until later in 2009 or 2010, but are paying big interest payments as they struggle with high debt loads and shrinking revenues. Some of the retailers that analysts say they are watching carefully are struggling regional department store Bon-Ton Stores Inc., of York, Pa., and apparel retailer Goody's Family Clothing Inc., which filed for bankruptcy protection in June but emerged from Chapter 11 in October. Officials from Bon-Ton and Goody's did not immediately return calls seeking comment. This week Parent Co., the operator of etoys.com, filed for Chapter 11 bankruptcy protection and said it will consider selling some or all of its operations. Chris Byrne, a New York-based toy consultant, said that etoys.com couldn't compete with the aggressive tactics embraced by Toys R Us and Wal-Mart Stores Inc., the nation's top two toy sellers.
Retailers who do file for bankruptcy are also under more pressure now than in the past because of 2005 changes to the code that cut down the amount of time they have to file a complete reorganization plan, said Ken Simon, managing partner at Loughlin Meghji + Co., a restructuring advisory firm. Another big problem for them, Simon said, will be securing additional financing to keep operating because of the tight credit markets. The dire problems facing retailers also spell bigger problems for suppliers, which have already been seeing merchants cut or cancel orders. Allan Ellinger, senior managing partner at New York-based MMG, an investment banking and strategic advisory practice, foresees a shakeout in the apparel industry and said those who survive are going to have a hard time meeting the financial needs of stores. He estimated that apparel companies have slashed their 2009 spring inventory by 20 percent to 25 percent from a year ago, because they would rather be reacting to hot sellers than be stuck with too much merchandise. "You have to go into deep survival mode," Ellinger added.
Dollar, pound, euro or yen - which currency is the safest bet for 2009?
Which currency will be a safe harbour of value in 2009? It is not an easy contest to call. Dollar, yen, euro, pound: each has structural deficiencies and plenty of scope to leak value. But in this contest of inadequate defences, some harbour is bound to prove better. Recent history teaches caution. In 2008, there was extreme currency volatility and an apparent disconnect between fundamentals and prices. The dollar plunged until August - and then rallied hard, even as the US economy sank, before stalling in December. The yen powered up late in the year from multi-year depths, in spite of Japan heading towards recession. The currency fight is not straightforward, especially in this time of global financial crisis.
Deleveraging, forced liquidation, safe-haven flows: these are undercurrents that are powerful yet not so easily seen. The dollar, still the world's reserve currency, has on the surface four huge forces against it: the cutting of interest rates to zero; huge boosts to the money supply through so-called quantitative easing; spiralling government deficit and debt; and an external deficit that remains close to 5pc of GDP. These risk sending the dollar to multi-year lows yet again. Were other countries without serious problems, that would be likely - and it may indeed occur. But other factors may weigh against it. The desperate times for the countries that consumed their way into trouble - the US and UK - are also desperate times for their suppliers.
Germany, the world's biggest exporter, will suffer a big contraction in GDP in 2009 - a fall of 2.7pc, according to the Kiel Institute. China, the second biggest, has cut interest rates five times since mid-September and announced a fiscal stimulus of $580bn. Japan's exports were down by 26.7pc in November on a year earlier. Yet the yen is close to a thirteen-year high against the dollar, partly because traditionally low Japanese rates are now matched by novel but just as exiguous policy interest rate in the US. The yen's recent rally is also partly technical. For years speculators borrowed in yen in order to finance the purchase of higher yielding currencies and assets. They have recently beat a rapid retreat. When all those carry trades are reversed, the yen could therefore suffer, especially if other economies show signs of recovery.
For the euro, too, the slowdown in global trade brings risks. The European Central Bank has been slow to cut rates. But as unemployment bites it is likely to follow its peers in Japan, the US and UK in moving the overnight policy rate down to very low levels. Moreover, eurozone economies face their first test by recessionary fire. That may inspire countries which once devalued in hard times - such as Spain and Italy - to think about leaving the single currency. Even vague talk of departures would unsettle the markets and undermine the euro's appeal. The ECB's sluggishness, too, could hurt the euro if recession looks to be deepening and persisting. Nor will the strong euro help exports or recovery, especially as the currencies of so many of its important customers are weak.
The UK is in that group. Recovery there isn't near at hand. The pound has plummeted against the euro and yen, and also the dollar. The UK has all the US's fiscal and monetary deficiencies, but the pound has none of the dollar's reserve status. Its path remains down. Parity with the euro looks inevitable. The more exciting question is how close the pound, worth $2 as recently August, might come to parity with the dollar. That suggestion may seem outlandish. But suppose the huge fiscal and monetary stimulus creates a revival of some sort in the US economy. Then the dollar could rise to, say, $1.20 per recession-weakened euro. If the euro has climbed to a value of £1.05, the pound would buy just $1.14 - not far from parity. So is the dollar the best bet in 2009? A currency supported by a zero interest rate, a deficit-ridden government and a recession-stricken economy ought not to be. And might not be. The currency risks investors will run in 2009 will again be frightening. Finding a safe currency is almost as hard as finding a safe bank.
Treasury provides financial support to 43 more banks
The Treasury Department said Monday that it has provided $1.9 billion to 43 banks as part of the government's $700 billion financial rescue program. Buffalo, N.Y.-based M&T Bank Corp. received the most, getting $600 million from the Treasury in return for preferred stock and warrants. Fulton Financial Corp., based in Lancaster, Pa., received $376.5 million, the department said. The department previously announced that it was providing the money but did not reveal the recipients' names until late Monday. Some of the funds were granted to 20 privately held banks. A total of 34 private banks have now received funds from the financial rescue program.
So far, Treasury has invested more than $162 billion in 207 banks. The department set aside $250 billion from the bailout fund to be used for direct investments in banks. The investments are intended to bolster banks' balance sheets and spur them to step up lending to counter the worst financial crisis to hit the country in 70 years. But critics contend that many banks are not using the money for that purpose. An Associated Press survey earlier this month of 21 banks that received at least $1 billion each in government support found that none of them would provide specific answers on how the money was used. Other companies have received preliminary approval to receive funds but haven't finalized the transactions. Last week, credit card giant American Express Co. said it had received preliminary approval for $3.39 billion in government money. And commercial finance company CIT Group Inc. said it had received approval to obtain $2.33 billion.
GMAC to Get $6 Billion Aid Deal
The federal government Monday deepened its involvement in the U.S. automotive industry by committing $6 billion to stabilize GMAC LLC, a financing company vital to the future of struggling car maker General Motors Corp. In a sign the government's role in the industry could become open-ended, the Treasury Department said Monday it had set up a separate program within the Troubled Asset Relief Program, a fund originally designed to help banks, to make investments directed at the auto industry. A Treasury official said the new program didn't have a specific dollar limit. The Treasury purchased $5 billion in senior preferred equity in GMAC and offered a new $1 billion loan to GM so the auto maker could participate in a rights offering at GMAC. That loan comes in addition to the recent $17.4 billion emergency plan to rescue GM and Chrysler LLC.
The move represents the second tranche of government aid that redounds to the benefit of giant private-equity firm Cerberus Capital Management, which owns Chrysler and, until these recent moves, a majority stake in GMAC. John Snow, a top player at Cerberus, was the Bush administration's Treasury secretary before Henry Paulson. In bailing out GMAC, Treasury officials aren't just stabilizing an auto-finance company but a major player in the housing market's boom and bust. GMAC played a big role in pushing riskier adjustable-rate mortgages. The collapse of the housing market put additional strain on GMAC. The difficulties of GMAC and Chrysler's financing arm, Chrysler Financial, are a big reason GM and Chrysler have suffered steep drops in auto sales and fallen into financial trouble in the past few months, said Michael J. Jackson, chief executive of AutoNation Inc., the country's largest chain of auto dealerships, in a recent interview. Both financing companies have been restricting credit as their own finances worsened. "Consumer credit is the jet fuel of the auto business," Mr. Jackson said. "The majority of consumers can't buy a car without getting a loan."
GMAC finances about 80% the wholesale purchases of GM's cars by dealers world-wide. It has traditionally been the largest source of financing for the actual buyers of those vehicles once they reached the showroom. The car company said last month that a 45% sales skid for October was fueled by GMAC's restricted lending, which cost GM anywhere from 45,000 to 60,000 sales in the month. About 25% of GM vehicle sales were financed through GMAC last month, down from more than 40% a year ago. The move by Treasury is the second part of a two-step rescue by the government of GMAC. Last week, the Federal Reserve approved the finance company's application to become a bank-holding company, a move sought by other companies, too, to take advantage of new government programs aimed at stabilizing banks.
The Fed's approval was conditional on GMAC raising new capital, which the company tried to do through a debt-equity swap that expired Friday. The company's goal was to raise $30 billion by converting 75% of its issued debt into preferred-stock holdings. Last week, less than 60% of bondholders had signed on and the offering had been extended four times. At the same time as the Treasury announcement Monday, GMAC said it had raised enough capital to satisfy the Fed's conditions. It wasn't clear whether the government's intervention prompted or followed GMAC's meeting the capital requirement. Cerberus bought 51% of GMAC in 2006. GM has a 49% stake in GMAC. As a result of the Fed's move, Cerberus must reduce its interest to a maximum of 14.9% in voting shares and 33% in total equity. It will do this by distributing its positions in GMAC directly to Cerberus investors. GM will transfer part of its stake in GMAC to a trust whose trustee will be approved by the Treasury.
Treasury has now spent virtually all the first half of a $700 billion financial-market rescue package Congress approved in early October. Treasury Secretary Paulson said two weeks ago that the first half of the bailout fund was essentially spent and that Congress would soon need to release the second installment. The Treasury official who briefed reporters on the plan Monday wouldn't break down how all of the money had been allocated, but said "from a short-term cash-flow basis" the department hasn't exceeded the first $350 billion installment. It is "not fair to say we've overcommitted the 350" billion, he said. Treasury officials briefed members of President-elect Barack Obama's transition team on the new plan, a Treasury spokeswoman said. Treasury said GMAC would pay an 8% dividend as part of the $5 billion investment, which the government said was "part of a broader program to assist the domestic automotive industry in becoming financially viable." Treasury will receive warrants from GMAC, which will be additional preferred equity equal to 5% of the preferred-stock purchase that will pay a 9% dividend if exercised.
Treasury's investment doesn't carry any direct requirement to lend any of the money. A similar lack of conditions for funds loaned to banks has been a source of criticism, especially among congressional Democrats who charge as a result that the bailout isn't working. As part of the deal, GMAC agreed to limit compensation on its top 25 executives including a ban on severance packages for the top five employees. The limits won't apply to executives at Cerberus. Cerberus spokesman Peter Duda said the firm had no comment on Treasury's investment. GM officials couldn't be reached. GMAC said in a statement that becoming a bank-holding company improved its ability to make consumer and business loans. "In particular, the company intends to act quickly to resume automotive lending to a broader spectrum of customers to support the availability of credit to consumers and businesses for the purchase of automobiles," the company said. As a federally chartered bank, GMAC can have its debt temporarily guaranteed by the Federal Deposit Insurance Corp. GMAC also could get access to the Fed's discount window for inexpensive, short-term emergency loans.
Retail in ruin?
The specter of tens of thousands of retail stores being shuttered looms large after holiday retail sales look to be as dismal as predicted, driving up long-held skepticism that America is over-stored. Four retail analysts -- Britt Beemer, Howard Davidowitz, Larry Freed and Michael Niemira -- believe retail names will be wiped off the map and thousands of stores will close in the new year. Davidowitz estimates retailers will shutter 12,000 money-losing stores in 2009; Beemer predicted that half of today's retailers will be in big trouble -- perhaps at risk of shutting down -- next year; Freed believes 20 to 40 retail chains will go out of business in the first three months of the new year, and Niemira predicts 73,000 retail locations will close in the first half of 2009.
Niemira is chief economist for the International Council of Shopping Centers, which predicts, using U.S. Bureau of Labor Statistics data, that 148,000 stores will shut down in 2008. That would be the largest number since 151,000 closings in 2001, during the last recession. The United States had 1.11 million retail locations in 2002. Beemer, chairman of America's Research Group, said 30 percent of shoppers his company surveyed are concerned about their jobs this holiday season. "That puts them in a survival mind-set," he said. Retailers count on November and December sales for as much as half of their year-round business and profits. Shoppers' anxiety has combined with a tight credit market to make the future untenable for shaky retailers, said Freed, CEO of Foresee Results, an online measuring firm based in Ann Arbor, Mich.
Bon-Ton Stores, owner of Carson Pirie Scott & Co., ended its relationship with CIT, which lends money against vendors' receivables. The York, Pa.-based retailer issued a statement saying, "We believe Bon-Ton has an appropriate capital structure and financial base to meet our obligations." The Carson's owner said it is working directly with its vendors affected by the situation. Early results show holiday sales dropped 2.5 percent to 4 percent this year from last year -- the worst showing in 50 years. Retailers report official results on Jan. 8. The data showed online shoppers pinched pennies too. Online sales fell anywhere from 1 to 2 percent to 12 percent from Nov. 1 through Christmas Eve from the year-ago period, depending on the survey, marking the first decline since the dot-com boom started. An online shopping satisfaction survey to be released today showed that shoppers were looking for bargains as a higher priority than ever before, said Freed, whose company conducts the research for the American Customer Satisfaction Index. The top 10 scorers online this holiday were Amazon.com, Netflix, QVC, Apple, Barnes & Noble (BN.com), L.L.Bean, Newegg, Wal-Mart, Avon and Staples.
A Black Hole in German Banking Bailout
Prosecutors in Germany are investigating accusations of insider trading at Hypo Real Estate, the Munich-based mortgage lender that has recieved billions of euros in government bailouts -- the most of any company so far -- as a result of risky investments in US subprime loans. They arrived early in the morning in large teams and they raided numerous offices and private residences at the same time. In November 2006, the Siemens corruption scandal came to light with a major police raid -- an affair whose first chapter ended several days ago with a multibillion dollar settlement with the United States government. As news came recently of the Siemens judgment in the US, it almost seemed like deja vu when investigators launched spectacular raids in what could become Germany's next great business scandal.
Yet again, dozens of investigators mounted simultaneous raids on numerous locations. But this time the investigations aren't into corruption. Investigators are looking into charges of speculation, market manipulation, breach of trust and deception, insider trading and incompetence among greedy finance managers at the Munich-based Hypo Real Estate, one of the German banks that has been the most deeply entangled in the finance crisis. The sums of money involved in this scandal far exceed those in the Siemens affair. Just three months ago, the German government, the German central bank (Bundesbank) and several credit institutions agreed to provide HRE with €50 billion ($71.7 billion) in liquidity to prevent the bank's collapse and a chain reaction that would have hit other German banks. The government then had to provide an additional €30 billion in credit guarantees to the crippled bank.
The Munich mortgage lender, together with the Irish subsidiary Depfa that it acquired in 2007, had burned massive amounts of money through risky US real estate securities and other reckless business dealings. The company also appears to have covered up the scope of its misdealings. That, at least, is the assumption of public prosecutors who are now investigating HRE executives. According to the search warrant issued, prosecutors are investigating alleged "false statements," "market manipulation," and "breach of trust" by current and former members of HRE's board. In a six-page paper, prosecutors take a tough stance on managers. They claim they made "deliberately false statements" about the company's dramatic situation and that they were guilty of "deliberately concealing" important information and that they had violated their obligation to safeguard company assets.
Prosecutors believe that the company's former board withheld information from the public about the company's true state for more than a year. The Munich public prosecutor's office has also confirmed that it has been investigating the company since February for suspected insider trading among other things. According to several criminal complaints, HRE managers or their relatives and friends are accused of having sold large numbers of HRE shares before the company first warned of its financial woes on January 15. Share prices in HRE have hit rock bottom since the company's financial troubles hit the headlines. In their search warrant, investigators claim the main reason for the company's current financial misery is that the board failed to take steps needed to restructure the company at the necessary time. Contacted by SPIEGEL, a spokesman refused to comment on the developments. Other executives, however, have defended the company's leadership, saying it had not been given sufficient warning about the true state of HRE. The former chief excutive, Georg Funke, 53, along with other top executives, has since been fired. The bank's new chief, Axel Wieandt, 42, who was hired in October, has just fired two other members of the management board and announced that by 2011, he will have to lay off more than half of the bank's 1,800 employees. What will remain of the company will be a shell of its former self -- and a raft of unanswered questions.
HRE's holiding company, HRE Holding, was only partially regulated under Germany's Banking Act. The country's banking regulator, BaFin, was in charge of supervising HRE's domestic subsidiaries in Germany and, together with its Irish colleagues, HRE's Depfa unit in Dublin. But it appears that nobody had a complete picture of what was happening at HRE. That led to a disastrous lapse in banking supervision. "So far, we have not been able to comprehensively oversee financial holding companies," a BaFin spokeswoman confirmed. German lawmakers are now moving to change existing legislation. According to the latest amendment to German securities law, firms can voluntarily subject themselves to the rules and implement systems to reduce their risks. But experts are calling for tougher rules. "HRE is to Germans what insurance company AIG is to the Americans," said one prominent banker. Both firms were long considered trouble-free, slumbering giants, but in the end, they have emerged as black holes in the industry in which billions in bailout money are rapidly disappearing. The casual approach that had been taken by management should have served as a warning signal long before.
As early as May 2007, Michael Thiemann, the manager of HRE subsidiary Collineo, admitted, "You don't have the time to take a close look at each borrower." Shortly afterward, Collineo and Citigroup sold a massive package of highly complex property loan investments, of which almost half were US subprime mortgages. Recklessness, bravado and greed were the hallmarks of the troop of executives surrounding Gerhard Bruckermann, who ran Depfa -- a company registered under Irish law for the financing of government projects -- before selling it to HRE in the summer of 2007. Five years earlier he had moved important parts of the company, which was supposedly rock solid but whose management took too many risks, to tax havens in order to save on taxes. Bruckermann rewarded himself and his management board for such creativity by raising the board's salary by 100 percent in 2003 -- to €20 million. He went on amass an even greater personal fortune: he is believed to have earned €100 million through the HRE deal.
The undeniable shift to Keynes
More than three decades have passed since Richard Nixon, the Republican US president, declared: "We are all Keynesians now." The phrase rings truer today than at any time since, as governments seize on John Maynard Keynes’s idea that fiscal stimulus – public spending and tax cuts – can help dig their economies out of recession. The sudden resurgence of Keynesian policy is a stunning reversal of the orthodoxy of the past several decades, which held that efforts to use fiscal policy to manage the economy and mitigate downturns were doomed to failure. Now only Germany remains publicly sceptical that fiscal stimulus will work. The new Keynesian consensus was set out in the communiqué issued by the Group of 20 leading industrialised and emerging economies in November, in which they vowed to "use fiscal measures to stimulate domestic demand to rapid effect" within a policy framework "conducive to fiscal sustainability".
The incoming administration of Barack Obama is preparing a two-year fiscal stimulus package with a reported price tag of $675bn-$775bn, which many Washington-based analysts believe could swell to $850bn (£580bn, €600bn) or even $1,000bn – between 5 per cent and 7 per cent of national income. Gordon Brown, UK prime minister, told reporters in late December that if monetary policy was impaired – in large part because of problems within the financial system – "then governments have to use fiscal policy, and that has been seen in every country of the world". Launching France’s fiscal stimulus, President Nicolas Sarkozy said: "Our answer to this crisis is investment because it is the best way to support growth and save the jobs of today – and the only way to prepare for the jobs of tomorrow."
But not all policymakers have been so keen to jump on board what they see as a dangerous journey, not back to the theory Keynes laid out to combat a deep and protracted economic slump but to the failed fiscal fine-tuning of the 1970s, in which governments tried to maintain full employment at all times. Germany has voiced the strongest principled objections to large-scale fiscal stimulus packages. Peer Steinbrück, the finance minister, has complained about the "crass Keynesianism" pursued by Mr Brown, accusing him of "tossing around billions" and saddling a generation with having to pay off British debt. Jürgen Stark, an executive board member of the European Central Bank, who was previously vice-president of the Bundesbank, warned of a "substantial risk" of a repeat of the 1970s. "I really cannot see why discretionary fiscal policies, which have proven to be ineffective in the past, should work this time," he said.
Jean Claude Trichet, ECB president, has taken a cautious stance, arguing in a Financial Times interview for countries to allow their deficits to rise in line with the so-called automatic stabilisers – such as higher unemployment benefits and reduced tax revenues during a recession – but warning that the prospect of future tax rises could reduce consumer confidence. "One might lose more by loss of confidence than one might gain by additional spending," he said. In the US, Lawrence Summers, the former Treasury Secretary now lined up to head Mr Obama’s National Economic Council, said the fiscal stimulus will address the need to increase investment in energy, education, health and infrastructure as well as the need to stimulate the economy. Laurence Boone, a Paris-based economist at Barclays Capital, argued that large European countries fall into two camps. In one are countries with highly indebted consumers where housing markets have made a big contribution to economic growth in recent years – namely the UK and Spain. Here, fiscal stimulus packages were larger and focused on supporting consumers and housing.
Elsewhere, especially Germany and France, stimulus plans were less ambitious and "are set to rely more heavily on public sector investment, especially in infrastructure, with little support to consumption", Ms Boone notes. The contrasting rhetoric is more exaggerated than the reality of the differing positions. In gung-ho Britain and France, for example, the planned fiscal stimulus is no bigger than in reluctant Germany. And in all three countries, reduced tax revenues and higher welfare state payments will contribute the vast majority of prospective higher budget deficits, not the discretionary measures introduced in recent months. The US stimulus package appears to dwarf the European efforts. But any fiscal stimulus has to be larger in the US to have a similar effect because more generous European social safety nets guarantee higher payments to the unemployed. Mr Trichet argues that these "automatic stabilisers… have perhaps twice as much influence… as a percentage of GDP in the euro area as compared with the US".
But it is clear a worldwide shift towards Keynesian deficit financing has occurred this year. Partly this is the result of the credit crisis impeding the effectiveness of monetary policy, partly the fact that interest rates cannot be cut further in the US and Japan, and also partly because banks will not lend to many households and companies even if they want to borrow. But the move towards using fiscal policy as a means of boosting advanced economies still has limits, recognised by all those who experienced the 1970s. Unsustainable fiscal positions can destroy confidence. The US, which issues the dollar, the world’s reserve currency, has more latitude than most. But even Mr Obama has been keen to stress his ambition to "get our mid-term and long-term budgets under control". Smaller countries with fragile currencies, such as the UK, are even more vulnerable to the effects of the confidence of foreign investors. The UK government announced a five-year government austerity package to reduce deficits from 2011 at the same time as its stimulus in an attempt to provide evidence of its longer-term good intentions. Continental European economies are bound by the stability and growth pact, limiting both budgets and debt. But the deterioration of the outlook for the global economy has been so rapid that addressing the immediate problems has overtaken consideration of longer-term consequences.
This trend was first evident almost a year ago in January, when Dominique Strauss-Kahn, the managing director of the International Monetary Fund, stunned delegates at the World Economic Forum in Davos when he called for "a new fiscal policy [as]… an accurate way to answer the crisis". On the podium with him was Mr Summers. He remarked: "This is the first time in 25 years that the IMF managing director has called for an increase in fiscal deficits and I regard this as a recognition of the gravity of the situation that we face." Mr Summers now argues that the outlook has deteriorated further. With the prospect of the economy remaining weak and unemployment high for a protracted period, he believes spending on projects that continue beyond 2009 is justified. Critics said this was a convenient cover for spending programmes that the Democrats wanted anyway. However, many economists agreed with the argument. "The US economy needs not only a large package of fiscal stimulus in 2009 but one that provides substantial support beyond next year," said Ed McKelvey, an economist at Goldman Sachs.
IMF argues for large stimulus packages
Across-the-board tax cuts or bail-outs of troubled industries such as the automotive sector are likely to waste government money while doing little to stimulate the global economy, the International Monetary Fund warned on Monday. As governments around the world bring in tax cuts and boost spending to combat the global recession, a study by the IMF said such programmes must be large but carefully designed. "There is a strong case for doing too much rather than too little," said Olivier Blanchard, the fund’s chief economist. But, he added, tax cuts should be aimed at people likely to spend money rather than save it.
Although the IMF said it would resist giving a running commentary on policies, Mr Blanchard said signs of the stimulus plan emerging from the camp of US president-elect Barack Obama appeared to be hopeful. "The size corresponds roughly to what we think is needed," he said. Tax cuts needed to concentrate on individuals who were having difficulty getting access to credit rather than those who were saving instead of spending. "In those respects the [US] programme currently indicated seems to meet those requirements," Mr Blanchard said. Mr Obama’s team is reportedly considering a fiscal stimulus worth $675bn-$775bn, or 5-6 per cent of US gross domestic product, likely to include substantial long-term investment spending.
The IMF cast doubt on small cuts in value-added taxes, such as that announced by the UK, as a way of boosting the economy. While the fund said the UK’s policy of pre-announcing the reversal of the cut would help reassure investors about government borrowing, "It is questionable whether decreases in the VAT of just a few percentage points are salient enough to lead consumers to shift the timing of their purchases." The fund said focusing help on high-profile sectors such as the car industry was likely to be perceived as unfair and could set off tit-for-tat protectionism.
The fund, whose economists were among the first forecasters in the official sector to recognise the extent of the global downturn, said governments should apply a range of spending increases and tax cuts to their economies, given the uncertainties about which might work. "Governments don’t want to put all their eggs in the same fiscal basket," said Carlo Cottarelli, director of the fund’s fiscal affairs department.
Loans to eurozone firms, households stagnate in November
Lending to euro zone companies and households stagnated in November, the weakest result on record, bolstering expectations that the European Central Bank will keep cutting interest rates to ward off a deep recession. ECB figures on Tuesday showed loans to the private sector rose by just 1 billion euros month-on-month, a percentage increase of zero, the smallest rise since records began in 1991. The stagnation brought annual growth in private sector loans down to 7.1 percent, from 7.8 percent in October. Money supply growth also slowed more than expected and economists said the figures supported the case for a Jan. 15 rate cut.
"The sharp slowdown in euro zone private sector lending in November is likely to raise concern at the ECB over a credit crunch in the region," ING Financial Markets economist Martin Van Vliet said. "In all, the latest set of euro zone economic data is likely to reinforce market expectations that the ECB is unlikely to pause at their policy meeting next week and may cut its key interest rate by 25 basis points." The ECB has already cut benchmark rates by 175 basis points since early October to 2.5 percent, but economists expect more to come as the economy stumbles and inflation rates plummet. M3 money supply growth, which the ECB sees as an indicator of looming inflation pressures, fell to 7.8 percent annually from 8.7 percent, below expectations of a fall to 8.5 percent.
The figures showed household borrowing has been harder-hit by the economic downturn than business loans. Annual growth in household loans fell to a new record low of 2.5 percent. Corporate borrowing growth was the weakest in 2-1/2 years, although it still came in at 11.1 percent annually. Bank of America economist Gilles Moec said growth rates remained suprisingly high compared to anecdotal evidence from the corporate sector. "(The slowdown) is very gradual, it's not what you expect if you believe in a credit crunch scenario," he said. "It could be, however, that banks right now are refocusing on their core business of loans to the real economy."
FBI steps up search for evidence in Bernard Madoff scandal
The FBI is understood to be monitoring key individuals connected to the $50 billion (£34 billion) Bernard Madoff investment scandal as the federal agency comes under increased pressure to construct a criminal case against the 70-year-old financier. The agency is scrutinising bank withdrawals made by former employees of Mr Madoff and their personal activities, including where they travel and with whom they mix. The use of such methods came to light as it emerged that Frank Dipascali, Mr Madoff's chief financial officer, has been interviewed by investigators over his role at Madoff Investment Securities. Marc Mukasey, Mr Dipascali's lawyer, failed to return calls yesterday.
As regulators scour documents seized from Mr Madoff's offices in Manhattan, the financier is under pressure to meet tomorrow's deadline to provide details of all investments, assets, loans, lines of credit and accounts held by his company to the US Securities and Exchange Commission (SEC). Under the terms of a court order issued by Louis Stanton, a US district judge, on December 18, Mr Madoff must supply the lists by New Year's Eve and must include all assets held by the financier for his "direct or indirect benefit". Mr Madoff's foreign operations - such as the now-closed office off Berkeley Square in Central London - have until January 26 to hand over their own lists.
Ira Lee Sorkin, Mr Madoff's lawyer,refused to be drawn yesterday on whether Mr Dipascali was assisting Mr Madoff with his audit tasks or whether Mr Madoff's sons, Mark and Andrew, who claim to be victims of the alleged fraud, are helping their father with the audit. Mr Sorkin did say that under his bail terms Mr Madoff, who is being held under house arrest at his flat on East 64th Street in the Upper East Side area of Manhattan, is allowed to have visitors outside members of his close family. The SEC is already expecting documents from Friehling & Horowitz, the three-man accounting firm that audited Mr Madoff's accounts, after a New York court issued a subpoena requesting information. Once Mr Madoff submits his asset lists, the SEC will begin to review the completeness of the data. It is believed that regulators are unsympathetic to claims that many documents detailing the firm's assets are in the hands of the authorities. The FBI failed to return calls yesterday.
Veterans of ’90s Bailout Hope for Profit in New One
A tight-knit group of former senior government officials who were central players in the savings and loan bailout of the 1990s are seeking to capitalize on the latest economic meltdown, enjoying a surge in new business in their work now as private lawyers, investors and lobbyists. With $700 billion in bailout money up for grabs, and billions of dollars worth of bad debt or failed bank assets most likely headed for sale or auction, these former officials are helping their clients get a piece of the bailout money or the chance to buy, at fire-sale prices, some of the bank assets taken over by the federal government. "It is a good time to be me," said John L. Douglas, a partner in Atlanta at the law firm Paul Hastings and a former lawyer for bank regulators who helped create the agency that administered the last federal bailout, the Resolution Trust Corporation.
Some of these former federal officials, like L. William Seidman, the first chairman of the R.T.C., are serving as advisers — sharing ideas with Treasury Secretary Henry M. Paulson Jr. and the transition team for President-elect Barack Obama — even while they are separately directing investors or banks on how to best profit from this advice. "It is an enormous market," said Mr. Seidman, who has already joined two such potential money-making efforts and is evaluating proposals to participate in a third. "I am enjoying this." David B. Iannarone, a former R.T.C. lawyer who is managing partner at a firm that handles defaulted commercial real estate loans, said, "The people who worked on this back in the early 1990s are back in vogue." The agency was set up by the government in 1989 to sell off what ultimately grew to $450 billion worth of real estate and other assets assembled from 747 collapsed savings banks.
What is obvious to former R.T.C. officials is that, like the last go around, a great deal of money will be made by a select group of investors and business operators, particularly those with government contacts. The former government officials said in interviews that much of what is motivating them is a desire to help the nation recover from this latest stumble. But they acknowledge they intend to be among the winners who emerge. "Fortunes will be made here, no doubt about it," said Gary J. Silversmith, one of more than a dozen former R.T.C. officials interviewed who now are involved in enterprises seeking to profit from bank bailouts. The busiest money-making arena so far for these R.T.C. alumni is in helping distressed banks line up cash infusions from the Treasury, as they seek a piece of the bailout.
Robert L. Clarke, controller of the currency under the first President Bush and a former Resolution Trust board member, has been advising banks throughout the South on how to get their share of the bailout money. "I have been absolutely inundated," said Mr. Clarke, who now works at Bracewell & Giuliani, the law firm based in Houston affiliated with the former New York mayor and presidential candidate Rudolph W. Giuliani. Mr. Clarke’s labor on behalf of his clients has included calling federal regulators to urge them to reconsider plans to reject applications for federal bailout money. He would not identify the banks, saying it might undermine public confidence in them. But Mr. Clarke said his intervention, in at least some cases, has been successful.
Eugene Ludwig, the comptroller of the currency under President Bill Clinton during the final stages of the savings-and-loan cleanup, runs Promontory Financial Group, a banking consultant group whose clients include struggling banks. "I must get an e-mail a day from people who I worked with back then about what to do about the current mess," Mr. Ludwig said. "It is not so much capitalizing on it as really just, how do we contain the flames?" Many of the former federal officials like Mr. Ludwig have stayed in the field, working as lawyers or contractors who buy up and resell seized bank properties. What is remarkable now is just how busy they are.
"It is a great time to be a banking lawyer," said Thomas P. Vartanian, a partner in the Washington office of Fried Frank, who is the former general counsel to the Federal Savings and Loan Insurance Corporation, which led a bank bailout effort in the 1980s. The planned sale by the F.D.I.C of the assets of IndyMac, the failed bank, has turned into an alumni event of sorts for veterans of the R.T.C. era, including John J. Oros, who was chairman of a financial industry council that advised bank regulators during the savings and loan crisis. Now he is a partner in J. C. Flowers, one of the private equity firms negotiating to buy part of IndyMac. In the space of one weekend in September he explored buying out the troubled insurer A.I.G. and worked with Bank of America on an aborted acquisition of Lehman Brothers. Then he advised Bank of America on its last-minute switch to buy Merrill Lynch before Lehman’s collapse hammered Wall Street.
Although the financial meltdown is a disaster for the country, Mr. Oros said, "the opportunity going forward is unprecedented. It is fantastic. It is as if I had been training for this for the last 40 years of my career." The biggest profits will most likely be made, the former federal bank officials agreed, by those who figure out a way to benefit from what could turn into one of the greatest fire sales of bad debt and bank assets in American history. Through September of this year, 25 banks had failed, compared with three in 2007. An additional 171 are on the Federal Deposit Insurance Corporation's list of troubled banks, more than double the watch list at the end of last year. As a result of these failures, and other related industry troubles, billions of dollars’ worth of real estate or at least mortgage-backed securities and other "illiquid" financial instruments will most likely need to be sold off at discounted prices to investors who stand to profit if they can sell the assets at a higher price once the economy recovers.
The question right now is just how this unloading of bad debt will take place. So far, the federal government is relying on financial institutions to find a way on their own to sell off bad debts or assets they end up with as a result of foreclosures. But some financial industry players are arguing that a modern-day R.T.C. should be established, to help set prices for this bad debt, and speed the move toward a recovery. The R.T.C. alumni are prepared to profit through either route. Mr. Seidman, for example, has been hired as an adviser to SecondMarket, a company based in New York that early next year will start a virtual marketplace that intends to resell some of the trillions of dollars worth of distressed mortgage-backed securities, the financial instruments that helped fuel the surge in housing prices.
Mr. Seidman has already set up meetings between company executives and federal regulators, including at the F.D.I.C., said Barry E. Silbert, the company’s founder. Mr. Silversmith, meanwhile, who during the savings and loan crisis helped arrange the sale of thrift assets, has teamed with Barry Fromm, the chief executive of Value Recovery Holding, one of the big government contractors who handled these sales. The two in recent weeks have held meetings with some of Mr. Silverstein’s former colleagues, including James Wigand, the deputy director in charge of the F.D.I.C. division that sells seized assets, to work on a plan to get ahold of some of the new wave of properties the federal government intends to put on the market as a result of recent bank failures.
Many of the investors who built legendary fortunes during the savings and loan crisis — like Sam Zell, the chief executive of the Tribune Company, and Joseph E. Robert Jr., the chief executive of J. E. Robert Companies — are also looking for ways to get back into or expand their distressed assets trade. Mr. Zell, who has fared less well in his Tribune investment, recalled the instinct for capitalizing on the misfortune of others that earned him the sobriquet "the grave dancer" when he started buying up properties from failed savings and loans. "When I started the first opportunity fund in 1988, I was the only one bidding — if they didn’t sell to me, they didn’t sell to anyone," Mr. Zell recalled.
Now, he said, "The best opportunity right now is in the debt area, mortgages. We have been buying all along." R.T.C. experience is certainly no guarantee of success, the agency veterans acknowledge. Peter Monroe, who was president of the R.T.C. oversight board from 1990 to 1993, has already bought about 300 distressed properties in Detroit, through a venture capital company he formed called Wilherst Oxford. Figuring out a way to profit from the investment — even though some of the houses cost him only a few hundred dollars — has proven to be a challenge. "It is like a high-hurdle race: you can get going fast, but you have to jump over one hurdle after the other," Mr. Monroe said. "It has turned out to be more complicated than even I expected."
M&A Looks Grim for 2009
Dow Chemical's ugly end to 2008, with its stock decimated and its acquisition of rival Rohm & Haas in doubt, is emblematic of the state of M&A in the new year: conservative and fearful. If the last few days of 2008 are a sign of things to come, the prospects for mergers and acquisitions in the new year are certainly bleak. The latest evidence is the trouble facing Dow Chemical's (DOW) proposed $15.3 billion acquisition of rival Rohm & Haas (ROH). The deal was put in doubt Dec. 29 after the Kuwait government cancelled a joint venture with Dow that would have indirectly provided key financing for the buyout. The Rohm & Haas deal could be saved or renegotiated, but if it's cancelled it would hardly be a rarity in such a troubled climate for mergers and acquisitions. According to preliminary data from Dealogic, 1,309 M&A deals, totaling $911 billion, were scrapped in 2008. Deal volume in the U.S. is off 29% from 2007, but M&A activity has all but halted more recently.
U.S. deal volume plunged 86% in November 2008 compared to the previous November, according to R.W. Baird. "It's a staggering number" that reflects the fall's sharp tightening of credit markets and fears of a global economic slowdown, says Baird investment banker Howard Lanser. "December isn't looking any better." The past year "was a horror show," says William Lawlor, a partner and M&A specialist at the Dechert law firm. The primary problem was the drying up of credit markets. Since the fall, even well-respected companies have found it hard to borrow to finance acquisitions. Never mind the riskier private equity shops: Their access to capital dried up earlier in 2008, with Dealogic estimating financial sponsor M&A buyouts fell 71% in the past year. A second problem is fear: Executives and boards, along with stock investors and lenders, have trouble predicting where the economic and financial environment will take their companies. "If you don't have that confidence as a catalyst, deals just don't get done," Lawlor says.
Still, companies remain hungry to make acquisitions for a variety of reasons. Many deals under consideration are "mergers of necessity," says Robert Filek, a partner in PricewaterhouseCoopers' Transaction Services Group. Companies are "forced into [deals] by economic realities." Companies may need to sell assets to raise capital, he says. Or weaker rivals may need to be swallowed up by stronger competitors, which can then cut costs in the merged company. The troubled financial sector was a hotbed of these sorts of deals, with Bank of America's (BAC) $44.3 billion buyout of Merrill Lynch (MER) one of many examples. In 2009 companies may be able to take advantage of opportunities created by market turbulence. The stock market is pricing companies at "great deals," Lawlor says. "There's just too much opportunity out there."
Marino Marin, managing director at New York-based investment bank Gruppo, Levey & Co., predicts dealmakers in 2009 could look for M&A possibilities in industries like mining, health care, media, and technology. Baird's Lanser predicts deals in technology, health care, and education and training outfits. He says private equity investors, with about $350 billion "in capital sitting on the sidelines," may also start hunting for opportunities. But even those optimistic about the M&A environment admit conditions must change before buyers start making, rather than cancelling, big deals. Credit markets have recovered somewhat since October. But that is only after "an almost complete failure of the banking system in the United States," Lanser says. "Banks are still hoarding money" needed to finance deals, he says. "You've got a bottleneck in credit." And then there is the general uncertainty that hangs like a dark cloud over the entire economy.
Filek offers two extreme examples: In the energy industry, the big swings in fuel prices scramble all calculations of oil and gas firms' future financial results. That makes energy executives reluctant to pursue deals. Meanwhile, consolidation in the automotive sector is being prevented by big questions about the future of the U.S. auto industry. "Automotive M&A can't get rolling until there is some visibility into what a restructured U.S. auto industry looks like," he says. The best hope for a revival in M&A comes from a gradual stabilization of both the economic environment and the credit markets. "With the new year comes new hope," Lanser says. Until then, Marin says, bankers will need to be "very creative" to get deals done. Efforts to save the Rohm & Haas buyout may be an early 2009 test of the ability to get deals completed despite the toughest M&A conditions in a generation.
ECB Pressured to Cut Rates by Weaker Sales, Lending
The European Central Bank will begin the new year under pressure to keep cutting interest rates after retail sales fell for a seventh successive month and loans to households and companies grew at the slowest pace in four years. Retailers reported sales, jobs and profit margins all contracted this month as the deepening recession curbed consumer confidence and spending, the Bloomberg purchasing managers’ index showed. Tighter credit standards at banks meant private sector lending slowed for an 11th month in November, rising 7.1 percent after a 7.8 percent increase in October, the ECB said.
The deteriorations mean the 15-nation euro area will mark a decade of the single currency on Jan. 1 facing a deepening recession. That leaves investors betting the ECB will reduce interest rates as early as next month even as its officials signal a reluctance to do so after cutting their benchmark by 175 basis points to 2.5 percent since early October. "The ECB will have to go further," said Gilles Moec, an economist at Bank of America Corp. in London and a former Bank of France official. The euro region faces "a severe and protracted recession." The measure of retail sales in the euro area rose to 41.4 in December from 40.6 in November, remaining below the 50 limit that indicates shrinkage. The Bloomberg index, based on a poll of around 1,000 executives by Markit Economics, also showed that retailers sliced jobs for a ninth month and by the most in four years. Profit margins fell at a record pace.
"Consumer spending going forward will remain as weak as it has been in the last few months," said Nick Kounis, chief European economist at Fortis in Amsterdam. M3 money supply, which the ECB uses as a gauge of future inflation, slowed to 7.8 percent from a year earlier as demand for the most liquid assets retreated. Economists had expected the rate to decelerate to 8.5 percent from 8.7 percent in October, according to the median of 28 forecasts in a Bloomberg survey. "The recent steady downward trend suggests that tighter credit conditions are impacting more," said Howard Archer, chief European economist at Global Insight Inc. in London. Today’s reports were the latest to suggest the euro-area’s recession deepened this quarter. Consumer confidence fell to a 15- year low in November, while manufacturing and services industries contracted in December at the fastest pace in at least a decade.
Price pressures are also fading throughout the region as the recession continues and after the price of crude oil fell more than 70 percent from a July peak of $147 a barrel, the Bank of Spain said in a report today. The inflation rate in Germany this month dropped to the lowest level in more than two years after, the Federal statistics Office said in Wiesbaden today. Investors are predicting slumping growth and fading inflation will force the ECB to lower rates by 50 basis points when its governing council convenes Jan. 15, Eonia forward contracts show. BlackRock Inc., Schroder Investment Management and Standard Life Investments Ltd., which together oversee $1.6 trillion, are buying German debt securities in a sign they expect deeper cuts from the ECB next year. That’s despite recent comments from ECB officials such as President Jean-Claude Trichet that suggest the bank may pause in January after its unprecedented 75-basis-point rate cut on Dec. 8.
Trichet said Dec. 15 that policy makers "have a feeling there is a limit to the decrease in rates" amid frozen credit markets and that they would like to "concentrate at this stage on getting what we already decided to be really operational." Governing Council member Ewald Nowotny said in an interview with the newspaper Die Zeit that the ECB may have to react quickly as the economy slides. "We will see a decline of gross domestic product, which we haven’t had in the postwar period," Zeit reported Nowotny as saying in an e-mailed pre-release of an interview to be published tomorrow. "They are reluctant to cut rates, but the numbers today tip the balance in favor of a cut," said Martin van Vliet, an economist at ING Group in Amsterdam. "The data is consistent with a sharp contraction in the economy."
Baltic states face harsh economic hangover in 2009
The Baltic states face a severe economic hangover in 2009. Latvia, Estonia and Lithuania enjoyed euphoria-producing benders in 2006-07, with 10pc growth and double-digit payments deficits. Now they must close their payments deficits without devaluing. By entering into stabilisation packages, they can usefully blame austerity on the EU and the IMF. The Baltic states’ problems mostly derived from economic success and cheap money. Having effectively privatised and reduced government spending below 40pc of gross domestic product, they grew rapidly in 2003-07, as their efficiency and cost advantages compared to other EU countries brought heavy foreign investment.
Their currency links to the euro allowed for domestic borrowing from international banks at low euro interest rates, even though domestic wage and price inflation remained relatively high. Decreasing competitiveness and heavy foreign currency borrowing naturally produced huge balance of payments deficits, over 10pc of GDP in Estonia and Lithuania and over 20pc of GDP in Latvia. With funding availability for emerging markets way down, the Baltics must now balance their books. Devaluation, the traditional means of doing so, is not readily available. All three currencies are formally linked to the euro, so devaluation would be a major blow to economic credibility. It would also increase the domestic currency value of citizens’ foreign borrowings, probably producing widespread defaults.
To balance the books, all three counties must increase exports and reduce imports. Lithuania is doing the best job on exports, which were up 34pc in January-September 2008 over the previous year. Latvia has opted for domestic deflation and a "reform" package designed by the IMF, centring on wage reduction, banking-sector reform and public-sector austerity. Estonia, with the freest market and the smallest public sector, is relying on increased services exports and domestic deflation. Harsh deflation over a prolonged period will be highly politically unpopular and runs the risk of a populist backlash. Only Latvia has addressed that risk directly – it can now blame the IMF and the EU. Lithuania and Estonia may yet find the convenient scapegoat even more useful than the cash.
Recession is spreading from U.S. to Mexico's economy
Twice in the last three decades, Mexico has demonstrated that one country's profligacy and mismanagement can spell economic catastrophe beyond its borders. In 1982, the country defaulted on its foreign debt and set off a Latin American debt crisis that led to a decade of anemic growth across the region. In 1994, the peso collapsed and halted capital flows to emerging markets around the world, until the Clinton administration arranged a $50 billion Mexican bailout. But in this recession, it is the United States pulling down Mexico.
Mexico is credited by economists with economic policies that reduced debt and tamed inflation, but that has not saved it from the pain of a global recession. When the American economy began to spiral downward, Mexican officials argued that Mexico's macroeconomic stability would protect it. Now, as each week brings more bad news from the United States, those forecasts seem quaintly optimistic. The North American Free Trade Agreement, which so tightly bound Mexico and the U.S., is helping drag Mexico down just as it helped bolster it when times were good north of the border. When the American economy was growing, successive Mexican governments counted on foreign investment and exports to generate growth. Exports account for almost a third of Mexico's gross domestic product. But more than 80 percent of them go to the U.S., and when Americans stop buying, there is no market for Mexican-made goods.
The effect on Mexico is becoming clear. Unemployment is at the highest level in eight years. The peso has fallen 25 percent, leading to a spike in the price of imports, hurting consumers and businesses that rely on imported goods. Exports, industrial production and retail sales have all fallen in the last few months. After a decade of sound economic management, Mexico's government does have some room to maneuver. Next year the government will run its first budget deficit in five years as it increases spending to give the economy a push. It is also taking on new loans from the World Bank and the Inter-American Development Bank to support social and environmental projects. The central bank has almost $85 billion in reserves to defend the peso and room to bring down interest rates.
On top of that, the finance ministry has dealt with the economy's most glaring vulnerability – the dependence on oil export revenue to finance almost 40 percent of the country's budget. In addition, over the last few years, Mexico and Latin America have finally managed to achieve some success in reducing poverty. The percentage of poor in the region has dropped to 33 percent, from 44 percent, since 2002. Extreme poverty has also fallen, to 13 percent, from about 19 percent. Remittances from relatives working in the United States have also helped reduce poverty in many regions, but those have dropped nearly 2 percent this year.
"There have been substantial gains by the main Latin American countries from the mid-1990s to 2006," said Santiago Levy, a vice president at the Inter-American Development Bank in Washington, who started the Mexican program 11 years ago. He recommends that governments shift their spending over to infrastructure projects that create jobs, like building much-needed rural roads. But Mr. Levy warns against any temptation to loosen the disciplined fiscal policies that Mexico and other developing countries have kept over the last years. "Those gains were very hard to get," he said. "We know how to preserve them. And we know how to avoid falling back."
Japanese banks could receive $110 billion bail-out
Japan is reportedly planning an ambitious scheme to relieve the country's banks of trillions of yen in bad loans in a desperate attempt to breathe life back into the ailing economy. The Sankei Shimbun, a daily broadsheet, reported today that the government and the Bank of Japan are considering spending $110bn (£75bn) on bad loans and assets, such as corporate debt, stocks, commercial paper and derivatives. The report, which did not name its sources, comes soon after gloomy data predicted a troubled year ahead for the world's second biggest economy, which has already slid into recession and faces a period of deflation next year for the second time in a decade.
The package, which may be in place as early as March, bears the hallmarks of Japan's last big bank bail-out between the late 1990s and 2005, when the government spent billions of yen on bad loans to keep the country's banking system afloat. The reported scheme is the latest of a raft of emergency measures designed to pull the Japanese economy back from the brink of ruin. Experts are predicting a third consecutive quarter of contraction amid warnings that consumer price inflation risks slipping into negative territory next year, while unemployment is approaching levels not seen since the dark days of the 1990s. Exporters, including corporate powerhouses Sony and Toyota, have slashed output and cut staff as the soaring yen and weak demand batter sales around the world.
As a result Japan's industrial output marked a record fall last month, figures out last week showed. Manufacturing output sank by 8.1% in November, the government said, the biggest drop since records began in 1953. In response to the crisis the Bank of Japan has cut interest rates twice since the end of October - most recently by 20 basis points to 0.1% - and moved to ease the pressure on corporate funding. The BoJ will help firms gain access to new funds by increasing its outright purchase of Japanese government bonds to ¥1.4 trillion (£10.74bn) a month from ¥1.2tn, and temporarily buying commercial paper - a form of short-term unsecured borrowing - outright.
The government, meanwhile, has unveiled ¥12trn in extra stimulus spending and a record ¥88.5trn budget for next year as the export-dependent economy feels the full force of the credit crisis unfolding in the US and Europe. Some analysts believe, however, that the measure reported today may be an overreaction to the banks' current bad loan problem. Bad loans held by Japanese banks totaled ¥11.4tn in March this year, a fraction of the ¥33.9tn in March 1999 at the height of Japan's "lost decade" of recession. "I do not see how this would be particularly effective, as the amount of bad loans is smaller than those banks were saddled with in late 1990s," Hironari Nozaki, a bank analyst at Nikko Citigroup, told Reuters.
The problems facing the Japanese economy in 2009 were underlined today when the Tokyo Stock Exchange closed for the year ruing its biggest annual percentage loss on record. Modest gains in December - the first since May - were scant consolation for the benchmark Nikkei stock average's yearly loss of more than 42%. Atsushi Saito, the exchange's president, told employees at a closing ceremony that the stockmarket was "facing harsh winds we have hardly experienced before". Asia's biggest stockmarket will learn exactly how harsh those winds are when it reopens on 5 January.
Japanese car industry will be caught up in Detroit’s wreckage
Japan’s mighty automotive industry, which comprises at least ten big manufacturers, could soon be reduced to a Detroit-style Big Three. According to Osamu Suzuki, president of Suzuki Motors, there is no truth to the idea that Japanese carmakers enjoy any immunity to the crisis affecting the industry worldwide and the downturn that has pushed General Motors, Chrysler and Ford to the brink of oblivion will also shake their Japanese counterparts. The turmoil, he said, would lead Japan into a period of consolidation that is viewed by many investors as long overdue. The tally of ten large carmakers, including Mazda, Fuji Heavy [Subaru], Mitsubishi Motors and Isuzu, could quickly be reduced in the stampede for cost-cutting and survival.
Given that Suzuki is far smaller than Nissan, Honda and Toyota, brokers in Tokyo said that, on one reading of the president’s comments, it could appear that the Shizuoka-based company was effectively putting itself up for sale. The fallout from a strong yen and slumping sales in the United States, Europe and Asia is already being felt. Last week Toyota, the largest of the Japanese carmakers, predicted that fiscal 2008 would end in the company’s first full-year loss since the 1940s, while Honda stunned investors with its own earnings downgrade and a symbolically recessionary withdrawal from the glamour of Formula One motor racing.
Mr Suzuki said that even after the unprecedented global sales collapse over the past few months, the worst was still to come. "There is a time-lag between what is happening with the Big Three US carmakers and the impact that will have in Japan. It is as if tsunami waves are rolling toward Japanese shores. I believe a real wave will hit us around July or August next year, with car sales hitting rock bottom." He went on to say that the world was "entering a period in which more than ten Japanese carmakers could be consolidated into a Japan Big Three." His comments have triggered intense market speculation about the shape and constituents of the consortiums that might emerge. Some loose alliances, such as Toyota’s stake in Hino and Fuji Heavy, exist already and may form the core of the new giants.
Many assume that Toyota, Honda and Nissan would take the lead in proposing any tie-ups, focusing their attention on areas of overlap in technology, geography or shared parts suppliers. Honda and Suzuki, for example, are makers of both cars and motorcycles and are based in the same city. The sheer speed of the slump has caught many analysts off-guard. Last week Kota Yuzawa, of Goldman Sachs, revisited his forecasts only a week after publishing a report. "Our worst case has now become our best case," he said, adding that the most pessimistic reading of the situation had become realistic. Toyota could rack up operating losses of 550 billion yen (£4.2 billion) in the coming financial year, while Nissan could suffer losses of Y300 billion, he said.
UK automobile production to fall by 20% in year of 'carnage'
The UK motor industry will build nearly one in five fewer cars next year, sending production down to the lowest level for more than 20 years, according to the latest estimates. Overall, the UK industry made 1.62 million vehicles in 2008, nearly 6 per cent fewer than the previous year. But 2009 will see production fall by another 18.9 per cent to just 1.32 million – the fewest since 1986, preliminary forecasts from PricewaterhouseCoopers indicate.
Motor manufacturers and related industries – which between them employ nearly one million people – are already calling on the Government to help ease the dual crises of reduced consumer spending and scanty access to credit. Overall production was down by 33.3 per cent in November alone, big names like Jaguar Land-Rover and the dealership Inchcape are cutting staff, and all major manufacturers have instituted unusually long periods of downtime over Christmas. But far worse is to come, says PwC. "We have only had two quarters of declining sales so far, compared with 11 consecutive quarters in the last recession – so we are really only at the start," Matthew Alabaster, a director, said. "It is carnage."
Only Turkey and Mexico are expected to see greater proportional falls in production than the UK next year, but the picture is not rosy anywhere. Germany will make 11 per cent fewer cars, France 12 per cent fewer, the US more than 15 per cent fewer. The European sector as a whole will see a 12 per cent contraction to 16 million – a 12-year low. Asia-Pacific will drop by 6.5 per cent, eastern Europe by 10 per cent, North America by 17 per cent to 10.5 million, the continent's worst result since the early 1980s. Even the emerging markets are looking shakey. China has gone from double-digit growth in 2007, to 7.4 per cent growth this year and just 1.5 per cent predicted for 2009. India will go from 10 per cent growth this year to a 3 per cent contraction next.
Half of Britain’s middle class home owners fear losing their homes
Nearly half of middle class homeowners fear that they could lose their properties next year because they are struggling to pay their mortgages. The news comes after the Council for Mortgage Lenders forecast that the number of repossessions is likely nearly to double to 75,000 next year. A YouGov poll, carried out for a new report from Tory MP Grant Shapps, found that 44 per cent of mortgage holders are worried that lenders could force them out of their properties next year. A similar proportion were worried about not being able to meet mortgage payments between now and the end of 2010.
The study - The New Homeless - found that the concern among homeowners about losing the roof over their heads in the economic downturn stretched across society. It found that 42 per cent of middle class professionals were worried about not paying the mortgage over the next year, compared with 46 per cent of blue collar households. The study found that nearly one in seven people were in the highest category of being "very worried" about making the repayments over the next year. More higher earners - 15 per cent - described themselves as "very worried" about being able to make the payments, compared with 12 per cent of those in less affluent groups, possibly because they over-borrowed during the property boom.
Part of the problem was that bills have far outstripped increases in family income. Figures show that while average pay increased by 13 per cent in the four years to the end of March 2008, fixed household costs jumped by 45 per cent. Mr Shapps said: "Householders up and down the country and in every kind of housing are now concerned, as never before, about their ability to maintain a roof over their heads over the next 12 months. "While Gordon Brown would like us to believe that they fixed the roof when the sun was shining, it's now becoming clear that for many hard working families concern about keeping their home is greater than at any time before. "Despite this, the Government continues to release a series of poorly thought out announcements which are often contradictory and confusing for the public." YouGov polled 1,208 people across the UK on 9 December.
Britons stop spending and pay loans
New signs of a deep contraction in the British economy emerged yesterday with further evidence that householders have cut retail spending and started to reduce debt. Bank of England figures showed that property-owners paid a record £5.7 billion off their mortgages in the three months to September - the largest figure since the 1970s and more than double the £2 billion repaid in the second quarter. It is only the second time in almost ten years that consumers have injected cash into their mortgage debt rather than increase their secured borrowing levels. At the start of last year, they were taking out more than £13 billion to pay for holidays, shopping and luxury items. The change underscores the end of a decade-long borrowing binge driven by soaring property prices.
Andrew Montlake, partner at Cobalt Capital, the independent mortgage broker, said: "Not so long ago, an Englishman's house wasn't just his castle, it was his cash machine, too. This, clearly, is no longer the case." Economists said that the latest figures represented further evidence that British consumers were preparing for a sustained period of retrenchment and that this would be a big factor contributing to a sharp contraction in economic growth next year. Howard Archer, chief UK and European economist at Global Insight, said: "Sharply falling house prices have made housing equity withdrawal increasingly unattractive, while very tight credit conditions have made it more difficult to carry out the process as well as to take out new mortgages. "In addition, increasingly lower savings rates have made it relatively more attractive for many people to use any spare funds that they have to reduce their mortgages."
Yesterday's figures will make bleak reading for Britain's retailers, who will be bound to feel the effects of consumers tightening their purse strings. Global Insight forecasts that the economy will contract by 2.7 per cent next year, while consumer spending will drop by 2 per cent. House prices nationwide fell by 8.7 per cent this year and will fall further in 2009, according to Hometrack, a leading property researcher. Hometrack, which found that property prices in London fell by a sharp 1 per cent in December alone, had predicted that prices would fall by 10 per cent over the next 12 months. Its forecast echoes similar views from Rightmove, the property site, and the Royal Institution of Chartered Surveyors.
Two more UK chains go bust as retail meltdown accelerates
Two more retailers have collapsed into administration, becoming the latest victims of the Christmas retail crisis and sparking fears over hundreds of jobs. USC, the 58-store branded fashion chain backed by the business tycoon Sir Tom Hunter, appointed the accountancy firm PKF as administrator yesterday afternoon. Sir Tom's investment vehicle, West Coast Capital, has bought USC out of administration in a pre-pack deal that will see USC continue trading from 43 stores, but 15 of its loss-making stores will close.
Meanwhile, Passion for Perfume, a 45-store fragrance chain, has also called in the administrators over the past week. It is understood that the chain's stores will close by 31 December and more than a hundred staff could lose their jobs. Passion for Perfume declined to comment, but Sharon Tippett, a store manager with Passion For Perfume in Barnstaple, is reported to have said: "The store will be closed by 31 December and all 45 shops in the chain will be axed too." The collapse of USC and Passion for Perfume brings the total of retailers to fall into administration over the past weeks to six. They follow the appointment of administrators by Whittard of Chelsea, the coffee and tea specialist, The Officers Club, the menswear chain, and Zavvi, the entertainment retailer.
Yesterday, Adams, a 260-store childrenswear chain, confirmed it is to enter into administration. Adams said the directors are working with its funders to resolve the situation. Whittard of Chelsea and The Officers Club were bought out of pre-pack administration last week. Sir Tom bought USC, which was founded in 1989, in 2004, but it has struggled since 2006. The pre-pack administration of USC will preserve 1,100 of USC's 1,427 employees. However, about 300 staff – of whom the majority are part-time – are likely to lose their jobs. Jim McMahon, a partner in West Coast Capital, said: "The survival of the core business could only be secured through this deal."
He added: "Having taken that action we are now confident that with the support of our suppliers and landlords, with whom we are now negotiating, that we can deliver a strong and profitable business with sustainable employment prospects for the remaining staff going forward." Mr McMahon added that West Coast Capital would "continue to invest in the business". USC is not the only retail chain backed by Sir Tom to be struggling. He is set to lose a significant part of his stake in the garden centre group Wyevale in a debt-for equity-swap with his bank HBOS, which is imminent. However, the performance of the shoe chain Office, which is also backed by Sir Tom, is understood to be more robust.
USC posted a loss of £8.8m in the year to 27 January 2006. However, USC is understood to have suffered poor trading this year, along with many other fashion retailers, and widening losses. USC stocks brands including Diesel, Firetrap, Henri Lloyd and Replay. While some retailers enjoyed a bumper day on Boxing Day, driven by hefty discounting, retail analysts expect it to come too late for some high-street chains. The corporate rescue and restructuring firm Begbies Traynor expects up to 15 high street retailers to fall into administration before mid-January. Yesterday, Patonz, a global retail network, said that the number of retailers that launched their Boxing Day sale with "Up to 70% off" was 23 – more than double the 13 recorded in 2007.
U.S. Airlines Grab Cash In Crunch Over Credit
U.S. airlines, largely unprofitable and saddled with poor debt ratings, are enjoying surprising success raising money at a time when other companies are struggling amid the credit crunch. Airlines are building cash as a bulwark against global recession and losses on fuel-price hedging efforts. They are selling stock, selling and leasing back planes, refinancing assets and tapping the debt markets for secured loans. They are also turning to a collection of vendors, suppliers and business partners that stand to make money if the airlines just stay aloft. The largest airlines have been raising cash all year, but their efforts have accelerated recently. The drop in fuel prices has bolstered 2009 prospects, but has also hurt some airlines that used hedging contracts to lock in fuel prices when they were higher.
Several airlines that didn't expect oil prices to drop sharply, including UAL Corp.'s United Airlines and Delta Air Lines Inc., have had to post hundreds of millions of dollars apiece in collateral to trading partners on fuel-hedging contracts. Overall, many large carriers have less cash on hand than they did a year ago, or even at the end of the third quarter. That's galvanizing them to find new sources of capital. This month, Delta picked up $1 billion in cash from American Express Co., issuer of the airline's co-branded SkyMiles credit card, and it will get another $1 billion through 2010. Last week, Southwest Airlines Co., which has an investment-grade credit rating, said it would raise about $350 million by selling and leasing back 10 of its planes. It brought in another $400 million by selling notes backed by other aircraft.
Describing the economy's decline since Sept. 30 as "staggering," Gary Kelly, Southwest's chairman, said this month that "we want to boost our liquidity." Beverly Goulet, treasurer of AMR Corp., said: "The credit-market problems underscore the importance of our efforts over the past few years to shore up our balance sheet." AMR, parent of American Airlines, this year has raised nearly $2 billion from stock sales, aircraft-backed financing, a revolving credit line, and by divesting itself of a money-management unit. This month, it sold a fleet of 39 turboprop planes to Danish investors and leased them back, a deal expected to generate $200 million in cash. "Never underestimate the ability of airlines to raise money," says Bill Warlick, airline debt analyst at Fitch Ratings. Given the industry's historic volatility, airlines are accustomed to tough credit conditions. They rely mostly on long-term debt, not shorter-term instruments such as commercial paper that evaporated in the recent market turmoil.
Now that lower fuel prices are easing airlines' cost pressures, both investors and airline partners are betting the carriers will be able to generate positive cash flow even as travel demand falls in the recession. Some analysts expect U.S. carriers to be profitable next year, thanks to the cheaper fuel, shrinking route networks, and an influx of new revenue, such as fees for checked bags. For passengers, the route cutbacks mean that planes have been getting fuller and fares have been rising. The new fees airlines have tacked on have further boosted the cost of travel. For the airlines, financing isn't easy or cheap. In its three-year private note placement, Southwest is paying an annual interest rate of 10.5% -- more than double the 5.2% the airline committed to in May, when it borrowed $600 million in a 12-year secured-term loan, says Douglas Runte, an airline and aircraft debt analyst for Piper Jaffray & Co.
Ed Bastian, president of Delta and chief executive of its newly acquired Northwest Airlines unit, says airlines can't afford to pass up fund-raising opportunities. "From a cash position, we're about husbanding...resources and staying strong until we see where the demand picture settles out," he says. Airlines also must keep an eye on coming debt maturities, interest payments and aircraft-leasing commitments. Fitch estimates the seven largest U.S. airlines face $4.4 billion of debt and capital-lease maturities next year, and $6 billion in 2010. Another motivation is financial pressure from bad bets on fuel-price hedges. In the third quarter, UAL's loss included a $519 million noncash loss on fuel hedges, and US Airways Group Inc. reported $488 million of unrealized losses from mark-to-market adjustments on its fuel hedges. Several airlines have had to post collateral to trading partners on the fuel hedges. United had to pony up $900 million, and American expects to post $550 million in hedge collateral by year end. Delta said it posted $1.1 billion in collateral for fuel hedges earlier this month. Even so, airlines are benefiting greatly overall from lower oil prices.
Some aerospace executives say financing for new planes is the biggest challenge globally, although most U.S. airlines have arranged funding to cover at least some of the modest number of planes they expect to buy over the next two years. Airlines continue to tap partners with a history of coming to their aid -- even in bankruptcy proceedings. Credit-card issuers often supply one-time cash infusions by buying frequent-flier miles in advance from airlines. The Delta-American Express deal greatly boosts Delta's cash position. American Express, which says it will take a $100 million charge in the current quarter to account for the deal, stands to gain new card members due to the merger of Delta and Northwest. US Airways raised $200 million by selling miles to Barclays PLC's Barclaycard US. US Airways raised another $750 million in a deal that included getting a $200 million advance from Airbus. "Airlines continue to defy expectations by raising more cash," says Philip Baggaley, an airline debt analyst for Standard & Poor's Corp. "But the cookie jar is getting close to empty for many of them. Assets that could be turned into cash already have."
Northwest seeks to delay some U.S.-China service
Northwest Airlines, due to poor market conditions in light of the weakened global economy, is the latest carrier seeking to delay or cut back long-coveted U.S.-China service. The subsidiary of Atlanta-based Delta Air Lines Inc. said in a filing earlier this month with the Department of Transportation that it was seeking to delay proposed daily Seattle-Beijing service by a year from March 2009 to March 2010 and delay startup of Detroit-Shanghai nonstop service by more than two months from March 25, 2009, to June 3, 2009. Northwest said the current economic problems that are affecting the global economy are having a particular impact on demand for U.S.-China air transportation. Data show year-over-year U.S.-China bookings declined dramatically after the close of the Summer Olympics, and advance bookings for March 2009 are down nearly 30 percent, according to Northwest's motion to the DOT.
Its move follows requests from other carriers, including American Airlines, US Airways and United Airlines, to delay U.S.-China service. Delta and Continental Airlines previously requested permission to scale back some of their U.S-China service. U.S. carriers have fought for years for permission to launch service to China. "Northwest is very disappointed that it will not be able to operate its full schedule of U.S.-China combination services in the upcoming year," the carrier said in a Dec. 19 motion to the DOT. "However, China remains of critical strategic importance to the Delta/Northwest network." Northwest noted that the DOT has already granted dormancy waivers to American, a unit of Fort Worth, Texas-based AMR Corp., Tempe, Ariz.-based US Airways Group Inc., Chicago-based UAL Corp., the parent of United, and Houston-based Continental Airlines Inc.
In several of those requests, the airlines cited high fuel prices. Oil peaked at a record $147 a barrel in July. Since then, oil prices have fallen dramatically and are currently at around $40 a barrel. Airlines, however, are still losing money because the global financial crisis has reduced demand for air travel. American sought to defer the startup of Chicago-Beijing service, while US Airways sought to defer the startup of Philadelphia-Beijing service and United sought to defer the startup of San Francisco-Guangzhou service. Continental sought to convert two Newark, N.J.-Beijing and Newark, N.J.-Shanghai frequencies from year-round to seasonal service, while Delta earlier this year received permission to convert two of its Atlanta-Shanghai frequencies from year-round service to seasonal service. Delta acquired Northwest on Oct. 29 to create the world's biggest carrier.
Gazprom, Once Mighty, Is Reeling
A year ago, Gazprom, the Russian natural gas monopoly, aspired to be the largest corporation in the world. Buoyed by high oil prices and political backing from the Kremlin, it had already achieved third place judging by market capitalization, behind Exxon Mobil and General Electric. Today, Gazprom is deep in debt and negotiating a government bailout. Its market cap, the total value of all the company’s shares, has fallen 76 percent since the beginning of the year. Instead of becoming the world’s largest company, it has tumbled to 35th place. And while bailouts are increasingly common, none of Gazprom’s big private sector competitors in the West is looking for one. That Russia’s largest state-run energy company needs a bailout so soon after oil hit record highs last summer is a telling postscript to a turbulent period. Once the emblem of the pride and the menace of a resurgent Russia, Gazprom has become a symbol of this oil state’s rapid economic decline.
During the boom times, Gazprom and the other Russian state energy company, Rosneft, became vehicles for carrying out creeping renationalization. As oil prices rose, so did their stocks. But rather than investing sufficiently in drilling and exploration, Russia’s president at the time, Vladimir V. Putin, used them to pursue his agenda of regaining public control over the oil fields, and much of private industry beyond. As a result, by the time the downturn came, they entered the credit crisis deeply in debt and with a backlog of capital investment needs. (Under Mr. Putin, now the prime minister, Gazprom and Rosneft are so tightly controlled by the Kremlin that the companies are not run by mere government appointees, but directly by government ministers who sit on their boards.) "They were as inebriated with their success as much as some of their investors were," James R. Fenkner, the chief strategist at Red Star, a Russian-dedicated hedge fund, said of Gazprom’s ambition to become the world’s largest company. "It’s not like they’re going to produce a better mousetrap," he said. "Their mousetrap is whatever the price of oil is. You can’t improve that."
Investors are now fleeing Gazprom stock, once such a favorite that it alone accounted for 2 percent of the Morgan Stanley index of global emerging market companies. Gazprom is far from becoming the world’s largest company; its share prices have fallen more quickly than those of private sector competitors. The company’s debt, amassed while consolidating national control over the industry, is one reason. After five years of record prices for natural gas, Gazprom is $49.5 billion in debt. By comparison, the entire combined public and private sector debt coming due for India, China and Brazil in 2009 totals $56 billion, according to an estimate by Commerzbank. Mr. Putin used Gazprom to acquire private property. Among its big-ticket acquisitions, in 2005 it bought the Sibneft oil company from Roman A. Abramovich, the tycoon and owner of the Chelsea soccer club in London, for $13 billion. In 2006 it bought half of Shell’s Sakhalin II oil and gas development for $7 billion. And in 2007, it spent more billions to acquire parts of Yukos, the private oil company bankrupted in a politically tinged fraud and tax evasion case.
Rosneft is deeply in debt, too. It owes $18.1 billion after spending billions acquiring assets from Yukos. And in addition to negotiating for a government bailout, Rosneft is negotiating a $15 billion loan from the China National Petroleum Corporation, secured by future exports to China. Under Mr. Putin, more than a third of the Russian oil industry was effectively renationalized in such deals. But unlike Hugo Chavez of Venezuela or Evo Morales of Bolivia, who sent troops to seize a natural gas field in that country, the Kremlin used more sophisticated tactics. Regulatory pressure was brought to bear on private owners to encourage them to sell to state companies or private companies loyal to the Kremlin. The assets were typically bought at prices below market rates, yet the state companies still paid out billions of dollars, much of it borrowed from Western banks that called in the credit lines in the financial crisis. Rosneft, which was also held up as a model of resurgent Russian pride and defiance of the West as it was cobbled together from Yukos assets once partly owned by foreign investors, was compelled to meet a margin call on Western bank debt in October.
Critics predicted Russia’s policy of nationalization would foster inefficiency, or at the very least disruption as huge companies were bought and sold, divided up and repackaged as state property. At stake were assets worth vast sums: Russia is the world’s largest natural gas producer and became the world’s largest oil producer after Saudi Arabia reduced output this summer to support prices. A deputy chief executive of Gazprom, Aleksandr I. Medvedev, predicted the company would achieve a market capitalization of $1 trillion by 2014. Instead, its share price has fallen 76 percent since the beginning of the year and its market cap is now about $85 billion. By comparison, Exxon's share price Monday of $78.02 is down 18 percent since January. The company’s market capitalization is $393 billion. And the Standard & Poor's 500-stock index stocks is down more than 40 percent for the year. Mr. Medvedev, the Gazprom executive, defended Gazprom’s performance and attributed the steep drop in its share price relative to other energy companies to the company’s listing on the Russian stock exchange, which is volatile and lacks investors who put their money into companies for the long term.
Mr. Medvedev said the share price "does not reflect the company’s value" and blamed the financial crisis that began on Wall Street for the company’s woes. It is true that Gazprom is far from broke. The company made a profit of 360 billon rubles, or $14 billion, from revenue of 1,774 billion rubles, or $70 billion, in 2007, the most recent audited results released by the company. Valery A. Nesterov, an oil and gas analyst at Troika Dialog bank in Moscow, said Gazprom’s ratio of debt to revenue — before interest payments, taxes and amortization — was 1 to 5 in 2007, high by oil industry standards but not so excessive as to jeopardize the company’s investment grade debt rating. The company, meanwhile, says it will go ahead with capital spending to develop new fields in the Arctic, and continues to pour money into subsidiaries in often losing sectors like agriculture and media. It is also assuming, through its banking arm, a new role in the financial crisis of bailing out struggling Russian banks and brokerages.
Investors say an unwillingness to cut costs in a downturn is a common problem for nationalized industries, and another reason they have fled the stock. When oil sold for less than $50 a barrel in 2004, Gazprom’s capital outlay that year was $6.6 billion; for 2009, the company has budgeted more than $32 billion. Gazprom executives say they are reviewing spending but will not cut major developments, including two undersea pipelines intended to reduce the company’s reliance on Ukraine as a transit country for about 80 percent of exports to Europe. Gazprom and Ukraine are again locked in a dispute over pricing that Gazprom officials say could prompt them to cut supplies to Ukraine by Thursday. "All our major projects in our core business — upstream, midstream and downstream — will continue with very simple efforts to meet demand both in Russia and in our export markets," Mr. Medvedev said.
But revenue is projected to fall steeply next year. Gazprom received an average of $420 per 1,000 cubic meters for gas sold in Western Europe this year; that is projected to fall to $260 to $300 in 2009. "For them, like everybody else, sober realism has intruded," Jonathan P. Stern, the author of "The Future of Russian Gas and Gazprom" and a natural gas expert at Oxford Energy, said in a telephone interview. A significant portion of the country’s corporate bailout fund — about $9 billion out of a total of $50 billion — was set aside for the oil and gas companies. Gazprom alone is seeking $5.5 billion. For a time, Gazprom, a company that evolved from the former Soviet ministry of gas, had been embraced by investors as the model for energy investing at a time of resource nationalism, when governments in oil-rich regions were shutting out the Western majors. In theory, minority shareholders in government-run companies would not face the risk their assets would be nationalized.
But with 436,000 employees, extensive subsidiaries in everything from farming to hotels, higher-than-average salaries and company-sponsored housing and resorts on the Black Sea, critics say Gazprom perpetuated the Soviet paternalistic economy well into the capitalist era. "I can describe the Russian economy as water in a sieve," Yulia L. Latynina, a commentator on Echo of Moscow radio, said of the chronic waste in Russian industry. "Everybody was thinking Russia had succeeded, and they were wondering, how do you keep water in a sieve?" Ms. Latynina said. "When the input of water is greater than the output, the sieve is full. Everybody was thinking it was a miracle. The sieve is full! But when there is a drop in the water supply, the sieve is again empty very quickly."
Gazprom Second-Quarter Net Tripled Before Oil’s Drop
OAO Gazprom said second-quarter profit almost tripled as Russia’s largest energy producer reaped higher prices before oil prices tumbled from records. Net income climbed to 300 billion rubles ($10.2 billion) in the quarter ended June 30 from 103 billion rubles in the same period last year, the Moscow-based company said today. Since then, Gazprom has fallen 69 percent on the Micex Stock Exchange amid a collapse in Russian shares and has been admitted to a list of companies eligible for priority state loans. State-run Gazprom expects to have a record 2008 as gas prices for European consumers lag behind oil prices that peaked in July. The subsequent drop in crude and the credit crunch mean Russia’s largest company is now bracing for lower revenue.
The average European price in 2009 will likely be $260 to $300 per 1,000 cubic meters, down from more than $500 in the second half of this year, Deputy Chief Executive Officer Alexander Medvedev said Dec. 18. "The earnings were surprisingly strong," Ronald Smith, head of research at Alfa Bank, said by telephone. "Higher than expected revenues fed down into net income." Gazprom rose as much as 2.81 rubles, or 2.7 percent, to 106.40 rubles and was 0.4 percent higher at 104 rubles at 1:18 p.m. Moscow time. Second-quarter sales rose 58 percent to 840 billion rubles. Net income beat a median estimate of 232 billion of six analysts surveyed by Bloomberg News.
Gazprom insists the financial crisis won’t affect plans to build two new pipelines to Europe that will bypass neighboring Ukraine. The board on Dec. 23 approved planned spending of 921 billion rubles in 2009. The gas exporter faces a repeat of a 2006 dispute with Ukraine in which Gazprom cut supplies, leading to a drop in volumes across Europe. Gazprom says Ukraine must settle a debt for November and December or face a cutoff on Jan. 1. Dmitry Medvedev left his position as chairman of Gazprom’s board of directors in the second quarter after being sworn in as Russian president. Former Russian Prime Minister Viktor Zubkov replaced him at Gazprom. Gazprom borrowed $403 million in the past two months as it seeks to pay down $10.6 billion in debt by the end of June. The company received $153 million of financing this month from Vnesheconombank, the Russian bank handling bailout funds for companies, and $250 million from Societe Generale SA, Gazprom said on its Web site today.
Total debt stood at 1.12 trillion rubles at the end of the first half of 2008 and the company must pay almost 28 percent of that by the end of the first half 2009, Gazprom said. The Vnesheconombank loan was taken at 5 percentage points above the London interbank offered rate to refinance part of a loan from Deutsche Bank AG, while the Societe Generale loan pays 3.6 percentage points over Libor. The global credit crisis may affect Gazprom’s ability to obtain new borrowing and could increase re-financing costs, the company said. Lower cash flows could also hinder debt repayments, according to the Russian company. The gas exporter must pay back $6.6 billion in 2009 and $11.1 billion in 2010, which includes loans held by OAO Gazprombank, according to Bloomberg data. Gazprom’s total debt fell after it stopped consolidating Gazprombank’s financial information in the first half of this year.
Net debt fell 24 percent to 837 billion rubles as of the end of June, after Gazprombank was deconsolidated, compared with 1.1 trillion as of the end of March, Gazprom said. "Management is unable to estimate reliably the effects on the group’s financial position of any further deterioration in the liquidity of the financial markets and the increased volatility in the currency and equity markets," Gazprom said. The company said management "believes it is taking all necessary measures to support the sustainability and growth of the group’s business in the current circumstances."
Newsletter of the year? Harry Schultz. Really.
My choice for investment letter of the year: The International Harry Shultz Letter. I usually say that my selection method is highly scientific (I choose whoever I feel like). And I have to say it particularly loudly this year. Schultz was Letter of the Year in 2005. But over the past 12 months through November, Schultz is down a heart-stopping 76.05% by Hulbert Financial Digest count, vs. negative 36.68% for the dividend-reinvested Dow Jones Wilshire 5000. This loss has wiped out Shultz's strong post-2000 run, when he benefited from the gold and commodities boom. Now, over the past 10 years, the HFD shows the letter achieving an annualized loss of negative 8.73%, even worse than the negative 1.16% annualized loss for the total return DJ-Wilshire 5000. And it's an unpleasant arithmetical fact that even future triple-digit gains (which aren't impossible) will not dig Schultz out of this hole. (But, if you're a new investor starting at the bottom, who cares?)
The reason I pick Schultz: the extraordinary prescience he showed in predicting what he called a "financial tsunami" well over a year ago. Well? He was right, wasn't he? Why didn't his prescience translate into better performance? The reason may be technical. Schultz makes scores of recommendations. The HFD monitors only what he (perhaps unwisely) calls his "model portfolio", which is always 100% invested. In contrast, his investment allocation model, which the HFD does not follow, is currently only 8%-10% in non-gold stocks and 35%-45% in (mostly non-U.S.) Treasury notes and short-term bonds. Beyond this, the HFD system of constructing and monitoring model portfolios simply does not always catch the value investors glean, sometimes quite subjectively, from reading between the lines of some letters. Currently, Schultz is writing about a 20-year V pattern in markets and the economy -- "buying power (etc.) for everyone will shrink for 10 years (with strong 1-year counter-trend rallies) and then rise for 10 years (with strong counter-trend 1-year declines), getting back to 2007-08 levels by approximately 2027-28." By that time, incidentally, Schultz will be well over 100.
In the short-term, Shultz sees deflation and has argued strongly that gold will not make a decisive move until it's over. Which could be soon. He writes: "This deflation will demand increasing cash/credit transfusions from governments. This supposed "cure" will create its own collapse as public's remaining confidence in currencies & government's phony or failed fixes suddenly evaporates, perhaps overnight, and the world leaps not back into inflation, but probably to hyperinflation. You see, if this view is correct, normal inflation gets bypassed because all sense of value at that point is largely gone. The last chicken comes home to roost. "One investment conclusion: "This may be your last chance to get out of the U.S. dollar before it falls to historic lows. Note, if you own U.S. stocks, you own U.S. dollars! E.g., if you own U.S. oil, energy, food, resource stocks, you own U.S. dollars. You can sell such stocks and buy similar companies in Europe, Asia, Canada & Oz." Another cheerful point: Schultz predicts that the government will seize and nationalize private 401(k) plans.
He throws in this cheerful thought that he claims comes from Thomas Jefferson: "This country is headed toward a single and splendid government of an aristocracy founded on banking institutions and monied corporations, and if this tendency continues it will be the end of freedom and democracy; the few will be ruling and riding over the plundered plowman and the beggar." Schultz's terse comment: "And it came to pass."
Skaters Jump In as Foreclosures Drain the Pool
On a recent morning, a 27-year-old skateboarder who goes by the name Josh Peacock peered into a swimming pool in Fresno, Calif., emptied by his own hands — and the foreclosure crisis — and flashed a smile as wide as a half-pipe. "We have more pools than we know what to do with," said Mr. Peacock, who lives in Fresno, the Central Valley city where thousands of homes, many with pools behind them, are in foreclosure. "I can’t even keep track of them all anymore." Across the nation, the ultimate symbol of suburban success has become one more reminder of the economic meltdown, with builders going under, pools going to seed and skaters finding a surplus of deserted pools in which to perfect their acrobatic aerials. In these boom times for skaters, Mr. Peacock travels with a gas-powered pump, five-gallon buckets, shovels and a push broom, risking trespassing charges in the pursuit of emptying forlorn pools and turning them into de facto skate parks. "We can just hit them back to back," said Mr. Peacock, who preferred to give his skateboarding name because of the illegality of his activities.
Skaters are coming to places like Fresno from as far as Germany and Australia. Mr. Peacock said his floor and couch were covered by sleeping bags of visiting skateboarders each weekend. Some skateboarders use realty tracking sites likerealquest.com and realtor.com to find foreclosed houses with pools, while others trawl through satellite images from Google Earth. On the Web site skateandannoy.com, where skaters trade tips about how to find and drain abandoned pools, one poster wrote about the current economic malaise. "God bless Greenspan," the post read, "patron saint of pool skatin’." Pool builders feel differently, of course. In Phoenix, for example, where scorching summers can make pools seem like a survival tool, the city has issued fewer than half the number of residential pool permits this year as in 2007, as builders are being pummeled by declining home construction and evaporating credit for potential buyers.
Several large companies have gone bust this year, including Riviera Pools, which once sponsored the swimming pool at Chase Field, where the Arizona Diamondbacks play baseball. Smaller contractors, retailers and pool cleaning companies have also failed, leaving unpaid bills and unfinished projects. "You’ve got people that still want to build pools, but now you’re getting maybe 20 percent or 10 percent that can actually qualify now," said Dave Brandenburg, a pool builder in north Phoenix who estimated business was off 40 percent to 70 percent. "Before it was, ‘Sure, no problem.’ Now it’s like, ‘Sorry.’ " Business is just as bad in Florida, where builders like Ben Evans, the chief executive at American Pools and Spas in Orlando, said he had let much of his staff go as orders for pools dropped to 150 this year, from about 1,000 in 2007. "I’m just looking for my bailout money," Mr. Evans said, ruefully. "Do you know where that is?"
In many warmer states, the authorities are trying literally to bail out pools, using pumps, dredges and strong stomachs to attack a surge in abandoned ones that have attracted all manner of nastiness — rats or belligerent raccoons, or algae, dead leaves and worse. These so-called green pools can become a breeding ground for mosquitoes carrying West Nile virus. California officials estimate that there are tens of thousands of abandoned pools in the state, with as many as 5,000 in places like Sacramento County, where a building boom in the capital’s suburbs has gone bust. California law calls for fines of up to $1,000 per day for egregious cases of pools left with standing water, but officials say the sheer numbers of cases are daunting. John Rusmisel, the district manager for Alameda County’s mosquito abatement district, said he used a promotional company that flies banners over football games and other events to help find the fetid swimming pools.
"They were up there seeing all these funky pools," said Mr. Rusmisel, who added that his workload had doubled in the last year. "So they just started to take pictures." Once he finds a problem pool, his workers treat it with a combination of insecticide and mosquitofish, pinky-size carp that find mosquito larvae delectable. But they do not empty any pools, he said, because in a good rain, an empty pool can be partially lifted out of the hole by groundwater, he said. "I’ve seen them float up a foot or two," Mr. Rusmisel said. Dirk Voss, a code enforcement agent in Oxnard, Calif., northwest of Los Angeles, said even those residents who manage to stay in their homes often could not maintain the pool. "They don’t want to pay for the power to run the motor or pay for the chemicals to treat them," Mr. Voss said. But skaters do not mind doing the work, whether it is that of scouting for pools or scouring them. Adam Morgan, 28, a skater from Los Angeles, said it used to take months to find a good skating pool. Now the task is a breeze.
"There are more pools right now than I could possibly skate," Mr. Morgan said. "It’s pretty exciting." Mr. Peacock travels around town in his pickup searching for the addresses of homes he has learned have been foreclosed on, either via the Internet or from a friend who works in real estate. He has also learned to spot a foreclosed house, he said, by looking for "dead grass on the lawn and lockboxes on the front door." Once he has found a pool he likes — he prefers older, kidney-shaped ones — he drains the water into the gutter with his pool pump, sometimes setting up orange cones on the sidewalk to appear more official. Later, he returns to shovel out the muck, and then lets the pool dry. In order to maintain a sense of public service, the skateboarders adhere to basic rules: no graffiti, pack out trash and never mess with or enter the houses. A day or two later, the skating begins, often in short bursts during the workday to avoid disturbing neighbors or attracting police attention. Twice in recent weeks, Mr. Peacock said, the police caught the skateboarders in an empty pool and demanded they leave but did not issue citations. Mr. Peacock said he was helping the environment. "I’m doing the city a favor," he said, by emptying fetid pools. "They’re always talking about West Nile on the news. Those little fish can only eat so much."
Bumpy Crop: Farming's Sudden Feasts and Famines
Benjamin Riensche has just come off two of his best years in farming. But like growers all over the globe, he is in the midst of a more turbulent era of sharply rising and then suddenly falling prices. Now the 47-year-old, who grows corn and soybeans across 10,000 acres in Iowa, fears he will incur losses in 2009 that would be his first red ink in 16 years. His revenue is falling, but the costs of seed, fertilizer and machinery have remained high. Mr. Riensche bought most of his supplies months ago, when grain prices were still high. Many of his suppliers are still trying to pass along the higher costs they absorbed in recent years for everything from metal and chemicals to natural gas. To lower his costs, he could idle land, but figures raising a crop at least gives him a chance to benefit if prices move back up, as some predict. "I never thought the stakes could get so big," Mr. Riensche says. "We've gone from the nickel slots to world-class poker." All this is happening even though the world has been producing more grain than ever.
Demand has grown faster than farmers could increase their production most years of this decade, helping to drain grain reserves. Unusually good weather in most of the world this year is refilling grains stocks once again. But the situation could easily change. Some economists worry that the world will consume more grain than it produces by 2010, particularly if oil prices recover enough to make the production of ethanol from corn more profitable again. The situation is a headache for farmers even though it can mean years of big profits. Commodity prices are changing more quickly than farmers can plan which crops to grow. The price of a bushel of corn rarely varied by more than a dollar in a year's time for most of the 1980s and the 1990s. But this year, many U.S. corn farmers have seen the price of their crop swing by $4 a bushel. The rapid change in the fortunes for Mr. Riensche is not uncommon for farmers around the world, who are experiencing an unprecedented era of volatility. After prices of crops peaked in the summer, bumper crops recently helped reduce prices, dousing the anger behind riots in nearly 60 countries. But crop reserves remain unusually low while demand continues to grow. That means the slightest disruption -- flooding, drought, disease, or extra-cautious farmers -- could have a much bigger impact on prices than it would have had in recent decades.
"There's no cushion," said Daniel W. Basse, president of AgResource Co., a Chicago commodity forecasting concern. "It's a very volatile situation." Successful farming is partly about divining future demand, which has been high as new consumers emerge around the world. Mr. Riensche's corn and soybeans flow into a U.S. commodity sector that fattens livestock for Asian consumers, fills food-aid cargo ships to Africa, and supplies corn-fed ethanol plants in the Midwest. Just last year, his Blue Diamond Farming Co. saw its profits double into the six figures. Hearing agricultural experts predict a decade of strong crop prices, Mr. Riensche felt confident enough to build a new home on the site of the farmhouse where his father was born. The two-and-a-half story, red-brick Georgian is roughly three times the size of the Reinsches' cramped, 1,130-square-foot home in town, where their four children share two bedrooms. Within a few weeks, the girls and a boy will each have their own room. "For a long time, I figured our standard of living had slipped behind where we would be if I had stayed in banking," says Mr. Riensche, who earned an M.B.A. from the University of Chicago, then worked for Swiss Bank Corp. He returned home in 1993 to run the family farm after his brother died in a harvest accident.
For many years, U.S. farmers received about $2 per bushel for their corn, so close to their break-even point that they depended on federal farm subsidies to stay in business. "Only in the last few years were we able to catch up," Mr. Riensche says. The boom hit home for him in 2006, when a new energy law forced the oil industry to blend billions of gallons of ethanol into motor fuel. Dunkerton Co-op, which buys Mr. Riensche's crops, suddenly began supplying half of its members' corn to the ethanol plants sprouting around the farms he works with his father, Roland, 78. At the same time, the world's appetite for U.S. corn, soybeans, wheat, pork and poultry was steadily expanding. Demand was so great that even the June flooding that inundated nearby Waterloo and Cedar Rapids -- delaying Mr. Riensche's planting season by nearly a month -- didn't dent the farmer's optimism. With grain stockpiles already perilously low, grain buyers panicked that the world might run out. Speculators helped drive prices skyward. The Dunkerton grain elevator bought some of Mr. Riensche's corn for three times what he typically has collected: $6.24 a bushel.
In July, the weather turned ideal for growing, leading to the U.S.'s second-biggest corn crop ever. But as harvesting began in September, the Wall Street meltdown fueled fears that a global economic slowdown would chill foreign demand. Then, in October, the sibling source of demand -- ethanol -- took a big hit. Ethanol giant VeraSun Energy Corp., owner of a plant in nearby Dyersville, filed for protection from creditors under Chapter 11 of the federal bankruptcy code. Corn prices plummeted further. "Who could believe prices could rise that high or fall that fast?" said Mr. Riensche as his 12-man crew raced to finish a field before a November nightfall. Every 20 minutes, a semi-trailer hauling 1,000 bushels of corn lumbered down the road to an ethanol plant paying him about $4 per bushel. Not long ago, Mr. Riensche would have been ecstatic to get that much for his corn. But his suppliers and the owners of the land he leases jacked up their prices to cash in on the grain boom. His seed costs for next year are jumping 33%, and his fertilizer bill is more than doubling. Hog producers who used to pay to have manure removed from their barns are now making corn farmers pay for its value as fertilizer.
Mr. Riensche figures it will cost him close to $5 to grow a bushel of corn next year and about $11 to grow a bushel of soybeans -- not good with prices where they are at the moment. Taking their cues from the Chicago Board of Trade, local buyers are offering about $4 a bushel for corn that farmers promise to deliver next year, while soybean processors are offering about $9. Federal subsidy checks aren't likely to help U.S. farmers as much as they once did. Corn and soybean prices are still above the levels that automatically trigger price-support related checks from the government. The chance of red ink returning to the Farm Belt is prompting rural bankers to tighten their lending standards, which could force farmers to draw down their savings in order to stay in business. Bankers already expect some of their most indebted farmers to get out of the business next year.
"There's a phenomenal change in the whole structure of the farm economy," says Shane Tiernan, a business development officer at Grundy National Bank, Conrad, Iowa, which lends to hundreds of growers. "We've never seen farm incomes swing this dramatically before." Quitting isn't an option for Mr. Riensche. Unlike many U.S. farmers, he has a child who wants to follow in his footsteps. "My dad is a pretty successful guy," says nine-year-old Hans as he plays in his father's shop with his model farm. "We are taking a big leap of faith," Mr. Riensche says as hunches over his personal computer, staring at commodity price charts. "We are praying for a change in the markets."
Ilargi: Ellen Brown, author of Web of Debt, on fractional banking.
Borrowing From Peter To Pay Paul:
The Wall Street Ponzi Scheme Called Fractional Reserve Banking
Bernie Madoff showed us how it was done: you induce many investors to invest their money, promising steady above-market returns; and you deliver at least on paper. When your clients check their accounts, they see that their investments have indeed increased by the promised amount. Anyone who opts to pull out of the game is paid promptly and in full. You can afford to pay because most players stay in, and new players are constantly coming in to replace those who drop out. The players who drop out are simply paid with the money coming in from new recruits. The scheme works until the market turns and many players want their money back at once. Then it's game over: you have to admit that you don't have the funds, and you are probably looking at jail time.
A Ponzi scheme is a form of pyramid scheme in which earlier investors are paid with the money of later investors rather than from real profits. The perpetuation of the scheme requires an ever-increasing flow of money from investors in order to keep it going. Charles Ponzi was an engaging Boston ex-convict who defrauded investors out of $6 million in the 1920s by promising them a 400 percent return on redeemed postal reply coupons. When he finally could not pay, the scam earned him ten years in jail; and Bernie Madoff is likely to wind up there as well.
Most people are not involved in illegal Ponzi schemes, but we do keep our money in accounts that are tallied on computer screens rather than in stacks of coins or paper bills. How do we know that when we demand our money from our bank or broker that the funds will be there? The fact that banks are subject to "runs" (recall Northern Rock, Indymac and Washington Mutual) suggests that all may not be as it seems on our online screens. Banks themselves are involved in a sort of Ponzi scheme, one that has been perpetuated for hundreds of years. What distinguishes the legal scheme known as "fractional reserve" lending from the illegal schemes of Bernie Madoff and his ilk is that the bankers' scheme is protected by government charter and backstopped with government funds. At last count, the Federal Reserve and the U.S. Treasury had committed $8.5 trillion to bailing out the banks from their follies.1 By comparison, M2, the largest measure of the money supply now reported by the Federal Reserve, was just under $8 trillion in December 2008.2 The sheer size of the bailout efforts indicates that the banking scheme has reached its mathematical limits and needs to be superseded by something more sustainable.
Penetrating the Bankers' Ponzi Scheme
What fractional reserve lending is and how it works is summed up in Wikipedia as follows:"Fractional-reserve banking is the banking practice in which banks keep only a fraction of their deposits in reserve (as cash and other liquid assets) with the choice of lending out the remainder, while maintaining the simultaneous obligation to redeem all deposits immediately upon demand. This practice is universal in modern banking. . . .The nature of fractional-reserve banking is that there is only a fraction of cash reserves available at the bank needed to repay all of the demand deposits and banknotes issued. . . . When Fractional-reserve banking works, it works because:Like in other Ponzi schemes, bank runs result because the bank does not actually have the funds necessary to meet all its obligations. Peter's money has been lent to Paul, with the interest income going to the bank. As Elgin Groseclose, Director of the Institute for International Monetary Research, wryly observed in 1934:
1. Over any typical period of time, redemption demands are largely or wholly offset by new deposits or issues of notes. The bank thus needs only to satisfy the excess amount of redemptions.
2. Only a minority of people will actually choose to withdraw their demand deposits or present their notes for payment at any given time.
3. People usually keep their funds in the bank for a prolonged period of time.
4. There are usually enough cash reserves in the bank to handle net redemptions.
If the net redemption demands are unusually large, the bank will run low on reserves and will be forced to raise new funds from additional borrowings (e.g. by borrowing from the money market or using lines of credit held with other banks), and/or sell assets, to avoid running out of reserves and defaulting on its obligations. If creditors are afraid that the bank is running out of cash, they have an incentive to redeem their deposits as soon as possible, triggering a bank run."A warehouseman, taking goods deposited with him and devoting them to his own profit, either by use or by loan to another, is guilty of a tort, a conversion of goods for which he is liable in civil, if not in criminal, law. By a casuistry which is now elevated into an economic principle, but which has no defenders outside the realm of banking, a warehouseman who deals in money is subject to a diviner law: the banker is free to use for his private interest and profit the money left in trust. . . . He may even go further. He may create fictitious deposits on his books, which shall rank equally and ratably with actual deposits in any division of assets in case of liquidation."How did the perpetrators of this scheme come to acquire government protection for what might otherwise have landed them in jail? A short history of the evolution of modern-day banking may be instructive.
The Evolution of a Government-Sanctioned Ponzi Scheme
What came to be known as fractional reserve lending dates back to the seventeenth century, when trade was conducted primarily in gold and silver coins. How it evolved was described by the Chicago Federal Reserve in a revealing booklet called "Modern Money Mechanics" like this:"It started with goldsmiths. As early bankers, they initially provided safekeeping services, making a profit from vault storage fees for gold and coins deposited with them. People would redeem their "deposit receipts" whenever they needed gold or coins to purchase something, and physically take the gold or coins to the seller who, in turn, would deposit them for safekeeping, often with the same banker. Everyone soon found that it was a lot easier simply to use the deposit receipts directly as a means of payment. These receipts, which became known as notes, were acceptable as money since whoever held them could go to the banker and exchange them for metallic money.If a landlord had rented the same house to five people at one time and pocketed the money, he would quickly have been jailed for fraud. But the bankers had devised a system in which they traded, not things of value, but paper receipts for them. It was called "fractional reserve" lending because the gold held in reserve was a mere fraction of the banknotes it supported. The scheme worked as long as only a few people came for their gold at one time; but investors would periodically get suspicious and all demand their gold back at once. There would then be a run on the bank and it would have to close its doors. This cycle of booms and busts went on throughout the nineteenth century, culminating in a particularly bad bank panic in 1907.
Then, bankers discovered that they could make loans merely by giving their promises to pay, or bank notes, to borrowers. In this way, banks began to create money. More notes could be issued than the gold and coin on hand because only a portion of the notes outstanding would be presented for payment at any one time. Enough metallic money had to be kept on hand, of course, to redeem whatever volume of notes was presented for payment.
Transaction deposits are the modern counterpart of bank notes. It was a small step from printing notes to making book entries crediting deposits of borrowers, which the borrowers in turn could 'spend' by writing checks, thereby 'printing' their own money."
The public became convinced that the country needed a central banking system to stop future panics, overcoming strong congressional opposition to any bill allowing the nation's money to be issued by a private central bank controlled by Wall Street. The Federal Reserve Act creating such a "bankers' bank" was passed in 1913. Robert Owens, a co-author of the Act, later testified before Congress that the banking industry had conspired to create a series of financial panics in order to rouse the people to demand "reforms" that served the interests of the financiers.4 Despite this powerful official backstop, however, the greatest bank run in history occurred only twenty years later, in 1933. President Roosevelt then took the dollar off the gold standard domestically, and Federal Reserve officials resolved to prevent further bank runs after that by flooding the banking system with "liquidity" (money created as debt to banks) whenever the banking Ponzi scheme came up short.
"Too Big to Fail": The Government Provides the Ultimate Backstop
When these steps too proved insufficient to keep the banking scheme going, the government itself stepped up to the plate, providing bailout money directly from the taxpayers. The concept that some banks were "too big to fail" came in at the end of the 1980s, when the Savings and Loans collapsed and Citibank lost 50 percent of its share price. Negotiations were conducted behind closed doors, and "too big to fail" became standard policy. Bank risk was effectively nationalized: banks were now protected by the government from loss regardless of risk-taking or bad management.
There are limits, however, to the amount of support even the government's deep pocket can provide. In the past two decades, the bankers' lending scheme has been kept going by an even more speculative scheme known as "derivatives." This is a complex subject that has been explored in other articles, but the bottom line is that more dollars are now owed in the derivatives casino than exist on the planet. (See Ellen Brown, "It's the Derivatives, Stupid!" and "Credit Default Swaps: Derivative Disaster Du Jour," www.webofdebt.com/articles.)
Attempting to fill the derivatives black hole with taxpayer money must inevitably be at the expense of other essential programs, such as Social Security and Medicare. Interestingly, Social Security and Medicare themselves are in some sense Ponzi schemes, since earlier retirees collect their benefits from the contributions of later workers. These programs, too, may soon be facing bankruptcy, in this case because their mathematical models failed to account for a huge wave of Baby Boomers who would linger longer than previous generations and demand expensive drugs and care through their senior years, and because the fund money has have been drawn on by the government for other purposes.
The question here is, should the government be backstopping private banks that have mismanaged their investment portfolios at the expense of workers contractually entitled to a decent retirement from a fund they have paid into all their working lives? The answer, of course, is no; but there may be a way that the government could do both. If it were to nationalize the banking system completely if the government were to assume not just the banks' losses but their profits, oversight and control it might have the funds both to maintain Social Security and Medicare and to provide a sustainable credit mechanism for the whole economy.
Replacing Private with Public Credit
Readily available credit has made America "the land of opportunity" ever since the days of the American colonists. What has transformed this credit system into a Ponzi scheme that must continually be propped up with bailout money is that the credit power has been turned over to private parties who always require more money back than they create in the first place. Benjamin Franklin reportedly explained this defect in the eighteenth century. When the directors of the Bank of England asked what was responsible for the booming economy of the young colonies, Franklin explained that the colonial governments issued their own money, which they both lent and spent into the economy:
"In the Colonies, we issue our own paper money. It is called 'Colonial Scrip.' We issue it in proper proportion to make the goods pass easily from the producers to the consumers. In this manner, creating ourselves our own paper money, we control its purchasing power and we have no interest to pay to no one. You see, a legitimate government can both spend and lend money into circulation, while banks can only lend significant amounts of their promissory bank notes, for they can neither give away nor spend but a tiny fraction of the money the people need. Thus, when your bankers here in England place money in circulation, there is always a debt principal to be returned and usury to be paid. The result is that you have always too little credit in circulation to give the workers full employment. You do not have too many workers, you have too little money in circulation, and that which circulates, all bears the endless burden of unpayable debt and usury."
In an article titled "A Monetary System for the New Millennium," Canadian money reform advocate Roger Langrick explains his concept in contemporary terms. He begins by illustrating the mathematical impossibility inherent in a system of bank-created money lent at interest:"[I]magine the first bank which prints and lends out $100. For its efforts it asks for the borrower to return $110 in one year; that is it asks for 10% interest. Unwittingly, or maybe wittingly, the bank has created a mathematically impossible situation. The only way in which the borrower can return 110 of the bank's notes is if the bank prints, and lends, $10 more at 10% interest . . . . The result of creating 100 and demanding 110 in return, is that the collective borrowers of a nation are forever chasing a phantom which can never be caught; the mythical $10 that were never created. The debt in fact is unrepayable. Each time $100 is created for the nation, the nation's overall indebtedness to the system is increased by $110. The only solution at present is increased borrowing to cover the principal plus the interest of what has been borrowed."
The better solution, says Langrick, is to allow the government to issue enough new debt-free dollars to cover the interest charges not created by the banks as loans:"Instead of taxes, government would be empowered to create money for its own expenses up to the balance of the debt shortfall. Thus, if the banking industry created $100 in a year, the government would create $10 which it would use for its own expenses. Abraham Lincoln used this successfully when he created $500 million of 'greenbacks' to fight the Civil War."
National Credit from a Truly National Banking System
In Langrick's example, a private banking industry pockets the interest, which must be replaced every year by a 10 percent issue of new Greenbacks; but there is another possibility. The loans could be advanced by the government itself. The interest would then return to the government and could be spent back into the economy in a circular flow, without the need to continually issue more money to cover the interest shortfall.
The fractional reserve Ponzi scheme is bankrupt, and the banks engaged in it, rather than being bailed out by its victims, need to be put into a bankruptcy reorganization under the FDIC. The FDIC then has the recognized option of wiping their books clean and taking the banks' stock in return for getting them up and running again. This would make them truly "national" banks, which could dispense "the full faith and credit of the United States" as a public utility. A truly national banking system could revive the economy with the sort of money only governments can issue debt-free legal tender. The money would be debt-free to the government, while for the private sector, it would be freely available for borrowing at a modest interest by qualified applicants. A government-owned bank would not need to rob from Peter to advance credit to Paul. "Credit" is just an accounting tool an advance against future profits, or the "monetization" (turning into cash) of the borrower's promise to repay. As British commentator Ron Morrison observed in a provocative 2004 article titled "Keynes Without Debt":"[Today] bank credit supplies virtually all our everyday means of exchange, and this brings into sharp focus the simple fact that modern money is no longer constrained by outmoded intrinsic values. It is pure fiat [enforced by law] and simply a glorified accounting system. . . . Modern monetary reform is about displacing the current economic paradigm of 'what can be afforded' with 'what we have the capacity to undertake.'"5The objection to government-issued money has always been that it would be inflationary, but today some "reflating" of the economy could be a good thing. Just in the last year, more than $7 trillion in purchasing power has disappeared from the money supply, including wealth destruction in real estate, stocks, mutual fund shares, life insurance and pension fund reserves.6 Money is evaporating because old loans are defaulting and new loans are not being made to replace them.
Fortunately, as Martin Wolf noted in the December 16 Financial Times, "Curing deflation is child's play in a 'fiat money' a man-made money system." The central banks just need to get money flowing into the economy again. Among other ways they could do this, says Wolf, is that "they might finance the government on any scale they think necessary."7
Rather than throwing money at a failed private banking system, public credit could be redirected into infrastructure and other projects that would get the wheels of production turning again. The Ponzi scheme in which debt is just shuffled around, borrowing from one player to pay another without actually producing anything of real value, could be replaced by a system in which the national credit card became an engine for true productivity and growth. Increased "demand" (money) would come from earned wages and salaries that would increase "supply" (goods and services) rather than merely servicing a perpetually increasing debt. When supply keeps up with demand, the money supply can be increased without inflating prices. In this way the paradigm of "what we can afford" could indeed be superseded by "what we have the capacity to undertake".
Kathleen Pender, "Government Bailout Hits $8.5 Trillion," San Francisco Chronicle (November 26, 2008).
"Federal Reserve Statistical Release H.6, Money Stock Measures," www.federalreserve.gov (December 18, 2008).
Robert de Fremery, "Arguments Are Fallacious for World Central Bank," The Commercial and Financial Chronicle (September 26, 1963), citing E. Groseclose, Money: The Human Conflict, pages 178-79.
Robert Owen, The Federal Reserve Act (1919); "Who Was Philander Knox?", www.worldnewsstand.net/history/PhilanderKnox.htm. (1999).
Ron Morrison, "Keynes Without Debt," www.prosperityuk.com/prosperity/articles/keynes.html (April 2004).
Martin Weiss, "Biggest Sea Change of Our Lifetime," Money and Markets (December 22, 2008).
Martin Wolf, "'Helicopter Ben' Confronts the Challenge of a Lifetime," Financial Times (December 16, 2008).