National American Ballet
Ilargi: Last month I started warning of millions of lay-offs to come in the US economy. Since then, we've seen a November job loss of 533.000, as well as predictions of pink slip totals of a million and more every single month in 2009. The main media for now restrict most of their job loss reporting to the financial sector, and the US in particular. At least, I have yet to see a claim that Europe will be hit by millions of newly employed. Still, looking around the financial world today I can't escape the feeling that it will all get much worse than even I thought, and that Europe can't escape a fate much worse than it thinks is in store.
The Bank for International Settlements (BIS) issued a report on global lending and bond issuance that says both are down 70-80%, with bonds in Euros dropping 94%. This means companies can't borrow from banks, nor can they expect to raise capital in the bond markets. The result should be obvious: tons of companies, from small to large, will inevitably have to declare bankruptcy. This is true in the US, in Europe, in Japan, and the bankruptcy and job loss wave will spread from there to the rest of the planet, in a self-reinforcing manner, feeding off itself.
And I may be naive, but I would truly expect governments to prepare for this wave. However, I see no such action anywhere. Which I think will have very dire consequences, with millions of people on both sides of the Atlantic, and in markets worldwide, with no chance of finding work, and no hope of receiving government -financial- support: there'll be too many of them. All this will put enormous pressure on individual countries and their political systems.
Moody’s predicts corporate -bond- defaults to rise almost 4-fold in the US, and 10-fold in European markets. These are companies that will have to lay off people simply because they have no way of paying for inventory. This starts to look like the 1930's, when the labor was there, and so were the resources, but the financial markets made it impossible for both to come together.
We should have taken care of basic human needs, by taking them out of profit markets. But we haven't, and so supermarket shelves will be as empty as electronics stores, though both serve entirely different needs and demands. Governments, meanwhile, use what money they can get to prop up an insolvent financial system, whereas their prime concern should be to feed and clothe their citizens, and make sure they have shelter and clean water. If you know of a government that is looking at these issues today, I’d like to know about it.
The most disconcerting words these days concern the credit default swap market. Yves Smith linked to an article by the pretty brilliant and solid voice of Christopher Whalen at Institutional Risk Analytics that lays out the risks loud and clear. He quotes a large investor who claims three banks, two French and one German are so deep in the CDS casino that EU officials ponder a moratorium on CDS payments. The banks would then need, and get, 10 years(!) to clean up the mess they've made. Which is an illusion, of course: once you cut the payments, the whole machine grinds to a halt. Whalen thinks that's a good idea, and I fully agree, as you all know, since such a policy would force the exposure of all Atlantic City toilet paper.
If one country starts, the rest will be forced to follow suit, including the US. And yes, as Whalen says, this is the prime condition for restoring investor confidence. But it will be extremely painful. Chris Whalen calculates that a very conservative, absolute minimum tab for the players in the CDS market will be $15 trillion. A more likely scenario, though, is this:
The rise in loss rates for all type of collateral over the next 24 months could easily make the portion of CDS "in the money" grow to more like 60-70%. That is $40 plus trillion in notional payments vs. a recovery rate in single digits.
And before you knee-jerk that the central banks and Treasuries will simply print these amounts: the EU payment moratorium will come because the countries can't pay: “the positions are beyond the ability of the EU governments to bail them out without a cessation of CDS payments”. They can't, it's end of the line, no hyper-inflation, a giant default wave, more morose attempts to save banks that should have been thrown out the window years go, and no money to take care of the millions of desperate citizens roaming the streets. Note that Whalen's focus is only on the CDS market, and there is a quadrillion dollars more in other derivative instruments aimlessly floating around out there, certain to hit a shore somewhere one stormy day soon.
Banking and investing as we've known it won't be back for at least decades. The upcoming round of bank failures, which will leave very few, if any, standing, cannot be prevented. A lot of the suffering among ordinary people can, if only through using the current bail-out funds to make sure every American and European can get at least their basic needs fulfilled . But no politician anywhere is even looking at this reality, and the citizenry has been kept in the dark. It makes the implosion of entire societies an easily predictable fact.
Outlook for 2009: It's All About CDS
This time last year, we put down a marker regarding what we expected to be the issues for 2008, namely the collapse of the housing bubble and the related slide in the US economy. Today we make another prediction: that the unwind of Wall Street's rancid leverage pile will dominate the economic and political scene in 2009, both in the US and around the world. The chief engine of that deleveraging will be CDS, the vast, unregulated market in leveraged bets fostered and encouraged over two decades by former Fed Chairman Alan Greenspan and the academic economists who populate the Fed staff in Washington.
Now Treasury Secretary Hank Paulson and Fed of NY chief Tim Geithner are trying to protect this massive pile of unfunded gaming contracts from inevitable liquidation. The under-collateralized wagers that are CDS contracts threaten the solvency of financial institutions around the globe, this despite the efforts to reform the system via enhanced clearing mechanisms, increased collateral and margin requirements. One IRA reader named Marco waxes effusive as to the palliative effects of enhanced margin requirements: "Just as regulators set the minimum amount of margin for securities/options (giving brokers flexibility to ask for MORE margin), and can increase it/ decrease it by fiat, the same should be done for CDS margin requirements. In this manner, whenever it appears that the tail is beginning to wag the entire dog, these margin increases will prevent exaggerated movements from taking place."
Would that it were so. You see, if you go back to the positions taken by NY State Insurance Commissioner Eric Dinallo, who has recently backed away from his proposal to unilaterally regulate entities that write CDS protection to insurance companies, the minimum margin would effectively be a letter of credit that demonstrates the ability of the writer of CDS protection to fund the purchase of the underlying bond at par. But alas, one of Wall Street's dirty secrets is that most of the CDS dealer banks don't post margin with one another at all! If CDS dealer banks were actually compelled to post real, effective collateral with other dealers to back performance, then the entire CDS market would collapse. Indeed, that is what is happening right now, in slow motion. As leverage in the global banking system is being forced down, the CDS market is being squeezed out of existence by a market that can no longer ignore the inherent contradictions in these OTC options.
Now you know why we have taken the view that the only way to deal with situations such as AIG is bankruptcy. Funding the AIG CDS portfolio is an open-ended proposition. But of course Paulson, Geithner et al would rather use tax dollars to subsidize this example of global casino gambling rather than tell the American people the truth about AIG and the other large CDS dealer banks such as C and JPM. And the truth, in our view, is that these large, CDS dealers are basically insolvent, with or without the distorting effects of fair value accounting. And the solvency problems arise not only because of their own CDS positions, but because their dealer counterparties have problems of their own. You may recall a couple of years ago that our former boss Gerry Corrigan, who is now global risk honcho for Goldman Sachs, started to complain publicly about the horrendous state of the back office procedures for clearing CDS.
While GS is and has been one of the chief beneficiaries of the global CDS casino, Corrigan finally started to agitate for change back in 2004 - change that only slowly came online until the DTCC picked up the ball and made it happen. You may also recall that Tim Geithner et al at the Fed began to jawbone the CDS dealers to start "netting out" their CDS exposures with one another. But the op-risk issues with CDS are as nothing compared to the pricing and funding problems with these contracts. In that sense, the focus on back office problems facing CDS and indeed all OTC derivatives has been a canard, a distraction from the real issue, namely the bankrupt intellectual basis for the CDS contracts themselves. What Geithner and Fed Chairman Ben Bernanke failed to tell the Congress, President-elect Barack Obama and the American people is that CDS dealers don't post any effective collateral at all with other dealers. So much for the legal requirements for safety and soundness in 12 CFR. If Barack Obama and the Congress ever needed a final reason to strip the Fed of all regulatory responsibility for financial institutions, the coming nuclear winter of CDS unwind is it.
You see, in the make believe world of interdealer CDS, when a "margin call" occurs, no cash or securities actually change hands. Instead the CDS dealers merely shuffle some paper around and effectively rely on the overall credit standing of the other banks, much as they do in foreign exchange or money market transactions. And virtually none of these dealers even attempt to model the actual default risk in CDS! "When CDS first began to appear in the markets, traders did try to do some work on the probability of default of a given name" one senior risk manager in New York tells The IRA. "Unfortunately, all of these efforts have been dropped in favor of a more efficient if less sound methodology based upon short-term volatility." The risk manager, who is responsible for the portfolio of one of the largest universal banks in the world, goes on to say that while he expects to see CDS evolve into a different product configuration, he doubts that an exchange model will work because "it implies a huge decrease in leverage" for the dealer banks.
Our contacts in Chicago agree. One reader of The IRA named Bob, who has close ties to the CME and the Chicago futures community, says that clearing members are reluctant to put their capital on the line to support a new CDS contract because they view the current market as toxic waste. Why should any clearing member of the CME put their capital at risk behind a central counterparty for CDS when the pricing of this market is so clearly out of alignment with the underlying risks? The fact of the matter is that, in many financial institutions, single name CDS has become a tool for supporting equity prop trading, not insuring against obligor default. Most traders of CDS have no idea about the probability of default or P(D) of the underlying credit. Nor can they demonstrate why the spreads on a given CDS contract has any relationship with the underlying P(D) credit basis, the cost of funds for that name, or anything else.
And where do CDS traders get their P(D) for their tactical trading desk "models," if we can dignify these methods with that label? Well from the Bloomberg terminal of course! Bloomberg and other global data vendors collect survey CDS spread "data" from the dealer community and calculate what is called P(D) based on - you guessed it - volatility! Equity volatility, bond volatility or just the VIX, depending on the trader. It is just market prices and efficient market theory all over again. As long as the players of this version of Liar's Poker agree that the P(D) on the Bloomberg is right, the market appears to function. But the basic relationship between spread/price in no way adequately quantifies the actual risk of default or the cash flow requirements for a provider of protection. CDS spreads are all just about trading short-term equity volatility, thus our long standing position that using CDS spreads as an indication of credit worthiness is a truly ridiculous position, especially when CDS spreads are used in contracts and securities indentures! Can you imagine obligating your organization contractually based upon a nonsensical indicator such as volatility or CDS spreads? But today there are lawyers and bankers in the marketplace who are advising clients to do just that.
As another CDS trader at a major pension fund told The IRA last week: "There are no models in CDS today. If you have an ISDA counter-party agreement between institutions, then there is no collateral at the individual transaction level. It is all dealt with via the ISDA treaty at the institution-to-institution level and thus there is no effective limit on leverage." Or as another risk manager opined: When NY Insurance Commissioner Dinallo made his proposal to unilaterally regulate CDS early in 2008, was he playing a win-win scenario? Was he merely a stalking horse for the other regulators or did Dinallo ever really mean to regulate CDS? Good questions. Given the description above, we must ask: is the dealing of CDS within large global banks "safe and sound?" Does allowing large banks to trade CDS vs. ephemeral benchmarks such as equity volatility not put the entire global financial system in peril? Well, we may find out the answer to that question sooner rather than later.
We hear from a very well placed Buy Side investor with extensive business interests in the US and EU that three primary banking institutions in Europe, two French and one German, have such significant CDS exposure and other problems that they cannot even begin to fund the payouts anticipated over the next quarter. The funding squeeze reportedly is exacerbated by a near-collapse among weaker players in the hedge fund market, who were accustomed to receiving loans from one large French institution, which then stupidly converted the loans into equity. That's right. This past summer, when the bank put out a call for redemptions of $4 billion in hedge fund investments, says the source, only $400 million was returned. And the French bank also used these same hedge funds and others to reinsure some of its own CDS exposure. Sound familiar? Yup, just like AIG.
Unlike the approach taken by Paulson and Geithner to bailout AIG and JPM (via the Bear Stearns rescue), however, the investor claims that EU officials are considering a moratorium on CDS payments by the three Euroland banks in question. The banks would be given ten years to write down their CDS and hedge fund exposures and would receive additional infusions of capital by their respective governments. The source claims that French banks have such huge exposure to both hedge funds and CDS, sometimes linked together, that the positions are beyond the ability of the EU governments to bail them out without a cessation of CDS payments. The IRA was not able to obtain a comment from EU officials over the weekend about these allegations. We'll be making some calls Sunday night and Monday. But if this unconfirmed report turns out the be true, then the beginning of the end of the CDS market as we have known it will be at hand. And ironically, the catalyst for the final solution will come not from the failure of a US dealer, but instead by a moratorium on CDS payments by an EU bank.
In the event, as other governments around the world follow the very reasonable example of the EU, the OTC derivatives market will implode and these unfunded liabilities may very well force the nationalization/liquidation of C, JPM and AIG, among others. And in the event, Hank Paulson, Tim Geithner, Alan Greenspan, Ben Bernanke and other senior officials at the Fed in Washington are going to have a lot of explaining to do to the Congress, to a new President and the global financial community. Tell us again, Chairman Greenspan and Chairman Bernanke, just why do you believe dealing in OTC derivatives and particularly CDS contracts are activities that are safe and sound for global banking institutions?
Put the credit default swaps market out of its misery
"Effectively, there isn't any CDS market now." David Goldman, an old friend and credit strategist turned private investor, still goes through the credit run sheets from the dealers. "The business looks like the window of a Brezhnev-era Soviet butcher shop. Mouldy scraps hanging in the window. Old women lining up at 4am to try and buy credit protection on General Motors. What are reported as trades are really ways to establish prices to satisfy the auditors."
For several years, I have been among those calling for thoughtful, prudent, moderate steps for the reform of the credit default swaps market. They should be put on exchanges, put through central clearing houses, settlement backlogs reduced and then eliminated . . . etc. I was wrong. The global credit default swaps market should just be liquidated, the contracts allowed to expire and the booby traps defused. Where they can't be defused, they will explode, and we will have to deal with the loss of capital and litigation. Essentially, while the back office messes of the CDS market are being cleaned up, that leaves the question of why we need these things. We don't. The outstanding credit default swaps should be offset against each other, where possible, and the rest allowed to run off or be paid out as defaults occur.
Some of the counterparties will default; those losses should be accepted as the price of another huge pile of wasted effort, along with cold war bomb shelters and media studies doctorates. There are three possible defences for treating the CDS market as a going concern: its support for capital raising, its utility for price discovery and its role as a risk-management tool. All have melted like so many Lehman deal cubes in waste incinerators.
Consider capital raising. Writers of protection in the CDS market must now hold increasing amounts of cash as margin against the probability of default for the "reference entities" or borrowers they bet on. This has led to the sale of tens of billions, if not hundreds of billions, of dollars, euros and pounds worth of securities to raise that cash. Or, in the case of banks, capital that could support new sound lending is tied up, waiting to fund payouts to the buyers of protection on a long line of prospective defaults. Some of those buyers hold actual exposure in the form of bonds or supplier contracts; many more have just made side bets. In the meantime, those forced sales and frozen balance sheets have helped ensure that the issuance of new shares and bonds trails off to a trickle.
That leads to the value of such swaps for price discovery. Bad joke. Price discovery is a useful economic function; that is the rationale for commodities markets. But CDS are derivative instruments, whose price is "discovered" these days as a function of equity volatility, since buying equity puts is one way to dynamically hedge the illiquid legacy books. So CDS dealer sales of Citigroup equity through derivatives means higher equity volatility, then higher CDS spreads, leading to more margin calls, leading to more sales of bank stocks . . . This has become a system-wide tail-swallowing exercise in lunacy. If the default rates implied in investment grade CDS spreads were to occur, the only economic activity would be court-supervised reorganisation. The CDS market has been preventing efficient price discovery.
So, CDS as a risk-management tool. Let's ignore the smoking Krakatoa of AIG Financial Products' value at risk, and look at one facet of risk modelling in the market as a whole. A credit default swap is a very different creature than the traded equity of a "reference entity". CDS cover only one on-off risk, that is, default on reference obligations. So in the airless world of ideal models, CDS values are better considered as binomial probability distributions, rather than as the continuous probability distributions that are closer approximations of equity values.
Yes, there are problems with formalistic dependency on either family of distributions, but not as many as with using equity volatilities to price CDS. When implied probability of default, and equity volatility, are relatively low, you can do some seemingly plausible regression analyses to fit the series. But at high levels of default risk and equity volatility, if you hedge the one with the other you get frantic, self-defeating activity. Risk management with CDS was largely about what the bankers called "reg cap arb" (regulatory capital arbitrage), or making big spreads and bonuses by scamming the regulators whose employers, the taxpayers, now have the bill.
Howard Simons, one of the Chicago traders who always loathed the New York CDS dealers, speaks for many of his comrades in rejecting the trading of CDS on the futures exchanges. "The clearing members of the CME [Chicago Mercantile Exchange] think trading this stuff is the stupidest idea in the world. I didn't work my whole life so some investment bank can take all our capital. Do I look like Hank Paulson?" Let's rebuild real capital markets.
What Barack Obama Needs to Know About Tim Geithner, the AIG Fiasco and Citigroup
On Friday, the FDIC closed and facilitated the sale of two CA savings banks, Downey Savings and Loan, the bank unit of Downey Financial Corp and PFF Bank and Trust, Pomona, CA. All deposit accounts and all loans of both banks have been transferred to U.S. Bank, NA, lead bank unit of US Bancorp. All former Downey and PFF Bank branches reopen for business today as branches of U.S. Bank. Earlier this year we wrote positively about Downey and the funding advantages it had over larger thrifts such as Washington Mutual due to the solid deposit base and strong capital. Indeed, as of Q3 2008, the bank's Tier One leverage ratio was over 7.5%, more than two points over the minimum, and its charge offs had actually fallen compared with the gruesome 400 basis points of default reported in the previous period.
But since the September resolution of WaMu and Wachovia, the FDIC, it seems, is not willing to wait to resolve institutions, even banks that are apparently solvent and not below any of the traditional regulatory triggers for closure. The visible public metrics indicating soundness did not dissuade the Office of Thrift Supervision and FDIC from seizing both banks and selling them to USB. The purchase of Downey and PFF is good news for the depositors and borrowers, who will all be offered the FDIC's prepackaged IndyMac mortgage modification program as a condition of the USB acquisition. Bad news for the investors and creditors, who now see their already impaired investments wiped out.
The resolution of Downey illustrates both the best and the worst aspects of the government's remediation efforts. On the one hand, we have argued that the government should be pushing bad banks into the arms of stronger banks to improve the overall condition of the system. The good people at the FDIC do that very well - when politics does not intervene. In the case of Downey and PFF, it appears that the OTS and FDIC projected forward from the current above-peer loss rates and concluded that a prompt resolution was required. Reasonable people can argue whether this is the right call. But when we see the equity and debt holders of DSL, Washington Mutual or Lehman Brothers taking a total loss, we have to ask a basic question: why is it that the debt holders of Bear Stearns and AIG are granted salvation by the Federal Reserve Board and the US Treasury, but other investors are not?
If the rule of driving money to the strong banks safety and soundness is to be effective, it must be applied to all. And now you know why we have questions about the nomination of Tim Geithner to be the next Treasury Secretary. If you look at how the Fed and Treasury have handled the bailouts of Bear Stearns and AIG, a reasonable conclusion might be that the Paulson/Geithner model of political economy is rule by plutocrat. Facilitate a Fed bailout of the speculative elements of the financial world and their sponsors among the larger derivatives dealer banks, but leave the real economy to deal with the crisis via bankruptcy and liquidation. Thus Lehman, WaMu, Wachovia and Downey shareholders and creditors get the axe, but the bondholders and institutional counterparties of Bear and AIG do not.
Few observers outside Wall Street understand that the hundreds of billions of dollars pumped into AIG by the Fed of NY and Treasury, funds used to keep the creditors from a default, has been used to fund the payout at face value of credit default swap contracts or "CDS," insurance written by AIG against senior traunches of collateralized debt obligations or "CDOs." The Paulson/Geithner model for dealing with troubled financial institutions such as AIG with net unfunded obligations to pay CDS contracts seems to be to simply provide the needed liquidity and hope for the best. Fed and AIG officials have even been attempting to purchase the CDOs insured by AIG in an attempt to tear up the CDS contracts. But these efforts only focus on a small part of AIG's CDS book. The Paulson/Geithner bailout model as manifest by the AIG situation is untenable and illustrates why President-elect Obama badly needs a new face at Treasury. A face with real financial credentials, somebody like Fannie Mae CEO Herb Allison. A banker with real world transactional experience, somebody who will know precisely how to deal with the last bubble that needs to be lanced - CDS.
Last Thursday, we gave a presentation to the New York Chapter of the Risk Management Association regarding the US banking sector and the long-term issues facing same. As part of the presentation , IRA co-founder Chris Whalen argued the case made by a reader of The IRA a week before, that until we rid the markets of CDS, there will be no restoring investor confidence in financial institutions. Here is how we presented the situation to about 200 finance and risk professionals in the auditorium of JPM last week. Of note, nobody in the audience argued.
- Start with the $50 trillion or so in extant CDS.
- Assume that as default rates for all types of collateral rise over next 24-36 months, 40% of the $50 trillion in CDS goes into the money. That is $20 trillion gross notional of CDS which must be funded.
- Now assume a 25% recovery rate against that portion of all CDS that goes into the money.
- That leaves you with a $15 trillion net amount that must be paid by providers of protection in CDS. And remember, a 40% in the money assumption for CDS is VERY conservative. The rise in loss rates for all type of collateral over the next 24 months could easily make the portion of CDS in the money grow to more like 60-70%. That is $40 plus trillion in notional payments vs. a recovery rate in single digits.
Q: Does anybody really believe that the global central banks and the politicians that stand behind them are going to provide the liquidity to fund $15 trillion or more in CDS payouts? Remember, only a small portion of these positions are actually hedging exposure in the form of the underlying securities. The rest are speculative, in some cases 10, 20 of 30 times the underlying basis. Yet the position taken by Treasury Secretary Paulson and implemented by Tim Geithner (and the Fed Board in Washington, to be fair) is that these leveraged wagers should be paid in full. Our answer to this cowardly view is that AIG needs to be put into bankruptcy. We'll take our cue from NY State Insurance Commissioner Eric Dinallo and stipulate that we pay true hedge positions at face value, but the specs get pennies on the dollar of the face of CDS. And the specs should take the pennies gratefully and run before the crowd of angry citizens with the torches and pitchforks catch up to them.
President-elect Obama and the American people have a choice: embrace financial sanity and safety and soundness by deflating the last, biggest speculative bubble using the time-tested mechanism of insolvency. Or we can muddle along for the next decade or more, using the Paulson/Geithner model of financial rescue for the AIG CDS Ponzi scheme and embrace the Japanese model of economic stagnation. And, yes, we can put AIG and the other providers of protection through a bankruptcy and force the CDS market into a quick and final extinction. Remember, when AIG goes bankrupt the insurance units are taken over by NY, WI and put into statutory receiverships. Only the rancid CDS positions and financial engineering unit of AIG end up in bankruptcy. And fortunately we have a fine example of just how to do it in the bankruptcy of Lehman Brothers.
Our friends at Katten Muchin Rosenman in Chicago wrote last week in their excellent Client Advisory: "On November 13, 2008, Lehman Brothers Holdings Inc. and its U.S. affiliates in bankruptcy, including Lehman Brothers Special Financing and Lehman Brothers Commercial Paper (collectively, "Lehman") filed a motion asking that certain expedited procedures be put in place to allow Lehman to assume, assign or terminate the thousands of executory derivative contracts to which they are a party. If Lehman's motion is granted, counterparties to transactions that have not been terminated will have very little time to react and will likely find themselves with new counterparties and no further recourse to Lehman because, by assigning contracts to third parties, Lehman will effectively receive, by normal operation of the Bankruptcy Code, a novation."
The bankruptcy court process also allows for parties to terminate or "rip up" CDS contracts, something that has also been fully enabled by the DTCC. The bankruptcy can dispose and the DTCC will confirm. BTW, while you folks in the Big Media churned out hundreds of thousands of words last week waxing euphoric about the prospect for enhanced back office clearing of CDS contracts, the real issue is the festering credit situation in the front office. Truth is that the DTCC and the other dealers, working at the behest of Mr. Geithner, Gerry Corrigan and many others, have largely fixed the operational issues dogging the CDS markets. The danger of CDS is not a systemic blowup - though that will come soon enough. It is the normal operation of the now electronically enabled CDS market wherein lies the threat to the entire global financial system, this via the huge drain in liquidity illustrated above as CDS contracts are triggered by default events.
The only way to deal with this ridiculous Ponzi scheme is bankruptcy. The way to start that healing process, in our view, is by the Fed emulating the FDIC's treatment of DSL, withdrawing financial support for AIG and pushing the company into the arms of the bankruptcy court. The eager buyers for the AIG insurance units, cleansed of liability via a receivership, will stretch around the block. By embracing Geithner, President-elect Barack Obama is endorsing the ill-advised scheme to support AIG directed by Hank Paulson et al at Goldman Sachs and executed by Tim Geithner and Ben Bernanke. News reports have already documented the ties between GS and AIG, and the backroom machinations by Paulson to get the deal done. This scheme to stay AIG's resolution cannot possibly work and when it does collapse, Barak Obama and his administration will wear the blame due through their endorsement of Tim Geithner.
The bailout of AIG represents the last desperate rearguard action by the CDS dealers and the happy squirrels at ISDA, the keepers of the flame of Wall Street financial engineering. Hopefully somebody will pull President-elect Obama aside and give him the facts on this mess before reality bites us all in the collective arse with, say, a bankruptcy filing by GM. You see, there are trillions of dollars in outstanding CDS contracts for the Big Three automakers, their suppliers and financing vehicles. A filing by GM is not only going to put the real economy into cardiac arrest but will also start a chain reaction meltdown in the CDS markets as other automakers, vendors and finance units like GMAC are also sucked into the quicksand of bankruptcy. You knew when the vendor insurers pulled back from GM a few weeks ago that the jig was up.
And many of these CDS contracts were written two, three and four years ago, at annual spreads and upfront fees far smaller than the 90 plus percent payouts that will likely be required upon a GM default. That's the dirty little secret we peripherally discussed in our interview last week with Bill Janeway, namely that most of these CDS contracts were never priced correctly to reflect the true probability of default. In a true insurance market with capital and reserve requirements, the spreads on CDS would be multiples of those demanded today for such highly correlated risks. Or to put it in fair value accounting terms, pricing CDS vs. the current yield on the underlying basis is a fool's game. Truth is not beauty, price is not value.
If you assume a recovery value of say 20% against all of the CDS tied to the auto industry, directly and indirectly, that is a really big number. The spreads on GM today suggest recovery rates in single digits, making the potential cash payout on the CDS even larger. As Bloomberg News reported in August: "A default by one of the automakers would trigger writedowns and losses in the $1.2 trillion market for collateralized debt obligations that pool derivatives linked to corporate debt… Credit-default swaps on GM and Ford were included in more than 80 percent of CDOs created before they lost their investment-grade debt rankings in 2005, according to data compiled by Standard & Poor's." At some point, Washington is going to be forced to accept that bankruptcy and liquidation, the harsh medicine used with other financial insolvencies, are the best ways to deal with the last, greatest bubble, namely the CDS market. When the end comes, it will effect some of the largest financial institutions in the world, chief among them Citigroup, JPMorganChase, GS and MS, as well as some large Euroland banks.
The impending blowback from a CDS unwind at less than face amount is one of the reasons that the financial markets have been pummeling the equity values of the larger banks last week. Any bank with a large derivatives trading book is likely to be mortally wounded as the CDS markets finally collapse. We don't see problems with interest rate or currency contracts, by the way, only the great CDS Ponzi scheme is at issue - hopefully, if authorities around the world act with purpose on rendering extinct CDS contracts as they exist today. Call it a Christmas present to the entire world. Indeed, as this issue of The IRA goes to press, news reports indicate that C is in talks with the Treasury for further financial support under the TARP, including a "bad bank" option to offload assets. A bad bank approach may be a good model for applying the principle of receivership to the too-big-too fail mega institutions, but the cost is government control of these banks.
Q: Does a "bad bank" bailout for C by Treasury and FDIC qualify as a default under the ISDA protocols!? We've been predicting that Treasury will eventually be in charge of C. On the day the government formally takes control, we say that Treasury should call Sheila Bair and hire FDIC to start selling branches and assets. Thus does the liquidation continue and we get closer to the bottom of the great unwind. Stay tuned.
Who Should Be the Next President of the Fed of New York?
Treasury Secretary: "Sir, you try my patience!"
Rufus T. Firefly: "Don't mind if I do. You must try mine sometime."
Groucho Marx, Duck Soup (1933)
First, in the category of being constructive we have a couple of names for candidates for Treasury and/or the Federal Reserve Bank of New York: For Treasury, if not now perhaps next in line, we hear the name of Roger Ferguson, former Federal Reserve Board Vice Chairman and now President and Chief Executive Officer of TIAA and CREF. One of the smartest people on the planet, Ferguson has the professional and intellectual credentials to command respect from everybody in the room - including Larry Summers, who he knows very well through his seat on the Harvard Board of Overseers.
For the FRBNY, we urge the Board of the Federal Reserve Bank of New York to select from people either now serving, such as Terrence J. Checki, Executive Vice President and Head of the Federal Reserve Bank of New York's emerging markets and international affairs group and William Rutledge, likewise head of the bank's Bank Supervision function. Or consider an outsider who's a member of the Fed family and who could easily serve at the Fed of NY or as Treasury Secretary: Brian Roseboro, former Under Secretary of the Treasury for Domestic Finance and now at JPMorgan Chase focused on public policy. A former head currency trader at the FRBNY and later worked in the private options industry in Chicago, Roseboro has the technical knowledge and market experience to understand the complex financial issues facing the US economy.
Tested professionals like those we highlight above are not alone within the Fed system. Christine Cumming, the Fed of NY's First VP and de facto CEO, is another good candidate. Point is, the Board of the Fed of New York, which is dominated by Wall Street insiders, should look at them all and first, before going outside in the search for candidates. Remember, their predecessors like Paul Volcker and Gerry Corrigan were inside hires. It's high time for the Fed to select from among its own ranks to broaden the pool of experience within the Fed's Board of Governors and also within the Federal Open Market Committee. The Board of the NY Fed can do this by moving away from political patronage appointments and selecting from people with actual operational and financial skills that meet the needs of the public, as required by law. And no more academic economists please!
We also want to take note of the fine job being done by the DTCC in the world of credit default swaps or CDS, both in terms of providing actual back office services and providing information about same. The information on the DTCC web site on OTC Derivatives is worth perusal, especially the information regarding "Misconceptions About CDS." So for example, the outstanding CDS net of the dealer positions is now reckoned to be only $34 trillion instead of $50 trillion something. And DTCC says that, were they to go bankrupt, Chrysler would result in about $2.3 billion in net CDS payouts; Ford Motor, about $2.9 billion; and General Motors, about $3.4 million. No problem, right? Our friends at Financial Week quote CreditSights as saying that: "We believe that, despite all the worries to the contrary, the CDS market is capable of withstanding auto-related defaults, assuming that counterparty risk is disseminated in similar fashion as in the past."
Those last few words encapsulate our continuing worry, namely that the particular flow of payments and not the net amounts reported by DTCC are where the risk is and further disclosure need occur. Those sounds of rending metal and splintering wood are the damage being done to the balance sheets of funds and financial institutions around the world as default rates rise and CDS payments are required. Note the news reports about rising corporate default rates and the OCC data on re-defaults of modified mortgages. Yes, thank you, it is good to know that the "net" notional CDS is only $34 trillion. But we still have the same basic concerns about the cost of performing on these contracts in a high default rate environment. Over the next 12-18 months, we certainly will find out if CDS works as advertised and at what cost!
Speaking of costs, we'd like to see CDS fail data from DTCC and also concentration data, both for single names and other contract types. Then we'll start "getting happy." But great sloppy kudos to DTCC for shining a light and hopefully ever more public disclosure on CDS will come. It took a crisis and the dedication of the DTCC and a lot of other people to get this done, but at least it is getting done. Finally, on Friday we issued a challenge to Treasury Secretary designate Tim Geithner to debate on us on the bailout and what model of political economy should apply going forward. We think that the bailout of Bear and AIG were horrible errors and that these two names should be in bankruptcy along with Lehman Brothers. The idiocy of the Fed and Treasury rescuing Bear, but then letting Lehman go bankrupt and finally propping up AIG is monumental. At the time we felt bad for Bear, but now that $10 per share seems like quite a gift. We think these and other issues deserve discussion.
And then there is the other brand of wishful thinking coming from Washington, namely loan modification as a means to prevent home foreclosure. Some of you will recall the conversations we had with Josh Rosner over the past couple years and his focus on the poor results of loan modification in terms of re-default rates as well as the social good aspects of these policies. According to the OCC, more than a third of borrowers that received modified loans during the first quarter fell back into default within three months, 53 percent redefaulted within six months and 58 percent within eight months. The results were worse for loans modified in the second quarter. Within three and six months, Dugan said 39 percent and 58 percent of those loans were delinquent.
The high rate of redefault on modified loans surprised federal bank regulators, and "not in a good way,'' U.S. Comptroller of the Currency John C. Dugan said during a panel discussion. Maybe if Mr. Dugan spent more time reading the ample research produced in the regulatory community on this subject and less time traveling around the globe on government-paid PR trips, he would not be so surprised by the tendency of modified loans to redefault. For the record, most people we know in the regulatory community are not surprised by these results. As the interview with Eric Hovde that we will be featuring in a future issue of The IRA makes clear, the only way out of the current mess is to resolve insolvent banks and rebuild the banking system by putting new capital behind solvent institutions, which means no more capital infusions for the top three banks. This is what we call the Prime Solution. We'll be supporting same in the coming months by publishing a classical version of our Bank Stress Index, in a 1-5 quintile format, in 2009. Stay tuned.
Risk management guru throws down the gauntlet to Geithner
Timothy Geithner, President-elect Barack Obama’s choice for Treasury Secretary, has been called out. In a widely dispersed e-mail, Christopher Whalen, former investment banker and co-founder and managing director of consultancy Institutional Risk Analytics, challenged Mr. Geithner to a two-hour public debate. The subject? “On the Bailout To Date and the Model of Political Economy that Should Apply Going Forward.”
In his e-mail, Mr. Whalen said that the debate was not intended to be a waltz. “When our Founding Fathers spoke of the ‘checks’ in checks and balances,” Mr. Whalen wrote, “I believe they had something in mind like NHL hockey—maybe even the Moscow league. When you step on the ice of public policy leadership, you have to take the shots. I am giving you a chance to take a shot at me in front of a live, nationally televised audience.”
Mr. Whalen claimed CNN had agreed to televise the debate—assuming Mr. Geithner, who is currently president of the Federal Reserve Bank of New York, decides to pick up the gauntlet. A spokesman for the Federal Reserve Bank of New York had no comment.
In an interview with Financial Week, Mr. Whalen said he does not think Mr. Geithner is the right person for the job of Treasury Secretary. He cited Mr. Geithner’s supposed missteps so far in the financial crisis, and his close ties to current Treasury Secretary Henry Paulson. “He has a lot to account for,” Mr. Whalen said, including an explanation of why Bear Stearns was saved and Lehman Brothers was allowed to fail, as well as how certain banks like Citigroup are being propped up.
“The people in the financial community are just thirsting for someone to explain what’s going on, and why certain things were done,” Mr. Whalen added. “He’s going to have to do this in front of the Congress anyway. I want to be fair to Tim Geithner. If he wants to make a case for himself, I hope he takes my invitation.” Indeed, more citizens should follow suit and challenge public leaders, Mr. Whalen added. “As a nation, our public debate has become stifled, and people need to speak up. We can’t give these people a free ride.”
Text of Christopher Whalen’s letter to Timothy Geithner:
Dear Mr. Geithner:
With this note, I hereby challenge you to a two hour public debate “On the Bailout To Date and the Model of Political Economy that Should Apply Going Forward.” I propose that the debate be held in New York as soon as possible. I have asked my colleagues at Professional Risk Managers International Association to facilitate the event and to act as organizer to ensure a free and fair exchange. The have agreed to do so. I copy Steve Lindo, Executive Director of PRMIA, and James Tunkey, Regional Director of the NY Chapter, on this note.
I have also asked CNN to televise the event and to provide a facility for PRMIA members and members of the public to attend. They have agreed to do so. I copy Caleb Silver, Executive Producer of CNN Money on this note. I propose our colleague Josh Rosner of Graham Fisher & Co. as moderator. Josh knows the subject matter of the bailout as well as any, he is an independent researcher, and is also known for his fairness and intellectual rigor. Obviously you would have to agree or we could discuss other candidates. I copy Josh on this note.
Let me say that while I have been critical of you in the past, this is not personal. I have the greatest respect for all of my former colleagues in the Federal Reserve System and the other bank regulatory agencies. My colleagues at IRA and I honor their service, including yours. But when our Founding Fathers spoke of the “checks” in checks and balances, I believe they had something in mind like NHL hockey—maybe even the Moscow league. When you step on the ice of public policy leadership, you have to take the shots. I am giving you a chance to take a shot at me in front of a live, nationally televised audience.
My colleagues at PRMI will ensure that this event is civil and informative, Indeed, this is a great opportunity for you to talk directly to the financial community and make the case of why you should be the next Treasury Secretary of the United States. If you have the courage to accept this invitation, then I might think about believing you got what it takes for the job. In any event, I wish you good luck in the future. Bcc: everyone I know in the regulatory community and the media for the record.
Yours, Christopher Whalen, Managing Director
Bernanke ‘War Powers’ Undermine Fed Bank Presidents
The Federal Reserve’s interest-rate target is getting close to zero, and so is the power of the Fed’s regional bank presidents. The district chiefs’ authority over borrowing costs has been marginalized in the past two months as Chairman Ben S. Bernanke and the Fed Board of Governors in Washington made their own decisions on emergency measures to flood the economy with cash.
“The Board has usurped authority,” said William Poole, former president of the St. Louis Fed and now a senior fellow at the Cato Institute in Washington. “This dramatic change in policy direction has not been announced or even acknowledged.” Bernanke must now try to bring the Federal Open Market Committee, which includes district presidents and Fed governors, along as he turns to more radical strategies, such as buying Treasuries to drive down long-term rates. A lack of consensus at next week’s FOMC meeting could result in muddled communication that confuses investors and undermines confidence.
“Whatever our communications problems are now, they are going to be magnified in this new world we are going to be in,” James Bullard, Poole’s successor at the St. Louis Fed, said in an interview. “We have a bunch of analysis in the works right now. Frankly, I am mulling it over myself.” Yields on 10-year Treasuries this month slid to the lowest level since at least 1962, in anticipation of Fed purchases and weaker growth. The notes yielded 2.73 percent at 10:32 a.m. in New York, compared with an average of 4.70 percent in the past decade.
A conference call last month showed how little say the central bank’s 12 regional presidents now have in some of the Fed’s biggest decisions. The regional bank chiefs were invited to listen as officials in Washington outlined their decision on a new $600 billion program to help the housing market. The presidents weren’t asked to vote on the initiative, even though it aimed at cutting borrowing costs, something they vote on in regular FOMC meetings.
“If I am a regional Fed bank president, I have had my power diminished a lot,” said Ethan Harris, co-head of U.S. economic research at Barclays Capital Inc. in New York, who used to work at the New York Fed. “I think of it as war powers for the Board of Governors.” Many of the new facilities have been studied and recommended by the New York Fed, whose president, Timothy Geithner, is the vice chairman of the FOMC. Geithner, President-elect Barack Obama’s nominee to be Treasury secretary, is leaving the FOMC and will be replaced at the Dec. 15-16 meeting by Christine Cumming, the New York Fed’s first vice president.
Regional bank presidents don’t have a vote when the Board uses emergency powers to lend to firms other than banks in “unusual and exigent circumstances,” as it’s done repeatedly this year. The district-bank chiefs by design are supposed to offer a counterbalance to the Board, and in the past haven’t been shy about challenging chairmen. In February 1994, former chairman Alan Greenspan had to argue against four presidents who wanted to raise rates at least a half percentage point, compared with his own preference for a quarter-point move.
Greenspan worried about the effect on markets of an abrupt move, transcripts of FOMC discussions showed. He said he “also would be concerned if this committee were not in concert. If we are perceived to be split on an issue as significant as this, I think we’re risking some very serious problems in this organization.” The Fed has deployed two main strategies during the current credit crisis. The FOMC, which currently includes five governors and five presidents, has lowered its benchmark federal funds rate target by 4.25 percentage points since September 2007.
Acting separately, the Board of Governors has provided emergency funding to gridlocked markets and troubled institutions such as American International Group Inc. that were on the brink of failure. Those actions have made the key rate less relevant as a tool of policy, because they’ve driven down the overnight lending rate between banks below the target set by the FOMC. While the target is 1 percent, the effective federal funds rate averaged 0.33 percentage point in the past week.
“The federal funds rate is trading persistently below target,” said Poole, who is a contributor to Bloomberg News. “That can’t be an accident.” With its new $600 billion program, the Fed has stepped out of its traditional role of backstop liquidity provider, making a direct effort to manipulate long-term mortgage rates. Some presidents are wary of any strategy that appears to subsidize debtors by pushing rates below yields set by the market.
“Central bank lending policies should avoid straying into the realm of allocating credit across firms or sectors of the economy,” Philadelphia Fed President Charles Plosser said Dec. 2. Richmond Fed President Jeffrey Lacker warned last week that officials should avoid any plan that would have the central bank pay for a fiscal stimulus. Obama has put an economic recovery program at the top of his agenda when he takes office Jan. 20. Lawmakers in Congress have suggested that the size of such a program may be between $500 billion and $700 billion.
“I personally do not believe the Fed should tie asset purchases to any specific fiscal programs, whatever their merits,” Lacker said after a speech in Charlotte, North Carolina, Dec. 3. At the same time, he said he was open to purchasing U.S. government debt for the purpose of fighting the danger of deflation. At next week’s meeting, Board officials will likely propose ways to lower longer-term interest rates so mortgage and corporate borrowers can borrow more cheaply. Bernanke said in a Dec. 1 speech the Fed could purchase Treasury or agency securities in “substantial quantities.” District presidents may simply be asked to support and expand on what the Board has already done.
“The Board’s importance has grown at the expense of the FOMC,” said Dino Kos, former markets director at the New York Fed and now managing director of research firm Portales Partners LLC. “The FOMC meeting itself is going to become a very uncomfortable place if people don’t know what they are there for. Institutional issues are at stake.”
Getting Out of the Credit Mess
The federal government has announced a series of actions in the past few weeks ostensibly designed to make consumer credit more available and invigorate the economy. Obviously, the country is in recession and the recession is likely to get deeper. But will these actions reduce the depth and duration of the recession? Or, in the long run, will they make matters even worse?
Last month the Federal Reserve and the Treasury announced that the government would buy $500 billion in mortgages guaranteed by Fannie Mae and Freddie Mac. They also announced they would lend $200 billion against securities backed by car loans, student loans, credit-card debt, and small business loans. The purpose of both moves is to create lending capacity across key elements of the consumer sector.
Most recently, the government announced that it would subsidize new home mortgages by one percentage point, effectively lowering monthly payments on a 30-year loan by about 10%. The stated reason was to help the housing market, which is crucial to an economic recovery. With each announcement, the Fed and Treasury were careful to point out they might take additional action in support of these sectors and others as well. And it is a virtual certainty the government will cobble together some program to reduce foreclosures to keep people in their homes. I'm sure that, as other industries or sectors come under pressure, there will be new programs to help. The automobile industry will not be the last to come to Washington.
To begin to understand today's problem, we have to have a sense of how we got there. Between 1994 and second quarter 2008, the U.S, housing stock more than doubled in value from $7.6 trillion to $19.4 trillion. Almost three quarters of that increase was due to a speculative bubble, the root cause of which was government policies designed to increase home ownership, largely among people who would be considered nonprime borrowers -- i.e., people without sufficient documented income or employment history and little or no savings or credit history.
The intellectual start of this mess was in a flawed Boston Federal Reserve study published in 1992 that purported to show that minorities were treated less well than whites. That study led to increased political pressure on banks to modify their standards with increased emphasis through the Community Reinvestment Act, and aided by U.S. Department of Housing and Urban Development regulations in the Clinton administration that required parity of outcomes in the lending process.
The effect of all of this meddling was compounded by the lax or incompetent supervision of Fannie Mae and Freddie Mac. All in all, the government got into the business of encouraging and then forcing lending institutions to make mortgage loans to people who could not pay them back. What we ended up with is a failure of government, which we have erroneously termed a failure of capitalism. The standards applied to these subprime loans began to be applied to what heretofore had been prime borrowers who also increasingly became overextended. But, as housing prices increased, owners cashed out their equity and bought cars, appliances and other items, including using the freed-up equity to pay for everyday living purchases. Over the past decade alone, U.S. households have taken on some $8 trillion in debt, bringing the nation's current consumer debt load to $14 trillion.
This cynical and unsustainable cycle was abetted by mortgage originators who had little interest in making sure loans were good quality, investment banks that securitized and packaged these loans, rating agencies who forgot fundamental laws of gravity, and purchasers who bought securities they could not possibly understand. This was fueled by borrowers who committed fraud and bought houses, or speculated in them, when there was no realistic chance they could afford them. All of this led to a huge overleveraging in the consumer market. The increase in debt burden fueled much of the nation's economic growth over recent decades, aided somewhat by increases in productivity and underpinned by easy money from the Federal Reserve. Since consumers represent about 70% of the nation's GNP, and since leverage cannot increase forever, we were bound to see the bubble burst and eventually enter a substantial recession.
So, are the current credit easing actions likely to be helpful or not? In my judgment, measures to create liquidity are likely to be helpful. Financial institutions that lend money to credit-worthy people for reasonable purposes have experienced a substantial reduction in available funding from which they can make loans. Hence the programs to support the securitization markets are sensible because money used for this purpose will be lent and used for purchases. Programs that deliver a short-term reduction in mortgage rates will, at the margin, help absorb some of the available housing stock, reducing the time it will take for housing to reach market-clearing levels.
However, measures intended to reduce foreclosures, per se, are likely to be ineffective at best and morally flawed at worst. When analysts say that people are being foreclosed because house values have declined they are missing the point. A large number of foreclosures are taking place because people can no longer refinance and take value out. They could not afford the houses to begin with and greed or stupidity -- not a falling real-estate market -- have caused their problems. On the other hand, measures to subsidize homeowners facing foreclosures because they have lost their jobs can be helpful.
In the longer term, our nation must delever -- either by reducing the amounts of borrowing or by increasing consumer earning power through economic growth. Relying on growth alone implies a growth rate higher than we have ever experienced in our nation's history. Nonetheless, our public policy must encourage economic growth by lowering tax rates for corporations and individuals while at the same time avoiding what would be growth killers, including "card check" legislation and trade restrictions. Public policy should support higher savings rates, and avoid encouraging increased consumer spending funded by further debt, which may be helpful in the short term but catastrophic in the longer term.
It is not only consumers that must delever. Governments must as well. State and local governments across the nation have incurred direct and indirect debt or obligations in the tens of trillions of dollars -- obligations that cannot be met under any set of reasonable circumstances without an explosion in growth and tax revenues. In fact, we continue to incur debt for politically palatable ideas, like rebate checks, which have very little stimulative power but increase the depth of the hole we're in. To solve this problem for ourselves and future generations, we must get back to our historic reliance on personal responsibility and market forces, and get government out of economic management. It doesn't do a good job, as the current economic mess amply proves.
Mr. Golub is a former chairman and CEO of American Express.
BIS warns of collapse in global lending
The City of London has suffered a dramatic collapse in its core business as global lending falls at the steepest rate since records began, according to new figures from the Bank for International Settlements (BIS). Cross-border loans worldwide fell by $1.1 trillion (£740bn) in the first half of the year, reflecting the scramble by the financial industry to cut leverage by pulling credit lines and slashing risky exposure. Foreign lending by UK banks fell by a staggering $884bn, equal to 81pc of the entire contraction in international lending. The City is facing a double blow since worldwide issuance of bonds and securities has also gone into freefall, plummeting 77pc from over a trillion dollars to $247bn in the third quarter.
The City has been the epicentre of Europe's structured credit industry. The collapse in bond issuance reflects the near-total closure of the capital markets in the late summer as credit spreads surged. Bonds issued in euros dropped by 94pc from $466bn to $28bn over the quarter. The UK banking sector includes branches of US, European, Asian and Mid-East institutions. These banks tend to use London as a base for their global credit and investment operations. Though foreign, they make up a crucial part of the City nexus and are a mainstay for accounting firms, lawyers and the panoply of financial services that enrich the City.
In its quarterly report, the BIS warned the US Federal Reserve, the Bank of England and other central banks that near-zero interest rates and emergency monetary stimulus may come at a cost. By opening the cash spigot, the authorities risk displacing the money markets and may "discourage banks from lending to other banks". The money markets are a crucial lubricant for the financial system, but they cannot function if rates fall too low. The sector can wither away, as Japan discovered during its "Lost Decade".
The BIS also hinted that the European Central Bank and Sweden's Riksbank may have blundered by raising rates this year to contain the oil shock. It said short-term energy spikes have no lasting effect on inflation or wage deals. "Evidence suggests an absence of strong second-round effects on inflation. The temporary inflationary impulse will soon drop out," it said.
Illinois Threat to Bank of America Is Dangerous, Critics Say
Illinois Governor Rod Blagojevich’s threat to halt the state’s dealings with Bank of America Corp. over a shut-down factory in Chicago extends a “dangerous” trend of politicians meddling with commerce, a former general counsel of the Federal Deposit Insurance Corp. said.
Blagojevich, a Democrat, yesterday said the biggest U.S. retail bank won’t get any more state business unless it restores credit to Republic Windows & Doors, whose workers are staging a sit-in. John Douglas, an attorney with Paul Hastings Janofsky & Walker in Atlanta, said Blagojevich and Senator Christopher Dodd -- who called on General Motors Corp. to fire Chief Executive Rick Wagoner -- can’t tell companies how to run their business.
“This is a very dangerous thing,” said Douglas, who was at the FDIC from 1987 to 1989 and has since represented financial institutions including Bank of America. “There becomes an expectation that these government officials have some say over what the institution does,” he said in an interview. The Illinois governor met Republic Windows & Doors employees who remained at the factory since Dec. 5, after Bank of America canceled a credit line. The members of the United Electrical, Radio and Machine Workers Union have won support from politicians including President-elect Barack Obama, who said the 250 workers are justified in demanding benefits and pay.
“They’re absolutely right,” Obama, who gave up his U.S. Senate seat from Illinois last month, said over the weekend. “These workers, if they have earned these benefits and their pay, then these companies need to follow through on those commitments.” Bank of America isn’t empowered to tell a company how to manage its business, spokeswoman Julie Westermann said yesterday. Republic is unable to operate profitably in the current economy, she said.
“Bank of America has worked with the company and shared our concerns about the company’s situation and its operations for the past several months,” she said. “It is unfortunate that the company has been unable to reverse its declining circumstances.” Robert Topel, a labor and economics professor at the University of Chicago, said it’s “just silly” that a governor or member of Congress would seek to “micro-manage” a business.
“What does Chris Dodd know about running an auto company?” Topel asked. “Is Bank of America supposed to pick and choose which line of credit they want to keep open based on political pressure? It’s not Bank of America’s obligation to make sure the employer has funds to pay its employees.” Dodd, the Senate Banking Committee chairman, made his comment Sunday on CBS’s “Face the Nation.” Dodd, a Connecticut Democrat, said Wagoner should be replaced if GM is to receive federal aid. U.S. lawmakers may vote this week on a $15 billion rescue of U.S. automakers.
Cook County Commissioner Mike Quigley said he’ll introduce an ordinance to block the state’s biggest county from doing business with Bank of America. “I’m usually cautious, but this is an extraordinary example at an extraordinary time,” Quigley said in an interview. Commercial banks have restricted lending as ripples from the financial crisis that began on Wall Street widen into the broader economy. More than half a million U.S. jobs were lost in November and economists have drawn a direct link between the deepening recession and the seizure in credit markets which has so far resulted in $981 billion in writedowns and losses globally.
Republic told the bank on Oct. 16 it planned to cease manufacturing in January after losing $5.7 million during the first nine months of this year and a total of $12.7 million in 2007 and 2006, according to a press release. The company faced “the impossible position of not having the ability to further reduce fixed costs, coupled with severe constrictions in the capital debt markets and an unwillingness of the current debt holder to continue funding the operations,” Republic said in the release.
Workers and supporters, warmed by a fire roaring in a trash bin, kept a vigil last night at the plant on Chicago’s north side. Signs mocked Bank of America, with one reading: “You got bailed out. We got sold out.” Bank of America has received $15 billion from the U.S. Treasury as part of its effort to boost capital, while Merrill Lynch & Co. is receiving $10 billion. Bank of America is buying Merrill, the world’s largest securities brokerage. The taxpayer funds were intended to help Republic Windows and other companies preserve jobs, Blagojevich said at a news conference.
Ricardo Caceres, 39, and father of two, was among the Republic workers outside the factory last night. About 100 volunteers, bundled against the cold, distributed bags of food for the employee sit-in inside the plant. Caceres worked at Republic for 15 years assembling windows. He said workers were brought to the cafeteria at lunchtime last week, and told they would soon be out of work. “Everyone was in shock,” when the plant closing was announced, said Caceres, who lives in Chicago. The employees are heartened by the outpouring of support from politicians and people in the community, Caceres said. “I never imagined this.”
Post-Lehman company defaults to soar
Default rates for speculative grade companies are forecast to jump threefold next year following the fall of Lehman Brothers, the world’s biggest bankruptcy, according to Moody’s, the US ratings agency. The implosion of Lehman on September 15 is widely regarded as a significant milestone, turning the credit crunch into a fully blown economic crisis. Jim Reid, credit strategist at Deutsche Bank, said: “We are at a turning point for default rates, with much bigger monthly rises from now on. “Two or three months after Lehman’s collapse, we are starting to see the impact on the real economy, particularly for those companies on short-term funding.”
European companies defaulting on their bonds are also set to outpace those in the US, although analysts suggest this is because the European junk-grade market is smaller, meaning any rise in defaults has a greater impact in percentage terms, rather than pointing to a deeper recession. Global default rates are forecast to rise to 10.4 per cent by November 2009 – from 3.1 per cent last month – to levels last seen in 2001 following the dotcom crash. Rates are forecast to jump to 4.2 per cent by the end of this year. A year ago, the global rate was 0.9 per cent. In Europe, default rates are predicted to rise to 12.5 per cent a year from now, compared with 10.7 per cent in the US. Rates in Europe are currently 1.3 per cent, compared with 3.4 per cent in the US.
Moody’s predicts the durable consumer goods sector is likely to see the highest default rate in Europe over the next year, while in the US the most troubled sector is expected to be consumer transportation. The ratings agency’s distressed index, which measures the number of companies with bonds trading at more than 1,000 basis points over government paper, rose to 51.8 per cent at the end of last month, up from 48.5 per cent at the end of October, and the highest level since Moody’s launched the index in 1996. This reflects the deepening problems for company funding. Even some investment grade companies are now trading at distressed levels.
The year-to-date global total of defaulted companies has risen to 80, compared with only 17 in the same period last year. In another sign of growing credit problems for riskier companies, Standard & Poor’s put almost 200 notes issued by collateralised loan obligations on review for downgrade last week “due to rapid deterioration in the credit quality of the corporate loans [backing the deals] in recent weeks”. The deals facing rating cuts are valued at almost $4bn and represent about 5.5 per cent of deals rated by S&P.
Tough Terms for Detroit Bailout
In extending help to Detroit, Congress has the whip hand and will be using it. Congress, having worked through the weekend, delivered a bill on Monday, Dec. 8, to the White House that is designed to bail out the ailing U.S. auto industry with $15 billion in loans. Despite lingering objections by the Bush Administration and Congressional Republicans, it looks as though the aid package will pass. Speaker of the House Nancy Pelosi (D-Calif.) agreed over the weekend to tap a $25 billion loan program from the Energy Dept. that was meant to help automakers and suppliers retool factories to build greener vehicles. The White House said it would not consider approving any other source of funds, such as the $700 billion Wall Street bailout fund, a measure favored by Democrats.
The primary sticking point for the White House and Republicans is that there is no clear-cut language in the bill requiring the automakers to restructure their enormous debt before they take on new debt to taxpayers. "Once bond holders see that the government is in this, they will have no incentive to write down the value of the debt they hold," said Senator Bob Corker (R-Tenn.), a member of the Senate Banking Committee who has been influential during the negotiations despite his freshman status. "These companies cannot be restructured for success without a complete restructuring of their debt and labor and retiree obligations, and the debt is the biggest issue," said Corker, who added, "I wanted to see more teeth in the bill."
General Motors, for example, already has $42 billion in secured and unsecured debt, plus it owes the United Auto Workers $21 billion in future payments to a fund meant to pay health-care benefits for workers and retirees. Corker and other analysts have recommended bond holders take a writedown of as much as 20% on the face value of the debt, and accept a swap of stock for another 50% of the bonds' value. They are also encouraging the union to take equity for half the future health-care payments. Such moves would make the union, the bond holders, and the government the largest owners of GM. To that end, the UAW is, according to congressional aides, looking for a seat on GM's board as part of the government-supervised overhaul and oversight of the companies. Representative Barney Frank (D-Mass.), chairman of the House Financial Services Committee, said Monday there is some negotiating to do on final language, but that he is confident that the framework for a vote this week is in place.
General Motors shares rose by 21%, while Ford Motor shares climbed 24% on the news. Chrysler is private and majority-owned by private equity firm Cerberus Capital Management.
Ford's balance sheet is in better shape, though. It has said it will not be seeking a short-term bridge loan. Pelosi said Monday that she feels the bill will be successful in bringing stakeholders to the table to make sacrifices, though there are few specifics spelled out in the draft bill. "I call this the barber shop," said Pelosi. "Everyone is going to get a haircut—management, bond holders, labor, dealers." The term "haircut" describes when stakeholders agree to take less than what they are owed to avoid a Chapter 11 bankruptcy in which they might end up with nothing.
The bill, expected to be voted on by Wednesday, Dec. 10—if the White House and Republicans, whose votes are needed, can hammer out a compromise on the language—puts many limits on how the automakers can operate as long as they remain indebted to the taxpayer.
• No stock dividends, no executive bonuses paid to the top 25 executives, no golden parachutes, no owned/leased corporate aircraft.
• All transactions exceeding $25 million would be authorized by a "car czar" to be designated by the White House.
• The car czar, which some are calling the "Financial Viability Advisor (FVA)," would establish guidelines and measurements of success for each company by Jan. 1, and then report to Congress by Feb. 15 as to their progress.
• Speaker Pelosi said the companies' financial viability would be determined by the FVA, Congress, and the Government Accountability Office (GAO) by Mar. 31. By that time, all the money needed will have been allocated by legislation, the Treasury Dept., or a combination of the two.
• The companies would have to drop all lawsuits and opposition to meeting Federal and state regulations on fuel economy and greenhouse gas emissions. If this provision makes it through the White House, it paves the way for California's emissions rules, tougher than those proposed at the federal level, to be the de facto national standard.
• The Treasury would get stock warrants in the companies equal to 20% of the total aid package to each automaker.
• Automakers would pay 5% interest on the loans for the first five years. The FVA can set longer terms on the loans, but it would cost the companies 9% after five years.
• Open books at the automakers would be reviewed by the FVA and GAO.
• The companies must explore with the FVA the viability of using closed auto factories to build transit buses and rail cars in demand from many cities and municipalities.
The selection of the car czar, or FVA, will be of keen interest to both political parties and the companies. One name floated by congressional and White House staffers is Ken Feinberg, a lawyer who oversaw the federal September 11 victims' compensation fund. Other names to surface include that of former Massachusetts Governor Mitt Romney, a former business owner and financier who has experience in corporate restructuring, a familiarity with the auto industry, and a facility for dealing with government bureaucracy. GM officials said they support the idea of a car czar and have been prepared to have its operations scrutinized and micromanaged to the point where every transaction of at least $25 million is subject to oversight. "We are very prepared to work with an oversight board," said GM Executive Vice- President Troy Clarke. Of course, the automakers don't really have much choice. GM and Chrysler have both said they will run out of cash by the end of the year.
Washington Takes Risks With Its Auto Bailout Plans
When President-elect Barack Obama talked on Sunday about realigning the American automobile industry he was quick to offer a caution, lest he sound more like the incoming leader of France, or perhaps Japan. "We don't want government to run companies," Mr. Obama told Tom Brokaw on "Meet the Press." "Generally, government historically hasn't done that very well."
But what Mr. Obama went on to describe was a long-term bailout that would be conditioned on federal oversight. It could mean that the government would mandate, or at least heavily influence, what kind of cars companies make, what mileage and environmental standards they must meet and what large investments they are permitted to make — to recreate an industry that Mr. Obama said "actually works, that actually functions."
It all sounds perilously close to a word that no one in Mr. Obama's camp wants to be caught uttering: nationalization. Not since Harry Truman seized America's steel mills in 1952 rather than allow a strike to imperil the conduct of the Korean War has Washington toyed with nationalization, or its functional equivalent, on this kind of scale. Mr. Obama may be thinking what Mr. Truman told his staff: "The president has the power to keep the country from going to hell." (The Supreme Court thought differently and forced Mr. Truman to relinquish control.)
The fact that there is so little protest in the air now — certainly less than Mr. Truman heard — reflects the desperation of the moment. But it is a strategy fraught with risks. The first, of course, is the one the president-elect himself highlighted. Government's record as a corporate manager is miserable, which is why the world has been on a three-decade-long privatization kick, turning national railroads, national airlines and national defense industries into private companies.
The second risk is that if the effort fails, and the American car companies collapse or are auctioned off in pieces to foreign competitors, taxpayers may lose the billions about to be spent. And the third risk — one barely discussed so far — is that in trying to save the nation's carmakers, the United States is violating at least the spirit of what it has preached around the world for two decades. The United States has demanded that nations treat American companies on their soil the same way they treat their home-grown industries, a concept called "national treatment."
Yet so far, there is no talk of offering aid to Toyota, Honda, BMW or the other foreign automakers that have built factories on American soil, employed American workers and managed to make a profit doing so. "If Japan was doing this, we'd be threatening billions of dollars in retaliation," said Jeffrey Garten, a professor at the Yale School of Management, who as under secretary of commerce in the 1990s was one of many government officials who tried in vain to get Detroit prepared for a world of international competition. "In fact, when they did something a lot more subtle, we threatened exactly that," referring to calls for import restrictions.
Mr. Garten said he was stunned by the scope of the intervention that Washington was now considering. "I don't know that we've seen anything like this since the government told the automakers what kind of tanks to make during World War II," he said. "And that was just for the duration of the war — this could be for much, much longer." It is hard to measure just what kind of chances Mr. Obama may be taking with this plan, in part because so many parts of it are still in motion.
In the short term, Democrats are floating the idea of linking $15 billion in immediate loans to the designation of a "car czar" who, in doling out the money, could require or veto big transactions or investments — essentially a one-man board of directors. The White House indicates that President Bush, who has spent his entire presidency proclaiming that the government's role is to create an environment that spurs free enterprise and minimizes government regulation, would very likely sign the rescue plan.
The first $15 billion and the car czar who oversees it, however, are only the beginning. "After that, we're in uncharted water," said Malcolm S. Salter, a professor emeritus at Harvard Business School who has studied the auto industry for two decades and, until a few years ago, was an adviser to General Motors and Ford. "Think about this: Who in the federal government would have the tremendous insight needed to fix this industry?"
Depending on how the longer-term revamping of the industry proceeds, Washington could become a major shareholder in the Big Three, it could provide loans, or, in one course that Mr. Obama seemed to hint at on Sunday, it could organize what amounts to a "structured bankruptcy." In that case, the government would convene the creditors, the unions, the shareholders and the company's management, and apportion a share of the hit to each of them. If that "consensus building" sounds a lot like the role of the Japanese Ministry of International Trade and Industry in the 1970s and the 1980s, well, it is.
To promote the Japanese car industry on the way up, the trade ministry nudged companies toward consolidation, and even tried to mandate which parts of the market each could go into. (Soichiro Honda, the founder of the company, rebelled when bureaucrats told him he was supposed to limit himself to making motorcycles.) By the 1980s, Congress was denouncing this as "industrial policy," and arguing that it put American makers at a competitive disadvantage — and polluted free enterprise.
Now, it is Congress doing exactly that, but this time as emergency surgery. Other nations will doubtless complain, or begin doing the same for their own companies. "We're at this moment in history, in which the Chinese are touting that their system is better than ours" with their mix of capitalism and state control, said Mr. Garten, who has long experience in Asia. "And our response, it looks like, is to begin replicating what they've been doing."
Fed Opposes Auto Aid Without Congressional Action
Federal Reserve Chairman Ben S. Bernanke said the central bank opposes lending to U.S. automakers without congressional action to aid the companies, and suggested options including a bankruptcy reorganization.“The Federal Reserve would be extremely reluctant to extend credit where Congress has actively considered providing assistance but, after due consideration, has decided not to act,” Bernanke said in a Dec. 5 letter to Senate Banking Committee Chairman Christopher Dodd.
While the Fed has used emergency-lending authority over the past year to aid financial firms, short-term debt markets and mutual funds, those decisions were aimed at financial stability and the broader economy, Bernanke said. By contrast, Congress is “best suited” to determine whether to assist a specific U.S. industry, he said.
“Even if the companies have sufficient collateral, lending to an auto manufacturing company would represent a marked departure from that policy, and would take us into distinctly new realms of policymaking,” Bernanke said. “In particular, it would raise the question as to whether the Federal Reserve should be involved in industrial policy, which has traditionally been outside the range of our responsibilities.”
The letter, a copy of which was forwarded by the Senate banking panel, represents Bernanke’s first public comments on whether the Fed would extend credit to the beleaguered car industry.General Motors Corp., Ford Motor Co. and Chrysler LLC have asked U.S. lawmakers for as much as $34 billion in aid. Congress is discussing a $15 billion rescue proposal where the Treasury would get warrants for stock equivalent to 20 percent of any government loans.
The Fed chief said Congress should also consider a “range of possible policy actions” besides direct aid, including a government-assisted “orderly bankruptcy reorganization” or company mergers.
Chrysler turns up the heat on Canada
Chrysler Canada Inc. has warned Ottawa and Queen's Park that it could close its two assembly plants in Canada, eliminating more than 8,000 direct jobs, and shift the work to the United States if the two governments fail to provide $1.6-billion in emergency financial help. In a 14-page restructuring plan filed with officials last week, Chrysler compares the two assembly plants in Canada with facilities in the United States that could make the models now being produced here, according to people who have been briefed on the document. "In the context, it could be seen as a veiled threat," said one of the people. The document talks about the challenges of maintaining a "Canadian footprint" and notes the company has the "same type of plant, set up exactly the same" on both sides of the border, the source said.
Government and industry sources have been worried that the U.S. government would attach strings to its final aid package that, in the absence of Canadian assistance, would favour the companies' operations south of the border. As officials in the two governments digested the requests by Chrysler, Ford Motor Co. of Canada Ltd. and General Motors of Canada Ltd. for $6-billion in loans, loan guarantees and lines of credit, U.S. lawmakers reached a deal yesterday that would give their parent companies a $15-billion (U.S.) lifeline.
It is hoped these funds would keep the car makers alive until after the new administration of Barack Obama takes office in late January. The amount is about half of what the car companies are asking for, and the deal gives Washington the right to buy up to 20 per cent of the companies and would put the government ahead of other shareholders in getting its money back. Congress is expected to consider the legislation this week. The U.S. deal increases the pressure on the Canadian governments to come through with a rescue package for the companies' Canadian arms, which submitted proposals for assistance that could amount to as much as $7.2-billion (Canadian) if the auto slump deepens and GM Canada needs to draw down an additional backstop of $1.2-billion, which would be on top of a $2.4-billion initial request.
Chrysler spells out the grim prospects for its Canadian operations in its restructuring proposal. The company said it could switch minivan production out of Windsor, Ont., to a plant in St. Louis that is now idled, the sources said. Production of large sedans made in Brampton, Ont., could be transferred to a plant in Detroit. Closing the two Canadian plants would be a devastating blow to Ontario and especially to Windsor, which has already been battered by thousands of job losses at Ford and GM operations in the city.
It would also lead to the loss of tens of thousands of jobs at auto parts makers in the two cities and elsewhere in the province. Chrysler Canada president Reid Bigland said last week that 420 suppliers in Canada account for 50,000 jobs. "Everything depends on whether there are strings attached to the U.S money," according the person who had been briefed on Chrysler's proposal. In the initial round of assistance so far in Washington, the Canadian side is not seeing the U.S. government insist on conditions that would disadvantage assembly plants in Canada.
Democratic lawmakers in Washington said yesterday they have a draft $15-billion (U.S.) bailout bill they believe both the White House and Congress will support. The compromise would require the Detroit Three to produce detailed restructuring plans by March 31. The government would also designate a "car czar" to oversee the rescue, according to a draft of the bill. Ontario Finance Minister Dwight Duncan said last night that he has not seen the restructuring plans proposed by the Canadian subsidiaries of the Detroit Three. "We have to ensure that whatever the outcome of the arrangement in the United States, that it doesn't prejudice the footprint of the auto sector here in Ontario," he said. "But we will be there to do our fair share."
Mr. Duncan said the Canadian governments will be asking the auto makers to make a commitment to produce certain vehicles in this country in return for financial aid. "I think one of the challenges is that any package may not guarantee everything we want guaranteed on either side of the border," he said. It would be relatively easy for Chrysler to switch minivan production to the St. Louis plant, which closed this fall amid the slump and a decline in the minivan market. One problem in gearing it back up, however, would be in restoring the supplier base, because some companies, such as Magna International Inc., closed nearby plants that shipped components to the Chrysler factory.
The Windsor plant outperformed St. Louis in productivity last year according to the Harbour Report, an annual study of North American auto assembly plants. Chrysler's Brampton plant ranked fifth of six in its category – large, non-premium conventional cars. The auto maker's Jefferson North Assembly Plant's performance on the Grand Cherokee topped the mid-size non-premium utility vehicle category. Switching production of full-sized sedans to Detroit from Brampton "is not something you could do overnight," said one industry source.
But the source noted that both plants are operating at less than full capacity. The third shift at the Brampton plant was eliminated earlier this year amid poor demand for the Chrysler 300 and Dodge Charger models made there. The reborn Dodge Challenger muscle car has been a hit for Chrysler, but not enough to sustain a full shift of production. Windsor is producing minivans on three shifts a day, but some of that is production of the Volkswagen Routan, a vehicle Chrysler is building for Volkswagen AG. The Windsor plant will cease production for all of January because of poor sales, union officials said.
China's Chery halts Chrysler talks, cool to U.S. assets
Chinese car maker Chery Automobile has halted talks with Chrysler LLC to sell cars to South America, a company spokesman said on Tuesday. Chery has also no plans to buy auto assets in the United States, its chairman was quoted by state media as saying. In July 2007, Chery and the No. 3 U.S. automaker had agreed to manufacture compact cars under the Chrysler badge for sale in the Americas and the two parties held talks to execute the plan. "We have now decided to end the talks due to the changes in the internal strategies of each company," Chery spokesman Jin Yibo told Reuters on Tuesday.
Nissan Motor Co agreed in April to build a subcompact car for Chrysler to sell in North America. Chrysler also has held talks with China's Great Wall Motor Co about a partnership. Chery also had an initial agreement with Italy's Fiat to set up a car manufacturing joint venture in China, which was scheduled to start production next year. Jin said the two-parties were still in discussion. Ford Motor Co, which owns Volvo, and General Motors Corp, owner of Saab, are trying to sell those units as they seek a multi-billion dollar government bailout, but so far Chinese auto makers have not expressed an interest in buying.
Chery, which secured a 10 billion yuan ($1.45 billion) bank loan from the China Import-Export Bank this week, will use the money to improve its product quality rather than buying auto assets in the United States, Chairman Yin Tongyao told the Shanghai Securities News on the sidelines of a company event. Dongfeng Motor Group Co, China's third-largest automaker, is monitoring the situation of Detroit's troubled automakers, but a source with direct knowledge of the matter told Reuters last week it was too early to say if it would be interested in buying any of their assets. Chery is expected to ship more than 140,000 vehicles this year, mostly to the emerging markets, Yin was quoted as saying. It sold 119,800 units overseas in 2007.
Bank of Canada Cuts Lending Rate to Lowest Since 1958
The Bank of Canada lowered its benchmark interest rate by more than anticipated to a half- century low and signaled more action may be needed as economic growth sputters amid a “broader and deeper” global slump. Governor Mark Carney and his rate-setting panel slashed the target rate for overnight loans between commercial banks by three-quarters of a point to 1.5 percent, the lowest since 1958. Two of 23 economists surveyed by Bloomberg predicted the move, with 20 calling for a half-point cut and one calling for a quarter point.
Canada’s economy “is now entering a recession,” the central bank said in a statement from Ottawa today, the first time it has made that assessment outright. “The Bank will continue to monitor carefully economic and financial developments in judging to what extent further monetary stimulus will be required.”
Since Carney said Nov. 19 that a recession was a possibility, reports have shown employment fell by 70,600 in November and housing starts on an annualized basis plunged 19 percent. Meanwhile, manufacturers such as General Motors Corp. are scaling back operations in Ontario, Canada’s industrial heartland, and lower commodity prices are paring investment in the western province of Alberta’s oil fields.
“They are indicating that if the economic data warrants it they are prepared to move further, but they would need to see a worsening of economic conditions,” said Paul Ferley, assistant chief economist at Royal Bank of Canada in Toronto, the country’s biggest lender.
The Canadian dollar weakened 1.6 percent to C$1.2708 per U.S. dollar at 9:17 a.m. in Toronto from C$1.2504 late yesterday. The European Central Bank trimmed its main rate by three- quarters of a point to 2.5 percent on Dec. 4, the biggest reduction in its 10-year history. The Bank of England that day chopped its rate by one percentage point to 2 percent. Canada’s decision comes a week before the U.S. Federal Reserve’s next meeting, followed by the Bank of Japan two days later.
Carney’s rate cut today was the Bank of Canada’s biggest since October 2001. He had already surprised economists with his decisions four times this year including twice in October. Canada’s rate was 4.5 percent at the start of last December. Policy makers haven’t cut the rate below their 2 percent inflation target since that benchmark was established in 1993. The International Monetary Fund sees recessions next year in the U.S., Japan and the euro area, and economists in a separate Bloomberg survey say Canada will follow suit.
Economic growth will shrink at a 1.2 percent annualized pace for the October-through-December period and at a 0.5 percent rate in the first quarter of 2009, according to the median of 10 estimates gathered by Bloomberg News Nov. 6-12. The Bank of Canada today didn’t lay out a detailed growth forecast. Policy makers said waning expansion means their measure of so-called core inflation will be slower than they predicted in an October report. The central bank said then that inflation excluding eight volatile items would slow to a 1.6 percent year-over-year pace in the second half of 2009.
Canada sends three-quarters of its exports to the U.S., where a global credit squeeze spurred by the subprime mortgage meltdown is sapping demand for shipments of automobiles and lumber. Still, signs of weakness have spread beyond exports to the domestic spending that propped up the economy for much of this decade. “There certainly is a nervousness,” George Fraser, president of Fraser & Hoyt, a company offering insurance and travel services, said in Pictou, Nova Scotia. “People aren’t going to be spending the way we have.”
Before the drops in employment and housing starts, home sales fell 14 percent in October from September, the biggest 1- month decline since 1994. Canadian banks, rated the soundest in the world by the World Economic Forum, are reluctant to lend after the worst financial malaise since the Great Depression toppled institutions such as Lehman Brothers Holdings Inc. in the U.S. and Fortis in Europe.
The Bank of Canada stimulus comes as government aid for the economy is on hold until Parliament re-opens in January. Prime Minister Stephen Harper last week “prorogued” or shut down the country’s legislature for seven weeks in a bid to stave off a challenge from opposition parties seeking to bring down his government. The opposition proposed to form a coalition government to speed up an economic stimulus package. The record low for Canada’s key rate was 1.12 percent in 1958, a time when it was based on treasury yields rather than actions by policy makers.
Flaherty says an auto bailout can be done
Canada's finance minister said Monday that a request by the Detroit-three automakers for $6 billion in emergency aid from the Ontario and federal governments is "capable of being dealt with," but cautioned that all company stakeholders will have to make concessions before funding is disbursed. Jim Flaherty said federal and Ontario officials are reviewing the viability plans submitted Friday by the Canadian arms of General Motors Corp., Ford Motor Co. and Chrysler LLC as a condition for aid.
Asked for his initial impressions of the business plans submitted, the minister said: "It's capable of being dealt with," adding that more discussions are needed. "All participants in the industry are going to need to come to the table. To invest taxpayers' money will require terms and conditions." Flaherty said he expects federal and state governments in the United States, along with his administration and Ontario, to be involved in the aid discussions.
GM, Ford and Chrysler submitted plans Friday requesting a combined $6 billion in aid to help them stabilize their Canadian operations and fund future manufacturing in the midst of a financial crisis some say is the worst since the Great Depression. U.S. lawmakers were working Monday toward a bill that would provide U.S. government support of more than $14 billion US to the Detroit-three automakers. That's the amount GM and Chrysler have said they need to continue operating until the end of March.
Meanwhile, Ford's request that Ottawa and the Ontario government consider suspending the taxes for Canadians buying new vehicles is picking up steam as General Motors said Monday it backs that idea. "People are sitting back on new vehicle purchases because of a lack of confidence" and in some cases available credit, said David Paterson, vice-president of corporate affairs for GM's Canadian arm. "If the governments can take some of the taxes off, that would be good stimulus."
Ford made the request Friday as part of its submission. Ford of Canada "is asking the governments to consider a variety of consumer stimulus actions, such as tax holidays for new-vehicle purchases and incentives to encourage consumers to trade in older vehicles and buy new, lower-emission vehicles," the company said in a statement.
Vehicle sales in the United States have declined for 13-straight months and plummeted more than 30 per cent year-over-year in the past two months alone. Consumers who have access to credit are reining in spending as the housing and equity markets fall and unemployment rises. And in many cases, consumers who don't have access to credit can't buy at all. The weakness finally spilled over to Canada last month as auto sales fell 10.3 per cent to 105,221 vehicles, the lowest November tally in a decade. Six of the top-10 volume automakers reported lower sales.
Cuts to new hires, trips as 2010 Olympic organizers wrestle weakened economy
Cutting travel and freezing new hires are among Vancouver Olympic organizers' plans to create a larger financial umbrella to protect the Games from the economic storm brewing across the world. While there's been no indication that any revenue for the 2010 Games is in immediate danger, organizers can't be naive, said John Furlong, the chief executive officer of the committee, known as Vanoc.
"All of the things we have relied on have stood up," Furlong said in an interview with The Canadian Press. "But our feeling was that given the rapid changing environment around us and the fact that it was affecting everybody, we just simply took the position that it's just not reasonable to assume that we would not be confronted with new challenges." A revised Games budget will be presented to Vanoc's board of directors at a meeting Tuesday.
The current budget is $1.6 billion, which doesn't include the $580 million spent on the venues. Major revenue generators for the Games are sponsorship and ticket sales and both targets were exceeded for 2008, organizers have said. A scheduled budget review had already been underway but Furlong said the market crash this fall forced everybody back to the table. "For us to continue without improvising and preparing for a potential challenge here and there would simply not be responsible," Furlong said.
Cuts are being made both to internal operations at Vanoc and to Games-times operations, he said. Furlong said fewer new hires will be made in the months leading up to the Games and fewer trips will be made for Games business. For example, he said the committee is reviewing whether hard copy publications can be placed online instead of printed. Furlong said contingency planning so far hasn't extended to looking for other "official" suppliers in case existing contracts fall through, but now that they're about to start spending $1 billion, they're looking for strict guarantees any new dealers will be able to deliver what they promise.
They're also looking for new revenue streams - like increasing the number of seats available in B.C. Place Stadium for the opening and closing ceremonies. The ultimate goal, Furlong said, is to have a contingency fund that could make up any shortfalls. The current contingency fund is $100 million. It will be higher in the revised budget, Furlong said, but he declined to give a figure. "I don't think what we're doing will hurt us long term at all, ultimately it will lead to a better outcome," he said.
General Motors has committed $67 million to the Games, in cash and in kind. Last week the company went to the federal government seeking a $2.4 billion loan and $800 million in cash immediately to get through liquidity problems. And they aren't the only sponsor in trouble. Teck Cominco, contracted to provide the metal for the 2010 medals, is selling off assets and slashing capital spending in a bid to cut expenses as it struggles with debt. Nortel, which is the communications supplier for the Games along with Bell, lost $3.4 billion in the third quarter of 2008.
Furlong said Games sponsors have indicated they view the Olympics as a top priority and not a single one has defaulted on commitments. From his company's point of view, the Olympics is helping counter the perception that Nortel is in trouble, said David Johnson, general manager of Olympic programs. "It allows us to talk to new customer segments, it allows us to get past the muck of today's environment to talk about something that's positive," he said. It's "a very positive message in a very dark time."
In London, the Olympics Minister Tessa Jowell had earlier made headlines by saying Britain would probably not have bid for the 2012 Games had it known that a global economic downturn was coming. But the International Olympic Committee is on board with the need to be fiscally responsible, Furlong said. When the IOC last visited in Vancouver in October, members said they were helping Vancouver organizers split the must-haves from the nice-to-haves.
In a recent address to European Olympic committees, IOC president Jacques Rogge stressed the need for organizers to hold down the cost of the Olympics. "The Games are not anymore in a growth mode, they are in a conservation mode," he said. Rogge said the IOC has secured about US$900 million in global sponsorship revenue for the 2009-12 Games through deals with nine sponsors. From 2005 to 2008, the committee had 12 sponsors, raising US$866 million, but Johnson & Johnson, Kodak, Lenovo and Manulife declined to renew their contracts. Vancouver organizers depend as well on the money raised by the IOC and Furlong said he's confident they'll make good on the commitment.
China's Economy: Some Reason for Hope
Soaring stocks, rising steel prices, and a glimpse of a real estate recovery suggest business confidence is growing as China's massive stimulus package kicks in. The economic news from China looks anything but encouraging these days. The export slump is deepening, corporate earnings in the third quarter fell 13% from a year earlier, while industrial output growth has hit a seven-year low and cash-flow problems are plaguing airlines, manufacturers, and beleaguered property companies. The latest evidence of a slowdown: China's auto sales fell 10% in November from a year earlier.
But this litany of woes may indeed mark the beginning of the end of China's economic travails, say China watchers. "Don't be disheartened by disappointing numbers in the fourth quarter," says Jing Ulrich, managing director and chairman of China equities at JPMorgan Chase in Hong Kong, who says growth in industrial production and exports may be negative. "I feel there is a glimmer of hope, and the second quarter will show signs of economic recovery." By that time the benefits of China's massive $582 billion stimulus package could start to flow through, and the economy could kick into a higher gear once again. Annual gross domestic product growth could well slow to 7% in the first half but exceed 8% in the second half, says Ulrich, ensuring that the economy chugs along fast enough to prevent unemployment from rising.
Investors were certainly feeling hopeful in trading on Dec. 8. Asian stocks rose sharply, with Japan's Nikkei up 5.4% and South Korea's Kospi up 7.5%. In Hong Kong the benchmark Hang Seng index soared 8.6% on optimism about further stimulus measures from Beijing as well as the incoming Obama Administration. Contributing to the upbeat mood was the opening of an annual meeting of economic policymakers in Beijing. The government's three-day Central Economic Work Conference began on Monday amid widespread speculation that Chinese officials were gearing up for additional measures to stimulate the economy. A recovery in China could also help pull the rest of the region along, says Ulrich. "China is the single biggest trading partner for all regional economies, and if China recovers it will have a multiplier effect," she says.
While the picture is grim now, Ulrich isn't the only China watcher seeing some cause for optimism. Merrill Lynch economists Ting Lu and T.J. Bond, for instance, in a Dec. 8 research report point to a slight rise in the Commerce Ministry's weekly price index of producer goods. After falling for 19 straight weeks since July, the index rose for the week ended Nov. 30, albeit by just 0.2%. However, Lu and Bond describe as "especially eye-catching" a rise in steel prices that has now lasted for three weeks. Following a 60% drop since mid-June, "the turnaround in steel prices may suggest that business confidence is to some extent returned," they write.
Recovery could be particularly strong for building materials companies such as cement maker Anhui Conch Cement and China Shenhua Energy, which stand to benefit from construction of high-speed railways, highways, airports, and power grids, accounting for 45% of the $582 billion pump-priming package, or 6.75% of GDP. "In China's recently announced stimulus plan, cement is the biggest beneficiary among the basic materials," write Credit Suisse analysts Trina Chen, Kevin You, and Ada Dai in a Dec. 3 report. In the second half of 2009, they write, demand will start to pick up as construction projects under the stimulus plan get under way.
That's not to say that China's recovery faces no obstacles. Indeed, the massive increase in bankruptcies and nonperforming loans will place a huge strain on the financial system. Although China has cut interest rates four times since September, money is still tight as banks favor large, state-backed companies instead of cash-strapped small and midsize enterprises that are perceived as greater credit risks. "We need to get prepared for a slew of extremely weak data in the coming months," write Lu and Bond.
Things could still unravel if the property market fails to recover. Property accounts for 25% of all fixed-asset investment, and is a principal form of wealth holding for Chinese consumers who have few alternatives apart from the stock market, which has cratered more than 60% in the past 12 months. "The property market is the crux of overall consumer demand," says Ulrich, who points out that construction accounts for 50% of China's steel demand, so a slump at home will mean lackluster prices globally, too.
There are, however, tentative signs of recovery in the housing market. In Shanghai volume sales jumped 47% in November from the previous month, while in Chongqing, another bellwether market, sales are also starting to recover. To be sure, prices could still soften further, but getting cash in the door now is essential to keeping more property developers from going under. China punches well above its weight as a source of global economic growth. Although the country accounts for just 6% of global GDP, it is expected to account for about 60% of global growth next year.
Luckily for the rest of the world, China is unlikely to abandon its long-term path of a strengthening currency. Ulrich points out that the 1% depreciation of the yuan against the dollar in the past month does not suggest Beijing has rethought its currency strategy. "The export sector faces huge challenges, but don't expect a devaluation that would trigger competitive devaluations across the region," says Ulrich. "As the economy recovers, the [yuan] should resume a steady path of appreciation."
Obama to Borrow China’s Wealth, Clout in Effort to Steady World
Thirty years ago this month, President Jimmy Carter held secret negotiations to establish formal diplomatic ties with a poor, insular communist China. President-elect Barack Obama will inherit a relationship with a China whose wealth and influence are essential to rescuing the world economy. Resolving almost any international problem now -- from reducing North Korea’s potential nuclear threat to slowing global warming -- requires Beijing’s cooperation. The financial crisis also underscores China’s importance: Its $1.9 trillion in foreign reserves will be indispensable in helping to avert a global economic meltdown.
While this means China will likely get immediate attention from Obama, the new president probably won’t reorient U.S. policy toward the world’s fourth-largest economy.
Factory closures and job losses in Michigan and China’s Guangdong province “vividly remind us how interdependent our countries are now,” says Susan Shirk, a former deputy assistant secretary of state for China who has advised both Obama and Hillary Clinton his choice for secretary of state. “Although this could lead to conflict and friction, it also gives the U.S. a strong incentive to cooperate with China.”
Every president since Carter has come to office lambasting Beijing about espionage, unfair trade practices, violations of human rights and threats to Taiwan -- before being compelled to work with the Chinese government on common interests. Obama may be the first to start out less confrontationally. During George W. Bush’s presidency, the two countries have forged unprecedented lines of communication, forming working groups on Africa and Latin America and holding economic summits like one last week with Treasury Secretary Henry Paulson.
The current administration “has handled the U.S.-China relationship perhaps better than any bilateral relationship of the last seven years,” says Ken Lieberthal, a former national security adviser on Asia under President Bill Clinton who advised Hillary Clinton, 61, and then Obama, 47, during the presidential campaign.
Even so, “mutual distrust about both sides’ intentions has grown,” says Lieberthal, 65, a visiting scholar at the Brookings Institution in Washington.
On a recent trip to Beijing, he says he discovered that many Chinese -- officials and ordinary citizens -- believe the U.S. purposely triggered a global financial crisis to thwart China’s growth. Likewise, many Americans assume a stronger China would marginalize the U.S. “Each side hedges against what they fear the other might try to do,” Lieberthal says.
As economic conditions worsen, both countries are under pressure at home to protect their domestic markets. Obama spoke out during the campaign against what he called unfair trade practices and currency manipulation, which has left Chinese policy makers nervous about his intentions. China, meanwhile, is shielding its own economy by slowing the appreciation of the yuan against the U.S. dollar and giving Chinese exporters a larger tax rebate.
With the U.S. now officially in a recession, China holds more cards than it did even a few months ago. Washington is more reliant on Beijing -- the largest holder of U.S. Treasuries -- to buy more government securities to finance deficit spending. China’s massive trade surplus has enabled it to accumulate more foreign-currency reserves than any other nation, according to Bloomberg data.
“It’s one of the few players in the world, besides the Saudis, who is sitting on a lot of cash and can help save the international financial system,” says Victor Shih, author of “Factions and Finance in China.” Some fear America’s reliance on China’s money means the White House will bite its tongue when the country acts against U.S. interests or values.
“If there were not a global recession and crisis, I would expect the Obama administration to take a stronger stand on Tibet and human rights,” says Shih, a professor at Northwestern University near Chicago. The upside of interdependence is that the two nations should be less likely now to take punitive measures against each other, says Nicholas Lardy, an economist who specializes in China at the Peterson Institute for International Economics in Washington. There’s no incentive for China to stop buying U.S. securities; it needs a safe investment for dollar reserves, and its growth depends on the health of the U.S. economy. Congress also may hesitate before demanding trade barriers against a country that’s the main source of cheap goods for budget- conscious consumers.
The Communist Party’s legitimacy rests on its ability to deliver rising standards of living, without which the government’s grip on power becomes tenuous, China watchers say. So the country’s leaders have reason to worry about an economic slowdown that is pushing growth below the estimated 8 percent a year economists say is needed to create enough jobs for its citizens. Authorities are also anxious about rising discontent and daily protests over corruption, unemployment, housing and tainted food.
Obama should have a contingency plan for “what we would do if there’s a major collapse of the political order,” says Roderick MacFarquhar, a China scholar at Harvard University in Cambridge, Massachusetts. The president-elect will be able to turn for help to the China-savvy individuals he has brought into his circle. Timothy Geithner, 47, Obama’s choice for Treasury secretary, studied Chinese and has lived in China. His transition team includes Jeffrey Bader, a China specialist with a 27-year career in government that spans trade and national security.
Among the possible candidates for ambassador are John L. Thornton, a former chairman of Goldman Sachs Asia who has been a professor in Beijing; Richard Holbrooke, 67, who dealt with China as Clinton’s United Nations ambassador; and Shirk, 63, a visiting fellow at the Asia Society in New York. Lieberthal expects Obama’s administration will engage Beijing in what he describes as “critical transnational issues of the 21st century.” Interdependence will work to both countries’ advantage, Shirk says, “if it motivates us to do our best to cooperate rather than taking potshots.”
China’s Exports Shrink, Output Cools
China’s exports may have contracted last month as industrial output cooled, adding pressure for policy makers meeting in Beijing this week to do more to sustain economic growth. "Things are not so good," Fan Gang, an adviser to the central bank, said at a Beijing forum today. "November figures will come out soon, and industrial growth will be something around 5 percent and export growth will be negative."
The government has already unveiled a 4 trillion yuan ($582 billion) stimulus package and cut interest rates by the most in 11 years as a global recession reduces demand for toys, textiles and electronics. A decline in exports would be the first in seven years and increase the risk that the slowdown in the world’s fourth-biggest economy will become a slump. "It doesn’t really matter what China does to try to revive exports, they are going to be bad for the foreseeable future," said Paul Cavey, an economist with Macquarie Securities in Hong Kong. "The key now is what can be done to boost domestic demand." Exports grew 19.2 percent in October.
Inflation slowed in November for the seventh straight month, central bank statistics head Zhang Tao said at the forum. Prices may have climbed less than 3 percent, Zhang said. The CSI 300 Index of stocks closed 2.6 percent lower. China’s trade figures may be released as soon as today. Chinese leaders, meeting for three days in Beijing to set economic policy, may cut taxes and roll out measures to support the stock market, according to Merrill Lynch & Co. Industrial-output growth of 5 percent would be the weakest since Bloomberg data began in 1999 and worse than the 7.2 percent median estimate of 14 economists in a Bloomberg News survey. Production rose 8.2 percent in October.
Economists exclude figures from January and February each year because of distortions caused by Lunar New Year holidays. Fan’s comments on exports come after a Chinese newspaper, the 21st Century Business Herald, said Dec. 7 that shipments may have fallen. Taiwan and South Korea’s exports declined last month by the most since 2001 as the world recession took a growing toll on Asian economies. In the U.S., retail sales fell last month by the most since data began in 1969. China needs to prepare for a "worst case scenario" as the global slump deepens, Central bank Governor Zhou Xiaochuan said Dec. 4. Exporters of toys, clothes and furniture are cutting production or closing down, triggering a surge in labor disputes and increasing the risk of social unrest in the world’s most populous nation.
Labor disputes almost doubled in the first 10 months of this year as businesses closed and some owners fled, the official China Daily newspaper reported Dec. 5. Sacked workers rioted at a toy factory in Guangdong province last month and Zhang Ping, the nation’s top planner, warned of the risk of "massive unemployment" and "social instability." The central bank has cut the key one-year lending rate to 5.58 percent from 7.47 percent in September and dropped quotas limiting lending by banks. The "aggressive" monetary response is likely to continue, said Grace Ng, an economist with JPMorgan Chase & Co. in Hong Kong, who expects the rate to fall to 3.96 percent next year. The yuan’s biggest one-day decline in three years on Dec. 1 also has prompted speculation that China may allow its currency to depreciate, helping exporters by making their products cheaper in overseas markets.
The yuan may weaken as much as 10 percent against the dollar, Morgan Stanley said last week. In contrast, Commerce Minister Chen Deming said that the nation won’t rely on currency depreciation to help exporters who are suffering because of shrinking demand. China should stick to a "gradual" approach on the currency and policy makers shouldn’t bow to pressure for a sharp fall, central bank adviser Fan said today. He is the only academic member of the bank’s monetary-policy committee. China’s economy grew 9 percent in the third quarter, the slowest pace in five years.
Rouble exodus hits Russia credit rating
Russia on Monday became the first G8 country since the start of the financial crisis to have its credit rating downgraded after Standard and Poor’s took fright at the recent exodus from the rouble and sharp drop in oil prices. S&P said it had lowered Russia's foreign currency credit rating by one notch from BBB+ to BBB because of the “rapid depletion” of the country’s foreign exchange reserves and the “difficulty of meeting the country’s external financing needs”. It said the outlook for the rating was negative. Russia’s reserves have fallen by $128bn since August to $455bn, as the country battles the capital flight that began following the war with Georgia and escalated as the oil price fell and the global crisis worsened.
S&P said Russia could be forced to spend all $200bn now parked in its two sovereign wealth funds on recapitalising the banking system and covering fiscal deficits in 2009 and 2010. The agency expects Russia to run a current account deficit next year of 2.6 per cent of gross domestic product due to the oil price fall, putting further pressure on the balance of payments. “There are a lot of layers of concern,” said Frank Gill, primary credit analyst at Standard and Poor’s. “There are macroeconomic and political risks . . . and Russia has not operated a current account deficit since 1997 and that was less than 1 per cent of GDP.”
Vladimir Putin, Russia’s prime minister, has staked his political credibility on avoiding a sharp rouble depreciation. The thought of devaluation raises the spectre of the 1998 rouble crash that wiped out Russians’ savings, although economists say any devaluation this time would be far less severe.
Japanese economic slowdown worsens
Japan’s gross domestic product contracted much more rapidly in the third quarter than initially thought, underscoring the weakness of the world’s second largest economy at a time of international financial turmoil. Revised gross domestic product data released on Tuesday showed a quarter-on-quarter fall of 0.5 per cent for the three months to September, compared with a preliminary estimate issued last month of a 0.1 per cent decline. On an annualised basis, the third quarter contraction – which put Japan officially into recession – is now estimated at 1.8 per cent, rather than 0.4 per cent as previously. While the downward revision was worse than many economists expected, Japanese stock investors greeted it calmly, with the benchmark Nikkei index actually rising slightly in morning trade. However, the revised data are likely to fuel pessimism about the prospects for the Japanese economy.
Even senior figures in the government are sceptical about the likely impact of planned stimulative spending, and many economists say that a return to economic health is unlikely unless there is a revival in external demand. Analysts also expect further bad news from the Bank of Japan’s Tankan survey of sentiment among manufacturers, which will be released next week. Analysts surveyed by the Bloomberg and Dow Jones news agencies have predicted that the survey would show the worst deterioration in sentiment in more than 30 years. Companies are also facing difficulties raising funds through the capital markets, prompting the most rapid rise in bank lending since records became available in 1992. A representative of the National Federation of Small Business Associations said this week that companies appeared to be rushing to secure funds out of concern latecomers would find it difficult to borrow. ”Many companies are borrowing now because they see no prospect for sales in the new year,” he said.
UK slowdown deepens as output slumps
Industrial production fell at the fastest pace in six years in October in the clearest sign yet that the UK slowdown is deeper and sharper than many expected. Official figures showed that industrial production tumbled 1.6pc in September, much steeper than the 0.5pc fall predicted by economists, and significantly bigger than the 0.9pc drop in September. The October production figure - the eighth monthly fall in row marking the longest run of falling output since 1980 - dragged annual output down by 5.2pc, the sharpest year-on-year decline since 1991 when the UK was last in recession. Among the worst hit areas in manufacturing, which fell by 1.4pc overall, were the transport industry and printing and publishing industries.
Hetal Mehta, senior economic advisor to the Ernst & Young ITEM Club said the figures indicated that a 1pc fall in gross domestic product (GDP) in the fourth quarter was "not out of the question". The National Institute of Economic and Social Research went further predicting that the fall will be larger than 1pc. The UK will officially enter a recession at the end of the fourth quarter when it satisfies the technical definition of recession - two consecutive quarters of economic contraction. GDP fell by 0.5pc in the third quarter, and economists were expecting a similar fall in the fourth quarter but a raft of recent gloomy data, including today's figures from the Office for National Statistics, has heightened the belief that the downturn is already deep and getting worse.
The Centre for Economics and Business Research said that today's industrial production numbers pointed towards "an ugly fourth quarter growth figure". If GDP fell by more than 1pc, it would put the severity of the start of the recession roughly in line with the last recession, where GDP contracted by 1.2pc in the third quarter of 1990, falling officially into recession in the fourth quarter when GDP shrank by 0.6pc.
Separately the ONS said that the UK trade in goods deficit widened to £7.8bn in October from £7.4bn in September, showing that the recent depreciation in sterling has not boosted manufacturing exports enough to outweigh slowing demand from the UK's key export markets in the Eurozone and US. "The widening in the trade in goods deficit shows that manufacturers are feeling little benefit from the 20pc odd fall in the pound," said Paul Dales, UK economist at Capital Economics. "Looking ahead, the marked deterioration in overseas activity in recent months suggests that things are only going to get worse from here."
Regulators preparing rescue of credit unions: report
Federal regulators are preparing a rescue plan to shore up the finances of some large credit unions, using billions of dollars in new government borrowings, the Wall Street Journal reported. The plan is not a taxpayer-funded bailout, but a short-term "mechanism to stabilize the credit-union system" while regulators work on other steps, to be announced early in 2009, Michael Fryzel, chairman of the National Credit Union Administration told the paper.
A related program also to be announced by NCUA will provide as much as $2 billion in inexpensive loans to credit unions, which the institutions can use to reduce mortgage interest rates for homeowners, the paper said. Fryzel told the paper he does not know how much new federal borrowing the two programs would entail. Funding for the loan programs will come through the Treasury Department. NCUA and the Treasury Department could not be immediately reached for comment.
Credit unions are non-profit cooperatives owned by their depositors, or members. Credit unions are as a rule much smaller than commercial banks, with average assets of $93 million in the United States in 2007 according to the Credit Union National Association, compared to $1.53 billion for banks. According to CUNA, there are more than 8,000 credit unions in the country.
How Fumbling the Bailout Led to the Chicago Sit In
Over the last couple months I've warned that one main reason banks aren't lending, and are cutting off credit lines to businesses and individuals, is because they are hoarding money in order to buy competitors. In the Chicago factory sit in, the key moment which caused Republic Windows to shut down was when Bank of America cut off their line of credit, which they did just before they approved a $50 billion takeover of Merrill Lynch.
Bank of America has bought out LaSalle Bank and Countrywide, and bank shareholders just approved a $50 billion buyout of Merrill Lynch. B of A has recently settled the largest suit against Countrywide. Meanwhile, according to a source familiar with the nature of the bank's finances, Bank of America has issued $9 billion of secured debt insured by the FDIC. Yet, as with almost all banks, it has been tightening its credit to businesses and consumers.
A lot of banks still have plenty of money. Bank of America has plenty of money. The amount of money required to keep Republic Windows open is trivial to them—$10 million, perhaps. But right now, they as with other banks, are keeping their powder dry. Money loaned out can't be used to buy up competitors at cents on the dollar.
If the Feds are serious about getting banks to lend again they have to make it clear that failed banks will no longer be sold to their competitors at fire sale prices but will instead be put in receivership and held for years before any sale is considered. This needs to be explicit policy. Until they do, banks will horde cash, looking for their chance at once in a lifetime buying opportunities. All that will happen to the money being given to the banks is that they will use it for more buyouts. And more businesses like Republic Windows will go under because their lines of credit were withdrawn.
AIG Says More Managers Get Retention Payouts Topping $4 Million
American International Group Inc., the insurer whose bonuses and perks are under fire from U.S. lawmakers, offered cash awards to another 38 executives in a retention program with payments of as much as $4 million. The incentives range from $92,500 to $4 million for employees earning salaries between $160,000 and $1 million, Chief Executive Officer Edward Liddy said in a letter dated Dec. 5 to Representative Elijah Cummings. The New York-based insurer had previously disclosed that 130 managers would get the awards and that one executive would get $3 million. "I remain concerned, as do many American taxpayers, that these retention payments are simply bonuses by another name," Cummings said in letter responding to Liddy.
AIG, which received a U.S. rescue package of more than $152 billion, has been criticized for saying it will eliminate bonuses for senior executives while still planning to hand out "cash awards" that double or triple the salaries of some managers. The payments are designed to keep top employees at AIG while Liddy seeks to sell units and pay back the federal government, which owns 79.9 percent of AIG. "We are indeed fortunate to have benefited from the assistance extended to us by the U.S. government and we are grateful for the support of American taxpayers," Liddy wrote. "We would be doing a disservice to the taxpayer -- and would place AIG’s asset divestiture plan at risk -- if we did not act decisively to ensure that our key employees remain."
Cummings, a Maryland Democrat on the House Committee on Oversight and Government Reform, asked AIG to disclose how much each of the 168 recipients made in salary, bonuses and other kinds of pay. In a letter dated today, Cummings also asked for an estimate of what AIG would have spent on employee compensation in 2008 had the firm not sought U.S. help, compared with what it expected to spend. AIG is selling businesses including its U.S. life-insurance and retirement-services operations. Collectively, the assets for sale equal "almost 65 percent of our company and employ approximately 70,000 people," Liddy wrote. Total employment is about 116,000, he said. AIG spokesman Joe Norton declined to comment. Another AIG spokesman, Nicholas Ashooh, previously said that many AIG managers have lost their life savings.
AIG’s managers have overseen a record $37.6 billion in net losses so far this year. Cummings has called for Liddy’s resignation and said AIG should provide names of those getting retention pay and explain why the awards are needed. Firms accepting taxpayer money shouldn’t enrich employees, he said. Keeping the managers is necessary to maintain credit ratings and meet requirements in some reinsurance agreements, Liddy wrote. AIG disclosed the initial list of 130 managers in a September filing without saying how much most of the recipients will get. Another 38 people were added "subsequently," according to Liddy’s letter, which didn’t disclose the new recipients or say when they had been added.
The list was expanded so AIG can retain people with "key client relationships" and who have a high "degree of flight risk," Liddy wrote. He cited their "deep experience, extremely valuable business relationships, and unique ties to the many local communities where they live and work." Recipients will get the payments in two installments starting this month, while 13 top managers agreed to delay the first award until April, Liddy said in the Dec. 5 letter.
Holding CEOs Accountable
The failure of the General Motors board of directors to fire CEO Richard Wagoner provides a rare glimpse into the inner-workings of big-time corporate boards of directors. The sight is not pretty. When Mr. Wagoner took the helm eight years ago the stock was trading at around $60 per share. The stock had fallen to around $11 per share before the current financial crisis. It's now below $5 per share. In 2007, Mr. Wagoner's compensation rose 64% to almost $16 million in a year when the company lost billions. The board has been a staunch backer of Mr. Wagoner despite consistent erosion of market share and losses of $10.4 billion in 2005 and $2 billion in 2006. In 2007 GM posted a loss of $68.45 a share, or $38.7 billion -- the biggest ever for any auto maker anywhere.
The GM board is now reportedly meeting several times a week. But beneath the appearance of activity, nothing is happening at GM other than the company's poorly articulated pleas for a government bailout and threats of dire consequences if GM is not bailed out. When Connecticut's Sen. Chris Dodd mentioned that Mr. Wagoner might have to go, GM spokesman Steve Harris was quick to defend him: "GM employees, dealers, suppliers and the GM board of directors feel strongly that Rick is the right guy to lead GM through this incredibly difficult and challenging time."
The average pay for chief executives of large public companies in the United States is now well over $10 million a year. Top corporate executives in the United States get about three times more than their counterparts in Japan and more than twice as much as their counterparts in Western Europe. In my new book "Corporate Governance: Promises Made, Promises Broken," I argue that executive compensation is too high in the U.S. because the process by which executive compensation is determined has been corrupted by acquiescent, pandering and otherwise "captured" boards of directors.
Like parents unable to view their children objectively, boards reject statistical reality and almost always view their firms as above average. Because directors participate in corporate decision-making, they inevitably take ownership of the strategies that the corporation pursues. In doing so, directors become incapable of evaluating management and strategies in a detached manner. As board tenure lengthens, it becomes increasingly less likely that boards will remain independent of the managers they are charged with monitoring.
The capture problem is exacerbated by the incentives of managers to develop close personal ties with directors. Mr. Wagoner has had 10 years to cultivate his board. Of the 13 "independent" directors on the board, eight of them have served with Mr. Wagoner since 2003. Once an opinion, such as the opinion that a CEO is doing a good job, becomes ingrained in the minds of a board of directors, the possibility of altering those beliefs decreases substantially. All too often, it is only when an outsider takes an objective look does anybody realize the obvious: That the directors of a company are generally the last people to recognize management failure.
We need to encourage market solutions -- not bureaucratic ones -- as the best strategy for addressing the corporate governance failures we face today. Hedge funds and activist investors like Carl Icahn are the solution, not the problem. The market for corporate control should be deregulated and the SEC's restrictions on all sorts of equity trading should be lifted at once. Little if anything has changed at GM since dissident director H. Ross Perot dubbed his board colleagues "pet rocks" for their blind support of then CEO Roger Smith. The broader problem is that there are far too many pet rocks on the boards of other U.S. companies.
Half of rescued borrowers default anyway
More than half of delinquent homeowners whose mortgages were modified earlier this year ended up redefaulting within six months, a top bank regulator said Monday. Some 53% of borrowers with loans modified in the first three months of 2008 and 51% of those with loans modified in the second quarter could not keep up with payments within six months, according to U.S. Comptroller John Dugan, who spoke at a housing conference.
The report, which will be released in full next week, covers nearly 35 million loans worth a total of $6 trillion -- or 60% of all primary mortgages in the United States. The high redefault rate raises concerns about the long-term effectiveness of loan modifications, which many are pushing as a key solution to the nation's financial crisis.
A record 1.35 million homes are in foreclosure, while the number of borrowers who have fallen behind on their payments soared to a record 6.99%, the Mortgage Bankers Association said last week. Meanwhile, 1.7 million homeowners have been helped in 2008 through the Hope Now Alliance, a coalition of lenders, servicers, investors and counselors working with delinquent borrowers on modifications and repayment plans.
Dugan said the Office of the Comptroller of the Currency is asking servicers for more details on the loans in his report to determine what went wrong. He wants to know whether the modifications reduced the monthly payments to affordable levels or whether the borrowers had too much other debt to keep their head above water. "These answers are important, because they have important ramifications for the foreclosure crisis and how policymakers should address loan modifications, as they surely will in the coming weeks and months," Dugan said.
Other regulators speaking at the conference questioned the quality of the loan modifications, saying that early efforts to restructure loans were not very effective. Many simply tacked on the missed payments and penalties to the end of the loan. "The quality of the modifications are not what they should be," said FDIC Chairwoman Sheila Bair, a vocal proponent of adjusting loans by reducing interest rates, extending loan terms and deferring principal.
Also, verifying income is very important. Modifications that include an interest rate reduction have a 15% redefault rate, said Bair, citing a recent Credit Suisse study. Last month, Bair unveiled a plan to address the foreclosure crisis by modifying loans to as low as 31% of a borrower's gross monthly income. This could be done by setting interest rates to as low as 3% or extending loan terms to 40 years. Principal could also be deferred free of interest to the end of the loan.
To entice servicers and investors to participate, Bair's plan calls for the government would share up to 50% of losses should the loan redefault. But that guarantee only kicks in after the borrower has made six monthly payments to better ensure the mortgage modification is sustainable long-term. It would cost $24.4 billion, which Bair has said could come from the rescue funds. Bair's efforts have been widely praised, but the Bush administration has yet to act on it.
As the housing crisis continues to spin out of control, lawmakers, economists and community activists are increasingly demanding that financial institutions and the Bush administration do more to help homeowners by modifying loans to affordable monthly payments. In recent months, banks and federal agencies such as the Federal Deposit Insurance Corp. and Fannie Mae and Freddie Mac have stepped up efforts to adjust loans so that payments are no more than 38% of a borrower's monthly income.
Rep. Barney Frank, D-Mass, who heads the powerful House Financial Services Committee, said Monday that Congress will not give the Bush administration the $350 billion left in the $700 billion financial system bailout package unless loan modifications are part of the plan. However, other regulators said that federal money may be better spent on economic stimulus and job creation since a growing number of foreclosures are caused by unemployment. In those cases, loan modifications won't help.
The unemployment rate soared to 6.7% and is expected to go higher with companies announcing massive downsizings almost daily. "I have to wonder whether or not focusing on job creation..is a better way to focus federal dollars than on a loan modification process that may be only partially effective," said John Reich, director of the Office of Thrift Supervision.
Nobel winner Krugman's worst case: a lost decade
Paul Krugman, winner of this year's Nobel economics prize, said on Monday that the world could face a Japan-style, decade-long slump. Speaking in Stockholm where he will collect his 10 million Swedish crowns ($1.3 million) prize, U.S. economist Krugman again called on policy makers to spend liberally to cushion a withering global downturn. "A scenario I fear is that we'll see, for the whole world, an equivalent of Japan's lost decade, the 1990s -- that we'll see a world of zero interest rates, deflation, no sign of recovery, and it will just go on for a very extended period," he told a news conference. "And that's unfortunately very easy to see happen."
Krugman added that in his worst case scenario there would also be a series of extremely serious crises "in particular countries that are in big trouble." He said there were already premonitions of economic and political crises in line with those in Argentina and Indonesia in the 1990s-early 2000s, particularly "in the European periphery." Iceland and Latvia are among European countries that have been hit hard by the global financial crisis. "We can easily be talking about a world economy that is depressed until 2011 and maybe beyond," Krugman said. "If there's a safe place I can't see it." Krugman is in the Swedish capital for the "Nobel Week," when laureates attend news conferences and events culminating with the prize ceremony and a gala dinner on Wednesday.
Restore the Uptick Rule, Restore Confidence
The last time the stock market suffered from extreme volatility and risk of market manipulation as severe as we are experiencing today, our grandparents' generation stepped up to the plate and instituted the uptick rule. That was 1938. For nearly 70 years average investors benefited immensely from that one simple stabilizing act.
Unfortunately, in a shortsighted move, the Securities and Exchange Commission (SEC) eliminated the rule in July 2007, just as we were about to need it most. Investors have now been whipsawed by what appears to be manipulative trading, what we used to call "bear raids," which drive stock prices down without warning and at breakneck speed. Average investors feel the deck is stacked against them and are losing confidence in the markets. For the sake of our children and grandchildren, and to avoid a needless future repeat of a bad situation, it is time to restore the uptick rule.
The uptick rule may seem far from a kitchen-table issue, but it is critically important to ordinary investors. With more than half of all U.S. households invested in the stock market, either directly or through a retirement plan, it matters a great deal. The average 401(k) retirement account has lost 20%-30% of its value over the last 18 months -- more than $2 trillion in retirement savings has been wiped out. Behind those numbers are real people who planned and saved, and who are suddenly facing an uncertain retirement and the prospect of working longer.
In the wake of the Great Depression, the uptick rule was established to eliminate manipulation and boost investor confidence. The rule said that short sales could be made only after the price of a stock had moved up (an "uptick") over the prior sale. This slowed the short selling process making it more expensive and limiting the ability of short sellers to manipulate stocks lower by piling on, driving the share price quickly down and quickly profiting from the downdraft they created. In July 2007, however, the SEC repealed the uptick rule after a brief study. Manipulative short sellers couldn't believe their luck.
The SEC's study took place during a period of low volatility and overall rising stock prices in 2005 through part of 2007 and didn't anticipate the kind of market we are experiencing today. We live in an environment now where 200 point drops or more in the Dow Jones Industrial Average are increasingly common, where a stock losing 20%, 30% or even more of its value in a single day barely warrants a second glance at the ticker. Ironically, it was just this sort of volatility that inspired the regulators of the 1930s to implement the uptick rule in the first place. Without this vital control mechanism, short sellers have been having a field day, betting heavily on lower prices and triggering panicked investors to sell even more.
Don't get me wrong. Legitimate short selling where a trader has borrowed shares for future delivery and believes those shares will lose value over time plays an important and stabilizing role in our markets. It provides a check on overexuberant prices on the upside, and provides natural buyers on the downside. The uptick rule, however, prevents short selling from turning into manipulative activity. Reinstating it will help smooth out the markets and reduce the speed of price drops. It will limit the ability of a small number of professional investors to trigger fast dramatic price drops that create panic among investors.
The SEC has an opportunity to make a real difference in helping to control future market stability and restore confidence in the fairness of our capital markets. But the SEC has been strangely silent as the crisis has worsened. It did step in earlier this fall to implement short stock borrowing restrictions and a temporary ban on short selling, first on 19 stocks in the financial services sector, and later in a broader swath of 900 stocks across several sectors. But these steps were a temporary half-measure and didn't fix the problem for the long term. Clearly, the SEC will need to work on some of the mechanics of reinstating the uptick rule. Regulators should act quickly to establish a framework and solicit public comment, then reinstate the rule and remain flexible and willing to fine tune it if necessary.
Ordinary investors' expectations for investing are reasonable. They want a fair playing field. They want to be successful. They want to provide for their families, support their children's education, have a comfortable retirement, and maybe even leave a little bit for future generations. But they can't succeed when the markets are gripped by fear and manipulated by those who want to profit from that fear, at the expense of everyone else. It may be too late for the restoration of the uptick rule to have much impact on where we are today. But there is no reason to wait and we need the protection in place for the future. It is time to restore it. It's what our grandparents did for us in 1938, and it worked for nearly 70 years. With that kind of track record, we should tip our hats to the regulators of yesteryear and acknowledge that they had it right all along.
Charles Schwab is the founder and chairman of the financial services firm that bears his name.
Sony Will Cut 16,000 Jobs as Recession Curbs Demand
Sony Corp., the world’s second-biggest consumer-electronics maker, plans to eliminate 16,000 jobs in the largest reduction announced by a Japanese company since the credit crunch drove the world into recession. Sony will curb investments, outsource production and move away from unprofitable businesses by March 2010 to save more than 100 billion yen ($1.1 billion) a year, the company said today. The cuts include 8,000 full-time employees, or 5 percent of the company’s electronics workforce, and another 8,000 part-time and seasonal workers, Sony said.
The reductions highlight the severity of the slump in consumer spending at a time when companies typically focus on the peak Christmas shopping season. Tokyo-based Sony, led by Chief Executive Officer Howard Stringer, said a “much” larger-than- anticipated deterioration in the economy spurred the measures and the company may revise its profit targets. “I can’t see how the company will regain its charm with consumers,” said Hiroshi Sato, chief investment officer of Tokyo-based GCSAM Co., who sold his Sony holdings. “The company might suffer from a bigger earnings decline in the second half, or even losses, if it doesn’t take any measures.”
It’s the second time Stringer, 66, is turning to major job cuts to boost earnings. In 2005, when the company projected its first annual loss in more than a decade, the Welsh-born U.S. citizen announced plans to eliminate 10,000 workers. Sony said it will announce the financial effect of the measures in January when it reports fiscal third-quarter results.
The job reductions beyond full-time employees will affect subcontractors, seasonal workers and people hired on a daily, weekly or monthly basis, said Mami Imada, a Sony spokeswoman. Temporary workers typically don’t get the same benefits Sony’s full-time workers receive, she said. “The reason for this move is the deterioration of the economy, which was much larger than we expected,” Senior Vice President Naofumi Hara said.
Sony said on Oct. 23 that net income will probably drop 59 percent in the year ending March 31, reducing the outlook by 38 percent as the stronger yen and slumping demand undermine sales of its electronics including Bravia televisions. The company will review the effect of the reorganization and revise its current-year and mid-term profit targets if needed, Hara said. Sony faces no problem with cash flow, he said.
Panasonic Corp., the world’s biggest consumer-electronics maker, cut its full-year profit outlook by 90 percent Nov. 27. “We are working on reorganizing our global operations, reducing costs and speeding up structural changes to weather this crisis,” Akira Kadota, a spokesman at Panasonic in Tokyo, said today. He declined to comment on the possibility of job cuts. All reductions will take place by March 31, 2010, Sony said. Hara declined to provide the number of people on contract.
Faltering consumer spending led companies including AT&T Inc. and DuPont Co. to announce more than 15,000 job cuts this month. The number of people on jobless benefit rolls in the U.S., one of the biggest markets for Asian exporters including Sony and Panasonic, climbed to a 26-year high in the week ended Nov. 22.
The Bravia-brand TV maker said it will “adjust” pricing to cope with the stronger yen, two weeks after saying it didn’t have plans for “massive cuts” in prices in the U.S. The yen has surged 21 percent against the dollar and 38 percent versus the euro this year, hurting Sony’s overseas earnings. Sony shares traded at the equivalent of 1,906 yen as of 2:11 p.m. in Frankfurt, up 0.5 percent from the Tokyo closing price.
Sony said it will invest 30 percent less in its electronics business than planned under its mid-term strategy, without giving figures. The company will also cut the number of manufacturing sites by 10 percent by the end of next fiscal year, from 57 currently.
Sony will postpone investment plans at its Nitra plant in Slovakia that assembles liquid-crystal-display televisions for the European market. The electronics maker plans to end production at two overseas manufacturing sites, including one in France that produces tape and other recording media. “These initiatives are in response to the sudden and rapid changes in the global economic environment,” Sony said.
Science paves way for climate lawsuits
People affected by worsening storms, heatwaves and floods could soon be able to sue the oil and power companies they blame for global warming, a leading climate expert has said. Myles Allen, a physicist at Oxford University, said a breakthrough that allows scientists to judge the role man-made climate change played in extreme weather events could see a rush to the courts over the next decade. He said: "We are starting to get to the point that when an adverse weather event occurs we can quantify how much more likely it was made by human activity. And people adversely affected by climate change today are in a position to document and quantify their losses. This is going to be hugely important."
Allen's team has used the new technique to work out whether global warming worsened the UK floods in autumn 2000, which inundated 10,000 properties, disrupted power supplies and led to train services being cancelled, motorways closed and 11,000 people evacuated from their homes - at a total cost of £1bn. He would not comment on the results before publication, but said people affected by floods could "potentially" use a positive finding to begin legal action. The technique involves running two computer models to simulate the conditions that led to extreme weather events. One model includes human-caused emissions of greenhouse gases, the second assumes the industrial revolution never happened and that carbon levels in the atmosphere have not increased over the last century. Comparing the results pins down the impact of man-made global warming. "As the science has evolved this is now possible, it's just a question of computing power," he said.
Allen and his colleagues previously demonstrated that man-made warming at least doubled the risk of heatwaves such as the 2003 event that killed 27,000 people across Europe. No legal action resulted, but Allen said that was partly because most of the deaths were in France, where the legal system makes such cases difficult. "We can work out whether climate change has loaded the dice and made extreme weather more likely. And once the risk is doubled, then lawyers get interested," he said. Peter Roderick, director of the Climate Justice programme, said the most likely route for seeking damages would be tort cases, which deal with civil wrongs. Several have been attempted by US states against power and car companies only to be rejected by the courts.
Roderick said developing countries such as Nepal could also sue for compensation over damage caused by global warming. "As the issue of damages gets worse and worse, the chances of this happening will get greater and greater," he said. "I hope it happens." Lawyers say it is only a matter of time before class actions are brought. However, Stephen Tromans, an environmental law barrister, said establishing causation would be one of the main difficulties. "It is one thing to be able to link levels of greenhouse gases with a specific event causing damage but, even assuming you can do that, quite another to establish causation against a particular company or industrial sector."
There are legal precedents for making exceptions to normal rules of causation. One example is the decision of the House of Lords on mesothelioma, where past employers can be liable for having contributed to the overall exposure, though the harm cannot be scientifically attributed to any specific period of employment. "In that case an exception was made to the normal rules on causation in order to prevent an injustice that would otherwise have occurred," Tromans said. There may also be grounds for a case on the basis that firms have tried to misinform the public - as in US cases against tobacco firms - about the effects of their business. Owen Lomas, head of environmental law at City firm Allen & Overy, said: "If you look at the extent to which certain major companies in the US are accused of having funded disinformation to cast doubt on the link between man-made emissions and global warming, that could open the way to litigation."
Taking flight to London in search of a job
KEVIN DOWNES rubs his tired eyes as he boards the early-morning flight from London, embarking on another hectic weekend of hurling for his home county of Cavan. The routine for the county's former player of the year during the championship season is exhausting: up in the early hours of Saturday, flying to Dublin, getting a lift to Cavan, playing a match, flying back to London that night, and playing the next day for his adopted club Tir Chonnail Gaels near Wembley.
It's been this way since he emigrated to London in June. Work dried up in his field of environmental consultancy, one of many sectors hit since the collapse of the construction industry. "There were lots of people asking me to hang around, but no one could guarantee me a job. All the factories were shedding staff. Often in the GAA there's a builder who might throw you some work, but things were so tight that that wasn't even possible," he says.
He's not sure how long he can keep up with the chaotic commute between the UK and Ireland. In any case, it mightn't be a problem for much longer. As the recession hits the UK, he thinks he'll be looking even farther afield for work before long. "I'm not alone. There are lots of teams being affected, mostly country teams with tradesmen, carpenters, electricians. Over the next year, every team is going to lose at least a handful of players. This is only the tip of the iceberg, as I see it." The emigration of one of the county's brightest GAA talents is a stark reminder that the spectre of forced emigration may be descending on a young generation which has only ever experienced good times.
Figures show that the majority of those being laid off are aged between 20 and 34 years. On top of that, Cavan, like other commuter belt counties, is being disproportionately hit by the rapid rise in unemployment. Live register figures jumped by 86 per cent at the social welfare office at Cavan town and 93 per cent in Ballyconnell over the past year, compared to a national average of 66 per cent. Most of those being laid off are from commuter belt areas in the south of the county such as Virginia, Ballyjamesduff and Kingscourt, which expanded rapidly during the boom years. And it's to places such as Kingscourt that you go to see the recession at its most visible on the streets, in the shops and on the factory floors.
For the best part of a century this bustling market town, located near Meath, Louth and Monaghan, has been a hive of industrial activity. The rich deposits of gypsum, the main ingredient in the manufacture of plasterboard, gave rise to Gypsum Industries. Other major construction firms followed, such as the building suppliers Kingspan, brick producers Kingscourt Brick, O'Reilly Concrete and Hangar industrial doors. At the height of the boom, the streets would be congested with articulated lorries, commercial vans and private vehicles. It could take minutes for pedestrians to be able to cross the busy roads. But today, on a cold, wintry afternoon, everything is quiet. "You can fly through here now," says David Blake (39), who runs Blake's pub on the main street, which has been in the family for three generations.
"The big traffic jams are gone. In the plants, a lot of workers are just standing around doing nothing. There are no orders coming in. They've been letting a lot of people go in dribs and drabs. All in all, well over a hundred have been let go so far, and there's talk of more over the next few months." His own trade on week days has been hit, with younger men either leaving the area or cutting back on spending. Deli counters at the shops are quiet too, he says, while retail is down across the board. "The vans which would be going off to Dublin with a few lads have basically stopped," says Blake. "Many of them have headed off to the UK, Australia or the US - anywhere they can find work."
These are worrying times for people like Declan Ferry, Siptu's recently appointed Cavan branch organiser, whose days are regularly taken up with crisis calls from employees in firms that are going to the wall. "It's bad in Kingscourt but, at least for the moment, many businesses are trying to hold their own and trying to ride through the storm," he says. There have been some positives amid an overwhelming drip-feed of bad news, though. A Belgian firm which makes wind turbines expanded its workforce by 70, while another firm is hiring 30 others for research and development into green energy. Otherwise, though, the live register locally continues to head in the wrong direction.
For public representatives, anger on the doorsteps is palpable, no matter of what political hue they are. "In the last few months you can feel the frustration and fear in people," says Seán McKiernan, a Fine Gael councillor in his late 20s and based in Bailieborough. "You see the people you went to school with, the same age as you, maybe with a few kids, and they haven't worked in a few weeks. They're looking out at you from a house which has lost a lot of its value, but they still have to serve a very big mortgage." Some of these people were on very good salaries, he says, buying a second home because everyone else was, but who are now facing an incredibly precarious financial situation. Many of these young couples are up to their necks in debt, after getting easy credit from almost every available source at the height of the boom.
Anne McKiernan, the co-ordinator of Cavan's Money Advice and Budgeting Service, is seeing them on a regular basis. Demand for appointments at the office in Cavan town is so strong that a backlog extends right up until mid-January. "There can be a lot of denial from people who are embarrassed and ashamed at the way they've over-borrowed," she says. "People are very grateful for whatever advice or support we can give. Their heads can be in such a muddle, even though they have been successful in business. "They'll often have a large mortgage, three or four credit cards, a personal loan and car loans. They were going to be heading for disaster anyway, but it's all happened very quickly for many of them."
When the agency works with these people, dramatic changes in lifestyle tend to follow. First their social life goes, followed by cutting off direct debits for TV or the internet. The car will go soon after, to avoid it being repossessed by the finance company. "Some people with very nice houses don't even have the money for fuel," McKiernan adds.
As recrimination over the dramatic collapse in the economy continues, some point to grassroots work by the community and voluntary sector as evidence of a more sustainable economic model. The Bailieborough Development Association Ltd, for example, was established in 1996 by a number of local people who were concerned about the social and economic well-being of the area. It has established an enterprise centre on the site of an old factory and a childcare service for school-age children, allowing parents to work full-time or undertake education and training.
For public representatives like Seán McKiernan, it's a sign of what cohesive communities can do when they come together. Following a major study into the needs of the area, the development association in Bailieborough is going to target the potential to create "green" jobs, as well as research and development. "There is a lot of frustration that the wealth created over the last few years hasn't resulted in better roads or a better developed tourism sector," he says. "But communities can do an awful lot for themselves. The thinking in the community and voluntary sector here is, let's address the problems we see ourselves."
More Glaswegians sleeping rough, credit crunch congress told
The economic crisis could result in an increase in the number of people sleeping rough in Glasgow, voluntary sector workers warned yesterday. Speaking at a credit crunch conference in Glasgow University, Claire Frew, development co-ordinator for the Glasgow Homelessness Network, said more needed to be done to help those at the sharp end of the downturn. During the conference, attended by delegates from voluntary sector organisations across Scotland, Ms Frew said that figures from Glasgow street services showed that between April and June 2007, there was a 106% increase in the number of people sleeping rough over the same quarter in the previous year. She said homelessness charities in Glasgow in particular are under "real strain".
Speaking to delegates, who had gathered to discuss ways of lessening the impact of the credit crisis, she quoted a case study concerning a homeless male who presented himself to staff at Glasgow City Council in October seeking accommodation. According to Ms Frew, he was told by council staff that there was no accommodation available and that he should "access a sleeping bag" from one of the voluntary sector services. The man then slept rough for three nights in Castlemilk before accommodation was arranged for him by the council. Ms Frew urged local authorities to implement a winter emergency plan for what is becoming a priority issue.
A Glasgow City Council spokeswoman said: "No increase in rough sleeping in the city has been reported to the Homelessness Partnership by the Street Team, Glasgow Community Safety Services, Strathclyde Police or other services working with homeless people in the city." Stewart Maxwell, communities and sport minister, said the Scottish Government will devote approximately £1m to fund additional face-to-face guidance for those in financial difficulty. Meanwhile, the Office of Fair Trading announced plans to carry out a market study into the home-buying and selling process.
Number of hungry people rises to 963 million
9 December 2008, Rome - Another 40 million people have been pushed into hunger this year primarily due to higher food prices, according to preliminary estimates published by FAO today. This brings the overall number of undernourished people in the world to 963 million, compared to 923 million in 2007 and the ongoing financial and economic crisis could tip even more people into hunger and poverty, FAO warned.
"World food prices have dropped since early 2008, but lower prices have not ended the food crisis in many poor countries," said FAO Assistant Director-General Hafez Ghanem, presenting the new edition of FAO's hunger report, The State of Food Insecurity in the World 2008."For millions of people in developing countries, eating the minimum amount of food every day to live an active and healthy life is a distant dream. The structural problems of hunger, like the lack of access to land, credit and employment, combined with high food prices remain a dire reality," he stressed.
Prices of major cereals have fallen by over 50 percent from their peaks earlier in 2008 but they remain high compared to previous years. Despite its sharp decline in recent months, the FAO Food Price Index was still 28 percent higher in October 2008 compared to October 2006. With prices for seeds and fertilizers (and other inputs) more than doubling since 2006, poor farmers could not increase production. But richer farmers, particularly those in developed countries, could afford the higher input costs and expand plantings.
As a result, cereal production in developed countries is likely to rise by at least 10 percent in 2008. The increase in developing countries may not exceed even one percent."If lower prices and the credit crunch associated with the economic crisis force farmers to plant less food, another round of dramatic food prices could be unleashed next year," Ghanem added. "The 1996 World Food Summit target, to reduce the number of hungry by half by 2015, requires a strong political commitment and investment in poor countries of at least $30 billion per year for agriculture and social protection of the poor," Ghanem said.
The vast majority of the world's undernourished people - 907 million - live in developing countries, according to the 2007 data reported by the State of Food Insecurity in the World. Of these, 65 percent live in only seven countries: India, China, the Democratic Republic of Congo, Bangladesh, Indonesia, Pakistan and Ethiopia. Progress in these countries with large populations would have an important impact on global hunger reduction .With a very large population and relatively slow progress in hunger reduction, nearly two-thirds of the world's hungry live in Asia (583 million in 2007). On the positive side, some countries in Southeast Asia like Thailand and Viet Nam have made good progress towards achieving the WFS target, while South Asia and Central Asia have suffered setbacks in hunger reduction.
In sub-Saharan Africa, one in three people - or 236 million (2007) - are chronically hungry, the highest proportion of undernourished people in the total population, according to the report. Most of the increase in the number of hungry occurred in a single country, the Democratic Republic of Congo, as a result of widespread and persistent conflict, from 11 million to 43 million (in 2003-05) and the proportion of undernourished rose from 29 to 76 percent. Overall, sub-Saharan Africa has made some progress in reducing the proportion of people suffering from chronic hunger, down from 34 (1995-97) to 30 percent (2003-2005). Ghana, Congo, Nigeria, Mozambique and Malawi have achieved the steepest reductions in the proportion of undernourished. Ghana is the only country that has reached both the hunger reduction target of the World Food Summit and the Millennium Development Goals. Growth in agricultural production was key in this success.
Latin America and the Caribbean were most successful in reducing hunger before the surge in food prices. High food prices have increased the number of hungry people in the sub-region to 51 million in 2007. Countries in the Near East and North Africa generally experience the lowest levels of undernourishment in the world. But conflicts (in Afghanistan and Iraq) and high food prices have pushed the numbers up from 15 million in 1990-92 to 37 million in 2007. Some countries were well on track towards reaching the summit's target, before food prices skyrocketed but "Even these countries may have suffered setbacks - some of the progress has been cancelled due to high food prices. The crisis has mainly affected the poorest, landless and households run by women," Ghanem said. "It will require an enormous and resolute global effort and concrete actions to reduce the number of hungry by 500 million by 2015."
The world hunger situation may further deteriorate as the financial crisis hits the real economies of more and more countries. Reduced demand in developed countries threatens incomes in developing countries via exports. Remittances, investments and other capital flows including development aid are also at risk. Emerging economies in particular are subject to lasting impacts from the credit crunch even if the crisis itself is short-lived.