Inaugural ceremony, East Front of Capitol.
Woodrow Wilson being sworn in as 28th president of the United States.
Ilargi: First of all, I don't want to deny anyone the right to a party. Still, as I said yesterday, I have the feeling that many people think that the higher the price-tag, the more the event will be enjoyed. I know from my own experience that this is not true. The best parties are the ones that come with the most spontaneity. In the case of Washington these days, spontaneity is nowhere to be found. We have to party, we must, because we are so desperate for change, because we need so badly for some person or some event to give us hope.
That's why we will party, for instance because Bush is gone, and we can project all bad things on the man, so the future looks cleansed of all evil, and we can in turn project all good things on the new man. To achieve that goal, we willingly forget that the foundations for the economic downfall that stresses us so much and feeds the grinding need for hope of any kind, were laid to a very large extent under a Democratic president, not under Bush. And that would still be alright, what lies in the past cannot be repaired, what's done is done and we need to do the best we can in the future that starts tomorrow.
Yes. Right. But. The core of Obama's economic team is formed by the very same people who under Clinton were responsible for the policies that made it possible for the financial system to incur the losses that are devastating our societies today. The policies directly responsible for the unparalleled and unprecedented debt levels individuals and societies find themselves in on the eve of tomorrow's inauguration. Now, I like to believe, and I like to hope, as much as the next person. But that doesn't mean that I will believe that the same cabal that gutted the legislative principles which kept the banking system from preying on the common people, will all of a sudden do a U-turn and save the system from the very damage they themselves did to it a decade ago.
If people want me to believe that sort of thing, I get an awfully eery feeling about the slogan "Change We Can Believe In". I want more than faith from, and in, the crew that is supposed to save the world from gutter-wrenching disaster. I don't just want to hope that they can accomplish that. But I'm not getting anything more than faith and hope, than religion and great expectations. It's not just that Robert Rubin and Lawrence Summers, who were singularly responsible for the disastrous 1999 repeal of Glass-Steagall, are now back in their power saddles. There's also the fact that many of the representatives who voted for Gramm-Leach-Bliley are still around. When it comes to doing what is needed, I don't trust these people, I have no faith in them, and they wipe out all the hope I may once have had that there will be a change I can believe in.
In the past while, I've been criticized a lot for saying things like this. Expressing doubts about any religion's building blocks is of course always a risky venture. In belief systems, the truth is self-evident, there is no need for proof. These reactions make me feel like I’m taking a favorite toy away from a whining toddler, who has no idea that the brightly colored object with the soothing sounds that (s)he’s contentedly been sucking on contains a highly toxic and potentially lethal brew of dyes.
We can all cheer our throats dry if Obama close Guantanamo Bay, the hell-hole that will linger for decades around the planet as the true image of what the United States of America stands for. If we have some cheers left in us, we can rejoice if the president activates a bunch of windmills or pays for a pack of destitute former GM workers to pave roads their cars no longer drive on.
But that is not where out main problems are. They are in the financial system, in the economy, in debt, in unemployment, in foreclosures and in general in an irreparably broken American Dream. And when it comes to these, the main and most urgent problems, all we have to show for ourselves is hope and belief, dashed even before the get-go moment by the appointments of the wrong people in the most crucial positions, as well as the announcements about taxpayers’ funds that will soon be used for the same purposes, just in even higher amounts, that $8 trillion have so far been thrown at, in the worst imaginable policy failure, so bad that the term criminal will hang over it.
Believe, hope and party all you will. Just take a moment to wonder if perhaps the price for the festivities will be far higher than the $50 million you have seen in the media. The news coming out of Europe today is terrible. RBS lost 66.57% of its value in one day. That is our present, and it is our future. Believe what you will.
President Obama 'has four years to save the Earth'
Barack Obama has only four years to save the world. That is the stark assessment of Nasa scientist and leading climate expert Jim Hansen who last week warned only urgent action by the new president could halt the devastating climate change that now threatens Earth. Crucially, that action will have to be taken within Obama's first administration, he added. Soaring carbon emissions are already causing ice-cap melting and threaten to trigger global flooding, widespread species loss and major disruptions of weather patterns in the near future. "We cannot afford to put off change any longer," said Hansen. "We have to get on a new path within this new administration. We have only four years left for Obama to set an example to the rest of the world. America must take the lead."
Hansen said current carbon levels in the atmosphere were already too high to prevent runaway greenhouse warming. Yet the levels are still rising despite all the efforts of politicians and scientists. Only the US now had the political muscle to lead the world and halt the rise, Hansen said. Having refused to recognise that global warming posed any risk at all over the past eight years, the US now had to take a lead as the world's greatest carbon emitter and the planet's largest economy. Cap-and-trade schemes, in which emission permits are bought and sold, have failed, he said, and must now be replaced by a carbon tax that will imposed on all producers of fossil fuels. At the same time, there must be a moratorium on new power plants that burn coal - the world's worst carbon emitter.
Hansen - head of the Goddard Institute of Space Studies and winner of the WWF's top conservation award - first warned Earth was in danger from climate change in 1988 and has been the victim of several unsuccessful attempts by the White House administration of George Bush to silence his views. Hansen's institute monitors temperature fluctuations at thousands of sites round the world, data that has led him to conclude that most estimates of sea level rises triggered by rising atmospheric temperatures are too low and too conservative. For example, the Intergovernmental Panel on Climate Change says a rise of between 20cm and 60cm can be expected by the end of the century.
However, Hansen said feedbacks in the climate system are already accelerating ice melt and are threatening to lead to the collapse of ice sheets. Sea-level rises will therefore be far greater - a claim backed last week by a group of British, Danish and Finnish scientists who said studies of past variations in climate indicate that a far more likely figure for sea-level rise will be about 1.4 metres, enough to cause devastating flooding of many of the world's major cities and of low-lying areas of Holland, Bangladesh and other nations. As a result of his fears about sea-level rise, Hansen said he had pressed both Britain's Royal Society and the US National Academy of Sciences to carry out an urgent investigation of the state of the planet's ice-caps. However, nothing had come of his proposals. The first task of Obama's new climate office should therefore be to order such a probe "as a matter of urgency", Hansen added.
See full interview at the bottom of this post
Four fixes for America’s fiscal fiasco
It is safe to assume that in his address on Tuesday, Barack Obama will invoke the need for shared sacrifice. The idea is a banker, forgive the expression, for any inaugural, but especially now. Equally predictable is that he will develop the theme with a certain inattention to detail. It is inspiring to call for sacrifice but something of a downer to tell people too precisely what that sacrifice is going to be. Allow me to shoulder this burden. The US economy’s perilous condition calls for extreme fiscal activism. The new administration’s stimulus plans are by no means over the top. If anything, a fiscal injection of $800bn (€602bn, £543bn) over two years is too modest. But the implication of so strong a fiscal boost is a swift and severe worsening of the country’s long-term fiscal position. During his eight years in office – fat ones, for the most part, from a fiscal point of view – President George W. Bush moved the budget balance from surplus to structural deficit.
Demographic and other pressures will worsen the position over the next decade or two. Now comes a fiscal expansion that will be only partly counter-cyclical: some of the new president’s spending will not reverse automatically as the economy recovers. A structural deficit of the sort taking shape is unsustainable and will be corrected one way or the other – if not by a timely change in policy, then by a new and potentially even worse financial calamity. What would it take for the milder of these alternatives to prevail? The short answer, once the economy has recovered, is this: higher taxes. This is not to say that “entitlement reform” – to curb spending on programmes such as Social Security and (especially) Medicare – should not be tried. Peter Orszag, the incoming budget director, is a specialist in this area. One can take it for granted that he will do what he can, through improvements in efficiency, to rein in these costs.
But this will get the budget only part of the way back towards balance. Reversing the Bush tax cuts, which Democrats are rabid to do on a point of principle, regardless of the fiscal outlook, also helps but is still not enough. In this election, the US has chosen bigger government over smaller government. Bigger government means higher taxes: higher, in view of the prospective deficits and the new president’s spending ambitions, than they were before Mr Bush cut them. But the country has an idiotic income tax system. Because the tax has a narrow base (to say nothing of its ever-proliferating complexity), it requires relatively high marginal rates on those who pay it to raise surprisingly little revenue. Without wholesale base-broadening reform, using this system to fill more than a small part of the revenue hole should be out of the question. Attempting such reform is of course one option, but who knows what atrocity would emerge from Congress if that heroic project were taken on. Simpler, bolder fixes may be the only way to assure the country’s creditors that public borrowing is to be brought back under control.
Very well. Here is what needs to be done, starting in 2011, but to be announced and enacted as soon as possible. First, raise the retirement age. Second, phase out income tax relief on new mortgage loans. Third, introduce a carbon tax. Fourth, introduce a national value added tax, tied to healthcare reform. Each of these changes would be desirable even if a fiscal emergency were not in prospect. (In that case, the revenues could be used to lower other taxes.) A higher retirement age is justified by the recent improvement in life expectancy alone. Generous tax relief for mortgages – and the home ownership fetish it gratifies – helped cause the current mess. If any tax subsidy should be marked for extinction once the economy has recovered, this is it. The Obama administration has already promised a cap-and-trade regime for carbon emissions. A carbon tax would achieve the same environmental goal with greater clarity, fewer opportunities for gaming and a firmer commitment to gather additional revenue. A cap-and-trade system with all permits auctioned and some other tweaks would be the next best thing.
I wrote about a proposal to tie universal healthcare to a new VAT in this space on May 18 last year, acknowledging the immense political difficulties but saying that the idea had great merit. Circumstances have changed and today the case for this approach is stronger. Linking outlays on health to the proceeds from a VAT would bring a new element of fiscal discipline and political accountability to controlling the country’s runaway health spending. And now, much more than before, the government needs the money. Many Democrats will object to these ideas on the grounds that they are regressive, as measures to broaden the tax base tend to be. If they stick to that line, the result will be dangerously large deficits until the crunch comes and punishingly high rates of income tax as well. Many Republicans will also object, on the grounds that new sources of revenue will fuel ever faster expansions of government spending. They subscribe to the masochistic school of thought that says raising taxes should hurt as much as possible, to curb the growth of the state. On this view, enormous deficits are a way to “starve the beast”. History shows they do not. New taxes. This is what shared sacrifice – as opposed to letting somebody else pay – looks like. Too ugly to dwell on in the inaugural address, the implacable fiscal arithmetic will still be there when the ovations have stopped.
Ilargi: Ambrose Evans-Pritchard has been swinging his teeny tiny little pen in a wild and drunken manner lately. Here he is suggesting that a government may make a profit on the toxic assets a bad bank accumulates: after all, this happened (sorta kind of) in the S&L crisis. It’s not 100% impossible, but what are the odds? It’s not just gambling, it’s a stupid bet, and only the most desperate losers would consider it. Which they will, mind you, as long as they have access to other people’s money. A jubilee is a fancy idea, but it would wipe out the entire financial system, which is what all the boyz are trying to prevent.
Biblical debt jubilee may be the only answer
Once again, Britain leads the world in the macabre speciality of saving banks. The Treasury's £200bn plan to soak up toxic debt will be followed within days by a US variant from the Obama team. Germany cannot be far behind. As one bail-out succeeds another at ever more inflated price tags, rescue fatigue is becoming palpable. People are bewildered, fearing that good money is being thrown after bad. The doubts are understandable but there are tentative signs of a thaw in the global credit system. Libor lending rates in the US, Britain and Europe have fallen sharply. US mortgage rates have dropped from 6.5pc to 4.88pc since October. Companies can issue bonds again.
"It is easy to conclude that none of the Government's policies are working," said Professor Peter Spencer from York University. "We must not lose sight of the fact that they have prevented the collapse of the monetary system." This is not does mean that recovery is imminent. Nothing can prevent a long purge as years of credit leverage give way to debt deflation. It means only that the downward spiral – the "adverse feedback loop" feared by central banks – has been arrested. The first three pillars of the global bail-out are in place. Government money is rebuilding the annihilated capital of banks. This has further to run. Core lenders in the US, Europe and parts of Asia will be nationalised, but that is a detail at this point. It scarcely matters who owns the banks – unless you are a shareholder – so long as they lend.
The Fed has cut rates to zero. It is buying mortgage securities on the open market, and eying Treasury debt next. Fellow central banks are exploring their own ways to print money. The $3 trillion (£2 trillion) fiscal blitz by the US, China, Japan and Europe plugs an emergency gap. With luck, it will keep the world economy on life-support just long enough to stop recession and banking crises from feeding on each other with lethal effect, as they did in 1931. The latest plans to "ring-fence" bad debts in sceptic tanks puts in place the fourth pillar. The UK Treasury's version involves a state insurance scheme, letting banks shuffle off their crippling loads and escape mark-to-market torture. The US version is a "bad bank" for mortgage debt. It is more or less the old "TARP" passed by Congress, before the funds were diverted into bank recapitalisations. This method worked after the Savings & Loan crisis in the 1980s. The market found a floor. The Treasury even made a profit.
German finance minister Peer Steinbrück said he "could not imagine" a bad bank in his country. Time will tell. Der Spiegel reports that Germany's top 20 banks have €300bn (£270bn) of bad debt, booked at "illusory" prices. They have written down just a quarter of their losses. Taken together, the rescues may make the difference between global recession and a deeper slump that causes mass unemployment and social turmoil, perhaps destroying the open global order we take for granted. We can only guess. There is no guarantee that the measures will succeed. The vast scale of government borrowing may exhaust the stock of global capital. Markets are already beginning to question the credit-worthiness of sovereign states. The Fed may find it harder than it thinks to disengage from colossal intervention in the bond markets. In the end, the only way out of all this global debt may prove to be a Biblical debt Jubilee. Creditors are not going to like that.
How the Ensure that an Aggregator (or Bad) Bank Isn't Another Taxpayer-Financed Boondoggle for the Banks That Got Us Into This Mess
It looks increasingly likely that a big chunk of the TARP II funds will be used to set up what's being called an "aggregator" -- or "bad" -- bank to buy up the bad assets that continue to hobble the balance sheets of private-sector banks. That's what Hank Paulson and Sheila Bair suggested Friday. Obama officials-in-waiting seem to view the idea favorably. A Bad Bank is surely better than the piecemeal, unpredictable, and opaque approach of TARP I. But in order that the Bad Bank not turn into another giant taxpayer-financed boondoggle for the benefit of shareholders, creditors, executives, traders, and directors of the banks that got us into this mess in the first place, any Bad Bank purchase of their toxic assets ought to carry conditions similar to the ones I suggested recently for dispensing TARP II funds.
Until the taxpayer-financed Bad Bank has recouped the costs of these purchases through selling the toxic assets in the open market, private-sector banks that benefit from this form of taxpayer relief must (1) refrain from issuing dividends, purchasing other companies, or paying off creditors; (2) compensate their executives, traders, or directors no more than 10 percent of what they received in 2007; (3) be reimbursed by their executives, traders, and directors 50 percent of whatever amounts they were compensated in 2005, 2006, 2007, and 2008 -- compensation which was, after all, based on false premises and fraudulent assertions, and on balance sheets that hid the true extent of these banks' risks and liabilities; and (4) commit at least 90 percent of their remaining capital to new bank loans.
Ilargi: When even Krugman loses his buy buy buy religion, there must be something wrong with the idea.
More on the bad bank
OK, I’ve been doing more homework on the “bad” or “aggregator” bank idea that seems to be gaining ground. And here’s what I think: it’s mainly based on a false analogy. What people are thinking about, it’s pretty clear, is the Resolution Trust Corporation, which cleaned up the savings and loan mess. That’s a good role model, as far as it goes. But the creation of the RTC did not rescue the S&Ls. The S&Ls were rescued by (1) having FSLIC seize them, cleaning out the stockholders (2) having FSLIC pay down enough debt to make them viable (3) reselling them to new investors. The RTC’s takeover of the bad assets was just a way for taxpayers to reclaim some of the cost of recapitalizing the banks.
What’s being contemplated now, if Sheila Bair’s interview is any indication, is the creation of an RTC-like entity without the rest of the process. The “bad bank” will pay “fair value”, whatever that is, for the assets. But how does that help the situation? It looks as if we’re back to the idea that toxic waste is really, truly worth much more than anyone is willing to pay for it — and that if only we get the price “right”, the banks will turn out to be solvent after all. In other words, we’re still in Super-SIV territory, the belief that fancy financial engineering can create value out of nothing. Color me skeptical. I hope the buzz is wrong, and that something more substantive is being planned. Otherwise, we’re looking at Hankie Pankie II: Paulson may be gone, but officials are still determined to believe in financial magic.
TARP: The Sequel
Now, the debate over how to spend the second $350 billion of the government rescue program. This time, distressed homeowners may get help. There was great dissension among economists and public policy experts over the use of the first $350 billion from the Troubled Asset Relief Program last fall after numerous false starts and even after the Treasury Dept. settled on its primary TARP strategy: pumping money into a handful of financial service companies in hopes of preventing a repeat of the failure of Lehman Brothers. With the success of that initial effort still in doubt, how the second tranche of the financial rescue funds should be applied (once the Obama Administration is in place) will be no less contentious.
This week, senior officials at the Federal Reserve cited the need for further cash infusions into the weaker financial institutions, even as one of the original TARP recipients, Citigroup (C), announced the sale of a controlling stake in its retail brokerage unit, Smith Barney, to Morgan Stanley (MS) to bolster its capital position. Citi has already gotten $45 billion in cash and a government guarantee for up to $300 billion in losses on its balance sheet. So the bank's need for more cash doesn't inspire much confidence that the TARP funds have been well spent. Fed Chairman Ben Bernanke acknowledged the gulf between the preferential treatment of the financial sector and other ailing industries, such as auto manufacturers, but said it "appears unavoidable" in view of the U.S. economy's reliance on the credit the financial industry provides. On Jan. 15, the U.S. Senate voted 52-48 to approve the release of the second tranche of TARP funds to the Treasury Dept. With so much riding on the recovery of the U.S. financial system, BusinessWeek asked banking and economic experts to weigh in on the best use of the remaining funds.
David Beim, a professor in the finance and banking department at the Columbia Business School, says he doesn't support giving more money to the banks, especially if they themselves don't know whether they're solvent or not, as they can't be sure of the value of their own assets. And "asset values remain in doubt because we don't know how deep the recession is going to be, and because the securitized mortgage bonds (both commercial and home) are still too complex for investors to analyze," he wrote in an e-mail. Once the condition of the banks becomes clear, those that are undercapitalized should be required to raise more capital or sell assets, while those that are insolvent should be closed, just as the FDIC closed several thousand banks and thrifts between 1986 and 1992, he said. Beim recommended that the remaining TARP money be directed toward complex and illiquid assets, but in a more creative way than Treasury first proposed. Rather than buying assets, Treasury would do better to lend the money to private entities, such as institutional investors "willing to put their own capital at risk to buy them," he said. "This is the time to encourage 'vulture funds' and others to come out of the woods and go to work." That would stimulate the private sector to discover the right price level and jump-start a market for toxic assets, he added.
Others argue that TARP has failed because it hasn't cut to the root of the credit crisis: the rise in foreclosures on poorly vetted home loans, which has turned a vast assortment of securitized products into a toxic brew. H.R. 384, the bill proposed by Rep. Barney Frank (D-Mass.) under the working title of the TARP Reform & Accountability Act of 2009, suggests setting aside a portion of the rescue funds—"up to $100 billion but in no case less than $40 billion"—to prevent and reduce residential foreclosures. President-elect Obama has promised to use as much as $100 billion of the TARP money in this way. In testimony before Congress on Jan. 13, John Taylor, president and chief executive of the National Community Reinvestment Coalition (NCRC), proposed using the doctrine of Eminent Domain as the legal basis for the government to buy 3 million to 5 million home loans at a 30% to 35% discount from homeowners who still have jobs and are good credit risks. That would allow the principal on these mortgages to be reduced so that families can afford to stay in their homes.
A number of congressmen balked at the idea, wary of trumping states' rights, says Taylor. Given that the continuing decline in home values and mounting foreclosures pose the biggest threat to the value of securitized assets on financial institutions' balance sheets, it seems logical to modify home loans in order to forestall additional foreclosures and minimize further writedowns of bank assets. Opponents of that solution, however, cite a recent report by the Office of the Comptroller of the Currency showing that more than half the borrowers who received loan modifications in the first six months of 2008 have defaulted on their new loans as well. The prospect of modifying mortgages is further complicated by the political pushback that's likely to result from giving more irresponsible homeowners a break at the expense of taxpayers who didn't overreach their means and have kept up with their monthly payments, says Bert Ely, a principal at Ely & Co., an Alexandria (Va.) consulting firm for financial institutions.
Professor Cornelius Hurley, director of the Graduate Program in Banking and Financial Law at the Boston University School of Law, likes the idea of setting up a separate entity for all the bad assets the government could take off the banks' balance sheets—the so-called good bank/bad bank solution used to resolve the savings and loan crisis in the early 1990s. Although in one respect it's only cosmetic, such a measure would probably succeed "because it puts the focus on getting rid of bad assets and allows the core bank that is generating operating earnings to be identified as such," he says. Allowing the government to take an ownership stake in the banks in the form of preferred shares would also lower the risk of over- or underpricing the assets being acquired, which scuttled the original intended use of TARP funds. If the Treasury pays too much for an asset, it has essentially paid itself, because now it would be a shareholder in the institution it bought from, says Hurley.
But before the government resorts to a good bank/bad bank solution, "you've got to know what assets are in these institutions, since splitting off the bad assets can result in such a capital hole—filled by new investors in the good bank—that the original shareholders could be wiped out," says Henry Owsley, a partner at the Gordian Group, a financial advisory firm that provides services to companies in distress. How the TARP money is used is ultimately much less important than reinvigorating regulators' will to get a handle on the actual condition of bank balance sheets, he believes. Owsley says he's appalled at the government's readiness to invest in these banks "simply by throwing money blindly and recklessly at problems it doesn't understand," without any due diligence with respect to the value of their assets or demanding more transparency on the balance sheets. "None of these things would happen in the private sector," he says. Regulators were far more proactive in dealing with the S&L crisis, he says. "The Office of Thrift Supervision made institutions mark their capital down, and when there was a problem, it made institutions merge with healthier institutions," he says.
Small and midsize banks should be allowed to fail, but that can't be an option for the handful of truly large banks that have such extensive interaction with the U.S. and global economies, says Richard Marston, finance professor at the University of Pennsylvania's Wharton School of Business. Hence, he sees injecting cash to strengthen the capital at these larger banks as the most important use of the remainder of the TARP funds. "Some are so large that even if we knew that their asset positions had to be marked down, we should still inject equity into them," he says. "There's no doubt there's some very rotten assets on the balance sheets of these big banks, even JPMorgan (JPM). The federal authorities in doing due diligence recognize that." One government program that makes sense to Gordian's Owsley, and that he hopes will succeed, is the term asset-backed securities loan facility, or TALF, which the Fed announced right before Thanksgiving. Under the $200 billion program, which takes effect in February, the government will provide a major part of one-year financing to investors willing to buy new triple-A securitizations of credit card, student, auto, and small business loans.
If it works, it could be expanded to include mortgage loans and other distressed assets, says Owsley, though others disagree. Owsley likes the fact that TALF requires third-party purchasers to step in and put at least some money down on assets, which would amount to a "pretty fair test of value." Changing the bankruptcy laws to allow homeowners to renegotiate the terms of their mortgages with servicers so that they have an alternative to continuing to make payments they can't afford or to getting out of their homes is another good idea, says Owsley. The current laws make loan servicers unwilling to consider anything outside the confines of the original servicing agreement for fear of getting sued, he says. Intelligent restructuring of mortgages would help avoid the social costs of putting families on the street and would preserve more value for the lenders than foreclosure sales, he adds. There is no lack of ideas surrounding the potential uses of TARP Part II. However the remaining $350 billion ends up being used, though, the result is certain to be political contention and will likely mirror a truth the film industry discovered long ago: The sequel is usually less well-received than the original.
Brussels Paints Dark Picture of EU Economy in 2009
The 16 nations which use the euro will see their economies shrink by 1.9 percent, while the EU-wide contraction will be almost as bad at 1.8 percent, according to the European Commission, the EU's executive. Those dire numbers are just one portion of a grim tableau the commission presented on Monday, describing the economic crisis as the worst faced by the world since World War Two, with overall outlook still exceptionally uncertain. "Except for government consumption and public investment, all demand components are forecast to put a drag on GDP growth," the commission said in presenting the forecasts.
The current forecast is a dramatic downward revision from previous EU estimates. The commission's last estimate in November predicted the euro-zone economy would manage to eke out growth of 0.1 percent. The economic contraction could lead the EU back to the bad old days of high unemployment, Brussels said. The EU labor market is expected to be hard hit by the global crisis, with 3.5 million jobs disappearing in the EU in 2009. Unemployment hit a record low of 7.2 percent in March last year, but began creeping up as the economic situation darkened. The jobless rate will likely rise to 9.3 percent this year and reach 10.2 percent in 2010, the first time unemployment has surpassed 10 percent since 1998.
Some EU countries could see jobless rates shoot even higher. Spain, which has been especially affected by the housing market crash, could see its unemployment rate expand from 11.3 percent in 2008 to 16.1 percent next year and reach a breathtaking 18.7 percent in 2010. Germany, Europe's economic powerhouse, will not be spared the fallout. The EU predicts its export-heavy economy will contract by 2.3 percent this year. That is a slight improvement over estimates put forward by some economists over the past few weeks who had predicted the German economy could shrink by as much as four percent in 2009.
The commission said Germany's two economic stimulus packages would help the economy weather the worst of the storm. Still, the downturn could turn out to be Germany's worst in more than 60 years. Brussels said the euro-zone would not begin to pull itself out of the slump until mid 2009 at the earliest and even then, growth is estimated to only be about 0.5 percent in 2010. Last week, the European Central Bank cut rates by half a percentage point to two percent in response to the deeping recession. The stimulus packages launched by European governments in December totalled some 200 billion euros ($265 billion) and since then, some governments, such as Germany's, have announced new stimulus measures or are considering them.
Also on Monday, UK Prime Minister Gordon Brown warned of depending on national plans to attack what is a global crisis. "Unless we come together to address these problems in a coordinated way, the world is at risk of a damaging spiral of de-globalizing. It is fueled by a combination of deleveraging and national-only policy solutions," he said at a press conference to unveil a second major bank rescue package. That stance gets a nod from many economists, who have criticized some countries, including Germany, for being too cautious with their stimulus or of not thinking beyond their own borders.
Just months ago, Berlin resisted spending large sums on stimulus packages, even criticizing other countries such as the UK for their "crass Keysianism." Even after a first stimulus package was put together in November, German Chancellor Angela Merkel was dubbed "Madame Non" in some European quarters. That stimulus package was attacked as being too small to give Europe's largest economy the shot in the arm it badly needed. The attitude in Berlin toward spending changed as the economic outlook became more dire. "(Berlin) has realized this is a global crisis," Michael Burda, an economist at Berlin's Humboldt University, told Deutsche Welle.
Berlin's new 50-billion-euro ($66 billion) rescue plan mixing infrastructure investments and tax cuts unveiled this month has won praise, including from Prime Minister Brown. Still some economists think a more coordinated EU effort would be more effective in the face of such a large economic meltdown. "It doesn't make any sense to have one country doing on its own what it could achieve more efficiently in coordination with other European countries," Burda said. "But a lot of Germans don't trust Brussels, and a lot of other people don't either, so we just have to live with what we've got."
Eurozone will not break up: EU
The death of the eurozone has been grossly exaggerated despite growing strains in the government bond market, a top EU economics official insisted on Monday. The spread between interest rates on debt issued by high-deficit eurozone countries compared to low-risk German government bonds widened last week to the highest levels since the eurozone was formed in 1999. The eurozone's detractors have long argued that the bloc would not be able to hold together if the divergence between the interest euro governments pay on their debt grows too. EU Economic and Monetary Affairs Joaquin Almunia on Monday insisted that the move in the markets was not an ominous sign that the shared-currency block would break apart.
"I am not worried at all by those who have announced for 10 years in a row that the euro area will split. Honestly I dont think that this is a real hypothesis," he told journalists in Brussels. "It is normal that the market asses the risks. So the existence of a spread in euro area government bonds is logic because not all members of the euro area have the same fiscal position over the medium to long term," he said. The commission updated its economic forecasts on Monday, estimating that the combined public deficit of the eurozone would balloon from 1.7 percent of output to 4.0 percent in 2009 and 4.4 percent in 2010. However, the overall figure masked a much more dire situation with Ireland's deficit for example expected to swell to a stunning 13 percent in 2010 and Spain's hitting 5.7 percent the same year.
The spread between low-risk German government bonds and debt issued by Greece, Ireland, Portugal and Spain widened recently after ratings agency Standard and Poor's cut Greece's rating and warned of a downgrade for the other three countries. By coincidence, S and P reduced its rating on Spanish debt on Monday as Almunia spoke, cutting it to AA-plus from a coveted AAA level -- the highest possible and indicating virtually there is no risk of default. Almunia said that while the risk of default could never be ruled out, it was next to non-existent for any euro area country. "In the case of the euro I don't think that the risks (of default) are high or are significant," he said as he presented forecast for the eurozone economy to contract by 1.9 percent this year.
"Those who have not consolidated their public finances in due time, in good times -- now that the market is paying more attention to credit risk -- (they) should pay higher spreads. This is an element of market discipline," he said. Likewise, analyst Ben May at consultants Capital Economics warned that although market talk of default looked "overblown," that spreads would only keep widening unless governments convincingly tackle their deficits. "But looking ahead, a prolonged economic contraction, rising government debt and relatively high government borrowing costs will only raise such concerns (about default) and could even trigger calls for some of these economies to leave the single currency," he warned.
In light of the growing government bond spreads, Almunia acknowledged that the idea of common issuance of debt by euro area governments had been revived. He said that it was one proposal among others such as a group of countries issuing a bond together and some kind of multilateral guarantee of debt issued by euro members. However, he insisted that although such ideas have been around at least since the eurozone was formed in 1999, the talks were only in the early stages and "will not produce immediate consequences."
‘What if’ becomes the default question
What if one of the member states of the eurozone were to default on its debt? On the occasion of the euro’s 10th birthday, this has become the most frequently asked question about the single currency zone. The probability of a default is low but clearly rising. The decision by Standard & Poor’s, the ratings agency, to downgrade Greek sovereign debt and to put Spanish and Irish debt on watch seriously rattled investors last week, for good reason. If the financial crisis has taught us one thing, it is to take perceived tail-risks more seriously. Before I answer the question, it is best to consider what would not happen. For a start, the eurozone would not fall apart. A government about to default would be mad to leave the eurozone. It would mean that, in addition to a debt crisis, the country would also face a currency and banking crisis. Bank customers would simply send their euros to a foreign bank to avoid a forced conversion into a new domestic currency. So if a default were to happen, it would almost certainly happen within a eurozone that remained intact. If you put your mind to it, it is quite difficult, even in theory, to think of a circumstance in which the eurozone would blow apart. One theoretical possibility would be for the European Central Bank to generate massive inflation, prompting Germany to leave in disgust – not exactly the most likely scenario right now.
So we are stuck with the eurozone for better or for worse. If a default happens, the central banks and governments of the eurozone would be forced to co-ordinate their policies whether they liked it or not. Under its statutes, the euro system, which includes the ECB and the national central banks, is not allowed to monetise (that is, buy) new sovereign debt or to grant overdraft facilities. But the ECB is allowed to buy debt in the secondary markets, which is a way of monetising debt. All it would take is a decision by the ECB’s governing council. What about a direct fiscal bail-out by other member states? I suspect that the non-defaulting governments would be reluctant initially. Many of them had difficulty selling austerity-type policies to their domestic electorates and they might not achieve the parliamentary majorities needed for a bail-out. Some would no doubt argue that a bail-out would carry the risk of moral hazard. But governments would soon discover that simply saying No was not going to work either. Back in the real world, governments would have to take into account the risk of contagion. For example, a sovereign default by a small country could wreak havoc on the markets for credit default swaps and might even destroy financial institutions in other eurozone countries.
A default could also trigger a panic rise in bond yields elsewhere, which could turn the threat of contagion into a self-fulfilling prophecy. If confronted with this more realistic situation, governments would, I suspect, react similarly to the way they responded in the aftermath of the collapse of Lehman Brothers, the US investment bank. Complacency would be followed by anger and by grandstanding lectures on the virtues of fiscal discipline (I can see a speech coming by the German finance minister). This would be followed by an emergency meeting one weekend in Brussels in which the European Union, perhaps together with the International Monetary Fund, would agree a package of credits to stabilise the defaulter. The recipient would, in turn, have to accept an austerity programme, perhaps even the temporary loss of fiscal sovereignty, to ensure that the loan was repaid and to reduce moral hazard. In other words, the Europeans would bail out one of their own, but it would not be fun for anyone, especially not for the defaulter. In the long run, a conditional bail-out combined with persistently positive bond spreads could even be a healthy development for the eurozone. Putting roughly the same value on Greek and German debt – which is what financial markets did for most of the last 10 years – never made sense.
If that situation had been allowed to persist, it would have produced serious difficulties for the eurozone further down the road. When the euro was launched in 1999, many commentators, including me, predicted that the markets would exert sufficient pressure on member states to run responsible fiscal policies. It took 10 years for that prediction to prove correct (which means, of course, that it was not such a great prediction). A far more serious threat would be a cascading series of defaults that would eventually include one or more of the eurozone’s large countries. That would be a momentous challenge for the system but the policy response would be no different, only faster. In extremis, you could conceive of a scenario under which the bail-out had to be so large that it would bring down the entire system. This could then provide the non-defaulters with an economic incentive to leave. But dream on. If Germany, for example, had such an incentive to leave, it would almost certainly forgo that perceived economic benefit and stay for political reasons. If you assume the worst-case scenario of a default by five or six countries, a full fiscal union would be more probable than a break-up. Most likely, we will see neither, but we may see conditional bail-outs.
Britain's economy in even worse state than government thinks, says EC report
Britain’s economic performance this year will be much worse than the government has predicted, the European Commission said today, with the economy due to contract by 2.8 per cent — the worst performance since 1946. Unemployment will rise to 8.2 per cent with exports too weak to stop output plummeting, according to Brussels, but it is the forecast of such deep recession that is the most worrying. One of the biggest drops in the European Union, it compares to the Government’s own forecast of negative growth of between 0.75 per cent and 1.25 per cent.
Annual net borrowing will rise to 8.8 per cent of GDP this year, more than the 8 per cent forecast by Alastair Darling in November, while the gross national debt will rise from 44.1 per cent of GDP in 2007 to 72 per cent in 2010, the Commission predicted, largely due to the multi-billion pound bank bailouts. Britain will be one of the hardest-hit of the 27 EU countries, but all are in for a tough year, with the overall EU economy due to contract by 1.8 per cent this year before recovering to 0.5 per cent growth in 2010. Britain is forecast by Brussels to experience two quarters of negative inflation in the last half of this year, but this will not amount to an annual judgment of deflation in 2009, said Joaquin Almunia, the EU’s economic and monetary affairs commissioner.
“In annual terms in 2009, inflation [in Britain] according to our forecast is 0.1 per cent and next year 1.1 per cent,” said Mr Almunia this morning. “The situation is more worrying in public finance because the UK had not consolidated public finances during the good times,” he added. “According to our forecasts and also the British government forecasts, their situation in deficit and debt will deteriorate very rapidly.” The European Commission report also suggested that Britain’s manufacturing base was now too small to take advantage of the weak pound. “Despite the sharp fall in the effective exchange rate over 2007-8, net external demand will provide only limited support to growth in 2009, given the weakening of growth in UK export markets.
Output is likely to show only a modest recovery in 2010, with annual growth of one quarter of one per cent. Given the pronounced fall in output, the unemployment rate is likely to rise to around 8 per cent this year.” It added that “the likelihood that economic activity in 2010 will be weaker than envisaged by the UK authorities also carries a risk that the fiscal tightening measures announced to 2010 will not be fully implemented, which would raise the deficit forecast in 2010-11 by up to three-quarters of a percentage point of GDP.”
Another shot in the arm
“Bad bank” and “toxic assets” were terms studiously avoided by the British government on Monday January 19th as it announced new measures to bolster the country’s leading banks. The measures include prolonging extension of guarantees on debt issued by banks, guarantees for top-rated asset-backed securities, perhaps buying up to £50 billion ($74 billion) of higher-rated assets, and, in time, guaranteeing banks’ assets which are tradable but difficult to value in today’s markets. The first package in October, committing £37 billion of capital and £350 billion in refinancing facilities, was a rescue operation. It supposedly stabilised the system but gave banks perverse incentives to hoard capital rather than lend.
The aim now is to get those banks to lend to the real economy which, say business lobby groups, is being starved of credit. A scheme launched on January 14th to guarantee 50% of up to £20 billion of lending to small and medium-sized businesses was clearly not enough. Other proposals being kicked around, such as nationalising some of the banks, or creating a “bad bank” for the difficult-to-value assets, have been brushed aside. The rationale is apparently to keep the banks interested in making good credit decisions rather than peddling rubbish. But the hidden political agenda may be to save the government from admitting to previous mistakes.
Royal Bank of Scotland (RBS), already 58% state-owned, will cancel £5 billion of preference shares owned by the government, in exchange for ordinary shares, which will take the state shareholding to 70%. Yet the government is still reluctant to treat RBS as a nationalised bank. Even less so Lloyds and HBOS, which started trading on the London Stock Exchange on Monday as Lloyds Banking Group; after the merger it is owned 43% by the government. RBS has undertaken to turn its £600m annual saving on the preference shares into £6 billion of new loans to British customers. But that will be difficult to monitor unless the government gets involved in lending decisions. Despite repeated government claims it is not interested in running banks, creeping nationalisation may be on the way: Northern Rock, which was nationalised in February 2008, has said in the same vein that it will no longer work on shrinking its mortgage book and will maintain lending.
But these are bits and pieces. There is little in the new package to give banks the incentive to put their profit motive aside and help to reflate the economy. RBS and Lloyds have some private shareholders who could sue if they suspected their interests were being abused. Unhappily, the government’s new measures do not dispel the uncertainty that continues to weigh on banks’ balance sheets. Most early reports of banks’ year-end results include further write-downs on the toxic assets, such as exposure to collateralised debt obligations (CDOs) or the monoline insurance companies, which supposedly insured them. RBS has just announced a further £2.6 billion of reserves against these two items.
Although the government may end up as owner of these assets it has chosen a slow and complex route. It intends to have a mechanism in place by February 2nd, whereby it could buy up to £50 billion of “high-quality” paper, including commercial paper, bonds, syndicated loans and some commercial loans. Then it will take until the end of February to unveil a scheme to guarantee lower-quality untradable assets. Valuing and putting a risk premium on those assets will take serious negotiation between banks and the government. It may be months before enough have been cauterised to give banks greater confidence to lend.
A more hopeful line of endeavour is the international move to relax the Basel 2 capital regime for banks, which has tended to exacerbate capital requirements in the downturn. Since November the Basel Committee, which drew up those rules, has been promoting an amendment that would make the requirements less “pro-cyclical”. Britain’s watchdog, the Financial Services Authority, has shown signs of softening its stance on banks’ core capital requirements in a downturn. The catch, in all these attempts to direct bank behaviour, is that the world’s systemically important banks have regulators over a barrel. Since the badly managed demise of Lehman Brothers in September no systemic bank has been allowed to fail. Britain’s main banks know they will be kept alive and, until their pre-crunch management is kicked out, their priority will continue to be the interests of private shareholders, not that of taxpayers.
Banking fears grip European markets
European stock markets fell Monday with banks in free fall as investors fretted over a second British government bailout of the sector in three months and some predicted that cash-strapped Royal Bank of Scotland Group PLC would end up fully nationalized. Europe's early gains were erased as the investors were spooked by fears that the British government's latest move was a step toward full nationalization of one or more banks, and that other governments will have to step in to save their leading banks. Germany's DAX closed down 50.14 points, or 1.2 percent, at 4,316.14, while France's CAC-40 fell 27.06 points, or 0.9 percent, at 2,989.69. Most attention was on the FTSE 100 index of leading British shares, which was down 38.59 points, or 0.9 percent, at 4,108.47, even though the British government said it would be creating a progam to insure bank loans in the hope that the banks will start lending again.
Any hopes that the government had that the announcement would ease the stock market pressures on the banks evaporated as they suffered another day of frenzied selling. Fears focused on the Royal Bank of Scotland which saw nearly two-thirds of its market value wiped out following its disclosure that it will likely report a full year loss of 28 billion pounds ($41.3 billion), which would be the biggest loss ever reported by a British company. Shares traded at only 12 pence (15 U.S. cents) a share. Among the raft of measures unveiled earlier, the British government said it will be increasing its stake in RBS to 70 percent from 58 percent by converting preference shares into ordinary shares. "It is clear from the markets reaction today that it increasingly believes that RBS is to end up fully in government ownership," said Nic Clarke, an analyst at Charles Stanley stockbrokers in London.
The other remaining British banks suffered too, with newly-merged Lloyds Banking Group PLC down by nearly a third. And Barclays PLC, which had earlier recouped most of its 25 percent decline on Friday, was back under pressure, with its shares 10 percent lower. "Sentiment and confidence is absolutely shot to pieces in the banks and the markets are voting with their feet," said Howard Wheeldon, senior strategist at BGC Partners in London. The British banking sector's latest stock market woes came after the government unveiled a new plan that would require banks to identify their riskiest assets and allow them to pay a fee to insure them with the government in return for lending more money. By offering to insure bank loans, the government is exposing taxpayers to billions of pounds of potential losses.
In addition, the government gave the Bank of England the green light to, in effect, start printing money by buying 50 billion pounds ($74 billion) of whatever bank assets it considers to be necessary. The problems in Britain's banking system sent shockwaves through Europe too. In Germany, Deutsche Bank AG, which last week reported a 4.8 billion euro ($6.4 billion) loss for the fourth quarter, sank 8 percent while Commerzbank AG was 4 percent lower. In France, BNP Paribas SA and Societe Generale SA were down too. The problems potentially facing Europe's banks were stoked last week by Citigroup Inc.'s announcement that it will split its operations in two, separating its traditional banking business from the company's riskier assets, as it posted a massive $8.3 billion fourth quarter loss. Bank of America Corp. also revealed a $2.4 billion quarterly loss and had to tap the U.S. government for a cash injection of $20 billion in exchange for stock.
Stock markets around the world had started 2009 on a relatively strong footing, glad to have put the previous year behind them and hopeful that the incoming Obama administration would be able to limit the length and depth of the recession in the U.S. with its massive stimulus plan. Those hopes of a turnaround in the world economy by the middle of this year have evaporated as investors grappled with increasingly grim economic and corporate data from across the world. Earlier, most Asian stock markets following a rally on Friday on Wall Street. Japan's Nikkei 225 stock average edged up 26.70 points, or 0.3 percent, to 8,256.85, South Korea's Kospi gained 1.4 percent to 1,150.65 and Hong Kong's Hang Seng recovered early losses to rise 0.6 percent to 13,339.99.
Shanghai's benchmark rose 1.7 percent and markets in Australia and Singapore also gained. Thailand and Malaysia retreated. Wall Street was closed Monday for the Martin Luther King Day national holiday, and the focus will be on Barack Obama's inauguration as President when trading resumes Tuesday. On Friday, the Dow Jones industrials rose 68.73 points, or 0.8 percent, to 8,312 and the S&P500 gained 9.9 points, or 1.2 percent, to 858.50. Oil prices continued to languish with light sweet crude for February delivery down $2.36 at $34.15 a barrel in electronic trading on the New York Mercantile exchange. The dollar was down 0.4 percent to 90.37 yen while the euro fell 1.2 percent to $1.312
The rescue has failed: it's time to fess up, reboot and start again
It's official. Government policy isn't working. As bank shares collapse amid renewed carnage on global markets, we now know the worst isn't over. This crisis just entered a whole new phase. Gordon Brown's "rescue plan" lies in tatters. Perhaps now the Prime Minister – and his counterparts across the Western world – will do what needs to be done. Regular readers know what's coming next. I've been writing the same thing for months. But I make no apologies – for this ghastly episode will only end once senior bank executives are forced, under threat of custodial sentence, to FULLY DISCLOSE to one another and the authorities, on the basis of all available evidence, the extent of their sub-prime liabilities. I accept that's not easy. The toxic debts have been sliced, diced and securitised – then sold on many times. Millions of trades must be unravelled, often across international borders.
But this onerous task must be done. Then the losses must be written-off. Only after such purging will the banks begin to rebuild mutual trust – allowing the interbank market to reboot, so restoring the credit lines that are so vital to the broader economy. And all this needs to happen BEFORE more public money is spent recapitalising our banking sector. I know what I'm saying is drastic. But this is a drastic situation. In the UK and US, in particular, the banks aren't playing ball. They think they're more powerful than our elected officials, and for the last six months they have been getting away with hiding losses and burying mistakes while screwing many billions of pounds out of taxpayers. Look at the cause of this latest spasm. Opposition politicians point to the Government's decision to lift the ban on short-selling – allowing traders to pile pressure on bank stock. That misses the bigger picture. Bank shares collapsed on Friday because of renewed fears that said banks have simply enormous liabilities on their books that they're still trying to hide.
In the US, Citigroup, Bank of America and Merrill Lynch unveiled a $25bn combined loss for the final quarter of 2008. But what was really shocking was that $15bn was sustained at Merrill Lynch – and the Bank of America, which bought the brokerage last year, didn't even know. In a bid to save his job, Ken Lewis, Bank of America's boss, admitted he hadn't foreseen such a "significant deterioration" in Merrill's finances. But his words lifted the lid on the extent to which financial institutions are disguising the true state of their balance sheets – even to their own parent companies. No wonder rumours then swirled of vast buried losses at Barclays and Royal Bank of Scotland. No wonder their prices collapsed. And such fears will fester and keep bursting to the surface until our banks "fess it all up" – and a credible number is put on potential losses at each of our major banks. Yes, those numbers will be horrific. Yes, bank shares will be hit once more. But until we do the maths and swallow the write-offs, the rumours will continue and trust will remain elusive – to say nothing of long-term financial stability.
There is much talk of Franklin D Roosevelt. Trying to justify big pork-barrel spending, and yet more government borrowing, politicians on both sides of the Atlantic are employing the rhetoric of the depression-era President's New Deal. One important lesson we can learn from FDR is to restore the Glass-Steagall firewall he erected between commercial and investment banking – so foolishly removed by the "bankers-turned-public servants" who dominated Bill Clinton's administration in the 1990s and who are now back, in the Obama fold. But we may now even need to revisit America's 1933 Emergency Banking Act – closing our banks for a period, flooding them with government inspectors, killing off the technically insolvent and reorganising those strong enough to survive. As if all this renewed banking angst wasn't enough, yet another fear is now stalking international capital markets.
Last week, any remaining hope the eurozone had escaped the worst of this crisis was blown out of the water. Economic sentiment is now at a post-war low. Even the European Central Bank, admirably restrained until now, could resist the political pressure no longer and cut its interest rate to 2pc. This column has long questioned the eurozone's long-term survival. Now global markets are doing the same. At the start of last year, the average 10-year government bond yield among the weaker member states (Portugal, Greece, Spain, Ireland and Italy) was just 25 basis points above the comparable number in Germany. That spread is now six times bigger. Credit default swaps (the cost of insuring against a government default) among the most feckless eurozone members have reached Latin American levels. Would French and German taxpayers bail out another eurozone member? The longer this crisis goes on, the larger that incendiary question looms.
RBS faces record £28 billion ($44 billion) loss
Royal Bank of Scotland shares slumped by over 40pc this morning after the bank said it could face losses of up to £28bn for 2008 from increasing bad debts and writedowns. The bank made the announcement in a trading update as the Government increased its stake in the bank to almost 70pc, as part of its most far-reaching package yet to rescue Britain's banks and try to restore confidence to the sector. RBS said the Government had increased its holding in the bank by converting its £5bn current preference shares into ordinary stock. This should allow the bank to lend more as it will not have to pay the government the 12pc dividend it demanded as a preference share holder. The bank expects to report losses of between £7bn and £8bn for 2008 after increasing bad debts and expected writedowns of £15bn-£20bn mostly as a result of its acquisition of Dutch bank ABN Amro. The loss is the largest corporate loss ever in the UK but RBS hopes that by coming clean to the market it can reassure investors.
RBS Group chief executive, Stephen Hester, said: "I do feel sorry for shareholders - I'm one of them. This is not the sort of record any enterprise would be proud of, it's our job to fix things now." Mr Hester said he did not think the Government wanted to fully nationalise the bank, adding that the latest plan was aimed at supporting assets not taking full control. "The dislocation of credit markets and the global economic downturn continue to hit RBS hard, as with many other banks. We are making progress in recognising excess risk and dealing with it," he continued. "Significant uncertainties and risks inevitably remain. In this context, the support we are receiving from Government benefits all our stakeholders and enables us to provide more customer support in return.
"With enhanced core capital, removal of the preference share dividend and the prospect of further asset and liquidity measures, RBS is able to continue its strategic restructuring purposefully." The conversion of the preference shares into ordinary shares sees the governments stake in the bank rise from 58pc to 68pc. In October, the Government injected £37bn into RBS, Lloyds TSB and HBOS, and pledged £450bn to guarantee banks' debt and enhance the special liquidity scheme (SLS) to make funding easier. But there have been rising fears in recent weeks that banks have suffered billions more pounds of losses in the last few months of 2008, which will mean that they could announce worse than anticipated losses at their full-year results in a few weeks' time.
Gordon Brown lambasts RBS for 'irresponsible' actions
Gordon Brown today said he was "angry" with the Royal Bank of Scotland over a strategy that has left it with potential losses of £28 billion, as the Prime Minister defended the Government’s second attempt to rescue Britain’s struggling lenders. Mr Brown said this morning that Britons had a right to be furious at "irresponsible" behaviour which saw RBS spend billions last year acquiring ABN Amro, the Dutch bank which had exposure to US sub-prime mortgages, as well as investing directly in the American home loan market. “Yes, I’m angry about what happened at the Royal Bank of Scotland," he said.
The bank's expansion strategy was led by the former chief executive, Sir Fred Goodwin, who left last year to be replaced by Stephen Hester, the former chief at British Land. Sir Tom McKillop, the chairman at RBS who worked closely with Sir Fred, is being replaced Sir Philip Hampton, the chairman at J Sainsbury, who joins the bank today but will take over the role in April when Sir Tom retires. Mr Brown added: "Now we know that so much was lost in sub-prime loans in the US and now we know that some of that was related to the purchase of ABN Amro, I think people have a right to be angry that these write-offs are happening and that these write-offs were caused by decisions that were made about international investments that were clearly wrong investments.” RBS confirmed this morning that it will report a full-year loss in February which could hit £28 billion - with £20 billion of the total related to the acquisition of ABN.
It is the biggest-ever loss in British corporate history and is nearly double to current £15 billion record set by Vodafone, the UK telecoms giant, in 2006.
RBS also confirmed that the Government is set to increase its stake in the bank from 58 per cent to 70 per cent. Last October, the Treasury sank £37 billion into the banking sector – the Government’s first attempt to stabilise the market – with RBS taking £20 billion of funding. Both Mr Brown and Alistair Darling, the Chancellor, refused to comment on whether RBS will now be nationalised, following the Government's takeover of Northern Rock early last year. However, the emergence of larger-than-expected losses at RBS, and the prospect of full-state ownership sent shares in the once-mighty bank tumbling by 42.9 per cent to 19.8p - the lowest since 1985. Commenting on the need for a second bailout of British banks, Mr Darling said: “There is no doubt that because the economic downturn has been much sharper, especially over the last few weeks, that has exacerbated the situation.”
While the Government will increase its stake in RBS, Lloyds TSB, which from today will be known as the Lloyds Banking Group after officially taking over HBOS, is reportedly fighting against increase state-ownership. As part of last year's first attempt at stabilising the UK banking sector, Lloyds TSB and HBOS, owner of Halifax and Bank of Scotland, took £17 billion in funding from the Government in exchange for a 43 per cent state in the combined bank. Mr Darling said: “I have said that in the longer term, I don’t believe that governments ought to be running banks. Provided that they are properly supervised and regulated, provided their boards take proper decisions on who they lend to and they lend responsibly.” Mr Brown and Mr Darling appeared at a joint press conference in order to deflect criticism over introducing a second bailout of the banking sector just three months after a first attempt.
The Prime Minister denied that the Government was writing a “blank cheque” for the banks, and there would be “legally binding” commitments in return for state support. Banks will be encouraged to lend again under new measures announced by the Government. The latest deal with the banks will require the taxpayer to pour billions of pounds into the troubled companies in the form of guarantees for new lending and the purchase of a range of loans and other assets now on their books, in addition to the £37 billion funding pledged in October. The actual eventual cost is at this stage impossible to quantify, but some experts have warned that the resulting huge rise in Government borrowings could put intolerable pressure on the public finances. Details of the package this morning include the extension of the £250 billion credit guarantee scheme announced with the last group of measures in October until the end of this year.
There is also a new facility to guarantee loans and mortgages issued by the banks to encourage them to lend again, while there is a new scheme replacing the existing arrangements, which end this month, providing banks with access to Government bonds in return for other assets. The Bank of England will set up a special fund to buy high quality loans and other assets direct from the banks, to be funded by the Treasury, with an initial £50 billion set aside. The Treasury said that the package was designed to reinforce the stability of the financial system and increase confidence and the banks' capacity to lend. A statement said that over the past two months, since the last raft of measures to help the banks and the November pre-Budget report, "the global financial and economic situation has continued to deteriorate". The Treasury and the banks have been in negotiations over the weekend after it became apparent that the October package was not enough to rebuild confidence in the financial system and persuade the banks to open their coffers again.
Mr Darling said that the measures were needed because if the banking system collapsed, the economy "would come down with it". But he also said regulation of the banking sector would be reviewed, stating that "in the world we’re living in just now we do need to look again at the way we supervise and regulate these banks”. There have been worrying signs that even successful and profitable companies have been refused access to much-needed credit, while the rash of collapses and bankruptcies of companies such as Woolworths have caused concern over existing debt. Northern Rock confirmed that it was slackening off its attempt to reduce its mortgage book and would as a result be repaying loans to the Government at a slower rate. It would mean that more of its customers would be able to keep their mortgages with the bank. RBS also said that it will increase lending by £6 billion after announcing plans to convert £5 billion of preference shares to ordinary shares to increase the Government's 58 per cent stake to 70 per cent.
UK bonds tumble as Government admits no cap on taxpayer risk in banks bailout
Bonds tumbled as the Government admitted there is not yet any cap on the risk taxpayers will have to bear as a result of its plan to insure banks from billions of pounds of losses on bad loans. Gordon Brown has formally announced a scheme to allow banks to exchange cash or shares for a Government guarantee on their "toxic" debts, transferring any losses they suffer from the banks to the taxpayer. But the Government has conceded that it can't estimate how much taxpayers' money will be on the line in the latest bank assistance package. UK bond prices fell sharply as the financial markets digested the prospect of further Government borrowing. Ministers say the new package, which comes only three months after another £500 billion bailout, is vital to restore bank lending and help companies get credit and stay in business.
At a press conference in Downing Street to announce the package Mr Brown said that "people are right to be angry" about what he called irresponsible lending by banks. Mr Brown also reacted angrily to suggestions that he was handing a "blank cheque" to the banks by offering to protect them against the consequences of that lending. He said: "You are completely misunderstanding this to suggest this is a blank cheque. Quite the opposite. It is for the Treasury to decide, after an analysis, what the insurance will be." But he admitted that ministers have not yet set any upper limit on the value of loans they support or the level of risk taxpayers will bear. As part of the rescue package, the taxpayer has taken an even bigger stake in Royal Bank of Scotland, which has today announced losses of over £20 billion – the biggest loss in British corporate history. The Government is also offering to increase its stake in Lloyds Banking Group.
The state could even take shares in Barclays and HSBC in exchange for insuring their loans in its new Asset Protection Scheme. HSBC said that it had not sought capital support from the UK Government "and cannot envisage circumstances where such action would be necessary". It is the second rescue package in three months, which is aimed at getting the banks to lend to businesses and homeowners. If it fails, banking experts say the only option left for Mr Brown will be full nationalisation of the banking system. In a statement to the City, the Treasury said the Asset Protection Scheme scheme is expected to operate for "not less than 5 years." "To increase confidence and capacity to lend, and in turn to support the recovery of the economy the Government is today announcing its intention to offer protection on those assets most affected by the current economic conditions," the Treasury statement said. In the first instance it will be open to the major British banks, but the Treasury said it was possible that insurance will ultimately be extended to the British subsidiaries of foreign banks. The Government also announced:
- A plan to make government bonds available to banks to support £100 million of loans for some home owners and small businesses, as recommended by Sir James Crosby, former HBOS chief executive;
- An extension until the end of this year of the Government's £250 billion Credit Guarantee Scheme to support lending between banks;
- An expansion of the Bank of England's £200 billion Special Liquidity Scheme. The Bank will now accept consumers' car loans in exchange for Government bonds, a move intended to support the failing motor industry;
- Northern Rock, the state-owned bank, will be told to offer more home loans, reversing previous instructions for it to get rid of mortgage customers by charging punitive rates of interest.
Despite £500 billion having been pledged for a rescue package in October, the banks are not lending at the levels ministers and business groups say are needed for the economy to function normally. As a result, the country is mired in a recession which experts are forecasting could be the worst for generations. The Chancellor, Alistair Darling, also suggested that the bailout would be accompanied by new measures to control the banks' behaviour. He said: "It's quite clear in the world we're living in just now we do need to look again at the way we supervise and regulate these banks." George Osborne, the Tory shadow chancellor, said the Government had no choice but to help the banks again because the October package had "failed." He said: "I don't like the idea but it's a question of what options there are." Mr Osborne added that strict scrutiny must be applied to bank assets to protect taxpayers' interests. "We need to know exactly what the Government is proposing to insure. We need a full audit, an independent audit," he said.
The centrepiece of today's package is to provide Government guarantees against losses that the banks might incur on loans that have now turned sour amid collapsing house prices and a shrinking global economy. The banks will pay a "significant" fee to the Government for each loan they insure. They will be able to pay that fee in either cash or shares. That could open the way to the state holding stakes in all of Britain's four biggest banks for the first time. Shares in Barclays fell by more than 20 per cent on Friday amid City speculation that the bank is exposed to huge losses. It tried to calm that speculation by pre-announcing significant profits, but its shares are likely to come under fresh pressure. In the October package, ministers offered Barclays billions of pounds in new capital, but – unlike RBS and Lloyds – Barclays rejected the offer and chose to raise new funds from Gulf investors. Treasury sources said the proposal to insure Barclays's loans in exchange for shares would effectively repeat that offer. Some believe that the bank will find it almost impossible to reject state help this time. Despite raising the prospect of increased government holdings in the banks, ministers insist that outright nationalisation remains a last resort.
The loan insurance scheme is being proposed as an alternative to the creation of a state-controlled "bad bank" to house the toxic assets. Officials say the insurance plan avoids some of the complexity and delay involved in valuing and buying the assets from the banks. But it means the Government cannot know exactly what losses it would incur if the loans it insures go bad. As well as paying substantial fees in cash and shares for the loan insurance, banks will also have to sign "contractual agreements" with the Treasury about their future lending, committing them to increase lending and focus new credit on British customers ahead of foreign borrowers. Separately, the Government could increase its stake in RBS and the Lloyds Banking Group, potentially making the taxpayer the majority shareholder in Lloyds.
In October, some of the state's holding in RBS and Lloyds was taken in the form of preference shares, holdings that committed them to paying hundreds of millions of pounds to the taxpayer before they did anything else. The banks say those obligations have shackled them and forced them to divert money that could otherwise have been used to lend. In exchange for reducing what it takes from the preference shares, the Government wants more normal shares, effectively diluting the value of private investors' holdings and increasing state influence over RBS and Lloyds. RBS has accepted the deal, taking the state's ownership to 70 per cent. Lloyds is more reluctant to accept the offer, which could see the Government share exceed 50 per cent.
HSBC snubs Government bank rescue scheme
HSBC has turned down the chance to tap the Government's offer of emergency funding as several high street banks begin to strike a more defiant note about the state of their finances. The UK's largest banking group, which also shunned the Government's first bailout plan in October, said today that it had not asked for any money. It said: "HSBC has not sought capital support from the UK Government and cannot envisage circumstances where such action would be necessary. "HSBC has long been one of the world's most strongly capitalised banks and is committed to maintaining this position," it said, adding that it would be publishing its annual results as scheduled in early March.
The stance means that HSBC joins Barclays in employing every effort to ensure that it does not cede any shareholding or management control to the Government. Today, the Treasury launched its second bailout drive for UK lenders. The Treasury said that it would provide backstop insurance against bank losses. In exchange it is demanding that banks step up their lending to both consumers and business customers. Gordon Brown has also indicated that he would like to see a crackdown on banks' bonus culture. This is likely to be easier to introduce in institutions that are partially state-owned. The Times reported today that Barclays was heading for a run-in with the Treasury as a result of its unwillingness to draw on emergency state funds.
At the same time, both Barclays and HSBC said that they welcomed today's specific measures by the Treasury to try to free up lending. John Varley, Barclays' chief executive, said that the bank would need to study the detail. HSBC said: "HSBC will continue to work constructively with the authorities to ensure that these initiatives are taken forward in a way that is beneficial for the economy." HSBC pointed out that it had commited to lend £15 billion in mortgages this year. Shares in Barclays, which lost a quarter of their value in the last hour of trading on Friday, rebounded up to 17 per cent this morning as the country's number-three bank said that it could not explain the sudden drop.
Barclays said that its pre-tax profits for last year would be "well ahead" of the £5.3 billion forecast by analysts. Shares were last trading, up 5.7p at 103.7p, some 5.8 per cent higher on the day. HSBC dropped 1.8 per cent, down 9.75p at 526p. HSBC is under pressure from some of its activist shareholders to walk away from Household, the US sub-prime lender that it bought for $14 billion in 2002. Knight Vinke, which is thought to hold less than 1 per cent of HSBC, said last night that ditching Household would save the bank about $35 billion. Speculation has been mounting in recent weeks that HSBC might need to turn to its shareholders for additional funds. Analysts at Goldman Sachs and Morgan Stanley have suggested that HSBC might have to raise up to $20 billion.
A recession of Olympic proportions
After the euphoria of London's winning 2012 bid, reality is kicking in. So, 2008 was the year the credit crisis gripped the 2012 London Olympic project. With banks on the brink of collapse and equity markets losing billions daily, even Tessa Jowell, the Olympics Minister, admitted: "Had we known what we know now, would we have bid for the Olympics? Almost certainly not." The lack of available credit scuppered plans last year to raise private funding for two of the main 2012 schemes – the Olympic village and the media centre – and 2009 promises further economic challenges. With the world falling into a deep recession, the biggest building project in Europe will be stepping up construction and trying to resolve key funding issues. The Olympic site in Stratford covers 270-acres and, as the Olympic Delivery Authority (ODA) revealed last Friday as it marked the halfway point between London winning the Games and the opening ceremony in 2012, 30,000 workers will be involved in building the project. Gordon Brown, the Prime Minister, is planning to bring forward £3bn of investment in the public sector to stimulate the economy but the £9.3bn Olympic project is an example of a public development already supporting UK businesses.
Contracts worth £6bn will emerge from the project, according to the ODA, and there are 75,000 business opportunities through direct contractors and supply chains. Out of the 800 contractors that have already won work, 68pc are small- and medium-sized businesses and 98pc are based in the UK. However, there are also larger companies involved – Balfour Beatty will construct the aquatics centre, Australian developer Lend Lease is behind the Olympic village, Carillion will build the media centre, and the private construction group Sir Robert McAlpine the Olympic stadium. As Ms Jowell also said in her infamous speech: "It [the Olympics] has the potential to be economic gold at a time of economic need." The sharp downturn means that the Olympic work being undertaken by businesses has increased in significance since they signed up. "When the Olympics were announced it was like a nice little cherry on top of the cake because things were booming," Andrew Gibb, a construction analyst at Oriel Securities, said. "The fact is that these businesses were not relying on the work from the Olympics. But now it's a bit of a Godsend given that a lot of their activities, especially for the smaller players, have fallen off a cliff." However, working on a project of this size is unlikely to be a smooth ride and contractual disputes could emerge this year, he warned.
Australian construction group Multiplex, now known as Brookfield Construction, suffered a torrid time during the development of the £750m Wembley Stadium – lowering its profits forecast five times in 2005 as problems mounted. It is still involved in a £250m legal battle over the delay to the stadium's completion. According to Mr Gibb, the big UK contractors generally stayed away from the major Olympic developments because of the problems high-profile public projects have suffered in the past. "The fact is that the Government really struggled to get contractors involved, certainly in the big ticket items. From what I understand they were on their knees to the big players e_SEmD like Balfour Beatty and Carillion e_SEmD and practically giving it away." The man with the task of running the construction of the Olympic sites is Howard Shiplee, who previously masterminded the £200m redevelopment of Ascot Racecourse – a project not without its own controversies. The project triggered angry complaints over poor viewing from the Royal Enclosure. In a bid to prevent disputes, the ODA's director of construction has presented contractors with contracts that emphasise that the developments are a partnership and include obligations that issues that may grow into a dispute are highlighted at the earliest possible stage.
He has also established a 10-strong Independent Dispute Avoidance Panel, which will act as a "point of common sense" if there are disagreements between the ODA and a contractor. "I'm very hopeful that our commitments, and our partners' commitments, will ensure that we have ways to resolve our issues," Mr Shiplee said. As well as managing disputes, Mr Shiplee also faces the risk of business partners collapsing as the economic slump worsens. The ODA has cut payment times to 18 days from 30 days to improve cash flow but Mr Shiplee admitted that there were especially concerns about businesses in the supply chain. The problems facing contractors and suppliers are being taken "extremely seriously", he said, before adding: "In a situation where insolvency is an issue we would see how we could support the businesses so that they could complete the work." The financial crisis has already posed serious problems for two of the Olympic projects – the village and the media centre. The developer of the £1bn Olympic Village, Australia-based Lend Lease, has a Spring deadline to raise its £650m share of the project's funding and has struggled so far. The village has already been controversially downsized from 4,000 homes to 2,700 in order to cut costs and the ODA has injected £95m from the public contingency fund e_SEmD which makes up £2.2bn of the £9.3bn budget e_SEnD to ensure construction can continue. Two housing associations are already involved in the project e_SEmD First Base and East Thames Group e_SEmD and a third, Southern Housing Group, has reached an "in-principle" agreement also to provide funding. However, a further injection of public money seems likely.
Construction on the £400m media centre is also due to begin this Spring but doubts have arisen over what form the Main Press Centre and International Broadcast Centre will take. The scheme has so far failed to attract any private investment, causing Carillion and Igloo to leave their role as developers, although Carillion will remain as contractors. The project now seems likely to be entirely funded by the public sector, and Ms Jowell told the Culture, Media and Sport Select Committee in December that use of the contingency fund "should not be seen as any kind of failure". Initial plans for a 1.3m sq ft development in Hackney could be changed into a temporary structure and offices at Westfield's new Stratford City shopping centre. However, the ODA insists that the base case e_SEmD the project which they are working towards at present e_SEmD is still a permanent structure with a legacy beyond 2012. In 12 months, the ODA will be hoping the issues with the village and media centre have been largely resolved. It will also be looking for construction, so far on schedule, to continue smoothly. However, with an economic slump that shows no signs of weakening, 2009 could be the year that defines whether the 2012 Olympic project is "economic gold" or a costly mistake.
Darling warns of economic collapse without latest banking bail-out
Alistair Darling today insisted he was right to use hundreds of billions of taxpayers' money in a fresh bail-out of the banking sector, saying the recession would be much worse if he did not act. But shares in the banking sector plunged despite the new support package. Royal Bank of Scotland lost more than 70% after it said it will make a loss of up to £28bn for 2008 - the biggest loss in UK corporate history. The new measures to support mortgage lending and consumer loans were attacked as a "blank cheque" by critics this morning, but the chancellor warned that the consequences of inaction would be grim.
"If the banking system collapses, every single one of us would see the obvious problems. The economy would come down with it," Darling told the BBC. "The cost of not doing anything would be far, far greater. If we don't get lending going, the recession will be longer, deeper and more painful." "It may seem a very wet, miserable January morning, things out there look very grim, but we will get through this," Darling added. Gordon Brown told a Downing Street press conference that the loss showed the consequences of "irresponsible lending". Under the new plans, the government will insure bank loans for corporate and consumer debt. By offering to cap potential losses, the government hopes to encourage banks to lend again. Economists said the Asset Protection Scheme looks like a form of quantitative easing - effectively pumping more money into the economy.
The government is also making a three-pronged effort to stimulate the mortgage market: up to £100bn will be provided to underwrite new mortgage lending, the existing £200bn scheme will be extended, and state-owned Northern Rock is being given a new mandate to increase its lending. The Bank of England is also being given new powers, in addition to its control of interest rates. It has been authorised to spend up to £50bn buying a range of assets from the banks, both to increase corporate credit and for monetary policy purposes. The government said it was taking the measures - just three months after its first £37bn bail-out - after the global financial and economic situation continued to deteriorate. It said that it was "essential" to meet demand for lending from businesses, homeowners and consumers.
The plan means that the taxpayer is exposed to billions of pounds of potential losses. In return, the government plans to force the banks to increase their lending to help the UK economy through the recession. Banks will be charged a fee, which can be paid in cash or shares - suggesting that companies like Barclays and HSBC could soon be partially owned by the government. Vince Cable, Liberal Democrat Treasury spokesman, said the original bail-out had failed because the government had not forced the banks to increase their lending in return for their capital injections. "It's now clear that the money was not used for lending, but was instead used to cover bad debts," said Cable. "I don't like to talk about blank cheques, but I fear that's where we are now," he added. And Peter Spencer, from the Item Club, said that "it sounds like heads the banks win, tails the taxpayer loses".
The chancellor insisted today that the banks will have to pass the money on offer into the wider economy. "If the banks use the measures we are offering today then they will have to enter into legally binding measures to increase lending. Just hoarding the money doesn't help us as businesses or individuals," Darling said. The Treasury is also changing the terms of the first banking bail-out, which has failed to revitalise the sector. It will swap its existing preference shares in RBS, which carried a high rate of interest, for ordinary shares, taking its stake in the bank to almost 70%. In return, RBS has promised to increase its lending over the next 12 months by £6bn - another attempt to get money flowing to borrowers.
The City had given today's measures an early welcome, with the FTSE 100 up by nearly 1.8% this morning. But by 1.30pm the index had fallen by 40 points to 4108, with RBS shares changing hands for just 17.5p and Lloyds Banking Group down by 35% in its first day's trading following the takeover of HBOS. The new measures, which come three months after the first banking bail-out, were announced this morning following a weekend of talks between the government and bank chiefs. The banking crisis reared up again last week when America's Merrill Lynch posted an unexpectedly large loss and which culminated with Barclays shares plunging by 25% in the last hour of trading on Friday afternoon. It insists, though, that it made a profit of at least £5.3bn last year.
Bank of England to buy bonds and loans in first step towards quantitative easing
The Government has taken the first step towards quantitative easing by authorising the Bank of England to buy up to £50bn of private sector assets as part of a wider drive to get banks lending again. Under the scheme the Bank will be able to buy corporate bonds and consumer loans under the Government's new credit guarantee scheme. Mervyn King, the Bank's Governor, said the new facility would "provide an important additional tool to improve financing conditions in the economy." The move is not quantitative easing as it does not involve an increase in the money supply, but some said it could mark the beginning of a shift in that direcion. "This framework could readily evolve into full-blown quantitative easing - we would expect it to do so given the proximity of Bank Rate a de facto zero bound and deteriorating economic conditions, perhaps as soon as March/April," said Ross Walker, economist at Royal Bank of Scotland.
Quantitative easing, also known as printing money, is a more unconventional tool available to the Bank beyond interest rates as it attempts to halt the pace of economic decline in the UK. The programme announced by the Treasury today comes into effect on February 2, before the next vote on interest rates by the Bank's Monetary Policy Committee on February 5. "In effect one can argue that this makes the Bank of England the UK's 'bad bank', even if there are some limits to the risk that is being transferred," said Marc Ostwald, strategist at Monument Securities. "Cynics could also argue that Brown and Darling are merely passing the buck to the MPC in terms of exit strategy." It is part of a broader programme announced by the Treasury this morning allow banks to exchange cash or shares for a Government guarantee on their "toxic" debts. As part of the rescue package, the taxpayer has taken an even bigger stake in Royal Bank of Scotland. The package comes before the first official confirmation on Friday that the UK is in recession. The Office for National Statistics is expected to reveal a sharp decline in gross domestic product in the final quarter of 2008, following a 0.6pc contraction in the third quarter. A technical recession occurs when the economy shrinks for two successive quarters.
Investor puts pressure on HSBC to let US sub-prime unit go bankrupt
HSBC came under pressure to let Household, its American sub-prime bank, go bankrupt yesterday, in order to avoid an expensive rights issue or government bailout. The proposal was dismissed by HSBC, although the bank is to consider making a cash call in the coming months that some analysts believe could involve it asking for £13.5billion from shareholders. Knight Vinke, the activist investor, told The Times last night that HSBC should refuse to pay the bondholders that fund Household's business, which it estimated would save the bank an estimated $35 billion. (£23.6 billion). Eric Knight, Knight Vinke's chief executive, said: “Why should HSBC's shareholders take all the pain when these [Household] bondholders are unsecured?” To do this, HSBC would have to threaten to allow Household to take Chapter 11 bankruptcy protection.
On a day when Stephen Green, the HSBC chairman, attended a meeting at the Treasury where British banks were offered more help from the Government, Mr Knight said that HSBC was too focused on its reputation. “Why should the HSBC board carry on just to save their own reputations when many other banks in the world are now considering similar moves?” HSBC said that the proposal was unrealistic, as it would hamper the ability of the bank - Europe's biggest - to raise money from American bondholders. A source close to the company said: “If HSBC did this they would be counting themselves out of any future big US bond issue. And they would probably have their US banking licence revoked.” Household has 40 million customers. Insiders indicated that if the bank needed capital it would ask investors via a rights issue to help to provide a cushion to get through the credit crunch. Morgan Stanley and Goldman Sachs have indicated that they believe the bank will need to raise up to $20 billion.
Mr Knight has long been critical of HSBC's acquisition of Household, a sub-prime mortgage lender and credit card company, which it bought for about $15 billion in 2003. “You can't afford to be lending to people who live in clapboard houses and cannot afford even to pay the interest on their loans and at the same time build up a substantial private bank,” Mr Knight said. He added that HSBC might otherwise have to launch a deeply discounted rights issue that could lead the bank's share price to fall to 400p. HSBC shares closed on Friday at 535p. Writedowns at HSBC are thought to have exceeded £15 billion last year, a figure that will be disclosed when the bank reports results on March 2. In February, 2007, the bank fired its top US chiefs as sub-prime debts began to mushroom. By the end of the year HSBC had racked up total writedowns of $17.2 billion. By March last year, HSBC had stepped up the rate at which it was writing off loans to poor Americans to an unprecedented $51 million a day as it grappled with an increase in people defaulting on their mortgages, credit cards, personal loans and car finance.
Further UK price falls may cause remortgagers more problems
A further 15% house price fall - well within the orbit of many forecasts for this year - will see at least 1.5m homebuyers stuck with loans worth more than 90% of the value of their properties. And with few lenders prepared to offer mortgages over 90% loan to value (LTV), these home purchasers could find it impossible to remortgage when their deals run out. According to Peter Tutton at Citizens Advice, who cited the figures in evidence to a Treasury select committee last week, homebuyers in this position could be forced on to their lender's less competitive standard variable rates.
But for thousands of customers of Abbey, one of Britain's biggest mortgage lenders, going over the 90% LTV line could involve more than having to switch to a higher interest rate when they have to remortgage. Small-print clauses hidden in Abbey's mortgage documentation show these borrowers could face demands for cash payments to bring their loans down to the original proportion. A homebuyer on a 90% LTV mortgage, whose home was originally valued at £200,000, would have borrowed £180,000. If their property's value plummeted 25% to £150,000, a 90% LTV would only equate to £135,000. Under Abbey's clause, it could demand the homebuyer pay the £45,000 shortfall between £180,000 and £135,000.
Last week, the Treasury select committee heard how one Abbey borrower had been sent such a demand. Labour MP Nick Ainger revealed that Abbey had sent one of his Carmarthen constituents a demand to repay such a gap within three months. "The lender asked for an extra contribution from this borrower even though the family had never missed a payment on the loan since taking it out in 2007," Ainger said. Some Carmarthen properties have been hard hit, with estate agents reporting the price of flats falling over 50% since 2007. Ainger wrote to Abbey on behalf of his constituent, causing the bank to back down. "Abbey says it has no intention of invoking this clause in its terms and conditions. But the threat still hangs over this family," he said.
Abbey's clause only applies to flexible mortgages, which allow borrowing or repaying freely within limits - it has 60,000 customers on these deals. Michael Coogan, the director general of the Council of Mortgage Lenders (CML), told the committee it was a "commercial decision on Abbey's part to write the letter". But he admitted that the Financial Services Authority had "reminded" the CML last week about "unfair terms". The FSA recently persuaded Halifax to back down from imposing a "collar" (a minimum interest rate) on tracker loans. This was written in the small print but not made clear at the point of sale.
Observer Cash asked other leading lenders if there were similar clauses hidden in mortgage documentation. "We do not have these terms and do not revalue properties for existing customers, although we must look again when someone remortgages," said Barclays (including Woolwich). Similar answers were given by Cheltenham & Gloucester (part of Lloyds TSB), Nationwide, NatWest and Halifax. Abbey says: "We have not invoked this clause and have no intention to do so. What we would say though, is that in a falling house-price environment, it is prudent for people on flexible deals who find themselves at over 90% LTV to look at whether they can afford to make any overpayments." It continued: "This letter was sent to a small number of people and the clause should not have been mentioned. We cannot remove it from the terms and conditions. Our mortgage advisers are aware of this clause."
Spain's credit rating cut by S&P
Spain's sovereign credit rating was cut to AA+ from AAA Monday by Standard & Poor's Ratings Service. "The downgrade of the sovereign reflects our expectations that public finances will suffer in tandem with the expected decline in Spain's growth prospects, and that the policy response may be insufficient to effectively counter the related economic and fiscal challenges," S&P analyst Trevor Cullinan said in a press release. Spain is the second member of the euro-zone to see its credit rating cut. Last week, Greece had its credit rating downgraded. Portugal and Ireland have been placed on negative credit watch.
"Spain's membership of the European monetary union protects the economy from exchange rate crises, but also puts greater onus on microeconomic and fiscal policies," Cullinan said. The lower rating means the costs of public borrowing will rise just as the nation is likely to mount new public spending efforts to boost its deteriorating economy. The agency said it expects the correction in Spain's "unsustainably high" current account deficit of about 10% of GDP in 2008 to take place over the medium term, leaving Spain with a potential growth rate of 2%. That's well below the country's 2003-2007 average gross domestic product growth of 3.5%.
"In our view, at one-quarter of GDP, the export capacity of the Spanish economy is insufficient to provide an immediate channel to offset this fall in domestic demand, especially since Spain has no monetary or exchange rate flexibility in the current global environment," the S&P analyst said. Over the medium term, the agency expects public finances in Spain will be put on a more sustainable footing. It expects net general government debt will rise by 18% of GDP over the next four years, but cautioned that that figure could expand dramatically if recapitalization needs of the banking system rise towards its worst-case scenario of over 4% of GDP.
Spain is among the European countries hit hardest by the global slowdown. Its economic growth has been heavily reliant on construction and housing over the past several years, an industry that has all but collapsed here. Last week, Spain's finance minister Pedro Solbes downgraded the country's economic outlook and suggested it could face the sharpest contraction in the last 50 years. Unemployment in the country is expected to reach near 16% in 2009, with the economy forecast to contract at a negative 1.9% annual rate. Analysts at Gain Capital, in a note last week, said Spain could also face EU sanctions for violating maximum Maastricht deficit/GDP ratios.
Help Ireland or it will exit euro, economist warns
A leading Irish economist has called on Dublin to threaten withdrawal from the euro unless Europe's big powers do more to rescue Ireland's economy. "This is war: countries have to defend themselves," said David McWilliams, a former official at the Irish central bank. "It is essential that we go to Europe and say we have a serious problem. We say, either we default or we pull out of Europe," he told RTE radio. "If Ireland continues hurtling down this road, which is close to default, the whole of Europe will be badly affected. The credibility of the euro will be badly affected. Then Spain might default, Italy and Greece," he said. Mr McWilliams, a former UBS director and now prominent broadcaster, has broken the ultimate taboo by evoking threats to precipitate an EMU crisis, which would risk a chain reaction across the eurozone's southern belt, where yield spreads on state bonds are already flashing warning signals.
The comments reflect growing bitterness in Dublin over the way the country has been treated after voting against the EU's Lisbon Treaty. "If we have a single currency there are obligations and responsibilities on both sides. The idea that Germany and France can just hang us out to dry, as has been the talk in the last couple of days should not be taken lying down," he said. Mr McWilliams cited the example of New York's threat to default in 1975. President Gerald Ford "blinked" at the 11th hour and backed a bail-out to prevent broader damage. As yet, there is no public support for withdrawal from the euro. A Quantum poll published by the Irish Independent yesterday found that 97pc reject such a radical move. Three-quarters are in favour of a national government, an idea floated by Unilever's ex-chief Niall Fitzgerald. "The economic disaster we are facing is unlike anything which has happened in my lifetime.
It is a national crisis and needs a government of national unity," Mr Fitzgerald said. Mr McWilliams said EMU was preventing Irish recovery. "The only way we can win this war is by becoming, once again, an export country. We can do what we are doing now, which is to reduce our wages, throw more people on the dole and suffer a long contraction. The other model is what the British are doing. Britain is letting sterling fall so that the problem becomes someone else's. But we, of course, have ruled this out by our euro membership. "We are paying twice for the euro: once on the exchange rate and once more on the interest rate," he said. "By keeping with the current policy, the state is ensuring that Ireland turns itself into a large debt-repayment machine. Is this the sort of strategy to win wars? " he said.
German Banks Face Further Big Losses
Germany's top 20 banks still have around 300 billion euros of toxic securities on their books and have written off only a quarter of that, according to an official survey, SPIEGEL reports. That means they face further big losses. German banks face further losses totalling billions of euros because they have only written off a fraction of their non-performing securities linked to American mortgages and student loans, according to a survey of 20 major German banks conducted by the German central bank and banking watchdog BaFin.
All the country's top commercial banks and the publicly owned regional banks known as Landesbanken took part in the survey which revealed that the banks hold so-called "toxic" securities totalling just under €300 billion ($398 billion), of which only a quarter has been written off. They hold the remainder in their books at values that are now illusory. The government expects the banks to make further writedowns as a result, which should lead to further big losses for the banks. That in turn means that even more banks are likely to require government cash injections in the near future. The Finance Ministry in Berlin estimates that the entire German banking sector is still holding risky securities totalling up to €1 trillion.
Given that volume, Finance Minister Peer Steinbrück of the center-left Social Democrats, believes it would be irresponsible for the government to set up a so-called Bad Bank as a respository for toxic assets stemming largely from the devastated subprime mortgage market, as banks have suggested. "In the worst case that would cause the federal government debt to more than double," said one member of Steinbrück's staff. At present the federal government debt amounts to almost €1 trillion. Several banks have said that stalled bank lending won't resume unless banks can offload their toxic securities in a Bad Bank.
Japan in move to the left with 'tenderhearted capitalism'
Japan must break free of the heartlessness of Wall Street and create a new brand of “tenderhearted capitalism” to lessen the pain of the worst economic crisis since the Second World War, the economics minister told parliament today. Kaoru Yosano’s comments were matched by an even more striking public attack on western-style capitalism by Yasuhiro Nakasone – the former prime minister responsible for privatising Japan Railways, Japan Tobacco, Japan Airlines and NTT, the former state telecoms corporation. “The laissez-faire principle of US economic policy has lacked humanity and was heartless capitalism,” Mr Nakasone told reporters, “the current crisis has revealed that this US-style capitalism has its limits.” Eventually, he said, Japan will shift towards a Japanese brand of “benevolent and humanistic capitalism”.
The anti-capitalist rhetoric comes amid record-breaking declines in Japanese industrial output, which plunged 8.5 per cent in November from the previous month in a nosedive that was far worse than expected. The phrase “tenderhearted capitalism” sent an instant thrill of horror through the stock market, with brokers forwarding a transcript of Mr Yosano’s speech with a reminder that, even during the days of supposedly “heartless” capitalism, shareholders in Japanese companies were never high on the list of management priorities. Many foreign observers are convinced that Japan already operates a system of capitalism which bears little relation to the Anglo-Saxon version practised on Wall Street and in the City.
Investors were quick to charge that countless recent incidents on the Japanese stock exchange and the attitudes of companies listed there had, in the words of one senior Tokyo fund manager “undermined any sense that Japan took capitalism seriously at all”. Hundreds of anti-takeover defences, cross shareholdings networks and a constant leakage of price-sensitive information have topped the list of complaints levelled against corporate Japan by foreign shareholders. But both Mr Nakasone’s and Yosano’s comments come as large parts of Japanese society have made an apparent political jump to the left – a shift that has not yet been tested at the polls, but has found expression in the recent mass popularity of fiercely anti-capitalist literature and the works of Karl Marx himself.
Despite the appearance that Japanese companies command high levels of employee loyalty and enjoy reputations as responsible employers, recent interviews with factory workers at Toyota suggest that many disagree. Japanese is, after all, a language that has a special legal word for “death by overwork”. “The idea that the strong win and the weak lose has no place in Japanese society,” Mr Yosano said, adding that it was only by developing a breed of “kindly capitalism” that the country could expect to return to its former prosperity. The surprise outburst has stoked fears among investors that both the government and corporate sectors of Japan may, in an attempt to pander to the new mood of anti-capitalism, be planning to unravel all of the country’s recent market-led reforms in favour of a more overtly socialist approach.
One highly visible sign of that has been the sudden interest from politicians and business leaders on the concept of “work sharing” – a system of company-wide pay and working hour reductions ostensibly for the sake of preserving jobs. The concept, say its many critics, disguises the fact that companies which have supposedly preserved numerous jobs through work sharing have also cut many thousands more by quietly sacking contract workers and temps. Mr Yosano’s use of the emotive phrase “society’s winners and losers” comes as Japan Inc is fighting desperately to save its reputation as a benevolent backbone of civil society and is casting about for ways to cut costs while appearing responsible.
Buffett says US in 'economic Pearl Harbor'
Billionaire investor Warren Buffett says the U.S. is engaged in an "economic Pearl Harbor." In an interview that aired Sunday on "Dateline NBC," the chairman and CEO of Berkshire Hathaway Inc. said the nation's economic situation is not as bad at World War II or the Great Depression, but it's still pretty severe. Buffett said Americans are in a cycle of fear, "which leads to people not wanting to spend and not wanting to make investments, and that leads to more fear. We'll break out of it. It takes time." Buffett's interview centered on President-elect Barack Obama and the tough task he faces in fixing the U.S. economy.
"You couldn't have anybody better in charge," the Omaha resident said of Obama, who'll be sworn into office on Tuesday. As one of Obama's economic advisers, Buffett said the president-elect listens to what his advisers say, but ultimately comes up with better ideas. He predicted that Obama will be able to convey the severity of the economic situation to the American people and explain their part in alleviating it. As to how long the crisis would continue, Buffett said he didn't know. "It's never paid to bet against America," he said. "We come through things, but its not always a smooth ride." Omaha-based Berkshire owns a diverse mix of more than 60 companies, including insurance, furniture, carpet, jewelry, restaurants and utility businesses. And it has major investments in such companies as Wells Fargo & Co. and Coca-Cola Co.
GM fears failing key bail-out clause
General Motors has signalled that it might be unable to meet a key condition of the $13.4bn lifeline extended by the US Treasury requiring a two-thirds reduction in the carmaker's unsecured debt. Ray Young, GM's chief financial officer, said that the company might not be able to secure the agreement of all bondholders for the proposed debt-for-equity swap, which aims to reduce public unsecured debt from $27.5bn to $9.2bn. However, Mr Young told analysts that the company views the two-thirds requirement as a "guideline" and that "the ultimate test is financial viability of our enterprise".
More generally, the ailing carmaker is understood to take the view that vaguely worded provisions of the government loan agreement might be open for discussion and modification with a "car czar", to be appointed by the Barack Obama administration. GM's stance comes amid signs that it is preparing to use the threat of a bankruptcy filing to persuade bondholders and the United Auto Workers union to acquiesce to concessions required under the bail-out. In contrast to categorical earlier statements ruling out bankruptcy, Rick Wagoner, GM's chief executive, said this week "the tough thing is that some of the [bail-out requirements] are not within our control. For example . . . we've got to get the people who own the bonds to exchange them. So . . . it's only prudent for us to be prepared for all options."
GM has stepped up the pressure by lowering its assumption of 2009 US car sales to 10.5m vehicles, from 12.5-13m in the plan submitted to Congress last month. GM and Chrysler, which has received $4bn in government funds, are due to present detailed restructuring proposals to the government by February 17, and to finalise them by March 31. The deadline can be extended to the end of April. They have begun talks with the UAW on reducing labour costs to levels competitive with foreign-owned plants in the US. GM says this can be achieved without wage cuts.
The company is also seeking agreement from the UAW to pay half of its $20.4bn contribution to a union-managed healthcare fund in the form of equity. The fund is due to be set up next year as part of GM's drive to reduce healthcare costs. Rod Lache, analyst at Deutsche Bank, told the Society of Automotive Analysts this week that the "probability is greater than not that there will be bankruptcy, but not the kind of disruptive, scary bankruptcy with calamitous impact that a lot of suppliers are afraid of today".
Are We Going To Sit On Our Hands?
Any premise that the "global bank bailout" scam could possibly work was dashed to pieces this morning. The entirety of the European banking system was routed, with share price losses ranging from 50 to 75 percent - in one day. HSBC, Barclays and RBS were all decimated as the truth has started to leak out and is no longer able to be ignored. This came following BAC, Citibank, Wells Fargo and others in the US being similarly destroyed on Friday, and now State Street (STT) has said they may have another $9 billion in "hidden" (unrealized and un-admitted) losses. It is time to quit screwing around. If the politicians will not do it, we must force them by any means possible - and necessary.
The simple reality is that Bernanke and Paulson have between them guaranteed or "bought down" some seven trillion in debt thus far, and its not enough. Proof of this is found in the fact that the banks keep coming back to the well time after time. I said close to two years ago right here on The Ticker that we were likely facing $2-3 trillion in residential real estate losses - real losses. It appears I was too conservative and the actual losses in residential real estate alone will be at least double that amount. We couldn't afford the original $2-3 trillion. Why not? Because it doesn't end with residential real estate.
The carnage also extends to commercial real estate, car loans, student loans, credit cards and more. In short, it is found in every area of debt, without exception. None of it is safe, and the money is simply not there, nor can it be conjured, to "put things right" with some sort of "tarp it over" scheme. This must be stopped, and stopped now. To the extent we are able, we must recall the money that has been committed. We must eject from policy roles all who had a hand in this so-called "rescue attempt", and for those who threaten to continue it, they must face indictment for fraud - which is exactly what their policies, at this point, are.
We now know these approaches will not and cannot work. The math said they couldn't work at the outset, but now we can add proof that comes with time and experience - the actual experience now matches the projections, and it all sucks. It is time for President Obama (as of tomorrow) to take the stand and say in a loud, clear voice - NO MORE. If you're broke, you're broke. Its unfortunate but true. The bankruptcy provisions must be rolled back so that consumers, as well as businesses, can avail themselves of liquidation. It is what this nation - and indeed all nations - need. As for the markets, Obama's "pretty candy from the rear end" rally may not come - and certainly, it may not last. If this is yet another attempt by the banks to twist his arm by manufacturing an "imminent crisis" that demands that he throw money at the problem, one can only hope that either he, or China, will simply say "uh uh" and halt the charade.
The fact of the matter is that we have been systematically looted so that a handful of people can steal their last bonus check to the tune of $70 billion, another $200 billion has been blown into a black hole of fraudulent accounting under the pretense that these securities "will come back" and all of it is gone. We have "promised" that which we cannot deliver, and the check is on the table.Mellon had it right, and it is time for people to rally to this cry - "Liquidate, liquidate, liquidate. Liquidate it all." There is a bottom folks. In the stock market, in real estate, in commercial space. It's just a hell of a lot further down than people want to admit, but until we do admit it, we will do further damage and dig the hole deeper.
The time to stop was in the spring of 2007 when I first called "BS" on WaMu's earnings report; the cops should have descended on them and other similarly-situated banks and shut 'em down. They refused, and we refused to force the issue. Now we have proof through time that the approach taken was wrong - and I, along with the few other voices in the wilderness demanding that open, honest accounting along with bankruptcy were the only and proper course - were right. When in a hole the first rule is to STOP DIGGING.
Cost of Borrowing Zooms Up for US Corporations
Like consumers and homeowners, American corporations binged on easy credit when times were flush, racking up huge debts. Now the bills are due, and paying them back will not be easy, or cheap. This year alone, more than $700 billion in corporate loans will come due, according to Standard & Poor's. That is the size of the federal bailout of the financial sector. Many companies were counting on being able to borrow more money to meet those obligations and kick their debt further down the road. But with the credit markets still tight, corporations are being forced to pay much higher interest rates than they did a few years ago, putting more strain on balance sheets already hammered by falling profits and a grinding recession.
It is a lesson the discount carrier Southwest Airlines learned firsthand in December, when it went to the bond markets to raise $400 million, in part to cover its losses from betting that fuel costs would remain high. Southwest, the only domestic airline with an investment-grade credit rating, put up 17 of its Boeing jets as collateral and agreed to pay interest of 10.5 percent, nearly double the rate it had paid in 2004 to raise $350 million. The company chafed at the costs, but it paid them because it needed cash and did not know what credit markets would look like in six months or a year. "That's the market now," said Laura Wright, the airline's chief financial officer. "There is not money available at the rates we were able to get a year ago." Southwest said it had seized the opportunity to raise cash at a time when other companies could not borrow at all. Companies with poor credit ratings are virtually locked out of credit markets or face the prospect of paying 20 percent interest. Many of them are cutting costs, canceling projects or putting assets up for sale to avoid defaulting on their debts.
Despite huge government rescue programs and drastic reductions in the Federal Reserve's benchmark interest rate, borrowing costs for companies have remained stubbornly high. Investors are wary of anything riskier than ultrasafe Treasury bills, and banks, which lost billions of dollars making bad loans, have tightened their lending. "This is going to be a very challenging year for corporate treasurers," said Roger Lister, chief credit officer at the financial institutions unit of DBRS, the credit rating firm. Still, borrowing costs have fallen from record levels in October and November, especially for investment-grade bonds, and more companies have sold new debt in recent weeks. Investors who are getting scant returns - or none at all - from Treasury securities are starting to gamble again on relatively safe corporate debt. "You are getting a very nice return in real terms," said Jim Swanson, chief investment strategist at MFS Investments, a mutual fund firm in Boston. "Companies are willing to pay the price, and the market is willing to take on new issuance." Despite this, capital markets are still shaky.
Even companies with strong credit ratings are paying about 5 percentage points more than the U.S. government to borrow money, according to Standard & Poor's. That is more than double the premium they paid last January. Companies with so-called junk credit ratings are paying premiums of 15 percent. "That's an extraordinary spread," said Diane Vazza, head of global fixed-income research at Standard & Poor's. "That's unprecedented in the speculative-grade market." On top of this, corporate bonds are at risk of being crowded out of the market as the government issues piles of new Treasury notes to combat the financial crisis. And another flood of government bonds is likely if Congress passes an $825 billion economic stimulus measure. What is more, the government guaranteed nearly $108 billion in cheap debt for financial companies in the last two months of 2008 as part of the rescue package. In contrast, relatively few nonfinancial companies have been able to raise money in recent months.
And those doing so have paid dearly for it. For example, Nabors Industries, an oil services company, issued $1.1 billion in 10-year bonds two weeks ago, agreeing to an interest rate of 9.25 percent. A year earlier, when oil prices were shooting up, the company had to pay just 6.15 percent to borrow $975 million. Taking out $1.1 billion at the rates paid last year could have cut annual interest payments by about $34 million. The higher interest bill may be too much to bear for some companies. "Can existing business models support the significantly higher cost of debt that exists now?" asked Max Bublitz, chief strategist at SCM Advisors, an investment firm in San Francisco. "That's a real issue."
In all, corporations in the United States borrowed about $172.7 billion in the fourth quarter, down slightly from $179.1 billion issued in the last three months of 2007, according to DeaLogic. Some businesses planned well for the refinancing crisis, having accumulated cash or set up lines of credit with banks that allowed them to refinance debt at predetermined rates, said Ed Liebert, chairman of the National Association of Corporate Treasurers. Others that need to bring new debt to market could sell shorter-term notes at lower interest rates or turn to institutional investors like pension funds or insurance companies and issue debt privately, in hopes of negotiating better rates. Companies with shaky credit are especially vulnerable as their debts come due and are likely to be among the earliest of many expected defaults this year if they cannot find more cash.
A Trillion-Dollar Deficit?
Continued declines in consumer spending and car sales matched weak manufacturing data, pointing to the longest and perhaps the deepest recession in postwar history. We now expect the drop in real gross domestic product (GDP) during this downturn to be similar to the declines in 1975 (3.1%) and 1982 (2.9%), the previous record holders. In addition, we expect the unemployment rate to reach 9% in early 2010, with the real economy bottoming out in mid-2009, 18 months after the recession began. Credit markets remain locked up. The spread between speculative-grade bond yields and U.S. Treasuries recently reached a record 1,700 basis points. Even investment-grade bonds are trading 500 basis points above Treasuries. This partially reflects unusually low Treasury yields, as international capital has flowed into the United States in search of safety despite near-zero returns.
Trade had been a support for the economy over the last two years, but that sector is turning sour. Foreign economies are dropping as fast as the United States. The stronger dollar (recently at 1.35 euros) is also cutting into export strength. Although imports are expected to drop even farther than exports, the drop in exports will prevent the trade sector from helping out the economy very much. The stimulus package winding its way through Congress gives some excuse for optimism, though mostly for the second half of this year. Incoming President Barack Obama has proposed a package concentrating on infrastructure spending and with about $300 billion in tax cuts, apparently intended to make the package more palatable to Republicans, and $200 billion in assistance to state governments with perhaps a focus on Medicaid.
The exact contents of the package remain unclear, but it will clearly be the biggest stimulus ever, and will lead to the first trillion-dollar deficit (and perhaps $2 trillion). The total cost of the various U.S. government and Federal Reserve packages so far exceeds $3 trillion, although much of that is not included in government outlays or the deficit calculation. Consumers have become the weak spot in the economy after supporting it for so many years. But with the saving rate averaging less than 1% from 2002 to 2007 and home prices now subtracting from wealth instead of adding, consumers are beginning to back away from their free-spending ways. We expect the saving rate to jump temporarily to 5.8% this year, as taxpayers hoard much of their rebate checks, but then it should drop back to an average of 3% from 2010 through 2012.
Autos have been the hardest-hit area. The 10.3 million annualized selling pace in the fourth quarter was the weakest since the summer of 1982, and the 13.2 million sold in 2008 were the weakest since 1992. It is hard to know how much of the recent slump in car sales has been due to drivers not wanting to buy or lenders not wanting to lend. The high gasoline prices last summer kept buyers out of dealer showrooms. Although gasoline prices have since come down, consumers don’t quite believe it yet and are remaining cautious. In addition, many potential buyers with poor credit ratings have been pushed out of contention by the tighter credit standards enforced by the auto dealers and finance companies, whose access to credit has been curtailed.
The government funds being shoved into the car companies might ease some of that problem and could lead to a quicker rebound in car sales than we expect. We currently forecast 10.3 million unit sales in 2009, which would be the weakest calendar year since 1970. Housing-related purchases have also been soft. Furniture and appliance sales have dropped because they are often tied to the purchase of a new home. With home sales down, so are furniture and appliance sales. Recently, other big-ticket items — including electronics — have also begun to weaken, which reflects both the new caution among buyers as well as difficulties in borrowing money. On a positive note, household debt has begun to decline as a share of disposable income, and we expect this to continue. Payrolls declined every month in 2008, and the total job loss of 2.8 million was the worst since monthly data began (1945).
The unemployment rate rose to 7.2% in December, its highest level since 1993 but still moderate compared with past recessions. The rate has risen from 4.4% in March 2007, and we expect it to continue to climb to 9% in early 2010. Note that the unemployment rate is not likely to peak until at least six months after the economy starts to recover. The job outlook is reflected in the weak consumer confidence data. Confidence is very low compared with other recessions that were statistically much worse than the current one; we expect this downturn to challenge the record decline of 1975 before it is over, however. On the positive side, consumers will get a significant check from the Treasury, about half of which is likely to be spent. The drop in oil prices since last summer gives consumers another $200 billion of purchasing power, and we think consumers will spend it. The surge in mortgage refinancings has added to household purchasing power as well. Unlike the refinancings earlier this decade, homeowners aren’t taking cash out of their homes, but they are cutting their monthly payments.
Congress to help cities, muni bonds: Rep Frank
The U.S. Congress is likely to help cities' struggling economies not only through the stimulus bill it is expected to pass soon but through measures to boost the municipal bond market, Rep. Barney Frank told a mayors' meeting Sunday. Frank has put high on his agenda the creation of a bond insurer that the federal government would operate, and which would charge premiums based on the risk of bonds' defaults, he told Reuters. Most bonds do not default and, therefore, do not need insurance but "the market may still want it," said Frank, who heads the House Financial Services Committee. Lower-rated municipal bond issues frequently used insurance to boost their credit ratings, which drove down the interest payments they had to pay to attract buyers. Over a year ago, credit rating agencies began downgrading the insurers and bonds were left trading on their underlying ratings.
Since then bond issuers have struggled to bring new debt to market and many have to pay higher interest rates. That has proven difficult during the year-long recession when municipalities have seen their tax revenues drop and demand for their social services spike. The National League of Cities and other groups have proposed creating a collective insurance group with seed money from the federal government that would be operated by cities and states. Frank, though, told Reuters he envisioned a program administered by the federal government to back full faith and credit general obligation bonds. Frank has introduced legislation to tighten oversight of the Troubled Asset Relief Program, which the U.S. government has used to bailout financial institutions, that would authorize some of the program's funding to support municipal bonds. President-elect Barack Obama, who will take office Tuesday, has requested the second installment of $350 billion of TARP funds.
"We put into our bill, which the administration has told us they plan to abide by even if it does not pass the Senate, specific authority to help municipal bonds," Frank told the U.S. Conference of Mayors. "We will get help in the short-term for municipal bonds for this." A poll released by Zogby International on Saturday found most Americans believe there was little to no transparency in how the first chunk of the bailout money was used. Frank said the Obama administration had agreed to ask for more disclosure from financial institutions helped by the program. "No institution will get new money without the requirement that they tell us exactly how they are going to spend it," he said.
State and local governments are facing their most serious financial challenges in decades, Moody's Investors Services said on Friday. Obama has called for an economic recovery package that would include heavy public works spending as well as assistance for state and local governments. Last week the House presented a version that Speaker Nancy Pelosi, a California Democrat, said would likely be passed in February. Frank said many grants for towns are included in the proposed plan and the Community Development Block Grant program, used to combat blight, would get a 25 percent boost.
More Americans Joining Military as Jobs Dwindle
As the number of jobs across the nation dwindles, more Americans are joining the military, lured by a steady paycheck, benefits and training. The last fiscal year was a banner one for the military, with all active-duty and reserve forces meeting or exceeding their recruitment goals for the first time since 2004, the year that violence in Iraq intensified drastically, Pentagon officials said. And the trend seems to be accelerating. The Army exceeded its targets each month for October, November and December — the first quarter of the new fiscal year — bringing in 21,443 new soldiers on active duty and in the reserves. December figures were released last week. Recruiters also report that more people are inquiring about joining the military, a trend that could further bolster the ranks. Of the four armed services, the Army has faced the toughest recruiting challenge in recent years because of high casualty rates in Iraq and long deployments overseas. Recruitment is also strong for the Army National Guard, according to Pentagon figures. The Guard tends to draw older people.
“When the economy slackens and unemployment rises and jobs become more scarce in civilian society, recruiting is less challenging,” said Curtis Gilroy, the director of accession policy for the Department of Defense. Still, the economy alone does not account for the military’s success in attracting more recruits. The recent decline in violence in Iraq has “also had a positive effect,” Dr. Gilroy said. Another lure is the new G. I. Bill, which will significantly expand education benefits. Beginning this August, service members who spend at least three years on active duty can attend any public college at government expense or apply the payment toward tuition at a private university. No data exist yet, but there has traditionally been a strong link between increased education benefits and new enlistments. The Army and Marine Corps have also added more recruiters to offices around the country in the past few years, increased bonuses and capitalized on an expensive marketing campaign.
The Army has managed to meet its goals each year since 2006, but not without difficulty. As casualties in Iraq mounted, the Army began luring new soldiers by increasing signing bonuses for recruits and accepting a greater number of people who had medical and criminal histories, who scored low on entrance exams and who failed to graduate from high school. The recession has provided a jolt for the Army, which hopes to decrease its roster of less qualified applicants in the coming year. It also has helped ease the job of recruiters who face one of the most stressful assignments in the military. Recruiters must typically talk to 150 people before finding one person who meets military qualifications and is interested in enlisting. Dr. Gilroy said the term “all-volunteer force” should really be “an all-recruited force.”
Now, at least, the pool has widened. Recruiting offices are reporting a jump in the number of young men and women inquiring about joining the service in the past three months. As a rule, when unemployment rates climb so do military enlistments. In November, the Army recruited 5,605 active-duty soldiers, 6 percent more than its target, and the Army Reserve signed up 3,270 soldiers, 16 percent more than its goal. December, when the jobless rate reached 7.2 percent, saw similar increases in recruitments. “They are saying, ‘There are no jobs, no one is hiring,’ or if someone is hiring they are not getting enough hours to support their families or themselves,” said Sgt. First Class Phillip Lee, 41, the senior recruiter in the Army office in Bridgeport, Conn. The Bridgeport recruitment center is not exactly a hotbed for enlistments. But Sergeant Lee said it had signed up more than a dozen people since October, which is above average.
He said he had been struck by the number of unemployed construction workers and older potential recruits — people in their 30s and beyond — who had contacted him to explore the possibility. The Army age limit is 42, which was raised from 35 in 2006 to draw more applicants. “Some are past the age limit, and they come in and say, ‘Will the military take me now?’ ” Sergeant Lee said. “They are having trouble finding well-paying jobs.” Of the high school graduates, a few told him recently that they had to scratch college plans because they could not get students loans or financial aid. The new G. I. bill is an especially attractive incentive for that group. The Army Reserve and the National Guard have also received a boost from people eager to supplement their falling incomes. Sean D. O’Neil, a 22-year-old who stood shivering outside an Army recruitment office in St. Louis, said he was forgoing plans to become a guitar maker for now, realizing that instruments are seen as a luxury during a recession. Mr. O’Neil, a Texas native, ventured to St. Louis for an apprenticeship but found himself $30,000 in debt. Joining the Army, his Plan B, was a purely financial decision. With President-elect Barack Obama in office, he expects the troop levels in Iraq to be lowered.
Going to war, although likely, feels safer to him. “I’m doing this for eight years,” he said. “Hopefully, when I get out, I’ll have all my fingers and toes and arms, and the economy will have turned around, and I’ll have a little egg to start up my own guitar line.” Ryen Trexler, 21, saw the recession barreling toward him as he was fixing truck tires for Allegheny Trucks in Altoona, Pa. By last summer, his workload had dropped from fixing 10 to 15 tires a day to mending two to four, or sometimes none. As the new guy on the job, he knew he would be the first to go. He quit and signed up for the Jobs Corps Center in Pittsburgh, a federal labor program that would pay for two years of training, figuring he would learn to be a heavy equipment operator. When a local Army recruiter walked into the center, his pitch hit a nerve. Mr. Trexler figured he could earn more money and learn leadership skills in the Army. Just as important, he could ride out the recession for four years and walk out ready to work in civilian construction.
Although the other branches of the military have not struggled as much as the Army to recruit, they, too, are attracting people who would not ordinarily consider enlisting. Just a few months ago, Guy Derenoncourt was working as an equity trader at a boutique investment firm in New York. Then the equity market fell apart and he quit. Last week, he enlisted for a four-year stint in the Navy, a military branch he chose because it would keep him out of Afghanistan and offer him a variety of aviation-related jobs. “I really had no intention to join if it weren’t for the financial turmoil, because I was doing quite well,” Mr. Derenoncourt, 25, said, adding that a sense of patriotism made it an easier choice. The Army has struggled to attract the same caliber of enlistee that it did before the war.
In 2003, 94 percent of new active-duty recruits had high school degrees. Last year, the number increased slightly from 2007, but it was still 82 percent. The percentage of new recruits who score poorly on the military entrance exam also remains comparatively high. The same is true for enlistees who need permission to enter the military for medical or “moral” reasons, typically misdemeanor juvenile convictions. Last year, 21.5 percent of the 80,000 new recruits in the Army required a so-called medical or moral waiver, 2 percent higher than in 2006. Fewer recruits needed waivers for felony convictions, though, compared with 2007.
New York to lead US cities in job losses
Only five metropolitan areas in the U.S. will escape job losses this year, according to a forecast released Saturday by the U.S. Conference of Mayors.
New York is expected to take the biggest hit as thousands of jobs are lost on Wall Street. Big financial firms are slashing workers as they cope with bad debt. Other companies have gone under, like Lehman Brothers Holdings Inc., which filed for bankruptcy in September. The New York area is expected to lose 181,000 jobs in 2009, the report said. Consulting company IHS Global Insight produced the report for the group. The Los Angeles area is expected to see 164,000 lost jobs, in part because of the huge drop in home prices that has punctured the California economy.
After New York and Los Angeles, the Miami area is expected to see the greatest loss, with a decline of 85,000 jobs. Chicago and the surrounding area are next, with losses projected at 80,000. Unemployment is expected to top 10 percent in 70 areas, from already hard-hit cities like Detroit and Cleveland to places that had until recently been prosperous like the Riverside-San Bernardino area in California. Other big cities like Denver and St. Louis are expected to see unemployment rise above 9 percent. Ithaca, N.Y.; Fairbanks, Alaska; and St. George, Utah, are among the handful of the nation's 363 metropolitan areas expected to see employment remain flat or increase slightly.
An Economy of Faith and Trust
Once there was just Newtonian physics and the world seemed neat and mechanical. Then quantum physics came along and revealed that deep down things are much weirder than they seem. Something similar is now happening with public policy. Once, classical economics dominated policy thinking. The classical models presumed a certain sort of orderly human makeup. Inside each person, reason rides the passions the way a rider sits atop a horse. Sometimes people do stupid things, but generally the rider makes deliberative decisions, and the market rewards rational behavior. Markets tend toward efficiency. People respond in pretty straightforward ways to incentives. The invisible hand forms a spontaneous, dynamic order. Economic behavior can be accurately predicted through elegant models.
This view explains a lot, but not the current financial crisis — how so many people could be so stupid, incompetent and self-destructive all at once. The crisis has delivered a blow to classical economics and taken a body of psychological work that was at the edge of public policy thought and brought it front and center. In this new body of thought, you get a very different picture of human nature. Reason is not like a rider atop a horse. Instead, each person’s mind contains a panoply of instincts, strategies, intuitions, emotions, memories and habits, which vie for supremacy. An irregular, idiosyncratic and largely unconscious process determines which of these internal players gets to control behavior at any instant. Context — which stimulus triggers which response — matters a lot. This mental chaos explains how people can respond so quickly and intuitively to so many different circumstances. But it also entails a decision-making process that is more complicated and messy than previously thought.
For example, we don’t perceive circumstances objectively. We pick out those bits of data that make us feel good because they confirm our prejudices. As Andrew Lo of M.I.T. has demonstrated, if stock traders make a series of apparently good picks, the dopamine released into their brains creates a stupor that causes them to underperceive danger ahead. Biases abound. People who’ve been told to think of a high number will subsequently bid much more for an item than people who’ve been told to think of a low number. As Jonah Lehrer writes in his forthcoming book, “How We Decide,” there are certain circumstances (often when there are many options) in which gut instincts lead to the best decisions, while there are other circumstances (sometimes when there are a few options) when calm deliberation is best. Most important, people seek relationships more than money. If behaving a certain way helps a stock trader or a regulator fit in with his crowd, he’s likely to keep doing it without too much rigorous self-examination.
A thousand mental shortcomings contributed to the financial meltdown. Republicans have tried to explain it by pointing to irresponsible policies at Fannie Mae. But that only explains a piece of what’s happening. This crisis represents a flaw in the classical economic model and its belief in efficient markets. Republicans haven’t begun to grapple with the consequences. For years, Republicans have been trying to create a large investor class with policies like private Social Security accounts, medical savings accounts and education vouchers. These policies were based on the belief that investors are careful, rational actors who make optimal decisions. There was little allowance made for the frailty of the decision-making process, let alone the mass delusions that led to the current crack-up. Democrats also have an unfaced crisis. Democratic discussions of the stimulus package also rest on a mechanical, dehumanized view of the economy. You pump in a certain amount of money and “the economy” spits out a certain number of jobs. Democratic economists issue highly specific accounts of multiplier effects — whether a dollar of spending creates $1.20 or $1.40 of economic activity.
But an economy is a society of trust and faith. A recession is a mental event, and every recession has its own unique spirit. This recession was caused by deep imbalances and is propelled by a cascade of fundamental insecurities. You can pump hundreds of billions into the banks, but insecure bankers still won’t lend. You can run up gigantic deficits, hire road builders and reduce the unemployment rate from 8 percent to 7 percent, but insecure people will still not spend and invest. The economic spirit of a people cannot be manipulated in as simple-minded a fashion as the Keynesian mechanists imagine. Right now political and economic confidence levels are running in opposite directions. Politically, we’re in a season of optimism, but despite a trillion spent and a trillion more about to be, the economic spirit cowers. Mechanistic thinkers on the right and left pose as rigorous empiricists. But empiricism built on an inaccurate view of human nature is just a prison.
'We have only four years left to act on climate change - America has to lead'
Along one wall of Jim Hansen's wood-panelled office in upper Manhattan, the distinguished climatologist has pinned 10 A4-sized photographs of his three grandchildren: Sophie, Connor and Jake. They are the only personal items on display in an office otherwise dominated by stacks of manila folders, bundles of papers and cardboard boxes filled with reports on climate variations and atmospheric measurements. The director of Nasa's Goddard Institute for Space Studies in New York is clearly a doting grandfather as well as an internationally revered climate scientist. Yet his pictures are more than mere expressions of familial love. They are reminders to the 67-year-old scientist of his duty to future generations, children whom he now believes are threatened by a global greenhouse catastrophe that is spiralling out of control because of soaring carbon dioxide emissions from industry and transport.
"I have been described as the grandfather of climate change. In fact, I am just a grandfather and I do not want my grandchildren to say that grandpa understood what was happening but didn't make it clear," Hansen said last week. Hence his warning to Barack Obama, who will be inaugurated as US president on Tuesday. His four-year administration offers the world a last chance to get things right, Hansen said. If it fails, global disaster - melted sea caps, flooded cities, species extinctions and spreading deserts - awaits mankind. "We cannot now afford to put off change any longer. We have to get on a new path within this new administration. We have only four years left for Obama to set an example to the rest of the world. America must take the lead."
After eight years of opposing moves to combat climate change, thanks to the policies of President George Bush, the US had given itself no time for manoeuvre, he said. Only drastic, immediate change can save the day and those changes proposed by Hansen - who appeared in Al Gore's An Inconvenient Truth and is a winner of the World Wildlife Fund's top conservation award - are certainly far-reaching. In particular, the idea of continuing with "cap-and-trade" schemes, which allow countries to trade allowances and permits for emitting carbon dioxide, must now be scrapped, he insisted. Such schemes, encouraged by the Kyoto climate treaty, were simply "weak tea" and did not work. "The United States did not sign Kyoto, yet its emissions are not that different from the countries that did sign it."
Thus plans to include carbon trading schemes in talks about future climate agreements were a desperate error, he said. "It's just greenwash. I would rather the forthcoming Copenhagen climate talks fail than we agree to a bad deal," Hansen said. Only a carbon tax, agreed by the west and then imposed on the rest of the world through political pressure and trade tariffs, would succeed in the now-desperate task of stopping the rise of emissions, he argued. This tax would be imposed on oil corporations and gas companies and would specifically raise the prices of fuels across the globe, making their use less attractive. In addition, the mining of coal - by far the worst emitter of carbon dioxide - would be phased out entirely along with coal-burning power plants which he called factories of death.
"Coal is responsible for as much atmospheric carbon dioxide as other fossil fuels combined and it still has far greater reserves. We must stop using it." Instead, programmes for building wind, solar and other renewable energy plants should be given major boosts, along with research programmes for new generations of nuclear reactors. Hansen's strident calls for action stem from his special view of our changing world. He and his staff monitor temperatures relayed to the institute - an anonymous brownstone near Columbia University - from thousands of sites around the world, including satellites and bases in Antarctica. These have revealed that our planet has gone through a 0.6C rise in temperature since 1970, with the 10 hottest years having occurred between 1997 and 2008: unambiguous evidence, he believes, that Earth is beginning to overheat dangerously.
Last week, however, Hansen revealed his findings for 2008 which show, surprisingly, that last year was the coolest this century, although still hot by standards of the 20th century. The finding will doubtless be seized on by climate change deniers, for whom Hansen is a particular hate figure, and used as "evidence" that global warming is a hoax. However, deniers should show caution, Hansen insisted: most of the planet was exceptionally warm last year. Only a strong La Niña - a vast cooling of the Pacific that occurs every few years - brought down the average temperature. La Niña would not persist, he said. "Before the end of Obama's first term, we will be seeing new record temperatures. I can promise the president that."
Hansen's uncompromising views are, in some ways, unusual. Apart from his senior Nasa post, he holds a professorship in environmental sciences at Columbia and dresses like a tweedy academic: green jumper with elbow pads, cords and check cotton shirt. Yet behind his unassuming, self-effacing manner, the former planetary scientist has shown surprising steel throughout his career. In 1988, he electrified a congressional hearing, on a particular hot, sticky day in June, when he announced he was "99% certain" that global warming was to blame for the weather and that the planet was now in peril from rising carbon dioxide emissions. His remarks, which made headlines across the US, pushed global warming on to news agendas for the first time.
Over the years, Hansen persisted with his warnings. Then, in 2005, he gave a talk at the American Geophysical Union in which he argued that the year was the warmest on record and that industrial carbon emissions were to blame. A furious White House phoned Nasa and Hansen was banned from appearing in newspapers or on television or radio. It was a bungled attempt at censorship. Newspapers revealed that Hansen was being silenced and his story, along with his warnings about the climate, got global coverage. Since then Hansen has continued his mission "to make clear" the dangers of climate change, sending a letter last December from himself and his wife Anniek about the urgency of the planet's climatic peril to Barack and Michelle Obama. "We decided to send it to both of them because we thought there may be a better chance she will think about this or have time for it. The difficulty of this problem [of global warming] is that its main impacts will be felt by our children and by our grandchildren. A mother tends to be concerned about such things."
Nor have his messages of imminent doom been restricted to US politicians. The heads of the governments of Britain, Germany, Japan and Australia have all received recent warnings from Hansen about their countries' behaviour. In each case, these nations' continued support for the burning of coal to generate electricity has horrified the climatologist. In Britain, he has condemned the government's plans to build a new coal plant at Kingsnorth, in Kent, for example, and even appeared in court as a defence witness for protesters who occupied the proposed new plant's site in 2007. "On a per capita basis, Britain is responsible for more of the carbon dioxide now in the atmosphere than any other nation on Earth because it has been burning it from the dawn of the Industrial Revolution. America comes second and Germany third. The crucial point is that Britain could make a real difference if it said no to Kingsnorth. That decision would set an example to the rest of the world." These points were made clear in Hansen's letter to the prime minister, Gordon Brown, though he is still awaiting a reply.
As to the specific warnings he makes about climate change, these concentrate heavily on global warming's impact on the ice caps in Greenland and Antarctica. These are now melting at an alarming rate and threaten to increase sea levels by one or two metres over the century, enough to inundate cities and fertile land around the globe. The issue was simple, said Hansen: would each annual increase of carbon dioxide to the atmosphere produce a simple proportional increase in temperature or would its heating start to accelerate? He firmly believes the latter. As the Arctic's sea-ice cover decreases, less and less sunlight will be reflected back into space. And as tundras heat up, more and more of their carbon dioxide and methane content will be released into the atmosphere. Thus each added tonne of carbon will trigger greater rises in temperature as the years progress. The result will be massive ice cap melting and sea-level rises of several metres: enough to devastate most of the world's major cities.
"I recently lunched with Martin Rees, president of the Royal Society, and proposed a joint programme to investigate this issue as a matter of urgency, in partnership with the US National Academy of Sciences, but nothing has come of the idea, it would seem," he said. Hansen is used to such treatment, of course, just as the world of science has got used to the fact that he is as persistent as he is respected in his work and will continue to press his cause: a coal-power moratorium and an investigation of ice-cap melting.
The world was now in "imminent peril", he insisted, and nothing would quench his resolve in spreading the message. It is the debt he owes his grandchildren, after all.The climate in figures
• The current level of carbon dioxide in the atmosphere is 385 parts per million. This compares with a figure of some 315ppm around 1960.
• Carbon dioxide is a greenhouse gas that can persist for hundreds of years in the atmosphere, absorbing infrared radiation and heating the atmosphere.
• The Intergovernmental Panel on Climate Change's last report states that 11 of the 12 years between 1995-2006 rank among the 12 warmest years on record since 1850.
• According to Jim Hansen, the nation responsible for putting the largest amount of carbon dioxide in the atmosphere is Britain, on a per capita basis - because the Industrial Revolution started here. China is now the largest annual emitter of carbon dioxide .
• Most predictions suggest that global temperatures will rise by 2C to 4C over the century.
• The IPCC estimates that rising temperatures will melt ice and cause ocean water to heat up and increase in volume. This will produce a sea-level rise of between 18 and 59 centimetres. However, some predict a far faster rate of around one to two metres.
• Inundations of one or two metres would make the Nile Delta and Bangladesh uninhabitable, along with much of south-east England, Holland and the east coast of the United States.