Firestone Rubber plant in Akron, Ohio. "Conversion. Beverage containers to aviation oxygen cylinders. Before completion of the fourth and final welding operation in the manufacture of shatterproof oxygen cylinders for high altitude flying, all straps are subjected to physical tests to determine the strength of the weld. Occasional radiographic inspections are made to insure the quality of workmanship after the two halves of the cylinder are brought together in this atomic welding machine and made one unit. Here, the operator has just completed the union and is about to remove the whole cylinder."
Ilargi: It’s just not going to stop anytime soon, is it? The markets will keep plunging and the unmitigated disaster that the Obama administration has turned out to be will continue to get worse day after grueling day.
"The U.S. government stands firmly behind the banking system...."Oh yeah? Well, that's not where the US government belongs. The US government should stand firmly behind its citizens. Standing behind the banking system? You better wear a helmet, because it's busy falling apart. These people live in a parallel universe, and that is a very bad idea when things are in need of repair. The government in Washington, like those in Paris, London and all the other capitals of the world has to come up with a plan, very very soon, to lay a bottom underneath its economy and society. And that is not happening at all, there's nothing happening. Instead of focusing on the people, on what will become of the children, on what the children will eat, the government is focusing on the banks. The banks are dead. The children are not. Yet. This 3 Stooges circus is busy fixing the roof while the foundations of the house are collapsing. Economic growth, you said, Mr. President? We don't need those dead banks, and we don't need economic growth. We need to feed our children, so they can grow. This is getting serious, and it's deteriorating at the speed of light. Current policies are calamitous, and that's not just in the US. There are no guarantees that we can fix this to the point where we won't see children dying of hunger in our streets. There is, though, the guarantee that we will see them if we don't adopt a radically different approach to our problems. The banks may have financed your campaign, but it's the people who voted you in office. It's real simple: you can't save both. Time to choose. So far, so bad. A spectacular failure.
U.S. Stocks Fall, Sending Market Below Lowest Close Since 1997
U.S. stocks fell, sending the Standard & Poor’s 500 Index below its lowest close in 12 years, as concern that the deepening recession will erode earnings offset the government’s pledge to give more capital to banks. Hewlett-Packard Co. and Intel Corp. slid at least 4.6 percent as Morgan Stanley said technology stocks are the most vulnerable among economically sensitive industries. Nucor Corp. helped lead a decline in steelmakers after UBS AG said the group has increased output too quickly. Bank of America Corp. rose 9.5 percent and Citigroup Inc. climbed 19 percent as concern eased that the U.S. government will seize control of the lenders.
The S&P 500 lost 2.9 percent to 747.64 at 3:34 p.m. in New York, below its lowest close since April 1997. The six-day losing streak in the U.S. stock benchmark ranks as the longest since October. The Dow Jones Industrial Average decreased 207.48 points, or 2.8 percent, to 7,158.19, below its lowest close since October 1997. The Russell 2000 Index lost 3.1 percent. "Many investors simply can’t contemplate any more stock market risk in their portfolios," said Fritz Meyer, the Denver- based senior market strategist for Invesco Aim, which oversees $357 billion. "Sentiment in the market is very weak and negative." Bank of America and Citigroup, each with losses exceeding 65 percent this year, have dragged the S&P 500 to a 17 percent decline in 2009, the worst start on record. President Barack Obama and Treasury Secretary Timothy Geithner failed to assuage investor concerns with an $787 billion economic stimulus plan comprised of tax breaks and government spending.
Financial shares led the market higher at the open, rising as much as 4.6 percent collectively, after U.S. regulators said they will begin examining which banks have enough capital to survive a deeper recession. Banks that need more funds after so- called stress tests and cannot raise the money from private investors will be able to tap taxpayer funds. Losses in shares of Nucor Corp., U.S. Steel Corp. and AK Steel Holding Corp. pushed a group of raw-materials producers in the S&P 500 to a 5 percent loss, the most among 10 industries. Steelmakers need to limit supply to support a "sustained recovery," said UBS analyst Andrew Snowdowne in a research report. He cut his rating on ArcelorMittal, the world’s biggest steelmaker, to "neutral" from "buy," while SSAB Svenskt Staal AB, the largest supplier of high-tensile steel, was reduced to "sell" from "neutral." Morgan Stanley strategist Jason Todd advised clients to remain "underweight" technology and raw-materials companies as the global economy continues to deteriorate.
"Sell the recent rally," Todd wrote. "Tech is a momentum sector where generally valuations alone are not enough to drive outperformance if earnings momentum is negative and valuations are just ‘fair.’" The S&P 500 Information Technology Index, which has lost 8.1 percent this year for the second-best performance among 10 industries, fell 3.8 percent today. Hewlett-Packard, the world’s largest personal-computer maker, declined 5.3 percent to $29.60 for a fifth straight day of losses. Intel, the biggest chipmaker, fell 5.3 percent to $12.10. "We’re still being governed by how deep the recession be," said Mike Ryan, head of wealth management research for the Americas at UBS Financial Services Inc. "There just don’t seem to be any clear signs that some of the problems have run their course." The MSCI Asia Pacific Index increased 0.3 percent today and Europe’s Dow Jones Stoxx 600 Index slipped 0.9 percent. Yields on benchmark 10-year U.S. Treasury notes were little changed at 2.80 percent, according to BGCantor Market Data, as the government prepared to sell a record amount of notes this week.
Humana Inc. fell the most since April 1999 after the U.S. government proposed fee increases of less than 1 percent to companies providing subsidized health coverage for the elderly. S&P 500 health-care stocks collectively lost 2.3 percent. Humana tumbled 25 percent to $30.54 for the biggest drop in the S&P 500. The second-largest provider of U.S.-funded health insurance said the new rates, scheduled for 2010, would have a "significant adverse impact."
The fastest reduction in U.S. dividends since 1955 is depriving investors of the only thing that gave stocks an advantage over government bonds in the last century. U.S. equities returned 6 percent a year on average since 1900, inflation-adjusted data compiled by the London Business School and Credit Suisse Group AG show. Take away dividends and the annual gain drops to 1.7 percent, compared with 2.1 percent for long-term Treasury bonds, according to the data.
Governments across the world are stepping up measures to stem the worst global recession since World War II. Bank of America and Citigroup have received a combined $90 billion in U.S. aid in four months. Federal officials said today that they will make sure banks have enough capital to boost lending and spur economic growth. The joint statement from regulators, including the Federal Reserve and Treasury, promised they will stand "firmly behind the banking system during this period of financial strain." Bank of America snapped a six-day losing streak, gaining 33 cents to $4.12. Citigroup rallied 34 cents to $2.29. Citigroup is in talks with federal officials that may result in the government holding as much as 40 percent of its common stock, the Wall Street Journal said. Executives at the bank would prefer the stake to be closer to 25 percent, the newspaper reported. Citigroup spokesman Jon Diat declined to comment. "The government measures will prevent the world from going under," said Rudolf Buxtorf, who manages the equivalent of $114 million at RBS Coutts Bank in Zurich. "We won’t see a bankruptcy or an even worse catastrophe."
Regulators Stand Firmly Behind Banking System
Amid renewed fears about the health of the U.S. financial sector, regulators on Monday issued a rare joint statement to make clear they stand behind the U.S. banking system and that they have options for aiding "systemically important" firms. One of the new options, which the Obama administration could use to aid Citigroup Inc., is for the government to convert the preferred shares it already has in banks into common equity shares. That new conversion option will enable firms "to maintain or enhance the quality of their capital," regulators said Monday.
Under the Bush administration, the Treasury Department had purchased senior preferred shares in banks as part of the broad $700 billion financial rescue effort. Now, however, the Obama administration plans to inject capital in the form of mandatory convertible preferred shares that can be turned into common equity shares "only as needed over time to keep banks in a well-capitalized position and retired under improved financial conditions before the conversion becomes mandatory." Meanwhile, officials plan on Wednesday to start analyzing banks' balance sheets through new "stress tests" to see whether firms need additional capital. In their statement, regulators made clear they're prepared to provide "a temporary capital buffer" for firms found to need additional funds and that government injections will not imply a new capital standard for the firms.
"The U.S. government stands firmly behind the banking system during this period of financial strain to ensure it will be able to perform its key function of providing credit to households and businesses," said the joint statement by the U.S. Treasury Department, the Federal Deposit Insurance Corp., the office of the Comptroller of the Currency, the Office of Thrift Supervision and the Federal Reserve. "The government will ensure that banks have the capital and liquidity they need to provide the credit necessary to restore economic growth. Moreover, we reiterate our determination to preserve the viability of systemically important financial institutions so that they are able to meet their commitments."
The statement comes as struggling banking giant Citigroup, according to The Wall Street Journal, is in talks with federal officials that could result in the federal government expanding its ownership of the bank. The deal could give the government its largest ownership of a financial-services company since the government bailed out insurer American International Group Inc. (AIG) in September. According to the Journal, the government's $45 billion in preferred shares could be converted into common stock. While that move would not cost taxpayers additional money, other Citigroup shareholders could see their stock diluted.
Meanwhile, regulators released details on the stress tests they plan to start conducting this week as part of the revamped financial stability plan the Treasury Department announced earlier this month. Through its Capital Assistance Program, Treasury is aiming to evaluate banks' capital needs and balance-sheet risks.
The regulators' said that if a stress test indicates that an additional capital buffer is needed, firms will have an opportunity to raise private capital. Otherwise, the temporary capital buffer will be made available from the government, they said. "This additional capital does not imply a new capital standard, and it is not expected to be maintained on an ongoing basis," they wrote. "Instead, it is available to provide a cushion against larger than expected future losses, should they occur due to a more severe economic environment, and to support lending to creditworthy borrowers." Additionally, the regulators said that previous injections under the $700 billion financial rescue plan will also be eligible to be exchanged for the mandatory convertible preferred shares.
Friday proved to be a nasty day for bank stocks. U.S. officials responded by trying to ease growing fears that the U.S. would have to nationalize large banking firms such as Citigroup and Bank of America (BAC). Still, a key lawmaker - Senate Banking Committee Chairman Christopher Dodd, D-Conn., said on Bloomberg Television Friday that the Obama administration may end up having to nationalize banks, at least for a short time. Some analysts have argued that the fears pushing bank stocks down are the result of a lack of clear details on how the Obama administration's new bank rescue plan - and the stress tests in particular - will work. In their statement, regulators said major banking systems have capital in excess of the amounts required to be considered well-capitalized. They added that the program should help banks provide the credit necessary to prop up the ailing economy.
"This program is designed to ensure that these major banking institutions have sufficient capital to perform their critical role in our financial system on an ongoing basis and can support economic recovery, even under an economic environment that is more challenging than is currently anticipated," the statement said.
Meanwhile, they reiterated that they prefer not to take greater control of the banking system. "Because our economy functions better when financial institutions are well managed in the private sector, the strong presumption of the Capital Assistance Program is that banks should remain in private hands," the statement said.
U.S. Pledges Capital for Banks as Stress Tests Begin
U.S. financial regulators pledged to inject additional funds into the nation’s major banks to prevent their collapse and will this week begin examinations to determine whether they have enough capital. Banks that cannot privately raise the additional capital they need after the so-called stress tests will get taxpayer money, regulators said in a statement in Washington. Government funds would be in the form of "mandatory convertible preferred shares" that would be exchanged into common equity "only as needed over time." Stakes the Treasury has already bought will be eligible to be changed to convertible preferred shares.
While the new injections could leave the government with majority ownership of several lenders, Citigroup Inc., Bank of America Corp. and other banks rallied on speculation shareholders won’t be wiped out. Officials said that the move would be a temporary effort to ensure firms stay in business and keep providing credit to households and businesses. "The goal here is to incrementally provide as much support as necessary," up to what could be called "temporary nationalization," said Kevin Petrasic, a former official at the Office of Thrift Supervision, who is now a lawyer at the Paul, Hastings, Janofsky & Walker law firm in Washington.
The Standard & Poor’s 500 Banks Index advanced 2.8 percent to 59.82 at 12:12 p.m. in New York, still leaving it down 56 percent since the start of the year. Citigroup gained 9.2 percent to $2.13 after plunging 44 percent last week on concern it can’t keep going without some form of nationalization that hurts shareholders. Bank of America rose 6.6 percent to $4.04. "The market is voting and saying ‘this is a good thing, it looks like they’re not going to do anything stupid,’" said Michael Holland, who oversees assets worth $4 billion, including JPMorgan Chase & Co. shares, as chairman and founder of Holland & Co. in New York. "I need a lot more beef before I think they’re getting it right," Holland added. The Treasury already has bought more than $280 billion worth of stakes in U.S. financial companies since Congress approved a $700 billion financial-rescue fund in October. That’s failed to stem an exodus of investors from banks on concern credit losses will surge further this year.
The new government funds are designed to provide a "temporary" buffer for firms against increased losses during the crisis, the Treasury, Federal Reserve, Federal Deposit Insurance Corp., Office of the Comptroller of the Currency and Office of Thrift Supervision said. "The U.S. government stands firmly behind the banking system during this period of financial strain," the Treasury and bank regulators said in today’s statement. "The government will ensure that banks have the capital and liquidity they need to provide the credit necessary to restore economic growth." Officials are open to considering requests to exchange existing stakes into common equity shares if the bank and its regulator believes it would help it survive, Treasury spokesman Isaac Baker said late yesterday. Supervisors will start the stress tests on Feb. 25 to assess whether banks have enough capital to withstand "a more challenging economic environment." The statement didn’t specify the tests that bank examiners will run or say when the results will be known.
"They don’t want to announce to the world that a third of the banks are undercapitalized and have to be nationalized," said Sean Egan, managing director of Egan-Jones Ratings Co. in Haverford, Pennsylvania. "So they’re trying to finesse it." U.S. business economists in a survey today projected that the country’s recession will be the worst in more than three decades as job losses mount and consumers and companies retrench. The world’s largest economy will shrink by 1.9 percent this year and a total of 2.8 percent in the current downturn, the most since the 1973-75 slump, according to the median estimate in a poll taken by the National Association for Business Economics. Another 3.2 million Americans will be cut from payrolls in 2009, pushing unemployment to 9 percent by year-end, NABE said.
Sliding bank shares have given momentum to the idea of nationalizing banks in recent weeks. Nouriel Roubini, the economist and professor at New York University’s Stern School of Business, Republican Senator Lindsey Graham of South Carolina and former Federal Reserve Chairman Alan Greenspan have all suggested it as a solution to banks’ woes. Fed Chairman Ben S. Bernanke said last week "there’s a very strong commitment on the part of the administration to try to return banks or keep banks private or return them to private hands as quickly as possible." Senate Banking Committee Chairman Christopher Dodd said in a Feb. 20 Bloomberg Television interview that "short-term" government takeovers may be unavoidable. By converting its preferred shares to common, the government could pad too-thin tangible common equity, or TCE, ratios. TCE strips out intangible assets, goodwill -- the premium above net assets paid for acquisitions -- and preferred stock, including shares issued to the U.S. Treasury. The ratio measures TCE against tangible assets.
The government holds $52 billion of preferred shares in Citigroup, five times the bank’s market value as of Feb. 20. If the U.S. were to convert all of its holdings into common shares, it would own more than 80 percent of the company. Charlotte, North Carolina-based Bank of America, which has received $45 billion in TARP funds in exchange for preferred shares and warrants, would be 66 percent owned by the government if its entire stake were converted to common equity, according to data compiled by KBW Inc., a New York-based investment bank. The figure would be 69 percent at Regions Financial Corp. in Birmingham, Alabama, which has received $3.5 billion from the U.S. It would be 83 percent at Fifth Third Bancorp, the largest Ohio-based lender, which got $3.4 billion. KBW calculated the government stakes based on a conversion price of 80 percent of the stock’s value as of Feb. 5.
Bank of America, Citigroup and Wells Fargo & Co. in San Francisco are among more than 400 financial institutions that have received cash in exchange for preferred shares under the program. The regulators today said major U.S. banks are currently meeting their existing capital requirements. "Major U.S. banking institutions have capital in excess of the amounts required to be considered well capitalized," the regulators said. Still, analysts and investors anticipate that writedowns will climb. President Barack Obama has also said that some lenders haven’t fully recognized likely losses. The International Monetary Fund estimates that writedowns and credit losses on U.S. mortgage-related assets will reach $2.2 trillion, after a total of about $1.1 trillion so far.
Officials are still "attacking the symptoms of the problem as opposed to the underlying cause," Egan said. "The base problem in the financial markets right now that has yet to be addressed is the valuation and pricing of structured finance assets." Treasury Secretary Timothy Geithner outlined earlier this month a Public-Private Investment Fund designed to address the toxic assets. Officials have yet to specify how the program, which may reach $1 trillion, will work.
Ilargi: Citi's market cap is $10.6 billion. And the government supposedly owns $45 billion in shares. I see this stuff and I bless the fact that I don't have to make this up. I couldn't if I tried. This is borderline insanity at the wrong side of the tracks, outright delusional politics. Yep, that means they’re probably going to do it.
Citi presses officials to take 40% stake
Citigroup is pressing the US government to agree on a new capital injection that would increase the authorities’ stake in the troubled bank to about 40 per cent but stop short of an outright nationalisation. The talks come after Citi’s shares slumped last week as investors feared it would be nationalised. Citi insiders said they expected a decision on the company’s future in the coming weeks but warned that it would have to come earlier if its shares fell again in the next few days.
People close to the situation said Citi executives had been in discussions with regulators during at the weekend over a plan that would enable the government and other shareholders to convert up to $75bn of preferred shares into common stock. According to its proponents, the injection of common stock would bolster Citi’s capital base while at the same time allaying market fears of a nationalisation. Under the plan, first revealed by the Financial Times last week, Citi could also try to raise fresh equity with a public share offering. The aim would be to keep the government stake to no more than 40 per cent or at least below 50 per cent, said people familiar with the plan.
People familiar with the plan said it would hinge on the price at which the government and other shareholders, which include sovereign wealth funds and Prince Al Waleed, convert their shares as well as how many of its $45bn-worth of shares the government converts. However, the US Treasury has so far not expressed an opinion on the idea and it is unclear whether the government would agree to convert its preferred shares into Citi’s common shares without demanding a controlling stake. Top Government Officials – who are trying to establish seeking a want a more strategic and less ad hoc response to the crisis – were and are anxious to avoid if possible the type of Sunday night crisis announcement that became a staple for Hank Paulson for ’s crisis management at the Treasury last year.
They apparently believe that the market response to White House and Treasury statements on Friday reaffirming the administration’s commitment to private ownership of financial institutions buys them some time to come up with a way forward. The Treasury said secretary Tim Geithner would "preserve a financial system that is owned and managed by the private sector". The authorities indicate a strong preference for supporting banks in private markets wherever possible – not least because of the potential international disruption that could ensue if a large global bank failed. But Treasury did not rule out nationalisation in all circumstances. Most analysts believe that even if the authorities reject full nationalisation of Citi via the Federal Deposit Insurance Corporation the government will end up taking a substantial stake in the bank. Private sector executives and foreign government officials complain that Treasury is still not staffed up with enough mid and senior level officials to develop and communicate policy at the pace required by the crisis.
US ‘open’ to equity stake in Citi
The US government on Monday signaled that it was willing to raise its equity stake in Citigroup – a move that would further nationalise the troubled bank but avoid full nationalisation. The Treasury said it was willing to convert its existing preferred shares into common stock – an idea proposed by the ailing bank as a means of shoring up investor confidence. "We are open to considering a request to so do," a spokesman said. Citi is pressing the government to agree on a new capital injection that would increase the authorities’ stake to about 40 per cent but stop short of an outright nationalisation. The Treasury spokesman said that under the Financial Stability Plan announced two weeks ago, financial institutions could ask for their existing preferred stock to be converted into new convertible preferred stock, which could in turn be "exchanged into common equity shares at the option of the company as needed to strengthen their capital structure".
The talks come after Citi’s shares slumped last week as investors feared it would be nationalised. Citi insiders said they expected a decision on the company’s future in the coming weeks but warned that it would have to come earlier if its shares fell again in the next few days. The Treasury spokesman added that the government would "do what is necessary to strengthen and stabilise the financial system so that it can provide the credit necessary to support economic recovery." He said the framework for financial stability outlined by Tim Geithner, Treasury secretary, was "designed to make sure that there is capital available where it is needed, and that it is provided in a way that will facilitate the replacement of public support with private capital as soon as that is possible". Citi’s German-listed shares jumped €0.40 or 29 per cent at €1.91 in Monday morning Frankfurt trading. The US-listed shares fell 22 per cent to $1.95 on Friday. People close to the situation said Citi executives had been in discussions with regulators at the weekend over a plan that would enable the government and other shareholders to convert up to $75bn of preferred shares into common stock.
According to its proponents, the injection of common stock would bolster Citi’s capital base while at the same time allaying market fears of a nationalisation. Under the plan, first revealed by the Financial Times last week, Citi could also try to raise fresh equity with a public share offering. The aim would be to keep the government stake to no more than 40 per cent or at least below 50 per cent, said people familiar with the plan. People familiar with the plan said it would hinge on the price at which the government and other shareholders, which include sovereign wealth funds and Prince Al Waleed, convert their shares as well as how many of its $45bn-worth of shares the government converts. However, the US Treasury has so far not expressed an opinion on the idea and it is unclear whether the government would agree to convert its preferred shares into Citi’s common shares without demanding a controlling stake.Top government officials – who are trying to establish a more strategic and less ad hoc response to the crisis – are anxious to avoid the type of Sunday night crisis announcement that became a staple of Hank Paulson crisis management at the Treasury last year.
They apparently believe that the market response to White House and Treasury statements on Friday reaffirming the administration’s commitment to private ownership of financial institutions buys them some time to come up with a way forward. The Treasury said Mr Geithner would "preserve a financial system that is owned and managed by the private sector". The authorities indicate a strong preference for supporting banks in private markets wherever possible – not least because of the potential international disruption that could ensue if a large global bank failed. But Treasury did not rule out nationalisation in all circumstances. Most analysts believe that even if the authorities reject full nationalisation of Citi via the Federal Deposit Insurance Corporation the government will end up taking a substantial stake in the bank. Private sector executives and foreign government officials complain that Treasury is still not staffed up with enough mid and senior level officials to develop and communicate policy at the pace required by the crisis.
AIG Seeks More Aid, May Lose $60 Billion
American International Group Inc., the insurer rescued by the government, is in talks with the U.S. for more funding as it prepares to report the biggest corporate loss in American history, CNBC reported, citing unidentified people familiar with the situation. AIG may report a loss of as much as $60 billion, CNBC’s David Faber said. The company is also exploring bankruptcy, which is an unlikely outcome, Faber said. A loss may cast doubt on the New York-based insurer’s ability to repay the government, which controls 80 percent of the shares. AIG’s rescue package was expanded to about $150 billion in November as regulators tried to reduce losses at firms that did business with the company.
The insurer posted more than $60 billion in writedowns and unrealized losses in two years through Sept. 30, 2008. Fourth-quarter results, which may be announced next week, will probably include writedowns on assets including securities tied to commercial mortgages, CNBC said today. The company’s board will meet this weekend to discuss another expansion of the rescue, the network reported. AIG spokeswoman Christina Pretto didn’t immediately return a call from Bloomberg seeking comment. The insurer slipped 4 cents to 50 cents at 2:59 p.m. in New York Stock Exchange composite trading, and has plunged 99 percent in the past 12 months.
Hillary Clinton pleads with China to buy US Treasuries as Japan looks on
US Secretary of State Hillary Clinton has pleaded with China to continue buying US Treasury bonds amid mounting fears that Washington may struggle to finance bank bail-outs and ballooning deficits over the next two years. "It's a safe investment. The United States has a well-deserved financial reputation," she told Chinese television stations at the end of her diplomatic tour of Asia. "We are truly going to rise and fall together. Our economies are so intertwined, the Chinese know that to start exporting again to their biggest market the United States has to take some very drastic measures with this stimulus package, which means we have to incur more debt," she said.
Chinese media reports say Mrs Clinton has offered emphatic assurances to premier Wen Jiabao and President Ju Jintao that the Obama administration intends to restore the health of US public accounts and safeguard the interests of bondholders once the economy has begun to recover. Asian investors have expressed concern over the flood of debt in the United States, fearing that it could tempt Washington to engineer a stealth default by allowing inflation to creep up. The Treasury says it needs to raise almost $500bn (£350bn) in debt in the first quarter alone. Estimates for 2009 reach as high as $2 trillion, a huge sum in a world starved of capital at a time almost all the major governments are launching fiscal rescue packages.
Yields on 10-year Treasuries have risen from just above 2pc before Christmas to 2.77pc last week. This has pushed up the cost of mortgages, undermining efforts by the Federal Reserve to stabilize the housing market. The Treasury's International Capital (TICS) data shows that foreigners sold a net $26bn on long-term Treasuries in November. This rebounded somewhat to plus $15bn in December, but China, Russia, and other big reserve powers have continued dumping their holdings of US agency mortgage bonds. Mrs Clinton's plea for Beijing to keep buying US bonds comes in sharp contrast to comments during the presidential primaries when she said Chinese ownership of US government debt had become a threat to national security. Fears that she would break with the Sinophile policies of the Bush administration and opt for a much tougher line against Beijing have so far proved unfounded.
Chinese officials said last week that Beijing had no plans to halt purchase of Treasuries, although just 25pc of its recent reserve accumulation has been going into dollar assets. China already owns $696bn of US government debt but it still needs to find a safe place to invest a monthly current account surplus reaching $40bn. There are very few AAA-rated assets to choose from. If the Chinese falter, it looks increasingly likely that Japan will step into the breach. Albert Edwards, global strategist at Societe Generale, said Tokyo may be poised to intervene with massive purchases of US bonds to help drive down the yen. The currency has risen 30pc in trade-weighted terms over the last 18 months. The Bank of Japan last launched a buying blitz in 2003 as an emergency measure to halt the downward spiral into deflation.
This culminated in $150bn of US bond purchases in the first quarter of 2004, a move that stunned the markets and helped stabilize the Japanese economy. The yen is a safe-haven currency, like the Swiss franc. It tends to appreciate in global economic downturns as Japanese investors bring home their vast overseas wealth. This exacerbates the industrial squeeze on Japanese exporters. On this occasion the effect has been catastrophic, leading to a 12.7pc contraction in Japanese GDP in the fourth quarter on an annualized basis. "Japan is clearly set to fall into depression. The yen is now massively vulnerable," said Mr Edwards. Any move by Japan to force down its currency will put pressure on China to follow suit given the gravity of Asia's slump, creating the risk of a wave of beggar-thy-neighbour devaluations. While this would cause serious trade frictions, the side effect would at least be renewed appetite for US bonds, eurozone, and sterling, by Asian central banks.
Swiss warn on US move over UBS clients
Switzerland’s finance minister has accused US authorities of "shock" tactics to compel holders of undeclared UBS accounts to come forward, but warned that court action to discover the names of thousands of clients would not succeed. Hans-Rudolf Merz, finance minister and Switzerland’s head of state this year under its rotating presidency, defended the Swiss government’s role in prompting the world’s biggest wealth manager to breach hallowed bank secrecy and last week reveal some 250-300 client names to the US. But Mr Merz said the disclosure last week of a limited number of account holders suspected of tax fraud did not mean UBS, or the Swiss government, would bow to a separate US drive to identify all the bank’s American clients with offshore accounts in Switzerland.
The comments came amid fierce debate in Switzerland, home to an estimated one-third of the world’s offshore assets, about the future of bank secrecy. Politicians from across party lines accused the government of weakness and ineptitude in submitting to US pressure and putting bank secrecy at risk. Financial services account for about 13 per cent of Switzerland’s gross domestic product, and bank secrecy is seen as a cornerstone of the country’s success as a financial centre. The accusations followed last week’s unprecedented decision by Finma, the Swiss bank and insurance regulator, to order UBS to transfer the 250-300 client names to the US Department of Justice. The move came after fears the US authorities would indict Switzerland’s biggest bank, or impose swingeing fines, either of which could have endangered its future. Eugen Haltiner, Finma chairman, said the authority had had to act to prevent a crisis of confidence at UBS that could have threatened the future of Switzerland’s biggest bank and the world’s biggest wealth manager.
But Finma’s disclosure order, taken at the indirect behest of the government, has also triggered a judicial crisis, with lawyers of incensed UBS clients now pressing for it to be declared illegal. Switzerland’s Federal Administrative Court, the highest body involved, will this week consider motions filed by UBS clients arguing that Finma’s order breached bank secrecy laws. Late on Friday the court issued a temporary injunction barring the release of further client details. Well-placed bankers said the 250-300 names had already been transferred to the US authorities as part of the $780m settlement negotiated by UBS in return for the suspension of criminal charges of assisting in tax evasion filed against it by the DoJ. Mr Merz and his critics were united in saying Switzerland would defend bank secrecy in the separate civil action being pursued against UBS by the US Internal Revenue Service. The IRS is demanding the bank reveal the names of all its US offshore clients, rather than just the tiny minority who set up sham companies to evade tax and whose names were disclosed last week. Mr Merz echoed senior Swiss bankers in questioning the chances of such an attempt succeeding in court.
There's no reason for non-recourse
We don't know exactly what Timothy Geithner has in mind for the "Public-Private Investment Fund". But we do have a few hints. First, we know that among its purposes is that itallows private sector buyers to determine the price for current troubled and previously illiquid assets.And we also know, that on the very day Mr. Geithner offered his outline of a financial stability plan, the Federal Reserve announced its intention to expand its Term Asset-Backed Securities Lending Facility, or "TALF" to up to a trillion dollars, coincidentally the round number that Geithner suggested the "PPIF" might expand to. Hmmm. What is the TALF again?Under the TALF, the Federal Reserve Bank of New York will provide non-recourse funding to any eligible borrower owning eligible collateral... As the loan isDoes your head spin, acronym upon acronym, non-recourse, warranties, and covenants? Well, unspin it. The New York Fed is telling us, in plain and simple legalese, that it is planning to make a very generous gift to investors that participate in this program (and indirectly to the banks that sell assets to them). A non-recourse loan bundles an ordinary loan with an option to "put" the collateral back to the lender instead of paying off the loan. Sometimes this is not much of a gift: When a pawnbroker lends you half of what your Fender Stratocaster is worth, and the fact that you can surrender the guitar rather than pay off the loan is cold comfort. But if someone fronts you substantially all of what an asset is worth, and the value of that asset is uncertain and volatile, then the put option bundled into the "loan" becomes extraordinarily valuable. If the asset appreciates, you take the profits and "ka-ching!". If the asset falls in value, the lender takes the trash and eats the loss.
non-recourse, if the borrower does not repay the loan, the New York Fed will enforce its rights in the collateral and sell the collateral to a special purpose vehicle (SPV) established specifically for the purpose of managing such assets... The TALF loan is non-recourse except for breaches of representations, warranties and covenants, as further specified in the MLSA.
A near-the-money option is itself a valuable asset. Offering non-recourse loans to participants in the PPIF would directly contradict the program's goal of "allow[ing] private sector buyers to determine the price for... troubled... assets." Private sector buyers would not be pricing the assets themselves: they would be pricing a portfolio containing a troubled asset and a free, three-year put option, courtesy of the Fed. Depending on how much of the transaction the government is willing to finance, the value of the put option could represent a substantial fraction of the value of the asset being priced. This is a subsidy, that would be incorporated in the sales price of the asset and split by banks and private investors. It amounts to the government bribing investors to certify banks as more solvent than they are, by overvaluing bank assets in subsidized purchases.
John Hempton wrote a very brilliant essay on what it means for a bank to be solvent. If you haven't read it, go do. Hempton's definitions 2 and 3 of bank solvency — current accounting value (which implies mark-to-market valuation for many assets) and economic value as an ongoing enterprise — diverge because the cost of funding for investors in risky bank assets is unusually high. Under these condition, Hempton reasonably suggests, private fund managers will be unable bid assets up to their best estimates of "hold-to-maturity value", less a "normal" risk premium, because investors are desperately unwilling to hold anything other than government guaranteed securities. Definition 3 is a very generous view of what it means for a bank to be solvent, because it implies that the actual market risk premium is wrong, that an estimate of hold-to-maturity asset values by a reasonable analyst, even accounting for risk, would put those values above current market bids. But in evaluating bank solvency we should be generous: Since an insolvent bank must be nationalized (reorganized, received, conserved, preprivatized, whatever), we should try to avoid declaring as insolvent banks that do have positive economic value, since that would amount to a capricious expropriation of private property.
But generosity in evaluation is distinct from a generous cash gifts from taxpayers to banks and investment funds. What is required to get a generous but still accurate evaluation of bank solvency is inexpensive funding, so that analysts willing to bet on what a "toxic asset" is worth can borrow the funds they need to back their spreadsheets with shekels without giving away all the upside to nervous lenders. What is not needed, what is in fact positively counterproductive, is to give investors a special bonus in the form of a free option if they buy the asset. This guarantees that assets will not be accurately priced (they will be overpriced), and reduces analyst incentives to value assets carefully and generate reliable market prices.
I actually think having the government offer cheap, full-recourse loans on a maturity-matched basis to investors willing to bear the risk of holding currently disfavored assets is a clever idea. ("Maturity-matched" means investors don't have to worry about margin calls: as long as they get the long-term values right, they can ride out any tempests in mark-to-maket prices.) We do need a market in these assets, and if it is true that funds availability for people willing and able to bear the risk of ownership is preventing such a market from arising, then by all means, that's a "market failure" the government can correct. But the key point is that a market price is the price at which private parties are willing to bear that risk. If funds are provided non-recourse, much or all of the risk of ownership is absorbed by the lender. Any prices that result from "private" purchases by investors funded at high-leverage on a non-recourse basis are not market prices at all. Such prices would be sham prices, smoke-and-mirror prices, sneaky off-balance sheet public subsidy prices.
We are all tired of the lies, Mr. Geithner. By all means, let nationalization be a last resort, and do all you can to offer liquidity to private parties willing to take both the upside and downside of speculating in questionable paper. But if you keep nationalizing the downside and privatizing the upside, it will not be very long at all before the public concludes that stress tests and market prices are just a sleight-of-hand for Davos man while he picks our pockets, again. Act fairly, and you may end up nationalizing the worst few of the larger banks. Keep up the games, and we will insist that you nationalize them all. It is getting hard to believe that there is a banker in the land who has not already robbed us. Eventually we will tire of drawing fine distinctions.
Afterthought: There's another way to generate price transparency and liquidity for all the alphabet soup assets buried on bank balance sheets that would require no government lending or taxpayer risk-taking at all. Take all the ABS and CDOs and whatchamahaveyous, divvy all tranches into $100 par value claims, put all extant information about the securities on a website, give 'em a ticker symbol, and put 'em on an exchange. I know it's out of fashion in a world ruined by hedge funds and 401-Ks and the unbearable orthodoxy of index investing. But I have a great deal of respect for that much maligned and nearly extinct species, the individual investor actively managing her own account. Individual investors screw up, but they are never too big to fail. When things go wrong, they take their lumps and move along. And despite everything the professionals tell you, a lot of smart and interested amateurs could build portfolios that match or beat the managers upon whose conflicted hands they have been persuaded to rely. Nothing generates a market price like a sea of independent minds making thousands of small trades, back and forth and back and forth.
Junk in GM's trunk could lead to blowout
General Motors is battling to survive collapsing auto demand, tight credit and uncertain prospects for recovery in its biggest markets. But its most-pressing crisis is simpler: too much debt. As GM begins a second round of make-or-break concession talks with creditors and its major union, analysts and bondholders are raising concerns its restructuring plan does not go far enough to scour its balance sheet. The risk is that even if GM wins the high-stakes deals it needs to eliminate some $28 billion in debt by issuing new shares, it could end up wiping out those gains by borrowing even more from the U.S. government.
Bondholders worry that would leave the automaker vulnerable to a second and even-more wrenching restructuring—only this time they would be the equity owners of the ailing company. "Everybody is going to have to give at the office to make this work," said a person with direct knowledge of GM’s talks with bondholders. "But this would leave bondholders behind a monstrous debt claim." On Friday, GM’s loss-making Swedish unit Saab won legal protection from creditors to allow it to restructure and seek new funding for continued production. In the plan submitted to the U.S. Treasury, GM said Saab would become an independent business as of January 1, 2010.
In its court filing, Saab said GM has said it "would not fund further the projected losses of the company (Saab)," but would provide liquidity for the company to pursue a reorganization. That may solve one problem for GM’s management team. But analysts warn that the risk of bankruptcy at the automaker remains large. A day after GM submitted its restructuring plan to U.S. officials, ratings agency Moody’s Investors Service put the risk that GM or Chrysler, or both, are forced into bankruptcy at 70%, unchanged from its view in December. The issue of GM’s debt load as it fights to restructure outside bankruptcy will be central to a high-pressure round of negotiations between GM and its bondholders now set to begin.
GM bondholders, led by a committee of big investors, are being asked to cut the $27 billion they are owed by two-thirds in exchange for shares in a recapitalized automaker. The other $18 billion in bond debt would disappear from GM’s balance sheet. That equity-swap could give bondholders a stake of some 65% of the new GM that the automaker hopes will emerge from its "Renaissance" plan, according to an early estimate from Credit Suisse analyst Chris Ceraso. The talks will have to be wrapped up around the third week of March to launch the equity exchange by March 31 as mandated by GM’s bailout, the person close to the talks said.
That leaves GM with about five weeks to conclude negotiations on three fronts: It needs deals with bondholders and its union on debt concessions and an agreement with the government’s auto restructuring panel headed by Treasury Secretary Timothy Geithner on funding. Failure on any front risks bankruptcy. "Is it likely to happen outside of a bankruptcy setting? In my view it’s not," said Douglas Bernstein, managing partner at Plunkett Cooney who is not engaged by the Detroit automakers. He added: "It turns into a game of chicken." The United Auto Workers union is owed some $20 billion by GM to fund a trust for retiree healthcare and faces pressure to take $10 billion of that amount in stock in a new GM. Those talks also have to be concluded by the end of March.
Bondholders and the union have been widely seen as competing for a share of the same shrinking pie at GM. Bondholders are not demanding an equal payout with the union fund, but want to see their investments protected by the terms of the swap, the person close to the talks said. GM bondholders could also support efforts by the government to take over some of the healthcare and other retirement liabilities owed to the union, the person said. GM President Fritz Henderson also suggested the automaker may need support for its pension to keep debt levels down. "The level of leverage is not something we’re satisfied with," Mr. Henderson told analysts. "We need to look at pensions. We need to look at alternatives."
GM has already received $13.4 billion from the U.S. government and asked to raise that to up to $30 billion in aid in a plan submitted last week to the U.S. Treasury. In a step aimed at keeping its debt from spiraling back out of control, GM has suggested that up to $16.5 billion of its U.S. government aid could come in preferred equity. But the total amount of support from the U.S. government could rise to as much as $50 billion, including other loans from the U.S. Department of Energy, GM said.
Add another $13 billion in potential borrowing from foreign governments and others and GM’s debt could rise to almost $75 billion five years out, according to its own projections. That would mark a 50% increase from the struggling automaker’s debt balance in 2009. GM CFO Ray Young warned that could prompt another round of cost-cuts and debt reduction. "This frankly is not sustainable," Mr. Young told analysts. "If we were into this particular scenario, there would be a major operating restructuring and frankly a major balance sheet restructuring beyond what we’ve talked about thus far."
E.U. Leaders Turn to I.M.F. Amid Financial Crisis
The leaders of Germany, Britain, France and other European nations called Sunday for the resources of the International Monetary Fund to be doubled, to $500 billion, to help head off new problems in countries already hit hard by the global economic and financial crisis. And in a statement clearly aimed at hedge funds and other big private pools of capital, the leaders said that "all financing markets and participants" must be regulated in the future. They also vowed to press for sanctions against tax havens. The leaders met in an effort to hammer out a common European position ahead of the April meeting of the Group of 20, the group of industrialized economies and developing countries, in London. The meeting on Sunday also included leaders from Italy, Spain, the Netherlands and the Czech Republic, the current holder of the European Union’s rotating presidency.
Eyeing a contagion that is rapidly spreading to Eastern Europe and even countries that use the euro, the leaders highlighted the crisis-prevention role of the monetary fund, an institution whose relevance to the global economy seemed in doubt only a few years ago. In Germany, a growing unease that the crisis is about to strike close to home has contributed to a shift away from a reluctance to bankroll efforts to ease the financial crisis — whether in the form of bank bailouts or stimulus packages — for fear of paying for other countries’ mistakes. German officials appear to have concluded that their own economy, underpinned until recently by booming exports, cannot stay afloat if its neighbors crash. Also, international officials from the I.M.F. and the World Bank have argued strongly in private to German officials that Berlin has underestimated the extent to which the crisis has torn at the hard-fought economic integration of Europe.
In Eastern Europe, currencies have tumbled sharply against the euro as financial markets have bid up the odds of an all-out collapse along the lines of Asian countries in the late 1990s. Already, Hungary and Latvia, both European Union members that do not use the euro, have gotten rescue packages from the monetary fund and the European bloc. And among the countries that use the euro, particularly Greece and Spain, financial chaos has meant that government borrowing costs have grown in relation to stalwarts like Germany. The French president, Nicolas Sarkozy, endorsed support for fellow European countries on Sunday, while warning that those in need of help would have to revamp their policies. "If someone needs solidarity, they can count on their partners," Mr. Sarkozy said at the conclusion of the economic summit meeting here. "Their partners also need to count on them to follow certain basic rules."
Last week Peer Steinbrück, the German finance minister, suggested that Germany would help finance rescues if necessary. Those developments foreshadow difficulties this year for countries that must borrow on international capital markets to refinance old debt and raise fresh cash. Between expressions of solidarity and a newfound emphasis on the I.M.F., the European leaders appeared to be corralling the resources, both political and financial, that would allow bailouts of additional European countries if needed. Daniel Gros, director of the Center for European Policy Studies in Brussels, said the shift in Berlin and Europe more generally "opens the door to German dominance" of politics in the 27-nation European Union since its financial heft is likely to become vital as the crisis drags on. Leaders in Berlin also made calls to study the creation of a common bond issue among the 16 countries that use the euro, a move that would partly extend Germany’s sterling credit rating to its shakier neighbors.
EU leaders back sweeping financial regulations
European leaders mounted a united front against the global financial crisis Sunday, proposing sweeping new market regulations, but it remained unclear whether economic giants like the United States and China would go along. Heads of government and finance ministers from Europe's largest economies joined German Chancellor Angela Merkel in Berlin to lay the groundwork for a common European position on economic reforms before an April 2 summit of the Group of 20 nations in London. "Europe will own up to its responsibility in the world," Merkel told reporters following the talks.
Leaders from Britain, France, Germany, Italy, Luxembourg, Spain, the Netherlands and the Czech Republic agreed to press for sanctions on tax havens, caps for managers' bonus payments and a stronger role and increased funding for the International Monetary Fund. While the plans were based on an agenda adopted by the G-20 in November, the measures announced Sunday were more far-reaching and concrete, particularly on long-disputed issues such as hedge fund regulation. However, analysts say other G-20 members, including the U.S., China, Japan and developing nations like India and Brazil, might not share Europe's zeal for blanket global regulations.
During Germany's turn at the presidency of the Group of Eight two years ago, Merkel pushed hard for more transparency on global financial markets and, especially, hedge fund regulation. But her efforts ran into against stiff resistance from Washington and London. Even the global crisis and a change of administration may not be enough to convince the U.S. to hand over its autonomy. "I see the U.S. as wary of giving away powers of oversight and regulation," said Robert Brusca of New York-based Fact And Opinion Economics. Financial industry leaders, on the other hand, may have lost too much credibility in the current crisis to fight off heavy restrictions on their practices.
"What the industry thinks is irrelevant," Brusca said." It has squandered any good will it had by being given a leash of self regulation — then running amok." French President Nicolas Sarkozy said that "Europe wants the system to be refounded," and stressed the importance of the April meeting. "We all want London to be a success and we are all aware that it's (our) last chance," Sarkozy said. "We cannot afford a failure in London." European leaders also backed Merkel's call for a "charter of sustainable economic activity" that would subject all financial market activities around the globe to regulation, including credit rating agencies. Merkel's proposal envisions giving increased powers to the IMF, which the leaders agreed needed to receive double its current funding in order to help members respond "swiftly and flexibly" to a crisis.
British Prime Minister Gordon Brown called for a "global New Deal" to be adopted to help right the world economy, saying international financial institutions need some $500 billion to do the job. That could prove complicated unless the U.S. agrees to cede the needed authority to the IMF to make it effective, analysts say.
"The IMF is a policeman without a whistle, let alone a gun," Brusca said. "I see more international cooperation as essential but still difficult." Other key points agreed to Sunday included adopting a "sanctions mechanism" to penalize tax havens and urging banks to keep larger reserves of capital. "A new system of regulation without sanctions would not have any meaning," said Sarkozy.
He said European countries should jointly draw up a list of tax havens, as well as sanctions they might face for continuing reckless financial activity.
Merkel also warned the United States to avoid protectionism in its automobile market. "When I look at the restructuring plans of some American companies, there are a lot of state funds flowing into them," Merkel said, swiftly adding that "this is not an accusation." She said the European Commission would be asked to examine whether the U.S. was violating global trade laws. In Washington, the Obama administration did not comment specifically on the measures being advanced by Europe but said the United States was ready to work with other countries to improve financial market regulation.
"We look forward to continuing to work through the G-20 process with our colleagues in Europe and the world to put in place sound regulatory regimes so such a financial crisis does not occur again," said U.S. Treasury Department spokeswoman Heather Wong. She said that the administration had worked "at unprecedented speed" to gain congressional passage of a $787 billion economic stimulus plan as well as unveiling new programs to stabilize the U.S. financial system and stem the housing foreclosure crisis. Officials said a final copy of the summit agreement would not be circulated Sunday, in order to allow European Union members not present to view it first. All 27 EU members are to debate the document next week, and it is to be taken up by the European Council on March 19-20, then presented to the G-20. That summit will be President Barack Obama's first and a test of just how much regulation the U.S., and other world leaders, is willing to accept in an effort to prevent another meltdown.
Ilargi: Nah! Really?
Forecasters see higher unemployment in 2009
Brace yourself: The recession is projected to worsen this year. The country stands to lose a sizable chunk of economic activity in 2009 as consumers at home and abroad retrench in the face of persistent economic troubles. And the U.S. unemployment rate -- now at 7.6 percent, the highest in more than 16 years -- is expected hit a peak of 9 percent this year. That gloomy outlook came from leading forecasters in the latest survey by the National Association for Business Economics to be released Monday. The new estimates are roughly in line with other recent projections, including those released last week by the Federal Reserve. "The steady drumbeat of weak economic and financial market data have made business economists decidedly more pessimistic on the economic outlook for the next several quarters," said NABE president Chris Varvares, head of Macroeconomic Advisers.
All told, Varvares and his fellow forecasters now expect the economy to shrink by 1.9 percent this year, a much deeper contraction than the 0.2 percent dip projected in the fall. If the new forecast is correct, it would mark the first time since 1991 the economy actually contracted over a full year and would be the worst showing since 1982, when the country had suffered through a severe recession. Vanishing jobs, shrinking nest eggs, rising foreclosures and tanking home values have forced American consumers to cut back, which in turn has caused businesses to lay off workers and slash costs in other ways, feeding a vicious downward cycle for the economy. The current recession, which started in December 2007, is posing a major challenge to Washington policymakers, including President Barack Obama and Fed Chairman Ben Bernanke. That's because its root causes -- a housing collapse, credit crunch and financial turmoil -- are the worst since the 1930s and don't lend themselves to easy or quick fixes.
"As the news on the economy has darkened, so too, have the forecasts," said Ken Mayland, president of ClearView Economics. "We are suffering a period of maximum stress on the economy." The economy is expected to remain feeble this year -- even with new efforts by the administration and Congress to provide relief. Just over the past few weeks, a $787 billion recovery package of increased government spending and tax cuts was signed into law, the president unveiled a $75 billion plan to stem home foreclosures and Treasury Secretary Timothy Geithner said as much as $2 trillion could be plowed into the financial system to jump-start lending. In terms of lost economic activity in 2009, the biggest hit will come in the first six months, forecasters said. NABE forecasters now expect the economy to slide backward at a staggering pace of 5 percent in the current January-March quarter.
That's a sharp downgrade from the 1.3 percent annualized drop projected in the old survey. "Further pronounced weakness in housing and deteriorating labor markets underscore the risks for 2009," Varvares said. Many economists believe that the current quarter will be the worst of the recession in terms of the bite to gross domestic product, which is the value of all goods and services produced within the U.S. and is the broadest barometer of the country's economic health. The second quarter of this year also will be a lot weaker, with the forecasters now calling for the economy to contract at a 1.7 percent pace, compared with the prior projection of 0.5 percent growth. In the second half of this year, the economy should expand, but still less than what economists thought just a few months ago.
NABE forecasters believe home sales and housing construction should hit bottom by the middle of the year, which would help stabilize the economy. Home prices, however, are expected to keep falling, according to other experts. NABE forecasters predicted that when all is said and done the recession will have caused GDP to decline 2.8 percent. That would be "slightly less than the 3.1 percent during the early '70s," according to the survey of 47 forecasters taken between Jan. 29 and Feb. 12. Even in the best-case scenario, with the recession ending sometime in the second half of this year, employment conditions will be tough. Some of the forecasters said the nation's unemployment rate could rise as high as 9 percent for all of 2009 and hit 10 percent next year.
In 2008, the jobless rate averaged 5.8 percent, the highest since 2003. The survey's median forecast -- or middle point -- called for the unemployment rate to rise to 8.4 percent this year and 8.8 percent next year. Companies touching every part of the economy have announced thousands of layoffs already this year and more cuts came last week. Goodyear Tire & Rubber Co., said it will cut nearly 5,000 jobs, or almost 7 percent of its work force, this year, following the elimination of about 4,000 jobs in the second half of last year. General Motors Corp. and Chrysler, which are asking the government for billions more in aid to remain viable, announced plans to cut 50,000 more jobs, 47,000 of which would be at GM. The Fed said the unemployment rate could stay elevated into 2011.
Some analysts think the jobless rate won't drift down to a more normal range of around 5 percent until 2013 -- at the earliest. Companies won't ramp up hiring until they feel confident that any recovery has staying power. That's why employment is usually the last piece of the economy to reap the benefits of a recovery. "A meaningful recovery is not expected to take hold until next year," said Varvares. NABE predicts GDP will rebound in 2010, averaging 2.4 percent over the course of the year. The Fed, too, is forecasting that the economy will grow again in 2010-- and will pick up momentum in 2011. Even so, the Fed is still guarded about any turnaround. Given all the negative forces weighing on consumers and businesses, the economic recovery "would be unusually gradual and prolonged," the Fed said.
Will pension funds suffer the next financial implosion?
If you are troubled by the loss in value in your 401(k) or other retirement account, you have plenty of company. Even professionally managed pensions suffered an average 26 percent loss in 2008, marking the worst recorded year for defined benefit funds, according to Northern Trust Investment Risk and Analytical Services. Despite the grim results, two radically different retirement profiles have emerged. One is workers with defined benefit plans. These employees are guaranteed monthly payments at retirement based on a set percentage of their last paycheck.
Some 80 percent of public-sector employees and 20 percent of private-?sector employers participate in defined benefit programs. The Center for Retirement Research (CRR) at Boston College estimates that 20 million active participants and millions of retirees are enrolled in these retirement programs. The other group includes workers with 401(k) and other defined contribution accounts. These employees are exposed to market downturns with no set retirement benefits. Last year, many of them were too heavily committed to the stock market, suffering losses between 30 and 40 percent.
"While a bad year for every investor, 2008 was particularly bruising for 401(k) members forced to navigate sophisticated, complex market environments largely on their own, exposed to individual portfolio risks far greater than the pooled risk of professionally managed benefit programs," says Keith Brainard, research director for the National Association of State Retirement Administrators, whose members oversee pension benefits of most state and local government employees. Employees with 401(k) plans who are five to 10 years from retirement are now faced with the possibility of delaying retirement or drastically reducing their lifestyle when they do.
For younger workers with 10 or more years of potential employment, the hope is that investment markets will rebound in 2009 and that 8 to 10 percent returns will once again prevail. For employees with defined benefit plans, however, personal retirement plans remain largely on course. But there are problems here, too. Corporate pension plans are underfunded by $409 billion, according to consulting firm Mercer. The CRR estimates that private firms need to increase contributions by about $90 billion this year, as required by the 2006 Pension Protection Act. The law stipulates that firms must eliminate unfunded pension obligations within a seven-year period. But those restrictions were relaxed in December due to the current economic slump.
In an effort to meet funding requirements, some private companies have already announced layoffs or pension freezes. Others have gone bankrupt. As a result, the CRR estimates employees over 50 years of age who work for companies that have taken these actions will face severely reduced benefits at retirement as they are unlikely to have saved independently of their pension plan. Public-sector entities are not under the same requirements to supplement their unfunded obligations, and no reliable estimate exists of what additional contributions are required. "It will take longer than expected for the total cost effect to become clear in public funds," Mr. Brainard says, "as actuarial updates lag market realities and public funds utilize smoothing formulas that extend market losses over extended numbers of years."
Unless the markets suddenly recover and reverse lost profits, defined benefit plans will require dramatic increases in funding by their sponsors. Taxpayers will face footing the bill to finance public-sector retirement programs and shareholders of companies will need to allocate limited dollars from the balance sheets to fund corporate plans. Neither group is likely to be generous when their own retirement funding is not secure. Redefining a retirement system for all Americans that achieves retirement security may become the next politically explosive issue. Alicia Munnell, director at CRR, has proposed a third tier of mandated retirement savings to augment 401(k) savings and Social Security benefits.
To better understand defined benefit plans, consider these actions:
• Those fortunate to have this type of pension can check its funded status by requesting Form 5500 from your plan administrator or by visiting FreeERISA.com. If there is a shortfall, discuss with your employer what actions it will take to remedy the situation.
• Understand the effect of unfunded pension liabilities on taxpayers. To identify your state's exposure, visit publicfundsurvey.org and review the 2007 Public Fund Survey.
• To see if your plan is covered by government-funded Pension Benefit Guaranty Corporation in the event your employer goes bankrupt, visit pbgc.gov.
Will Germany deliver on the Faustian bargain that created monetary union?
If Der Spiegel is correct, the German finance ministry is drafting rescue plans to prevent default on the edges of the eurozone leading to a full-blown collapse of Europe's monetary system. This is an entirely appropriate policy in economic terms. One dreads to think what would happen if the world's twin reserve currency were to disintegrate at this stage. But what about the solemn pledge to voters by Germany's political elites – promiscuously given over the years – that monetary union would never leave them on the hook for the debts of half Europe? The vast imbalances that have been allowed to build up under the seductive protection of EMU leave German taxpayers facing bail-out liabilities that exceed the cost of reparations after the First World War, in proportional terms. The political ground has not been prepared for this. EMU was foisted on the German people without a referendum, in the face of deep public scepticism and scathing criticisms by the professoriat. This failure to secure a mandate for such a revolutionary undertaking is coming back to haunt them.
Berlin is at last having to deliver on the Faustian bargain made by Germany's political class when it swapped the D-Mark for French acquiescence in reunification. It must either go the whole way towards EMU fiscal union and take responsibility for Italy's public debt (111pc of GDP by next year), Austria's loans to Eastern Europe (70pc of GDP), the adventures of Ireland's 'Canary Dwarf' (€400bn or so in liabilities), and Spain's housing collapse (1m unsold homes), or jeopardize its half-century investment in the political order of post-war Europe. Letting EMU fail at this stage would have far higher costs than never having launched the project in the first place. The alleged bail-out options include "bilateral bonds" where big brother countries agree to shoulder the credit risk for siblings, (who vouches for Italy and Spain?), or some form of EU bond. Finance minister Peer Steinbruck – erstwhile Scrooge – has become the unlikely champion of open-ended help for all. "We have a number of countries in the eurozone that are clearly getting into trouble ... Ireland is in a very difficult situation ... The euro-region treaties don't foresee any help for insolvent states, but in reality the others would have to rescue those running into difficulty," he said.
In case there was any misunderstanding, he upped the ante two days later with a pledge to "show ourselves to be capable of acting" if any euro member proves unable to roll over its debts. This is a radical shift in policy. For now, the bail-out talk has cowed speculators. The euro has rallied after weeks of sharp descent against the dollar. Credit default swaps (CDS) on Irish debt have fallen back below the red alert level of 400 basis points. But it has not been lost on the markets that Germany's own CDS spreads have risen to a record 86. Are traders starting to ask whether Berlin is in a fit state to rescue anybody? The German economy contracted at an 8.4pc annual rate in the fourth quarter as exports to Eastern Europe, Club Med, and the Anglo-sphere collapsed. The GM subsidiary OPEL is running out of cash and risks going the way of Sweden's SAAB without a €3.3bn rescue. Mortgage lender Hypo Real Estate is imploding despite €87bn in state guarantees and capital injections. Mr Steinbruck said nationalisation is inevitable. If Hypo collapses with €400bn of liabilities, it would risk a "second Lehman Brothers", he said. Like Northern Rock, it relied on short-term funding to lend long. Game over.
Hypo has been infecting the €850bn Pfandbriefe market (covered bonds), the rock core of Germany's credit system. Spreads on Postbank issues have jumped from 40 to 80 basis points. Pfandbriefe are not covered by Berlin's emergency guarantees (unlike 3-year bank debt). That may need to be changed soon. Mr Steinbruck still insists that German banks are in fine fettle. The rest of us notice their leverage ratio is 52, the highest of any major country in the world. We are assured they have good assets. Let us hope so. Time will judge whether Mr Steinbruck's bail-out rhetoric is hollow. I wonder whether any German government can in fact deliver on his pledge. He is unlikely to be finance minister after the elections in September. The Social Democrats are heading for the most crushing defeat in a free election since July 1932 – and for the same reasons – because they are associated with a deflationary collapse of Germany's core industry. Their Left flank is peeling away to the neo-Marxist Linke party, just at it peeled away to the Communists in 1932. There is much talk in the German and global media perpetuating the myth that it was German hyperinflation in 1923 that destroyed Weimar and led to Nazism. This is a fatal misreading of events. What led to Hitler was the Bruning deflation of the early 1930s.
What is true is that the 1923 trauma caused the Reichsbank to wait too long to ease monetary policy from 1930 to 1933, though Gold Standard ideology played its part. The European Central Bank has done better. At least it has followed Bagehot's advice to "lend generously" even if rates have been too high, but it has been paralysed by its own institutional hang-ups and its need to prove itself a hard-money successor to the Bundesbank. Last week chief economist Jurgen Stark attempted to head off the bail-out plans, reminding Berlin last week that rescues are prohibited by EU law. This is not strictly true – Article 100.2 allows aid in "exceptional circumstances" – but it gives powerful cover to anybody wishing to oppose the Steinbruck policy. But whatever the legal theory, the political reality is that 700,000 Germans are going to lose their jobs this year as unemployment rises to 4.3m (IFO Institute). Voters are not going to look kindly on any party seen to divert German savings to Ireland or Club Med. Architects of EMU were well aware that a one-size-fits-all monetary policy for vastly disparate nations would create serious tensions over time. They gambled that this would work to their advantage. The EU would be forced to create new machinery to safeguard its investment in the euro. It would be a "beneficial crisis", bringing about the great leap forward to full union. We are about to find out if they were right.
Europe Wants Greater Financial Safety Net
Leaders from the European Union's biggest economies gathered in Berlin on Sunday and expressed support for greater oversight of the world's financial markets. German Chancellor Angela Merkel also declared war on tax havens. Commentators say they'll believe it when they see it. The global finance summit may still be more than a month down the road. But Europe this weekend made it clear exactly what it expects when leaders from the world's top 20 economies, the so-called G-20, gather in London on April 2: a radical increase in global market regulation. The agreement was the product of a weekend meeting in Berlin which saw the leaders and finance ministers of European G-20 members meet to come up with a unified position ahead of the spring meeting.
"It is important that both the people and the markets see that policy-makers have learned from the crisis," German Chancellor Angela Merkel said. One of those lessons, European leaders said on Sunday, is that oversight of various financial products must be improved. "All financial markets, products and participants -- including hedge funds and other private investment groups that represent a systemic risk -- have to be covered by an appropriate oversight or regulation," the group decided, according to a posting on the Chancellery Web site. In addition, Merkel and her colleagues vowed to go after offshore tax havens. Merkel argued for a "mechanism of sanctions" to deal with those countries or territories which prove uncooperative in the fight against tax evasion.
The gathered leaders also proposed that funding for the International Monetary Fund be doubled to €500 billion ($643.6 billion) so that the organization has more capital available to help members in need. Furthermore, Europe is calling on banks to build up equity in boom times to provide a cushion during downturns. Merkel, French President Nicolas Sarkozy and British Prime Minister Gordon Brown were joined by leaders from Italy, the Netherlands, Spain, the Czech Republic and Luxembourg. The European Central Bank and the European Commission were also represented. "We can't afford failure in London," French President Nicolas Sarkozy said on Sunday.
"We have to succeed and we cannot accept that anyone or anything will get in the way of this summit. ... If we fail, there will be no safety net." The meeting came as economic clouds continue to darken in both the European Union and around the world. A forecast released by Deutsche Bank on Monday predicts that the German economy will shrink much further than expected. The bank's chief economist, Norbert Walter, expects Germany's gross domestic product to shrink by 5 percent, according to a report in the Monday edition of the tabloid Bild. And, he made clear, it could be worse. "The German economy will shrink by only 5 percent in 2009 if we see a turnaround in the second half of the year," he said. If no such turnaround materializes, "then greater shrinkage can no longer be ruled out." The German government forecasts a shrinkage of 2.25 percent. German commentators on Monday examine the economic intentions of European leaders.
The center-left daily Süddeutsche Zeitung writes:
"One can doubt whether the good will shown by Merkel and Finance Minister Peer Steinbrück will be enough to fundamentally renew the finance system. The problems on the global capital markets are large; they don't come from just a few meaningless things having gone wrong. No, this system ... has developed into a monster. And a monster cannot be controlled with a couple of nice speeches. A monster needs chains that limit its movements. As such, the proposals made by Merkel and Steinbrück this weekend at the EU summit in Berlin took steps in the right direction, but some don't go far enough or are too nebulous. Real reform of global finances will fail if the G-20 states, at their summit in London, don't do three things. First, in the future no derivative, no certificate and no finance instrument can be allowed without first being approved by a national or international agency. Second, financial firms should no longer be allowed to undertake any business activity that doesn't appear in their books. The shadow banking system that has developed in recent years in parallel to the normal banking system must be made to disappear. Third, all tax havens must be closed down. There should no longer be any regions in the world where no taxes are collected and where there is no financial oversight."
The center-right daily Frankfurter Allgemeine Zeitung writes:
"The call for more transparency and more control over participants in the financial markets may very well be justifiable. But one should recall that the current crisis did not result from a lack of data. Everything that is being complained about today was known: the current accounts imbalance, the pyramids of credit held by the banks, the trade with complicated securities, the bonuses paid to bankers. Earlier, though, no one complained about such things -- indeed, they were considered chic. The British journalist and economist Walter Bagehot once wrote 'all people are most credulous when they are most happy.' That will remain true even after strict regulations are passed."
The Financial Times Deutschland looks at what European financial oversight should look like in the future:
"Financial oversight on a strictly national level is no longer contemporary. Global financial markets make it an absolute necessity to establish cross-border controls. In the mid-term and long-term, there is simply no way to avoid an integrated system on a Europe-wide -- or better yet, worldwide -- basis. Such a system cannot, indeed should not, be responsible for every small institution; indeed, the micro-level can (remain the responsibility of the nation-states). But for the larger institutions, there is no way around a collective supervision. So far, many attempts in this direction have failed because they would mean a loss of power for national authorities. As with the unified currency and monetary policy, it will take time to overcome such hurdles. It will, however, become problematic should national egotism lead to limitations on the amount and quality of information that is exchanged across borders, especially should such shortcomings result in an inaccurate pictures of risks faced by financial institutions acting on a global scale. The necessary change in mentality must also include an increase in courage among overseers, particularly when it comes to identifying risks. Without question, there is a danger that such warnings can unleash a crisis. But instead of listing all conceivable risks in financial reports hundreds of pages long, it would be helpful were it made clearer where the central risks are to be found."
Eastern crisis that could wreck the eurozone
The crisis started in the US, but Europe is where it might turn into catastrophe. A senior policymaker told me last week that the present situation reminded him of the 1992 crisis of Europe’s exchange rate mechanism, when one country after another became subject to speculative attacks – leading to the expulsion of the UK and Italy from the system. In a monetary union, you can no longer bet on exchange rates. But thanks to credit default swaps, you can place convenient bets on the break-up of the eurozone. Last week, speculators bet on an Irish default, and these bets make it more expensive for Ireland to refinance its debt, thus threatening to turn into a self-fulfilling prophecy. But Ireland is not the biggest danger for the eurozone. If the country goes down, the eurozone will bail it out. Even the Germans accept this now. A far more imminent danger lurks in central and eastern Europe. The possibility of a financial collapse there is the most urgent policy issue the European Union must confront at this point. If mishandled, it could bring down the eurozone.
The crisis has hit central and eastern Europeans so disproportionately hard because of two policy errors by their governments. The first was to encourage households to obtain mortgages in foreign currencies. In Hungary, almost every mortgage is a foreign currency mortgage, mostly denominated in Swiss francs. The choice of Swiss francs is plainly ludicrous – testimony to economic illiteracy. I could just about understand foreign currency borrowings in euros, since Hungary will eventually join the eurozone. But Hungary will presumably not join the Swiss Federation. The money that Hungarian households saved on cheap Swiss interest rates has been more than wiped out by the rise in the Swiss franc. The second policy error is directly related to the first. The new EU members treated eurozone membership as a voluntary policy choice. This is a misinterpretation of their own accession treaties.
When they signed up to EU membership, they signed up to the euro as well. Only the UK and Denmark have a legal opt-out. Of course, as newly industrialised economies, they were not under an obligation to join immediately, but they were under an obligation to conduct policies consistent with eventual membership. If they had pursued such policies, they would almost all be members by now. Slovenia and Slovakia have demonstrated that, given the right policies, it was possible to enter the eurozone early on. Both these countries are now safe. For the others, the decision to procrastinate turned out to be a financial stability disaster. If confronted with a crisis such as this, you do not want to be a small open economy, on the fringes of the eurozone, with an irrelevant currency and lots of Swiss franc mortgages.
But the central and eastern Europeans got one thing right. They made sure their banks were owned by foreigners. Austrian banks are among the most active. Their exposure to eastern Europe is about 80 per cent of Austria’s gross domestic product. If Hungarian households default, it is not Hungary that will go down, but Austria. Italy and Sweden are also exposed. A central and east European crisis is therefore a systemic event for the eurozone as well. One should not therefore treat this as someone else’s problem – because it is not. What are the policy options? Naturally, the EU could provide financial help – through the International Monetary Fund – but it is not clear that this would stop a contagious balance-of-payments crisis in the region. If exchange rates were to drop further, household defaults could rise dramatically.
Would we bail out those households as well? In my view, the smartest answer to the prospect of meltdown is the adoption of the euro as quickly as possible. There is no need to switch over tomorrow. All we need tomorrow is a credible and firm accession strategy – one for each country – which would include a firm membership date and a conversion rate, backed up by credible policies. Obviously, this would require the long overdue abandonment of the eurozone’s defunct entry criteria. Of those, the most nonsensical is the reference rate for inflation, calculated as the average of the lowest three national rates. Soon, this will be a deflation rate. So an aspiring member state would be in the absurd position of having to deflate as a precondition for euro entry. The inflation criterion is not only insane, it is also in conflict with other parts of European law.
Since price stability counts as an important overriding goal of EU economic policy, enforcing a deflation criterion would be a clear breach of this objective. The same goes for the exchange rate criterion. Forcing a country into a two-year sentence of membership of the exchange rate mechanism – in which its currency would fluctuate against the euro in a fixed band – is an open invitation to speculators and would risk further instability. The accession criteria are inconsistent with basic stability rules. They should be declared invalid and certainly not be abused as a bureaucratic hurdle to prevaricate in a dangerous crisis. If calamity strikes, the EU will pay up. This is laudable, but will probably not solve the problem, especially if the crisis spreads. Granting financial aid without a firm commitment to euro membership would be irresponsible. Euroisation is the way to go.
EU agrees hedge fund controls
European leaders have agreed on draconian measures to crack down on hedge funds, rating agencies and all financial instruments, going beyond proposals by Prime Minister Gordon Brown for soft regulation designed to avoid stifling free enterprise. The move to regulate hedge funds poses a potential threat to an industry that has been a mainstay of London's financial growth over the last decade. The only restriction imposed so far is an obligation to disclose all "short" positions on equities. German Chancellor Angela Merkel, who hosted yesterday's summit of German, French, Italian, Spanish, Dutch and British leaders in Berlin, said the sort of rampant speculation and misuse of leverage that occurred in the credit bubble would not be tolerated. "We have today underscored our conviction that all financial markets, products and participants must be subject to appropriate oversight or regulation, without exception and regardless of their country of domicile.
This is especially true for those private pools of capital, including hedge funds, that may present a systemic risk," she said. The purpose of the gathering was to thrash out a common EU policy in advance of London's G20 summit in April, when world leaders aim to set the foundations of a new financial order for the 21st century. The exact details of the accord will not be released until all EU states have reviewed the text but the proposals are clearly more radical than the UK Treasury's plan for calibrated measures. Diplomats say Mr Brown agreed to restrictions on hedge funds in order to clear the way for an accord. Speaking afterwards, Mr Brown said the summit backed efforts to boost the fire-fighting reserves of the International Monetary Fund. "We need international action to help, for example, in central and eastern Europe, where a number of foreign banks have withdrawn to their home banking territories and where it is difficult to recapitalise the rest of the banking system. So we are proposing today a $500bn (£346bn) fund that enables the IMF not only to deal with crises when they happen but to prevent crises," he said.
The EU communique also called for punitive action against tax havens. "A list of uncooperative jurisdictions and a toolbox of sanctions must be devised as soon as possible," it said. French president Nicolas Sarkozy said Europe would not accept a "cheap fix" on financial regulation. "We want regulation of hedge funds, and we're not going to put up any longer with the bonus reward system of traders and bankers. Sanctions are key. Without sanctions, new regulations are meaningless," he said. The concerted attack on hedge funds is ominous for the City, which commands 21pc of global hedge fund business and four-fifths of Europe's total. While the UK's 900 funds have taken a beating over the last 18 months, they have fared better than banks. Their average leverage is far lower, and though down 19pc last year, they easily beat global stock indexes.
Trichet says regulation must be extended
Regulation and oversight needs to be extended to all "systemically important" financial institutions and markets, Jean-Claude Trichet, the head of the European Central Bank said on Monday. The ECB president also warned that the current financial crisis had begun to cause net credit flows to fall in the eurozone in recent weeks, partly reflecting the increasingly tight financing conditions as banks try to deleverage – or reduce the debt element – in their balance sheets. "It is here that we have to closely watch developments. If such behaviour became widespread across the banking system, it would undermine the raison d’etre of the system as a whole," he said. The ECB president added that there were some "more positive" developments, for companies seeking funds – notably the performance of the corporate bond market. There, he said, issue volumes had remained "significant" and with euro-based issuances by non-financial companies reaching a record high in January.
However, Mr Trichet conceded that pricing had become tougher and not all companies were benefiting equally from this market. Addressing a conference in Paris, the central banker urged a "holistic" reform of the current system of financial regulation and oversight. "The current crisis is a loud and clear call to extend regulation and oversight to all systemically important markets – notably hedge funds and credit rating agencies – as well as all systemically important markets, in particular the over-the-counter derivatives (or swaps) market," he said. He welcomed the proposed legislation on credit rating agencies, which is currently working through the European Parliament, saying "it goes in the right direction", and reiterated the ECB’s view that there would be "merit" in having a clearing system for credit default swaps market located within the eurozone area.
Although the derivatives industry has finally agreed to co-operate with the development of a clearing system for the huge CDS market, it is unclear whether this will end up being centred in London – which might be preferred by some of the big dealer firms – or a eurozone capital, such as Frankfurt or Paris. The ECB president, speaking just days before a high-level group headed by French banker Jacques de Larosiere is due to release its recommendations on how to reform financial supervision in the EU, also stressed again the ECB’s willingness to play a greater role in high-level prudential oversight. "The ECB and the euro system have the technical capacity to assume a stronger role in macro-prudential supervision. Indeed, it would be a natural extension of the mandate already assigned to us by the (ECB) treaty, namely to contribute to financial stability," he said. Mr Trichet said this role could include monitoring and analysis of financial stability, developing early warning systems for the risks in the financial system, conducting "stress-testing" exercises, and advising on financial regulation and supervision from a financial stability perspective.
Ilargi: Yes, Mr. Halligan, there will likely be inflation somewhere down the road. But you need to travel that road first. Talking inflation today is like discussing frostbite in August.
Inflation is the greatest danger to the British economy
On BBC Radio 4's Today last week, I was accused of being "bonkers". That was after I argued the UK faces serious inflationary dangers – not least due to the impending use of the Bank of England's printing press. My concerns that our "borrow-more, spend-more" bail-out will make a bad situation worse were similarly dismissed as "absurd". Allow me to explain why the real issue is inflation – and not the deflationary spectre that's been conjured up to scare us. Allow me to outline how to escape this crisis, the path our politicians should be taking, rather than their current disastrous course. Then you, dear reader, can judge who is "bonkers", whose reasoning is "absurd".
UK interest rates have been slashed to 1 per cent – a 315-year low. Our budget deficit is heading for a colossal 10 per cent of GDP – bigger than the shortfalls that saw the UK go "cap in hand" to the International Monetary Fund in the mid-1970s. Government borrowing, having risen sharply in recent years, will soon spiral to levels not seen since the Second World War. Meanwhile, the pound has lost a third of its value in less than a year – pushing import prices up. All these developments are inflationary. Fiscal and monetary policy are wildly out of control. Yet inflation, we're told, isn't a problem. Inflation is yesterday's news. Politicians and their pet commentators warn of deflation under every stone. I accept that falling prices warp incentives, increase real debt burdens and – if expected to continue – stymie retail spending. That's what plunged Japan into a decade-long recession in the 1990s.
But UK deflation simply doesn't exist. In December, annual CPI inflation fell to 3.1 per cent – way above the Bank's 2 per cent target. That number was used as "evidence" we're on "the brink of deflation". Anyone examining this data could see the lower inflation rate was driven by the one-off 2.5 point VAT cut. Adjusted for tax, the CPI actually rose – from 3.9 to 4.1 per cent. That's not surprising given that our ailing currency saw import prices rise a painful 14 per cent. CPI inflation fell to 3 per cent in January. Again, the detailed data is instructive. Food price inflation hit 10.3 per cent. Even "core inflation" – excluding food and fuel – rose, despite the screams of "deflation" from Whitehall and beyond. Why are our so-called leaders creating deflationary fears? As an excuse for grabbing monetary policy back off the Bank of England and nailing interest rates to the floor, while junking fiscal caution and borrowing in a fashion akin to that of a banana republic. Our historically ignorant politicians – and their pliable, time-serving technicians – have responded to the credit crunch by avoiding the real issues. Using "deflation" as an alibi, they've taken the line of least resistance. Now, in a final desperate throw of the dice, we're seeing "quantitative easing" – in other words, "printing money". How will this ridiculous policy help? Have we learnt nothing from Zimbabwe, Argentina or the Weimar Republic? The huge inflationary dangers of "QE" are obvious – in particular alongside massive government borrowing, a tumbling currency and repeated interest rate cuts.
The UK's policy will make historians wince. But being seen to be "doing something" is easier than doing what really needs to be done. For that would involve politicians tackling powerful vested interests and admitting to previous regulatory mistakes. Ministers, first and foremost, need to hose down a banking sector that's holding the country to ransom. Our most senior bankers should be gathered in a locked room and – under threat of custodial sentence – be forced to disclose the full extent of their potential sub-prime losses. At the moment, banks are lying about the liabilities they face. That's why they won't lend to each other – which has gridlocked the inter-bank market, blocking crucial credit lines to firms and households. Banks rendered insolvent must be merged and/or nationalised – with the bad loans "fessed up" and written off before more taxpayer money is spent on recapitalisation. Gordon Brown has taken a "head-in-the-sand" Japanese approach – creating the UK's "zombie banks" which are technically alive (allowing powerful executives to keep their jobs and save face) but commercially dead, and a drain on society given the extent of their toxic debts. We instead need the kind of hard-headed banking purge the Swedes used to escape financial crisis in the early 1990s. Until that happens, and the inter-bank market re-boots, the UK will continue to haemorrhage jobs.
Beyond this, Brown's regulatory regime must be scrapped, returning responsibility for bank supervision to the Bank of England, where it belongs. The split between the Old Lady and the Financial Services Authority is inefficient and dangerous – as we've seen. In addition, the Bank needs greater power to impose counter-cyclical reserve requirements – so banks create less credit when the economy is booming, but more in a downswing. That would take the pressure off interest rates as a tool of demand management – a blunt, discredited instrument. Above all, we need desperately to reimpose the split between commercial banks (which take in deposits, then lend to ordinary businesses) and investment banks (which use higher risk strategies). The removal of this "Glass-Steagall" firewall in the UK and the US is the prime reason for the crisis. By merging with commercial banks, leveraging their taxpayer-backed deposits and using them to place reckless bets, the investment banks have destroyed the financial strength of the Western world. Yet still, our politicians hesitate. Bewitched by the power of the money men, they fail to do what must be done. If he had any self-awareness, Gordon Brown would hang his head in shame. His big spending, and debt accumulation, contributed mightily to our grave situation. But the Tories need to examine their conscience, too. For years, they backed Labour's irresponsible spending plans. Since the crisis began, their ideas on banking and regulatory reform have been vague and incoherent. The UK faces a wave of inflation, a potential gilts strike and the danger of another IMF bail-out. What is HM Opposition doing to stop this policy vandalism? Has David Cameron got the courage to risk ridicule by pointing to the madness of the policy consensus?
Denmark's Fionia Bank board throws in towel
The financial crisis has now hit Denmark’s 11th largest bank, which is transferring its activities to a new company. The Fionia Bank Board is in trouble and to avoid further problems has entered into an agreement with the national Financial Stability company. The agreement means that the banking activities in the current Fionia Bank are to be transferred to a new company which has been established and owned by Fionia Bank, but which is controlled by Financial Stability. "The agreement requires approval of the Financial Supervisory Authority, the EU and competition authorities. At its annual general meeting on 10 March 2009 the Board will explain the contents of the agreement. There are proposals to change the name of the current bank to Fionia Bank Holding A/S and give the new company the name Fionia Bank A/S," the company says in a news release. The bank’s board and management will continue in the new company.
Jørn Kristian Jensen, a former member of the Executive Board of Nordea, has been proposed to the board. "This is not a liquidation but a strengthening of our ability to operate the bank," says Fionia Bank CEO Jørgen Bast. "The solution reached with the Financial Stability means that the bank's shareholders for a period lose control of the company, but retain ownership. The control can be retained after the agreement, if the bank succeeds in creating enough positive results to return and repay the capital," Bast says. In the pledge period, voting rights are transferred to Financial Stability. Fionia Bank is to release its 2008 annual accounts on Tuesday. The Executive Board says that preliminary key figures are in line with previous forecasts, including depreciaition of DKK 1,218 million. "The bank has a satisfactory core earning at 348 million. The Bank's profit before tax shows a deficit of 960 million, and the bank's solvency is before the agreed strengthening of the capital base 8.3 per cent of which the core capital is 4.2 per cent," the bank says. It adds that after discussions with the Supervisory Authority, Fionia Bank set the bank's needs above 8.3 percent. "With the capital increase of approx. one billion DKK the solvency of the bank will be around 13 per cent," the bank says.
Ilargi: Say what you will about Britain, reading this article will convince you they still produce real good drugs.
Beware prophets of doom – the numbers don't stack up
In 1930, real US gross domestic product (GDP) fell by 9pc -but the consensus forecast of 2009 real GDP is a fall of just 0.3pc. While the financial news may seem unremittingly bleak, medium- to long-term investors should remember that the experts who predict gloom today did not see the current crisis coming – and may not see the recovery, either. The other day I was in the opticians for my annual check-up and in walked a former next-door neighbour, a builder who retired a few years ago. He wondered if I had retired too and was surprised I was still at work. He wondered why. I said I wanted to see out the stockmarket recovery, in which my investments would grow significantly over the next three years. He said it wasn't just my eyes that needed testing. According to him, everybody knows we won't see a recovery of economies or stockmarkets in our lifetimes. Obviously he believes the experts who pump out the bad news that surround us right now. These are the same experts who last summer advised us property was a key investment for our retirement savings.
They're the same ones who confidently told us the US dollar would plummet. And who predicted gold, when it was at £1,000 an ounce, would double over the next 12 months. As oil hit over $145 a barrel, the same experts predicted it was heading to $200 and higher with continuing prices in hard and soft commodities. Every one of these predictions ended up wide of the mark. History tells us that when all the experts are agreed, it's time to take a different view. It tells us to be afraid when things look too good and to be optimistic when things look too bad. So given all the bad news it's time to look for reasons to be cheerful, and there are plenty. Successful investors buy when markets are oversold and sell when they are overbought. They like fair value. Right now estimates here and in America suggest stockmarkets to be 42pc too cheap. Corporate insiders, who don't make many mistakes, are currently net buyers of their shares.
Private investor sentiment, too, is rarely misleading. Or should I say rarely right. You can measure this mathematically. Ned Davis Research shows that, in the US, when private investors are at extremes of optimism or pessimism it's a perfect contrarian indicator for long-term investors. In other words, when the masses are overly pessimistic it's a good time to buy, and vice versa. Experts tell us we're heading for the Great Depression of the 1930s again. Even US President Barack Obama agrees. He said: "By now it's clear to everyone we've inherited an economic crisis as deep and dire as any since the days of the Great Depression." I'm afraid the numbers don't actually add up. In 1930, real US gross domestic product (GDP) fell by 9pc, the next year it fell 6.5pc, and in 1932 it fell 13pc. But in 2007 real US GDP rose by 2pc, and last year it rose 1.5pc. The consensus forecast of 2009 real GDP is a fall of 0.3pc. Right now, monetary policy is loose, interest rates have been slammed down to almost zero and job losses and mortgage foreclosures are far less than they were in the Great Depression.
Always check the numbers. I read that, according to experts, unemployment in the US shows the worst job losses since December 1974 at 600,000. But what they don't tell you is that the US labour force today is 65pc larger than it was in December 1974. They tell us advertising revenues are dropping. That's funny – because when you look at the online ad revenues in the US they're up 8pc year on year, with strong performance in the fourth quarter of last year. That doesn't quite go along with the Depression theory. Levels of cash on the sidelines from experienced investors are also important. A US survey shows in January experienced investors had 42pc in deposit, a record level since records began in the 1980s. Incidentally, the last two occasions when deposits were almost as high – at 38pc in 1991 and 39pc in 2002 – were the previous two best occasions to have bought equities since late 1987. Finally, studying US stockmarkets, after presidential inauguration days, going back all the way to 1900 is also encouraging. The average gain in the stock market following an incoming Democrat president, replacing an outgoing Republican, is 13pc 126 days later. Usually, the first month after inauguration shows weakness. So there are plenty of reasons to be cheerful. Those prepared to take at least a two- or three-year view, hoping to have decent income and capital gains, could do a lot worse than tuck away a selection of good-quality UK equity and international income funds.
The Gold Rush: Don't Get Burned
With the yellow metal near $1,000 per ounce, investors are clamoring for coins and bullion. But buying gold in its physical form can be tricky.If you had any doubt that the prime motivation for investors has shifted from greed to fear, look at the price of gold. The spot price for the yellow metal reached $992.43 an ounce on Feb. 20, its highest level since hitting $1,002.70 on Mar. 17, 2008, the day that Bear Stearns collapsed. The spot price has climbed more than 39% from a near-term low of $712.30 on Nov. 12, 2008. Demand for physical gold has exploded as the deepening financial crisis and ongoing slide in stock prices has pushed nervous investors into safe-haven investments. But new investors need to be careful about who they buy from, since inexperienced people seeking to take advantage of opportunities in the market are opening coin dealerships without being aware of the financial risks or legal compliance issues involved.
"These days, with everything going on with the [Bernard] Madoff scandal and now the [Allen] Stanford scandal, you have to know exactly who you're dealing with," says David Beahm, vice-president at Blanchard & Co., a leading retail dealer of gold coins and other precious-metals products based in New Orleans. The best way to ensure the quality of what you're buying is to do your due diligence when choosing a dealer, he says. The Better Business Bureau is a good place to start, at least to be able to see whether a certain dealer's clients are satisfied or not. And the Internet makes due diligence that much easier. For instance, you can check whether a dealer belongs to the Professional Numismatists Guild (PNG), a nationwide association based in Fallbrook, Calif., on the PNG Web site.
Be wary of incoming cold calls from dealers unless it's someone with whom you have a long-standing relationship, advises Diane Piret, industry affairs director at the Industry Council for Tangible Assets (ICTA), the national trade association for rare coin and precious-metals dealers. Investors are better off seeking out dealers on their own. It's a good idea to look for companies whose dealers are members of the PNG, which requires dealers to have five years of experience as numismatists, have a net financial worth of at least $250,000, and be elected to the guild by a majority of the present members. PNG members must abide by guild rules, which include an arbitration process to resolve any dispute over product quality between buyers and sellers. It's treacherous to enter the bullion market with no understanding of how tight the margins are and how rapidly investors can lose their shirts, given the volatility in gold prices, says Piret.
Although she has received five or six inquiries recently from people asking which laws they need to comply with in order to establish a dealership, she doubts many of them have subsequently opened a business. "A dealer who buys and sells over $50,000 with all [his] customers of bullion-related products…needs to be compliant with section 352 of the Patriot Act and have a compliance officer," she says. "Cash reporting laws and money laundering laws are very serious." New investors in the yellow metal also need to keep an eye on the spot price of gold to ensure they're not being charged too high a premium for gold coins. It's common these days for dealers to sell gold coins at 8% or 9% above the spot price, and that's not necessarily bad, given the supply constraints for the retail product due to higher demand, says Dave Meger, managing director of metals services at Alaron Trading in Chicago. His firm has had to turn away orders occasionally in recent months when it hasn't received fresh product from the U.S. Mint.
During the fourth quarter of 2008, U.S. consumer demand for gold coins and bars jumped to nearly five times the amount from a year earlier, to 34.8 metric tons, according to the World Gold Council. Between Sept. 15 and early December, Blanchard sold more gold than it had in the prior three years, despite the Mint's 45-day suspension of sales of one-ounce American gold eagle coins after the collapse of Lehman Brothers. Blanchard had to sell "whatever product we could get our hands on"—Canadian maples or South African krugerrands—until supply of American eagles resumed, says Beahm. "At that particular time, nobody really cared what they had as long as they had gold." To keep the premium they pay over the spot price to a minimum, Meger at Alaron recommends investors buy from one of the four authorized distributors that buy directly from the U.S. Mint.
The Mint charges premiums of 3% on one-ounce gold coins, 5% on half-ounce coins, and 7% on quarter-ounce coins when it sells to authorized purchasers, which in turn mark up prices to dealers and individual investors. While Alaron can't buy directly from the Mint, it benefits from having a partnership with a firm that is an authorized purchaser. Meger also suggests buying from a dealer who is linked to a brokerage firm with a reputable name in the commodities industry and who sells only exchange-approved brands, hallmarked bars, and reputable mint coins. "We can offer clients the ability to hedge their purchases with options or futures contracts," he says. A buy-and-hold investor who expects to see gold prices pull back in the short term isn't likely to go to the trouble of taking gold out of the warehouse to sell it, but might think it advantageous to hedge his position by selling a futures contract. "It's nice to be able to deal with a brokerage firm that offers you that ability," he says.
Only a few of the 30 or so refiners whose brands are listed on the New York Mercantile Exchange's Web site sell gold bars in retail sizes of one, five, and 10 ounces. Until about a month ago, those smaller retail forms of gold were in short supply, but now that refiners realize they can get significantly higher premiums for them, they are starting to shift resources from jewelry and other industrial fabrication to increase production of the smaller retail forms, says Meger. When ordering coins from a dealer, it's best to send your money in as quickly as possible, since dealers will only lock in prices once they've received "good funds" in the form of a bank wire transfer or cash. "The price could change from the time you contact us until the funds are good," says Beahm. From a cost perspective, there are far more efficient ways to buy gold than coins or bars, where uncertainty about the size of markups is compounded by shipping costs, says Leonard Kaplan, president of Prospector Asset Management in Evanston, Ill. "The alternatives are so much better and so much safer.
You can either buy futures or ETFs. Then you're dealing with regulated industries, known quantities, not Joe Schmo coin dealer who's been around for two weeks," he says. Gold investors have to pay shipping and storage costs on top of the hefty premiums they're already paying above the spot price. "Is it worth $6,000 to $8,000 on 100 ounces of gold to have it in your hand, and to lose liquidity, and to pay storage? I don't think so," Kaplan says. Some strategists suggest waiting for a pullback in gold prices, to around $950, before buying more. But $992 may prove to be cheap a few months from now if things break the gold bulls' way. Beahm at Blanchard believes spot gold is poised to reach at least $1,500 by the end of this year, in view of all the liquidity the government is putting into the economy, which will eventually boost inflation. Right now, the fundamentals look good for gold. But remember that the yellow metal has tripped up smart investors in years past, and will likely do so in the current boom.