Organ deposited by flood on a farm near Mount Vernon, Indiana
Ilargi: I’m afraid the intro space will be a bit longer than usual today. I have something to get off my chest myself, and I want some space for our regular Dan W.'s play with numbers.
As we see increasing scrutiny of who exactly is part of Obama's administration, and I have of course questioned the role played by Rubin, Geithner and Summers from day one, let's look at a Wall Street Journal article that deals with a specific plan being considered (one of -too- many), just to point out how far we have wandered off into left field. By the way, reading that the Obama camp considers re-naming the TARP purely because of PR reasons, makes me laugh out loud. Also, I abhor having to agree with right wing politicians. There's nothing right wing about me, in fact I only have one wing, a left one. And I see nothing in republican plans for mass tax cuts. Thing is, I see nothing in Obama's plans either. They won't just not work, they will exacerbate the problems exponentially. Here's a large excerpt, I don't really know what to leave out:
Hoping to jump-start the financial system, the Obama administration is considering turning to a new program run by the Federal Reserve that has been a challenge to launch and depends heavily on hedge funds. The Term Asset-backed Securities Loan Facility, or TALF, was announced in November after investors stopped buying securities backed by consumer debt. Under the $200 billion program, the Fed will make loans to almost any U.S. firm that is willing to use the government financing to buy securities tied to credit-card, small-business, student and auto loans.
Some hedge funds, which often use borrowed money to boost returns, are lining up to get in on the Fed program, seeing a chance to make high double-digit-percentage returns with little downside using low-cost loans made on easy terms. Some officials inside the Fed are nervous about relying on unregulated hedge funds. But they see it as a trade-off in order to get capital to consumers.
Broader philosophical issues could arise if the program is expanded. The White House has promised more transparency in how its funds are used. But lending to hedge funds may be problematic because their operations are opaque. Moreover, the program depends on many of the practices that helped to fell Wall Street firms in the first place, such as leverage, structured-debt investments and a dependence on credit ratings. Depending on the different types of collateral, investors will get roughly $100 of lending for every $5 to $16 of cash they put up to invest. The rate investors will have to pay will be set at one percentage point over interest rates based on London interbank offered rates.
The loans the Fed makes to investors are nonrecourse, meaning investors can't lose any more than the money they put upfront on the security. If a hedge fund defaults to the Fed, its collateral is the securities themselves. There also are no margin calls, meaning the Fed can't demand additional payments of cash from borrowers if the underlying securities fall in value. Investors see these as important inducements to the program. But a Treasury Department inspector general warned that the program was vulnerable to fraud by the private sector.
The activities of hedge funds are another potential issue. Some investors have privately expressed worries that hedge funds could game the system to use cheap Fed financing to fund other trading positions that run counter to U.S. goals. A firm might, for instance, buy debt backed by car loans with Fed financing and use the cash flows from the investment to fund short positions on auto makers that pay off if they struggle.
Among funds that bankers and investors have spoken to about the TALF are Magnetar Capital LLC, a multibillion-dollar Evanston, Ill., fund, which made bets during the housing boom that paid off when mortgage defaults rose. Magnetar also helped to fuel issuance of complex debt instruments known as collateralized debt obligations.
Long story short -sorry, but I think it's good material-: Securities that presently have no buyers will be sold to hedge funds for 5 cents on the dollar, while providing them with capital they can use to engage in shorting the firms on whose collateral the securities were originally issued. If you think a company will fail, you buy $100 million of its securities, the Fed hands you $500 million, and you use $400 million of that to buy credit default swaps or put options betting against the company. Your maximum loss is $100 million, but the $400 million is more than enough to buy insurance against that. The potential profit runs in the many billions of dollars. This is nothing but another side door, open exclusively to the money class, to skim more cream off the public trough.
Note that the Fed sets the price at 5 cents on the dollar. That's what they think is a reasonable price for the paper. Not exactly an insignificant detail . Instead of forcing the companies the Fed bought the sh*t from to take the obvious losses, it's reinserted into the financial system, where it can do more damage that will eventually and inevitably bounce back onto the taxpayers’ tab. The program seems to have a $200 billion limit, but it's not crystal clear if that, at the 20X leverage rate indicated, means the Fed will sell just $10 billion in bad assets -excuse me, securities (can we lose that word, please?)- or if $200 billion can balloon into $4 trillion. And you know what, it doesn't matter. Total insanity is what it is, whether you blow it up to 20 times its size is not the issue. It's like you can't be a little married, or a little dead.
The scheme gets its icing on the cake from the fact that funds that are directly responsible for much of the losses suffered by the US economy will now get a chance to make up for some of their "pain" by gaming the taxpayer once more, courtesy of the Federal Reserve and the Obama administration. I absolutely love the way the Wall Street Journal phrases it: Broader philosophical issues could arise if the program is expanded. It often looks like Bizarro's World these days, doesn't it? Or is that just me and Jon Stewart?
Of course, there's another small issue: we all know that (over-) leveraging is the no. 1 problem in our economies. And now the Fed actively encourages more leverage? The best we can hope for is that banks simply refuse to go along. Still, that leaves the carrion feeders to feast on our carcasses.
One last little quote from today:
Government officials, however, argue that they have a responsibility to pursue the least costly solution, and that they continue to believe smaller steps than nationalization can resolve the crisis. While some banks have large concentrations of troubled assets, the bulk of the problem is spread across many of the nation's 8,300 banks. Nationalizing enough banks to clean up the problem would be hugely inefficient, officials say. A source familiar with the administration's thinking said he thinks that would make sense only if the economic situation deteriorated massively. And in that dire eventuality, the source said, "The government will end up owning everything anyway."
If the WSJ is right that "the bulk of the problem is spread across many of the nation's 8,300 banks", and we already know that the top 3 banks own $170 trillion in "troubled assets", we will be in for some serious fun times.
PS: For those who don't recognize the title of today's post, see below for Darwin's anniversary:
""Descended from the apes!" exclaimed the wife of the bishop of Worcester. "Let us hope that it is not true, but if it is, let us pray that it will not become generally known.""
Anyway, here's Dan W. with his pocket calculator:
It's Just Basic Math!!! It's neither 'gloom-and-doom' hocus pocus, nor decidedly a-factual Nostradamus-esque visions of the future...it's just math.
- The United States population is roughly 305,000,000
- About 79% of Americans live in cities or suburbs
- Over 50% live in cities with populations over 50,000
- Over 250 cities in the U.S. have over 100,000 people
- 9 cities have more than 1 million residents
- There are roughly 6000 registered hospitals in the US
- 10 to 15% of Americans live below the poverty line
- In 2007, 37.3 million Americans lived in poverty.
- The richest 10% of Americans possess 70% of the wealth
- The top 1% possesses 33.4% of net wealth.
- Government activity accounts for about 12% of GDP.
- The service sector accounts for about 65% of GDP
- The leading sector by income is finance and insurance
- Agriculture accounts for less than 1% of GDP
- About 150 million people “are” employed with earnings
- 80% are full-time jobs
- 79% are employed in the service sector
- Health care is the leading field of employment
- There are roughly 70 million public school students
- There are about 25 million businesses in the US
- Small businesses are about 50% of the workforce
- Roughly 29 million children get free lunch
- There are roughly 95,000 public schools in the U.S.
- There are roughly 6.8 million teachers
- The national average salary for teachers is $45,000
- Average 4 year college tuition, about $35,000
- About $8,000 per-pupil is spent
- 26,300 food pantries in the United States
OK, let’s have fun with extrapolation!!
We’ll begin with unemployment. At 15% (U6) give or take, the actual number of U6 unemployed is 22.5 million people. These numbers are growing by 500,000 per month, or approximately 2.2%/month. Now, it’s important to consider the following: layoffs in public education cannot begin until June of this year, when contracts expire. So as the figures above demonstrate, with roughly 6.8 million teachers in the country, the U6 numbers will see a pretty dramatic jump for June as schools cut about 150,000 teachers, or 2.2% (reflective of the general 2.2% losses per month in the other sectors) of the teaching force. And so U6 unemployment numbers, which currently stand somewhere in the neighborhood of 15%, and which are increasing by an average of just over 2% monthly, will experience an addition bump from 2.2% to just shy of 3%, as unemployment numbers for the month of June jump from roughly 500,000 to 650,000.
These of course are conservative estimates, as the layoffs in many sectors (colleges, hospitals, manufacturing) are just beginning to ramp up. And so conservatively, we are looking at U6 unemployment rates of close to 25% by the end of June, 2009. 25%!! In real numbers: 28.3 million people unemployed. CONSERVATIVELY! I haven’t even accounted for the fact that 50% of full time workers work in companies that employ under 500 people, and it is those small businesses that are going to suffer the most under a regime of disappearing credit and no support from the public sector. Or that, since the service sector and health care are the predominant employment sectors in the US, and since both of those sectors are going to face dramatic collapses as consumer spending totally dries up and as insurance coverage evaporates, unemployment figures may in fact accelerate even further than expected.
Next let’s examine poverty. In 2007 it is estimated that some 37.3 million American lived in poverty. Again, let’s extrapolate, shall we? For the sake of our calculations, let’s argue that the U6 unemployment at the end of 2007 was just south of 10%. Let’s also say that 75% of those unemployed had “incomes” that placed them below the poverty line. (Obviously a very generous estimate in that probably closer to 100% of those unemployed were below the poverty line, right? Oh, and just to keep the information flowing, the poverty threshold for a family of FOUR is $21,000/year of income: less than $1750/month BEFORE taxes.) So, of the 37.3 million Americans living below the poverty line---of whom approximately 50% are working-age adults---roughly .75 x 37/2 were unemployed adults. That number: about 13.9 million people. 13.9 million unemployed adults living below the poverty line at the end of 2007.
Now let’s jump forward to June of 2009, some 18 months later. If we’re looking at 25% unemployment this coming June, then 13.9 x 25/10 x .75, or just over 26 million unemployed adults will be living under the poverty line. And that number represents 50% of the total number (kids, remember??): 53 million people living below the poverty line by June of this year: One sixth of the entire population of our great country, living below the poverty line. Isn’t math grand? And please recognize that these numbers are conservative estimates. For example, 79% of the fulltime employees in the U.S. work in the service sector. But with so much unemployment and so little capital and “credit” to be had, the service sector is going to experience a collapse that probably leaves my numbers a tad of the optimistic side. And I have a few questions: How are 27,000 some-odd food pantries going to help 53 million people in need of food? How are 53 million people going to receive food stamp subsidies from states that are bankrupt as we speak? How are the 6000 or so registered hospitals in the United States going to care for 53 million people who cannot pay their bills?
How about growth: my favorite subject! Let’s see: The richest 10% of Americans possess 70% of the country's wealth, and the top 1% possesses 33.4% of the riches. The service sector makes up about 65% of GDP. Of course, the leading sector of the GDP by income is finance and insurance. Well, if I’m not mistaken, finance and insurance are broke!! They are in the hole tens of trillions of dollars because they played Ponzi games with derivatives and securitized instruments of all shape and kind. And they’ve admitted that their busted! No extrapolation needed here! So if the leading sector of GDP income is bankrupt, doesn’t that say something about growth? Hmmm, call me silly. Also, with 1% of the nation’s population holding over one third of the wealth, do you really believe that this 1% is going to open their check books during this financial cataclysm and help fund the services that state and local governments are going to supposedly support?!?
Look, the numbers simply refuse to lie. I know that our leaders keep trying to make them lie, but they cannot. They are objective little units of measure. And let me add this: In the exercise above, as you may have noticed, I erred on the conservative side time and again. How? I ignored exponents! I didn’t take into account how 2.2% unemployment growth one month probably means 2.35% the next month, and so on. I didn’t explain how subsidizing food aid for 50 million people one month leaves less in the way of resources for the following month, which in turn makes those resources more costly, each month, by comparison. Anyone can play the numbers game, y'know. I invite you to take a close look at the list above and have fun with extrapolation, just like me.
The Fierce Urgency of Pork
"A failure to act, and act now, will turn crisis into a catastrophe." -- President Obama, Feb. 4.
Catastrophe, mind you. So much for the president who in his inaugural address two weeks earlier declared "we have chosen hope over fear." Until, that is, you need fear to pass a bill. And so much for the promise to banish the money changers and influence peddlers from the temple. An ostentatious executive order banning lobbyists was immediately followed by the nomination of at least a dozen current or former lobbyists to high position. Followed by a Treasury secretary who allegedly couldn't understand the payroll tax provisions in his 1040. Followed by Tom Daschle, who had to fall on his sword according to the new Washington rule that no Cabinet can have more than one tax delinquent.
The Daschle affair was more serious because his offense involved more than taxes. As Michael Kinsley once observed, in Washington the real scandal isn't what's illegal, but what's legal. Not paying taxes is one thing. But what made this case intolerable was the perfectly legal dealings that amassed Daschle $5.2 million in just two years. He'd been getting $1 million per year from a law firm. But he's not a lawyer, nor a registered lobbyist. You don't get paid this kind of money to instruct partners on the Senate markup process. You get it for picking up the phone and peddling influence.
At least Tim Geithner, the tax-challenged Treasury secretary, had been working for years as a humble international civil servant earning non-stratospheric wages. Daschle, who had made another cool million a year (plus chauffeur and Caddy) for unspecified services to a pal's private equity firm, represented everything Obama said he'd come to Washington to upend. And yet more damaging to Obama's image than all the hypocrisies in the appointment process is his signature bill: the stimulus package. He inexplicably delegated the writing to Nancy Pelosi and the barons of the House.
The product, which inevitably carries Obama's name, was not just bad, not just flawed, but a legislative abomination. It's not just pages and pages of special-interest tax breaks, giveaways and protections, one of which would set off a ruinous Smoot-Hawley trade war. It's not just the waste, such as the $88.6 million for new construction for Milwaukee Public Schools, which, reports the Milwaukee Journal Sentinel, have shrinking enrollment, 15 vacant schools and, quite logically, no plans for new construction.
It's the essential fraud of rushing through a bill in which the normal rules (committee hearings, finding revenue to pay for the programs) are suspended on the grounds that a national emergency requires an immediate job-creating stimulus -- and then throwing into it hundreds of billions that have nothing to do with stimulus, that Congress's own budget office says won't be spent until 2011 and beyond, and that are little more than the back-scratching, special-interest, lobby-driven parochialism that Obama came to Washington to abolish. He said. Not just to abolish but to create something new -- a new politics where the moneyed pork-barreling and corrupt logrolling of the past would give way to a bottom-up, grass-roots participatory democracy.
That is what made Obama so dazzling and new. Turns out the "fierce urgency of now" includes $150 million for livestock (and honeybee and farm-raised fish) insurance. The Age of Obama begins with perhaps the greatest frenzy of old-politics influence peddling ever seen in Washington. By the time the stimulus bill reached the Senate, reports the Wall Street Journal, pharmaceutical and high-tech companies were lobbying furiously for a new plan to repatriate overseas profits that would yield major tax savings. California wine growers and Florida citrus producers were fighting to change a single phrase in one provision.
Substituting "planted" for "ready to market" would mean a windfall garnered from a new "bonus depreciation" incentive. After Obama's miraculous 2008 presidential campaign, it was clear that at some point the magical mystery tour would have to end. The nation would rub its eyes and begin to emerge from its reverie. The hallucinatory Obama would give way to the mere mortal. The great ethical transformations promised would be seen as a fairy tale that all presidents tell -- and that this president told better than anyone. I thought the awakening would take six months. It took two and a half weeks.
YOU, the U.S. Taxpayer, Can't Handle the Truth
The Wall Street Journal just came out with a piece outlining a multiple-choice hairball of options which Treasury Secretary Geithner is considering. The sad truth is this: his plan will fail. Why? Excessive complexity. For a plan of this magnitude to work, it needs to be straight-forward, easy to understand, clearly communicated, brutally transparent, and ruthlessly executed. The chance of the Treasury and Congress arriving at a plan that meets these criterion appears to be approaching zero. Further, the plan is still missing a few key components, such as transparency of bank asset values and avoiding the forced requirement to lend money, flying in the face of rational decision-making and market forces. But wait, it gets even better. Consider this comment from Rep. Brad Miller, a Democrat from North Carolina and a member of the House Financial Services Committee:"If we had regulators go in an examine the books like we did at Fannie Mae and Freddie Mac a great number of our systemically important financial institutions could be insolvent."And this is exactly what Mr. Miller and Treasury Secretary Geithner want to avoid; the transparency necessary to figure out exactly where the industry stands, in order that a proper prescriptive can be put in place to begin real healing, not some illusory band-aid that will only set us up for greater suffering down the road. For a member of the House Financial Services Committee to make a comment like this only highlights the disconnect between the politicians and the real problem: dealing with the systemic insolvency that threatens our country.
Mr. Miller would have you believe that putting our collective heads in the sand is a better approach. He is just so wrong. He knows the problem is there, but is unwilling to face into the truth. He thinks we can't handle it. Reality is, we can handle the truth: it's he and his scared-out-of-their-minds Congresspeople that can't handle the truth. We need some different people making the big decisions. They appear too big and too important for our small-minded Congresspeople to make.
Obama's team of zombies
Even under the new president, Washington is the same one-party town it always has been -- controlled not by Democrats or Republicans, but by thieves. Only weeks ago, the political world was buzzing about a "team of rivals." America was told that finally, after years of yes men running the government, we were getting a president who would follow Abraham Lincoln’s lead, fill his administration with varying viewpoints, and glean empirically sound policy from the clash of ideas. Little did we know that "team of rivals" was what George Orwell calls "newspeak": an empty slogan "claiming that black is white, in contradiction of the plain facts."
Obama's national security team, for instance, includes not a single Iraq war opponent. The president has not only retained George W. Bush's defense secretary, Robert Gates, but also 150 other Bush Pentagon appointees. The only "rivalry" is between those who back increasing the already bloated defense budget by an absurd amount and those who aim to boost it by a ludicrous amount. Of course, that lockstep uniformity pales in comparison to the White House's economic team -- a squad of corporate lackeys disguised as public servants.
At the top is Lawrence Summers, the director of Obama's National Economic Council. As Bill Clinton's treasury secretary in the late 1990s, Summers worked with his deputy, Tim Geithner (now Obama's treasury secretary), and Clinton aide Rahm Emanuel (now Obama's chief of staff) to champion job-killing trade deals and deregulation that Obama Commerce Secretary Judd Gregg helped shepherd through Congress as a Republican senator. Now, this pinstriped band of brothers is proposing a "cash for trash" scheme that would force the public to guarantee the financial industry's bad loans. It's another ploy "to hand taxpayer dollars to the banks through a variety of complex mechanisms," says economist Dean Baker -- and noticeably absent is anything even resembling a "rival" voice inside the White House.
That's not an oversight. From former federal officials like Robert Reich and Brooksley Born, to Nobel Prize-winning economists like Joseph Stiglitz and Paul Krugman, to business leaders like Leo Hindery, there's no shortage of qualified experts who have challenged market fundamentalism. But they have been barred from an administration focused on ideological purity. In Hindery's case, the blacklisting was explicit. Despite this venture capitalist establishing a well-respected think tank and serving as a top economic advisor to Obama's campaign, the Politico reports that "Obama's aides appear never to have taken his bid (for an administration post) seriously." Why? Because he "set himself up in opposition" to Wall Street's agenda.
The anecdote highlights how, regardless of election hoopla, Washington is the same one-party town it always has been -- controlled not by Democrats or Republicans, but by Kleptocrats (i.e., thieves). Their ties to money make them the undead zombies in the slash-and-burn horror flick that is American politics: No matter how many times their discredited theologies are stabbed, torched and shot down by verifiable failure, their careers cannot be killed. Somehow, these political immortals are allowed to mindlessly lunge forward, never answering to rivals -- even if that rival is the president himself. Remember, while Obama said he wants to slash "billions of dollars in wasteful spending" at the Pentagon, his national security team is demanding a $40 billion increase in defense spending (evidently, the "ludicrous" faction got its way).
Obama also said he wants to crack down on the financial industry, strengthen laws encouraging the government to purchase American goods, and transform trade policy. Yet, his economic team is not just promising to support more bank bailouts, but also to weaken "Buy America" statutes and make sure new legislation "doesn't signal a change in our overall stance on trade," according to the president’s spokesman. Indeed, if an authentic “rivalry” was going to erupt, it would have been between Obama's promises and his team of zombies. Unfortunately, the latter seems to have won before the competition even started.
Someday historians may look back at Tom Daschle’s flameout as a minor one-car (and chauffeur) accident. But that will depend on whether or not it’s followed by a multi-vehicle pileup that still could come. Even as President Obama refreshingly took responsibility for having “screwed up,” it’s not clear that he fully understands the huge forces that hit his young administration last week. The tsunami of populist rage coursing through America is bigger than Daschle’s overdue tax bill, bigger than John Thain’s trash can, bigger than any bailed-out C.E.O.’s bonus. It’s even bigger than the Obama phenomenon itself. It could maim the president’s best-laid plans and what remains of our economy if he doesn’t get in front of the mounting public anger.
Like nearly everyone else in Washington, Obama was blindsided by the savagery and speed of Daschle’s demise. Conventional wisdom had him surviving the storm. Such is the city’s culture that not a single Republican or Democratic senator called for his withdrawal until the morning of his exit. Membership in the exclusive Senate club, after all, has its privileges. Among Daschle’s more vocal defenders was Bob Dole, who had recruited him to Alston & Bird, the law and lobbying firm where Dole has served as “special counsel” when not otherwise cashing in on his own Senate years by serving as a pitchman for Pepsi and Viagra.
In New York, editorial pages on both ends of the political spectrum, The Wall Street Journal and The Times, called for Daschle to step down. But not The Washington Post. In a frank expression of the capital’s isolation from the country, it thought Daschle could still soldier on even though “ordinary Americans who pay their taxes may well wonder why Mr. Obama can’t find cabinet secretaries who do the same.” As Jon Stewart might say, oh those pesky ordinary Americans! In reality, Daschle’s tax shortfall, an apparently honest mistake, was only a red flag for the larger syndrome that much of Washington still doesn’t get. It was the source, not the amount, of his unreported income that did him in. The car and driver advertised his post-Senate immersion in the greedy bipartisan culture of entitlement and crony capitalism that both helped create our economic meltdown (on Wall Street) and failed to police it (in Washington). Daschle might well have been the best choice to lead health-care reform. But his honorable public record was instantly vaporized by tales of his cozy, lucrative relationships with the very companies he’d have to adjudicate as health czar.
Few articulate this ethical morass better than Obama, who has repeatedly vowed to “close the revolving door” between business and government and end our “two sets of standards, one for powerful people and one for ordinary folks.” But his tough new restrictions on lobbyists (already compromised by inexplicable exceptions) and porous plan for salary caps on bailed-out bankers are only a down payment on this promise, even if they are strictly enforced. The new president who vowed to change Washington’s culture will have to fight much harder to keep from being co-opted by it instead. There are simply too many major players in the Obama team who are either alumni of the financial bubble’s insiders’ club or of the somnambulant governmental establishment that presided over the catastrophe.
This includes Timothy Geithner, the Treasury secretary. Washington hands repeatedly observe how “lucky” Geithner was to be the first cabinet nominee with an I.R.S. problem, not the second, and therefore get confirmed by Congress while the getting was good. Whether or not this is “lucky” for him, it is hardly lucky for Obama. Geithner should have left ahead of Daschle. Now more than ever, the president must inspire confidence and stave off panic. As Friday’s new unemployment figures showed, the economy kept plummeting while Congress postured. Though Obama is a genius at building public support, he is not Jesus and he can’t do it all alone. On Monday, it’s Geithner who will unveil the thorniest piece of the economic recovery plan to date — phase two of a bank rescue. The public face of this inevitably controversial package is now best known as the guy who escaped the tax reckoning that brought Daschle down.
Even before the revelation of his tax delinquency, the new Treasury secretary was a dubious choice to make this pitch. Geithner was present at the creation of the first, ineffectual and opaque bank bailout — TARP, today the most radioactive acronym in American politics. Now the double standard that allowed him to wriggle out of his tax mess is a metaphor for the double standard of the policy he must sell: Most “ordinary Americans” still don’t understand why banks got billions while nothing was done (and still isn’t being done) to bail out those who lost their homes, jobs and retirement savings.
As with Daschle, the political problems caused by Geithner’s tax infraction are secondary to the larger questions raised by his past interaction with the corporations now under his purview. To his credit, Geithner, like Obama, has devoted his career to public service, not buckraking. But he still has not satisfactorily explained why, as president of the New York Fed, he failed in his oversight of the teetering Wall Street institutions. Nor has he told us why, in his first major move in his new job, he secured a waiver from Obama to hire a Goldman Sachs lobbyist as his chief of staff. Nor, in his confirmation hearings, did he prove any more credible than the Bush Treasury secretary, the Goldman Sachs alumnus Hank Paulson, in explaining why Lehman Brothers was allowed to fail while A.I.G. and Citigroup were spared.
Citigroup had one highly visible asset that Lehman did not: Robert Rubin, the former Clinton Treasury secretary who sat passively (though lucratively) in its executive suite as Citi gorged on reckless risk. Geithner, as a Rubin protégé from the Clinton years, might have recused himself from rescuing Citi, which so far has devoured $45 billion in bailout money. Key players in the Obama economic team beyond Geithner are also tied to Rubin or Citigroup or both, from Larry Summers, the administration’s top economic adviser, to Gary Gensler, the newly named nominee to run the Commodity Futures Trading Commission and a Treasury undersecretary in the Clinton administration. Back then, Summers and Gensler joined hands with Phil Gramm to ward off regulation of the derivative markets that have since brought the banking system to ruin. We must take it on faith that they have subsequently had judgment transplants.
Obama’s brilliant appointees, we keep being told, are irreplaceable. But as de Gaulle said, “The cemeteries of the world are full of indispensable men.” You have to wonder if this team is really a meritocracy or merely a stacked deck. Not only did Rubin himself serve on the Obama economic transition team, but two of the transition’s headhunters were Michael Froman, Rubin’s chief of staff at Treasury and later a Citigroup executive, and James S. Rubin, an investor who is Robert Rubin’s son. A welcome outlier to this club is Paul Volcker, the former Federal Reserve chairman chosen to direct Obama’s Economic Recovery Advisory Board. But Bloomberg reported last week that Summers is already freezing Volcker out of many of his deliberations on economic policy. This sounds like the arrogant Summers who was fired as president of Harvard, not the chastened new Summers advertised at the time of his appointment. A team of rivals is not his thing.
Americans have had enough of such arrogance, whether in the public or private sectors, whether Democrat or Republican. Voters turned on Sarah Palin not just because of her manifest unfitness for office but because her claims of being a regular hockey mom were contradicted by her Evita shopping sprees. John McCain’s sanctification of Joe the Plumber (himself a tax delinquent) never could be squared with his inability to remember how many houses he owned. A graphic act of entitlement also stripped naked that faux populist John Edwards. The public’s revulsion isn’t mindless class hatred. As Obama said on Wednesday of his fellow citizens: “We don’t disparage wealth. We don’t begrudge anybody for achieving success.” But we do know that the system has been fixed for too long. The gaping income inequality of the past decade — the top 1 percent of America’s earners received more than 20 percent of the total national income — has not been seen since the run-up to the Great Depression.
This is why “Slumdog Millionaire,” which pits a hard-working young man in Mumbai against a corrupt nexus of money and privilege, has become America’s movie of the year. As Robert Reich, the former Clinton labor secretary, wrote after Daschle’s fall, Americans “resent people who appear to be living high off a system dominated by insiders with the right connections.” The neo-Hoover Republicans in Congress, who think government can put Americans back to work with corporate tax cuts but without any “spending,” are tone deaf to this rage. Obama is not. It’s a good thing he’s getting out of Washington this week to barnstorm the country about the crisis at hand. Once back home, he’s got to make certain that the insiders in his own White House know who’s the boss.
GOP's Sanford: It's Time to 'Rip the Band-Aid Off'
If Republicans want a "take-your-medicine" presidential candidate in 2012, South Carolina Gov. Mark Sanford might fit the bill. "The bottom line is we're going to go through a deleveraging and it is going to be painful," Sanford told ABC News. "And the only question is do we stick a bunch of Band-Aids over it and hopefully ease some of the pain, but frankly prolong and deepen the pain? "Or do we rip the Band-Aid off, recognize it's going to hurt, but get this thing over with sooner rather than later?" Sanford, who was recently named one of the GOP's four rising stars by party chair Michael Steele, was in Washington, D.C., on Wednesday to deliver a scathing critique of President Barack Obama's stimulus package to supporters of the Republican Governors Association, a group he chairs.
While some Republican governors back Obama's plan which includes billions in state aid for education, health care, and infrastructure, Sanford considers the plan a "mistake" and warns that it will not have the intended effect of reviving the nation's slumping economy. Sanford thinks federal efforts to get consumers buying again through increased government spending won't work because, in his view, the current economic downturn is a "balance sheet-driven slowdown" rather than a "typical recession caused by an excess in production or inventory." "We can't fall into the trap that stimulus is just checks out of Washington," said Sanford. Sanford told RGA members that the push to bailout various U.S. industries is putting the country's free-market economy at risk. "With all due respect to the Fed and Treasury, they have become the modern-day equivalent of a savior," he said.
The trouble with bailing out industry, in Sanford's view, is that businesses stop investing and instead focus on winning favor with government leaders. "You got to be careful on … this business of picking winners and losers," he said. "A problem of too much debt will never be solved with more debt." While making the anti-bailout case, the former three-term congressman took notice of the auto-industry representatives attending the RGA's breakfast event. "With all due respect to the automotive companies, I got some friends in this room who staunchly and well-represent folks on that front, but do you really want to have just three automotive companies?" he asked. "Do you really want to have a system where you pick just a couple of businesses?" Rather than promising to save certain American industries, Sanford, who worked as a real estate investor before entering politics, portrayed economic pain as a fact of life in a free-market economy.
"I come from the deep south," said Sanford. "It wasn't all that long ago we went through absolute carnage in the world of furniture. It wasn't all that long ago we went through carnage in the world of textiles." "I can still take you to little towns in South Carolina that are to this day impacted by the fact that the little mill in town that was the center of town is closed," he added. "So I don't know that you want to get into the business of saying (let's save the) Big Three, because it never ends at the Big Three." Following his RGA event, Sanford met with a group of Senate Republicans. But he did not hold back in his interview with ABC News from taking issue with a plan which has been touted this week by the Senate GOP leader.
Asked about Sen. Mitch McConnell's, R-Ky., proposal for the government to guarantee 4 percent interest rates on home loans for credit worthy buyers, Sanford, said, "In the long run, it ain't going to solve the problem." "You can have a loan at 4 percent, you can have a loan at 7 percent, but if you've got too much debt, at the end of the day, there's going to be an adjustment," he added. Later this month, Sanford will address the California Republican Party's convention in Sacramento. Asked if his California trip is the first step towards 2012, he quipped, "I'm trying to survive the week."
U.S. Housing Slump Has 'Just Begun,' Says Forecaster Talbott
Let’s say you own a $1 million home in Santa Barbara, California. The house seemed like a steal when you bought it with that adjustable-rate mortgage in 2005. You still love the white beaches and those yachts bobbing up and down in the harbor. Then you awaken early one morning, troubled that your monthly payments will soon double. You go out to pick up your newspaper and see for-sale signs on five houses on the street. One identical to yours just sold for $500,000. Are you going to pay the bank $1 million plus interest for your place? John R. Talbott, a former investment banker for Goldman Sachs, poses that hypothetical question in his latest book of financial prophesy, "Contagion." His answer: "I don’t think so," he says. "If I’m right, then this housing decline has only just begun."
Talbott is an oracle with a track record: His previous books predicted the collapse of both the housing bubble and the tech-stock binge before it. A friend who runs a New York steak house introduces him as Johnny Nostradamus, he says. What sets him apart from other doomsayers is his relentless emphasis on simple arithmetic. He walks you through the numbers to show how U.S. house prices got so out of kilter with wages, rental prices and replacement values -- the cost of buying a property and building a home. ("Homes in California by 2006 were selling at three to five times what it would cost to build a similar home from scratch," he writes.)
Talbott’s latest predictions are sobering. The U.S. is only halfway through the total potential decline in housing prices, he says. Home values will continue to deteriorate for four to five years, he forecasts. Adjustable-rate mortgages issued in 2004 and 2005, for example, are only now resetting for the first time, he notes. Bankers may "try to blame the crisis on poor Americans with bad credit histories, but that is not the real cause of the housing crisis," he says. "The greatest home-price appreciations and the homes most subject to price readjustment are in America’s wealthiest cities and its glitziest neighborhoods."
At the end of 2008, a record 19 million U.S. homes stood empty and homeownership sank to an eight-year low as banks seized homes faster than they could sell them, the U.S. Census Bureau said this week. Almost one in six owners with mortgages owed more than their homes were worth, Zillow.com said the same day. By the time the crash ends, Talbott predicts, homeowners will have lost as much as $10 trillion, with investors and banks worldwide losing almost $2 trillion. And just as the U.S. starts getting over a prolonged recession, the first big wave of baby boomers will retire, depriving the economy of their productivity (and high consumption), he says.
So how far will the price of your home on the range fall? Citing historical data and trends, Talbott concludes that real prices should return to their average 1997 levels, adjusted for inflation. Why 1997? A 120-year historical graph shows that real home prices in the U.S. stayed relatively flat for 100 years, then began rising in 1981 and surged from 1997 to 2006. A return to 1997 prices "would get us out of the heady, crazy days from 1997 to 2006 in which banks were lending large amounts of money under poor supervision and aggressive terms."
How did we get into this mess? Talbott blames everyone from average Americans who caught "the greed bug" to hedge funds and credit-default swaps. The single biggest error, he says, was for U.S. citizens to allow their national politicians to take large campaign contributions from big business and Wall Street -- a theme Kevin Phillips developed in "Bad Money." "This crisis was no accident," he says. It began, in Talbot’s view, because the U.S. government was "co-opted" into deregulating the financial industry. Politicians were "paid to deregulate industry," taking billions of dollars each year in campaign contributions.
His investment advice for this prolonged recession: Hang on to cash and invest in gold or Treasury Inflation-Protected Securities, or TIPS. If he had to invest in stocks, he would put his money in China. Living in smaller houses with their savings gutted, U.S. baby boomers will face yet another big challenge, Talbott says: "The toughest job to get in the future will be the elderly person greeting you as you enter the local Wal-Mart."
U.S. Weighs Fed Program to Loosen Lending
Hoping to jump-start the financial system, the Obama administration is considering turning to a new program run by the Federal Reserve that has been a challenge to launch and depends heavily on hedge funds. The Term Asset-backed Securities Loan Facility, or TALF, was announced in November after investors stopped buying securities backed by consumer debt. Under the $200 billion program, the Fed will make loans to almost any U.S. firm that is willing to use the government financing to buy securities tied to credit-card, small-business, student and auto loans.
In essence, the government, which doesn't want to buy these securities itself, is lending money to professional investors so they can buy them. In some cases, the government itself is guaranteeing payment on the loans that back these securities.The Fed on Friday announced terms of the loans it will make available to investors. As the Fed moves toward launching the program this month, Mr. Obama's economic team is exploring ways to expand it to help its financial-rescue efforts. Treasury Secretary Timothy Geithner is expected to announce his financial-rescue efforts in a speech Monday.
Some hedge funds, which often use borrowed money to boost returns, are lining up to get in on the Fed program, seeing a chance to make high double-digit-percentage returns with little downside using low-cost loans made on easy terms. Some officials inside the Fed are nervous about relying on unregulated hedge funds. But they see it as a trade-off in order to get capital to consumers. "This is exactly what the financial system needs," said Andrew Feldstein, chief executive of Blue Mountain Capital Management LLC, a multibillion hedge fund that is gearing up to participate in the Fed program. The program, he said, "is like sending an ambulance through a traffic jam."
Officials have spent weeks trying to hash out details of how to make loans to private investors and how to safeguard the program. Fed lending, even its emergency programs, typically runs through banks. To get this program going, the Fed has had to consider questions it hasn't dealt with before, such as whether it should do business with offshore accounts of a U.S. hedge fund, which it has found a way to do. Because the Fed is so eager to attract participants, it has limited restrictions on which firms can participate.
Broader philosophical issues could arise if the program is expanded. The White House has promised more transparency in how its funds are used. But lending to hedge funds may be problematic because their operations are opaque. Moreover, the program depends on many of the practices that helped to fell Wall Street firms in the first place, such as leverage, structured-debt investments and a dependence on credit ratings. Depending on the different types of collateral, investors will get roughly $100 of lending for every $5 to $16 of cash they put up to invest. The rate investors will have to pay will be set at one percentage point over interest rates based on London interbank offered rates.
The loans the Fed makes to investors are nonrecourse, meaning investors can't lose any more than the money they put upfront on the security. If a hedge fund defaults to the Fed, its collateral is the securities themselves. There also are no margin calls, meaning the Fed can't demand additional payments of cash from borrowers if the underlying securities fall in value. Investors see these as important inducements to the program. But a Treasury Department inspector general warned that the program was vulnerable to fraud by the private sector. A Fed spokeswoman said the central bank is working closely with the Treasury to establish a strong compliance program for TALF.
The activities of hedge funds are another potential issue. Some investors have privately expressed worries that hedge funds could game the system to use cheap Fed financing to fund other trading positions that run counter to U.S. goals. A firm might, for instance, buy debt backed by car loans with Fed financing and use the cash flows from the investment to fund short positions on auto makers that pay off if they struggle. Some of the largest names in the hedge-fund world have showed initial interest in the Fed-lending program.
Among funds that bankers and investors have spoken to about the TALF are Magnetar Capital LLC, a multibillion-dollar Evanston, Ill., fund, which made bets during the housing boom that paid off when mortgage defaults rose. Magnetar also helped to fuel issuance of complex debt instruments known as collateralized debt obligations. Magnetar said it isn't in a position to make a decision given the information available about the program. Bankers and investors said they have spoken to several funds that may be intrigued by the program, including Citadel Investment Group LLC, and D.E. Shaw & Co., among many others. D.E. Shaw declined to comment.
Traditional money managers, including Pacific Investment Management Co., BlackRock Inc. and Prudential Financial Inc. also have been gearing up for the program. BlackRock said it is interested in the program. Pimco didn't respond to a request for comment. Another concern is whether credit ratings, which the Fed will depend upon to make decisions about what investments to support, are reliable. Credit-ratings firms have come under fire for missing warning signs on various debt instruments before the crisis hit. "The rating agencies have lost a tremendous amount of credibility," said Jonathan Lieberman, of Angelo Gordon & Co., a distressed-debt fund that is considering whether to participate. He said his firm doesn't rely on credit ratings.
Fed Assets Shrink to $1.85 Trillion as Currency Swaps Decline
The Federal Reserve’s loans, securities and other balance-sheet assets shrank to $1.84 trillion over the past week as the amount of foreign-currency swaps tumbled. The total value of assets on the Fed’s consolidated balance sheet fell by $75.6 billion to $1.85 trillion over the past week, the Fed said today in a weekly release. Currency swaps, part of a program to supply central banks in Europe, the U.S. and other countries with dollars to lend to banks, dropped $78.2 billion to $387.4 billion as of yesterday. Fed Chairman Ben S. Bernanke and fellow policy makers have indicated they’re ready to build on the $1 trillion increase in the central bank’s total assets over the past year to revive the economy and stem the risk of deflation. In December, the Fed switched to using emergency credit programs as the main tool of monetary policy rather than changes in the main interest rate.
Short-term debt held by the Fed in its Commercial Paper Funding Facility rose in value by $10.6 billion, or 4.3 percent, to $258.1 billion. Discount-window lending to commercial banks fell to $66.2 billion as of yesterday from $68.3 billion a week earlier, the Fed said. Wall Street bond dealers pared their borrowings from the central bank to $27.2 billion yesterday from $32.2 billion last week. Holdings of federal agency and mortgage-backed securities rose as the central bank conducted outright purchases of debt to support housing markets. The Fed reported mortgage-backed securities holdings of $7.38 billion as of Feb. 4, and a $1.55 billion increase in federal agency securities to $29.9 billion. The report doesn’t reflect a $22.3 billion purchase of mortgage-backed securities announced today by the New York Fed. The central bank plans to purchase, by June, as much as $500 billion of mortgage-backed securities and $100 billion of debt from housing-finance companies Fannie Mae, Freddie Mac and Ginnie Mae.
Aid to American International Group Inc., the insurer rescued by the government in September, rose to $82.2 billion from $81.8 billion, while the Fed’s loans to a program providing liquidity to the asset-backed commercial paper market and money- market funds rose to $16.9 billion from $16 billion. The Fed said the M2 money supply rose by $19.8 billion in the week ended Jan. 26. That left M2 growing at an annual rate of 9.3 percent for the past 52 weeks, above the target of 5 percent the Fed once set for maximum growth. The Fed no longer has a formal target. The central bank reports two measures of the money supply each week. M1 includes all currency held by consumers and companies for spending, money held in checking accounts and travelers checks. M2, the more widely followed, adds savings and private holdings in money market mutual funds. During the latest reporting week, M1 fell by $1.5 billion. Over the past 52 weeks, M1 rose 14.5 percent. The Fed no longer publishes figures for M3.
U.S. manufacturing woes spread to Canada...quickly
Largely unnoticed yesterday by the U.S. media is: that the struggling U.S. manufacturing industry - manufacturing cut a whopping 207,000 jobs in the U.S. January establishment survey - is bringing the Canadian labor market down. Yesterday, 1.5 hours before the U.S. release, Statistics Canada released the following: Employment fell by 129,000 in January (-0.8%), almost all in full time, pushing the unemployment rate up 0.6 percentage points to 7.2%. This drop in employment exceeds any monthly decline during the previous economic downturns of the 1980s and 1990s. This is an awful report. As a comparison, the U.S. population is roughly nine times the size of the Canadian population; and therefore, a 129,000 decline in Canadian payroll compares to more than 1,000,000 jobs lost over the month in the U.S. This blows the U.S. decline, 598,000, out of the water.
But on the ever-so-slightly brighter side, the Canadian report was not as broad-based as was the U.S. report. Although the headline number, -129,000 job cuts, is massive, the job loss was concentrated almost entirely in the manufacturing sector, 101,000 jobs slashed. The service sector job loss paled by comparison with 9,000 jobs lost.
While oil was surging in the middle of 2008, Canada resisted the U.S. contraction on strong commodity-based profits, incomes, and employment. But now the commodities markets are declining sharply, and there is no offset to the contraction in manufacturing.
This chart illustrates the sharp increase in the unemployment rate in the U.S. and Canada. Relative to a long-run level, the U.S. unemployment rate is probably slightly higher, but Canada's unemployment rate rose 1.4% since Jan. 2008, or its biggest annual decline since 1992.
The BLS conducts two surveys of the U.S. labor market: the household survey that is used to calculate the unemployment rate, and the establishment survey that is used to calculate the nonfarm payroll by sector. Canada conducts just one survey, the Labour Force Survey (LFS), from which it extracts both industry payroll and employment detail. The illustrations compare the joint employment declines across the U.S. and Canada using the comparable LFS and household survey.
This chart illustrates the sharp decline in annual employment growth in the U.S. and Canada. Note that this is not the payroll number from the establishment survey in the U.S., but the employment number from the household survey.
Canada's employment fell into negative territory in January for the first time since 1992. On the other hand, U.S. annual employment growth has been negative since June 2008 (after revisions), but the 2.88% annual decline is the biggest since 1954 (55 years, over half a century).
The Canadian and the U.S. labor markets are now quickly declining contemporaneously. The strength from the commodity markets that drove employment and earnings in Canada during the first half of 2008 is now gone. The near-term outlook for countries hangs in the balance, but more importantly, tied to the stabilization of the U.S. manufacturing sector.
Reform City or we face second crunch, warns pension expert
The seeds of the next credit crunch are being sown on Wall Street and in London's Square Mile, while politicians and bankers focus on short-term measures to shore up the financial system, according to a leading pensions adviser. A second boom and bust is only a few years away if traders, fund managers and others continue to rely on commissions and bonuses from short-term buying and selling of stocks, and not expanding their portfolios, according to the BT pension fund Hermes.
Colin Melvin, the head of the fund's advisory arm, said that without fundamental reforms the "transaction culture" in the City would return once the worst of the recession was over. Hermes claims to be one of the few pension funds to have questioned Britain's bankers over their exposure to credit derivatives and other risky investments in the run-up to the credit crunch. Melvin said he had campaigned for several years to persuade investors that their interests were not served by their agents and advisers in the City. But the boom in share prices and property values, which was fuelled by a frenzy of transactions, had drowned out his protests.
He called for pension funds to rebel against payments to fund managers and investment banks for short-term gains, as a key defence against another boom based on falsely inflated asset prices. "Pension funds are major clients of the finance industry and the owners of corporate Britain. They need to recognise they were part of the problem because it was their support or indifference that allowed banks and other companies to take excessive risks," he said.
"Now we have a situation where the stimulus packages on both sides of the Atlantic are leaving the current practices in place at a time when they desperately need to change," he added. The UK Shareholders Association, which represents thousands of small investors, said it wanted to curb "the corrosive culture of excessive executive pay and boardroom greed, particularly within the financial services industry".
Summers Crafts Broad Role in Reshaping Economy
An hour after the release of Friday's grim jobs report, Lawrence Summers was in the Oval Office giving President Barack Obama his daily economic briefing. The chief White House economic adviser told his boss with econometric precision that there was a roughly 80% chance -- "in the low 80s" -- that the $800 billion stimulus bill being revised in the Senate would create as many jobs as Mr. Obama's original proposal. The president asked whether that is "83% or 84%," poking fun at Mr. Summers's tendency to quantify an event's chances and shun the usual briefer's hedges of "likely" and "unlikely."
It was a rare bit of a humor, recounted by Mr. Summers later in the day, in a continuing bleak dialogue between the two men as they try to figure out how to correct the nation's worsening economy. In an interview in his spartan White House office with only a few papers and Diet Coke on his desk, Mr. Summers said: "It's a grave situation that I never envisioned. I thought these crises would stay in the history books." As he helps to devise economic policy from his perch running the National Economic Council, Mr. Summers is instrumental in shaping the Obama administration's plans on economic stimulus, bank bailouts, budget deficits and financial regulation.
But the scope of his influence is broader -- getting into the policy and politics of health-care reform, environment-friendly jobs and Detroit auto makers. "The real challenge is to do things to jolt the economy back to its potential," he said. He faces a personal challenge as well, one that has existed throughout his professional life: to control his tendency to say exactly what he thinks, which has gotten him into trouble. No one argues that Mr. Summers isn't innovative in finding economic solutions -- they just find his style sometimes abrasive. In these early days of the Obama administration, Mr. Summers, 54 years old, has already tussled with Treasury Secretary Timothy Geithner over the bank-bailout plan, energy and environment czar Carol Browner on the effect of green changes on the economy, and pushed some staff members hard on their economic-policy proposals, said people who have been in the meetings.
One person who has been on the receiving end of his forceful personality, Council of Economic Advisers chief Christina Romer, said a tough public debate with Mr. Summers is "the ultimate sign of respect." Mr. Summers's stance highlights an underlying tension in how Washington is dealing with the economic meltdown. It requires immediate action from him and other officials with a deep understanding of the financial system, but also a need to build camaraderie and consensus to craft a complex, multifaceted package, ranging from new spending and tax cuts to rewriting the rules for how America's financial system works in the 21st century.
The son of economists, Mr. Summers has been a star economist since early in his career. He served as the chief economist for the World Bank and then as a Treasury official in the Clinton administration, succeeding Robert Rubin to become Treasury secretary. From 2001-2006, he was president of Harvard University, ultimately resigning under pressure for remarks some women interpreted as a suggestion that females aren't as adept in science and math as men. In recent years, while teaching at Harvard, Mr. Summers has become a favorite economist for Democrats, helping the Democratic leadership in Congress, according to Rep. Carolyn Maloney, head of the congressional Joint Economic Committee.
Mr. Summers is widely seen as having ambitions beyond his current job. He has long been described as a possible chairman of the Federal Reserve -- a job that could come open as soon as 2010, if Mr. Obama chose not to reappoint Ben Bernanke when his term runs out. Mr. Summers dismisses those questions as "hypotheticals," saying "there are enough really hard actual questions" for him to focus on. With the gloomy prospects for the economy, Mr. Summers has already canceled his spring plans for tennis camp -- which he usually attends with Mr. Geithner and other Clinton administration economic alumni: Lee Sachs, expected to be Mr. Geithner's undersecretary for domestic policy, and Gene Sperling, a Geithner adviser who held the NEC job Mr. Summers now has. The group decided they couldn't leave en masse this year. "We're all seeing plenty of each other these days," Mr. Summers said of his usual campmates. As part of his current job, Mr. Summers runs daily economic briefings for Mr. Obama -- an innovation of the new White House, modeled on the daily intelligence briefings long given to presidents by the director of national intelligence. Mr. Summers tries to come up with a "topic of the day," and always brings in different administration experts.
At a briefing last week, Mr. Summers provided Mr. Obama with a 30-page book outlining options to beef up financial regulation. He asked former Fed Chairman Paul Volcker -- an Obama adviser during the campaign who Friday unveiled his new economic-recovery panel of advisers -- to lead the discussion. Other briefings have included health care, particularly on changes that can be made in the economic-stimulus and budget plans in anticipation of a health-care overhaul. The former Harvard economist is constantly doing his own first-person research. At the Alfalfa Club dinner this past Saturday night, Mr. Summers worked the room with a mission -- gathering evidence on how the president's economic-stimulus package could work. When he saw an auto-industry official, he pushed for information on car sales to gauge the state of consumer demand.
As NEC director, Mr. Summers is also supposed to be Mr. Obama's honest broker, mediating disputes over economic policy from disparate parts of the administration. He did that earlier this week, as officials were finalizing plans for a Wednesday announcement setting new limits on executive pay for financial firms receiving federal funds. Mr. Summers mediated between Mr. Geithner, who wanted some flexibility for Wall Street firms to attract top talent, and White House Chief of Staff Rahm Emanuel, who wanted a "hard-hitting crackdown" on exorbitant pay packages, said one participant. But some rivals see Mr. Summers as using his West Wing office and proximity to the president to sometimes promote his own his agenda, not always to sift through those of others. Mr. Summers will "do business in the White House corridors," said one Democratic adviser. "If he sees the president or Rahm, he'll plunge ahead." Regarding his tendency to push people, Mr. Summers said "the pushing is not really because I have an agenda -- in most cases it's because I want to help the arguments be as strong as they can possibly be."
Obama Administration Will Unveil Bank Bailout Plan on Tuesday
During our interview on "This Week" President Obama's top economics adviser Larry Summers said the Obama administration will unveil its bank bailout plan on Tuesday of this week.Treasury Secretary Tim Geithner had planned to unveil how the remainder of the $700-billion in TARP money will be spent on Monday. However Summers said the administration wants to keep the focus on the stimulus wrangling.
"There's a desire to keep the focus on the economic recovery program," Summers said. "The focus will be on increasing credit flow with transparency, accountability and consistency we haven’t seen so far. Yes there will be support for struggling banks, the credit markets more generally, and support and pressure to assure these needless foreclosures are confined."
Summers says private capital key to bank bailout
A key Obama administration official said Sunday that new, soon-to-be-announced financial measures by the Treasury will include creating incentives for the private sector to invest in troubled banks. "It can't all be private capital, but with the right kinds of government guarantees and the right kinds of financing, strategic approaches, [Treasury Secretary Timothy] Geithner believes we can bring in substantial private capital," said Obama's chief economic advisor Lawrence Summers on Fox News Sunday. One measure the Treasury is considering would create a "bad bank" or "aggregator bank" that would buy illiquid mortgage securities. It would be partly funded by some of the remaining money from the existing $700 billion Troubled Asset Relief Program fund, but the majority of the funds would come from the private sector, according to a Wall Street Journal report Sunday.
In addition to the creation of a bad bank, the Treasury plans to guarantee mortgage securities, provide new capital injections into financial institutions, help out troubled homeowners on the verge of foreclosure and expand a consumer lending program. Geithner was scheduled to propose a "comprehensive" financial rescue plan Monday, but Summers said the announcement of such a program won't take place until later this week. Summers said Obama and his team are instead concentrating on completing a massive stimulus package that is being debated in the Senate. "The desire right now is to keep the focus right now on the economic recovery program," Summers said.
Geithner's expected proposal to make new capital infusions into struggling banks would be an extension of an existing program, but it would come with subtle variations intended to include private capital. As of Jan. 23, the Treasury had allocated $294 billion of the bailout funds, most of which went to buy large minority stakes in 317 financial institutions. The Treasury is reportedly considering using a chunk of the remaining $350 billion in bank bailout funds to make capital injections using a form of security that would pay interest like bonds but would be convertible into common shares after a set period of time, perhaps seven years.
Banks would have an incentive to buy out the government's stake before the conversion because once they become common shares the investment would dilute common shares, lowering the value of the bank's shares. So far, the Treasury's capital injections into banks have mostly been in the form of preferred shares and warrants for preferred shares that pay out dividends. With the existing program participating banks must pay Treasury a dividend at a rate of 5% a year for five years, after which the dividend rises to 9%. This dividend step-up is an existing incentive for banks to buy out the government's stake within five years.
Obama’s bank rescue package may not be enough
The Obama administration hopes the new bailout plan it announces on Monday will rescue the U.S. banking system, but experts caution it will be difficult to get through Congress, difficult to implement and may ultimately fail. U.S. banks are in a world of pain right now, as the mortgage crisis has destroyed a lot of assets, earnings and capital, and losses in areas such as commercial real estate and credit cards have only just started to ramp up. U.S. Treasury Secretary Timothy Geithner is expected to announce a series of steps on Monday to heal bank balance sheets, including government insurance of bad assets, a plan to shift toxic securities off bank balance sheets and money to modify homeowner mortgages.
Some analysts fear the plan will be a mishmash of efforts that have already failed and new programs that may help the system, but will not fix it. "Basically, banks can’t recover again until the economy does well again and the underlying economy continues to deteriorate and housing prices continue to decline," said Ray Soifer, an independent bank consultant. "A rescue package is necessary for banks to recover, but it’s not sufficient." Estimates of potential capital needs for the banking system top $1 trillion, far less than the roughly $350 billion the government still has left in its Troubled Asset Relief Program, which was set up in October, and any additional support expected from Geithner’s plan Monday.
Former Federal Reserve Chairman Paul Volcker warned a Senate committee on Wednesday that "lots more billions of dollars" will be needed to resolve the credit market crunch. But getting a costly bank rescue package through Congress will be difficult, because so many people involved seem to have different points of view regarding the best way to help the system. For example, only this week there were differing views over whether changing accounting rules could help. U.S. Senate Banking Committee Chairman Christopher Dodd said on Wednesday he was open to considering modifying mark-to-market accounting, but a day later a source said the Treasury and the Securities and Exchange Commission said they were not discussing changing those accounting rules.
Some bankers and investors have blamed the accounting rules for exacerbating the crisis, saying they force banks to mark down assets to artificially low prices. And Congress is already working hard on a separate $780 billion stimulus package, said Bert Ely, a banking industry consultant in Alexandria, Virginia. That has taken a lot of hard bargaining and significant changes to get near the stage where it can pass through Congress, which Obama is hoping will happen by February 16. "If they press for legislation right away (on banks), it could overload the legislative process," Mr. Ely said.
To be sure, bank stocks rose on Friday in part because of investor hopes about the new bank plan. But those increases follow a brutal year so far. A Nasdaq index tracking the stocks of banks that received the first $350 billion of TARP money has fallen nearly 40 percent since January 5, compared with an 11 percent decline in the broader index, noted Tom Sowanick, chief investment officer at Clearbrook Financial. The bailout proposals currently being discussed have complications that will make them difficult to implement quickly or that may blunt their impact. If the government guarantees assets or sets up a bank to buy them, it will have to resolve the thorny question of the proper value at which to insure or purchase the securities, a problem that plagued the original Troubled Asset Relief Program.
And banks have already been trying to modify mortgages, which has perhaps made the housing crisis better than it would have been, but has hardly turned the sector around. A relatively high percentage of modified loans end up redefaulting, suggesting borrowers are wrestling with problems too big to fix easily by changing mortgage terms. Lawrence J. White, an economics professor at New York University’s Stern School of business, said: "I tend to be an optimist when it comes to these programs, but I am continually proven wrong." Working out the details of the plan could take months. "I think we're in for the long haul here," he added.
Stimulus Battle May Signal Tough Sell for Bank Rescue
President Barack Obama’s struggle to push an economic stimulus bill through Congress may seem easy compared to what he’ll encounter when he returns to Capitol Hill for additional funds to rescue the banking system. Obama will likely need to ask Congress for more money to recapitalize banks, as much as $1 trillion on top of the roughly $300 billion remaining in the current Troubled Asset Relief Program, according to an estimate by former Federal Reserve economist Ward McCarthy. That will be an even tougher sell for the new president than the stimulus plan, which is headed for a Senate vote this week after passing the House with no Republican support.
That package, at least $780 billion of spending and tax cuts aimed at boosting consumer demand and creating jobs, is just a part of what it will take to pull the economy out of the 14- month-old recession. The stimulus will be effective only if credit markets, currently frozen by illiquid assets clogging banks’ balance sheets, begin to function again. "It will take an enormous effort to build broader public support" for another bank rescue plan, said Thomas Mann, a congressional scholar at the Brookings Institution in Washington. "Had the stimulus gone through swimmingly it would have made it easier." New steps to be outlined this week by Treasury Secretary Timothy Geithner will include fresh capital injections into banks and ways to deal with toxic securities still on their balance sheets, according to people familiar with the matter.
Geithner’s speech has been pushed back one day to Feb. 10 to avoid distracting attention from the economic-stimulus bill, White House economics director Lawrence Summers said today. That is the same day the Senate is scheduled to vote on the bill. "There’s a desire to keep the focus right now on the economic recovery program, which is so very, very important," Summers said today on ABC’s "This Week." Treasury will probably propose a combination of buying toxic bank assets, providing guarantees for other assets, and making additional capital infusions to banks, said McCarthy, now a principal at Stone & McCarthy Research Associates, an economic research firm in Skillman, New Jersey. "The remaining TARP funds are not going to be enough for the job," said McCarthy, who estimates that up to $1.5 trillion in government aid will be needed to save the banking system. "If they want to get the job done, they will have to scrape up more cash," said McCarthy.
New funding for the banking system will be all the harder to justify because the original TARP, which so far has provided almost $400 billion to more than 360 banks, hasn’t shown much in the way of tangible benefits. "They continue to assume that if you do something and it hasn’t worked, you have to continue to do more of it," said Representative Darrell Issa, a Republican from California. "That’s the definition of insanity." Obama and his staff struggled last week to win support for the stimulus package from several moderate Republicans in the Senate, including Susan Collins and Olympia Snowe of Maine and Arlen Specter of Pennsylvania. Support for another round of cash for ailing banks may be even tougher to win after reports last week raised new questions about the cost and effectiveness of the assistance provided already.
The chairman of the TARP’s Congressional Oversight Panel told the Senate Banking Committee that Treasury paid $254 billion of TARP funds for bank equity worth $176 billion, an overpayment of $78 billion. And even after the infusions of taxpayer funds, a majority of U.S. banks still made it tougher for consumers and businesses to get credit at the end of 2008, a Feb. 2 Federal Reserve report showed. Such findings give ammunition to lawmakers such as Utah Republican Senator Bob Bennett of Utah who say they were misled about how the TARP would work. "Can we believe what we are told next time?" Bennett said at the Senate committee hearing. "Those of us who decided we were going to take the political risk of voting for this the first time will be faced with a constituency that will say, ‘Fool me once, OK, but don’t fool me twice.’"
Other lawmakers may balk at the idea of providing more rescue funds after hearing of banks that took billions in taxpayer money and continued to provide bonuses and lavish perks to employees. New York financial institutions doled out $18.4 billion in bonuses last year, the sixth-biggest haul in history. A Merrill Lynch & Co. executive spent $1.2 million to redecorate his office while the company accepted $10 billion in government funds. Insurer American International Group Inc. hosted a $440,000 conference at a California resort in September after agreeing to a federal bailout. "It will be harder for Obama to keep all the Democrats on board," said Washington-based political analyst Stuart Rothenberg. Not only will they resist the idea of additional money for banks, Rothenberg said, "but there may be some sort of hangover from the stimulus bill, with Democrats feeling as though the Senate compromised too much to get two or three Republican votes."
The original TARP legislation failed to pass the House by a dozen votes on Sept. 29, sending the Dow Jones Industrial Average down 777 points. It was approved on a second attempt after several lawmakers changed their votes. This time around fiscally conservative Blue Dog Democrats, troubled by another piece of legislation with a price tag in the hundreds of billions of dollars, may be the biggest obstacle for Obama. "Blue Dog Democrats and Republicans will line up to tell Obama, you’ve got to do better than to say, ‘give us the money and trust us,’" said Representative Issa. Obama has already begun a public-relations push to build popular support for additional bank bailouts. Last week he introduced new executive pay guidelines for financial institutions needing government help to remain solvent. They included a $500,000 cap on executive pay and new disclosure rules on perks like corporate jets and holiday parties.
In addition, he continues to ratchet up his rhetoric on extravagant bank compensation and perks. "For top executives to award themselves these kinds of compensation packages in the midst of this economic crisis is not only in bad taste, it’s a bad strategy, and I will not tolerate it as president," Obama said when he announced the new restrictions on Feb. 4. He’ll also have to make any new financial rescue plan look starkly different from TARP, said Stan Collender, a former analyst for the House and Senate budget committees, now at Qorvis Communications in Washington. "The new plan has got to have a different goal, a lot more for homeowners and individuals," said Collender. "It’s got to be more than banks holding on to the money."
US bail-out faces radical overhaul due to poor public image
The US government is considering renaming the $700bn (£474bn) Troubled Asset Relief Programme (TARP) and spinning it off into a separate body in an attempt to improve the poor public image of America's banking bail-out. The move is one of a range of measures being considered by President Barack Obama's administration. Treasury Secretary Tim Geithner will announce his wide-ranging road map to drive the US banking sector back to stability tomorrow. The package of measures may include a second round of capital injections into banks, which would carry tougher terms going beyond caps on executive pay.
Banks and other companies which receive hand-outs may have to promise to give details on how the money will be used. The administration is also considering giving the Federal Deposit Insurance Corporation (FDIC), run by Sheila Bair, a bigger role. This may include handing it the power to dismantle large financial firms other than banks. Currently the FDIC only has authority over deposit-taking institutions. Mr Geithner may also propose the creation of a $500bn "bad bank" – to be known as an aggregator bank – which would buy up toxic mortgages and other distressed assets from the sector, working hand-in-hand with extended guarantees to cover losses on such assets that banks choose to keep on their balance sheet.
However, the scale and complexity of creating a bad bank may mean it is kept in reserve, as it has been in the UK for similar reasons. Federal housing agencies Fannie Mae and Freddie Mac are likely to play a significant role, mopping up mortgages that have gone wrong and re-writing the terms to ensure borrowers can remain in their homes, before repackaging them and selling them on. The Federal Reserve will also play a crucial role in the fresh bail-out, and is likely to leverage up Treasury funds in order to make them go further.
Mr Geithner is keen to avoid the perils of the first round of the banking bail-out, led by his predecessor Hank Paulson, in which each one of the nine major American banks was made to take a share of $125bn of capital – a move that has failed to kick-start bank lending and led to certain banks, including Bank of America and Citigroup, requiring more drastic investments. One option under consideration is to place the entire TARP system under the auspices of a new agency.
Geithner Said to Tell Lawmakers Banks Must Modify Loans for Aid
Treasury Secretary Timothy Geithner told Democratic lawmakers that banks getting U.S. aid will be required to modify mortgages to help borrowers avoid foreclosure, according to a person at a briefing. Geithner said other requirements will be imposed on banks under the Obama administration’s plan to capitalize the financial system, the person said. Geithner, who is scheduled to unveil his plan Feb. 9, spoke today in Williamsburg, Virginia, where House Democrats met for a retreat.
A requirement to modify mortgages would be a departure from the approach of Geithner’s predecessor, Henry Paulson, who rejected policies requiring the industry to modify loans for troubled borrowers. Paulson helped to launch a voluntary effort called the Hope Now Alliance to reach borrowers at risk of foreclosure and help them change their loan terms. Democrats in Congress faulted Paulson for spending $350 billion from the $700 billion Troubled Asset Relief Program without setting requirements for use of the money. Lawmakers have urged President Barack Obama to set limits on how banks spend the fresh U.S. capital, and require stepped up lending and foreclosure relief.
House Financial Services Committee Chairman Barney Frank has sponsored legislation, passed by the House, that would direct further expenditure of funds approved for the TARP to mortgage forbearance and other methods of aiding consumers at risk of losing their homes. "Any request for any future funding in that regard, should that be necessary, would have to be conditioned on the Barney Frank legislation, with transparency and accountability," House Speaker Nancy Pelosi said today at the retreat. "Not only do we want to know where the money is going, we want to make sure that those priorities are addressed."
US Treasury to pump billions more into banks
Timothy Geithner, the US Treasury secretary, will tomorrow set out the American government’s plan to inject billions of dollars into the country’s troubled banks and ringfence their toxic assets. The announcement is seen in the markets as key to steering the global economy out of its deepest postwar recession, along with President Barack Obama’s $820 billion (£555 billion) fiscal-stimulus plan. It follows gloomy news, including a 598,000 drop in non-farm payroll employment on Friday, a figure described by analysts as "horrific".
The US Treasury plan for the banks, a revamp of the original $700 billion bailout plan agreed with Congress by the Bush administration’s Treasury secretary, Henry Paulson, is expected to involve a wide range of measures but will stop short of creating a so-called "bad bank". Geithner is likely to indicate the Treasury’s willingness to increase its stakes in banks considered short of capital, but will not take majority ownership, as has happened in Britain. The US government will not move towards nationalising its banks, sources in Washington said. This is regarded as even more controversial and unpopular in America than in Britain.
If any bank was so short of capital that this appeared likely to occur, officials would decide whether to liquidate the institution, place it into receivership or retire its assets over time. About half of the original $700 billion had been allocated by the time George Bush left office. Geithner, formerly head of the New York Fed, is set to expand the lending facility originally set up last year to purchase asset-backed securities from the banks. This, originally established as a $200 billion programme, involved lending by the Federal Reserve to finance education, car and credit-card loans. "They need to get credit flowing again," said Kenneth Rogoff, a Harvard University professor and former chief economist at the International Monetary Fund. "To do that they need to clear the decks somehow. The financial system is just dead in the water."
Stephen , chief economist at Monument Securities, said markets were keenly awaiting tomorrow’s announcement. "They have faith in Mr Geithner to find a way to banish the spectre of bad debts and writedowns, so freeing the banks to lend again as they did in the past," he said. Rumours the administration would seek to suspend so-called "mark to market" accounting, which has exacerbated the problems of the banks’ bad loans, boosted Wall Street last week, though were subsequently played down by officials. Obama has already signalled that he will insist on a $500,000 salary ceiling for institutions helped out under the plan.
In Geithner's Overhaul, Aggressive Use of All Available Tools Expected
The nation's top economic policymakers were putting the finishing touches yesterday on a financial rescue plan that will deploy hundreds of billions of dollars to spur the flow of credit to consumers and businesses. The Obama administration aims to ease the financial crisis through a series of steps -- including a program to insure banks against extreme losses on mortgages and other loans, a new round of investments in banks, help for homeowners at risk of foreclosure and the broadening of a Federal Reserve program to prop up lending. It could also purchase toxic assets from banks, possibly with financing from the private sector. The plan amounts to an overhaul of the financial rescue undertaken by the Bush administration. It was scheduled to be announced Monday, though yesterday the administration was considering delaying it until Tuesday to maintain focus on the stimulus. No decision had been made, a source said.
The approach reflects Treasury Secretary Timothy F. Geithner's philosophy of how governments should respond to financial crises. He favors aggressive use of all available tools, both to deal directly with the massive losses in the financial sector and to bolster confidence in the future. Too little government response during a severe crisis poses a greater risk than too much response, he said at his confirmation hearing. "There's a sense that there have been too many false starts and changes of direction," said Martin Neil Baily, a Brookings Institution senior fellow and chairman of the Council of Economic Advisers in the Clinton administration. "We need a bold and sweeping comprehensive framework that will get us through this, keeping in mind it won't turn the recession around immediately." Yesterday, Treasury officials huddled in conference rooms, working through details, as did their counterparts at the Federal Reserve, the Federal Deposit Insurance Corp. and at other financial regulators, all of whom are likely to play a role in the rescue. Last night, many of the details of what Geithner will announce remained in flux, though the broad outlines were becoming clear.
Some of the policies he plans to announce are continuations of ideas developed under former Treasury secretary Henry M. Paulson, though with new twists. For example, there are likely to be new government investments in banks. But so far, the investments have come in the form of "perpetual preferred" stock, and the government has extracted no real control over how banks run themselves or what they do with the money. The new approach is likely to make the investments convertible into common stock after some fixed period of time, perhaps seven years. If the banks are unable to raise private capital in that span, the government would receive more explicit control. Moreover, banks receiving investments will have to report to the government and to the public, and the government is likely to insist that the new capital be used to expand lending. "Public assistance is a privilege, not a right," Geithner yesterday told House Democrats at a closed-door meeting in Williamsburg, Va., according to Democratic sources.
Geithner and his team have been trying to find a way to resuscitate the original idea of the Troubled Assets Relief Program, which Congress passed Oct. 3. Paulson pitched the plan to Congress as a program to buy troubled assets off of banks' books, then changed direction and invested the money in the banks instead. One major reason Paulson changed direction was that he concluded that asset purchases would involve too many technical complications to enact quickly. Geithner and his team have grappled with the same challenges. They appear to be settling on an approach that amounts to financial triage, meant to give investors confidence that banks will not encounter vast new losses so that they are willing to invest private money. One major problem facing banks is that the true value of the assets they hold on their books could vary widely depending on how bad the economy gets. That uncertainty makes banks unwilling to lend, increasing the chances that the economy will get significantly worse and that the losses will be massive.
Geithner and his colleagues are hoping to break that cycle by protecting banks against the kinds of losses that would occur if the economy goes into a tailspin. For assets that banks intend to hold until maturity, the government would offer, in essence, an insurance policy against severe future losses. This approach, called an asset wrap, has been used already for Citigroup and Bank of America. It has the advantage of stabilizing the institutions that receive the guarantees, but does not do much to restart markets for mortgage and other troubled securities. By partnering with the private sector, the government could also create a program to buy up other toxic assets that banks hold in their trading portfolios. Outside analysts call this strategy the creation of a "bad bank," though the Obama administration resists that terminology. The Federal Reserve and Treasury will likely announce an expansion of a program that is being created to try to jump-start lending outside the banking system. In November, the agencies launched a program, called the Term Asset-Backed Securities Loan Facility, that will devote $200 billion for credit card, auto, student and small-business loans. Its launch is expected in the coming weeks.
The Fed and Treasury are likely to enlarge that program and expand it to support lending for commercial real estate and residential mortgage loans. Geithner could also announce a plan to inject government money into companies known as monoline insurers. These play a vital role in enabling states and municipalities to borrow money. Mortgage-related losses by the insurers has made it harder for states to issue the municipal bonds that would help them ride out the recession without aggressive budget cuts. Geithner is likely to roll out a plan, worth $50 billion to $100 billion, to encourage the modification of mortgages for homeowners who are otherwise at risk of foreclosure. It could be based loosely on a strategy for foreclosure relief engineered by FDIC Chairman Sheila C. Bair when the FDIC took control of the failed bank IndyMac last year. Extensive details of how the plan will work may not be complete when Geithner delivers his speech, however. "Institutions that get assistance will have to participate in loan modifications and meet other standards that we set," Geithner told the House Democrats yesterday, the sources said.
A Tricky Third Way: Saving Banks Without Nationalization
Citigroup still has shareholders, a chief executive and a board of directors, but the New York company's major decisions now are subject to Washington's approval. The federal government, Citigroup's largest investor, has forced the company to slash its dividend, pursue the sale of units including its Smith Barney retail brokerage and modify mortgage loans according to a government formula. A corporate jet was sold at the urging of federal banking regulators, and the company's chairman was replaced. The bank must issue public reports on its use of government money. But senior officials in the Obama administration insist that Citigroup has not been nationalized. Despite calls from some economists and members of Congress, officials say they are determined to maintain the appearance, and in important respects the reality, that banks remain under private ownership. Chastened by the results of the government's September seizure of American International Group, they say that true nationalization would open a Pandora's box, and that they are focused on cheaper and more efficient solutions to the financial crisis.
Treasury Secretary Timothy F. Geithner was scheduled to unveil a new government plan tomorrow to help banks deal with troubled assets. Officials continued to discuss details yesterday. One thing that's clear: Nationalization is on the table only as a last resort for preventing the collapse of large banks. "We have a financial system that is run by private shareholders, managed by private institutions, and we'd like to do our best to preserve that system," Geithner told reporters recently. The word nationalization calls to mind banks owned and run by the government in perpetuity, as with China's largest banks. In Western economies, however, nationalization more often resembles detox. The government takes control, scrubs away problems and returns the company to private ownership. Countries including the United States have a long history of temporarily nationalizing large, troubled banks. Smaller banks that get into trouble can be absorbed by healthy companies, but the largest banks often can be absorbed only by the government itself.
The most recent domestic example was the July nationalization of IndyMac Bancorp, a California mortgage lender. The company was seized and run by the Federal Deposit Insurance Corp. for about six months before the government sold the company to private owners last month. John Bovenzi, the FDIC's chief operating officer, served as chief executive. But IndyMac is an example of a company that needed to be seized. The nationalization now envisioned by proponents, including lawmakers and economists, would involve companies that could remain private, at least for now. The basic problem confronting the government is that banks hold large quantities of assets they consider more valuable than the prices investors are willing to pay. Banks cannot sell the assets without incurring massive losses, but holding the assets is tying up vast amounts of money and inhibiting new lending. There is widespread agreement among policymakers and economists that the government must deal with the troubled assets, either by buying them or by guaranteeing to limit banks' losses. The price is the problem. If the government buys or insures the assets at market prices, banks may not survive the massive losses. If it agrees to the prices banks consider fair, taxpayers could incur massive losses when the assets eventually are sold. Nationalizing troubled banks would allow the government to take distressed assets without having to set a price.
The model for such an approach is Sweden, where the collapse of a real estate bubble led the government to take control of two of the country's largest banks, Nordbanken and Gota, in 1992. The government stripped the banks of their bad assets, which it kept in a pair of new companies known as "bad banks." The remnant "good banks" were then merged into a single company and launched back into the marketplace. "The government is going to own these assets one way or the other because the banking system can't deal with them," said Paul Miller, an analyst at Friedman, Billings, Ramsey who favors temporary nationalization. "You say, management get lost, I'm running the institution, I clean up the institution and I can sell that out to the street, without all of the problems." Government officials, however, argue that they have a responsibility to pursue the least costly solution, and that they continue to believe smaller steps than nationalization can resolve the crisis. While some banks have large concentrations of troubled assets, the bulk of the problem is spread across many of the nation's 8,300 banks. Nationalizing enough banks to clean up the problem would be hugely inefficient, officials say. A source familiar with the administration's thinking said he thinks that would make sense only if the economic situation deteriorated massively. And in that dire eventuality, the source said, "The government will end up owning everything anyway."
Officials also are nervous that placing banks under government control would put them within reach of politicians and policymakers with their own agendas. They are concerned that using banks to implement public policies risks compromising their core role as lenders. Countries where banks are nationalized on a permanent basis often direct institutions to make loans that serve public policy purposes without adequate regard for risk or return, which tends to reduce lending capacity in the long term, according to many economists who have studied nationalization. Some say IndyMac offers a recent example. The FDIC's chairman, Sheila C. Bair, implemented a new kind of program at the company to modify mortgage loans to help homeowners avoid foreclosure. Bair imposed a similar program on Citigroup when the company requested a second round of government assistance. The FDIC argues that the modifications are in the best financial interest of the institutions.
The government's view of nationalization has evolved substantially in recent months. Following the seizure of IndyMac, the government took control of mortgage finance companies Fannie Mae and Freddie Mac in early September, then AIG at the end of the month. Some senior officials now view AIG as a cautionary tale. The company has been forced to sell valuable business units into a market that is lackluster at best. In addition, AIG has promised nearly a billion dollars in retention pay to employees it says are vital, only to be scolded by lawmakers for wasting taxpayer money. Insurance brokers have become reluctant to push the company's products. The brand has been badly tarnished, reducing the government's ability to return the company to private investors. When the government started investing $250 billion in banks in November, officials limited the resulting ownership stakes by accepting warrants that could be converted to common stock equaling only 15 percent of the amount invested.
Geithner and top White House economic adviser Lawrence H. Summers have long believed that nationalization is problematic, and the AIG experience reinforced that, according to sources familiar with their thinking. The current administration therefore plans to continue the approach of limiting ownership stakes. Banks' low share prices make it difficult to invest billions of dollars without acquiring majority control. Citigroup's market value, for example, is just $21 billion, less than a tenth of its market value before the financial crisis. To get around this, the government is preparing to invest money in exchange for convertible bonds -- guarantees of repayment that could be converted into shares of common stock later, according to people familiar with the discussions. That way the government could recapitalize banks but not initially increase its ownership stake in the companies. The limited ownership stakes have not changed the reality, however, that banks are taking money from the government. And restive politicians on Capitol Hill have made increasingly clear that they expect more than money in return. They want the banks to increase lending and decrease spending on executive salaries and airplanes and dividends for shareholders. And they want banks to prevent home foreclosures by modifying mortgage loans.
The investments also have changed some customers' views of their banks. Irene Sanders, a Washington area resident, is furious that her bank has continued to raise interest rates despite the government's investment. She said she believes banks should be required to explain in detail what it is doing with government money. "I've been a shareholder in companies, and I get reports, I get information," Sanders said. "In this case, we're all stockholders, but we're not being treated like stockholders." Citigroup has become a prime target. The government has invested $45 billion in the company, and guaranteed to limit the losses on a $301 billion portfolio of troubled assets. As part of the intervention, government regulators, led by the Federal Reserve Bank of New York, have taken an increasingly active role in the company's affairs, specifying strategic objectives and approving the company's plans to meet those goals, according to people familiar with the matter.
The government also has taken a heavy hand with Bank of America, insisting that the Charlotte company complete a planned deal for the troubled investment bank Merrill Lynch despite an unexpected spike in that company's losses. Bank of America has received $45 billion in government assistance, plus a guarantee to limit losses on a portfolio of $118 billion in troubled loans. Still, the government controls less than 10 percent of the shares in each company. The decision to intervene without taking majority control has greatly benefited the companies' shareholders, but officials insist that was beside the point. Rather, they say they are committed to the principle that private ownership should be maintained whenever possible.
Watch It, Ken
Countrywide Losses Next For Bnak of America
So far Merrill Lynch has been a well-publicized nightmare merger for Bank of America's Ken Lewis. However, it's the CEO Lewis' slapdash acquisition of mortgage giant Countrywide Financial for $4.1 billion that could haunt the financial giant in the future. Charlotte, N.C.-based BofA may wrack up cumulative mortgage losses stemming from its Countrywide purchase of as much as $33 billion, according to financial analyst Paul Miller at Friedman, Billings, Ramsey & Co. That's $10 billion more than the roughly $23 billion BofA set aside to reserve against future losses in its entire mortgage portfolio. BofA agreed to buy Countrywide two years ago last month for $4.1 billion after a $2 billion cash injection months prior didn't help the subprime-laden lender stay afloat - or independent.
The projected losses BofA may face also are double the whopping $15 billion fourth-quarter loss that Merrill Lynch's CEO John Thain laid at Lewis' feet. Across Countrywide's entire loan book, FBR estimates that losses in home-equity loans could hit $17 billion, losses in option-adjustable rate mortgages may touch $11.4 billion and losses in hybrid first-lien loans could reach $5 billion. "[Countrywide] was a horrible deal," Miller told The Post. Many speculate those future losses that BofA will face by virtue of Countrywide and its other exposures to consumer debt - like its massive credit-card operation - have already been factored into its performance by investors. Perhaps.
However, Miller believes that many banks have to be sanguine about their views on such things as the unemployment rate, which hit 7.6 percent last week. "A lot of the executives I speak to are projecting unemployment of 8 or 9 percent. But when I ask what happens [to losses on their consumer loan portfolios] if we see double digit [unemployment] they go blank," Millers notes. In a CNBC interview on Friday Lewis said BofA's maintains that the unemployment rate could hit 8 percent or 8.5 percent but also allowed for the possibility that it could reach 9 percent. Ballooning jobless claims over the next several quarters will only place more pressure on BofA's portfolio of mortgages as well as its exposures to credit cards and other consumer debt.
The Incredible Shrinking U.S. Job Market
U.S. joblessness is at its worst level in decades, and further deterioration is in the cards. The Labor Department reported Friday that 598,000 private sector jobs were lost in January, pushing the unemployment rate to 7.6%, up from 7.2% in December. (See "U.S. Jobs Hemorrhage In '08.") Economists had expected only 540,000 jobs would be eliminated, with an unemployment rate to 7.5%. The amount of Americans out of work will probably grow. The labor market lags behind economic output, and with the U.S. economy widely expected to contract in the first half of the year, the unemployment rate could reach 9.0%. Even with the best-case scenario of an economic turnaround in the second half of 2009, the labor market wouldn't see an improvement at least until the end of the year.
"It's going to get worse before it gets worse," said Doug Roberts, chief investment strategist for Channel Capital Research.com. The massive jobless figure actually led to significant market gains Friday, as investors bet the shock would move Congress into passing President Barack Obama's economic stimulus package. Mark King, chief investment officer for Bell Investment Advisors, said it would take a double-digit employment rate to provoke a decline in stocks, indicating that Wall Street has already built a lot of pessimism into stock prices. U.S. Treasury bonds, on the other hand, fell sharply, as bond investors expected the data to lead to massive government debt issuance, an inevitable consequence of federal bailout and stimulus plans that investors seem to have overlooked until the past few weeks. The bellwether 10-year Treasury note's decline raised its yield to 2.99% from 2.90% on Thursday and up from 2.08% late last year.
December job losses were revised to 577,000, from 524,000. More than 11.6 million Americans are now unemployed, and since December 2007, 3.6 million jobs have been lost, about half in the final three months of 2008. The speed and scale of the January layoffs were staggering. In the past week alone, Macy's laid off 7,000, Eastman Kodak announced 4,500 job cuts and Starbucks let go of 6,700 workers, to name only a few as payroll cuts were made throughout sectors and industries. The only exceptions in the January data were education, health and government jobs. "Businesses are rushing to cut as rapidly as possible and the more they cut now, the less we will see being cut three or four months down the road. They are shortening the adjustment period," said Joel Naroff, an economist at Naroff Advisers. In fact, the job losses did slow a bit in the opening week of February.
The massive job loss in the United States has led to a vicious cycle of spending cuts. "Consumers will continue to pull back on spending, and become more cautious given the negative job outlook," said Terrin Griffiths, an economist with the California Credit Union League, "and this contributes to the lack of business spending, which results in more job losses." That cycle has already caused the U.S. gross domestic product to fall at the fastest clip in more than 20 years during the final quarter of 2008, as businesses and consumers react to the spasms of a deepening credit crisis and the housing quagmire that sparked it. President Barack Obama has reacted aggressively to surging unemployment with an approximately $900.0 billion economic stimulus package that now awaits Senate approval. Thing is, there's little it could for jobs in the near-term if was even passed today. "Based on what the package looks like now, as much as two-thirds wouldn't hit until next year, or the year after," Roberts said. "That leaves one-third as a short-term stability bill, but the question is how much of that initial third would be productive."
The so-called "bridges to nowhere" and other projects billed as "shovel-ready" that may not foster meaningful economic growth. "I don't write off the bill at once. I have some hope for it, but people have to believe. I think we'll get something from the stimulus package, but it's going to take awhile," said Naroff. The grim government data do not include the growing group of Americans who have given up on finding a job or who cannot land a full-time position and so settle for something part time instead. The number of workers considered underemployed in the United States "has been shooting through the roof," according to Michael Feroli, an economist at JP Morgan Chase. "Underutilization in the labor force is worse than it seems, and it seems pretty bad." Among the unemployed, the number who ended up with temporary jobs increased to 7.0 million in January. This measure has grown by 3.2 million during the past yea
Ford May Need to Add $4 Billion to Pensions, Spurring Aid Bid
Ford Motor Co. may have to contribute $4 billion to its pension plan after a 2008 shortfall, a cash drain that risks dragging the second-largest U.S. automaker closer to a federal bailout. The collapsing stock market left the fund with a $4.1 billion deficit for its projected obligations, after 2007’s $3 billion surplus, Ford said in its fourth-quarter financial results. That may force an infusion of money starting next year, according to the viability plan filed with Congress in December. Such spending would add to the strain on the only Detroit automaker not relying on government aid. With U.S. auto sales at their lowest since the early 1980s, Ford said Jan. 29 it lost a record $14.6 billion last year and tapped its entire $10.1 billion credit line while the money was still available.
"The pension is another demand on cash at a time when Ford cannot really afford it," said Pete Hastings, a fixed-income analyst with Morgan Keegan Inc. in Memphis, Tennessee. Ford is working to pare costs through steps such as closing plants and is trying to raise money by selling its Volvo unit. The Dearborn, Michigan-based automaker is in early talks with China’s Geely Automobile Holdings Ltd., people familiar with the matter have said. The pension fund hasn’t been a drain on Ford’s resources in recent years, and the company last contributed to the program in 2005, with a $1.4 billion deposit. Chief Executive Officer Alan Mulally said again on Jan. 29 that Ford believes it has enough liquidity to avoid asking for federal aid.
"Any time you’re underfunded, that’s not a good thing," Executive Vice President Mark Fields said in an interview. "We’ve got to watch it carefully."
Ford’s filing to Congress on Dec. 2 signaled concern that the company might have to kick in money for the fund that provides retirement benefits to 335,000 former employees. The plan experienced a "significant, unexpected reduction" in value because of the stock market’s 2008 slump, Ford said. "Without an improvement in market conditions, required contributions to our major U.S. pension plan are expected," Ford said in the filing. The contribution would be $3 billion to $4 billion, "starting in 2010."
The prospect of a pension contribution is "further stressing cash levels," and Ford may need to seek government assistance later this year, Barclays Capital analyst Brian Johnson in Chicago wrote in a Feb. 2 report. He rates the stock as "underweight/neutral" with a $1 target price.
Ford gained 1 cent to $1.94 at 4:15 p.m. in New York Stock Exchange composite trading. The shares have declined 77 percent since a 52-week high of $8.48 on May 1. Ford’s 7.45 percent bonds due in July 2031 dropped 0.75 cent to 20 cents on the dollar, yielding 37.25 percent, according to Trace, the bond-pricing service of the Financial Industry Regulatory Authority. Available cash fell $21 billion last year to $13.4 billion, Ford reported. The automaker has $38 billion in bonds and loans coming due by 2011, according to Bloomberg data. Johnson expects Ford to reach its minimum cash levels in the second half of 2009. Ford won’t say how much cash it needs to operate.
"If auto sales don’t recover and in 2010 they have to put $3 billion or $4 billion into the pension fund, that means they’ll have to get cash from the government," Johnson said in an interview. General Motors Corp., which has been pledged $13.4 billion in federal loans, has said its pension plan had a shortfall of $1.8 billion as of Oct. 31, down from a $20 billion surplus 10 months earlier. The biggest U.S. automaker has said it has no plans to contribute to the fund soon. Ford and GM’s pension liabilities also may put stress on the government. The Pension Benefit Guaranty Corp., which bails out failed retirement plans, estimated that there was a collective pension shortfall of $47 billion at companies with debt ratings below investment grade, a group that includes Ford and GM. Almost half of the deficit was from manufacturers including automakers and suppliers.
The PBGC said it has worked with 13 bankrupt auto-parts companies since 2005 to keep their plans from failing, and took control of the program at partsmaker Collins & Aikman Corp. after its 2007 liquidation. Among the 1,500 largest U.S. companies, pension-plan deficits ended 2008 at a record $409 billion, from a $60 billion surplus a year earlier, according to a Jan. 7 report from New York-based consulting firm Mercer. U.S. companies’ contributions this year to cover fund shortfalls will be $109 billion, predicts consultant Watson Wyatt Worldwide Inc. of Arlington, Virginia.
Cap $1,000-an-Hour Lawyer Fees While You Are at It
As you may have noticed, these aren’t especially happy times for those used to the good life or those who merely get by. New York’s Rainbow Room is shutting down after 74 years as the dining room of the glamorous and the rich. U.S. President Barack Obama calls Wall Street bonuses "shameful." Uncle Sam passes out tourniquets to financial firms. Carmakers gasp for survival. Each week, another friend gets kicked off a payroll. Then there are the bankruptcy lawyers. For them, these are grand times. The business of going under is one of the few booming ones these days, and fees paid to those who guide sick or dead companies through bankruptcy are, too. Rates broke through the $1,000-an-hour barrier for the priciest bankruptcy legal advice, running up to $1,110 at Kirkland & Ellis LLP, based in Chicago. Circuit City’s recent liquidation sales disappointed bargain-seekers, but its bankruptcy could become a bonanza for its lawyers at Skadden, Arps, Slate, Meagher & Flom LLP. Their rates top out at $1,050 an hour. (Whether the firm actually charges that hasn’t been decided, said the lead lawyer on the bankruptcy, Gregg Galardi.)
In any case, rates like that make fees claimed for the largest bankruptcy in history, Lehman Brothers Holdings Inc., look cut-rate. Weil, Gotshal & Manges LLP is seeking as its top rate in the case a mere $950 an hour. "We do not believe we should be pushing the envelope at the highest edge of hourly rates," says Harvey Miller, lead lawyer in the Lehman bankruptcy and an icon in bankruptcy law. Somehow, they will probably muddle through. True, most of the work done in these cases goes to lower- paid lawyers and staff. And if creditors find the fees exorbitant, they can object to the judge, who can shave the lawyers’ requests. But in the main, the lawyers get every penny they seek. We are talking big, big bankruptcies that lead to big, big fees. Lehman Brothers owed $613 billion when it went belly up. "Everyone’s just sort of thinking in large numbers," says Jay Westbrook, who teaches bankruptcy law at the University of Texas. That’s one of the reasons "fees are getting out of hand."
That doesn’t just go for bankruptcy lawyers. All sorts of corporate lawyers get paid astronomical sums partly because they schmooze with other people who are so paid. "Top lawyers are having lunch with the top CEOs, who are receiving absolutely stunning amounts of money," says Westbrook. So, the scales get skewed. Yes, but it is one thing to represent seemingly viable companies. It is another to be pulling down $18 a minute when your client is broke, when every dollar you get is a dollar not going to creditors, who won’t get everything they are owed. That was the prevailing thought before Congress amended the law in 1978. Until then, bankruptcy specialists took in less than when they or their counterparts represented financially healthy clients. Congress changed that in the belief that the bankruptcy lawyer’s job is to hunt down as many assets as possible and oversee a fair dismantling or reorganization of the company. How well that’s done, especially in big, complex cases, has far-flung consequences.
"The decisions that they make are very important -- economically important and important to individual human beings," says Westbrook. So bankruptcy lawyers essentially got parity 30 years ago. And as legal fees for corporate lawyers climbed, so did theirs. Enough is enough. Tell the laid-off, $40,000-a-year administrative assistant trying to feed her family to cheer the awarding of $1,000 hourly fees to lawyers working the carcass of her former employer. Don’t expect Chicago Tribune reporters who have watched their Trib-heavy retirement funds vanish and fear job loss to rejoice that their employer hired Sidley Austin LLP lawyers for as much as $1,100 an hour. This is the same company that was shrinking its Washington bureau even as a history-making, hometown senator became president. No doubt, lawyers with other practices, such as those who handle once-thriving corporate deal-making, are pondering what it takes to move into bankruptcy. Firms let go more than 1,500 lawyers last month alone, according to the Layoff Tracker at Lawshucks.com. For every lawyer fired, one or two staff members had to go, too.
The whole concept of billable hours is getting reconsidered in law firms trying to give their financially strapped clients a break. But that isn’t likely to change the bankruptcy practice any time soon. Perhaps gearing down executive pay could have the same downward effect that its ratcheting-up had on legal fees, however indirect. Obama proposes a $500,000 salary cap for top executives whose firms take in an especially big load of government bailout cash, although they could get more in restricted stock. It’s a limited proposal. Too bad it can’t apply retroactively and to more companies. As for legal fees, bringing those rates down in bankruptcy court will require outraged creditors and judges sensitive to the economic hurt that the failed companies inflict on employees, bondholders and shareholders. Obama, himself a former lawyer at Sidley Austin, can’t order fees capped. But he could point a finger of shame.
Europe's New Wave of Toxic Debt
More toxic debt soon could come crashing through the global financial system. The surprising source: Europe Inc. Once-stodgy Old World companies, from cement makers to phone operators to chemical companies, went on an unprecedented borrowing spree over the past decade that has left them up to their necks in debt. Corporate debt in the euro zone stands at more than $11 trillion, equaling some 95% of the region's economy, vs. only 50% in the U.S. Hundreds of billions in payments are coming due just as sales are slumping in the global economic crisis. In better times, companies might have gone to the bank to refinance. No more. Bank lending to euro zone companies plunged 40% last fall as the credit squeeze tightened.
That helps explain why Europeans in January issued $159 billion in bonds, the highest level in two years. But the price is steep. Average yields on investment-grade European corporate bonds have almost tripled during the past year, even for relatively healthy companies such as Nokia and German utility group E.ON. The higher cost of servicing debt "will entail a restriction in hiring, wage growth, and investment," says Gilles Moëc, a London economist with Bank of America. "The amount of debt to roll over is huge."
Many businesses are struggling already. Moody's Investor Services says 249 Western European companies were hit with credit-rating downgrades in 2008, the highest number since 1990. Thomson, a $7.2 billion-a-year French provider of video equipment and services, acknowledged on Jan. 29 that it was about to breach agreements with lenders on some of its $2.7 billion debt. Thomson is scrambling to raise cash by selling off businesses such as Grass Valley, a California-based maker of video production equipment it bought in hopes of becoming a key supplier to Hollywood. Although the situation is painful, "We had to tell the truth to our company, our investors, and our employees," says Chief Executive Frédéric Rose.
How did Europe get into this mess? Conservative bank regulations barred most risky mortgage lending, so banks had plenty of money to offer businesses. Private equity funds, smelling opportunity in undervalued Old World companies, poured in hundreds of billions more. With interest rates low and the euro strengthening, companies were eager to borrow to finance acquisitions. Take Paris-based Lafarge, the world's largest cement maker. It shelled out $11 billion last year to buy the cement business of Egypt's Orascom Construction Industries. Lafarge now has $22 billion in debt, with payments of more than $3.4 billion due this year. A Lafarge spokeswoman says lenders have agreed to let the company delay all but about $500 million in payments until 2010. But that may only postpone the day of reckoning, as Lafarge sales are forecast to drop 2.7% this year on a sharp downturn in construction worldwide.
The outlook is even scarier for companies that were grabbed by private equity funds. Standard & Poor's estimated last June that 58% of European companies that underwent leveraged buyouts were saddled with higher debt than originally projected, while 56% were running behind forecasts on operating earnings. Things have gotten a lot worse since then. London-based 3i, one of the region's biggest private equity groups, on Jan. 28 took a $942 million writedown totaling 21% of the value of its biggest holdings. Some LBO targets have already succumbed. Edscha, a $1.4 billion German auto-parts maker acquired by U.S. private equity outfit Carlyle Group in 2003, declared bankruptcy on Feb. 2. Another, British chemical company Ineos Group, in December narrowly avoided default on its $10 billion in debt by persuading lenders to suspend agreements setting a ceiling on its debt-to-profit ratio.
Rising defaults could send shock waves through global markets. Just as with subprime mortgages in the U.S., corporate bonds and loans were packaged and resold to investors in vehicles called CDOs and CLOs, or collateralized debt obligations and collateralized loan obligations. "There was a flood of cheap debt, lower and lower terms," says Jon Moulton, head of London private equity group Alchemy Partners, "and with less and less due diligence."
Bank to issue grimmest warning yet on economy
Mervyn King will this week present the Bank of England's most pessimistic assessment yet of the outlook for Britain's economy, after a slew of official figures confirming that activity has "fallen off a cliff" since the autumn. When the Bank's monetary policy committee reduced borrowing costs to just 1% last Thursday, it acknowledged that "the global economy is in the throes of a severe and synchronised downturn".
Its latest forecasts, to be published on Wednesday, will reveal how hard it expects the UK to be hit. "The upcoming inflation report is likely to show a bleak forecast, with a severe recession," predicted Michael Saunders, UK economist at Citigroup. King said in a speech to the CBI last month that there was a consensus among the Bank's contacts in the UK and abroad that after Lehman Brothers went bust in September, "orders and confidence had, in the same telling phrase, 'fallen off a cliff'".
Official figures on Friday showed industrial production fell at the fastest pace since the 1970s in the final quarter of 2008, a pattern echoed across the eurozone and in the US. Economists will be scrutinising the report for signals that the MPC is preparing to jump to "quantitative easing", the radical approach of pumping more cash into the economy. On Friday the Bank said it will begin buying companies' debts using £50bn of taxpayers' money, in a new attempt to unblock the flow of credit
RBS ‘toxic’ loans chief paid £40m
A Royal Bank of Scotland executive who led its investments into "toxic" sub-prime loans was paid close to £40m in just three years, The Sunday Times can reveal. Jay Levine, 47, was the bank’s highest-paid employee, earning almost four times more than former chief executive Sir Fred Goodwin. Levine, who ran the group’s American investment bank RBS Greenwich Capital, received the bumper pay deals over 2005, 2006 and 2007, according to sources close to the bank. His pay has never been disclosed since he was not a main-board director. The pay deals came as the bank ramped up its exposures to sub-prime mortgages, asset-backed securities and collateralised debt obligations (CDOs).
Levine, who lives in well-heeled Riverside, Connecticut, became co-head of Greenwich in 2000 after RBS acquired the business as part of its takeover of NatWest. In 2004 he was promoted to a larger role that also saw him head up corporate banking for the group across North America. RBS has unveiled about £12 billion of write-downs since the credit crunch began and is poised to unveil full-year losses of up to £28 billion – the biggest loss in UK corporate history. There are now six class-action lawsuits that have been filed against the group in the Southern District Court of New York, alleging that RBS misled investors on the true state of its accounts in a series of filings with the US Securities and Exchange Commission (SEC).
One of the lawsuits details how the bank’s exposures to CDOs ballooned from 2005 onwards. The filing, lodged under the name Gary Kosseff, quotes an SEC document in which RBS said that 76% of its £5.9 billion CDO portfolio had been acquired since 2006. Other suits allege that RBS was "negligent" in due diligence on its acquisition of ABN Amro, or that it misled investors at the time of its £12 billion rights issue last April. RBS said it was aware of the actions and that they would be "defended vigorously".
Levine announced he was retiring from RBS in December 2007, but has since been appointed chief executive of Capmark Financial, a lender specialising in commercial real estate. At Capmark he replaced William F Aldinger III, the banker who sold sub-prime mortgage business Household Financial to HSBC in 2003. Levine has donated thousands of dollars to the US Democrats over the past three years. Some of his biggest donations have gone to Chris Dodd, the head of the US Senate’s banking committee. He also supported former New York mayor Rudy Giuliani, a Republican, in his presidential campaign. And Levine was on the board of a financial lobby group that sued the state of Connecticut over new laws that would force political donors to disclose donations made through spouses or children.
Royal Bank of Scotland to pay staff £1 billion in bonuses
The Royal Bank of Scotland (RBS) is proposing to pay close to £1 billion in bonuses to its staff, just months after it was rescued by a £20 billion taxpayer bail-out, The Sunday Telegraph can reveal. The bank’s board has begun discussions about the bonuses with UK Financial Investments (UKFI), the body set up by the Treasury to manage the Government’s shareholdings in Britain’s ailing banks. The scale of the plan is likely to increase public anger as the recession deepens, and add to the frustration of ministers. It comes as Alistair Darling, the Chancellor, announces in The Sunday Telegraph today his plans for an independent review of the way banks are managed, including the bonus system.
The review, which ministers hope will address voters’ concerns about big payments to executives, will examine the roles of directors and institutional investors and study how British banks compare with overseas institutions. "We cannot return to business as usual," writes Mr Darling in this newspaper. "It is in everyone’s interest to get banks’ governance right. It would be wrong to reward people whose excessive risk-taking brought the banks down, causing misery to millions of their customers. Success should be rewarded. Failure should not." The Chancellor will announce the detailed terms of reference of the review, and its chairman, tomorrow. In an attempt to appease ministers, RBS has indicated that no individual banker will receive a bonus with a cash element of more than £25,000 under its plans.
The remainder of the bonuses, to be paid next month, will be in RBS shares, with a large proportion of them deferred or not paid at all if an employee leaves RBS within an agreed period, or if their area of the bank makes significant losses in the following two years. The bank has decided it will not pay any bonuses to employees who work in loss-making areas of the business. UKFI, which is led by John Kingman, a senior Treasury official, is considering the proposals. About half of the bank’s "bonus pool" will consist of payments that RBS believes it is contractually obliged to pay. Much of this sum will be paid to employees of ABN Amro, the Dutch banking group for which RBS is now acknowledged to have overpaid at the height of the banking boom. The proposed remaining bonus pool, worth about £500 million, is discretionary.
Although the sum of nearly £1 billion will provoke outrage, it represents a fall of about 60 per cent on the previous year’s bonus payments. The cash component is understood to be about 80 per cent down on last year. RBS, which has a new chairman and chief executive in place of their sacked predecessors, is sensitive to accusations that it is paying "rewards for failure". Stephen Hester, the new boss, will give evidence to the Commons Treasury select committee on Wednesday, when he is likely to be questioned about the bonuses. His predecessor, Sir Fred Goodwin, will appear on Tuesday. A statement issued by UKFI last week said that "as a majority shareholder in RBS, [UKFI] is in discussions on possible approaches to remuneration. No decisions have yet been taken."
The row over bonuses will also affect employees at Lloyds, in which the taxpayer owns a 43pc stake, and Barclays. Lloyds’ executive directors are understood to be planning to retain their share-based bonuses for last year. Barclays is understood to be planning to pay £600?million in bonuses following the announcement of its full-year results tomorrow. That represents a fall of more than 50 per cent from last year. Barclays has remained free from government investment but it is likely to participate in the asset insurance scheme being devised by the Treasury, which officials have decided will include binding commitments on pay policies. RBS declined to comment.
U.K. to Probe Pay at Rescued Banks as Anger Mounts
The U.K. will investigate payouts awarded to executives at banks bailed out by the government and plans to overhaul the way financial institutions are managed, Chancellor of the Exchequer Alistair Darling said. "No-one who is associated with these large losses, this excessive risk-taking should be allowed to walk away with big cash bonuses," Darling told the British Broadcasting Corp.’s Andrew Marrprogram today. "The whole culture in the boardrooms of British banks needs to change."
The Treasury is examining bonus arrangements as Prime Minister Gordon Brown faces growing pressure to limit pay at banks while the economy is mired in recession. In the U.S., President Barack Obama plans to cap pay at $500,000 a year for top executives at banks rescued by the government. The inquiry in the U.K. will examine the connection between salaries and risk-taking, Darling wrote in the Sunday Telegraph. "What a lot of these bankers need to understand is that some of these banks wouldn’t be standing if the taxpayer hadn’t stepped in," Darling told the BBC. "If they want any government help in future, that will be tied to strict conditions not just in terms of lending but also in terms of pay to staff." Royal Bank of Scotland Group Plc will pay almost 1 billion pounds ($1.5 billion) in bonuses after receiving a 20 billion- pound capital injection from the government, the newspaper reported. Lloyds Banking Group Plc is planning to pay bonuses based on stock, the Sunday Times reported.
Edinburgh-based RBS said it was in talks with the government about pay and no decision had been made. "Any bonuses will be dramatically reduced and there would be no reward for failure in those bits of its business where the losses were concentrated," the bank said in a statement today. Lloyds executives agreed to defer any bonus they may receive until the end of this year and to have payouts in stock, Eleanor Ross, a spokeswoman, said by telephone today. "While directors are entitled to a cash bonus in respect of performance in 2008, they have agreed to take any bonuses awarded in shares," she said. The government’s review will also consider the role of institutional investors and international standards in setting the way banks are run, Darling wrote. The British Bankers Association said in a statement today it "will gladly engage" with the investigation.
Lawmakers from all political parties have pressed Brown to clamp down on bonuses and risk-taking at financial institutions. Communities Secretary Hazel Blears told Sky News today that "there does need to be a change of culture." "The party is over for the banks," George Osborne, who speaks for the opposition Conservative party on Treasury matters, told the BBC. "It is totally unacceptable for these large banks which have large tax shareholdings to pay large cash bonuses to their senior management." Vincent Cable, Treasury spokesman for the Liberal Democrats, told Sky News a cap on compensation for executives may be an appropriate short-term measure. "It’s outrageous that banks that have failed and collapsed and have been supported by the taxpayer are being paid out bonuses," Cable told the news channel.
Public support for the governing Labour Party is at the lowest level since Brown’s bank bailout in October, the Sunday Telegraph said, citing an ICM Research poll. Twenty-eight percent of respondents backed Labour, leaving it 12 percentage points behind the Conservatives on 40 percent and six points ahead of the Liberal Democrats, on 22 percent ICM interviewed a random sample of 1,010 adults by telephone on Feb. 4 and Feb. 5, the newspaper said. Brown told reporters last week he supported Obama "strongly" on the need to change the way bankers are rewarded. Rather than capping pay, Brown and Business Secretary Peter Mandelson are urging executives toward restraint. Brown has twice refused to say he would ban bonuses at RBS. Darling also refused to accept a cap on payments, saying the government had to take into account incentives for employees.
Barclays Plc plans to pay 600 million pounds in bonuses, the Sunday Telegraph reported, without saying where it got the information. HBOS Plc, the Edinburgh-based bank taken over by Lloyds, paid cash to some executives from share-based performance plans, the Guardian newspaper reported yesterday. The U.K. government is taking a 70 percent stake in RBS after the bank tapped part of the Treasury’s 50 billion-pound recapitalization fund. It has no stake in Barclays, and a 43 percent holding in Lloyds. U.K. bankers have reaped more than 31 billion pounds in bonuses over the past four years, according to the Centre for Economics and Business Research. Moves to restrict payouts are hampered by the contracts of bank workers, some of which guarantee compensation levels. "Now obviously there are contractual problems with some staff," Darling told the BBC. "If you look at your average teller across the counter who you meet, they’re not terribly well paid and I don’t think anyone would quarrel with making sure they’re properly rewarded."
Taxpayer to insure Treasury's £400bn toxic loan scheme
The Treasury's scheme to ring-fence toxic loans made by British banks is likely to involve more than £400bn of assets being insured by the taxpayer, The Sunday Telegraph has learnt. Although the details of the scheme announced last month are still being finalised, submissions from Royal Bank of Scotland and discussions with Lloyds Banking Group suggest that the total value of assets that will ultimately be included in the scheme will be significantly larger than the original estimate of £200bn. Sources close to the Treasury emphasised last night that the size of the scheme would not necessarily increase the risk to the taxpayer if portfolios of relatively healthy assets were also insured as part of the Treasury's plan to release capital to allow banks to lend more freely.
The Treasury is still aiming to announce details of the scheme, including its pricing, before the end of the month. Some senior bankers believe the timing should be accelerated, however. Ernst & Young and PricewaterhouseCoopers, the accounting firms, have been brought in to advise the Treasury alongside Credit Suisse and Citigroup, while KPMG is working with RBS and Lloyds. Paul Myners, the City minister, is understood to have met with the chairs of the audit committees of each of the major banks to discuss their reviews of the institutions' balance sheets. Lord Myners is also considering convening a conference of experienced City non-executive directors and leading institutional investors to discuss governance issues across the industry.
This weekend, the Treasury is also assisting UK Financial Investments on its analysis of banks' proposed bonus payments. RBS has indicated that it wants to make about £500m of discretionary payments to employees, with several hundred million pounds more to be paid according to contractual agreements with former employees of ABN Amro and RBS Sempra Commodities, a joint venture where the bonus policy is not dictated by RBS. About £40m is also to be paid to RBS branch staff under a profit-sharing agreement. People close to RBS insisted last night that no employees in any loss-making areas of RBS would receive a bonus and said that the overall bonus pool was being cut by 60pc.
The cash component of the bonus payments is being slashed by 80pc, they said, reflecting the political sensitivity surrounding the issue. Barclays, which is also likely to participate in the asset protection scheme, has drawn up plans to pay discretionary bonuses of about £600m, a 55pc fall on last year. Tomorrow, Barclays will provide an unprecedented level of detail on the state of its balance sheet when it announces full-year pre-tax profits of about £6bn. The bank will say it enjoyed a strong start to the year in Barclays Capital, its investment banking arm. In an unusual move, Robert Le Blanc, Barclays' director of risk, will present the results to City analysts alongside the bank's chief executive and finance director.
If the Treasury's asset insurance scheme follows a proposed version in the US, fees for banks will be about 4pc of the insured assets. As the Treasury has said the scheme will last for at least five years, banks may be able to pay the fee over a similar period, analysts at JP Morgan Cazenove said. One of the main aims of the scheme is to allow banks to slash the risk weighting of the assets on their balance sheet, which will free up capital. It is expected that banks will be forced to take the first 10pc of losses in the value of assets, plus 10pc of any further losses. The Treasury will take the hit for any remaining deterioration in value. Cazenove said: "In most instances, we do not anticipate cumulative losses in excess of 10pc. Yet the insurance provides a restriction on the extent to which the impairment charge can rise for the insurance assets."
Barclays and RBS declined to comment.
Turn failed banks back into mutuals, Labour told
Pressure is mounting for the government to explore ways to remutualise Northern Rock and Bradford & Bingley, nationalised after the shares crashed amid fears that they could collapse amid the world financial crisis. Both companies were mutuals before becoming stockmarket-listed banks in the 1990s. Labour MPs are pushing for the government to expand the role of mutuals, which are owned by depositors and borrowers. They do not have shareholders who may be more interested in diverting profit to bolster dividends than getting customers a better deal.
Mutually owned building societies are widely viewed as more cautious than banks, which have been accused of irresponsible lending during the boom. Societies are barred from funding more than half their mortgages from the wholesale money markets, which have frozen up in the wake of the credit crunch. One option would be to remutualise Northern Rock and B&B, both of which have been rescued by the taxpayer at a huge cost, although part of B&B was acquired by Spanish bank Santander. The principle of remutualisation is supported by the Co-operative party which sponsors 29 Labour MPs, including schools secretary Ed Balls.
The Co-op's general secretary Michael Stephenson said: "The government could consolidate Northern Rock and its holding into one institution; when all debts are paid back, the institution could be converted into a building society. Alternatively, government could give existing financial mutuals (such as Nationwide) the right of first refusal when it decides to put the institutions it nationalised up for sale." John McFall, Labour chairman of the Treasury select committee and a Co-op sponsored MP, says: "If ever there was a time for an expanded mutual sector, it's now. We desperately need to restore faith in financial services in this country." Although he stopped short of calling for a firm commitment to remutualise the Rock and B&B, he told the Observer that the idea was "a fertile area for debate".
He was backed by Mark Lazarowicz, Labour MP for Edinburgh North and Leith, who says: "This is an issue that is worth airing at a time when confidence in the banks is at an all-time low." Martin Weale, director of the National Institute of Social and Economic Research, said remutualising Northern Rock and B&B could be a relatively simple, albeit lengthy, process with money owed to the taxpayer repaid by borrowers who redeem their debts over time. New "membership" shares could be issued to depositor/members, he said.
It emerged this weekend that the Building Societies Association is to commission academic research into how the mutual sector could be expanded in Britain, after banks that ditched mutuality in favour of plc status have either been nationalised or taken over in "mercy killings" by rival institutions. They include HBOS, which has been merged with Lloyds TSB, and Alliance & Leicester, which was bought by Santander. Stephenson said: "When the last Conservative government encouraged building societies to demutualise, it plundered generations of assets from mutual societies, replacing prudent mortgage providers with some of the worst culprits of casino capitalism."
Key Labour employment plan close to collapse
The government's flagship policy to revolutionise welfare by paying private companies to find jobs for the unemployed was in crisis last night as firms said there were too many people out of work - and too few vacancies - to make it viable. News that Labour's radical plan is in turmoil and facing possible legal challenges comes as unemployment is about to pass the two million mark for the first time in more than a decade. Analysts believe it will hit three million before the end of this year. Responding to warnings that his reforms will not work without major changes, James Purnell, the work and pensions secretary, has abandoned plans to announce the preferred bidders for the multi-million-pound contracts this week. This follows demands from the firms involved for hundreds of millions more in "up-front" cash. A crisis meeting between top department officials and the bidding companies was cancelled on Friday after Whitehall announced a "short pause" in the tendering process.
The Department for Work and Pensions (DWP) said it had been called off "because of the snow", but one company manager involved remarked: "The most telling thing is that no new date was set." The difficulties besetting Gordon Brown's core welfare policy present a severe headache to ministers, who vowed last year - when jobs were abundant and unemployment low - to bring more private-sector rigour into the welfare system by paying employment firms and the voluntary sector "by results". This meant they would receive a sum for each person for whom they found a job, with extra cash when workers stayed in their new posts for more than 26 weeks.
The drive to "privatise" the welfare system is one of the most radical and controversial policies of Labour's entire third-term agenda. Richard Johnson, managing director of welfare-to-work policy at Serco, a provider of "outsourced public services" bidding for eight contracts from the DWP, said it was vital the government rescued the policy - but it would have to be more flexible. "We recognise that, with twice as many people signing on and three times as many becoming unemployed, the services and funding we agreed 12 months ago is no longer fit for purpose," he added. Under the current contracts on offer, worth a total of more than £1bn over five years, firms and voluntary sector organisations chosen in a tendering process would be paid 20% "up front" as a service fee and the remaining 80% when they placed people in work. Now many are demanding the service fee element be raised to 50%.
Colin Birchall, chief executive of Pertemps People Development Group, which has been bidding for eight contracts under the "flexible new deal", agreed that the government will have to release more capital at an earlier stage to satisfy bidding companies: "We need to review where we are, because we have a results-driven contract. Because the programme has become larger, the requirement for capital outlay from each company will be greater." In a further twist, ministers have also been told by the industry that companies which decided last year not to bid for the contracts on the basis that there was not enough up-front cash on offer, may launch legal action against the government if it now offers more generous terms to existing bidders but refuses to start the entire tendering process from scratch.
In a submission to ministers sent on Friday, before the cancelled meeting, and leaked to the Observer, the representative body for the industry - the Employment Related Service Association - suggested the entire bidding process may have to start again. "The current context is so different from that originally envisaged that, no doubt, the DWP will have considered carefully whether procurement law required the competition to restart from the beginning," says the letter. Mark Lovell, executive chairman of A4e which is bidding for several contracts, said he had heard that some failed bidders may try to take the government to court once the terms are redrawn. "I have heard about possible legal action, but would caution against it because I think the steps being taken by the government are appropriate. I cannot see what other bidders could say or what information they could provide that would change the outcome," he said.
Mark Serwotka, general secretary of the Public and Commercial Services union, which opposes privatisation, said the policy stood little chance of getting under way as planned in the autumn. "Nobody can have any confidence in the claim that the flexible new deal can start in October. Any attempts to rescue these flawed plans will result in taxpayers handing a blank cheque to the preferred bidders." The DWP refused to comment on the problems in the tendering process or the reasons for the delay. But officials insist the policy remains on track. However, a letter sent to bidders by senior officials in Purnell's department on January 30 spelt out the extent of the problem and the need for an urgent rethink.
China Institute Proposes Weaker Yuan to Boost Growth
China should "actively guide" the yuan’s exchange rate to about 6.93 against the dollar to help maintain economic growth and bolster employment, according to a report by the Ministry of Finance’s research institute. The nation should also increase purchases of commodities from abroad and build up energy reserves to offset pressures on the Chinese currency to rise, said the report, published today in the Shanghai Securities News. Rising labor costs and a stronger yuan have slowed overseas shipments of Chinese-made textiles, toys and machinery as the worldwide recession saps demand. The People’s Bank of China wants to avoid big movements in the yuan and the global crisis will be the key determinant of currency policy, Governor Zhou Xiaochuan said this week in Beijing.
"Depreciating the currency would be little help," Li Wei, a Shanghai-based economist at Standard Chartered Bank Plc, said today in an interview. "The slowdown in exports is mainly due to lack of demand." The world’s third-largest economy will continue to slow in the first half, the ministry report said. Growth will "stabilize" in the second half thanks to the government’s stimulus measures. China in November announced a 4 trillion yuan ($585 billion) spending plan to boost growth. The central bank should continue to cut lending rates "by relatively large margins" in the first half to boost investment and prop up the real estate and stock markets, today’s report said. China has cut interest rates five times since September.
Deposit rates should also be lowered further to benchmarks in U.S. and other markets to help maintain a "normal" exchange rate level, the report said. China’s one-year deposit rate stands at 2.25 percent, with the lending rate at 5.31 percent. The Chinese economy expanded by 6.8 percent in the fourth quarter, the slowest pace in seven years. The yuan traded at 6.8344 a dollar at the 5:30 p.m. close in Shanghai yesterday, from 6.8367 per dollar the day before, according to the China Foreign Exchange Trade System.
The yuan’s level of about 6.83 against the dollar is "slightly lower" than the average costs 65 major textile companies in east China’s Jiangsu Province pay for each dollar they earn from exports, today’s report said. Growth in textile and garment shipments slipped by 10.7 percentage points in 2008. "Weakening the yuan to boost exports would give ammunition to people accusing China of protectionism," Li said. "I don’t think this report can represent finance ministry policy." The report predicted China’s fiscal revenue to grow by 10 percent this year to 6.7 trillion yuan. Expenditures may rise by 14 percent to 7.2 trillion yuan.
The People's Sheriff of Chicago
Cook County Sheriff Tom Dart, like his counterparts across the nation, has been evicting people from their homes in ever increasing numbers. In 2008 the Chicago Democrat and his deputies conducted 4,487 court-ordered mortgage foreclosure evictions, an increase of 153 percent over the office's 2006 numbers. But on October 8 Dart stood before TV cameras and said he'd had enough. Criticizing banks and mortgage companies as heartless, careless and taking advantage of taxpayers, he suspended all mortgage foreclosure evictions. Suddenly Dart appeared to be the kind of lawman Tom Joad might have clapped on the back.
In a recent interview Dart said that over the summer he'd become aware that the eviction orders increasingly lacked evidence of the due diligence the banks were supposed to perform. In one instance, he said, his deputies arrived to evict residents from a building that no longer existed, and in other cases they found residents had documents showing they were rightfully in the house. "It was a disaster," he said. "Just complete chaos out there."
The tipping point came with the crisis at 4914-16 North Spaulding, an apartment building full of Hispanic immigrant families in Chicago's Albany Park neighborhood. Mihail Stancu, a Romanian immigrant, had purchased the building in October 2006 under the guise of MKST Enterprises, and he'd gone on to become the kind of owner Tom Joad might have clapped on the head with a shovel. According to City of Chicago senior assistant corporation counsel Steven McKenzie, Stancu's corporation sold the seven units as seven condos, the buyer being Stancu himself, who'd borrowed from seven lenders. Stancu was then in possession of a lot of cash and a lot of debt, and according to McKenzie the Romanian simply abandoned the latter, pocketing as much as $1.2 million, after which he disappeared. McKenzie, who has filed charges against Stancu, reports that the fugitive has been spotted in Spain and Romania.
Stancu had regularly collected rents from his tenants, but the collections stopped after about a year. Unable to reach the owner, tenant Esteban Cruz, an immigrant landscaper and gardener, began collecting the rents, paying for repairs and utilities, and depositing the remainder into a bank account belonging to Stancu. None of the tenants were particularly worried until May 28 of last year, when what seemed to be an eviction notice was posted on the front door and on the mailboxes of all the units. A second threatening notice followed shortly thereafter. Cruz brought the paperwork to the offices of the Albany Park Neighborhood Council. APNC recognized the notices as bank-generated, not court-generated, discovered the condominium ruse and laid out the problem before a housing court judge. The judge recognized that the best course was to put the building into receivership and try to find a single buyer who would convert the condos back into affordable rental housing. Armed with that decision, the tenants should have been safe.
But the eviction threats continued. A locksmith arrived and told one family they had thirty minutes to vacate. APNC organizer Emily Burns fended him off. Not long thereafter, Sheriff Dart's deputies pounded on the door of apartment 1A, demanding entry, armed with eviction papers. They left after finding the family was not listed on their papers, but according to Burns, they said they'd be back in a week to put the family out. Alma Aquino, who works as a cashier at a restaurant in the Loop, says she went to work every morning afraid that her family's possessions would be at the curb when she got home. Her parents, visiting from Mexico, asked what they should do if the deputies came back. "I say, 'Just don't open the door, and call the police.' But my father said, 'They are the police.'"
The APNC decided the sheriff was the problem, and on August 13 the council staged a protest rally in Daley Plaza, denouncing the sheriff, after which APNC board member Diane Limas and six of the Spaulding tenants, including two children, walked into Dart's office asking for a meeting. Three of Dart's aides sat down with the delegates and promised to investigate. Sheriff's spokesman Steve Patterson recalls that within about two days of the protest, Dart said, "You know, these people are right." On October 8, with the APNC's Burns and Limas in attendance, Dart announced he was suspending mortgage foreclosure evictions. "These mortgage companies only see pieces of paper, not people, and don't care who's in the building," Dart said. "They simply want their money and don't care who gets hurt along the way. On top of it all, they want taxpayers to fund their investigative work for them. We're not going to do their jobs for them anymore. We're just not going to evict innocent tenants. It stops today."
There was some furor in response, particularly from the banking industry; one prominent member denounced Dart as a vigilante. But Richard Gottlieb, a lawyer who chairs the legislative committee of the Illinois Mortgage Bankers Association, says the policy wasn't so radical at all. "It was all about being more humane to the people who had no idea that there was even a foreclosure action against the property. And it was the right thing to do, because people weren't doing it right." Gottlieb points out that for more than a decade, Illinois law has required the listing of all residents on motions for eviction and eviction orders, and it is likely that for years, sheriffs have been breaking the law by evicting people whose names have not been listed. "Dart basically did this to force the hand of the courts and the foreclosure lawyers to get it right.... In the end result, there was nothing terribly troubling about what occurred."
In the wake of his announcement, Dart sat down with the chief judge of the Chancery Court and worked out new procedures; the suspension ended ten days after it began. Dart, however, is still receiving paperwork filed before the new procedures were imposed, so he has continued to reject orders. Between October 20 and January 13, he received 232 requests for eviction, and he performed twenty-four. Part of his slow pace can be explained by the annual holiday moratorium on evictions and by cold weather (if it's fifteen degrees or colder at 6 am at O'Hare Airport, no evictions take place). But it also appears that Dart, enjoying the camaraderie of the Joad camp, has no great enthusiasm for getting back up to speed. He and APNC housing leaders met in mid-January to work on proposed legislation that would require eviction orders to list each occupant's birth date. Dart's intention is to have a social worker present if children or seniors are being evicted so they can be informed of available social services.
In the meantime, the Spaulding tenants have continued to receive threatening notices from banks and their agents. By mid-January, eleven such notices had been posted. But Jack Markowski, president of the Community Investment Corporation and the receiver appointed to administer the building, thinks the residents will be able to stay for years to come. Markowski says the CIC has discovered more than 200 buildings in the city, an estimated 2,000 units, where the same scheme has played out, usually with a very different outcome: after the landlord/condo developer absconds, no one pays the building's utilities; shutoffs result and tenants leave; squatters and/or drug dealers move in; and finally mortgage bankers from different institutions, successful with their foreclosure motions, discover that each owns one unit in a vacant, trashed building.
According to Markowski, such buildings have no value in part because no lender is in charge, and reassembling it as a single entity is not the province of a loan officer in a single bank and too much work for the possible return in a depressed market. So the building is boarded up, taxing the police, the patience of the neighbors and the value of surrounding property. Thus the Spaulding Luxury Condominiums are more than the site of impressive fraud and more than the impetus for reform in the county's eviction process. They are also the site of a small urban miracle, performed by an immigrant landscaper and his fellow tenants, who decided to save a building they didn't own.
Double Blow for Police: Less Cash, More Crime
Philadelphia officials are leaving 200 police positions unfilled and cutting back on overtime. Sheriff's deputies in Polk County, Fla., are picking up more work after the state highway patrol froze hiring and four local police agencies disbanded. And police in Atlanta are shouldering a 10 percent pay cut after all 1,770 employees and the police chief agreed to a furlough of four hours per week. The nation's economic trouble has hit state and local law enforcement, with two out of three large departments reporting budget cuts or hiring freezes. And at the same time, leaders at more than a quarter of the 233 departments that responded to a survey by the Police Executive Research Forum say they are noticing an uptick in property crime that they blame, at least in part, to economic unrest. Local police departments already have been grappling with tighter budgets in recent years as the federal government has shifted funding from law enforcement to homeland security.
As Congress has debated a huge economic stimulus bill this year, Democratic lawmakers have pushed for it to include $2.64 billion in crime-fighting grants and more than $1 billion in funds to hire 50,000 police officers. But such federal money typically comes with a requirement that localities match 25 percent of the total with funds from other sources. Police groups are lobbying the Obama administration to relax that policy. If police departments receive the stimulus funding, it could still take them 18 months or longer to advertise for recruits, weed through applications and put the probationary employees through training before they ever appear on the beat, experts said. Personnel is by far the single biggest expense for police forces, experts say, and many of the recent trims have meant cutting staff. The effects have included restrictions on overtime and delayed recruiting efforts. In some cases, departments have urged victims to report some crimes online or make a trip to the police department rather than call officers to their homes.
Among the other items on the chopping block, warned Philadelphia Police Commissioner Charles H. Ramsey, are special units designed to combat narcotics traffic, gangs and other community problems. Ramsey, who served nine years as the D.C. police chief, said Washington and other cities may have to curtail successful programs that have flooded crime "hot spots" with officers. Around the Washington area, counties are also feeling the constraints. Fairfax County officials agreed last fall to a one-day furlough of nonessential county employees. Prince George's has faced the prospect of layoffs, and Montgomery County's firefighters union announced last month that it had agreed to wage concessions. James Alan Fox, a criminologist at Northeastern University, reported in a recent paper that the number of police officers per capita across the nation has been reduced by 9 percent since 2000. "The connection between the economy and crime is an indirect one," Fox said, "but where the economy does play a role is through the ability of municipalities and cities to fund crime control. We just don't have the resources to maintain successful programs and crime-control initiatives."
In response to pleas from state and local officials, the Obama administration is looking to loosen restrictions on how a portion of $3 billion in annual homeland security grants can be spent. Homeland Security Secretary Janet Napolitano said recently that she hopes to help state and local governments cope with plummeting tax receipts. "They're just struggling to pay their basic costs," said Napolitano, a former Arizona governor and federal prosecutor. Pleas for federal funding from state and local law enforcement are rekindling a political debate. Critics say that state officials are exaggerating the risk of increased crime and assert that federal support encourages municipalities to be fiscally irresponsible. David B. Muhlhausen, a senior policy analyst at the Heritage Foundation, told the Senate Judiciary Committee last month that fighting crime is primarily the responsibility of state and local governments. "The federal government should not become a crutch on which local law enforcement becomes dependent," he testified.
The funding debate has intensified as the demand for services has increased, according to victims rights advocates. Mary Lou Leary, a former U.S. attorney in the District who now directs the National Center for Victims of Crime, said that members of her organization, which helps crime victims across the country, reported a 25 percent increase in calls from October 2007 to October 2008 "as job losses and economic stress factor into increased violence." "More people are getting victimized," she added. "There are fewer service providers open because of the economy. Victims coming in have a broader range of needs. . . . It is a very challenging environment." Law enforcement officials are warning about another potential source of trouble: the difficulty that prisoners returning to the community will have finding work and job-training programs. Meanwhile, Polk County Sheriff Grady C. Judd, who runs an 1,800-member force in the Florida county, said he is taking a long view. "I've done this 36 years, so I've seen the good times and the bad times in the delivery of police services," he said. "You can just predict: if you reduce the number of police officers, it will increase the level of crime in the community."
Iceland: downfall of 'a foolish little nation'
Iceland's humiliation begins at Heathrow. Try buying the currency, the krona, at Travelex and you will discover it is no longer held. "And whatever you do," says the woman at the counter, "don't bring any back." The words "failed state" bring to mind ungovernable Third World hell-holes, but Iceland is a new kind of failed state, a financially failed one. Without cash from the International Monetary Fund it would be as near to bankrupt as a country can be. The latest aftershock was felt in Britain this week when the holding company Baugur, with stakes in a string of British high street chains, went into administration. The group, which has major shareholdings in House of Fraser, Iceland, Hamleys, and Mappin & Webb, collapsed with debts of more than £1 billion. The future of 3,500 stores and some 50,000 jobs is in doubt.
However, the turmoil engulfing Iceland's economy is far from evident on arriving at Keflavik airport, 40 minutes' drive from the capital, Reykjavik. The air is clean, the roads good and the houses that dot the stark volcanic landscape well maintained. The cars are big, too: four-wheel drives and high-end marques. But then the stories begin. The taxi driver on the Keflavik run was in his sixties, respectable, softly-spoken and, to all intents and purposes, bankrupt. "I keep on working and pay what I can. The bank knows I can't do more. There is no point in shutting me down." His tale is similar to thousands of others. He had needed a new car and went to his bank for a loan – Icelanders, for so long a frugal people dependent on fish and agriculture, have become as addicted to debt as the British. His lender suggested using a "currency basket", made up of different strong currencies, to buy a secondhand Cadillac from America because the krona was weak.
The little currency had suffered from volatility in the past but no one predicted what came next. In October, the banking system imploded under the weight of an enormous mountain of debt. The three big banks had boasted assets many times the size of the country's GDP, but their liabilities were of a similar order. When the government nationalised the banks, it was left with liabilities in excess of $60 billion (£40 billion), more than three times GDP. The krona nose-dived and borrowers like the taxi driver woke up one cloudy morning to discover that, in krona terms, their loans had doubled in size. With the krona effectively dead, the country has been forced to seek the shelter of a bigger currency – probably the euro. There were other shocks in store. Inflation soared as import prices rose, hitting the many mortgages in Iceland that are index-linked. Repayments went through the roof and the overheated housing market collapsed. Unemployment soared towards 10 per cent. The construction industry seized up. Now, lifeless cranes dominate the skyline of Reykjavik, monuments to hubris.
The banks had done something else besides lending money they did not have. Thousands of Icelanders had been persuaded to swap bank deposits for what were effectively stakes in the banks themselves. For them, the banking collapse threatened personal ruin. "Many people who live in beautiful houses and drive beautiful cars are completely broke," says political commentator Egill Helgason. "None of it can be sold, they have lost their jobs. People look wealthy, but worry about the next meal." Iceland's fall from grace has been swift. In 2005, it was ranked in the top 10 in the world in terms of GDP per head, and between 1996 and 2006 its economy grew by 50 per cent. It has routinely figured near the top of the human development index, which combines economic and social measures. Now, interest rates are 18 per cent and inflation 20 per cent; and each man, woman and child could owe as much as $250,000 to foreign creditors.
Tear gas had been used in Iceland only twice before last month – in 1949, during protests against Iceland's membership of Nato, and in 1959, when a dance in a remote fishing town in the north turned into a riot. Icelanders are not given to public demonstrations, but last month a mob pelted eggs at the car of the prime minister, Geir Haarde. Out came the tear gas and out went Haarde's Right-leaning coalition government. The Left-wing coalition now serving as a caretaker government, until elections in April, is headed by 66-year-old Johanna Sigurdardottir. Respected rather than loved, she is a traditional Left-winger. Except for a few traditionalists in the backwoods, no one cares that she is a lesbian, having swapped the father of her children for her current partner. What matters is that she harks back to another world, before the rise of Iceland's mini-oligarchs, the group of 30 or so men and women who, from the mid-Nineties, took an isolated, conservative society and transformed it into a freewheeling outpost of capitalism.
Some are well known in Britain. Jón Ásgeir Jóhannesson, 41, typified the new elite, the so-called Viking Conquerors. He set up a supermarket chain which blossomed into Baugur. As his wealth grew, so did his ambition. He acquired a yacht, a house with a bullet-proof panic room and a beautiful wife, Ingibjörg Pálmadóttir. Her customised Mercedes is known in Reykjavik as the "white pearl". A conviction for false accounting did him little harm, but the banking collapse did. The other big Icelandic name in Britain is Björgólfur Gudmundsson, who snapped up West Ham United. His son Thor was the original Icelandic success story, making millions from a brewing venture in post-Soviet Russia.
The "Vikings" thrived because of the intimacy of society. The political and financial worlds in Reykjavik are intertwined – it is said in Iceland that by the age of 50 you will have met half of the 320,000-strong population. When the three main banks were privatised in 2002, the business elite assumed control, turning them from sober institutions into aggressive vehicles for venture capitalism. The banks were used to financing foreign acquisitions and the domestic companies of their main shareholders. Iceland's financial supervisory system was primitive and the media silent – most of it having been bought up by the Vikings. No one asked where the money was coming from. The seemingly unlimited amounts of cash led to suggestions that they were drawing on "funny money" from Russia. The allegations, so far, have not been substantiated.
'The madness started with privatisation of the banks in 2002 and their transfer to the cronies of the political parties," says Helgason. "The true worth of the banks and the companies they were feeding with loans became obscured. Anything and everything was used to boost balance sheets. "There is a market for cod fishing quotas," adds Helgason. "A kilo of cod was sold for 4,000 krona in this market. If you went to a shop you could buy it for 1,200 krona. So the cod swimming in the sea was worth more than cod that had been caught – madness." The madness threatened dire consequences for British savers when Landsbanki, one of the three big banks, set up the internet operation Icesave, offering very competitive interest rates to European savers, including many individuals, councils and charities. When it collapsed, Gordon Brown used anti-terror legislation to freeze the UK assets of Landsbanki and another Icelandic bank, Kaupthing.
For Icelanders, the classifying of their banks with organisations suspected of funding al-Qaeda was an insult too far. Iceland's foreign minister Ossur Skarphedinsson is still shocked by Brown's actions. "Iceland has always looked on Britain as a helping hand, except during the cod wars. In your darkest hour in the Second World War, we offered you the use of our country. No one in Britain knows that Iceland lost proportionally the same number of people as America in the war. [Many lives were lost on Icelandic ships after its occupation by British and, later, American troops.] To suffer the humiliation of having a friendly country stigmatising you as terrorists was terrible. It was a disgusting thing to do."
A special prosecutor has been appointed to investigate the banking collapse. One of his jobs will be to discover the fate of assets thought to have been transferred to off-shore accounts by some businessmen shortly before the crisis. Rumours abound in the still chic bars of Reykjavik's small centre about billions salted away overseas. Icelanders are a stoic lot, though, and the feeling in the hot pools where people congregate, is that the nation will, as always, pull through – helped by cheap geothermal energy, healthy fish stocks and a beautiful, if forbidding, landscape, attractive to tourists. However, the days of hubris, of the Icelandic David taking on the Goliath of international finance, are over. "People don't want blood, but they want the truth," says Helgason. "In the end, we were a foolish little nation who thought we had found some new way of making money. We hadn't."
Can We Fix the Banks, Help Homeowners, and Rebuild the Mortgage Markets? Can do.
"The economic spiral starts and ends with housing. If we do not slow and stop the erosion of the ad valorem tax base in this country, we are going to have really serious problems. If you put the mortgage credit relationship and the servicing back into the hands of the local bankers who know the market and the people, we can save millions of home owners from foreclosure and dozens of banks from failure. We may never be able to resurrect the asset securitization market as it was, but we can stabilize the housing market and the local tax base by getting these assets back into the hands of bankers who understand how to manage credit. I've had transient customers along the Mexican border who would disappear for months at a time and then reappear at my office with six months of mortgage payments in cash. Only local bankers have these kind of relationships. You cannot manage a credit or really service a loan over the telephone. Give America's community bankers these toxic assets and we'll make the most of these credits."
An IRA reader from Laredo, TX
Changing Places: Is BAC now Behind C on the Problem Bank List?
In the NY Times on Sunday, the saga of Bank of America CEO Ken Lewis is documented. All we can say about BAC and Ken Lewis is that this bank has gone from arguably the most stable large money center to one of the most unstable, just behind Citigroup. We attribute this remarkable transformation to the ill-advised Countrywide and Merrill Lynch transactions, both of which were done without a receivership to restructure the target companies. As one banker told The IRA Friday: "We can still save Bank of America if we just put Merrill into bankruptcy. But the Fed does not want to see the last significant primary dealer fail. For many people, Merrill really is the only dealer left. Morgan Stanley does not seem committed to the markets and Goldman Sachs does not seem to care either."
Forgive our broken record, but just compare the Countrywide and Merrill transactions to the way in which Jamie Dimon, CEO of JPMorganChase bought WaMu, cleansed through an FDIC receivership. As we describe in further detail for our advisory clients this week, we don't think JPM will outrun the economic tsunami, but hats off to Dimon and his operating team for buying his organization valuable time to restructure and change their risk profile. That may be the difference in terms of outcome for creditors of JPM and BAC.
Frankly, the more we look at the mess at BAC, the more we wonder if BAC should not put ahead of Robert Rubin and the directors of C on the bank director incompetence index. We'll be coming back to our view of the failure of Lewis and the BAC board to exercise sufficient oversight of the bank's M&A activity in a future comment focusing on the duties and responsibilities of the directors of bank holding companies. But we spend overmuch much time on dead zombie banks. Let's switch gears now and talk about how strong, well-managed banks are helping the FDIC and state regulators create what we've called the Prime Solution, putting troubled assets and deposits in strong hands, and how this ongoing process is the example members of Congress should be taking in developing responses to the crisis.
The Prime Solution in Action: Westamerica Bank Inc.
The FDIC closed and/or merged several more banks on Friday, adding to the list of resolutions to date. For example, after the close Friday, County Bank, Merced, California, was closed by the California Department of Financial Institutions, which appointed the Federal Deposit Insurance Corporation (FDIC) as receiver. To protect the depositors, the FDIC entered into a purchase and assumption agreement with the sole bank unit of Westamerica Bank Inc. (NASDAQ:WABC), San Rafael, California, to assume all of the deposits of the $1.8 billion asset County Bank. At the end of Q3 2008, County was rated "F" by the IRA Bank Monitor with a overall stress score of 21.6 vs. the 1.5 industry averaged stress or more than one order of magnitude above the industry mean for Q3.
This resolution fits the pattern of past FDIC actions, with high stress scores for ROE degradation and charge-offs, but County's efficiency and capital stress scores were also above average. County had been rated an A as of Q1 2008, but slipped to "F" in Q2 2008 due to a large surge in charge-offs and operating losses. The bank had FHLB advances equal to 8% of total assets at the end of Q3 2008. The estimated loss rate to the FDIC from the County transaction will be $135 million or less than 10% of the failed banks total assets, not a terrible outcome if the actual resolution tracks the projections.
All 39 branches of County Bank will reopen as branches of WABC's subsidiary bank today and FDIC personnel will be on hand to facilitate the handoff to WABC managers. Americans should be very proud of the thousands of FDIC, other federal and state regulatory personnel, government contractors, legal and financial advisers, and employees of the federal bankruptcy courts, who worked all weekend to make this and other resolutions possible. Notice how the FDIC and other regulators are managing this resolution process, scheduling the closures of several institutions on Friday and thereby minimizing public stress and anxiety. And the list of banks, funds and investors actively participating in the shelf facilities established to help FDIC to quickly move failed bank assets into strong hands is growing.
By the way, WABC was rated "A+" by the IRA Bank Monitor as of Q3 2008, with an aggregate level of stress of 0.7 vs. 1.5 for the entire industry. At Q3 2008, WABC was 30% below below the 1995 stress baseline in the IRA Bank Stress Index for the entire industry. WABC's bank unit boasts an efficiency stress rating of 0.6 vs. 1.2 for the entire industry. The efficiency ratio for the sole bank unit of WABC was an amazing 39% at the end of Q3 2008. We call that righteous.
WABC's bank unit had "only" 6.35% leverage at end of Q3 and about the same in Q4, putting them slightly below peer in terms of capital, but with an ROE of 13% at the end of Q3 and 14.9% at the end of Q4 2008, equity capital is not an issue. Charge-offs for WABC bank unit increased from 31bp in Q3 to 52bp at year-end 2008, well below peer loss rates for both periods. But analysts note the two key positives on WABC as it ends 2008: strong earnings and excellent operating efficiency.
With the branches of County Bank, WABC will be a $5 billion asset regional player in CA and well positioned to take advantage of opportunities as 2009 proceeds. Did we mention that WABC closed over $48 on Friday, up 10% for the day? The 90-day equity volatility on WABC is 167% based in the EOD pricing from our friends at Morningstar, which is less than half the implied volatility of larger bank names. For all of you stock pickers out there who are users of the IRA Bank Monitor, consider that a hint.
If members of Congress and the Obama Administration take one lesson from us this week, then they ought to look at the growing crowd of investors - several who are working with IRA - forming to purchase assets cleansed through the process of insolvency. Banks, branches and individual loans are being bought and sold by investors with capital and the ability to manage credit. These are the beginnings of economic recovery and are an early indicator that the bull case is reappearing for financials - if not yet ripe.
Fix Housing, Fix the Banks and the Securitization Markets Both
As this issue of The IRA goes out, in Washington the Obama Administration is wrestling with three basic issues: dealing with troubled banks, restoring illiquid securities markets and restarting economic growth - though not necessarily in that order of priority. The political issue of "helping homeowners" is significant as well. But perhaps it is time to consider whether the Wall Street-centric priority of restoring function to the existing securities markets for "toxic assets" is not independent of these other very real priorities. Reports that Treasury Secretary Geithner is focusing additional spending on spurring new market activity and not remediation of existing securities is, to us, good news. This does not mean that private label securitization is dead or that the toxic cannot be cleansed. Indeed, we've heard from a number of practitioners in the channel on the state of the securitization markets in recent weeks, partly as we have been working to organize an all-day event in Washington on May 4, 2009 sponsored by PRMIA, "Market & Liquidity Risk Management In Post-Bubble Markets."
One confirmed participant in that event, Sylvain Raynes of RR Consulting, told The IRA last week:"The securitization market will come back because the next generation will not remember what happened here, in the same way this one forgot the depression, the 1929 Crash, and even the S&L crisis. Is that ancient history? As far as how this "come back" will emerge, that's easy. What we will see is an accelerated version of the first cycle, i.e. the one that took 25 years to unfold first time around. First, prime RMBS will start-up again with simpler and more meaningful underwriting criteria (that's already happening) then the prime credit card and auto sectors will be brought back to life. Maybe US medical receivables will be the next big, 'exotic' asset class to take off."
So the good news seems to be that the private securitization markets are beginning to fix themselves, albeit without a vital federal leadership role in terms of setting standards for the future. Raynes lists three areas where such leadership and perhaps legislation is needed:
* First, define a meaningful template for data disclosure regarding all securitizations and OTC contracts, and enforce it. This is already largely done in the form of Regulation AB for securitizations. Enforce it.
* Second, mandate monthly valuation-feedback via a monitoring system that uses remittance reports and publicly published models from the rating agencies. That's much harder to do, but will soon happen.
* Third, mandate educational standards in the area of structuring and primary market valuation for securitizations and OTC contracts.
With those positive thoughts on the private securitization market in mind, we come back to the central task facing the Obama Administration, namely to help the banks, help homeowners and also the broad economy. One interesting idea we heard from a veteran banker in South Texas might provide food for thought in terms of how to deal with the existing body of toxic assets on the balance sheets on banks, the key issue that must be resolved if banks are to start lending again. As part of the Obama Administration's efforts to support the primary market for new mortgage securitizations and also provide new capital to banks, below we describe an approach that harkens back to the market maker model The IRA described last year when we first started talking about the need for more bank capital.
Here's the basic approach:
* The US Treasury would tender for all of the private label CDO/MBS extending between a range of dates, say 2004 forward to year-end 2007, representing trillions of dollars in assets held by investors and banks globally. The pricing on this paper will reflect current market prices, but say the average price was 50% of face value. Only issues that actually have an enforcable legal claim to collateral will be eligible. Derivative structures without collateral will not be eligible.
* Treasury then transfers all of the purchased toxic paper to the FDIC Deposit Insurance Fund, which acting as receiver under 12 USC restructures the trusts that are the legal issuers of the bonds and recovers legal ownership of the underlying collateral. The FDIC arguably has the power to call in all bonds and related investment contracts, and extinguish the claims of those parties which do not respond to the Treasury tender. The legal finality of an FDIC-managed receivership under 12 USC is what is required to end the toxic asset issue once and for all. The bankruptcy courts could be used in a similar fashion, but the unique legal authority of the FDIC suggests to us that this agency should run the process as part of its larger asset sale operations.
* This now "clean" whole loan collateral will then be re-sold to solvent banks in the localities where the property is located, using zip codes and other means to identify eligible buyers, priced at say 90 cents on the dollar, with a full recourse guarantee from the FDIC and financing from the Federal Reserve Bank in the relevant district. The banks will initially be guaranteed a minimum net interest margin and servicing income, and immediately begin to service the loan and manage the credit locally. Indeed, the participating bank must agree to retain and service the loan so long as government financing is used. The bank has the option to repay the financing from Treasury and take full, non-recourse possession of the loan.
We don't pretend that this simple outline is sufficient treatment of this proposal, but we have heard several permutations of this approach from veteran bankers in the loan origination channel all over the US. We see several advantages to this "community bank" approach to the crisis, which might be combined with modest additional capital infusions to solvent community and regional banks like WABC, if they even need it.
* First, it puts the trillions of dollars in now illiquid mortgage loan collateral trapped inside thousands of securitization deals back into strong local hands, who are responsible and incentivized to both manage and service the loan.
* Second, it re-liquefies the balance sheets of the US banking industry and it will vastly improve the prospects for home owners and housing markets around the country. If we are going to further lever the balance sheets of the Treasury and Fed, let's do it for a real reason and with a clear purpose.
* Third, the approach outlined above provides the Obama Administration and the US Treasury with maximum bang for the buck in terms of both addressing the solvency problems facing the banks and also helping the economy and the housing industry.
One downside: This new market paradigm suggests that loan servicing as a standalone business may be at risk. Once community banks begin to accumulate significant local servicing portfolios, they may rediscover the benefits of keeping the credits that they originate. Sorry Wilbur! And what about valuation? Well, as our friend Kyle Bass of Hayman Capital likes to remind us, all of these assets are valued and traded every day. It's just a matter of organizing the purchase process in a transparent and competent fashion. Starting with our friends at shops like Hayman, Black Rock and RW Pressprich, we know people who know how to trade illiquid assets. Of interest, securitization experts like Raynes believe that servicing will remain a viable business model, but only time will tell. We notice that nobody seems to want the Lehman Brothers servicing portfolio that is still sitting in the NY bankruptcy of the parent.
In the course of the ongoing financial crisis, we’ve been ceaselessly reminded of the dangers of moral hazard—the idea that if people are insulated from the negative effects of their gambles they are more likely to act rashly. When Bear Stearns was bailed out, last spring, the move was attacked for exacerbating the threat of moral hazard. When Lehman Brothers was allowed to go bankrupt, in mid-September, the decision was praised by some for reducing the risk of moral hazard. These days, moral-hazard concerns are making policymakers cautious about stemming the rise in foreclosures, and about dealing with ailing banks: if we bail out banks or homeowners, we’re told, it will only encourage more recklessness.
The concept of moral hazard seems commonsensical. A frequently cited example is fire insurance: people who know they’ll be reimbursed if their house burns down supposedly won’t worry as much about preventing fires, and so will have more fires than people who don’t have insurance. By extension, the argument goes, if banks think that the government will bail them out in a pinch, they’re more likely to make risky bets. That’s why moral-hazard fundamentalists advocated letting Lehman Brothers fail, and making it clear that bad decisions have consequences.
Of course, not acting also has costs, and sometimes—as in the case of Lehman’s failure—those costs are immense. So, if the threat of moral hazard is going to encourage inaction in a crisis, we should be sure that threat is real. And there certainly are situations where moral hazard does seem to have an effect on people’s choices. Deposit insurance can make depositors less vigilant about the quality of banks, increasing the likelihood that bankers will make bad gambles with depositors’ money, as they did during the savings-and-loan crisis of the eighties. In other circumstances, though, moral hazard seems to have a much smaller impact. And, in the case of public-sector intervention during financial crises, evidence for its dangers is surprisingly flimsy.
The International Monetary Fund, for example, has helped bail out developing countries across the globe. If those bailouts heightened moral hazard, you’d expect the recipient countries to be more reckless in their spending and borrowing, and outside investors to be more careless in their lending. Yet a number of studies looking at the effects of I.M.F. bailouts on things like credit spreads and capital flows have found little evidence for that. On the contrary, a 2002 study by Steven Kamin, of the Federal Reserve, found that, when it came to investing in developing countries, "investors appear to be discriminating among credit risks more carefully than ever." Similarly, the U.S. government’s bailout of banks this fall hasn’t led them to lend rashly; indeed, they’ve been attacked for not lending enough. Even the example of fire insurance doesn’t provide much proof of moral hazard: as it turns out, people who are insured often have fewer accidents, not more. A recent study of businesses in Taiwan suggests that this may be because companies with fire insurance actually take more precautions against fires—the reverse of what the theory of moral hazard predicts.
Why might the effects of moral hazard be smaller than expected? To begin with, most bailouts aren’t like deposit insurance, which is certain and quick. Financial bailouts are uncertain and messy, and they typically occur only after institutions have already suffered extensive damage. Bear Stearns, for instance, was "saved" only after its shares had fallen almost ninety-five per cent from the previous year, and it seems unlikely that either its laid-off workers or its battered shareholders came out of the experience anxious to engage in more foolhardy behavior.
The moral-hazard argument also assumes that the most important factor shaping corporate decisions is the interest of the company as a whole. But, more often, what’s shaping those decisions is the interest of individuals, and on Wall Street those interests are often only loosely connected to the long-term health of companies. The fact that people can reap enormous rewards for decisions that are beneficial in the short term but costly in the long term is likely to lead to reckless behavior, regardless of whether companies are bailed out or not. Even if we allow Citigroup to fail, after all, Chuck Prince, the former C.E.O., will still have walked away with a package reportedly worth more than seventy million dollars.
Finally, the biggest reason that moral hazard matters less than it might is that it can operate only if people actively countenance the possibility that their decisions could lead to complete disaster. But it’s well documented that people generally, and investors particularly, are overconfident and significantly underestimate the chances of being wiped out. The moral-hazard fundamentalists argue that banks and other financial institutions will act recklessly if they think they’ll be rescued in the event of failure. But Wall Street was reckless because it never believed that failure was even a possibility.
The patchiness of the moral-hazard argument doesn’t mean that we should simply rubber-stamp another bank bailout; that may be both unjust and a poor strategy for whipping the financial sector into shape. But it does mean that the failure of Lehman Brothers was an unnecessary and costly sacrifice to moral-hazard fundamentalism. It also means that we should not sit quietly by because we fear that government action today will lead to reckless market behavior years from now. Moral hazard has its costs. But, so far, our fear of it has proved much more expensive. ?
You Try to Live on 500K in This Town
Private school: $32,000 a year per student. Mortgage: $96,000 a year. Co-op maintenance fee: $96,000 a year. Nanny: $45,000 a year. We are already at $269,000, and we haven’t even gotten to taxes yet. Five hundred thousand dollars — the amount President Obama wants to set as the top pay for banking executives whose firms accept government bailout money — seems like a lot, and it is a lot. To many people in many places, it is a princely sum to live on. But in the neighborhoods of New York City and its suburban enclaves where successful bankers live, half a million a year can go very fast.
“As hard as it is to believe, bankers who are living on the Upper East Side making $2 or $3 million a year have set up a life for themselves in which they are also at zero at the end of the year with credit cards and mortgage bills that are inescapable,” said Holly Peterson, the author of an Upper East Side novel of manners, “The Manny,” and the daughter of Peter G. Peterson, a founder of the equity firm the Blackstone Group. “Five hundred thousand dollars means taking their kids out of private school and selling their home in a fire sale.” Sure, the solution may seem simple: move to Brooklyn or Hoboken, put the children in public schools and buy a MetroCard. But more than a few of the New York-based financial executives who would have their pay limited are men (and they are almost invariably men) whose identities are entwined with living a certain way in a certain neighborhood west of Third Avenue: a life of private schools, summer houses and charity galas that only a seven-figure income can stretch to cover.
Few are playing sad cellos over the fate of such folk, especially since the collapse of the institutions they run has yielded untold financial pain. But in New York, where a new study from the Center for an Urban Future, a nonprofit research group in Manhattan, estimates it takes $123,322 to enjoy the same middle-class life as someone earning $50,000 in Houston, extricating oneself from steep bills can be difficult. Therefore, even if it is not for sympathy but for sport, consider the numbers. The cold hard math can be cruel. Like those taxes. If a person is married with two children, the weekly deductions on a $500,000 salary are: federal taxes, $2,645; Social Security, $596; Medicare, $139; state taxes, $682; and city, $372, bringing the weekly take-home to $5,180, or about $269,000 a year, said Martin Cohen, a Manhattan accountant. Now move to living expenses.
Barbara Corcoran, a real estate executive, said that most well-to-do families take at least two vacations a year, a winter trip to the sun and a spring trip to the ski slopes. Total minimum cost: $16,000. A modest three-bedroom apartment, she said, which was purchased for $1.5 million, not the top of the market at all, carries a monthly mortgage of about $8,000 and a co-op maintenance fee of $8,000 a month. Total cost: $192,000. A summer house in Southampton that cost $4 million, again not the top of the market, carries annual mortgage payments of $240,000. Many top executives have cars and drivers. A chauffeur’s pay is between $75,000 and $125,000 a year, the higher end for former police officers who can double as bodyguards, said a limousine driver who spoke anonymously because he does not want to alienate his society customers.
“Some of them want their drivers to have guns,” the driver said. “You get a cop and you have a driver.” To garage that car is about $700 a month. A personal trainer at $80 an hour three times a week comes to about $12,000 a year. The work in the gym pays off when one must don a formal gown for a charity gala. “Going to those parties,” said David Patrick Columbia, who is the editor of the New York Social Diary (newyorksocialdiary.com), “a woman can spend $10,000 or $15,000 on a dress. If she goes to three or four of those a year, she’s not going to wear the same dress.” Total cost for three gowns: about $35,000. Not every bank executive has school-age children, but for those who do, offspring can be expensive. In addition to paying tuition, “You’re not going to get through private school without tutoring a kid,” said Sandy Bass, the editor of Private School Insider, a newsletter that covers private schools in the New York City area. One hour of tutoring once a week is $125. “That’s the low end,” she said. “The higher end is 150, 175.” SAT tutors are about $250 an hour. Total cost for 30 weeks of regular tutoring: $3,750.
Two children in private school: $64,000. Nanny: $45,000. Ms. Bass, whose husband is an accountant with many high-end clients, said she spends about $425 every 10 days on groceries for her family. Annual cost: about $15,000. More? Restaurants. Dry cleaning. Each Brooks Brothers suit costs about $1,000. If you run a bank, you can’t look like a slob. The total costs here, which do not include a lot of things, like kennels for the dog when the family is away, summer camp, spas and other grooming for the human members of the family, donations to charity, and frozen hot chocolates at Serendipity, are $790,750, which would require about a $1.6-million salary to compensate for taxes. Give or take a few score thousand of dollars.
Does this money buy a chief executive stockholders might prize, a well-to-do man with a certain sureness of stride, something that might be lost if the executive were crowding onto the PATH train every morning at Journal Square, his newspaper splayed against the back of a stranger’s head? The man would certainly not feel like himself on that train, said Candace Bushnell, the author of “Sex and the City” and other books chronicling New York social mores. “People inherently understand that if they are going to get ahead in whatever corporate culture they are involved in, they need to take on the appurtenances of what defines that culture,” she said. “So if you are in a culture where spending a lot of money is a sign of success, it’s like the same thing that goes back to high school peer pressure. It’s about fitting in.” By the way, the frozen hot chocolate costs $8.50.
Recession? No, It's a D-process, and It Will Be Long
Nobody was better prepared for the global market crash than clients of Ray Dalio's Bridgewater Associates and subscribers to its Daily Observations. Dalio, the chief investment officer and all-around guiding light of the global money-management company he founded more than 30 years ago, began sounding alarms in Barron's in the spring of 2007 about the dangers of excessive financial leverage. He counts among his clients world governments and central banks, as well as pension funds and endowments.
No wonder. The Westport, Conn.-based firm, whose analyses of world markets focus on credit and currencies, has produced long-term annual returns, net of fees, averaging 15%. In the turmoil of 2008, Bridgewater's Pure Alpha 1 fund gained 8.7% net of fees and Pure Alpha 2 delivered 9.4%.
Here's what's on his mind now.
Barron's: I can't think of anyone who was earlier in describing the deleveraging and deflationary process that has been happening around the world.
Dalio: Let's call it a "D-process," which is different than a recession, and the only reason that people really don't understand this process is because it happens rarely. Everybody should, at this point, try to understand the depression process by reading about the Great Depression or the Latin American debt crisis or the Japanese experience so that it becomes part of their frame of reference. Most people didn't live through any of those experiences, and what they have gotten used to is the recession dynamic, and so they are quick to presume the recession dynamic. It is very clear to me that we are in a D-process.
Why are you hesitant to emphasize either the words depression or deflation? Why call it a D-process?
Both of those words have connotations associated with them that can confuse the fact that it is a process that people should try to understand.
You can describe a recession as an economic retraction which occurs when the Federal Reserve tightens monetary policy normally to fight inflation. The cycle continues until the economy weakens enough to bring down the inflation rate, at which time the Federal Reserve eases monetary policy and produces an expansion. We can make it more complicated, but that is a basic simple description of what recessions are and what we have experienced through the post-World War II period. What you also need is a comparable understanding of what a D-process is and why it is different.
You have made the point that only by understanding the process can you combat the problem. Are you confident that we are doing what's essential to combat deflation and a depression?
The D-process is a disease of sorts that is going to run its course.
When I first started seeing the D-process and describing it, it was before it actually started to play out this way. But now you can ask yourself, OK, when was the last time bank stocks went down so much? When was the last time the balance sheet of the Federal Reserve, or any central bank, exploded like it has? When was the last time interest rates went to zero, essentially, making monetary policy as we know it ineffective? When was the last time we had deflation?
The answers to those questions all point to times other than the U.S. post-World War II experience. This was the dynamic that occurred in Japan in the '90s, that occurred in Latin America in the '80s, and that occurred in the Great Depression in the '30s.
Basically what happens is that after a period of time, economies go through a long-term debt cycle -- a dynamic that is self-reinforcing, in which people finance their spending by borrowing and debts rise relative to incomes and, more accurately, debt-service payments rise relative to incomes. At cycle peaks, assets are bought on leverage at high-enough prices that the cash flows they produce aren't adequate to service the debt. The incomes aren't adequate to service the debt. Then begins the reversal process, and that becomes self-reinforcing, too. In the simplest sense, the country reaches the point when it needs a debt restructuring. General Motors is a metaphor for the United States.
As goes GM, so goes the nation?
The process of bankruptcy or restructuring is necessary to its viability. One way or another, General Motors has to be restructured so that it is a self-sustaining, economically viable entity that people want to lend to again.
This has happened in Latin America regularly. Emerging countries default, and then restructure. It is an essential process to get them economically healthy.
We will go through a giant debt-restructuring, because we either have to bring debt-service payments down so they are low relative to incomes -- the cash flows that are being produced to service them -- or we are going to have to raise incomes by printing a lot of money.
It isn't complicated. It is the same as all bankruptcies, but when it happens pervasively to a country, and the country has a lot of foreign debt denominated in its own currency, it is preferable to print money and devalue.
Isn't the process of restructuring under way in households and at corporations?
They are cutting costs to service the debt. But they haven't yet done much restructuring. Last year, 2008, was the year of price declines; 2009 and 2010 will be the years of bankruptcies and restructurings. Loans will be written down and assets will be sold. It will be a very difficult time. It is going to surprise a lot of people because many people figure it is bad but still expect, as in all past post-World War II periods, we will come out of it OK. A lot of difficult questions will be asked of policy makers. The government decision-making mechanism is going to be tested, because different people will have different points of view about what should be done.
What are you suggesting?
An example is the Federal Reserve, which has always been an autonomous institution with the freedom to act as it sees fit. Rep. Barney Frank [a Massachusetts Democrat and chairman of the House Financial Services Committee] is talking about examining the authority of the Federal Reserve, and that raises the specter of the government and Congress trying to run the Federal Reserve. Everybody will be second-guessing everybody else.
So where do things stand in the process of restructuring?
What the Federal Reserve has done and what the Treasury has done, by and large, is to take an existing debt and say they will own it or lend against it. But they haven't said they are going to write down the debt and cut debt payments each month. There has been little in the way of debt relief yet. Very, very few actual mortgages have been restructured. Very little corporate debt has been restructured.
The Federal Reserve, in particular, has done a number of successful things. The Federal Reserve went out and bought or lent against a lot of the debt. That has had the effect of reducing the risk of that debt defaulting, so that is good in a sense. And because the risk of default has gone down, it has forced the interest rate on the debt to go down, and that is good, too.
However, the reason it hasn't actually produced increased credit activity is because the debtors are still too indebted and not able to properly service the debt. Only when those debts are actually written down will we get to the point where we will have credit growth. There is a mortgage debt piece that will need to be restructured. There is a giant financial-sector piece -- banks and investment banks and whatever is left of the financial sector -- that will need to be restructured. There is a corporate piece that will need to be restructured, and then there is a commercial-real-estate piece that will need to be restructured.
Is a restructuring of the banks a starting point?
If you think that restructuring the banks is going to get lending going again and you don't restructure the other pieces -- the mortgage piece, the corporate piece, the real-estate piece -- you are wrong, because they need financially sound entities to lend to, and that won't happen until there are restructurings.
On the issue of the banks, ultimately we need banks because to produce credit we have to have banks. A lot of the banks aren't going to have money, and yet we can't just let them go to nothing; we have got to do something.
But the future of banking is going to be very, very different. The regulators have to decide how banks will operate. That means they will have to nationalize some in some form, but they are going to also have to decide who they protect: the bondholders or the depositors?
Nationalization is the most likely outcome?
There will be substantial nationalization of banks. It is going on now and it will continue. But the same question will be asked even after nationalization: What will happen to the pile of bad stuff?
Let's say we are going to end up with the good-bank/bad-bank concept. The government is going to put a lot of money in -- say $100 billion -- and going to get all the garbage at a leverage of, let's say, 10 to 1. They will have a trillion dollars, but a trillion dollars' worth of garbage. They still aren't marking it down. Does this give you comfort?
Then we have the remaining banks, many of which will be broke. The government will have to recapitalize them. The government will try to seek private money to go in with them, but I don't think they are going to come up with a lot of private money, not nearly the amount needed.
To the extent we are going to have nationalized banks, we will still have the question of how those banks behave. Does Congress say what they should do? Does Congress demand they lend to bad borrowers? There is a reason they aren't lending. So whose money is it, and who is protecting that money?
The biggest issue is that if you look at the borrowers, you don't want to lend to them. The basic problem is that the borrowers had too much debt when their incomes were higher and their asset values were higher. Now net worths have gone down.
Let me give you an example. Roughly speaking, most of commercial real estate and a good deal of private equity was bought on leverage of 3-to-1. Most of it is down by more than one-third, so therefore they have negative net worth. Most of them couldn't service their debt when the cash flows were up, and now the cash flows are a lot lower. If you shouldn't have lent to them before, how can you possibly lend to them now?
I guess I'm thinking of the examples of people and businesses with solid credit records who can't get banks to lend to them.
Those examples exist, but they aren't, by and large, the big picture. There are too many nonviable entities. Big pieces of the economy have to become somehow more viable. This isn't primarily about a lack of liquidity. There are certainly elements of that, but this is basically a structural issue. The '30s were very similar to this.
By the way, in the bear market from 1929 to the bottom, stocks declined 89%, with six rallies of returns of more than 20% -- and most of them produced renewed optimism. But what happened was that the economy continued to weaken with the debt problem. The Hoover administration had the equivalent of today's TARP [Troubled Asset Relief Program] in the Reconstruction Finance Corp. The stimulus program and tax cuts created more spending, and the budget deficit increased.
At the same time, countries around the world encountered a similar kind of thing. England went through then exactly what it is going through now. Just as now, countries couldn't get dollars because of the slowdown in exports, and there was a dollar shortage, as there is now. Efforts were directed at rekindling lending. But they did not rekindle lending. Eventually there were a lot of bankruptcies, which extinguished debt.
In the U.S., a Democratic administration replaced a Republican one and there was a major devaluation and reflation that marked the bottom of the Depression in March 1933.
Where is the U.S. and the rest of the world going to keep getting money to pay for these stimulus packages?
The Federal Reserve is going to have to print money. The deficits will be greater than the savings. So you will see the Federal Reserve buy long-term Treasury bonds, as it did in the Great Depression. We are in a position where that will eventually create a problem for currencies and drive assets to gold.
Are you a fan of gold?
Have you always been?
What about bonds? The conventional wisdom has it that bonds are the most overbought and most dangerous asset class right now.
Everything is timing. You print a lot of money, and then you have currency devaluation. The currency devaluation happens before bonds fall. Not much in the way of inflation is produced, because what you are doing actually is negating deflation. So, the first wave of currency depreciation will be very much like England in 1992, with its currency realignment, or the United States during the Great Depression, when they printed money and devalued the dollar a lot. Gold went up a whole lot and the bond market had a hiccup, and then long-term rates continued to decline because people still needed safety and liquidity. While the dollar is bad, it doesn't mean necessarily that the bond market is bad.
I can easily imagine at some point I'm going to hate bonds and want to be short bonds, but, for now, a portfolio that is a mixture of Treasury bonds and gold is going to be a very good portfolio, because I imagine gold could go up a whole lot and Treasury bonds won't go down a whole lot, at first.
Ideally, creditor countries that don't have dollar-debt problems are the place you want to be, like Japan. The Japanese economy will do horribly, too, but they don't have the problems that we have -- and they have surpluses. They can pull in their assets from abroad, which will support their currency, because they will want to become defensive. Other currencies will decline in relationship to the yen and in relationship to gold.
Now we have the delicate China question. That is a complicated, touchy question.
The reasons for China to hold dollar-denominated assets no longer exist, for the most part. However, the desire to have a weaker currency is everybody's desire in terms of stimulus. China recognizes that the exchange-rate peg is not as important as it was before, because the idea was to make its goods competitive in the world. Ultimately, they are going to have to go to a domestic-based economy. But they own too much in the way of dollar-denominated assets to get out, and it isn't clear exactly where they would go if they did get out. But they don't have to buy more. They are not going to continue to want to double down.
From the U.S. point of view, we want a devaluation. A devaluation gets your pricing in line. When there is a deflationary environment, you want your currency to go down. When you have a lot of foreign debt denominated in your currency, you want to create relief by having your currency go down. All major currency devaluations have triggered stock-market rallies throughout the world; one of the best ways to trigger a stock-market rally is to devalue your currency.
But there is a basic structural problem with China. Its per capita income is less than 10% of ours. We have to get our prices in line, and we are not going to do it by cutting our incomes to a level of Chinese incomes.
And they are not going to do it by having their per capita incomes coming in line with our per capita incomes. But they have to come closer together. The Chinese currency and assets are too cheap in dollar terms, so a devaluation of the dollar in relation to China's currency is likely, and will be an important step to our reflation and will make investments in China attractive.
You mentioned, too, that inflation is not as big a worry for you as it is for some. Could you elaborate?
A wave of currency devaluations and strong gold will serve to negate deflationary pressures, bringing inflation to a low, positive number rather than producing unacceptably high inflation -- and that will last for as far as I can see out, roughly about two years.
Given this outlook, what is your view on stocks?
Buying equities and taking on those risks in late 2009, or more likely 2010, will be a great move because equities will be much cheaper than now. It is going to be a buying opportunity of the century.
Agriculture Census Shows Growing Diversity in Farming
The number of farms in the United States has grown 4 percent and the operators of those farms have become more diverse in the past five years, according to results of the 2007 Census of Agriculture released today by the U.S. Department of Agriculture's National Agricultural Statistics Service (NASS). "The Census of Agriculture is a valuable tool that provides the general public with an accurate and comprehensive view of American agriculture. It's also a set of benchmarks against which this Department must measure and demonstrate its performance to agriculture and the taxpayer," said Secretary Tom Vilsack. " In the spirit of President Obama's call to make government more transparent, inclusive, and collaborative, I will be directing my team at USDA to review the findings of the 2007 Census and propose ambitious, measurable goals to make sure that the People's Department is hard at work for all the people – our diverse customers and the full diversity of agriculture."
The 2007 Census counted 2,204,792 farms in the United States, a net increase of 75,810 farms. Nearly 300,000 new farms have begun operation since the last census in 2002. Compared to all farms nationwide, these new farms tend to have more diversified production, fewer acres, lower sales and younger operators who also work off-farm. In the past five years, U.S. farm operators have become more demographically diverse. The 2007 Census counted nearly 30 percent more women as principal farm operators. The count of Hispanic operators grew by 10 percent, and the counts of American Indian, Asian and Black farm operators increased as well. The latest census figures show a continuation in the trend towards more small and very large farms and fewer mid-sized operations. Between 2002 and 2007, the number of farms with sales of less than $2,500 increased by 74,000. The number of farms with sales of more than $500,000 grew by 46,000 during the same period.
Census results show that the majority of U.S. farms are smaller operations. More than 36 percent are classified as residential/lifestyle farms, with sales of less than $250,000 and operators with a primary occupation other than farming. Another 21 percent are retirement farms, which have sales of less than $250,000 and operators who reported they are retired. In addition to looking at farm numbers, operator demographics and economic aspects of farming, the Census of Agriculture delves into numerous other areas, including organic, value-added, and specialty production, all of which are on the rise. The 2007 Census found that 57 percent of all farmers have internet access, up from 50 percent in 2002. For the first time in 2007, the census also looked at high-speed Internet access. Of those producers accessing the Internet, 58 percent reported having a high-speed connection. Other "firsts" in the 2007 Census include questions about on-farm energy generation, community-supported agriculture arrangements and historic barns. The Census of Agriculture, conducted every five years, is a complete count of the nation's farms and ranches and the people who operate them. It provides the only source of uniform, comprehensive agricultural data for every county in the nation. Census results are available online at www.agcensus.usda.gov .
How Congress Trumps Darwin
"Descended from the apes!" exclaimed the wife of the bishop of Worcester. "Let us hope that it is not true, but if it is, let us pray that it will not become generally known." An American majority resists such an annoying notion, endorsing the proposition that "God created human beings pretty much in their present form at one time within the last 10,000 years." Still, evolution is a fact, and its mechanism is natural selection: Creatures with variations especially suited to their environmental situation have more descendants than do less well-adapted creatures. This Thursday, the 200th anniversary of the births of Charles Darwin and Abraham Lincoln, remember that Lincoln mattered more. Without Darwin, other scientists would have discerned natural selection. Indeed, Darwin's friend Alfred Wallace already had. Without Lincoln, the United States probably would have been sundered into at least two nations. Probably into more: Southerners, a fractious tribe, would not have played nicely together in the Confederacy for very long.
Unlike Lincoln, Darwin still disturbs humanity's peace of mind. Some people flinch from the idea of natural selection, a.k.a. "survival of the fittest," because it suggests Lord Tennyson's "nature, red in tooth and claw." But Darwin, in the last paragraph of "The Origin of Species," saw beauty: "Thus, from the war of nature, from famine and death, the most exalted object which we are capable of conceiving, namely, the production of the higher animals, directly follows. There is grandeur in this view of life, with its several powers, having been originally breathed into a few forms or into one; and that, whilst this planet has gone cycling on according to the fixed law of gravity, from so simple a beginning endless forms most beautiful and most wonderful have been, and are being, evolved." Walt Whitman, seared by Lincoln's war to guarantee the nation's survival, adopted a materialist's mysticism about the slaughter: Human immortality is in earth's transformation of bodies into an "unseen essence and odor of surface and grass, centuries hence."
After Copernicus dislodged humanity from the center of the universe, Marx asserted that false consciousness -- we do not really "make up our minds" -- blinds us to the fact that we are in the grip of an implacable dialectic of impersonal forces. Darwin placed humanity in a continuum of all protoplasm. Then Freud declared that the individual's "self" or personhood is actually a sort of unruly committee. All this dented humanity's self-esteem. Still, many people of faith find Darwinism compatible with theism: God, they say, initiated and directs the dynamic that Darwin described. In the end, Darwin, in spite of perfunctory rhetorical references to "the Creator," disagreed. As a scientist dealing with probabilities, and with a profoundly materialist theory, he had no intellectual room for a directing deity that wills a special destination for our species. Darwin's rejection of premeditated design helped to validate an analogous political philosophy. The fact of order in nature does not require us to postulate a divine Orderer, and the social order does not presuppose an order-giving state. As a practical matter, we cannot expel government from our understanding of society as Darwin expelled God from the understanding of nature. But Darwinism opens the mind to the fecundity of undirected, spontaneous, organic social arrangements -- to Edmund Burke and Friedrich Hayek.
Speaking of government, in 1973, Congress passed the Endangered Species Act. It said that when identifying an "endangered" or "threatened" species, the government should assess not only disease, predation and threats to its habitat but also "other natural . . . factors affecting its continued existence." Natural factors? Four years later, the act held up construction of a Tennessee dam deemed menacing to the snail-darter minnow. Ed Yoder, a learned and sometimes whimsical columnist, noted that it was under Tennessee's "monkey law" that John Scopes was tried in 1925 for teaching biology in a way considered incompatible with Genesis. While not equating Tennessee's law with "a measure so enlightened" as the 1973 act, Yoder noted: "Both measures involve legislative interposition in the realm of biological change; and which will have involved the greater hubris is yet to be seen. Tennessee's ambitions were comparatively modest. It sought only to conceal the disturbing evidence of natural selection from impressionable school children. The Congress of the United States, one is intrigued to learn, intends to stop the nasty business in its tracks." With that accomplished, it should be child's play for Congress to make the climate behave. Pick your own meaning of "child's play."
Why sustainable power is unsustainable
Renewable energy needs to become a lot more renewable – a theme that emerged at the Financial Times Energy Conference in London this week. Although scientists are agreed that we must cut carbon emissions from transport and electricity generation to prevent the globe's climate becoming hotter, and more unpredictable, the most advanced "renewable" technologies are too often based upon non-renewable resources, attendees heard. Supratik Guha of IBM told the conference that sales of silicon solar cells are booming, with 2008 being the first year that the silicon wafers for solar cells outstripped those used for microelectronic devices. But although silicon is the most abundant element in the Earth's crust after oxygen, it makes relatively inefficient cells that struggle to compete with electricity generated from fossil fuels. And the most advanced solar-cell technologies rely on much rarer materials than silicon.
The efficiency of solar cells is measured as a percentage of light energy they convert to electricity. Silicon solar cells finally reached 25% in late December. But multi-junction solar cells can achieve efficiencies greater than 40%. Although touted as the future of solar power, those and most other multiple-junction cells owe their performance to the rare metal indium, which is far from abundant. There are fewer than 10 indium-containing minerals, and none present in significant deposits – in total the metal accounts for a paltry 0.25 parts per million of the Earth's crust. Most of the rare and expensive element is used to manufacture LCD screens, an industry that has driven indium prices to $1000 per kilogram in recent years. Estimates that did not factor in an explosion in indium-containing solar panels reckon we have only a 10 year supply of it left. If power from the Sun is to become a major source of electricity, solar panels would have to cover huge areas, making an alternative to indium essential.
The dream of the hydrogen economy faces similar challenges, said Paul Adcock of UK firm Intelligent Energy. A cheap way to generate hydrogen has so far proved elusive. New approaches, such as using bacterial enzymes to "split" water, have a long way to go before they are commercially viable. So far, fuel cells are still the most effective way to turn the gas into electricity. But these mostly rely on expensive platinum to catalyse the reaction. The trouble is, platinum makes indium appear super-abundant. It is present in the Earth's crust at just 0.003 parts per billion and is priced in $ per gram, not per kilogram. Estimates say that, if the 500 million vehicles in use today were fitted with fuel cells, all the world's platinum would be exhausted within 15 years.
Unfortunately platinum-free fuel cells are still a long way from the test track. A nickel-catalysed fuel cell developed at Wuhan University, China, has a maximum output only around 10% of that a platinum catalyst can offer. A new approach announced yesterday demonstrates that carbon nanotubes could be more effective, as well as cheaper, than platinum. But again it will be many years before platinum-free fuel cells become a commercial prospect.
Biofuels, like ethanol fermented from maize, are the most infamous examples of the doubtful sustainability of supposedly renewable forms of energy. This time the non-renewable resource at risk is the world's arable land, Ausilio Bauen of Imperial College London said at the meeting. Again, there are potential solutions, but none that are ready for market. Biofuels from cellulose or even lignin can be derived from inedible plant material and wood rather than food crops. Algae, grown in outdoor tanks, continues to attract attention, and extracting biofuel from marine algae or seaweed could sidestep land use issues altogether. Renewable energy technologies remain the great hope for the future, and are guaranteed research funds in the short term. But unless a second generation of sustainable energy ideas based on truly sustainable resources is established, the renewable light could be in danger of dimming