Ilargi: I read this piece on Ciudad Juarez today, it's at the bottom of today's post. I’ve never been, and I don't feel like it should be in my top 10 places yet to visit either. Juarez takes me back to While you were sleeping (PLEASE DO READ IF YOU HAVEN"T YET!), something I referred to on April 9, 2008 in While you were sleeping: A financial coup d'état.
Juarez also makes me think of Dylan, whose reference to the town allegedly was a mystery to his fans for years; they had no clue what he said. Juarez on the Texas-Mexico border is a sort of Mad Max come alive, and don't get caught on the wrong side of that line. It’s the most outstanding example I can think of of what we do to other people, without any compassion or pity. In order to keep our junk trinkets cheap, we sacrifice many a human life just across one single bridge. One bridge away from the US, the Mexican government is powerless. Mad Max rules the day. To what extent the CIA rules Mad Max, I can but guess. Still, knowing to what degree the secret services of the planet fund their operations through drug trade, I'd venture that the US' own bureaus play a significant part in the chaos developing on its very doorstep.
Dylan's words date back 45 years. Who would recognize his Ciudad Juarez today? Read about Juarez, and then realize it's a important part of NAFTA. People live through hell and beyond to be part of that treaty. Free trade is nothing but yet another way of saying I'm going to suck dry the blood of your virgin daughters. These days, it's more "When you’re lost in the hell in Juarez".
Just Like Tom Thumb's Blues
When you're lost in the rain in Juarez
And it's Eastertime too
And your gravity fails
And negativity don't pull you through
Don't put on any airs
When you're down on Rue Morgue Avenue
They got some hungry women there
And they really make a mess outa you.
Now if you see Saint Annie
Please tell her thanks a lot
I cannot move
My fingers are all in a knot
I don't have the strength
To get up and take another shot
And my best friend, my doctor
Won't even say what it is I've got.
The peasants call her the goddess of gloom
She speaks good English
And she invites you up into her room
And you're so kind
And careful not to go to her too soon
And she takes your voice
And leaves you howling at the moon.
Up on Housing Project Hill
It's either fortune or fame
You must pick up one or the other
Though neither of them are to be what they claim
If you're lookin' to get silly
You better go back to from where you came
Because the cops don't need you
And man they expect the same.
Now all the authorities
They just stand around and boast
How they blackmailed the sergeant-at-arms
Into leaving his post
And picking up Angel who
Just arrived here from the coast
Who looked so fine at first
But left looking just like a ghost.
I started out on burgundy
But soon hit the harder stuff
Everybody said they'd stand behind me
When the game got rough
But the joke was on me
There was nobody even there to bluff
I'm going back to New York City
I do believe I've had enough.
U.S. Government Acts, but Losses Pile Up
U.S. stocks declined, sending the Standard & Poor's 500-stock index and Dow Jones industrial average to 12-year lows, as the government rescued Citigroup and shares of drugmakers and insurers fell on President Obama's health-care plan. Citigroup slid 23 percent, extending losses over the past year for what was once the largest U.S. bank to 94 percent. Humana led the health-care industry's retreat on concern Obama will cut Medicare payments to insurers and raise rebates drugmakers must provide to Medicaid recipients. Sallie Mae, the largest U.S. student lender, tumbled 40 percent as the president's first budget called for an end to loan subsidies.
"Before the end of a bear market, every group gets taken out and shot, and that's what we're experiencing here," said Robert T. Lutts, president of Cabot Money Management in Boston. "The prospect of a recovery is good, but not in the short term." The S&P 500 dropped 4.5 percent, to 735.09, its lowest close since December 1996. The Dow fell 302.74 points, or 4.1 percent, to 7062.93, its lowest close since May 1997. The Nasdaq composite index fell 4.4 percent, to 1377.84. Financial stocks as a group rose despite Citigroup. Federal Reserve Chairman Ben S. Bernanke said he hoped to avoid government control of banks in favor of a public-private partnership the United States would eventually exit.
Banks are driving S&P 500 companies as a group to their first quarterly loss. The 74 financial companies in the index that have reported fourth-quarter results lost a combined $50.5 billion, their third straight quarterly shortfall, according to data compiled by Bloomberg. Profit fell 37 percent on average at the 457 companies in the S&P 500 that have reported quarterly results since Jan. 12. Those reporting next week include American International Group, the insurer in talks to restructure its $150 billion government bailout, and Costco, the nation's biggest warehouse-club chain. Yields on Treasury securities climbed as the government sold a record $94 billion of new debt to finance a budget deficit that's expected to widen to a record $1.75 trillion this year. The benchmark 10-year note's yield rose to 3.02 percent, from 2.79 percent. The Treasury will auction $31 billion of three-month bills and $29 billion of six-month bills on Monday. They yielded 0.28 percent and 0.46 percent, respectively, in when-issued trading. One-month bills will be sold Tuesday.
Obama Will Seek Another $750 Billion for Banks if Necessary, Orszag Says
President Barack Obama’s administration will seek congressional approval for as much as $750 billion in new aid to bolster U.S. financial institutions if it is needed, White House budget director Peter Orszag said. “If additional efforts become necessary, we’ll work with Congress on the scale and scope of them,” Orszag said today on ABC’s “This Week” program. “The budget is intending to be responsible. We put a placeholder in there just as an insurance policy.” Obama’s first budget, a plan to spend $3.55 trillion during fiscal year 2010, seeks standby authority for $750 billion for financial firms while planning for a health-care system overhaul and almost $1 trillion in higher taxes for 2.6 million of the richest Americans.
U.S. firms have reported more than $700 billion in losses and writedowns since the start of 2007. The government last week ratcheted up its effort to save Citigroup Inc., agreeing to a third rescue attempt that will cut existing shareholders’ stake. The Treasury Department said it would convert as much as $25 billion of preferred shares into common stock provided private holders agree to the same terms. The conversion would give the U.S. a 36 percent stake in the New York-based company. Obama said yesterday he expects a fight to get the budget through Congress because it will challenge Washington interest groups and lobbyists. The president, in his weekly radio address, said the spending plan reflects the promises he made during the campaign to change the government’s priorities and take the nation in a new direction.
Senate Minority Whip Jon Kyl of Arizona criticized the budget for expanding the government’s role in the economy. “I think it’s terrifying in the policy implications as well as mind- boggling in the numbers,” Kyl said on “Fox News Sunday.” Obama’s budget is an attempt to “stimulate the economy through government expenditure,” House Minority Whip Eric Cantor said on the “This Week” program. “At best what that can do is redistribute wealth. It can’t create jobs. It can’t create wealth. We’ve got to get back to focusing on job creation and creating prosperity.”
The Obama administration forecasts the gross domestic product, the value of all goods and services, will contract 1.2 percent for the entire year, reflecting the deepening recession, and rebound to an average growth rate of 3.2 percent in 2010. The 2010 forecast is more optimistic than the 1.5 percent growth rate estimated by the nonpartisan Congressional Budget Office in January or the February Blue Chip consensus for an increase of 2.1 percent. Obama’s proposed budget “is putting us on a path to restore fiscal responsibility, but he’s starting in a big hole,” Representative Peter DeFazio, a Democrat from Oregon, said on CNN’s “State of the Union” program today. “So I’m going to work with the president to tighten this budget wherever we can.
We need shock and awe policies to halt depression
As ordinary citizens with no power over the levers of policy, we watch from the sidelines, and weep. The whole global economy has tipped into a downward spiral. Trade and output are contracting at rates that outstrip the leisurely depression of the 1930s. Debt deflation has simply washed over the drastic measures taken by governments everywhere. Judging by the latest Merrill Lynch survey of fund managers, investors have a touching faith that China is going to rescue us all and re-ignite the commodity boom. How can this be? Taiwan's exports to China fell 55pc in January, Japan's fell 45pc. These exports are links in the supply chain for China's industry. Manufacturing output in the Shanghai region fell 12pc in January.
My favourite China guru, Michael Pettis from Beijing University, is in despair – as you can see on his blog (http://mpettis.com). The property bubble is bursting. Developers have built more offices in Beijing since 2006 than the entire stock in Manhattan. There is a 14-year supply glut. We have seen this movie before. Factory output is collapsing at the fastest pace everywhere. The figures for the most recent month available are, year-on-year: Taiwan (-43pc), Ukraine (-34pc), Japan (-30pc), Singapore (-29pc), Hungary (-23pc), Sweden (-20pc), Korea (-19pc), Turkey (-18pc), Russia (-16pc), Spain (-15pc), Poland (-15pc), Brazil (-15pc), Italy (-14pc), Germany (-12pc), France (-11pc), US (-10pc) and Britain (-9pc). Norway sails blissfully on (+4pc). What do they drink up there?
This terrifying fall has been concentrated in the last five months. The job slaughter has barely begun. Social mayhem comes with a 12-month lag. By comparison, industrial output in core-Europe fell 2.8pc in 1930, 5.1pc in 1931 and 3.9pc in 1932, according to RBS. Stephen Lewis, from Monument Securities, says we have been lulled into a false sense of security by the lack of "soup kitchens". The visual cues from Steinbeck's America are missing. "The temptation for investors is to see this as just another recession, over by the end of the year. But this is not a normal cycle. It is a cataclysmic structural breakdown," he said. Fiscal stimulus is reaching its global limits. The lowest interest rates in history are failing to gain traction. The Fed seems paralyzed. It first talked of buying US Treasuries three months ago, but cannot seem to bring itself to hit the nuclear button.
As the Fed dithers, a flood of bond issues from the US Treasury is swamping the debt market. The yield on 10-year Treasuries has climbed from 2pc to 3.04pc in eight weeks. The real cost of money is rising as deflation gathers pace. US house prices have fallen 27pc (Case-Shiller index). The pace of descent is accelerating. The 2.2pc fall in December was the worst month ever. January looks just as bad. Delinquenc-ies on prime mortgages were 1.72pc in September, 1.89pc in October, 2.13pc on November and 2.42pc in December. This is the trajectory eating away at the banking system. Graham Turner, from GFC Economics, fears the Dow could crash to 4,000 by summer unless there is a "quantum reduction" in mortgage rates. The Fed should swoop in to the market – armed with Ben Bernanke's "printing press" – and mop up enough Treasuries to force 10-year yields down to 1pc and mortgage rates to 2.5pc. Monetary shock and awe.
This remedy is fraught with risk, but all options are ghastly at this point. That is the legacy we have been left by the Greenspan doctrine. We are at the moment of extreme danger in Irving Fisher's "Debt Deflation Theory" (1933) where the ship fails to right itself by natural buoyancy, and capsizes instead. From all accounts, the Fed was ready to launch its bond blitz in January. Something happened. Perhaps the hawks awoke in cold sweats at night, fretting about Weimar. Perhaps they feared that China and the world will pull the plug on the US bond market. If so, it is time for Washington to get a grip. America remains the hegemonic global power. The Obama team should let it be known – and perhaps Hillary Clinton did just that on her trip to Asia – that any country playing games with the US bond market in this crisis will be treated as an enemy and pay a crushing price.
Pacific allies already know that they cannot take the US security blanket for granted. As for China – and others pursuing a mercantilist strategy of export-led growth – they must know that the US can shut off its market and wreak havoc to their economy. To Europe, they might make it clearer that unless the European Central Bank is brought to heel by the Continent's leaders (whatever Maastricht says) and forced to play its full part in emergency efforts to save the global economy, the NATO military alliance will wither and the region will be left to fend for itself against a revanchist Russia. Should the main threat come from an exodus of private wealth, Washington may have to impose temporary capital controls. Never forget, America is the one country with enough strategic depth to go it alone, if necessary. The US is not going to let foreigners keep it trapped in a depression.
I doubt matters will ever come to this. Japan is already in dire straits. Exports crashed 46pc in January, year-on-year. The Bank of Japan may soon start buying US Treasuries for its own reasons – just as it did from 2003 to 2004 – in order to reverse the 30pc rise of the yen over the last 18 months. If it helps preserve the Sino-US defence alliance in the face of Chinese naval expansion, so much the better. In any case, the storm has shifted across the Atlantic to Europe. Germany faces 5pc contraction this year (Deutsche Bank). The bill has come from the burst bubble in the ex-Soviet bloc. Europe's banks are on the hook for $1.6 trillion (£1.1 trillion). For the first time since the launch of monetary union, Europe's leaders are speaking openly about the risk of EMU break-up. A run on the US dollar looks a remote threat as the euro drama unfolds. The Fed may soon have all the room for manoeuvre it needs. Small comfort.
Abu Dhabi reviewing Citigroup investment -sources
Abu Dhabi is assessing its $7.5 billion investment in Citigroup as the bank's problems deepen and consequences of a possible nationalisation become clearer, according to sources close to the Abu Dhabi Investment Authority (ADIA). ADIA invested $7.5 billon last year in Citi through convertible bonds that pay 11 percent in interest, but it must start converting the bonds into 235.6 million shares in Citigroup from March next year. "Nothing has changed from ADIA's perspective at this point. ADIA's convertible bonds are due for conversion in a phased manner between March 2010 and September 2011, and that stands," an Abu Dhabi government official told Reuters. "But it is carefully assessing its options due to the latest events -- although no decision is taken yet," he said, declining to be named.
Abu Dhabi is the wealthiest of seven emirates within the United Arab Emirates, the world's fifth-largest petroleum exporter. ADIA's returns as a bondholder have been unaffected by continuing troubles at Citigroup, but the dramatic fall in Citi's share price has eroded the conversion value of the mandatory convertible bonds. In the original deal with ADIA, the Citi securities must be converted into common stock at a price between $31.83 and $37.24 a share between March 2010 and September 2011. Citi last traded at $1.50 a share. Options for the investment include holding them through to the conversion, which may allow enough time for the share price to recover, or converting them early, in a move that may head off the possibility of the U.S. government nationalising it.
"We know ADIA is following the recent developments closely, but as a bondholder, ADIA's investments are secure because the U.S. government has left bond holders untouched, unlike other investors such as preferred shareholders," a senior Abu Dhabi-based banker close to ADIA said. "However, it is early days, and we need to wait and see what ramifications the latest events would have and whether there would be pressure on investors in bonds to convert (early)," he said. Citi, he said, has been urging preferred shareholders and convertible bond holders to convert to common stock to help avoid nationalisation by the U.S. government.
On Friday, the U.S. government announced it would convert up to $25 billion of its $45 billion worth of preferred stock into common equity at $3.25 per share. Other preferred shareholders, including the Government of Singapore Investment Corporation and Saudi Arabia's Prince Alwaleed, will convert up to $27.5 billion of their holdings at the same price. "Compared to Alwaleed or Singapore, ADIA has no aspirations in any controlling stake or a board seat and is just happy to ride along as an investor with regular returns. At least for the moment, ADIA's investment is safe," an Abu Dhabi-based financial analyst said. "ADIA is a long-haul investor and is in a different boat compared to other investors in Citi," he said, declining to be named due to company policy.
Gulf sovereign funds have been badly burned buying into troubled U.S. banks, with the Kuwait Investment Authority investing last year in U.S. banks Citigroup and Merrill Lynch before both stocks dived and the latter was sold for a fraction of its earlier price to Bank of America. Major sovereign wealth funds are now holding off big investments abroad, with some focusing on investing at home to stimulate economies in the wake of the global crisis, a recent survey showed.
AIG May Get $30 Billion in Additional U.S. Capital
American International Group Inc., the insurer deemed too important to fail, may get a commitment for as much as $30 billion in new government capital after a record quarterly loss, said two people familiar with the matter. The insurer may also be allowed to make lower payments on government loans, said the people, who declined to be identified because there was no public announcement. New York-based AIG may forfeit part of stakes in its two largest non-U.S. life insurance divisions to lower the firm’s debt, the people said. AIG, first saved from collapse in September with a package that grew to $150 billion, had to restructure its bailout after failing to sell enough units to repay the U.S. Firms including banks relied on AIG to back more than $300 billion of assets through derivative contracts as of Sept. 30, making the insurer a “systematically significant failing institution” that has to be propped up, according to the Treasury.
“The government has accepted all the downside with little chance of upside,” said Phillip Phan, professor of management at the Johns Hopkins Carey Business School in Baltimore. “They are trying to protect the global financial system from a complete meltdown.” AIG, which agreed in September to turn over an 80 percent stake to the government, is set to announce a fourth-quarter loss of about $60 billion tomorrow, according to three people familiar with the matter. The company’s board was scheduled to meet today to vote on the revised bailout, according to two other people familiar with the matter. The insurer had been in talks in the past week with regulators to restructure its bailout to stave off credit-rating downgrades that would have caused further costs tied to credit- default swaps. AIG had to seek an $85 billion federal loan in September after credit-rating downgrades left the company facing more than $10 billion in potential payments to debt investors who bought swaps from the insurer to protect against losses.
Downgrades by Moody’s Investors Service and Standard & Poor’s may force AIG to post more than $7 billion in collateral to counterparties, the insurer said in a November filing. AIG’s units could also lose access to the federal commercial paper program if they are downgraded, the company said. Rating agencies have signed off on the latest rescue, the Wall Street Journal reported today, citing unidentified people. AIG may give up stakes in American International Assurance Co. and American Life Insurance Co., two life insurance divisions that operate in countries from China to the U.K. The holdings would go to a so-called special purpose vehicle to eventually position them for sale so AIG doesn’t have to divest them at distressed prices, according to one person familiar with the matter.
Chief Executive Officer Edward Liddy, appointed by the government to run AIG in September, had to scrap his strategy to repay a $60 billion government credit line by selling AIG units after potential buyers were hobbled by their own losses. AIG struck deals to raise about $2.4 billion through sales. Under Liddy’s plan, revealed in October, AIG was to emerge as a firm mostly providing property-casualty coverage to businesses. The Standard & Poor’s 500 Insurance Index fell by half since Liddy announced his plan, reducing the prices AIG units could fetch and thinning the pool of companies strong enough to bid for them. The $60 billion credit may be reduced to under the latest revision, a person said. The company had tapped about $38.9 billion of the facility as of Dec. 31.
Liddy said AIG was on the “road to recovery” after securing a bailout valued at $150 billion in November. That package included the $60 billion credit line, a $40 billion capital investment and $50 billion to wind down liabilities tied to mortgage-backed securities the insurer owned or backed through swaps. Liddy said then that terms of the original rescue, disclosed a day after Lehman Brothers Holdings Inc. collapsed, were unsustainable. Goldman Sachs Group Inc., Societe Generale SA, Deutsche Bank AG and Merrill Lynch & Co. are among the largest banks that bought swaps from AIG, according to a person familiar with the situation. The insurer handed over about $18.7 billion to financial firms in the three weeks after the September bailout, said the person, who declined to be named because the information hasn’t been made public.
Liddy, the CEO at auto insurer Allstate Corp. for eight years through 2006, was appointed to AIG by then-Treasury Secretary Henry Paulson, who knew Liddy from the executive’s service on the board of Goldman Sachs, where Paulson was CEO. AIG is winding down the trades and closing the unit that sold the swaps. The unit is under investigation by the U.S. Department of Justice, the Securities and Exchange Commission and U.K.’s Serious Fraud Office. The U.S. probes involve how AIG executives valued its swap portfolio and disclosed information about the contracts to investors, AIG said in a November regulatory filing.
AIG, once the world’s largest insurer, operates in more than 100 countries, providing protection to individuals and businesses. It insures against some of the biggest risks, covering planes and commercial shipping and providing protection against terrorist attacks. The biggest insurers in North America posted more than $150 billion in writedowns and unrealized losses linked to the collapse of the mortgage market from the start of 2007, with AIG representing more than a third of that total. The company has units that insure, originate and invest in home loans. The U.S. Senate’s banking committee has scheduled a hearing for March 5 to discuss AIG’s bailout and the government involvement. New York Insurance Superintendent Eric Dinallo and Donald Kohn, vice-chairman of the Federal Reserve Board of Governors, were scheduled to testify.
Bank of America carries loans $44 billion above market value
Bank of America Corp is carrying loans on its balance sheet marked at more than $44 billion above their fair value, the company said in its annual report filed with U.S. regulators on Friday. The bank said it ended 2008 with $886.2 billion in loans, but estimated the fair value -- or market price -- for these loans as $841.6 billion. The bank intends to hold these loans to maturity, not for sale, said spokesman Scott Silvestri, explaining why the loans are marked above market value. The report showed the bank struggled throughout the year as losses on consumer debt including mortgages, home equity and credit cards piled up.
Falling home prices prompted the bank to modify more than 230,000 mortgages in 2008 to help homeowners stay in their homes -- but the value of these mortgages has continued to fall. Along with losses from mortgages and other consumer loans, the bank said it holds $6.45 billion in impaired commercial loans, up from $2.14 billion at the end of 2007, according to the report. Separately, Bank of America's investment bank lost more than $10 million on one in every four trading days in 2008. The Charlotte, North Carolina-based bank has reported write-downs and credit losses of more than $60 billion since the credit crisis began in the middle of 2007.
Bank of America shares finished down more than 25 percent on Friday at $3.95, amid a broad rout of financial stocks after the announcement the government is converting its position in Citigroup Inc's (C.N) preferred stock to common shares to help restore investor confidence in that bank's capital position. Shares in Bank of America have fallen 72 percent since the start of the year.
The Great Solvent North
Has the world turned upside down? America, the capital of capitalism, is pondering nationalizing a handful of banks. Meanwhile, Canada, whose banking system had long been notorious for its stodgy practices and government coddling, is now being celebrated for those very qualities. The Canadian banking system, which proved resilient in the global economic crisis, is finally getting its day in the sun. A recent World Economic Forum report ranked it the soundest in the world, mostly as the result of its conservative practices. (The United States ranked 40th).
President Obama has joined the adoring throng. He recently said that Canada has “shown itself to be a pretty good manager of the financial system in the economy in ways that we haven’t always been here in the United States.” Paul Volcker, former chief of the United States Federal Reserve, commented that what he’s arguing for “looks more like the Canadian system than the American system.” Most people don’t know that the vision behind Canada’s banking system, made up of a few large, national banks with branches from coast to coast, actually had its beginnings in the United States. Canada’s system is the product of a banking framework inspired by Alexander Hamilton, the first American secretary of the Treasury. Hamilton envisioned the First Bank of the United States, chartered in 1791, as a central bank modeled on the Bank of England.
Canadians found inspiration in Hamilton’s model, but not all Americans did. In the 1830s, President Andrew Jackson opposed extending the charter of the Second Bank of the United States, perceiving it as monopolistic. Money-lending functions were then assumed by local and state-chartered banks, eventually giving rise to the free-market, decentralized system that America has today. Today, Canada’s system remains truer to Hamilton’s ideal. The five major chartered banks, the few regional banks and handful of large insurance companies are all regulated by the federal government. Canadian banks are relatively constrained in the amounts they can lend. Canadian banks are required to have a bigger cushion to absorb losses than American banks. In addition, Canadian government regulations protect the domestic banks by limiting foreign competition. They also keep banks broadly owned by public shareholders.
Since Canada’s financial services sector was deregulated in 1987, permitting the banks to buy brokerage houses, they have enjoyed vast earnings power because of their diverse businesses and operations. And in contrast to the recent shotgun marriages at bargain prices between ailing Wall Street brokerages and American banks, Canadian banks paid top dollar decades ago for profitable, blue-chip investment firms. Canadian banks are known to be risk-averse, and this has served them well. While their American counterparts were loading up their books with risky mortgages, Canadian banks maintained their lending requirements, largely avoiding subprime mortgages. The buttoned-down banks in Canada also tended to keep these types of securities on their books, rather than packaging them and selling them to investors. This meant that the exposures they did have to weak mortgages were more visible to the marketplace.
The big five Canadian banks — Royal Bank of Canada, Toronto-Dominion Bank, Bank of Nova Scotia, Canadian Imperial Bank of Commerce and Bank of Montreal — survived the recent turmoil relatively unscathed. Their balance sheets remain intact and their capital ratios are comfortably above requirements. Yes, Prime Minister Stephen Harper’s government may buy as much as 125 billion Canadian dollars (about $100 billion) worth of mortgages, increasing banks’ capacity to lend. But this is small change compared with the scale of Washington’s bailout. Few would have predicted that Canadian banks, long derided as among the least autonomous because of stringent government oversight, would emerge from the global mayhem as some of the more independent international players.
Since Mr. Obama seems to admire the Canadian banking system, his administration might want to take a page out of its playbook. This would entail building a national banking system based on a small number of large, broadly held, centrally and rigorously regulated firms. Imitating the Canadian model would require sweeping consolidation of American banks. This would be a very good thing. Washington had difficulty figuring out the magnitude of the financial crisis because there are so many thousands of banks that it was impossible for regulators to get into all of them. Washington is already on the path to achieving consolidation. Eventually, some of the larger banks into which the government is injecting taxpayer money will probably be deemed beyond help, and will either be allowed to die or be partnered with other banks.
The market will take its cues from this stress-testing, and make its own bets on which banks will survive. It’s hard to predict how many will have survived when the dust settles, but the new landscape might consist of only 50 or 60 banking institutions. More radically, Washington could take over the licensing of banks from the states, or, at the very least, consider more stringent regulation of global and super-regional banks. After all, the Canadian system is considered successful not only because it has fewer banks to regulate, but because regulation is based on the tenets of safety and soundness. There is no time to waste. Reconfiguring the American banking structure to look more like the Canadian model would help restore much-needed confidence in a beleaguered financial system. Why not emulate the best in the world, which happens to be right next door? At the very least, Hamilton would have approved.
EU’s Eastern States Plead for Aid as Crisis Escalates
Eastern European leaders pleaded with richer western European countries to boost financial aid and keep trade flowing, warning that the recession risks splitting the European Union. The worst slump since World War II is devastating the ex- communist economies in the EU’s east, sinking their currencies and driving two countries -- Hungary and Latvia -- to tap international aid to avert default. “They are in a deep crisis and they need our solidarity,” Swedish Prime Minister Fredrik Reinfeldt told reporters before a meeting of EU leaders in Brussels today. The EU’s $17 trillion economy will contract 1.8 percent in 2009, the European Commission predicts. Latvia, the bloc’s star performer only three years ago, will shrink 6.9 percent. Growth in Poland, the biggest eastern economy, will tumble to 2 percent, the slackest pace since 2002.
Called by Czech Prime Minister Mirek Topolanek to show the EU’s unity in the face of economic turmoil, the summit has turned into a crisis session over how to bolster the floundering eastern economies. Nine eastern leaders held a pre-summit meeting early today to warn the West against putting up new walls in Europe, five years after the EU overcame the division of the continent by admitting its first eastern members. “We all wish that Europe avoids the temptation of protectionism,” Polish Prime Minister Donald Tusk said after the eastern-only gathering. French President Nicolas Sarkozy triggered the east-west clash over protectionism by saying on Feb. 5 that it “isn’t justified” for recession-hit French carmakers to build plants in places like the Czech Republic instead of creating jobs at home. European regulators yesterday forced Sarkozy to guarantee that 6 billion euros ($7.6 billion) in loans to Renault SA and PSA Peugeot Citroen, France’s two largest carmakers, won’t put foreign rivals at a disadvantage.
The EU leaders were set to reject calls to dip into EU funds to prop up the car industry, which is likely to suffer an 18 percent drop in sales this year, according to EU forecasts. Instead, the leaders will endorse “the reinforcement of European coordination” of national carmaker-aid plans and call for a system to monitor rescue packages in Europe and the U.S., according to a draft statement released at the start of today’s summit. Investors fleeing eastern Europe to cover losses at home have pushed down Poland’s zloty by 28 percent against the euro in the past six months, Hungary’s forint by 21 percent, Romania’s leu by 18 percent and the Czech koruna by 12 percent.
Hungarian Prime Minister Ferenc Gyurcsany last week called for an EU aid package of as much as 180 billion euros for eastern European economies and banks, including funds for non-EU members Croatia and Ukraine. Gyurcsany also called on the EU to extend the euro currency more quickly into eastern Europe by shortening the 24- month waiting period during which countries must peg their currency to the euro. There is a precedent for bending the rules. When Italy won approval in May 1998 to become one of the 11 founding members of the euro, it had spent just over 17 months in the exchange- rate grid. Estonian Prime Minister Andrus Ansip said the east deserves the same help as any other region and shouldn’t be treated as a special case. “I’m strongly against creating small blocs inside the European Union,” Ansip said. “We have to keep together and act together.”
As the EU confronts multiple crises, the World Bank, the European Bank for Reconstruction and Development and the European Investment Bank on Feb. 27 announced loans of up to 24.5 billion euros for eastern European banks. The Luxembourg-based EIB is run as a project-financing bank by EU governments. The bank’s head, Philippe Maystadt, warned against taking a one-size-fits-all approach to eastern Europe’s economic woes. “Some countries are in a better position than others,” Maystadt said today. “That’s the reason why we think we must keep a country-by-country approach.” Banks in the 16-nation euro region have lent $1.25 trillion to eastern Europe. The most heavily exposed banks in Austria and Sweden may face credit-rating downgrades as the economy deteriorates, Moody’s Investors Service warned on Feb. 17. The spillover of the economic crisis to eastern Europe has overshadowed other summit business, including discussions of EU guidelines on recapitalizing banks and a proposal for new agencies to coordinate bank supervision.
The leaders’ reactions to the call for tighter regulation will feed into proposals to be sketched out next week by the Brussels-based commission, the EU’s executive arm. Work on the new structures would get under way later this year. EU leaders are also at odds over how to finance and where to spend a proposed 5 billion euros for energy and infrastructure projects as part of a bloc-wide stimulus package. A decision isn’t due until the next summit, on March 19-20, when the EU maps out its strategy for the April 2 Group of 20 meeting on the financial crisis in London. So far, national stimulus packages, welfare spending and cash from the EU’s central budgets have pumped 3.3 percent of EU- wide GDP into the economy, the commission estimates. The draft summit statement set no deadline for governments to erase swelling budget deficits. The aggregate gap in the 27- nation EU will rise to 4.4 percent of gross domestic product in 2009 from 2 percent last year, the EU forecasts. The statement pledged to “assure the long-term viability of public finances,” without setting a timeframe. A deadline for euro-area countries to eliminate their deficits has regularly been pushed back since 2002.
EU Rejects Pleas for Eastern Aid Package, Bailout for Carmakers
European Union leaders rejected pleas for an aid package for eastern Europe and EU funds for carmakers, bowing to German concerns over budget deficits as the economic slump deepens. EU leaders vetoed a call by Hungary for loans of 180 billion euros ($228 billion) for ex-communist economies in eastern Europe, and told automakers such as General Motors Corp.’s European arm to look to national governments for help. “I would advise against taking huge numbers into the debate,” German Chancellor Angela Merkel told reporters at an EU summit in Brussels today. “I see a very different situation -- you can compare neither Slovenia nor Slovakia with Hungary.”
The worst economic crisis since World War II is devastating eastern Europe, putting at risk EU goals of stitching together a continent-wide free market. The EU’s $17 trillion economy will contract 1.8 percent in 2009, the European Commission predicts. Latvia, a former Soviet republic that was the bloc’s star performer only three years ago, will shrink 6.9 percent. Growth in Poland, the biggest eastern economy, will tumble to 2 percent, the slackest pace since 2002. Investors fleeing eastern Europe to cover losses at home have pushed down Poland’s zloty by 28 percent against the euro in the past six months, Hungary’s forint by 21 percent, Romania’s leu by 18 percent and the Czech koruna by 12 percent.
Nine eastern leaders held a pre-summit meeting early today to warn the West against putting up new walls in Europe, five years after the EU overcame historic divisions by admitting its first eastern members. “We all wish that Europe avoids the temptation of protectionism,” Polish Prime Minister Donald Tusk said.
Merkel, representing the biggest contributor to the EU budget, said aid for eastern Europe needs to be channelled through international institutions like the International Monetary Fund. Last week three international lenders -- the World Bank, the European Bank for Reconstruction and Development and the European Investment Bank -- announced loans of up to 24.5 billion euros for eastern European banks.
As budget deficits swell beyond the EU’s limit of 3 percent of gross domestic product, Merkel’s plea for “a return to solid fiscal management” met with a mixed response. The EU set no deadline for governments to erase their deficits. So far, national stimulus packages, welfare spending and cash from the EU’s central budgets have pumped 3.3 percent of EU-wide GDP into the economy, the Brussels-based commission estimates. As a result, it forecasts that the 27-nation EU’s overall budget gap will rise to 4.4 percent of GDP in 2009 from 2 percent last year.
Hungary, already the recipient of 6.5 billion euros in EU aid, also sowed divisions among eastern leaders, with some saying the EU’s newcomers shouldn’t be singled out as an economic trouble spot. “I’m strongly against creating small blocs inside the European Union,” Estonian Prime Minister Andrus Ansip said. “We have to keep together and act together.” Opposition to a one-size-fits-all approach to eastern Europe’s economic woes also came from Philippe Maystadt, head of the Luxembourg-based EIB, an EU-operated bank that provides project finance. “Some countries are in a better position than others,” Maystadt said today. “That’s the reason why we think we must keep a country-by-country approach.”
French President Nicolas Sarkozy triggered an east-west clash over protectionism by saying on Feb. 5 that it “isn’t justified” for recession-hit French carmakers to build plants in places like the Czech Republic instead of creating jobs at home. European regulators yesterday forced Sarkozy to guarantee that 6 billion euros in loans to Renault SA and PSA Peugeot Citroen, France’s two largest carmakers, won’t put foreign rivals at a disadvantage. The leaders rejected calls to dip into EU funds to prop up the car industry, which is likely to suffer a sales drop of as much as 18 percent this year, according to EU forecasts. Instead, the leaders said it is up to each country to step in. General Motors, the biggest U.S. carmaker, last week sought 3.3 billion euros in assistance for its European operations. GM last week reported a loss of $30.9 billion for 2008, including $2.8 billion from Europe. The EU has already promised to double EIB lending for green transport projects including cleaner cars to 4 billion euros in each of the next two years. Merkel called today for a further boost to spur “modern engine technologies.”
The Odor Across the Oder
To the global recession, add an emerging market meltdown. This time Southeast Asia and Latin America are ceding the dishonors to Eastern Europe. The old Soviet bloc shot up this decade. But then the credit crunch hit and capital fled, and it has spiraled down fast. Three countries have already gone hat in hand to the International Monetary Fund, and more may be on the way. The lesson isn't about market failure or the downside of open borders for capital. It's about the importance of sound economic policy. From far away, the region east of the Oder River blends into a single space of collapsing living standards. But there is more than one Eastern Europe. The Baltics and Balkans succumbed to the same bubblenomics as house-happy Central California or Iceland. Double-digit growth in Latvia, Lithuania and Estonia was fueled by debt and short-term capital inflows.
Now these gains are being reclaimed, with GDP slated to fall by double digits in the Baltic states this year. The scene of the crash looks familiar. Residential mortgage debt as a share of GDP in Latvia and Estonia climbed, respectively, to 33.7% and 36.3% -- worryingly high because a lot is denominated in foreign currency, though still not as high as Iceland's 121%. The government in Latvia, a regional banking hub, fell last week after the IMF imposed austerity measures. Standard & Poor's downgraded its debt to junk; Romania is the other noninvestment grade member of the European Union. In Russia, Vladimir Putin spooked investors with his assault on property rights, and the collapse in oil prices did the rest last year. The Moscow stock market fell further than any other in the world, straining companies that borrowed heavily overseas. For now, Russia has deep enough reserves to avoid a repeat of its 1998 default-devaluation.
Ukraine isn't as fortunate. It suffered when prices for its chief export (steel) fell while its chief energy input (natural gas) rose. Though a vibrant democracy, Ukraine isn't blessed with a mature political class able to put its economy on stable footing. The IMF has stepped in there, as it has in Hungary. Elsewhere more virtuous behavior has partially shielded countries with stronger fundamentals. The Czech Republic and Poland avoided the worst of easy-money mania and attracted capital for direct investment, often in export industries, that can't flee at the first hint of trouble. Their economies have made the transition from communism to a market economy built on the rule of law. But in a global downturn, they're also seeing growth fall and unemployment rise. The Polish zloty has dropped 15% against the euro this year, the hardest hit of the non-euro EU currencies. The Czech koruna is down as well on (by most accounts, exaggerated) fears about mortgage debt and current account difficulties.
Tainted by association with an ugly neighborhood, the Poles and Czechs now better realize that safety from currency attacks can only come with the euro. The EU needs to keep close watch, what with Western European bank exposure to the region at $730 billion. On Sunday, the European Union will discuss ways to prop up weakened financial systems and get credit flowing. (Sounds familiar to an American.) The bloc's bright idea is to double funding for the IMF, which can help with emergency cash as long as it leaves its antigrowth ideas in Washington. After the global boom, the bust is hitting all -- but not equally. The worst affected in Eastern Europe repeated mistakes made in Asia and Latin America in previous crises. It's a painful, but potentially useful, lesson.
Europe Mulls 'What If' On Defaults
Policy makers in Europe are debating how to prevent a prospect that until recently seemed too improbable to consider: the default of one of the 16 nations that use the euro. No euro countries appear on the verge of economic collapse, but among those seen as most vulnerable to default are Portugal, Ireland and Greece. In some countries, the global downturn is beginning to strain federal budgets as they balloon to stimulate the economy amid falling tax receipts. In many, bank-rescue and fiscal-stimulus plans will boost borrowing mightily. Should one nation teeter toward default, some of the bloc's stronger economies have indicated they likely would waive euro-zone rules against bailing out members and leap in with aid. The issue of how to head off a euro-zone default is likely to figure at a meeting Sunday of European Union leaders in Brussels.
Any response is bound to rely heavily on Germany's deep pockets, making Europe's biggest economy the fiscal taskmaster for the euro bloc's weakest members -- a role Germany says it doesn't want. Asked on Thursday about the prospect of intervention, German Chancellor Angela Merkel said, "we have acted in solidarity so far and we will find ways forward based on solidarity." Any Germany-backed aid package would likely come with strict conditions requiring recipients to get their fiscal houses in order, even if belt-tightening made a local recession worse. EU rules stipulate that euro-zone members keep their deficits below 3% of gross domestic product. Seven euro-zone members are set to breach that ceiling this year. The euro zone is facing its worst economic slowdown in decades. According to reports released Friday, the bloc's unemployment rate rose to 8.2%, up from 8% in December and matching a high from September 2006. Inflation slowed to 1.1% from 1.6% in December as businesses cut costs across the board.
The cost of buying insurance on Greek, Irish and Spanish debt hovered around record highs Friday. Skyrocketing debt loads led ratings agency Standard & Poor's to downgrade the debt of Portugal, Greece and Spain in January. Analysts say Ireland is likely to lose its triple-A rating this year. Fellow euro-zone member Austria also is taking a hit. The cost of insurance against its default nearly doubled over the past three weeks and is now the bloc's second-highest after Ireland, according to credit information firm Markit Group. The possibility that some countries might not meet their debt obligations is boosting the premium they must pay investors to buy their bonds. The gaps between the yield on German bonds, deemed the bloc's safest, and the bonds of more-vulnerable countries including Italy and Greece are hovering around highs not seen since the euro zone's inception a decade ago. Germany's assurances that it has its neighbors' backs have helped to narrow those gaps somewhat in recent days.
A euro-zone default would have enormous costs for Germany and the bloc as a whole. Spooked investors would likely pull capital from other euro-zone countries perceived as risky. That could trigger a wave of defaults in other countries with already-shaky finances, wreaking economic havoc across the bloc. Euro-zone countries are Germany's main export market, which would put pressure on Berlin for a bailout, in the same way that Mexico's financial woes in the early 1990s pushed Washington to lend billions of dollars there. But in doling out financial aid, policy makers would need to work around rules in Europe's founding treaty that bar bailouts between countries. The prohibition -- a legacy of Germany's reluctance to fund fiscally profligate countries at the euro's outset -- can be lifted in "exceptional occurrences," according to the treaty.
That raises the prospect of a Europe in which Germany wields control over other countries' fiscal policies. Already, there have been reports in Irish media of concerns that Germany will make Ireland raise its corporation tax rate, which at 12.5% is one of Europe's lowest. Germany remains wary of treading on its neighbors' turf too directly, so it is likely that any assistance would come through collective institutions such as the EU's executive arm, the European Commission, Ms. Merkel said. That way, she said, "one big country doesn't issue directives." One option: Germany and other financially strong countries such as the Netherlands could lend money to EU institutions including the European Investment Bank, which could act as a go-between. Countries that receive help would have to repair their public finances, including taking such unpopular steps as raising taxes and cutting spending.
AIG near deal on new terms of U.S. bailout
American International Group Inc is close to a deal with the U.S. government that would ease the terms of its bailout, provide a further equity commitment and help it pay down debt, a person familiar with the matter said on Saturday. The revision would be the latest sign of how federal regulators are having to tweak bailout packages for financial institutions deemed too big to fail as the economy and markets worsen. The board of the troubled insurer is due to meet on Sunday to vote on the deal, which could be announced when AIG reports its quarterly results on Monday, the source said. That would be just days after the government agreed to boost its equity stake in Citigroup Inc to as much as 36 percent in a bid to bolster another financial giant that taxpayers had already poured billions of dollars into.
The revised AIG agreement is expected to include an additional equity commitment of about $30 billion, more lenient terms on an existing preferred investment, and a lower interest rate on a $60 billion government credit line, the source said. The new equity commitment would give AIG the ability to issue preferred stock to the government at a later date, the source said. The London Interbank Offered Rate floor on the interest rate AIG pays on the government's credit line is expected to be removed under the new terms, which would save the insurer about $1 billion a year, the source said. The company currently pays 3 percentage points above Libor.
AIG will also give the U.S. Federal Reserve ownership interests in American Life Insurance , which generates more than half of its revenue from Japan, and Hong Kong-based life insurance group American International Assurance Co in return for reducing its debt, the source said. The insurer had been trying to sell Alico and a part of AIA in a bid to raise money to pay back the government. AIG may also securitize some U.S. life insurance policies and give them to the government to further reduce its debt, the source said. Last year, AIG said it plans to sell all assets except its U.S. property and casualty business, foreign general insurance and an ownership interest in some foreign life operations, to pay back the government.
While the company has announced some sales, it has been difficult for it to find buyers and get a good price for assets amid the financial crisis. Credit for deals remains difficult to arrange due to the crisis and many would-be buyers are struggling with their own problems. A new deal would come as the insurer struggles to sell assets amid the financial crisis and prepares to post the largest quarterly loss in corporate history. AIG is expected to post a roughly $60 billion fourth-quarter loss on Monday, produced in large part by write-downs on certain tax assets and commercial mortgage backed securities, the source said. The loss -- which works out to about $460,000 per minute -- is mostly non-cash, the source said.
The revised bailout would allow the insurer to avoid a credit ratings downgrade that could have had serious ramifications on the insurer's liquidity and hurt its businesses, the source said. Customers could, for instance, cancel their insurance policies if a minimum rating was no longer satisfied. AIG, which counted 74 million customers at the end of 2007, has said it has also been losing business and finding it harder to win new clients since it was first rescued in September after bad mortgage bets left it on the verge of collapse. The government stepped in at the time with an $85 billion bailout and subsequently offered additional financing, bringing the support up to $123 billion. Then in November, the government had to revise its bailout package, raising its aid further, to about $150 billion.
AIG talks weigh securitizing life policies
American International Group Inc may securitize some U.S. life insurance policies and have the interest rate on a government loan lowered, as talks continue to help the insurer deal with its financial problems, a source familiar with the matter said on Friday. The U.S. government, AIG and credit rating agencies, including Moody's, S&P and A.M. Best, are in discussions, the source said, as the troubled insurer prepares to post a roughly $60 billion quarterly loss. The loss, which equates to about $460,000 per minute, would be the largest in corporate history. The possibilities of relief for AIG, once the world's largest insurer by market value, include eliminating the London Interbank Offered Rate floor on the interest rate it pays on the government's $60 billion credit line. The company currently pays 3 percentage points above Libor.
AIG may also try to securitize some life insurance policies and hand them over to the government as repayment of its debt, the source said. The thought is that additional availability under the government's lending commitment would give more comfort to the rating agencies, the source said. Discussions also include the possibility of easing the dividend on the government's preferred investment, although talks appeared to be tending away from eliminating it altogether, the source said. These are among a wide variety of options still under discussion, the source said, adding that the situation was still in flux as negotiators try to meet a Monday deadline for AIG to post its results. But the timing of an agreement also depends on rating agencies, as negotiators would have more time to reach a deal if AIG can avoid an immediate downgrade, the source said. AIG declined to comment.
A key focus of the talks is to avoid a ratings downgrade, which could have serious ramifications on the insurer's liquidity and hurt its businesses. Customers could cancel their insurance policies if a minimum rating is no longer satisfied. AIG was first rescued in September after bad mortgage bets left it on the verge of collapse. The government stepped in with a $85 billion bailout and subsequently offered additional financing, bringing the support up to $123 billion. Then in November, the government had to revise its bailout package, raising its aid further, to about $150 billion. Last year, AIG said it would sell all assets except its U.S. property and casualty business, foreign general insurance and an ownership interest in some foreign life operations, to pay back the government. While the company has announced some sales, it has been difficult to find buyers and get a good price for assets amid the financial crisis. Credit for deals remains difficult to arrange and many would-be buyers are struggling with their own problems.
If AIG could find a better way to reduce its debt than selling assets in a tough market, it may do that, the source said. The talks with the government also include the possibility of providing financing to buyers of AIG's assets to facilitate sales as well as doing a debt-to-equity swap with the government for some businesses instead of an outright sale in a tough market, the source told Reuters on Thursday. AIG's shares closed down 10 cents, or 19.2 percent, at 42 cents on the New York Stock Exchange.
Propping Up a House of Cards
Next week, perhaps as early as Monday, the American International Group is going to report the largest quarterly loss in history. Rumors suggest it will be around $60 billion, which will affirm, yet again, A.I.G.’s sorry status as the most crippled of all the nation’s wounded financial institutions. The recent quarterly losses suffered by Merrill Lynch and Citigroup — “only” $15.4 billion and $8.3 billion, respectively — pale by comparison. At the same time A.I.G. reveals its loss, the federal government is also likely to announce — yet again! — a new plan to save A.I.G., the third since September. So far the government has thrown $150 billion at the company, in loans, investments and equity injections, to keep it afloat. It has softened the terms it set for the original $85 billion loan it made back in September. To ease the pressure even more, the Federal Reserve actually runs a facility that buys toxic assets that A.I.G. had insured. A.I.G. effectively has been nationalized, with the government owning a hair under 80 percent of the stock. Not that it’s worth very much; A.I.G. shares closed Friday at 42 cents.
Donn Vickrey, who runs the independent research firm Gradient Analytics, predicts that A.I.G. is going to cost taxpayers at least $100 billion more before it finally stabilizes, by which time the company will almost surely have been broken into pieces, with the government owning large chunks of it. A quarter of a trillion dollars, if it comes to that, is an astounding amount of money to hand over to one company to prevent it from going bust. Yet the government feels it has no choice: because of A.I.G.’s dubious business practices during the housing bubble it pretty much has the world’s financial system by the throat. If we let A.I.G. fail, said Seamus P. McMahon, a banking expert at Booz & Company, other institutions, including pension funds and American and European banks “will face their own capital and liquidity crisis, and we could have a domino effect.” A bailout of A.I.G. is really a bailout of its trading partners — which essentially constitutes the entire Western banking system.
I don’t doubt this bit of conventional wisdom; after the calamity that followed the fall of Lehman Brothers, which was far less enmeshed in the global financial system than A.I.G., who would dare allow the world’s biggest insurer to fail? Who would want to take that risk? But that doesn’t mean we should feel resigned about what is happening at A.I.G. In fact, we should be furious. More than even Citi or Merrill, A.I.G. is ground zero for the practices that led the financial system to ruin. “They were the worst of them all,” said Frank Partnoy, a law professor at the University of San Diego and a derivatives expert. Mr. Vickrey of Gradient Analytics said, “It was extreme hubris, fueled by greed.” Other firms used many of the same shady techniques as A.I.G., but none did them on such a broad scale and with such utter recklessness. And yet — and this is the part that should make your blood boil — the company is being kept alive precisely because it behaved so badly.
When you start asking around about how A.I.G. made money during the housing bubble, you hear the same two phrases again and again: “regulatory arbitrage” and “ratings arbitrage.” The word “arbitrage” usually means taking advantage of a price differential between two securities — a bond and stock of the same company, for instance — that are related in some way. When the word is used to describe A.I.G.’s actions, however, it means something entirely different. It means taking advantage of a loophole in the rules. A less polite but perhaps more accurate term would be “scam.” As a huge multinational insurance company, with a storied history and a reputation for being extremely well run, A.I.G. had one of the most precious prizes in all of business: an AAA rating, held by no more than a dozen or so companies in the United States. That meant ratings agencies believed its chance of defaulting was just about zero. It also meant it could borrow more cheaply than other companies with lower ratings.
To be sure, most of A.I.G. operated the way it always had, like a normal, regulated insurance company. (Its insurance divisions remain profitable today.) But one division, its “financial practices” unit in London, was filled with go-go financial wizards who devised new and clever ways of taking advantage of Wall Street’s insatiable appetite for mortgage-backed securities. Unlike many of the Wall Street investment banks, A.I.G. didn’t specialize in pooling subprime mortgages into securities. Instead, it sold credit-default swaps. These exotic instruments acted as a form of insurance for the securities. In effect, A.I.G. was saying if, by some remote chance (ha!) those mortgage-backed securities suffered losses, the company would be on the hook for the losses. And because A.I.G. had that AAA rating, when it sprinkled its holy water over those mortgage-backed securities, suddenly they had AAA ratings too. That was the ratings arbitrage. “It was a way to exploit the triple A rating,” said Robert J. Arvanitis, a former A.I.G. executive who has since become a leading A.I.G. critic. Why would Wall Street and the banks go for this? Because it shifted the risk of default from themselves to A.I.G., and the AAA rating made the securities much easier to market.
What was in it for A.I.G.? Lucrative fees, naturally. But it also saw the fees as risk-free money; surely it would never have to actually pay up. Like everyone else on Wall Street, A.I.G. operated on the belief that the underlying assets — housing — could only go up in price. That foolhardy belief, in turn, led A.I.G. to commit several other stupid mistakes. When a company insures against, say, floods or earthquakes, it has to put money in reserve in case a flood happens. That’s why, as a rule, insurance companies are usually overcapitalized, with low debt ratios. But because credit-default swaps were not regulated, and were not even categorized as a traditional insurance product, A.I.G. didn’t have to put anything aside for losses. And it didn’t. Its leverage was more akin to an investment bank than an insurance company. So when housing prices started falling, and losses started piling up, it had no way to pay them off. Not understanding the real risk, the company grievously mispriced it.
Second, in many of its derivative contracts, A.I.G. included a provision that has since come back to haunt it. It agreed to something called “collateral triggers,” meaning that if certain events took place, like a ratings downgrade for either A.I.G. or the securities it was insuring, it would have to put up collateral against those securities. Again, the reasons it agreed to the collateral triggers was pure greed: it could get higher fees by including them. And again, it assumed that the triggers would never actually kick in and the provisions were therefore meaningless. Those collateral triggers have since cost A.I.G. many, many billions of dollars. Or, rather, they’ve cost American taxpayers billions.
The regulatory arbitrage was even seamier. A huge part of the company’s credit-default swap business was devised, quite simply, to allow banks to make their balance sheets look safer than they really were. Under a misguided set of international rules that took hold toward the end of the 1990s, banks were allowed use their own internal risk measurements to set their capital requirements. The less risky the assets, obviously, the lower the regulatory capital requirement. How did banks get their risk measures low? It certainly wasn’t by owning less risky assets. Instead, they simply bought A.I.G.’s credit-default swaps. The swaps meant that the risk of loss was transferred to A.I.G., and the collateral triggers made the bank portfolios look absolutely risk-free. Which meant minimal capital requirements, which the banks all wanted so they could increase their leverage and buy yet more “risk-free” assets. This practice became especially rampant in Europe. That lack of capital is one of the reasons the European banks have been in such trouble since the crisis began.
At its peak, the A.I.G. credit-default business had a “notional value” of $450 billion, and as recently as September, it was still over $300 billion. (Notional value is the amount A.I.G. would owe if every one of its bets went to zero.) And unlike most Wall Street firms, it didn’t hedge its credit-default swaps; it bore the risk, which is what insurance companies do. It’s not as if this was some Enron-esque secret, either. Everybody knew the capital requirements were being gamed, including the regulators. Indeed, A.I.G. openly labeled that part of the business as “regulatory capital.” That is how they, and their customers, thought of it. There’s more, believe it or not. A.I.G. sold something called 2a-7 puts, which allowed money market funds to invest in risky bonds even though they are supposed to be holding only the safest commercial paper. How could they do this? A.I.G. agreed to buy back the bonds if they went bad. (Incredibly, the Securities and Exchange Commission went along with this.)
A.I.G. had a securities lending program, in which it would lend securities to investors, like short-sellers, in return for cash collateral. What did it do with the money it received? Incredibly, it bought mortgage-backed securities. When the firms wanted their collateral back, it had sunk in value, thanks to A.I.G.’s foolish investment strategy. The practice has cost A.I.G. — oops, I mean American taxpayers — billions. Here’s what is most infuriating: Here we are now, fully aware of how these scams worked. Yet for all practical purposes, the government has to keep them going. Indeed, that may be the single most important reason it can’t let A.I.G. fail. If the company defaulted, hundreds of billions of dollars’ worth of credit-default swaps would “blow up,” and all those European banks whose toxic assets are supposedly insured by A.I.G. would suddenly be sitting on immense losses.
Their already shaky capital structures would be destroyed. A.I.G. helped create the illusion of regulatory capital with its swaps, and now the government has to actually back up those contracts with taxpayer money to keep the banks from collapsing. It would be funny if it weren’t so awful. I asked Mr. Arvanitis, the former A.I.G. executive, if the company viewed what it had done during the bubble as a form of gaming the system. “Oh no,” he said, “they never thought of it as abuse. They thought of themselves as satisfying their customers.” That’s either a remarkable example of the power of rationalization, or they were lying to themselves, figuring that when the house of cards finally fell, somebody else would have to clean it up. That would be us, the taxpayers.
Rating Agencies Endorse Revised AIG Bailout
Major credit rating agencies have signed off on the latest revamp of American International Group Inc.'s $150 billion government rescue package, people familiar with the matter say, removing the most immediate threat to the plan's implementation. Both Standard & Poor's and Moody's Investors Services have quietly endorsed the terms of the revised bailout, which was negotiated over a period of months between AIG and government officials, the people said. A spokesman for S&P said: "We are aware of aspects of the plan and it's likely that we'll put out a public response after the announcement."
The agreement clears the way for the insurer's board to give its final approval when it meets on Sunday. AIG's latest restructuring, the third iteration since the company's near collapse in September, is expected to be announced with the insurer's results on Monday. Without the support of the credit rating agencies, AIG would have faced crippling cuts to its ratings. The downgrades would likely have forced it to post billions in collateral on an array of financial contracts. It would have also triggered the termination of many corporate insurance policies, costing AIG billions more. The credit rating agencies have faced harsh criticism for not highlighting the risks in AIG's operations that led to its crisis. But their assessment of the insurer's creditworthiness remains a decisive factor in many of the contracts AIG has entered into with trading partners and insurance clients.
In a November filing with the Securities and Exchange Commission, AIG warned that a one-notch downgrade of its long-term rating could cause it to have to pay out around $8 billion to its counterparties, including collateral and "termination payments" on contracts it has written. The filing said the impact of a two-notch downgrade from current levels could be much bigger, giving counterparties the right to terminate transactions that cover nearly $48 billion in debt. AIG has since exited or posted collateral against some of those positions, so its actual cash outflow in such a situation would likely be less than that amount. AIG sought the latest revision of the terms on the government aid after its plan to repay up to $100 billion in assistance through asset sales failed. The company has blamed the financial crisis and the scarcity of credit for the difficulties. But the insurer's continued crisis – its fourth-quarter loss is expected to top $60 billion due mainly to asset write-downs – has also substantially weakened its negotiating position with potential suitors.
Many details of the new plan aren't clear but like the original, it will result in a complete reconfiguration of AIG. Compared to the original agreement, however, which placed harsh conditions on the insurer, the new plan is more forgiving. The revised plan relies on a series of complicated financial maneuvers that will reduce AIG's interest and debt burdens, while also deepening government involvement and taxpayer exposure. Asset sales remain a feature of the new blueprint. It also foresees AIG repaying some of its debt through the transfer of certain assets to the government and the securitization of others. The government's stake in AIG, which is now just under 80%, isn't expected to change substantially.
In November, after it became clear that the original rescue package was inadequate, the government agreed to changes. The original deal involved a two-year loan of up to $85 billion that carried an interest rate of 8.5% plus three-month Libor. Under the November revision, AIG received a loan of up to $60 billion due in five years. Interest on the loan was cut to 3% plus Libor. (Libor, the London interbank offered rate, is a common short-term benchmark.) In addition, the government made a $40 billion investment in AIG in return for preferred shares that paid a 10% interest rate. Separately, the government set aside $50 billion to deal with many of AIG's distressed assets.
Life insurers now in question following downgrades
The outlook for U.S. life insurers dimmed badly on Friday after an across-the-board downgrade from a key ratings agency sent stocks of major companies in the industry plunging by 20 percent or more. Standard & Poor's Ratings Services late Thursday lowered its ratings on several U.S. life insurers and life insurance holding companies, saying the troubled economy is putting increased pressure on their assets. S&P lowered its credit and financial strength ratings on 10 groups of U.S. life insurers, and its credit ratings on seven U.S. life insurance holding companies. Among them were major players like MetLife Inc. Hartford Financial Services Group Inc., Prudential Financial Inc. and Conseco Inc.. The agency said the global economy and severe declines in the stock market would weigh on the companies' operations. The Dow Jones industrial average closed Friday at less than half its record high reached on October 2007.
Share of major life insurance companies took a beating Friday. MetLife plunged 23.1 percent, Hartford lost 14.8 percent, and Conseco fell 21.9 percent. Aflac Inc. lost 11.6 percent, and Principal Financial Group Inc. sank 24.6 percent. "Given the disarray in the credit and capital markets, most insurers' financial flexibility has decreased in the past six months," the S&P report said. Despite those concerns, S&P said "we continue to believe the credit fundamentals of the life insurance industry are strong." Rating agencies have been revising their rating outlooks lower on life insurers this month, and in some instances downgrading them. Insurance companies recently reported lower operating earnings, high investment losses and increased unrealized losses. Investors are also concerned about capital requirements associated with the companies' variable annuity businesses.
In the past, life insurers have been able to pile up big returns by investing cash flow from premiums in the market before they eventually have to pay out money after policyholders die or begin collecting on annuities. But plunging stock prices and credit market disruptions are putting stress on that business model, leaving investors worried that insurers will have to dip into reserves to help meet minimum payment obligations of their policyholders. Adam Sherman, president Firstrust Financial Resources, a life insurance advisory firm in Philadelphia, said the industry could face even bigger investment losses going forward. Part of the concern is that healthy insurance carriers used to rise to the occasion to bail out or buy less healthy insurance carriers, but would be reluctant to do so now.
"Today, because each company is concerned about their own balance sheet, and the future health of their own company, I don't think there is enough comfort level among the industry to help out or merge or acquire the unhealthy players." Insurers have been under pressure to maintain solid capital positions to avoid damaging downgrades by ratings agencies. Keeping high ratings is key for insurers because lower ratings can mean higher costs, and in some cases, even a loss of business. In January, Moody's Investors Service indicated it might downgrade ratings on large variable annuity writers by one to two notches if the S&P 500 index falls to the 650 to 750 range. On Friday, the S&P 500 index fell 17.74 to 735.09.
Banks shift bankruptcy tactics
Big banks, scrambling to prevent the government from forcing them to rewrite mortgages for struggling homeowners, are using their lobbying clout to press the Obama administration and Congress to scale back a key measure to rescue borrowers from foreclosures. The legislation, expected to pass the House on Thursday, would let bankruptcy judges reduce the principal and interest rate on a home loan. That essentially would require mortgage companies to let debt-strapped homeowners reduce their monthly payments rather than lose their main residences. Obama called for it last week as part of his housing rescue plan. Democrats and consumer advocates regard it as crucial to slowing the rapid rate of foreclosures.
But the mortgage industry contends the measure will impose steep and unpredictable costs on its companies, which will be forced to pass them along to borrowers in the form of higher fees and interest rates. The industry spent millions last year on a successful lobbying effort to kill the bill, which almost all Republicans oppose. Opponents call it the "cram-down." This year, with Obama in the White House and Democrats enjoying a broader majority, a rift has emerged in the industry. One major player, Citigroup Inc., has bowed to the new political reality and moved to grab a seat at the negotiating table. It cut a deal last month with Democrats to back the plan, as long as it applied only to existing loans made before enactment and was limited to homeowners who try working with their lender to adjust their loans before seeking relief in bankruptcy.
Other banks have changed their strategy, but not their position. They are continuing efforts to squash the legislation, but also have stepped up their bid to gut key provisions. Among their goals: restrict the measure to certain kinds or sizes of home loans, certain borrowers, or situations where the mortgage holder _ known as the loan servicer _ agrees to the changes. "I don't see a scenario where we can ever support this, but we're trying to make it the least-worst way to do the wrong thing," said Scott Talbott, a lobbyist for the Financial Services Roundtable, a trade group representing large banks. The group spent $7.8 million last year lobbying on this and other issues. "There are efforts being made to change the bill right now," Talbott said Wednesday, as Democratic leaders were putting the last touches on the measure to be voted on Thursday.
That legislation, sponsored by Rep. John Conyers, D-Mich., the Judiciary Committee chairman, is part of a broader housing plan. It includes a boost in the Federal Deposit Insurance Corporation's borrowing authority and other steps to prevent foreclosures. In the Senate, Sen. Dick Durbin of Illinois, the No. 2 Democrat, has teamed with the Banking Committee chairman, Chris Dodd, D-Conn., and Sen. Charles E. Schumer, D-N.Y., on the bankruptcy measure. A vote could come in a few weeks. The change in tactics has paid off for the banks, now actively bargaining with top Democrats on the details of the legislation. "We continue to be opposed to the bill and that hasn't changed, but we do live in the real world, and we do understand that this is very likely to happen, and we owe it to our members to recognize that reality and to limit the damage as much as possible," said Francis Creighton, a lobbyist for the Mortgage Bankers Association, which spent $4.2 million on lobbying last year. "We're encouraged by the fact that the bill is moving to limit the damage of cram-down rather than make it worse."
Aside from Citigroup, two other large banks, JPMorgan Chase & Co. and Bank of America Corp., have been in discussions with top Democrats. Neither has signed onto the bill, however. Industry players have pushed to limit the measure to home loans originated in the last several years. House Democrats agreed late Wednesday to strengthen the requirement that borrowers prove they tried other ways of modifying their mortgages before resorting to bankruptcy. They also restricted the measure to people who could not otherwise afford to make their home loan payments. "The bank opposition has had a profound impact on the bill as it stands today. They're very powerful special interests. They're a force in Washington," said Michael Calhoun of the Center for Responsible Lending, a consumer group. "Look at the concessions they extracted from the bill and are still extracting."
Lobbyists and congressional aides close to the negotiations say the banking industry has recognized that some sort of action on the bankruptcy measure is virtually certain, and is actively seeking a deal on the issue that will limit its cost. In an internal research report last month, Credit Suisse said it expected the legislation to be enacted and projected it could lead to a 20 percent reduction in foreclosures. Citigroup had an interest in showing a willingness to cooperate with the new administration in getting the foreclosure crisis under control. It has taken $45 billion from the government's financial bailout program already and is in discussions about getting even more federal assistance. The government is guaranteeing billions in risky Citigroup assets, meaning taxpayers are essentially on the hook for losses it could incur through the bankruptcy change.
Even Worse for Young Workers
The employment situation in the U.S. is, if anything, worse than most people realize. And huge numbers of young people, ages 16 to 30, are being beaten down in ways that could leave scars for a lifetime. Much of the attention in this economic downturn has focused on the growing legions of men and women who are officially counted as unemployed. There are now more than 11 million of them. But a better picture of the economic distress related to employment emerges when the number of jobless Americans is combined with two other categories of workers: the underemployed (those who are working part time, for example, because they can’t find full-time work) and the so-called labor force reserve, workers who have abandoned their job searches but who would work if employment became available.
This total pool of underutilized labor has now risen above 24 million, according to researchers at the Center for Labor Market Studies at Northeastern University in Boston. That total will only grow in the coming months. The Obama administration has more than enough on its plate at the moment, but before long it will likely have to consider a range of additional strategies, beyond the recently passed stimulus package, for putting jobless Americans to work. A comparison of the number of people being thrown out of work in this recession with that of the severe recession of 1981-82 will indicate why. The peak unemployment rate was higher in that earlier recession than today’s 7.6 percent, largely because the last big wave of the baby-boom generation was entering the job market in the early ’80s. Those boomers who couldn’t find work were officially counted as unemployed.
What is different and more frightening about the current downturn is the number of people actually losing their jobs — being laid off or fired. That number is dramatically, dangerously higher. The government uses two different surveys to gauge employment data. The household survey, based on telephone interviews, showed that job losses in the 13 months that followed the beginning of the 1981-82 recession reached 1.53 million. In the first 13 months of this recession, the number of jobs lost, according to the household survey, has been a staggering 4 million. The payroll survey, which is based on employment records, showed job losses of 1.7 million in the first 13 months of the earlier downturn compared with 3.5 million in the current recession.
Pick your poison. This is not the kind of downturn Americans are used to. The ones who are being hit the hardest and will have the most difficult time recovering are America’s young workers. Nearly 2.2 million young people, ages 16 through 29, have already lost their jobs in this recession. This follows an already steep decline in employment opportunities for young workers over the past several years. Good jobs were hard to find for most categories of workers during that period. One of the results has been that older men and women have been taking and holding onto jobs that in prior eras would have gone to young people. “What we’ve seen over the past eight years, for young people under 30, is the largest age reversal with regard to jobs that we’ve ever had in our history,” said Andrew Sum, the director of the Center for Labor Market Studies. “The younger you are, the more you got pushed out of this labor market.”
There were not enough jobs to go around before the recession took hold. So the young, the poor and the poorly educated were already suffering. Now that pool of suffering is rapidly expanding. This has ominous long-term implications for the country. The economy cannot perform well with such a large cohort of young people condemned to marginal economic status. Young men and women who remain unemployed for substantial periods of time find it very difficult to make up that ground. They lose the experience and training they would have gained by working. Even if they eventually find employment, they tend to lag behind their peers when it comes to wages, promotions and job security. Moreover, as the economy worsens, even the college educated are feeling the crunch.
According to a report by researchers working with Mr. Sum: “While young college graduates have fared the best in maintaining some type of employment, a growing fraction of them are becoming mal-employed, holding jobs in occupations that do not require much schooling beyond high school, often displacing their less-educated peers.” Employment problems have festered in the United States for decades. The economy will never be brought to a state of health until those problems are more thoughtfully and more directly engaged. This will become more and more clear with each passing month of this hideous recession.
American Boomers: 30% underwater
Many of those nearing retirement will have very little to live on thanks to an erosion of home equity.
What a turnaround for the American Dream! According to a report released Wednesday, the real estate market bust and stock market declines have carved a huge chunk out of the assets of baby boomers. So much home equity has been lost that 30% of boomers, aged 45 to 54, are underwater in their homes, according to "The Wealth of the Baby Boom Cohorts After the Collapse of the Housing Bubble. " The report, released by D.C.-based think tank the Center for Economic and Policy Research, also found that 18% of boomers aged 55 to 64 would owe money at close if they sold their homes.
The CEPR also found that people who were renting homes in 2004 will have more wealth in 2009 than those who were owners. That's true for all five wealth groups the study analyzed, from the poorest to the wealthiest. "The collapse of the housing bubble, which led to the current recession, has already destroyed almost $6 trillion dollars in housing wealth for homeowners," said report co-author Dean Baker. "This reality is compounded by the recent collapse of the stock market. Many baby boomers will only have Social Security and Medicare to rely on in their retirement." Boomers between 45 and 54 have lost 45% of their median net worth, leaving them with just $80,000 in net worth, including home equity, according to the report. Older boomers have fared marginally better. Those between 55 and 64 have lost 38% of their net worth, leaving them with $140,000. But this group is rapidly nearing retirement age and they have few working years left to make up the losses.
To come up with their estimates Baker and co-author David Rosnick analyzed the assets of boomer-headed families and projected their wealth through September 2009. They used data from the November 2008 Case-Shiller 20 City Price Index as well as the 2004 Survey of Consumer Finance - a survey of the balance sheet, pension, income, and other demographic characteristics of U.S. families put out by the Federal Reserve. The authors then factored in stock and housing market changes since then. Baker and Rosnick presented their findings by income group under three scenarios they considered most likely: House prices remain at November 2008 levels (the latest data they had); house prices fall by 5% from November levels; or house prices fall by 15%. In all three cases, the vast majority of these families will have lost a substantial portion of their net wealth compared with 2004. "We've always boasted about how mobile we are as a society," said Baker, "but this can make us a lot less mobile."
Peter Schiff, president of Euro Pacific Capital, an investment firm specializing in overseas investments and a noted bear on housing market issues, thinks there's a good chance home prices will continue their steep decline. "Real estate has to be priced like any other goods," he said. "Home prices have to reflect the economic reality. You buy for shelter, not to make money. You don't need to own a house. I'm a perfect example." He has rented for years and reports that the owners of his current home, after subtracting for property taxes and insurance, are receiving a cash-flow return on their investment of less than 1%. "Real estate is overpriced if owners get just a 1% return," he said. Baker pointed out that the stock market and home equity losses magnify the importance of safeguarding programs like Social Security and Medicare, the twin safety nets that could provide a higher portion of retirement support than many boomers originally bargained for. "Now that tens of millions of families have just seen much of their wealth disappear," he said, "it is especially important to pursue policies that ensure retirement security for those on the brink of retirement."
Ilargi: I addressed this issue yesterday, and I still wonder why the FDIC is at this point in time not simply funded through Treasury. It's more than obvious that the banks' fees should have been way higher in the past decade, but that doesn't change the fact that higher fees now will topple a number of banks. Why would the FDIC, or the Treasury for that matter, want that to happen? Is this a veiled power grab, a way to consciously and deliberately liquidate insttutions? It would seem strange, seeing that the FDIC is already in financial and human resources difficulties. They started rehiring retired former staff last year, but that can't possibly be enough. Look, if Citi is run down further in the markets the next few weeks, leading to a sub-$1 share price, the government's hand will be forced. But it's an empty hand. What do you think will happen when not only the markets, who've clued in a while back, but also the public starts to see behind the curtain? Sure the US dollar has many advantages, but the US and UK also are host to the majority of the world banking system. If their banks fail, their problems are that much bigger than other countries as well.
FDIC’s latest levy will smack larger banks
A deepening recession forced U.S. bank regulators on Friday to more than double to $83 billion the projected cost through 2013 to a fund that protects customer deposits and to raise insurance fees on banks. Without the extra money, the Federal Deposit Insurance Corp said its insurance fund would be wiped out by bank failures this year. Currently the fund insures up to $250,000 per depositor. The FDIC deposit insurance fund took a big hit during the fourth quarter, plunging almost 50% to $18.9 billion in preparation for actual and expected bank failures. So far this year 14 banks have failed, a pace that could result in the FDIC seizing more than 100 banks by the end of 2009. By comparison, 25 banks failed in 2008 and just 3 in all of 2007.
The FDIC board of directors voted 4-1 to approve a package of measures aimed at raising as much as $27 billion this year in assessment revenues, including $15 billion from a one-time fee in the third quarter. Last year, the FDIC raised $3 billion in fees from banks. FDIC Chairman Sheila Bair, who voted in favor of the increased fees, said regulators tried to balance the agency’s need to restore its insurance fund with banks’ ability to lend to consumers and businesses. “I believe that the regular assessment rates we’re considering and the special assessment rate achieve that balance,” she said at an open board meeting. The FDIC’s budget is financed by more than 8,300 banks, which pay the agency to insure customer deposits. Congress is considering making permanent this year’s $250,000 deposit coverage, up from $100,000 to boost confidence in banks.
The FDIC’s plan for a special assessment represents the first such move since 1996, when regulators took similar action in the aftermath of the savings and loans crisis. The 20 basis point fee, to be paid in the third quarter of 2009, amounts to $200,000 per $100 million in domestic deposits. Such a charge won’t be inconsequential for larger banks. Bank of America, for example, had over $700 billion in domestic deposits as of October, according to FDIC data. A 20 basis point special charge on those deposits would seem to leave B of A with a $1.4 billion onetime payment in the third quarter. The FDIC board also voted to raise the range of regular quarterly fees that banks must pay to obtain deposit insurance, beginning in the second quarter of 2009. If conditions deteriorate, and the FDIC faces an emergency, the agency said it could also impose a special 10 basis point quarterly assessment.
The 25 U.S. bank failures in 2008 cost the agency $18 billion, the FDIC said. Another $65 billion in bank failure costs is expected from 2009 to 2013, it said. Previously the FDIC had thought $40 billion from 2008-2013 would be adequate. On Thursday, the FDIC said the number of problem banks jumped by nearly 50% to 252 in the fourth quarter of 2008. The list of banks, which were not identified by name, is based on regulators’ confidential evaluations of capital adequacy, risk management, asset quality and other factors. The FDIC has set aside $22 billion for expected payouts by the FDIC insurance fund for bank failures in 2009. Bair did not rule out the possibility that the FDIC might have to tap a line of credit with the U.S. Treasury Department to cover the costs of bank failures. The FDIC has access to $30 billion from Treasury and Congress is considering raising that to $100 billion. Board member John Reich, the departing head of the Office of Thrift Supervision, said he voted against the fee increase because it would hurt banks. Reich said he opposed a one-time assessment on banks “when they can least afford it.”
A Line for General Motors
No wonder General Motors asked for more taxpayer money. Last week, Detroit’s biggest carmaker reported it had lost $9.6 billion in the last three months of 2008. That is more than $100 million a day — and more than two-thirds of the money it has borrowed from the government since December. The government should probably heed G.M.’s request, if only to avoid a disorderly liquidation and a stampede of job losses in an economically vulnerable time. General Motors said it had only about $14 billion in cash on hand, and it is burning it at a rate of $2 billion a month. Yet President Obama’s auto sector task force should not agree to fork over the extra $16 billion that G.M. has requested until the company, its bondholders and its union have reached watertight agreements to slash its liabilities and stanch the hemorrhage of money, as they promised to do when they first asked for a taxpayer handout in December.
We are troubled by the slow pace of G.M.’s negotiations with bondholders and the autoworkers union to swap debt for equity in the company and to allow it to pay a big chunk of its contributions to a retiree health-care fund in stock. These steps are absolutely essential if General Motors is to be set on more sustainable footing. The promise of government assistance does not seem to be spurring the carmaker and its stakeholders into action. Ford, which has not received taxpayer money, has already cut a deal on the health-care contributions. G.M. and Chrysler have not. The Obama administration needs to remind them, forcefully, that in exchange for their first helping of taxpayer billions, both automakers committed themselves to ironing out a basic deal with the union and bondholders by Feb. 17. The government must stand by the original deadline of March 31 for the automakers to have sewn up such agreements and to have started to carry them out. And it should consider creating a mechanism to provide bankruptcy financing to help G.M. in case it fails to meet the deadlines — to ensure that the bankruptcy that may then become inevitable is not a disorderly process and that the company will emerge as a viable concern at the other end.
We realize that allowing General Motors to go bankrupt would be very risky. The company said it could need up to $100 billion in financing to get through the process. Considering the catatonic state of the debt markets, it is likely that the Treasury would have to supply much of this. And the company warned that its fortunes could deteriorate further if bankruptcy discouraged drivers from buying its cars. Still, the taxpayers’ assistance was designed to be a bridge to a sustainable future. If G.M. cannot deliver on its promises to the government to achieve self-sufficiency, giving it more aid will simply push the decision about whether to let it go bankrupt a few billion dollars and a couple of months down the road. If the government draws a clear, believable line, G.M., its creditors and its union might find it in themselves to bite the bullet and cut the necessary deals.
Jim Rogers Doesn't Mince Words About the Crisis
In 1970 a young Wall Streeter named Jim Rogers hooked up with George Soros to start the legendary Quantum Fund. The ensuing decades have seen Rogers build an iconoclastic career as an author, adventurer, and creator of the Rogers International Commodities Index. And throughout, Rogers—now based in Singapore—has remained an outspoken global investor. Today is no different. He has harsh words for former Fed Chairman Alan Greenspan, suggests President Barack Obama and his economic team are not up to the task, and thinks tough love is the answer for America.
What do you think of the government's response to the economic crisis?
Terrible. They're making it worse. It's pretty embarrassing for President Obama, who doesn't seem to have a clue what's going on—which would make sense from his background. And he has hired people who are part of the problem. [Treasury Secretary Tim] Geithner was head of the New York Fed, which was supposedly in charge of Wall Street and the banks more than anybody else. And as you remember, [Obama's chief economic adviser, Larry] Summers helped bail out Long-Term Capital Management years ago. These are people who think the only solution is to save their friends on Wall Street rather than to save 300 million Americans.
So what should they be doing?
What would I like to see happen? I'd like to see them let these people go bankrupt, let the bankrupt go bankrupt, stop bailing them out. There are plenty of banks in America that saw this coming, that kept their powder dry and have been waiting for the opportunity to go in and take over the assets of the incompetent. Likewise, many, many homeowners didn't go out and buy five homes with no income. Many homeowners have been waiting for this, and now all of a sudden the government is saying: "Well, too bad for you. We don't care if you did it right or not, we're going to bail out the 100,000 or 200,000 who did it wrong." I mean, this is outrageous economics, and it's terrible morality.
You have said Bear Stearns and Lehman would still be around if Greenspan hadn't bailed out Long-Term Capital Management in 1998. Can you explain?
Well, if Long-Term Capital Management had been allowed to fail, Lehman and the rest of them would've lost a huge amount of money, their capital would've been impaired, and it would've put a terrible crimp on Wall Street. It would've slowed them down for years. Instead of losing capital, losing assets, and losing incompetent people, they hired more incompetent people.
Should AIG (AIG) have been allowed to fail, too?
First of all, banks and investment banks and insurance companies have been failing for hundreds of years. Yes, we would've had a terrible two years. But you're dragging out the pain. We had 10 years of the worst credit excesses in world history. You don't wipe out something like that in six months or a year by saying: "Oh, now let's wake up and start over again."
What about Citigroup? What about the car companies?
They should be allowed to go bankrupt. Why should American taxpayers put up billions to save a few car companies? They made the mistakes! We didn't make the mistakes! I'm sure they'll give them the money, but I'm telling you, it's a mistake. It's a horrible mistake.
I totally understand what you're saying, but the banks are under massive pressure.
They all took huge, huge profits. Who was the head of Citigroup? Chuck Prince? I mean, how many hundreds of millions of dollars did Prince take out of the company? How many hundreds of millions of dollars did other Citibank execs take out of the company? Wall Street has paid something like $40 billion or $50 billion in bonuses in the past decade. Who was that guy who was the head of Merrill Lynch?
Right, Stan O'Neal. He got $150 million for leaving, even though he ruined the company. Look at the guy at Fannie Mae (FNM), Franklin Raines. He did worse accounting than Enron. Fannie Mae and Freddie Mac (FRE) alone did nothing but pure fraudulent accounting year after year, and yet that guy's walking around with millions of dollars. What the hell kind of system is this?
Are you worried the economic crisis will lead to political turmoil in China and elsewhere?
I absolutely am. We're going to have social unrest in much of the world. America won't be immune.
What does all this mean from an investment standpoint?
Always in the past, when people have printed huge amounts of money or spent money they didn't have, it has led to higher inflation and higher prices. In my view, that's certainly going to happen again this time. Oil prices are down at the moment, but that's temporary. And you're going to see higher prices, especially of commodities, because the fundamentals of commodities are enhanced by what's happening.
Which commodities are worth buying or holding on to?
I recently bought more of all of them. But I really think agriculture is going to be the best place to be. Agriculture's been a horrible business for 30 years. For decades the money shufflers, the paper shufflers, have been the captains of the universe. That is now changing. The people who produce real things [will be on top]. You're going to see stockbrokers driving taxis. The smart ones will learn to drive tractors, because they'll be working for the farmers. It's going to be the 29-year-old farmers who have the Lamborghinis. So you should find yourself a nice farmer and hook up with him or her, because that's where the money's going to be in the next couple of decades.
Buffett says U.S. Treasury bubble one for the ages
Warren Buffett, whose Berkshire Hathaway Inc sits on $25.54 billion (17.8 billion pounds) of cash, said worried investors are making a costly mistake by buying up U.S. Treasuries that yield almost nothing. In his widely read annual letter to Berkshire shareholders, the man many consider the world's most revered investor said investors are engulfed by a "paralyzing fear" stemming from the credit crisis and falling housing and stock prices. Treasury prices have benefited as investors flocked to the perceived safety of the "triple-A" rated debt. But Buffett said that with the U.S. Federal Reserve and Treasury Department going "all in" to jump-start an economy shrinking at the fastest pace since 1982, "once-unthinkable dosages" of stimulus will likely spur an "onslaught" of inflation, an enemy of fixed-income investors.
"The investment world has gone from underpricing risk to overpricing it," Buffett wrote. "Cash is earning close to nothing and will surely find its purchasing power eroded over time." "When the financial history of this decade is written, it will surely speak of the Internet bubble of the late 1990s and the housing bubble of the early 2000s," he went on. "But the U.S. Treasury bond bubble of late 2008 may be regarded as almost equally extraordinary." Investors' flight to quality followed years of excessive borrowing, especially in housing, and Buffett used his letter to make plain his dismay with a variety of mortgage lenders. He said many ignored Lending 101 by not checking customers' ability to pay off home loans, or foisting "teaser" rates that reset to higher unaffordable levels.
In contrast, Buffett said, Berkshire's manufactured housing unit Clayton Homes had a 3.6 percent foreclosure rate at year end on loans it made, up from 2.9 percent in 2006, though more than one in three borrowers had "subprime" credit scores. The unit was profitable in 2008, earning $206 million before taxes, though earnings fell 61 percent, Berkshire said. "The present housing debacle should teach home buyers, lenders, brokers and government some simple lessons that will ensure stability," Buffett wrote. "Home purchases should involve an honest-to-God down payment of at least 10 percent and monthly payments that can be comfortably handled by the borrower's income. That income should be carefully verified." Omaha, Nebraska-based Berkshire reduced its cash stake from $44.33 billion a year earlier largely by investing in preferred, convertible and fixed-income securities yielding 10 percent or more, and issued by familiar companies including General Electric Co. and Goldman Sachs Group Inc..
Still, Buffett has said he would be comfortable taking Berkshire's cash stake down to $10 billion. "It is curious how dismissive he is about cash, and yet Berkshire has a large cash position," said Bill Bergman, a senior equity analyst at Morningstar Inc. "The Berkshire enterprise is attractive in part because of the large cash positions. So maybe Buffett's prescriptions for the rest of us don't apply as generally to Berkshire." Indeed, Buffett said that to fund new investments, he sold parts of some equity holdings he wanted to keep -- among them, oil company ConocoPhillips, drug company Johnson & Johnson (JNJ.N) and consumer products company Procter & Gamble Co.. Buffett said he "will not trade even a night's sleep for the chance of extra profits," and wanted Berkshire to have more than ample cash. He also cautioned Treasury investors not to feel "smug" when they see commentators endorsing their investments. "Beware the investment activity that produces applause," Buffett wrote, "the great moves are usually greeted by yawns."
‘Our Country Has Faced Far Worse Travails’
A paralyzing fear has engulfed the country. But America's best days lie ahead.
Warren Buffett's annual letter to Berkshire Hathaway share-holders is a highly anticipated, market-moving event. This year Buffett, who is a director of The Washington Post Company, NEWSWEEK's parent, offered his views on the brutal business climate. Edited excerpts: Over the last 44 years (that is, since present management took over), the book value of Berkshire Hathaway Inc. has grown from $19 to $70,530, a rate of 20.3 percent compounded annually. But 2008 was the worst of those 44 years for both Berkshire's book value and the S&P 500 index. The period was devastating as well for corporate and municipal bonds, real estate and commodities. By year-end, investors of all stripes were bloodied and confused, much as if they were small birds that had strayed into a badminton game.
As the year progressed, a series of life-threatening problems within many of the world's great financial institutions was unveiled. This led to a dysfunctional credit market that in important respects soon turned non-functional. The watchword throughout the country became the creed I saw on restaurant walls when I was young: "In God we trust; all others pay cash." By the fourth quarter, the credit crisis, coupled with tumbling home and stock prices, had produced a paralyzing fear that engulfed the country. A freefall in business activity ensued, accelerating at a pace that I have never before witnessed. The U.S.—and much of the world—became trapped in a vicious negative-feedback cycle. Fear led to business contraction, and that in turn led to even greater fear.
This debilitating spiral has spurred our government to take massive action. In poker terms, the Treasury and the Fed have gone "all in." Economic medicine that was previously meted out by the cupful has recently been dispensed by the barrel. These once-unthinkable dosages will almost certainly bring on unwelcome after-effects. Their precise nature is anyone's guess, though one likely consequence is an onslaught of inflation. Moreover, major industries have become dependent on Federal assistance, and they will be followed by cities and states bearing mind boggling requests. Weaning these entities from the public teat will be a political challenge. They won't leave willingly.
Whatever the downsides may be, strong and immediate action by government was essential if the financial system was to avoid a total breakdown. Had that occurred, the consequences for every area of our economy would have been cataclysmic. Like it or not, the inhabitants of Wall Street, Main Street and the various Side Streets of America were all in the same boat. Amid this bad news, however, never forget that our country has faced far worse travails. In the 20th century alone, we dealt with two great wars (one of which we initially appeared to be losing); a dozen or so panics and recessions; virulent inflation that led to a 21 percent prime rate in 1980; and the Great Depression of the 1930s, when unemployment ranged between 15 percent and 25 percent for many years. America has had no shortage of challenges.
Without fail, however, we've overcome them. In the face of those obstacles—and many others—the real standard of living for Americans improved nearly seven-fold during the 1900s, while the Dow Jones Industrials rose from 66 to 11,497. Compare this with the dozens of centuries during which humans secured only tiny gains, if any, in how they lived. Though the path has not been smooth, our economic system has worked extraordinarily well over time. It has unleashed human potential as no other system has, and it will continue to do so. America's best days lie ahead.
One of Berkshire Hathaway's businesses is Clayton Homes, the largest company in the manufactured-home industry. Its recent experience may be useful in the public policy debate about housing and mortgages. [During the 1990s] much of the manufactured-home industry employed sales practices that were atrocious. The need for meaningful down payments was frequently ignored. Sometimes fakery was involved. Moreover, impossible-to-meet monthly payments were being agreed to by borrowers who signed up because they had nothing to lose. The resulting mortgages were usually packaged ("securitized") and sold by Wall Street firms to unsuspecting investors. This chain of folly had to end badly, and it did.
Clayton, it should be emphasized, followed far more sensible practices in its own lending. Indeed, no purchaser of the mortgages it originated and then securitized has ever lost a dime of principal or interest. But Clayton was the exception; industry losses were staggering. And the hangover continues to this day. This 1997–2000 fiasco should have served as a canary-in-the-coal-mine warning for the far-larger conventional housing market. But investors, government and rating agencies learned exactly nothing from the manufactured-home debacle. Instead, in an eerie rerun of that disaster, the same mistakes were repeated with conventional homes in the 2004–07 period: Lenders happily made loans that borrowers couldn't repay out of their incomes, and borrowers just as happily signed up to meet those payments. Both parties counted on "house-price appreciation" to make this otherwise impossible arrangement work. It was Scarlett O'Hara all over again: "I'll think about that tomorrow." The consequences of this behavior are now reverberating through every corner of our economy.
Clayton's 198,888 borrowers, however, have continued to pay normally throughout the housing crash. Why are our borrowers—characteristically people with modest incomes and far-from-great credit scores—performing so well? The answer is elementary, going right back to Lending 101. Our borrowers simply looked at how full-bore mortgage payments would compare with their actual—not hoped-for—income and then decided whether they could live with that commitment. Simply put, they took out a mortgage with the intention of paying it off, whatever the course of home prices. Just as important is what our borrowers did not do. They did not count on making their loan payments by refinancing. They did not sign up for "teaser" rates that upon reset were outsized relative to their income. And they did not assume that they could always sell their home at a profit if their mortgage payments became onerous. Jimmy Stewart would have loved these folks.
Of course, a number of our borrowers will run into trouble. They generally have no more than minor savings to tide them over if adversity hits. The major cause of delinquency or foreclosure is the loss of a job, but death, divorce and medical expenses all cause problems. If unemployment rates rise—as they surely will in 2009—more of Clayton's borrowers will have troubles, and we will have larger, though still manageable, losses. But our problems will not be driven to any extent by the trend of home prices. Commentary about the current housing crisis often ignores the crucial fact that most foreclosures do not occur because a house is worth less than its mortgage (so-called "upside-down" loans). Rather, foreclosures take place because borrowers can't pay the monthly payment. Homeowners who have made a meaningful down payment—derived from savings and not from other borrowing—seldom walk away from a primary residence simply because its value today is less than the mortgage. Instead, they walk when they can't make the monthly payments.
Homeownership is a wonderful thing. My family and I have enjoyed my present home for 50 years, with more to come. But enjoyment and utility should be the primary motives for purchase, not profit or refi possibilities. And the home purchased ought to fit the income of the purchaser. The present housing debacle should teach homebuyers, lenders, brokers and government some simple lessons that will ensure stability in the future. Home purchases should involve an honest-to-God down payment of at least 10 percent and monthly payments that can be comfortably handled by the borrower's income. That income should be carefully verified. Putting people into homes, though a desirable goal, shouldn't be our country's primary objective. Keeping them in their homes should be the ambition.
Last year I made a major mistake of commission (and maybe more; this one sticks out). I bought a large amount of ConocoPhillips stock when oil and gas prices were near their peak. I in no way anticipated the dramatic fall in energy prices that occurred in the last half of the year. I still believe the odds are good that oil sells far higher in the future than the current $40–$50 price. But so far I have been dead wrong. Even if prices should rise, moreover, the terrible timing of my purchase has cost Berkshire several billion dollars …
On the plus side last year, we made purchases totaling $14.6 billion in fixed-income securities issued by Wrigley, Goldman Sachs and General Electric. We very much like these commitments, which carry high current yields that, in themselves, make the investments more than satisfactory. But in each of these three purchases, we also acquired substantial equity participation as a bonus. To fund these large purchases, I had to sell portions of some holdings that I would have preferred to keep (primarily Johnson & Johnson, Procter & Gamble and ConocoPhillips). However, I have pledged—to you, the rating agencies and myself—to always run Berkshire with more than ample cash. We never want to count on the kindness of strangers in order to meet tomorrow's obligations. When forced to choose, I will not trade even a night's sleep for the chance of extra profits.
The investment world has gone from underpricing risk to overpricing it. This change has not been minor; the pendulum has covered an extraordinary arc. A few years ago, it would have seemed unthinkable that yields like today's could have been obtained on good-grade municipal or corporate bonds even while risk-free governments offered near-zero returns on short-term bonds and no better than a pittance on long-terms. When the financial history of this decade is written, it will surely speak of the Internet bubble of the late 1990s and the housing bubble of the early 2000s. But the U.S. Treasury bond bubble of late 2008 may be regarded as almost equally extraordinary.
Clinging to cash equivalents or long-term government bonds at present yields is almost certainly a terrible policy if continued for long. Holders of these instruments, of course, have felt increasingly comfortable—in fact, almost smug—in following this policy as financial turmoil has mounted. They regard their judgment confirmed when they hear commentators proclaim "cash is king," even though that wonderful cash is earning close to nothing and will surely find its purchasing power eroded over time. Approval, though, is not the goal of investing. In fact, approval is often counter-productive because it sedates the brain and makes it less receptive to new facts or a re-examination of conclusions formed earlier. Beware the investment activity that produces applause; the great moves are usually greeted by yawns.
Obama challenges lobbyists to legislative duel
President Barack Obama vowed to fight America's powerful interest groups as he seeks to push through Congress a budget plan so breathtaking in its scope and ambition that it could help reshape American society. While tackling the economic crisis, Obama is asking Congress to enact contentious measures that have been debated, but not decided, in calmer times: cut subsidies for big farms; combat global warming with a pollution tax on industries; raise taxes on the wealthy; and make big changes to the health care system.
"The system we have now might work for the powerful and well-connected interests that have run Washington for far too long," Obama said Saturday in his weekly radio and video address. "But I don't. I work for the American people." He said the budget plan he presented Thursday will help millions of people, but only if Congress overcomes resistance from deep-pocket lobbies. "I know these steps won't sit well with the special interests and lobbyists who are invested in the old way of doing business, and I know they're gearing up for a fight," Obama said, using tough-guy language reminiscent of his predecessor, George W. Bush. "My message to them is this: So am I."
The tone underscored Obama's combative side as he prepares for a drawn-out battle over his tax and spending proposals. Sometimes he uses more conciliatory language and stresses the need for bipartisanship. Often he favors lofty, inspirational phrases. On Saturday, he was a full-throated populist, casting himself as the people's champion confronting special interest groups that care more about themselves and the wealthy than about the average American. Well-financed interest groups are likely fight back furiously, and the challenges Obama faces are daunting. The U.S. economy contracted by a stunning 6.2 percent in the final three months of 2008, its worst showing in a quarter-century. Obama says the crisis calls for gutsy actions.
Under the president's proposal, America's wealthiest 5 percent would pay a whopping $1 trillion in higher taxes over the next decade, while most others would get tax cuts. Industries would buy and trade permits to emit heat-trapping gases. Higher-income older people would pay more for government health insurance benefits. Drug companies would receive smaller profits from the government. Banks would play a much smaller role in student loans. Passing the budget, even with a Democratic-controlled Congress, "won't be easy," Obama said. "Because it represents real and dramatic change, it also represents a threat to the status quo in Washington."
Obama's climb is steep. Even with solid Democratic majorities in the House and Senate, he secured a $787 billion stimulus package only after accepting compromises that irked liberals but won the support of three Republican senators. Not a single House Republican backed it. Judging from House Republican leaders' immediate condemnation of his budget blueprint, Obama can expect more of the same. Almost every day brings another "multibillion-dollar government spending plan being proposed or even worse, passed," said Sen. Richard Burr of North Carolina, who gave the Republicans' weekly address. He said Obama is pushing "the single largest increase in federal spending in the history of the United States, while driving the deficit to levels that were once thought impossible."
Also Saturday, a White House source said Obama has chosen Kansas Gov. Kathleen Sebelius to be his secretary of health and human services, and plans to formally announce his decision Monday. Sebelius, 60, was an early Obama supporter. She picked his presidential campaign over that of Hillary Rodham Clinton, now the secretary of state, worked tirelessly for Obama's bid and was a top surrogate to women's groups. Obama's first choice for health secretary, former Senate Majority Leader Tom Daschle, withdrew after disclosing he had failed to pay $140,000 in taxes and interest. As governor, Sebelius made addressing rising health care costs and making sure more people have coverage top priorities. Obama turned his attention to the looming battle over his budget plan a day after he consigned the Iraq war to history. He set a firm withdrawal timetable for getting U.S. troops out of Iraq, declaring he will end combat operations within 18 months and open a new era of diplomacy in the Middle East.
More Than One Way to Take Over a Bank
Few words conjure the specter of radicalism quite so well as nationalization. Seizing control of large industries — nationalizing them — is often among the first acts of a leftist government. Lenin did it, and so did Hugo Chávez. Even the comparatively tame François Mitterrand made the nationalization of some banks and heavy industry the centerpiece of his agenda when he became France’s president in 1981. He held it out as the alternative to the laissez-faire ideology of Ronald Reagan and Margaret Thatcher. So it is a bit odd to watch Barack Obama, who aspires to finally end the era of Reaganomics, spend his early weeks in the White House swatting away calls for nationalization from decidedly nonleftist quarters. Lindsey Graham, a Republican senator from South Carolina, recently said that, given the depth of the credit crisis, he wouldn’t rule out nationalizing banks. Alan Greenspan went further a few days later. “I understand that once in a hundred years this is what you do,” Greenspan, an Ayn Rand disciple before he was a central banker, told The Financial Times.
Graham and Greenspan were merely following the lead of various liberal and centrist economists who have been warning of the severity of the financial crisis over the past year. Only the government, their thinking goes, has the ability to remove the dead parts of the financial system so that the rest of it can start functioning again. But Obama and his Treasury secretary, Timothy Geithner, aren’t interested, at least not yet. They want to give the private sector another chance to clean up its own mess. And that has made some people wonder whether it is now the left — or at least Obama’s Democratic Party — that’s too afraid of a little nationalization.
There are really two different kinds of nationalization. The first draws on a belief that the government can run large enterprises more justly and efficiently than self-interested capitalists can. This is the nationalization of Lenin, Chávez and Mitterrand, and its record is pretty dismal. France’s economy staggered through the 1980s, as government-run banks backed political pet projects that didn’t work out. The second version of nationalization is the one that today’s advocates point to. It is a temporary takeover born out of crisis. Sweden pursued this kind of strategy in the early 1990s to clean up its banking system. Even the United States has nationalized banks on occasion, including IndyMac Bank last year.
In these cases and others, the government had none of the grand ambitions that Mitterrand-style nationalizers had. The same would clearly be the case with a nationalization of banks today. “Nobody in their right mind wants the government to be in the banking business any longer than it needs to be,” said Adam Posen, an economist in Washington and a prominent voice for nationalization. Instead, the federal government would declare a bank insolvent, wipe out its existing shareholders, fire its top executives and inject enough money to keep it functioning. The government could then siphon off the worst assets into a so-called bad bank — pooling them with toxic assets from other nationalized banks — and resell the bank’s healthy parts to private investors. Once the crisis lifts, some of the toxic assets may even have value.
The promise of nationalization is that it, and only it, can break a self-reinforcing cycle in which banks continue to make bad bets in an effort to dig themselves out of a hole. It’s frequently said that bankers, paralyzed with fear, have been unwilling to make any new investments. But Posen points out that this isn’t quite right. In the months before they collapsed, both Washington Mutual and Lehman Brothers made the financial equivalent of a Hail Mary pass: investments that had little chance of paying off but at least had the potential to put them back in the black.
Nationalization ends the game. In particular, it prevents the banks from making Hail Mary investments with bailout money from taxpayers. As Obama himself has suggested in interviews, recent history seems to argue for nationalization. Sweden nationalized and emerged from its crisis relatively quickly. Japan dithered with half measures and suffered through a lost decade. “The weight of the historical evidence,” as a Brookings Institution report dryly put it, “is on the side of the proponents of tough action.”
Obama and his advisers offer several arguments against nationalization. This country has many more banks than Sweden and would have to find many more crisis managers to run them. Our political system is also messier, and the banks could be vulnerable to political meddling. But their best argument is that nationalization would probably cost a whole lot of money. Once a few banks were taken over, shareholders might abandon others, fearing that their stock would also soon be worthless. These banks would then need government support. If Geithner’s plan — to lend banks money, in effect, and let them solve their own problems — has a chance of working, it would probably be much cheaper.
The question, obviously, is whether it is too late for such moderation and, if not, whether Obama’s economic team will be able to see when it is. His top advisers, including Geithner and Lawrence Summers, have spent much of their careers trying to persuade other Democrats of the virtues of private enterprise. They have pushed the party to grasp the folly of Mitterrand and acknowledge the limits of government. As this crisis has made clear, the private sector has its limits, too. Will the people who have Obama’s ear be able to acknowledge those limits when the time comes?
Ilargi: Yo, paperboys! I got your answer. If there were one paper in the States that would tell the truth, the whole truth and nothing but the truth, it would be a huge hit. Your reporting has been largely deceitful, plain wrong nad when it comes to financial trouble, exasperatingly late. Every single one of you has focused its attention on the lowest common denominator on one part of the demographic or another. That sort of thing works when times are good. When people's welfare is undersiege, they will look for the truth. And you guys don't have the infrastructure anymore to provide it. Neither do TV stations. You don't provide information, you provide a worldview that you think will sell both papers and ads. You're as out of touch as Detroit's Big 3. And you deserve to go down the same road.
Under Weight of Its Mistakes, Newspaper Industry Staggers
Denver Mayor John Hickenlooper recalls getting "a feeling in the pit of my stomach" when he learned that the Rocky Mountain News was shutting down. "Even when they were uncovering corruption in the city, even when they were embarrassing us or causing us discomfort, they were making the city better," he says. "It's a huge loss." The grim echoes of the nearly 150-year-old paper's demise Friday could be heard in newsrooms and communities across the country. Although the Denver Post will still cover Hickenlooper's region, some cities -- most notably San Francisco -- are facing the prospect of life without a major newspaper. Others, from Philadelphia to Chicago to Minneapolis, have watched their papers slide into bankruptcy, while still others are being served by dailies with newsrooms that have shriveled by half.
Why a once-profitable industry suddenly seems as outmoded as America's automakers is a tale that involves arrogance, mistakes, eroding trust and the rise of a digital world in which newspapers feel compelled to give away their content. "Most of the wounds are self-inflicted," says Phil Bronstein, editor at large of the San Francisco Chronicle, which Hearst Corp. has threatened to close unless major cost savings are achieved or a buyer is found. Rather than engage the audience, he says, "the public was seen as kind of messy and icky and not something you needed to get involved with." As the newsroom staff has shrunk from 575 when Bronstein took over as editor in 2000 to 275 now, "it's objectively true that there's less in the paper," he says. "You can't deny a loss is a loss."
Tom Fiedler, the Miami Herald's former executive editor, says if that paper folds -- McClatchy Newspapers is looking for a buyer -- "nobody else will step in and do the occasionally extraordinary reporting that newspapers do. The difference that a good newspaper makes to the quality of life in any community is vital. It's like a healthy heart." Fiedler, now dean of Boston University's College of Communication, says the Herald's newsroom staff has dwindled from about 420 to 260 in nine years. "My fear is that newspapers will become what local television became a long time ago," he says. "When there's yellow tape around it or the county commission meets to take a vote, we'll cover it."
At a time when such companies as General Motors, Home Depot and Citigroup are ordering mass layoffs, the loss of 12,000 newspaper jobs last year may seem small. But the industry's woes -- plunging advertising revenue, declining circulation and burgeoning high-tech competition -- seem to be worsening by the week. And that has critics questioning why newspaper companies didn't adapt to the Internet more quickly. "Years ago," says Jeff Jarvis, a blogger who has worked for the Chicago Tribune, the San Francisco Examiner and the New York Daily News, "why didn't we take more aggressive action and use the power of our megaphone to promote the product and change the organization?" The answer is that newspapers were "a cash cow," he says. "We thought too much about trying to preserve what we had."
The last big wave of newspaper consolidation took place three decades ago, eliminating such names as the Washington Star, the Philadelphia Bulletin, the Chicago Daily News and the Los Angeles Herald-Examiner and leaving most cities with one highly profitable paper. Now, with a number of major papers up for sale, industry analysts say the recession has all but eliminated willing buyers. New-media enthusiasts say newspapers, saddled with costly printing presses and delivery trucks, are not irreplaceable. But Josh Marshall, whose Web site, Talking Points Memo, has six reporters -- and plans to hire more -- does not minimize the loss of dailies. "If all the big papers disappeared right now and we replaced them with 50 TPMs, it wouldn't come close to doing the job," he said. "But we're in a broader transformation where models like ours and others are going to evolve that can fill the void."
For now, though, most original reporting is provided by newspapers. "If you don't have people out working as full-time reporters, there's this category of information that's not going to appear magically out of nowhere," said Nicholas Lemann, dean of Columbia University's School of Journalism, who argues that papers made a mistake by giving away their wares online. "In a world where all content is free, original newsgathering doesn't happen. We really need to face up to the fact that this is going to be lost." On Friday, Hickenlooper, a Democrat who rode the Rocky Mountain News's endorsement to the mayor's office, visited the tabloid to say goodbye. He recalls an investigation by the newspaper that showed Denver's high school graduation rate was far lower than official statistics indicated. "They did cutting-edge coverage," he said.
Although E.W. Scripps Co. said three months ago that it might pull the plug, the Rocky's death still came as a shock. "A great watchdog is dead. . . . More stories will go untold," reporter Laura Frank told Columbia Journalism Review. Longtime subscriber Harry Puncek, 68, told the newspaper that the shutdown was "like losing a relative." Another reader, Randy Brown, 56, who had tried to warn police about the Columbine High School killers, said: "Your newspaper made a heck of a difference in our lives . . . getting the truth out." But most younger people lack such emotional attachment to their newspapers, and partisans on the left and the right call the coverage biased. With the old business model crumbling, some analysts say newspapers must find a way to charge for online content -- perhaps through "micropayments" of the kind popularized by iTunes, which offers songs for downloading at 99 cents apiece. Others say papers must go the nonprofit route, relying on donors to raise endowments, much like universities.
Private owners, freed from the short-term pressures of Wall Street, were once seen as potential saviors. But that was before the debt-laden Tribune Co. filed for bankruptcy in December, a year after being bought by Chicago real estate mogul Sam Zell, and before Philadelphia Newspapers LLC, which was bought by public relations executive Brian Tierney in 2006 and which owns the Inquirer and the Daily News, did the same last week. Newspapers are killing sections and closing bureaus, particularly in Washington. The Detroit News and the Detroit Free Press have cut back home delivery to three days a week. The Washington Times has dropped its Saturday print edition. The Christian Science Monitor is switching to Web-only publication in April. Gannett Co., publisher of USA Today, is forcing staffers to take a week-long furlough. Hearst plans to close the Seattle Post-Intelligencer unless it gets a buyer.
The country's biggest papers have struggled as well. The New York Times has borrowed $250 million from a Mexican financier at 14 percent interest, eliminated its quarterly dividend last month to conserve cash and folded its Metro section into the paper. Rupert Murdoch's News Corp., which bought the Wall Street Journal in late 2007, has taken a roughly $3 billion write-down on the value of its newspaper unit, which includes the New York Post. Newsday is drawing up plans to end free access to its Web site. The Washington Post, whose earnings dropped 77 percent in the fourth quarter of last year, has undergone three rounds of buyouts, killed its Sunday Source section and folded Book World as a separate section. Executive Editor Marcus Brauchli, who is merging the downtown newsroom with the Arlington-based Web operation, has cited the need to cut costs and focus on the core areas of the paper's coverage.
And on Friday, the American Society of Newspaper Editors canceled its convention, saying too many members planned to stay home. Determined to adapt, newspapers are adding blogs, podcasts, online chats and contributions from local citizens. The New York Times will launch two Web sites tomorrow aimed at five communities in Brooklyn and New Jersey. The Post launched a similar "hyperlocal" site for Loudoun County in 2007. Some newspaper executives say Google is eating their lunch by appropriating their content. But Jarvis, author of the book "What Would Google Do?," says the software giant is adding to newspapers' value by linking to their stories. "Google is the new newsstand," he says. Jarvis, who now reads the New York Times on a Kindle electronic device during his subway commute, says print publications are the past. "Paper has become the comfort blanket for newspeople, and it's time to snatch the blanket out of the kids' hands," he said.
Fed should switch other assets for Treasuries: Plosser
An agreement with the U.S. Treasury to swap Treasury bonds for non-government debt on the Federal Reserve's balance sheet could help the central bank unwind its extraordinary credit-easing policies, a top Fed official said on Friday. The move would also help draw a clearer distinction between monetary and fiscal policy to ensure the Fed's independence does not come under attack, Philadelphia Federal Reserve Bank President Charles Plosser said in remarks prepared for delivery to a forum on monetary policy. "The current crisis and the Fed's interventions have dramatically altered the composition of the assets on our balance sheet and created confusion in the minds of many as to the respective roles of the central bank and the fiscal authority," Plosser said.
The U.S. central bank's balance sheet has more than doubled to around $2 trillion as it pumped hundreds of billions of dollars into key credit markets. It has bought assets that it would not usually hold on its balance sheet, including agency debt and agency mortgage-backed securities. An agreement with the Treasury to switch U.S. government bonds for these less-liquid non-traditional assets on the Fed's balance sheet would help the central bank focus on conducting traditional monetary policy. "With Treasuries back on the balance sheet, the Fed will be able to drain reserves in a timely fashion with minimal concerns about disrupting particular credit allocations or the pressures from special interests," said Plosser, who is not a voting member on the Fed's policy-setting committee this year.
He said such an agreement would transfer funding of the credit programs to the Treasury, "thus ensuring that credit policies that place taxpayer funds at risks are under oversight of the fiscal authority. "Second, it would return control of the Fed's balance sheet to the Fed, so that we can continue to conduct independent monetary policy," he said. Plosser said it is important for the Fed to articulate a clear exit strategy from its credit policies and anticipate that political pressures could make it more difficult to shrink its balance sheet quickly enough when the time comes. Longer-term assets, such as agency MBS, "may prove difficult to sell for an extended period of time if markets are viewed as 'fragile' or specific interest groups are strongly opposed," he said, adding that this could lead to inflation down the road.
"We must ensure that our current credit policies do not constrain our ability to conduct appropriate monetary policy in the future," Plosser said. He said the "jury is still out" as to how effective these so-called credit easing policies will be. Plosser reiterated his call for an explicit inflation target and said the Fed should publicly commit to achieving that target over an intermediate time horizon. "Such a commitment would help anchor expectations more firmly and diminish concerns of persistent inflation or persistent deflation -- not an inconsequential issue in the current environment," he said. It could also be useful, Plosser said, for the policy-setting Federal Open Market Committee to publish quarterly projections of members' assumed policy paths.
He said the Fed also needs to clarify the criteria under which it steps in as a lender of last resort. "We must spell out when we will intervene in markets or extend unusual credit to firms -- and then we must be willing to stick to those criteria," he said. Plosser said the lack of clear ground rules can lead to markets speculating on what the next asset class or company the Fed will rescue. This is counterproductive and can lead to increased market volatility, he warned.
So long, farewell, auf wiedersehen: is it game over for Swiss banks
Treasure, in fairytales, is stored underground and guarded by gnomes. The gnomes of Zurich have over the years performed heroically. They have succeeded in protecting from the world's tax authorities nearly a third of the world's $7 trillion of privately held wealth. But against their will, Swiss bankers are being dragged from subterranean vaults into the light. The fairytale that has delivered a standard of living envied by the rest of the world is slipping away. And the country's power brokers know it. Last Tuesday, on the day Switzerland's biggest bank, UBS, saw its share price sink to an all-time low, the country's president, Hans-Rudolf Merz, himself a former UBS banker, suggested for the first time that bank secrecy - his country's most precious commodity - is no longer non-negotiable.
A historic moment, it was followed a day later by the sudden resignation of the chief executive of UBS, once its richest institution. The departure of Marcel Rohner, who lasted just 20 tempestuous months, is yet another calamitous milestone in the collapse of what is arguably Europe's most powerful bank. For Switzerland, these are dark days. Private banker to the world, the country - and in particular its shadowy financial elite - has suffered a wave of unprecedented humiliations. No European bank has suffered bigger write-downs than UBS. Its reputation for risk-free sobriety in shreds, UBS has dumped $40bn worth of toxic sub-prime mortgages and CDOs into a "bad bank" and required a $3bn government bail-out. It has even been forced to order bankers to hand back bonuses after the traditionally phlegmatic Swiss public reacted with fury when it realised UBS was doling out $2bn to loss-making money-men.
Even more damagingly, UBS is embroiled in a multi-million-dollar tax evasion scandal in the United States that has led to the bank being sued by the US Department of Justice, which is demanding the identities and details of 52,000 of its American account holders. The future of Swiss banking hangs on this case. Two weeks ago, UBS paid a $788m fine and handed details of 250 private accounts to US investigators after court documents revealed that UBS wealth managers smuggled diamonds in toothpaste tubes, deliberately destroyed offshore bank records on behalf of clients and assisted wealthy Americans to conceal ownership of their assets by creating "sham" offshore trusts. Misleading and false documentation was routinely prepared to facilitate this. The motivation, according to a former senior UBS executive who last year entered into a plea bargain to reduce his sentence, was to ensure the bank managed a staggering $20bn of assets owned by wealthy US individuals, which generated the bank $200m in fees each year. The scandal has seen a huge outflow of funds from UBS since it broke last summer and sparked a wave of litigation against the bank from wealthy clients furious at having their identities revealed.
Switzerland is now an international whipping boy. This year it suffered the indignity of being refused an invitation to the international G20 conference to be held in London in April to discuss reforms to the global financial system - despite a plea by president Merz, who doubles as his country's finance minister, to Gordon Brown at the World Economic (WEF) meeting in the Swiss ski resort of Davos at the end of January. For the world's seventh largest financial centre, the snub is more than an embarrassment. It means the country has become neutered, unable to influence events that could shape globalisation for decades to come. The problems have led the country's justice minister, Eveline Widmer-Schlumpf, to fly to Washington next week to talk to her American counterpart in a desperate bid to resolve the escalating legal dispute between the two countries.
The mainstream Swiss business community is praying for a breakthrough. Switzerland has also spawned some of the world's biggest non-banking corporations, including food giant Nestlé; Roche, the pharmaceuticals firm; and Glencore, one of the world's most powerful mining companies. Mindful of the harmful ramifications of the tax scandal, leading executives appear to be backing a form of financial glasnost to counter the threat of being isolated on the world stage. Johann Schneider-Ammann, a board member with many of Switzerland's leading firms, an industrialist and an influential political figure, said last week that tax evasion should be treated as a crime. In Switzerland, this is a revolutionary statement. What makes it unique as a major European country is its distinction between tax evasion, which is legal, and tax fraud, which is not. To make matters harder for international revenue investigators, the Swiss will only co-operate with tax officials if the issue they are pursuing is also a crime in Switzerland. It is a situation that helps the world's richest individuals hide trillions of dollars.
And despite growing international pressure for it to lift the veil of secrecy, powerful conservative forces are massing, determined to stand up to what they argue is hypocritical bullying by the international community. When earlier this month Brown and Alistair Darling both attacked Swiss secrecy, its bankers were beside themselves with rage. They argue that the UK is at the forefront of aggressive tax evasion through a nexus that connects the City of London with the Channel Islands, the Isle of Man and the Caribbean. But a senior UK figure working for a Swiss bank said while London bankers are adept at hiding cash from the tax man, Switzerland's role is also crucial: "Swiss and other banks use the same methods in London as they did in the US, including offshore entities in the British Virgin isles et al, indirect telecommunications, credit card accounts linked to the Swiss account, utility bills sent to the bank for payment, even account officers collecting cash from Switzerland."
It is one thing contending with the ire of Britain, France and Germany. But the Swiss have to deal with an increasingly hostile US administration. US officials are infuriated at what they see as obstruction from the Swiss who, they believe, do not have a leg to stand on. President Barack Obama's officials are acutely aware of how leading figures in the Swiss government backed his presidential opponent, John McCain, last year. The country that helped finance Hitler's rise to power, hid gold looted from Holocaust victims and protected the illicit fortunes of some of the world's most corrupt rulers will not go down without a fight. Right-wing parties have started collecting 100,000 signatures to trigger a referendum to enshrine bank secrecy in Switzerland's constitution.
But the decline in Switzerland's fortunes is largely tied to the collapse of UBS: if the bank was not so weak, the country's financial community believes they would have more chance of resisting international pressure. The anger among UBS bankers towards board members who not only sanctioned huge investment in sub-prime assets at the top of the market, but failed to stop its wealth management arm breaking US law - despite being so advised by its staff - is palpable. "The board were a third-rate Swiss old boys' network," says a senior UBS figure in London. "They are far too distant. They deserve to be shot." That opinion is shared by the Swiss media and most of the public. Last month, the Zurich headquarters of UBS was attacked by furious protesters, who splattered its imposing whitewashed stone walls with paint. The Swiss media has, unusually, lambasted its financial elite, helping to force UBS bankers to hand back a portion of their windfall.
Bankers are unused to derision. And it shows. Shrunken and nervous, Rohner's last public act as UBS chief executive last Tuesday was to tell viewers on Swiss television talk show Club that the bank would not give an inch on secrecy. "To disclose and divulge bank data: this is a conception of the world that I do not share," Rohner said. The next day, he lost his job. A UBS spokesman this weekend said that with the appointment of Oswald Grübel - seen as the man who rescued Credit Suisse after it was laid low by its part in the dotcom flotation scandal - as the new chief executive, the bank was now fighting back. "UBS is going through change," he said. "We are addressing and solving problems. The problems led to outflows. That's quite clear: it's not just a flight of clients. Clients are deleveraging. "But we are paying back debt. We are on the way. We think we will be profitable in 2009. We are rebuilding trust. We have clearly acknowledged fraud. We took responsibility. It's part of our deferred prosecution that we will overhaul our compliance and control framework. Also in our offshore overseas operations, this is something we are working on."
Grübel is seen as UBS's last hope of survival. But those close to the bank say it has suffered such huge shocks that another blow could be fatal. The risk of corporate loan defaults and its exposure to international credit markets during a recession are cited as major risk factors. Swiss insiders suggest it will offer to pay a proportion of tax on its wealthy clients so long as it can protect their identities. But the future of Switzerland lies in Obama's hands. He has promised a crackdown on tax havens. If he convinces fellow world leaders at the G20 that bank secrecy cannot be tolerated at a time when the world needs every penny to haul itself out of the mire, then Switzerland will be done for. This was not the way the fairytale was meant to end.
The secret history
The secrecy of Swiss banks dates back to the middle ages and was used to hide wealth by many of Europe's dynasties and the Vatican, even though Switzerland had embraced Protestantism. Secrecy became official Swiss government policy during the First World war and was made law in 1934. Swiss financiers have faced criticism for destabilising democracy during the last 100 years. In 1923, Adolf Hitler visited Zürich to raise money for his party, and was said to have met bankers at the famous Hotel St Gotthard. Swiss banks were used by the Nazis to stash looted gold. A UBS security guard blew the whistle on the bank's attempts to destroy records dating back to that time; he was sacked for his trouble. In 1998, an independent panel of experts found Swiss banks were guilty of accepting Nazi deposits, even though they knew those deposits involved theft. Up to 19 Swiss banks, including Credit Suisse, were used by corrupt former Nigerian ruler Sani Abacha, who looted £3bn from his country. But the Swiss Bankers' Association points out that its report revealed the banks' identities, which is more than British regulators managed in the Abacha case.
EU overflowing with unsold cars
Faced with a shortage of storage space, Japanese car manufacturer Toyota is currently hiring a ship in the Swedish port of Malmo to store thousands of unsold cars the depressed EU market does not seem to want. "It's an emergency measure that we had to take due to storage space issues," Toyota press spokeswoman Anne Gaublomme told EUobserver. "Our vehicle logistics centre in Malmo had reached a maximum capacity as core sales in the region have decreased recently." The decision to store 2,500 cars aboard a vessel owned by car transporting specialists Wallenius Wilhelmsen was made last month when the Malmo port facility reached its limit of 12,000 cars. "We hope to keep the time of this measure as short as possible, as we are continuously adapting our production level," said Ms Gaublomme.
Robert Minton-Taylor of Norwegian-owned Wallenius Wilhelmsen said the company was approached by Toyota regarding storage but that he didn't expect much future development in the area. "We are happy to oblige because obviously it's good business, but also secondly [Toyota] have been a long-standing customer of our company," he said. Car sales have seen a huge slump in recent months as worried consumers put off any major fresh expenses. Exacerbating the situation, production-cutting measures such as reduced working hours can take several weeks to produce an effect, leading to the current backlog of unsold cars. New figures released by the European Statistics Office on Tuesday (24 February) showed December industrial orders for the EU27 down 6.4 percent on the month before. Toyota currently has European car production plants in France, the UK, Czech Republic, Russia and Turkey.
The shipping storage manoeuvre appears unique to Toyota, but a number of its competitors around the world have also resorted to unusual locations. Chrysler is currently using the Downsview military base in Ontario to store cars, according to news website Canada.com. While one part of the automobile sector is forced to take extreme action, another is experiencing an unlikely upturn in some countries. A number of EU member states, in particular Austria, France Germany, and Spain, have introduced car scrapping schemes in a bid to boost dwindling sales of new models. "We have got more work at the moment than we have had for five years," said Volker Muller, manager of Berlin scrapyard Auto-Ferch, according to reports in the Financial Times earlier this month.
The German scheme offers €2,500 to consumers who scrap an old car at least nine years old and purchase a new model. However, Scrap Yard SI, a Spanish company based in Malaga, told EUobserver that business had not improved despite the introduction of similar measures by the Spanish government. The Czech EU presidency has called on the European Commission to draft EU-wide guidelines, fearing individual measures may distort the internal market. Czech deputy prime minister Alexandr Vondra called on the commission earlier this month "to come up immediately with a proposal on how to encourage, in a co-ordinated manner, a European car-fleet renewal." So far, the commission has resisted such plans, saying the matter should be dealt with on a national basis.
Arsonists Torch Berlin Porsches, BMWs on Economic Woe
When Berlin resident Simone Klostermann returned from vacation and couldn’t find her Mercedes SLK, she thought it had been towed. Police told her the 35,000- euro ($45,000) car had been torched. “They’d squirted something flammable into the car’s engine block in the gap between the windshield and the hood,” said Klostermann. “The engine was completely destroyed.” The 34-year-old’s experience isn’t unique in the German capital. At least 29 vehicles were destroyed in arson attacks this year, most of them luxury cars, according to police. The number is already about 30 percent of the total for 2008. The latest to go up in flames was a Porsche, on Feb. 14, two days after a Mercedes was set alight in a public car park.
While youths in Athens protest by throwing Molotov cocktails, in Paris by toppling barricades, and in Budapest by hurling eggs at politicians, protesters in Berlin rage at their economic plight by targeting the most expensive cars -- symbols of German wealth and power. A group calling itself BMW -- the initials stand for Movement for Militant Resistance in German -- has claimed responsibility for several attacks in left-wing magazines and Web sites, police spokesman Bernhard Schodrowski said. One-third of the incidents are classed as “political,” prompting officers to assign a special unit to investigate, Schodrowski said. No arrests have been made. Schodrowski attributed the arson to “a protest against the world economy and rising rents.”
German unemployment began to rise last November after almost three years of declines. Deutsche Bank AG Chief Economist Norbert Walter predicts the German economy, Europe’s biggest, may shrink by more than 5 percent this year. The worst recession since World War II is fueling anger among youths across Europe who “perceive their future as rather precarious,” said Margit Mayer, a politics professor at Berlin’s Free University. “Whether you look at the Berlin events or these anarchist groups in other European cities and countries, they are all making reference to the deepening economic crisis and how the various governments are dealing with them,” said Mayer, a specialist in urban social and protest movements.
Some groups are “very quick to attack whoever they can make out as responsible for having robbed them of decent life prospects,” according to Mayer. The Berlin car burnings have been concentrated in up-and- coming neighborhoods such as Prenzlauer Berg, where Klostermann’s car was destroyed in May. There, new housing and building redevelopments are pushing out the squatter scene that flourished after East and West Berlin were reunited in 1990, said Andrej Holm, a sociologist at Goethe University in Frankfurt who has studied the change. Rents that were about half the city average 10 years ago are now about 40 percent above the average, and the car attacks are an attempt to drive wealthy newcomers away, Holm said.
“It means: ‘rich people, don’t move in here -- your cars will be trashed, we don’t want you here’,” he said. Representatives from Porsche Automobil Holding SE, Daimler AG, the maker of Mercedes, and Bayerische Motoren Werke AG declined to comment on the attacks. Daimler spokeswoman Ute von Fellberg said the matter was about security in Berlin. “This is not a matter for the producer, rather it’s a matter for the city of Berlin,” BMW spokesman Alexander Bilgeri said today in a phone interview. While Prenzlauer Berg and other central neighborhoods such as Friedrichshain and Kreuzberg are thriving, at least in parts, Berlin as a whole remains Germany’s “subsidy capital” almost 20 years after the Berlin Wall fell, said Tobias Just, a real-estate economist with Deutsche Bank in Frankfurt. Unemployment, at 14.1 percent in February, is almost double the national average.
Oliver Kappelle, who moved with his wife and two children to Friedrichshain, is unfazed by the perceived threat. One night last month, Kappelle came across a “heap of junk that used to be a Porsche the night before,” he said. “I was just relieved that he didn’t park in the empty space behind me.” Berlin has a history of political protest, with anarchist demonstrators regularly clashing with police on the streets of Kreuzberg during May 1 marches. Kreuzberg, which abutted the Berlin Wall, is represented in parliament by the Green Party’s Hans-Christian Stroebele, a former lawyer who defended members of the Baader-Meinhof gang in court.
Likewise, arson attacks on cars are not new: a Web site, “Burning Cars,” was set up to track the incidents in May 2007, one month before a summit in the northern German resort of Heiligendamm of the Group of Eight industrialized nations. There have been 290 attacks on cars since then, among them 55 Mercedes and 29 BMWs damaged or destroyed by fire, the site records. “I wouldn’t advise someone to park their Porsche on the street” in Kreuzberg, Berlin police commissioner Dieter Glietsch told the Taz newspaper in June last year. As the frequency of attacks increases, Klostermann, a company manager who has lived in Prenzlauer Berg for 12 years, remains unbowed. “I would never want to be regarded as someone who can be driven out of a place where I enjoy living,” she said.
‘Petty thief’ emerges as working class heroine
A 50-year old German supermarket cashier who was sacked for allegedly stealing coupons worth €1.30 (Dh6) has become a working-class heroine symbolising a growing sense of social injustice in the financial crisis that has begun to drag down Europe’s largest economy. Barbara Emme worked for the Kaiser’s supermarket chain for 31 years, most recently in Berlin, until she was fired in January last year after the management accused her of using two bottle return coupons lost by customers in the store – one worth €0.48 and the other €0.82 – to pay for groceries. She denied the charge and took legal action but a senior labour court in Berlin ruled in her employer’s favour last week. The judge said the firm did not need to prove her guilt before sacking her because mere suspicion of wrongdoing was enough justification. A supermarket, the judge argued, must be able to have total faith in its cashiers.
The ruling met with disbelief and outrage across the nation. Politicians and trade unionists warned that it could undermine faith in the legal system and reinforce the view that Germany is a two-class society following lenient sentences for major tax evaders and billion-euro bailouts for high-rolling bankers. “It’s a barbaric and antisocial verdict,” said Wolfgang Thierse, the deputy president of the Bundestag lower house of parliament and a senior member of the centre-left Social Democratic Party. It could end up shaking confidence in democracy, he said. The case has struck a chord with people in the current environment of economic doom. With fear of unemployment mounting, the notion that there is one rule for the rich and one for the poor is especially damaging, politicians said. The dismissal has been front page news and Ms Emme was invited to take part in one of the country’s best-known TV talk shows last week. “I didn’t do what I’m accused of and I would never do it because I worked heart and soul for Kaiser’s. It was my life,” she said.
Ms Emme is a single mother of three grown children and has had to move into a smaller apartment because she is on an unemployment benefit and has little prospect of getting a new job. Her lawyer, Benedikt Hopmann, said he will take the case to Germany’s highest court, the Federal Constitutional Court. “There’s huge interest in the case because most people identify with it, most people sense an increasing uncertainty. The little people get hanged, and the big ones are let go,” Mr Hopmann said in an emotional outburst on the Johannes B Kerner talk show last week. Liberal newspaper Die Zeit commented: “Barbara E has become a symbol for the fact that even in the biggest crisis, it’s always the wrong people who get hurt.” Uwe Polkaehn, a regional official of the DGB German trade union federation, said: “The verdict lacks all sensitivity. It’s unfair. Because bank managers can fritter away billions of euros and go on claiming bonuses without being called to task.”
Last month bankers at investment bank Dresdner Kleinwort Benson came under fire after reports that they were considering suing the bank to protect their bonuses for 2008 despite huge losses. Chancellor Angela Merkel has joined the international criticism of high bonus payments for bankers, and has called for curbs. The cashier’s treatment has been compared with that of Klaus Zumwinkel, the former chief executive of Deutsche Post AG, the mail and logistics group, who escaped a jail sentence in a court verdict in January even though he admitted evading €970,000 in tax. He paid a €1 million fine under a deal struck between his lawyers and the state prosecution, and he now plans to emigrate to Italy to live in a castle he owns on Lake Garda. A survey published yesterday found 67 per cent of Germans regarded the verdict as unjust. Among people on relatively low income of between €1,000 and €1,500 per month, the percentage was 77 per cent, according to the survey conducted by the Emnid polling institute for Bild am Sonntag newspaper.
Kaiser’s insists that Ms Emme stole from it. She has alleged that her dismissal is linked to her membership of a trade union and participation in a retail workers’ strike in autumn 2007 against cuts in shift supplements, but the firm has denied that. The company’s Berlin regional manager, Tobias Tuchlenski, said the store had no option but to fire Ms Emme. “We have to dismiss anyone who’s dishonest, even if they only steal a chewing gum,” he said. “Five, 10 or 100 euros – where do you draw the line?” So far, Ms Merkel has stayed out of the debate, which is politically explosive because it coincides with growing concern about the plight of ordinary people in the financial crisis and about massive government spending to shore up a financial sector reeling from its own reckless speculation. Thousands of workers at car maker Opel, the German subsidiary of ailing US group General Motors, demonstrated last week against threatened job cuts and plant closures in the course of GM’s planned global restructuring. Opel has been American-owned since 1929 but it remains a quintessentially German brand and an icon of the country’s post-war economic miracle.
Its possible demise, following the insolvency in recent months of other venerable brands such as the porcelain maker Rosenthal, the underwear firm Schiesser and the model train manufacturer Märklin, has sparked fears that the global recession will do irreparable damage to Germany’s industrial base. “Is ‘Made in Germany’ Going Kaput?” wrote the country’s best-selling daily, Bild, last month. Mrs Merkel’s government is under intense pressure to help Opel, which employs 29,000 workers, after it bailed out the country’s bankers. If it does not, Mr Hopmann’s statement that the “little people get hanged and the big ones are let go” will be ringing in Mrs Merkel’s ears all the way up to the general election in September.
China nears deflation trap as rail freight collapses
Railway freight in China’s Shanghai region plunged 31pc in January and industrial production fell 12pc, dashing hopes that Beijing’s stimulus policies will soon begin to fuel recovery. The country’s central bank said the economic outlook was going to bad to worse was still gathering pace, rains the risk that China could tip into a Japan-style deflation trap. “External demand is shrinking, some sectors have overcapacity, and urban unemployment is rising. Downward pressure on economic growth is increasing. There exists a big risk of deflation,” said the bank. Factory gate inflation has dropped to minus 3.3pc. “We will use various tools, including interest rates and banks’ reserve requirement ratios, to ensure reasonable monetary and credit growth,” it said. The bank has cut interest rates and relaxed credit rules fives times since September.
China’s economy continued to eke out headline growth of 6.8pc in the fourth quarter of 2008 but all the rise was in the early part of the year. On a month-to-month basis the economy has been flat for several months, and may even have started to contract. Electricity use has fallen sharply The Shanghai industrial data is being watched closely as a proxy for the country since there is no nationwide data for January owing to the Lunar New Year. The output fall is adjusted for the holidays. The fall in absolute terms was 21pc, year-on-year. The figures tally with the catastrophic drop in exports from Japan, Korea, Taiwan, and Singapore over the last three months. These countries are an integral part of the supply chain for Chinese industry.
Taiwan said yesterday that export orders to China fell 55pc in January, suggesting that Asian trade will remain trapped in depression deep into Spring. The fall in total orders was 41pc, while industrial output fell 43pc. Separately, Japan’s finance minister Kaoru Yosano said Tokyo is examining plans to a special body to buy shares in banks to help shore up the stock market after the Nikkei index fell to a 26-year low. “Excessive stock falls are undesirable. The government will consider what it can do if stock prices fall too much,” he said.
China warns of unemployment risk
The biggest challenge facing China is not slowing growth but unemployment, which could trigger social unrest, a Chinese government minister has said. Commerce Minister Chen Deming told the BBC that when economic growth slowed "the chances of possible social unrest increase as well". Mr Chen also said China was taking steps to improve social security. He made his remarks as British and Chinese firms signed trade deals worth $1.9bn (£1.3bn). About 10 million migrant workers have lost their jobs in China as the global economic slowdown has deepened. "I don't worry a lot about the GDP growth, however the biggest challenge to China is unemployment," the minister said.
"We need to create sufficient jobs for university graduates and the redundant workforce from the countryside." He said the Chinese government was planning to invest billions of dollars in creating a better rural social security network to help farmers. "We need to provide better medicare insurance for them, we need to provide better guarantees for their children's schooling and better guarantees for their pensions." Mr Chen is in Britain as part of a tour of Europe by Chinese companies and trade officials. Before arriving in London, he visited Berlin, where German and Chinese firms signed new business contracts worth more than $10bn.
On Friday, engine maker Rolls-Royce signed a $1.2bn deal to supply and service aircraft engines for China's Hainan Airlines Airbus fleet. Car firm Jaguar Land Rover signed a "very significant" order to supply 13,000 vehicles to China over a three-year period. Business Secretary Peter Mandelson said the visit of the Chinese trade delegation showed "how highly the Chinese value their trade with the UK". In his interview with BBC business editor Robert Peston, Mr Chen said that China was "heavily dependent" on the global economy. "Given such a high degree of openness it is impossible for China to survive in an isolated way from the financial crisis." The commerce minister said he expected that in the first six months of this year, the global slowdown would have a larger impact on the Chinese economy.
China's economic growth was forecast to slow, but would still grow by around 8% in 2009, he said. But he saw no sign of a quick upturn in the global economy, saying: "All countries in the world are in the same boat, and we share the same destiny." He ruled out major changes in the value of China's currency, despite pressure from the United States. The US has long been angered that China does not allow the yuan to float freely, saying the artificially low currency makes Chinese exports unfairly cheap. Mr Chen said he did not think "for the next period of time" there would be a "remarkable change" in the value of the yuan.
Guess What Got Lost in the Loan Pool?
We are all learning, to our deep distress, how the perpetual pursuit of profits drove so many of the bad decisions that financial institutions made during the mortgage mania. But while investors tally the losses that were generated by loose lending so far, the impact of another lax practice is only beginning to be seen. That is the big banks’ minimalist approach to meeting legal requirements — bookkeeping matters, really — when pooling thousands of loans into securitization trusts.
tated simply, the notes that underlie mortgages placed in securitization trusts must be assigned to those trusts soon after the firms create them. And any transfers of these notes must also be recorded.
But this seems not to have been a priority with many big banks. The result is that bankruptcy judges are finding that institutions claiming to hold the notes that back specific mortgages often cannot prove it. On Feb. 11, a circuit court judge in Miami-Dade County in Florida set aside a judgment against Ana L. Fernandez, a borrower whose home had been foreclosed and repurchased on Jan. 21 by Chevy Chase Bank, the institution claiming to hold the note. But the bank had been unable to produce evidence that the original lender had assigned the note, which was in the amount of $225,000, to Chevy Chase. With the sale set aside, Ms. Fernandez remains in the home. “We believe this loan was never assigned,” said Ray Garcia, the lawyer in Miami who represented the borrower. Now, he said, it is up to whoever can produce the underlying note to litigate the case. The statute of limitations on such a matter runs for five years, he said.
Mr. Garcia has another case in which a borrower tried to sell his home but could not because the note underlying a $60,000 second mortgage cannot be found. The statute of limitations on the matter will expire in October, he said, and if the note holder has not come forward by then, the borrower will be free of his obligation on the second mortgage. No one knows how many loans went into securitization trusts with defective documentation. But as messes go, this one has, ahem, potential. According to Inside Mortgage Finance, some eight million nonprime mortgages were put into securities pools in 2005 and 2006 and sold to investors. The value of these loans was $797 billion in 2005 and $815 billion in 2006.
If notes underlying even some of these mortgages were improperly assigned or lost, that will surely complicate pending legislation intended to allow bankruptcy judges to modify mortgage terms for troubled borrowers. A so-called cram-down provision in the law would let judges reduce the size of a loan, forcing whoever holds the security interest in it to take a loss. But if the holder of the note is in doubt, how can these loans be modified? Bookkeeping is such a bore, especially when there are billions to be made shoveling loans into trusts like coal into the Titanic’s boilers. You can imagine the thought process: Assigning notes takes time and costs money, why bother? Who’s going to ask for proof of ownership of these notes anyhow?
But as the Fernandez case and others indicate, bankruptcy judges across the country are increasingly asking these pesky questions. Two judges in California — one in state court, another in federal court — issued temporary restraining orders last month stopping foreclosures because proper documentation was not produced by lenders or their representatives. And in another California case, a borrower’s lawyer was awarded $8,800 in attorney’s fees relating to costs spent litigating against a lender that could not prove it had the right to foreclose. California cases are especially interesting because foreclosures in that state can be conducted without the oversight of a judge. Borrowers who do not have a lawyer representing them can be turned out of their homes in four months.
Samuel L. Bufford, a federal bankruptcy judge in Los Angeles since 1985, has overseen some 100,000 bankruptcy cases. He said that in previous years, he rarely asked for documentation in a foreclosure case but that problems encountered in mortgage securitizations have made him become more demanding. In a recent case, Judge Bufford said, he asked a lender to produce the original of the note and it turned out to be different from the copy that had been previously submitted to the court. The original had been assigned to a bank that had then transferred it to Freddie Mac, the judge explained. “They had no clue what happened after that,” he said. “Now somebody’s got to go find that note.” “My guess is it’s because in the secondary mortgage market they have been sloppy,” Judge Bufford added. “The people who put the deals together get paid for the deals, but they don’t get paid for the paperwork.”
A small but spirited group of consumer lawyers has argued for years that the process of pooling residential mortgages into securities was so haphazard that proper documentation of the loans was never made in many cases. Leading the brigade is April Charney, a foreclosure lawyer at Jacksonville Legal Aid in Florida; she now trains consumer lawyers around the country to litigate these cases. Depending on the documentation defect, lawyers say, investors in the trust could try to force the institution that sold the loan to the trust to buy it back. Many of these institutions would be unable to do so, however, because they are defunct. In the meantime, when judges are not persuaded that the documentation is proper, troubled borrowers can remain in their homes even if they are delinquent.
The woes brought on by sloppy bookkeeping in securitizations will be on the agenda at the American Bankruptcy Institute’s annual spring meeting on April 3. An article titled “Where’s the Note, Who’s the Holder,” co-written by Judge Bufford and R. Glen Ayers, a former federal bankruptcy judge in Texas, will be the basis of a discussion at the meeting. Mr. Ayers, who is a lawyer at Langley & Banack in San Antonio, said he expects that these documentation problems will halt a lot of foreclosures. That will mean pain for investors who hold the securities. The problem for those who expect to receive the benefit of the note, Mr. Ayers said, is that they “may not be able to show to the judge they have a right to foreclose.” “It’s a huge problem,” he added. “It’s going to be expensive, I don’t know how expensive, ultimately to the bondholders.”
Farm-fuelled fall clouds India growth figures
India’s economy grew from October to December at its slowest quarterly pace in six years, according to government figures that cloud forecasts for the full year and the following one. The data also opened a new flank of worry: agriculture output, which makes up 20 per cent of the economy, fell by 2.2 per cent during the third quarter. In the corresponding period last year, farm output had risen by 6.9 per cent. Manufacturing continued to be flat, fuelling demands for and hopes of an interest rate cut by the RBI. Overall, the gross domestic product clocked a growth of 5.3 per cent — far lower than the 8.9 per cent in the corresponding period last year and the 7.6 per cent in the second quarter (July-September) of 2008-09. Gross domestic product is the value of goods and services produced in a country within a particular period and is considered the best measure of the economy.
The figures, topping a flood of grim statistics from across the world and reports of job losses in the country, prompted economists to question the government’s predictions. “The economy would have to grow by at least 8 per cent in the fourth quarter (January-March 2009) to reach 7.1 per cent. This appears a very tough task indeed,” said Partha Mukhopadhyay of the Centre for Policy Research. Some saw the problems going beyond this March and well into 2009-10, when the government says the growth will be 7 per cent, despite the impact of the global downturn. “My belief is it will take a minimum of two years for the global economy to revive. How can we expect great rates? We may grow by 4 per cent next year,” said Ashok V. Desai, The Telegraph columnist and once a finance ministry consultant.
The Centre put up a brave face, saying it had expected the growth pace to drop. “We will grow at 7 per cent... the December quarter figures had been anticipated,” junior finance minister Pawan Bansal said. Finance ministry officials seem to be pinning hopes on the three-stage stimulus packages announced over the past few months. “You can expect results from March-April,” said an official. Policy makers and analysts say the country needs to sustain growth of 8 to 9 per cent to make inroads against mass poverty and to promote employment. If economic expansion slips below 6 per cent, it could lead to more unemployment. The fall in farm output — the first since 2004 when a poor monsoon had caused a 6.48 per cent decline — this time has been blamed on a weak start to the rains, though the overall trend was normal.
Desai dubbed the weak start a “mere accident”. Desai dubbed the weak start a “mere accident”. “It is really a mere accident,” he said. Most others said early monsoon jitters had hit sowing. Agriculture ministry data showed coarse grain was sowed on 171 lakh hectares this season, down from 194 lakh hectares, as farmers didn’t get rains on time. For pulses, the drop was from 105.7 to 89.8 lakh hectares, and oilseeds from 164.5 to 163.9 lakh hectares. Another problem, though not specific to a particular period, is the inability to develop breakthrough seeds or farming techniques, which has driven down productivity in the grain bowls of Punjab, Haryana and western Uttar Pradesh. Matters haven’t been helped in these areas with the drop in groundwater levels and soil contamination because of excessive use of chemical fertilisers. “There is a fall in productivity of farmland and the government hasn’t been spending much to address the issue,” said Jayati Ghosh of Jawaharlal Nehru University. The slow growth rate, part of it also stemming from a near-unchanged rise in manufacturing output, left business leaders worried and sparked calls for more rate cuts.
Iran threatened with economic meltdown
The sharp downward spiral of oil prices has prompted economists to predict that Tehran is facing severe financial hardship within the space of a few months. Iran's presidential contenders have to address the budget deficit brought about by the plummeting oil prices and the world banking crisis. The country's economy is almost totally dependent on oil, which accounts for 80% of the country's foreign exchange receipts, while oil and gas make up 70% of government revenue. Cash rolled in when the price of oil was above $140 a barrel and the country amassed huge foreign currency reserves, but with the price falling to around $40, that revenue has dried up accordingly.
For the first time since the Islamic revolution in 1979, Iranians will turn away from geopolitics and focus instead on the state of their economy when they go to the polls in June. On top of the recession and falling oil prices, Iran also has to grapple with sanctions imposed by the United States and the United Nations. The US sanctions imposed in 1980, after the hostage-taking by students in Tehran, prohibit American citizens from having dealings with Iran. They also make it difficult for other oil and gas companies to invest in Iran and then get US business. The UN sanctions were imposed because of Iran's alleged attempts to develop nuclear weapons by enriching uranium, something it denies. Under those sanctions, the foreign assets of 13 Iranian companies are frozen, some officials are banned from travelling abroad and the sale of products with a possible military use is forbidden.
An advisor to the European Union, Dr Mehrdad Emadi-Moghadam from Staffordshire University in England, says the UN sanctions are more effective because they include regions and countries which were not co-operating with the US sanctions. "Iran cannot enter into American or EU trade agreements, so it has been forced to acquire its goods though second parties," he says. "When it needs technology or commodities, Iran has to pay between 12 and 20% more than it would otherwise have cost them." Being unable to update its technology has resulted in Iran having an antiquated manufacturing base. In a country where the government is the biggest employer and the biggest contractor, companies are suffering from the harsh economic downturn. "A number of our projects, mostly from ministries which have ordered them, have been halted because of a lack of funds," says Ali Pahlavan, who works in an engineering company in Tehran.
Popular unrest grew in the 1970s when oil revenue was not distributed fairly "We are a one-product economy to some extent - diversification and modernisation has not taken place to the extent it should have," he concedes. He admits that many of the country's problems are due to the sanctions, but says the government is also at fault. "The revolutionary government pursues mostly ideological and political goals," he says, "The economy has taken a back seat and is not the number one priority." Despite having a heavily state-controlled economy, there is a private sector operating in Iran. "Iranians have always been innovative, but the private manufacture and construction sectors do not receive the kind of government support or regulation to help support exports," Dr Mehrdad Emadi-Moghadam says.
The social problems of chronic and growing unemployment are also a cause for concern. Despite its considerable oil wealth, the country still has 26% inflation and a high level of unemployment. More than 35% of the population aged under 30 are experiencing long-term unemployment. Iran wants Opec to cut oil production to force up the price per barrel worldwide Dr Emadi-Moghadam sees a dichotomy, whereby one part of the population is very familiar with the latest Western innovations, while the other side is prevented from having access to ideas freely and connecting to the world economy through commercialising their ideas and activities. As Iran commemorates its 30th anniversary of the revolution, he does not believe that it has achieved its stated objectives.
"When you take the overall view, Iran has actually regressed and is now in the bottom third of countries which receive foreign investment or perform well in international trade," he says. The country also performs badly in almost every internationally-recognised index of bribery and corruption. Iran is one of the wealthiest nations as far as natural resources is concerned and its citizens expect the government to provide things such as cheap fuel. Thirty years after the revolution, fuel is still heavily subsidised. "The revolution was partly due to economics. Shah Muhammad Reza Shah Pahlavi couldn't provide what the people wanted when the oil price dropped," Dr Mehrdad Emadi-Moghadam says.
By any orthodox standard, Iran's economy is run in a bizarre fashion. With its currency pegged to the US dollar, the regime's petrodollars are worth less and less every year and the government is unable to put up taxes, because such a move would be too unpopular. The president has been attempting to resolve some of the difficult economic decisions the government has to make. He recently introduced an Economic Reform Plan, with the aim of enabling the government to reduce dependence on oil revenues and tackling the country's economic problems, including rising inflation. The plan would cut costly energy subsidies and redistribute a larger portion of the sum among citizens.
Twelve million of Iran's population of 69 million live in the capital. The president says only his original proposal could achieve the objectives his government seeks in maintaining the economy, but it has not been approved by lawmakers. The government had asked for $35bn to implement the plan, but parliament only approved $8.5bn. Although Iran is a democracy, the clerics have veto powers over any legislation. When Mahmoud Ahmadinejad campaigned for his present position, he fought on a platform of fighting corruption and achieving fairness in distribution of revenue. Dr Mehrdad Emadi-Moghadam says the president has failed on all accounts in the last four years and his achievements, or lack of them, will play a key role in the forthcoming elections.
Louisiana bank is first to return TARP funds
Iberiabank Corp. became the first bank to pull out of the government's bailout program Friday, saying it would be returning the $90 million it received from the government in early December under the Troubled Asset Relief Program. The Lafayette, La., bank said it will buy back the 90,000 class A shares held by the Treasury, plus a pro-rated dividend accrual of $575,000. That will make Iberiabank the first institution to return TARP funds, according to a Treasury spokesman. TARP has helped provide stability to the banking system overall but recent changes would put IBERIA at a disadvantage, said Daryl Byrd, the bank's chief executive. "We believe recent actions, interpretations, and commentary regarding various aspects of the program places our company at an unacceptable competitive disadvantage," said Byrd in a statement.
Due to highly publicized losses at larger institutions such as Citigroup and Bank of America, Congress has tightened restrictions on recipients of TARP funding, noted Andy Stapp, senior analyst with investment research firm B. Riley & Co. "A lot of these small-cap banks remain profitable, and it just doesn't make much sense for the government to try to dictate the way they should operate their business," said Stapp, adding "I think you'll see more banks returning TARP money." Earlier this week several congressmen, including Sen. John Kerry, D-Mass., expressed outrage at Chicago-based Northern Trust, a relatively unscathed bank which received $1.6 billion through the TARP program in November, for throwing a lavish party for clients at a golf tournament.
"Absolutely, some banks regret taking TARP. The enormous amount of mistrust the government has created in banks is something we've never seen," Chris Kelly, head of capital markets at law firm Jones Day, told CNNMoney.com when discussing Northern Trust earlier this week. Since TARP was enacted in October, 442 regional institutions in 48 states and Puerto Rico have received nearly $200 billion.
Jumbo Mortgages, Jumbo Headaches
Washington is trying to ease the mortgage crisis by helping people refinance into home loans with better terms. But one group is being left on the sidelines: borrowers with loans too big to qualify for government backing. President Barack Obama's housing stability plan, announced last week, excludes such borrowers from nearly all of its mortgage-bailout provisions. Instead, it focuses on middle-income consumers who have lower, so-called conforming loans. Such loans top out at $417,000 in most parts of the country, though they can run as high as $729,750 in certain pricier markets, such as parts of California, New York and Hawaii. Anything bigger is called a "jumbo" loan -- and not only is the government ignoring this segment of the market, so are lenders, few of whom are originating or refinancing jumbo mortgages. The reason: Jumbo loans are too large to be guaranteed by a government-backed mortgage agency, such as Fannie Mae or Freddie Mac, meaning banks assume the risk if the loan goes bad. In the current lending environment, few banks want to take on any risk.
That's hurting borrowers like Pete Zipkin, who's the kind of affluent customer that banks once coveted. The 35-year-old technology executive -- who says he has a spotless credit record and at least 20% equity in his home -- has come up empty-handed in his search for a jumbo mortgage of more than $1 million for his recently built five-bedroom home in Alamo, Calif., near San Francisco. Unable to find a fixed-rate mortgage when his construction loan expired last fall, Mr. Zipkin now has a variable-rate loan that adjusts monthly. The rate is currently 5%, but it can go as high as 12%. He says banks have turned him down in part because they are worried about falling home prices in California, even though price declines in Alamo, where the median home price is $1.3 million, have been less severe than in the rest of the state. "If somebody has the income, the equity and the credit rating," they should qualify for a loan, Mr. Zipkin says.
Many homeowners in high-priced markets are experiencing similar difficulties, and are left with few options other than to raid their savings or retirement accounts and use the cash to "buy down" their mortgages. In some cases, home buyers need to put up a large down payment, often 25% or more, to qualify for a jumbo mortgage. Others are bypassing jumbos altogether and putting up enough cash to become eligible for a lower-rate conforming loan. "Every single day I'm talking to people who have a jumbo loan, and I can't do anything for them," says Jeff Lazerson, a mortgage broker in Laguna Nigel, Calif. While total mortgage originations fell by 17% in the fourth quarter from the previous quarter, jumbo originations fell by 42% to $11 billion, according to Inside Mortgage Finance. That's the lowest volume ever tracked by the trade publication, which has figures dating to 1990. ING Direct, a unit of ING Groep NV, is one of the few lenders that is boosting jumbo originations, though it requires a minimum 30% down payment in the most expensive housing markets, up from 20% earlier last year. For condos, ING requires a minimum 45% down payment.
"If you have been able to ... save for a down payment, that to us speaks volumes about your character," says Bill Higgins, ING's chief lending officer. Like most jumbo lenders, ING offers mainly "hybrid" adjustable-rate mortgages that carry a fixed-rate for five or seven years and then reset annually to an adjustable rate. ING is offering initial rates as low as 5.5% for a seven-year adjustable-rate jumbo mortgage. Last week, the average for a 30-year conforming mortgage was 5.22%, according to HSH Associates, a financial publisher. Jumbo borrowers have always paid slightly higher rates than conforming-loan borrowers, in part because luxury homes can be harder to sell quickly for their full price if a homeowner defaults. But the gap between jumbo and conforming loans, historically around 0.3 percentage point, is now about 1.55 points, with jumbo rates averaging about 6.77%.
Some banks, though, are quoting much-higher jumbo rates. Mortgage brokers say that indicates that lenders are reluctant to make jumbo loans and are setting their prices high to deter new deals. For example, Taylor, Bean & Whitaker Mortgage Corp. in Ocala, Fla., recently listed a 7% rate on a 30-year fixed-rate jumbo loan, but charges up-front origination fees equal to 5% of the loan. Real-estate professionals say that the lack of financing for high-income consumers is putting extra pressure on affluent communities and causing prices to fall even further. "The million-dollar-and-above market is sinking like a lead weight," Mr. Lazerson says. That is frustrating potential buyers like Brandon Steele, a vice president of marketing for a food-products company, who was approved by his credit union for a $990,000 loan last year to buy a home in the Sherman Oaks section of Los Angeles. He had hoped to move his growing family out of the single-family house he has rented for the past four years and into a larger one. Those plans fell through when his credit union told him in December that they were getting out of jumbo lending.
"We thought we were being prudent by not jumping into the housing market when it was overinflated," he says. "It's a catch-22. Now that we want to purchase, we cannot get financing." Mr. Steele says that he and his wife have high incomes and a solid credit rating, but that the money he had planned on using to make a larger down payment was lost in the stock market. He says his only option now is to wait for home prices to fall another 20% or to save an additional $100,000. "Short of moving into a two-bedroom apartment or not funding my 401(k), I can't save that kind of money in a year," he says. "If you live in a high-cost area, there's a whole different standard. Everything's a jumbo loan." Mr. Steele says that for now, he's hoping his credit union, where he's been a customer for 10 years, will reinstate his pre-approved status and fund the loan. The lack of financing is particularly acute in markets where rising home prices have made jumbo loans a necessity for even middle-class borrowers, such as New York City, coastal California and Washington, D.C.
"If you own a $650,000 home in many parts of this country, you're not a wealthy person by any stretch, and you're being cut out of any relief," says Guy Cecala, publisher of Inside Mortgage Finance. Around 4% of all borrowers have loans that exceed conforming limits, according to an estimate by First American CoreLogic. But that share rises in high-cost states such as California, at 17%, and New York, at 8%. Some jumbo clients -- enticed by historically low conforming rates -- are willing to dip into their retirement savings to lower their balances. Neil Littman, for one, estimates that he'd save $300 a month if he paid $25,000 to bring his loan down to the $417,000 limit in Erie, Colo., a bedroom community about 30 minutes east of Boulder. "Right now I'm trying to conserve cash, but to get the savings on the interest rate, I'm willing to put more money down," says the 38-year-old, a commercial real-estate broker.
Mr. Littman, who purchased his four-bedroom home in April 2007, laments the fact that the Boulder area doesn't have a higher conforming-loan limit. Median home prices in Boulder are nearly $650,000, though median prices for the county are much lower, at around $360,000. Other borrowers are raiding their 401(k) accounts in order to qualify for a cheaper mortgage. Jon Eisen, a San Diego mortgage broker, says that one of his clients -- a dentist with a $1 million jumbo loan -- is considering pulling $450,000 from a retirement savings account to pay down his "interest-only" adjustable rate mortgage, in which principal payments are deferred for a set period. That would allow him to refinance into a fixed-rate conforming loan.
Randy Kobata, who lives in Santa Monica, Calif., says he's considering taking $70,000 out of his savings to pay down his mortgage in order to get to the conforming limit. He isn't able to refinance his adjustable-rate jumbo loan from Washington Mutual Inc., now a unit of J.P. Morgan Chase & Co., because the value of his two-bedroom home has declined by $100,000 in the past two years. Meanwhile, the 31-year-old, who works in commercial real estate, has asked the bank for a rate reduction. Rather than dip into savings to get a better rate, some advisers say, clients are better off holding tight. "If your home has lost 15% in two years, why pay down just to refinance?" says Craig Vogt, a mortgage broker in Brooklyn, N.Y. "It's like losing money two times."
The Not-So-Great Depression
The Great Depression. Those chilling words have become something of a staple of economic utterance these days, enjoying promiscuous use by both those dour souls who cry out that the end of the world is nigh and those determinedly smiley types eager to bolster the sagging spirit of the increasingly distressed masses. The gloom-and-doom-meisters use the hair-raising phrase as the template of what we're in for. Those striving to buck up the fretting populace use it to demonstrate that however bad our current plight may be, it pales in comparison with the horrors that defined that sorry epoch. It's one of those instances when each side has a piece of the truth and you can plausibly argue which has more of it. The end of the world isn't going to happen tomorrow; but we can't speak for the day after. As to things not being as bad as they were in the Great Depression, we say, so what? As Friday's disclosure that gross domestic product shrank 6.2% in '08's final quarter -- the biggest dive in 25 years -- demonstrates they're more than bad enough.
And while the financial ordeal we're suffering doesn't match that inflicted by the Great Depression -- not yet, anyway -- it's far too ferocious and all-encompassing to be dubbed with that anomalous term "recession," which was invented by semantically correct economists fearful of scaring the heebie-jeebies out of people by calling a depression a depression. Something between recession and depression might better serve to describe the relentlessly worsening pickle we're in, and perhaps convey its urgency without igniting widespread panic. Addressing the appellative problem, that estimable pair Jay and David Levy have dusted off a label they've pinned on earlier serious setbacks, calling the current state of the economy a "Contained Depression." Frankly, given the global scope and depth, we don't think that quite does justice to the severity of our wretched condition.
And then there's this: Those recurring claims by Federal Reserve chief Ben Bernanke and former Treasury Secretary Henry Paulson that the subprime crisis and the banking debacle and economic downturn were "contained" grossly abused and debased an otherwise perfectly respectable word. Our own humble nomenclatural offering -- which we know you couldn't wait to hear -- is the "Not-So-Great Depression." Granted, it's a bit of a mouthful. But it has (to us, anyway) the linguistic virtue of sending a sober chill down your spine that's commensurate with the seriousness of the present slump, but stops short of invoking the nightmare of the Great Depression redux. Hardly a day passes (and then only on weekends, when the spigot is temporarily turned off) that we're not doused with an outpouring of dispiriting news on the economy. Among last week's negative reports, that on jobs -- and more specifically the lack of them -- was prominent. New claims for unemployment insurance shot up to 667,000, the most in 27 years, while continuing claims mounted to 5.1 million, another record high since 1967 and a mighty leap up from 2.8 million a year ago.
If you're keeping score, you can toss in another 1.4 million getting benefits under a program launched last year, raising the total on the dole to 6.5 million. And the Labor Department revealed that mass layoffs (50 or more in one very fell swoop) doubled in January, and put roughly 235,000 people out of work. All of which raises the odds that come Friday, when the government releases its February employment report, last month's payroll losses will zoom above 700,000, perhaps to as high as 750,000, and the unemployment rate will move up at least several notches; 8% seems as good a bet as any. With jobs vanishing at an alarming rate, consumer confidence is dwindling apace. The latest Conference Board reading sank to 25, the poorest showing in the four decades since the survey was started. Moreover, as Goldman Sachs' Seamus Smyth points out, the real shocker in the dismal data is consumer's expectations, which are as close to nil as we hope and pray they'll every get: an unprecedented 27.5, sharply below the previous low of 45.2 set back in December 1973, when the economy and the stock market were going big-time into the tank.
If nothing else, the consumer's sour, even forlorn, sentiment makes a mockery of the notion that the good old boy will come riding to the rescue, brandishing his wand of plastic. Not a chance; the poor guy lacks both the will and, more important, the wherewithal, to go charging off on a spending binge. As MacroMaven's savvy Stephanie Pomboy puts it in her usual understated style: "The U.S. consumer's legendary lust for credit died with the housing bust. As he vows to live within his means -- or even (children, cover your ears) reduce his debt -- all of Ben's horses and Nancy's men cannot get consumers to borrow and spend." Stephanie goes on to warn that if, as she suspects, households attempt to live the way they did before assets were confused with income, consumer spending is destined to be restrained for a long, long stretch.
That means, she logically infers, that corporate profits "will be depressed for years (not just quarters) to come." A dire prospect, she allows, that has not exactly gone unnoticed by investors, as evident in the pathetic performance of equities. In sum, nothing in the cruel hard data or the more ephemeral mood of the citizenry persuades us that we've seen even the beginnings of the end of the Not-So-Great Depression. So do yourself a favor: In viewing the stock market, no matter how tempting the occasional upticks, stay skeptical. Not the least of its many troubles, Wall Street had to ponder both Mr. Obama's televised address to an audience consisting of the Congress and some 50 million curious citizens on Tuesday and a few days later, his budget. Selling, not analysis, has always been Wall Street's strong suit, as even a cursory review of its record as a seer, whether of market trends or of particular stocks, will readily confirm.
It follows then that despite some vigorous head-scratching and a lot of squinting at text and mental crunching of numbers (which, in case you wondered, explains that strange clunking sound), the Street couldn't make up its mind just how to react to either Mr. Obama's rhetoric or his arithmetic. Accordingly, the stock market spent a lot of the week wandering around inconclusively, and in the final session, prices fell off as traders decided to travel light over the weekend. Tom Donlan points out in his piece on the budget elsewhere in this issue, it's all very tentative anyway, since Congress hasn't even begun to do its damage yet. What bothers us is that most of the proposals to provide the economy with a lift are on the come, so any possible beneficial impact won't likely show up until at least next year or 2011. As we've been saying, it seems like forever, and as everyone but a few dunderheads in Washington now knows, this economy is one sick baby and it badly needs a shot-in-the-arm right now.
We also think the advertised "trickle-up" character of the administration's economic program (a cutesy phrase presumably to distinguish it from Ronald Reagan's supposed "trickle down" approach the Dems moaned so much about) is apt to prove more trickle out than trickle up. One problem is that Obama & Co. still haven't got their act together. As Paul Volcker, a pillar of reason in a sea of confusion, not so gently observed last week, it wouldn't hurt if the powers-that-be got around to installing a deputy secretary of the Treasury. Off his less than silken performance so far, we'd venture that Mr. Geithner needs all the help he can get. We dimly recollect that very early in this tumultuous century, when instead of the $1.75 trillion deficit being projected for this fiscal year and monster budgetary red-ink for years on end in the future, there was a surplus. Really, kids, a surplus: You know, more money was flowing into federal coffers than pouring out. Some of us naïve folks thought that was something to celebrate. We were taught in our little red school houses that when it came to budgets, whether the family's or the country's, income was better than outflow. Much to our surprise, that revered voice of experience, Alan Greenspan, sought to teach us the error of our assumption.
In his famously obscure but learned way, Mr. Greenspan explained that the devil (he was referring to Uncle Sam, but he politely refrained from saying so aloud, trusting barely veiled allusions to convey his meaning) would use the surplus to buy shares in America's great corporations and put the dead hand of government on the controls. Well, as it turned out, Mr. Greenspan, soon after he expressed such fears was able to relax. The surpluses disappeared with breath-taking swiftness. And ever since, this proud nation has been blessed with deficits. And the good news is, as noted, Mr. Greenspan need worry no more about what evil the devil might commit with surpluses. That devil is some devil, however, and even without the benefit of surpluses, he snuck into the market, and now owns 36% of Citigroup and even more of AIG. From all indications, his portfolio is bound to grow. But, please, should you happen to run into Mr. Greenspan (he's a star of the speech circuit), don't mention any of this. Although a congratulatory murmur about his striking triumph over surpluses certainly wouldn't be out of order.
How the Economy Was Lost
by Paul Craig Roberts
The American economy has gone away. It is not coming back until free trade myths are buried six feet under. America’s 20th century economic success was based on two things. Free trade was not one of them. America’s economic success was based on protectionism, which was ensured by the union victory in the Civil War, and on British indebtedness, which destroyed the British pound as world reserve currency. Following World War II, the US dollar took the role as reserve currency, a privilege that allows the US to pay its international bills in its own currency. World War II and socialism together ensured that the US economy dominated the world at the mid 20th century. The economies of the rest of the world had been destroyed by war or were stifled by socialism.
The ascendant position of the US economy caused the US government to be relaxed about giving away American industries, such as textiles, as bribes to other countries for cooperating with America’s cold war and foreign policies. For example, Turkey’s US textile quotas were increased in exchange for over-flight rights in the Gulf War, making lost US textile jobs an off-budget war expense. In contrast, countries such as Japan and Germany used industrial policy to plot their comebacks. By the late 1970s, Japanese auto makers had the once dominant American auto industry on the ropes. The first economic act of the “free market” Reagan administration in 1981 was to put quotas on the import of Japanese cars in order to protect Detroit and the United Auto Workers.
Eamonn Fingleton, Pat Choate, and others have described how negligence in Washington DC aided and abetted the erosion of America’s economic position. What we didn’t give away, we let be taken from us while preaching a “free trade” doctrine at which the rest of the world scoffed. Fortunately, our adversaries at the time, the Soviet Union and China, had unworkable economic systems that posed no threat to America’s diminishing economic prowess. The proverbial hit the fan when Soviet, Chinese, and Indian socialism collapsed around 1990, to be followed shortly thereafter by the rise of the high speed Internet. Suddenly, American and other first world corporations discovered that a massive supply of foreign labor was available at practically free wages.
To get Wall Street analysts and shareholder advocacy groups off their backs, and to boost shareholder returns and management bonuses, American corporations began moving their production for American markets offshore. Products that were made in Peoria are now made in China. As offshoring spread, American cities and states lost tax base, and families and communities lost jobs. The replacement jobs, such as selling the offshored products at Wal-Mart, brought home less pay. “Free market economists” covered up the damage done to the US economy by preaching a New Economy based on services and innovation. But it wasn’t long before corporations discovered that the high speed Internet let them offshore a wide range of professional service jobs. In America, the hardest hit have been software engineers and information technology (IT) workers.
The American corporations quickly learned that by declaring “shortages” of skilled Americans, they could get from Congress H-1b work visas for lower paid foreigners with whom to replace their American work force. Many US corporations are known for forcing their US employees to train their foreign replacements in exchange for severance pay. Chasing after shareholder return and “performance bonuses,” US corporations deserted their American workforce. The consequences can be seen everywhere. The loss of tax base has threatened the municipal bonds of cities and states and reduced the wealth of individuals who purchased the bonds. The lost jobs with good pay resulted in the expansion of consumer debt in order to maintain consumption. As the offshored goods and services are brought back to America to sell, the US trade deficit has exploded to unimaginable heights, calling into question the US dollar as reserve currency and America’s ability to finance its trade deficit.
As the American economy eroded away bit by bit, “free market” ideologues produced endless reassurances that America had pulled a fast one on China, sending China dirty and grimy manufacturing jobs. Free of these “old economy” jobs, Americans were lulled with promises of riches. In place of dirty fingernails, American efforts would flow into innovation and entrepreneurship. In the meantime, the “service economy” of software and communications would provide a leg up for the work force. Education was the answer to all challenges. This appeased the academics, and they produced no studies that would contradict the propaganda and, thus, curtail the flow of federal government and corporate grants. The “free market” economists, who provided the propaganda and disinformation to hide the act of destroying the US economy, were well paid. And as Business Week noted, “outsourcing’s inner circle has deep roots in GE (General Electric) and McKinsey,” a consulting firm. Indeed, one of McKinsey’s main apologists for offshoring of US jobs, Diana Farrell, is now a member of Obama’s White House National Economic Council.
The pressure of jobs offshoring, together with massive imports, has destroyed the economic prospects for all Americans, except the CEOs who receive “performance” bonuses for moving American jobs offshore or giving them to H-1b work visa holders. Lowly paid offshored employees, together with H-1b visas, have curtailed employment for older and more experienced American workers. Older workers traditionally receive higher pay. However, when the determining factor is minimizing labor costs for the sake of shareholder returns and management bonuses, older workers are unaffordable. Doing a good job, providing a good service, is no longer the corporation’s function. Instead, the goal is to minimize labor costs at all cost. Thus, “free trade” has also destroyed the employment prospects of older workers. Forced out of their careers, they seek employment as shelf stockers for Wal-Mart.
I have read endless tributes to Wal-Mart from “libertarian economists,” who sing Wal-Mart’s praises for bringing low price goods, 70% of which are made in China, to the American consumer. What these “economists” do not factor into their analysis is the diminution of American family incomes and government tax base from the loss of the goods producing jobs to China. Ladders of upward mobility are being dismantled by offshoring, while California issues IOUs to pay its bills. By shifting production offshore, offshoring reduces US GDP. When the goods and services are brought back to America to be sold, they increase the trade deficit. As the trade deficit is financed by foreigners acquiring ownership of US assets, the change in ownership means that profits, dividends, capital gains, interest, rents, and tolls leave American pockets for foreign ones.
The demise of America’s productive economy left the US economy dependent on finance, in which the US remained dominant because the dollar is the reserve currency. With the departure of factories, finance went in new directions. Mortgages, which were once held in the portfolios of the issuer, were securitized. Individual mortgage debts were combined into a “security.” The next step was to strip out the interest payments to the mortgages and sell them as derivatives, thus creating a third debt instrument based on the original mortgages. In pursuit of ever more profits, financial institutions began betting on the success and failure of various debt instruments and by implication on firms. They bought and sold collateral debt swaps. A buyer pays a premium to a seller for a swap to guarantee an asset’s value. If an asset “insured” by a swap falls in value, the seller of the swap is supposed to make the owner of the swap whole.
The purchaser of a swap is not required to own the asset in order to contract for a guarantee of its value. Therefore, as many people could purchase as many swaps as they wished on the same asset. Thus, the total value of the swaps greatly exceeds the value of the assets. The next step is for holders of the swaps to short the asset in order to drive down its value and collect the guarantee. As the issuers of swaps were not required to reserve against them, and as there is no limit to the number of swaps, the payouts can easily exceed the net worth of the issuer. This was the most shameful and most mindless form of speculation. Gamblers were betting hands that they could not cover. The US regulators had abandoned their posts. The American financial institutions abandoned all integrity. As a consequence, American financial institutions and rating agencies are trusted nowhere on earth.
The US government should never have used billions of taxpayers’ dollars to pay off swap bets as it did when it bailed out the insurance company AIG. This was a stunning waste of a vast sum of money. The federal government should declare all swap agreements fraudulent contracts, except for a single swap held by the owner of the asset. Simply wiping out these fraudulent contracts would remove the bulk of the vast overhang of “troubled” assets that threaten financial markets. The billions of taxpayers’ dollars spent buying up subprime derivatives were also wasted. The government did not need to spend one dime. All government needed to do was to suspend the mark-to-market rule. This simple act would have removed the solvency threat to financial institutions by allowing them to keep the derivatives at book value until financial institutions could ascertain their true values and write them down over time.
Taxpayers, equity owners, and the credit standing of the US government are being ruined by financial shysters who are manipulating to their own advantage the government’s commitment to mark-to-market and to the “sanctity of contracts.” Multi-trillion dollar “bailouts” and bank nationalization are the result of the government’s inability to respond intelligently. Two more simple acts would have completed the rescue without costing the taxpayers one dollar: an announcement from the Federal Reserve that it will be lender of last resort to all depository institutions including money market funds, and an announcement reinstating the uptick rule. The uptick rule was suspended or repealed a couple of years ago in order to permit hedge funds and shyster speculators to rip-off American equity owners. The rule prevented short-selling any stock that did not move up in price during the previous day. In other words, speculators could not make money at others’ expense by ganging up on a stock and short-selling it day after day.
As a former Treasury official, I am amazed that the US government, in the midst of the worst financial crises ever, is content for short-selling to drive down the asset prices that the government is trying to support. No bailout or stimulus plan has any hope until the uptick rule is reinstated. The bald fact is that the combination of ignorance, negligence, and ideology that permitted the crisis to happen is still present and is blocking any remedy. Either the people in power in Washington and the financial community are total dimwits or they are manipulating an opportunity to redistribute wealth from taxpayers, equity owners and pension funds to the financial sector. The Bush and Obama plans total 1.6 trillion dollars, every one of which will have to be borrowed, and no one knows from where. This huge sum will compromise the value of the US dollar, its role as reserve currency, the ability of the US government to service its debt, and the price level. These massive costs are pointless and are to no avail as not one step has been taken that would alleviate the crisis.
If we add to my simple menu of remedies a ban, punishable by instant death, for short selling any national currency, the world can be rescued from the current crisis without years of suffering, violent upheavals and, perhaps, wars. According to its hopeful but economically ignorant proponents, globalism was supposed to balance risks across national economies and to offset downturns in one part of the world with upturns in other parts. A global portfolio was a protection against loss, claimed globalism’s purveyors. In fact, globalism has concentrated the risks, resulting in Wall Street’s greed endangering all the economies of the world. The greed of Wall Street and the negligence of the US government have wrecked the prospects of many nations. Street riots are already occurring in parts of the world. On Sunday February 22, the right-wing TV station, Fox “News,” presented a program that predicted riots and disarray in the United States by 2014. How long will Americans permit “their” government to rip them off for the sake of the financial interests that caused the problem? Obama’s cabinet and National Economic Council are filled with representatives of the interest groups that caused the problem.
The Obama administration is not a government capable of preventing a catastrophe. If truth be known, the “banking problem” is the least of our worries. Our economy faces two much more serious problems. One is that offshoring and H-1b visas have stopped the growth of family incomes, except, of course, for the super rich. To keep the economy going, consumers have gone deeper into debt, maxing out their credit cards and refinancing their homes and spending the equity. Consumers are now so indebted that they cannot increase their spending by taking on more debt. Thus, whether or not the banks resume lending is beside the point. The other serious problem is the status of the US dollar as reserve currency. This status has allowed the US, now a country heavily dependent on imports just like a third world or lesser-developed country, to pay its international bills in its own currency. We are able to import $800 billion annually more than we produce, because the foreign countries from whom we import are willing to accept paper for their goods and services.
If the dollar loses its reserve currency role, foreigners will not accept dollars in exchange for real things. This event would be immensely disruptive to an economy dependent on imports for its energy, its clothes, its shoes, its manufactured products, and its advanced technology products. If incompetence in Washington, the type of incompetence that produced the current economic crisis, destroys the dollar as reserve currency, the “unipower” will overnight become a third world country, unable to pay for its imports or to sustain its standard of living. How long can the US government protect the dollar’s value by leasing its gold to bullion dealers who sell it, thereby holding down the gold price? Given the incompetence in Washington and on Wall Street, our best hope is that the rest of the world is even less competent and even in deeper trouble. In this event, the US dollar might survive as the least valueless of the world’s fiat currencies.
The violent battle for control of a border city
CIUDAD JUÁREZ, Mexico
Thousands of Mexican soldiers began pouring into this gritty city on the U.S. border over the weekend, an attempt by the federal government to restore law and order to a place where drug gangs have become so powerful that they effectively dictated the removal of the police chief last month. Mayor José Reyes Ferriz is supposed to be the one to hire and fire the chief of police in Ciudad Juárez, a city at the center of Mexico's drug war. It turns out, though, that real life here does not follow the municipal code. It was drug traffickers who decided that Roberto Orduña Cruz, a retired army major who had been on the job as chief since May, should go. To make clear their insistence, they vowed to kill a police officer every 48 hours until he resigned.
They first killed Orduña's deputy, Sacramento Pérez Serrano, the operations director, together with three of his men. Then another police officer and a prison guard turned up dead. As the body count grew, Orduña eventually did as the traffickers had demanded, resigning his post on Feb. 20 and fleeing the city. Replacing Orduña will also fall outside the mayor's purview, although this time the criminals will not have a say. With Ciudad Juárez and the surrounding state of Chihuahua under siege by heavily armed drug lords, the federal government last week ordered the deployment of 5,000 soldiers to take over the Juárez Police Department. With the embattled mayor's full support, the country's defense secretary will pick the next chief. Chihuahua, which prior to the new deployment order already had about 2,500 soldiers and federal police on patrol, had almost half of the 6,000 drug-related killings in all of Mexico in 2008. It is on pace for an even bloodier 2009. Juárez's strategic location at the busy border crossing with El Paso, Texas, and its large population of local drug users have prompted a fierce battle among rival cartels for control of the city.
"Day after day, there are so many horrible things taking place there," said Howard Campbell, an anthropologist at the University of Texas at El Paso who studies Mexico's drug war. "The cartels are trying to control everything." Nothing is surprising in Chihuahua anymore. Gunmen recently shot at one of three cars in Governor José Reyes Baeza's motorcade, killing a bodyguard and wounding two agents. The drug cartels routinely collect taxes from business owners, shooting those who refuse to pay up. As for the Juárez mayor, who has made cleaning up the notoriously corrupt police department his focal point, the cartel recently threatened to decapitate him and his family unless he backed off. The handwritten threat that it issued went further than that. Like many people in Juárez, Reyes has homes on both sides of the border, splitting his time between El Paso and Juárez. The note threatening him made it clear that the assassins going after him would have no qualms about crossing into the United States to finish off the mayor and his family.
"We took the threat seriously," said Chris Mears, a spokesman for the El Paso Police Department. "I'm not going to tell you what actions were taken, but we've taken actions." In an interview in his wood-paneled office overlooking the United States, Reyes, 46, whose father was mayor in the early 1980s, said he was not going to allow criminals to run the city, despite the inroads they are making. He said he had initially opposed his police chief's decision to resign because he did not want the outlaws to feel empowered. He acceded only as a lifesaving gesture, he said. "I'm not going to give in," he vowed in an interview, welcoming the arrival of soldiers so that the traffickers will feel the heat even more. Nearly 2,000 soldiers entered Ciudad Juárez on Saturday, the first contingent of the 5,000 to be deployed, Reuters reported.
Right now, the Juárez police are no match for the outlaws. Last year, the senior uniformed officer was killed, one of 45 local police officers killed since January 2007, and a former police chief pleaded guilty to charges of smuggling a ton of marijuana from Juárez to El Paso. Orduña, who lived at the police station to avoid being killed, had replaced another chief who fled to El Paso after receiving threats last year. If the army had not come in, the mayor would no doubt have had a difficult time finding somebody to head the department. Introducing a nationwide police recruitment campaign, the mayor has raised salaries and benefits enough that he is attracting new recruits to replace the many officers being fired for their links to organized crime. "I know the dangers, and I accept them," said José Martín Jáuregui López, one of the 289 cadets now being trained at Juárez's police academy. "There are a lot of people afraid for me: my mom, my relatives. But this is what I want to do."
As a sign to the traffickers that he was not running from them, Reyes appeared Friday to be like any other mayor, giving a speech at the opening of a shopping center, signing a memorandum of understanding with a developer, reassuring residents that he would keep loiterers from gathering in front of their homes. But the bodyguards holding assault rifles who clung close to him made it clear that Juárez remained a city under siege. "There's no square inch of the city that has been untouched by the violence," said Lucinda Vargas, an economist who works by day to remake the city as executive director of Juárez Strategic Plan, but retreats to El Paso at night. "There's a lot of evidence that Juárez, in a micro sense, is becoming a failed state. But I still think we haven't failed yet and that we could still rescue ourselves."