Worker inspecting a locomotive on a pit in the roundhouse at the Chicago & North Western RR's Proviso Yard
Ilargi: Six months ago, in October 2008, the IMF predicted that American financial institutions would have to write down $1.4 trillion in toxic loans and securities. Three months later, it increased the prediction to $2.2 trillion. We find ourselves another three months later today, and the number has risen to $2.7 trillion, or roughly two thirds of the $4.1 trillion the IMF claims will need to be written down globally. I don't know about you, but I know a trendline when I see one: the chance that the IMF has this time gotten the numbers right, as in high enough, are zilch and nada.
Of the "American" $2.7 trillion, about one third has been actually processed so far, which means US banks will need to write down another $1.8 trillion. Against that backdrop, we need to turn to Elizabeth Warren, who has estimated that $4 trillion has to date been injected into the US financial system. If we were to simplify the issue somewhat, we might say it has taken $4 trillion to write down $900 billion, and that's without counting the remaining $8.8 trillion in loans that are floating out there somewhere in the economy.
What we’ve seen the past few days are positive earnings reports form the main banks, which were so obviously founded on accounting tricks and other bells and whistle style decorating that Bank of America got rewarded with a 25% share value loss yesterday, basically for trying to fool the markets. Today is supposed to be Super Tuesday, the day that midsize and small banks come with their numbers. First off was Bank of New York Mellon, which reported first-quarter net income was down 51%. This should be fun.
But it's the larger picture emerging from all this that we should focus on. The $4 trillion the banks received so far under the guise of encouraging them to restart lending, the actual numbers for new loans are down 23%. Yet, here's a New York Times headline today: "Credit Markets Still Sputtering, Geithner Says" You pump one third of the entire annual US GDP into them, they react by cutting lending 23%, and you call that "sputtering"? Let's get a life, shall we, Tim?
In other words, it's all been a complete failure. Another failure became apparent this morning, when lawyers at the Treasury whistled back their boss, Secretary, Tim Geithner, who had declared that under his $1 trillion PPiP plan, limits to executive pay would not apply. His own lawyers say the limits do apply. And that is probably the end for yet another Geithner fast-track idea, because Wall Street execs are not very likely to buy into any scheme even if it lets them openly rob the American People, if that scheme won't allow their own paychecks to fatten. Also this morning, TARP Special Inspector General Neil Barofsky stated that TARP exposes the taxpayer to "potential unfairness", and the government to outright fraud. All in all, great day for Geithner. His own people start calling him a fool, even if they don't use the word. What on earth is he still doing there?
Back to the larger picture: if commercial banks lend 23% less, despite all those trillions in incentives designed to make them lend more, the question arises: What is their core business, how do they make money? Right, by making loans available. So the less they lend, the less they are likely to recover or even survive. Catch 22,3,4. And how do you get out of that catch? By throwing in another $4 trillion? The first batch didn't work, why would the second?
Still, overseeing how Bush bail-out policies have done a seamless metamorphosis into the Obama hand-out plans, all I can personally really see is that there still is no plan B. Remember a few weeks ago, when Geithner was questioned at Capitol Hill about the PPiP plan? He then said there was no need for a plan B, because "this plan WILL work". The Secretary's on the Hill again today, and his own legal advisors have told him the plan WILL NOT work.
American banks have much more than the IMF estimate of $1.8 trillion in additional write-downs ahead of them. In fact, it's so much more that the US government and the Federal Reserve cannot possibly save them. $12.8 trillion into the rescues, things have only gotten worse, never mind the green spinning shoots. If the government doesn't start failing who needs to fail, simply based on numbers instead of political favoritism, the mess will become impossible to either oversee or overcome. And if that is their goal, they are right on track.
Popular writer and Automatic Earth fan James Kunstler once famously said that the greatest misallocation of resources in the history of the world is the infrastructure of American suburbia. Here's saying there's a strong competitor waiting in the wings, and ready to take the crown. America's Got Talent.
I.M.F. Puts Bank Losses From Crisis at $4.1 Trillion
With the global economic downturn deepening and confidence in the financial system still elusive, the International Monetary Fund estimates that banks and other financial institutions face aggregate losses of $4.1 trillion in the value of their holdings as a result of the crisis. In its global financial stability report, released Tuesday, the fund estimated that financial institutions would have to write down an estimated $2.7 trillion in loans and securities originating in the United States from 2007 to 2010. That estimate is up from $2.2 trillion in the fund’s report in January, and $1.4 trillion last October. The financial crisis "is likely to be deep and long lasting," the report said, noting that global financial stability has deteriorated further since its October report, especially in emerging markets, particularly in Europe, where banks face more write-downs and may require fresh equity, even as businesses seek to refinance debt.
The authorities "have been proactive in responding to the crisis," the fund said, but "policies are being challenged by the scale of resources required." The fund also cast doubt on recent market optimism, noting that in spite of "some improvements in short-term liquidity conditions and the opening of some term funding markets, other measures of instability have deteriorated to record or near-record levels." The report has become a closely watched barometer of the severity of the crisis, in which the fund has taken a leading role, dispensing more than $55 billion in loans. Leaders of Group of 20 nations agreed in London this month to provide about $1 trillion in new funding for the organization. Among European countries, Hungary, Serbia, Romania, Iceland, Ukraine, Belarus and Latvia have all sought loans from the fund since the start of the crisis.
On Tuesday, Colombia became the second Latin American country to seek aid, requesting $10.4 billion. On Friday, the fund approved a $47 billion line of credit for Mexico, making it the first country to qualify for a lending facility for strong-performing emerging economies. Underscoring the degree to which credit-related losses have spread beyond the United States, losses in loans and securities originating in Europe are now estimated at $1.12 trillion. Japan remains comparatively insulated, with projected losses of $149 billion. Until this report, the fund had not tried to calculate the potential losses from "toxic assets" outside the United States. Banks are expected to shoulder about two-thirds of the write-downs, the fund estimated, though other institutions, like pension funds and insurance companies, also face heavy losses.
Banks have raised about $900 billion in fresh capital since the crisis began, the fund said, but that is far outweighed by $2.8 trillion in credit-related losses. The fund estimates that the banks have already taken about one-third, or $1 trillion, of those write-downs. The report also illustrates the uneven pace of the response to the crisis. The fund estimates that in the United States, for example, banks reported $510 billion in write-downs by the end of 2008 and face an additional $550 billion in 2009 and 2010. In the euro zone, banks reported just $154 billion in write-downs by the end of last year and still face $750 billion. British banks are in somewhat better shape: having written down $110 billion, they face $200 billion more, the fund said.
The "Great White Wash" of 1Q Bank Earnings: Meredith Whitney
End of Economic Gloom? Not as Early as You Wish.
Mild signs that the rate of economic contraction is slowing in the United States, China and other parts of the world have led many economists to forecast that positive growth will return to the US in the second half of the year, and that a similar recovery will occur in other advanced economies. The emerging consensus among economists is that growth next year will be close to the trend rate of 2.5 per cent. Investors are talking of 'green shoots' of recovery and of positive 'second derivatives of economic activity' (continuing economic contraction is the first, negative, derivative, but the slower rate suggests that the bottom is near). As a result, stock markets have started to rally in the US and around the world. Markets seem to believe that there is light at the end of the tunnel for the economy and for the battered profits of corporations and financial firms.
This consensus optimism is, I believe, not supported by the facts. Indeed, I expect that while the rate of US contraction will slow from -6 per cent in the last two quarters, US growth will still be negative (around -1.5 to -2 per cent) in the second half of the year (compared to the bullish consensus of +2 per cent). Moreover, growth next year will be so weak (0.5 to 1 per cent, as opposed to the consensus of 2 per cent or more) and unemployment so high (above 10 per cent) that it will still feel like a recession. In the euro zone and Japan, the outlook for 2009 and 2010 is even worse, with growth close to zero even next year. China will have a more rapid recovery later this year, but growth will reach only 5 per cent this year and 7 per cent in 2010, well below the average of 10 per cent over the last decade. Given this weak outlook for the major economies, losses by banks and other financial institutions will continue to grow. My latest estimates are $3.6 trillion in losses for loans and securities issued by US institutions, and $1 trillion for the rest of the world.
It is said that the International Monetary Fund, which earlier this year revised upward its estimate of bank losses, from $1 trillion to $2.2 trillion, will announce a new estimate of $3.1 trillion for US assets and $0.9 trillion for foreign assets, figures very close to my own. By this standard, many US and foreign banks are effectively insolvent and will have to be taken over by governments. The credit crunch will last much longer if we keep zombie banks alive despite their massive and continuing losses. Given this outlook for the real economy and financial institutions, the latest rally in US and global stock markets has to be interpreted as a bear-market rally. Economists usually joke that the stock market has predicted 12 out of the last nine recessions, as markets often fall sharply without an ensuing recession. But, in the last two years, the stock market has predicted six out of the last zero economic recoveries -- that is, six bear market rallies that eventually fizzled and led to new lows. The stock market's latest 'dead cat bounce' may last a while longer, but three factors will, in due course, lead it to turn south again.
First, macroeconomic indicators will be worse than expected, with growth failing to recover as fast as the consensus expects. Second, the profits and earnings of corporations and financial institutions will not rebound as fast as the consensus predicts, as weak economic growth, deflationary pressures and surging defaults on corporate bonds will limit firms' pricing power and keep profit margins low. Third, financial shocks will be worse than expected. At some point, investors will realise that bank losses are massive, and that some banks are insolvent. Deleveraging by highly leveraged firms -- such as hedge funds -- will lead them to sell illiquid assets in illiquid markets. And some emerging market economies -- despite massive IMF support -- will experience a severe financial crisis with contagious effects on other economies.
So, while this latest bear-market rally may continue for a bit longer, renewed downward pressure on stocks and other risky assets is inevitable. To be sure, much more aggressive policy action (massive and unconventional monetary easing, larger fiscal-stimulus packages, bailouts of financial firms, individual mortgage-debt relief, and increased financial support for troubled emerging markets) in many countries in the last few months has reduced the risk of a near depression. That outcome seemed highly likely six months ago, when global financial markets nearly collapsed. Still, this global recession will continue for a longer period than the consensus suggests. There may be light at the end of the tunnel -- no depression and financial meltdown. But economic recovery everywhere will be weaker and will take longer than expected. The same is true for a sustained recovery of financial markets.
Geithner defends bank rescue program amid warnings
Treasury Secretary Timothy Geithner defended the bank rescue program devised by the Obama administration Tuesday as the International Monetary Fund predicted U.S. financial institutions could lose $2.7 trillion from the global credit crisis. Geithner, testifying before the rescue plan's Congressional Oversight Panel, faced several questions about how Treasury is using the $700 billion Troubled Asset Relief Program and how it intends to help rid financial institutions of their bad loans and securities. His testimony came in the wake of a watchdog agency report that warned Obama administration initiatives could increasingly expose taxpayers to losses and make the government more vulnerable to fraud.
A special inspector general assigned to the bailout program concluded in a 250-page quarterly report to Congress that a private-public partnership designed to buy up bad assets is tilted in favor of private investors and creates "potential unfairness to the taxpayer." Geithner said the new plan "strikes the right balance" by letting taxpayers share the risk with the private sector while at the same time letting private industry use competition to set market prices for the assets. "If the government alone purchased these legacy assets from banks, it would assume the entire share of the losses and risk overpaying," Geithner said in his remarks. "Alternatively, if we simply hoped that banks would work off these assets over time, we would be prolonging the economic crisis, which in turn would cost more to the taxpayer over time."
Geithner said "the vast majority of banks" have more capital than they need to be considered well-capitalized. But he said the economic crisis and the bad assets have created uncertainty about the health of individual banks and reduced lending across the system. "For every dollar that banks are short of the capital they need, they will be forced to shrink their lending by $8 to $12," he said. While credit conditions have improved in the past few months, "reports on bank lending show significant declines in consumer loans, including credit card loans, and commercial and industrial loans," Geithner said. In a letter Tuesday to oversight panel chairwoman Elizabeth Warren, Geithner said that $109.6 billion in resources remain in the rescue fund. But officials expect the fund will be boosted over the next year by about $25 billion as some institutions pay back money they have received.
But under questioning from panel members, Geithner said that even if banks want to pay back the money, that doesn't mean the government would necessarily accept the payment. "Ultimately we have to look at two things, one is do the institutions themselves have enough capital to be able to lend and does the system as a whole, is it working for the American people for recovery," Geithner said. The government's effort to stabilize the financial sector and unclog the credit markets has come under heavy scrutiny. Treasury officials say the Obama administration has been holding participants more accountable. Geithner sent key members of Congress six-page letters last week spelling out his department's measures. Still, Inspector General Neil Barofksy, using blunt language, offered a series of recommendations to protect the public and took the Treasury to task for not implementing previous advice.
Overall, the report said the public-private partnership -- using Treasury, Federal Reserve and private investor money -- could total $2 trillion. "The sheer size of the program ... is so large and the leverage being provided to the private equity participants so beneficial, that the taxpayer risk is many times that of the private parties, thereby potentially skewing the economic incentives," the report stated. In particular, the report cited funds that would be used to purchase troubled real estate-related securities from financial institutions. Under plans unveiled by Treasury, for every $1 of private investment, Treasury would invest $1 and could provide another dollar in a nonrecourse loan. That money could then leverage a loan from another government fund backed mostly by the Federal Reserve, a step that Barofsky said would dilute the incentive for private fund managers to exercise due diligence. Barofsky recommended that Treasury not allow the use of Fed loans "unless significant mitigating measures are included to address these dangers."
Among Barofsky's recommendations:
- Treasury should set tough conflict of interest rules on public-private fund managers to prevent investment decisions that benefit them at taxpayer expense.
- Treasury should disclose the owners of all private equity stakes in a public-private fund.
- Fund managers should have "investor-screening" procedures to prevent asset purchase transactions from being used for money laundering.
Geithner Weighs Bank Repayments
Treasury Secretary Timothy Geithner indicated that the health of individual banks won't be the sole criterion for whether financial firms will be allowed to repay bailout funds, a position that might complicate their efforts to give back the cash. In an interview, Mr. Geithner laid out some broad principles, including the need to consider the overall health of the financial system and the flow of credit in judging whether banks can repay their government investment. Among large banks, Goldman Sachs Group Inc. and J.P. Morgan Chase & Co. have both said they want to repay the government. "We want to make sure that the financial system is not just stable, but also not inducing a deeper contraction in economic activity. We want to have enough capital that it's going to be able to support a recovery," Mr. Geithner said.
Mr. Geithner also said he plans to discuss signs of improvement in the U.S. economy with his counterparts at the coming Group of Seven finance-ministers meeting. But he said a "dramatic" mobilization of resources is still needed across the world to avert a deeper global recession. "We're trying...to make sure there's as strong and broad a global consensus on stimulus, financial repair and quick deployment of resources to emerging economies so that we can avert risks of a deeper downturn world-wide." Closer to home, the Obama administration is wrestling with a problem as some banks, wary of government strings tied to bailout funds, look to repay the money. At the same time, regulators aren't yet done conducting stress tests on the nation's 19 largest banks to determine how much assistance they might need to continue lending. Firms will get six months to raise money from private investors or get additional investments from the government.
Confidence in the banking sector remains weak and on Monday the Dow Jones Industrial Average fell more than 3.5% as investors retreated over concerns that results in the first quarter of the year may prove difficult to sustain amid signs that borrowers are falling behind on their debts. Obama administration officials worry that the repayment of bailout money, combined with a general disinclination toward partnering with the U.S., could undermine their efforts to restore health to the financial sector and the broader economy. "We want to be out of the financial system. We want people to be paying back the government. But we don't want people to be paying back the government in ways that will put themselves right back in trouble and leaving themselves with inadequate capital," Lawrence Summers, chairman of the president's National Economic Council, said Sunday on NBC's "Meet the Press."
Mr. Geithner made it clear the administration believes the steps it is taking to shore up the financial sector are necessary to averting a worse and prolonged economic downturn. The government has announced a series of steps, including a $275 billion plan to help homeowners, an effort to help purchase so-called toxic assets clogging bank balance sheets and additional investments into banks. But distrust of the government's programs runs high and Mr. Geithner said he has tried to make a simple case to lawmakers and others as to why it is necessary to use taxpayer money to help the financial system. "You can't have economic recovery without a financial system," he said. "Without a financial system you have no credit, which means higher unemployment, lower production capacity and a higher number of failing institutions."
With the U.S. economy's recovery tied to what happens in the rest of the world, Mr. Geithner plans to reiterate his message for a coordinated global response at this week's meeting of the G-7 finance ministers in Washington, D.C. At the finance minister's meeting in London last month, Mr. Geithner pressed his counterparts to embark on a fresh round of spending to stimulate economies world-wide. He said he will continue to push for that this week, in part because the tentative signs of stability in the U.S. could be undermined by worsening global conditions. "Mostly we want people reinforcing the need to execute and act on the commitments we all made together because a coordinated response is going to be more forceful," Mr. Geithner said.
Treasury Lawyers Say Limits May Apply To Toxic-Asset Relief Program
Treasury Department lawyers have determined that firms participating in a $1 trillion program to relieve banks of toxic assets could be subject to limits on executive compensation, contradicting the Obama administration's previous public position, according to a report to be released today by a federal watchdog agency. The disclosure comes amid a congressional investigation into whether the administration is abiding by a law limiting lavish pay for executives at firms that have benefited from the $700 billion bailout for the financial system. Speaking last month about the initiative to buy toxic assets, Treasury Secretary Timothy F. Geithner said, "The comp conditions will not apply to the asset managers and investors in the program."
But Treasury lawyers have told the special inspector general for the federal bailout that executives involved with that initiative and another $1 trillion consumer lending program "could be subject to the executive compensation restrictions," according to the report from Special Inspector General Neil M. Barofsky. The Treasury's general counsel's office said in an April memo attached to the report that pay for employees of the Federal Reserve Bank of New York could also be limited because of their role in running the consumer lending program. The 247-page report by the special inspector general criticizes the Treasury Department for failing to adequately oversee the bailout program, which now includes 12 programs that could involve nearly $3 trillion in public and private funds. As of last month, $590.4 billion had already been spent from the $700 billion fund allocated to Treasury by Congress, the report found.
The inspector general noted that the bailout office's compliance division has only about 10 employees to oversee 500 financial firms. "The current resource commitment for this vitally important function appears plainly inadequate," the report concludes. The report also says the department has not hired a firm to manage the assets acquired from bailed-out companies nor developed an investment strategy. Barofsky's report raised concerns about potential conflicts of interest and money laundering in the program to buy toxic assets, and renewed his call for the administration to require bailout recipients to report on their use of taxpayer funds. "Time is running short to address these shortfalls," Barofsky said in an interview. "The time is now for a comprehensive oversight and compliance framework."
Barofsky's report revealed that his office has opened almost 20 criminal investigations, including those into large corporate and securities fraud related to bailout investments, tax issues, insider trading, public corruption and mortgage-modification fraud. In response to the report, Neel Kashkari, head of the bailout program, defended the government rescue plan. "Our actions must be in the long-term interest of taxpayers, considering both the potential risks to taxpayers of action and also the potential risks to taxpayers of inaction," Kashkari wrote. "We believe our programs strike the right balance."
Bailout overseer draws fire from right
Elizabeth Warren, the Harvard law professor charged by Congress with overseeing trillions in financial rescue funds, has a surprising secret weapon: Dr. Phil. The outspoken consumer advocate has appeared on Phil McGraw’s show twice to talk about the financial difficulties facing middle-class families. Another visit, Warren argues, could help explain the complexities of regulatory reform to a wider audience. But this time, families in need of “money makeovers” aren’t the only ones she has to convince. While the bubbly and brilliant 59-year-old professor is a darling of Democrats, Warren has become the scourge of conservative Republicans, who question her panel’s exploration of more-liberal approaches such as nationalization and bank liquidation. Financial services lobbyists, who’ve long disliked Warren for highlighting predatory lending and abusive credit card fees, argue that she’s using her post to push her own, anti-industry agenda. “A number of people wonder if this is the new Warren commission or the congressional oversight panel,” said Wayne Abernathy, executive director for financial institutions policy at the American Bankers Association. “It’s looking more like the former than the latter.”
On Tuesday, Warren will spark controversy once again when her panel questions Treasury Secretary Timothy Geithner. The Treasury Department has resisted testifying before the committee for months. Although Warren credits Geithner with being more transparent than the Bush administration, she still wants detailed information about the department’s overall financial rescue strategy, goals and metrics. “The role of congressional oversight is to ask the tough questions, to push back on the decisions, to request additional information and to recheck the numbers,” Warren said in an interview with POLITICO. “It’s our job to be cranky.” But some of that crankiness has wormed its way into the panel itself. Two members, AFL-CIO associate council Damon Silvers and New York State Superintendent of Banks Richard Neiman, signed on to the tepid six-month review of the Troubled Asset Relief Program released by the group last month. The two other members - former Sen. John Sununu (R-N.H.) AND Republican Rep. Jeb Hensarling - voted against the entire report. "The panel did not reach an agreement on either the economic assumptions underlying strategic choices or on the optimal strategy to pursue," wrote Sununu and Neiman, in a dissenting opinion that raised questions about the report.
The dissenters worried that the alternative approaches presented in the report, including nationalization, management changes and the liquidation of failed banks, implied that the banking system was insolvent and that the current plan was already a failure. Warren says that the report is the product of interviews with dozens of experts across the political and intellectual spectrum. “That majority report was based on an understanding that came from many different voices,” Warren said. “I think we write panel reports that reflect a broad spectrum of ideas.” The lack of consensus has fueled Republican criticisms that Warren is reaching far beyond the original intent of the panel by suggesting regulatory changes. In private conversations, even some Democrats complain that Warren’s role as a constant Cassandra could undermine already tenuous public support for the bank, auto industry and other financial rescue programs.
The panel specializes in calculating the kinds of scary numbers that the Obama administration would rather not broadcast too loudly. Like $4 trillion. That’s the amount the Treasury Department, Federal Reserve and Federal Deposit Insurance Corp. have spent on financial stability efforts so far, according to the panel’s most recent report. And that huge number may not address some smaller — but no less worrisome — statistics, like the 29.1 percent that national housing prices have fallen since their peak in the second quarter of 2006, according to the report. Warren, who proudly calls herself an “outsider’s outsider,” is comfortable announcing those kinds of very uncomfortable figures, even if that means taking some political punches. “I’ve never held a government job, and I’m not looking for a government job after this,” she said. “I’m not out there trying to go and find my next landing spot.”
She grew up in Oklahoma, the daughter of Depression-era, money-conscious parents. She won a debate scholarship to George Washington University and later went to Rutgers Law School in New Jersey. Warren eventually got a post at Harvard, where she slowly branched out from writing legal papers to producing mass-market books detailing the financial struggles of the middle class. In 2003, she coauthored the book “The Two-Income Trap: Why Middle-Class Mothers and Fathers Are Going Broke” with her daughter, a former McKinsey consultant. The book got significant media attention and built her reputation as an advocate for middle-class families and consumers. Hillary Clinton and Barack Obama both consulted with Warren during the presidential campaign. But Warren was still shocked when Senate Majority Leader Harry Reid asked her to chair the TARP panel. “I did say to him, ‘Senator, are you sure you want me?’” she said. “I confess, I was really surprised. I don’t do Washington stuff much.”
Since then, Democrats have jumped on an idea that Warren first proposed two years ago, introducing legislation that would create a Financial Product Safety Commission charged with overseeing new consumer lending and investment products. Warren argues that a commission modeled after the Consumer Product Safety Commission, which oversees the security of toys and small appliances, would have kept the subprime mortgages that sparked the current recession off the market in the first place. “It is impossible to buy a toaster that has a one-in-five chance of bursting into flames and burning down your house,” Warren wrote in Harvard Magazine last May. “But it is possible to refinance your home with a mortgage that has the same one-in-five chance of putting your family out on the street — and the mortgage won’t even carry a disclosure of that fact.” President Obama backed the proposal on “The Tonight Show With Jay Leno” last month, using the toaster analogy to explain the idea.
The commission idea is opposed by conservatives and financial services firms, who argue it would prohibit innovation and impose unnecessary additional regulations on financial services companies. “We wouldn’t be able to invest in anything the commission didn’t decide was absolutely safe for us,” said Peter Wallison, co-director of the American Enterprise Institute’s program on financial policy studies. “There wouldn’t be any innovation and there wouldn’t be any new ideas.” Whether or not the commission is created, one thing is clear: Warren doesn’t plan on missing out on her moment in history. “The decisions that are made in the next six months or so are likely to set the economic course of this country for the next 50 years,” she said. “That’s what happened coming out of the Great Depression, and I think that will happen now.”
Pelosi Sets Wall Street Probe Modeled on Pecora in 1933 After Market Crash
Wall Street may be heading for the deepest investigation of its practices since a congressional panel’s probe of abuses following the 1929 stock market crash. House Speaker Nancy Pelosi plans to push for a comprehensive inquiry, saying that three-quarters of Americans want to know what led to the bankruptcy of Lehman Brothers Holdings Inc. and the collapse of Bear Stearns Cos. and Merrill Lynch & Co. She favors one patterned after Senate Banking Committee hearings led by Ferdinand Pecora starting in 1933, according to her spokesman, Nadeam Elshami. The Pecora review "was probably the single most important congressional investigation in the history of our country, except perhaps the Watergate hearings," Donald Ritchie, associate historian for the U.S. Senate, said in an interview.
Congress is reacting to an economic collapse that has generated $1.3 trillion in financial industry losses, $700 billion in U.S. taxpayer cash infusions and loans, and $37 trillion in destroyed world stock market value since 2007. The Pecora Commission generated public support for creating the Securities and Exchange Commission and laws that governed financial services for seven decades.
Pelosi, a California Democrat, will speak about hearings this week to lawmakers, including Representative Barney Frank, chairman of the panel that writes banking law, Elshami said. "I think it’s useful to have it, but that should not be a reason to hold off on legislating," Frank, a Massachusetts Democrat, said of Pelosi’s proposal after a speech in Washington yesterday. President Barack Obama, Frank and other congressional leaders have made rewriting the rules governing Wall Street a top priority.
Several lawmakers have proposed a commission or select committee to investigate the causes of the meltdown. Pelosi’s backing, expressed during an appearance in San Francisco last week, was the first show of support from the congressional leadership. "We truly want to find out what happened to this country and level with the American people," said Representative John Larson of Connecticut, the No. 4 House Democratic leader, who has proposed a nonpartisan independent commission. "We need to provide a narrative." Wall Street firms have cut more than 180,000 jobs during the worst credit crisis since the Great Depression. The retrenchment helped boost New York City’s unemployment rate to 8.1 percent in February from 6.9 percent in January, a record month-to-month increase, according to the state Labor Department.
City Comptroller William Thompson predicted in March that 250,000 jobs would be lost in New York before the recession ends. People need "to have a clearer understanding of as to how we got here and what the exposure is to the taxpayer to all of this," Pelosi said April 15, according to a tape of an appearance at the Commonwealth Club of California. She said she told Treasury Timothy Geithner about her plan. Senate Majority Leader Harry Reid, a Nevada Democrat, hasn’t indicated a preference for a new inquiry. "There are a variety of proposals in the Senate," said Regan Lachapelle, Reid’s deputy communications director, in an e-mail. "Senator Reid is exploring these different approaches and plans to discuss them with the speaker at the appropriate time." Some lawmakers say passing reforms without a complete study of the credit crisis would be premature. Senator Richard Shelby of Alabama, the senior Republican on the Senate Banking Committee, made that point at a hearing on modernizing financial rules in February. He cited the Pecora hearings as the "best precedent."
Senator Christopher Dodd, the Connecticut Democrat and committee chairman, responded: "Certainly we want to examine what happened, but also we need to move forward." Members of Congress may be reluctant to tackle the recommendations of such an inquiry because of financial industry donations to political campaigns, said Wall Street historian Charles Geisst. Financial services has been the biggest contributor in every U.S. election cycle in the last 20 years, according to the Center for Responsive Politics, a Washington research group that tracks campaign money. Its individual and political action committee donations in 2007 and 2008 totaled $463.5 million, compared with $163.8 million from the health-care industry and $75.6 million from energy companies. Individual and PAC donations from Goldman Sachs Group Inc. which totaled $30.9 million, and Citigroup Inc., at $25.8 million, were higher than those from any other company except AT&T Inc.’s $40.9 million over the last 20 years, the center’s compilation of Federal Election Commission data shows.
"How can you seriously propose a law when you’ve been taking money from ‘The American Poodles for Wall Street’ or whatever fund for the past 10 years," said Geisst, a professor of finance and economics at Manhattan College in New York and author of "Wall Street: A History." Senators John McCain, an Arizona Republican, and Byron Dorgan, a North Dakota Democrat, say they’re concerned congressional turf disputes might hamper the effort. "The magnitude of a serious investigation and the conflicts likely to arise from fragmented committee jurisdictions suggest that a bipartisan select committee is necessary," they wrote March 8 in the Washington Post. Larson said he has sought Dodd’s support for his bill.
"He has a different take on it," Larson said. "Given his position, he’d like to have more of his input on this, but he definitely embraces the concept." Dodd’s office didn’t respond to requests for comment. Pelosi, who wasn’t available yesterday, would prefer the hearings be handled by a newly created subcommittee of an existing congressional panel, which is more tailored to the Pecora Commission’s approach, according to spokesman Elshami. In citing the Pecora model, advocates of a full-scale probe are harkening back to an investigation that captivated the nation in the 1930s. It centered on an intense examination of bankers and brokers and how their actions helped contribute to the stock market’s implosion.
Pecora exposed practices that benefited the wealthy at the expense of ordinary investors, such as giving favored clients insider prices on stock offerings, Ritchie said. "Stock exchanges were operated as private clubs up to that point," he said, adding that the investigation "brought back to Earth once-Olympian bankers." The Pecora hearings were steeped in drama -- and comedy. In one incident, the publicity-shy financier J.P. Morgan sat alone at the witness table during a break and was surprised when a circus promoter, seeking a chance to use the hearings to get publicity for his show, placed a dwarf in Morgan’s lap, Ritchie said. Photos of the awkward moment appeared on front pages across the nation and the shot became a symbol of the humbling of the nation’s top bankers.
Jack Bauer can't stop 'The Goldman Conspiracy'
Two mind-numbing fast-paced dramas. Two parallel worlds. One real, one fiction, both deadly. Jack Bauer, mythic hero of "24." Dying from a deadly bio-pathogen leaked from weapons developed by Starkwood, a rogue mercenary army attacking the presidency, hell-bent on taking over America. The other drama in play: "Hank the Hammer" Paulson, iconic Wall Street hero, a Trojan Horse placed inside Washington by Goldman Sachs as Treasury Secretary in control of America's $15 trillion economy. Goldman, a modern dynasty with vast financial powers much like those once used by the de' Medici, Rothschilds and Morgans to control nations. Both dramas play high-stakes games with financial WMDs that have lethal consequences. Jack compresses thrills, kills and chills into 24 hours. Hank, Goldman and their army of Wall Street mercenaries move with equally blinding speed, heart-pounding action.
Drama? You bet. Six short months ago Hank led an assault on Congress. The scene parallels one in "24:" Sangala War Lord Juma's brazen attack inside the White House. But no AK-47s necessary. The Hammer assaulted Congress with just a two-and-a-half page memo in hand. Like a crack special-ops warrior, he took down the enemy, demanding $750 billion, absolute control, total secrecy, no accountability and emergency powers to act immediately ... warning that inaction was not an option, that collapse of America's banking system was imminent, would bring down the global monetary system, pushing world's economies into a "Great Depression II." Congress surrendered.
Here's the whole plot:
Scene 1. American government is now run by the 'Goldman Conspiracy' Oh, you really think just I'm plotting a television series? Or just paranoid, exaggerating this power grab? You better read "The Usual Suspects," Matthew Malone's brilliant article in Portfolio magazine: He "exposed" the "Goldman Sachs 'conspiracy' to take over the U.S. financial system." Read it in this context: America's financial sector has exploded from 19% of corporate profits in 1986 to 41% today, becoming a magnet for every wannabe billionaire. They know why Wall Street must control Washington.
Malone focuses on the incestuous "conspiracy" of Goldman alumni in Treasury, Bank of America, Merrill Lynch, AIG, Citigroup, Washington lobbyists and politicians.
Scene 2. Huge conflicts motivating Wall Street's 'Trojan Horse' And just in case you think any emphasis on The Hammer's conflict of interest was invented purely to increase drama, please remember that he worked at Goldman for three decades after serving under Nixon. He got $38 million his last year as CEO in 2006 before becoming Treasury Secretary. Then during the market meltdown six months ago the $700 million personal fortune he built at Goldman was threatened by Goldman's huge $20 billion derivatives exposure at AIG: Suddenly his responsibilities at Treasury merged with a strong self-interest in protecting his personal fortune. AIG was "saved."
Scene 3. Wall Street's 'quiet coup' also runs world's banking system There's another equally disturbing expose in "The Quiet Coup," Simon Johnson's great article in Atlantic magazine. A former chief economist at the International Monetary Fund, Johnson also warns that America's "financial industry has effectively captured our government" and is "blocking essential reform." Worse, he says that unless we break Wall Street's stranglehold (unlikely in the new Washington) we will be unable "to prevent a true depression," warning that "we're running out of time," echoing many of our predictions of the "Great Depression II" coming soon.
Scene 4. Wall Street used the meltdown to take over America's government Matt Taibbi, author of "The Great Derangement," captured this drama in a Rolling Stone piece, "The Big Takeover, how Wall Street insiders are using the bailout to stage a revolution." A must-read: "As complex as all the finances are, the politics aren't hard to follow. By creating a crisis that can only be solved by those fluent in a language too complex for ordinary people to understand, the Wall Street crowd has turned the vast majority of Americans into non-participants in their own political future. ... in the age of CDS and CBO, most of us are financial illiterates." Wall Street "used the crisis to effect a historic, revolutionary change in our political system -- transforming a democracy into a two-tiered state, one with plugged-in financial bureaucrats above and clueless customers below."
Scene 5. How Obama is keeping alive Bush's 'disaster capitalism' Back in 2007 at the start of the meltdown, Hank was misleading us in Fortune: "This is far and away the strongest global economy I've seen in my business lifetime." In the real world, Naomi Klein, author of "The Shock Doctrine: Rise of Disaster Capitalism," was warning us that "during boom times it's profitable to preach laissez faire, because an absentee government allows speculative bubbles." But "when those bubbles burst, the ideology becomes a hindrance and goes dormant while big government rides to the rescue." Then, free-market "ideology will come roaring back when the bailouts are done. The massive debts the public is accumulating to bail out the speculators will then become part of a global budget crisis." TARP paybacks: Obama has a new "disaster capitalism."
Scene 6. Wall Street's CEOs rule like dictators in a banana republic Seriously, here's how bad Taibbi sees it: "Paulson and his cronies turned the federal government into one gigantic half-opaque holding company, one whose balance sheet includes the world's most appallingly large and risky hedge fund, a controlling interest in a dying insurance giant, huge investments in a group of teetering megabanks, and shares here and there in various auto-finance companies, student loans, and other failing business." And let's include $5.5 trillion in Fannie Mae and Freddie Mac. Wall Street's greed and stupidity resembles the self-destructive reigns of banana republic dictators.
Scene 7. Wall Street makes an un-American bet on 'disaster capitalism' Today as you ponder buying some Goldman stock, remember, you're really betting that "disaster capitalism" is back, strong, tightening its stranglehold on Washington and on the American taxpayers, who will guarantee all Wall Street's future failures. Yes, this is un-American, but so what? The "Goldman Conspiracy" is still probably a good short-term buy ... if you're interested in betting on America's new "democracy of capitalists, by capitalists, and for capitalists," with "The Conspiracy" leading the joint chiefs of this new mercenary army ... and it only took six short months for their "Quiet Coup!"
Scene 8. Banks recycle TARP money, pump earnings, cheat America Here's how it worked: The Hammer conned a clueless Congress, then shelled out $350 billion of our taxpayer money (Helicopter Ben Bernanke helped by upping the ante with a couple trillion side-bet), buying toxic debt to save his ol' Wall Street buddies. They stopped lending and used the dough to doctor their balance sheets. So no surprise that Goldman, Wells Fargo and J.P. Morgan Chase are now reporting "blockbuster" first-quarter earnings, says the New York Times, while just months ago "many of the nation's biggest banks were on life support." Get it? They screwed taxpayers and borrowers so they can repay TARP with (you guessed it) our recycled TARP money. Now it's back to business-as-usual, with no restrictions on CEO pay and bonuses ... no thank-yous ... no admissions of guilt ... while some even arrogantly deny that they ever needed TARP money.
Scene 9. Wall Street's already set the stage for new disaster Right after the election in November, at the peak of the banking crisis, when Hank, Goldman and the Wall Street mercenary armies were divvying up the $350 billion TARP money, we detailed 30 reasons for the "Great Depression II" likely coming around 2011. We quoted John Whitehead, former Goldman Sachs chairman, former chairman of the New York Fed, former Reagan deputy secretary of state. He warned America's problems will take years, burn trillions, result in massive deficits: "This is a road to disaster," he said. "I've always been a positive person and optimistic, but I don't see a solution here." He did see a depression at the end of that road, one you can call the "Great Depression II."
Scene 10. Obama turned 'The Goldman Conspiracy' into a superpower Do you see the parallels: Jack and Starkwood, Hank and Goldman? Jack's a great mythic hero. We need to believe a hero will defend the little guy, stand between us and total annihilation. But Jack Bauer's "dead." Yes, dead. Jack's not real. Never was "alive." Jack's a fiction, a figment of Main Street America's vivid imagination, the symbol of "hope" for a populist revolution. Hope that Jack, Barack or some other new hero will emerge, take power back from Wall Street and return it to the people. Unfortunately that won't happen, folks. Yes, on TV Jack will come back from near-death, again. But in real life, Hank, Goldman and Wall Street's mercenaries are winning the war. Read and weep Portfolio's chilling finale: "Obama's victory and Geithner's appointment are the completion of Goldman's meticulously crafted plan to become a superpower. The firm now has the clout to impose its will on the financial markets, and the world."
GOP or Dems? Conservatives or liberals? It doesn't matter. We'll all controlled by "The Conspiracy." So why not surrender, let them have the power? The truth is, through their lobbyists and surrogates in Washington, they already rule America. Surrender is a mere formality. Accept reality. Hold them accountable later. After the next crisis. After the next meltdown of disaster capitalism -- if there's anything left after the "Great Depression II" sweeps like a pandemic across the planet, consuming all economies, for a long time. But for now, Goldman and other banks may well be short-term buys. Just be ready to dump them in the near future ... a scenario that will be here sooner than you think.
Regulators Give Greater Weight to Loan Quality in U.S. Tests
Regulators conducting the stress tests on the 19 largest U.S. banks are increasingly focusing on the quality of loans the companies made after finding wide variations in underwriting standards, a regulatory official said. Supervisors concluded that banks’ lending practices would need to be given as much weight as macroeconomic scenarios after finding a wide variation in standards for mortgages and other loans as about 200 examiners poured through the portfolios, the official said. The expanded criteria for the assessments will allow regulators to identify how much of each bank’s vulnerabilities stem from the economy’s deterioration, and how much comes from management decisions. Treasury Secretary Timothy Geithner has said he’s prepared to make management changes in any firms requiring "exceptional" amounts of fresh taxpayer funding.
"There was a heavy assumption" that soaring loan defaults in recent months were caused by the recession, said Kevin Petrasic, who served at the Office of Thrift Supervision from 1989 to 2008 and is now an attorney at law firm Paul Hastings in Washington. "If they find out that these were business decisions, that, in an odd way, is probably a good sign because you can fix this. There are very hard lessons to be learned." The official’s remarks provide insight into the release April 24 on the regulator’s methodology for the tests. Supervisors are addressing an error made two years ago when basing foreclosure projections on economic assumptions and concluding that poorly written loans may default regardless of the economy’s performance. The person also said the tests don’t amount to solvency judgments, noting that estimates of each bank’s losses over the coming two years won’t necessarily equal the amount of new capital it needs to raise.
The goal of the reviews is to keep the major financial institutions lending over the next two years, and to determine how much capital they might need should the economic downturn worsen. Assumptions about capital will be forward-looking, the official said. Supervisors will take into account how much capital each company now has, the ability to retain earnings over the next few years, access to private capital in the future and how aggressively they have already written down some assets. Federal Reserve officials are coordinating the exams, dedicating a staff of about 140 people to the effort. All told about 200 regulatory officials are involved, with information percolating up from front-line bank examiners. While the tests are a central element of the Obama administration’s financial rescue plan, the Treasury charged the Fed, Office of the Comptroller of the Currency, Federal Deposit Insurance Corp., and Office of Thrift Supervision to conduct them.
Some of the findings on how portfolio quality varied will be revealed April 24 when supervisors release the white paper on the methodology. Final results of the tests will be released May 4. No decision has been made yet on how to publish the results, with some regulators concerned about a lack of uniformity in the releases if each firm discloses its own results, the official said. The methodology paper will discuss what supervisors describe as a propensity for loss among loan portfolios. Some categories of lending, such as credit cards, are highly correlated with macroeconomic data such as rising unemployment. More variance might be expected in other kinds of assets, such as commercial real estate or mortgages, where assumptions about clients’ ability to repay played a larger role. There, default rates have soared on some products because they were originated with little regard for a borrowers’ underlying payment ability.
U.S. supervisors failed to prevent the plunging credit standards that surrounded the home-lending boom earlier this decade. They also underestimated how the housing shock would reverberate through the financial system, tightening credit, and worsening overall economic conditions. In a review of the crisis, Phillip Swagel, former assistant Treasury secretary of economic policy, said Treasury and Fed officials in May 2007 predicted that "the foreclosure problem would subside after a peak in 2008." Swagel wrote in a March 30 Brookings Institution paper that supervisors realized they "missed" the fact that "problems were baked into the mortgage at origination" and that the quality of the underwriting was another issue on top of how credits respond to changes in the broader economy.
Foreclosure rates on subprime mortgages soared to 13.7 percent in the fourth quarter of 2008, up from 8.65 percent the same quarter a year earlier, according to the Mortgage Bankers Association. Mortgage delinquencies increased to 7.9 percent of all loans in the final three months of last year, the highest level in records going back to 1972. Geithner announced the stress tests in February, including two economic scenarios. Under the assessments’ "more adverse" scenario, the unemployment rate is seen rising to 10.3 percent in 2010 from 8.5 percent currently. Bank of America Corp., the largest U.S. lender by assets, fell the most in almost two months of New York trading April 20 after putting aside $6.4 billion to cover a growing pool of uncollectible loans. Kenneth D. Lewis, chief executive officer of the Charlotte, North Carolina-based bank said unpaid loans are rising because of the weak economy and higher unemployment.
Bank of America is one of the 19 firms, along with Citigroup Inc., Capital One Financial Corp., GMAC LLC and regional lenders including Keycorp and Regions Financial Corp. Goldman Sachs Group Inc. and JPMorgan Chase & Co. have said they plan to return the taxpayer funds they’ve received under the Treasury’s $700 billion Troubled Asset Relief Program. Geithner said in an interview with the Wall Street Journal published April 20 "we want to make sure that the financial system is not just stable, but also not inducing a deeper contraction in economic activity. We want to have enough capital that it’s going to be able to support a recovery."
A Backdoor Nationalization
Just when you think the political class may have learned something in months of trying to fix the banking system, the ghost of Hank Paulson returns to haunt the Treasury. The latest Beltway blunder -- and it would be a big one -- is the Obama Administration's weekend news leak that it may insist on converting its preferred shares in some of the nation's largest banks into common equity. The stock market promptly tumbled by more than 3.5% yesterday, with J.P. Morgan falling 10% and financial stocks as a group off 9%, as measured by the NYSE Financials index. Note to White House: Sneaky nationalizations aren't any more popular with investors than the straightforward kind.
The occasion for this latest nationalization trial balloon is the looming result of the Treasury's bank strip-tease -- a.k.a. "stress tests." Treasury is worried, with cause, that some of the largest banks lack the capital to ride out future credit losses. Yet Secretary Timothy Geithner and the White House have concluded that they can't risk asking Congress for more bailout cash. Voila, they propose a preferred-for-common swap, which can conjure up an extra $100 billion in bank tangible common equity, a core measure of bank capital. Not that this really adds any new capital; it merely shifts the deck chairs on bank balance sheets. Why Treasury thinks anyone would find this reassuring is a mystery. The opposite is the more likely result, since it signals that Treasury no longer believes it can tap more public capital to support the financial system if the losses keep building.
Worse, wholesale equity conversion would mean the government owns a larger share of more banks and is more entangled than ever in their operations. Giving Barney Frank more voting power is more likely to induce panic than restore confidence. Simply look at the reluctance of some banks -- notably J.P. Morgan Chase -- to participate in Mr. Geithner's private-public toxic asset sale plan. The plan is rigged so taxpayers assume nearly all the downside risk, but the banks still don't want to play lest Congress they become even more subject to political whim. A backdoor nationalization also creates more uncertainty, not less, by offering the specter of an even lengthier period of federal control over the banking system. And it creates the fear of even more intrusive government influence over bank lending and the allocation of capital. These fears have only been enhanced by the refusal of Treasury to let more banks repay their Troubled Asset Relief Program (TARP) money.
As it stands, banks and their owners at least know how much they owe Uncle Sam, and those preferred shares represent a distinct and separate tier of bank capital. Once the government is mixed in with the rest of the equity holders, the value of its investments -- and the cost to the banks of buying out the Treasury -- will fluctuate by the day. Congress is also still trying to advance a mortgage-cramdown bill that would hammer the value of already distressed mortgage-backed securities, and now the Administration is talking up legislation to curb credit-card fees and interest. Both of these bills would damage bank profits, but large government ownership stakes would leave the banks helpless to oppose them. (See Citigroup, 36% owned by the feds and now a pro-cramdown lobbyist.)
We've come to this pass in part because the Obama Administration is afraid to ask Congress for the money for a meaningful bank recapitalization. And it may need that money now in part because Mr. Paulson's Treasury insisted on buying preferred stock in all the big banks instead of looking at each case on its merits. That decision last fall squandered TARP money on banks that probably didn't need it and left the Administration short of funds for banks that really do. The sounder strategy -- and the one we've recommended for two years -- is to address systemic financial problems the old-fashioned way: bank by bank, through the Federal Deposit Insurance Corp. and a resolution agency with the capacity to hold troubled assets and work them off over time. If the stress tests reveal that some of our largest institutions are insolvent or nearly so, it's then time to seize the bank, sell off assets and recapitalize the remainder. (Meanwhile, the healthier institutions would get a vote of confidence and could attract new private capital.)
Bondholders would take a haircut and shareholders may well be wiped out. But converting preferred shares to equity does nothing to help bondholders in the long run anyway. And putting the taxpayer first in line for any losses alongside equity holders offers shareholders little other than an immediate dilution of their ownership stake. Treasury's equity conversion proposal increases the political risks for banks while imposing no discipline on shareholders, bondholders or management at failed or failing institutions. The proposal would also be one more example of how Treasury isn't keeping its word. When he forced banks to accept public capital whether they needed it or not, Mr. Paulson said the deal was temporary and the terms wouldn't be onerous. To renege on those promises now will only make a bank recovery longer and more difficult.
TARP cop: 20 criminal probes
The top cop tracking the government's $700 billion bailout program said Tuesday that he has opened 20 criminal investigations and six audits into whether tax dollars are being pilfered or wasted. Neil Barofsky, the special inspector general overseeing the Troubled Asset Relief Program, released a 250-page report detailing a long list of concerns about government efforts to prop up hundreds of banks, Wall Street firms and auto companies. Barofsky, whose investigations could lead to criminal charges, told CNNMoney.com in an interview that he wants taxpayers to understand where their money is going. At the same time, he wants to alert officials to weaknesses in TARP that could invite corruption or fraud.
"Our recommendations are forward looking and there are no vulnerabilities that can't be addressed," Barofsky said. "The balance of what we're trying to do is to inform, bring transparency and make appropriate recommendations." The report reveals that Barofsky is looking into whether bailout decisions were influenced by those who stood to benefit from them and whether companies receiving bailout dollars are adhering to caps on executive pay. Barofsky's report also makes several recommendations to Treasury Secretary Tim Geithner and other officials charged with implementing the bailout. Among them: Require all TARP recipients to detail how they use bailout dollars and safeguard a new mortgage rescue effort against scams.
The report comes as public outcry over government bailouts is mounting. The Treasury Department is under increasing pressure to protect tax dollars even as it attempts to repair the financial markets - agendas that are often at odds with each other. Geithner is set to appear Tuesday before a separate congressional watchdog group, the five-member Congressional Oversight Panel, which released its own oversight report two weeks ago. The overall bailout scrutiny is wearing on the financial sector and, one expert said, has caused confusion over the government's unprecedented entanglement with the private sector. "It's become chic to demand more oversight of how the government is spending money to stabilize the financial system, yet we already have so many oversight entities in place, that it's hard to say who's responsible for ensuring how the money is spent," said Jaret Seiberg, policy analyst at Concept Capital's Washington Research Group.
Barofsky, in the interview, insisted his goal is to inform the public that someone is minding the store and that bailout programs are not a "black hole." "It's not trillions of dollars going out the door without anyone keeping tabs on it," said Barofsky, who will testify before Congress on Thursday about his findings. As an inspector general, Barofsky has legal firepower. He can use subpoenas to compel disclosure and is tasked by federal law to track the details of how banks are spending taxpayer dollars. Barofsky, appointed by then-President Bush last November, has so far hired 35 members of a staff he expects to grow to 150. Currently working out of the main Treasury compound next to the White House, Barofsky and his staff are securing their own offices in the same building in downtown Washington that houses the Treasury staffers that administer TARP.
Barofsky, 38, is a former federal prosecutor from New York who spent years chasing after white-collar criminals, organized crime figures and drug traffickers. In one recent high-profile case, he prosecuted a trading firm that filed for bankruptcy a few months after raising millions in its initial public offering. The chief financial officer of that company, Refco, pled guilty to fraud and money laundering last year. Barofsky told CNNMoney.com that he believes one of his report's most urgent recommendations is that Treasury develop a system to better figure out the value of the different types of shares it now owns in financial institutions. The Treasury has invested hundreds of billions in companies in exchange for shares of preferred stock. He said the need to better understand the value of the government shares is even more important now that the administration is considering a plan to convert preferred shares into common shares, which is the kind of stock that consumers usually hold.
"There needs to be asset valuation strategy so the Treasury can make the most informed decisions," Barofsky said. "I don't think anything bad has happened, but it's time for them to do that." The report also warns federal officials, in great detail, against expanding a Federal Reserve-run program to allow investors to use cheap government financing to purchase questionable mortgage-backed securities. The program poses "significant fraud risks," according to the report. In addition, Barofsky also warns federal officials to create safeguards barring conflicts of interest among banks and investors participating in the new Public- Private Investment Program to prevent "collusion between participants, and vulnerabilities to money laundering."
Finally, he said he is concerned about the Obama administration's nascent mortgage rescue program, which aims to help millions of homeowners get affordable loans. He's worried that the program could spur a wave of real estate fraud and suggests officials take steps to confirm the identities of participants and make sure homeowners know that they aren't required to pay fees to take part. Barofsky's report did not detail the 20 criminal investigations, which it said "vary widely" and include securities fraud, tax, insider trading and public corruption matters. He has previously reported working with New York Attorney General Andrew Cuomo to investigate how bonuses were given to high-ranking employees of American International Group. The report also says that the $182 billion AIG bailout is the subject of two separate audits. One is looking at federal oversight of the bonuses. The other is probing bailout disbursements to AIG counterparties who had purchased insurance-like products from AIG.
AIG, Morgan Stanley Should Recoup $5 Billion of Executive Pay, Pension Fund Says
American International Group Inc., Morgan Stanley and other companies squandered more than $5 billion on executive pay since 2005 and must recoup the payments or face lawsuits, a pension fund said. The Service Employees International Union’s pension fund said today it sent letters to 29 companies, which also include Goldman Sachs Group Inc. and JPMorgan Chase & Co., demanding that directors recover "incentivized executive pay" based on derivatives or other investments whose values were written off. "The collective choices of top executives to reward themselves despite their failure to deliver a profit on their investments negatively impacted our pension fund and left our economy in shambles," Andy Stern, the union’s president, said in a statement.
Subprime mortgages that defaulted as part of the U.S. real estate collapse helped force financial firms worldwide to write off more than $700 billion last year. JPMorgan Chase, the second-largest U.S. bank by assets, said last week it had $711 million in writedowns on leveraged loans in the first quarter and an additional $214 million on mortgage-related securities. Mark Lake, a Morgan Stanley spokesman, said the firm has taken steps to address executive pay issues. "We’ve already instituted a clawback provision on executive pay effective for 2008 and ongoing payments," Lake said in an interview today. New York-based Morgan Stanley is the fifth-biggest U.S. bank by assets. Joe Evangelisti, a JPMorgan spokesman; Ed Canaday, a spokesman for Goldman Sachs; and Mark Herr, an AIG spokesman, declined to comment on the letters. All three companies are based in New York.
The union contends the companies reported inflated profits tied to investments that later turned out to be worthless. Executive bonuses and stock-option grants were based on those earnings, Stern said. AIG, the insurer bailed out by the U.S. government four times since September, came under fire last month when it disclosed $165 million in bonuses paid to employees at one of its units. In February, Morgan Stanley offered a total of as much as $3 billion in retention bonuses to brokers to stay with the company’s joint-venture brokerage with Citigroup Inc., according to a person familiar with the matter. "It’s as if these guys got a windfall payoff for betting the family’s savings on the wrong horse," Stern said. Grant & Eisenhofer, a Wilmington, Delaware-based law firm representing the pension fund, sent the so-called demand letters on April 17. The $1.3 billion fund lost an undisclosed amount of money by investing in the companies, Stern said.
The letters will give the companies time to act on the union’s complaints without litigation, Jay Eisenhofer, one of the pension fund’s lawyers, said in an interview. The SEIU represents more than 2 million workers in health-care, public services and property services, according to its Web site. "If we’re not able to resolve these issues, then SEIU will consider filing derivative lawsuits," Eisenhofer said. The suits will based on the idea that the pay was a waste of corporate assets and a mistake, he said. Among other companies targeted by the union were New York- based Citigroup and New York-based American Express Co. Joanna Lambert, an American Express spokeswoman, said she couldn’t immediately comment. Jon Diat, a Citigroup spokesman, wasn’t immediately available for comment.
In the wake of a public backlash over executive compensation issues, Morgan Stanley officials added a permanent clawback provision to the firm’s compensation policies, according to Dec. 8 company memo. Under that provision, part of an employee’s cash bonus will be set aside and restricted so that it can be recouped in later years if the employee’s actions damage the firm. John Mack, Morgan Stanley’s chief executive officer, didn’t take a bonus in 2008 or 2007 after being awarded a $40 million stock bonus in 2006. Mack, who gets an $800,000 salary, agreed last month to start reimbursing Morgan Stanley for his personal use of the company’s aircraft.
The government’s tab for rescuing AIG has swelled to $182.5 billion from an initial $85 billion in September. The disputed bonuses were paid less than two weeks after AIG reported a $61.7 billion loss for the fourth quarter, the largest in U.S. corporate history. The payments to employees of AIG’s Financial Products unit prompted the U.S. House of Representatives to approve legislation last month to set a 90 percent tax on bonuses at companies that received at least $5 billion in bailout aid. Senators are retreating from a similar proposal after President Barack Obama said the U.S. shouldn’t "govern out of anger" and AIG employees began returning their bonuses.
Bank of New York 1Q Net Down 51%, Dividend Cut 63%
Bank of New York Mellon Corp.'s first-quarter net income slumped 51% on weak fee revenue and investment losses as the company slashed its dividend by nearly two-thirds. Shares fell 9.1% in premarket trading to $25.48 as the quarter's results fell short of analysts' expectations. While Bank of New York Mellon managed to remain profitable last year, it is coming off a tough fourth-quarter when its earnings plunged on investment write-downs. Chairman and Chief Executive Robert P. Kelly said the dividend cut was made with the aim of repaying the government's $3 billion capital injection into the bank. The quarterly dividend cut to 9 cents from 24 cents a share will save Bank of New York Mellon some $660 million a year.
The company is a "custodial bank," which generally holds investments and securities for other investors but it has recently faced troubles related to secondary businesses, such as managing money-market funds. The asset manager and securities adviser, formed in July 2007 when Bank of New York acquired Mellon Financial, reported net income of $370 million, or 28 cents a share, down from $750 million, or 65 cents a share, a year earlier. Excluding write-downs and merger costs, earnings fell to 53 cents from 78 cents. Revenue decreased 24% to $2.85 billion as fee revenue dropped 20% to $2.43 billion amid the market's woes.
Analysts polled by Thomson Reuters most recently were looking for earnings of 63 cents on revenue of $3.66 billion. Assets under management fell 20% to $881 billion on falling market values. There were $12 billion in net outflows during the quarter, mostly owing to people pulling money out of money-market funds amid historically low interest rates. The bank's unrealized losses soared to $4.5 billion from $74 million a year earlier. The tangible capital equity ratio, which measures how much of a bank's total assets are actually owned by common shareholders, dropped to 4.2% from 4.4% but rose from the fourth quarter's 3.8%.
Stocks Fall As Firms Warn of Turmoil
U.S. stock markets plunged yesterday after several major firms cautioned that the recession continues to weigh on their businesses, prompting investors to lock in profits from the past month's rally. The Dow Jones industrial average fell 3.6 percent, or 289.60 points, to 7841.73. The broader Standard & Poor's 500-stock index dropped 4.3 percent, or 37.21 points, to 832.39, while the tech-heavy Nasdaq composite index was down 3.9 percent, or 64.86 points, to 1608.21. Stocks have rallied in recent weeks after plummeting to historic lows in March. The S&P has risen for six consecutive weeks, the longest run in two years. But the sell-off yesterday morning signaled that many investors remain skeptical that the economy has truly turned the corner.
A report by the Conference Board released yesterday showed that an index of leading economic indicators fell 0.3 percent in March, the ninth consecutive month of decline. "It's a question of still some uncertainties out there, and that's causing investors to take a more cautious outlook," said Peter Cardillo, chief market economist with Avalon Partners in New York. Bank of America reported profit of $4.25 billion during the first quarter, 3 1/2 times what it made in last year's first quarter. The company attributed the gains to trading in financial products and a rush to refinance homes as interest rates drop. But the bank also warned that the economy continues to face "extremely difficult challenges" as the unemployment rate rises. Bank of America's stock fell 24 percent, or $2.58, to $8.02. The news dragged down the rest of the financial sector, which fell 6.6 percent. Citigroup plummeted 19 percent, while Wells Fargo fell 16 percent. J.P. Morgan Chase dropped 11 percent.
"I think the news from Bank of America really hit investors over the head with a cold shower that there are still some banks that are going to have troubles," said Len Blum, managing director for Westwood Capital. "Credit losses aren't over." Larry Smith, chairman and chief investment officer at Third Wave Global, said investors should expect volatility, particularly in financial stocks, as the markets digest the rapid gains of the past month. But he said he thinks the worst is over. "I don't think we're returning back to the type of scenario that people are referring to as a meltdown," he said. Other companies reporting earnings yesterday included the pharmaceutical company Eli Lilly, which announced that first-quarter profit rose 23 percent, to $1.3 billion, beating analysts' expectations. Its stock closed down 2.3 percent. The energy firm Halliburton edged up 0.1 percent after reporting a 35 percent drop in earnings, to $378 million. The company said profit was affected by severance packages for employees.
Tech stocks were also big movers yesterday. Oracle announced a $7.4 billion deal to buy Sun Microsystems after IBM abandoned its bid for the software company. Sun's stock shot up 37 percent, to $9.15, in heavy trading. Oracle, however, fell 1.3 percent, to $18.82. The technology sector was down 3.5 percent for the day. "The more merger activity that we see going forward," Smith said, "the better it will be for the equity markets."
Bank of America Spoils the Banking Party
It hardly helps the great bank recovery story when the nation's largest by assets comes out with ugly results. Bank of America's first-quarter numbers took 24% off the bank's recently highflying stock and helped drag down the KBW Bank Index 15%. There were several black spots. Though the bank made a profit of $4.25 billion before payments on preferreds, a chunk of it came from low-quality sources such as the quirky gains booked when the market value of its own debt deteriorates. Another was a fall in the net interest yield that BofA makes from borrowing at a certain rate and lending at a higher one. Bank-stock bulls hope that historically low interest rates will help banks earn their way out of trouble. Worst of all was a 46% increase in nonperforming loans, taking this pool of defaulted credits to $24 billion in the first quarter, from $18.2 billion in the fourth.
The headache for investors is gauging whether credit losses and subpar revenue generation could push BofA's capital ratios below a level the government is comfortable with. In that case, the Treasury might use BofA's stress-test results to force conversion of some of its preferred stake into common stock. As with Citigroup, that would dilute investors, potentially give the government a sizable voting stake and raise fears about political interference. So how might things play out for BofA? If credit deterioration hasn't slowed since the first quarter, the government likely has to be tough and convert part of its stake to common shares, giving the bank a stronger buffer against losses. While BofA's loan-loss reserve has been going up, it has been falling as a percentage of nonperforming loans. It dropped to 121% in the first quarter, from 141% in the prior period. Granted, if nonperformers start to fall, this ratio can improve. But there is almost nothing to suggest that this is happening.
Lending profits can fill the hole left by credit losses. And Bank of America, like others, did report strong revenue from writing new mortgages as low rates sparked a refinancing boom. But lower rates also can erode profitability, if the yield on banks' assets falls by more than borrowing costs, which can be kept high by the presence of long-term debt. In the first quarter, Bank of America's net interest yield was 2.7%, lower than any of the previous four quarters. This margin also deteriorated because it placed more assets in lower-risk, lower-yielding assets. Despite the first-quarter ugliness, Bank of America's stock price isn't likely to fall back to its recent low of $3.14. At $8.02, it trades at 74% of the bank's $10.88 in tangible common equity. That is about the same ratio as for Citigroup, assuming the bank has $3.90 a share of TCE after its preferred conversion.
CDS Clearing House Will Not Fix Credit Default Swap Mess
A central clearing house will do little to fix the mess created by the misuse of credit default swaps, according to a new paper* by Darrell Duffie, professor of finance at the Stanford Graduate School of Business. In the preliminary research paper, Duffie, and GSB doctoral student Haoxiang Zhu, conclude that the central clearing houses founded to rationalize the $27 trillion market for credit default swaps will not remove nearly as much risk as regulators might hope. What’s more, despite a mistaken belief by some commentators, the clearing houses are unlikely to bring much needed transparency to trades of credit-default swaps, or CDS.
Duffie, a member of the Financial Advisory Roundtable of the New York Federal Reserve Bank, supported the establishment of a clearinghouse in testimony last year to the U.S. Senate Committee on Banking, Housing, and Urban Affairs. He still supports the idea, but maintains that the current implementation is flawed in several respects. Although the worldwide market for credit default swaps is huge at $27 trillion, it has shrunk by more than 50 percent in the past year, and is too small—and the number of participating institutions is too small—for a clearinghouse that deals only in CDS to efficiently reduce counterparty risk, says Duffie. Instead, Duffie and Zhu suggest that the clearinghouse should clear a much larger fraction of trades made in the $500 trillion market for over-the-counter (off-exchange) derivatives.Our results make it clear that regulators and dealers should carefully consider the tradeoffs involved in carving out a particular class of derivatives, such as credit default swaps, for clearing.
The great shift in global power just hit high gear, sparked by a financial crash
We have entered one of those rare historical periods that is characterised by a shift in global hegemony from one great power to another. The last such was between 1931 and 1945, and marked the end of Britain's financial ascendancy and its replacement by that of the United States. It might be argued that the cold war represented a similar period, but that is a fallacy: the cold war was an ideological struggle between two powers that were always hopelessly ill-matched. This new period is marked by the rise of China and the decline of the US. Arguably the process started around a decade ago, but at that stage it was barely noticed, such was the west's preoccupation with 9/11 and its after-effects. Indeed, the Bush administration was thinking in exactly the opposite terms: that the world was entering a golden age of American global power.
It is more appropriate, however, to date the beginning of the new era from 2008. First, the election of Barack Obama signalled a recognition by the US of the limitations of its own power and the need for it to co-operate with other nations. Second, China has reached a point where it is now clearly prepared, on the basis of the advances of the last three decades, to assume a more active global role. And third, the onset of the global financial crisis provides the context for the decline of American economic power and illustrates the extent to which it has become dependent on China for the continuation of its global financial hegemony. Such periods of transition are profoundly unstable, deeply uncertain and fraught with danger. The world is fortunate - for the time being, at least - that it has an American president in Obama who is prepared to take a conciliatory and concessive attitude towards America's decline and that it has a Chinese leadership which has been extremely cautious about expressing an opinion, let alone flexing its muscles.
The picture, however, is changing rapidly; indeed, this year has already witnessed a marked change in Chinese attitudes. Ever since Deng Xiaoping, the Chinese approach has been based on taoguang yanghui - hide one's capabilities and bide one's time. But a succession of statements and initiatives suggest that Chinese policy has now entered a new phase. Premier Wen Jiabo expressed a strong confidence at the Boao Forum in Hainan on Saturday that China was successfully weathering the effects of the global economic crisis. During his visit to Europe for the Davos meeting, he made clear that reckless western economic policy, especially by the US, was responsible for the crisis. He also declared that China would not give funds to the IMF unless the latter was subject to major reform.
Later he expressed strong concern about US financial policy and its impact on the dollar, seeking reassurance that the value of China's US treasury bonds would not be prejudiced. In a carefully staged run-up to the G20 summit, Vice-premier Wang Qishan set out a vision of a new monetary order while, most dramatically of all, the central bank governor, Zhou Xiaochuan, called for a new global currency based on using the IMF's special drawing rights, an idea immediately rejected by the US. Meanwhile, a meeting of the finance ministers and central bank chiefs from China, India, Russia and Brazil that preceded the G20 summit called for greater voting rights for developing countries in international financial organisations.
This new assertiveness is finding other forms of expression in Chinese society. A new book by five nationalistic authors, Unhappy China, argues that China has no choice but to become a superpower: published in March, it immediately shot to the top of the bestsellers list. There has also been an intense public debate about whether the country should continue purchasing US treasury bonds, especially given their extremely low interest rate. It is now abundantly clear that China is prepared to take an active and interventionist role in international financial affairs. Given that the global financial crisis is at the top of every agenda and that reform of the existing global financial order is now irresistible, this has far-reaching implications: China will be a central player in whatever new architecture emerges from the present crisis.
This represents an extraordinary change even compared with two years ago, let alone five years ago, when China was not even included in discussions on such matters. But it also has a much wider significance. The rise of China and the decline of the US will, at least during this period, be enacted overwhelmingly on the financial and economic stage. And China has now demonstrated that it intends to be a full-hearted participant in this process. It is not difficult to predict some of the likely consequences: the G20 will in effect replace the G8 and the IMF and the World Bank will be subject to reform, with the developing countries acquiring a greater say.
The most audacious proposal that has so far emanated from Beijing, almost completely unforeseen, is the suggestion for a new global currency which might, in time, replace the role of the dollar as the world's reserve currency. Whether or not such a proposal would ever see the light of day, or indeed work, given that reserve currencies have always depended on a powerful sovereign state, it nonetheless provides us with an insight into the strategic financial thinking that now informs the Chinese government's approach. Clearly they recognise that the days of the dollar as the dominant global currency are numbered. This would also, incidentally, signal the end of New York as the global financial centre.
But this is only one side of the picture. On the other side is the growing role of China's currency, the yuan, which has so far attracted little attention. Although the yuan remains non-convertible, it is evident that the Chinese are seeking to progressively internationalise its role. The Chinese government recently concluded a number of currency swaps with major trading partners, including South Korea, Argentina and Indonesia, thereby widening the use of the renminbi outside its own borders. It is also in the process of taking steps to increase the yuan's role in Hong Kong. This is significant because of the latter's international position. In addition, the government has announced its intention of making Shanghai a global financial centre by 2020.
The likely longer-run trends, then, are perhaps not so difficult to decipher; the short term, however, in the context of a highly volatile financial climate, certainly is. The dollar's strength over the past couple of years remains something of an anomaly, given the catastrophic state of the US financial system. It would be a brave person who bet on the dollar's strength continuing; it is much more likely, in fact, that at some point its value will plummet. Should that happen, then the dollar's global position could rapidly be undermined and the need for more fundamental global financial reforms made more urgent. All of this would only serve to accelerate the decline of the US and the rise of China.
Ilargi: All you need to know: The lenders have access to the president, the borrowers do not.
U.S. credit card firms seek to limit crackdown
U.S. credit card companies are expected to use a White House meeting to put their best foot forward, despite an avalanche of negative publicity, aiming to blunt a congressional push for tougher regulations. Fees and interest rates will be topics at the meeting set for Thursday between 14 credit card company executives, President Barack Obama, National Economic Council Director Lawrence Summers, and other government officials. Executives from Bank of America Corp, American Express Co, Citigroup Inc, Wells Fargo & Co, JPMorgan Chase & Co, Capital One Financial Corp, MasterCard Inc and Visa Inc are expected to be at the meeting.
White House spokesman Robert Gibbs said on Monday the discussion will include the transparency of the credit card companies' lending practices, and the interest rates and fees they charge. "The president believes that we can increase transparency involved, cut down on these deceptive practices, and ensure that any system that is involving fees is done in a way that is fair," Gibbs said. Lenders are expected to argue that they are asking customers to contact them if they lose their jobs or feel under financial stress to try to renegotiate the credit card debt -- even by suspending fees or interest rates. Scott Valentin, an analyst at Friedman, Billings, Ramsey, said credit card companies could also eliminate some late payments, or over-limit fees, to please Washington. "The card companies are sensitive to what is going on around them, and public perception, and the government actions that are being contemplated, and are trying to put on a good face," he said.
Credit card issuers have received over $120 billion in taxpayer funds since October, money the government has asked them to use to expand lending. But with U.S. credit card defaults at record highs, lenders are trying to protect themselves by tightening credit limits and closing accounts, actions that have infuriated lawmakers, consumers, and even triggered a New York state attorney general inquiry. "Some of the very banks we rescued compound the hardships of ordinary Americans with unfair fees and interest charges," said Senator Carl Levin, a Michigan Democrat who has co-authored credit card legislation. Citigroup Chief Financial Officer Ned Kelly said in a conference call Friday with analysts to discuss the bank's quarterly results that the credit card business has shifted from growth to risk management. He added that higher prices on credit cards helped the bank, one of the largest U.S. credit card issuers, to cushion its losses.
In some cases, public anger has forced banks to withdraw fee hikes. JPMorgan stopped charging a new monthly fee to cardholders and agreed to refund the money collected, while Bank of America suspended a planned increase in some fees. The White House meeting is scheduled for a day after a U.S. House of Representatives committee is set to consider legislation aimed at curbing deceptive billing and interest rate practices. The Federal Reserve tightened rules on credit-card practices in December, but the proposed legislation would take that further: it would give customers more time to pay their bills, limit interest rate increases, add more regulations, and ban credit cards access to people under 21 or 18 years of age. Credit card companies are concerned that the legislation could become a way to severely restrict their discretion to charge fees, especially at a time when banks are struggling to emerge from the financial crisis.
"Our expectation is that discussions will involve broad-based economic factors such as purchasing trends, delinquencies, and challenges ... that affect the funding of credit card loans," the American Bankers Association (ABA) spokesman Peter Garuccio said. Valentin said credit card companies would prefer to stick to the Fed's rules, but could scrap some more fees to meet government demands. "The industry would like to avoid what is being discussed now, but it... has to make some type of deference to meet what the administration and Congress want," Valentin said. He said further limits on interest rates and fees like those proposed by Congress could cost the industry $12 billion in revenue per year, with 70 percent coming from fewer interest and 30 percent from lower fees. The ABA trade group, which represents the biggest credit card companies, has warned that more rules could make it more difficult to price a customer's risk level and therefore reduce the availability of credit. "The administration clearly wants to keep the money flowing to the consumer, and the credit card companies are trying to protect themselves, hopefully there will be a middle ground some place," said Anton Schutz, president of Mendon Capital.
Debt Settlers Offer Promises but Little Help
Tyna Carter, burdened with $25,000 in credit card debt, did not want to be a deadbeat. After looking for help on the Internet, Mrs. Carter, a West Virginia homemaker, wound up in the hands of a sweet-talking "credit specialist" from Texas. He claimed his company, Credit Solutions of America, could set her on the road to a debt-free life. But what really happened, Mrs. Carter says, is that Credit Solutions pocketed nearly $4,000 of the couple’s income, a little bit each month. Now they are in a deeper hole than ever. It is a pervasive problem these days. With the economy on the ropes, hundreds of thousands of consumers are turning to "debt settlement" companies like Credit Solutions to escape a crushing pile of bills.
As many as 2,000 settlement companies operate in the United States, triple the number of a few years ago. Settlement ads offering financial salvation blanket radio and late-night television. Consumers who turn to these companies sometimes get help from them, personal finance experts say, but that is not the typical experience. More often, they say, a settlement company collects a large fee, often 15 percent of the total debt, and accomplishes little or nothing on the consumer’s behalf. State attorneys general are being flooded with complaints about settlement companies and other forms of debt relief. In North Carolina, complaints doubled last year, while in Florida they tripled, spokeswomen for the state attorneys general said. In Oregon, complaints have quadrupled since 2006. The rapid rise of debt settlement is the result of two colliding forces: Americans owe more on their credit cards than ever, a result of the spending binge of the last decade. But as the recession deepens, their ability to pay is declining.
Kaulkin Ginsberg, a consulting firm, estimated that the amount of consumer credit at risk of default increased in February by $5 billion, to $24.5 billion. High credit card rates and fees have been a point of contention for consumer advocates. On the NBC program "Meet the Press" on Sunday, the administration’s chief economic adviser, Lawrence H. Summers, said President Obama planned to crack down on abusive credit card lending that forces Americans to pay excessive interest rates. For many consumers, their only hope for solvency is to get their balances down to a manageable level. But the card companies — concerned for their own solvency — are not inclined to let them off the hook. Debt settlement companies claim they help both creditor and consumer by bridging the abyss between them.
"There is overwhelming demand for this service," said Robby H. Birnbaum, a lawyer who is a board member of the Association of Settlement Companies, a trade group. "People want to avoid bankruptcy, and this is their last resort."
In practice, however, the debt settlement firms frequently manage to please no one. An executive of the American Bankers Association, representing the credit card industry at a recent forum, labeled debt settlement companies "very harmful" to both creditor and consumer. Even debt collectors are upset, saying the settlement companies prevent them from collecting. The premise of debt settlement is simple: A consumer stops trying to pay even the minimum on his cards. Instead, he accumulates money in an account that the settlement company promises to use to strike a bargain with creditors. Confronted with the certainty of some money now versus the possibility of no money later, the card company settles for 40 cents on the dollar or less. Even if the goal makes sense, achieving it can be difficult. Once the consumer stops paying the minimums, the card companies increase efforts to collect. Their fees and interest charges do not stop. They may sue. The consumer’s credit score falls through the floor.
Long before making any attempt at a deal with creditors, the settlement companies take a fee. Credit Solutions deducted $233 from the Carters’ checking account for three months, and then $116 a month for the next 27 months — a total of about $3,825 by early this year. It was a fee Mrs. Carter and her husband, Willard Carter, a miner who retired after he was injured, could ill afford — especially since, by their account, the company put little effort into their case. "After they got their money, they ran," said Mrs. Carter, 51. The Carters went to the West Virginia attorney general’s office in January, joining a flood of that state’s citizens complaining about debt relief schemes. "We’re being overwhelmed," an assistant attorney general, Norman Googel, said. Since 2005, Mr. Googel and his colleagues have successfully pursued cases against 14 companies promoting debt relief and debt settlement, resulting in refunds to 3,443 consumers, and they are pursuing more. And yet, he said, the complaints keep coming.
On March 26, Credit Solutions was sued by the State of Texas, which accused it of engaging in "false, deceptive and misleading acts and practices." The suit says the company misrepresents its success rate, noting that the company’s own data "show that over 80 percent of the debts enrolled in the program do not settle." Those debts that are settled, the suit says, are for higher amounts than the promised 40 cents on the dollar. Credit Solutions said it would not comment on pending litigation. The settlement companies are the latest response to an old question: How can debt-ridden people avoid bankruptcy? The first answer was nonprofit credit counseling, which began in the 1960s. The counselors, financed by the credit card industry, helped consumers formulate debt management plans and negotiated lower interest rates.
Counseling lost some of its appeal after creditors largely stopped offering the concessions needed to get people solvent again. The National Foundation for Credit Counseling, an umbrella group for legitimate counseling services, announced last week that the country’s top 10 credit card issuers had agreed to make changes to provide additional relief. The diminishing effectiveness of nonprofit efforts created an opening for commercial settlement companies. Debt settlement is not regulated by federal law, as debt collection is, though general fraud and deceptive-marketing laws may apply. The Federal Trade Commission has successfully pursued seven cases against debt settlement companies since 2001, but one of the agency’s commissioners, J. Thomas Rosch, said that such cases take time and staff.
"I favor self-regulation that’s not a fig leaf," Mr. Rosch said. After inquiries from The New York Times, Credit Solutions sent a full refund to the West Virginia couple, the Carters, saying it was committed to customer satisfaction. The company blamed "communications problems" for troubles with the Carters’ account. The Carters need every penny of their refund. They now owe much more than when they enrolled with Credit Solutions three years ago. For instance, interest and fees have increased the balance on one of their cards to $18,000, from $8,000. "I was trying to do the right thing," Mrs. Carter said, "but it didn’t work that way."
US Student Loan Default Rates Are Soaring
Defaults on student loans are skyrocketing amid a weak job market for graduates and steadily rising tuition costs. According to new numbers from the U.S. Department of Education, default rates for federally guaranteed student loans are expected to reach 6.9% for fiscal year 2007. That's up from 4.6% two years earlier and would be the highest rate since 1998. The situation is mirrored in the smaller private student-loan market. In 2008, SLM Corp. also known as Sallie Mae, wrote off 3.4% of its private loans that were already considered troubled, according to its latest annual report -- more than double the figure in 2006. Student Loan Corp., a unit of Citigroup Inc., wrote off 2.3% of those loans in 2008, compared with 1.5% a year earlier. "The volume of people in trouble is definitely increasing," says Deanne Loonin, a staff attorney at the Boston-based National Consumer Law Center who counsels low-income consumers on student loans and other debt issues.
Lenders say they are hearing more pleas for help as the unemployment rate worsens and debt levels soar among graduates. Sarah Kostecki, a 24-year-old sales associate in New York, graduated last year from DePaul University with a major in international studies and $87,000 in debt, translating to monthly payments of $685, the vast majority of which are private loans. The payments represent more than a third of her take-home pay, and to help her make ends meet, her grandparents are giving her $200 a month toward her debt this year. Beginning in January, she'll be on her own, and she worries about falling behind. "It feels like I'm being punished for having gone to school," Ms. Kostecki says. She has contemplated some of the options offered by private loan companies, such as temporary interest-only payments. But after two years, her payments would jump by almost $200 a month on top of what she's paying now, she says. "I don't want that."
Borrowers having trouble repaying their federally backed loans can call their lender to request that their payments be put on hold until they get back on their feet. Most types of federal loans qualify for "forbearance" -- meaning the borrower can suspend payments temporarily but is still on the hook for the interest that continues to build while payments are on hold, which is then amortized over the life of the loan. Certain need-based loans qualify for "deferment," which means the government will cover any interest payments for a set period. Deferments and forbearances can each be used for a maximum of three years per loan. There are fewer options for borrowers with private loans, which have soared in recent years as limits on federal borrowing failed to keep up with rising college costs. Students borrowed $19 billion in private loans in the 2007-2008 school year, six times the amount they borrowed a decade earlier, after factoring in inflation, according to the College Board, a New York-based nonprofit.
In the past, it was relatively easy to get a forbearance on a private loan, says Ms. Loonin. The lenders "gave these loans to a lot of people that couldn't afford them," she says. "To mask the problem, they kept giving forbearances." But as more borrowers are running into trouble, lenders are becoming stricter, she says. Some major lenders, such as First Marblehead Corp. and J.P. Morgan Chase & Co., declined to say how many forbearances they've been granting. Others, including Wells Fargo & Co. and the nonprofit Vermont Student Assistance Corp., said they are granting more lately. For private borrowers, finding what assistance programs are available is often a chore; information on Web sites can be sparse and hard to find. Here's how some private lenders are working with students who are having trouble paying back their loans:
- Sallie Mae. The lending giant, which makes both federally backed and private loans, says it grants private borrowers forbearances in increments of up to three months, and may be extended several times, typically up to a total of 24 months. There's a forbearance fee of $50 per loan, up to a maximum of $150. Another option may be to extend the repayment period by several years, which in turn lessens monthly payments, though the minimum balance must be at least $20,000.
- Key Corp. Key says it grants forbearances in six-month increments, with conditions depending on individual circumstances. For instance, someone struggling with a job loss may have greater need than someone else whose pay was cut. While some borrowers may qualify for a full forbearance, others may qualify only for reduced payments. Either way, Key says it doesn't charge any additional fees.
- Student Loan Corp. Borrowers in trouble can make interest-only payments for a period of either two or four years. They might also qualify for a forbearance, generally up to a maximum of 12 months. There are no fees for either option.
- Wells Fargo. Borrowers can apply for forbearance, granted "generally in cases of extreme financial hardship," a spokeswoman says. There are no fees, and length of time is based on individual circumstances.
Japan to Sell Additional $110 Billion in New Bonds to Finance Stimulus
Japan’s Finance Minister Kaoru Yosano said the government will sell 10.8 trillion yen ($110 billion) of additional new bonds this fiscal year to pay for Prime Minister Taro Aso’s record stimulus package. The extra debt sale will bring the government’s new bond sales for this fiscal year to a record 44.1 trillion yen. Of the additional issuance, 7.3 trillion yen will be in construction bonds, with 3.5 trillion yen in deficit-covering bonds, Yosano said at a press conference in Tokyo today. Aso on April 10 unveiled a 15.4 trillion yen stimulus package to help revive an economy headed toward its worst recession since World War II. Bond yields rose to a five-month high that day on concern that debt sales would keep rising as Aso seeks to spend his way out of the nation’s slump. "It’s important that bond issuances don’t distort the market," Yosano said. "There needs to be a careful dialogue with investors." The yield on the benchmark 10-year bond fell two basis points to 1.45 percent as of 10:05 a.m. in Tokyo.
Most of the stimulus spending will be included in an extra budget for the year starting April 1 and will total 13.9 trillion yen, according to a proposal released by the finance ministry. The Cabinet is expected to approve the extra budget proposal and submit it to parliament next week. Japan’s debt burden, already the world’s largest, will probably spiral to 197 percent of gross domestic product next year, according to the Organization for Economic Cooperation and Development. The OECD estimate was published before the government released the stimulus package. Including so-called zaito bonds, which are used for loans to state-owned financial institutions, extra bond sales will be around 17 trillion, two finance ministry officials said last week. In December, the government said it will sell 113.3 trillion yen of debt to investors in the year started April 1. Aso’s package includes measures to bolster the job market, encourage investment in energy-efficient technology and provide credit to struggling companies.
Most people will have heard about the dramatic collapse in dry bulk shipping rates that occurred in October/November following the paralysis that hit global trade in the weeks after the Lehman Brothers collapse. However, tanker rates didn’t respond quite as dramatically at the time.
Now, a good six months on, there is no denying tanker rates have finally responded with the same calamitous descent downwards. The fall may have been more haphazard than that of Baltic Dry — most likely due to the contango in the oil market which saw demand come in for vessels as storage — but the decline is no less serious, and is consequently creating some unusual dynamics in the energy market.
As shipping news provider Lloyd’s list wrote on Friday:Tankers are being chartered for voyages at spot rates that fail to cover bunker and port costs, as earnings dramatically plunge across all tanker types in both dirty and clean trades. Worldscale rates for clean tankers operating on some major routes are now translating to dollar-per-day earnings of less than zero, according to derivatives broker, Imarex. The rates decline has sharply accelerated this month, pushing rates below $10,000 per day for aframax, suezmax and very large crude carriers on all but a handful of world’s key tanker journeys, and well below operating costs for most owners.The case is particularly worrisome for the world’s VLCC routes (very large crude carrier). As Lloyd’s List explains:On the world’s largest VLCC trading route, from the Middle East to Japan, rates have fallen to under $8,000 per day, just over 10% of the $70,000 per day seen at the beginning of 2009. “There’s no reason why the market should be where it is,” said Frontline acting chief executive Jens Martin Jensen. “It doesn’t make any sense. If [a crude oil trader] pays $50 a barrel and you have 2m barrels on board [a tanker] worth $100m, who cares if you are paying $10,000 or $20,000 per day? It doesn’t make any difference. It’s weakness in certain owners minds.”
Here, for comparison, are charts of the Baltic Dry index (which provides an average rate for the cost of moving raw dry materials like metals) and the Baltic Dirty Tanker index (which provides a measure of tanker rates for transporting unrefined crude oil).
The Baltic Dry:
The Baltic Dirty Tanker Index:
The same decline is also true of clean tanker rates, which measure the price of transporting refined products like gasoline, gasoil, naphtha and jet fuel:
As Lloyd’s List sums up, the drop in VLCC tanker rates has much to do with the fallback in Opec production. This can be clearly seen in the marked and sustained fall in the TD3 route particularly, which marks rates from the Arab Gulf to Japan.
So what are the implications for the market, including oil and products prices? Well, it could be argued that had it not been for the market drop in tanker prices this month the contango in crude prices may have abated. As it is, rates are so low that traders who would normally have unwound their Q4 contango trades, have had every reason to keep them on. If low tanker rates are indeed responsible for suspending the natural flattening of the contango that would have occurred when traders repositioned themselves, it is this area arguably that must be watched most closely for hints of future price direction. The theory being: any dramatic recovery in tanker rates in the weeks, months to come could be enough to backtrack the contango once and for all. That said, currently, that looks an unlikely possibility.
Meanwhile, in the products arena - low clean rates have led to the unusual development of tankers being used for gasoline storage. This is because with inventories running high across many prominent markets, and traditional onshore storage full, it has become cost-effective to overcome the usual problems that come along with storing gasoline for long periods of time on vessels (the fact that gasoline is much more unstable than unrefined crude and can evaporate). Amongst the first to initiate this gasoline ‘contango’ trade on a large level have been the Iranians. As Reuters reported last week:DUBAI, April 7 (Reuters) - Iran is storing 7.7 million barrels of gasoline on ships as part of efforts to secure supplies ahead of its presidential election in June, industry sources said on Tuesday. An Iranian official told Reuters Iran was storing the gasoline, but declined to say why.“We will continue to store gasoline to make sure we are always in a comfortable position,” an official from the National Iranian Oil Company (NIOC) said, but declined to offer more details. “We want to make sure we have no supply shorts.”
Tehran was expected to lift imports of gasoline for May and June by up to 25 percent from April as it looked to guarantee plentiful supply before the presidential vote, traders said. The pricing structure for gasoline was encouraging storage, traders said, as prices for prompt delivery were lower than those for buying the fuel later. The fuel is being kept on 12 oil tankers anchored off Kharg Island, Iran’s largest crude oil terminal, the NIOC official said. OPEC-member Iran was set to import around 128,000 barrels per day (bpd) of gasoline in April, traders said.
While the Iranians may give the impression the trade has been initiated to create some sort of supply security ahead of elections, there are reports of other parties doing the same thing. In which case, the expectation in the market could be that gasoline prices are bound to go up — perhaps on the view that as the world’s less complex refineries become increasingly punished on account of ineffective margins, they will be forced out of business. As Olivier Jakob at Petromatrix points out, US demand for products, for example, is 1.8m barrels per day lower than a year ago, while refinery runs are almost unchanged. As he writes:... this imbalance can not be maintained and refiners still have to adjust refinery production lower to match the much lower demand.
If lower production comes at the expense of small non-complex refineries going out of business completely (with sites actually being mothballed), the consequence would be much less refining capacity for the world’s disposal. Ironically, this rebalancing could be supportive for gasoline prices — making the gasoline storage trade very profitable. Distillate prices, however, are another story. The overhang here is simply so much larger than in gasoline — which may seem curious considering the exact opposite was true last year when gasoline demand fell much faster than demand for distillates. This led some to suggest the US motor market had become more diesel-oriented because of the fuel’s greater efficiency.
While that may have been the case initially, it’s becoming increasingly clear the overhang now tells a completely different US recession story. Distillate demand has come crashing down (lagging demand destruction in gasoline) because it is only now that industrial production — the key driver of distillate consumption — has fallen. As Bloomberg reports, the latest US industrial production figures have been dire:Industrial production in the U.S. fell for the 14th time in the last 15 months as factories trimmed unwanted stockpiles. Output at factories, mines and utilities dropped 1.5 percent last month, more than anticipated and matching the prior month’s decrease, according to a report from the Federal Reserve today in Washington. The amount of industrial capacity in use fell to 69.3 percent, the lowest level since records began in 1967.All of which suggests the future for distillate prices (and small non-complex refineries for that matter) is anything but bright. Even a suspension in the rate of industrial production decline (which doesn’t look hopeful yet) would be hard-pressed to rebalance the supply overhang that currently exists.
Canada Talks Are Crucial to Chrysler Survival
While Chrysler’s fate will be determined in Washington and Turin, Italy, Fiat’s hometown, a key component to its survival is the effort to reach a new labor deal in Canada. And three participants in Canadian labor talks that resumed Monday in Toronto not only have Canadian connections but direct links to the Windsor, Ontario, headquarters of the company’s Canadian operations. Thomas W. LaSorda, Chrysler’s president and vice chairman, grew up near the sprawling plant that now produces all of Chrysler’s minivans. Ken Lewenza, the president of the Canadian Auto Workers union, began his working life in that factory at the age of 18. And Sergio Marchionne, the chief executive of Fiat, received both his undergraduate degree and an M.B.A. from the University of Windsor. Those local links, however, have not proved to be a lubricant that could smooth negotiations. Mr. Lewenza remains adamant that his members will not offer Chrysler any concession beyond those they ceded to General Motors of Canada.
To underscore that position, several workers at the minivan plants last week symbolically burned letters from Mr. LaSorda warning that without significant labor concessions, the company would leave Canada. Further inflaming the debate, Mr. Marchionne told a Toronto newspaper that Fiat would not partner with Chrysler unless both the Canadian and American unions agreed to further cuts. Observers of the Canadian auto industry were reluctant to forecast the outcome of the talks. "Certainly some of this is Ken Lewenza talking to his members and telling them what they want to hear," said Tony Faria, a professor at the University of Windsor business school, where Mr. Marchionne once studied. "A few weeks ago, I thought this was a normal starting point in bargaining. But I’m starting to become more pessimistic over the whole thing."
The position of Fiat, Chrysler and the government of Canada, which has promised conditional assistance to the company, is clear: the union members must agree to match the total wage and benefit costs of workers at Honda and Toyota factories in Canada. Unfortunately, there is no agreement on exactly what the labor costs are at those Japanese-owned factories. Chrysler and Mr. Marchionne say that it is 57 Canadian dollars (about $46) an hour, about 19 Canadian dollars less than what Chrysler now pays. General Motors of Canada, however, pegged the number at 47.50 Canadian dollars in a recent study. The union, which disagrees with both Chrysler’s measure of its own costs and the company’s estimates for its competitors, claims the cost gap is just 5 Canadian dollars an hour. Professor Faria said he has tried in vain for years to obtain reliable hourly labor cost figures for Honda and Toyota. And, as far as he can determine, no one else has been any more successful.
Mixed in with the debate about costs is the union’s apparent determination to maintain a common contract with the three automakers based in the United States, a concept it calls pattern bargaining. In this case, General Motors provided the pattern in a contract that reduces hourly costs by about 7.25 Canadian dollars. Exactly how Chrysler proposes to close its Canadian dollar cost gap is unclear. In the letter to the company’s 8,000 unionized employees in Canada, Chrysler said that it has suggested a number of cuts to the union that not do involve wages or pensions. Mr. Lewenza "has certainly been consistent," said Chris Piper, a professor at the Richard Ivey School of Business at the University of Western Ontario. "There’s a tendency on the parts manufacturers’ level of the C.A.W. letting plants fail. The question is: to protect the wages at Ford and G.M. are they going to sacrifice Chrysler?"
For Windsor, the city that ties the three protagonists together, that result would be an economic disaster. General Motors is about to close its last plant in Windsor. Ford has cut back at its engine operations and a foundry in the city. Not only does that leave the Chrysler minivan plant as the city’s biggest employer, parts companies in the Windsor area are excessively dependent on both it and Chrysler factories in nearby American states. "I certainly worry about the city of Windsor if anything happens to Chrysler," Professor Faria said.
Spain’s Falling Prices Fuel Deflation Fears in Europe
Faced with plunging orders, merchants across this recession-wracked country are starting to do something that many of them have never done: cut retail prices. Prices dipped everywhere, from restaurants and fashion retailers to pharmacies and supermarkets in March. Hoping to increase sales, Fernando Maestre reduced prices by a third on the video intercoms his company makes for homes and apartment buildings. But that has not helped, so, along with many other Spanish employers, he is continuing to fire workers. The nation’s jobless rate, already a painful 15.5 percent, could soon reach 20 percent, a troubling number for a major industrialized country.
With the combination of rising unemployment and falling prices, economists fear Spain may be in the early grip of deflation, a hallmark of both the Great Depression and Japan’s lost decade of the 1990s, and a major concern since the financial crisis went global last year. Deflation can result in a downward spiral that can be difficult to reverse. As unemployment rises sharply and consumers cut spending, companies cut prices. But if sales do not pick up, then revenue can decline further, forcing more cuts in workers or wages. Mr. Maestre is already contemplating additional job and wage cuts for his 250 employees. Nowhere is this cycle more evident than in Spain. Last month, it became the first of the 16 nations that use the euro to record a negative inflation rate. The drop, though just 0.1 percent, had not happened since the government began tracking inflation in 1961, and Spanish officials have said prices could keep dropping through the summer.
Some of the decline came as volatile food prices sank; the cost of fish fell 6.2 percent, and sugar was down 5.7 percent. But even prices in normally stable sectors like drugs and medical treatments fell 0.7 percent in March, and there were slight declines in footwear, clothing and prices for household electronics. "Alarm bells are going off," said Lorenzo Amor, president of the Association of Autonomous Workers, which represents small businesses and self-employed people. "Economies can recover from deceleration, but it’s harder to recover from a deflationary situation. This could be a catastrophe for the Spanish economy." Deflation is not just a Spanish concern. Luxembourg, Portugal and Ireland have reported price drops, too. While the declines have been slight — and prices rose modestly after factoring out food and energy prices, which can fluctuate widely — other figures released this month suggest the risk of deflation is growing.
In Germany, wholesale prices dropped 8 percent in March from a year ago, the steepest fall since 1987. In Japan, wholesale prices fell 2.2 percent on an annual basis. In the United States, the Consumer Price Index fell 0.1 percent in March, year over year, the first decline of its kind since 1955, though prices rose 0.2 percent excluding food and energy. "It doesn’t mean it will spread here to the U.S., but we need to look closely at Spain and other places to understand the dynamic," says Simon Johnson, a professor at the Sloan School of Management at the Massachusetts Institute of Technology and a former chief economist for the International Monetary Fund. "It’s like the front line of a new virus outbreak."
The trends have unnerved even well-established businesses. "There is such a huge lack of confidence in the politicians, in the European Union and in the banks," said Arturo Virosque, 79, president of Valencia’s chamber of commerce and the owner of a local logistics company. Ticking off crises going back to the Spanish Civil War in his youth, he said, "this is different. It’s like an illness." After price cuts by competitors, Mr. Virosque’s company reduced charges for storage and transportation, and slashed its work force to about 170, from 250. "The worst thing is that we have to cut the young people," he said, because higher severance makes it too expensive to fire older workers. While unemployment traditionally is higher in Spain than in much of Europe, the sharp increase has many here nervous. The jobless rate for those under 25 is at a Depression-like level of 31.8 percent, the highest among the 27 nations of the European Union.
Before cutting prices in early 2009, Mr. Maestre ordered several rounds of job cuts at his company, Fermax, as sales of the intercoms collapsed with Spain’s housing bubble. "It’s a question of survival for everybody," he said. Still, the lower prices have not translated into higher sales. Fermax’s orders fell 25 percent in the first quarter. Prices for some intercom parts that he buys, like video screens, have also come down, but it is not enough to make up for the sales drought. "Prices have to come down more and we will have to spend less," he said. The effects of this downward spiral are evident at Valencia’s principal soup kitchen, in an imposing stone building constructed a century ago as an alms house. Each day, a line forms around the block by noon. The Casa de la Caridad, or House of Charity, is helping three times as many people as it did a year ago. More than 11,000 meals were served in March, and it expects to top 12,000 this month.
As the economic decline has broadened, so has the range of people seeking help. In the past, most were out-of-work immigrants or the homeless, said the center’s director, Guadalupe Ferrer. Today, "it’s more and more people like us who had a house, a respectable job, but are now unemployed." The employed worry that falling prices will endanger their jobs as well. Yolanda Garcia has worked as a butcher under the arches of Valencia’s soaring Art Nouveau central market for a decade, but she’s troubled that a drop in the price of chicken, to 5.99 euros a kilo, from 6.99, has not attracted more customers to her stall. "Of course, we’re worried the boss will have to reduce staff," said Ms. Garcia, 38, whose husband, a construction worker, was laid off two months ago.
All this has made deflation, once a subject largely reserved for economists who studied the Great Depression, into front-page news here. The American economy is less vulnerable to deflation, in part because of the Federal Reserve’s decision to cut interest rates to near zero and increase lending by $2 trillion. The European Central Bank has also cut rates, though more slowly, and it has resisted the lending measures adopted by the Fed and the Bank of England to prop up spending. When Spain had its own currency, the peseta, the central bank could have simply devalued it, or cut interest rates to zero. But that is not an option in the era of the euro, when monetary policy is controlled from the European Central Bank’s headquarters in Frankfurt, said Santiago Carbó, a professor of economics at the University of Granada. "If we enter into a deflationary period, we won’t have the monetary tools to sort it out," Mr. Carbó said.
Gilt Sales to Increase 20% in Brown Budget, Primary Dealers Say
The U.K. will boost bond sales by 20 percent to a record this year as Prime Minister Gordon Brown fights the deepest recession in three decades, according to a survey of the banks that bid at government debt auctions. The Treasury will issue 180 billion pounds ($262 billion) of gilts in the fiscal year through March 2010, according to the median estimate of 14 of the 16 primary dealers. The Debt Management Office will announce the borrowing plan after Chancellor of the Exchequer Alistair Darling’s budget report to Parliament tomorrow. British government bonds lost 2.7 percent so far this year, compared with 2.6 percent for U.S. Treasuries and 0.6 for German bunds, according to Merrill Lynch & Co. indexes. The deficit will double to 150 billion pounds in the next 12 months, according to the Institute for Fiscal Studies. Darling said this month that the recession was deeper than he expected, after forecasting in November that the economy would contract by as much as 1.25 percent.
"The government will have to take a serious reality check after their hugely optimistic economic growth forecasts," said Richard McGuire, a fixed-income strategist in London at Royal Bank of Canada who forecast the government will raise as much as 200 billion pounds this year. "It’s obviously a negative in terms of the supply the market is being asked to absorb." Yields on two-year government notes will rise to 1.99 percent in the second quarter of 2010, from 1.42 percent now, according to the average of seven analysts’ forecasts compiled by Bloomberg. The Debt Management Office said March 18 that it would sell 147.9 billion pounds of bonds this year. Investors expect the amount to increase after the economy contracted 1.6 percent in the final three months of 2008, more than economists estimated. The Treasury borrowed 146.4 billion pounds in the fiscal year that ended March 31 and an average of 47 billion pounds in the five years before 2007.
An increase in sales raises the risk auctions will fail, according to former U.K. Chancellor of the Exchequer Norman Lamont. The debt office couldn’t find enough buyers for 40-year bonds on March 26, the first time since 2002 that demand fell short. "There is a real risk in the markets that we might get a funding strike," Lamont, who was chancellor between 1990 and 1993, said on Bloomberg Television yesterday. "We can’t assume just because we’re a large country that the deficit will be funded." Britain’s deficit more than tripled in the first 11 months of the fiscal year through March to a record 75.2 billion pounds, the Office for National Statistics said on March 19. It will expand to 150 billion pounds, or 10 percent of gross domestic product, in the next 12 months, according to the fiscal studies institute, 32 billion pounds more than Darling forecast in November.
"The U.K. fiscal outlook is terrible, and there’s no other way of describing it," said David Scammell, a money manager who oversees $158 billion at Schroders Plc in London and is buying gilts because of the worsening economic outlook. A YouGov Plc poll published on April 5 showed Brown’s Labour Party has the support of 34 percent of voters, compared with 41 percent for the Conservatives, led by David Cameron. Unemployment rose to 6.5 percent, the national statistics office said March 18. Darling said in November that Britain’s economy may contract this year, compared with the 2.25 to 2.75 percent expansion the government initially predicted. The Organization for Economic Cooperation and Development said March 31 the U.K. will shrink 3.7 percent in 2009. Brown is increasing bond sales to pay for rescuing banks that have reported $121 billion in credit-related losses and writedowns since the start of 2007. The government pledged 40 billion pounds to recapitalize banks and hundreds of billions of pounds in loan guarantees.
"You can’t really accuse the government of doing nothing to get the country out of the mess," said John Anderson, a money manager at Rensburg Fund Management in London who oversees about $3 billion of sterling-denominated assets. "They have done a lot. The problem is how much more can they do ahead of the election? The pot is already empty." Countries are selling record amounts of debt for stimulus programs and bank bailouts. The U.S. needs to raise as much as $3.25 trillion this fiscal year, according to Goldman Sachs Group Inc. Germany’s government said on March 25 it will sell a record 346 billion euros ($452 billion) of debt this year. Gilt sales will probably remain above 100 billion pounds for several years even as the economy recovers, according to Deutsche Bank AG, the world’s biggest bond trader in 2008, according to Euromoney Institutional Investor Plc.
"The high number reflects continued deterioration of public finances, and a big amount of bond redemption," said George Buckley, chief U.K. economist at Deutsche Bank in London. "Governments around the world are competing for money." The Bank of England’s plan to buy 75 billion pounds of assets with new cash may provide some support for gilts, according to F&C Asset Management.
"The investment world has become more risk averse and people might want to hold more, rather than less, gilts," said Paul Grice, who helps manage about $13.5 billion as head of U.K. government bonds at F&C. The 14 banks that participated in the survey belong to the group of 16 so-called Gilt-Edged Market Makers, or GEMMs: Barclays Capital, BNP Paribas SA, Citigroup Inc., Credit Suisse Group AG, Deutsche Bank, Dresdner Bank AG, Goldman Sachs Group Inc., HSBC Holding Plc, JPMorgan Securities, Morgan Stanley, Nomura International Plc, Royal Bank of Canada, Royal Bank of Scotland and UBS AG. The forecast includes 16 billion pounds of payments for bond redemptions forecast by the Debt Management Office for the fiscal year 2009/2010.
Russia May Reduce Government Spending by 30% Next Year as Reserves Dwindle
The Russian government may cut planned expenditures by as much as 30 percent next year as the world’s biggest energy exporter runs through its cash reserves, Deputy Finance Minister Tatyana Nesterenko said. "The situation next year will be very difficult," Nesterenko told reporters in Moscow on April 17. "We won’t see an increase in revenues, while our cash reserves will be stretched to the limit." Finance Minister Alexei Kudrin said on April 14 that 2010 spending may be cut by 10 percent to about 9 trillion rubles ($269 billion) as revenue is expected to decline by more than 30 percent compared with 2009. Russia is bracing for recession as tumbling demand cuts tax revenue and pushes down the price of Urals crude oil, its chief export earner. The Russian government has revised the 2009 budget based on a $41 per barrel price for oil and expects a deficit equal to 7.4 percent of gross domestic product. The previous budget was based on an average price of $95 per barrel.
The government had a budget deficit for the first time since 1999 as the government spent 50.5 billion rubles more than it collected in the first quarter. Nesterenko said 124 billion rubles had been spent from Russia’s oil funds as of April 16 to cover some of the shortfall. Nesterenko said falling revenues from custom duties and taxes may leave an additional 800 billion ruble hole in the budget this year. "I am confident the budget will allow us to fulfill all of the obligations we have this year," Nesterenko said. "But we might use the reserve more than we’d like and this could seriously hurt the 2010 budget." The government’s forecast of a 2.2 percent economic contraction this year compares with the World Bank’s prediction of 4.5 percent shrinkage and the Organization for Economic Cooperation and Development’s estimate of 5.6 percent.
The Global Downturn Lands With a Zud on Mongolia's Nomads
Waves from the global economic downturn hit Sodnomdarjaa Khaltarkhuu when bank officials showed up at his tent on the edge of the Gobi desert and threatened to foreclose on his goats, sheep and camels. Falling demand for cashmere among recession-hit shoppers in the West is cutting into earnings among nomadic herders in Mongolia, whose goats produce the soft fiber used in high-end sweaters, scarves and coats. The result: herder loan defaults. Mongolians are calling the current situation a financial zud, invoking a local term for unusually harsh winters that devastate herds. After Mr. Sodnomdarjaa couldn't pay back a $2,700 loan, he says bank officials pressed him to sell his livestock -- which he used as collateral. The bank says he misrepresented the number of animals he owned, which he denies. Now a judge has ordered the seizure of Mr. Sodnomdarjaa's family home -- a tent -- if he doesn't come up with the rest of the money soon.
"We don't have any animals," says Mr. Sodnomdarjaa, sitting in his tent, heated by camel dung burned in a cast-iron stove. "How can we pay?" Mongolian nomads' troubles show that the ravages of the economic crisis have spread to even the most remote parts of the world. More than a quarter of the households in Mongolia -- which has a population of about 2.6 million -- earn a living raising animals. The credit crisis on the steppe has root causes similar to those of the subprime mess in the U.S. Some herders, betting on continued strong cashmere prices, borrowed more than they should have, and spent the money on the Mongolian equivalent of conspicuous consumption: motorbikes and solar panels to provide electricity for their tents. Banks, looking to cash in on rural prosperity in the good years, didn't pay enough attention to risk management and lent too freely, some bankers say.
Bankers say pressuring herders to sell animals and moving to foreclose on other collateral are last resorts. "We try our best to have flexible policies," says Daimaa Batsaikhan, deputy chief executive of Khan Bank. He said the bank's own forecasts for cashmere prices last year were "inaccurate" and that the bank has changed its risk-management practices. He says his bank and other lenders have been working with herders. Khan Bank says it has restructured 7,000, or nearly 11%, of its outstanding herder loans, essentially extending the time borrowers have to repay. Ultimately, though, the money lent to herders is "money deposited by other Mongolians," the banker says, and it is the bank's responsibility to protect their interests. Many banks have cut back on new lending. And a flood of forced sales has helped drive down prices for animals, skins and meat.
Munkhbat Tsedendorj, a 30-year-old animal dealer, based in Altai, the capital of the province where Mr. Sodnomdarjaa lives, says animals for sale in the city's central market have been fetching about half of what they were before the downturn. "I've been in this business 10 years, and I've never seen anything like it," he says, standing before a blue truck piled with skinned and frozen carcasses of sheep and goats. "They are bankrupting the herders." Debt is a main topic of conversation here in Tsogt, a settlement of tents, government buildings and a few shops. Sheriffs from the provincial capital delivered a new round of court orders in January, barring defaulters from disposing of their possessions until courts can rule on foreclosure proceedings.
Naranchimeg Sonom, 45, says she had to sell her herd of more than 300 animals to pay off her defaulted loan. Otherwise, she says, the bank would have foreclosed on her tent, known here as a ger, and on the decorative mirror that graces its back wall. She says bank collection officers said: "You are all beggars. Why did you take a loan if you can't pay it back?" In recent years, commercial banks started competing to extend credit to herders, who typically earn significant cash just twice a year -- in the spring through cashmere and wool sales, and in the autumn through sales of animal skins and meat. The money helped families get through the times in between, usually at a cost of between 2% and 3% in interest per month.
Troubles began when demand for cashmere started falling after the U.S. slipped into recession in late 2007. By last June, the price for cashmere in Mongolia had fallen by more than 33% from a year earlier, hitting about 28,000 togrog, or $19, a kilogram. Prices have dropped further. "Everyone says now that we are just taking care of banks' animals," says Janchiv Nyambuv, a 65-year-old herder who borrowed 500,000 togrogs, or $350, that he must repay in May. Herders who have sold their herds to repay loans have struggled to find other sources of income. Purevdelger Budkhuu, a 38-year-old widow, says she was forced to sell her family's 128 goats and sheep after she couldn't pay back a six-month loan of $1,270. Now, she and her two children live in a tent near Altai's grimy central market. She says she has looked for work, to no avail, at shops, restaurants and hotels. "I don't know what to do. I can't go back to the countryside because I have no animals," she says. "And I can't stay here because I can't find a job."
Mr. Sodnomdarjaa says he went to a Khan Bank branch at the beginning of 2008 to get a loan to help repay those who had given him animals to start his herd and buy food and clothes for his wife and four children. Mr. Sodnomdarjaa and his wife, Altantsetseg Tseyentsend, 38, say they intended to repay the loan by selling cashmere and other products from the 90 or so goats and sheep they owned, as well as from another more than 170 animals they were looking after for others. "We'd never taken a loan before" but, Mr. Sodnomdarjaa says, the bank officer he talked to seemed eager to give him money. The bank says it checked government records of herders' animals, which said Mr. Sodnomdarjaa owned 267 animals and had no reason to doubt their accuracy. The bank said that after Mr. Sodnomdarjaa defaulted, it discovered just 90 of the animals belonged to him. Bank officials said that if they had known that, he wouldn't have qualified for such a large loan. Mr. Sodnomdarjaa denies any wrongdoing and says bank officials in Tsogt never asked him about the makeup of his herd.
When the loan was due, Mr. Sodnomdarjaa says he was unable to pay. He says the bank eventually pushed him to sell his animals. The bank says Mr. Sodnomdarjaa still owes more than 2.7 million togrogs, or about $1,900. Mr. Sodnomdarjaa says he and his wife are determined to repay the loan and plan to look for construction or mining work. These days, the couple cares for other families' camels. Their only regular compensation is the right to milk the herd. About half the milk, they drink. The other half they sell. Two months' earnings are about enough to buy a sack of flour. "The kids want to eat meat, but we have nothing to give them," says Mr. Sodnomdarjaa.
Slides: Deeper Into Poverty
Video: Mongolian Way of Life at Risk
Your credit is no good here
U.S. banks need to stop the charade, ignore the political and public pressure and admit they're not lending. It's not because they don't want to, but because it's bad business. Don't think so? Take this pop quiz. On Monday, Bank of America Corp. announced smashing profits for the first quarter. Ken Lewis, the bank's chief executive, claims B. of A. is lending as if the good times never ended. So, in the bank's conference call, which one of the following statements did Lewis make?
A. "Credit is bad and we believe credit is going to get worse before it will eventually stabilize and improve."
B. "Even our internal economists are a little at odds as to the timing with some seeing recovery earlier (than year-end)."
C. "We believe unemployment levels won't peak until next year at somewhere in the high single-digits."
D. All of the above.
E. None of the above.
For a CEO whose bank is lending as if it's 2006, you might be surprised that the same Lewis who proclaims to be bullish on loans is bearish on the economy. The answer is D. There's only one problem. No bank CEO can reconcile more lending with a deteriorating economy -- especially one in which economic conditions are the worst than they've been in generations. But that's exactly the claim he's making. Lewis described a deep recession that's going to be here for months. Still, B. of A. touts that it's "helping" homeowners and small businesses with new loans. It claims to have added 45,000 customers and provided them credit. The reality, however, is less impressive: Bank of America loaned $183 billion during the quarter, up just 1.6% from the last quarter of 2008, when lending took a big dive industry-wide. This isn't to single out Bank of America. All of the major big banks, including Wells Fargo Corp. , J.P. Morgan Chase & Co. and Citigroup Inc. have been doing the credit double talk that goes something like this: these are terrible conditions to be lending in, but we're lending in them without risk.
If those claims sound a little too good to be true, it's because they are. Almost all the big banks that have taken cash from the Troubled Asset Relief Program have curtailed lending, according to The Wall Street Journal. One of the intentions behind TARP was for it to be a kind of stimulus program made through the banks. After plugging holes on each bank's balance sheet, the TARP cash was supposed to flow into new mortgages, auto loans, credit card lines and corporate lending. Six months later, it's fair to say TARP has helped prop up some banks, but it hasn't flowed into the consumer credit markets the way the framers intended. Now, critics have argued that the banks should be loaning this money to help stimulate the economy. Companies need credit to expand and hire, they say, and consumers need credit to buy products and help feed the economy.
In almost any other economic time, this would be true, but not in a time where an overextension of credit created the recession we are fighting. Credit cycles by definition are periods where banks overextend credit and then pull back to correct the overextension. If the government forces banks to lend to at-risk borrowers, we're going to aggravate an already dire credit picture and require more government intervention. You can easily see how lending to home buyers not worthy of credit would fuel the nation's housing woes and create more housing problems, but what about the loans most people assume are helpful to the economy: small-business loans? It turns out that existing small-business loans are defaulting at an alarming rate. More than 4.4% of small-business loans were in 30-day default, up from 3.48% a year ago, 1.29% were delinquent 90 days, up from 1.04% a year earlier and 0.63% were 180 days delinquent, double the rate a year ago, according to PayNet, a small-business payment network.
It doesn't matter what type of loan, lending into an economic downturn is an invitation to trouble. The steep rise in defaults and non-performing loans suggests that the economic conditions Bank of America's Lewis talked about will make it hard for banks to simultaneously set aside reserves and lend more money out. Small businesses will lay off workers before they start missing loan payments, and the unemployed can't pay off their credit cards and car loans. Taxpayers fuming about the banks' unwillingness to loan government money into the system might reconsider, given that the banks are actually being prudent with taxpayer cash. Now that banks have been backstopped by the Federal Reserve and Treasury Department, they have less incentive to scrutinize credit. The risk of bad loans has been shouldered by Washington.
Banks have made a lot of missteps in the financial crisis -- from overreaching with credit to big paydays, to misuse of taxpayer cash, to punitive interest costs for consumers, to a lack of sensitivity -- but reining in credit is not one of them. So, when Lewis and his counterparts at competing banks brag about how much lending they're doing, take it with a grain of salt. In most cases, this is posturing by CEOs looking to fend off criticism they're not doing enough to help the economy. What critics fail to acknowledge is that we all benefit from banks adhering to lending standards. When that doesn't happen we get financial collapses that compare to the darkest times in our history.
The Wail of the 1%
The rage of the privileged class as it loses its privileges
Shortly after 1:30 on the afternoon of March 18, two dozen traders in AIG’s financial-products division stepped away from their Bloomberg terminals and huddled around televisions to watch their boss, CEO Edward Liddy, testify before Congress. There was much at stake. These were the people who received the greater part of $165 million in “retention bonuses” that had suddenly become, to borrow a phrase, toxic. As the hue and cry to return the money grew, the traders had thought that Liddy would stand up for them. The ruddy-faced, 63-year-old former Allstate CEO, who had been installed by Treasury Secretary Hank Paulson in September, was, if not exactly one of them, at least someone who understood the rules of the game as it had been played—and who understood what they were entitled to under those rules, even if those rules were unspoken. In AIG’s glory years, executives like Joseph Cassano, the former head of financial products, took home more than $300 million. That was the kind of money you couldn’t talk about.
But as Andrew Cuomo stoked public outrage by threatening to release the names of the bonus recipients, it became clear that the game was changing. When AIG employees had arrived at their desks that morning, they found a memo from Liddy asking them to return 50 percent of the money. The number infuriated many of the traders. Why 50 percent? It seemed to be picked out of a hat. The money had been promised, was the feeling. A sacred principle was at stake, along with, not incidentally, their millions. Everyone on Wall Street is prepared to lose money. Bankers have expressions for disastrous losses: clusterfuck, Chernobyl, blowing up … But no one was prepared to lose money this way. This felt like getting mugged.
Jake DeSantis, a 40-year-old commodities trader at AIG, was an unlikely face of Wall Street greed. Stocky and clean cut, with an abiding moral streak, he’d worked summers for a bricklayer in the shadow of shuttered steel mills outside Pittsburgh; he was valedictorian of his high-school class and attended college at MIT. Compared with the way many of his Wall Street brethren lived, with their Gulfstreams, Hamptons mansions, and fleets of luxury cars, his life wasn’t one to invite scorn. He had canvassed for Obama in Scranton on Election Day and drove a Prius. His division at AIG was profitable. And since joining the company in 1998, he had never traded a single credit-default swap. Now his boss was selling him out. DeSantis left work that day feeling that his world was falling apart. The next day, the House passed—by a wide margin—a bill that would levy a 90 percent tax on bonuses at firms that were bailed out. The Connecticut Working Families Party planned to bus protesters to the homes of AIG executives in Fairfield County. There were death threats. “It’s been terrifying,” says his wife’s mother, Lynnette Baughman. “It’s like a witch hunt.”
It was in this environment that DeSantis sent his remarkable resignation letter to the New York Times. In the letter, which ran as an op-ed on March 25, he compared himself to a plumber (“None of us should be cheated of our payments any more than a plumber should be cheated after he has fixed the pipes but a careless electrician causes a fire that burns down the house”) and announced that he would quit AIG and donate his bonus to charity. The letter, passionate and wounded and oddly out of touch with ordinary Americans, put a human face on Wall Street’s anger. When DeSantis arrived at the office the morning his letter appeared in the paper, the AIG traders gave him a standing ovation. In some quarters of the press, he was vilified. (As Frank Rich put it in the Times, “He didn’t seem to understand that his … $742,006.40 (net) would have amounted to $0 had American taxpayers not ponied up more than $170 billion to keep AIG from dying.”) But the fracas was useful: DeSantis had succeeded in opening up an honest conversation—as typically emotional and awkward and neurotically charged as is any conversation on the subject—about money, the first this town has had in years.
In a witch hunt, the witches have feelings, too. As populist rage has erupted around the country, stoked by canny politicians, an opposite rage has built on Wall Street and other arenas where the wealthy hold sway. Its expression is more furtive and it’s often mixed with a kind of sublimated shame, but it can be every bit as vitriolic. “AIG pissed some people off, and now you’re gonna screw everyone on Wall Street?” rails a laid-off JPMorgan vice-president. (Despite the honesty of the conversation, many did not wish to be quoted by name.) “No offense to Middle America, but if someone went to Columbia or Wharton, [even if] their company is a fumbling, mismanaged bank, why should they all of a sudden be paid the same as the guy down the block who delivers restaurant supplies for Sysco out of a huge, shiny truck?” e-mails an irate Citigroup executive to a colleague. “I’m not giving to charity this year!” one hedge-fund analyst shouts into the phone, when I ask about Obama’s planned tax increases. “When people ask me for money, I tell them, ‘If you want me to give you money, send a letter to my senator asking for my taxes to be lowered.’ I feel so much less generous right now. If I have to adopt twenty poor families, I want a thank-you note and an update on their lives. At least Sally Struthers gives you an update.”
It is difficult to sympathize with these people, their comments laced with snobbery and petulance. But you can understand their shock: Their world has been turned on its head. After years of enjoying favorable tax rates, they are facing an administration that wants to redistribute their wealth. Their industry is being reordered—no one knows what Wall Street will look like in a few years. They are anxious, and their anxiety is making them mad. Their anger takes many forms: There is rage at Obama for pushing to raise taxes (“The government wants me to be a slave!” says one hedge-fund analyst); rage at the masses who don’t understand that Wall Street’s high salaries fund New York’s budget (“We’re fucked,” says a former Lehman equities analyst, referring to the city); rage at the people who don’t “get” that Wall Street enables much of the rest of the economy to function (“JPMorgan and all these guys should go on strike—see what happens to the country without Wall Street,” says another hedge-funder).
A few weeks ago, I had drinks with a friend who used to work at Lehman Brothers. She had come to Wall Street in the mid-eighties, when the junk-bond boom spawned a new class of globe-trotting financiers. Over two decades, she had done stints at all the major banks—Chase, Goldman, Lehman—and had a thriving career directing giant streams of capital around the world and extracting a substantial percentage for herself. To her mind, extreme compensation is a fair trade for the compromises of such a career. “People just don’t get it,” she says. “I’m attached to my BlackBerry. I was at my doctor the other day, and my doctor said to me, ‘You know, I like that when I leave the office, I leave.’ I get calls at two in the morning, when the market moves. That costs money. If they keep compensation capped, I don’t know how the deals get done. They’re taking Wall Street and throwing it in the East River.”
Now, a lot of people in New York have BlackBerrys, and few of them expect to be paid $2 million to check their e-mail in the middle of the night. But embedded in her comment is the belief shared on Wall Street but which few have dared to articulate until now: Those who select careers in finance play an exceptional role in our society. They distribute capital to where it’s most effective, and by some Ayn Rand–ian logic, the virtue of efficient markets distributing capital to where it is most needed justifies extreme salaries—these are the wages of the meritocracy. They see themselves as the fighter pilots of capitalism. Wall Street people are not moral idiots (most of them, anyway)—it’s not as if they’ve never pondered the fairness of their enormous salaries. “One of my relatives is a doctor, we’re both well-educated, hardworking people. And he certainly didn’t make the amount of money I made,” a former Bear Stearns senior managing director tells me. “I would be the first person to tell you his value to society, to humanity, is far greater than anything that went on in the Bear Stearns building.”
That said, he continues, “We’re in a hypercapitalistic society. No one complains when Julia Roberts pulls down $25 million per movie or A-Rod has a $300 million guarantee. We have ex-presidents who cash in on their presidencies. Our whole moral compass has shifted about what’s acceptable or not acceptable. Honestly, you can pick on Wall Street all you want, I don’t think it’s fair. It’s fair to say you ran your companies into the ground, your risk management is flawed—that is perfectly legitimate. You can lay criticism on GM or others. But I don’t think it’s fair to say Wall Street is paid too much.” Of course, it is precisely the flawed risk management that has brought Wall Street salaries under scrutiny. No one has ever been hurt—not financially, anyway—by a Julia Roberts movie. But with their jobs in jeopardy and their 401(k)s in the toilet thanks to a market in which banks took risks with great upside and seemingly little downside, the Minions of the Universe are looking at the Masters with a newly skeptical eye.
“There’s this perception that the people on the Street were making money for nothing,” says a mortgage-investment banker. “You have a political and media class who make the mortgage originators and bankers out to be the villains. But are they? They were doing what Congress wanted them to do. Is the guy who lied on his mortgage application the victim here? This whole narrative that the downtrodden were the victims and the money guys were the perpetrators really doesn’t stand up to rational challenge.” But the issue of pay is hardly ever discussed rationally. “Compensation gets so emotional,” says the Bear Stearns managing director. “Everyone has a point of view. The truth is, the market determines what people are worth. Did I think I was overpaid? You betcha. But a lot of people are overpaid.” The fault line in the argument over compensation is whether the last 30 years of wealth accumulation are part of the natural order of the economy, to be tampered with at the nation’s peril, or an aberration—a giddy, delirious break from reality in which eight-figure bonuses were considered normal.
For those who spent their entire careers in the boom, the natural order of things looked something like this: Newly minted Ivy League graduates flocked to the city to position themselves close to the ever-expanding capital pie and collect the seven-figure crumbs. In return, they joined charity boards, donated to philanthropic causes, booked reservations at restaurants, bought art, kept the waiters and artists and chefs employed, and, yes, paid taxes that cleaned up the city. Consumption and benevolence merged into an enlightened, if garish, form of economic organization. The noblesse oblige was trickle-down.
As Washington denuded the regulations that had constrained finance, the banks themselves encouraged their employees to pursue maximum risk. Bonuses were paid based largely on short-term profits. “It was the culture of what some called IBG-YBG: I’ll be gone, you’ll be gone,” says Jonathan Knee, a senior managing director at Evercore Partners. Wall Street championed the ethos of “Eat what you kill.” The most aggressive employees, those who took the greatest risks, thought of themselves less as members of a firm and more as independent contractors entitled to their share of the profits. In this system, institutions tended to be hostage to their best employees. “The feeling is, if people don’t get compensated adequately, they’re going to go out and do this on their own,” says Alan Patricof, who founded the private-equity firm Apax Partners.
For these people, it is difficult to imagine a world in which they are not at the top of the socioeconomic heap. But a number of economists and academics are arguing that it was not always this way, and that what we’re seeing now is “a return to normalcy,” as Mitchell Moss, a professor of urban policy and planning at NYU, puts it. Until the late seventies, banking was a career choice more akin to being a corporate lawyer or a doctor than a high-flying hedge-fund manager. Until the eighties, Wall Street counted for about 20 percent of all corporate profits in America, but by the peak of the bubble, it had grown to an astounding 41 percent. “Wall Street became a high-margin business because of the deregulated environment,” Moss says. “You basically had a casino culture operating in the financial-services industry.” And that huge profitability led to great influence. “The system as a whole became unstable because Wall Street developed this disproportionate influence. It’s an entire system of belief they had to create,” says Simon Johnson, the former chief economist of the IMF. In a recent Atlantic article, Johnson describes Wall Street’s influence as a ruling oligarchy, not dissimilar to those of the crony capitalists that have controlled the levers of power in places like Russia, Argentina, and Indonesia. The solution, according to people like Paul Krugman, is to make banking regulated, less profitable, and “boring” again.
It should come as no surprise that being a banker—indeed, simply being rich—is going to be a lot less fun under an Obama administration. In winter 2007, as the Democratic-primary contest got under way, Obama showed up at a Goldman Sachs client meeting to explain his economic agenda to a conference room full of potential campaign contributors. When he opened up the session to questions from the audience, one attendee lobbed the question that was surely on the mind of everyone in the room. “Are you going to raise my taxes?” Obama looked out across the millionaires sitting around him. “Yes,” he answered, without a flicker of hesitation, according to a person familiar with the meeting. During the campaign, Obama was never shy about his promise to undo the Bush tax policies. But it was easy to ignore his occasional lapses into populist rhetoric and focus on his intense intelligence and Ivy League education. Now, in the wake of the crisis, Wall Street’s politics are shifting rightward. “All the rich people I know took George Bush for granted,” says an analyst at a midtown hedge fund. “I’m a Democrat, but I agree with Rush Limbaugh on a lot of this stuff,” rails the wife of a former AIG executive. The anger masks a deeper suspicion that Obama fundamentally doesn’t respect their place at the table. “I think he doesn’t have an appreciation for how hard it is to build these companies, the blood, sweat, and tears that goes into them,” says a senior executive from a failed Wall Street firm.
“It’s just that he has no passion for it. He speaks dispassionately about the whole situation, except when he’s beating up on the Wall Street fat cats.” The argument that Obama has in fact done a great deal to help Wall Street—to the tune of trillions of dollars—doesn’t have much truck with these critics. “If you really take a look at what Obama is promising, it’s frightening,” says Nicholas Cacciola, a 44-year-old executive at a financial-services firm. “He’s punishing you for doing better. He doesn’t want to have any wealth creation—it’s wealth distribution. Why are you being punished for making a lot of money?” As a Republican corporate lawyer puts it: “It’s the politics of envy, and that’s very dangerous.” “Nobody likes having their taxes go up,” says Whitney Tilson, who runs the investment firm T2 Partners and was a member of Obama’s Tri-State Finance Committee. This was a view that was comically on display at the scores of anti-tax “tea parties” that took place across the country last week. “Rich Democrats don’t like having their taxes raised either … Naturally, when you try and take the bone away, even if they didn’t deserve that bone in the first place, nothing starts a fight more than raising taxes.”
The crisis seems to have exposed a generation gap on Wall Street. For a bit of perspective, I spoke with a Goldman veteran who had left years ago to run his own private-equity firm. He’s 55, which is old by Wall Street standards—at some firms, if you’re not upper management, you’re encouraged to get out, with your substantial nest egg, by 50. He had arrived on Wall Street in 1980, on the eve of the junk-bond mania, and watched how radically his peers changed the city. “When I started, people made a lot of money, but it was an order of magnitude less than what people made from 1995 to 2005. You know, some of my friends and I, we complained bitterly that we had bad luck that we started when we did. We said, ‘Gee, I wish we had graduated from school in 1990, not 1980.’ We thought we’d be making a hell of a lot more money. And now, the guys who graduated from school in 2005, arguably those guys won’t make very much money at all. So the truth is, when you hit Wall Street determines in large part whether or not you’re wealthy.”
To Wall Street people who have grown up in the bubble, the meaning of the crisis is only slowly sinking in. They can’t yet grasp the idea of a life lived on less. “Without exception, Wall Street guys have gotten accustomed to not being stuck in the city in August. So it becomes a right to have a summer home within an hour or two commute from Manhattan,” says the Goldman vet. “There’s a cost structure of going with your family on summer vacation that’s not optional. There’s a cost structure of spending $40,000 to send your kids to private school that is not optional. There’s a sense of entitlement, that you need that amount of money just to live, that’s not optional.” “You can’t live in New York and have kids and send them to school on $75,000,” he continues. “And you have the Obama administration suggesting that. That was a very populist thing that Obama said. He’s being disingenuous. He knows that you can’t live in New York on $75,000.” That was an argument I heard over and over: that the high cost of living like a wealthy person in New York necessitates high salaries. It was loopy logic, but expressed sincerely. “You could make the argument that $250,000 is a fair amount to make,” says the laid-off JPMorgan vice-president. “Well, what about the $125,000 that staffers on Capitol Hill make? They’re making high salaries for where they live, maybe we should cut their salary, too.”
Part of the problem, the Goldman vet explains, is that there’s a vast divide between where the public is and where the bankers are. The public registers how fundamentally the system has changed; the bankers are far from getting to that point. “When I talked to my friends in November and December at firms like Goldman, they would tell me, ‘If the government doesn’t bail us out, we’re going down.’ They really thought they were going to zero, and without exception, they all forget that now,” he says. “They forget that their company’s stock was going to zero. It’s a state of delusion; they don’t remember those days. The flip side of that is, every guy except the Goldman guy remembers that Goldman was bailed out.” I asked him what will happen if Congress succeeds in regulating compensation. “These guys will not work on Wall Street,” he says flatly. “People go to Wall Street out of greed. When I was interviewing for jobs, frequently some form of the question came up: How much do you want to make money? If my answer was something like—and it wasn’t—but if my answer was, ‘I’m here for intellectual betterment,’ their response might have been, ‘University is a great place for you.’ They want people who think ‘I’m greedy, I want to be a billionaire.’ That was viewed as a really good thing.”
The greed won’t disappear, of course. “The smart people are going to make money in good times and bad times,” one investment adviser tells me. “They’ll figure out how to game the system,” says the former Bear Stearns managing director. “You may get a new set of players. This may be a movement back to partnerships and boutique firms. This could be their moment.” There’s a vast woundedness now on Wall Street, which is hard to contemplate after the period of triumphalism so recently ended. In this conversation about money, there’s a lot to work through. Just months ago, the masses kept what anger they had to themselves, and the bankers were close-lipped about what they thought they were owed by society. There wasn’t much of a dialogue about the haves and have-nots and who was entitled to what. For the privileged, it was a lot more comfortable when things remained unspoken. Almost more than the loss of money, they are concerned with the loss of status and pride.
“I was at a cocktail party on Friday. Some guy said to me, ‘You work on Wall Street? How’s that working out for you?’?” says the JPMorgan banker who was forced out in a recent round of layoffs. “There was a little bit of nastiness there.” It was a feeling I heard a lot as I spoke with Wall Street bankers, analysts, and traders. They had believed Wall Street was where the winners of American capitalism went. Now they were feeling shamed for their work. “You wear a nice suit on the subway, and people look at you,” the former JPMorgan VP continues. “I know it’s not wrong to be an investment banker in New York these days, but I get that feeling. Now anyone who made money on Wall Street has done the American people wrong?” Could this really be the new pecking order? A future where banking is boring, salaries are capped, taxes are high, and—worst of all—you get to carry the blame for the Great Recession of ’09? It’s almost too much to bear. “I always thought what I did was somewhat honorable,” the mortgage-investment banker recently told me. He had been trading Fannie Mae and Freddie Mac securities he thought were triple-A- rated investments until his fund blew up and put him out of work. “Suddenly, the simple fact I work on Wall Street means that I’m a bad person? You know, I lost my job. I’m more of a victim.”