Sunbathers at the city park swimming pool in Caldwell, Idaho
The girls are rubbing olive oil on each other
Ilargi: We're all made to believe that the financial crisis is a mightily complicated issue, that the best minds the country has to offer (whatever country you live in) are working day and night to find the solution that best serves the people and will restore consumer happiness as fast as possible. Looking at things like Obama's poll numbers and the March stock exchanges, you'd be tempted to have faith in what the media feed you.
But when you look at things like mortgage delinquencies, at foreclosures, at unemployment numbers, at credit availability and health care costs, belief becomes a true effort. And when the losses just keep on piling up at financial institutions, followed at lightning speed by increasingly blue whale sized bank bail-out programs executed with the money that rightfully belongs to the newly unemployed and homeless, how can you keep faith? Just stand in front of the mirror and ask yourself (or make it a family game at the next birthday party):
- Do you believe we've seen the last bank bail-out?
- Do you believe home prices will start rising again soon?
- Do you believe that we will see a reversal in job losses, that anytime in the foreseeable future more jobs will be created than lost?
- Do you believe your pension plan will make up for its 2008 losses before 2012?
- Do you believe your municipality and state will get their finances under control by 2010?
- Do you believe your municipality and state will be able to avoid bankruptcy?
- Do you believe your employer will be able to avoid bankruptcy?
- Do you believe your children will be better off than you are?
- Do you believe your children will be better off than your parents were?
- Do you believe global trade will recover to its 2005-6 highs?
- Do you think it should, given how much consists of trinkets?
- Do you believe we will have enough energy to burn when the time comes to rebuild?
- Do you believe alternative energy forms will be able to replace fossil fuels in the recovery, if and when it comes?
- Do you believe banks that have trillions in gambling losses have a right to your money to keep them standing?
- Do you believe it's a good idea to have employees from broke(n) banks enter government in order to make decisions on their fate?
- Do you feel confident about your future?
- Do you feel confident about the future of your children?
You can make it a simple Yes or No quiz, or you can insert some more shades of grey. You can add some questions of your own. Whichever appeals more to you,d o let us know what time the first party hats went home.
In the meantime, I don't want to spoil the fun, but I’ll let you know that my answers to these questions make me think of a song named Five Years.
Bowie at the Dinah Shore show in 1975
Don't adjust your set
Pushing thru the market square, so many mothers sighing
News had just come over, we had five years left to cry in
News guy wept and told us, earth was really dying
Cried so much his face was wet, then I knew he was not lying
I heard telephones, opera house, favourite melodies
I saw boys, toys electric irons and T.V.'s
My brain hurt like a warehouse, it had no room to spare
I had to cram so many things to store everything in there
And all the fat-skinny people, and all the tall-short people
And all the nobody people, and all the somebody people
I never thought I'd need so many people
A girl my age went off her head, hit some tiny children
If the black hadn't a-pulled her off, I think she would have killed them
A soldier with a broken arm, fixed his stare to the wheels of a Cadillac
A cop knelt and kissed the feet of a priest,
and a queer threw up at the sight of that
I think I saw you in an ice-cream parlour,
drinking milk shakes cold and long
Smiling and waving and looking so fine,
I don't think you knew you were in this song
And it was cold and it rained so I felt like an actor
And I thought of Ma and I wanted to get back there
Your face, your race, the way that you talk
I kiss you, you're beautiful, I want you to walk
We've got five years, stuck on my eyes
Five years, what a surprise
We've got five years, my brain hurts a lot
Five years, that's all we've got
We've got five years, what a surprise
Five years, stuck on my eyes
We've got five years, my brain hurts a lot
Five years, that's all we've got
We've got five years, stuck on my eyes
Five years, what a surprise
We've got five years, my brain hurts a lot
Five years, that's all we've got
We've got five years, what a surprise
We've got five years, stuck on my eyes
We've got five years, my brain hurts a lot
Five years, that's all we've got
NB: I just have to add this 1972 version, from The Old Grey Whistle test.
US mortgage delinquencies double from year earlier
Mortgage delinquencies more than doubled from a year ago, according to credit reporting bureau Equifax. In February, seven percent of homeowners with mortgages were at least 30 days late, up more than 50 percent from the same period a year earlier. The delinquency rate for subprime borrowers increased to 39.8 percent from 23.7 percent last year, meaning four out of ten of these homeowners can’t make their monthly mortgage payments. Dann Adams, president of U.S. Information Systems for Equifax Inc, said the increase in delinquencies foreshadows more foreclosures, short sales, and home price declines, despite recent optimistic reports talking about a housing bottom on the horizon. Rising unemployment is adding to these woes, forcing more borrowers to turn to credit cards for relief.
Unfortunately, banks are clamping down on borrowers’ credit cards as well; during February, eight million credit card accounts were closed, reducing the number of outstanding cards to 400 million from a July 2008 peak of 483 million. Credit limits are also being slashed on open cards, down to a combined $3.27 trillion from a July 2008 peak of $3.59 trillion. Meanwhile, bank card delinquency is at its highest level in the past five years, with 4.5 percent of bank-issued credit cards 60 days or more past due in February, a 32.7 percent from a year ago. This double whammy could put even more homeowners on the road to foreclosure, delaying that recovery some seem to think is just months away.
Are FHA loans the next housing time bomb?
Ready to burst - again? As private mortgage lending all but dried up over the past year, the federal government swooped in and repositioned the Federal Housing Administration’s (FHA) insured-mortgage program to pick up a lot of slack. For those who aren’t familiar, the FHA program allows folks with middling credit scores and little down payment to qualify for a loan. However, borrowers must pay an upfront mortgage insurance fee of about 1.5% of the loan amount as well as an ongoing fee of 0.5% each month. Over the past year more than one-third of new mortgages are FHA-insured loans, compared to less than 3% at the peak of the real estate bubble. Moreover, in recent Senate testimony the inspector general for Housing and Urban Development said FHA-insured mortgages accounted for about 70% of loan biz in the first quarter. One of the big drivers of the increased FHA presence is the move that raised FHA-insured loan limits to as high as $729,750 in certain high cost markets.
That made the program a viable option for plenty more borrowers. But rather than a glowing example of how the federal government can step in and boost an ailing financial market, there’s growing concern that the massive role taken by FHA to buoy the ailing mortgage market, could in fact lead to yet another taxpayer bailout. It turns out that a whole lot of borrowers getting FHA-insured loans can’t make the payments. At the end of February about 7.5% of FHA loans were "seriously delinquent;" up from 6.2% a year ago. (Seriously delinquent = 90 or more days overdue.) Not surprisingly, the reserve fund FHA keeps handy to cover bad loans has been seriously eaten into over the past year: it is down to about $13 billion today, compared to $21 billion a year ago.
This past Thursday, HUD inspector general Kenneth Donohue conceded that the trend is not encouraging. Asked about the prospect of a taxpayer bailout, Donohue sidestepped making a prediction but did say: "Based on the numbers we’re seeing, I think it’s going in the wrong direction," he said. And it’s not too hard to see why. In theory-and in practice for many years-the FHA program helps folks who wouldn’t otherwise be able to afford a home, make the purchase. But the very structure of FHA-insured loans makes them a potential landmine in a economy where job security and home values are sinking. You can have a crappy credit score of just 600 or so and qualify for an FHA-insured loan at the same low interest rate that private lenders typically reserve for borrowers packing 740+ scores. And you need only a 3.5% down payment for an FHA-insured loan.
While that’s slightly more than the zero-down loans pushed by sub-prime lenders during the bubble, it’s nowhere near the 10%-20% private lenders are now requiring as insurance that borrowers have enough skin in the game to stay in the game amid declining home values. Add in the fact that the new higher loan limits make FHA-backed loans a suddenly viable option in many pricier regions and you’ve got yourself a potentially toxic brew. And as we all know, when it comes to toxic assets, it’s the taxpayer who ends up paying.
Dream Mortgage Bailout Has a Darker Side
It will go down as one of the biggest -- and most popular -- bailouts of the credit crunch. But who will pay for it later? The Federal Reserve is buying hundreds of billions of dollars of low-interest-rate mortgages guaranteed by Fannie Mae and Freddie Mac. The purchases, which so far amount to $250 billion and could grow to $1.25 trillion, have driven mortgage rates to historical lows, inducing house purchases and sparking a refinancing wave. This serves key social and political goals: It helps shore up house prices, while the lower mortgage rates put extra money into the pockets of people who aren't struggling to service their mortgages. This then makes them less likely to oppose taxpayer-funded moves to support homeowners facing foreclosure.
What's more, banks holding Fannie and Freddie securities get to book big gains as the Fed's buying spree drives up prices. Analyst Meredith Whitney estimates the top 10 banks by assets increased their holdings of securities issued by Fannie and Freddie and government agencies by $128.6 billion, or 30%, in the fourth quarter. Those will be marked higher in the first quarter. Most convenient of all: This mortgage buying is being done by the Fed, which doesn't need approval from Congress for the purchases. On paper, it is a dream bailout. It benefits not just large banks but also ordinary people, it is hard for politicians to tamper with, and the Fed doesn't have to borrow money to fund the purchases -- it just prints it instead. When something looks this good, it pays for investors to dig deeper. And the risks abound.
The biggest is that the purchases will deal another blow to the credibility of the Fed, whose monetary policies helped stoke the credit boom. Of course, printing money carries inflation risk. And the Fed's aggressive actions, led by Fed Chairman Ben Bernanke, mess with market pricing. The mortgage purchases could help increase assets on the Fed's balance sheet to $3 trillion, equivalent to more than 20% of gross domestic product. So when it stops buying, mortgage rates could rise sharply. The size of the Fed purchases are already overwhelming private markets. Right now, there is limited investor demand for Fannie and Freddie mortgages with coupons under 5%, due to the risks of holding such low-yielding paper. Filling that gap, the Fed purchased $192 billion of 4% and 4.5% conforming mortgages, on a gross basis, in the four weeks ended March 25.
Holding this risky paper could damage the Fed later on. If it wants to sell 4% mortgages to private investors, it would likely have to do so at a price that creates a yield above 5%, potentially triggering a loss for the Fed. It could, of course, choose to hold the mortgages to maturity, with any credit losses covered by Fannie and Freddie. The mortgage buying also could alter the Fed's core mission in a detrimental way. In an unusual joint statement last month, the Fed and Treasury said the Fed's job wasn't to "allocate credit to narrowly defined sectors or classes of borrowers." Yet focusing so much money on residential mortgages, and thus homeowners, seems to do just that. Investors might come to expect support-purchases every time an asset gets into trouble. Finally, the Fed's actions may attract congressional scrutiny. "Everything's fine as long as the Fed is making perfect decisions," says Rep. Scott Garrett (R., N.J.). "The challenge for Congress is: Can we do anything to create oversight to address that."
Mortgage Assistance Guarantee: Hook, Line, or Sinker?
As though the $8,000 non-repayable first-time home buyer tax credit recently passed as part of the national stimulus weren’t enough of an incentive to become a homeowner, certain industry groups are now supplementing the up-front tax credit with an incentive of their own on the back end of the mortgage process. In the event of sudden job loss due to unexpected layoffs, some qualified first-time home buyers are now being guaranteed up to six months of mortgage payment assistance to stay in their homes and avoid foreclosure. But the question remains whether these programs will have the desired effect of encouraging home ownership, and just what impact they will eventually have on retaining home ownership for borrowers that lose their jobs or health and are unable to make payments for longer than six months.
The California Association of Realtors (CAR) announced late last week it would offer a new "mortgage protection program" that promises qualified first-time home buyers — buyers that have not bought a home in the last three years — the guarantee of up to $1,500 per month for six months in the event of job loss due to layoffs. The CAR program is applies to first-time home buyers that close on or before Dec. 31, 2009, purchase a home in California, are considered a W-2 employee but not self-employed and use a California Realtor in the process. CAR said it would provide buyers with up to $1,500 per month for six months, and co-buyers with up to $750 per month for up to six months, in the case of layoffs. The program also includes benefits for accidental disability as well as a $10,000 death benefit, CAR said.
A separate localized effort, announced Monday by North Carolina-based Brookside Homes, will pay up to $1,000 per month for six months in the event of job loss due to layoffs. The buyer must have occupied the home for at least 60 days before the job loss and have been continuously employed 12 consecutive months before settlement. Brookside also said in the event of a spouse’s job loss, it would pay for the share of income the spouse earned (if a homebuyer’s wife made 60 percent of the combined income before being laid off, Brookside will pay $600 per month). The catch? Under Brookside’s program, only homes purchased in a specific community, Leland, N.C.-based Ashton Place, will qualify for the program. The community boasts seven floor plans; the three- to four-bedroom homes range from $184,500 to $209,500 with an average 1,600 square feet. The community’s Web site and builder media statement encourage the use of the $8,000 first-time home buyer credit as an incentive to purchase in the community under the mortgage payment guarantee program.
"These payments will be covered by the community’s developer," officials said at Ashton Place’s Web site. "Their bets are on the improving economy and the resilience of all Americans. The difficult times will be short lived, and you have an opportunity to buy when the most value is available and the best interest rates." According to statements made by Brookside owner Page Robertson in the media statement about the program, jobless rates in the qualifying area are "now over 10 percent." If that’s not a risky enough bet for any home buyer considering relocating just to take advantage of the program, there’s always the issue that finding another job within six months of being laid off is not part of the guarantee.
Oh, and did we mention the Brookside program only applies to 25 buyers? You read that correctly: two dozen, plus one. And that’s not even the first 25 buyers to be laid off within the Ashton Place community. That’s just the first 25 people to buy within the community that will be guaranteed under the program. These and similar guarantee programs in the face of rising joblessness may have the desired effect of soothing consumer fears and coaxing buyers onto the market and into homes in some local areas. They may work as intended and provide a backstop against delinquency, default and foreclosure in the case of extended joblessness. Or they may provide only temporary relief for borrowers that find themselves locked out of job markets that continue to dry up.
With the promise of "We’ll pay your mortgage if you lose your job," indeed, few prospective home buyers may be able to resist. Hooked in also by mortgage rates that continue to linger at historic lows and an $8,000 non-repayable tax credit, borrowers may come flocking to California Realtors and North Carolina communities. Once on the line for mortgage payments, however, the issues of job scarcity, of payment non-affordability and home prices that continue to sink don’t disappear, even if part of the monthly payment is guaranteed temporarily by mortgage assistance guarantee programs.
Government Intervention In Housing: Pros and Cons
Ask the average person what they think of the government intervening in the mortgage market on behalf of consumers (and in many cases lenders, too), and you could receive a wide ranging number of answers. Many people are upset at the seemingly rampant spending of taxpayer dollars, and voice concerns (a valid one) about the future value and stability of our currency. On the other side there are those that are happy to see the little guy get some assistance during hard economic times. Recent programs have gone a long way in providing assistance to new and existing homeowners alike, but the real question is, ultimately, what will the cost of such help be, and who will take on the burden of paying those costs?
One advantage for homeowners is that rates are incredibly low, and so they’re scrambling to take advantage. It may or may not be worth it to go ahead and try to get a better loan in this market, but the Obama administration has a fix in mind. The new program, which begins as of this month, will allow borrowers whose loans are owned by Freddie or Fannie to be able to refinance for up to 105% of a home’s value. Credit scores, which have thus far prevented many from obtaining refinancing, may not be such a huge hurdle, as refis are an available opportunity for those with credit scores that are as low as 620. It makes me uneasy hearing that (isn’t lending to troubled borrowers what got us here in the first place?) but it isn’t exactly a free lunch. You’ll need to be current on your mortgage, and you’ll also need a solid payment history. Full details can be found at Makinghomeaffordable.gov.
Now yes, this does provide tangible benefits to the average consumers, even to those that aren’t drowning with an underwater house or bit off more than they could chew, but let’s look at the cost. At present, the Federal Reserve is buying hundreds of billions of dollars in these low interest mortgages. Present tab is running $250 billion, but expect that number to grow as time goes on, up to $1.25 trillion. Running the printing press to pick up these mortgages has problems in and of itself. Inflation (weren’t we just worried about deflation?) is a real risk here. In addition, these buys tip the mortgage purchases balance on the Fed’s balance sheet, which in total could run up to 20% of the country’s GDP. Once Uncle Sam bows out of the buying spree, it seems likely that mortgage rates could rise sharply once again. The question then becomes when exactly should the Fed get out, before investors come to assume that the government will step in if problems arise again in the future.
U.S. Local Governments Get Moody’s Negative Outlook
U.S. local governments were assigned a negative outlook by Moody’s Investors Service, the first time the New York-based credit rating company gave such an assessment to the overall group of debt issuers. The collapse in housing, turmoil in financial markets and what may become the broadest and deepest national recession since the 1930s will pressure "many if not most local governments" over the next 12 to 18 months, Eric Hoffmann, a Moody’s analyst, said in a news release today. Moody’s cited "unprecedented fiscal challenges" faced by American counties, cities and school districts after a month when the U.S. unemployment rate jumped to a 25-year high of 8.5 percent. The gauge may reach 10 percent by 2010, the company said, citing some economists’ forecasts.
Investing in local government debt "demands greater attention" to credit analysis than for states, which have more power to balance their budgets and can’t declare bankruptcy, BlackRock Inc. municipal-bond portfolio managers led by Peter Hayes said in a report this month. "Local governments have a higher risk of default and may declare bankruptcy, but bankruptcies, if any, will be minimal and isolated to mismanaged and weak credits," BlackRock said. Investors have favored top-rated municipal bonds in the past 12 months, sending an index of AAA rated tax-exempt debt to a 4.3 percent gain, according to a total-return index compiled by Merrill Lynch & Co., part of Bank of America Corp. State and local bonds in the A category, representing the fifth through seventh highest of 10 investment grades, have lost 1.9 percent during the same period.
The localities most at risk of having their Moody’s bond ratings downgraded will be those with: industries such as real estate, auto manufacturing or financial services; reliance on falling revenue sources such as sales and real-estate transfer taxes; volatile variable-rate debt; and a high proportion of fixed or legally mandated costs, according to today’s report. "This could be offset by the demonstrated willingness and ability of management to make rapid, if not multiple, mid-year budget adjustments, and to maintain consistently conservative budget assumptions," Hoffmann said.
The outlook for the sector is different from a negative view on an individual borrower, which implies future rating cuts, and doesn’t mean the creditworthiness of all localities is "uniformly negative," according to Moody’s. "The governance strength of individual issuers and their willingness and ability to adapt will determine the overall trend in individual ratings," Hoffman said. "We expect most local governments’ ratings will be maintained." The report doesn’t cite any new changes to the ratings or outlooks for specific municipalities, except to mention Jefferson County, Alabama, as the "only" issuer with "insurmountable problems" related to variable-rate debt. Jefferson County, home to Birmingham, is facing insolvency after interest rates on $3 billion of adjustable-rate sewer debt surged last year as companies that insured the bonds lost their top credit ratings.
Let's Play Pretend!
by Peter Schiff
When elementary school kids want to escape the confines of their circumstances they pretend to be pirates, princesses, and Jedi knights. Now, with the relaxation of "mark to market" valuation rules announced yesterday by the accounting trade's self-regulatory body, our bankrupt financial institutions can escape their own reality by pretending to be solvent. The unraveling of our fairytale economy over the last few months has not yet convinced us that the time has come to put away childish things. The applause that greeted the news yesterday on Wall Street is a clear sign that we still have some growing up to do.
The imaginative conceit that lies behind the accounting change is that the toxic assets polluting bank balance sheets are not really toxic at all. They are in fact highly valuable assets that for some irrational reason no one wants to buy. Using the "mark to market" accounting method, mortgage-backed securities were valued relative to the latest prices fetched by the sale of similar assets on the open market. Currently, those bonds are being sold at deep discounts to their original value. By "marking" their unsold bonds down to those prices, the insolvency of our financial institutions had been laid bare. The new accounting changes will allow the nervous owners to assign more "appropriate" (i.e. higher) values. Problem solved.
It is important to note that the Financial Accounting Standards Board made their rule modifications only after intense pressure had been applied by Washington and Wall Street. In their heart of hearts, I can't imagine that there are too many bean counters happy with the outcome. The banks and the government have argued that the assets should be valued based solely on current cash flow. Most mortgages, after all, are not delinquent. Therefore, a few bad apples should not spoil the whole cart, and those that are not yet delinquent should be valued at par. This method assumes we have no ability to look into the future and make assumptions about what is likely to happen, which is presumably what the market is already doing by valuing the assets lower than the banks wish.
All kinds of bonds (corporate, government and municipal, etc.) that are not in default frequently trade at discounts. In fact, the reason that agencies such as Moody's and Standard and Poor's rate bonds is to assess the probability of default. The higher that probability, the lower the value placed on the bonds, regardless of their current cash flow. For example, GM bonds that mature 10 years from now currently trade for only 8 to 10 cents on the dollar, despite the fact that GM is current on all interest payments. The 90% discount reflects investor awareness that GM will likely default long before the bonds mature. By the new logic, financial institutions with GM bonds on their balance sheets should be able to ignore the market and value these bonds at par.
Some argue that the comparison is invalid because GM's bonds are liquid while mortgage-backed securities are not. However, if sellers of GM bonds were holding out for 70 or 80 cents on the dollar, those bonds would be illiquid too. The reason GM bonds are trading is that sellers are realistic. The same should apply to bonds backed by mortgages. To assume that a 30-year, $500,000 mortgage on a house that has declined in value to $300,000 has a high probability of remaining current to maturity is ridiculous. The borrower could lose his job, his ARM might reset higher, or he may simply tire of paying an expensive mortgage for a house that is unlikely to be sold at a profit. Any bond investor with half a brain will factor in these probabilities and look for deep discounts. The only way to accurately assess a real present value is to let the market discover the price.
Mortgages Lack Value. . . not Liquidity Despite the pleas from bankers and politicians, mortgages are not plagued by a lack of liquidity but a lack of value. If sellers would be more negotiable, there would be plenty of liquidity. Who knows, at the right price I might even buy a few. The problem is that putting a market price on these assets would render most financial institutions insolvent, which is precisely why they do not want to let that happen. Simply pretending that all these mortgages will be repaid does not solve the underlying problems. It may keep some banks alive longer, but when they ultimately do fail, the losses will be that much greater. In the meantime, solvent institutions are deprived of capital as more funds are funneled into insolvent "too big to fail" institutions — hiding their toxic assets behind rosy assumptions and phony marks.
Going from the sublime to the completely ridiculous, in a speech at the just-concluded G20 summit in London, President Obama urged Americans not to let their fears crimp their spending. It would be unwise, he argued, for Americans to let the fear of job loss, lack of savings, unpaid bills, credit card debt or student loans deter them from making major purchases. According to the president, "we must spend now as an investment for the future." So in this land of imagination (where subprime mortgages are valued at par), instead of saving for the future, we must spend for the future. I guess Ben Franklin had it wrong too — apparently a penny spent is a penny earned.
AIG Payments to Goldman Sachs, Banks Probed by U.S. TARP Watchdog
The Treasury’s chief watchdog for the U.S. financial rescue program is probing whether American International Group Inc. paid more than necessary to banks including Goldman Sachs Group Inc. after the insurer’s bailout. Neil Barofsky, special inspector general for the Troubled Asset Relief Program, opened an audit last week into whether there were attempts made by New York-based AIG or the government to reduce the payments, according to an April 3 letter to Representative Elijah Cummings. The Maryland Democrat had requested the probe last month along with 26 other members of Congress. Lawmakers, frustrated with the cost of an AIG bailout that has expanded three times, have asked why about $50 billion was paid after the initial September rescue to banks that bought credit-default swaps from the firm. The audit will reveal who made "critical decisions" regarding the payments and provide an explanation for the actions, Barofsky said.
"To what extent did AIG pay counterparty claims at 100 percent of face value and was any attempt made to renegotiate and close out these claims with ‘haircuts?’" Barofsky wrote. "Questions concerning whether AIG paid more than necessary to counterparties and whether Treasury adequately monitored such payments are clearly relevant." AIG, under pressure to show how its $182.5 billion U.S. bailout was being spent, revealed on March 15 that banks including Goldman Sachs, Deutsche Bank AG and Societe Generale SA were top recipients. Barofsky will also examine if there was any review about the ability of banks "such as Goldman Sachs" to sustain losses on the swaps, he said in the letter. Barofsky is a former New York-based federal prosecutor who was made inspector general for the $700 billion TARP plan in December.
The lawmakers’ query concerns payments made to unwind some of AIG’s swaps, contracts similar to insurance that pay investors if bonds don’t pay as promised. AIG sold swaps to more than 20 U.S. and foreign banks. "We would like to know if the AIG counterparty payments, as made, were in the best interests of the taxpayers," lawmakers led by Cummings said in a March 25 letter to Barofsky. Competing insurers including Ambac Financial Group Inc. and the predecessor of Syncora Holdings Ltd. reached agreements with banks such as Citigroup Inc. and Merrill Lynch & Co. to cancel similar contracts at discounts to their expected losses. The Government Accountability Office said last month that the Treasury should demand that AIG seek concessions from banks as a condition of the latest U.S. aid.
"If such concessions are not considered to be in the government’s interest, the reasons should be clearly articulated and explained," the congressional auditors said. Kristine Belisle, a spokeswoman for Barofsky, confirmed the authenticity of the April 3 letter. Results of the audit will be made public, she said, declining to comment further. After AIG was rescued by the U.S. from collapse last year, banks that bought credit-default swaps got $22.4 billion in collateral and $27.1 billion in payments to retire the contracts, the insurer said last month. The letter from Congress asked whether holders received 100 cents on the dollar for their securities, even if they hadn’t defaulted. Credit-default swaps, conceived by bondholders, allow investors to buy protection against a possible default.
As the market expanded, speculators started using them to bet on a borrower’s creditworthiness. The contracts pay the holder face value for the underlying securities or the cash equivalent should a company fail to repay its debt. The $50 billion in payments made to banks for credit- default swaps after AIG’s bailout represent about half of the money that the insurer sent to financial firms and U.S. states from the middle of September to the end of 2008. Banks also got about $44 billion tied to securities lending, AIG said in a March 15 statement. Cummings, 58, a member of the House Oversight and Government Reform Committee, was among the first lawmakers last year to question AIG’s plans to pay $1 billion in retention bonuses. A firestorm of criticism about the payments prompted President Barack Obama to demand that some bonuses be blocked or recovered.
Buyers Arise for AIG Unit as Some Bids Scrape Floor
About a half-dozen bidders have emerged for American International Group Inc.'s asset-management business, according to people familiar with the matter. But the sale of the $100 billion portfolio has become complicated by client withdrawals and declines in asset prices. The auction is for the piece of AIG Investments that handles outside asset management for pension funds, insurance companies and wealthy individuals. The division's portfolio consists of a wide range of investments, including private-equity stakes, hedge-fund interests and stocks and bonds. The sale shows the pressures on AIG, which is controlled by the U.S. government. At the same time AIG is trying to prevent dumping assets at low prices, it also must show it is committed to paying back up to $173 billion in government aid. AIG hopes to wrap up the sale by the end of May, but could pull the auction if prices aren't high enough.
Several buyers have submitted offers between $400 million and $800 million, said the people familiar with the matter. That would register below the typical price for asset-management businesses, which historically have been valued at 1% to 2% of assets, which would value AIG's unit at between $1 billion and $2 billion. Private-equity firms Ashmore Investment Management Ltd., Hellman & Friedman LLC, Rhône Group LLC and TA Associates Inc. are among groups that have shown interest, these people said. So have mutual-fund manager Franklin Templeton Investments and asset manager Southgate Alternative Investments. The list of suitors is expected to be pared this week. The potential buyers declined to comment.
Bidders' low prices have come from concerns about valuations of private-equity and hedge-fund stakes. There also are worries that AIG personnel and clients are defecting. One recent client departure was Highland Good Steward Management, an Alabama-based investment firm. "It was a very difficult decision," said William T. Mills, a managing member at Highland. Selecting hedge-fund firms "is a vital and critical role, and we need to contract with a very stable organization." Austria's Raiffeisen Capital Management in December replaced AIG as adviser on about $300 million in assets. AIG's circumstances make valuations difficult, said Rob Haines, a CreditSights analyst. "Everyone is going to be gaming the system to an extent, knowing this is AIG and they want to get assets off their books. That bakes in a certain discount that will be incorporated into bids."
Buyers could end up splitting the AIG Investments holdings, with one buyer taking stock and bond portfolios and another the hedge-fund and private-equity investments.
AIG's hedge-fund investments overseen for external clients fell about 15% in 2008, people familiar with the business said. That is better than the 19% investment decline of hedge funds on average, according to data-tracker Hedge Fund Research Inc. As of February, the roughly $100 billion portfolio up for sale included about $34 billion in so-called alternative assets. Of those, private-equity holdings were nearly $26 billion and hedge-fund investments were $6.8 billion, according to a February AIG document reviewed by the Wall Street Journal. Since then, the hedge-fund assets have declined to nearer $5 billion, people familiar with the business say.
U.S. public pension funds mull toxic bank assets
At least a dozen U.S. public pension funds, including the nation's biggest, are mulling whether to put money behind the federal government's plans to rid banks' balance sheets of toxic assets. The U.S. government hopes that if banks dispose of troubled assets, they will be better positioned to increase lending. For their part, investors may scoop up the assets on the cheap with government-backed low-interest loans. "People are exploring options which could potentially allow them to move forward," the chairman of one public pension fund looking at investing in the assets said on Monday. "There is enough interest in the concept that people are going to try to work on options on how to potentially pursue it," said the fund official, who requested anonymity.
The official was one from a dozen public pension funds, including representatives of funds from California, New York and New Jersey, who with some state treasurers, including Bill Lockyer of California, discussed the U.S. government's plans on Friday by telephone with Sheila Bair, chairman of the Federal Deposit Insurance Corp. The FDIC, which insures bank deposits and manages banks in receivership, and the U.S. Treasury are launching the Public-Private Investment Program to help sell distressed bank assets and are urging investors to join in. The program will use government funds and private capital to buy up to $1 trillion in distressed loans and securities. Investors would receive low-cost financing from the U.S. government to buy the "legacy" assets at auctions.
The U.S. government also plans to match private investment with its funds and to share in expenses and gains of the pools of distressed assets. The FDIC is handling auctions to sell banks' whole loans and the Treasury and Federal Reserve will oversee programs to handle banks' mortgage-related securities. The Treasury on Monday eased terms for fund managers to apply to its toxic securities investment program and said it will consider widening the number of companies it allows to run public-private investment funds under the program. FDIC spokesman David Barr said Friday's conference call was one of Bair's first steps to brief investors on the programs. "The FDIC is seeking as much input as possible from various participants during our open comment period in order to fully inform our rulemaking process and ensure the greatest opportunity for success of the program," Barr said.
"We expect to hold an open call with the investor community next week and will announce the timing and details shortly," Barr added. Among the pension funds' with representatives on Friday's call with Bair were the $174 billion California Public Employees' Retirement System, known as Calpers and the nation's biggest public pension fund, and its sister fund, the California State Teachers' Retirement System, or Calstrs. Calpers spokesman Clark McKinley declined to comment on the call. Calstrs spokeswoman Sherry Reser said the $114 billion fund already has a program in place to invest in assets of distressed companies with the potential for returns that are better than fixed income. "We're certainly assuming that there are going to be some diamonds amid the bits of coal," she said. Calstrs, however, is waiting to learn more about the U.S. government's plan for distressed bank assets. "We're seeing how this program is going to gel," Reser said. "We're not making any commitments. It's just way too early in the discussions."
General Motors in 'intense' bankruptcy preparations
General Motors Corp is in "intense" and "earnest" preparations for a possible bankruptcy filing, a source familiar with the company's plans told Reuters on Tuesday. A plan to split the company into a new company made up of the most successful units, and an 'old company' of its less-profitable units is gaining momentum and is seen as the company's best configuration for the future, said another source familiar with the talks. The sources asked for anonymity saying they were not authorized to speak on the record. GM Chief Executive Fritz Henderson has said the company prefers to restructure out of court but could go to court if needed. GM declined to comment furth
U.S. consumer credit falls sharply in February
U.S. consumer borrowing fell more steeply than expected in February as credit and charge card use dropped by the most on record, a Federal Reserve report showed on Tuesday. February's consumer credit dropped $7.48 billion, or at an annual rate of 3.5 percent, after advancing at a rate of 3.8 percent or an upwardly revised $8.14 billion the prior month, previously reported as a $1.8 billion rise. Analysts polled by Reuters were expecting a $1 billion drop in consumer borrowing for February. Non-revolving credit, which includes closed-end loans for big-ticket items like cars, boats, college educations and holidays, rose $313 million, or at a 0.2 percent rate. However, revolving credit, made up of credit and charge cards, plunged at a 9.7 percent rate, or $7.79 billion in February, the largest dollar drop since the Fed started tracking the series in 1968. In percentage terms, the 9.7 percent decline was the biggest since January 1978, when it dropped 15.7 percent.
Spring Has Come and Gone for Goldman and Peers
Global investment banks had a remarkable start to the year. But the rally has gone far enough. Shares in Goldman Sachs Group, Morgan Stanley and J.P. Morgan Chase have doubled from their lows, while European wholesale banks also are up sharply. Shares in Barclays, for instance, have tripled since early March. Yet big questions remain over their future business models, making further price rises hard to justify. Sure, the banks were due a rally after they used their 2008 results to finally mark toxic exposures to realistic prices. That relief turned to excitement as it became clear the industry was enjoying a substantial profit recovery in the first quarter. Investors also will have rightly noted that policy makers on both sides of the Atlantic are making it abundantly clear they are standing behind the industry.
But if the bank's survival now looks assured, the challenge for investors is to figure out what multiple of book value to pay for them -- and what the size of that book might be. That is much less clear-cut. At the peak of the boom, the average investment banks were earning returns on equity of about 25%, well above the then-cost of equity of 10%, while book value was growing fast. That enabled the banks to trade on high multiples of book. But these days, it is far from clear banks will be able to earn returns over their cost of equity, which is now around 13%, while book value may even fall. True, the first quarter has been encouraging, with most banks reporting a boom in certain product areas such as foreign exchange, swaps, fixed-income trading and commodities.
And with so many competitors gone margins are up anywhere from 50% to 300%, according to Morgan Stanley research. But not all areas are performing well: Equities and mergers and acquisitions are weak. Besides, the positive impact of higher margins is likely to be at least partially offset by deleveraging. The 15 largest investment banks have so far shrunk their balance sheets by $3.6 trillion and are likely to shed a further $2 trillion in 2009, equivalent to 13% of their assets, according to Morgan Stanley. The European wholesale banks in particular still look very highly leveraged, with average common equity of 2.6% of tangible assets, well below the 4% that appears to be becoming the de facto industry standard.
The banks also face significant regulatory risk as new capital and liquidity requirements and new rules on compensation take effect. Where does that leave investors? Morgan Stanley assumes average industry returns hit 13% -- although long-term industry winners such as Barclays, Credit Suisse and Deutsche Bank with strong positions in the new hot areas of flow trading should do better -- while growth in book value is subdued. With returns in line with cost of equity, valuations in excess of book value look hard to justify. Yet U.S. investment banks already are trading well above book value, while the average European wholesale bank trades on 1.1 times average 2009 tangible book value, based on Morgan Stanley forecasts. To buy into the investment banks from here is to bet on a lot of cards falling into place for the industry: no more credit losses, a rapid economic recovery and an easy ride from regulators. That is surely asking too much.
The US Treasury requests volunteers for suicide; any takers?
by WIllem Buiter
According to today’s Financial Times, "Tim Geithner warned on Sunday that the US government would consider ousting board members at American banks as a condition for giving the institutions "exceptional" assistance in the future." The next time I teach Econ 101, Economic Principles - Microeconomics, I will use this as a school book example of how not to structure incentives. When a bank is undercapitalised and new lending and borrowing are encumbered by an overhang of bad, dodgy or toxic assets, the one thing you should not do is offer public financial support to rectify this situation on terms that are very painful for the key decision makers in the banks, painful that is, for those who decide on whether to accept the state’s financial aid.
Perhaps you believe that the CEOs, CFOs, COOs, other top executives and board members whose recklessness, incompetence and misfeasance brought the banks they were responsible for (and for which they indeed had a fiduciary duty) to the edge of the precipice (and at times beyond it) are likely to commit personal professional and financial suicide by doing the right thing for the bank and the wider community, accepting public money even when doing so will result in their being fired. If you do, you probably invested all you money with Bernie Madoff. This point has been made many times before, as has the point that if the state wants to recapitalise banks and clean up their balance sheets, it has two options. The first is to make acceptance of state money voluntary - at the discretion of (in order of importance) the management of the bank, the board of directors, the unsecured creditors and the shareholders. In that case, the terms have to be easy on those in a position to veto the deal.
The state effectively gives the money away. This was the approach adopted thus far by the US authorities vis-à-vis its large banks. After the first, tough tranche of financial support, it was also the approach adopted by the US authorities vis-à-vis AIG, after the first tough tranche of financial support. The second approach is to make the terms painful for the decision makers. In that case, acceptance of financial support has to be mandatory, not a choice of the incumbent management and board. This can be accomplished in many ways. Full nationalisation is one way. Putting the wonky banks into a special resolution regime would be another. In an SRR with promp corrective action powers, the management and board can be fired by the Conservator/Administrator, the unsecured creditors can be forced to take a haircut or can be metamorphosed into shareholders, and most prior contracts and obligations are null and void or at least open for renegotiation (including pension obligations, golden parachutes, severance pay etc. commitments etc.).
Or the government can simply announce a list of banks that will have to take government financial assistance, willy-nilly, and whose management, boards, shareholders and unsecured creditors will be subject, as a result of this mandatory financial transfer, to various potentially painful sanctions/interventions. Instead, the US Treasury is now following the UK and German example by trying to be a little bit pregnant: offer state money, make it painful and expensive for the incumbent management, board and other vested insider interests, but keep it voluntary. I am sure they are going to be lining up in droves to take advantage of this unique opportunity to do the right thing. What is going on in the Obama economics team? Has no-one on Pennsylvania Avenue heard of incentives? They even have, during a short interlude of enlightenment, given themselves the tools to do the job properly.
The Financial Stability Plan includes, as one of the three key components of the Financial Stability Trust, "A comprehensive Stress Test for Major Banks" (the other two components are "Increased Balance Sheet Transparency and Disclosure" and the "Capital Assistance Program". With an army of recently laid-off financial experts and toxic asset wizards at the disposal of the US Treasury to implement the comprehensive stress tests for major banks, surely the US authorities must know by now which bank needs public money and how much. Tell those banks identified as both in need of public money and capable of using it in the public interest (possibly after a change of management and board leadership) to take the money. Don’t ask. Tell. It isn’t hard. Take a leaf from Winnie the Pooh. Pooh was a bear of very little brain, but at least he had courage. Or from the Wizard of Oz, a literary reference perhaps closer to those in charge (but not in control) of US economic policy, take a leaf from the Scarecrow and the Cowardly Lion. With a little bit of brain power and a little bit of courage, this crisis can be overcome.
Oops! Two cheers for the IASB
by WIllem Buiter
In my post of April 3, 2009 "How the FASB aids and abets obfuscation by wonky zombie banks", I dumped on both the Financial Accounting Standards Board and on the International Accounting Standards Board for a second relaxation of mark-to-market valuation and accounting rules since the start of the crisis. I was wrong in including the IASB in the second installment of this roll call of members of the IAHS (the International Accounting Hall of Shame). The IASB did, in a statement on October 2, 2008, follow the lead of the FASB by allowing banks greater freedom to reclassify financial securities between the three categories of "held for trading", "available for sale" and "held to maturity". However, it did not follow the FASB in the second surrender to the lobbyists of the zombie banks. In fact, the IASB on March 20, 2009 published a request for comments (to be submitted by April 20, 2009) on the two mark-to-market-dismembering proposals of the FASB (Proposed FSP No. FAS 157-e Determining Whether a Market is Not Active and a Transaction is Not Distressed and Proposed FSP No. FAS 115-a, FAS 124-a, and EITF 99-20-b Recognition and Presentation of Other-Than-Temporary Impairments).
Then, on April 2, 2009 the Trustees of the International Accounting Standards Committee Foundation, following a review of the IASB’s response to the financial crisis, made the following statement (I have underlined the bits that amount to a clear repudiation of the FASB’s hurried surrender to the vested interests of Wall-Street-holed-below-the-water-line)."At their November 2008 and April 2009 meetings, the G20 highlighted the need for convergence of accounting standards. The Trustees have welcomed the IASB’s commitment to achieve (with the US Financial Accounting Standards Board) globally accepted and high quality accounting standards. At the same time, the Trustees believe that even in moments of crisis, the standard-setter should follow an agreed due process, which enables interested parties to comment, even if on an accelerated basis. This is a clear message that the Trustees received from interested parties during the first part of the Constitution Review. International stakeholders also expressed this view at public round tables in the fourth quarter of 2008 held to discuss issues emanating from the financial crisis." The FASB thus received a double kick in the baubles from the IASB, one as regards procedure ("…respecting due process.") and one as regards substance ("..comprehensive.. rather than …piecemeal"). Following this indictment by its peers, it ought to be clear even to the most blinkered captive accountant, that the FASB is damaged goods - a standard setter captured by those who are supposed to be constrained by the standards it sets - the SEC of the accounting standards world. Perhaps a comprehensive overhaul of its leadership and institutional structure will suffice to restore both the reality and the perception of backbone and integrity. I doubt it. Best to scrap the organisation and create a new body, structured to be less amenable to capture by the vested interests its standard-setting activities are intended to keep in check. But as regards the IASB, apologies and two cheers, at least until six months from now, when the results of the deep thought processes currently under way are scheduled to be revealed to an early anticipating world. Until then, we will have to see through a glass, darkly.
While the Trustees acknowledged the desire to achieve commonly accepted positions between US GAAP and IFRSs, they also urged the IASB to avoid piecemeal approaches that would undermine the ability to address broader issues related to accounting for financial instruments raised by the crisis. This was also the view expressed most frequently at the IASB’s public round tables. Sir David Tweedie, Chairman of the IASB, reported to the Trustees that at their joint meeting last week the IASB and FASB agreed to undertake an accelerated project to replace their existing financial instruments standards (IAS 39 Financial Instruments, in the case of the IASB) with a common standard that would address issues arising from the financial crisis in a comprehensive manner. Though the IASB is consulting on FASB amendments related to impairments and fair value measurement, the Trustees supported the IASB’s desire to prioritise the comprehensive project rather than making further piecemeal adjustments. This project should result in a proposal being published within six months. The Trustees welcome this timetable and will monitor progress closely….".
Commenting on the announcement, Gerrit Zalm, Chairman of the Trustees of the IASC Foundation said: "The Trustees unanimously support the IASB’s initiating a thorough and urgent re-examination of financial instruments accounting. It is far better to undertake a fundamental re-assessment than adopting a piecemeal approach to a standard that is widely recognised as being outdated. The Trustees will support the IASB’s work and monitor its progress as the IASB completes this work whilst respecting due process.
Bad news gets worse for euro zone
The euro-zone economy's record contraction in the final three months of 2008 was even deeper than previously thought, statistics agency Eurostat said Tuesday in its final estimate of fourth-quarter gross domestic product. Eurostat revised down its estimate of fourth-quarter activity to show a 1.6% drop in GDP compared to the third quarter. Compared to the final quarter of 2007, GDP fell 1.5%, wider than an earlier estimate of a 1.3% decline. Economists had largely expected no change in the final estimate
The euro zone tipped from economic growth into recession during the third quarter of 2008, when data showed that GDP declined by 0.3% for a second consecutive quarter. Two consecutive quarters of lower GDP is an informal but widely used definition of a recession. Households' final consumption dropped 0.3%, a reversal after a 0.1% rise the previous quarter, Eurostat said. Investments plunged 4% in the final three months of the year, steeper after a 0.7% decline in the third quarter. Exports plunged 6.1%, also far worse than a 0.2% decline in the previous quarter, Eurostat said. Imports dropped 4.7%, turning lower following a 1.3% increase in the third quarter.
Germany’s policy of containment
The industrial barges that ply the Rhine towards Europe’s seaports never reach a great speed. But stacked high with goods for export, they were an expression of German manufacturing might – until late last year. Erich Staake, chief executive of Duisburger Hafen, a sprawling inland port at the confluence of the Rhine and Ruhr rivers in Germany’s industrial heartland, noticed the change in November. "Container handling dropped enormously, almost from one day to the next," he recalls. The eerie calm in Duisburg highlights why Germany has suddenly become a global concern. Long a nation of shippers, not shoppers, Europe’s largest economy has been caught out by the slide in global demand – a focus of attention of last week’s Group of 20 international summit in London – putting Berlin under exceptional pressure to act to avert an imposion that would have big implications for the rest of the world. A cigar-puffing logistics industry veteran, Mr Staake expects the German container business to contract by 25 per cent or more this year, but hopes the decline in Duisburg can be kept to less than 20 per cent. "Before, when ships arrived, the containers were stacked four or five high. Now there are only two layers," he says. "In peacetime, there has never been anything approaching this crisis."
With its reliance on steel and coal trading, Duisburg was among the parts of the country worst hit in the Depression that followed the 1929 Wall Street crash. After the second world war, it was one of the winners during the industry-led Wirtschaftswunder, or economic miracle. Duisburg’s latest slowdown is only part of a gloomy national picture. German gross domestic product will contract by 5.3 per cent this year – unprecedented in modern times, the Organisation for Economic Co-operation and Development forecast last week. "Our destiny hangs on exports," says Jörg Krämer, chief economist at Commerzbank in Frankfurt, who thinks GDP could fall by up to 7 per cent. The country is set to fare significantly worse than the US and UK, forecast by the OECD to contract by 4 per cent and 3.7 per cent respectively. The unemployment rate rose from a 16-year low of 7.6 per cent last September to 8.1 per cent in March. Axel Weber, Bundesbank president, warned last week that the severity of the recession had been consistently underestimated and "the labour market could face the threat of a massive hit if the expectations of companies are repeatedly dashed".
The risk is that – like Japan in the 1990s – Germany faces a "lost decade", or a protracted period of economic malaise as it waits for the global economic tides to turn and struggles to find domestically generated sources of growth. "I am convinced it is going to be a slow recovery," says Mr Staake. "Who is going to be buying anything?" This downfall is all the more galling because, even a year ago, the country could have expected to weather the global economic storms. There was no danger of a housing crash; prices had been flat for a decade. Consumers had saved; companies had not increased leverage dramatically. "From a structural point of view, this recession should never have happened," says Commerzbank’s Mr Krämer. With hindsight, however, Germany was a sitting target after the collapse of Lehman Brothers investment bank in mid-September. Its exports were equivalent to more than 47 per cent of GDP last year – compared with less than 20 per cent in Japan and about 13 per cent in the US. Its industrial base is skewed towards producing machinery and equipment – "investment goods" account for more than 40 per cent of its exports – and towards emerging European and Asian economies.
While the crisis was focused on US housing and capital markets, Germany was unaffected. But after Lehman’s failure paralysed banks, and confidence nosedived globally, companies around the world shelved investment plans – leaving German factories turning out goods nobody wanted to buy. Industrial production in January was more than 20 per cent lower than a year before; overseas orders for investment goods had almost halved. The BGA exporters’ association expects exports to fall by up to 15 per cent this year. Germany’s focus on exports owes a lot to economic conditions in the decades after 1945. With its pre-war record of defaults and hyperinflation, it had little option but to run a trade surplus, argues Albrecht Ritschl of the London School of Economics. The same factors encouraged fiscal and monetary policy conservatism – there was no scope for experiments. As a result the country became used to dealing with global trade cycles, and its export dependency "is not perceived as a problem", says Prof Ritschl. After the fall of the Berlin wall in 1989, Germany struggled to maintain fiscal discipline in the face of the costs of reunification. It entered Europe’s monetary union 10 years later at what many economists argue was too high an exchange rate, and growth in the early part of this decade was sluggish. But after extensive corporate restructuring and wage restraint, it succeeded in restoring international competitiveness and in reaping the benefits of the most intense period of global economic growth since the second world war.
Still, economic performance was never spectacular. Growth peaked at an annual rate of 3 per cent in 2006, slightly higher than the 2.9 per cent in the eurozone as a whole and the 2.8 per cent reported by the US. But that followed 10 years in which it had, on average, lagged far behind both. Export dependency "was always a problem to some extent because it was at the cost of domestic demand", says Gustav Horn of the union-backed Hans-Böckler research foundation. During good years Germany squandered the chance to boost real wages. "The only thing we can do now is to have a very expansionary fiscal policy to stimulate domestic demand to compensate for at least some of this export decline." Without additional government action, he says, "I think, after the big fall in GDP, we will have a scenario of stagnation throughout next year. That means unemployment will rise and rise ... It is a kind of Japanese scenario." Past fiscal prudence would give Berlin room to spend its way out of recession, as many outside the country believe it should. "There are countries that understand the importance of fiscal mobilisation and there are some other countries that do not," remarked Taro Aso, Japan’s prime minister, pointedly in an interview with the Financial Times last week. Government debt last year was equivalent to about two-thirds of GDP, below the eurozone average, and the budget was more or less balanced. But, even with federal elections looming in September, Berlin has set limits on what it is prepared to spend. Angela Merkel, chancellor, told the Financial Times recently that action taken so far to boost demand was equivalent to 4.7 per cent of GDP over two years, which put the country "in the leading group" of those contributing to the stabilisation of the world economy.
Her strategy seems clear – sit out the crisis, preserving industrial strength as much as possible, and await the eventual upturn. The reliance on exports "is not something you can change in two years", Ms Merkel said. "It is not something we even want to change." One reason for Berlin’s caution is the idea that Germans are unresponsive to government attempts to get them spending. The European Central Bank cites so-called Ricardian effects – named after David Ricardo, the early 19th century economist – by which consumers fear that government spending today will mean higher tax bills in the future, so they cut their own outlays. This idea is controversial among economists, however. Tullio Jappelli from Naples University says that "a fair reading of several dozen studies in the past three decades suggests that government deficits significantly lower national savings, albeit less than one for one". Experience, too, suggests the idea is flawed: a financial subsidy offered by Berlin to those trading in old cars has been surprisingly successful in reviving sales (though the country’s own manufacturers may not be the biggest winners, and there are signs other retailers are suffering as a result). However, Berlin’s fears of the inflationary consequences of loose fiscal policies "are probably greater than elsewhere given its historical experience with hyperinflation", says Prof Jappelli. What outsiders may fail to realise is that Germans already feel over-indebted, adds Prof Ritschl at the LSE. On top of the government’s existing debts are the implicit costs of funding a generous pay-as-you-go pension system when the population is ageing rapidly. "What is happening in the US and UK in terms of fiscal and monetary policies would make every German extremely nervous," says Prof Ritschl. "People on the street would be talking about hyperinflation again."
That leaves little option but to hope for a longer-term economic rebalancing. Bart van Ark, chief economist at The Conference Board, the New York-based business research organisation, argues a large economy cannot be run on "export fuel only" in the long term. German manufacturers may be highly efficient but their focus on overseas business means much of the benefit of their success seeps abroad. "If you work for a German manufacturer, you get higher wages, which is great, but you are only one of a few. The dominant effect of Germany’s manufacturing efficiency is that consumers abroad benefit from the lower prices of goods the Germans produce." To generate better domestic demand, the focus should be on creating productive jobs in service sectors that sell locally, Mr van Ark says. Dismantling obstacles to competition in services would encourage greater efficiency, higher productivity and lower prices that benefited consumers and led to higher real wages. "That is the sort of dynamic upward spiral that an economy needs to keep growing." In Duisburg, work is continuing on extending riverside logistics facilities on the site of a former steelworks. The aim is to broaden the services the port can offer, for instance in warehousing or packaging, taking advantage of outsourcing by German manufacturers. But the port’s future still depends on the export business. Mr Staake sees no alternative for Germany. "If we really want to have good growth back, we can only do it through exports. It is not just the German mentality – it is our strength. We are the land of engineers. We build the best cars, the best machines. Thank goodness for that."
World Bank Sees Bleak Prospects For Asia
The recession isn't leaving Asia anytime soon and rising unemployment is causing severe pain, according to a new World Bank report. The developing countries of East Asia--that's everywhere in the region except already-industrialized Japan, South Korea, Singapore, Taiwan, and Hong Kong--are dealing with twin dilemmas: shrinking markets for their exports of commodities and manufactured goods, and soft domestic demand, according to the global development lender. It estimates that the developed economies will contract 3.1% in 2009, while developing East Asia will post GDP growth of just 5.3%, down from 8% last year. Excluding China, which the World Bank projects will grow 6.5%, it expects developing Asia will post tepid growth of 1.2%.
With worldwide demand dropping and factories shuttering, unemployment in the region officially hit 24 million in January--and that's just the official numbers, which are likely several times too low. Exports are down, remittances from abroad are falling as overseas migrants lose their jobs, and those at home have been scared into belt-tightening. Of the developed Asian countries not covered in the report, co-author Vikram Nehru, chief economist for East Asia and the Pacific, told journalists at the lender's offices here, "Japan has been particularly hard hit as an exporter of capital goods because of the demand in the rest of the world." The Bank projects that Japan's GDP will shrink drastically, as much as 5%, because of the blow to its exports, he said.
The good news, said Nehru and co-author and Ivailo Izvorski, lead economist for the region, is that Asian governments aren't sitting idly by. "We've been quite impressed by the speed with which the governments have responded," Nehru said. Stimulus packages are being put through in nearly every country to the tune of nearly 4% of regional GDP, according to the report. History is not entirely repeating itself. The bank notes that countries like Thailand, Malaysia, Indonesia and the Philippines learned the lessons of the 1997 Asian financial meltdown and were in a better position to weather this economic storm. These countries had stronger banking regulations, more foreign-currency reserves, lower debt, and a more favorable balance of trade.
The report also sees some bright spots in the policies being used to combat the crisis. The best way to keep the developing Asian countries afloat, Nehru said, is through direct cash payments to the poor, who are more likely to spend the money rather than save it. Indonesia's program of stimulus handouts will target 19 million of the lowest-income households across the country--one-third of the population--in the hopes that the money will be spent immediately. That will in turn boost local economies and have a positive impact on wages, Nehru says. China and the Philippines also have transfer-payment programs.
One big problem: given their dependence on exporting to the West, no matter what the Asian countries do, "what happens in the rest of the world is going to be absolutely key," Nehru said. A recovery in the West isn't expected until 2010. Even then, rapid growth is unlikely to return, the World Bank said. With the U.S. savings rate expected to rise and consumption drop, "the region's outward-oriented economies are unlikely to enjoy the same success in the medium term as they did in the previous decade."
Homeward Rebound: Weathering the Storm With Kin
Unable to find work in Keosauqua, Iowa, Dustin and Michelle Wellman took their last $200, packed their belongings into a 1999 Dodge Neon and drove 1,000 miles with their four-year-old son back to Robertsdale, Ala., the town where Mr. Wellman grew up. Mr. Wellman, an unemployed welder, had heard from relatives that a shipbuilding company in nearby Mobile was hiring, and Ms. Wellman, a pharmacy technician, believed she could find work at a hospital or pharmacy. Those hopes didn't pan out. Today, the couple lives in a trailer on Dustin's mother's property. They borrow an uncle's pickup truck to travel to job interviews, and occasionally get cash from Michelle's father to buy gas. "I'd rather be home if I'm going to be broke," says Ms. Wellman.
Families around the country are weathering out the recession by hunkering down with relatives and friends. It's not just a lower-income phenomena either. The homeward bound are former white-collar and blue-collar workers who believe they might have a better chance finding work in their hometown because they know more people, who, in turn, know still more people. But with jobs scarce, that doesn't always work, and rumors of jobs are just that. At home, though, they can at least get help with food, shelter and clothing. "As Americans face tougher economic conditions, we'll likely see more of this," said Jim Toedtman, a vice president with AARP, which analyzed Census data. More adult children are living with their parents -- about 6.2 million in March 2008, the latest figures available -- up from 6.1 million the year before, continuing a gradual upward trend from 2000.
The latest number doesn't include the most recent and most intense series of layoffs from the last three months, and is likely to be significantly higher now, says Mr. Toedtman. The duration of home stays may also increase if the economic downturn persists. Envisioned as short-term layovers, some are turning into long-term engagements. In early 2008, Jeffrey Murray was laid off from a project-management position at Perot Systems, and soon moved with his wife and young daughter into his in-laws house near Portsmouth, N.H. "We thought we'd be there for maybe six months to get settled on our feet and then start looking for our new home," said Mr. Murray, 38 years old. But in March, he was laid off again from a global insurance company. His daughter is now three, and another child is expected in the next few weeks.
As he watches house prices continue to fall, Mr. Murray said he is glad he didn't rush out to buy a new home. His in-laws have three floors in their spacious house and his family has a separate entrance. "I don't think we really infringe on their privacy," said Mr. Murray, who restacks the woodpile and does other manual chores around the house when he's not job searching or networking. "It's not an ideal situation, but we're fortunate to be able to do this as we ride this out," he said. Moving back home is not easy for anyone involved and is often chosen as the last resort. Pam Wilson, 37, earned $60,000 as a social worker, and shared a house with her mother, 67, in Kentucky. After unsuccessfully looking for work, depleting her $25,000 in savings and exhausting her unemployment-insurance benefits, she realized she and her mother couldn't afford to live on their own. So she made the difficult decision for them to move back to Georgia to live with her two sisters. The four women share the house.
Ms. Wilson and her mother share a queen-size bed. Ms. Wilson cooks, and says she sometimes does extra things around the three-bedroom house like making her sisters' bed, or taking out the trash. "You just want to make sure that you're not perceived as some type of burden or freeloader," she said. When company comes over, she feels like she might be in the way and retreats to her room. She knows she is welcome, but can't help feeling ashamed. In February, Ms. Wilson was hired as a claims examiner, earning a little less than $40,000, for the Department of Veterans Affairs in Decatur, Ga. She would like to buy a house, but isn't sure how long her job will last; her contract is only for 13 months. Kin is becoming the safety net of last resort in part because overwhelmed social-service agencies are reaching their giving limits. Across the country, waiting lists are mounting for people who need help paying for food, rent and utilities. Agencies are seeing more demand just as the traditional sources of revenues -- individual, foundation and government support -- are cutting back.
"Unlike previous recessions, every major revenue source that social-service providers turn to is in decline," says Scott Allard, associate professor at the University of Chicago's School of Social Service Administration. "Families, friends and social networks are becoming more important ways that people are coping." The Wellmans returned to Robertsdale, population 4,800, thinking they would have a better chance finding work there, rather than in largely rural Iowa. The area had two big employment prospects, but plans are being delayed or canceled. In January, ThyssenKrupp Stainless USA said it was pushing back the start-up at a stainless-steel plant in nearby Mobile, which would employ 900. Last year, the federal government said a $35 billion contract to Northrop Grumman Corp. -- to build Air Force refueling planes that would have created several thousand jobs in Mobile -- would have to be rebid.
"Everybody was waiting for these two companies to save the day," said Deann Servos, who runs the Prodisee Food Pantry operating out of a Methodist Church in nearby Spanish Fort, Ala. Each week, about 95 families receive boxes of food to feed a family of three for a week, up from 50 families in September. The Wellmans had relied until recently on Prodisee Pantry and local churches for food, including First Baptist Church in Robertsdale, which also gave their son, David, a red-and-white tricycle and toy yellow bulldozer. The Wellmans had given away most of their belongings in Iowa because they didn't have the money to rent a U-Haul, which cost $1 a mile. For just about every bare necessity in their life, the couple relies on a long list of family and friends. The trailer belonged to Dustin's mother, Susan, and has been furnished with second-hand furniture and damaged floor tiles from Ace Hardware, where his mother works and had her own hours cut to 35 from 40, making $7.50 an hour.
Susan Wellman's hen provides an egg most days. Her boyfriend built a small porch for the couple from a shipping pallet discarded by the shipyard. Another friend bought clothes for David. "It's been a group effort," said Ms. Wellman, who's 52. The couple reciprocates whenever they can. Dustin changed the oil and cleaned the truck of Michelle's uncle, who lent the couple his white GMC pickup so they could drive to job interviews. Michelle applied at CVS and Rite Aid pharmacies between their house and Pensacola, Fla., 35 miles to the east. She started a job last Monday at a Nike outlet about 45 minutes away in Foley, Ala., as a seasonal associate earning $8.50 an hour. After paying for groceries, gas and a student loan, she said the family is still struggling. Dustin, 27, tried to get a job at an agricultural seed company, a Bass Pro Shop, paper factory, gas stations and with the city hauling garbage. Getting work through friends is hard. One friend, an electrician, and another, a plumber, both lost their jobs. "Everybody I know is laid off," said Dustin.
Ilargi: Great graphs, important article. But then there's this:
The good news, of course, is that the policy response is very different. The question now is whether that policy response will work.Why is something good news if you have no idea what it will lead to? Am I the only one who sees that as complete nonsense? isn't it just simply true that if the present policy response fails, we will be untold trillions deeper in the hole than even in the 1930's? "Oh, it's great that you don't do what they did in the past, because that didn't work." Yeah, I understand, but why is that so much more important than that what is done now actually works? It seems like nobody in the economic policy field can look beyond its narrow boundaries anymore.
A Tale of Two Depressions
Often cited comparisons – which look only at the US – find that today’s crisis is milder than the Great Depression. In this column, two leading economic historians show that the world economy is now plummeting in a Great-Depression-like manner. Indeed, world industrial production, trade, and stock markets are diving faster now than during 1929-30. Fortunately, the policy response to date is much better. The parallels between the Great Depression of the 1930s and our current Great Recession have been widely remarked upon. Paul Krugman has compared the fall in US industrial production from its mid-1929 and late-2007 peaks, showing that it has been milder this time. On this basis he refers to the current situation, with characteristic black humour, as only “half a Great Depression.” The “Four Bad Bears” graph comparing the Dow in 1929-30 and S&P 500 in 2008-9 has similarly had wide circulation (Short 2009). It shows the US stock market since late 2007 falling just about as fast as in 1929-30.
Comparing the Great Depression to now for the world, not just the US
This and most other commentary contrasting the two episodes compares America then and now. This, however, is a misleading picture. The Great Depression was a global phenomenon. Even if it originated, in some sense, in the US, it was transmitted internationally by trade flows, capital flows and commodity prices. That said, different countries were affected differently. The US is not representative of their experiences. Our Great Recession is every bit as global, earlier hopes for decoupling in Asia and Europe notwithstanding. Increasingly there is awareness that events have taken an even uglier turn outside the US, with even larger falls in manufacturing production, exports and equity prices.
In fact, when we look globally, as in Figure 1, the decline in industrial production in the last nine months has been at least as severe as in the nine months following the 1929 peak. (All graphs in this column track behaviour after the peaks in world industrial production, which occurred in June 1929 and April 2008.) Here, then, is a first illustration of how the global picture provides a very different and, indeed, more disturbing perspective than the US case considered by Krugman, which as noted earlier shows a smaller decline in manufacturing production now than then.
Figure 1. World Industrial Output, Now vs Then
Source: Eichengreen and O’Rourke (2009).
Similarly, while the fall in US stock market has tracked 1929, global stock markets are falling even faster now than in the Great Depression (Figure 2). Again this is contrary to the impression left by those who, basing their comparison on the US market alone, suggest that the current crash is no more serious than that of 1929-30.
Figure 2. World Stock Markets, Now vs Then
Source: Global Financial Database.
Another area where we are “surpassing” our forbearers is in destroying trade. World trade is falling much faster now than in 1929-30 (Figure 3). This is highly alarming given the prominence attached in the historical literature to trade destruction as a factor compounding the Great Depression.
Figure 3. The Volume of World Trade, Now vs Then
Sources: League of Nations Monthly Bulletin of Statistics, http://www.cpb.nl/eng/research/sector2/data/trademonitor.html
It’s a Depression alright
To sum up, globally we are tracking or doing even worse than the Great Depression, whether the metric is industrial production, exports or equity valuations. Focusing on the US causes one to minimise this alarming fact. The “Great Recession” label may turn out to be too optimistic. This is a Depression-sized event.
That said, we are only one year into the current crisis, whereas after 1929 the world economy continued to shrink for three successive years. What matters now is that policy makers arrest the decline. We therefore turn to the policy response.
Policy responses: Then and now
Figure 4 shows a GDP-weighted average of central bank discount rates for 7 countries. As can be seen, in both crises there was a lag of five or six months before discount rates responded to the passing of the peak, although in the present crisis rates have been cut more rapidly and from a lower level. There is more at work here than simply the difference between George Harrison and Ben Bernanke. The central bank response has differed globally.
Figure 4. Central Bank Discount Rates, Now vs Then (7 country average)
Source: Bernanke and Mihov (2000); Bank of England, ECB, Bank of Japan, St. Louis Fed, National Bank of Poland, Sveriges Riksbank.
Figure 5 shows money supply for a GDP-weighted average of 19 countries accounting for more than half of world GDP in 2004. Clearly, monetary expansion was more rapid in the run-up to the 2008 crisis than during 1925-29, which is a reminder that the stage-setting events were not the same in the two cases. Moreover, the global money supply continued to grow rapidly in 2008, unlike in 1929 when it levelled off and then underwent a catastrophic decline.
Figure 5. Money Supplies, 19 Countries, Now vs Then
Source: Bordo et al. (2001), IMF International Financial Statistics, OECD Monthly Economic Indicators.
Figure 6 is the analogous picture for fiscal policy, in this case for 24 countries. The interwar measure is the fiscal surplus as a percentage of GDP. The current data include the IMF’s World Economic Outlook Update forecasts for 2009 and 2010. As can be seen, fiscal deficits expanded after 1929 but only modestly. Clearly, willingness to run deficits today is considerably greater.
Figure 6. Government Budget Surpluses, Now vs Then
Source: Bordo et al. (2001), IMF World Economic Outlook, January 2009.
To summarise: the world is currently undergoing an economic shock every bit as big as the Great Depression shock of 1929-30. Looking just at the US leads one to overlook how alarming the current situation is even in comparison with 1929-30. The good news, of course, is that the policy response is very different. The question now is whether that policy response will work.