Cossitt Library, a Romanesque red sandstone structure, at Front and Monroe on the banks of the Mississippi, was Memphis's first public library when it opened in 1893
Ilargi: It's funny to see things like yesterday's hair's breadth rise in US homebuilders' confidence pushing up stocks 3%, only to be followed the very next morning with reports that housing starts and permits are at their lowest on record, dating back to 1959. When the US population was about half of what it is today. And though those are pretty strong indicators, you don’t have to go back that far for clarity in numbers. April 2008 was not a great time for housing starts; fear had taken a firm hold already. Still, last month's housing starts were 54,2% lower than a year ago. But if you'd have thought that brings down share prices: hell no, the recovery delusion is far too strong.
There's more "Really dumb things to say" today. Here's economist Brad Setser:
"The most probable scenario is one where Chinese demand for Treasuries re-emerges on the back of renewed Chinese reserve growth..."
This from a Reuters article that contends China's economy will indeed grow so fast it will be forced to buy US debt to keep the renminbi down, but it will still have to fight over its share of the $8 trillion(!) to be issued in 2009 with US domestic demand. Yeah, dream on. No party except for Ben Bernanke is in the market for more than a sliver of it.
Economists Ken Rogoff and Greg Mankiv are not to be outdone: they plead for more inflation, 6% or thereabouts. What makes that sound real dumb is a report that Britain is in its worst deflation since at least 1948. The US and UK economies are quite comparable, and none of Gordon Brown's quantitative easing measures has helped to prevent the deflation.
So good luck with attempts to thwart that exact same development in the US. American retail sales are still down hugely, and Fannie and Freddie are the next calamity in line, after California and General Motors, to detonate into Obama and Geithner's faces, followed closely by hundreds of regional banks that can no longer hide their commercial real estate and toxic investment losses, and they in turn have a very narrow lead over a few dozen additional states that are about to cut off many essential services for their citizens and raise taxes wherever they can.
Washington's approach to the incessant stream of disaster tidings is a variation on the don't look don't tell policy that's been so succesful in so many fields. How do you do that, when so much is going visibly wrong? You talk about fuel efficiency standards. For cars that you know full well will never be built.
US housing starts, permits hit record lows in April
New U.S. housing starts and permits unexpectedly fell to record lows in April, a government report showed on Tuesday, denting hopes that stability in the housing market was imminent. The Commerce Department said housing starts fell 12.8 percent to a seasonally adjusted annual rate of 458,000 units, the lowest on records dating back to January 1959, from March's upwardly revised 525,000 units. "It obviously calls into question the notion that the housing market is stabilizing," said Brian Dolan, chief currency strategist at Forex.com in Bedminster, New Jersey.
Compared to the same period last year, housing starts tumbled 54.2 percent. Analysts polled by Reuters had expected an annual rate of 520,000 units for April. U.S. stock index futures pared gains after the data. Government bond prices extended losses despite the weak report. Peter Kenny, managing director at Knight Equity Markets in Jersey City, New Jersey, said the weak housing starts data was "not encouraging." However, he noted that the drop in building permits, which also fell to record lows, could set the stage for a housing rebound later.
"The first step to healing the housing sector is to eat into inventory. There is so much inventory on the market that the sooner we stop building and start eating into existing inventory the better off we'll be," he said. New building permits, which give a sense of future home construction, dropped 3.3 percent to 494,000 units, the lowest since records started in January 1960, from 511,000 units in March. That was well below analysts' forecasts of 530,000 units. Compared to the same period a year-ago, building permits plunged 50.2 percent.
A National Association of Home Builders survey on Monday showed U.S. home builder sentiment surged to an 8-month high in May, with industry leaders hopeful the three-year housing slump was nearing a bottom and market stability around the corner. Collapsing domestic home prices and the resultant global credit crisis pushed the U.S. economy into recession in December 2007 and restoring stability to the housing market is a key element to a recovery in the economy. Building completions rose 4.9 percent to 874,000 units, Tuesday's data showed. Meanwhile, aggressive cost-cutting helped Home Depot Inc, the word's largest home improvement chain, to report on Tuesday a bigger-than-expected profit in the latest quarter despite the deep U.S. housing slump.
Britain sinks into deepest deflation since at least 1948
Inflation on the Retail Prices Index (RPI) measure, which includes housing costs, dropped sharply to -1.2pc in the year to April, from -0.4pc in March, the Office for National Statistics (ONS) said on Tuesday. It was the lowest RPI figure since records began in 1948, and weaker than economists had expected. Jonathan Loynes at Capital Economics said the inflation figures served as a reminder that "excessively low inflation, or deflation, is still a bigger risk over the next few years than a rapid rise in inflation." The main driver of the fall was lower mortgage interest payments following the Bank of England's decision to cut interest rates by half a percentage point to 0.5pc in March, the ONS said.
Other contributing factors were falling house prices and rental costs, lower council tax costs, lower gas and electricity bills and falling food prices. Housing-related costs fell by a total of 12.1pc in the year to April. Although in the short term falling prices will appeal to consumers, RPI is used to calculate wage increases so the sharp fall in April is likely to add to downward pressure on salaries already caused by higher unemployment and falling corporate profits "As a result, many workers are likely to wage freezes or even pay cuts," said Howard Archer, chief UK economist at IHS Global Insight. Deflation poses a further threat to the economy if people expect prices to fall further and put purchasing plans on hold which can, if the trend persists, lead to lower output and even more job losses.
The Consumer Prices Index (CPI), which excludes housing costs and is the Government's preferred measure of inflation, fell to 2.3pc in April from 2.9pc in March. The number fell back mainly because of lower utility bills and food prices. Although CPI is now close to the 2pc target, it is expected to fall to below 2pc in the coming months as oil prices remain relatively low, utility and food bills fall further, and retailers reduce prices to attract customers. Once it falls below target the Bank of England expects it to remain there over the next three years, it indicated last week. "It looks as if the disinflationary impact of the recession has started to overwhelm the inflationary impact of the weaker currency," Credit Suisse analysts said.
Fannie and Freddie in 'critical' condition
Fannie Mae and Freddie Mac, charged with helping lead the nation out of its housing crisis, are facing "critical" financial problems, federal regulators said Monday. The companies suffer from severe financial, operational and compliance weaknesses, the Federal Housing Finance Agency said a report to Congress detailing its annual examinations of the firms. Taken over by the government in September, Fannie and Freddie are not able to operate without federal assistance. "With new senior management teams, each enterprise has made strides in remediating problems," the agency said. "But they still face numerous significant challenges including building and retaining staff and correcting operational and credit management weaknesses that led to conservatorship."
Fannie and Freddie play a vital role in the national housing market, accounting for a combined share of 73% of mortgage originations in the second half of 2008. They also serve central roles in the Obama administration's foreclosure prevention plan. To continue functioning, the firms have drawn down about $60 billion of their combined $400 billion lifeline from the federal government. Fannie reported a $23.2 billion quarterly loss and Freddie a $9.9 billion quarterly loss earlier this month. One hurdle to putting Fannie and Freddie back on firm financial footing is the many vacancies in their executive ranks. Hiring has been slowed by compensation concerns, the agency said.
While the housing meltdown prompted the companies' near collapse in 2008, this year will also be difficult. Fannie Mae will face challenges as it works with servicers to help troubled borrowers and to manage and sell a growing inventory of foreclosed properties, the agency said. Freddie Mac, meanwhile, needs to improve its internal controls and find a chief executive officer. "The problems of the last two years in the financial markets are slowly abating, but the challenges in the housing markets continue," said James Lockhart, the agency's director.
Green Shoots In Retail? Ha!
Looking for those so-called green shoots in consumer spending? As this chart, which has been going around, shows, there's still not much to get excited about. (via Paul Kedrosky)
Local Banks Face Big Losses
Commercial real-estate loans could generate losses of $100 billion by the end of next year at more than 900 small and midsize U.S. banks if the economy's woes deepen, according to an analysis by The Wall Street Journal. Such loans, which fund the construction of shopping malls, office buildings, apartment complexes and hotels, could account for nearly half the losses at the banks analyzed by the Journal, consuming capital that is an essential cushion against bad loans. Total losses at those banks could surpass $200 billion over that period, according to the Journal's analysis, which utilized the same worst-case scenario the federal government used in its recent stress tests of 19 large banks. Under that scenario, more than 600 small and midsize banks could see their capital shrink to levels that usually are considered worrisome by federal regulators. The potential losses could exceed revenue over that period at nearly all the banks analyzed by the Journal.
The potential losses on commercial real estate are by far the largest problem facing the midsize and small banks, easily exceeding losses on home loans, which could total about $49 billion, according to the Journal's analysis. Nearly one-third of the banks could see their capital slip to risky levels because of commercial real-estate losses, the Journal found. The Journal, using data contained in banks' filings with the Federal Reserve, examined the financial health of 940 small and midsize banks. It applied the loan-loss criteria that the Fed used in its stress tests of the largest banks. The findings are a stark reminder that the U.S. banking industry's problems stretch far beyond the 19 giants scrutinized in the government stress tests. Regulators and investors have focused on too-big-to-fail banks such as Bank of America Corp. and Citigroup Inc. But more than 8,000 other lenders throughout the country are being squeezed by the recession and real-estate crash.
"They are in just much worse shape" than the big banks, says Terry McEvoy, an Oppenheimer & Co. analyst who reviewed the Journal's analysis. "There is a lot less earnings power at these banks." The Fed this month estimated that the 19 stress-tested banks could face losses of $599 billion if the agency's gloomiest economic scenario comes true. For the 10 large companies found to need additional capital, most of the shortfalls are manageable. Few smaller banks are likely to attract the bargain-hunting investors now expressing interest in recapitalizing the industry's giants. Many smaller banks are trying to bolster their capital by selling assets and making fewer loans. A further drop in lending threatens to prolong the recession. "It's certainly a challenge for the economy," says Allen Tischler, a senior credit officer at Moody's Investors Service.
Banks unable to replenish capital could face a tightening regulatory vise. Some of the weakest institutions are likely to fail, although few analysts predict anything close to the 1,256 closings between 1985 and 1992. Regulators have seized 58 banks since the start of 2008, including 33 so far this year. In the government's stress tests, the Fed measured how much capital banks might need to raise to achieve a so-called Tier 1 common capital ratio, or capital buffer, equal to 4% of assets. The Journal's stress-test analysis includes 940 bank-holding companies that filed financial reports with the Fed for the year ended Dec. 31. The companies range from large regional banks to mom-and-pop banks in rural towns. The financial reports also include U.S.-based subsidiaries of foreign banks.
The banks examined by the Journal had total assets of $2.8 trillion at year end. That is less than the combined assets of Bank of America and Wells Fargo & Co., two of the nation's largest banks. The 19 big banks that underwent a Fed stress test weren't included in the Journal's calculations. The Journal projected potential losses by using the "more adverse" scenario in the government's stress test -- the scenario the Fed used to calculate how much capital the big banks should raise. That worst-case hypothetical situation includes a 2010 unemployment rate of 10.3%, compared with 8.9% in April, and a two-year cumulative loss rate of as much as 12% on commercial real-estate loans and as much as 20% on credit cards.
Using the Fed's milder "baseline" scenario, in which unemployment would have hit 8.8% next year, banks would fare much better. Total losses at the 940 banks could hit $92 billion through 2010, and only 185 banks would see their capital levels dip into risky territory, the Journal found. Several banking experts who reviewed the analysis said it is a reasonable way to assess the overall health of the U.S. banking industry. Still, the calculations don't reflect any efforts made by individual banks since the start of this year to shore up their capital, such as shedding assets or cutting costs. Some banks have gotten recent taxpayer-funded infusions through the Treasury Department's Troubled Asset Relief Program, and more help is likely on the way. Last week, Treasury Secretary Timothy Geithner said the government plans to recycle into smaller banks the capital repaid by banks that no longer need or want TARP money.
Another limitation in the Journal's analysis is that it is impossible to estimate loan losses as precisely as regulators did in the stress tests without access to information that isn't disclosed in publicly available financial reports. Under the loan-loss assumptions used in the Fed's stress tests, Synovus Financial Corp., a Columbus, Ga., bank-holding company, could face losses of as much as $3.4 billion through 2010, according to the Journal's analysis. About two-thirds of the estimated losses are from commercial real-estate loans, which Synovus barreled into when the economy was booming, especially in the Atlanta area. Synovus last year got $968 million from TARP, keeping the bank well above what it needs to be considered "well capitalized" by banking regulators. But the company's estimated losses could far exceed its revenue by the end of next year, consuming all of its capital, the analysis shows.
"From a straight math exercise, we can't disagree with you," says Thomas Prescott, Synovus's chief financial officer, although he notes he isn't "endorsing" the Journal's projections. Mr. Prescott says the Journal's projections would be more accurate if they were based on first-quarter revenue, which rebounded from lackluster 2008 levels. Nevertheless, Synovus has been selling loans in a bid to fortify its capital. In the first quarter, the company's loan portfolio shrank by an annualized 2.8%. Even using the Fed's more optimistic "baseline" economic scenario, some banks appear troubled. Under that scenario, Truman Bancorp Inc., a Clayton, Mo., lender with six branches and about $500 million in assets, could face nearly $22 million in loan losses through next year, the Journal analysis found. That would exhaust all of its capital.
"We don't see anything along the lines you're saying," says Truman Chairman Richard Miller of the Journal's estimate of potential losses. He says the bank, which lost $11.5 million last year and an additional $1.2 million in the first quarter, plans to replenish its capital by selling up to $10 million in new shares. "We're expecting to start to break out of the old pattern and get back in the black later this summer," he says. At 923 of the 940 banks examined by the Journal, estimated losses under the federal government's worst-case scenario would exceed bank revenue projected by the analysis. At 634 banks, the gap would be large enough to reduce capital below the level considered comfortable by regulators, unless the banks can somehow steady themselves.
Schwarzenegger Puts Legacy on the Line With Budget Vote
With 20 months left in office, California Gov. Arnold Schwarzenegger wants to leave behind a state that's governable. "I came in here to fix what is broken in California," he said in an interview. But his best shot at building that legacy now looks like a longshot. On Tuesday, Californians vote on a slate of ballot measures meant to address the battered finances of the nation's most-populous state. The Republican governor has spent much of the past two months crisscrossing the state to pitch the ballot's lead proposition, which he says will help pull the Golden State from the brink of insolvency and help it weather the kind of busts that have dogged it for decades.
Californians are projected to reject the measure: 57% of voters opposed it, according to poll results released late Monday by the nonpartisan Survey USA. For Mr. Schwarzenegger, a defeat would mark a repeat of the hard lesson learned by many of his predecessors: California is essentially ungovernable, especially during an economic crisis. Mr. Schwarzenegger acknowledges the poll results but remained optimistic. "I never give up," the former bodybuilder and actor told reporters Monday. In the past 12 months, California's tanking economy caused the state's budget deficit to balloon to $42 billion. A deeply polarized legislature spent 15 weeks squabbling over fiscal solutions as the budget hole deepened. The latest estimates suggest that by mid-2010, California will sink at least $15 billion further into the red.
Death Row inmates in San Quentin, California have a highly coveted view that the state and developers eye as opportunity. It's a view shared with a tiny housing community whose main street shares an entrance to the prison. Stacey Delo reports. Mr. Schwarzenegger, 61 years old, believes the state can prevent such meltdowns. His pet ballot measure, one of six up for vote, would place a spending cap on state lawmakers, California's first since a previous spending limit was nullified in the late 1980s. It would require the legislature to more than double the amount of money it socks away in good times for use as a rainy-day fund.
It would also extend a slate of tax increases imposed by the budget accord for another two years. If the proposition is voted down, lawmakers will have to find a way to make up $16 billion in revenue that the tax-hike extension was projected to bring in from July 2011 to June 2013. "Even though we fixed a lot of different things, one of the things we couldn't fix yet is the broken budget system," said Mr. Schwarzenegger at an appearance in Culver City, Calif., a week ago. "So I wanted to fix that so that we live within our means and move forward."
California's hard-to-govern reputation is hard-won. The state has passed a tangle of voter-initiated spending mandates and voter-approved antitax rules. Lawmakers have little leeway to raise revenue or slash spending in deficit years. That makes California highly dependent on one volatile stream of revenue -- personal income taxes, which account for about 53% of the general fund. Unlike many other states that rely on local property taxes to pay for schools, California pays for education primarily from its general budget. Property taxes go principally to local communities and were capped by the antitax Proposition 13 in 1978. Also, California's districts are heavily gerrymandered. The result is a hyperpartisan legislature, with pitched battles in a statehouse that requires a two-thirds majority vote to pass budgets.
In good times, these difficulties recede amid a wash of revenue. The state's economic base is so big and diverse, its talent pool so deep and its resources so rich, that the state runs a surplus and most parties prosper. In bad times, revenues from personal income taxes fall, budget deficits swell and the divided legislature tends to deadlock. The combination bedeviled several of Mr. Schwarzenegger's predecessors. In 1991, Republican Gov. Pete Wilson faced a $14.4 billion deficit and a revolt among fellow Republicans when he agreed with Democrats to raise taxes temporarily. In 2002, Democratic Gov. Gray Davis faced a $35 billion budget gap that renewed a partisan clash over how to bridge it. To balance the budget, lawmakers typically resorted to accounting gimmicks -- such as suspending a guaranteed funding increase for schools -- borrowing and other quick fixes. State finances recovered only after the economy did.
But this recession is the most severe in decades, and the state is in a deeper hole. "What California learns over and over again is that our political and fiscal system is very inflexible," says Mark Baldassare, president and chief executive of the Public Policy Institute of California, a San Francisco think tank. When Mr. Schwarzenegger was elected in 2003, he promised voters he would repair the muddled government in Sacramento. For several years, it looked like he had succeeded. He gave tax cuts to the Republicans. He forged deals with the Democrat-led legislature on measures such as combating global warming. Presidential candidates sought advice from the "post-partisan" governor on how Republicans and Democrats could work together.
But that was during a boom. A rebound in the economy after 2003 pumped so much cash into state coffers that budget disagreements in Sacramento were muted. General-fund revenues shot up 33% to $102.6 billion from 2003 to 2007. During those years, Mr. Schwarzenegger sought to address some of the causes of California's woes. In 2005, he asked voters to approve a spending cap for the state. He proposed three other ballot measures that, among other things, would curb the power of Democratic-leaning unions to make political contributions, and would make it easier to fire teachers. The measures were aimed in part at reining in union-backed big spending, which critics of California government have blamed for budget run-ups. Unions and social-services groups argued the initiatives would crimp needed spending for education, health care and other services. Californians rejected all four propositions, handing the popular governor his first major defeat.
Last year, Mr. Schwarzenegger won one victory by helping persuade voters to pass Proposition 11. That measure transferred the task of drawing the state's legislative-district boundaries from politicians to an independent commission, a move many observers say should make the districts less intensely partisan. But by then, California's economy was cratering. Personal income taxes, which soared 70% from 2002 to 2007, dropped 14% last year. By mid-2008, the budget for the fiscal year beginning July 1, 2008, had plunged a projected $15 billion into the red. The shortfall hit just as Mr. Schwarzenegger was trying to pass his next budget. He ran into the familiar stalemate. Democrats favored increased taxes. Republicans pushed for steeper spending cuts.
The legislature blew past its budget deadline of June 15, 2008. In the impasse that followed, the state was forced to lay off workers, cut wages and implement a hiring freeze. It agreed to a spending plan only in September. Following that month's shocks to the national economy, Mr. Schwarzenegger declared a fiscal emergency in November because the budget deficit for fiscal 2008 had grown by an additional $11.2 billion. The governor began near-daily meetings in his cabinet room with the "Big Five" -- Mr. Schwarzenegger and the Democratic and Republican leaders of the state Senate and state Assembly. Their goal was to cut a budget deal to close the current year's deficit, as well as cover projected red ink for the fiscal year beginning July 1, 2009. The two Republican leaders, Dave Cogdill in the Senate and Mike Villines in the state Assembly, refused to consider new taxes. They pushed their Democratic counterparts, Assembly Speaker Karen Bass and Senate President Darrell Steinberg, for more budget cuts.
By December, the projected deficit had reached $42 billion through June 2010. That same month, to preserve cash, a state board voted to shut off $3.8 billion in financing for thousands of infrastructure projects. The state controller warned that California's coffers would run dry by February. Mr. Schwarzenegger says there was no indication things were improving. "You look at the numbers and you see the decrease of the revenue and you say to yourself, 'Where is this going?'" he recalls. After intense negotiations, the Big Five struck a deal in early February that called for a compromise of tax increases, tax breaks to large corporations and budget cuts. The five leaders put their hands together like a basketball team breaking a huddle and downed shots of the governor's Schnapps to celebrate. It took several more days of wrangling with rank-and-file lawmakers for the new budget to be passed.
As part of the deal, Mr. Schwarzenegger proposed his ballot measure to cap state spending and enhance the rainy-day fund. "Because of the crisis, we were able to go and talk about budget reform," he says. "If there would be no crisis, no way." The negotiations resulted in five other ballot measures, including a proposition that would allow lawmakers to tap future lottery proceeds to pay for current spending. Another would shore up funding guarantees for schools, a measure that helped the governor gain the support of the powerful California Teachers Association. The governor's pet measure faces stiff opposition from taxpayer-rights groups and from Republican lawmakers such as Tony Strickland, the state Senate's assistant minority leader. The governor "believes his form of a spending cap...will be a step in the right direction and worth $16 billion in new taxes," Mr. Strickland says. "I say no."
Also opposed are unions such as the California Faculty Association and California Nurses Association, which say the spending cap would make it harder for the state to keep up with rising health-care costs and force service cuts even in good times. Unions and taxpayer-rights groups have separately campaigned against the measures with television ads, but have been outspent by campaigners for the "Yes" side. Perhaps the biggest strike against Mr. Schwarzenegger, however, is that these days, Californians don't like their politicians. The governor's approval rating is at an all-time low, at 33%, according to a May 1 poll by Field, a nonpartisan group. The legislature's approval rating is 14%. The only ballot measure that has overwhelming support is one that prohibits pay raises for elected state officials in years that the budget is in the red. Mr. Schwarzenegger, who is termed out of office in January 2011, says he remains determined to make California more governable. "This is not about my legacy, it's not about the politicians in Sacramento, it's not about Democrats versus the Republicans, none of that," he said at his Culver City appearance. "It's about putting the Golden State back on track."
Working on help for states but no bailout-Geithner
U.S. Treasury Secretary Timothy Geithner on Monday held the door open to possible aid to states and cities hammered by the recession but said they must work to bring their economies back to health. Geithner, speaking at a luncheon at Newsweek magazine, said he is working closely with congressional leaders to find solutions, particularly for problems related to financing. 'Of course, a lot of it will depend on how much confidence they (states) are able to engender in addressing their underlying fiscal problems,' he said. Many states had deep structural problems before the financial crisis, which then became worse.
As for any assistance, 'I wouldn't use the words 'bailout' or 'federal,'' Geithner said. 'I would say we're in close consultation with people who are looking at ways to make sure these markets are working so states and municipalities can meet their needs.' Since the recession began in December 2007, states and cities have pressed the federal government for assistance with a variety of economic troubles. In recent testimony before Congress, Geithner said he would like to help, but he has yet to hear a good idea. Last week, California State Treasurer Bill Lockyer pleaded with Geithner to have the federal government buy the state's debt using funds from the financial bailout. Although legislation authorizing the Troubled Asset Relief Program allows some money to go to states, the government has yet to send a single dollar.
At the luncheon, Geithner was asked about California's shortfall of at least $15.4 billion and its potential plans to issue $6 billion in revenue anticipation notes to stay afloat. 'We're in close touch with them, as we are with treasurers across the country,' he said. 'The municipal markets were very damaged by the early stage of the crisis.' Geithner would not say if the Treasury might take any of the steps requested by California or other states for help. State housing finance agencies, unable to sell the bonds needed for low-cost loans for first-time home buyers, have asked for assistance. On Monday the National League of Cities released a plan to create a bond insurer with a $5 billion interest-free loan from the U.S. government.
The $2.6 trillion municipal bond market has been touched by every knot of the current financial tangle. Cities and authorities were invested in Lehman Brothers and lost millions when the bank failed in September. Before that, bond insurers were downgraded by the credit ratings agencies, which forced issuers whose debt is deemed risky to pay higher interest rates. The market for auction-rate debt, long-term bonds with interest rates frequently reset at auction, froze in the middle of 2008, before the entire market seized up at the end of the year. The federal government's economic stimulus plan created a new type of debt for infrastructure known as Build America Bonds.
The Economy Is In A Sleeper Hold
After the sturm und drang of the financial crisis, the markets have gone very very quiet. Even with some gigantic crises looming (hello, California), stocks tick steadily up on light volume. There's no real sign of an economic recovery. Global trade remains way down. The folks on TV try to get excited over the fact that housing starts are edging closer to 0. The VIX is at a level not seen since early September. For now, the government has succeeded in stemming the crisis by transfering trillions of dollars in liabilities over to the public ledger, and as shoes continue to drop (maybe commercial real estate, maybe muni defaults) that will continue to be the plan. What's more, in all of our moribund or backwards industries, from cars to health, the strategy is to increase government control.
As David Goldman recently put it, the situation is "No risk, no volatility, no economy." Or as we'd put it, the government has the economy in a sleeper hold. It hasn't killed the economy, it's just put it to bed. Everything is safe and quiet. As long as the government watches over the economy, it'll make sure that we can sleep restfully, but with a pulse. But if something happens to the government -- if our foreign lenders get nervous about all this spending, with so little tax money coming in -- then watch out. That's the real last shoe to drop, because while we can always bail out California and the 600 local banks with souring commercial real estate loans, we can't bail out ourselves.
Derivatives Market Declines for First Time on Record
The derivatives market shrank for the first time in the second half of 2008 as the global financial crisis curbed trading, the Bank for International Settlements said in a report. The amount of outstanding contracts linked to bonds, currencies, commodities, stocks and interest rates fell 13.4 percent to $592 trillion, the Basel, Switzerland-based bank said yesterday. That’s the first decline in 10 years of compiling the data. The amount of credit-default swaps protecting investors against losses on bonds and loans fell 27 percent to cover a notional $41.9 trillion of debt. Investors shunned derivatives as demand for risky assets withered after Lehman Brothers Holdings Inc.’s failure in September. Trading volume may decline further after more than 2,000 banks, hedge funds and asset mangers that trade credit- default swaps agreed to a "Big Bang Protocol" last month that will make it easier to move the contracts to a clearinghouse and eliminate overlapping trades.
"Severely strained credit markets combined with efforts to improve multilateral netting of offsetting contracts" helped cut notional volumes, BIS analysts Jacob Gyntelberg and Carlos Mallo wrote in the report. The credit derivatives market contracted as traders have already started canceling redundant default swaps to appease regulators and help reduce day-to-day payments and the potential for error. "At some point you will reach the point where you have netted all your positions and then there is no possibility to further compress any trades," said Tim Brunne, a Munich-based strategist at UniCredit SpA. "Then I would expect a small increase due to presumably increasing trading activity."
The cost of protecting corporate debt against default doubled in the second half of 2008, according to the Markit iTraxx Europe Crossover index of credit-default swaps linked to high-risk, high-yield companies. The increase boosted the amount of money at stake in the contracts to $5.7 trillion from $3.2 trillion in the first half of last year, according to the BIS. The Obama administration announced proposals last week to expand regulation of derivatives, which have been blamed for contributing to the failures of Lehman Brothers and American International Group Inc., leading to the seizure of credit markets and causing more than $1.4 trillion in losses and writedowns by financial companies. If changes are not made "we will be haunted by our failure for years to come," Brooksley Born, the former U.S. official who lost the fight to regulate derivatives a decade ago, said yesterday as she accepted a Profiles in Courage award from the John F. Kennedy Library.
The data compiled by the BIS, which was formed in 1930 to monitor financial markets and regulate banks, are based on contracts traded outside of exchanges in the over-the-counter market. Interest-rate derivatives remained the largest part of the market, falling 8.6 percent in the second half of 2008 to $418.7 trillion outstanding, the report said. Foreign exchange contracts fell by 20 percent to $49.8 trillion. The amount of equity derivatives declined 36 percent to $6.5 trillion and those linked to commodities contracted by 67 percent to $4.4 trillion. Derivatives are financial instruments derived from stocks, bonds, loans, currencies and commodities, or linked to specific events like changes in interest rates or the weather. Credit- default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements
U.S. Needs More Inflation to Speed Recovery, Say Mankiw, Rogoff
What the U.S. economy may need is a dose of good old-fashioned inflation. So say economists including Gregory Mankiw, former White House adviser, and Kenneth Rogoff, who was chief economist at the International Monetary Fund. They argue that a looser rein on inflation would make it easier for debt-strapped consumers and governments to meet their obligations. It might also help the economy by encouraging Americans to spend now rather than later when prices go up. "I’m advocating 6 percent inflation for at least a couple of years," says Rogoff, 56, who’s now a professor at Harvard University. "It would ameliorate the debt bomb and help us work through the deleveraging process." Such a strategy would be risky. An outlook for higher prices could spook foreign investors and send the dollar careening lower. The challenge would be to prevent inflation from returning to the above-10-percent levels that prevailed in the 1970s and took almost a decade and a recession to cure.
"Anybody who has been a central banker wouldn’t want to see inflation expectations become unhinged," says Marvin Goodfriend, a former official at the Federal Reserve Bank of Richmond. "The Fed would have to create a recession to get its credibility back," adds Goodfriend, now a professor at Carnegie Mellon University’s Tepper School of Business in Pittsburgh. For the moment, the Fed’s focus is on preventing deflation -- a potentially debilitating drop in prices and wages that makes debts harder to repay and encourages the postponement of purchases. The Labor Department reported May 15 that consumer prices were unchanged in April from the previous month and were down 0.7 percent from a year earlier. "We are currently being very aggressive because we are trying to avoid" deflation, Fed Chairman Ben S. Bernanke told an Atlanta Fed conference on May 11.
The central bank has cut short-term interest rates effectively to zero and engaged in what Bernanke calls "credit easing" to spur lending to consumers, small businesses and homebuyers. Bernanke, 55, said the risk of deflation was receding and that the Fed was ready to reverse course when needed to maintain stable prices and prevent an outbreak of undesired inflation. The Fed has implicitly defined price stability as annual inflation of 1.5 percent to 2 percent, as measured by a price index based on personal consumption expenditures. Even after all the Fed has done to stimulate the economy, some economists argue that it needs to do more and deliberately aim for much faster inflation that would also lift wages. With unemployment at a 25-year high of 8.9 percent, workers are being squeezed. Wages and salaries rose 0.3 percent in the first quarter, the least on record, according to the Labor Department, as companies including Memphis, Tennessee-based based package-delivery company FedEx Corp. and newspaper publisher Gannett Co. of McLean, Virginia slashed pay.
Given the Fed’s inability to cut rates further, Mankiw says the central bank should pledge to produce "significant" inflation. That would put the real, inflation-adjusted interest rate -- the cost of borrowing minus the rate of inflation -- deep into negative territory, even though the nominal rate would still be zero. If Americans were convinced of the Fed’s commitment, they’d buy and borrow more now, he says. Mankiw, currently a Harvard professor, declines to put a number on what inflation rate the Fed should shoot for, saying that the central bank has computer models that would be useful for determining that. In advocating that the Fed commit itself to generating some inflation, Mankiw, 51, likens such a step to the U.S. decision to abandon the gold standard in 1933, which freed policy makers to fight the Depression. Faster inflation might be preferable to increased unemployment, or to further budget stimulus packages that push up the national debt, says Mankiw, who was chairman of the Council of Economic Advisors under President George W. Bush.
The White House has forecast that the budget deficit will hit $1.84 trillion this fiscal year, or 12.9 percent of gross domestic product. Rogoff doubts that politicians will be willing to reduce that shortfall by raising taxes as much as needed. Instead, he sees them pressing the Fed to accept faster inflation as a way of easing the burden of reducing the deficit. Inflationary increases in wages -- and the higher income taxes they generate -- would make it easier to pay off debt at all levels. "There’s trillions of dollars of debt, in mortgage debt, consumer debt, government debt," says Rogoff, who was chief economist at the Washington-based IMF from 2001 to 2003. "It’s a question of how do you achieve the deleveraging. Do you go through a long period of slow growth, high savings and many legal problems or do you accept higher inflation?" Laurence Ball, a professor at Johns Hopkins University in Baltimore, says it’s risky to try to engineer a temporary surge in inflation because it might spark a spiral of rising prices.
Even so, he sees good reasons for the Fed to lift its implicit, medium-term inflation target to 3 percent to 4 percent from 1.5 percent to 2 percent now. To battle recession, the Fed had to cut interest rates to 1 percent in 2003 and zero in the current period. That implies its inflation target has been too low because it’s left the Fed running up against the zero bound on nominal interest rates. "The basic advantage of pushing inflation a little higher is that it would make it less likely that we run into the problem of the interest rate hitting zero and the Fed not being able to stimulate the economy if necessary," Ball says. John Makin, a principal at hedge fund Caxton Associates in New York, wants the Fed to go further and target the level of prices instead of simply a rate of inflation. Such a policy would mean that if inflation fell short of 2 percent over a period of time, the Fed would have to push inflation above that rate subsequently to make up for the shortfall and keep prices rising on the desired trajectory.
While that might sound radical, it’s the same sort of policy that Bernanke advocated Japan follow in 2003 to fight deflation. In a speech in Tokyo that year, then-Fed Governor Bernanke called on the Bank of Japan to adopt "a publicly announced, gradually rising price-level target." Some investors are already worried that Bernanke will go too far. "We’re on the path of longer-term, higher inflation," says Axel Merk, president of Merk Investments LLC in Palo Alto, California. "It’s good for debtors but it’s bad for creditors. It’s dangerous and irresponsible." Billionaire investor Warren Buffett, chairman of Berkshire Hathaway Inc. in Omaha, Nebraska, suggested that faster inflation was all but inevitable. "A country that continuously expands its debt as a percentage of GDP and raises much of the money abroad to finance that, it’s going to inflate its way out of the burden of that debt," he told the CNBC financial news television channel on May 4, adding, "That becomes a tax on everybody that has fixed- dollar investments."
Brazil and China eye plan to axe dollar
Brazil and China will work towards using their own currencies in trade transactions rather than the US dollar, according to Brazil’s central bank and aides to Luiz Inácio Lula da Silva, Brazil’s president. The move follows recent Chinese challenges to the status of the dollar as the world’s leading international currency. Mr Lula da Silva, who is visiting Beijing this week, and Hu Jintao, China’s president, first discussed the idea of replacing the dollar with the renminbi and the real as trade currencies when they met at the G20 summit in London last month. An official at Brazil’s central bank stressed that talks were at an early stage. He also said that what was under discussion was not a currency swap of the kind China recently agreed with Argentina and which the US had agreed with several countries, including Brazil.
"Currency swaps are not necessarily trade related," the official said. "The funds can be drawn down for any use. What we are talking about now is Brazil paying for Chinese goods with reals and China paying for Brazilian goods with renminbi." Henrique Meirelles and Zhou Xiaochuan, governors of the two countries’ central banks, were expected to meet soon to discuss the matter, the official said. Mr Zhou recently proposed replacing the US dollar as the world’s leading currency with a new international reserve currency, possibly in the form of special drawing rights (SDRs), a unit of account used by the International Monetary Fund.
In September, Brazil and Argentina signed an agreement under which importers and exporters in the two countries may make and receive payments in pesos and reals, although they may also continue to use the US dollar if they prefer. An aide to Mr Lula da Silva on his visit to Beijing said the political will to enact a similar deal with China was clearly present. "Something that would have been unthinkable 10 years ago is a real possibility today," he said. "Strong currencies like the real and the renminbi are perfectly capable of being used as trade currencies, as is the case between Brazil and Argentina." In what was interpreted as a sign of Chinese concern about the future of the dollar, the governor of China’s central bank proposed in March that the US dollar be replaced as the world’s de-facto reserve currency.
In an essay posted on the People’s Bank of China’s website, Zhou Xiaochuan, the central bank’s governor, said the goal would be to create a reserve currency "that is disconnected from individual nations" and modelled on the International Monetary Fund’s special drawing rights, or SDRs. Economists have argued that while the SDR plan is unfeasible now, bilateral deals between Beijing and its trading partners could act as pieces in a jigsaw designed to promote wider international use of the renminbi. Any move to make the renminbi more acceptable for international trade, or to help establish it as a regional reserve currency in Asia, could enhance China’s political clout around the world.
China allows 2 banks in Hong Kong to sell yuan bonds
Two major banks outside mainland China said Tuesday they've become the first foreign companies granted approval to sell bonds in Chinese yuan - a step toward making it an international currency. The banks - London-based HSBC Holdings and Hong Kong-based Bank of East Asia - said in statements their subsidiaries in mainland China have been given permission by regulators to start issuing yuan-denominated bonds in Hong Kong. Other details, including the amounts and timing of the offerings, weren't released. It marks the first time firms based outside the mainland have been given the OK to sell such debt securities in Hong Kong, a move that furthers Beijing's goal of promoting the yuan as an alternative to the U.S. dollar for international trade and reserves. Tight government controls largely restrict the yuan's use beyond China's borders, giving Beijing influence over the currency's exchange rate, though that's slowly changing.
Last month, the government announced plans to allow Shanghai and four other major cities to settle foreign trade in yuan - also known as the renminbi - rather than in dollars. The central bank has signed a string of agreements in recent months promising to lend yuan to Hong Kong, South Korea, Malaysia, Indonesia, Belarus and Argentina that could lead more firms importing from China to pay in yuan. "The government is trying to become less reliant on U.S. dollars as a reserve currency, with a longer-term goal to make the renminbi a more global currency," said Kelvin Lau, regional economist at Standard Chartered Bank. Letting HSBC and Bank of East Asia issue bonds in Hong Kong also meshes with Beijing's ambitions for its currency. Doing so helps develop overseas financial markets for the yuan, in turn boosting its liquidity and attractiveness among investors.
For the banks, it means more yuan to lend out and fund their own operations on the mainland. "We believe that (a yuan) issue by HSBC China will help establish a representative pricing benchmark for foreign banks requiring funding, and will help the development of Hong Kong's offshore RMB market," Richard Yorke, chief executive of HSBC in China, said in a statement. Beijing has expressed unease about the dominance of the greenback, which it uses for the bulk of its trade and to store an estimated one-half of its nearly $2 trillion in reserves. China's central bank governor has called for a new global currency managed by the IMF to replace the dollar for trade and storing reserves. And in February, Premier Wen Jiabao appealed to Washington to avoid steps that might weaken the dollar or erode the value of China's holdings of Treasury bills and other dollar-denominated assets.
Wary of U.S. debt, China shifts gears on investment
China has engineered a subtle yet significant shift in the investment of its foreign exchange reserves, a sign of how it is willing to act on concerns about financing an explosion of U.S. debt. Beijing has been far and away the single biggest foreign buyer of Treasuries over the past year, but this apparent vote of confidence belies how it has turned its back on long-term U.S. debt in favor of shorter maturities. China's move to the shorter end of the U.S. debt spectrum is a defensive tactic adopted by the wider market as well on the view that the United States will have to raise interest rates down the road to control inflationary pressures when the economy recovers from the financial crisis.
But the shift also comes after pointed comments from Beijing expressing worries over the security of its U.S. investments and calls from Chinese government economists for a tough line with Washington in return for continued access to loans. "The United States is making policy decisions purely according to domestic considerations and is giving little thought to the outside world," said Zhang Ming, an economist at the Chinese Academy of Social Sciences (CASS), a leading think-tank. "This being so, the Chinese government should prepare its defenses," he said. "We can keep buying U.S. debt but we have to attach some conditions."
But China's leverage may be limited, despite sitting on the world's largest stockpile of foreign exchange reserves at $2 trillion. The very surge in U.S. debt -- the Treasury plans gross issuance this fiscal year of $8 trillion -- means China's heavy buying is increasingly looking like a drop, albeit a very big one, in the ocean. Beijing has also taken pains to stress that, while uneasy about the U.S. economic outlook, it views Treasuries as a safe investment. And it knows that it would lose a lot from a plunging dollar with so much invested in the U.S. already. So rather than cut off financing for the U.S.'s record budget deficit for this fiscal year, China has instead, little by little, shifted its buying out of longer-term bonds.
Between August 2008 and March 2009, China bought $171.3 billion of bills, debt that carries a maturity of up to a year, compared with just $22.9 billion of longer-term notes and bonds with a maturity of two years or more. It also sold $23.5 billion of long-term agency debt, U.S. data shows. That followed purchases of just $9.6 billion of bills against $47.8 billion of bonds and $45.6 billion of agency debt in the first half of 2008.
The shift illustrates how it was more than cheap talk when Premier Wen Jiabao said in March that he was "a little bit worried" about China's investments in the United States. The Chinese central bank was also unusually direct this month in expressing unease with U.S. economic policy, saying the dollar could come under serious pressure because the Federal Reserve was printing money to fend off the financial crisis. The most recent data shows China bought more long-term notes than bills in March, but a single month does not reverse the marked change over the past year. "Demand is weakening and it is being kept mainly at the short end," said Andy Xie, an independent analyst and formerly Morgan Stanley's chief China economist.
"This is an adjustment," he said of China's shift into Treasury bills. "This is not a collapse of confidence yet." Indeed, with its economy expected to speed up, China might soon have to contend with more speculative capital inflows, which would add to its forex reserves and force it to recycle yet more dollars into U.S. investments to cap yuan appreciation pressure. "The most probable scenario is one where Chinese demand for Treasuries re-emerges on the back of renewed Chinese reserve growth," said Brad Setser, an economist at the New York-based Council of Foreign Relations who tracks China's forex flows into the United States.
China has long pledged to diversify its reserves away from the dollar. The composition of its reserves is a state secret but analysts estimate the proportion in Treasuries has increased. They say about two-thirds are held in dollar-denominated assets with at least $1.2 trillion in Treasuries or U.S. government agency debt. With the United States needing to fund a huge deficit to support its recession-hit economy, Chinese government advisers have made bolder calls for Beijing to lock in better terms as its chief foreign financial backer. CASS economist Zhang said China should, for starters, mainly buy Treasury inflation-protected securities. Second, Beijing should ask Washington to issue foreign currency debt and even bonds convertible into U.S. bank stakes, he said.
Although not official policy, Zhang's views offer a window onto how Beijing is giving more thought to how to flex its muscles in the U.S. debt market. Yet China's ability to pressure the United States may be about to diminish, and quickly. China owns nearly a quarter of the U.S. debt held by foreigners, calculations based on Treasury data show. But its share of debt held by the public -- in the United States and abroad -- has leveled off at 11 percent and is likely to drop, as Washington is on course to issue about $2 trillion of net new debt this year to finance its mushrooming deficit. The bulk will be absorbed by Americans themselves, as the recession has driven U.S. households and firms to save far more.
"Conditions in the Treasury market will be increasingly determined by American demand for Treasuries and less determined by the scale of foreign demand," Setser said. This is very good news for both countries in at least one respect; it will help dismantle the "balance of financial terror" that has been said to define their relationship. The United States is now less reliant on China for financing, and China in turn can diversify away from Treasuries without destroying the value of its existing holdings. In theory, at least. Global markets' fixation with China's every move in managing its reserves will not fade away so easily. "There is still the emotional impact of the idea of China diversifying," said Stephen Green, chief China economist at Standard Chartered Bank in Shanghai. "If news of that leaked when the dollar was already weakening, the impact would be amplified."
Auditor Finds Some Chinese Stimulus Stuck in the Pipeline
A government audit of China's 4 trillion yuan (around $586 billion) stimulus plan shows that some bank funding is getting stuck in the pipeline instead of flowing to the real economy. China's National Audit Office's assessment adds to concerns about the stimulus plan's ability to propel the world's third-largest economy out of its worst growth slump in years. The auditors' report comes on top of worries that tentative recovery signs seen in the past couple of months may not add up to enough momentum to keep the economy on track once government-led investment and consumption peter out.
The report "has some substantial findings," said Xianfang Ren, analyst with IHS Global Insight. She said the issues it raised – speculative bill financing, funding delays, and not enough stimulus for small- and medium-sized enterprises – are big problems that have long been suspected. Among its recommendations, the auditor called for a review of how some financial institutions are carrying out their work in line with the government's goal of expanding domestic demand and promoting economic growth. The review would include some state-controlled commercial banks; Agricultural Bank of China; policy lenders Agricultural Development Bank of China and Export-Import Bank of China; and China Credit & Export Insurance Corp., or Sinosure, a policy-oriented export credit insurance firm.
A China Exim Bank spokesperson said he doesn't know when the review will take place. Reviews of state-owned institutions are regularly conducted by the audit office, he added. A spokesperson for Agricultural Development Bank of China said her department had no information about the planned review. The other financial institutions named weren't immediately available for comment. The auditor said some banks at the local or branch level aren't conducting adequate due diligence. The audit found some companies that applied for bill financing had put the funds into bank deposits to profit from interest rate differentials rather than use the money for short-term working capital.
Though 94% of the funds from the central government were in place for 335 new projects, supplementary funds to bring the projects to fruition were only 48% in place, the auditor said. As a result, some projects are unfinished, while others have been delayed, the report said. The auditor also discovered some false project reports and fund applications at the local level and noted that some new investment funds were used to repay project loans from earlier years. The report also said there is not enough support for small and medium-sized enterprises. "That's a big worry because SMEs are the biggest creator of jobs and if we can't provide enough jobs, then growth doesn't mean anything," said Ms. Ren. The audit office said it had discovered no "major violation problems" but recommended stepping up oversight of the stimulus plan going forward.
Lehman seeks probe into sale to Barclays
Lehman Brothers Holdings wants to investigate whether the sale of its US brokerage unit to Barclays Capital was undervalued, resulting in a "windfall" to the British bank of possibly billions of dollars.
In a court filing Monday, lawyers for Lehman Brothers Holdings said they have become aware of "apparent material discrepancies" relating to Barclays’ obligation to pay employee bonuses and cure amounts, which affected the sale price, and asset transfers related to repurchase agreements conducted during the week that the sale was negotiated.
"In the aggregate, these apparent discrepancies may have resulted in a windfall to Barclays at the expense of the estate, its creditors and other parties of interest, in an amount that could reach into the billions of dollars," the court documents say. Barclays had no comment. The move underscores tension between the company’s creditors and Barclays, which bought the North American arm of the investment bank for $1.5bn days after Lehman stunned the global financial community with its bankruptcy filing last September. Counsel for Lehman said in the filing that it tried with out success to get Barclays to voluntarily provide more information on the issues in question. The filing said that it appears that Barclays’ assumption of billions of dollars for bonuses and contract cures were "significantly overstated or inaccurate and, further, that Barclays may not have actually paid these obligations."
That raises questions, Lehman’s lawyers say, as to whether "the purported assumption of up to $4.25bn in liabilities, an integral component of the sale transaction, was genuine, adequate and fair consideration for the asset purchase…" They also question whether assets not addressed in the sale agreement were transferred to Barclays for repurchase agreements. A US bankruptcy court approved the sale of Lehman’s US brokerage business to Barclays last September less than one week after it was unveiled and during one of the most volatile weeks in Wall Street history. At the time, based on the lack of an alternative offer, the creditors committee did not oppose the sale, but it did not support it either, saying that there was insufficient time to determine whether it was the best deal Lehman could get. An informal group of bondholders, representing more than $9bn in Lehman debt, objected.
Gauging the Economy's Engine as It Sputters Along
Calling a Recession's End Is Tough Amid Conflicting Data, but Here's a User's Manual to the Gears and Measures
It's hard to tell the moment when a recession ends. The economy spews forth a stream of data daily. But at a recession's end, news typically turns mixed, as it has lately. Optimism prompted by good news can vanish quickly when bad news suggests the economy is relapsing. After a queasy period when the U.S. economy went from bad to dreadful beginning last fall, a series of improved reports has fueled hopes that the country is on the cusp of recovery. Corporate borrowing costs have fallen. Surveys of businesses and households show increased confidence. The labor market is showing tentative signs of improvement. Investors have seized onto these "green shoots," as Federal Reserve Chairman Ben Bernanke called them, sending the Dow Jones Industrial Average up 30% from its 12-year low in March.
Yet last week's government report that retail sales fell in April sapped hopes that consumer spending is on the rise. And the housing market, where the seeds of recession were sown, remains distressed. In brief, the signs of recovery so far have been inconclusive. "The shoots are still pretty green and pretty thin," warns economist James Hamilton of the University of California, San Diego. Recovery means different things to different people. Economists expect that gross domestic product, the value of all goods and services produced, will resume growing this summer. But that won't feel much like a recovery to many workers with or without a job. Companies tend to wait until they are certain that business is picking up before hiring again. "For most people, they're not going to think the bottom has been past until unemployment is falling, even if GDP is rising -- and why should they?" says Princeton University economist Alan Blinder, a former Fed vice chairman.
The official arbiters at the nonprofit National Bureau of Economic Research define recession as "a significant decline in economic activity spread across the economy, lasting more than a few months." Since the current one began in December 2007, the U.S. has lost 5.7 million jobs. GDP has contracted at more than a 6% annual rate the past two quarters, and is likely to contract further in the current quarter. The six-member NBER Business Cycle Dating Committee will probably wait to declare the recession over until the economy has improved to the point when GDP is restored to its former peak. "Until GDP and employment turn around, it's premature to declare any kind of victory," says Jeffrey Frankel, a Harvard University economist and a committee member. Nevertheless, Mr. Frankel draws comfort that credit conditions have improved markedly since the Lehman Brothers failure last September. One sign is that the short-term rates that banks charge each other to borrow money have fallen, though they're still high, compared with rates of U.S. Treasury debt. "If those get back to normal, and we dodge any new bullets, then things look very good," he says.
Financial markets are pointing to recovery. Investors are out of panic mode. A rally in corporate bonds has sent their yields lower. Investor willingness to take more risk has pushed down the prices of Treasury bonds, and thus pushed up their yields. The result is a narrowing in the gap between yields on corporate bonds and Treasurys, a development that is often a forerunner to economic recovery. Investors often sniff out the end to recession before it occurs, and rising markets often provide a confidence-boosting, all-clear signal to fretful consumers and business executives. Adding to optimism is the improving mood of manufacturing purchasing managers, surveyed monthly by the Institute for Supply Management in a report that precedes hard government data. The April survey found signs that the slowdown in manufacturing has eased. More purchasing managers said orders were picking up than said they were falling, a welcome sign.
In the labor market, one of the nearly instant measures is the weekly tally of Americans filing new claims for unemployment benefits. Even with a flurry of Chrysler workers furloughed, that number is below the peak hit earlier this spring. The four-week average, monitored because it smoothes week-to-week volatility, was 630,500 as of May 9 -- still high, but down from early April's peak of 658,750. A cresting in that measure has been a reliable signal that a recession is within six weeks of ending, says Northwestern University economist Robert Gordon, who sits on the NBER committee. "This thing does amazingly well," he says of the indicator. "Even if you were shut up in a dark room, you could forecast the end of the recession." In the wake of the financial crisis and the steep downturn it provoked, the economy may be at the start of an almost "garden-variety" recovery, thinks Mr. Gordon. That means improved confidence will yield a pickup in sales and, in turn, an increase in corporate investment and hiring.
But for an economy battered by the worst downturn in at least a quarter-century, there is still plenty that could go wrong. The economy shed 539,000 jobs last month, less than any month since October but still a very sharp decline. "It's hard to get euphoric about the snapshot for employment in April, since it was the worst number I've seen in my career, except for the last six months," says economist Robert Barbera of research and trading firm ITG. A recovery can begin even if jobs are slow to come back -- if households feel confident enough to increase spending in anticipation of better times. The problem now is that a persistent collapse in house prices has hurt many households' finances and tight-fisted lenders have limited their ability to borrow. That makes it even harder for them to spend more. "The optimistic interpretations of a number of recent statistics are incorrect -- too optimistic," says Harvard's Martin Feldstein, an NBER committee member. "There's a grabbing for good news, and when you dig down a little deeper, the news isn't good."
In the past, one signal that the economy was coming out of recession was an increase in the number of new single-family homes that builders started, often because lower interest rates prompted more building. This time, home building remains depressed. The latest data suggest that housing starts have stopped falling, finally, but they remain 50% below the year-earlier level and 80% below the 2006 peak. In every recession, the economy breaks some rule. This time around, it may be the rule that an ebb in unemployment claims presages recovery. Or that housing must recover for the all-clear signal to sound. While economists would like all the arrows to line up according to their theories, Harvard's Mr. Frankel says, "the reality is always much more jagged than that."
Small Firms Wait for a Credit Thaw
Big companies are rushing to issue stocks and bonds to suddenly hungry investors. But credit is still scarce for thousands of mostly smaller companies that rely on bank lending. U.S. corporations such as Ford Motor Co. and MGM Mirage Inc. raised more than $34 billion by selling stock in the first two weeks of May. At around the same time, Bill Mulrooney, chief financial officer of UniFoil Corp., was setting aside plans to borrow money for new equipment that the company had hoped would boost sales. "I hear about the credit markets' freeing, but it's clearly not the case for small businesses," Mr. Mulrooney says. UniFoil, a Fairfield, N.J., packaging maker with about $35 million a year in revenue, has been unsuccessfully shopping since January for a $2 million loan to buy equipment that would allow it to offer new features. J.P. Morgan Chase & Co. and other big banks declined. Smaller finance companies asked UniFoil, which posted losses in 2008 and 2009, to pay an $800,000 "deposit" to secure the loan.
"That defeats the purpose of what we're trying to do," Mr. Mulrooney says. "We're trying not to tie up capital." J.P. Morgan spokesman Tom Kelly said the bank continues to make loans using "disciplined and sound lending standards." Other small businesses are in similar straits as banks rein in credit and rebuild their capital bases. The lack of credit is weighing on a main source of U.S. jobs and hurting companies that buy equipment and other products from companies further up the food chain. Consider Cleveland-based Parker-Hannifin Corp. It boasts an untapped credit line of $1.5 billion, but CFO Timothy Pistell says the inability of Parker's customers to get loans in recent months has contributed to a collapse in demand for its hydraulic equipment, used on everything from bulldozers to airplanes. "If it's easing, it's not showing up in a positive way in our order book," Mr. Pistell says. "I just don't think banks -- with all these stress tests going on -- are yet willing to lend."
The Federal Reserve's April survey of bank loan officers found that 40% of U.S. banks had tightened standards for commercial and industrial loans since January. Nearly 70% of respondents said they had raised interest rates on credit lines. That's fewer banks than said they had tightened lending standards in the January survey. But only one of the 53 banks responding said it eased standards or loan terms. "What we're seeing is a return to more rational pricing of risk," says Bob Eisenbeis, chief monetary economist for Cumberland Advisors and former research director at the Federal Reserve Bank of Atlanta. Michael Porcelain, CFO of Comtech Telecommunications Corp., knows from experience that capital markets can be more welcoming now than banks. Earlier this year, the Melville, N.Y., telecom-equipment maker unsuccessfully sought a five-year line of credit.
Instead, on May 8, Comtech, whose shares trade on Nasdaq, raised $200 million by selling investors notes that can be converted into stock and pay 3% interest. The notes provided "financing from equity investors that we could not get from the banks today," Mr. Porcelain says. Comtech, with revenue of $562 million in the fiscal year ended July 31, wants the money for potential acquisitions and to solidify its access to capital in an uncertain economy. "Who knows what the economy is going to be like for the next 12 to 18 months?" Mr. Porcelain says. To be sure, banks are lending millions daily, and some companies say they're winning better terms than in years past. Joe Peregman, owner of Ocean Tents & Party Rentals in Mount Holly, N.J., says he recently obtained a $150,000 equipment loan and refinanced a $780,000 loan on a building from PNC Financial Services Group Inc., at rates one to two percentage points lower than he had been paying.
But Mr. Peregman says it took longer to win approval for the loans -- three to four months, compared with three to six weeks prior to the financial crisis. The delay "is holding up a lot of work we wanted to have accomplished," he says. Companies with fewer than 500 employees account for more than half the country's nonfarm private gross domestic product and about half of all private-sector employment, according to the U.S. Small Business Administration's Office of Advocacy. They also rely heavily on credit cards and bank loans for financing. But small businesses traditionally represent a riskier segment of the lending business, says Bob Seiwert, head of the American Bankers Association's Center for Commercial Lending and Business Banking.
Many companies continue to struggle to obtain credit. Designed Alloy Products Inc. is looking for $6.5 million to outfit a Chattanooga, Tenn., factory it bought in late 2007. Designed Alloy Products, a closely held Aurora, Ill., maker of nickel- and cobalt-based alloys with 2008 revenue of $72 million, purchased the building and began the renovation based on an oral agreement in late 2007 with Merrill Lynch & Co., its longtime lender. Designed Alloy Products CFO Kevin Maher says Merrill last summer said it would provide financing for only half of the project, which included a $1.5 million mortgage, renovations and new equipment. "Merrill told us to jump, and sort of let go of the bungee cord," Mr. Maher says.
Mr. Maher then approached Harris N.A., a Chicago-based banking unit of Toronto-based BMO Financial Group, which grew wary when Designed's sales slumped late last year. It ultimately offered a loan backed by all of Designed's $17 million in assets, including land, buildings and equipment. The deal stalled in March when Harris asked Mr. Maher for additional financial reports. Mr. Maher is looking for another potential lender, while the Chattanooga plant sits idle. A Harris spokesman declined to comment on specific customers, but says the bank "has a strong record of lending to small and medium-sized businesses." A Merrill spokesman also declined to comment on Designed, but says it tries to "create financing based on current market conditions."
Norway Falls Into Recession
Norway's non-oil economy sank into recession, reflecting sharply lower manufacturing output, Statistics Norway said Tuesday. Gross domestic product fell 1% in the first quarter compared with a downwardly revised contraction of 0.8% in the fourth quarter of 2008. Total GDP, which includes oil and gas and ocean shipping, contracted 0.4% in the first quarter, swinging from growth of 0.8% in the fourth quarter of 2008. Norway has fared better than many other economies in the global downturn, but activity has fallen, business failures have risen and joblessness is increasing also in this wealthy nation.
Statistics Norway said activity was lower across the board in the manufacturing sector, but production of basic metals and wood products "made a particularly strong contribution to the decrease." Interest rates in Norway are currently at 1.5%, but the central bank has indicated they could be cut to as low as 1% over the course of the year. Analysts at Handelsbanken said investment plunged even more than anticipated, due largely to lower industrial production and public outlays. "The latter underscores the long time lag in implementing the public stimulus package," they said. "We had expected flat development in imports due to somewhat higher domestic demand. However, the substantial fall in the first quarter indicates that this will take time," it added.
German Investor Confidence Rises to Three-Year High
German investor confidence rose more than economists forecast to a three-year high in May after stock markets rallied and data signaled the worst of the recession may have passed. The ZEW Center for European Economic Research said its index of investor and analyst expectations, which aims to predict economic developments six months ahead, increased to 31.1 from 13 in April. Economists expected a jump to 20, according to the median of 35 forecasts in a Bloomberg News survey. European stocks have gained for the past two months on the expectation that government and central bank efforts to revive economic growth will work. While the German economy shrank at a record pace in the first three months of the year, manufacturing orders and exports unexpectedly rose in March and business confidence rebounded from a 26-year low in April.
"It’s another sign that a recession will weaken substantially with a return to economic growth toward year- end," said Rainer Guntermann, an economist at Dresdner Kleinwort in Frankfurt. "Investor confidence has room to improve further over the coming months." German Chancellor Angela Merkel’s coalition will spend about 82 billion euros ($111 billion) to stem the country’s worst recession in more than six decades. The European Central Bank has trimmed its key rate to a record low of 1 percent and announced it will purchase 60 billion euros of covered bonds to help free up credit. The pan-European Dow Jones Stoxx 600 Index has rebounded 32 percent from this year’s low hit on March 9, with Germany’s benchmark DAX Index recording a similar gain. Commerzbank AG Chief Executive Officer Martin Blessing said May 15 that Germany’s second-biggest bank will return to profitability by 2011 and doesn’t need any more state aid. "We have reached a stabilization of the situation," ECB Executive Board member Gertrude Tumpel-Gugerell said in Berlin today. Still, the crisis isn’t over, she said.
Confidence in the global economy rose to the highest level in 19 months in May, a Bloomberg survey of users on six continents showed. Federal Reserve Chairman Ben S. Bernanke said May 5 that the U.S. housing market has "shown some signs of bottoming" after a three-year slump, which triggered the global recession. Still, Germany’s economy, Europe’s largest, contracted 3.8 percent in the first quarter from the fourth, the most since records began in 1970 and more than economists had forecast. The government expects gross domestic product to plunge 6 percent this year. ZEW’s gauge of the current situation fell to minus 92.8 from minus 91.6 in April. Bundesbank President Axel Weber tried to temper optimism about a recovery, warning against "exaggerating" recent positive signals.
"The crisis has yet to reach the people via job losses," he said in an interview with the Financial Times Deutschland published yesterday. "Calling an end to the crisis too early is very risky. People will be disappointed and that could have an enormous impact on confidence." German unemployment rose for a sixth straight month in April, pushing the jobless rate to a 16-month high of 8.3 percent. Holger Schmieding, chief European economist at Banc of America Securities-Merrill Lynch, said Germany is nevertheless ideally positioned to benefit from even a nascent global recovery. "Germany should be over the worst," he said. "While I’m not talking about a boom, the country will benefit from global catch-up demand in investment. It has fallen so dramatically that there will be significant upside now."
Russian Economy Minister Says Economy May Shrink up to 8%
Russian Economy Minister Elvira Nabiullina said the economy may shrink as much as 8 percent this year, revising down a January forecast. "The specific contraction numbers could be 4 percent or 6 percent or 8 percent," Nabiullina said in an interview with Bloomberg Television in Moscow today. "We’re doing various calculations, pessimistic and optimistic. We believe much depends on how efficient we are." The economy of the world’s biggest energy exporter contracted an annual 9.5 percent in the first quarter, the worst drop in 15 years.
Industrial output declined a record 16.9 percent in April as companies struggled to find funds for their businesses. The ministry revised down its forecast for the global decline to 1.4 percent from 0.3 percent this year, Nabiullina said. "The main thing is to prepare our policies and to respond," she said. "That’s the most important part of economic policy, not even the accuracy of the forecast, which changes every month, but knowing what to do for each possible scenario." The ministry will submit new forecasts for Russian economic growth by the end of the month. In January, it estimated gross domestic product may fall 2.2 percent, saying that was the most likely base scenario.
Russia, which is preparing to receive business leaders and heads of state at the St. Petersburg Economic Forum in June, attracted more than $9 billion of direct foreign investment in the first three months, Nabiullina said. "We have our problems, but we are moving consistently to improve the tax, administrative and judicial systems, and enhance access to infrastructure, transport and energy so that doing business here is more convenient and more profitable," she said. "Foreign investment is in our self-interest, most of all in order to diversify our economy."
US Farms Start to Feel Credit Pinch
The credit crunch is trickling down to the farm as agricultural lenders tighten credit standards, leaving some farmers short of money to feed their animals or put in crops as the planting season nears its end. Deepening slumps in the livestock, dairy and ethanol industries have contributed to mounting troubles for rural lenders. That is making it harder for some growers to borrow money they need to buy seed, fertilizer, equipment and animal feed. "It's tough," said Bruce Drinkman, a 46-year-old dairy farmer in Glenwood City, Wis., who recently had his credit line drastically reduced. "My whole lifetime of work could be destroyed."
Borrowing is important to farmers this time of year as they try to finish up planting before it's too late -- generally by mid-June, depending on the region. Fertilizer and other costs remain high; farm-production expenses this year are expected to make up 79% of gross farm income, an increase from last year, the Agriculture Department said. Lending woes are an about-face for the agriculture sector, which has remained a relative bright spot in the economy. Over the past two years, high grain prices and rising global demand for food and the biofuel ethanol lifted farmers' profits and helped rural businesses and banks. Debt-to-asset ratios for farmers are still at all-time lows. "A year ago, when I went around the country, ag bankers were saying, 'I don't have anything on my credit-watch list,' " said economist Michael Swanson of Wells Fargo, one of the nation's largest agriculture lenders.
Rural lenders tended to be more conservative in their lending and were less exposed to the subprime-housing debacle and other Wall Street tumult. But in recent months they have had to confront spreading troubles in the dairy, poultry, hog and ethanol businesses. The Federal Reserve Bank of Kansas City said Friday that "turbulent agricultural and macroeconomic conditions" are contributing to "tightened agricultural credit conditions" in its seven-state region. The Minneapolis Fed said much the same in an assessment of its six-state region last month. The Kansas City Fed said a record percentage of agriculture lenders surveyed in the first quarter reported raising their collateral requirements, a key indicator of credit standards. The same group of respondents reported the lowest farm-income and capital-spending levels in six years, a sign that farmers are tightening their belts.
Last week, Agriculture Secretary Tom Vilsack visited Brush, Colo., and was greeted by hundreds of farmers demanding financial assistance in the wake of the April 10 failure of New Frontier Bank in nearby Greeley. That failure alone "has shocked our system," said Gary Teague, a Fort Morgan, Colo., corn farmer, cattle rancher and feedlot operator who banked at New Frontier and is now scrambling to find a new lender. Mr. Drinkman, the Wisconsin dairy farmer, and his wife opted to cash out her individual retirement account to buy corn seed and meet other dairy-related expenses when they couldn't find a lender willing to replace the credit pulled back by Independence State Bank. "It's not fair to us to basically pull the rug out from under us," Mr. Drinkman said.
Dennis Meyer, president and chief executive of Independence Bank of Independence, Wis., said he couldn't comment on individual customers, but that his bank considers each prospective borrower's cash-flow projections and ability to service debt. "If it isn't there, it's really not right for the lender to say, 'We have enough collateral, and we'll just keep going with you,' " Mr. Meyer said. He cited the 1980s farm crisis, when a combination of excessive debt and high interest rates produced a wave of foreclosures and farmer suicides. "I'd rather have somebody upset with me and lose their business than to sell them out and go through those types of things again," Mr. Meyer said.
Loan applications at the federally backed Farm Service Agency, a lender of last resort, have surged to a 20-year high as farmers seek help after being turned away by traditional lenders. As of April 30, the agency had made about $728 million of direct operating loans for the fiscal year ending Sept. 30, up nearly 70% from a year earlier. The Farm Credit System, a federally chartered network of five banks and 90 borrower-owned associations, reported a nearly 20% decline in its first-quarter 2009 combined net income. Net income at AgStar Financial Services, an agricultural and rural lender based in Mankato, Minn., dropped 56% in the first quarter of 2009, while its provisions for loan and lease losses soared to $16.9 million, up from $713,000 the previous year.
Rodney W. Hebrink, AgStar's chief financial officer, said strong performance at the bank over the past few years meant a contraction was foreseeable. "When you start at the best you've ever been, there's only one place to go," he said. Mr. Hebrink said the bank hasn't tightened its lending standards. Douglas R. Stark, president and chief executive at Farm Credit Services of America, based in Omaha, said that while he thinks the agriculture economy is still "relatively strong," he is seeing more farm customers who require some sort of loan restructuring. Mr. Stark's bank saw a 41% drop in net income for its first quarter and a $29.5 million provision for loan losses, up from $583,000 the year prior. "Certainly, we would look at new requests for credit with a much more critical eye," he said.
The Barbarians At The Gate
by George Monbiot
The principal cause of man’s unhappiness is that he has learnt to stay quietly in his own room. If our needs are not met, if justice is not done, it is because we are not prepared to leave our homes and agitate for change. Blaise Pascal (”the sole cause of man’s unhappiness is that he does not know how to stay quietly in his own room”) couldn’t have been more wrong. We do not starve, we are not arbitrarily imprisoned, we may vote, travel and read and write what we wish only because of the political activism of previous generations. Almost all MPs, when pushed, will acknowledge this. Were it not for public protest they wouldn’t be MPs. Yet, though the people of this country remain as mild and as peaceful as they have ever been, our MPs have introduced a wider range of repressive measures than at any time since the Second World War. A long list of laws – the 1997 Protection from Harassment Act, Terrorism Act 2000, Regulation of Investigatory Powers Act 2000, the 2005 Serious Crime and Police Act and many others(1) - treat peaceful protesters as if they are stalkers, vandals, thugs and terrorists.
Thousands of harmless, public-spirited people now possess criminal records. This legislation has been enforced by policing which becomes more aggressive and intrusive by the month. The police attacks on the G20 protests (which are about to be challenged by a judicial review launched by Climate Camp) are just the latest expression of this rising state violence. Why is it happening? Before I try to answer this, let me give you an idea of just how weird policing in Britain has become. A few weeks ago, like everyone in mid-Wales, I received a local policing summary from the Dyfed-Powys force. It contained a section headed Terrorism and Domestic Extremism. “Work undertaken is not solely focussed on the threat from international terrorists. Attention has also been paid to the potential threat that domestic extremists and campaigners can pose.” I lodged a freedom of information request to try to discover what this meant. What threat do campaigners pose?
I’ve just been told by the police that they don’t intend to reply within the statutory period, or to tell me when they will(2). I’ll complain of course, and (in 2019 or so) I’ll let you know the result. But Paul Mobbs of the Free Range Network has found what appears to be an explanation. Under the heading “Protect[ing] the country from both terrorism and domestic extremism”, the Dyfed-Powys Police website repeats the line about domestic extremists and campaigners. “In this context, the Force was praised for its management management of the slaughter of what was felt to be a sacred animal from the Skanda Vale religious community in Carmarthenshire”(3). You might remember it: this Hindu community tried to prevent Shambo the bull from being culled by the government after he tested positive for TB. His defenders sought a judicial review and launched a petition. When that failed, they sang and prayed. That’s all.
Mobbs has also found a bulletin circulated among Welsh forces at the end of last year, identifying the “new challenges and changes” the police now face. Under “Environmental” just two are listed: congestion charging and “eco-terrorism”(4). Eco-terrorism is a charge repeatedly levelled against the environment movement, mostly by fossil fuel lobbyists. But, as far as I can discover, there has not been a single recorded instance of a planned attempt to harm people in the cause of environmental protection in the United Kingdom over the past 30 years or more. So what do the police mean by eco-terrorism? It appears to refer to any environmental action more radical than writing letters to your MP.
The Association of Chief Police Officers (ACPO) now runs three units whose purpose is to tackle another phenomenom it has never defined: domestic extremism. These are the National Extremism Tactical Co-ordination Unit (NETCU), the Welsh Extremism and Counter-Terrorism Unit and the National Public Order Intelligence Unit. Because ACPO is not a public body but a private limited company, the three bodies are exempt from freedom of information laws and other kinds of public accountability, even though they are funded by the Home Office and deploy police officers from regional forces. So it’s hard to work out exactly what they do, apart from libelling peaceful protesters. I wrote a column in December about the smears published by NETCU, which described villagers in Oxfordshire peacefully seeking to prevent a power company from filling their local lake with fly ash as a “domestic extremist campaign”(5).
It also sought to smear peace campaigners, Greenpeace and Climate Camp with the same charge. NETCU’s site went down on the day my column was published and hasn’t been restored since. But we have only patchy evidence of what else these three unaccountable bodies have been up to. They appear to have adopted the role once filled by Special Branch’s counter-subversion campaign, which spied on Labour activists, including Jack Straw and Peter Mandelson (sadly the spooks failed to bump them off while there was still time). But as Paul Mobbs points out in his new report on Britain’s secretive police forces, today the police appear to be motivated not by party political bias, but by hostility towards all views which do not reflect the official consensus(6).
Mobbs proposes that mainstream politics in Britain cannot respond to realities such as global and national inequality, economic collapse, resource depletion and climate change. Any politics that does not endorse the liberal economic consensus, which challenges the concentration of wealth or power, or which doesn’t accept that growth and consumerism can be sustained indefinitely, is off-limits. Just as the suffragettes were repressed because their ideas – not their actions - presented a threat to the state, the government and the police must suppress a new set of dangerous truths. By treating protesters as domestic extremists, the state marginalises their concerns: if people are extremists, their views must be extreme. Repression, in a nominal democracy, cannot operate accountably, so the state uses police units which are exempt from public scrutiny.
I am sure Mobbs is right. There is no place for dissenting views in mainstream politics. I was told recently by a Labour back-bencher – a respected MP untainted by the expenses scandal - that “if the door was open just an inch to new ideas, I would stay on. But it has been slammed shut, so I’m resigning at the next election.” Our grossly unfair electoral system, which responds to the concerns of just a few thousand floating voters and shuts out the minor parties; the vicious crackdown on dissent within parliament by whips and spin doctors; the neoliberalism forced upon governments by corporate power and the Washington Consensus; the terror of the tabloid press: all combine to create a political culture which cannot respond to altered realities without collapsing. What cannot be accomodated must be suppressed. The police respond as all police forces do; protecting the incasts from the outcasts, keeping the barbarians from the gate. The philosophy of policing has not changed; they just become more violent as the citadel collapses.