Men of Maynardville, Tennessee
Ilargi: The main difference -and 'distance'- between a financial slash economical crisis and a full blown all out political crisis in a democratic political system can be overwhelmingly found in two simple issues.
- What do the parties subject to the crisis, the citizens (voters), business leaders and policy makers, see and expect going forward?
- How truthful, and more broadly, how open, are the various parties amongst each other and towards the other parties?
We’ve been bombarded with guesses, estimates, broken promises and above all figures about the stress tests for 19 banks that have been conducted in the US. Two days before Thursday's latest announced deadline for publication of the data, how many among us still have faith that what will be publicized, be it Thursday or even later, will be close enough, for our liking, to the real objective truth? I can't look into your head, but I'd venture that this faith is subject to serious erosion. Paul Miller at FBR says only one bank, JPMorgan, effectively passed the test. I suggest you remember that for Thursday. Mind you, the official announcements will primarily be directed at confusing you, so by Friday morning you won't be able to tell left from right.
If this were an exception, the damage would be limited. It is not. Every single financial rescue and bail out policy undertaken in the past year and change by two -seemingly- different administrations have one thing in common more than any other: the way in which, and the degree to which, they are explained to the public, who happen to be forced to pay for all of it (ALL of it), is shallow at best and for all intents and purposes non-existent in most cases. Moreover, what does find its way into the public eye through a media industry that has long given up any semblance of truth finding, has a highly questionable degree of veracity.
There are in America today, as per the polls, millions who trust Obama no matter what he does, and many more whose curiosity is satisfied by the messages his spin campaign puts out. You need only to look at the rise in the Dow or the S&P indices to see that the campaign largely works so far. Even though there's no evidence that anything there says overall financial and economic conditions have improved, it does indicate a high level of gullibility. I refuse to even contemplate that i'm the only person who'd be baffled by the fact that the AIG bonuses blow-out fizzled as it did, and led to no other outrages, while injustices a thousand time larger go unnoticed.
But all that's just the way in which the second part of how you go from an economical crisis to a political one pans out. And it becomes boring, once you figure out that no-one can be trusted to believe in what they say, that presidents can be, and are, sold like detergents, that is, in reference to people's base instincts instead of their rational grasp of their lives. Bad enough as the lack of truth and openness may be, I do think that the number one reason I mentioned above that causes a financial crisis to explode into a political one, is more important (and I say that knowing that they feed off each other).
To reiterate, I posed this question: "what do the parties subject to the crisis, the citizens (voters), business leaders and policy makers, see and expect going forward?" The reason I think this is even more important than all the lies (I saw all politicians MUST lie or change jobs years ago), is that an entire gamut of policies all based on dead wrong assumptions on where things are headed is far more harmful than doing the right things without telling voters. I know, I risk eating my own tail here, don't I? Then again, what can you possibly expect to come from this:
Federal Reserve Bank of Minneapolis President Gary Stern said : "....come the middle of next year, I would expect to see a resumption of healthy growth".Followed by:
"... it is difficult at this stage to identify with conviction the engine, or engines, of expansion..."
See, it's a tremendous confidence booster to have Fed officials declare "healthy growth" is just around the corner, and follow that up with admitting they have not a single clue where that growth would come from. I believe, I believe. That's why what these people see going forward is crucial. And if you look closely, that's all we've got, and that's all we get, belief. And even without getting into the semantics of what sort of growth is "healthy" when you, just to name an example, have a ocean of plastic the size of Western Europe floating on top of the Pacific Ocean, cleaning up of which would take more than the entire and rapidly diminishing annual US GDP, at a certain point you’ll be forced to look into the mental health of Mr. Stern and all his counterpeers. Thing is, it'll be way too late once we get around to doing that. And that's how, and why, we find ourselves in a political crisis.
You can have a system in which a handful of people get very rich and are hardly questioned doing it. The one thing they will have to provide doing it, though, is enough basic resources for the rest of society to simply survive. A home, food, water, heating, clothing. We've today come to a point where those basic needs are used by the few to maintain and enhance their share of the riches, at the cost of what the many can't do without if they wish to live. And that will not work. There is no growth in sight going into the future. There is either redistribution or battlegrounds. And I see preciously few around me who’ll voluntarily choose the first option.
JPMorgan Chase Is Only Commercial Bank That Won't Need Funding, FBR Says
JPMorgan Chase & Co., the second- largest U.S. bank by assets, is the only lender among 12 commercial banks being stress-tested by the government that probably won’t need more capital, Friedman, Billings, Ramsey Group Inc. analyst Paul Miller wrote to clients today. All the commercial banks may need capital under a "more adverse" scenario, Miller wrote. The Treasury is testing 19 of the biggest U.S. financial firms, including credit-card lender American Express Co. and insurer MetLife Inc., with results expected to be made public later this week. Miller’s assessment mirrors that of JPMorgan Chief Executive Officer Jamie Dimon, who said yesterday on a conference call he didn’t believe the New York-based lender needed to raise more capital.
Dimon, 53, repeated his desire to repay the $25 billion his firm received in October as part of the government’s Troubled Assets Relief Program. The Federal Reserve plans to deliver results of the tests to executives today that may show 10 companies need additional capital to weather a deeper recession, people familiar with the matter said. Much of the needed capital would likely come from converting preferred shares to common stock, the people said. Bank of America Corp. and Wells Fargo & Co. would need a combined $31.35 billion in additional capital after the U.S. finishes stress-testing, the FBR report said.
JPMorgan fell 2.1 percent to $35.05 in 9:52 a.m. New York Stock Exchange composite trading. Bank of America, based in Charlotte, North Carolina, rose less than 1 percent to $10.43 and Wells Fargo, based in San Francisco, dropped 5.9 percent to $22.81. Bank of America, the largest U.S. bank by assets, will need $19.02 billion to achieve a 4 percent ratio of tangible common equity to risk-weighted assets, while Wells Fargo, the fourth- largest bank, will need $12.33 billion, said Miller, a former bank examiner. "Banks will most likely bolster their capital levels by converting preferred equity (including TARP) into common equity, as it is the cheapest and easiest route," Miller said.
We Can't Subsidize the Banks Forever
by Matthew Richardson And Nouriel Roubini
The results of the government's stress tests on banks, to be released in a few days, will not mark the beginning of the end of the financial crisis. If we are to believe the leaks, the results will show that there might be a few problems at some of the regional banks and Citigroup and Bank of America may need some more capital if things get worse. But the overall message is that the sector is in pretty good shape. This would be good news if it were credible. But the International Monetary Fund has just released a study of estimated losses on U.S. loans and securities. It was very bleak -- $2.7 trillion, double the estimated losses of six months ago. Our estimates at RGE Monitor are even higher, at $3.6 trillion, implying that the financial system is currently near insolvency in the aggregate. With the U.S. banks and broker-dealers accounting for more than half these losses there is a huge disconnect between these estimated losses and the regulators' conclusions.
The hope was that the stress tests would be the start of a process that would lead to a cleansing of the financial system. But using a market-based scenario in the stress tests would have given worse results than the adverse scenario chosen by the regulators. For example, the first quarter's unemployment rate of 8.1% is higher than the regulators' "worst case" scenario of 7.9% for this same period. At the rate of job losses in the U.S. today, we will surpass a 10.3% unemployment rate this year -- the stress test's worst possible scenario for 2010. The stress tests' conclusions are too optimistic about the banks' absolute health, although their relative assessment is more precise, because consistent valuation methods were used. Still, with Thursday's announcement of the results, it shouldn't be a surprise when the usual suspects emerge. We fear that we are back to bailout purgatory, for lack of a better term. Here are some suggestions for how to extricate ourselves.
First, while Treasury Secretary Timothy Geithner's public-private investment program (PPIP) to purchase financial firms' assets is not particularly popular, we hope the government doesn't give up on it. True, the program offers cheap financing and free leverage to institutional investors, which will lead to the investors overpaying for the assets. But it does promote price discovery and remove the assets from the bank's balance sheets -- necessary conditions to move forward. And to minimize the cost to taxpayers, banks must not be allowed to cherry-pick which legacy assets to sell. All the risky loans and securities banks were never meant to hold should be on the block. With enough investors participating in the PPIP program, the prices of the assets should be competitive, and there should be no issue of fairness raised by the banks.
Second, the government should stop providing capital, loan guarantees and financing with no strings attached. Banks should understand this. When providing loans to troubled companies, they place numerous restrictions, called covenants, on what these firms can do. These covenants generally restrict the use of assets, risk-taking behavior, and future indebtedness. It would be much better if the government focused on this rather than on its headline obsession with bonuses. For example, consider the fact that the government, while providing aid to banks, did not restrict their dividend payments. A recent academic study by Viral Acharya, Irvind Gujral and Hyun Song Shin (www.voxeu.org) notes that banks only marginally reduced dividends in the first 15 months of the crisis, paying out a staggering $400 billion in 2007 and 2008. While many banks have been reducing their dividends more recently, bank bailout money had been literally going in one door and out the other.
Consider also recent bank risk-taking. The media has recently reported that Citigroup and Bank of America were buying up some of the AAA-tranches of nonprime mortgage-backed securities. Didn't the government provide insurance on portfolios of $300 billion and $118 billion on the very same stuff for Citi and BofA this past year? These securities are at the heart of the financial crisis and the core of the PPIP. If true, this is egregious behavior -- and it's incredible that there are no restrictions against it. Third, stress tests aside, it is highly likely that some of these large banks will be insolvent, given the various estimates of aggregate losses. The government has got to come up with a plan to deal with these institutions that does not involve a bottomless pit of taxpayer money.
This means it will have the unenviable tasks of managing the systemic risk resulting from the failure of these institutions and then managing it in receivership. But it will also mean transferring risk from taxpayers to creditors. This is fair: Metaphorically speaking, these are the guys who served alcohol to the banks just before they took off down the highway. And we shouldn't hear one more time from a government official, "if only we had the authority to act . . ." We were sympathetic to this argument on March 16, 2008 when Bear Stearns ran aground; much less sympathetic on Sept. 15 and 16, 2008 when Lehman and A.I.G. collapsed; and now downright irritated seven months later. Is there anything more important in solving the financial crisis than creating a law (an "insolvency regime law") that empowers the government to handle complex financial institutions in receivership? Congress should pass such legislation -- as requested by the administration -- on a fast-track basis.
The mere threat of this law could be a powerful catalyst in aligning incentives. As the potential costs of receivership are quite high, it would obviously be optimal if the bank's liabilities could be restructured outside of bankruptcy. Until recently, this would have been considered near impossible. However, in 2008 there was a surge in distressed exchanges of debt for equity or preferred equity. Still, the recent negotiations with Chrysler's creditors suggest large obstacles. The size and complexity of large banks' capital structures make debt-for-equity exchanges an even taller task, particularly because creditors will want to hold out for a full bailout along the lines they have been receiving. The government should be able to dangle an insolvency law as an incentive to cooperate. This will result in a $1 trillion game of chicken. But given the size of the stakes, and the alternative of the taxpayers continuing to foot the bill, it's the best way forward.
More Banks Will Need Capital
The U.S. is expected to direct about 10 of the 19 banks undergoing government stress tests to boost their capital, according to several people familiar with the matter, a move that officials hope will quell fears about the solvency of the financial sector. The exact number of banks affected remains under discussion. It could include Wells Fargo & Co., Bank of America, Citigroup Inc. and several regional banks. At one point, officials believed as many as 14 banks would need to raise more funds to create a stronger buffer against future losses, these people said, but that number has fallen in recent days. Representatives from Wells, Bank of America and Citi declined to comment.
The Obama administration announced the stress tests -- a process of examining banks' ability to withstand future losses -- back in February. At the time, the news sparked concern among investors and depositors that the results would be used to shut down or nationalize some of the country's weaker institutions. But Federal Reserve Chairman Ben Bernanke and Treasury Secretary Timothy Geithner assured investors that none of the banks undergoing stress tests would be allowed to fail and that all would have access to government funds if needed. In fact, the stress-test regimen appears so far to have eased some of the fears that swept through financial markets in February, just as President Franklin D. Roosevelt's bank holiday did in 1933. He shut down the nation's banks for several days during a banking panic and only reopened those the government deemed safe. One possible explanation for the recent, calmer state of affairs: The problems the tests appear to be uncovering aren't as bad as some analysts' worst expectations.
Also, if multiple banks are being directed to boost their capital, that could make the process seem less daunting than if it were singling out a few companies as weak. In a sign of how much the doomsday scenario has faded, bank stocks surged Monday despite reports that Wells Fargo was identified in an initial review as one of the financial institutions needing a stronger buffer. The San Francisco bank's stock jumped 24%, or $4.64, to $24.25 in New York Stock Exchange composite trading at 4 p.m. Bank of America shares rose 19% on Monday, while Citigroup was up 7.7%. The stock prices of all three banks, which may need to raise tens of billions in new capital as a result of the stress tests, have tripled since early March. It's possible Wall Street is being overly optimistic about the impact of the results and the resulting dash by banks to bolster capital. One big risk worrying industry officials is that the market will view banks on the list as insolvent when the official results are announced Thursday, even though Fed officials have repeatedly said that's not the case.
Several banks are expected to already have enough capital to weather a worsening economy, including Goldman Sachs Group Inc. and J.P. Morgan Chase & Co. J.P. Morgan Chase Chairman and Chief Executive James Dimon expressed confidence Monday that the banking system can withstand losses from the recession, even though it will take years for the industry to recover. "The banking system can handle an awful lot of stress and be OK," he said in a Monday conference call sponsored by Calyon Securities Inc., a unit of Credit Agricole Group. Mr. Dimon also reiterated J.P. Morgan's goal to repay the $25 billion the New York bank received from the government last year "as soon as possible," saying company officials plan to discuss details of the potential repayment after the stress-test results are announced.
An initial stress test identified Wells Fargo as among the banks needing a bigger buffer, said a person close to the company. It is unclear whether Wells would be forced to raise fresh capital or if regulators would accept the bank's argument that it can earn its way through the losses in future years. Wells expects more clarity Tuesday. Any bank holding company with more than $100 billion in assets was required to undergo the tests, which were largely conducted by the Fed. Their purpose was to ensure that major financial institutions had enough capital to continue lending if the economy worsened through 2010. Government officials are expected to meet with banks beginning Tuesday to go over final results. Banks directed to raise more capital aren't necessarily in trouble today, but regulators think they don't have enough of a buffer against potential future losses.
Administration officials believe many banks will be able to raise capital without tapping the Troubled Asset Relief Program's remaining $109.6 billion. They're optimistic the bulk of the money will come from private investors made more confident by the glut of information provided by the tests. Banks could sell assets and stakes in their companies, a move that could accomplish another government goal of shrinking some of the country's largest banks. Officials say banks that can't tap private markets will be able to raise capital by agreeing to convert some of the government's existing preferred shares into common equity, a move that would leave the government owning chunks of the nation's largest banks. "There undoubtedly will be banks that need more capital," White House spokesman Robert Gibbs said Monday in a news briefing. He said he didn't believe the Obama administration would need to ask Congress for more money. "I think everyone involved will be looking for banks to raise this through either private means or the selling of some assets that they have or that they control."
The tests have set off some tense exchanges in private between Treasury officials and bank regulators at the Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency, who worried that disclosing too much information publicly could threaten the health of banks that are trying to repair themselves. The Fed plans to release the results of the stress tests on Thursday after U.S. stock markets close. Anticipating the test results, McGraw-Hill Cos.' Standard & Poor's Ratings Service unit put on watch for downgrade the credit ratings of 22 banks and one thrift. The affected companies face at least a 50% chance of being downgraded by at least one notch in the next 90 days.
J.P. Morgan's Dimon Expects Bank Consolidation to Accelerate
J.P. Morgan Chase & Co. Chief Executive Jamie Dimon on Monday said he expects America's biggest banks will continue to gain market share, and that the financial industry is ripe for more consolidation. Mr. Dimon, speaking on a conference call with investors and analysts, said the financial crisis will continue to restructure the banking industry for some time. He expects more deals will be done, and doesn't rule out an acquisition for his own company that will add more branches. He expects deals might pick up once major U.S. players receive results of the government's stress tests this week. The nation's 19 biggest financial companies are expected to receive their results late Wednesday.
"The banks in the stress test are roughly half the system for deposits and loans; that means the other 8,000 are the other half," he said on the call, sponsored by CLSA analyst Michael Mayo. "Some are good at what they do, but some will roll up over time. Some may not be able to survive, and I think you'll see consolidation." Mr. Dimon said he believes the biggest U.S. banks will be active in making acquisitions, despite debate in financial and political circles about banks growing too large. "The thing that drives size is economies of scale," he said. J.P. Morgan most recently acquired Bear Stearns and Washington Mutual, both organized by the government to help stabilize the banking system. Despite the financial crisis, Mr. Dimon said he believes the future earnings power of major U.S. banks will offset past losses. This echoes a similar statement made by billionaire investor Warren Buffett. "The banking system can handle an awful lot of loss and be OK," he said.
Mr. Dimon wouldn't comment on the release of his company's stress test. However, he said J.P. Morgan doesn't need more capital and he is prepared to repay the $25 billion it received under the government's Troubled Asset Relief Program "as soon as possible." He said business at J.P. Morgan, while certainly significantly lower compared with the past few years, has been steadily improving during the first three months of the year. Initial public offerings are getting done, merger-and-acquisition deals are beginning to thaw, and "the financial markets are healing," he said. Loans also aren't losing traction as the bank doles out $2 billion a day, he said. However, the firm's credit-card operation remains one of its most stressed businesses as consumers rein in spending. "One of the great misconceptions out there is that banks aren't lending," he said. "If you look at bank lending the last couple of quarters, it is up. They are lending."
Fed's Stern: Economic Recovery Likely Not Too Far Off
Another Federal Reserve official has joined the ranks of policy makers who see the end of the recession coming into view. In a speech Tuesday, Federal Reserve Bank of Minneapolis President Gary Stern said "in view of the policies already in place here and abroad, a resumption of growth should not be too far off." That put the central banker in the same camp as other Fed officials, including Chairman Ben Bernanke, who sees signs that the long and painful downturn is starting to end. Stern, who doesn't hold a voting role on the interest rate setting Federal Open Market Committee, spoke on the same day Bernanke addressed Congress and repeated the view of the FOMC that growth will return later this year. Like the chairman, Stern expects that "once the economic recovery begins, the pace of the expansion is likely to be subdued for a time."
But come the middle of next year, "I would expect to see a resumption of healthy growth," he said. Stern warned enough ground has been lost in the U.S. economy that it will likely take "several years" to reclaim the lost output. As the economy recovers, conditions for job seekers will move along a rougher path. Stern said it is "likely to take some time for labor market conditions to improve meaningfully." Still, Stern noted uncertainty hangs over his outlook. He said "it is difficult at this stage to identify with conviction the engine, or engines, of expansion ." The official counted himself as largely unworried about the outlook for prices. The prevailing fear is that overly weak economic activity will lead to deflation, but some worry the Fed's extraordinary interventions could fuel a future inflation boom. "There is scant evidence of deflation in so-called core measures of inflation," Stern said, adding "if economic growth resumes in the United States as I expect, the threat of deflation should diminish commensurately."
Over the longer run, "there is ample time for the Federal Reserve to withdraw excess liquidity as appropriate," Stern said. He added fears of a Fed-induced inflation are likely overdone. The official's comments came from a speech given before the Business Law Institute in Minneapolis. Stern is the longest serving regional Fed bank president and will retire from the institution at the end of the summer. In his remarks, he noted that consumer spending is showing signs of stabilizing. Meanwhile, "progress is under way in working off the inventory of unsold, unoccupied homes and condos." While banking and lending are defined by "a diverse set of circumstances" wherein some are faring well, and others are not, Stern allowed that as a whole "the financial system is impaired."
He added "appreciable strains persist," even as conditions "have improved over the past several months" on "aggressive" Fed policy actions, along with other moves by government. As he has in many of his recent speeches, Stern again reiterated his belief that the too-big-to-fail problem surrounding banks needs to be addressed. It can largely be done by correcting the incentives that drive business decisions and reducing confidence that bad bets will be bailed out by the government. Stern added he doesn't believe proposals that would simply make banks smaller will do what is need to eliminate future crack ups of the sort seen recently.
Real unemployment numbers and their consequences
The market's on fire, up more than 30% since early March, and there are economic green shoots all over the place. So what could go wrong?
Well, for one thing, that "lagging indicator" known as Unemployment, which could still come around and bite us in the arse.
In the first three months of 2009, more than 2 million jobs were lost, causing the unemployment rate to jump from 7.6% to 8.5%, the highest since November 1983. The unemployment rate increased in March in 46 states, with California, the world's eighth largest economy, hitting 11.2%, the highest since January 1941...
As noted in recent months, post World War II recessions have on average caused personal income to fall between 4% and 7%, and this one has further to go. Wages and salaries shrank at a 4% annual rate in the first quarter, and according to Deutsche Bank, payroll-tax withholding receipts collected by the Treasury Department are down 8.2% from a year ago. This suggests that personal income growth will remain weak in coming months, and shave more than $250 billion from total income and future demand. Changes in temporary jobs lead reversals in the overall labor market by 6 to 10 months. In 2007, a continuous decline in temporary jobs and hours worked led me to forecast a decline in jobs in 2008. When non-farm jobs fell in January 2008, most economists were shocked, and the stock market sold off sharply. In March, employers cut 71,700 temporary workers, so any real improvement in job growth is many months away.
Most economists are quick to note that unemployment is a lagging indicator, and they're right. But the magnitude of the job losses shouldn't be dismissed so glibly, given the impact they are having on the banking system. The American Bankers Association reported that 3.22% of consumer loans were delinquent at the end of 2008. That is the highest level since the ABA began tracking overall loan delinquency rates in the mid 1970's. And that was before 2 million jobs were lost in the first quarter.
An average of 5,945 bankruptcy petitions were filed each day in March, up 9% from February and 38% from a year ago. The soaring job losses since last September are certainly behind the increase in bankruptcies.
The surge in job losses are working their way up the income ladder, with an increasing number of middle income and upper middle income workers being affected. This is pushing many of those who previously were considered prime credit risks over the edge. Two-thirds of mortgages in the U.S. are held by the best credit risk, prime borrowers. According to the American Bankers Association, 5.06% of prime borrowers have missed at least one mortgage payment. Since prime borrowers are such a large group, this represents 1.8 million mortgages. Although the delinquency rate for sub prime mortgages is up to 21.9%, it only accounts for 1.2 million mortgages...
According to RealtyTrac, job losses result in a home foreclosure 10% to 15% of the time. If job losses narrow from the monthly average of 670,000 in the first quarter to 325,000, almost 3 million more jobs will be lost before year end. That will translate into another 300,000-450,000 foreclosures, and an unemployment rate of almost 11%. But what if that estimate of job losses is too optimistic?
New research by the Federal Reserve and Boston University of credit spreads of 900 non-financial companies from 1990-2008 predicted changes in the economy 'phenomenally' well. Based on their initial research on low to medium risk corporate bonds with more than 15 years to maturity, the researchers went back to 1973 and found the analysis still worked well. With the massive widening of corporate bond spreads last fall, the researcher's model predicts the economy will lose another 7.8 million jobs by the end of 2009, and industrial production will fall another 17%. In the spirit of optimism, let's assume this 'phenomenal' model is off by 35%, due to the extreme nature of this credit crisis. That still results in another 5.1 million lost jobs, and an 11% drop in industrial production. In that scenario, the unemployment rate climbs to near 12.5%, the underemployment rate breaches 20%, and another 500,000-750,000 foreclosures result.
An unemployment rate of 12.5%, if memory serves, is a tad higher than the Fed is using in those bank stress tests.
Bernanke Denies Asking Kenneth Lewis to Stay Quiet Over Merrill
Federal Reserve Chairman Ben S. Bernanke testified he never asked Kenneth Lewis, chief executive officer of Bank of America Corp., to refrain from publicly discussing losses at Merrill Lynch & Co. before the merger. "I absolutely did not in any way ask Mr. Lewis to obscure any disclosures or to fail to report information that he should be reporting," Bernanke said today in testimony to the congressional Joint Economic Committee. Lewis in February told investigators for New York Attorney General Andrew Cuomo that he was pressured in December by Bernanke and former Treasury Secretary Henry Paulson to complete the Merrill acquisition amid mounting losses at the brokerage firm. Bank of America acquired the brokerage on Jan. 1.
Lewis and the board were criticized at the bank’s annual shareholders’ meeting last week for not disclosing before a Dec. 5 merger vote that New York-based Merrill’s fourth-quarter loss was spiraling toward $15.8 billion. Shareholders voted to force the company to have an independent chairman, prompting Lewis’s removal and promotion of director Walter Massey to the post. "This has cast something of a cloud over Ken Lewis’s administration and it’s not good for him," said John Kanas, a senior advisor at WL Ross & Co. LLC and former CEO of North Fork Bancorp. "He found himself in a position that none of us would like to be in." Scott Silvestri, a spokesman for Bank of America, had no comment on Bernanke’s remarks. Cuomo released Lewis’s testimony last month after gathering the information during his investigation of the distribution of $3.6 billion of bonuses to Merrill employees.
Lewis said he was instructed by federal officials not to disclose Merrill’s losses, his desire to back out of the deal or about the intervention of regulators, according to a letter Cuomo released April 23 to lawmakers including Senate Banking Chairman Christopher Dodd. Regulators were concerned about "systemic risk" that might lead to the collapse of financial markets, the letter said. Paulson may have threatened to remove the management and directors of the Charlotte, North Carolina-based bank if they didn’t comply, Cuomo wrote. Lewis testified for more than four hours in Cuomo’s New York office Feb. 26 as part of the investigation into Merrill’s bonus payments. Cuomo’s letter was based on recollections by Lewis of a Dec. 21 conversation with Paulson. The letter said Paulson "largely corroborated Lewis’s account." Bank of America has sold $45 billion of preferred shares in the federal Troubled Asset Relief Program and received $118 billion in loan guarantees to absorb potential losses from Merrill. That agreement was reached after negotiations in December with federal regulators.
Bernanke Warns 'Relapse' in Banking System Would Stall Recovery
Federal Reserve Chairman Ben S. Bernanke warned that another shock to the financial system would undercut the central bank’s forecast that the U.S. recession will give way this year to a slow recovery. "A relapse in financial conditions would be a significant drag on economic activity and could cause the incipient recovery to stall," Bernanke said today in testimony to the congressional Joint Economic Committee. He highlighted that the economic contraction may be slowing and that the housing market has "shown some signs of bottoming" after a three-year slump. The Fed chief gave no indication the Fed intends to retreat from its unprecedented policy of keeping the main interest rate close to zero and boosting credit through emergency-loan programs and asset purchases. His remarks echo last week’s Fed statement that, while the outlook has "improved modestly" since March, the economy may "remain weak for a time."
Bernanke also said the Fed will soon provide on its Web site more information on its lending programs. That includes the number of borrowers, concentration of credit among borrowers, ratings of collateral and some details on contracts with private firms. The central bank will "continue to expand the range of information" it publishes, he said. The effort at greater transparency is in response to an April 2 nonbinding budget amendment sponsored by Senate Banking Committee Chairman Christopher Dodd, a Connecticut Democrat, and the panel’s ranking Republican, Alabama Senator Richard Shelby, Bernanke said. That proposal passed 96-2. The Fed chief did not mention a tougher measure, also nonbinding, sponsored by Vermont Senator Bernard Sanders, an independent, that called on the Fed to identify borrowers. The measure passed 59-39 on the same day.
Bernanke, who spoke two days before the planned release by the Fed and other U.S. regulators of the results from stress tests on the country’s 19 largest banks, gave no hint of the results. He said in prepared remarks in Washington that banks "will be required to develop comprehensive capital plans" and that funds from the government "will be available as needed." The lenders get their assessments from officials today, according to people familiar with the matter. About 10 of the banks will need additional capital to protect against a deeper recession, they said. Bank of America Corp. and Citigroup Inc. are among those requiring a bigger buffer, people familiar with the issue have said. The remarks were Bernanke’s first comments since the Fed’s Open Market Committee decided last week to refrain from expanding emergency credit programs amid signs the recession is easing.
"Readings from the credit default swap market and other indicators show that substantial concerns about the banking industry remain," Bernanke said. Economic figures in the past two weeks have shown smaller declines in house prices and stabilization in sales, a jump in consumer confidence and the smallest contraction in manufacturing in seven months. "Recent data also suggest that the pace of contraction may be slowing, and they include some tentative signs that final demand, especially demand by households, may be stabilizing," Bernanke said. Still, economists anticipate the job market will keep deteriorating after the sharpest contraction in gross domestic product in half a century. Employers probably eliminated 610,000 jobs last month, with the unemployment rate rising 0.4 percentage points to 8.9 percent, based on the median estimates of analysts surveyed by Bloomberg News. The Labor Department’s report is scheduled for May 8.
"The most recent information on the labor market -- the number of new and continuing claims for unemployment insurance through late April -- suggests that we are likely to see further sizable job losses and increased unemployment in coming months," Bernanke said today. Last week, the Commerce Department reported the U.S. economy contracted at a 6.1 percent annual pace in the first quarter, reflecting declines in housing and a record slump in inventories. The economy shrank at a 6.3 percent annual rate in the last three months of 2008. The housing market is showing signs of improvement after the Fed’s purchases of mortgage securities helped drive down home-loan rates to the lowest level in decades.
Bernanke and his colleagues moved in March to double purchases of housing debt to $1.45 trillion, and also to start buying $300 billion of long-term Treasuries. "The supply of mortgage credit is still relatively tight, and mortgage activity remains heavily dependent on the support of government programs or the government-sponsored enterprises," Bernanke said. Financial markets have also recovered in recent weeks. The Standard & Poor’s 500 Stock Index climbed to its highest level in four months yesterday. The London interbank offered rate that banks charge for three-month dollar loans today fell below 1 percent for the first time. The Libor-OIS spread, a gauge of banks’ reluctance to lend, reached its narrowest since Sept. 1.
Worries Rise on the Size of U.S. Debt
The nation’s debt clock is ticking faster than ever — and Wall Street is getting worried. As the Obama administration racks up an unprecedented spending bill for bank bailouts, Detroit rescues, health care overhauls and stimulus plans, the bond market is starting to push up the cost of trillions of dollars in borrowing for the government. Last week, the yield on 10-year Treasury notes rose to its highest level since November, briefly touching 3.17 percent, a sign that investors are demanding larger returns on the masses of United States debt being issued to finance an economic recovery. While that is still low by historical standards — it averaged about 5.7 percent in the late 1990s, as deficits turned to surpluses under President Bill Clinton — investors are starting to wonder whether the United States is headed for a new era of rising market interest rates as the government borrows, borrows and borrows some more.
Already, in the first six months of this fiscal year, the federal deficit is running at $956.8 billion, or nearly one seventh of gross domestic product — levels not seen since World War II, according to Wrightson ICAP, a research firm. Debt held by the public is projected by the Congressional Budget Office to rise from 41 percent of gross domestic product in 2008 to 51 percent in 2009 and to a peak of around 54 percent in 2011 before declining again in the following years. For all of 2009, the administration probably needs to borrow about $2 trillion. The rising tab has prompted warnings from the Treasury that the Congressionally mandated debt ceiling of $12.1 trillion will most likely be breached in the second half of this year.
Last week, the Treasury Borrowing Advisory Committee, a group of industry officials that advises the Treasury on its financing needs, warned about the consequences of higher deficits at a time when tax revenues were "collapsing" by 14 percent in the first half of the fiscal year. "Given the outlook for the economy, the cost of restoring a smoothly functioning financial system and the pending entitlement obligations to retiring baby boomers," a report from the committee said, "the fiscal outlook is one of rapidly increasing debt in the years ahead." While the real long-term interest rate will not rise immediately, the committee concluded, "such a fiscal path could force real rates notably higher at some point in the future."
In some ways, ballooning deficits should not matter. Deficits are a useful way for governments to use public spending to stimulate the economy when private demand is weak. This works as long as a country closes its deficit and pays back its borrowings after its economy starts to recover. The trouble is that government borrowing risks crowding out private investment, driving up interest rates and potentially slowing a recovery still trying to take hold. That is why the Federal Reserve announced an extraordinary policy this year to buy back existing long-term debt — $300 billion over six months — to drive down yields. The strategy worked for a while, but now the impact of that decision appears to be wearing off as long-term interest rates tick up again.
Then there is the concern that the interest the government must pay on its debt obligations may become unsustainable or weigh on future generations. The Congressional Budget Office expects interest payments to more than quadruple in the next decade as Washington borrows and spends, to $806 billion by 2019 from $172 billion next year. "You’re just paying more and more interest and having to borrow more and more money to pay the interest," said Charles S. Konigsberg, chief budget counsel for the Concord Coalition, which advocates lower deficits. "It diverts a tremendous amount of resources, of taxpayer dollars." Of course, no one is suggesting the United States will have problems paying the interest on its debt. On Wednesday, even as it announced its huge financing needs for the latest quarter, the Treasury said financial markets could accommodate the flood of new bonds. "We feel confident that we can address these large borrowing needs," said Karthik Ramanathan, the Treasury’s acting assistant secretary for financial markets.
One worry, however, is that there are fewer eager lenders to buy all that American debt. Most of the world is in recession, and other nations have rising borrowing needs as well. As other nations’ surpluses turn to deficits, America will face competition in global financial markets for its borrowing needs. For the moment, the United States is actually benefiting from a flight to quality into Treasuries brought on by the global financial crisis, which helped reduce rates to record lows this winter. But the influx will not continue forever. China has lent immense sums to the United States — about two-thirds of its central bank’s $1.95 trillion in foreign reserves is believed to be in United States securities — but it has begun to voice concerns about America’s financial health.
To calm nerves and fill the deficit hole, the government is getting creative. The Treasury is ramping up its auction calendar, holding more frequent sales of government debt and selling the debt in expanded amounts. It is now holding sales of its 30-year bond each month, up from four times annually. It is also resuscitating previously discontinued bonds, such as the seven-year note and the three-year note, to try to mop up any available money all along the yield curve. There is even talk of issuing billions of dollars of a new 50-year bond, though the idea has not won official approval. On a second front, the Treasury and the Federal Reserve are trying to bolster the mechanics of the market — to make sure every auction goes smoothly.
With such enormous sums involved, every extra basis point on the interest rate the government pays could mean extra billions of dollars for the taxpayer. Earlier this year, when demand was hesitant at a Treasury auction and when a British bond auction went poorly, investors grew nervous that the government might struggle to sell its mountain of debt. To avoid such an outcome and to keep borrowing costs low, the government is trying to expand the group of firms that bid at Treasury auctions. After the demise of such names as Lehman Brothers, the number of these firms, called primary dealers, has shrunk to 16, the smallest since this elite club was formed decades ago. Now the government is in discussions with smaller firms like Nomura and MF Global to persuade them to join.
London's City in danger of falling victim to EU wiles and becoming another Antwerp
The City of London is on borrowed time. Great banking centres can prosper for 40 years or so after the host country has lost industrial leadership but then some shock or political upset exposes the fragility of it all. "There is an extreme stickiness in financial centres," writes Peter Spufford, a Cambridge historian, reviewing the rise and fall of Genoa, Florence, Venice, Bruges, Antwerp, Amsterdam and London over eight centuries. The fall can be swift. Antwerp's arcaded "Beurs" was Europe's commercial hub in the 1550s. The tremors hit when the Spanish and French monarchies restricted debt payments to interest only, rolling over the principle. Then the Counter-Reformation queered the pitch, stifling free thought. Persecution of Portuguese Jewish financiers caused their flight from Antwerp to Amsterdam. Within half a century Antwerps' population had fallen from 100,000 to 40,000. It was hard to sell a house.
Amsterdam's demise was gentler but, by the late 18th century, Alexander Baring was shifting parts of his empire to London. So too was Abraham Ricardo, father of the economic theorist David. The coup de grace came from France. "The reason why Amsterdam eventually succumbed was political, the fear of what would happen to financiers when revolutionary Frenchmen were in charge," Ricardo said. There was eerie resonance to last week when the EU unleashed its assault on Britain's hedge funds and private equity. Those behind this drive are well aware that hedge funds were no more than bit players in the credit bubble. The real villains were banks with 30 to 50 times leverage and we know from the IMF that Europe's banks were the worst with their off-books "conduits". Given that 80pc of Europe's hedge business sits in Mayfair, the latest EU directive is a discriminatory political attack on the City and almost certainly the start of something broader and nastier.
Powerful forces in Paris, Berlin, and the EU institutions have long held a repressed urge to break the City's hold on chunks of global finance, from bonds to currencies and metals. Some wish to shut "Le Casino" altogether. They at last have the chance to act on it. Charlie McCreevy, the Irish Thatcherite in charge of the EU's market machinery, made a valiant effort to defang the hedge code but he will be gone soon. Gone too will be Commission President Jose Manuel Barroso, an Iberian reformer (of sorts), who placed free marketeers in the key posts of economic control in Brussels.As the tide turns against Anglo-Saxon influence, Britain will struggle to maintain its blocking alliance in the voting structures of the EU Council and the European Parliament.
East Europe is no longer in thrall to ultra-market Friedmanites in their 20s, siding eagerly with Britain against the Rheinland corporatists. The violence of economic collapse in parts of the ex-Soviet bloc may tarnish market capitalism for a political generation and it is fair to assume that the centre of ideological gravity will shift in Germany too as the economy contracts at 1931 rates. The Movement for Militant Resistance is already torching Porsches on Berlin's streets. While it is true that Europe's Left has not been able to capitalise on the window-smashing, boss-napping, backlash against banks, this is chiefly because the Right has beaten them to it.
In short, Britain is about to discover that it cannot easily stop the EU apparatus doing "an Antwerp" to London. One sympathizes with Poul Rasmussen, Denmark's ex-premier and head of the European Socialists, in raging at the locust raid on his country by the private equity pack of Apax, Blackstone, KKR, Permira and Providence. Their leveraged buyout of Denmark's telecoms group TDC was textbook provocation. They quickly extracted $7.6bn in special dividends, leaving the company and its workforce saddled with debt obligations going into the downturn.
I do not see why funds should be allowed to distort the market to their advantage in this fashion, nor do I see why any democracy should tolerate it. It seems blindlingly obvious that the City should stop this nonsense before it does any more damage to the reputation and interests of this country. That said, our predators did not cause the global financial crisis. The ultimate villains are the central banks of the US and Europe, which set the price of credit too low for year after year, and Asian governments holding down currencies for export advantage. The banks, buyout funds and assorted miscreants were mere instruments of destruction, not causal agents. If we fail to see that, we have learnt nothing.
Chrysler to lose $4.7 billion this year
Chrysler LLC expects to lose $4.7 billion this year and to continue to lose money for the next two years, according to a filing from one of the company's top financial advisers. Robert Manzo, a financial adviser hired by Chrysler for help with the company's bankruptcy process, estimated in the filing that the company will have cash expenditures far greater than losses for the next few years. Chrysler is estimated to go through about $15.7 billion this year as part of its restructuring.
The company filed for bankruptcy Thursday as part of a deal with the federal government, unions, some lenders and Italian automaker Fiat to keep the company from being shut down. Chrysler is a privately held company that has not publicly released its financial results since it was purchased by private equity firm Cerberus Capital Management in 2007, and analysts therefore do not publish loss estimates for the company. Analysts surveyed by Thomson Reuters forecast that larger rival General Motors, which is also facing the threat of a bankruptcy filing at the end of this month, will post a net loss of $18.4 billion this year, while Ford Motor, which is also significantly larger than Chrysler, is expected to lose $6.2 billion this year.
The filing also disclosed that Chrysler lost $16.8 billion in 2008. That's about the same as what GM lost in 2008, excluding special items, although not as bad as the $30.9 billion net loss at GM. But it was worse than the $14.6 billion lost by Ford last year. Manzo's filing forecasts that Chrysler will lose about $900 million in 2010 and another $300 million in 2011, before finally reporting a $100 million profit in 2011. The forecasts are far worse than the estimates Chrysler gave in a Feb. 17 filing with Treasury in which it requested additional government help. In that filing it estimated that a stand-alone Chrysler LLC would lose $1.1 billion this year, make a $600 million profit in 2010 before losing $600 million in both 2011 and 2012.
Foreclosure Trouble Spreads to Those Who Bet the Farm
The home-foreclosure crisis, which began in cities and suburbs, has spread to rural America. When the mortgage mess erupted, some economists believed that rural America wouldn't be heavily affected. Farms were prospering. The housing boom largely bypassed small rural towns. And exotic, new mortgages at first were seen as an urban and suburban phenomenon. But rural homeowners, it turns out, were just as susceptible to subprime loans and easy lending as the rest of the country, often refinancing existing mortgages to take out cash or pay off debts. "The idea that somehow rural America was going to escape this...is not proving to be the case," says David Dangler, who oversees rural initiatives at NeighborWorks America, a housing-aid nonprofit.
Foreclosure rates remain higher in cities and suburbs than in rural areas, and the change in home values from boom to bust hasn't been as severe. Since the peak, values have dropped 13% in rural areas and 23% in urban areas, according to Moody's Economy.com, while from 2000-2006, home values appreciated 45% in rural areas compared with 84% in urban areas. Still, defaults in rural counties are rising rapidly and setting off concerns that the population in these already sparsely populated towns will decline further. In Minnesota, where rural borrowers are much more likely to have a subprime loan than city homeowners, foreclosures outside of the Minneapolis-St. Paul region have increased 232% since 2005, according to the Greater Minnesota Housing Fund. Economists say foreclosures could erode rural economies faster than urban areas because when homeowners in small communities walk away from their homes, they often also abandon their towns.
That is the worry for McGregor, a town of some 400 people on northern Minnesota's lake-strewn frontier. Robert Sundberg first refinanced his two-bedroom home here in 1999, when he had just $2,000 remaining on his mortgage. "I wish I had never done it," the retired manufacturing worker says. "I just went and refinanced too much." Mr. Sundberg refinanced his home twice since then, once to pay medical bills and then two years ago to pay off car loans. The Sundbergs purchased their home for $24,000 in 1987. They owe $98,000 on the property, which is scheduled for a foreclosure auction on Thursday. Despite his difficulties, Mr. Sundberg says he won't consider leaving McGregor. Other residents feel they can't afford to stay. On an icy morning in February, Paul and Judy Perrine packed up the contents of their five-bedroom farmhouse, and, with 13 children and two horses in tow, left the town where they raised their family.
The Perrines purchased their McGregor home in 1994 for $30,000. Home values in the area began to climb as city dwellers scooped up lakefront property nearby. The Perrines also added on to their house, and after a series of refinancings, the mortgage swelled to $255,000 by 2007. Mr. Perrine, a self-employed carpenter, stopped making mortgage payments last fall when the economy soured. The home is headed into foreclosure, and the Perrines have moved to Rock Rapids, Iowa. "We overstepped common sense with regard to debt," he says. "[My] income was always pretty decent, so you always felt like you could make it up down the line."
High-cost loans, which are predominately subprime, accounted for nearly 40% of all refinance loans between 2004-2007 in Aitkin County, of which McGregor is a part, according to the Federal Reserve Bank of Minneapolis. Dan Williams, who oversees financial counseling for Lutheran Social Services in Duluth, Minn., says the risk for towns like McGregor is a rise in abandoned housing and population decline similar to the farm crisis of the 1980s. In the current crisis, full-scale farms are in somewhat better shape because agricultural mortgage lenders didn't follow the looser standards that prevailed elsewhere. Also, two years of record commodity prices have given farms a financial cushion.
But the manufacturing and construction trades that were tied to agriculture are reeling. In Faribault, Minn., a town of 20,000 south of Minneapolis, Jennifer Wicks still has her job as a secretary, but her husband has struggled to find construction work. They looked forward to one day running their own farm when they took out two loans to buy a $184,000, three-bedroom home on a 10-acre farm south of town three years ago. "Our goal had been to keep buying land around us, but it just hasn't worked out that way," says Ms. Wicks. Instead, they lost the home to foreclosure. Ms. Wicks says she was "naïve and stupid" about her loans, including a $147,000 adjustable-rate mortgage. Monthly payments were tough to make before they jumped to $2,000 from $1,200. "It's awful," she says. "Our whole way of life is going to change."
Ilargi: The next two articles have much in common, starting with their titles, and cross references too. But they still shine a sifficienly different light on an issue that I think is important to consider, namely yet another reason why home prices won't come back. Which once again must make us wonder what the administration's policies are aimed at. When reading this, don’t forget, the main reason it won't work is that the money's gone. The rest is just the icing on the collapsing cake.
House Prices May Be Crushed For A Generation
Whenever we discuss the gloomiest forecasts for housing, we inevitably hear from readers who believe that house prices will have have to start rising again very soon because demand for having a roof over one's head isn't going down. There's some truth in this: we're not giving up lifestyles in stationary shelters any time soon. The United States won't become a nation of nomads that shuns houses. But don't take this too far. While individuals may continue to desire to live in houses, overall demand for houses may decline. That's because of something that no meddling with interest rates can repair. You see, the huge baby boom generation didn't reproduce itself at the same rate it was produced, which means that the so-called Generation X is much smaller than the generation that preceeded it. And not only are they smaller, for a variety of reasons they probably won't generate the same demand for single family homes their parents did.
- College Debt Burden. Generation X is afflicted with an unprecedented amount of debt thanks to the boom in higher education. Wages haven't kept up with this mounting debt, which means that it takes even longer to work off this debt. It seems unlikely that banks with higher credit standards will be willing to lend to Gen X the way they did to the Boomers; and it's unlikely that debt stricken Xers will want to accumulate even more debt by taking out big mortgages.
- Dearth of Births. Only 44 million people were born into Generation X. There are currently 19 million empty homes in the US. That means that if Gen X pairs up through marriages, cohabitation or roommating, they can live in the empty homes without ever buying a new one.
- Boomers Trading Down. As John Wasik of Bloomberg points out, it's not just that Gen X is smaller. The Boomers are changing too because they are getting older. "Although we may not be headed for a 1930s-style Depression, there’s plenty of evidence to suggest that boomers are dumping their four- and five-bedroom suburban homes for two- and three- bedroom condominiums," he writes.
- Housing Scars May Last. The Boomers had a spectacular confidence in the strength of the housing market, built in large part on their historical experience of ever rising house prices. Gen Xers have had a quite different experience, one that is likely to make them far more wary of investing in homes.
The good news is that there's a slightly larger population group rising up behind the Gen Xers. Eventually, they may actually drive up housing demand, and prices may rise as well. But that's a long, long way off.
U.S. Home Prices May Be Lost for a Generation
We might be looking at a lost generation for U.S. home values. Far too many analysts are calling a bottom to the housing market after home prices in 20 metropolitan areas declined at a slower pace in February, according to the Standard & Poor’s/Case-Shiller Index. Don’t be blinded by the glint of optimism in headlines about rising consumer confidence and slowing price declines. Demographic and market realities tell a more sobering story. You won’t see a widespread housing rebound in an economy in which 600,000 jobs a month are lost and foreclosures ravage the most overleveraged areas. These are just the visible barriers to a recovery.
Mortgage lending has also been an unusually tightfisted process of late. Lenders are demanding a 20 percent deposit for home purchases, and want impeccable credit ratings. About 45 percent of U.S. banks surveyed by the Federal Reserve said they had "tightened their lending standards on prime mortgages." I suspect that number is much higher. Then there’s the reality that the market is glutted with homes. A record 19 million homes stood empty at the end of 2008. What you can’t see in the most recent housing numbers is the least-visible driver of home prices today: demographics. The baby-boomer generation, the largest in American history, will be buying fewer single-family homes.
The U.S. is experiencing a 40-year generational peak in consumer spending, one that will lead to "the first and last Depression of our lifetimes," author Harry Dent predicts in his book "The Great Depression Ahead" (Free Press, 2008). Although we may not be headed for a 1930s-style Depression, there’s plenty of evidence to suggest that boomers are dumping their four- and five-bedroom suburban homes for two- and three- bedroom condominiums. It’s also unlikely that the "Generation X," born between 1965 and 1976 (or more derisively called "baby busters"), will bid up home prices. They are only 44 million strong, not as wealthy and even more in debt from college loans. The baby boomers are reorganizing their finances after a rocky decade in stocks. They aren’t buying as many second homes and vacation properties in warmer climates.
That’s why it’s unlikely that there will be any swift recoveries in Phoenix, Las Vegas or San Francisco, where prices fell 35 percent, 32 percent and 31 percent respectively in February from a year earlier, according to the Case-Shiller Index. More setbacks are coming in central and Southern California and south Florida. One thing hasn’t changed in this recession: Those who are mobile will continue to move where jobs are relatively plentiful and housing is cheaper. The winners continue to be southeastern states and Texas. Some 67,000 single- and multifamily building permits were issued in the southern region in the first three months of this year, according to the U.S. Census Bureau. Texas alone accounted for more than 20,000 authorizations. Hot spots are still Houston, Dallas-Fort Worth and Austin.
Considering that almost 120,000 permits in the entire country were issued during that period, it shows that more than half of all new construction is in the South, where the cost of housing and living is significantly lower than in the Northeast, Midwest and on the West Coast. In contrast, just 5,571 units were approved in New York and New Jersey combined. While building permits don’t mean that housing will be built, they are one indicator of housing-market growth. Yet don’t confuse building with the ability to restore home equity. Simply moving to another area won’t rebuild the estimated $6 trillion that was lost during the bust.
One of the reasons the housing mania was so damaging was that median home prices rose to about three times average household incomes as opposed to double income levels in 1950. Wages simply weren’t keeping pace with housing inflation, so homeowners overleveraged to make up the difference. The wave of deleveraging will depress home prices in most markets. It’s time to assess your options. Your home may not be a nest egg. You may never recoup your losses from the dot-com and credit busts in the stock market. For most homeowners, wealth building and retention may depend more on a diversified, inflation-indexed bond portfolio than on real estate. This new reality, though, may be lost on those still trying to price their homes at 2006 levels.
U.S. Treasury bonds suffer huge technical breakdown... sell immediately
From Tom Dyson in The 12% Letter:
On March 18, the Federal Reserve announced it would buy $300 billion "longer dated" Treasury bonds. This was the news the "long-bond bulls" had been waiting for. It meant the world's most powerful central bank was going to pump $300 billion into their market over the next six months... The "long bond" is the nickname for the 30-year Treasury bond. It's the longest-dated debt the U.S. Treasury issues. Long-bond investors must have thought they were about to get rich... But the market didn't oblige. There were too many long-bond short sellers...
The old advice for short sellers is, "Throw your rocks into the wet paper bags." Eventually, the bag will break. The long-bond market is a wet paper bag. It's making new five-month lows. This market is so weak, not even the Fed's printing press can hold it up. If you own any long-dated Treasury bonds, sell them now. This market is in danger of imminent collapse. Look at this chart. The next major stop for this market is 112.5, the lows of 2008.
Small Banks Face Hits on Commercial Real Estate
Thursday's "stress-test" results will bring fresh scrutiny to the nation's biggest banks. They also are likely to highlight the woes from commercial real-estate loans that are piling up at large and small banks alike. In the worst-case scenario, federal regulators examining the 19 largest U.S. banks are projecting losses of up to 12% on commercial real-estate loans over two years, according to a document viewed by The Wall Street Journal. The regulators are likely to cite commercial-property debt problems as a major reason why at least some of the large banks need additional capital.
Such losses likely would cause even deeper misery, and risk of failure, at small and medium banks because they tend to have disproportionally more exposure to commercial real-estate loans than giant institutions. While regulators have indicated they won't allow the 19 stress-tested banks to fail, that group doesn't include more than 500 banks with assets of less than $1 billion that have too much exposure to commercial real estate and are at the most risk of failing, according to an analysis by Foresight Analytics LLC. During the housing boom, small and regional banks doubled down on lending to home builders and commercial-property developers and investors as they were largely squeezed out of the home mortgage market by large banks and Wall Street firms. Now many of those loans are going bad as vacancies rise, rents fall and developments open to anemic demand.
Analysts already had been forecasting hundreds of bank closures in the next five years. The stress-test assumptions, including a 10.3% jobless rate at the end of 2010, raise the specter that some of the failures could occur sooner. The 12% loss rate being used by regulators to scrutinize commercial real-estate loans surprised some analysts because default rates on such debt remain lower than those on home mortgages. The loss rate implies that the nation's banks and thrifts, which hold $1.8 trillion of commercial real-estate debt on their books, would incur $216 billion in losses by the end of 2010. With that loss rate, "you're talking about a depression in the U.S. economy and a major crisis in the banking system," says Richard Bove, an analyst at brokerage firm Rochdale Securities LLC.
In addition to the commercial real-estate loans clogging bank balance sheets, an additional $700 billion of those loans were packaged as securities and sold to investors. In light of plummeting property values and surging defaults, credit-rating firms have imposed downgrades on those securities. On Monday, Moody's Investors Service said it downgraded $52.9 billion in so-called collateralized debt obligations stuffed with commercial real-estate debt as part of its review of $83.1 billion in such CDOs amid worsening market conditions. While bank regulators aren't immediately applying the stress-test criteria to small and midsize institutions, banks with high commercial real-estate exposures are drawing greater scrutiny from regulators. Nearly 3,000 banks and thrifts are estimated to have commercial real-estate loan portfolios that exceeded 300% of their total risk-based capital, according to Foresight.
Regulators consider the 300% threshold as a red flag, although it doesn't necessarily mean all those banks are in danger of failing. Risk-based capital is a cushion that banks can dig into to cover losses. While the failure of a single small bank is unlikely to cause systemic damage to the nation's financial system, such institutions could have a big impact as a whole. Banks with commercial real-estate loan portfolios exceeding 300% of their total risk-based capital have total assets of about $2 trillion, compared with $2.3 trillion in assets at Bank of America Corp. Stress-tested banks that had a large exposure to commercial real-estate as of the end of 2008 include Regions Financial Corp., BB&T Corp., Fifth Third Bancorp and KeyCorp. "We are experiencing deterioration in other [commercial real-estate segments] such as the retail property group, which is dependent upon consumer spending to generally support rents," KeyCorp finance chief Jeffrey B. Weeden said in a conference call last month.
Commercial real-estate debt represented about 119% of the bank's total capital as of Dec. 31. "We remain well capitalized by any regulatory measure," Mr. Weeden said. To be sure, banks wouldn't get hit as hard from commercial real-estate under rosier scenarios or if government programs succeed in pulling the U.S. economy out of its funk. The Federal Reserve, for example, announced on Friday new terms on one of its lending programs that officials hope will help revive the commercial real-estate market. Since late 2007, 58 banks and savings institutions have failed, with assets totaling about $400 billion. About a dozen of the failed banks, including Great Basin Bank of Nevada and First Bank of Idaho, had unusually high commercial-mortgage exposure, according to Foresight.
A bank currently on the ropes because of commercial real estate is Corus Bankshares Inc., a big condominium-construction lender. In a securities filing Friday, the Chicago-based lender said it was "undercapitalized" as of March 31. Regulators might place the bank "into conservatorship or receivership," according to the filing. So far, banks have been generally reluctant to sell their troubled commercial-property loans partly because they would be insolvent if they sell at bargain prices being sought by investors. That might change if regulators put more pressure on banks to clean up their books. From January 2008 to the end of February, the Federal Deposit Insurance Corp. sold about $1.16 billion of distressed real-estate and other types of commercial loans from failed banks for about 59 cents on the dollar, according to industry data.
'Masters of Universe' Find Opportunity in Crisis
Being a bond trader used to be a big deal. It may be a big deal again. Before private-equity and hedge funds started to throw their weight around, before the advent of the quants and the derivative geeks, bond traders were the gunslingers of Wall Street, pulling down big profits and reveling in the status that went with them. In the 1980s, these "Masters of the Universe," as Tom Wolfe dubbed them in "The Bonfire of the Vanities," gravitated to an exclusive club of primary dealers. These are the banks and securities firms that deal directly with the Federal Reserve in its open market operations and are required to bid at Treasury auctions.
The primary dealer system was created in 1960 with 18 members. It was a sleepy sort of club until the late 1970s, when volatility in interest rates, rising deficits and an historic bull market provided the means and opportunity to reap huge profits. Large institutional investors would only do business with primary dealers. Dealers, in turn, benefited from the information gleaned from customer flows. The number of primary dealers peaked at 46 in 1988 before starting a steady descent, largely a result of consolidation, to 16 today. Even as banks swallowed up other banks, events were conspiring to reduce the allure of primary dealership. The availability of brokers’ screens to non-dealers increased transparency and chipped away at bid-ask spreads. The Japanese invasion of the 1980s -- first as investors, then as primary dealers -- disrupted the cushy franchise of dealers, who socialized with one another and were known to get together to "coup" an auction (collusion by any other name).
Electronic trading increased liquidity in the market, making it cheaper and easier to buy and sell plain-vanilla Treasuries. Customer business became a loss-leader for primary dealers, many of whom reinvented themselves as proprietary traders to justify (and underwrite) their existence. By the time the federal budget swung into surplus in the late 1990s, there were still 37 primary dealers sitting around picking their noses, worrying what they’d do in a world with no Treasury bonds. (Don’t laugh: This was a real concern, especially for the Fed in its conduct of open-market operations.) Who would have guessed brokering bonds would become a lucrative business again?
In a curious twist of fate, the Treasury finds itself facing monstrous financing needs with only a handful of primary dealers to underwrite the debt. The Congressional Budget Office is projecting a deficit for fiscal 2009, which ends Sept. 30, of $1.85 trillion, based on President Barack Obama’s preliminary budget request. Last week the Treasury said it expects to borrow $361 billion in the April-June quarter -- a traditionally "light" quarter because of the April 15 tax payment deadline -- and $515 billion in the third calendar quarter. Rare is the day when there isn’t a Treasury auction of some kind. (The only obvious break in the auction calendar is for official holidays.) Treasury revived old issues (the three- and seven-year note), boosted auction sizes and expanded the menu of cash management bills, historically used to manage "short- term" borrowing needs, to include 272-day and 296-day varieties.
This week, the Treasury will sell a record $71 billion of notes and bonds to raise $18.8 billion of new cash. This is happening at a time when dealers are taking less risk and are constrained by the balance sheet. The result has been a widening of bid-ask spreads, which means an opportunity to make money the old-fashioned way. The steep yield curve is an added inducement. Dealers can buy, say, a 10-year Treasury note yielding more than 3 percent and finance it (borrow against the securities) at the overnight repo rate of 0.2 percent. No wonder some broker-dealers are applying to the New York Fed to become a primary dealer. At least one dropout is looking for readmission.
Not only is it a good time to be a primary dealer, it’s a great time to be a bank -- assuming you aren’t one already. The Fed is practically giving money away to almost anyone that asks. Even if private credit demand is sluggish -- it always is in recession -- Uncle Sam has a huge appetite. Banks can borrow from the Fed at 0 percent to 25 basis points, turn around and "lend" to Uncle Sam, with the difference going to the bottom line. It may just be we’ve come full circle. The crisis saw big investment banks, such as Goldman Sachs and Morgan Stanley, apply for a commercial bank charter, accepting a greater degree of regulation in exchange for a steady source of funding (consumer deposits). Primary dealers are in a growth industry. Banks and brokers are chasing customer business instead of engineering profits from exotic derivative securities. Who knows? Before long, the U.S. may start manufacturing stuff again.
GOP Senator Criticizes New York Fed Chairman
The ranking Republican on the Senate Banking Committee called it "deeply disturbing" that Stephen Friedman, who is chairman of the Federal Reserve Bank of New York and a director of Goldman Sachs Group Inc., bought Goldman shares in December and January. Sen. Richard Shelby (R., Ala.) said the purchases heightened his intention to increase oversight of the Fed's 12 regional banks. The Wall Street Journal described Mr. Friedman's private and public entanglements in a page-one story Monday. After Goldman became a Fed-regulated bank-holding company, the Fed granted Mr. Friedman a waiver from rules that would have prevented him from holding any Goldman shares. Regional Fed banks are hybrid institutions, created by Congress in 1913, with boards of directors chosen from the private sector by commercial banks and the Federal Reserve Board. They play an important role in public policy, helping the Fed to set interest rates and supervising commercial banks.
"If we were setting up the system from scratch today, we would never consider this kind of private-sector involvement," said Louis Crandall, economist with Wrightson ICAP LLC, a Wall Street firm specializing in money markets. Although the financial crisis is prompting a re-examination of Fed governance by members of Congress, one key player said Monday that he doesn't anticipate changes this year. Rep. Barney Frank (D., Mass), chairman of the House Financial Services Committee, said he plans to examine the regional Fed banks with an eye toward altering their unusual structure and the role their presidents play in making monetary policy, but only after the financial crisis is over. "I've also got concerns about the role of the regional presidents on the FOMC [the Fed's interest-rate-setting Federal Open Market Committee]," Mr. Frank said. "The fact that the local business community appoints these people, that is a concern."
Mr. Frank said that he didn't intend to push the matter this year, because he doesn't want to hamstring the Fed while it is still fighting the crisis. Mr. Friedman was placed in an unusual position in September, when Goldman was allowed by the Fed to become a regulated bank-holding holding company to help halt its market slide. That put Mr. Friedman in violation of Fed rules that bar regional Fed bank board chairmen -- who are chosen to represent the public -- from owning bank shares or serving as directors or officers of banks. At the request of the New York Fed, the Fed in Washington granted him a waiver from the rule in January. He said last week he would step down from the New York Fed board at the end of this year. In December, before the waiver was granted, and again in January, after it was granted, Mr. Friedman bought additional Goldman shares.
Obama squares up to corporate America
Barack Obama squared up on Monday for what looks likely to be his administration's first major battle with big business, when he unveiled crackdowns on offshore tax avoidance and evasion by US companies and individuals. Mr Obama, who campaigned relentlessly on the issue of closing offshore loopholes, said the steps he announced would raise $210bn over 10 years and "make it easier" for companies to create jobs in Buffalo, New York, rather than in Bangalore, India. He said the measures, which would be enforced by the creation of nearly 800 new jobs at the Internal Revenue Service, would raise revenues to help pay for the permanent extension of the Research and Development tax credit for US corporations. But corporate America reacted with dismay, saying the rules - which will affect multinationals such as General Electric and Procter & Gamble - would put US companies at a disadvantage to foreign rivals. "It is the wrong idea, at the wrong time for the wrong reasons," said John Castellani, Business Roundtable president. "It will cripple growth, reduce the competitiveness of US companies overseas and destroy jobs."
The National Association of Manufacturers called the proposals "disastrous". The steps announced by the president would include closing down the notorious "check box" loophole that enables companies to avoid US and foreign taxes by shifting income to subsidiaries based in offshore tax havens. Mr Obama cited a Cayman Islands building where more than 18,000 US companies are housed. "Either this is the biggest building in the world or it is the biggest tax scam in the world," he said. The administration says more than a third of US foreign profits in 2003 came from Bermuda, the Netherlands and Ireland. It also estimated that US companies paid an effective tax rate of just 2.3 per cent on the $700bn they earned in foreign profits in 2004. Under Mr Obama's proposals - likely to be included in this year's budget document - US companies would no longer be able to claim deductions against their tax bill before they had paid taxes on offshore profits. The administration would also close the loophole whereby companies that claim a US credit on taxes paid overseas then inflate and accelerate those credits.
EU Finance Ministers Mull Recession Measures
Pessimism is rampant in the European Union with forecasts now assuming a 4 percent contraction in the bloc's economy this year. As budget deficits balloon and unemployment soars, finance ministers are meeting in Brussels on Tuesday to discuss measures to combat the crisis. Amid extremely gloomy economic forecasts, Europe is bracing itself for a huge hike in unemployment, mounting budget deficits and, according to some, possible social unrest. The issues promise to loom large on Tuesday as European Union finance ministers gather in Brussels. And with some new member states facing severe budget difficulties, the 27 ministers are expected to double the amount of money it lends to some struggling countries.
"It seems … the recession is at its worst, but hopefully next year we'll start coming out of it," Czech Finance Minister Miroslav Kalousek, who chairs the meeting, told reporters ahead of the meeting. Greece's Finance Minister Yannis Papathanassiou called on his counterparts to work at returning to fiscal discipline as soon as the crisis over. "We have to return to the limits of the Stability and Growth Pact," he said on Tuesday. The gathering comes a day after the European Commission said that the economy of the 27-member bloc would contract by 4 percent this year, more than double the prediction it made as recently as January. With exports and industrial output plummeting, unemployment is expected to soar to 11.5 percent by 2010 -- the equivalent of 8.5 million jobs disappearing over the next two years. Adding to these woes are the spiralling budget deficits as governments face mounting social welfare bills for the growing number of unemployed just as tax revenues shrink.
EU Economic and Monetary Affairs Commissioner Joaquin Almunia told a news conference on Monday that "the European economy is in the midst of its deepest and most widespread recession in the post-war era." However, he noted that the slump may be stabilizing. "We are no longer in a free fall," he told reporters. "But even if some positive signals are appearing, we do not have the critical mass of data to say we are out of the woods." Luxembourg Prime Minister Jean-Claude Juncker, who is also president of the Euro Group made up of the 16 countries that use the euro as their currency, warned about the potential social fallout from the current economic crisis.
"We are in the heart of an economic and financial crisis and we are headed towards a social crisis," he said after a meeting of the 16 euro zone finance ministers on Monday evening. Juncker urged employers to hold off on shedding staff and instead cut working hours, warning that the euro zone faced a potentially "explosive" situation. Nevertheless the euro zone finance ministers are resisting any increases to the amount they have devoted to stimulus packages in a bid to revive their flagging economies. "We need to first see the impact of the first round of measures," Dutch Finance Minister Wouter Bos said after Monday's meeting. EU countries are constrained from spending more on boosting their economies by their widening deficits and mounting debts. This year, fully 13 countries within the 27-member bloc are likely to break EU deficit rules, which call for a maximum budget deficit of 3 percent of gross domestic product. All together, EU countries are likely to run a deficit twice the maximum allowed. This figure is expected to rise to 7.25 percent or €900 billion ($1,205 billion) next year.
The commission predicts that even normally fiscally prudent Germany will see its deficit surge to 3.9 percent of its GDP in 2009 and 5.9 percent next year. Germany has been badly hit by the near collapse in global trade and Brussels now expects its economy to contract by a huge 5.4 percent in 2009 as demand slumps for typical exports such as cars and machinery. A first step towards dealing with the current recession and reducing unemployment involves the return to a fully functioning banking system. On Monday Brussels called on EU governments to move swiftly to clean up banks' balance sheets. Finnish Finance Minister Jyrki Katainen urged his counterparts to restore trust in the financial industry.
"We have to solve the banking crisis first," Katainen told Reuters. "We cannot expect any recovery in the real economy before trust has returned to the banking sector." Meanwhile, many EU states, particularly the newer states from Central and Eastern Europe, are struggling to balance their budgets and Brussels plans to help them out. During their meeting on Tuesday the finance ministers are expected to endorse plans to double to €50 billion the funds available to lend to countries in financial difficulties. The EU has already provided billions of euros in emergency loans to Hungary and Latvia and is now also about to help out Romania. Brussels is contributing up to €5 billion ($6.7 billion) to a much larger €20 billion ($26.48 billion) loan package approved for Romania by the International Monetary Fund on Monday.
European Commission demolishes Alistair Darling's recovery forecasts
Alistair Darling's rose-tinted forecasts of an economic recovery in Britain by 2010 have been demolished by the latest projections from the European Commission. The EC said UK GDP will grow at 0.1pc in 2010 – far below the Chancellor's bullish projection of 1.25pc growth. The Commission said that "the likelihood that economic activity in 2010 will be weaker than envisaged by the UK authorities" will compound a "very significant" deterioration in public finances. It expects UK unemployment to rise to 9.4pc by 2010 leaving 3m workers jobless. "The UK economy is now clearly experiencing one of its worst recessions in recent history," the EC said. It expects GDP to decline 3.8pc this year and projected that growth will remain negative for the first three quarters of 2009 followed by two quarters of "virtual stagnation and only a gradual return to slight positive growth by late 2010".
Timothy Kirkhope, the Conservative leader in the European Parliament, dismissed the Chancellor's forecasts as "pure fantasy". The outlook formed part of a wider warning from the EC that the economies of the 16 eurozone countries will shrink 4pc this year, double the decline it estimated only four months ago. Unemployment is expected to soar to 11.5pc by the end of next year, which equates to the loss of 8.5m jobs. However the EC reckoned the end of the worst recession in the post-war period is close, with the economy set to stabilise in 2010. The EC now expects a small decline in 2010 compared with its January forecast of 0.4pc growth, echoing more pessimistic forecasts from the IMF and the OECD. The EC expects the region's average budget deficit to widen to 6.5pc in 2010, three times the gap in 2008. The UK's budget deficit is seen ballooning to 13.8pc by 2010.
Eurozone inflation is expected to slow to 0.4pc this year before accelerating to 1.2pc in 2010, which remains below its 2pc target rate. European markets shrugged off the forecasts as shares hit a 16-week high. France's CAC 40 index added 2.5pc while Germany's DAX gained 2.8pc. The euro gained 0.6pc against the dollar to hit $1.334. The EC described the risk of a deflation scenario as "limited". However a report compiled by BDO Stoy Hayward posited that eurozone businesses see deflation as a real risk. BDO said that the UK appears to have seen off the threat of deflation and should recover quicker. Peter Hemington, partner at BDO, said: "Quantitative easing looks to have paid off so far for the Bank of England. As a result, the euro remains at too high a level and the eurozone is suffering."
Ulrich Leuchtmann, a currency strategist at Dresdner Kleinwort-Commerzbank, said traders would focus on the European Central Bank meeting on Thursday when a rate cut of 25 basis points appears to be a fait accompli. Mr Hemington said: "By accepting now that devaluation of the euro is a necessary evil to ensure eurozone countries can grow their way out of the recession, the ECB may be able to hasten recovery." Shadow Treasury minister Philip Hammond said: "Until our Government recognises the size of the hole we're in, and finds courage to stop digging, we will not get Britain back to sustainable growth."
UK embassies on alert amid fear of rising social unrest
David Miliband, the Foreign Secretary, has activated an early warning system to monitor economies at risk of suffering political and social unrest triggered by the global credit crisis, The Times has learnt. Teams of economists working within Britain’s embassies worldwide have been told to assess the risk of social unrest within their borders as a result of the global recession and then to report back to London. The Foreign and Commonwealth Office is worried that the next chapter of the downturn will involve unrest in fragile economies as asset values, employment, export markets and international supply chains are hit by the fall in demand. With the collapse of Lehman Brothers in September last year, stock markets and financial regulators realised the extent to which the world’s banking industry was intricately interwoven — with the demise of one lender capable of dragging down another.
Fears now exist that if a key country collapsed as a result of political turmoil, the global supply chain and exports could be at risk. It is understood that the Foreign Office is anxious about economies whose debt has been downgraded to junk status. Debt issued by countries such as Argentina, Pakistan, the Seychelles and Sri Lanka have been downgraded to well-below junk status over the past few months, Standard & Poor’s, the rating agency, said. Some of these countries are key suppliers to British companies, with textile factories in Sri Lanka and Pakistan providing goods for much of the UK high street. It is understood that the Government broadly believes that the International Monetary Fund, the European Union and possibly the British taxpayer may have to step in to support fragile economies in order to protect export markets and the manufacturing supply chain.
General Motors' European plants in peril over Fiat bid
Fiat's plans to take over General Motors Europe to create the world's second largest car firm would cost up to 10,000 jobs in Europe and Britain, according to a senior union leader who met Sergio Marchionne, the Italian firm's chief executive, . Klaus Franz, the labour leader of Opel, GM's German arm, told Reuters that Marchionne confirmed that plants in the UK, Germany and Italy would close if the rescue deal took place. But he did not specify whether the UK plants in Luton or Ellesmere Port would be axed. The German government has taken the lead in talks with GM Europe's US parent about hiving off the European subsidiary into a separate company and the possible deal with Fiat, which emerged at the weekend. Opel has about 26,000 workers in Germany.
Union leaders in Britain are concerned that the involvement of the German government, and now the Italians, could result in more job losses in the UK. Elections are looming in Germany which would make Angela Merkel's government keen to limit German job losses resulting from any restructuring. Tony Woodley, joint general secretary of the Unite union, urged the British government to take a more active role in negotiations to safeguard 5,000 jobs in the UK, including at the Vauxhall plant at Ellesmere Port on Merseyside. "The government is quick with promises and very slow on delivery," he said. "I'm genuinely concerned that this government and other European governments are not working together. If we are out of the loop by a day or two anyone could cut a deal which would be disastrous for Britain."
Barack Obama has given GM a deadline until the end of the month to come up with a restructuring plan to save it from collapse. As part of the project, GM will spin off its European subsidiary, which says it needs €3.3bn (£2.9bn) investment to stay afloat and wants to attract an outside investor to take a majority stake. GM Europe reckons that cost savings of $1.2bn (£800m) are needed to return the car ?company to profit. A preferred bidder could be announced within a fortnight. As well as Fiat, up to six unnamed bidders, including private equity firms and sovereign wealth funds, are in the running. Any new owner will make huge cuts to reduce overcapacity and losses.
European governments are in talks with GM Europe about providing finance and loan guarantees to the new company. GM UK has requested £600m in loan guarantees from the British government, but this backing will not be provided until it becomes clear what shape the new company takes. It wants a new hybrid car, the Ampera, to be built at the Ellesmere Port factory. But a take- over by Fiat, which specialises in making small, fuel-efficient cars, could jeopardise this. GM UK is understood to be concerned about the ability of Fiat, which has net industrial debt of €6.6bn, to revive the European subsidiary. GM Europe executives, who are having to take a back seat in discussions with Fiat, are said to prefer a tie-up with Canadian parts maker Magna. But Magna indicated it would only be prepared to take a 20% stake in GM Europe.
Signs of recovery in China's workshops raise fears for Asian industry and prices
Industry across Asia may be at risk from a sudden revival in Chinese manufacturing as the workshop of the world is lifted out of a nine-month slump with the help of a $600 billion (£400 billion) monetary and fiscal government stimulus. Traders in Shanghai and Hong Kong have taken yesterday's manufacturing data as a clear sign of recovery for the world's third-biggest economy. New jobs have been created, output has returned to positive territory and factories across a broad range of sectors received new orders in April. This is in sharp contrast to the scene late last year, when tens of thousands of factories closed and 20 million migrant workers were laid off. The revival in manufacturing was signalled by a striking bounce in the Asia-based brokerage CLSA's Purchasing Managers' Index for April — a closely watched monthly report viewed by many investors as a more reliable snapshot of the industrial status quo in China than the official figures produced by Beijing.
The survey of industry executives showed the index pushing narrowly back above the critical level of 50 for the first time since July last year. A number below that level — such as the dismal March figure of 44.8 — implies contraction in manufacturing; anything above it signals expansion. The recovery of the PMI to a level of 50.1 can be attributed to the country's vast stimulus package. according to CLSA's analsyis. Backed by record bank lending, the Government implemented measures designed to prevent the Chinese economy from tumbling too far below the politically sensitive GDP growth rate of 8 per cent. "China's Government has been extremely successful in stimulating investment and, combined with a sharp improvement in export orders, this has pushed the PMI back into positive territory in April," the report said, adding that the Government's spending should keep the PMI above 50 in coming months.
The CLSA report echoed an official survey produced by China's National Bureau of Statistics over the weekend, which also showed an April advance above the watershed mark of 50. These two reports support an optimistic view for a pick-up in the Chinese economy, economists at Barclay Capital said. However, the Chinese stimulus package may have serious consequences for the rest of the region. Despite the stock market euphoria that greeted the data, some analysts believe that Beijing may be creating new problems for other Asian countries in its haste to return to double-digit growth. The speed at which Chinese state-owned companies have been able to increase their capital spending — flying in the face of market signals — and the quality of those investments could create problems for the region, Eric Fishwick, chief economist at CLSA, said.
This kind of countercyclical investment is nothing new, but its scale and scope in China may create problems, for capacity will increase in areas where market forces would normally force it to contract. "Building additional industrial capacity in the face of falling prices is value-destructive — and not just for Chinese businesses," Mr Fishwick said. "China has the scale to generate profitdestructive deflationary pressures across Asia." He added that the global downturn may force many companies to fail, but as long as politics — rather than economics — influences Beijing's decision to bankroll wild investment by state-owned enterprises, these failures will be outside China. Heavy industry in the rest of Asia is "acutely at risk," Mr Fishwick said.
If China loses faith the dollar will collapse
Emerging economies such as China and Russia are calling for alternatives to the dollar as a reserve currency. The trigger is the Federal Reserve’s liberal policy of expanding the money supply to prop up America’s banking system and its over-indebted households. Because the magnitude of the bad assets within the banking system and the excess leverage of its households are potentially huge, the Fed may be forced into printing dollars massively, which would eventually trigger high inflation or even hyper-inflation and cause great damage to countries that hold dollar assets in their foreign exchange reserves. The chatter over alternatives to the dollar mainly reflects the unhappiness with US monetary policy among the emerging economies that have amassed nearly $10,000bn (€7,552bn, £6,721bn) in foreign exchange reserves, mostly in dollar assets. Any other country with America’s problems would need the Paris Club of creditor nations to negotiate with its lenders on its monetary and fiscal policies to protect their interests. But the US situation is unique: it borrows in its own currency, and the dollar is the world’s dominant reserve currency. The US can disregard its creditors’ concerns for the time being without worrying about a dollar collapse.
The faith of the Chinese in America’s power and responsibility, and the petrodollar holdings of the gulf countries that depend on US military protection, are the twin props for the dollar’s global status. Ethnic Chinese, including those in the mainland, Hong Kong, Taiwan and overseas, may account for half of the foreign holdings of dollar assets. You have to check the asset allocations of wealthy ethnic Chinese to understand the dollar’s unique status. The Chinese love affair with the dollar began in the 1940s when it held its value while the Chinese currency depreciated massively. Memory is long when it comes to currency credibility. The Chinese renminbi remains a closed currency and is not yet a credible vehicle for wealth storage. Also, wealthy ethnic Chinese tend to send their children to the US for education. They treat the dollar as their primary currency. The US could repair its balance sheet through asset sales and fiscal transfers instead of just printing money. The $2,000bn fiscal deficit, for example, could have gone to over-indebted households for paying down debts rather than on dubious spending to prop up the economy. When property and stock prices decline sufficiently, foreign demand, especially from ethnic Chinese, will come in volume. The country’s vast and unexplored natural resource holdings could be auctioned off. Americans may view these ideas as unthinkable. It is hard to imagine that a superpower needs to sell the family silver to stay solvent. Hence, printing money seems a less painful way out.
The global environment is extremely negative for savers. The prices of property and shares, though having declined substantially, are not good value yet and may decline further. Interest rates are near zero. The Fed is printing money, which will eventually inflate away the value of dollar holdings. Other currencies are not safe havens either. As the Fed expands the money supply, it puts pressure on other currencies to appreciate. This will force other central banks to expand their own money supplies to depress their currencies. Hence, major currencies may take turns devaluing. The end result is inflation and negative real interest rates everywhere. Central banks are punishing savers to redeem the sins of debtors and speculators. Unfortunately, ethnic Chinese are the biggest savers. Diluting Chinese savings to bail out America’s failing banks and bankrupt households, though highly beneficial to the US national interest in the short term, will destroy the dollar’s global status. Ethnic Chinese demand for the dollar has been waning already. China’s bulging foreign exchange reserves reflect the lack of private demand for dollars, which was driven by the renminbi’s appreciation. Though this was speculative in nature, it shows the renminbi’s rising credibility and its potential to replace the dollar as the main vehicle of wealth storage for ethnic Chinese.
America’s policy is pushing China towards developing an alternative financial system. For the past two decades China’s entry into the global economy rested on making cheap labour available to multi-nationals and pegging the renminbi to the dollar. The dollar peg allowed China to leverage the US financial system for its international needs, while domestic finance remained state-controlled to redistribute prosperity from the coast to interior provinces. This dual approach has worked remarkably well. China could have its cake and eat it too. Of course, the global credit bubble was what allowed China’s dual approach to be effective; its inefficiency was masked by bubble-generated global demand. China is aware that it must become independent from the dollar at some point. Its recent decision to turn Shanghai into a financial centre by 2020 reflects China’s anxiety over relying on the dollar system. The year 2020 seems remote, and the US will not pay attention to something so distant. However, if global stagflation takes hold, as I expect it to, it will force China to accelerate its reforms to float its currency and create a single, independent and market-based financial system. When that happens, the dollar will collapse.
Chinese ordered to smoke more to boost economy
Local government officials in China have been ordered to smoke nearly a quarter of a million packs of cigarettes in a move to boost the local economy during the global financial crisis. The edict, issued by officials in Hubei province in central China, threatens to fine officials who "fail to meet their targets" or are caught smoking rival brands manufactured in neighbouring provinces. Even local schools have been issued with a smoking quota for teachers, while one village was ordered to purchase 400 cartons of cigarettes a year for its officials, according to the local government's website. The move, which flies in the face of national anti-smoking policies set in Beijing, is aimed at boosting tax revenues and protecting local manufacturers from outside competition from China's 100 cigarette makers.
In total, officials have been ordered to puff their way through 230,000 packs of Hubei-branded cigarettes worth £400,000. China's government has ordered massive government spending at both national and provincial levels to prop up the economy following plummeting demand for Chinese exports abroad, however imposing a cigarette quota is unusual. "The regulation will boost the local economy via the cigarette tax," said Chen Nianzu, a member of the Gong'an cigarette market supervision team. China has 350 million smokers, about a million of whom die each year from smoking-related illnesses. Despite anti-smoking campaigns, cigarette taxes form a major component of China's annual tax-take at local level.
Local authorities in Gong'an county are taking the cigarette quota seriously and have established a "special taskforce" to enforce it. According to a local newspaper account, a teacher from a village middle school said officials burst unannounced into the school at around 3pm one afternoon and started sifting through the ashtray and bins in the staff-room. Three "non-compliant" cigarette butts were discovered by the "cigarette marketing consolidate team" which informed the teacher he had violated the related civil servants "cigarette usage rule" After some negotiation the school was spared a fine, but subjected to "public criticism" for "undisciplined practices".
Rising reserves of unused oil put strain on storage
Record inventories of crude oil are building up around the world threatening to swamp storage space and belying optimism in the markets about an imminent economic recovery. Rotterdam, Europe's biggest port, is running out of room for more oil, US reserves are at a 19-year record and tankers are being used as floating storage off Britain's south coast, even though OPEC is reducing production. "From a commodities point of view, world trade is appalling and the demand is just not there," said Ahmad Abdallah, commodities analyst at Gavekal, the economics consultancy. "All inventories are rising – they are bursting at their seams."
Oil prices rose to a five-week high last week above $53 a barrel in line with the recent bull run on the world's equity markets. Yet despite an OPEC decision last November to cut output by a record 4.2m barrels a day, a move which began to come into effect in February, the fall in demand has been even more striking. Goldman Sachs estimated last week that global storage capacity could be exhausted by June. Government figures in the US, the world's biggest oil consumer, put reserves at 375m barrels, rising by 4m barrels in one week in April alone. One estimate said that in addition 100m barrels were currently being stored in tankers at sea across the world – some of these are visible in Lyme Bay off the coast of Dorset and Devon. Mr Abdallah said official estimates of oil usage for this year had been based on more optimistic assumptions than economic reality. An average of analysts' predictions reckons on a reduction in demand of 1.5m barrels a day for 2009 over last year, while the International Energy Agency is predicting a fall of 2.5m barrels, but an estimate based purely on current economic growth figures would put the overall decline at 3m. He said it was a similar story in other commodities, with companies building up inventories while prices were cheap.
"I can't see demand picking up for the rest of this year," he said. "Even if it picks up next year it is going to be from a very weak base." Goldman Sachs set a price target 10pc lower than at present, at about $45, for July, while Peter Voser, chief financial officer for Royal Dutch Shell, told reporters last week that it was "difficult to see an uptick in the oil or gas price" in the next 12 to 18 months. The weak demand for oil will add fuel to the arguments of those who argue the current bull run on the equity markets is a classic fools' rally. "The further (the oil price) rises, the more sceptical you become," said Mark Pervan, head of commodities research at ANZ. "We are operating in a global recession and oil markets are a proxy for global growth."
Mental-Health Drug Usage Rises 73% in 10 Years
The number of seniors getting "psychotropic" medications, including antipsychotic and dementia drugs, doubled between 1996 and 2006, a new study found. Mental-health drug prescriptions for U.S. adults increased 73% and those for children rose 50% over the 10-year period, according to the new data. In 2006, one in 10 adults and one in 20 children reported having a prescription for a mental-health drug, the research said. A separate study found per-capital spending for mental-health care has grown more than 30% over the 10 years ended in 2006, with almost all the increase due to psychiatric drug costs. Both studies were being published Tuesday in the journal Health Affairs.
The increase in mental-health spending and the number of patients using these drugs largely indicate better access to care but "we've seen some stalling in recent years" in that trend, according to Richard Frank, an author on both studies and a health economist at Harvard Medical School. One reason could be that mental-health care has tipped toward the use of the psychiatric drugs while there hasn't been the same growth in the use of so-called psychosocial therapies, such as seeing a therapist. "What that says to me is the increase in drugs by itself -- just expanding the number of people who appropriately get drugs -- can get you improvement," said Dr. Frank. But, without adequate psychosocial support, simply prescribing more drugs "may not be enough," especially with people with severe disorders, he said. For about 30 years ending in 2000, the growth of mental-health costs remained relatively flat, consistently staying at around 1% of the gross domestic product, and growing at about half the rate of all other health-care spending.
But starting around 2000, mental-health-care costs began to climb more sharply. Cost growth in general health care is related to a variety of factors, such as spending for diagnostic imaging and hospital care, according to Dr. Frank. "In mental health, it's all drugs," he said of the added spending. In 2006, drug costs accounted for 51% of mental-health-care costs, while drugs accounted for just 26% of spending for all other health-care costs, according to data from a national household survey of health-care spending focusing on outpatient care. Per-capita spending for mental-health care between 1996 and 2006 grew about $40 to $148.56. The studies were funded by a combination of the John D. and Catherine T. MacArthur Foundation and the National Institutes of Mental Health.