"Foghorn Clancy Jr., youngest member of the rodeo to perform in Wild West show during the Shrine convention, Washington, D.C."
Ilargi: As the US dollar soars and gold plummets, fear is the master in the dark days before the Scrooge fest. Many are taking their profits and counting their losses before the end of the year. Here are 10 trends for 2010 and beyond. Some have started already, others won’t be big till after the next year, but all will be prominently in the news in the 12 months to come.
1) Sovereign DebtOne of the main themes lately, certainly in reports looking forward to 2010, is sovereign debt. That is not all that surprising, of course, given that if we take the US as an example, we see that in 2009 trillions of dollars of debt from the banking and housing industries have been transferred to the public sector, i.e. the taxpayer, the very party ultimately responsible for paying back that sovereign debt.
One may wonder what the taxpayer would do if only (s)he knew. Until then, though, that's simply economics 101 for you.
The American administration (and the House that -on paper- controls it), like many other governments around the world, sees the fact that it’s received 51% of the votes as a blanket permission to do with any amount of its voters’ money as it sees fit. And this includes spending during a single 4 year term in between elections what will take the voters 10 or 20 years to pay off, unless things go better than they ever have before in history.
This last example may be an exception, though still a truthful description of economic policies in the first year of the Obama administration, but it is undoubtedly true that in most if not all 4-year terms enough is spent for 5 or 6 years at the very least, with economic growth as the great provider and apologist. That’s why the debt has become so high.
We are on the doorstep of an era where is fast becoming more expensive for governments of all levels and well as businesses across the globe to borrow money, a development that will greatly exacerbate the problems. Printing presses are powerless to turn this around.
Sovereign debt is an issue in many countries today and going forward. Dubai, Greece, Ireland, Spain, Italy, Ukraine, Baltics, Argentina, Britain and Portugal are just a few of the most urgent cases.
2) Local Government DebtStates, towns, provinces, municipalities, no matter how specific nations have organized themselves, an unprecedented number among these entities are sailing into stormy weather. We can all see what happens in California and New York, but they're just the tip of the iceberg. The initial responses across the board will be to raise taxes wherever possible, which will lead to a lot of angry faces, and to cut services to the least vocal -who invariably are also mostly the most needy-.
Decent schools and health care facilities will begin to erode out of existence, while the longer term will bring deteriorating functionality in water and sewage systems as well as a diminishing state of repair of roads and other transport facilities. After that, likely after 2010, fire departments and police services will come under the knife. Some of these thing swill happen much sooner in some locales than in others, obviously.
3) Bank DebtToday, Citi can only repay TARP (and is being allowed to do so) by selling debt and shares so cheaply that even the Treasury wants no part of the deal. Expect them to come knocking again, let’s say in Q2 2010 at the latest. The 5 largest US banks count on their Too Big To Fail status, and feel sure the government will bail them out again next time they’re in trouble. That is what we call moral hazard. Come to think of it, nobody uses that term anymore today, when it has become more appropriate than ever.
The 8000 or so remaining US banks will start falling like dominoes, as they should have done over the past year if only the FDIC had done its job in a proper fashion. Already, the state of the banks that were closed recently has been much worse than those closed a year ago, and therefore much more costly to the public. If nothing else, this will turn into an increasingly embarrassing situation for Washington.
In many other countries, banks received support of one kind or the other. If and when the economy gets worse, their losses will mount and their positions will become untenable. Some closures will be exceedingly painful. Bank holidays in certain countries look inevitable.
4) Business DebtHuge numbers of businesses around the world will find that when they have to roll over their debt or extend their credit lines, the cost of servicing it will rise dramatically, which by itself will for many be the sign to throw the towel, while for many others the lines will simply be cut off. No matter what stories you may hear or read, and no matter how much money is dumped into the banking system, we are in a credit crunch.
5) Consumer DebtCredit will keep contracting (re: credit cards), home prices will keep falling and unemployment numbers will continue to rise. That should be all you need to know. It’s called a credit crunch.
6) Tax IncreasesGovernment tax revenues, federal and below, have been dropping throughout 2009 and will continue on their downward path. There is one initial reaction: raise taxes. We will see a lot of anger and a lot of misery on account of this. We’ll also see for instance people losing their homes because they can't afford the property taxes. Wait for stories about incidents of crazy tax raises somewhere. Good hearted fun if you're not a victim.
7) ForeclosuresSome 4 million in 2009. And more in 2010, but for a miracle. Resets of Alt-A and OptionARM’s are getting ready for their lift-off. Which means falling prices. Which means more foreclosures. Which means falling prices. Wich means more foreclosures. Ironically, as long as the government props up home prices, these prices will keep falling. Albeit more slowly. Prices that would constitute a market equilibrium in today's conditions are a long way down from here.
8) UnemploymentAgainst the backdrop of a 50+% stock market rally, job numbers have continued to plummet, and there's no indication (no, Larry Summers doesn’t count) that things will turn around. The downfall has slowed, just like the one in housing prices, but it hasn't stopped or reversed. The numbers of unemployed youth and long-term (i.e. more than a year) jobless are both staggering and worrisome.
9) Stock MarketsA 50% rally. Who in his right mind would expect that to keep rising when the main indicators are all worsening? Eventually, we’ll move back to a situation where only a few people will be invested in stocks, like in the days of old. To get there, it should be obvious that the masses invested now will have to absorb losses substantial enough to make the markets look highly unappetizing. And so it will come to pass.
10) UnrestThe main newbie and the rising star in 2010. We've seen instances the past year, which the media have hilariously all attempted to label "terrorism", but watch for a million different forms of unrest in a million different places, and all over the planet, some of it decidedly ugly. A lot of people stand to lose a lot of what they have long been led to believe is rightfully theirs, and they're not all going to take it lying down. Not anymore.
2009 was the year of the gullible victim.
2010 will be the year of the wake-up call.
Ilargi: Our Christmas fund is open for donations, and our advertisers are open for your visits. Don’t be a Scrooge or a Grinch. Spend like Bernanke!!
Moody’s warns of 'social unrest’ as sovereign debt spirals
Britain and other countries with fast-rising government debts must steel themselves for a year in which "social and political cohesiveness" is tested, Moody’s warned. In a sombre report on the outlook for next year, the credit rating agency raised the prospect that future tax rises and spending cuts could trigger social unrest in a range of countries from the developing to the developed world.
It said that in the coming years, evidence of social unrest and public tension may become just as important signs of whether a country will be able to adapt as traditional economic metrics. Signalling that a fiscal crisis remains a possibility for a leading economy, it said that 2010 would be a "tumultuous year for sovereign debt issuers". It added that the sheer quantity of debt to be raised by Britain and other leading nations would increase the risk of investor fright.
Strikingly, however, it added that even if countries reached agreement on the depth of the cuts necessary to their budgets, they could face difficulties in carrying out the cuts. The report, which comes amid growing worries about Britain’s credit rating, said: "In those countries whose debt has increased significantly, and especially those whose debt has become unaffordable, the need to rein in deficits will test social cohesiveness. The test will be starker as growth disappoints and interest rates rise."
It said the main obstacle for fiscal consolidation plans would be signs not necessarily of economic strength but of "political and social tension". Greece, where the government has committed to drastic cuts in public expenditure, has suffered a series of riots over the past year which are thought to have been fuelled by economic pressures.
Sovereign Debt: Will It Be Payback Time In 2010?
by Dave Rosenberg
We are not sure if this is a well known "fact", but the U.S. government has a record$2.5 trillion of its debt, including bills, bonds and notes, rolling over in 2010. That,my friends, is 35% of the outstanding level of Uncle Sam’s marketable obligations having to be refinanced in one single year. One has to wonder how the Fed is going to be able to raise interest rates in such a backdrop of massive rollovers;and if it doesn’t and the economy manages to exceed expectations or we get some inflation, how it is that the near-record steepness in the yield curve doesn’t continue in the coming year.
But very clearly, sovereign risk globally has taken over as the major potential flare-up for the coming year. Looking at the official projections for 2010, we have Japan’s government debt-to-GDP ratio hitting 227%; Italy at 120%; the U.S. and the U.K. both at 94%; Germany and France at 83%, and Canada at 79% (all levels of government). Rarely, if ever, has Canada been the one-eyed man to this extent in the land of the blind.
Sovereign debt risk in pictures
Here are a couple of charts from the latest edition of the Institute of International Finance’s excellent "Capital Markets Monitor" which graphically illustrate how markets are pricing the perceived risk of sovereign debt default.
The first one (below) shows the cost of insuring against default through credit default swaps. This is a quite thin market, so some analysts don’t give it much credence. Never the less, the signals it is sending out seem clear enough. The UK has for more than a year now been seen as a significantly bigger risk than either Germany of the US. Not too many surprises there. But having narrowed the gap somewhat over the summer and into the autumn, it is now widening markedly again. The markets are saying that unless more credible plans are produced soon to deal with the road crash in the public finances, then there will be a big price to pay in terms of the cost to the UK Government of borrowing from the bond markets.
The second chart (below) shows the spread over German bunds – generally regarded by investors as the safest Aaa rated security in the world – of Greek, Irish, Italian and Spanish counterparts. The illustration speaks for itself, particularly with regard Greece and Ireland. Britain isn’t shown, but the spread between gilts and German bunds has been widening too, albeit less dramatically.
In this morning’s Daily Telegraph I wrote about why I thought government bond markets as a whole were riding for a fall, but plainly some countries will fare better than others in the coming shake out. Of course, not everyone agrees with my central view. Capital Economics thinks the yield on 10 year US Treasury bonds will be down to 2.5 per cent by the end of next year. But to take that view, you have to believe the world is set on a powerfully deflationary course, where the only assets investors will want to hold are safe haven government bonds. I guess we are about to find out, but I see the next decade looking much more like a repeat of the 1970s for Britain and the US – turbulent, up and down and with bouts of inflation – than 1990s Japan. That’s not going to be good for gilts or government bonds anywhere. Add to that the monumental size of the net issuance which is about to hit markets and it’s hard to be anything other than bearish about the outlook for sovereign debt.
Obama weighs ordering new debt commission
President Barack Obama is seriously considering an executive order to create a bipartisan commission that could weigh sweeping tax increases and spending cuts to try slash the soaring federal deficit, CNN has learned.
Documents obtained by CNN show that top advisers to the president have been privately weighing various versions of a commission, and there are differing opinions about how to structure it. Officials say that some inside the administration are pushing for a narrow mandate because it's too complicated to tackle reform of the tax system and possible spending cuts to various popular programs like Social Security and Medicare all at once.
"Each major category of fiscal policy -- Social Security, Medicare, discretionary spending, revenues -- raises a complex and idiosyncratic array of policy problems and prescriptions," according to the documents detailing some of the administration's deliberations. "Achieving consensus on any one of these issues -- much less all of them simultaneously -- may be more than the political system can reasonably accommodate." But officials told CNN that other advisers to the president are pushing for the commission to have a broad mandate to put all of these big issues "on the table" at the same time.
"The nation's unsustainable fiscal course is the result of imbalance across the budget as a whole, not any component in isolation," according to the documents, which are marked "Preliminary and Pre-Decisional -- Not For Distribution." "And, in both the 1990 and 1993 budget deals, the final compromises encompassed both revenue enhancements and spending reductions," add the documents. "Such deals, touching on both sides of the budget ledger, perhaps offer the best way of achieving a bipartisan deficit reduction package."
The Obama administration's deliberations are taking on some urgency behind closed doors because the president is facing heavy pressure from Sens. Kent Conrad, D-N.D., and Judd Gregg, R-N.H., to appoint a commission. Conrad and Gregg, along with a group of moderates led by Sen. Evan Bayh, D-Ind., have been threatening to block a large increase in the nation's debt ceiling unless the president agrees to a commission.
While some critics charge a commission would be a cop-out because it would punt Congressional decisions to an outside panel, the senators pushing the plan believe the current system is broken and it will take a new mechanism to enact the wrenching changes that will be needed to get the budget back into balance.
"We are on a path to bankruptcy as a nation and it's that simple," Gregg said last week as he and Conrad officially introduced legislation that now has 33 co-sponsors. Leading Senators call for fiscal commission The Conrad-Gregg bill, which would need to pass both chambers of Congress and then be signed into law by Obama, would create a deficit commission with 10 Democrats -- eight members of Congress and two Obama officials -- and 8 Republicans -- all from the House and Senate.
The panel would have several months in 2010 to study the problem and then vote after the midterm elections on a reform package that could include dramatic tax hikes and spending cuts. If 14 of the 18 members approve the package, giving it a bipartisan nod, it would force an automatic up-or-down vote in both the House and Senate on whether to implement the recommendations.
If Obama signed an executive order to create the commission, however, it would not have the full force of law and thus the outside commission could not mandate that Congress vote up-or-down on the recommendations. This would also give the president more wiggle room to ignore the recommendations if the commissions suggests, for example, raising taxes on people earning less than $250,000 a year, which would break an Obama campaign promise.
Some administration officials also like the executive order idea because it could help the White House place more Obama officials on the commission to give the president more control. But the documents obtained by CNN note that also brings political risk: "The promise of greater say over the deliberations and final product of the commission, but the peril of being more deeply implicated in the event of failure."
House Backs $290 Billion Increase in Federal Debt Limit For 6 Additional Weeks of Operation-
The U.S. House of Representatives on Wednesday passed legislation giving the federal government the ability to borrow a whopping $290 billion to finance its operations for just six additional weeks. The 218-214 vote sends the must-pass bill to the Senate, which is expected to approve it as its last act before adjourning for the year. The alternative would be a market-rattling, first-ever default on U.S. obligations.
The measure is needed as a result of the out-of-control budget deficit, which registered $1.4 trillion for the budget year that ended in September. The current debt ceiling is $12.1 trillion and is set to be reached by Dec. 31. Democrats had hoped to pass a far larger increase of almost $2 trillion to avoid another vote before next year's midterm elections -- and to wrap the increase into the popular defense appropriations bill to give some political cover.
But that plan fell apart amid opposition from about a dozen Senate Democratic moderates, who say they will refuse to vote for a debt limit increase unless it is accompanied by legislation to establish a new bipartisan task force to come up with a plan to curb the deficit. That idea is opposed by Democratic leaders such as the leader of the House, Speaker Nancy Pelosi, a Democrat. Wednesday's bill delays the showdown in February.
Another complicating factor is moderate Democrats, who are demanding a "pay-as-you-go" budget law aimed at ensuring that new tax cuts or new spending programs don't increase deficits. Otherwise, they won't vote for the next debt increase. The Senate is generally opposed to the idea, even though it was the law of the land for more than a decade. Debate over the measure broke, predictably, along partisan lines. Because Democrats control both Congress and the White House, it was their job to muster the votes required to advance the bill, even though much of the increase is required due to economic conditions inherited by President Barack Obama as he took office. The down economy has cut tax revenues sharply.
Republicans -- who helped supply votes to increase the debt ceiling just last year -- unanimously opposed the legislation, which is required to issue new debt to pay for federal operations and deposit up to $50 billion into the Social Security trust funds that pay pensions. "We should not be asking for more credit, we should be developing a plan to pay down our deficit so that future generations are not trapped under this mountain of debt," said Rep Dave Camp, a Republican. "The bottom line is, having the government shut down is not an option," said Rep. Russ Carnahan, a Democrat.
US needs plan to tame debt soon, experts say
The U.S. government must craft a plan next year to get its ballooning debt under control or face possible panic in financial markets, a bipartisan panel of budget experts said in a report on Monday. Though the government should hold off on immediate tax hikes and spending cuts to avoid harming the fragile economic recovery, it will need to make such painful changes by 2012 in order to keep debt at a manageable 60 percent of GDP by 2018, according to the Peterson-Pew Commission on Budget Reform.
Without action, investors could lose confidence in the United States, driving down the dollar and forcing up interest rates, said the former lawmakers and budget officials who crafted the report. That could cause a sharp decrease in the country's standard of living. "We will be less free if we don't tackle this," said Jim Nussle, a Republican member of the commission who earlier served as a White House budget director and chairman of the budget committee in the U.S. House of Representatives.
The 34-member commission published its report as Congress was poised to raise the debt limit from its current $12.1 trillion level to allow the government to continue operating. The national debt has more than doubled since 2001, thanks to the worst recession since the 1930s, several rounds of tax cuts and wars in Iraq and Afghanistan. A looming wave of retirements over the coming decade is expected to make the situation worse.
The national debt currently accounts for 53 percent of GDP, up from 41 percent a year ago. That's likely to rise to 85 percent of GDP by 2018 and 200 percent of GDP by 2038 unless dramatic changes are made, the commission said. The commission did not issue specific prescriptions but said tax increases and spending cuts would probably be needed. It said Congress and the Obama administration should set specific targets each year, with automatic spending reductions and tax increases kicking in if they are not reached.
The Democratic-controlled Congress is unlikely to fix the problem on its own given the highly partisan atmosphere, commission members said. "You've got to have a few Republican votes, and there have been none. And there has been no possible way in the current political system yet to find that sensible center," said former Democratic Representative Charlie Stenholm. The commission backed the creation of an outside commission, similar to one used to close miliary bases, to create the necessary political cover.
Such a proposal is included in a crush of year-end legislation that could clear Congress this week but it is opposed by many key Democrats. The United States must act to ensure that it does not join Dubai, Greece, and other countries that risk losing the confidence of investors, the commission said. "It's imperative that we take action before the financial markets force us to," said Douglas Holtz-Eakin, a former Congressional Budget Office director who advised Republican John McCain's presidential campaign last year.
Debt disaster fears rumble from Athens to London
Rumors of a debt disaster are swirling around Europe, from Athens to Madrid and all the way to London. Investors have rushed to sell Greek bonds since the newly elected government of George Papandreou made a startling revelation: the deficit will soar to over 12% of gross domestic product this year, well above previous official projections.
Greece's predicament has escalated concerns about contagion in other European countries whose finances are in poor shape. Just this month, the ratings of Greece have been cut both by Fitch Ratings, and, late Wednesday, by Standard & Poor's, and major agencies have warned Spain and Portugal of possible cuts. The market reaction has been swift, and brutal. The euro has dropped below the key $1.50 level. Credit-default swaps on Greek government debt -- essentially, bets that Greece will default -- have ballooned.
The ASE Composite stock-market index has dropped more than 20% since mid-October, dragged by shares of lenders including Piraeus Bank, EFG Eurobank Ergasias and National Bank of Greece. Irish and Spanish institutions also have seen extreme bouts of turbulence of late. The most vulnerable countries like Greece and Spain indeed confront a mounting debt burden, which will likely lead to more ratings downgrades and more market sell-offs. The path to fiscal health will require painful, unpopular reforms.
But, most analysts agree that the European Union will, if necessary, bail out its members and never let a country's fiscal situation deteriorate to the point of sovereign default. Those rescue expectations continue even as terms of euro entry explicitly forbids such moves. "If you think Greece is going to default, you should sell all the bonds of Spanish and Italian and Portuguese companies, because you think the euro will fall apart," said Philip Gisdakis, credit strategist at UniCredit. "And that is something that I think is completely exaggerated."
"There is a lot of misunderstanding in the market about the importance of Europe and the euro-zone on a political level," he said. "Europe is a question of warranties. They are going to support countries like Greece and Ireland." The members of the European Union -- which is both a political and an economic alliance -- are closely interconnected and have too much to lose if one of them defaults. That is especially true for those 16 countries which share the euro as their common currency.
Greece's debt troubles are hardly new; it has been running high public deficits for years, and the state of the economy is not making things any easier. Real growth will be nearly flat next year after falling into a recession in 2009. The economic slump, together with high budget deficits, is projected to push public debt from 112.5% of GDP this year to over 135% of GDP by 2011, according to European Commission estimates.
Projections of weak growth and rising borrowing costs make it very challenging for Greece to repair its finances. The closely watched yield spread between Greek and German government bonds has widened significantly. For ten-year bonds, for example, Greece has to pay 2.5 percentage points more interest than Germany. "Consolidating public finances is truly a Herculean task," said Christoph Weil, analyst at Commerzbank, in a note to clients. "The greatest savings potential is doubtlessly found on the spending side."
In other words, Greece stands some chance of balancing its budget only if it implements massive spending cuts. Papandreou's government has vowed to implement reforms, but such a route is riddled with political potholes, as the local population seems unwilling to accept tough measures. That again leads to the question of E.U. support. "You have a budget deficit and that means you have to borrow, so debt keeps going up. Your growth has to carry you out of this debt spiral, but the economy is falling off a cliff," said Jason Manolopoulos, managing partner of Dromeus Global Opportunities Fund, a fixed-income hedge fund based in Geneva.
"The European Union, at some point, will have to say here's X [amount of money] to tide you over," he said, commenting on Greece's financial woes. Marc Chandler, currency strategist at Brown Brothers Harriman in New York, believes that a near-term default or an exodus from the euro zone is unlikely. "The most likely scenario seems to be some muddling through with measures that are not quite enough, but still a step in the right direction," Chandler wrote in a note.
While Greece's woes have been in the spotlight recently, several other countries are also getting some attention, including Spain, Ireland, and even the U.K. Analysts emphasize the importance of differentiating between European countries, because their predicaments are only partially comparable. For example, Ireland's deficit is high at 10.75% of GDP. However, its public debt ratio -- 65.8% of GDP -- in 2009 is roughly half of the debt ratio in Greece. Also, Ireland is planning massive spending cuts next year, while Greece has yet to implement the drastic structural reforms necessary to remedy the state of its public finances.
In Spain, the deficit is projected to rise to 11.25% of GDP this year from 4.1% in 2008. The collapse of the construction industry has triggered the worst recession in decades and sent the unemployment rate to the highest level in developed Europe. The deficit of the U.K., which is outside of the euro-zone, will surge to over 13% of GDP this year from 6.9% previously, as a result of the sharp economic contraction and the loss of tax revenues from the financial sector and the housing market.
"If you extrapolate, then every country whose finances weaken will end up defaulting and the U.K. would be next," said Adam Cordery, head of European and U.K. credit strategies at Schroders. "However, that isn't what tends to happen in a cyclical recession in relatively affluent societies that have a lot to lose, and Greece and Spain, like the U.K., would have a lot to lose," he said in emailed comments.
A default scenario would require a persistently weak global economy and lack of action on the part of domestic authorities and the E.U., all events that are unlikely, according to Cordery. "For sure, Greek and Spanish government bond yields could rise relative to Germany's before they fall," Cordery said. "But that doesn't imply default - just a change in perceptions of the risks today."
S&P downgrades Greece while concerns mount over secret defence budget
Standard & Poor’s has become the second rating agency to downgrade Greek sovereign debt to near junk levels of BBB+, issuing a withering verdict on Spartan plans unveiled this week by premier George Papandreou. "The downgrade reflects our opinion that the measures to reduce the high fiscal deficit are unlikely, on their own, to lead to a sustainable reduction in the public debt burden. If political considerations and social pressures hamper progress, we could lower the ratings further," it said.
The move came as Spyros Papanikolaou, head of Greece’s Public Debt Management Agency, held back-to-back meetings with bankers in London in a bid to stop the crisis spiralling out of control. Yields on 10-year Greek bonds surged to 5.75pc, a spread of 254 basis points over German Bunds. Borrowing costs are nearing levels that risk setting off an interest compound spiral. The public debt is already 113pc of GDP. S&P said it is likely to reach 138pc by 2012. "The increasing debt-service burden narrows the scope for debt stabilization," it said.
Fitch Ratings precipitated the Greek crisis earlier this month with a surprisingly harsh downgrade to BBB+, accompanied by a "negative outlook". It emerged yesterday that Greece had raised €2bn (£1.77bn) at a premium of 30 basis points in a private placement shortly after the Fitch move, avoiding the public glare of an auction. To make matters worse, there were fresh concerns yesterday about the true scale of Greek military spending, which is kept off the books of the debt agency. "Greek military accounts seem to be regarded as a state secret," said Chris Pryce, Fitch’s director of sovereign ratings.
"In every other EU country we can find out how much they spend on defence, but we don’t know for Greece. All we know is that their military spending is very large, around 5pc of GDP," he said. Analysts who have probed deeply into Greek accounts have been astonished to discover that parts of the public sector lack double-entry book-keeping, 700 years after it was invented by the Venetians.
Given Greece has misled the bond markets and Brussels in the past over its deficits, analysts suspect that Athens may try to hide problems behind a military veil. Mr Papandreou admits that Greece has lost "every shred of credibility".
Greece has already cut defence this year. It announced in September that it would not take delivery of four submarines built by ThyssenKrupp, alleging technical faults. This has led to accusations Athens is effectively defaulting on a €520m contract. Last week it cancelled tenders for a flight of maritime aircraft worth up to €250m. The Greek military, especially the air force, is highly regarded by NATO, but its size is increasingly hard to justify as tensions ease with rival Turkey.
Mr Pryce said that the austerity measures promised this week by Mr Papandreou were too vague to reassure the markets, even though they were enough to set off a wave of strikes, kicked off by teachers yesterday. The refusal to reduce the wages of most public employees contrasts sharply with Ireland, where public pay was cut 7pc in April and will be cut 6pc more in January, the most wrenching adjustment in a modern economy since the 1930s. "There is a lack of substance. The danger for the Greek government is that public pay becomes an icon for the market. The contrast with Ireland is something that all traders have noticed," Mr Pryce said.
Inflating away debt is not an option
Something important happened this week: for the first time since the start of the financial crisis, investors demanded a bigger premium in return for holding British debt than Spanish. Indeed, the cost of our government borrowing – as measured by the interest rate – is rising so quickly that within a month it could be higher than Italy's.
The fact that Britain is such a risky proposition in the market's eyes has hardly gone unnoticed in the Treasury. Since last week's pre-Budget report, the mood there has been a cocktail of misery and resentment. Misery because civil servants know full well that if they lose the faith of international investors, the resulting crisis will consign the country to an even more hideous decade than they are projecting. And resentment because, fearing precisely this reaction, they recommended more ambitious plans to reduce the eye-watering deficit, only to have them nixed by No 10.
Much of the worry has been over whether Britain will have its credit rating cut, but this is actually something of a sideshow. The credit ratings agencies are charged only with working out the likelihood that Britain will default on its debt – something that has never happened since the UK started issuing bonds in the 17th century, save for a fiddle with a loan from the First World War in the 1930s.
What is far more likely, or so investors fear, is that Britain will inflate the deficit away by debauching the currency: as inflation rises alongside the money supply, every pound we owe will be worth that little bit less. This is what we did in the 1970s – and most other times we have faced a debt crisis. So suspicions that a repeat performance is on the cards are not difficult to understand: the pound has already fallen by around a quarter since the start of the crisis; the Bank of England has embarked on a quantitative easing scheme that involves printing enough money to buy the annual economic output of Denmark; and inflation is threatening to leap well above the Bank's 2 per cent target.
Might history repeat itself? You can understand why the market thinks so: we are facing not only the debts from the current crisis (equivalent to those incurred in the Second World War) but a looming bill of almost double the size from the ballooning health and pension costs of an ageing population. Plus, one of the peculiarities of the British debt market – that the Treasury issues bonds that take far longer to mature than most other countries' – has historically made it easy for profligate governments to create the odd burst of inflation without being punished as badly as the Italians or French, whose bonds are short-term, and so need to be rolled over more often.
Yet however much today's politicians may be tempted to try to inflate away their debts, this avenue is in fact far more difficult than it was in the 1970s.
- First, it would mean throwing away the 2 per cent inflation target that the Bank of England has kept to for more than a decade.
- Second, investors are far more mobile than 30 years ago: one of the by-products of globalisation is the speed with which capital can be withdrawn from a country. That means, according to the International Monetary Fund, that inflation in single digits – say 6 per cent – would "not make much of a dent in the real value of the debt", because investors would charge the governments higher interest rates if they got even a sniff of impending inflation. Which implies that only inflation in the high double digits – 1970s style – would do the trick.
- Third – and perhaps most importantly – governments have, largely unwittingly, sewn safeguards into the debt market which make an inflation strategy pointless. Since the 1970s, we have issued an increasing amount of debt in the form of index-linked bonds, which now account for a quarter of the debt market. These are inflation-proof: the debts increase automatically alongside inflation. Then there are the country's other liabilities: public sector pensions (circa £800 billion), the state pension (£1.4 trillion) and the costs of private finance initiatives (£140 billion), all of which are tied to inflation.
In fact, around four fifths of the state's debt bill is inflation-proof. The only way ministers and mandarins could inflate their way out of the crisis would be to rip up all the contracts that tie these debts to inflation: possible in the case of the state pension (which is one reason why Gordon Brown's pledge to link it to earnings is probably doomed), difficult for all the rest.
And a good thing, too. As tempting as it is for profligate governments, permitting double-digit levels of inflation inflicts a baleful cost on households and companies. If we have forgotten this lesson from the 1970s – where the cost of the strategy was economic chaos and an IMF bail-out – it is just as well that these restrictions ought to prevent, or at least impede, the Government from taking that approach. No, the solution to today's fiscal crisis is the same as it has always been: to cut spending, reduce the deficit and learn to live within our means.
German Cabinet OKs 2010 Budget With Record Debt
The German Cabinet approved Germany's new center-right government's first budget, which includes plans for record debt levels and a 10.5% increase in spending next year, a German finance ministry spokesman confirmed Wednesday. The cabinet agreed to a record €85.8 billion in new borrowing next year, putting the total at around €100 billion when including spending for financial-sector bailouts and other extraordinary measures. The increased spending is the result of higher social welfare costs, which have risen as the economy has weakened.
Finance Minister Wolfgang Schaeuble said there is a consensus internationally that the crisis hasn't yet been overcome and the government's 2010 budget therefore had to take this into account and let borrowing rise dramatically. "It was, is and remains right that we didn't counter-steer in this dramatic slump...but aimed to prevent worse," he told the lower house of parliament in a hearing on the 2010 budget. The government opted against any austerity policy for next year and instead will let borrowing rise, in a move to stabilize the economy.
But it promised to start with a strict consolidation course from 2011, reducing its structural deficit by €10 billion annually. That is because the government has to get the structural deficit in line with the constitutional limit on structural debt, of 0.35% of gross domestic product, by 2016. "This will require great efforts," Schaeuble said. "It won't be easy" and it will result in decisions that might be unpopular, Schaeuble warned, asking lawmakers to support the government in its future consolidation efforts. The 2010 spending plan drawn up by Chancellor Angela Merkel's government suggests that more than one quarter of the €325.4 billion budget will be funded with new debt.
The €85.8 billion in new borrowing will also be more than double this year's slightly lowered new-debt target of €37.5 billion. New debt will next year reach a "level not seen in the history of the Federal Republic of Germany," the government's draft 2010 budget bill said. "However: In the present situation, there is no reasonable alternative to an expansive budget and fiscal policy. We will only be able to overcome the crisis sustainably and then return to a fiscal stabile path if we are successful in supporting the still fragile growth dynamic," it said.
The grim fiscal outlook implies that Germany's countrywide deficit will this year reach around 3% of GDP, roughly in line with the 3% limit stipulated under European Union budget rules. But the finance ministry expects Germany to overshoot the EU-mandated ceiling next year with a forecast spending gap of around 6%, although Schaeuble said the deficit might come in around 5%. Schaeuble said it is important for the euro zone's single currency that Germany reduces its budget deficit and bring it to below 3% of GDP, as required by the European Union's Stability and Growth Pact. For now, the government's 2010 budget foresees €325.4 billion of spending, up around 10.5% from its updated estimate of €294.5 billion for 2009. The 2010 forecast is also up 7.3% from the original €303.3 billion spending target.
Bundesbank President Axel Weber welcomed the government basing its budget on 1.2% growth expectations next year, which is less optimistic than the 1.6% growth the Bundesbank has forecast. "It's not bad that the budget is somewhat on the careful side," Weber told the cabinet, according to Schaeuble. The draft spending plan allocates the largest share to social welfare, including pensions and unemployment benefits. The second-largest budget item, as before, will be payments linked to federal debt.
Schaeuble will also brief the press on Wednesday on his 2010 budget draft.
US Initial Jobless Claims Increase
More Americans than anticipated filed first-time claims for unemployment benefits last week, a reminder that the labor market will take time to strengthen and may weigh on the economic recovery. Initial jobless claims rose by 7,000 to 480,000 in the week ended Dec. 12, from a revised 473,000 the prior week, Labor Department figures showed today in Washington. The number of people receiving unemployment insurance was little changed in the prior week, while those getting extended payments increased.
Federal Reserve policy makers yesterday said weakness in the labor market is restraining consumer spending, which accounts for about 70 percent of the world’s largest economy. Concerns over the lack of jobs prompted the central bank yesterday to reiterate a pledge to keep the benchmark interest rate low for an "extended period." "The level of new claims remains elevated," said Steven Wood, president of Insight Economics LLC in Danville, California. "The labor market is improving, but remains soft."
Stock-index futures were down after the report as Citigroup Inc. sold stock for a price so low the U.S. government delayed plans to shrink its one-third stake. The contract on the Standard & Poor’s 500 Index fell 0.9 percent to 1,096.2 at 8:49 a.m. in New York. Treasury securities rose. Jobless claims were projected to drop to 465,000 from 474,000 initially reported for the prior week, according to the median forecast of 43 economists in a Bloomberg News survey. Estimates ranged from 450,000 to 475,000.
The report showed the four-week moving average of initial claims, a less volatile measure, fell to 467,500 last week, the lowest level since September 2008, from 472,750. Continuing claims increased by 5,000 in the week ended Dec. 5 to 5.19 million. The continuing claims figure does not include the number of Americans receiving extended benefits under federal programs. Today’s report showed the number of people who’ve use up their traditional benefits and are now collecting extended payments jumped by about 144,000 to 4.73 million in the week ended Nov. 28. Seventeen of the 50 states and territories where workers are eligible to receive the government’s latest 13-week extension have begun to report that data, a Labor Department spokesman said.
A Simple Yet Comprehensive View Of America's Unemployed
by Tyler Durden
Lately there has been much back and forth over the definitions of (un)employment, of improving (deteriorating) trends therein, and of just what is going on with the labor pool in the U.S. Due to the lack of a definitive data series that tracks comprehensive unemployment over time, the possibility for loose interpretation exists and is (ab)used by many.
In order to hopefully mitigate a lot of the debate on the margin, here is probably one of the more comprehensive charts available, which tracks Initial Claims, Continuing Claims and Emergency Unemployment Compensation (the last being somewhat notorious lately, and a datapoint that has to be considered due to the skyrocketing exhaustion rate) since 1967. Pretty simple. The result does not need much commentary.
Nearly 50% of Detroit's workers are unemployed
Analysis shows reported jobless rate understates extent of problem
Despite an official unemployment rate of 27 percent, the real jobs problem in Detroit may be affecting half of the working-age population, thousands of whom either can't find a job or are working fewer hours than they want. Using a broader definition of unemployment, as much as 45 percent of the labor force has been affected by the downturn. And that doesn't include those who gave up the job search more than a year ago, a number that could exceed 100,000 potential workers alone.
"It's a big number, and we should be concerned about it whether it's one in two or something less than that," said George Fulton, a University of Michigan economist who helps craft economic forecasts for the state. Mayor Dave Bing recently raised eyebrows when he said what many already suspected: that the city's official unemployment rate was as believable as Santa Claus. In Washington for a jobs forum earlier this month, he estimated it was "closer to 50 percent."
Although the government doesn't produce an unemployment number that high, it's not hard to get close. Officially, the unemployment rate in Detroit was estimated at 27 percent in October. But that number does not include people working part-time who want full-time work, nor does it include "discouraged" workers, who have stopped looking for work. It also doesn't include people who have gone back to school rather than search for a job.
The Bureau of Labor Statistics estimated that for the year that ended in September, Michigan's official unemployment rate was 12.6 percent. Using the broadest definition of unemployment, the state unemployment rate was 20.9 percent, or 66 percent higher than the official rate. Since Detroit's official rate for October was 27 percent, that broader rate pushes the city's rate to as high as 44.8 percent.
Detroiter Michael Kapusniak, 61, is familiar with the problem. He lost his job at a Hamtramck bar when it closed earlier this year and the funeral home where he occasionally helps out has seen most of its business move to the suburbs. "Everybody's closing up," he said. "I've been looking everywhere." So Kapusniak is left to the fruitless task of filling out applications as his checking account dwindles. "There's nothing I can do. The bills are piling up," he said.
Bing returned to the White House on Tuesday to attend a holiday reception. "Jobs are the key to revitalizing Detroit," Bing said in a statement released to The Detroit News. "The statistics tell part of the story, but we can't run from the reality that the need for jobs and investment is far greater than any statistic could measure."
The monthly unemployment rates issued by the state count only the more traditional definition of the unemployed: folks who want work but don't have a job. It doesn't reveal problems just as serious -- those who aren't working enough or, worse, those who have gotten so discouraged that they have quit looking. Indeed, the way municipal unemployment rates are measured leaves a lot of wiggle room. Unemployment rates for the state and counties are based on monthly surveys and unemployment claims. But for cities, the estimate is derived by looking at how that community fared in the 2000 U.S. census.
For Detroit, that means its unemployment rate will reflect what percentage of the unemployed it had within Wayne County in 2000. Few would argue that conditions have worsened since then, meaning even the official unemployment rate could underestimate current conditions. "The qualitative point (Bing) was making is correct," Fulton said. "There is more unemployment out there than is officially recorded, and it's a very serious situation."
Marc Levine, director of the Center for Economic Development at the University of Wisconsin-Milwaukee who has studied unemployment in the Midwest, said it may be worse if the government counted those who are no longer considered part of the labor force. If a worker tells a surveyor that he quit looking more than a year ago, he isn't counted in any measure of unemployment. Early retirees, caused by corporate downsizing, also would affect the count. Levine said you can get a hint at the depth of the problem by looking at the male jobless rate, which avoids the problem of counting stay-at-home mothers.
For a variety or reasons -- access to transportation, job availability and work skills -- an estimated 48.5 percent of male Detroiters ages 20 to 64 didn't have a job in 2008, according to census figures. For Michigan, it's 26.6 percent; for the United States, 21.7 percent. In Detroit, many of those are truly unemployed and looking for work, but tens of thousands more are not, Levine said. If they were counted in the unemployment rate, he said it would be far higher -- approaching 50 percent. "I think it's a dramatic kind of conclusion, but you're not on soft ground," Levine said.
At the city of Detroit's one-stop job shop, counselors try to find training programs for prospective workers. Center director Ron Hunt said the most recent downturn has brought in a different clientele. It includes many with college degrees. But as in years past, it also includes those who had low-skill jobs. Now, rather than hope a recovery will mean a return of those jobs, Hunt said the center is trying to provide training that will give these job candidates skills they can use in the new, recovered economy. For many, that will mean work in health care fields as an aging population requires more care. "We're trying to put them in high-demand areas," Hunt said.
That's why Thennis Hadley, 56, of Detroit was signing up for training for a certified nursing assistant job. After three months of the training, she could be eligible to work in a nursing home or long-term care facility. For years, Hadley worked at local commercial laundries. Her last one closed up in June, and she knows that type of work won't return. Her next job, she said, will require a return to the classroom. "I need to be certified," she said. On the east side, Kapusniak can commiserate with Hadley. He said he'll continue to hunt for a steady paycheck because he knows no other way, even if he has a lot of company and competition. "I'll do anything if I could," he said. "I'm not lazy."
US housing report nothing less than shocking
by Dave Rosenberg
We still have no clue how the last U.S. nonfarm payroll report could show such a large increase in service sector employment at a time when the ADP and ISM reports flagged discernible declines. And, how it was that a flat raw retail sales result in November managed to translate into a 1%-plus spike in the government data base is again one of life’s mysteries. All we can say is that while all the components of GDP are pointing now to 4-5% real growth in Q4, this is not necessarily a sign that the economy is out of sickbay. Japan had nearly 60 quarters of positive GDP growth since its credit bubble burst two decades ago, and all they represented were noise around a flat trendline.
Let’s also recognize that most of the strength in the industrial production report for November was in materials (+1.2% MoM) and supplies (+1.0%). Finished consumer goods production was really an average +0.3% — the second weakest print since June, in fact. So, we would not exactly characterize it is at a broadly based report.
To little fanfare, the National Association of Home Builders (NAHB) housing market index fell back to 16 in December (consensus was at 18) from 17 in November and the nearby high of 19 in October. This was the lowest reading in six months and leading the decline was a two point slide in the future sales expectations. Considering the massive amount of stimulus out there in support of the residential real estate market, the December level is tied for the fifth weakest result in the 25-year history of the survey.
It is clear that there are secular changes afoot with respect to household attitudes towards credit, discretionary spending and homeownership. There is really no other way to explain a 16-print today in the NAHB index. To put a number like this into proper perspective is still below the troughs of the prior two recessions (20 and 46 respectively). This report is nothing less than shocking.
Why Is The Fed Happy Buying All Those Mortgages? Because You're Guaranteeing Them!
Despite the huge and unprecedented rise in the Federal Reserve’s exposure to mortgage backed securities, the Fed says that it is unlikely to face any losses because it is only buying securities backed by Fannie Mae, Freddie Mac and Ginnie Mae.
This is meant to reassure policy makers and the public that the Fed is prudently protecting its balance sheet against losses. Protection against losses at the Fed is important to the public for three reasons.
- Fed profits are an important source of revenue for the US Treasury. Any shortfall in that revenue will force the Treasury to borrow more or raise taxes.
- Losses at the Fed could hurt its flexibility when it comes to policy decisions. Despite all appearances, the Fed does not have unlimited flexibility to manipulate interest rates without triggering inflation. If the Fed is facing serious balance sheet losses, it will be more difficult to continue low interest rates to combat a recession.
- The prestige of the United States is on the line here. A faltering Fed will sap confidence around the world in the US, making it harder for both private and public institutions to raise capital in both debt and equity markets.
In short, the American people are hugely exposed to any losses at the Fed.
Which is what makes it so bizarre that we’re meant to be reassured by the fact that the Fed’s exposure to mortgage securities is limited by taxpayer guarantees from Fannie, Freddie and Ginnie. It’s taxpayer losses all the way down.
To make the situation even more mind boggling, we’ll add a further twist. The massive borrowing of the US government is supported, in part, by the Federal Reserve buying Treasuries. That is, the Fed is funding the very same government it is relying on to fund any losses from mortgage securities.
Look at it this way. Deep losses in the Fed’s mortgage portfolio would trigger payments from the Treasury backed mortgage insurers, which would have to be funded by the issuance of debt, some of which would have to be bought by the Fed to keep the borrowing costs down.
Don’t you feel safer already?
Mort Zuckerman: Big City Commercial Real Estate Is Holding Up, Small Cities Are Toast
Mort Zuckerman popped by CNBC Tuesday to talk commercial real estate, among other things. A key message. Big cities are actually holding up. Small cities. Not so good.
Paul Volcker:"Wake Up, Gentlemen"
by Simon Johnson
The guiding myth underpinning the reconstruction of our dangerous banking system is: Financial innovation as-we-know-it is valuable and must be preserved. Anyone opposed to this approach is a populist, with or without a pitchfork. Single-handedly, Paul Volcker has exploded this myth. Responding to a Wall Street insiders‘ Future of Finance "report", he was quoted in the WSJ yesterday as saying: "Wake up gentlemen. I can only say that your response is inadequate."
Volcker has three main points, with which we whole-heartedly agree:
- "[Financial engineering] moves around the rents in the financial system, but not only this, as it seems to have vastly increased them."
- "I have found very little evidence that vast amounts of innovation in financial markets in recent years have had a visible effect on the productivity of the economy"
and most important:
- "I am probably going to win in the end".
Volcker wants tough constraints on banks and their activities, separating the payments system – which must be protected and therefore tightly regulated – from other "extraneous" functions, which includes trading and managing money. This is entirely reasonable – although we can surely argue about details, including whether a very large "regulated" bank would be able to escape the limits placed on its behavior and whether a very large "trading" bank could (without running the payments system) still cause massive damage.
But how can Mr. Volcker possibly prevail? Even President Obama was reduced, yesterday, to asking the banks nicely to lend more to small business – against which Jamie Dimon will presumably respond that such firms either (a) are not creditworthy (so give us a subsidy if you want such loans) or (b) don’t want to borrow (so give them a subsidy). (Some of the bankers, it seems, didn’t even try hard to attend – they just called it in.)
The reason for Volcker’s confidence in his victory is simple - he is moving the consensus. It’s not radicals against reasonable bankers. It’s the dean of American banking, with a bigger and better reputation than any other economic policymaker alive – and with a lot of people at his back – saying, very simply: Enough. He says it plainly, he increasingly says it publicly, and he now says it often. He waited, on the sidelines, for his moment. And this is it.
Paul Volcker wants to stop the financial system before it blows up again. And when he persuades you – and people like you – he will win. You can help – tell everyone you know to read what Paul Volcker is saying and to pass it on.
The two faces of O
by Charles Gasparino
In public, President Obama is on a tear against Wall Street. In private, not so much
Over the weekend, Obama attacked fat-cat investment bankers, telling "60 Minutes" he didn't become president to aid and abet Wall Street -- which, only a year after the financial meltdown and taxpayer bailout, is now scheduled to hand out tens of billions of dollars in bonuses to its bankers and traders. But the president's meeting yesterday with the CEOs of the largest banks was nearly a lovefest, I'm told by attendees. Yes, White House spinmeisters advertised the gathering as a chance for Obama to channel the public's disgust over Wall Street's celebrating while Main Street still suffers 10 percent unemployment, thanks largely to Wall Street's bungling. But that's not what he did.
Obama started off with the obvious, reminding bankers that the bailout of insurance giant AIG benefited them because it meant they could actually collect on the AIG insurance policies (credit-default swaps) on their risky bond-market bets. But he also seemed to concede their dubious claim that some of them probably would've survived an AIG collapse, given all the other billions the government threw at them during the crisis. After that, people with first-hand knowledge of the sitdown said, it was a heavily scripted affair -- with none of the fireworks Obama displays in public.
Indeed, the White House last week sent the CEOs the president's talking points: bonuses (too high), lending (more loans to small businesses), the need for more regulation of the financial business (support the bill now before Congress), etc. So there were no surprises for the likes of Jaime Dimon of JP Morgan, Lloyd Blankfein of Goldman Sachs, John Mack of Morgan Stanley or Citigroup's Richard Parsons. Said one CEO who attended: "I expected to be taken to the woodshed, but the tone was quite the opposite." Said another senior exec with knowledge of the meeting: "The whole thing was so telegraphed that not much was accomplished, other than giving Obama a PR stunt . . . He might have sounded mean on '60 Minutes,' but during the meeting he was a hell of a lot nicer."
Maybe Obama's softened tone was recognition of Wall Street's election help. Campaign-finance filings show that firms like Goldman -- now getting ready to dish out $20 billion in bonuses after nearly imploding last year -- favored Obama over John McCain by a fairly wide margin. Nearly all the major Wall Street CEOs -- including Dimon, Blankfein and Mack -- have told people that they voted for Obama. Or maybe he was just tacitly admitting his own role in Wall Street's rebound. Yes, it was the Bush team that gave special privileges to the big banks and Wall Street firms last year to prevent an implosion of the financial system. But Obama's team has inexplicably kept those measures in place -- and so allowed the banks to rebound to megabonus levels.
The banks' profits are so huge that even Citigroup -- a longtime basket case -- now has the wherewithal to repay the tens of billions the government lent it last year and still compensate its traders and bankers this year. But if you want to know why they're rolling in the dough, look to Washington. As a matter of policy, the administration considers "systemically important" firms like Citi, Goldman and Morgan "too big to fail" -- signaling the markets that it'll bail them out if their losses again threaten to shut them down. Plus, Goldman and Morgan Stanley have been declared commercial bank-holding companies (even though you can't get a car loan or open a checking account at either), so they can borrow from the Federal Reserve in emergencies.
It all translates into cheaper borrowing costs. And the government is also backing up the firms' long-term debt -- so, on top of borrowing from the Fed, Goldman can borrow in the open market at favorable rates. Throw in the fact that the Fed has kept interest rates near zero -- a move that has weakened our national currency but lets financial firms borrow cheap -- and you can see how Wall Street has bounced back from the dead so quickly. Yesterday, the bankers told the president that they aren't lending because people aren't borrowing. In fact, small-business-loan volume is down because businessmen fear a future of higher taxes, thanks to "health-care reform" and other high-cost Obama policies.
More important, the banks just aren't focused on lending -- because it's so easy to make money by trading: Borrow cheaply at the low, government-backed rates, and put that cash in higher-yielding bonds. On Wall Street, it's known as the "carry trade" -- and the taxpayers are financing the vast profits from it, through all the ways listed above. There are many reasons to hate Wall Street, even if you haven't heard Goldman's Blankfein quip that he's doing "God's work" when he trades bonds and earns all that bonus money. But the ultimate culprit for the fact that these guys are raking it in while the rest of the nation suffers isn't Blankfein or the Wall Streeters at yesterday's meeting -- it's their enablers in government, including the man in the White House.
Do banks have a hidden agenda?
Citigroup Move to Repay TARP Could Backfire
For all the hubbub over Citigroup, Bank of America and Wells Fargo making good on their TARP loans, the companies remain under duress. Indeed, the repayments could actually hurt the banking giants. So concludes bank analyst Chris Whalen in a new report (no public link):We view the TARP repayments by [Bank of America, Citi and Wells] as, at best, a distraction and, at worst, a negative development for these names. Without the explicit support from the U.S. government for large U.S. banks, we fear that important foreign constituencies may accelerate their migration away from these and other U.S. counter-parties.
In other words, U.S. officials may be bullish on banking. But overseas investors, not so much — and certainly not without the American government to share what are likely to be rising financial losses. In exiting TARP, Citi is also ending a loss-sharing agreement with the FDIC, Federal Reserve Bank of New York and Treasury Department. The government had been sheltering the company from most losses on more than $300 billion in assets.
Citi execs claim the company is prepared to ride out any banking sector turmoil. After issuing new common stock to raise money to pay TARP. the company will have total common equity of more than $141 billion and combined tangible capital and loss reserves of $150 billion. Yet Whalen, managing director of research firm Institutional Risk Analytics, says that’s not as much it seems. Not when troubled loans at Citi account for 18 percent of its total loan portfolio, or roughly $93 billion. And not when the rough water ahead may require the company to raise more capital.
What many pundits (if not investors, as Citi shares continue to swoon) are ignoring is that bank earnings have yet to feel the full force of deteriorating commercial real estate and other loans. That won’t register on balance sheets at Citi, Bank of America and Wells until the first quarter of 2010. Exacerbating the problem is that big banks continue to rely on tricked up accounting rules to understate their credit problems.
Whalen also challenges Treasury Secretary Tim Geithner’s contention that banks are in stronger position to boost lending. Says the analyst:The apparent support for the TARP repayments from the Treasury and the Obama White House ensures that the U.S. banking industry will continue to shrink, decreasing the pool of available credit to support an economic recovery.
U.S. Delays Sale of Citigroup Stake as Shares Sell at Discount
Citigroup Inc., the last of the four largest U.S. banks to seek funds to exit a taxpayer bailout, raised $17 billion by selling stock for a price so low that the U.S. delayed plans to shrink its one-third stake in the lender. Citigroup sold 5.4 billion shares at $3.15 apiece, less than the $3.25 the government paid when it acquired its stake in September. The New York-based bank said the Treasury won’t sell any of its shares for at least 90 days.
Investors demanded a bigger discount from Citigroup than Bank of America Corp. or Wells Fargo & Co., which together raised more than $31 billion this month to exit the Troubled Asset Relief Program. Wells Fargo, which trumped Citigroup’s bid to buy Wachovia Corp. last year, leapfrogged its rival by completing a $12.25 billion share sale Dec. 15. JPMorgan Chase & Co. repaid $25 billion in June. "The market cast its vote and they’re low down on the ballot," said Douglas Ciocca, a managing director at Renaissance Financial Corp. in Leawood, Kansas. "Citigroup needs to show steps to reinstall the quality of the brand."
With the sale, Citigroup’s common shares outstanding increased to 28.3 billion. That’s up from 22.9 billion as of Sept. 30 and 5 billion at the end of 2007. "More shares outstanding means less value per share," said Edward Najarian, an analyst at International Strategy and Investment Group in New York, who has a "hold" rating on the shares. "The whole structure of their deal to pay back TARP wasn’t very good for common shareholders and that is being reflected in the pricing."
The lender’s shares fell 24 cents, or 7.2 percent, to $3.21 in trading after U.S. markets closed. The $3.15 price is a 20 percent discount from the closing price on Dec. 11, before Citigroup announced the plan to repay TARP. The government decided not to participate in the equity offering based on the pricing of the shares, according to a Treasury official. The U.S. expects to divest its ownership stake in Citigroup shares during the next 12 months, the official said.
The bank said it also raised $3.5 billion by selling "tangible equity units," securities that make quarterly payments of 7.5 percent a year and include a requirement to buy Citigroup shares in 2012. The total of $20.5 billion was the largest public equity offering in the history of U.S. capital markets, according to Citigroup. Citigroup’s Dec. 15 announcement that Abu Dhabi Investment Authority was trying to abort an accord to buy $7.5 billion of Citigroup stock may also have hurt confidence in the bank’s secondary stock offering, said Blake Howells, an analyst at Becker Capital Management in Portland, Oregon. Abu Dhabi "certainly couldn’t help," Howells said.
Citigroup said earlier this week that it would sell at least $20.5 billion of equity and debt to exit TARP. After that announcement, the Treasury said it would sell as much as $5 billion of its stake, in conjunction with the bank’s secondary offering, with the rest to be sold over the next year. The Treasury holds $25 billion in common stock in Citigroup, along with a $20 billion preferred equity stake and further preferred shares granted in connection with an asset- guarantee agreement. At the offering price of $3.15, the 7.7 billion shares are valued about $770 million less than the Treasury’s cost.
Bank of America, the largest U.S. lender, raised its funds on Dec. 3. The Charlotte, North Carolina-based bank, which yesterday named Brian Moynihan as its new chief executive officer, sold 1.286 billion so-called common equivalent securities at $15 each, a 4.8 percent discount to its closing price that day. Wells Fargo, whose largest shareholder is billionaire investor Warren Buffett’s Berkshire Hathaway Inc., completed its sale at a 1.9 percent discount. "Hitting all of the shares at the market at the same time is a bad idea," said Michael Johnson, chief market strategist at M.S. Howells & Co., a Scottsdale, Arizona-based broker- dealer.
U.S. gave up billions in tax money in deal for Citigroup's bailout repayment
The federal government quietly agreed to forgo billions of dollars in potential tax payments from Citigroup as part of the deal announced this week to wean the company from the massive taxpayer bailout that helped it survive the financial crisis. The Internal Revenue Service on Friday issued an exception to long-standing tax rules for the benefit of Citigroup and a few other companies partially owned by the government.
As a result, Citigroup will be allowed to retain billions of dollars worth of tax breaks that otherwise would decline in value when the government sells its stake to private investors. While the Obama administration has said taxpayers are likely to profit from the sale of the Citigroup shares, accounting experts said the lost tax revenue could easily outstrip those profits. The IRS, an arm of the Treasury Department, has changed a number of rules during the financial crisis to reduce the tax burden on financial firms. The rule changed Friday also was altered last fall by the Bush administration to encourage mergers, letting Wells Fargo cut billions of dollars from its tax bill by buying the ailing Wachovia.
"The government is consciously forfeiting future tax revenues. It's another form of assistance, maybe not as obvious as direct assistance but certainly another form," said Robert Willens, an expert on tax accounting who runs a firm of the same name. "I've been doing taxes for almost 40 years, and I've never seen anything like this, where the IRS and Treasury acted unilaterally on so many fronts."
Treasury officials said the most recent change was part of a broader decision initially made last year to shelter companies that accepted federal aid under the Troubled Assets Relief Program from the normal consequences of such an investment. Officials also said the ruling benefited taxpayers because it made shares in Citigroup more valuable and asserted that without the ruling, Citigroup could not have repaid the government at this time.
"This rule was designed to stop corporate raiders from using loss corporations to evade taxes, and was never intended to address the unprecedented situation where the government owned shares in banks," Treasury spokeswoman Nayyera Haq said. "And it was certainly not written to prevent the government from selling its shares for a profit." Congress, concerned that Treasury was rewriting tax laws, passed legislation earlier this year that reversed the ruling that benefited Wells Fargo and restricted the ability of the IRS to make further changes. A Democratic aide to the Senate Finance Committee, which oversees federal tax policy, said the Obama administration had the legal authority to issue the new exception, but Republican aides to the committee said they were reviewing the issue.
A senior Republican staffer also questioned the government's rationale. "You're manipulating tax rules so that the market value of the stock is higher than it would be under current law," said the aide, speaking on the condition of anonymity. "It inflates the returns that they're showing from TARP and that looks good for them." The administration and some of the nation's largest banks have hastened to part company in recent weeks. Bank of America, followed by Citigroup and Wells Fargo, agreed to repay federal aid. While the healthiest banks escaped earlier this year, the new round of departures involves banks still facing serious financial problems.
The banks say the strings attached to the bailout, including limits on executive compensation, have restricted their ability to compete and return to health. Executives also have chafed under the stigma of living on the federal dole. President Obama chided bankers at the White House on Monday for not trying hard enough to make small-business loans. The Obama administration also is eager to wind down a program that has become one of its largest political liabilities. Officials defend the program as necessary and effective, but the president has acknowledged that the bailout is "wildly unpopular" and officials have been at pains to say they do not enjoy helping banks.
Federal regulators initially told Citigroup and other troubled banks that they would be required to hold on to the federal aid for some time as they return to health. But in recent months, the government switched to pushing the companies to repay the money as soon as possible. All nine firms that took federal money last October now have approved plans to pay it back. This urgency has come despite the lingering concerns of many financial experts about the companies' health. These analysts said they worry that the firms could face rising losses next year as high unemployment and economic weakness continue to drive great numbers of borrowers into default.
"They are rolling the dice big time,"said Christopher Whalen , a financial analyst with Institutional Risk Analytics. "My fear is that the banks will definitely have to raise a lot more capital next year. The question is from whom and on what terms." The Citigroup repayment deal required significant sacrifices by both sides, underscoring the mutual determination to get it done. Citigroup was required to replace its federal aid with an equal amount of money from private investors, more than any other bank. The government concluded that Citigroup needed the IRS ruling because a reduction in the value of its tax breaks would have eroded its capital, forcing the company to raise more money, officials said.
Federal tax law lets companies reduce taxable income in a good year by the amount of losses in bad years. But the law limits the transfer of those benefits to new ownership as a way of preventing profitable companies from buying losers to avoid taxes. Under the law, the government's sale of its 34 percent stake in Citigroup, combined with the company's recent sales of stock to raise money, qualified as a change in ownership. The IRS notice issued Friday saves Citigroup from the consequences by stipulating that the government's share sale does not count toward the definition of an ownership change. The company, which pushed for the ruling, did not return calls for comment.
At the end of the third quarter, Citigroup said that the value of its past losses was about $38 billion, allowing it to avoid taxes on its next $38 billion in profits. Under normal IRS rules, a change in control would sharply reduce the amount of profits that Citigroup could shelter from taxes in any given year, making it much more difficult for Citigroup to realize the entire benefit before the tax breaks expired.
The precise value of the IRS ruling depends on Citigroup's future profitability and other factors, but two accounting experts said it was fair to estimate that Citigroup would save at least several billion dollars as a result. Treasury acknowledged that the tax break was significant, but a senior official said the benefit was unavoidable. Either the government changed the rules and parted ways with Citigroup or the company kept the government as a shareholder and kept the tax break anyway. "The choice is whether Treasury sells or doesn't sell," the official said.
Citi's Dubai Mistake: A Sign of More Bad Things to Come?
Perhaps Citi should have slept on Dubai. A year and a half ago, Citigroup became the first U.S. bank to relocate one of its rising stars, Alberto Verme, an investment banking executive, to the booming gulf state. At the time, Citi CEO Vikram Pandit said the move was a sign that the bank was "convinced of the region's long-term and immense growth opportunities."
It turned out to be a much shorter growth opportunity than Pandit and Citi thought. A few months ago, Verme was reassigned to London. Mohammed al-Shroogi, who headed Citi's United Arab Emirates operations, left in September. In late November, Dubai World, which is a for-profit development company controlled by the ruling family of the gulf state, indicated that it may have to default on a portion of its $60 billion in loans. The rush to Dubai has left Citi on the hook for billions of dollars of losses in the financially troubled gulf state.
According to research firm Creditsights, Citi has made an estimated $5.9 billion in loans in the U.A.E., which includes Dubai as well as its oil-rich neighbor Abu Dhabi. Of that, $1.9 billion was made to Dubai World. In the end, it might not lose that much. On Monday, Abu Dhabi said it would provide $10 billion in financing to help Dubai pay off its debts.
To be sure, Citi's potential losses in Dubai are not enough to bring down the bank. Citi has $2 trillion in assets. And the Dubai losses look puny compared to huge hits the bank took in subprime lending and the mortgage market in general. But Citi was far more aggressive in courting Dubai business and left itself open to far more losses in what now appears clear was a financial house of cards than any other U.S. bank. JPMorgan, the U.S. bank with the next highest loan exposure to Dubai, has $2.5 billion in loans outstanding in the U.A.E., less than half of what Citi may have to write off.
What's more, Citi's bid to expand in the Middle East at a time when the U.S. and the rest of the world was entering a financial crisis is yet another management blunder for what was once the world's largest bank. It's also a black eye for Citi as it tries to convince the U.S. government that is wealthy and wise enough to pay back its government support. And unlike the mortgage mistakes, which can be blamed on past management, the rush to profits in Dubai happened under CEO Pandit.
"Obviously, this is not a positive for Pandit," says Michael Holland, a money manager and the former chairman of Salomon Brothers Asset Management, which was acquired by Citigroup. "Being big everywhere is the business model he has chosen. That means when there are losses anywhere you are going to get hit." Things were booming there back in 2008 when Citi sent Verme to the gulf state. He had run the bank's Latin American operations before being promoted to co-head of investment banking. In 2006, trade publication the Banker named Verme one of the top 10 movers and shakers in the Latin American business. It was big news in banking circles when Citi tapped Verme for Dubai.
Massive building projects funded by debt offerings was driving Dubai's economy, creating lot of opportunities for bankers. Many other banks followed Citi's lead. Citi reportedly built up a staff of 50 bankers in the area. But as things started to unravel Citi remained deeply invested in Dubai. In late 2008, just weeks after Citi had received its initial TARP funding from the government, Citi helped arrange an $8 billion loan for Dubai's state-linked companies. It's unclear how much of the loan Citi held onto.
By that time, Citi's own research staff had begun to issue warnings that Dubai was the most vulnerable economy in the oil-rich gulf because of its exposure to real estate and debt. Nonetheless, Win Bischoff, who was Citi's chairman, said at the time of the financing, "This is in line with our commitment to the [U.A.E.] in general, and reflects our positive outlook on Dubai in general." These days it is clear that Citi's outlook was much more positive than it should have been. If that's the case in other areas of the world, Citi could be looking at more losses down the road
The Middle Class Collapse
Bankers must think we're stupid. How could they expect anyone to buy their performance at the recent White House/Wall Street confab during which, with hands on hearts, they swore allegiance to the American people? They want us to think they're Boy Scouts instead of rapacious profiteers who crashed our economy?
Meanwhile, Wall Street is the direct beneficiary of bailouts which represent the largest transfer of wealth since slavery. Only this time the money is going from a struggling middle class to the super-rich. The fundamental problem is clear: Too much wealth in the hands of the few. Bankers, however, are betting that we will reject any call for redistributing wealth. After all, most of us, like Joe the Plumber, view the accumulation of wealth as an inalienable right as long as it's earned fair and square.
But do the super-rich really earn their wealth? Financial wealth is a slippery concept especially as it slithers through a mountain of bailouts now running somewhere near $13 trillion. (TARP is a small part of the panoply of taxpayer financial guarantees for Wall Street.) Given that virtually every large bank would have gone under without our bailouts, how do we calculate who "earned" what? For the three years prior to the crash, the 19 largest banks and investment houses "earned" about $300 billion, half of which went to bonuses. We now know that these profits came primarily from creating and trading financial instruments that turned out to have little or no value.
Supposedly, Wall Street's financial engineers "earned" their massive bonuses because they invented new ways to eliminate risk from complex securities layered on pools of incredibly risky debt. Wrong. When the risk returned with a vengeance, the $300 billion in profits turned into $300 billion of losses. The entire financial system froze and began to collapse a la 1929, causing trillions of dollars to disappear from our economy.
At this point the billionaire bailout society revealed itself as did the modern meaning of "earned wealth." When the financial sector imploded, the government bailed it out with our money. Obviously the earlier profits were phony as were the bonuses of the previous three years. (Did the bankers give back the bogus bonus money based entirely on fictitious profits? Hell no!)
It gets worse. After we poured our trillions into the financial system, the banks became profitable again, even as the rest of the economy suffered record unemployment. The banks, in fact, still are refusing to lend, which further drives up unemployment. Instead they are returning to risky trading practices, knowing the government will back them. To get free of pay restrictions, even the most troubled banks are quickly repaying their TARP money through a series of Ponzi moves. (See "Wall Street's Latest Ponzi Scheme: Bailout Repayments?")
Ok, you tell me: Who earned what? What value was really produced on Wall Street as our bailouts prop up the entire financial sector? Are bankers are actually "earning" anything at all? More to the point, are you really worried about redistributing wealth that derives entirely from this casino/bailout scam? Our distorted wealth and income distribution, the worst since 1929, poses a clear and present danger to economic revival and to rebuilding a solid middle class. Here's one statistic from The Looting of America that still stuns me: In 1970 the ratio of the compensation of the top 100 CEOs compared to the average production worker was 45 to 1. By 2006 it was an astounding 1,723 to one! We didn't get there by accident.
Did these CEOs earn it fair and square? According to economic theory, that jump should reflect an enormous increase in their human capital. Did someone alter their genes to make them that much smarter? Does this reflect a miraculous jump in entrepreneurial skills?
The reality is much simpler. The rules changed.
From 1930 through the 1970s we understood that the key to America's well-being was a relatively compressed wealth and income distribution. Millionaires did not disappear, but during the Eisenhower years the marginal tax rate on those earning more than $3 million (in today's dollars) was 91 percent. Yes, there were loopholes galore, but the 1950s and 1960s are considered the most egalitarian years on record and working people developed into the world's largest middle class. This defined the American dream and it came about by design, not by accident.
During the deregulatory 1980s, the top tax rates dropped from 70 percent to 28 percent, while much of the New Deal's financial controls also were dismantled. You want to mint billionaires? That's how to do it. Once the billionaire class was off and running, we faced a mounting series of booms and busts - from the savings and loan fiasco to the housing bubble. There was so much money at the top that the wealthy literally ran out of investments opportunities in the real economy. Wall Street, now unchained, did its job: It created fantasy finance securities to meet the unfulfilled investment demand.
If we don't get a grip on the demand -- billionaires' excessive wealth -- the casino will blossom again as Wall Street comes up with ever more sophisticated fantasy finance instruments. With billions of dollars at stake, they will find a way around the new regulations. You can bet on that. This leaves us with two very problematic propositions:
First, the income distribution is so out of whack that progressive income taxes alone won't correct it. We also need wealth taxes on those with more than $500 million in net worth. (It's hard to make a case that anyone needs more than half a billion dollars.) Taxing 5 to 10 percent of this group's wealth each year would generate about $200 billion a year to help finance jobs programs and our growing debt. Also, it would help dry up demand for speculative investments
Second, we need to end casino banking: Instead of relying on a failed banking system and a new set of Rube Goldberg-like regulations, we should transform the 19 largest Wall Street firms (which control more than 60 percent of the nation's banking) into tightly regulated pubic utilities.
This is a frightening vision for libertarians, free-market ideologues, anti-government activists, Wall Street bankers and Joe the Plumber. But, if we truly value free enterprise in the real economy, we must seriously consider wealth redistribution and bank nationalization. The alternative is more of what we already have: a billionaire bailout society with a hollowed out middle class..
GDP Is Not Everything Part 2
by Dave Rosenberg
We mentioned two days ago, there is an outside chance that we could see Q4 real GDP approach a 4-5% range at an annual rate, well above current consensus expectations (currently the Bloomberg consensus is expecting a 3.0% increase in GDP). A good chunk of that is in inventories, not final demand, but so be it. The point we are trying to make is that GDP is not only revised massively in the future but it is not the best barometer of economic health, notwithstanding all the attention it receives. Let’s not forget that Japan has had nearly 60-positive GDP quarters since its bubble burst in the early 1990s.
Yesterday, a quote from The Becker-Posner Blog (taken from the article titled: Should We Jettison GDP as an Economic Measure?) was sent to us by a long time reader, and friend, and it encapsulates what we believe:"But it is necessary to emphasize that it is just a starting point. I disagree with economists who say the "recession" ended in the third quarter. The depression (as I think we should call it if only because of its enormous potential political consequences) has caused massive unemployment with all the associated anxieties and hardships, has greatly reduced household wealth, has caused private investment to turn negative, has cost the government trillions of dollars in lost tax revenues and recovery expenditures (TARP, the fiscal stimulus, the mortgage-relief programs, the auto bailouts, etc.), has undermined belief in free markets and altered the line between government and business in favor government, and is threatening a future inflation while deepening our dependence on foreign lenders. To view a change in GDP from negative to positive as signifying the end of a depression (by which criterion the Great Depression ended in 1933 and again in 1938) is to misunderstand the utility of GDP as a measure of economic activity."
Biggest World Risk Is US Dollar Carry Trade, Credit Suisse Says
An unwinding of the so-called U.S. dollar carry trade may pose the biggest threat to the global economy next year, Credit Suisse AG said. The carry trade is "the biggest time bomb," Tao Dong, a Hong Kong-based economist at Credit Suisse, said today at a press briefing in the city. He was referring to investors buying higher-yielding assets with money borrowed in nations with low interest rates. Such transactions may involve between $1.4 trillion and $2 trillion and "unwinding" the investments could cause volatility in currencies, commodities and emerging market stocks, Tao said.
Hong Kong’s central bank said yesterday that the city may face "sharp corrections" in asset prices should fund flows reverse, adding to concerns voiced by Japan, China and South Korea on the dangers from speculative capital. Donald Tsang, Hong Kong’s chief executive, said Nov. 13 that he was "scared" that money flowing into Asia and driving up asset prices could lead to another crisis. "The greatest risk in 2010 is the U.S. dollar and the unwinding of the carry trade," Tao said. The U.S. Federal Reserve has kept benchmark interest rates near zero percent since December 2008 to revive lending and counter the worst financial crisis since World War II, pledging yesterday to keep rates "exceptionally low" for an extended period.
The International Monetary Fund said last month that there are "indications that the U.S. dollar is now serving as the funding currency for carry trades." Nouriel Roubini, the economist who forecast the financial crisis in 2006, has said that investors are milking the "mother of all carry trades." "Everybody around the world today is borrowing in dollars at zero interest rates and is using these dollars to buy assets around the world, global equities, commodities, gold, credit, emerging-market asset classes," Roubini said Oct. 27 in Cape Town, South Africa.
Wells Fargo sells $10.65 billion in stock to exit TARP
Wells Fargo & Co sold $10.65 billion in stock on Tuesday, raising funds to help repay a $25 billion bailout received from the U.S. government last year. Wells Fargo and Citigroup Inc -- which expects to raise $20 billion on Wednesday to help repay its bailout money -- were the last of the largest banks to repay the funds, which were forced on banks amid the height of the financial crisis last year.
Wells Fargo's announcement on Monday that it would repay the funds and raise capital came as something of a surprise, after Chief Executive John Stumpf and other executives at the San Francisco-based bank had repeatedly said the bank would repay funds in a shareholder-friendly manner. "I think a lot of people expected them to earn their way out of TARP," said Keith Davis, an analyst at Farr Miller & Washington. The shares sold at $25 each, about 2 percent below Wells Fargo's closing share price on Monday of $25.49. The offering dilutes shareholders by about 10 percent, according to analysts.
"It's a little more dilutive than people were expecting," Davis said. The repayment will result in a charge of about $2 billion in the fourth quarter, according to the bank, but it will also cut its annual dividend expense by $1.25 billion. Wells Fargo said on Monday it intends to raise up to $1.5 billion of equity through asset sales and it will sell about $1.35 billion to benefit plans instead of contributing cash to them. The bulk of the $25 billion in TARP money will be repaid with the bank's $14.6 billion in cash, analysts said.
Wells Fargo's capital raise followed that of Bank of America Corp (BAC.N), which repaid its money from the Troubled Asset Relief Program last week. It comes as Citigroup, which also said on Monday it will repay its TARP funds, tries to place a large deal of its own which, at $20 billion, is almost twice the size of Wells Fargo's. While the largest U.S. banks have now either returned, or are in the process of returning, their TARP money, regional banks including PNC Financial Services Group have yet to repay funds they received under the program.
A reality check for California's excessive borrowing
Payments on bond borrowing are becoming uncomfortably high, crowding out funds for universities, healthcare, parks -- and all the other government services being slashed these days.
State Treasurer Bill Lockyer is playing Scrooge, admonishing Capitol politicians that they can't have everything they want -- or even think they need. It's a sound message not just for the politicians, but also for the California public. The state's credit card is about maxed out, the veteran Democratic office-holder warns. Payments on bond borrowing are becoming uncomfortably high, crowding out funds for universities, healthcare, parks -- and all the other government services being slashed these days.
Or, as Assembly budget chairwoman Noreen Evans (D-Santa Rosa) told a committee hearing Monday, bond payments are "the Pac-Man eating up the general fund" -- the state's main checking account that again is running a deficit. The latest projection is a $21-billion hole for the next 18 months. Lockyer's lecture has broad implications for rebuilding California's crumbling infrastructure.
One example: It could give many voters pause about an $11.1-billion water bond issue that Gov. Arnold Schwarzenegger and the Legislature recently placed on next November's ballot -- especially if the politicians don't strip out the pork, such as bike trails and "watershed education centers." Some of the bond's goodies "seem only remotely water-related," notes Lockyer, who hasn't taken a position on the measure.
But the treasurer's biggest concern about the water bond is that much of it would be financed by taxpayers. He'd rather that more of it be paid off by water users through higher fees, as the original state water project was financed. Then the bond wouldn't be gnawing away so much at the general fund. "Farmers essentially want subsidized water -- subsidized by the rest of the state," says Lockyer, a longtime legislator from the east side of San Francisco Bay before being elected attorney general and then treasurer. "Guess I don't blame them for asking, but shouldn't users pay, then add it to the cost of their products?"
The agriculture lobby argues that much of the bond money would be spent for "public benefits," such as Delta environmental restoration. Even so, under the bond provisions, taxpayers could wind up paying for up to half the cost of building new dams that would store water mostly for farmers. Water also must compete with other public works needs.
State Supt. of Public Instruction Jack O'Connell on Tuesday proposed a $9.9-billion bond for school facilities. "We cannot afford to wait," O'Connell asserted. "A school facilities bond would do much to further our long-term goal of creating a competitive workforce in California, as well as achieving the short-term goal of creating jobs."
Meanwhile, a Washington-based transportation think tank called TRIP reported Wednesday that annual spending on major roads, bridges and transit in California is running $11 billion short of what's needed. California has the second-worst roads in the nation, falling only behind New Jersey, the report said. And Los Angeles' roads "are the roughest" in the country, the report continued, with L.A. drivers also enduring "the worst congestion."
The think tank warned: "California must improve its [transportation] system . . . to foster economic growth, create jobs, avoid business relocations and ensure the safe, reliable mobility needed to improve the quality of life." No argument here. But how? Nonpartisan Legislative Analyst Mac Taylor has suggested raising the state gas tax by 10 cents per gallon -- it's now 18 cents -- to pay for road maintenance and repair. The tax hike also could finance repayment of highway construction bonds and relieve pressure on the general fund, he notes.
Voters approved a $19.9-billion transportation bond issue in 2006, but Lockyer has sold only $4.5 billion worth. Basically, he doesn't feel it's currently wise to borrow. California has the lowest bond rating of any state, requiring it to pay relatively high interest. Anyway, it needs to cling to cash to pay ordinary bills without resorting to IOUs. Every $1 billion in bonds requires $70 million annually for debt service.
"We're paying substantially more than Third World countries er, emerging markets," Lockyer told the Assembly Budget Committee. "We could benefit from a reasonably balanced budget -- an old-fashioned balanced budget. It really is affecting our credit rating." How to do that? Spending cuts, tax hikes and efficiencies, he replied. Nothing new there. These are some chilling facts laid out by Lockyer at the sparsely attended committee hearing:
- As of Dec. 1, California had $83.5 billion in long-term bond debt. By far the most, $64 billion, was in general obligation bonds, which are financed by all taxpayers from the deficit-ridden general fund. The state also had voter authorization for an additional $47.5 billion in unsold GO bonds.
- Since 1999, annual state debt service has increased 143% while general fund revenue has risen only 22%. Bond repayments this fiscal year are costing $6.1 billion, amounting to 6.9% of the general fund. By 2013, assuming voter approval of the water bond, annual payments are projected to rise to $10 billion, 11% of the general fund.
- This calendar year, the state has sold nearly $37 billion in debt, roughly $9 billion of it just to keep cash flowing. About $15 billion was for infrastructure projects. California in 2009 has been the largest issuer of long-term bond debt of any municipality, state or corporation in the nation.
The Capitol clearly needs to prioritize. Evans says that although "California is drowning in debt," the priority should be on borrowing that generates employment. On average, every $1 billion spent on infrastructure creates 18,000 jobs. Meanwhile, a new poll released by the Public Policy Institute of California on Wednesday shows that a whopping 82% of likely voters believe that the state is headed in "the wrong direction." It has been for a long time, partly because of imprudent borrowing in Sacramento.
'California more likely to default than to not default'
Bill Watkins, who runs the Center for Economic Research and Forecasting at California Lutheran University in Thousand Oaks, goes out on a limb today: He says the state should start discussing contingency plans with the Obama administration and the Federal Reserve for the day California defaults on its debt. "In my opinion, California is now more likely to default than it is to not default," Watkins wrote in an economic forecast excerpted on the newgeography.com blog. "It is not a certainty, but it is a possibility that is increasingly likely."
Not surprisingly, his commentary quickly triggered sharp rebukes from California Treasurer Bill Lockyer and Mike Genest, the outgoing director of the state’s Department of Finance. More on that later. Wall Street has for the last year harbored doubts about cash-strapped California’s willingness or ability to pay its creditors. The concerns are reflected in the state’s credit rating -- the lowest in the Union -- and in the above-average interest rates the state has had to pay to borrow.
But the fact that California still has been able to borrow tens of billions of dollars via short- and long-term muni bond debt in recent months shows that many investors don’t believe that default is a real possibility.
Watkins thinks muni investors are too sanguine. The state, he notes, resorted to a host of gimmicks to come up with a (temporarily) balanced budget last summer. Now Sacramento faces a $21-billion budget gap over the next two years. "The Democrats have declared that they will not allow budget cuts," Watkins wrote. "The Republicans will not allow tax increases." The political leadership has "no idea where to go." In his blog post he takes a look at how a default might unfold:What would a California default look like? In a sense, we’ve already seen California default, when the state issued vouchers. . . . Issuing vouchers didn’t trigger a California crisis because banks were willing to honor the vouchers. If banks refuse to honor the vouchers next time, employees and vendors won’t be paid, and state operations will come to a halt. This could happen if our legislature locks up and is unable to act on the current $21-billion problem.
Another possible California scenario is that the state will try to sell or roll over some debt, and no one buys it. Already, we’ve seen California officials surprised with the interest rates they have had to pay. What happens if no one buys California’s debt? We saw last September  what happens when lenders refuse to lend to large creditors.
Lockyer’s spokesman, Tom Dresslar, said in a statement that Watkins’ commentary "was nothing more than irresponsible fear-mongering with no basis in reality, only roots in ignorance."
Dresslar noted that the state Constitution mandates that tax revenue go first to pay education expenses and second for debt repayment. All other expenses come after debt service.
"After paying for education, the General Fund has tens of billions of dollars left to pay debt service," Dresslar said. "Even at historically high levels, debt service does not come remotely close to needing all the funds left over after schools get paid."
Genest, in a statement, echoed the constitutional safeguards, and also noted that "under state law debt service payments are a ‘continuous appropriation,’ meaning the payments are made even if the Legislature has not passed a state budget." "While our fiscal challenges remain substantial, to suggest or assert that the state will default is a scenario that has no grounding in either fact or history," said Genest, who will be stepping down at year’s end.
I asked Watkins about the constitutional provisions for debt repayment. He isn’t impressed. "There is also a constitutional requirement to have a balanced budget by every June 30," he said.
As for what he tells friends and relatives who own California muni bonds, he said: "I tell them to listen to what everybody has to say, and make up your own mind."
California Bonds Fail on Advice Bill Lockyer Couldn’t Refuse
For California Treasurer Bill Lockyer, the offer from Goldman Sachs Group Inc., JPMorgan Chase & Co. and Citigroup Inc. was too good to refuse. If California was willing to forgo competitive bidding for a $4.5 billion bond offering, the banks promised more orders from individuals and a lower bill to the taxpayers. The firms insisted that by negotiating with them, the state would benefit from its special relationship with the Wall Street troika and wind up with what two underwriters called a salutary "buzz" to boost demand for the debt.
When the October offering failed to sell as planned, California was forced to accept 8 percent less money than it needed and to pay as much as $123 million more in interest than the banks said was sufficient for the market. And the threesome made $12.4 million on the deal, contributing to record bonuses in the securities industry a year after getting a total of $80 billion in a federal bailout. "Just because someone earns a big wad of money doesn’t mean that they can do what they say they can do," said Marilyn Cohen, who watched the sale unfold from Los Angeles as president of Envision Capital Management, which oversees $250 million in bonds for individuals. "And shame on the state if they were drinking that Kool-Aid."
The California sale helped send the municipal-bond market to its worst month in a year. It ended a rally that had pushed borrowing costs for cities and states to a 42-year low, as measured by the Bond Buyer’s index of 20-year general obligation bonds. California, with a bigger economy than Russia’s, seeks bids for everything from building roads and schools to buying portable toilets and fire extinguishers. When the state with the worst credit rating sells municipal bonds, it usually chooses bankers through a negotiation process that lets experience and familiarity trump price.
For the October deal, state Treasurer Lockyer picked the world’s most profitable investment bank and the nation’s two biggest bond underwriters, which together have sold $31 billion of debt for California since he took office in 2007. The U.S. municipal bond market’s largest borrower has sold tax-backed debt nine times this year, for a total of about $37 billion, more than four times second-place New York’s total, data compiled by Bloomberg show.
House Considers Reinstating Glass-Steagall
Looking for ways to pressure banks to lend more, Democrats may revisit the 1999 law that allowed Citigroup and others to combine consumer and investment banking. The U.S. House is considering reinstituting the Depression-era Glass-Steagall Act, which barred bank holding companies from owning other financial companies, Majority Leader Steny Hoyer said. A renewal of the 1933 law "is certainly under discussion" by House members, Hoyer told reporters in Washington today. The Glass-Steagall law was repealed in 1999 to help pave the way for the formation of Citigroup (C). by the $46 billion merger of Citicorp and Travelers Group Inc. "As someone who voted to repeal Glass-Steagall, maybe that was a mistake," said Hoyer, a Maryland Democrat.
Hoyer made the comments when asked whether Congress and President Barack Obama's administration could do more to persuade banks to make more business loans and get credit flowing into the economy. Obama met yesterday with the chief executive officers of U.S. banks, urging them to lend more money. The Glass-Steagall law barred banks that took deposits from underwriting securities. The 1999 law that repealed it enabled the creation of "financial holding companies" that combine banks with insurers or investment banks. Enactment of that law has generated debate about whether it helped spawn reckless lending practices and financial speculation that led to the meltdown of credit markets last year and the $700 billion U.S. bailout of troubled banks, including Citigroup.
Legislation passed by the House on Dec. 11 to overhaul regulation of Wall Street didn't include a reinstatement of Glass-Steagall. It did include an amendment that would give federal regulators the power to take apart large, healthy firms if their size poses a risk to the U.S. financial system. The legislation is pending before the Senate. Treasury Secretary Timothy Geithner testified on Oct. 29 that regulators need authority "to force the major institutions to reduce their size or restrict the scope of their activities" if they become too risky. The 1999 repeal of Glass-Steagall made it possible for Goldman Sachs Group (GS) and Morgan Stanley (MS), the two biggest U.S. securities firms, to convert into bank holding companies, enabling them to get cheap funding from the Federal Reserve during the financial crisis. If the law hadn't been repealed, Bank of America (BAC). wouldn't have been allowed to acquire Merrill Lynch & Co.
Resurrecting Glass-Steagall might require undoing some of those transactions unless Congress included an exception for those already carried out. Such a change in law also would reduce the need for the taxpayer bailouts that added between 9 percent and 49 percent to the profits of the 18 biggest U.S. banks in 2009, according to Dean Baker, co-director of the Center for Economic & Policy Research in Washington. Even so, Fed Chairman Ben Bernanke told the Economic Club of New York on Nov. 16, "Plenty of firms got into trouble making regular commercial loans, and plenty of firms got into trouble in market-making activities."
"The separation of those two things per se would not necessarily lead to stability," Bernanke said. Obama's meeting with the bankers yesterday "was a good thing for the president to do," Hoyer said. "The president needs to make it very clear that we expect some help from the private sector to help bring this economy back." Obama "has got to go further than that," Hoyer said, noting that the administration is considering direct lending from the Troubled Asset Relief Program to small businesses. Former Citibank Chairman John S. Reed apologized in a Nov. 6 interview for helping engineer the bank's merger with Travelers and for his role in building a company that took $45 billion in U.S. assistance. Reed also recanted his advocacy of the repeal of Glass-Steagall.
The 1998 merger depended on Congress repealing Glass- Steagall before a five-year deadline that otherwise would have required Travelers to sell its insurance underwriting business. "We learn from our mistakes," Reed said in the interview. "When you're running a company, you do what you think is right for the stockholders," Reed said. "Right now, I'm looking at this as a citizen." Jim Leach, the former Republican chairman of the House Financial Services Committee, defended the repeal in an April 22 speech at a conference on financial reform sponsored by Boston University Law School and the Bretton Woods Committee. "Changes in Glass-Steagall did not precipitate this crisis," according to a text of the speech by Leach, an Iowan who now is chairman of the National Endowment for the Humanities.
Gulf petro-powers to launch common currency in latest threat to dollar hegemony
The Arab states of the Gulf region have agreed to launch a single currency modelled on the euro, hoping to blaze a trail towards a pan-Arab monetary union swelling to the ancient borders of the Ummayad Caliphate. "The Gulf monetary union pact has come into effect," said Kuwait’s finance minister, Mustafa al-Shamali, speaking at a Gulf Co-operation Council (GCC) summit in Kuwait. The move will give the hyper-rich club of oil exporters a petro-currency of their own, greatly increasing their influence in the global exchange and capital markets and potentially displacing the US dollar as the pricing currency for oil contracts. Between them they amount to regional superpower with a GDP of $1.2 trillion (£739bn), some 40pc of the world’s proven oil reserves, and financial clout equal to that of China.
Saudi Arabia, Kuwait, Bahrain, and Qatar are to launch the first phase next year, creating a Gulf Monetary Council that will evolve quickly into a full-fledged central bank. The Emirates are staying out for now – irked that the bank will be located in Riyadh at the insistence of Saudi King Abdullah rather than in Abu Dhabi. They are expected join later, along with Oman. The Gulf states remain divided over the wisdom of anchoring their economies to the US dollar. The Gulf currency – dubbed "Gulfo" – is likely to track a global exchange basket and may ultimately float as a regional reserve currency in its own right. "The US dollar has failed. We need to delink," said Nahed Taher, chief executive of Bahrain’s Gulf One Investment Bank.
The project is inspired by Europe’s monetary union, seen as a huge success in the Arab world. But there are concerns that the region is trying to run before it can walk. Europe took 40 years to reach the point where it felt ready to launch a currency. It began with the creation of the Iron & Steel Community in the 1950s, moving by steps towards a single market enforced by powerful Commission and European Court. The EMU timetable was fixed at the Masstricht in 1991 but it took another 11 for euro notes and coins to reach the streets.
Khalid Bin Ahmad Al Kalifa, Bahrain’s foreign minister, told the FIKR Arab Thought summit in Kuwait that the project would not work unless the Gulf countries first break down basic barriers to trade and capital flows. At the moment, trucks sit paralysed at border posts for days awaiting entry clearance. Labour mobility between states is almost zero. "The single currency should come last. We need to coordinate our economic policies and build up common infrastructure as a first step," he said.
Mohammed El-Enein, chair of the energy and industry committee in Egypt’s parliament, said Europe’s example could help the Arab world achieve its half-century dream of a unified currency, but the task requires discipline. "We need exactly the same institutions as the EU has created. We need a commission, a court, and a bank," he said. The last currency to trade in souks from Marakesh, to Baghdad and Mecca, was the Ottomon Piaster, known as the "kurush". It suffered chronic inflation as the silver coinage was debased.
There is a logic to an Arab currency. The region speaks one language, has the unifying creed of "Umma Wahida" or One Nation from the Koran, and has not torn itself apart in savage wars – ever – in quite the way that Europe has in living memory. Yet hurdles are formidable even for the tight-knit group of Gulf states. While the eurozone is a club of rough equals – with Germany, France, Italy, and Spain each holding two votes on the ECB council – the Gulf currency will be dominated by Saudi Arabia. The risk is that other countries will feel like satellites. Monetary policy will inevitably be set for Riyadh’s needs.
Hans Redeker, currency chief at BNP Paraibas, said the Gulf states may have romanticised Europe’s achievement and need to move with great care to avoid making the same errors. "The Greek crisis has exposed the weak foundations on which the euro is built. The gap in competitiveness between core Europe and the periphery has grown wider and wider. The obvious mistake was to launch EMU without a central fiscal authority and political union, as the Bundesbank warned in the 1990s," he said. "The euro was created for political reasons after the fall of the Berlin to lock Germany irrevocably into Europe. It was not done for economic reasons," he said.
Ben Simpfendorfer, Asia economist for RBS and an expert on the Middle East, told the FIKR conference that the rise of China had paradoxically disrupted the case for pan-Arab economic integration. There was a natural fit ten years ago between rich oil state and low-wage manufacturers in Egypt and Syria, but cheap exports from China have forced poorer Arab states to retreat behind barriers to shelter their industries. "The rationale for a single currency has become weaker," he said.
The GCC also agreed to create a joint military strike force – akin to the EU’s rapid reaction force – to tackle threats such as the incursion of Yemeni Shiite rebels into Saudi territory earlier this year. This is a major breakthrough after years of deadlock on defence cooperation. The Sunni Gulf states are deeply concerned about the great power ambitions of Shiite Iran and its quest for nuclear weapons, to the point where the theme of a possible war between Iran and a Saudi-led constellation of states has crept into the media debate. They nevertheless repeated on Tuesday that "any military action against Iran" by Western powers would be unacceptable.
It may be time to start selling gold
Some of the biggest buyers of gold may be sending the strongest signal to sell it, if past performance is indicative of future results. Central banks, holding about 18% of all gold ever mined, are expanding their reserves for the first time in a generation as a nine-year bull market drives prices to a record. The banks will buy 13.8 million ounces (429 metric tonnes) this year, worth $15.5 billion, for the first net expansion in reserves since 1988, New York-based researcher CPM Group estimates. Gold fell 15% that year and took another 15 years to trade again at the same price as central banks from Switzerland to the UK cut their holdings.
India, China and Russia are now adding to reserves as gold nears its longest winning streak since at least 1948. They’re joining a rush as investors in exchange-traded funds amass holdings to rival the biggest central banks. Clive Capital LLC, manager of the biggest commodities hedge fund, had its best return since May last month, led by gains in precious metals.
"This is late in the game to be buying gold," said Peter Morici, a professor of business at the University of Maryland in College Park and former economic adviser to the US government. "Central banks are not known for their investment acumen. What it reflects is a lack of confidence in the US economy and the long-term durability of the dollar as a store of value."
Countries were also increasing their holdings in 1980 when gold peaked at $850 an ounce, data compiled by the London-based World Gold Council show. The record was exceeded 28 years later.
They sold a net 4,880 tonnes since 1999, as prices tumbled to a 20-year low of $251.95 an ounce, according to estimates from London-based researcher GFMS. Prices began to recover in 2001, reaching a record $1,226.56 on December 3 and trading on Wednesday at $1,124.44 at 2:00 p.m. in Singapore.
This year’s 5.4% slump in the US Dollar Index, a measure against six counterparts, is increasing the appetite for bullion. While gold and the dollar are traditional stores of value in times of economic stress, the US currency proved no refuge as the Federal Reserve more than doubled its balance sheet to $2.19 trillion in 15 months.
Britain’s dismal choice: sharing the losses
by Martin Wolf
The UK is poorer than it thought it was. This is the most important fact about the crisis. The struggle over the distribution of the losses is going to be brutal. It will be made more so by the second most important fact about the crisis: it has had a huge effect on the public finances. The deficits are unmatched in peacetime. Happily, the general election would appear to offer a golden opportunity for a debate. Is that not the discussion the country ought to have? Yes. Is it the discussion it is going to have? No. What the government would do if re-elected remains, even after the pre-Budget report, "a riddle, wrapped in a mystery, inside an enigma", as Churchill said of Stalin’s Russia.
On the Treasury’s current forecasts, the economy will regain 2008 levels of economic activity in 2012. Four years of expected growth would have vanished. In last week’s pre-Budget report, the Treasury forecast growth of 1.25 per cent next year, 3.5 per cent in 2011 and 2012, then 3.25 per cent in 2013 and 2014. Suppose that growth were to continue at 3.25 per cent a year thereafter. It would still take until 2031 before the economy was as big as it would have been if the 1998-2007 trend had continued. The cumulative loss of output would be 160 per cent of 2007 gross domestic product. If growth after 2014 were at the pre-2008 trend rate, lost GDP would be almost three times 2007 GDP by 2030 (see chart). It is easy to imagine worse possibilities.
These losses in output have had a severe impact on the public finances. Indeed, the fiscal deterioration in the UK has been far bigger than in any other member of the Group of Seven leading high-income countries. The proximate explanation has been the collapse in government revenues. Between the 2008 Budget and the 2009 pre-Budget report, the forecast of total spending for this financial year has risen by just 4.4 per cent. The forecast of nominal GDP has indeed fallen by 9.1 per cent. But the forecast of revenue has collapsed by 18.1 per cent.
Yet the UK’s recession has not been more severe than that of other high-income countries. As Alistair Darling, the chancellor of the exchequer, noted in his speech on the pre-Budget report, the cumulative contraction in this recession, up to the third quarter of 2009, has been 3.2 per cent in the US, 5.6 per cent in Germany, 5.9 per cent in Italy, 7.7 per cent in Japan and only 4.75 per cent in the UK. The reason this not particularly dramatic decline in output, by the standards of this "Great Recession", has had an exceptionally big impact on revenues is that, in the UK, the financial sector played a huge role in supporting consumer expenditure, property transactions and corporate profits. No less than a quarter of corporate taxation came from the financial sector alone. Receipts from corporate taxes fell by 26 per cent between the 12 months to October 2008 and the 12 months to October 2009. Receipts from value added tax fell by 17 per cent over the same period. Over and above the general effect of the recession, this is, to a significant extent, a result of the vulnerability of the UK economy to the disruption in credit and collapse in profits of financial businesses.
What does this imply for the UK’s future? A good way of thinking about this question is that the UK has not only had a financial crisis, with the usual severe impact on output and the public finances, but that the UK has also been a "monocrop" economy, with finance itself acting as the "crop". Countries that depend heavily on output and exports of commodities whose markets are volatile are all too familiar with the cycles these can create. In booms, export revenues and government revenues are buoyant, the real exchange rate appreciates and marginal producers of tradeable goods and services are squeezed out – a fate sometimes known as the "Dutch disease" after the impact of discoveries of natural gas on the economy of the Netherlands. Often, both government and the private sector borrow heavily in these good times. Then comes the crash: exports and government revenues collapse, fiscal deficits explode, the exchange rate falls and, quite often, inflation surges and the government defaults.
The biggest mistake one can make in macroeconomics is to confuse the cycle with the trend. In monocrop economies, the danger is particularly big, because cycles can be so large. This, in retrospect, is the mistake the UK made. Thus, the Treasury has decided that the UK’s potential output suddenly fell by 5 per cent during this crisis. This is nonsense, as Robert Chote, director of the Institute for Fiscal Studies, has suggested. What the Treasury used to consider sustainable output was, instead, the product of the bubble in the UK’s monocrop financial sector, spread, directly and indirectly, to the economy and the public finances. If this view is right, it has three painful implications: first, properly measured fiscal policy was far looser than was thought during much of Gordon Brown’s period as chancellor; second, it is likely that the UK will suffer not only from a permanent loss of output, but also a permanent decline in the trend rate of economic growth; and, third, a huge fiscal tightening cannot be avoided.
At present, the government envisages a structural fiscal tightening of 5.4 per cent of GDP over two parliamentary terms, much of it unspecified (see chart). It now expects that a third of this will be achieved through higher taxes and two-thirds through cuts in spending. To make this credible, it envisages a fiscal consolidation plan that would, in some incomprehensible manner, be legally binding. Would a defaulting chancellor be taken to the Tower of London? But the problem with the plans is not only that they are barely credible, but also that the envisaged tightening is probably too little and the final level of public sector net debt, at around 60 per cent of GDP, too high for comfort, given the likelihood of further adverse shocks. Even so, cuts in spending are larger than in similar episodes in the postwar period.
While the chancellor has presented overall numbers, he has shied away from exploring the full implications and, still more, the nature of the choices the country faces. This is the debate the UK must have. It must start from a realisation: the country is poorer than was thought. So how should these losses be shared in ways that minimise both the harm done to vulnerable people now and to the country’s economic prospects for the longer term? Those are the big questions in UK politics. Serious politicians must not duck them.
ECB orders Austria to nationalise Hypo bank, fearing domino crisis
Austria has nationalised the Carinthian lender Hypo Group after it ran into trouble on hidden losses in Eastern Europe, offering a stark reminder that Europe's banks are not yet out of the woods. Finance minister Josef Pröll said the government had been forced by fast-moving events to take a 100pc stake in the bank, Austria's sixth biggest lender with assets of €42bn (£38bn). "The risk situation of this bank has created an enormous threat to Austria, to its future as a financial centre, and to the whole economic region in recent days and weeks," he said, speaking after a 14-hour emergency session overnight on Sunday.
Chancellor Werner Faymann sought to calm the fury of Austrian citizens and opposition leaders, saying there would have been "catastrophic consequences" if the bank had been allowed to fail. Austria's press said that Mr Faymann was under intense pressure from Jean-Claude Trichet, the head of the European Central Bank, who feared a "domino-effect" that would undermine other banks and damage Austria's sovereign rating. Samir Patel from the consultancy BH2, who advised clients this Autumn to prepare for a Balkan storm, said the Hypo rescue was unlikely to prove an isolated event. "We see this as the beginning. Things are still getting worse in the Balkans," he said.
Under the Hypo deal, majority shareholder Bayern Landesbank has agreed to surrender its 67pc stake for a token €1 and to waive a further €825m in liabilities. The Austrian state will provide up to €450m in fresh capital. The state-owned BayernLB bought Hypo during an expansionist spree at the height of the bubble in 2007. Its Austrian venture has cost Bavaria €3.8bn. BayernLB was itself rescued by German authorities in a €10bn bail-out last year. While the bank is in no danger itself, the latest losses will force it to tighten lending to boost capital ratios, risking a further credit squeeze over coming months.
The Hypo rescue casts doubt on assurances by Vienna's authorities that Austrian lending to Eastern Europe and the Balkans poses no threat to the banking system. Austrian banks have lent €230bn to the region, equal to 70pc of Austria's GDP, the highest exposure of any EU country. This led to jitters at the height of the crisis in February, prompting Mr Pröll to canvass EU states for a pan-European rescue. The G20 restored confidence at the London Summit in April, agreeing to triple the fire-fighting budget of the International Monetary Fund to $750bn. While this staved off a liquidity crisis, it has not solved the slow-burn problem of rising defaults on East European loans books.
Helmut Ettl, head of Austria's financial watchdog (FMA), said Hypo had kept its risks in the Balkan region "well hidden". The full exposure came to light recently in an "Asset Screening" by the FMA. Tim Ash from RBS said revelations that Hypo had lost almost €4bn would create fresh skittishness about the region. "This is not going to be credit-friendly for Eastern Europe," he said. Social Democrats called for the resignation of the Right-wing coalition in Carinthia, calling the debacle the "greatest financial scandal in the history of the state". Austria's hard-Left KPO party called for the total nationalisation of Austria's banks and insurance companies.
Italian banks fear 2010 crunch from Basel II banking rules
Italy's leading bankers and business leaders have called for the Basel II rules on bank capital to be shelved or delayed, fearing a serious credit crunch next year. The warnings came as Standard & Poor’s listed 17 Italian banks at risk of a downgrade as the delayed effects of rising defaults start to hit home. Giampaolo Galli, director-general of Italy’s business lobby Confindustria, said the economy could not withstand the shock of credit tightening if stricter rules start to bite next year as planned.
"We must convince the authorities that it is not only necessary to postpone the changes until 2011-2012 but also to soften them," he told Italy’s financial paper Il Sole. "There are going to be very serious difficulties. Firms have a great need for credit and they are going to reveal awful books for 2009, with the result that their access to credit will suffer," he said. Corrado Faissola, head of Italy’s banking federation ABI, said he had "serious concerns" over the new rules and called for the Bank of Italy to move with great care as it draws up enforcement plans.
German banks have also demanded a rethink on the new rules, predicting a serious crunch for small business over the coming months without a change of course. Professor Tim Congdon from International Monetary Research said the move to tighten capital rules in the middle of a deep downturn was a grave error, comparing it to the worst follies of policy-makers during the Great Depression. He fears that such tightening may tip Europe and America into deflation next year.
Italy’s banks fared well during the financial crisis because they had little exposure to US toxic debt, and Italy largely avoided a property bubble. No lenders have required a state rescue. However, it can take three years for the damage to surface from losses on corporate loans. Few banks have made full provisions. The Basel Committee met last week to thrash out plans. It is expected to offer guidance over the next month, moving towards a regime of "risk adjusted capital" (RAC) that puts more stress on how leverage is used and is less tolerant of hybrid capital. S&P says many of the Italian banks score badly on RAC metrics.