A heavy load for an old woman. Lafayette Street below Astor Place, New York City
Ilargi: A few months ago, Porsche was bidding to buy Volkswagen. Today, Porsche is on the verge of bankruptcy. Fiat has been struggling with its sales for years. Today, while still muddling through, Fiat wants to buy both Chrysler and Opel. Canada's Magna is a multi-billion dollar car parts supplier. Today, one of its main competitors, Visteon, went into Chapter 11, while Magna, which has never produced one single car, is in the race to acquire Opel, reasoning that to sell parts you need a client, and if no-one else wants to buy, maybe you can be your own client.
These are not incidents. It’s what corporations and governments do when the going's good, and they step it up a notch when the going gets tough. It's called double or nothing. Gambling. Mr Practical at Minyanville writes that total US bailouts, including government's asset purchases and everything else, now top $30 trillion. The present administration's debt accumulation makes all previous ones look like chump change. It would be funny to know how much of the bailout cash is being spent on more derivatives, securities and swaps, but I doubt we'll ever find out. For one thing, no-one may have a pocket calculator powerful enough to do the math.
Initial jobless claims were down 13.000. Continuing claims were up 110.000. Yes, that's in one week. Guess what makes the headlines? Recovery.
It's getting annoying. Mould and vomit may be green, but that doesn't make them positive. In the past two weeks, initial claim numbers were revised upward 6000 and 5000 respectively. So that initial claims number will likely be halved, and then if you throw in a reasonable margin of error you end up at zilch. The continuing claims number has a feature that generally fails to register: people get thrown overboard, pushed over the edge, when they've been collecting too long. And still there are almost 7 million Americans on the continuing claims list.
Want to go ask them about green shoots? How about the record numbers that lose their homes? Many of those are the same bunch. No job no house, especialy if it takes too long to find new work. And it's not about the poor: the largest share of new foreclosures now comes from prime loans. The deepening of the crisis may have halted temporarily -which is mistaken for recovery-, but it's definitely widening, sweeping up ever broader sections of the population in its wake.
The June 1 GM bankruptcy is being announced as a 90 day max affair. Someone should take a second look at the CDO's and other paper that was threatening to strangle the company three years ago, when it still owned GMAC. 90 days is possible only when the law is broken about 90 times in the process. Come to think of it, put it that way and all of a sudden 90 days looks entirely feasible.
It's a jungle out there, and only the alpha predators are safe. For a few more days. Or minutes.
Troubled mortgages hit record high
Despite all the hand-wringing and attempts to contain the foreclosure plague, the problem still spread during the first three months of 2009, as the number of foreclosure actions started hit a record high, according to a quarterly report. The National Delinquency Survey released Thursday by the Mortgage Bankers Association (MBA), reported the largest quarter-over-quarter increase in foreclosure starts since it began keeping records in 1972. Lenders initiated foreclosures on 1.37% of all first mortgages during the quarter, a 27% increase from the 1.08% rate during the last three months of 2008 and a 36% rise from the first quarter of 2008.
All told, more than 616,000 mortgages were hit with foreclosure actions. Delinquencies, the stage in which borrowers have fallen behind on payments but have not yet received foreclosure notices, also hit record highs, with the seasonally adjusted rate at 9.12% of all loans, up from 7.88% last quarter. The ugly report was sobering but not unexpected, according to Jay Brinkmann, MBA's chief economist. He pointed out that foreclosure rates had grown little during the previous three quarters, even as the number of homeowners falling behind on mortgage payments continued to soar. "We suspected that the numbers were artificially low due to various state and local moratoria, the Fannie Mae and Freddie Mac halt on foreclosures, and various company-level moratoria," he said in a prepared statement.
"Now that the guidelines for the administration's loan modification programs are known, combined with the large number of vacant homes with past due mortgages, the pace of foreclosures has stepped up considerably." And it looks like that pace may continue to increase. There has been a big jump in the number of loans that are 90-days or more overdue, which is a very bad sign since those delinquencies often progress into foreclosure starts. The number of loans 90 days past due rose to 3.39% of all loans, up from 3% a quarter earlier and is more than double the 1.56% level of 12 months ago.
Brinkmann said many seriously delinquent mortgage borrowers have already given up and moved out of their homes, and that these homes constitute a large share of all foreclosures. "Lenders are not proceeding against any foreclosures they think can be saved," said Brinkmann, "only against vacant properties and others they think have no chance of succeeding." The nature of these troubled loans is also changing. The mortgage meltdown was ignited back in 2007 by defaulting subprime loans, especially adjustable rate mortgage (ARMs). Now prime loans are the biggest problem.
"The original delinquency and foreclosure problems had a lot to do with loan terms - the toxic mortgages with interest rates that reset higher," said Nicholas Retsinas, the director of Harvard's Joint Center for Housing Studies. "Now we're back to the more traditional reasons why loans go bad. If people don't have jobs, they can't pay their mortgages." Subprime mortgages were usually issued to the least credit-worthy borrowers and potential payment problems had been offset for years by the hot housing market. Double-digit home-price increases had enabled cash-strapped borrowers to pay their bills by tapping their added home equity, through cash-out refinancings or home equity loans.
Once home prices began to fall, those options evaporated and subprime mortgages began to default at higher rates. The delinquency rate for subprime ARMs reached nearly 28% during the first quarter. Over the past 12 months, however, as the turmoil in the overall economy increased and job losses mounted, the percentage of foreclosure starts for prime, fixed-rate loans, which account for the majority of all mortgages, have more than doubled, to 0.61% from 0.29%. "For the first time since the rapid growth of subprime lending, prime fixed-rate loans now represent the largest share of new foreclosures," said Brinkmann.
"I don't see how it can't get uglier," said Dean Baker of the Center for Economic and Policy Research. "Unemployment will continue to go up and you'll have a lot of people out of work, prime workers in their 40s and 50s, who will exhaust their resources." They'll have no shot at saving their homes unless they can get new work. Regionally, the biggest contributors to the record foreclosure rates are the so-called "sand states," California, Florida, Arizona and Nevada. These four, which represent less than 18% of the nation's population, account for 46% of foreclosure starts. More than 10% of all mortgages in Florida are in foreclosure.
Those states had much higher rates of subprime lending than average. California, for example, which accounts for 13% of U.S. mortgages, had 18% of all subprime ARMs outstanding during the first quarter. These states also endured severe home price declines, forcing more homeowners into delinquency. The fact that delinquencies and foreclosures continue to rise is terrible news for the overall economy, according to Pat Newport, a real estate analyst for IHS Global Insight.
"Just about every number in the report is a record high," he said. "It indicates that the problems with the banks will continue for a long time." Brinkmann displayed little optimism for the immediate future, saying the level of mortgage defaults will not begin to fall until after the employment situation improves. "MBA's forecast, a view now shared by the Federal Reserve and others, is that the unemployment rate will not hit its peak until mid-2010," he said. "Since changes in mortgage performance lag changes in the level of employment, it is unlikely we will see much of an improvement until after that."
Ilargi: Must be a sign of the times: I found myself looking all over for a take on the jobless claims report that makes any sense. I ended up at the Kansas City Star(?!), which has the added benefit of two comments that make sense too.
Is the job market up or down?
Today's report from the U.S. Department of Labor that new claims for unemployment benefits fell last week by 13,000, compared to the previous week, looks like a good thing. But the previous week's reported number was revised higher. So we need to wait and see how improved the job market really is. Here's a fact to ease the wait: For the last nine weeks, new jobless claims have been trending lower. That makes it look like the pace of layoffs has clearly slowed.
But here's the reason for caution: Continuing claims -- for people who continue to look for work unsuccessfully -- ROSE by 110,000 last week to a RECORD 6.788 million. While new claims have been on an erratic nine-week slide, continuing claims have zoomed upward by 1.221 million. The number of workers getting continued unemployment benefits has risen 118.8 percent over the last year, notes Steven Wood, chief economist with Insight Economics. Clearly, we can celebrate a reduced pace of layoffs, but we need to delay the big party until more workers are able to return to work.
My 2 cents.My employer isn't only still laying people off (last week brought a new round of firings) but the survivors are taking hefty wage/benefit cuts. A 15% pay cut earlier this year is about to be added to in June. Direct employees are also being fired and brought back into their old jobs (off-site) as temps at lower wages. Yet, green shoots are sprouting? Not from where I'm sitting. As noted, as the pool of working people shrinks the pace of layoffs will naturally slow. When no one is left working, the layoffs will end and we can all finally party.
You have fallen victim to...You have fallen victim to the same foolishness of most in the media -- suckers for the second derivative: "There's less jobs being lost this week than last!" Yet, the number is still increasing. There is record unemployment, and it continues to climb. It's not a good thing in any fashion. Employers are running out of people to lay off. Keep firing people and there won't be anyone left to run the place. That's why the rate of change has slowed. Most people than can lose their jobs have already. And with GM soon to be bankrupt, and Chrysler already bankrupt, get ready for the fallout from that.
Ilargi: Nice slide show at the link. Here's a few examples.
Your Field Guide To The Mortgage Collapse
The housing market is crashing, and it's taking us, our banks, our economy, and our government down with it. Why? Because of the debt! The value of our houses is plummeting, but the value of our debt is staying just the same. You knew that already. What you didn't maybe know, or at least fully appreciate, is exactly what's happening in the mortgage market that's causing all this hideousness.
Well, thankfully, Whitney Tilson has laid it all out for us. Whitney's the managing partner at T2 Partners, a hedge fund and mutual-fund company. He's also just published a book called More Mortgage Meltdown: 6 Ways To Profit In These Bad Times. In the book, Whitney lays out the whole mortgage disaster in pictorial form. If you'd like to see updated, interactive versions, please visit www.moremortgagemeltdown.com. Or just head over to Amazon and buy the book.
New Home Sales Fall 34%
Another month, another disasterous housing data point:
- Sales of new one-family houses in April 2009 were at a seasonally adjusted annual rate of 352,000, according to estimates released jointly today by the U.S. Census Bureau and the Department of Housing and Urban Development. This is 0.3 percent (±14.5%)* above the revised March rate of 351,000, but is 34.0 percent (±11.0%) below the April 2008 estimate of 533,000.
- The median sales price of new houses sold in April 2009 was $209,700; the average sales price was $254,000. Median prices of a new home decreased 14.9%
- The seasonally adjusted estimate of new houses for sale at the end of April was 297,000. This represents a supply of 10.1 months at the current sales rate.
Note (once again) that the monthly data is statistical noise at 0.3% with a ±14.5% margin of error; the annual fall of 34% is statistically significant versus 11% error).
The usual headlines got it wrong:
- Bloomberg: New-Home Sales in U.S. Climbed 0.3% to 352,000 Pace
- Marketwatch: Home sales up a paltry 0.3%
- Reuters: US new home sales rose 0.3 percent in April
- Associated Press: April new home sales inch upward
- WSJ: New-Home Sales Rise as Prices Tumble
No, we cannot accurately state that home sales went up in April 2009. Yes, we do know that sales fell (between 23% and 45%) year over year. Note the Non-seasonally adjusted pattern is typical; the sales data follows the historical trend. Bottom line: Yet another bad RE number.
The Stunning Jobs Collapse
Everything from the housing market to credit card defaults to retail sales hinges on the ability of Americans to find jobs. As much as we hear about green shoots, the jobs market just keeps getting worse. As today's chart from Whitney Tilson's More Mortgage Meltdown shows, the severity of the jobs collapse blows away what we've seen in the recessions of the past 40 years. And since so many of our jobs during the boom came from the housing and finance sectors, where the new jobs come from? Government?
If you add up all the government bailouts, explicit and implicit, along with actual government purchases of assets (debt from banks) it comes out to a surreal $30 trillion. Markets are cheering that things have “stabilized” and “things are getting less bad”. I ask you seriously when the government throws $30 trillion at the “crisis” (one which bankers are now claiming is over), can you call that stable? That is like declaring a patient being kept alive on a heart-lung machine healthy.
Of course we have stabilized. The government has bankrupted our future to do it. The government(s) control the LIBOR market, the swaps market, the bond markets with all the “money” they are printing. They are feeding “money” to banks under the table at an alarming rate.
Those declaring the economy is now recovering do not understand (still) the problem: we are stuck with too much debt. The government’s solutions are to create more debt, as their next to be announced PPIP does. But an economy grows from production, not lending at the wrong price. This is a long term problem; the government has only addressed the short run symptoms.
Let me give you an example. Sixty to 70% of our economic growth depends on consumption. In order to “reflate” an economy (still the wrong way to do it but I will give the bulls the fact that you can drive up nominal asset prices by devaluing a currency), you need people to borrow money and spend it. In 2002 consumer debt as a percentage of disposable income was an all-time high of 90%.
Apparently that was still low enough to spur consumers into borrowing money against their houses and spend it. This drove the ratio up to 135%! By the first quarter of 2009 the ratio dropped to about 130%. Just look at what damage that did as consumers tried to get out of some debt. The ratio is still at least 125% (we will know for sure in at the end of June as the numbers are quarterly). There's no way to know for sure, but logic says to reflate from that high level of debt is going to be virtually impossible.
The government is going all out socializing markets and the economy. This is the exact opposite approach I would take. We need lower debt, not more. We need production, not lending. Unfortunately I offer no solutions other than let an economy grow from the bottom up, by savers finding a good investment and lending to entrepreneurs. When the government provides capital (printing) money, it crowds out production.
Risk is very high.
GM Will File for Bankruptcy June 1
General Motors Corp., the world’s largest automaker until its 77-year reign ended in 2008, plans to file for bankruptcy protection on June 1 and sell most of its assets to a new company, people familiar with the matter said. The U.S. Treasury will provide financing while the asset sale is arranged to a company formed by the government, GM said in a regulatory filing. GM’s path will be smoothed by an agreement today with some of its biggest bondholders on terms for an equity stake in the reorganized automaker.
GM, which would follow Chrysler LLC into bankruptcy, plans to build its new business around assets such as the Cadillac and Chevrolet brands. The 100-year-old automaker, battered by tumbling sales, fell short in a bid to cut debt by $44 billion by the U.S.-set June 1 deadline to restructure outside court. “By freeing GM of tens of billions of dollars in debt, bankruptcy will give it a new lease on life,” Lynn LoPucki, a law professor at the University of California, Los Angeles, said before the news of Detroit-based GM’s strategy. The people familiar with GM’s plans didn’t specify where the automaker might make its Chapter 11 filing. They asked not to be identified because the details aren’t public.
GM’s bankruptcy will be the third-biggest in U.S. history after Lehman Brothers Holdings Inc. and WorldCom Inc., based on GM’s reported global assets of $91 billion and total liabilities of $176.4 billion as of Dec. 31. Chrysler, which sought court protection on April 30, listed assets of $39 billion. The filing would end the suspense for GM, which said it expected to declare bankruptcy after failing to get enough support for a debt-for-equity exchange on $27.2 billion in unsecured bonds. Only 15 percent of bondholders approved the offer to trade their debt for a 10 percent stake in the new company, a person familiar with the matter said.
GM sweetened the plan today to promise warrants good for buying 15 percent more of the new enterprise, which would have an improved balance sheet based on a U.S. plan to trade bailout loans for equity. Another 20 percent of bondholders now supports the swap, according to a statement from the investors today. Bondholders would lose some or all of the warrants and their 10 percent stake in the new GM entity unless the company wins sufficient bondholder support to satisfy the Treasury by 5 p.m. New York time on May 30, according to a GM regulatory filing today. A plan in the filing shows the U.S. Treasury owning 72.5 percent of equity in the new GM, a union health-care trust with 17.5 percent and 10 percent going to the old GM to hand to creditors in the bankruptcy process.
The plan calls for debt to be carried by the new GM would consist of $8 billion in new loans from the Treasury, $2.5 billion owed to the United Auto Workers fund and $6.5 billion in dividend-paying preferred stock. Treasury will get $2.5 billion in preferred shares that pay a 9 percent annual dividend, bringing the issuance to $9 billion in preferred stock. GM’s revised offer “represents the best alternative for bondholders in the current difficult and dire situation,” the investors said. The accord with bondholders marks “another important step” in GM’s restructuring, an Obama administration official said in Washington.
GM’s 8.375 percent bonds due in July 2033 rose 0.88 cent to 8 cents on the dollar as of 12:32 p.m. in New York, according to Trace, the bond-pricing service of the Financial Industry Regulatory Authority. The yield was 103 percent. The shares rose 4 cents, or 3.6 percent, to $1.19 at 1 p.m. in New York Stock Exchange composite trading. The stock fell 64 percent this year through yesterday. GM, the world’s largest automaker until ceding the crown to Toyota Motor Corp., has been surviving with the aid of $19.4 billion in U.S. loans. The U.S. plans to fund GM’s trip through bankruptcy with about $50 billion, which includes the current borrowing, the company said in a statement.
GM wants to scrap the Pontiac line, sell its Hummer and Saturn units, and drop as many as 2,400 U.S. dealers by the end of 2010. Its Saab Automobile unit is in bankruptcy protection in Sweden, and the Opel division in Europe is up for sale. While Chrysler is already working toward a bankruptcy exit, GM’s size creates more obstacles in mopping up what remains in bankruptcy after the streamlined company is created. “They have to deal with not only their consumer issues, but their dealerships, their unions, their retirees, their investors and their existing shareholders,” said lawyer Jeanne Darcey of Edwards Angell Palmer & Dodge LLP in Boston, co-chair of the insolvency department.
The new GM may emerge from bankruptcy within 60 days, leaving the old company to linger in court as the judge sorts out claims by dealers, suppliers and other creditors, lawyers said. President Barack Obama set a similar quick schedule for Chrysler to create a streamlined entity to be run by Fiat SpA. GM reached a tentative agreement with the UAW on May 21 to modify the carmaker’s 2007 labor contract and a day later arrived at a similar accord with the Canadian Auto Workers to keep alive operations in that country. UAW members are voting this week on the contract changes and a plan to shrink GM’s obligation to a union-run trust fund for retirees’ medical expenses.
Struggling with the worst U.S. auto market since 1981, GM trimmed expenses by $3 billion last quarter and planned to shut 16 plants. It published no list of factories set to close. GM reported a $5.98 billion first-quarter net loss on sales of $22.4 billion, bringing losses to almost $88 billion since 2004, the company’s last profitable year. U.S. sales fell 34.4 percent in April, the 18th straight monthly drop. April ended with Chrysler’s Chapter 11 filing, the swine flu outbreak and GM’s race to beat its June 1 deadline, putting a lid on rising consumer confidence. GM sales dropped 33 percent in April, less than the 37 percent predicted by auto analysts.
GM says bondholders support sweetened offer
General Motors Corp. said Thursday a committee of bondholders has agreed to a sweetened deal to erase of the automaker's unsecured debt in exchange for company stock. A person familiar with the deal said that it is probable GM will file for bankruptcy protection. The person asked not to be identified by name because discussions are still under way with the U.S. and Canadian governments and there is a small chance that the company could avoid a bankruptcy filing. The company said in a statement that it offered bondholders 10 percent of the stock in a newly formed GM, with warrants to buy up to 15 percent if the bondholders agree to support selling the company's assets to a new company under bankruptcy court protection.
The company made the disclosure in a filing with the U.S. Securities and Exchange Commission. The filing says if the bondholders don't agree to support the sale, then the amount of stock and warrants they get would be substantially reduced or eliminated. Under the proposal, which has a deadline of 5 p.m. (2100 GMT) Saturday, GM would at some point enter bankruptcy protection and its good assets would be separated from bad ones. The U.S. Treasury would get 72.5 percent of the new company's shares, while a United Auto Workers' retiree health care trust fund will get 17.5 percent and the old GM would get 10 percent. The bondholders' stake would presumably be additional shares that would dilute the first batch issued by the new company. The UAW trust and others would get warrants for additional shares that would further dilute the stock. Trading of GM shares was halted for a short time Thursday morning, but resumed to rise 18 cents, or 15.7 percent, to $1.33.
Germans Angry with US Role in Opel Negotiations
Despite an entire night of non-stop negotiations in Angela Merkel's Chancellery, there is still no plan in place to save Opel from following GM into bankruptcy. The problem, say Berlin politicians, is a lack of transparency -- and a surprise 300 million euro demand -- from the Americans. By the end of the night, following almost 11 hours of negotiations aimed at finding a way to save the crisis-plagued carmaker Opel from the clutches of bankruptcy, Germany's political elite looked exhausted. It was 4:15 a.m. on Thursday morning by the time the team emerged from the Chancellery, and most eyes had dark rings under them. Finance Minster Peer Steinbrück even mumbled something about how desperately he needed sleep. But exhaustion wasn't the only problem.
The talks, as quickly became clear, had failed. And as deep and dark as the rings under most eyes were, the flash of anger was likewise unmistakable -- anger at Germany's negotiating partners from the US. Roland Koch, governor of the state of Hesse, which plays host to Opel headquarters, complained that the American role in the negotiations "was not exactly helpful." Economics Minister Karl-Theodor zu Guttenberg said "once again General Motors confronted us with surprises." With the US automobile giant General Motors facing imminent bankruptcy in the US, Berlin is doing what it can to prevent its German subsidiary Opel from going down with the ship. In addition to courting possible investors interested in buying a majority stake in Opel, Berlin -- in conjunction with the governors of the three German states which Opel factories call home -- is likewise trying to lubricate the sale with bridge financing to the tune of €1.5 billion ($2.07 billion).
But on Wednesday night, General Motors made a surprise demand for an additional €300 million ($415 million), catching German negotiators off guard. To make matters worse, the US had only bothered to send a low level representative who frequently had to confer with his superiors in Washington. Complaining that the night had been "absurd in parts," Guttenberg also said that he expected "more seriousness and a greater willingness to compromise on the part of the US." GM has in principle agreed to shed itself of Opel, but will make the final decision regarding a new investor. It is up to the German government, however, to decide on whether the new investor should receive temporary government support.
Both the Italian carmaker Fiat and the Canadian auto parts supplier Magna are still in the running while US financial investor Ripplewood Holdings LLC has reportedly withdrawn its offer. Guttenberg says more information from GM and from the US is needed before any decision can be reached and spoke of Friday as being "the absolute deadline." The issue has attracted massive attention in Germany, first and foremost because of the risk that thousands of jobs could be lost. Opel employs 25,000 people in Germany with many thousands more dependent on the company for their livelihoods. All of the potential investors currently courting Opel and Berlin have said that some job cuts would be unavoidable. And they wouldn't just be in Germany. GM's Europe division employs a further 25,000 people elsewhere in Europe and many countries have become angry that Germany has reserved a dominant role for itself when it comes to the future of GM's European subsidiaries.
It came out on Wednesday that Belgian Prime Minister Herman van Rompuy wrote to the European Commission urging the EU to make sure that a decision regarding the future of GM's holdings in Europe, which include Britain's Vauxhall, be fair to all involved. Belgium also plays host to an Opel factory, employing some 2,500 workers. According to a report in the Financial Times, EU rules may require that Opel cut capacity by up to 30 percent in order to balance out the distortion of competition any government aid would bring with it -- a cut that would likely result in massive job losses. According to a report in the business daily Handelsblatt, the German government has requested that any new Opel investor guarantee jobs in Germany. Such a guarantee, should it only apply to Germany, could violate EU rules, the report says.
Ongoing GM efforts to find a buyer for its Swedish subsidiary Saab are unconnected to the Opel negotiations. Making things more complicated in Germany, however, is the ongoing general election campaign in Germany -- and the ongoing recession. With the vote set for September, neither Chancellor Merkel's Christian Democrats, nor Peer Steinbrück's Social Democrats want to be seen as standing by as Opel sinks. But, if Berlin does too much, it could set an uncomfortable precedent given the numerous other large firms in Germany which are facing significant financial difficulties. The sports car icon Porsche, for example, is teetering on the edge of bankruptcy and may need public help. The ball-bearing giant Schaeffler and the retail conglomerate Arcandor, both large employers in Germany, are likewise far from healthy. And with the economic crisis still in full swing, there may be more to come.
Merkel's Christian Democrats (CDU) have been doing what they can to present their efforts on behalf of Opel as mere coordination between GM, Opel and the potential investors. Guttenberg, from the CDU's Bavarian sister party, the Christian Social Union, has shied away from direct government investment in Opel and has even held out bankruptcy proceedings as a possible outcome. The Social Democrats, for their part, have steered a more populist course. Finance Minister Steinbrück has largely avoided such electioneering, but Foreign Minister Frank-Walter Steinmeier, who is also the SPD's candidate for the Chancellery, was quick to throw his support behind direct government investment in Opel. He has also recently blasted Guttenberg for moving too slowly and in February, Steinmeier paid a visit to Opel headquarters to express his solidarity with the workers. Yet even as Steinmeier opens himself up to charges of shallow electioneering, it still seems that Merkel's CDU has the most to lose.
Were the Opel negotiations to fail and the carmaker to go out of business, she and her economics minister would likely bear the brunt of the blame. Furthermore, the three German states where Opel factories are located are all governed by senior Christian Democrats. For now, though, the US has managed to succeed where Berlin's political elite has failed for months: getting the CDU and SPD to agree. Both parties are unified in their excoriation of America's role in Opel negotiations thus far. "It seems to me," said Steinbrück on Thursday morning, "that transparency is in short supply on the US side. The half-life of the information received by Germany is very short."
More Leverage Won't Solve Bank Mess
Overleveraging is at the root of the economic crisis, but its perpetrators propose more of the same to get us out of this mess -- and this time, on the public dime. This summer the Public Private Investment Program, or PPIP, devised by Treasury Secretary Timothy Geithner is scheduled for implementation. This program has the objective of removing toxic assets from bank balance sheets to investor hands. The goal of the plan is to move up to $1 trillion questionable assets from the bank balance sheets and transfer them to the PPIP investors. PPIP investors can expect reward to risk ratios of 2/1, 3/1 and 4/1 (or even higher).
Because 85% of the purchase price for toxic assets purchased under the plan will come from FDIC non-recourse loans, the purchase of assets under this plan actually is more related to investor purchase of an option to buy, rather than an outright purchase. The PPIP has had notable critics, including Paul Krugman, Joseph Stieglitz and James K. Galbraith. But these earlier criticisms, did not include the manipulation now contemplated. The analysis referenced above also did not consider this. A Wall Street Journal article on Wednesday reports that "Banking trade groups are lobbying the Federal Deposit Insurance Corp. for permission to bid on the same assets that the banks would put up for sale as part of the government's Public Private Investment Program."
The article goes on to note that "critics see the proposal as an example of banks trying to profit through financial engineering at taxpayer expense, because the government would subsidize the asset purchases. 'The notion of banks doing this is incongruent with the original purpose of the PPIP and wrought with major conflicts,' said Thomas Priore, president of ICP Capital, a New York fixed-income investment firm overseeing about $16 billion in assets." The Journal did not say which banks would pursue this strategy, but it would presumably include most, if not all, of the major banks that were found lacking sufficient assets in the recent government stress tests. These include Bank of America, Citigroup, Wells Fargo, Morgan Stanley, Regions Financial and SunTrust, as well as four other large banks. Here is a summary of how the PPIP process will work:
- Banks will remove troubled assets from their balance sheets and receive a value determined by a bid/ask negotiation process with investors bidding and the banks asking.
- The negotiated price will be paid from the following sources: 7.5% private investor, 7.5% government (taxpayer) funds, and 85% loan from the FDIC.
- The FDIC loan is non-recourse. If the assets ultimately prove to be worth less than 85% of purchase price, the 15% of investor funds are wiped out and the FDIC will own the assets.
- The FDIC, a government sponsored enterprise (GSE), will be bailed out by the government (taxpayer), if necessary.
It should now be obvious why I compared this asset purchase to a call option. If the assets are worth more, ultimately, than the total purchase price, the investor partnership will repay the loan (exercise the call) and sell the assets for a profit. If the assets are worth less than 85% of the total purchase price, the investors will walk, essentially writing off the investment as an option premium paid for a call which expired worthless.
In the event the assets eventually are worth 15% more than original purchase plus loan interest, the investors (private and government) have doubled their money; if worth 30% more, they have a three-bagger. These are reasonable option trading risk/return parameters. The problem is that for every $7.50 risked by the private sector, the taxpayer is ultimately at risk for $92.50. Yet the potential returns for the taxpayer are far less than the private investor and the risk is far higher. Now, let's summarize what the newly proposed maneuver adds to this picture:
- Banks will remove troubled assets from their balance sheets and effectively move them off balance sheet, while still retaining 50% nominal ownership in partnership with taxpayers.
- Banks will, at the same time, receive a cash infusion of 92.5% of the "negotiated" transfer price. The quotes are used because trading with yourself is hardly an "arms length" transaction.
- Banks will receive transaction fees as both a buyers' agent and a sellers' agent. This is like selling 50% ownership of your house to a second party for 92.5% of the full value and pocketing an additional 6% realtor's fee. You would receive 98.5% of the house value and still own 50%.
Zachery Kouwe, writing in The New York Times Dealbook Blog, reviewed a newsletter from Elliott Management which included statements alluding to "cozy deals, conflicts of interest, massive taxpayer losses and concentrated large profits reaped by a small group of anointed gatekeepers." In the same post, Arthur Levitt, a former Securities and Exchange Commission chairman who is an adviser to private-equity firm Carlyle Group, is quoted (from The Wall Street Journal): "To allow the government to finance an off-balance-sheet maneuver that claims to shift risk off the parent firm's books but really doesn't offload it is highly problematic."
Back in April, Dealbook's Andrew Ross Sorkin criticized the PPIP, saying it was "trying to stabilize the system by adding more risk, not less risk, to the system." It appears that this new maneuver would add a further level of risk to the program, all of it concentrated on the taxpayer, for the further relief of the exposures born by the banks. First we had questions of moral hazard. Now, it could be said, we have "son of moral hazard."
Of course, there are other large banks which the stress tests determined did not need to raise capital. If these banks, including Goldman Sachs, JPMorgan Chase, State Street, US Bancorp and Bank of New York Mellon, choose not to sell any troubled assets under the PPIP, there does not appear to be any conflict of interest. Those most at fault for the overleveraging that caused the credit crisis have not suffered enough pain to have learned necessary lessons to avoid a repeat in the future. Can cranking the lever some more -- this time using public funds -- possibly resolve the crisis? The banks have bankrupted themselves with respect to private capital. Is the next benchmark bankrupting public capital (the taxpayer)?
FDIC Paints Dark Picture of U.S. Banking
U.S. banks reported a first-quarter profit of $7.6 billion, buoyed by revenue at a few larger companies, but overall the credit picture remained grim as the number of banks in trouble continued to rise and borrowers increasingly fell behind on their loans. The combined profit at more than 8,000 commercial banks and savings institutions insured by the Federal Deposit Insurance Corp. fell 61% from $19.3 billion in the first quarter of 2008. Still, the latest results were an improvement from the industry's net loss of $36.9 billion in last year's fourth quarter.
There also were plenty of negative signs in data released Wednesday by the FDIC. The number of banks on the FDIC's "problem" list climbed to 305 as of March 31, up from 252 three months earlier and the highest level since 1994. Banking regulators don't disclose the names of these problem banks. Meanwhile, the number of loans more than 90 days past due climbed across all major loan categories. "The first-quarter results are telling us that the banking industry still faces tremendous challenges," FDIC Chairman Sheila Bair said. "And that going forward, asset quality remains a major concern."
Banks continued to aggressively add to their reserves during the quarter. The FDIC said nearly two out of every three banks increased their loss provisions during the quarter and that the industry set aside $60.9 billion in loan-loss provisions. Despite those actions, banks were increasingly unable to build their reserves fast enough to keep up with noncurrent loans. The ratio of reserves to noncurrent loans fell to 66.5% in the first quarter from 74.8% in the fourth quarter. It was the lowest level in 17 years. "Troubled loans continue to accumulate, and the costs associated with impaired assets are weighing heavily on the industry's performance," Ms. Bair said.
The FDIC said that banks responded to the rising amount of troubled loans by charging off $37.8 billion during the first three months of 2009, led by loans to commercial and industrial borrowers, credit cards and real-estate construction loans. The agency said the high-level of charge-offs did little to slow the rise in loans at least 90 days past due, which increased $59.2 billion during the quarter, as the percentage of loans and leases considered non-current hit the highest level since the second quarter of 1991. The problems were spread across all major categories, though the FDIC said that real-estate loans accounted for 84% of the overall increase.
FDIC Chief Economist Richard Brown told reporters said regulators are seeing increasing woes in the commercial real-estate market. "That probably hasn't hit full-force yet," Mr. Brown said. The 21 bank failures during the first quarter were the most in any quarter since the last three months of 1992. The failures reduced the fund that protects consumers' deposits to $13 billion from $17.3 billion at the end of 2008.
The FDIC has already taken steps to address the declining fund, voting Friday to charge banks a special fee they project will raise $5.6 billion to replenish the fund. Ms. Bair said the FDIC has no plans to access its $100 billion line of credit with the U.S. Treasury Department to help stabilize the fund. "We really don't want to go to that step," she said. "For planning purposes, we intend to continue to rely on our industry-funded reserves."
What's driving the great bond freak out
The government is going deeper into hock and that's starting to make people nervous. Investors have been dumping long-term Treasurys as of late on concerns about a glut of bonds flooding the market this week. And that's pushed rates, which move in the opposite direction of bond prices, to their highest level since November. The yield on the U.S. 10-year Treasury note has shot up to about 3.7% this week following auctions of $40 billion auction in 2-year notes Tuesday, $35 billion in 5-year notes Wednesday and $26 billion in 7-year notes Thursday. Simply put, it's growing increasingly difficult to imagine that there will be enough demand for all these Treasurys.
"The market is having a tough time absorbing all this debt. There's so much supply," said Stephen Mahoney, a portfolio manager with Glenmede Investment Management, an investment firm in Philadelphia with about $4 billion in fixed income assets. The bond auctions are setting off alarm bells for people who believe the government is spending too much money to finance the myriad programs aimed at getting the economy back on solid footing.
The stimulus package passed by Congress and the alphabet soup list of rescue plans launched by the Treasury and Federal Reserve for the nation's financial system could cost more than $10 trillion. The fear is that all this liquidity will lead to inflation down the road. To that end, some point to the recent deterioration in the dollar versus other currencies and the rise in oil prices as evidence that inflation is already starting to creep back into the economic picture.
But let's take a step back and a deep breath for a moment. While the spike in bond yields is alarming because of how quickly it has taken place - the yield on the 10-year was as low as 2.2% in early January - rates are still, by all normal measures, relatively low. Long-term Treasury yields are now around the level they were at in early September before Lehman Brothers filed for bankruptcy. And much of the slide in yields between that point and earlier this year was due to investors panicking. They were unloading stocks, commodities and other assets and flocking to what they thought to be the only safe bet left on the planet - U.S. Treasurys.
Towns Rethink Self-Reliance as Finances Worsen
As the recession batters city budgets around the U.S., some municipalities are considering the once-unthinkable option of dissolving themselves through "disincorporation." Benefits of this move vary from state to state. In some cases, dissolution allows residents to escape local taxes. In others, it saves the cost of local salaries and pensions. And residents may get services more cheaply after consolidating with a county.
In Mesa, Wash., a town of 500 residents about 250 miles east of Portland, Ore., city leaders have initiated talks with county officials about the potential regional impact of disincorporating. Mesa has been hit by a combination of the recession and lawsuits that threaten its depleted coffers, leaving few choices other than disincorporation, said Robert Koch, commissioner of Franklin County, where Mesa is located. Two California towns, Rio Vista and Vallejo, have said they may need to disincorporate to address financial difficulties; Vallejo filed for bankruptcy protection last year. Civic leaders in Mountain View, Colo., have alerted residents that they are left with few options but to disincorporate because the town can't afford to pay salaries and services.
Incorporation brings residents a local government with the ability to raise money through taxes and bond issuances. It also gives them more control of zoning decisions and development, and usually provides for local services such as trash pickup and police as well. Dissolving a town government, on the other hand, often shifts responsibility for providing services to the county or state. A city's unexpired contracts usually remain binding, and residents are still obligated to pay off any debt. But long-term commitments such as pension liabilities and day-to-day services such as sewage and water can be folded into services run by the county, public-policy experts say.
Disincorporations are rare, usually resulting from population declines that leave too few residents to support the government. The most recent in California occurred in 1972, when stalled growth and political instability led Cabazon to dissolve itself, according to the California Association of Local Agency Formation Commissions. In Washington state, the last one occurred in 1965, when Elberton gave up its autonomy after 70 years, according to the nonprofit Municipal Research and Services Center in Seattle. Today, some small municipalities are exploring the step to escape some financial burdens that have been exacerbated by the recession.
Rio Vista says disincorporating would eliminate 38 jobs and shift its sewer services to the county. Vallejo says disincorporating would end public-safety-employee contracts, which city leaders blame for pushing the city into bankruptcy. Most talk of disincorporation appears to be exploratory, and some public-finance experts say towns may not have that option if it is being used to unload financial obligations. "This is somewhat of a legal gray area, because disincorporation was not designed to allow cities to escape financial hardship," said John Knox, a public-finance consultant with the San Francisco office of law firm Orrick, Herrington & Sutcliffe.
Mr. Knox, a bankruptcy consultant to Vallejo, said shifting oversight of a city's services to a county or state during the current economic environment would be a tall order. In California and many other states, the county or state must approve such a move, he said. Most counties are ailing as badly as cities, and are unlikely to readily approve a disincorporation, he said. That isn't stopping some towns from checking into the possibility. In Mountain View, a Denver suburb with about 500 residents, sales-tax revenue has shriveled with the departure of four businesses last year, undermining its ability to pay city-government employees or to afford police and sewage service.
"We were surprised that it got this bad this quick," said Betty VanHarte, mayor of the 104-year-old city. "We have really tightened our belt and increased fees to solve some of our problems, but it's been very difficult." Colorado recently hired public accounting and consulting firm Clifton Gunderson LLP to help Mountain View deal with its troubles. Chuck Reid, a consultant with Clifton Gunderson, said the town hopes to escape disincorporation, but its murky long-term financial outlook may make it the only option. The town could dissolve and be absorbed by the county, or merge with another nearby municipality, he said.
A group of residents of Spokane Valley, Wash., have a different motive for their campaign to disincorporate the city of 90,000 near the Idaho border: They want to keep their city's government from increasing taxes and fees that would finance construction of a modern downtown district. The growth plans are too costly and break from the region's tradition of bucolic living, said Susan Scott, owner of Larks Storage in Spokane Valley, and one of the disincorporation campaign's planners. "Too many people are hurting from how bad the economy is doing," she said. "We just can't put up anymore with what the government wants." Spokane Valley Mayor Richard Munson said that the city is providing services in a cost-effective manner, and that only a minority of citizens want to disincorporate.
California Cities Face Bankruptcy Curbs
As California seeks more funds from its cash-strapped cities and counties to close a $21 billion budget deficit, some state legislators are pushing a plan that could compound municipalities' pain by making it tougher for them to file for bankruptcy. The bill would require a California municipality seeking Chapter 9 bankruptcy protection to first obtain approval from a state commission. That contrasts with the state's current bankruptcy process, which allows municipalities to speedily declare bankruptcy without any state oversight so that they can quickly restructure their finances. The bill, introduced in January, has passed one committee vote and could reach a final vote by mid-July.
The bill was sparked by the bankruptcy filing last year of Vallejo, Calif., just north of San Francisco. Vallejo's city leaders partly blamed work contracts with police and firefighters for pushing the city into bankruptcy, and won permission from a bankruptcy court in March to scrap its contract with the firefighters' union. That spurred the California Professional Firefighters to push for statewide legislation to curtail bankruptcy, said Carroll Willis, the group's communications director. "What we don't want is for cities to use bankruptcy as a negotiating tactic rather than a legit response to fiscal issues," he said, adding that he worries cities may work in concert to rid themselves of union contracts by declaring bankruptcy.
If the bill passes, it could hurt cities and counties by lengthening the time before they can declare bankruptcy. That creates a legal limbo during which a municipality is more vulnerable to creditors. The proposed state bankruptcy commission would be staffed by four state legislators, which some critics worry could politicize the bankruptcy process. "This bill is impractical," said John Moorlach, a supervisor in Orange County, Calif., which filed for bankruptcy in 1994. "In many instances, haste is important. If you can't meet payroll but have to delay seeking protection, what do you do?"
California towns and counties face a catalog of troubles. Earlier this month, voters rejected five budget measures, sending the state deficit to $21 billion. To overcome the gap, Gov. Arnold Schwarzenegger has proposed borrowing $2 billion from municipalities, using a 2004 state law that lets California demand loans of 8% of property-tax revenue from cities, counties and special districts. But that proposal lands as California municipalities are already facing steep declines in tax revenue because of the recession. Dozens are staring at huge deficits, including Pacific Grove and Stockton, which have publicly said they are exploring bankruptcy.
Assemblyman Tony Mendoza, a Democrat who introduced the bankruptcy bill, said the initiative is needed to protect the credit rating of California and its ability to borrow and sell bonds. Mr. Mendoza added that he wants to avoid bankruptcy's repercussions on surrounding communities by offering a system that examines all of a municipality's options before filing for bankruptcy. "Municipalities should have a checks and balance system in place based on the fact that all economies are interconnected," he said. Dwight Stenbakken, deputy executive director for the California League of Cities, a nonprofit representing more than 400 cities, said the group is lobbying against the bill because "there's nothing a state commission can bring to the process to make this better."
Rise in taxes on US petrol ‘not feasible’
Steven Chu, US secretary of energy, on Wednesday said that it would not be politically feasible for the country to lower its reliance on oil by raising petrol prices to Europe’s levels through higher taxes or regulation. In the past Mr Chu, a Nobel laureate, has argued that if the US wanted to reduce its carbon emissions, policymakers would have to find a way to increase petrol prices to levels in Europe. But in an interview with the Financial Times, he said: “At this moment, let me be frank, it is not politically feasible.” Mr Chu’s comments come as oil prices surged to their highest level this year after Saudi Arabia’s oil minister said the global economy had strengthened enough to cope with oil at $80 a barrel.
Prices rose to $63.82 a barrel, almost double their February low of $32.70, after Ali Naimi, speaking in Vienna ahead of Thursday’s Opec meeting, said the world could withstand prices of between $75 and $80. This is a shift in policy for the oil cartel, which this year gave the impression it would not push prices higher too quickly. Mr Chu’s move against using taxes to raise US petrol prices is likely to frustrate environmental advocates who believe the only way to change Americans’ consumption habits is through higher prices. US fuel taxes are much lower than in Europe, leading to pump prices that are often one-third lower and to the average American consuming double the amount of oil as his European counterpart.
But Mr Chu warned that Americans will have to learn to live with higher petrol prices even if Washington does not enact policy that boosts them. “Regardless of what one does in any sort of taxation, I believe that prices of oil and natural gas will go up in the coming decades,” he said, adding: “They will naturally go up just because of fundamental supply and demand issues.” Congress is considering a cap-and-trade system that opponents say will substantially increase petrol prices as oil prices soar to their highest level in six months. Higher petrol prices are likely to be one of the biggest potential sticking points of the proposal when the bill moves from the Democrat-controlled House of Representatives to the more conservative Senate this year. Mr Chu was adamant that a cap-and-trade system would be necessary to cut emissions. “We need to begin to put a price on carbon,” he said. A key question, however, was “how to help the US make the transition”, as many states are heavily dependent on coal or have energy-intensive industries.
US regulators run to catch up with EU
For once, America is running at top speed to catch up with the European Union. In levying a record fine against Intel, the world’s largest chipmaker, the EU competition authorities have let it be known that a dominant company’s efforts to crush rivals by threatening customers or rigging a price schedule will not be tolerated. President Barack Obama’s new team is in the early stages of saying “we agree”. After years in which the Bush administration allowed dominant companies to just about do as they pleased, Christine Varney, the president’s new antitrust cop, is running around Washington telling business groups that the enforcement hiatus is over. Which is of special importance to high-tech industries. The new shift “will be bad news for heavyweights in the tech industries – companies like Google and Microsoft”, says Herbert Hovenkamp, a professor of law at University of Iowa College.
He might be right. If he is, any believer in the ability of free, competitive markets to produce a rapid rate of innovation and prices that do not include monopoly profits can only add: “Good thing.” I studied and wrote about the benefits to society of vigorous competition for decades before I became a consultant to Advanced Micro Devices; and I was not directly involved in that company’s legal challenges to Intel. Consumers benefit from fair prices and unimpeded innovation, and society benefits from the social mobility provided by rags-to-riches entrepreneurs who often gamble their personal savings on a new idea. But in recent years, the high-technology industries have persuaded US enforcement officials that they are different – that all that antitrust stuff is fine for “smokestack industries” but not for them.
Leave aside the question of just how to define a high-tech industry. After all, the robots and software in any auto plant hardly cause smoke to come out of the stack. Concentrate instead on what society needs from enterprises of the kind found in Silicon Valley. It needs rapid innovation. That comes from newcomers, either directly when they enter a market, or indirectly from the pressure they put on incumbents to innovate, surrender market share or, worse still, pass from the scene. Surely, the need to keep entry open, to prevent coercion of customers, to penalise anticompetitive pricing and other practices is as great, or perhaps even greater, when we deal with the innovative sector of the economy.
The venture capitalists who often provide backing for new entrepreneurs know this – without some assurance that the newcomer will not be unfairly squashed, they will zip their wallets. This is why the Obama administration’s new tack, in effect a repudiation of the soft settlement that the Bush administration negotiated with Microsoft, is so welcome. Nervous executives and their lawyers are saying that all of this is nothing more than a response to whingeing competitors that, unable to compete in the marketplace, try to win in the courtroom. There are, of course, such instances. But surely Ms Varney can winnow the wheat from the chaff and pursue only those complaints that appear to her to be based on legitimate concerns about anti-competitive practices. The fact that a complaint comes from a non-dominant company is no reason to dismiss it out of hand.
So this frequent critic of the EU bureaucracy, its tendency to regulate when markets are best left to work their efficiencies, has to raise two cheers to Neelie Kroes, the competition commissioner. But only two. She may have erred in claiming that Intel’s fine will benefit EU taxpayers. That has given critics reason to complain that she is, in effect, taxing an American company to ease the plight of over-taxed Europeans. Ms Kroes should, instead, have found a way to distribute any funds she might obtain to the consumers injured by the practices she has found illegal – perhaps making payments to consumers in proportion to their purchase of Intel chips. Not administratively easy, but helpful in winning support in the US for more vigorous antitrust enforcement.
Take it from a conservative economist who prefers less to more government: if markets are not competitive, or if they are otherwise failing to function properly, it takes the long arm of government to protect the invisible hand. Let us hope that this view is shared by Mr Obama’s Supreme Court nominee, Sonia Sotomayor – and that she is prepared to take on the formidable and otherwise estimable Justice Antonin Scalia, who has little use for the antitrust laws.
The National Debt Road Trip
How do the Obama deficits compare with past presidents? And how did the national debt get so big anyway. This video tries to answer those questions by looking at the debt as a road trip and seeing how fast different administrations have been traveling.
Single-Regulator Plan for US Banks Now Close
Top Obama administration officials are close to recommending that Congress create a single regulator to oversee the entire banking sector, people familiar with the matter said, a departure from the hodgepodge of federal agencies that failed to contain the financial crisis as it ballooned out of control last year. The new agency is expected to be a major plank in a proposal that Treasury Secretary Timothy Geithner and White House officials send Capitol Hill in a few weeks with the goal of overhauling supervision of financial markets. Other components under consideration are an agency to police financial products offered to consumers and a beefed-up investor protection regulator.
People involved in the process said much is still in flux and could change before a formal recommendation is made to Congress in mid-June. The new bank regulatory agency could prove controversial because it would consolidate the Office of the Comptroller of the Currency and the Office of Thrift Supervision and strip supervisory powers from the Federal Reserve and the Federal Deposit Insurance Corp. The Fed and the FDIC would gain other powers, though, as White House officials want the Fed to be able to oversee systemic risks in the economy. They also want the FDIC to have new powers to take large financial companies that aren't banks into receivership. "The President is committed to signing a regulatory reform package by the end of the year and officials at the White House and the Treasury department are continuing work with Congress on the final phases of a proposal, but there is no final proposal in place and any announcement will not be for a couple of weeks," White House spokesman Jennifer Psaki said.
Once the Treasury sends its plan to Capitol Hill, Congress would have to work through the details. Administration officials are hopeful that a final package could come together by the end of the year. White House and Treasury officials have met with numerous groups to discuss their plans to rework supervision of financial markets, and they have occasionally offered clues as to what their plans may look like. Mr. Geithner has said he thinks there needs to be consolidation and simplification in the oversight of banks, but he has declined to be more specific. Still, administration officials in recent weeks have suggested that they might decide not to pursue a major consolidation of the bank regulators and push for a more streamlined approach to supervision instead.
Government officials have been even less clear about how to handle a potential merger between the Securities and Exchange Commission and the Commodity Futures Trading Commission. Some Obama administration officials believe the agencies should be consolidated into one, but it would likely elicit a huge jurisdictional fight on Capitol Hill. Banks are overseen by a patchwork of state and federal regulators, and the Obama administration isn't expected to propose getting rid of the so-called dual banking system. Instead, the new regulator would serve as a secondary set of eyes for the more than 5,000 state regulated banks and the primary regulator for the nationally chartered banks and thrifts. The objective is to streamline supervision of banks and make it harder for banks to game the system by shopping for the lightest form of oversight.
Each of the banking agencies has dug in for a fight in recent weeks, and it is unclear how willing Congress will be to go along with a dramatic administration request. Senate Banking Committee Chairman Christopher Dodd (D., Conn.) has signaled that he is reluctant to give the Fed sweeping new powers to oversee systemic risks to the economy. Regulators still haven't decided the best way to oversee insurance companies at the federal level. Many other details haven't been worked out and might be left up to Congress. For example, the Treasury Department hasn't signaled which companies should be overseen directly by a new "systemic risk" regulator.
Europe tightens regulatory noose on City
The European Commission has seized on the financial crisis to bring the City under closer EU control and clip the wings of Britain's Financial Services Authority, unveiling far-reaching plans for a new EU regulatory machinery with binding powers. "It's now or never," said Commission President Jose Manuel Barroso. "If we cannot reform the financial sector when we have a real crisis, when will we?" Three new bodies are to be created with a permanent staff and powers to impose decisions on member states: a European Banking Authority in London; a European Insurance Authority in Frankfurt; and a European Securities Authority in Paris. Each will be composed of chief regulators from the 27 member states.
While they look much like the EU's existing "talking shop" committees, they are in reality executive agencies able to set binding standards and impose their overall philosophies. The Commission said the new authorities would have powers to "settle the matter" by imposing a decision – in effect, stripping Britain and other countries of the national veto. While the proposals fall short of a pan-European regulator, they may have a similar effect. The European Court of Justice is to have the final say over any appeal. "This is exactly what I feared would happen," said Ruth Lea, director of UK think-tank Global Vision. "The EU is taking advantage of the crisis to extend its control over the British financial system. It is very threatening because it is almost impossible to repeal anything in the EU, however damaging it proves to be."
The Barroso plan will go to EU heads of state in June. Legislation will be drawn up this autumn and submitted to European MPs, already itching to ratchet up the text. Klause-Heiner Lehne, a German MEP for the Christian Democrats, left no doubt that this is viewed as a chance to punish the City. "It's well-known that Gordon Brown has only the interests of London as a banking centre in mind and not the stability of financial markets. It must be clear to all of us that the role of the financial markets is allocating capital, not as a playground for gamblers making huge bets," he said. Mr Barroso said the new machinery should be up and running in 2010, adding: "We are not taking away national supervisors' day-to-day role." The plan includes an "early warning" body modelled on the US Federal Reserve's new system.
Charlie McCreevy, the EU's single market commissioner, said national regulators were not aware of problems developing in other countries during last year's banking crisis until they read about it in the newspapers, an untenable situation given that 40 banks controlling the bulk of EU assets operate as cross-border institutions, affecting everybody. Britain has few friends in this fight other than Luxembourg, which has its own financial centre. It hard for the UK to argue that its "light-touch" regime has been a great success after last year's banking debacles – although Europe's banks have yet to come clean on their own toxic debts.
Antonio Borges, chair of the Hedge Funds Standards Board, said the blizzard of EU proposals had been hijacked by political forces and were "out of control". "There is little intellectual foundation to what they are doing," he said. "You would have thought that since 80pc of Europe's hedge funds are in Britain, and are already regulated, that the FSA would have a big say [on hedge fund proposals], but the FSA was marginalised. The reality is that a great deal of regulatory power is going to Brussels."
'Serious Deficiencies' Cited at Munich's HRE
An auditing report by Germany's central bank, the Bundesbank, underscores the scale of mismanagment at Munich-based mortgage lender Hypo Real Estate. The bank was nearly consumed by the subprime lending crisis and had to be bailed out to the tune of billions by taxpayers. When Hypo Real Estate chief Georg Funke and his colleagues on the management board arrived at the offices of Germany's Federal Financial Supervisory Authority (BaFin), on July 31, 2008, just before 2 p.m., they knew it was going to be an uncomfortable meeting. BaFin had summoned the executives of the Munich-based bank to its Bonn offices. Commissioned by BaFin, Germany's Bundesbank central bank had conducted a study of the HRE Group and came to devastating conclusions.
"Serious deficiencies" had been identified, according to the minutes of the meeting. The negative audit result weighed especially heavy for HRE because it was considered a "system-relevant financial holding group" and was one of Germany's biggest bourse-listed companies. BaFin demanded that HRE's directors put an "immediate and complete stop to the deficiencies." The bankers assumed the role of the rueful sinners: "The directors emphasized that they would take the results of the audit very seriously," they said. But the bankers reacted too slowly. Six weeks after their severe, three-hour lecturing in Bonn, US investment bank Lehman Brothers collapsed, pulling HRE down with it. Within just a few days, the bank's sources of finance dried up. The government and banks were forced to come up a rescue package for HRE totalling more than 100 billion euros in the months that followed. The only thing left that can save it now is total nationalization. In April, a parliamentary committee launched an inquiry into the scandal. Opposition politicians want to determine whether German Finance Minister Peer Steinbrück and BaFin could have prevented the bank's near collapse.
One of the central documents in the investigation is the audit report by the Bundesbank from June 24, 2008, that set off alarm bells at BaFin. If you read the 159-page report, of which SPIEGEL has obtained a copy, you can see why: The mismanagement of HRE's multibillion euro risks is far greater than previously assumed. The Bundesbank's audit listed 49 "grave" violations of "proper business conduct and the functional capability of risk management". Twelve of those violations were categorized as severe. The audit report claimed that bankers at HRE based their actions on scenarios that "weren't fully in line with the risk profile of the HRE group." In other words: Instead of planning for the storm, the bankers prepared themselves for little more than a gust of wind. It appears that the management had been overstretched with the integration of Depfa, the Irish-based public sector lender it had acquired in the summer of 2007.
Internal structures didn't meet official guidelines. "Numerous organisational guidelines didn't represent the actual way daily business was conducted," the report said. Bankers also simply weren't capable of identifying all the significant risks in the market. The requirement that "investments with increased risks" be identified early enough had "not been fulfilled." The bank's daily liquidity report didn't show "all of the relevant inflows and outflows." HRE-subsidiary Depfa only calculated the market value of most of its securities and promissory notes on a quarterly basis. Certain transactions were even booked "mostly with a one-day delay," and across the entire bank there was "no sufficient, prompt representation of the actual profit situation." The auditors had seldom seen such sloppiness. But they didn't see the growing threat of insolvency at the company.
They suggested that HRE should deliver a first report by end-September on how it was remedying the problems. But by then, HRE was already relying on aid. Officials at the German Finance Ministry weren't completely surprised by events. HRE's vulnerability had long been an issue to them. For some reason the memorandum about the heated summer meeting at BaFin was dated Nov. 13, 2008, six weeks after the near collapse of the group. But officials knew already in March that HRE was being audited. On August 18 they even received a quarterly report from BaFin in which auditors had been critical of the "comprehensive short-term, unsecured refinancing of the Irish Depfa Bank." The ratings agencies had also downgraded their ratings for HRE and Depfa, which would "further burden the group's already strained liquidity situation." A further downgrade, controllers warned, would have "serious consequences for the refinancing of Depfa."
Financial crisis: We must mend our ways, not make more rules
We are all ultimately to blame for economic crises, says Edmund Conway. Earlier this week, a group of America's most intelligent and influential thinkers published a report heralded as the definitive solution to the financial crisis. The Committee on Capital Markets Regulation's study is getting on for 300 pages, so let me give you the gist: we must overhaul financial regulation, create a centralised market for the financial instruments behind so much of the trauma, find a more sensible way of dealing with collapsed investment banks and collect more information on hedge funds. All this is worthy, correct and important – and completely misses the point. Like most of the analyses produced in the wake of the crisis, this report entirely fails to get to its heart.
Yes, we have had a horrible crunch, which is sapping any energy from the economy. Yes, there is plenty wrong with the way the banking system works. But trying to save the world economy with new regulations and codes of practice is like trying to cure a cancer patient with plastic surgery. The financial disaster was the ultimate manifestation of a far deeper problem – a wholesale malfunction of the global economic system. The bankers and mortgage brokers may have been in the front line, but they were pushed there by forces far more powerful than any regulations. For decades, we in the Anglophone West borrowed too much, while the other half of the world saved too much. It was the tectonic collision of these imbalances which caused the crisis, which brought about the worst recession since the 1930s, and which could trigger another bust decades in the future.
Imbalances, of course, are nothing new. A country, or for that matter a town, will at any one time tend to import more than it exports, or vice versa. But being reliant on borrowing from abroad, which goes hand in hand with running a deficit, leaves you vulnerable. The history of economics over the past two centuries revolves around this quandary over international trade imbalances, and the series of crises they have caused. We have wrestled with different schemes to try to even out the imbalances – to ensure that countries do not get too far into deficit or surplus. In the 19th century, we tried the gold standard, whereby countries' exchange rates were fixed against its price. Its breakdown after the First World War contributed towards the Great Depression.
Next, in 1944, came the Bretton Woods agreement, a bodged compromise between the opposing visions of John Maynard Keynes of Britain and Harry Dexter White of the US, which fixed nations' currencies against the dollar, and that in turn against gold. Again, this broke down a few decades later, leaving us with today's mutant monetary system: half of the world on floating exchange rates, and the other (China, the Middle East and others) pegging their currencies to the dollar. Trace your finger back along almost any ledger of debts – whether in terms of the banking system or of government deficits – and you'll notice that the figures start rising pretty soon after Richard Nixon stuck the knife into the Bretton Woods system in 1971. So did the incidence of financial crises.
Without any kind of structure or balance, the world's monetary system has been barrelled around since the 1970s. Countries such as Britain and America borrowed more and exported less with impunity. Countries such as China and Germany have been allowed to build up massive current account surpluses. The result has been bigger booms, followed by nastier busts. A Bretton Woods-style system would have constrained both sides from generating these imbalances. It would be nice to think that this economic crisis contains the seeds of its own solution: that following the trauma of recession, we will change our spendthrift (or insufficiently consumerist) ways. But in the absence of any kind of mechanism to right these imbalances, there is little to suggest that anything of the sort will happen once the current drama is over.
What most alarms me is that not only is nothing being done by those in power to re-engineer the global monetary system, but that few of the great and good in the City have faced up to the fact that it is the imbalances, not the regulations, that are really to blame for our current situation. Remarkably, I strongly suspect that the ultimate solution will come not from Washington or London, but from Beijing. A couple of months ago, Zhou Xiaochuan, the governor of the People's Bank of China, put out a paper which alluded to precisely these problems. The detail most conspiracy theorists fixated on was the mention of a possible international reserve currency – was this part of a plan to dump the dollar and bring down the world's biggest economy? No, it wasn't. His point was a far broader one: that we need a new international pact on how we manage the flow of goods and cash around the world, in which a world currency plays a merely functional role. In other words, a new Bretton Woods. We should be thankful that while the western elites are fiddling around with piddling regulation, someone sensible is starting to consider how we can actually make the world economy work.
Geithner to Urge China Economy Shift
U.S. Treasury Secretary Timothy Geithner heads to Beijing this weekend to urge Chinese leaders to fundamentally alter the export-oriented economy that has created years of trans-Pacific trade tensions. In meetings with Chinese President Hu Jintao and Premier Wen Jiabao, Mr. Geithner is expected to reiterate U.S. support -- and gratitude -- for the giant stimulus package that China has implemented to combat the global recession. But he is also planning to press Beijing to take drastic measures to turn China's economy into one that depends heavily on sales to domestic consumers and less on sales to the U.S. and other foreign markets, according to a senior Treasury Department official.
That means encouraging Beijing to offer more generous health-care, retirement, welfare, educational and other benefits in order to persuade the average Chinese citizen that spending now doesn't mean starving later.
"The efforts China could take would be efforts to strengthen the comfort that Chinese households have in spending, which largely involves reducing or addressing the reasons why they feel such a great need to save for precautionary purposes," said the senior Treasury official, who briefed reporters Thursday in advance of Mr. Geithner's departure on Saturday. The message signals that Treasury is beginning to look beyond the current crisis toward preventing a return to ever-mounting trade deficits and the constant political tensions they generate between the U.S. and China.
The trip is Mr. Geithner's first to China as Treasury Secretary and an important step in resuming the dialogue pursued by his predecessor Henry Paulson. The trip is intended to lay the groundwork for a broader Strategic and Economic Dialogue meeting in Washington this summer in which Mr. Geithner will lead the U.S. side of economic talks, while Secretary of State Hillary Clinton will head up the political and strategic discussions. Mr. Geithner has been heartened by the fact that China's two-year, four trillion yuan package -- nearly $600 billion -- of government and corporate spending includes components to encourage a buying spree by Chinese consumers.
The government has compelled state-run banks to unleash a flood of credit, lending more in the first four months of this year than in all of 2008. And officials have announced a series of subsidies and other measures to encourage rural dwellers to splurge on such items as small-engine cars, home appliances and electronics. "There is certainly discussion about the importance of shifting towards a more balanced, more domestic-demand source of growth for assuring Chinese growth in the future," the Treasury official said, noting that the Chinese have included that goal in their five-year plan.
That will also require, in the U.S. view, allowing China's currency to move more freely against the dollar. But Mr. Geithner is unlikely to hector Beijing about the yuan very much during this visit. The issue has long been a sensitive one, with U.S. manufacturers and their political allies accusing China of manipulating its currency to get an unfair edge in foreign trade. Earlier this year during his confirmation process, Mr. Geithner labeled the country a currency manipulator, although the administration later backtracked and played down the comments.
The U.S., on a borrowing binge to restart the economy, needs China to continue to purchase dollar assets. Yet Chinese officials have, in recent months, expressed concern that big U.S. budget deficits and the threat of inflation might eat away at the value of their dollar holdings. So far, however, Beijing hasn't pulled back from investments in U.S. government securities, something the Obama administration wants to avoid. "The last thing Geithner wants to do right now is rock the boat," said Frank Vargo, vice president for international economic affairs at the National Association of Manufacturers. Mr. Geithner is scheduled to arrive in Beijing on Sunday for meetings Monday and Tuesday.
Japan May Scrap 50 Trillion-Yen Plan to Prop Up Stock Market
Japan’s ruling Liberal Democratic Party may abandon a bill that would set aside 50 trillion yen ($520 billion) to buy shares from the market because stocks have rebounded from a 26-year low, lawmakers said. “A system of buying stocks directly may provide a sense of relief when shares plunge,” Naokazu Takemoto, chief director of the LDP’s lower house finance committee, said in an interview in Tokyo on May 26. “But stocks have been stable, so the measures aren’t necessarily that essential.” Investor optimism that the worst of Japan’s deepest postwar recession is over has led the recovery in the Nikkei 225 Stock Average, which tumbled a record 42 percent last year.
Direct purchases would be the first among the Group of Seven industrialized nations and would affect prices more than the Bank of Japan’s program of buying shares from lenders to cushion their balance sheets. “I don’t think there’s really a crisis in Japanese stocks to begin with,” said Naomi Fink, Japan strategist at Bank of Tokyo-Mitsubishi UFJ Ltd. in Tokyo. “It might even undermine Japanese equities because foreigners are going to say ‘wow, the government is propping up prices and how do we know whether it actually reflects the value of the firms or not?’” The bill was submitted to parliament on April 27 as part of Prime Minister Taro Aso’s record 15.4 trillion yen stimulus package. Under the plan, the government would set up a state- owned entity to buy exchange-traded funds, which are instruments that track stock indexes, as well as equities listed in the indexes and related derivatives for three years.
The body would raise money by borrowing from the Bank of Japan or commercial lenders as well as issuing bonds, and the government would set aside 50 trillion yen to guarantee the investments. Deliberations on the law haven’t taken place because the opposition Democratic Party of Japan, which controls the upper house, is against the measure. While the ruling coalition can use its two-thirds majority in the lower house to pass the bill if it’s rejected, Takemoto, 68, signaled the LDP may not force the bill through parliament. “Whether we need to revote and pass the bill even after it’s defeated in the upper house depends on economic conditions,” Takemoto said. “People were split about the bill to begin with and even a majority of lawmakers regarded as economic experts in our party are opposed to the idea.”
Finance Minister Kaoru Yosano said on May 22 that “the argument is losing force” given that stock prices are recovering. The Nikkei has risen 34 percent since March 10, when it fell to 7,054.98, the lowest since October 1982. Masaharu Nakagawa, the DPJ’s shadow finance minister, said the party opposes the measure because it may distort stock prices. He said the government should consider buying stakes in financial institutions should plunging equities erode their capital. “It goes against the market’s mechanisms to begin with,” Nakagawa, 58, said in an interview on May 26. “We’re absolutely against it. Even discussing it would look bad.”
As a separate measure, the government has already set aside 20 trillion yen to purchase stocks owned by banks to bolster their capital. The Bank of Japan has decided to buy 1 trillion yen of shares held by lenders to ease a credit squeeze. The government last bought stocks owned by financial institutions from 2002 to 2006. Yoshinori Ohno, an LDP lawmaker who compiled the bill, said even though equities have recovered, it’s important to show the government is committed to preventing a plunge of stock prices given the severity of the current financial crisis.