THURSDAY, JULY 1, 2010
July 1 2010: The End of the Age of Credit
On the road with her family one month from South Dakota. Tulelake, Siskiyou County, California
Ilargi: The picture becomes increasingly clearer as Washington lifts its veil. A financial overhaul that was supposed to be a momentous effort has finally been voted in, only to reveal that none of the Wall Street banks will be effectively affected until 2022, which is the sort of number that you can read as meaning: "never". At the same time, Capitol Hill has thrown out a proposal to provide emergency support for millions of Americans who remain unemployed for more than 26 weeks, while those who haven't found a job for 99 weeks or more are in the indefinite doghouse.
It truly is a matter of bail the banks and screw the people. What remains to be seen is how those people will react. All the more so when they find out that those same Wall Street banks will soon come calling again for more bailouts, which is now inevitable and guaranteed to happen. Our fine leaders may try to find a creative way to do it, one that won't attract too much attention, but you can bet there’ll be more taxpayer money flowing to Lower Manhattan, while for "ordinary" citizens services will be cut, taxes raised, and jobs disappeared.
Nor is this an exclusively American phenomenon. European countries face the same fate, even though it's not as easy over there as a Republican filibuster to condemn citizens to abject poverty.
The options are dead(ly) simple. We will find out over the next few months that our banks are screamingly underfunded, and that not bailing them out will lead to bank runs and panics. How bad the situation already is becomes obvious through for instance Reuters' James Saft, who writes that in the next three years,
Global banks face $5 trillion rollover
Banks around the world must refinance more than $5 trillion of debts in the coming three years[..]
For banks in the UK, according to the Bank of England Financial Stability Report, the refinancings amount to about $1.2 trillion by the end of 2012. If banks in Britain raise funds at the same pace they have been this year, they will only collect half of their needs in time. [..]
U.S. banks have issued $230 billion of debts in the first five months of the year, about 60 percent of the rate they need to achieve over the three year period. Euro zone banks have issued $133 billion, or about 70 percent of their needed run rate. One easy to see consequence is that, all things being equal, the cost for banks to issue debt should rise, as should competition among banks for consumer deposits. [..]
The track record of the past three years tells us one thing is likely: the banks will get their money, courtesy of government support if needed. Unless there is a profound sovereign debt crisis, we can count on governments taking the needed steps to see that the banking system does not fall over for lack of funding. So, if liquidity or support schemes need to be extended or invented anew, they will be.[..]
The BOE used an assumption that for every 7 basis points of additional lending spread charged by banks should create a 0.1 percent permanent reduction of GDP. On their estimates upping capital in banking by one percent then equates to present value cost of about 4.0 percent of UK GDP. This puts into perspective not just how challenging it will be to create growth going forward, but just how artificially growth during the boom was goosed by very loose and easy lending.
For the UK and for Europe, this will be happening at the same time that fiscal austerity programmes will be dampening growth. Something has to give, and it will probably be monetary policy. Look for extraordinarily low rates for a very long time, and for new and bigger quantitative easing programmes.
Ilargi: In short: banks have enormous funding problems, and even if they can sell debt, they’ll have to pay a lot more to do so, in the same marketplace that's already drowning in sovereign and municipal debt. The ultimate consequence is going to be that not only will your wages, pensions, health care and other services fade and slowly vanish, what's left of your wealth will increasingly be confiscated and handed to a bunch of rich gamblers with political clout.
The BBC’s Robert Peston chimes in:
The risks of forcing banks off welfare
There are always moments of anxiety when benefit claimants are weaned off their welfare support. One such is today, as eurozone banks face up to the refusal of the European Central Bank to roll over €442 billion of exceptional one-year loans provided to them by the central bank.
Eurozone banks are hooked on credit provided by - in effect - the public sector. And are fearful of having to fend for themselves. To be clear, the ECB is not exactly throwing them on to the streets with its decision to demand repayment tomorrow of that €442 billion: it is today offering banks as much three-month money as they want. Which may seem bizarre, in that inevitably the ECB will tomorrow be repaid in part with funds it is providing today.[..]
For Spanish banks - and also for Greek and Portuguese ones - that real world looks scary right now. Spain's banks are finding it tough to tap commercial sources of wholesale finance, because of growing fears about potential losses stemming from the weakness of its property sector. And more-or-less the whole eurozone banking sector - including big German and French banks - is under the dark shadow cast by their huge holdings of eurozone government bonds, because of deep-seated fears that Greece and perhaps other overstretched eurozone states will eventually default on their sizeable debts.
But it would be quite wrong to see the welfare dependency of banks as a purely eurozone phenomenon. You'll recall that at the peak of the financial crisis in late 2008, public-sector support for the worlds' banks - in the form of loans, guarantees, insurance and investment - was equivalent to a quarter of everything the world produces, or more than $12 trillion. In the UK, support reached a maximum of around £1.3 trillion, almost 100% of GDP. These weren't just a few handouts. This was the biggest co-ordinated financial rescue operation the world had ever seen.
But to avoid a permanent fusing of the balance sheets of banks and the balance sheets of sovereign states, all that emergency financial support has to be unwound. In the UK, for example, UK banks face a deadline of the end of 2012 to repay £165 billion of high-quality liquid assets supplied to them by the Bank of England under the Special Liquidity Scheme. And over the same timescale, British banks will have to find £120 billion to pay back debt that has been guaranteed by the Treasury under the Credit Guarantee Scheme (there is an option to roll over a third of these government guarantees to 2014).
Now as bad luck would have it, this schedule for repaying the Bank of England and the Treasury coincides with a spike in repayments on other substantial debts of British banks, in the form of bonds and residential mortgage-backed securities. What this means, according to the Bank of England, is that banks need to refinance or replace up to £800 billion of term funding and liquid assets over the coming 30 months.
Here's the troubling news: what's required is 66% more debt issuance per month on average by banks than actually took place during the boom years of 2001-7. And banks are currently issuing (selling) less than half the debt that's needed. Now if you think there's safety in numbers, you might be reassured that French, German and Italian banks also face substantial increases in debts falling due for repayment.
And wherever you look in the rich West, from the US to the eurozone, banks are currently borrowing substantially less on debt markets than they require simply to replace their maturing debts. It has all the hallmarks of a second credit crunch.
Ilargi: Now that last line is of course grossly misleading: the first credit crunch simply never stopped. It's an ongoing process. And "..the biggest co-ordinated financial rescue operation the world had ever seen", the one that hid reality for a while, has now spectacularly failed. It’ll be interesting to see how various countries and their citizens react to the upcoming new rounds of cuts on the one hand and bailouts on the other, interesting but in all likelihood not particularly pleasant.
The banks have two additional Achilles heels that everyone conveniently fails to address these days.
First, as stock markets continue their way on the downward slope, financial institutions will see their shares tumble to precarious levels, which will bring along a whole new set of negative issues.
Second, they all still have huge amounts of ever more worthless paper on their books and balance sheets, much of it at face value while its real worth is pennies on the dollar. The term "toxic assets" will return with a vengeance, since you can't mark to fantasy forever. The resistance to mark to market valuations has thus far been defended with the magical everlasting growth line of "reasoning" (and the paper will be valuable again), but one day we will truly need to realize that it is but a mirage. The bond markets will make sure we do.
And don't be surprised if in the meantime these markets will suffer a complete breakdown. If every country, city and company needs to sell more debt in order to survive, there must inevitably come a point when there are no buyers. Prior to that, though, there'll first be sharp increases in interest rates on the debt, and volunteering to pay those rates appears utterly futile when you realize that for instance in the US, every dollar of additional debt only returns a few pennies.
A fine messy web we weave. Welcome to the end of the age of credit. This baby's going to hurt.
Global banks face $5 trillion rollover
by James Saft - Reuters
Banks around the world must refinance more than $5 trillion of debts in the coming three years, a massive rollover that poses threats to financial stability and growth. The need to replace these debts, which are medium and long term, will place pressure on bank profit spreads and in turn may either prompt deleveraging, where banks sell assets that they can no longer economically finance, or simply lead to a bout of credit rationing, where borrowers must pay more to borrow, thus crimping investment and economic growth.
For banks in the UK, according to the Bank of England Financial Stability Report, the refinancings amount to about $1.2 trillion by the end of 2012. If banks in Britain raise funds at the same pace they have been this year, they will only collect half of their needs in time. This is even before the fact that the banks need desperately to turn some of their riskier short-term funding into more reliable funding with a longer maturity.
"If funding costs increase dramatically, which is perfectly possible in what could be pretty febrile market conditions, that will hit profitability (and the banks ability to raise capital organically) until they are able to re-price loans and facilities," according to Richard Barwell, an economist at the Royal Bank of Scotland in London. "And to the extent that banks are unwilling or unable to roll over funds that would trigger forced deleveraging. Both outcomes imply a sharp contraction in credit conditions for those within and outside financial markets, putting considerable downward pressure on activity and asset prices."
Banks outside of Britain are perhaps doing marginally better in meeting their needs, but still face an uphill struggle. U.S. banks have issued $230 billion of debts in the first five months of the year, about 60 percent of the rate they need to achieve over the three year period. Euro zone banks have issued $133 billion, or about 70 percent of their needed run rate. One easy to see consequence is that, all things being equal, the cost for banks to issue debt should rise, as should competition among banks for consumer deposits. It is possible that a global desire to save more helps to blunt this effect, but even so the macroeconomic effect and the effect on asset prices will both be strongly downward.
Banks Will Have Their Funds
The track record of the past three years tells us one thing is likely: the banks will get their money, courtesy of government support if needed. Unless there is a profound sovereign debt crisis, we can count on governments taking the needed steps to see that the banking system does not fall over for lack of funding. So, if liquidity or support schemes need to be extended or invented anew, they will be. But a banking system that has not fallen over, while a precondition for strong economic growth, is not in and of it self sufficient to cause strong economic growth. Expensive funding and a rising term premium will stunt growth and they will impose a haircut on risk asset prices.
Viewed another way, however, higher funding costs for banks is really nothing other than the market demanding a different capital structure from banks. It is not simply that a lot of money needs raising all at the same time, but rather that the people who have in the past supplied the money have a new appreciation of the risks in lending to banks, or should that simply be of the risks of lending. The Financial Stability Report also looks at the costs and benefits of higher amounts of capital in banking. The benefits are straightforward: a reduced chance of systemic crises. Costs are thornier, but also quite high.
The BOE used an assumption that for every 7 basis points of additional lending spread charged by banks should create a 0.1 percent permanent reduction of GDP. On their estimates upping capital in banking by one percent then equates to present value cost of about 4.0 percent of UK GDP. This puts into perspective not just how challenging it will be to create growth going forward, but just how artificially growth during the boom was goosed by very loose and easy lending.
For the UK and for Europe, this will be happening at the same time that fiscal austerity programmes will be dampening growth. Something has to give, and it will probably be monetary policy. Look for extraordinarily low rates for a very long time, and for new and bigger quantitative easing programmes.
The risks of forcing banks off welfare
by Robert Peston - BBC
There are always moments of anxiety when benefit claimants are weaned off their welfare support. One such is today, as eurozone banks face up to the refusal of the European Central Bank to roll over €442 billion of exceptional one-year loans provided to them by the central bank.
Eurozone banks are hooked on credit provided by - in effect - the public sector. And are fearful of having to fend for themselves. To be clear, the ECB is not exactly throwing them on to the streets with its decision to demand repayment tomorrow of that €442 billion: it is today offering banks as much three-month money as they want. Which may seem bizarre, in that inevitably the ECB will tomorrow be repaid in part with funds it is providing today.
But central bankers take the view that the rehabilitation of banks requires that they become less dependent on longer term loans provided by the authorities. See it as the equivalent of moving the long-term unemployed off disability payments and on to a jobseeker's allowance: it's a message to the banks that they have to start to prepare for life back in the real world, where all but their short-term unexpected liquidity needs must come from depositors, wholesale creditors and investors.
For Spanish banks - and also for Greek and Portuguese ones - that real world looks scary right now. Spain's banks are finding it tough to tap commercial sources of wholesale finance, because of growing fears about potential losses stemming from the weakness of its property sector. And more-or-less the whole eurozone banking sector - including big German and French banks - is under the dark shadow cast by their huge holdings of eurozone government bonds, because of deep-seated fears that Greece and perhaps other overstretched eurozone states will eventually default on their sizeable debts.
But it would be quite wrong to see the welfare dependency of banks as a purely eurozone phenomenon. You'll recall that at the peak of the financial crisis in late 2008, public-sector support for the worlds' banks - in the form of loans, guarantees, insurance and investment - was equivalent to a quarter of everything the world produces, or more than $12trillion. In the UK, support reached a maximum of around £1.3trillion, almost 100% of GDP. These weren't just a few handouts. This was the biggest co-ordinated financial rescue operation the world had ever seen.
But to avoid a permanent fusing of the balance sheets of banks and the balance sheets of sovereign states, all that emergency financial support has to be unwound. In the UK, for example, UK banks face a deadline of the end of 2012 to repay £165bn of high-quality liquid assets supplied to them by the Bank of England under the Special Liquidity Scheme. And over the same timescale, British banks will have to find £120bn to pay back debt that has been guaranteed by the Treasury under the Credit Guarantee Scheme (there is an option to roll over a third of these government guarantees to 2014).
Now as bad luck would have it, this schedule for repaying the Bank of England and the Treasury coincides with a spike in repayments on other substantial debts of British banks, in the form of bonds and residential mortgage-backed securities. What this means, according to the Bank of England, is that banks need to refinance or replace up to £800bn of term funding and liquid assets over the coming 30 months. The Bank of England estimates that simply to replace this finance, British banks need to sell about £25bn of new bonds and asset-backed securities every month.
Here's the troubling news: what's required is 66% more debt issuance per month on average by banks than actually took place during the boom years of 2001-7. And banks are currently issuing (selling) less than half the debt that's needed. Now if you think there's safety in numbers, you might be reassured that French, German and Italian banks also face substantial increases in debts falling due for repayment.
And wherever you look in the rich West, from the US to the eurozone, banks are currently borrowing substantially less on debt markets than they require simply to replace their maturing debts. It has all the hallmarks of a second credit crunch. Not a short sharp financial crisis in this case (although that can't be ruled out as a possibility), but a squeeze on the funding available to banks that - barring a miracle - will also squeeze the volume of credit they're able to make available to households and businesses, or to all of us. As I said, coming off welfare is always painful. And as and when the banks feel pain, we're going to feel it too.
Update, 12:40: Eurozone banks have borrowed 131.9bn euros of three-month money from the ECB, which is about a third less than analysts were predicting. It certainly implies that strains in the wholesale funding market are less acute than some feared, and that fewer banks than it was thought are being deprived of finance from commercial sources. That said, 131.9bn euros is a non-trivial sum of money.
And with the market rate for bank-to-bank money on average 25 basis points - or 0.25% - cheaper than ECB money, it would be foolish to argue that eurozone banks are in tip-top condition: no bank would choose to borrow from the ECB, given the financial and reputational cost of doing so, unless it had to do so. Eurozone banks are still on welfare support.
Bank fragility means recovery remains precarious
by John Plender - Financial Times
After the Group of 20 meeting in Toronto and the passage of the US Financial Reform Bill, global economic recovery ought by rights to be in the bag. Yet the reality is otherwise. Like the fabled plane in the second world war, the global economy is limping along on a wing and a prayer, not least because the world’s debtor and creditor countries cannot agree on the way out of the present bind. In the meantime the financial system remains perilously fragile.
The onset of the Greek sovereign debt drama and the renewed funding difficulties of European banks has taken the crisis into new and challenging territory where, to change the metaphor, there is precious little left in the policymakers’ locker. As the newly published annual report from the Bank for International Settlements points out, Greece highlights the possibility that heavily indebted governments may not be able to act as buyers of last resort to save banks in a new crisis. If the debt of the government itself becomes unmarketable, the BIS adds, any future bail-out of the banking system would have to rely on external help. Yet where will the help come from?
Surely not from Germany, where taxpayer patience has already been exhausted after the €750bn ($914bn) "shock and awe" package for southern Europe. Whatever becomes of Angela Merkel’s troubled coalition, it is a safe bet that German policymakers will show little appetite for further public sector stimulus. Since those same policymakers seem to think they can export their way out of trouble while simultaneously demanding that their trading partners don a fiscal hair shirt, the prognosis for the eurozone looks dismal. The financial orthodoxy of the 1930s is back with a vengeance. The picture of the banking system painted by the BIS is also disturbing. While banks have returned to profit and strengthened their capital ratios, new capital injected into banks has not quite matched losses revealed during the crisis.
The profits are overly dependent on poor quality revenue from fixed income and currency trading, while in Europe there are doubts whether all crisis-related losses have been recognised. Meanwhile, the default risk on sovereign debt is not confined to Greece. The European banking system would need more capital even if there were no uplift in the regulatory capital requirements in prospect from the impending Basel III regime. Yet too many investors, from sovereign wealth funds to conventional institutions, have burned their fingers advancing fresh capital to banks to be willing to put up more for such shaky prospects. Nor will fiscally stretched governments rush to pump more money into the political equivalent of a leper colony.
It is an unfortunate fact that the global economy remains hostage to the bankers. A variety of worthy reforms are now in place in the US and Europe, not all of them relevant to the causes of the crisis, not all of them tried and tested. And policymakers have conspicuously failed to take the measure of the big issue that matters: banks that are too important to fail, in a market that has become even more concentrated because of shotgun marriages and bail-outs. The new regulatory framework will probably place disproportionate reliance on tougher capital ratios to address this, though there remains a big question mark over how tough and over what period tougher ratios will come in. The lobbying power of the banks will continue to be deployed to dilute the whole re-regulatory agenda.
So where does this leave us? In the middle of an unprecedented and unnerving global experiment is the short answer. The reluctance of the world’s largest current account surplus countries to rebalance their economies towards consumption means that the deficit countries cannot put their balance sheets in order without subtracting from global demand. The split on fiscal management within the G20 between the US and the rest suggests the US may continue to impart some stimulus to the world economy, but at the cost of continuing global imbalance and potential currency turmoil.
The dollar’s role as the pre-eminent reserve currency is not at issue. Yet as Francis Warnock points out in a paper for the Council On Foreign Relations, the US now confronts a dilemma first identified in 1961 by the Belgian economist Robert Triffin.* To supply the world’s risk-free asset, the country at the heart of the international monetary system has to run a current account deficit. In doing so, it becomes more indebted to foreigners until the risk-free asset ceases to be risk-free. The end-game to Triffin’s paradox is a global wholesale dumping of US Treasuries.
The tipping point is inherently impossible to forecast. Given the lack of alternatives to the dollar, as I argued here two weeks ago, it is probably some way off. It is nonetheless surprising, given the high-wire nature of this global experiment, that investors’ risk appetite in general remains relatively robust.
US banks off the hook until 2022
by Andrew Clark - Guardian
It was billed by Barack Obama as the toughest crackdown on Wall Street since the great depression. But top US banks could be given until 2022 to comply with the so-called Volcker rule, which is supposed to restrict financial institutions' risker trading activities. A string of delays and extension periods written into a final version of Congress's financial regulation reform bill means that firms such as Citigroup and Goldman Sachs could exploit loopholes until 2022 before withdrawing from "illiquid" funds such as private equity. The long gestation period is an example of the degree of compromise inserted into the package following months of lobbying on Capitol Hill by powerful banks.
"You can't just say 'stop', you can't just say 'unwind,'" said Lawrence Kaplan, a lawyer at Paul, Hastings, Janofsky & Walker in Washington, who said the delay was a dose of political reality. "These things have contracts and detailed legal frameworks. You can't undo them without doing considerable harm." The Volcker rule, championed by formed Federal Reserve boss Paul Volcker, stops banks from engaging in "proprietary trading" whereby they trade with their own capital, rather than clients' money. It also severely restricts their investments in high-risk hedge funds and private equity ventures.
Language in the act, according to Bloomberg News, allows for a six-month study and a further nine months of rule-making. The measure is supposed to become effective 12 months after the final rule is laid, then banks have two years to conform. But if they need to, they can apply for a three-year extension. On top of that, a five-year moratorium is available for "illiquid" funds that are hard to unwind. Complicated caveats in the bill are subject to interpretation. A spokesman for Jeff Merkley, a Democrat who proposed various changes to the rule, told Bloomberg that the maximum delay was supposed to be nine years.
Other measures in Obama's reforms include the creation of a consumer protection agency, the introduction of a vote by shareholders' on boardroom pay and new powers for authorities to seize troubled financial institutions. For Wall Street, the Volcker rule and curbs on derivatives trading are the most contentious changes. In a research note, analyst Jason Goldberg of Barclays Capital said JP Morgan, Bank of America and Citigroup would be most affected by a ban on proprietary trading. Taken together with the rest of the regulatory reform bill, Goldberg estimated that Obama's crackdown could cut earnings at 26 leading banks by 14% in 2013, eliminating nearly $18bn of profit.
Preparing for Next Big One
by Andrew Ross Sorkin - New York Times
The next Great Crash is coming. Guaranteed. Maybe not today and maybe not tomorrow. But, in all likelihood, sooner than we think. How can I be so sure? Because the history of modern markets is a story of meltdowns. The stock market crashed in 1987, the bond market in 1994. Mexico tanked in 1994, East Asia in 1997. Long-Term Capital Management blew up in 1998, Russia that same year. Dot-coms dot-bombed in 2000. In 2007 — well, you know the rest. And that was just the last 20 years or so. The stagflation of the 1970s, the Depression of the 1930s, the panics in the 1900s ... and back and back and back it goes, all the way to the Dutch and their tulip bulbs.
In those giddy years before the Great Recession, it seemed as if we had grown accustomed to the wild ride. Wall Street certainly had. Jamie Dimon, the chairman and chief executive of JPMorgan Chase and Company, likes to say that when his daughter came home from school one day and asked what a financial crisis was, he told her: ‘It’s the kind of thing that happens every five to seven years.’ " No one should be surprised, Mr. Dimon insists, that booms go bust. That’s the way markets work. Most Americans probably find that answer unsatisfying, to put it politely. After all, millions have lost their homes, their jobs, their savings. But now here comes the Dodd-Frank Act, which is supposed to ensure that we never repeat that 2008 finale of Wall Street Gone Wild.
The bill, if signed into law, might help us avoid another sorry episode like that. But one thing it won’t do is prevent another crisis — if only because the next one probably won’t be like the last one. So amid all the back-and-forth over this bill, keep in mind one of the most important aspects of the act: it would give Washington policy makers a powerful tool to mitigate the next too-big-to-fail blowup, however that blowup manifests itself. For the first time, Washington would have what is known as resolution authority, that is, the power to wind down a giant financial institution that runs into trouble. If policy makers had had that power during the tumultuous autumn of 2008, they might have averted the catastrophic failure of Lehman Brothers.
They might have placed the teetering American International Group into conservatorship. And they might have taken over Bank of America andCitigroup, and possibly even Goldman Sachs and Morgan Stanley. Senior management would have been tossed out. "We will have a financial crisis again — it’s just a question of the frequency," said the economist Kenneth Rogoff, who, with Carmen M. Reinhart, wrote a terrific book titled "This Time Is Different: Eight Centuries of Financial Folly." The title says it all. We’ve been through this before and will go through it again. While Dodd-Frank might avert another crisis in the short term, Mr. Rogoff says the legislation itself is less important than how regulators act on it — and keep acting on it over the years. Before World War II, "banking crises were epidemic," Mr. Rogoff said.
Then things settled down because "regulation had become pretty draconian" and laws were actually enforced. But memories fade. "Having a deep financial crisis is the best vaccination for another right away," Mr. Rogoff said. Down the road, a lot will depend on the regulators. Ten or 15 years after a crisis, and sometimes a lot less, the watchdogs start to doze. Political winds change. Regulators loosen up. Many on Capitol Hill insist Dodd-Frank means the end of the "too big to fail" culture, period. Many on Wall Street insist it means the end of American finance. Bankers and their lobbyists argue that American businesses and consumers will ultimately suffer, since all these rules will end up throttling the vital flow of credit through the economy.
Neither side is entirely correct. Businesses in general, and Wall Street in particular, often overreach in search of profits. And regulators, however stringent the laws, often struggle to keep up. We haven’t found a way to legislate around that sober reality. Consider the 2002 Sarbanes-Oxley law, which sought to reform corporate America after the Enron and WorldCom scandals. The Supreme Court upheld the constitutionality of Sarbanes-Oxley on Monday. It is a strong law that sought to hold executives accountable for accounting shenanigans. Many business people screamed that the law was too strict. Few experts ever argued that the law was too lax. Have companies engaged in financial fraud since? You bet. After the Exxon Valdez oil spill in 1989, the government enacted the Oil Pollution Act. Did that legislate away oil spills? Of course not.
Strong regulation is important. And Dodd-Frank goes a long way toward cracking down on some of the worst practices that led to this financial crisis. But my bet is that next time, the culprit won't be C.D.O.'s or swaps, or shady subprime mortgages. No, the culprit will be some other financial instruments something someone somewhere is probably dreaming up right now.In his memoir,Henry M. Paulson Jr., the former Treasurysecretary, recalled telling President George W. Bush in 2006 that it was impossible to spot a coming financial blowup."We can't predict when the next crisis will come," Mr. Paulson told the president. "But we need to be prepared." Dodd-Frank, whatever its pros and cons, helps prepare us for the next Big One — whatever that might be. But it won’t stop it.
Unemployment Extension Fails: Senate Rejects Jobless Benefits 58-38
by Arthur Delaney - Huffington Post
The Senate rejected Wednesday -- for the fourth time -- a bill that would have reauthorized extended benefits for the long-term unemployed, by a vote of 58 to 38. Democrats will not make another effort to break the Republican filibuster before adjourning for the July 4 recess. By the time lawmakers return to Washington, more than 2 million people who've been out of work for longer than six months will have missed checks they would have received if they'd been laid off closer to the beginning of the recession.
Only two Republicans, Sens. Olympia Snowe and Susan Collins of Maine, crossed the aisle to support the measure. That gave Democrats 59 of the 60 votes they needed to break the GOP filibuster, but without the late Sen. Robert Byrd (D-W.Va.), Nebraska Democrat Ben Nelson's nay vote was enough to kill the bill. (The final tally shows only 58 yea votes due to arcane rules of Senate procedure, which require Senate Majority Leader Harry Reid (D-Nev.) to vote against the bill in order to allow for another vote on it in the future.)
"We will vote on this measure again once there is a replacement named for the late Senator Byrd," Reid said in a statement after the vote. "In the meantime, I sincerely hope that Republicans will finally listen to the millions of unemployed Americans who need this assistance to support their families in these tough times. These Americans and millions more demand that Republicans stop filibustering support for unemployed workers." Already, more than 1.2 million people out of work for longer than six months have missed checks since federally-funded extended benefits lapsed at the beginning of June.
"Senators had a chance to put election year posturing aside and one too few rose to that challenge," said Judy Conti, a lobbyist for the National Employment Law Project. "It's a sad night, especially for the over one million workers and their families who will have little cause to celebrate this holiday weekend. It is a disgrace and an absolute slap in the face to basic human decency." During the past several weeks, in an effort to appease deficit hawks, Reid and Sen. Max Baucus (D-Mont.) trimmed a broader spending bill that included the benefits among a host of other domestic aid programs. They reduced the bill's 10-year deficit impact from $134 billion to $33 billion -- the cost of reauthorizing extended unemployment benefits through November -- but to no avail.
This week, Reid and Baucus pulled out the unemployment benefits as a $33-billion standalone bill, attaching an extension of the homebuyer tax credit, yet it wasn't enough of a sweetener to overcome the deficit demands of most Republicans and Ben Nelson. After the vote, the Senate unanimously consented to the extension of the tax credit, as Reid said would happen if the vote failed. Though there is some talk within their caucus of offsetting the cost of unemployment benefits to keep them from adding to the deficit, Democratic leaders refused to cave; they argued that because the cost of federally-funded extended benefits has never been offset, deficit neutrality shouldn't suddenly become a requirement for emergency aid.
Republicans offered alternative bills that would have paid for extended benefits with unused stimulus funds. "The only reason the unemployment extension hasn't passed is because our friends on the other side have refused to pass a bill that doesn't add to the debt," Senate Minority Leader Mitch McConnell (R-Ky.) said after the vote. Republicans and some Democrats are uneasy about the unprecedented duration of benefits made available to the unemployed by last year's stimulus bill and subsequent acts of Congress, which in some states reaches 99 weeks. Without those provisions, layoff victims are currently eligible for only 26 weeks of benefits in most states, while the average unemployment spell is 34 weeks.
Lurking beneath the deficit concerns for some members is the suspicion that the extended benefits discourage people from looking for work -- even though there are five people vying for every available job and a full third of the 15 million unemployed don't actually receive the benefits. If Congress eventually does reauthorize the aid, people eligible for extended benefits during the lapse will be paid retroactively. Failure to do so would be unprecedented: Since the 1950s extended federal benefits have never been allowed to expire with a national unemployment rate above 7.2 percent. The current rate stands at 9.7 percent. Reid vowed earlier on Wednesday that the Senate would try again. "We're not moving away from this issue," he said. "We'll be back to haunt [Republicans] for what they're doing to people who are in such desperate shape."
Middle class families face a triple whammy
by Edmund Conway - Telegraph
You don't usually expect radical neo-Marxism from the International Monetary Fund – the last great bastion of capitalism, spreading the gospel about the free market to the furthest reaches of the world. And yet, hidden away in an obscure IMF report a few years back is a short sentence that explains precisely the problems that Britain, and the rest of the Western world, have been sleepwalking towards for years.
The claim made by the IMF's Financial Stability Report in 2005, in a seemingly throwaway remark, was that households had become the financial system's "shock absorber of last resort". In other words, whereas in previous eras, much of the pain of recession and financial crisis was borne by businesses or governments, with families afforded some degree of protection by the pensions system or welfare state, it was now households who were far more likely to face the music.
At the time, the idea received little attention. But it has truly radical implications for economics and politics around the world. This is not merely about the financial crisis, but something more deep-seated: the way in which wealth is distributed around society. It is about the middle classes, and why they have become the biggest victims of all. The problem is that families face a threefold threat to their prosperity. The first issue – the one that the IMF was originally focusing on – is pensions. Not so long ago, households were lucky enough to receive gold-plated pensions that would guarantee a certain pay-out upon retirement. Most companies have closed their schemes after realising they are simply unaffordable. The public sector at last looks like following suit, if the BBC's decision this week to reduce the generosity of its pension plan is anything to go by.
This is, in the IMF's words, a "quantum leap". Suddenly households have gone from being able to rely on a constant stream of legally protected income from their employer to having to manage their own investments (as they technically do under the new breed of pensions). This would be fine if one could be assured that most people would have either the time or the inclination to understand these new responsibilities. But every piece of evidence – academic and anecdotal – suggests that they do not. The result is that the majority of households are heading blindly towards a future of relative poverty.
The second issue is that the welfare state has become unaffordable, and yet many of Britain's poorest families have become overly reliant on it. Here, too, there is to be a reckoning. Whereas Gordon Brown used his first Budget to save money by grabbing an annual £6 billion from pension funds (and the middle class), George Osborne used last month's emergency Budget for a similar-sized grab on the welfare class. Re-indexing tax credits against a lower measure of inflation will cost Britain's poorest families billions by the end of this parliament.
And it is not merely that the middle class and the poorest have found themselves squeezed so hard: it is that so much of the extra cash generated during the boom years (and even after them) has been actively funnelled towards the most wealthy. The median wage in the US, adjusted for inflation, has been stagnant for pretty much three decades. But the figures at the high end of the scale have soared; whereas in 1970 the average US chief executive made $25 for every dollar of their typical employee's salary, today the figure is more like $90.
Much of this disparity is down to globalisation. When the world is changing fast, those qualified to deal with the technology du jour (be it the steam engine or the internet) will earn more than their peers. But the fact remains that not only is inequality at the highest level since the Thirties, the pension and welfare systems set up then for the express purpose of levelling this divide are in an exponential decline, threatening to widen the gulf further.
Moreover, there is good reason to suspect, as Raghuram Rajan points out in his new book, Fault Lines, that policy-makers have only been able to persuade people to live with this manifestly unfair situation by pumping up ever bigger booms in the property and stock markets to give them the impression that they are actually making money. Now that the bubble has burst and debt is harder to procure, that illusion has evaporated.
All this before one even takes into account the third problem for households – that they are having to bear the costs of the clean-up for the financial crisis. The austerity budgets being imposed across Europe will mean that families are taxed more and receive less in the way of welfare and public services. Police numbers will be cut; university fees are likely to rise further. In other words, the cost of trying to live a stable, contented middle-class life will balloon.
So I have one simple question: when do the politicians intend to let the public know about the fate that awaits them? The longer they put it off, the nastier the reaction, the bigger the strikes and the greater the chance that governments will fall. Don't say you weren't warned.
Central banks warn of new crisis if exit left too late
by Sven Egenter and Ian Chua - Reuters
Governments must slash budget deficits decisively and central banks should not wait too long to raise borrowing costs as side effects from measures prescribed to tackle the global recession may create the next crisis, the Bank for International Settlements said. The global economy as well as financial markets were on the mend, though the recovery remained fragile in the advanced economies and in the euro zone the debt crisis put the recovery at risk, the BIS said in its annual report, published on Monday. Global leaders meeting in Toronto agreed to take different paths for shrinking budget deficits and making banking systems safer and Washington in particular has warned against cutting too fast.
The head of the BIS said there was no time to waste. "We cannot wait for the resumption of strong growth to begin the process of policy correction," BIS general manager Jaime Caruana told the bank's annual general meeting. "In particular, delaying fiscal policy adjustment would only risk renewed financial volatility, market disruptions and funding stress." Caruana later told a news conference that recently announced fiscal consolidation in some countries together with the publication of bank stress tests in Europe and the support of the G20 for regulatory reforms were important steps forward. The BIS, which acts as a bank to central banks and a discussion platform for policymakers, said reforms of the financial system remained key to prevent further crises.
Caruana said the benefit of making the financial system more resilient through tighter regulation outweighed any short-term growth losses. Top central bankers met at the BIS annual meeting June 26-28 in Basel, following the G20 summit where leaders acknowledged the uneven and fragile economic recovery in many countries. In a reversal from the unity of the past three crisis-era Group of 20 summits, the leaders left room to move at their own pace and adopt "differentiated and tailored" policies. But the BIS warned powerful support measures had strong side effects and said their dangers were starting to emerge. "To put it bluntly, the combination of remaining vulnerabilities in the financial system and the side effects of such a long period of intensive care threaten to send the patient into relapse," the BIS report said.
Fine Line
The BIS said if the extraordinary measures were kept in place for too long, policymakers ran the risk of creating "zombie" banks or companies, dependent on direct support. But it acknowledged the tricky situation for policymakers as the stakes were high and the risks from capping lifelines too early loomed large. Central banks especially were walking a fine line. The banking system was still far from sound, as recent profits from fixed income and currency trading and the low interest rate environment were hard to repeat and not all crisis-related losses may have been booked. "But the longer that policy rates in the major advanced economies remain low, the larger will be the distortions they create, both domestically and internationally," the BIS said.
Extremely low real or inflation-adjusted rates altered investment decisions, postponed the recognition of losses, increased risk-taking in the search for yield and encouraged high levels of borrowing, the BIS said. In addition, central bankers may underestimate inflation risks as the crisis may have lowered potential growth rate. Markets have pushed back expectations for rate increases in the United States and in the euro zone in the wake of the Greek debt crisis, and central bankers urged Europe to solve the crisis so as not to endanger uneven global recovery.
Speaking to Reuters on Monday, Jassim Al-Mannai, director general of the Abu Dhabi-based Arab Monetary Fund, said banks and policymakers had to beware of fuelling bubbles. "We have to avoid, every economic authority, not to see bubbles. Our economic policy needs to be prudent, especially monetary and even fiscal policy," he said. Challenges for emerging economies were different as they were recovering strongly and inflation was picking up, the BIS said. "Some EMEs could rely more on exchange rate flexibility and on monetary policy tightening," the BIS said. The Greek debt crisis had highlighted that many governments had to consolidate their finances immediately as highly indebted countries would not be able to rescue banks as a buyer of last resort in another crisis.
Global markets on 'cliff edge' amid fears over European banks
by Jill Treanor and Nick Fletcher - Guardian
• Value of top 100 UK firms fell by £100bn in six days
• US consumer confidence lowest for seven months
Fears that government austerity packages will hinder global growth have combined with fresh anxiety about the health of European banks to hammer investor confidence. Shares on both sides of the Atlantic dropped heavily amid warnings that markets were on a "cliff edge". In jittery trading ahead of a crucial repayment by Europe's banks of a €442bn (£362bn) European Central Bank loan on Thursday the rates at which banks lend to each other in euros rose to their highest levels in eight months as rumours swirled that some banks were finding it difficult to raise funds in the money markets.
The FTSE 100 has now fallen 14% since its April peak after losing 157.46 points to close at 4914.22, a 3% decline on the day and its lowest level since September last year. French and German markets lost about 3%. Wall Street was down 235 points by the time London closed, about 100 points below the 10,000 level. Analysts will be looking tomorrowfor an indication of whether banks are becoming less reliant on their taxpayer lifeline when the ECB offers a way to refinance the €442bn one-year loan hours before the repayment is due. If banks ask for more than €300bn to repay their existing loans with the more expensive three-month money being provided by the ECB, then concerns about the health of the banking system will escalate, analysts said.
Spanish finance minister Elena Salgado added to anxiety about the loan repayment by urging the central bank to heed the problems facing some Spanish banks. "The ECB says it doesn't like governments to tell it what to do. I simply say I hope that on this occasion, as in others, the ECB will be aware of the needs of the Spanish financial system," she told Spanish radio. The publication of European-wide stress tests on major banks in a fortnight was also adding to the nerves while a bigger than expected fall in consumer confidence in the US prompted a debate about whether economies were heading for a double-dip recession. Oil prices fell 3% and the Baltic dry freight index, which measures demand, fell to its lowest level for nine months.
Robert Talbut, chief investment officer at Royal London Asset Management, said: "The European banks' funding issue is a real issue and it is coming to a head in part because the ECB is trying to withdraw some longer term facilities. A number of European banks, it is rumoured, are struggling to get funding in the wholesale markets and that is evoking memories of the dog days of 2008/9. Simultaneously it's unhelpful that [the economic] data is sending more mixed messages leading to more questions on the durability of the recovery".
Today's fall means that in the past six trading days the FTSE 100 has lost about 380 points, wiping almost £100bn off the value of Britain's top companies. Worries that European austerity measures would hamper recovery were augmented by signs that the Chinese economy – which economists hoped would take up some of the slack – was also cooling off while the fall in the widely followed confidence index in the US, to its worst level for seven months, comes ahead of important non-farm payroll figures on Friday – a gauge of the strength of the US jobs market. Investors were seeking safety as rates fell in the US bond market. The yield on the 10-year note dropped to 2.97%, the first time it has fallen below 3% since April 2009.
Analysts at Royal Bank of Scotland were urging clients to position themselves for a economic downturn. "We strongly believe that a cliff-edge may be around the corner, for the global banking system, particularly in Europe, and for the global economy, particularly in the US and Europe" said Andrew Roberts, head of European rates strategy at RBS. Nick Parsons, head of UK and European research at National Australia Bank, said the scene was being set for a "bout of great nervousness". "It is inconceivable that tests on 100 banks can be published with the conclusion that all one hundred are fundamentally robust unless the assumptions behind the tests are relaxed to the point of nonsensical," Parsons said.
Amid the market anxiety, the UK pulled off its largest ever offering of government debt through a syndicate prompting Robert Stheeman, chief executive of the Debt Management Office, to insist that the market for gilts remained attractive.
Warning signals of a double-dip recession flash brightly across the world
by by Ambrose Evans-Pritchard - Telegraph
Global bond markets are flashing warning signals of a sharp slowdown in growth across the world and a possible slide toward a double-dip recession and outright deflation. The yield on two-year US Treasuries has fallen to a record low of 0.61pc in a flight to safety, a level not seen during the depths of the Great Depression. Ten-year yields dropped below the psychologically sensitive level of 3pc to 2.96pc. Such levels are clearly incompatible with assumptions on Wall Street for 3pc growth in the second half of this year. "If the bond market is correct then this recovery could be dead in the water," said Jim Reid, credit strategist at Deutsche Bank. The credit markets tend to sniff out trouble first and have acted as an early warning alert at every stage of the financial crisis over the past three years.
Mr Reid said deflation has emerged as the dominant risk in the West and will force central banks to renew quantitative easing, the Americans "pre-emptively" and the Europeans "only when their backs are against the world". Triple tremors from the banking crisis in Spain, crumbling confidence in the US, and a setback in China’s leading economic indicator all combined with a vengeance on Tuesday. "The market in risky assets has capitulated ?today amid fears that the global recovery is petering out," said Gavan Nolan, head of credit at Markit.
Rumbling in the background are influential voices warning of a global slide into economic quagmire. Nobel Laureate Paul Krugman said premature tightening in much of the North Atlantic region at the same time would lead to disaster. "We are now, I fear, in the early stages of a third depression, primarily a failure of policy. Both the United States and Europe are well on their way toward Japan-style deflationary traps. The Fed seems aware of these deflationary risks, but what it proposes to do is, well, nothing," he wrote.
China’s Shanghai composite index of equities fell 4pc on Tuesday and is now 55pc below its peak in late 2008. The authorities have been tightening this year to slow inflation and curb property speculation as home prices in Shanghai and Beijing reach 13 times incomes, but it is unclear whether they can engineer a soft-landing in an economy where state-owned banks have built up huge hidden debts. The Baltic Dry Index that measures freight rates for bulk goods – and watched as a proxy for the ups and downs of the Chinese economy – has dropped by 40pc over the past month.
In Europe, investors remain jittery as the European Central Bank prepares to shut its emergency facility of €442bn (£361bn) of one-year loans, the largest sum ever lent by a central bank. A report in the Financial Times that Spanish banks have been begging the ECB to extend the one-year scheme has heightened fears that they are totally shut out of the interbank markets. The shares of BBVA fell 7pc and Santander fell 7pc. The ECB is offering a three-month tender on Wednesday, which will indicate how many banks are under strain. Hans Redeker, curency chief at BNP Paribas, said this facility is unlikely to reassure the markets. "This just builds up a tidal wave of short-term funding needs that all need to be rolled over at the same time," he said.
The Spanish cajas or savings banks are clearly in trouble, relying on the ECB for 21pc of their funding. There were signs of an incipient run on Spanish banks on May 7, an episode described by ECB president Jean-Claude Trichet as perhaps the most serious crisis since the First World War. These pressures linger. The Spanish daily Expansion reports that the Bank of Spain has ordered inspectors to track capital flows abroad after the haemorrhage of €18bn in the first half of the year, mostly to accounts in Switzerland, Luxembourg and Ireland. "Foreign capital flight is under way. This can only make matters worse given the climate of insecurity and the country’s lack of credibility," said Borja Duran from Wealth Solutions in Madrid.
The latest twist is a rise in credit default swaps on Italian debt, which jumped 16 basis points to 203 yesterday. An auction of Italian bonds this week went badly, with low bid-to-cover ratios. The Bank of New York Mellon said its flow data had picked up a relentless flight from both Greek and Italian debt. It is clear evidence that the EU’s €750bn shield with the IMF for eurozone debtors has failed to restore the confidence of global investors, who fear that the EU’s austerity strategy risks setting off a self-defeating downward spiral. Spreads on Greek debt have jumped 350 basis points since the EU announced its plan in early May. Portuguese and Spanish yields have both jumped sharply despite direct action by the European Central Bank to force down yields. Private buyers are clearly dumping their holdings onto the ECB as fast they can.
Mr Redeker said Japanese life insurers and institutional investors are slashing their estimated $700bn holdings of European debt. The funds are being recycled into yen, which reached ¥107 against the euro yesterday, the strongest in nine years. The flight to safety in Tokyo depressed yields on Japanese 10-year bonds to 1.11pc. There are concerns in any case that Japan itself may be sliding back into deflationary deep freeze. Japan’s unemployment rose in May for the third straight month to 5.2pc. Industrial output fell slightly. Production of capital goods – a leading indicator – fell 4.4pc.
Italy has been largely immune to Europe’s bond crisis until now, thanks to high savings. None of its banks have required a rescue. However, fresh threats of secession by the Lega Nord and last week’s general strike over austerity measures have revived fears about the stability of the political system. Italy’s public debt is the third largest in the world after the US and Japan. Everybody knows that if the crisis ever reaches Rome, the game is up for monetary union.
EU agrees tough new bonus guidelines
by Nikki Tait and Brooke Masters
European Union lawmakers and member states backed the toughest restrictions on bankers bonuses seen so far on Wednesday, sowing confusion across an already jittery financial services sector. Under legislation expected to pass the European parliament next week, between 40 and 60 per cent of bonuses would have to be deferred for three to five years and half the upfront bonus would have to be paid in shares or in other securities linked to the bank’s performance.
As a result, the cash portion would be limited to between 20 per cent and 30 per cent, far tighter the limits currently used by most members of the 27-nation bloc. The agreement caught bankers and regulators by surprise and left them scrambling to figure out how the rules would work. The UK Financial Services Authority, which already has a remuneration code in place, said it was studying how the proposed directive would affect its practices.
Treasury officials in the UK said the proposal were in line with last weekend’s G20 communique and Basel agreements but that it was important that they were implemented "in a co-ordinated manner in all major financial centres". "These requirements will be implemented across Europe from next year after further detailed consultation," said one official.
National regulators will have some discretion in applying the rules to their own countries but the overall percentages appear to be fixed. Regulators would be able to impose financial or non-financial penalties on groups with risky remuneration policies. The legislation would also force banks to link bonuses more closely to salaries – with the aim of reducing the importance of such payments in the financial sector. Any banks bailed out by taxpayers must rebuild their capital first and repay those funds before focusing on employee pay.
On Wednesday, lawmakers and EU officials welcomed the agreement and said it should help to reduce the "bonus culture" in the banking sector. "This EU-wide law will... end incentives for excessive risk-taking," said Arlene McCarthy, the MEP steering the legislation through the European parliament. European Union internal market commissioner Michel Barnier described the new rules as "a step in the right direction".
Senior bankers contacted were reluctant to comment but said they believed the instruments would be difficult to design and warned that tough pay rules could drive business to Asia and the US, which have shunned strict limits on bonuses. Angela Knight, of the British Bankers’ Association, said politicians should realise most banks have already changed their pay practices and keep in mind that "this is an international and mobile business",
BIS plays with fire, demands double-barrelled monetary and fiscal tightening
by Ambrose Evans-Pritchard - Telegraph
The Bank for International Settlements has warned authorities across the developed world that they cannot rely on ultra-low interest rates to cushion the blow of austerity measures. Both fiscal and monetary policy may have to be tightened at the same time and before recovery is entrenched, a chilling possibility for asset markets. "Macroeconomic support has its limits," said the bank's annual report.
The Swiss-based "bank for central bankers" said ultra-low rates and massive fiscal stimulus saved the world from an economic meltdown during the credit crisis, but the balance of advantage has since shifted. "Such powerful measures have strong side-effects, and their dangers are becoming apparent. The time has come to ask how they can be phased out," it said. "There are limits to how long monetary policy can remain expansionary. Keeping interest rates near zero for too long, with abundant liquidity, leads to distortions and creates risks for financial stability. We cannot wait for the resumption of strong growth to begin the process of policy correction."
The clarion call for higher rates and an end to quantitative easing is controversial and pits the BIS against the International Monetary Fund in an epochal policy battle. If wrong, the BIS strategy risks pushing the global economy into depression. Dominique Strauss-Kahn, the IMF chief, warned against zealous self-flagellation at the G20 summit. "It could be a catastrophe if all the countries were tightening, it could totally destroy the recovery."
Gabriel Stein, of Lombard Street Research, said the BIS is playing with fire. "Fiscal and monetary tightening were tried in tandem in the early 1930s and it didn't work then. The BIS ought to know better," he said. The bank said the US and Europe made the fatal error of holding rates too low after the dotcom bust, fearing a slide towards deflation. The effect was to fuel asset bubbles and depress credit yields, pressuring lenders to chase risk. "Our recent experience with exactly these consequences a mere five years ago should make us extremely wary this time around," it said.
The BIS warned that central banks are luring banks into a fresh trap by shoring up lenders with cheap access to short-term funding, which is then used to buy long-dated bonds at higher yield – the so-called sovereign "carry trade". Some have already been caught out badly in Greek debt. "Financial institutions may underestimate the risk associated with this maturity exposure. They might face difficulty rolling over their short-term debt. An unexpected tightening of monetary policy might cause serious repercussions," it said.
The parallel with post dotcom errors is likely to rile critics. Housing markets and banks were robust at the time, whereas the damage now is deeply structural in the US, Britain and Europe. Yet the BIS has clearly concluded that it is better for indebted economies to take their punishment early rather than dragging out the ordeal as in Japan. On the spending side, the bank called for "immediate front-loaded fiscal consolidation" in key industrial states. "Public debt-to-GDP ratios are on unsustainable trajectories," rising from 76pc of GDP in 2007 to 100pc in 2011. The picture is worse than it looks since the crisis has "permanently" reduced output, and aging costs are soaring.
Yet fiscal austerity may be less of a drag on recovery than presumed. Denmark slashed its primary deficit by 13.4pc of GDP from 1983-1986, yet eked out growth of 3.9pc a year. Sweden grew by 3.7pc during its hair-shirt episode in the 1990s, Canada by 2.8pc, and Belgium by 2.3pc. These cases do not tell us what would happen if half the world tightens at the same time, feeding on each other. Even so, the BIS data challenges Keynesian claims about fiscal stimulus. State spending merely "crowds out" private activity. Besides, governments have no choice. They must retrench to appease the bond vigilantes in the new era of sovereign frailty. "A sudden loss in market confidence would be far worse," said the BIS.
Goldman admits it had bigger role in AIG deals
by Greg Gordon - McClatchy Newspapers
Reversing its oft-repeated position that it was acting only on behalf of its clients in its exotic dealings with the American International Group, Goldman Sachs now says that it also used its own money to make secret wagers against the U.S. housing market. A senior Goldman executive disclosed the "bilateral" wagers on subprime mortgages in an interview with McClatchy, marking the first time that the Wall Street titan has conceded that its dealings with troubled insurer AIG went far beyond acting as an "intermediary" responding to its clients' demands.
The official, who Goldman made available to McClatchy on the condition he remain anonymous, declined to reveal how much money Goldman reaped from its trades with AIG. However, the wagers were part of a package of deals that had a face value of $3 billion, and in a recent settlement, AIG agreed to pay Goldman between $1.5 billion and $2 billion. AIG's losses on those deals, for which Goldman is thought to have paid less than $10 million, were ultimately borne by taxpayers as part of the government's bailout of the insurer.
Goldman's proprietary trades with AIG in 2005 and 2006 are among those that many members of Congress sought unsuccessfully to ban during recent negotiations for tougher federal regulation of the financial industry. A McClatchy examination, including a review of public records and interviews with present and former Wall Street executives, casts doubt on several of Goldman's claims about its dealings with AIG, which at the time was the world's largest insurer.
For example:
- The latest disclosure undercuts Goldman's repeated insistence during the past year that it acted merely on behalf of clients when it bought $20 billion in exotic insurance from AIG.
- Although Goldman has steadfastly maintained that it had "no material exposure" to AIG if the insurer had gone bankrupt, in fact the firm could have lost money if the government hadn't allowed the insurer to pay $92 billion of American taxpayers' money to U.S. and European financial institutions whose risky business practices helped cause the global financial collapse.
- Goldman took several aggressive steps — including demanding billions in cash collateral — against AIG that suggest to some experts that it had inside information about AIG's shaky financial condition and therefore an edge over its competitors. While former Bush administration officials said AIG was financially sound and merely faced a cash squeeze at the time of the bailout, McClatchy has reported that the insurer was swamped with massive liabilities and was a candidate for bankruptcy.
A spokesman for Goldman, Michael DuVally, said that the firm followed its "standard approach to risk management" in its dealings with AIG. "We had no special insight into AIG's financial condition but, as we do with all exposure, we acted prudently to protect our firm and its shareholders from the risk of a loss. Most right-thinking people would surely believe that this was an appropriate way for a bank to manage its affairs." He said that Goldman didn't have "direct economic exposure to AIG."
The relationship between Goldman and AIG has drawn intense scrutiny over the past year because several Goldman alumni held senior Treasury Department jobs when the Bush administration guaranteed as much as $182 billion to bail out AIG, $12.9 billion of which AIG paid to Goldman, the most money it paid any U.S. bank.
On Wednesday and Thursday, a congressional panel investigating the causes of the financial crisis plans to question current and former senior Goldman and AIG officials, including Joseph Cassano, the former head of the London-based AIG unit that covered $72 billion in bets against risky home mortgages — wagers that cost U.S. taxpayers tens of billions of dollars when the housing bubble burst. The proprietary trades at issue were carried out using private contracts known as credit-default swaps, essentially bets on the performance of designated securities and traded in murky, loosely regulated markets with little disclosure about who placed wagers, who won and who lost.
Documents emerging from the AIG bailout and a Senate investigation of Goldman's secret bets against the housing market while it sold off tens of billions of dollars in mortgage-backed securities — first reported by McClatchy in November — have provided a window into some of these dealings. Until now, however, Goldman has said that the insurance-like contracts it bought from AIG from 2004 to 2006 — deals that have cost the insurer some $15 billion — were made to offset similar swaps the investment bank had written for clients who wanted to bet on a housing downturn.
The companies have revealed few details of some $6 billion in so-called synthetic deals, in which the parties bet on the performance of designated securities that neither side purchased. A person familiar with the matter, who declined to be identified because of its sensitivity, said that additional synthetic swap contracts between AIG and Goldman with a face value of $3 billion have yet to be unwound by the teams of specialists tasked with scaling down AIG's more than $2 trillion in exotic risks.
The proprietary trades occurred in the same Abacus series of synthetic securities that Goldman bundled offshore, according to the senior Goldman official. Another one of those 16 deals prompted the government to sue Goldman on civil fraud charges in April. Goldman also has long asserted that it was holding $10 billion in collateral and "hedges" and thus had "no material exposure" in the event that the government had allowed AIG's parent to go bankrupt in the fall of 2008, rather rescuing it. The emerging details of Goldman's offshore dealings, however, also call that into question.
AIG doled out tens of billions of dollars of the bailout money to pay off mortgage-related swaps with U.S. and European financial institutions at their full face value, a decision made by the Federal Reserve Bank of New York that triggered a public furor. The bailout enabled major financial institutions to honor billions of dollars in swap bets that they'd made with each other, especially in offshore deals that were pegged to the performance of loans to homebuyers with shaky credit. DuVally declined to say how much money Goldman had at stake if the value of these securities sank further and the big banks couldn't make good on their bets amid frozen credit markets.
According to court documents and a person who's seen records of some of the offshore deals, investment banks Morgan Stanley and Merrill Lynch, as well as large European banks, wrote protection for Goldman on these deals totaling hundreds of millions of dollars. In addition, The New York Times reported earlier this year that Goldman cut a deal with the Societe Generale in which the French bank paid Goldman a portion of the $11 billion it collected from the AIG bailout.
DuVally denied that Societe Generale and Goldman had a deal regarding the French bank's payout from AIG, but he declined to say whether Goldman collected a large sum from the French bank. Because Goldman was holding $7.5 billion in collateral from AIG and had placed $2.5 billion in other hedges, DuVally said, it "did not have direct economic exposure to AIG" in the event that the insurer's parent had been left to bankruptcy. "That said, we have always acknowledged that if a failure of AIG had resulted in the collapse of the financial system, we would have suffered just like every other financial institution," he said. DuVally declined to say who selected the securities for Goldman's Abacus deals with AIG.
AIG's chief executive, Robert Benmosche, was asked at the company's recent annual meeting whether it would seek to sue any banks for loading swap deals with securities on junk mortgages likely to default. Benmosche said that the firm is reviewing "all activities from that period" and, "to the extent we find something wrong that harmed AIG inappropriately, our legal staff will take appropriate action."
It's unclear when Goldman first suspected that AIG was at risk of a colossal meltdown, but the storied investment bank moved more nimbly than any other financial institution to shield itself. As the home mortgage securities lost value over a 14-month period beginning in the summer of 2007, Goldman's huge swap portfolio gained value. Under the terms of the contracts, Goldman began in July 2007 to demand that AIG post billions of dollars in cash as collateral.
DuVally said that Goldman had no inside information about AIG's finances, and merely protected itself by enforcing contract language that required the insurer to post cash whenever the mortgage securities underlying the bets lost value. "Our direct knowledge of AIG's financial condition was limited to the company's public disclosures," DuVally said. However, some experts are skeptical of that, especially because Goldman responded to AIG's refusal to meet all its demands for $10 billion in collateral by placing $2.5 billion in hedges — most of them bets on an AIG bankruptcy.
Sylvain Raynes, an expert on structured securities of the types that AIG insured, said it's "implausible that Goldman can say 'I had no idea that AIG was in dire straits or in weak financial condition.'" Raynes, a co-author of the newly published book "Elements of Structured Finance" and a former Goldman employee, said that a standard clause in the swaps contracts left open to discussion whether the company writing protection must post collateral. The buyer of coverage typically could demand to see financial information, including the number of similar positions held, he said.
"If you see the (company) has entered into 150 credit-default swaps totaling $65 billion, and that all of them are the same type as your credit-default swaps, you know that they have taken huge amounts of risk and have very little capital to back that up," Raynes said. "Unless you really want to close your eyes, you have to know what their condition is. If you don't know, then you're not doing your job, and I have too much respect for Goldman to say they are not doing their job."
DuVally said, however, that Goldman wasn't told about other swaps that AIG had written and didn't have access to AIG's internal financial information. Goldman had served as an investment adviser for the insurer since as far back as 1987 and as recently as 2006, setting up offshore companies affiliated with AIG that served as loosely regulated reinsurers. AIG's insurance subsidiaries shined up their balance sheets by shifting hundreds of millions of dollars in liabilities to reinsurers, including some of those formed with Goldman's assistance.
Federal prosecutors and state regulators eventually nailed AIG for falsifying its financial statements and for using so-called "sidecar" companies to help Pittsburgh-based PNC Financial Corp. and an Indiana firm, Brightpoint Inc., hide liabilities. AIG paid more than $1.7 billion on to settle those and other charges in 2004 and 2006. Goldman wasn't implicated. For years, Goldman and AIG have shared the same auditor, PricewaterhouseCoopers, a firm that AIG retained even after the SEC in 2006 directed it to find "an independent auditor."
They're also represented by the same New York law firm, Sullivan & Cromwell, which boasted on its website of its "significant experience in offshore reinsurance matters." The firm's senior chairman, Rodgin Cohen, is known as one of Wall Street's most formidable attorneys.
In August 2008, weeks before the rescue, AIG's newly installed chief executive, Robert Willumstad, invited senior officials of several major banks, including Goldman, Deutsche Bank, Lehman Brothers and Credit Suisse, to a meeting to see whether there was any way to reduce the insurer's huge portfolio of mortgage-related swaps. Documents from Blackrock, a financial services firm that was assisting the Federal Reserve Bank of New York with the bailout, show that Goldman offered to negotiate a settlement on some of the swaps, but the two sides were too far apart on valuation of the securities to cut a deal.
DuVally said that Goldman offered only to settle for payment of its estimate of the market value of the swaps, which had appreciated sharply due to the securities' decline in value. To do so would have required AIG to book a massive loss. On Aug. 18, 2008, Goldman's equity research department delivered another blow to AIG, issuing a sharply negative report on the insurer and lowering its target price for AIG shares to $23 from $30. The Goldman report heightened concerns among credit ratings agencies about AIG's condition, Willumstad said in an interview.
By September 2008, AIG was besieged with a chorus of collateral demands from other banks and a threat from credit ratings agencies to downgrade the insurer, an action that triggered more collateral calls and prompted Treasury Secretary Henry Paulson, a former Goldman chief executive, and Federal Reserve Chairman Ben Bernanke to initiate a bailout to prevent a meltdown of the global financial markets.
Goldman can't say how much it made from housing crash
by Greg Gordon - McClatchy Newspapers
A congressional commission pressed Goldman Sachs executives Wednesday to spell out how much their company has earned from its exotic bets against the housing market, including $20 billion in wagers that helped force a $162 billion taxpayer bailout of the American International Group. However, Goldman's president and chief risk officer told members of the Financial Crisis Inquiry Commission that their company never breaks out its figures that way. "We can dig and dig and dig," Goldman President Gary Cohn said in sworn testimony. "We won't find that report."
Many of Goldman's trades with AIG offset protection it wrote for clients on mortgage securities, but McClatchy reported Tuesday that Goldman wagered its own money on some swaps purchased from AIG. A special Senate investigations panel disclosed in April that Goldman bet billions of dollars of its own money on a housing downturn. The panel, which opened two days of hearings into Goldman's dealings with AIG, has been seeking information since February on how much the Wall Street giant reaped from bets against the housing market. Overall, Goldman posted profits of $2.32 billion in 2008, despite the meltdown, and $13.4 billion in 2009. Earlier in June, commission leaders subpoenaed Goldman, accusing the Wall Street giant of deluging them with 2.5 billion documents.
The commission also heard Wednesday from the man who oversaw AIG's disastrous decision to insure nearly $80 billion in subprime mortgage securities. Joseph Cassano, who recently was cleared of criminal wrongdoing after lengthy FBI and Securities and Exchange Commission inquiries, emerged publicly for the first time since the economic meltdown and said that his ouster might have cost taxpayers tens of billions of dollars. Cassano contended that his departure as the head of London-based AIG Financial Products in March 2008 apparently left no one with the expertise to fend off Goldman's demands for billions of dollars in collateral — demands that helped put AIG into a cash squeeze.
"The taxpayers would have been served better," Cassano said, if the company's chief executive hadn't requested his resignation. Cassano said that he'd succeeded for months in paring Goldman's demands for cash and would have continued to assert the insurer's "rights and remedies" in private contracts, known as credit-default swaps, that effectively insured Goldman against losses on risky home mortgages. The commission, which faces a December deadline to deliver a comprehensive report to Congress on the causes of the nation's financial crisis, has intensified its focus on Goldman and AIG while examining the role of swaps in mushrooming the dimensions of the economic collapse.
The panel released internal AIG e-mails and other documents tracing Goldman's demands for collateral, which ballooned from $1.8 billion in July 2007 to $10 billion, which stunned AIG executives. The two firms haggled for more than a year over the value of underlying mortgage securities as credit markets froze and the market for the securities shrank and all but disappeared. Cohn said, however, that the parties' trading agreements stated "very specifically" that if there were declines in "fair value" on the insured securities, AIG would have to post cash collateral to make up for the loss. As the securities lost value, he said, eventually trades occurred and "we used those actual real-live trades as reference points."
Commission members, however, questioned Goldman's motives in pushing AIG. When then-Treasury Secretary Henry Paulson, a former Goldman chief executive, and other Bush administration officials committed as much as $182 billion for a taxpayer bailout, Goldman collected $12.9 billion, the most of any U.S. bank. In an e-mail on Sept. 11, 2007, an AIG official reported after speaking with a representative of the French bank Societe Generale that Goldman had shared its "marks," or estimated values of offshore mortgage securities, with SocGen.
At first, SocGen disputed Goldman's estimates, which were lower than those of most banks, but by November, it, too, was demanding collateral from AIG. Goldman's value estimates ultimately proved accurate as the housing market continued to slide. In pressing for more information from Goldman, Commission Chairman Phil Angelides told Cohn and Craig Broderick, the firm's chief risk officer: "It's pretty clear that you (Goldman) helped build the bomb. It's pretty clear that you built a bomb shelter. Now the question I want to get to is, did you light the fuse?"
The panel detailed one Goldman bet with AIG, dating to 2004, in which Goldman paid the insurer $2.1 million annually for $1.7 billion in insurance coverage on a so-called synthetic deal in which neither party actually bought any mortgage securities. In the deal, one of the first in a series known as Abacus, Goldman wound up collecting $806 million in a negotiated settlement with AIG, the commission said. Cohn likened Goldman's bet to buying a fire insurance policy on a home. Such deals, he said, are "leveraged on the probability your house is going to burn down."
Cassano defended AIG's swap-writing on mortgage securities, saying that none of the securities acquired on behalf of taxpayers by the Federal Reserve Bank of New York has yet soured. "I still think that the underwriting standards we had set will support those transactions," he said. Cassano, who was flanked by former AIG President and Chief Executive Martin Sullivan and current chief risk officer Robert Lewis, noted that AIG stopped writing swaps on securities backed by subprime mortgages to marginally qualified borrowers. The commission noted that AIG's swap exposure tripled that year from $17 billion to $54 billion and reached $78 billion by 2007.
The federal inquiries into the behavior of Cassano and two other AIG executives related to whether the company illegally failed to disclose the declining value of the insured securities to shareholders.
Commissioner Byron Georgiou traced the events surrounding a Dec. 5, 2007, investor conference in which Sullivan played down AIG's housing-related risks, despite a $1.5 billion adjustment due to collateral calls. Georgiou said commission investigators were told that Sullivan, Cassano and other executives had discussed risks reaching $5 billion days earlier, prompting Sullivan to remark at the time that he was "going to have a heart attack." Sullivan testified that he didn't recall making such a comment.
After a review by AIG's auditor, PricewaterhouseCoopers, the insurer restated earnings two months later, making an $11.1 billion adjustment for mortgage risks. AIG's stock fell from $50 a share to $44. Angelides told Sullivan that he found his "lack of knowledge, lack of recognition disturbing" and reflective of the "failure of leadership and management" at AIG.
Europe's banks are still on 'life support', BIS warns
by Ambrose Evans-Pritchard - Telegraph
Europe's banks have yet to come clean over bad loans and may struggle to refinance short-term debt unless the region's bond crisis subsides soon, the Bank for International Settlements (BIS) has warned. The BIS said in its annual report that banks on both sides of the Atlantic remain "highly leveraged and still appear to be on life support. The essential task of reducing leverage and repairing balance sheets is simply not finished. The Greek sovereign debt crisis shows just how fragile the financial system still is. "Losses on European bank balance sheets are expected to mount over the next few years. Some banks are rolling over existing loans rather than inducing foreclosures, thus delaying loss recognition."
The BIS said ultra-low rates and fiscal stimulus by governments is exacerbating matters, causing moral hazard and leading to the sort of "zombie banks" seen Japan during its so-called "Lost Decade". "Such powerful measures have strong side-effects, and their dangers are becoming apparent. The time has come to ask how they can be phased out," it said. The bank called for both monetary and fiscal tightening to restore discipline, brushing aside concerns that recovery is still fragile. "Keeping interest rates near zero for too long, with abundant liquidity, leads to distortions and creates risks for financial stability. There are limits to how long monetary policy can remain expansionary," it said.
The BIS said lenders had become reliant on an unstable sources of funding, taking on short-term debt to buy longer-dated bonds for higher yield. Some already face big losses on Greek, Portuguese and Spanish debt. "Financial institutions may underestimate the risk associated with this maturity exposure," it said. "An unexpected tightening of monetary policy might cause serious repercussions." The BIS said low rates were playing havoc with the money markets, a crucial credit tool. They have encouraged "evergreening", or rolling over, loans that are not fundamentally viable.
The warnings come as the Bundesbank and Germany's BaFin regulator call banks to discuss the results of stress tests. Some German public banks may be forced to accept state aid on harsh terms to beef up asset ratios. BaFin said last year that German banks may face write-downs of €800bn (£653bn). The EU is conducting tests on up to 100 European banks to help restore confidence in frozen inter-bank markets. The results will be released in late July.
With federal stimulus funds running out, economic worries grow
by Alana Semuels - Los Angeles Times
Much of the $787-billion stimulus has been spent, creating jobs and extending jobless benefits. But with lawmakers reluctant to approve more funding, concerns are rising about staving off another recession. With home sales sliding, employers reluctant to hire and world stock markets gyrating wildly, the U.S. economy is in danger of stalling. Now one of its only reliable sources of fuel is running out: federal stimulus spending.
Funds flowing from the $787-billion legislation passed last year have helped create hundreds of thousands of jobs and propped up social programs such as unemployment benefits. But with much of that money spent and lawmakers reluctant to approve another big round of spending, concerns are rising about what will replace it in the short term to keep the economy moving. Jitters about a global slowdown pounded world markets Tuesday after an index forecasting Chinese economic activity was revised downward and Greek workers walked off the job to protest government budget cuts. In the U.S., the Dow Jones industrial average plunged 268 points on news from the Conference Board that consumer confidence fell in June after three straight months of gains.
Economists worry that the weak labor market will spook U.S. consumers, whose spending fuels the economy. Dwindling federal stimulus funds are only heightening those fears. California's $85-billion share of stimulus funding has repaired bridges and highways, built new barracks on military bases and renovated crumbling infrastructure. Disabled veteran Bill Vaughn says his biggest job this year was a stimulus project repairing a pipe at the VA Greater Los Angeles Healthcare System. Since that job ended in January, he hasn't found additional work for his firm, BCV Construction. "My company's on the verge of closing," said Vaughn, who lives with his in-laws in Northridge.
In addition to infrastructure improvement, about $18 billion of California's share of stimulus funds has been spent on social programs such as Medicaid, unemployment insurance and food stamps. Billions more flowed to schools and job centers. But with those funds now gone, officials are preparing for another round of belt-tightening. "It was unbelievable feast one year and famine the very next," said Blake Konczal, director of the Fresno Regional Workforce Investment Board, which used stimulus funds to help more than 2,000 unemployed people attend job retraining. The office's budget doubled thanks to $16.4 million in stimulus funds but will contract again in the new fiscal year, which begins July 1.
The American Recovery and Reinvestment Act has been contentious since Congress approved it in February 2009 to aid an economy mired in a deep recession. Republicans have been particularly critical of the program and its price tag, and the final bill was billions of dollars smaller than the one President Obama had originally proposed. But seventeen months later, those stimulus jobs, along with temporary government positions created for the 2010 census, are among the few bright spots in a dismal employment market. The nation's unemployment rate is 9.7% and companies have shown little willingness to hire. Private-sector employers added just 41,000 jobs in May, out of a total of 431,000 jobs created.
The government has few levers left to pull to produce quick growth. Interest rates are already at rock-bottom levels. Concerns about swelling U.S. deficits have many on Capitol Hill opposed to the idea of another stimulus. That has some economists worried. "There's an uncomfortably high probability that we slip back into recession," said Mark Zandi, chief economist of Moody's Analytics. "If we slip back, there's no policy response. We won't have the resources to respond."
To be sure, there are still thousands of ongoing stimulus projects and billions of dollars to be spent. The Obama administration is calling this "Recovery Summer" and will spotlight dozens of stimulus projects in the coming weeks. But many important programs are losing funding. Among the most crucial is unemployment insurance. Benefits vary from state to state, but the federal government has helped pay for five extensions that have boosted the duration of payments in states including California to as much as 99 weeks from the standard 26 weeks. Stimulus funds have also helped subsidize health benefits through the Consolidated Omnibus Budget Reconciliation Act, or COBRA, which gives jobless workers an opportunity to continue their coverage at group rates for a limited time.
Efforts to extend those provisions are stalled in Congress. The National Employment Law Project estimates that 1.63 million workers will exhaust their benefits by the end of this week, and at least 140,000 workers will lose COBRA coverage. In California, which has the nation's third-highest unemployment rate at 12.4%, the Employment Development Department estimates that 205,000 unemployed workers will not receive further benefits without congressional action. About 2 million Californians are unemployed; nearly half of them have been out of work for 27 weeks or more.
"There's nothing out there," said Jennifer Tilt, a 52-year-old resident of Bloomington, a town in San Bernardino County, whose unemployment benefits will expire soon. Tilt, who has a bachelor's degree, said she's applied for jobs at fast-food restaurants to no avail. She's dependent on her two grown children and her mother's Social Security check to pay the bills. Other programs are in jeopardy as well. The federal government temporarily increased the amount it contributed to state Medi-Cal payments by 11.6%. Without further congressional action, those contributions will end Jan. 1, halfway through the state's fiscal year. The state will have to find the money for Medi-Cal elsewhere, probably through $1.8 billion in further cuts, according to the governor's office.
"The human impact of requiring us to find another $1.8 billion in spending cuts to replace federal funding that was designed to help states avoid deep cuts … is both cruel and counterproductive," Gov. Arnold Schwarzenegger wrote to the state congressional delegation earlier this month. Republicans say extending benefits and other provisions of the stimulus bill will add to the country's trillion-dollar deficit. "Here's another idea Democrats should consider, one that Americans have been proposing loudly and clearly: Stop spending money you don't have," Republican leader Mitch McConnell of Kentucky said last week on the Senate floor.
But Democrats — and some economists — say that spending money now to create jobs and fund unemployment benefits is the only way to stave off another recession. "What worries me the most is this idea that austerity is going to be helpful," said Michael Reich, a professor of economics at UC Berkeley, who said that ending unemployment benefits could drive more people to file for disability and hamper long-term growth. "When you make an economy shrink, it makes it harder to pay back debt in the future."
The nation's construction industry provides a window into the tough choices facing lawmakers. Federal tax credits have helped drive home sales while stimulus spending on infrastructure has put laborers back to work. Such subsidies are unsustainable in the long run. But when to pull the plug? New-home sales dropped 33% in May as home-buyer tax credits ended. Construction employment declined in 25 states that same month, according to the Associated General Contractors of America.
"In the next few months, unless some other kind of work comes along, we're not feeling very optimistic," said Ken Simonson, chief economist for the contractors trade group. That's not what unemployed construction worker Hector Cardozo, 38, wants to hear. His hair has grayed from the stress of looking for work, and he's thinking of going on disability. "I can't find work, and the government doesn't have work for me," said the Corona resident. "What more can I do, put a gun to my head?"
Munis Underperform Treasuries as Default Speculation Mounts
by Darrell Preston - Bloomberg
Municipal bonds underperformed U.S. Treasuries in the first half as default speculation drove state and local government yields to the highest level relative to government bonds in 13 months. Ten-year municipal bond yields rose to 100 percent of Treasuries for the first time since May 2009, from 80 percent six months ago, according to Municipal Market Advisors data. Investors bought Treasuries, pushing two-year yields to a record low this week, on signs of slowing global economic growth and amid protests in Europe over austerity measures. The cost of contracts insuring against losses in municipal bonds almost doubled in the past two months, led by Illinois.
Greece and Spain led a surge in the cost of protecting sovereign debt. "The Treasury market rallied its brains out," said Brian Battle, vice president of trading for Performance Trust Capital, a Chicago-based institutional portfolio adviser. "Munis haven’t followed as much." Financial pressure on states and municipalities has built as revenue fell in the wake of the recession. More than two- thirds of states had a drop in revenue last quarter over the same period in 2009, the Nelson A. Rockefeller Institute of Government said this month. States will have confronted $296.6 billion of budget deficits from 2009 to 2012, the National Governors Association and National Association of State Budget Officers said.
Pennsylvania Capital
Harrisburg, Pennsylvania, capital of the sixth most- populous U.S. state, has considered filing for bankruptcy protection in the face of $68 million in debt payments tied to an incinerator project. Illinois, whose $13 billion deficit is about half its budget, had the cost of insuring its debt against default more than double since early April, to a record of 370 basis points, or $370,000 to protect $10 million of debt, according to CMA DataVision. A basis point is 0.01 percentage point.
"You’ve gotten a lot of negative press about municipal bonds," said J.R. Rieger, vice president of fixed-income indexes at S&P in New York. "Yields have been driven down on U.S. Treasury bonds due to a flight to quality." Investors in the $2.8 trillion municipal-bond market on average earned 3.13 percent this year through June 28, compared with about 7.3 percent in the same period of 2009, according to S&P’s Investortools Municipal Bond Main Index. Treasuries brought in about 5 percent, according to S&P. Corporate bonds returned 5.8 percent, Credit Suisse’s Liquid U.S. Corporate Bond Indexshows.
Municipal investors may be worrying unduly given the debt’s low default ratio relative to other asset classes, said Battle at Performance Trust and Jim Colby, a senior municipal strategist for New York-based Van Eck Associates, which has about $515 million of municipal bonds. Companies are 98 times more likely to default than muni issuers over a 10-year period, data from Moody’s Investors Service show. The volume of municipal defaults has also declined. Nineteen issuers have defaulted on about $1 billion of municipal debt this year, the Distressed Debt Securities Newsletter reported in its June issue.
In the two previous years a combined $14.5 billion defaulted, a rate of $3.6 billion every six months. There is a limit to how much municipal yields will fall as Treasury yields decline, said Matt Fabian, a managing director at Concord, Massachusetts-based MMA. Ten-year top-rated municipal bonds yield 3.08 percent, or about 60 basis points below their five-year average, according to MMA data. "Must municipal buyers are income buyers, and if there is no income, there are no buyers," said Fabian. "Yields can’t go much lower." Following are descriptions of pending sales of municipal debt in the U.S.:
DELAWARE RIVER PORT AUTHORITY, the regional transportation agency that owns and operates four toll bridges linking Pennsylvania and New Jersey, plans to offer $320 million in Build America Bonds tomorrow to finance capital improvements. The bonds, rated fourth-lowest at A3 and A- by Moody’s and S&P, respectively, will be used for capital-improvement projects and to refinance debt. Citigroup Inc. will lead a group of underwriters in marketing the securities. (Updated June 30)
LOS ANGELES COMMUNITY COLLEGE DISTRICT, the nation’s largest two-year system, with about 141,000 students, is scheduled to offer $125 million in taxable bonds today. The district is rated second highest at Aa1 by Moody’s and one step lower, at AA, by S&P. Citigroup will lead marketing of the securities, which will be used for improvements on the district’s nine campuses, including a green-technology student union at Los Angeles City College and a performing-arts center at Los Angeles Valley College. (Updated June 30)
NEW YORK LIBERTY DEVELOPMENT CORP., a state arm created to finance loans for lower Manhattan construction, will sell $650 million in tax-exempt municipal bonds today to refinance debt from the Bank of America Tower project at One Bryant Park. Bank of America Merrill Lynch and JPMorgan Chase & Co. will underwrite the securities, which are top-rated by Fitch and Moody’s. (Updated June 30)
U.S. VIRGIN ISLANDS, whose rum shipments to the mainland in 2009 reached 8 million "proof gallons," a measure for calculating federal excise tax, plans to offer about $396 million of tax-exempt debt through its public finance authority as soon as next week. About $308 million of the issue is senior obligations rated BBB+ by Fitch, third-lowest. The remaining subordinate bonds are rated BBB, second-lowest. Underwriters led by Jefferies & Co. will market the securities to investors.
New proposal would push US retirement age to 70 for Social Security benefits
by KMov
You could be forced to work until you're 70 just to cash in your Social Security retirement benefits. It's an attempt to make up for the Social Security budget crisis. The current age to retire and receive Social Security benefits is 65, but House Republican Leader John Boehner proposed pushing the retirement age back to 70. If approved, the new age would only affect those not set to retire for another 20 years. The proposal is being made to make up for the Social Security Administration's budget crisis.
Time to shut down the US Federal Reserve?
by Ambrose Evans-Pritchard
Like a mad aunt, the Fed is slowly losing its marbles. Kartik Athreya, senior economist for the Richmond Fed, has written a paper condemning economic bloggers as chronically stupid and a threat to public order. Matters of economic policy should be reserved to a priesthood with the correct post-doctoral credentials, which would of course have excluded David Hume, Adam Smith, and arguably John Maynard Keynes (a mathematics graduate, with a tripos foray in moral sciences).
"Writers who have not taken a year of PhD coursework in a decent economics department (and passed their PhD qualifying exams), cannot meaningfully advance the discussion on economic policy." Don’t you just love that throw-away line "decent"? Dr Athreya hails from the University of Iowa. "The response of the untrained to the crisis has been startling. The real issue is that there is an extremely low likelihood that the speculations of the untrained, on a topic almost pathologically riddled by dynamic considerations and feedback effects, will offer anything new. Moreover, there is a substantial likelihood that it will instead offer something incoherent or misleading."
You couldn’t make it up, could you? "Economics is hard. Really hard. You just won’t believe how vastly hugely mind-boggingly hard it is. I mean you may think doing the Sunday Times crossword is difficult, but that’s just peanuts compared to economics. And because it is so hard, people shouldn’t blithely go shooting their mouths off about it, and pretending like it’s so easy. In fact, we would all be better off if we just ignored these clowns." I hold my hand up Dr Athreya and plead guilty. I am grateful to Bruce Krasting’s blog for bringing this stinging rebuke to my attention. However, Dr Athreya’s assertions cannot be allowed to pass. The current generation of economists have led the world into a catastrophic cul de sac.
And if they think we are safely on the road to recovery, they still fail to understand what they did. Central banks were the ultimate authors of the credit crisis since it is they who set the price of credit too low, throwing the whole incentive structure of the capitalist system out of kilter, and more or less forcing banks to chase yield and engage in destructive behaviour. They ran ever-lower real interests with each cycle, allowed asset bubbles to run unchecked (Ben Bernanke was the cheerleader of that particular folly), blamed Anglo-Saxon over-consumption on excess Asian savings (half true, but still the silliest cop-out of all time), and believed in the neanderthal doctrine of "inflation targeting". Have they all forgotten Keynes’s cautionary words on the "tyranny of the general price level" in the early 1930s? Yes they have.
They allowed the M3 money supply to surge at double-digit rates (16pc in the US and 11pc in euroland), and are now allowing it to collapse (minus 5.5pc in the US over the last year). Have they all forgotten the Friedman-Schwartz lessons on the quantity theory of money? Yes, they have. Have they forgotten Irving Fisher’s "Debt Deflation causes of Great Depressions"? Yes, most of them have. And of course, they completely failed to see the 2007-2009 crisis coming, or to respond to it fast enough when it occurred.
The Fed has since made a hash of quantitative easing, largely due to Bernanke’s ideological infatuation with "creditism". QE has been large enough to horrify everybody (especially the Chinese) by its sheer size – lifting the balance sheet to $2.4 trillion – but it has been carried out in such a way that it does not gain full traction. This is the worst of both worlds. So much geo-political capital wasted to such modest and distorting effect. The error was for the Fed to buy the bonds from the banking system (and we all hate the banks, don’t we) rather than going straight to the non-bank private sector. How about purchasing a herd of Texas Longhorn cattle? That would do it. The inevitable result of this is a collapse of money velocity as banks allow their useless reserves to swell. And now the Fed tells us all to shut up. Fie to you sir.
The 20th Century was a horrible litany of absurd experiments and atrocities committed by intellectuals, or by elite groupings that claimed a higher knowledge. Simple folk usually have enough common sense to avoid the worst errors. Sometimes they need to take very stern action to stop intellectuals leading us to ruin. The root error of the modern academy is to pretend (and perhaps believe, which is even less forgiveable), that economics is a science and answers to Newtonian laws.
In any case, Newton was wrong. He neglected the fourth dimension of time, as Einstein called it, and that is exactly what the new classical school of economics has done by failing to take into account the intertemporal effects of debt – now 360pc of GDP across the OECD bloc, if properly counted. There has been a cosy self-delusion that rising debt is largely benign because it is merely money that society owes to itself. This is a bad error of judgement, one that the intuitive man in the street can see through immediately. Debt draws forward prosperity, which leads to powerful overhang effects that are not properly incorporated into Fed models. That is the key reason why Ben Bernanke’s Fed was caught flat-footed when the crisis hit, and kept misjudging it until the events started to spin out of control.
Economics should never be treated as a science. Its claims are not falsifiable, which is why economists can disagree so violently among themselves: a rarer spectacle in science, where disputes are usually resolved one way or another by hard data. It is a branch of anthropology and psychology, a moral discipline if you like. Anybody who loses sight of this is a public nuisance, starting with Dr Athreya. As for the Fed, I venture to say that a common jury of 12 American men and women placed on the Federal Open Market Committee would have done a better job of setting monetary policy over the last 20 years than Doctors Bernanke and Greenspan.
Actually, Greenspan never got a Phd. His honourary doctorate was awarded later for political reasons. (He had been a Nixon speech-writer). But never mind.
New York Governor David Paterson Vetoes Spending
by Jacob Gershman - Wall Street Journal
Seeking to regain the upper hand in the latest round of budget brinkmanship, Gov. David Paterson on Monday vetoed hundreds of millions of dollars of spending on education that had been approved hours earlier by Democratic lawmakers. The governor threatened to reject as much as $1 billion of spending, including politically valuable earmarks for nonprofits, unless lawmakers yielded on several key areas. Topping the list is the governor's demand that lawmakers account for the likelihood that Washington won't bail out the state with extra Medicaid money that had been counted on by Albany.
"It breaks my heart to do it. The only reason why I'm doing this is, otherwise, we're proverbially kicking the can down the road," Mr. Paterson told reporters in Albany, after signing a veto. "But the reality is the day of reckoning for this state has come." While lawmakers have technically passed a budget, approving the last remaining spending bills for a fiscal year that started three months ago, negotiations haven't drawn to a close. Since Senate Republicans are signaling they won't supply votes needed for an override, which requires a two-thirds majority in both houses, it appears Democrats will have to bargain with the governor to secure the education money.
Lawmakers voted to restore 40% of Mr. Paterson's proposed cut to public-school aid, adding about $600 million on a school-year basis to the governor's original plan. New York City's share of that increase is about $177 million. The vote was a close call in the Senate, where conservative-leaning Democrats uneasy with the Senate's alliance with the Assembly threatened to block the bill unless it steered more property-tax relief to suburban and upstate homeowners. To appease them, the two houses changed the bill so that it forces hundreds of school districts outside of New York City to use the extra dollars to lower property tax bills.
Lawmakers are wrapping up a revenue bill, which is expected to pass later this week. The governor has already accepted most of it, including a reduction in tax benefits for wealthy donors to charities, higher sales taxes on clothing under $110, and a provision that allows the state to borrow billions of dollars from its pension fund. Lawmakers also want to defer dozens of tax credits for three years, including ones benefiting developers of subsidized housing. All told, spending by the state will probably top off at around $136 billion this year, 1% to 2% more than last year.
For weeks, lawmakers settled into a defensive crouch, as the governor pressed ahead with a series of emergency spending bills that presented the Legislature with a Hobson's choice: Either they accepted the appropriations in their entirety or state government would grind to a halt. The tactic had never been attempted by past governors. But when the governor tried to push ahead with a property tax cap and an overhaul of public university tuition policy, Assembly Speaker Sheldon Silver struck back, boxing out the governor by brokering a deal with Senate Democrats.
Fiscal 2011 could be hardest yet for states
by Lisa Lambert - Reuters
U.S. states in fiscal 2011 could be facing the worst budget situation since the recession began in 2007, according to a think-tank report released on Tuesday. States' cumulative budget shortfall "will likely reach $140 billion in the coming year, the largest shortfall yet in a string of huge annual gaps that date back to the beginning of the recession," said the Center on Budget and Policy Priorities. Fiscal 2011 begins on Thursday for most states, which have turned to another round of cuts and tax increases to try to wipe out the gap. All states with the exception of Vermont must balance their budgets.
An estimated 10,000 families in Arizona will lose eligibility for temporary cash assistance and 284 workers who help low-income families enroll in assistance programs such as food stamps will be let go in Georgia, according to the report. The report also found many states are cutting public school funding and money for higher education. Meanwhile, Kansas, New Mexico, Arizona, and Colorado are raising their sales taxes.
State and local government spending cuts have been so severe that they reduced the country's Gross Domestic Product by half of a percentage point in the first quarter, CBPP said, citing the U.S. Bureau of Economic Analysis. The U.S. Congress has considered measures to ameliorate the effects of the deep recession on the states, but fiscal conservatives have raised concerns over adding to the deficit to help states maintain employees and assistance programs.
Last week, a measure that would send states additional money for Medicaid, the healthcare program for the poor administered by the states with federal reimbursements, stalled in the Senate. On Tuesday, members of the House of Representatives said they would soon introduce legislation that would send $10 billion to states for schools.
LA braces for pink slips
by Rick Orlov and C.J. Lin - LA Daily News
Thousands of government workers throughout Los Angeles could begin losing their jobs this week with the start of the new fiscal year, even as officials make last-minute bids to save positions through further service cuts, tax hikes and union concessions. Up to 4,300 jobs could be cut next fiscal year from local government agencies, including the city, county and schools, if officials and unions fail to reach deals to slash spending. Los Angeles Unified School District alone could shed up to 2,500 jobs this year, although that number is expected to fluctuate through the fall as officials negotiate with unions and monitor the state revenue picture. Among those who have already fallen victim to the district's budget woes is Steve Nairin, who was a fifth-grade teacher at San Jose Elementary School in Mission Hills last year.
Nairin received a pink slip in March, but has been offered a long-term substitute position at another local school. The father of three boys, each younger than 5 years old, said having a temporary job is better than nothing, but his pay will be less than half of what he made as a full-time teacher. "There are big-time concerns," Nairin said. "My wife is not working and I have three young boys at home. My concern is being able to make ends meet for them." Workers throughout the region are facing similar anxieties. At the Los Angeles city level, officials and union leaders were engaged in last-minute negotiations Tuesday to try to avoid the immediate layoff of 372 city workers starting Thursday.
A hard line
Several City Council members – led by Richard Alarcón and Paul Koretz – were fighting to delay the layoffs until October, hoping enough revenue will come in later to city coffers to save their jobs. But Mayor Antonio Villaraigosa and several other council members drew a hard line to go ahead with the layoffs to show the unions how serious the issue is and extract concessions in the current contract. In adopting its $6.07 billion budget for 2010-11, the Los Angeles City Council said the city will need to lay off at least 761 workers – and possibly 1,000 more, depending on revenue from the lease of city-owned garages.
The city has said it needs to get $51 million in concessions to avert immediate layoffs and another $57 million by the end of the year to keep the additional 1,000 workers. Councilman Dennis Zine, one of the members of the Executive Employee Relations Committee that is involved with the negotiations, said the issue is complicated because unions last year agreed to forego raises to prevent layoffs. "There is a cost to the city if we lay off workers," Zine said. "Last year, they agreed to pass on raises if there were no layoffs. If we lay off these workers we have to pay those raises." More than 300 workers at the city's public libraries have already been laid off even as the City Council on Tuesday ordered a ballot measure drafted for a $39 parcel tax to fund libraries.
The budget cuts are also forcing libraries to close a second day each week - Mondays - beginning July 18. Opening hours have been shortened on remaining days. Some librarians across the city have been wearing pink slips with the names of coworkers who had been laid off until the union could send them black armbands. "It's just very sad," said West Hills resident Doris Lichter, whose children go to the Woodland Hills branch several times a week. "The educational portion of everything is being cut." A total of 828 workers are left to staff the city's libraries after 328 were laid off this month based on seniority.
Carmen Nigro, who curated the science and technology section at Central Library, was one of them. "I hate to see it just gutted and desecrated," Nigro said. "There's a lot of harm being done in terms of service to the community." Although Nigro had worked as a part-time messenger clerk at the Sherman Oaks branch since 2005, she didn't become a full-time employee until September 2008. She was one of the hundreds whose last day on the job was June 17 although she had worked in the system for five years.
'Too early to predict'
Los Angeles County, which employs more than 100,000 people, is not planning any layoffs at this time, as officials look at savings through other methods, including a target of saving $115 million through a joint labor-management effort. But officials are still concerned about the possibility that the state could withhold even more money from the county as lawmakers look to close a $19 billion budget shortfall. The county estimates it could lose up to an additional $1.25 billion once the state budget is approved. "We are still very concerned about the budgetary actions the state might take," said county Deputy Chief Executive Officer Brence Culp.
"And whenever we know what those are we'll have to respond accordingly, but it's too early to predict the outcome of those actions yet." The Los Angeles County Office of Education, a state-funded public agency that is associated with but not part of the county government system, will see some reductions. On Thursday, LACOE is expected to eliminate about 70 of 397 positions, including teaching posts, in its Division of Alternative Education. The division runs community day schools and other alternative schools throughout the county.
LAUSD, facing a deficit of about $640 million for the 2010-11 school year, is looking at laying off 682 teachers, counselors, nurses and librarians and about 1,800 nonteaching employees such as janitors and office workers. But that is an improvement from the 6,300 jobs that the district was considering cutting earlier this year, and officials say the current figure could continue to change before the start of the school year. To save jobs, the district struck a deal with local unions that called for 12 furlough days – and a shorter school calendar – over the next two years, restoring about 2,000 positions. The district saved additional jobs and programs through increases in attendance, spending cuts and some additional state funding.
For example, originally district officials expected to cut elementary arts and music programs in half but scaled back the cut to only a third. Also, the number of schools that will be closed dropped from 11 to 3. Anne Young-Havens, LAUSD's interim deputy personnel director, said exactly which workers will lose their jobs is still unclear. Part of the problem is that while some jobs have been eliminated, some have been bought back by local schools during their local budgeting process. Young-Havens also said that the district is still negotiating with employee unions, and those negotiations could also result in additional jobs being saved or spared.
House Extends Deadline to Sept. for Homebuyer Tax Credit
by Lorraine Woellert - Bloomberg
The U.S. House of Representatives voted to give homebuyers who qualified for a federal tax credit more time to settle on their pending purchases. The House voted 409-5 to extend the deadline for closing home purchases to Sept. 30. The program initially required borrowers who signed contracts before April 30 to complete paperwork by July 1 to get a tax credit of as much as $8,000. The House measure accommodates borrowers at risk of being disqualified for the tax credit because lenders and loan servicers aren’t processing mortgages quickly enough. The Senate is considering similar legislation. "We owe this to the people who have essentially followed the rule who are caught by a closing date," House Ways and Means Committee Chairman Sander Levin, a Michigan Democrat, said before the vote.
As many as 180,000 homebuyers would lose their tax credit if Congress fails to push back the date, according to the National Association of Realtors, which sought the extension. Transactions at risk include as many as 75,000 short sales, or homes being purchased for less than the existing debt on them. The tax credit may have fueled a temporary increase in home sales, which fell after the April deadline passed. New-home sales dropped 33 percent to a record low of 300,000 in May, the Commerce Department reported. Applications for loans to purchase properties fell at the end of May to the lowest level since 1997, according to the Mortgage Bankers Association.
Homeowners 'living on rice' to pay mortgage
by George Roberts - ABC News
There are claims that Australians suffering mortgage stress are living on rice so they can avoid the shame of losing the family home. In a study partly supported by the Reserve Bank, University of Western Sydney researchers interviewed people suffering mortgage distress. University spokesman Professor Phillip O'Neill says shame prevented many people taking part in the study. But he says of those who did participate, some had resorted to eating less so they could keep up with mortgage repayments.
"This is not in the past tense; people are literally eating the bare minimum - just rice - obviously looking after their children, but putting the repayment of the mortgage above every other thing that they could possibly devote an expenditure to," he said. He says the Federal Government should be careful about overstating how easily Australia got through the crisis when so many people are still struggling. But he says the drastic moves my some homeowners has helped prevent the kind of mass mortgage defaults seen in the United States, during the global financial crisis. "If we did have large-scale defaulting in a neighbourhood in Australia, we would have a toxic affect spreading of negative equity and that would be alarming," he said.
Unemployed dumping car leases
by Mary Ann Milbourn - OC Register
The unemployed are walking away from their car leases in droves as more laid-off workers see their jobless benefits cut off, reports LeaseTrader.com. The company, which helps match up people who want out of their car leases with those looking for a shorter-term lease, said it expects to process 7.3% more listings in June from people whose unemployment benefits have ended or are about to end.
"Unemployment benefits have been keeping millions of Americans afloat since the recession began," said Sergio Stiberman, chief executive of LeaseTrader.com. "When the clock runs out on benefits, people still jobless look to find ways of further cutting their bills. The ability to transfer a car lease contract can save a person more than $500 each month while keeping their credit intact." The company said the majority of its lease listings are in California and other high-unemployment states including Florida, Arizona, Nevada and Michigan. California's unemployment was 12.4% in May, third highest in the nation.
LeaseTrader.com noted the surge in listings coincides with the failure by Congress to approve HB 4213, a bill that would allow extended unemployment benefits through November. One version of the bill was approved by the House just before Memorial Day, but it has gotten bogged down in the Senate in a disagreement over how to pay for the $100 billion cost. Unemployment aid is just one of a host of issues included in the bill that have delayed its passage. The California Employment Development Department estimates more than 234,000 laid-off workers in this state alone have had their benefits cut off since the last unemployment extension bill expired in early June.
Japan's economic recovery falters in May
by Tomoko A. Hosaka - AP
Japan's economic recovery faltered in May as moderating export demand dented factory output, household spending fell and the jobless rate unexpectedly rose for a third straight month. Industrial production dropped 0.1% from the previous month — the first decline in three months, the government said Tuesday. Shipments overseas fell 1.7%. Lower output from automakers such as Toyota and Honda dragged the index south, reflecting softening overseas demand. Factories also made less machinery used for semiconductors and flat-panel displays, according to the Ministry of Economy, Trade and Industry.
"Production momentum is slowing, and with the index coming in below expectation for a fourth month in a row, it seems to be doing so sooner than expected," said Goldman Sachseconomist Chiwoong Lee in a note to clients. The government predicts output to rebound 0.4% in June and 1% in July — notably smaller gains than in March and April. The results point toward weaker growth in the world's second biggest economy, which has relied on a rebound in exports to underpin recovery. Brisk overseas demand, particularly from Asia, drove annualized economic growth of 5% in the January-March quarter.
But that momentum is starting to cool as governments roll back stimulus measures and focus instead on controlling spending and debt. Data last week showed that while export growth is still robust, it has slowed every month since February. World leaders who gathered for the Group of 20 meeting in Toronto pledged Sunday to slash government deficits in most industrialized nations in half by 2013, despite warnings from U.S. President Barack Obama and others that overly aggressive austerity measures could derail the global recovery.
Japan's new Prime Minister Naoto Kan, who has made debt reduction a priority, has a more immediate concern. With upper house elections looming on July 11, he must convince voters that his party can also figure out a way to fuel growth and fight deflation. Separate data Tuesday showed that the country's seasonally adjusted jobless rate climbed to 5.2%, up from 5.1% in April and the highest level since December. The number of jobless stood at 3.47 million, which is unchanged from the previous year, according to the Ministry of Internal Affairs and Communications. Those with jobs fell 0.7% to 62.95 million. The export boom has been slow to translate into sustained improvements for workers and families, which has persistently dampened domestic demand and pushed prices down.
Government incentives for cars and energy-efficient household appliance gave consumption a much-needed boost earlier, but the effects now appear to be fading. Household spending in May fell a 0.7% from a year earlier as incomes retreated, the government said in another report. Average monthly household income fell a 2.4% from a year earlier to $4,714. A picture of the mood in corporate Japan will emerge Thursday when the central bank releases its closely watched "tankan" survey of business sentiment.
1.3 million Brits to lose jobs in 'Austerity Budget'
by Andy Bloxham and James Kirkup - Telegraph
Over a million people will lose their jobs due to the Government’s spending cuts over the next five years, a leaked document projects. George Osborne’s Budget last week said that there would be a net increase of 1.3m jobs by 2015 but the Chancellor did not mention the figures used to arrive at that conclusion. Last night, unpublished Treasury documents disclosed that officials had estimated 2.5m jobs would be created but that a total of 1.2m would be lost in the same period, the Guardian reported. Both the public and private sector are expected to be hit, the analysis concluded, with the losses narrowly greater in the private sector.
The Treasury said it stood by the prediction that the overall number of people in jobs would rise over the next five years. However, experts cast doubt on the private sector’s ability to be able to generate so many jobs in such difficult economic circumstances, meaning that the true gain in employment could be yet more modest. John Philpott, the chief economist at the Chartered Institute for Personnel and Development, said: "There is not a hope in hell’s chance of this [increase] happening: there would have to be extraordinarily strong private sector employment growth in a much less conducive economic environment than it was during the boom."
Brendan Barber, the TUC’s general secretary, said: "It is absurd to think that the private sector will create 2.5m new jobs over the next five years." An extract from a Treasury presentation for Mr Osborne’s budget – seen by the Guardian – said: "100-120,000 public sector jobs and 120-140,000 private sector jobs assumed to be lost per annum for five years through cuts." Alistair Darling, the shadow chancellor, said: "George Osborne failed to tell the country there would be very substantial job losses as a result of his budget.
"Hundreds of thousands of people will pay the price for the poor judgement of the Conservatives, fully supported by the Liberal Democrats." A spokesman for the Treasury said: "The OBR forecast unemployment to fall in every year and employment to rise in every year."
China Leading Index Gain Cut to Smallest in Five Months, Hammering Stocks
by Sophie Leung and Li Yanping - Bloomberg
The Conference Board revised its leading economic index for China to show the smallest gain in five months in April, in a release that contributed to the biggest sell-off in Chinese stocks in more than a month. The gauge of the economy’s outlook compiled by the New York-based research group rose 0.3 percent, less than the 1.7 percent gain it reported June 15. The Conference Board said in an e-mailed statement that the previous reading contained a calculation error for floor space on which construction began. Equities slumped in Asia and Europe as the prospect of a slowdown in the fastest-growing major economy fanned concern that the global recovery may weaken. With American consumers boosting their savings rates and European governments moving to cut spending and restrain fiscal deficits, emerging markets in Asia have led the rebound in the past year.
"We do see some moderation in growth in China, and in many ways that’s a welcome development" because the 11.9 percent annual gain in gross domestic product in the first quarter threatened overheating, said Brian Jackson, an emerging-markets strategist in Hong Kong at Royal Bank of Canada. At the same time, investors are concerned at the implications of slowing Chinese growth for the global economy, he said. Jackson, who previously worked at the U.S. Federal Reserve and U.K. Treasury, predicts Chinese economic growth will slow to an 8 percent pace by year-end. He added that while the Conference Board’s index is dated, as other data have already been released for May, it provides a "useful" composite of indicators for the nation’s economy.
Stocks Drop
The Shanghai Composite Index lost 4.3 percent to 2,427.05 as of 4:25 p.m. local time. The MSCI Asia Pacific index dropped 1.4 percent and the Stoxx Europe 600 Index retreated 1.7 percent. China’s shares were also down as an impending sale of as much as $20.1 billion of Agricultural Bank of China Ltd.stock hurt investor sentiment, said Lu Zhengwei, a Shanghai-based economist at Industrial Bank Co. The Conference Board’s index, published for the first time in May after four years of development, is designed to capture the outlook over the coming six months.
It would have signaled China’s growth slowdown in 2008 and the recession of the late 1980s, according to William Adams, resident economist for the Conference Board in Beijing. "This correction doesn’t affect our outlook for the Chinese economy," Adams said in a telephone interview. "Growth was not likely to accelerate in China, and in fact, a moderation is possible. This correction also supports the same view." Adams said at the time of the original release that new construction work, the key factor pushing up the indicator in April, may not continue to grow so quickly.
In the U.S., the Conference Board releases a benchmark gauge of consumer confidence. The reading for June is scheduled for later today, and is projected to fall for the first time since February, according to the median estimate in a Bloomberg News survey of economists. American households boosted their savings rate to 4 percent last month, the highest level since September, underscoring a preference to rebuild wealth after home values tumbled the most since the 1930s during the recession. The Commerce Department last week revised its first-quarter U.S. GDP growth estimate to 2.7 percent, from 3 percent previously, reflecting a smaller gain in consumer spending and a bigger trade gap.
Japan Weakens
Government figures today in Japan showed that the world’s second-largest economy is also slowing. Industrial production fell in May for the first time since February, the unemployment rate increased for a third month and household spending declined. Today’s Conference Board revision for China showed that total floor space started in April dropped 0.1 percent, instead of the 1.3 percent gain originally reported. China’s regulators have tightened rules for the property market in an effort to stem speculation and avert an asset bubble in the aftermath of a record credit expansion last year.
Premier Wen Jiabao’s government has also set a target to shrink new loans to 7.5 trillion yuan ($1.1 trillion) from 9.59 trillion last year. Officials have boosted requirements for the amount of money banks must hold as reserves, and used bill sales to withdraw cash from the financial system. China this month committed to ending its fixed exchange rate peg to the dollar, another step that may cause the expansion to ease. The yuan had been held at 6.83 per dollar since July 2008 after a 21 percent gain the three prior years, in an effort to shield exporters from the global crisis. The shift to a more flexible yuan will slow Chinese exports this year, adding to difficulties that include the European debt crisis and rising costs, Yu Jianhua, a Ministry of Commerce director general, told reporters in Toronto three days ago.
"The revision may have echoed existing market concern that China’s growth may slow later this year, though economic fundamentals are so far little affected by the European debt crisis," said Lu at Industrial Bank. China remains the world’s fastest growing major economy, and the yuan decision was taken after the government concluded the rebound had "become more solidly based," according to a June 20 People’s Bank of China statement. Indicators for May showed that exports climbed 48.5 percent from a year before, helping yield a $19.5 billion trade surplus for the month. Inflation accelerated to an annual 3.1 percent pace in May, surpassing officials’ target for the full year, retail sales gains quickened to 18.7 percent and industrial production jumped 16.5 percent, government reports showed three weeks ago.
Lending Growth
Lending growth also exceeded economists’ estimates for last month. Banks extended 639.4 billion yuan ($94 billion) of new loans in May, compared with the median forecast of 600 billion in a Bloomberg News survey of economists. The Conference Board’s coincident index for April, which is a measure of current economic activity, was unchanged from the release earlier this month. The coincident gauge increased 1.2 percent following a 0.4 percent increase in March. The error for the leading index was "unfortunate where the group has tried to be as transparent as possible," Adams said. The measure is based on data and surveys from the People’s Bank of China and the statistics bureau.
Europe's poorest send less money home
by Corneliu Rusnac and Alison Mutler - AP
Many of Europe's poorest migrant workers are sending less money home — another blow delivered to the continent's east by global economic and financial turmoil. Probably worst off is Moldova, Europe's poorest country according to the World Bank. There, money sent by people who left to find work made up an astonishing 30 percent of the economy of $6.6 billion (euro5.41 billion) just two years ago but fell last year to 22 percent. The Chicus are a case in point. Like many Moldovans, they realized that they could hardly afford to raise a family from local salaries.
Mihai Chicu, an engineer in a shoe factory that went bust after Moldova declared independence from the Soviet Union in 1991, left his wife Nina and sons Alexandru and Adrian in 1995. He ended up in Greece, where until recently he earned euro1,300 (US$1,600) a month as a laborer until this spring. Each month he sent home about euro800 (US$975). Nina, who made just $175 (euro145) as a nurse, also left in 2006 as the sons were finishing high school. Despite the economic meltdown in Greece, her host country, she still earns about euro1,000 ($1,220) picking lemons, sending home half of that, or euro500 ($610).
"Now that my father is out of work, we can barely cover utilities, food and basic costs with my mother's income," said Alexandru Chicu, 23, in an interview at three-room family apartment. "The money our parents send us is our only income." The sons live in the family's apartment in downtown Chisinau, purchased in 2007 for euro62,000 (US$75,650) — a feat enabled by the remittances from Greece. The elder son, Alexandru, is studying engineering and mechanics management at the Chisinau polytechnic while younger brother Adrian is studying telecommuncations there. Neither of them work.
Comfortable by Moldovan standards, the apartment sports a washing machine, computer and refrigerator — luxury items for anyone on the average Moldovan salary of $250 (euro202). It's a story that is playing out all over the region. For decades, workers in Eastern and Southeastern Europe have been a source of cheap labor for Spain, Portugal, Greece and Italy. They picked fruit, washed dishes and got their hands generally dirty in jobs the locals shunned. Now, as the EU's southern members tighten their belt to avoid bankruptcy, the foreign worker is often the first to be let go — and the flow of cash, or remittances as economists call the practice, are dwindling in regions that badly need it.
Migrants' troubles worsened starting with the financial and housing market plunges of 2007-9, followed by this year's debt crisis and resulting cutbacks in government spending. World Bank figures show Moldovan remittances dropped from $1.66 billion in 2008 to $1.18 billion in
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