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Rear of Republican Street, Providence, Rhode Island
Ilargi: I will be gone for a while after today, more looking from the outside in than doing day-to-day work. I hope the team I have assembled in the interim will please you. My friend OC will be the editor, Stoneleigh will keep a close eye on what goes on, 5-6 people will contribute, and I will not be entirely absent either.
You might want to think about participating in and donating to our upcoming Automatic Earth Christmas fundraiser. This site costs a lot of money to make, and it doesn't come back (though I am very gratefull for all donations received so far, don't get me wrong). I don't want to make it a pay-site, but at the same time something's got to give. We have saved a lot of people a lot of money and trouble, but have no way to get any -what i would consider- fair payment for it. And that is fine, as I've said before, it's my free choice, but it can't last.
So allow me to suggest something, and please think it over. There are a lot of regular, returning, daily, readers here. Most of them, if you'd suggest it to them, would agree that what The Automatic Earth provides is worth $1 per day, or even $0.50.
Why not, since 'tis the season to be jolly, add up what you feel that daily value is to you, and donate it once per month or per week, or in a lump sum for the next few months, or even add it up retroactively? It would make my work, and, believe me, that is a lot, much easier. I now often have to be a contortionist just to keep the wagons on the track.
It would make this site, and all the labor that goes into it, a lot more pleasurable, while the cost to you would be more or less negligible. 50 cents a day should be reasonable for most.
Here's Stranded Wind with his first guest comment:
Stranded Wind: Somewhere along this path we switched over from having a financial crisis with political overtones to having a political crisis with financial overtones. It's most apparent in the United States with the impending inauguration of Barack Obama and the long overdue exit of the Bush administration. We have a need for immediate, forceful action and the current administration's best thought is to beggar our offspring, having already done a capital job of that on the current generation.
The good ship S.S. America has been holed in many compartments and we're settling level; bailing any one compartment into another does nothing to raise the ship's prospects. This isn't stopping first class from pouring their mess into steerage and congratulating themselves on having saved the day. There are only two outcomes for this – a swift capsize taking all aboard down at once, or sinking by the stern, with those in the first class cabins forward learning too late of the powerful suction associated with a large vessel slipping beneath the waves. The option of our luxury cruise ship making for shore was a choice for the early fall of 2007 when the first two Bear Stearns funds collapsed, but it was one we lacked the wisdom to make at the time.
Either failure scenario gets people scrambling to lay hands on anything that will float as they try to make their way clear of the sinking hulk. The question now is the nature of the scrambling; women and children first while the band plays on, or every man for himself and the Cheney take the hindmost? The financial world has already made its choice but as is so often noted this crisis is "getting into the real economy".
The Great Depression holds many lessons, but that agricultural, still developing nation with the rule of the law and vast oil reserves is long ago and far away. The disintegrating Soviet Union, due to their oil supply peaking coupled with an expensive, unsuccessful adventure in Afghanistan, seems more promising, but perhaps we should look at two of the current foundering wrecks for a more contemporary model.
Iceland, tiny, ethnically homogenous, and geographically isolated, has become the first western nation to experience complete economic collapse. Their oligarchs (both of them!) have boarded their private jets and decamped after being booed in public. A third of the population wishes to emigrate and the old ones are digging out the instructions for how to prepare Hakarl, or fermented shark; their grocery store shelves are stripped due to the lack of currency for foreign trade.
Pakistan is at the opposite end of the spectrum. The second largest Muslim nation at a hundred and sixty five million, ethnically diverse, facing the failed state of Afghanistan and an ongoing war to the west which spills into their outlying provinces and on the other side fellow nuclear armed rival India and a long simmering water dispute over the source of the Indus in Kashmir's glaciers, this populous, developing, dry nation couldn't be any more different than Iceland. The common thread is financial distress; they've resorted to an IMF loan and their steel and textile industries are periodically shut down due to load shedding by their power industry.
The United States shares characteristics of both Iceland and Pakistan, but I would contend we're closer to Pakistan than Iceland in our pending reaction and prospects.
The United States is really eight or nine separate nations with a shared currency and language. New England and the Pacific Northwest share much with Iceland in temperament, while it is sadly all too easy to envision our southern border behaving like Pakistan's west once the economic collapse here gets the eleven million Mexican guest workers rounded up and deported to a country with revenues crashing due to the impending failure of the Cantarell oil field.
A study of U.S. voting from 2008 shows a clear rump Republican minority centered in the southeast and water stress there has nearly caused the evacuation of Atlanta, a city of four and a half million. Eight years of dualism, demonization of the loyal opposition from the other side of the aisle, and curve fitting of current economic, energy, and environmental issues to an apocalyptic worldview leave this region a fertile field for the seeds of domestic terror that are Joel's Army. And this region has a proud but dubious history of trying to shy away from the rest of the nation …
Our union was tested a century and a half ago in a curious interlude – civil war between uniformed armies backed by contiguous regions with fully functional governments. This is absolutely not the norm in civil conflict and we fail to notice and appreciate the seeds of a more traditional civil war that have been planted here. We have an ideologically cohesive, ethnically similar, religiously fanatic subset of the population who are primed to view the Obama administration as illegitimate based on both race and ideology. Sprinkle this dish with the spice of half a million troops who've been drug through years of urban combat, only to return home to a ruined economy with neither work nor promised benefits for them, and you've got an experience far different than the United States has ever seen.
The endless, flawed attempts to bailout Wall Street have potential consequences that run far deeper than a simple epic, crushing depression. We can begin looking for hints of how this will play out in the reaction of the workers of Detroit once they realize the game is up and they have a chance to assess how and when the new administration will bring relief. Ilargi and I are of one mind on this; if Obama brings the usual suspects to this party he'll get the same sort of results, and I shudder to think at how that plays out.
Citigroup Gets U.S. Rescue From Toxic Losses, Capital Infusion
Citigroup Inc. received a U.S. government rescue package that shields the bank from losses on toxic assets and injects $20 billion of capital, bolstering the stock after its 60 percent plunge last week. The second-biggest U.S. bank by assets surged as much as 64 percent in New York trading after the Treasury, Federal Reserve and Federal Deposit Insurance Corp. announced the aid plan in a joint statement. In return for the cash and guarantees, the government will get $27 billion of preferred shares paying an 8 percent dividend.
The regulators stepped in to protect Citigroup from losses on a $306 billion pile of troubled U.S. home loans, commercial mortgages, subprime bonds and corporate loans when the firm's tumbling share price sparked concern that depositors might pull their money and destabilize the company, which has $2 trillion of assets and operations in more than 100 countries. The $20 billion of new cash comes on top of a $25 billion infusion the bank received last month under the Troubled Asset Relief Program, passed by Congress to shore up the financial industry. "It really was a must-do thing," said Nader Naeimi, a Sydney-based strategist at AMP Capital Investors, which manages about $85 billion. "If they'd let Citigroup go, that would've been disastrous."
Citigroup's stock sank 83 percent this year and dropped below $5 last week for the first time since 1995. The shares closed last week at $3.77 on the New York Stock Exchange. They gained 40 percent to $5.28 at 9:48 a.m. in NYSE composite trading today, after rising as high as $6.20. Citigroup shareholders will be diluted in the "near term by the cost of the incremental preferred stock," Morgan Stanley analysts Betsy Graseck and Cheryl Pate wrote in a report today. Over the longer term, Citigroup will appreciate because of "the reduction in tail risk" from the troubled assets, they said. "There will surely be ongoing chatter about a breakup of Citi once the dust settles," analysts at Royal Bank of Scotland Group Plc, led by Tom Jenkins, said. "For now though, and indeed for the foreseeable future, Citi has oxygen."
Former Chairman Sanford "Sandy" Weill, 75, built Citigroup through more than 100 acquisitions during his 17 years at the helm. The company, which two years ago was the biggest by market value, has slipped to No. 6 after racking up four straight quarterly losses totaling $20 billion amid the worst financial crisis since the Great Depression. Citigroup shares declined at an annual rate of more than 5 percent, including reinvested dividends, since Weill formed the company in 1998 through the merger of Citicorp and Travelers Group Inc.
The government's preferred shares come with warrants to buy 254 million Citigroup shares at $10.61 each, allowing taxpayers to profit if the stock rallies following the government's investment, according to a term sheet that accompanied the agencies' statement. Citigroup is required to pay a quarterly dividend of no more than 1 cent a share for the next three years, down from 16 cents in the most recent quarter. "With these transactions, the U.S. government is taking the actions necessary to strengthen the financial system and protect U.S. taxpayers," the agencies said.
Citigroup Chief Executive Officer Vikram S. Pandit said the agreement addresses "market confidence and the recent decline in Citi's stock," and also strengthens the bank's "capital ratios." The company said its so-called Tier 1 capital ratio exceeds 9 percent with the support from the government. Terms of the asset guarantees mean Citigroup will cover the first $29 billion of pretax losses from the $306 billion pool, in addition to any reserves it already has set aside. After that, the government covers 90 percent of the losses, with Citigroup covering the rest from assets, including residential and commercial mortgages, leveraged loans and so-called structured investment vehicles.
Unlike the bailouts of insurer American International Group Inc. and mortgage companies Fannie Mae and Freddie Mac, no management changes were required and Pandit gets to keep his job, government officials said. The government will have a say over executive compensation at Citigroup. "This is a partial government takeover," Christopher Whalen of Institutional Risk Analytics, a Torrance, California- based research firm, said in a Bloomberg Radio interview. "We have been telling people for a while that some of the top banks were going to end up controlled by the government next year. It looks like that's happening sooner than even we expected." Gary Crittenden, Citigroup's finance chief, said on CNBC that the government aid is "not a nationalization in any sense."
Pandit, 51, a former Morgan Stanley banker, joined Citigroup last year as head of hedge funds and private equity, and he was picked in December to succeed Charles O. "Chuck" Prince after the bank's expansion in subprime mortgages and asset-backed lending backfired. Pandit announced a plan last week to eliminate 52,000 jobs and cut costs by about $2 billion per quarter. He and three top deputies bought 1.3 million shares in a show of confidence, and Prince Alwaleed bin Talal, one of the bank's biggest investors, said he would boost his stake to about 5 percent from 4 percent.
Citigroup also issued a statement last week saying the company had "a very strong capital and liquidity position and a unique global franchise," and Pandit held two conference calls with employees to reassure them. The stock kept plunging, forcing the bank's board to hold an emergency meeting on Nov. 21 and thrusting executives into a weekend of discussions with the Fed and Treasury. The slump was reminiscent of what happened to Bear Stearns Cos. in March before it was sold to JPMorgan Chase & Co. and to Lehman Brothers Holdings Inc. before it went bankrupt in September.
"Pretending that Citi is going to be a going concern I think is silly," said Whalen, of Institutional Risk Analytics. "We should be thinking about breaking this company up and redistributing the assets into stronger hands." The added capital and the asset guarantees are intended to provide confidence to investors that Citigroup has a big enough loss cushion to absorb bad loans as unemployment climbs and the economy sours. The rescue was "structured in a way that existing debt holders are not impaired and equity investors are not overly diluted," CreditSights Inc. analysts led by David Hendler wrote in a report today. "All in all, these actions should settle market jitters surrounding the company for now and provide a boost for bondholders."
Citigroup remains vulnerable to losses on loans and securities outside the U.S., said Peter Kovalski, a portfolio manager at Alpine Woods Capital Investors LLC in Purchase, New York, which oversees $8 billion and holds Citigroup shares. The government plan "gives them a little bit of breathing room, but longer term, things may deteriorate and losses increase," said Kovalski. "The Achilles heel with Citi is their exposure to emerging markets and what's going to happen when emerging markets turn down, as they're doing now."
Treasury Traders Paid to Borrow as Fed Examines Repos
Owners of Treasuries may soon get paid to borrow as the U.S. tries to break a logjam in the $7 trillion-a-day repurchase market. Treasuries are in such high demand that investors are lending cash for next to nothing to obtain the securities as collateral through so-called repos, which dealers use to finance their holdings. The problem is many parties involved in repos aren't delivering the bonds because there is no penalty for not doing so, causing "fails" to exceed $5 trillion, according to the Federal Reserve Bank of New York.
Now, an industry group is trying to fix the mess, which New York Fed Executive Vice President William Dudley said could cause U.S. borrowing rates to rise if not rectified. The Treasury Market Practices Group wants to impose a "penalty" on failed trades, a move that may result in borrowers who put their Treasuries up as collateral for loans effectively receiving 2 percent interest. "This is an extraordinary thing to perceive for a market of the size and significance of the U.S. repo market," said Lena Komileva, an economist in London at Tullett Prebon Plc, the world's second-largest interdealer broker. Failures to deliver or receive securities climbed to a record $5.311 trillion in the week ended Oct. 22. While the amount fell to $1.26 trillion by Nov. 12, that's still above the average of $165 billion before credit markets seized up in August of last year, based on Fed data that goes back to 1990.
The disruption in the repo market comes as the Treasury steps up debt sales to finance a record budget deficit and the bailout of the nation's banks. Gross issuance of Treasury coupon securities will rise to about $1.15 trillion in fiscal 2009 from $724 billion last year, according to New York-based Credit Suisse Securities USA LLC, one of the 17 primary dealers that are obligated to bid at the government's auctions. "The more chronic fails disrupt the Treasury market, the more it reduces its liquidity and efficiency," Dudley said in a Nov. 12 interview. "Over time, this could have some negative consequences for the ability of the U.S. Treasury to raise money at the lowest cost possible. Reduced liquidity also affects other markets as the Treasury market is used to hedge positions in other security classes."
Karthik Ramanathan, Treasury's acting assistant secretary for financial markets, "strongly" urged dealers, traders and investors on Nov. 5 to find a way to reduce the number of failed trades. Otherwise, he said, regulators would step in. In a repurchase agreement, one party provides cash to another in exchange for a security, and vice versa. Repos are typically used to finance holdings, meaning movements in the rates affect the cost of holding the securities in inventory. As of the end of June, primary dealers reported financing $4.22 trillion of fixed-income securities with repo agreements, according to the Fed. Since the bankruptcy of Lehman Brothers Holdings Inc. in mid-September traders, investors and dealers have been willing to lend cash to obtain Treasuries at almost zero interest. The lowest overnight repo rate on Nov. 21 was 0.05 percent for the five-year note maturing in October 2013, according to London- based ICAP Plc, the world's largest inter-dealer broker.
Repo trades go uncompleted when it's difficult to obtain the securities or the cost to get them becomes too expensive. Fails aren't usually considered a breach of contract and the parties involved typically keep re-scheduling delivery. A day after Ramanathan's warning, the Treasury said it was reviewing the trading of two- and five-year notes after a scarcity in the securities led to rising fails. The Treasury has conducted at least nine such reviews, known as "large position reports," to monitor against market manipulation since 1997. A week later the Treasury Market Practices Group recommended imposing a penalty rate that equals either 3 percent minus the Fed's target rate for overnight loans between banks, or zero, whichever is greater. The central bank's target is 1 percent. The TMPG said it plans to discuss by Jan. 5 a potential plan to implement the measures.
"A negative rate repo is somewhat counterintuitive as basically, a lender is not only lending money, but paying a borrower to take that money," said Robert Toomey, managing director of the Securities Industry and Financial Markets Association, a New York-based trade group. "The borrower has something, in this case a particular security, that the lender really wants. It's essentially paying a premium to get a particular security." Negative repo rates have happened before. The Bank of Japan's decision to adopt a zero interest-rate during the "Lost Decade" of the 1990s because of deflation and a protracted banking crisis triggered the phenomenon for Japanese government debt. Rates less than zero surfaced in the U.S. in 2003, when the Fed's target interest rate fell to 1 percent and traders sought to cover bets against 10-year Treasuries after their yields jumped more than a percentage point in about a month.
Demand for short-term Treasuries may increase if repo rates turn negative as investors would receive interest, as opposed to typically paying it, for money they borrow to finance their holdings. Credit Suisse expects the two-year Treasury note's yield to fall to 0.5 percent by the end of the first quarter from about 1 percent last week. "For certain sectors of the Treasury curve, such as the short-end, the implementation of negative repo rates would provide a significant kick to the market," said Ira Jersey, an interest-rate strategist at Credit Suisse in New York. "Yields have room to fall further, with the front end outperforming the long end." Treasury yields tumbled to record lows last week, with two- year notes dropping below 1 percent for the first time, as deepening recessions in Asia, Europe and the U.S. and signs of deflation drove investors to the safest assets.
The yield on the 1.5 percent note due October 2010 slid 9 basis points to 1.11 percent, according to BGCantor Market Data. The price, which moves inversely to the yield, rose 5/32, or $1.56 per $1,000 face amount, to 100 24/32. Five-year note yields dropped as low as 1.87 percent, the least since the Fed first started keeping records in 1954. Yields rose for a second day in New York. Like in Japan in the 1990s, traders have increased bets that the Fed will cut the target federal funds rate as the economy sinks deeper into recession, further increasing the chances of negative repo rates. JPMorgan Chase & Co. economists forecast a reduction to zero percent. Fed policy makers predict the U.S. economy will contract until the middle of next year, according to minutes of their Oct. 28-29 meeting released Nov. 19. Government figures showed that consumer prices excluding food and fuel costs fell for the first time since 1982 last month.
Citi may run out of ideas and time
Citigroup CEO Vikram Pandit has aggressively written down assets, slashed his work force, fought to acquire Wachovia, substantially upped his stake in the company he leads and generally made the tough decisions he was brought on to make. But it's still not enough. One analyst even estimates the bank could use at least $160 billion in additional capital, and rumors swirled on Friday that the Treasury might provide some of it.
"We have spent the last year 'getting fit,' are more streamlined, and are in a strong competitive position," Mr. Pandit, at the helm of Citi for just under a year, told employees at a "town hall" meeting last Monday. But the embattled CEO also announced about 50,000 more employee layoffs and cost cuts of 20% in 2009. Nevertheless, the stock dropped 6.6% that day. News emerged on Wednesday that Citi would unwind its remaining structured investment vehicles, which have already cost the bank over $3 billion in write-downs this year. Investors responded by sending the shares down to under $7, rendering Citi a smaller firm by market cap than U.S. Bancorp.
The following day, Citi's largest individual shareholder, Prince Alwaleed bin Talal, stepped in, announcing his support of management and raising his stake to 5%. The bank's stock fell even further, along with many other financial institutions and the broader market. Reportedly, Citi has begun lobbying to get a temporary short-selling ban on financials reinstated. Some investors who saw Citi as a great bargain years ago, only to see it grow cheaper, are frustrated.
"It's such a value trap," sighed Keith Stribling, a portfolio manager at HighMark Capital Management in Los Angeles, who holds about 850,000 Citi shares in the HighMark Value Momentum fund and in separate accounts. "Citi has always had potential, but there's just no other way to describe it." Still, he's holding on. "I don't think it's going to zero," Mr. Stribling said. In afternoon trading Friday, Citi shares were down another 20%, to under $4.
A spokesman emphasized in a statement Friday the progress the company has made: "Citi has a very strong capital and liquidity position and a unique global franchise. We are focused on executing our strategy, including targeted expense and legacy asset reductions, and believe the benefits will be seen over time." The spokesperson also refused to comment on rumors that Citi was considering selling itself, piecemeal or as a whole. Reportedly, there was a company-wide conference call Friday morning, and a board meeting was scheduled for the afternoon.
Judging from last week's performance, many investors are shooting first and asking questions later. They are concerned that Citi still has too many risky assets on its balance sheet; that it's too reliant on short-term funding, especially after its bid for Wachovia failed; and crucially, that earnings are soon to be hit by steep loan losses. Over the past year, Citi has been aggressively trimming its assets and reducing exposure to riskier holdings. Overall, its exposure to instruments including subprime-backed CDOs, Alt-A securities and leveraged loans, among others, was about $113 billion at the end of the third quarter, down from $203 billion at the end of the fourth quarter 2007. Still, that adds up to 5.5% of total assets, compared with 1.2% of total assets for J.P. Morgan Chase, which has about $27 billion worth of similar instruments.
As borrowers default, and Citi keeps shaving off the assets, more write-downs will be necessary, especially since Citi is moving $80 billion in "problem" assets from "mark-to-market" to held to maturity, or held for investment and available for sale. The company will avoid having to mark to market each quarter, but the transfer will result in about $3 billion of net write-downs this quarter, David Trone, an analyst at Fox-Pitt Kelton Cochran Caronia Waller, estimated in a note. That pales in comparison, however, to the fourth quarter of last year, when it took $17 billion in charges.
"You have to recognize the progress management has made in reducing a lot of the risk in these various categories," said Joe Scott, a Citi analyst at Fitch Ratings. He rates Citi's debt AA- but has it on 'watch negative,' primarily because future loan losses are likely. Vigorous competition for deposits also has many market players concerned that Citi won't be able to diversify the sources of its funding on pace with competitors, especially after it lost its bid for Wachovia to Wells Fargo.
It's been widely reported that Citi may be eyeing Chevy Chase, a Maryland thrift. But in a note last week, CreditSights analyst David Hendler dismissed that as a "consolation prize," with only 300 branches in the D.C. area. "Even with Chevy Chase," he wrote, "Citi would lack the critical mass of branches and deposit funding compared to larger national competitors such as [Bank of America] and J.P. Morgan Chase." Another analyst was vocal last week about the importance of so-called core deposits.
Overall, the six largest banks (Bank of America, J.P. Morgan, Citi, Wells Fargo, Goldman Sachs and Morgan Stanley), plus AIG and GE Financial, may need about $1 trillion in new capital, since they have relied on non-deposit funding. Their combined ratio of tangible common equity, at 3.4%, is "simply too low," Friedman Billings Ramsey analyst Paul Miller wrote in a note to clients on Wednesday. Citi may need $160 billion in additional capital to steady its balance sheet, Mr. Miller wrote.
Citi has already raised $75 billion since Jan. 1 in private and public capital and from the Treasury's Capital Purchase Program. Its tier one ratio is now 10.4%, against 10.8% for the combined J.P. Morgan and WaMu on the same basis, and about 9.8% for B of A/Merrill and Wells Fargo/Wachovia. They may need that capital for loan losses as the economy gets weaker, however.
Mr. Pandit said last week that net charge-offs on consumer loans would be up to $2 billion higher than they were last quarter in the first and second quarters of 2009, based on his expectation for an unemployment rate of between 7% and 9%. The company put aside $24 billion in loan-loss reserves in the third quarter, up about $8 billion since the beginning of the year. Reserves now constitute 3.4% of total loans.
"Understanding that we're only halfway through the fourth quarter, the environment is affecting both asset values and consumer credit," Mr. Pandit said at the company town hall meeting last week. Consumer credit quality is "the center of their problems," Mr. Scott at Fitch Ratings said. "And it looks like the losses there are going to continue to increase well into 2009. It's going to put a lot of pressure on earnings in future quarters. I think they can dig out of this problem, but it's going to take a lot of time."
Goldman, Morgan Stanley May Want Citigroup
A purchase of Citigroup Inc. would "significantly" add to Goldman Sachs Group Inc. or Morgan Stanley's earnings as long as the U.S. government absorbed losses on the embattled bank's assets, according CreditSights Inc. Buying Citigroup "would be significantly accretive to Goldman and Morgan Stanley's earnings as the potential buyer would be acquiring a significant future earnings stream for a relatively low price," David Hendler, an analyst at CreditSights in New York, wrote in a report yesterday. The buyer "would probably receive government support if it was needed."
Led by Chief Executive Officer Vikram Pandit, Citigroup lost 60 percent of its market value last week as investor confidence in the New York-based company's prospects faltered after four consecutive quarterly losses. The share-decline may rattle Citigroup's customers, counterparties and employees, threatening the operations of the second-biggest U.S. bank by assets, according to Hendler's report. "We sense that Citi's board will also recognize the difficult chain of events which can be brought about by its low stock price, and prefer to take action in the next few days or weeks," Hendler wrote.
Pandit, 51, told employees on a Nov. 21 conference call that he doesn't plan to break up the company. He and Chief Financial Officer Gary Crittenden said they don't expect to sell the Smith Barney brokerage unit, two people who listened to the call said at the time. Citigroup's board, led by Chairman Win Bischoff and independent director Richard Parsons, met the same day to discuss the bank's options. Citigroup issued a statement last week saying the company has "a very strong capital and liquidity position and a unique global franchise." Spokeswoman Christina Pretto didn't return phone calls seeking comment today.
Goldman Sachs and Morgan Stanley were the two biggest U.S. securities firms before converting to bank holding companies in September. They took the step after smaller rival Lehman Brothers Holdings Inc. was forced into bankruptcy, undermining investors' faith in investment banks that rely on the constricted debt markets for financing. All three firms are based in New York. Goldman and Morgan Stanley have said they would consider acquisitions to help build their deposit bases. Spokespeople for both companies declined to comment on whether they would consider buying Citigroup.
Citigroup's $2 trillion of assets would have to be booked by any acquirer at current market values, which could translate into about $100 billion of writedowns, CreditSights estimated. To help facilitate a transaction, the Federal Deposit Insurance Corp. could provide loan-loss support or the U.S. Treasury could contribute money from the $700 billion Troubled Asset Relief Program passed by Congress in October, the report said. Even without an acquisition, the government could intervene if Citigroup's depositors start to withdraw money because the company would be considered an institution whose failure could threaten the entire financial system, the report said.
"Government intervention could take place under the purview of one or more of several federal departments, including the Treasury department, TARP program, the Federal Reserve, or the FDIC," Hendler wrote. Citigroup's debt remains on review for downgrade by both Moody's Investors Service and Standard & Poor's. Moody's rates Citigroup's senior unsecured debt Aa3, while S&P has an AA- rating. A downgrade to A1 by Moody's or to A+ by S&P is possible as the bank's falling stock price could be deemed to hamper the company's "financial flexibility," the report said.
A single-A rating at the parent-company level should be manageable as long as the company's banking subsidiaries maintain double-A ratings, CreditSights said. JPMorgan Chase & Co., now the biggest U.S. bank by assets, managed to endure with single-A ratings earlier in the decade, the report notes. "That said, Citi does not disclose what additional collateral it might need to post if it faced a downgrade to high- A territory, so we do not have any hard numbers as to whether a downgrade would cause a sizeable collateral call," the report said.
Ilargi: I find it incredible that serious reporters still claim that the government didn't know how bad the situation is. Sure, they've hoped for divine intervention, but Paulson and Bernanke have known for a long time about how much Citi has in toxic assets, and how much other financials hold. And yes, yesterday's deal does send a clear signal about how bad it all is. Just not that they didn't know.
After last night's $326 billion rescue bail-out hand-out for Citi, the flood doors are now wide open: it'll be up to Obama to close them, but in his press-op today he has given no indication that he intends to do so. And that will mean that the US government has declared its willingness to buy up trillions of dollars in bad assets, anything to prevent bankrupt institutions from actually going bankrupt. There is only one way to go from now: bankrupt the state, and its citizens. Something's got to give.
Citi will go down regardless, first because of the consistent refusal to unveil the value of the assets (so still no rebuilding trust), and second because the bank has far more than $300 billion in casino toilet paper.
Think investors don't understand that, or would be fooled by Washington's sleight of hand? Don't count on it. The US will buy the vast majority of banks, and that will hammer its rating, sooner or later.
Citigroup's government rescue signals depth of banking woes
Trouble at the nation's largest banks likely goes much deeper than regulators initially anticipated, given the government's decision to potentially absorb hundreds of billions of dollars of losses on loans and other assets languishing on Citigroup's books. The full scope of the industry's woes will become evident in the months ahead as the economic downturn takes its toll on consumers' ability to repay loans and the quality of commercial real estate mortgages, which will further erode the value of securities backed by such loans.
Citigroup's problems have been thinly veiled, given the tap dance the bank and regulators performed in an effort to keep the New York bank's purchase of Wachovia on track even after a private buyer, Wells Fargo, stepped forward with a higher price as part of an offer that didn't require assistance from the Federal Deposit Insurance Corp. Citi was also seen by some as the major bank needing government help when the Treasury Department debuted a program in which it required nine major banks to accept direct government investments in their companies.
In addition to loan problems contributing to about $20 billion in losses over the previous four quarters, the bank has deep-rooted problems in integrating the many pieces stitched together over the last decade or so. With investors pummeling Citibank's shares toward $2 last week, the government stepped in Sunday night with a plan to rescue what was once the nation's most powerful bank. Under the rescue plan unveiled by the Treasury Department, the Federal Reserve and the FDIC, Citigroup and the government have targeted a pool of about $306 billion in troubled assets. Citigroup will assume the first $29 billion in losses from the pool and 10 percent of losses beyond that point. Additional losses from the pool will be dumped on the nation's taxpayers.
The government will also receive warrants to purchase shares in the bank as part of the plan in which it will invest a further $20 billion into Citigroup on top of the $25 billion invested in the bank as part of the Treasury's direct investment. "With these transactions, the U.S. government is taking the actions necessary to strengthen the financial system and protect U.S. taxpayers and the U.S. economy," the Treasury Department, Fed and FDIC said in a joint statement Sunday.
Citigroup's Citibank is a significant player in the San Francisco Bay Area banking, with about 1,500 employees and 108 branches in the 10-county region. Citi has a total of about 3,100 employees in the Bay Area. San Francisco is also home base for the president of Citibank California, Rebecca Macieira-Kaufmann. Under the terms of the bailout, Citigroup cannot pay a dividend on its common stock of more than a penny per share per quarter for the next three years.
It would not be surprising to see a public backlash emerge over the Citibank rescue plan, specifically in not requiring a change in the top management nor the sale of parts of the bank. The rescue plan emerged even as General Motors, Ford and Chrysler are being criticized for coming to Washington for a federal bailout with no plan in hand for how their businesses will be restructured for long-term survival. The Citibank rescue is also likely to come under criticism for privatizing profits made from the bank's high-risk bets, but placing losses on the taxpayers' shoulders. President George W. Bush already said Monday that there could be similar plans based on the Citigroup rescue for other financial institutions needing help.
US Home Resales Fall, Prices Tumble Most on Record
Home resales in the U.S. dropped in October and prices fell by the most on record, signaling a deepening housing recession going into 2009. Purchases of existing homes slid to an annual rate of 4.98 million, lower than forecast, a National Association of Realtors report showed in Washington. The median price fell 11.3 percent from a year earlier, the most since the group began collecting data in 1968. Today's figures indicate a renewed downturn in an industry that showed signs of stabilizing this year, hurt by the credit squeeze and record mortgage foreclosures. That may raise pressure on President-elect Barack Obama to aid homeowners and potential buyers as he assembles a record stimulus package.
"Home sales will continue to fall over the next few months because of tightening credit conditions," said Sal Guatieri, senior economist in Toronto at BMO Capital Markets, which had the closest estimate for the sales level among 67 forecasts in a Bloomberg News survey. "Underlying demand appears very weak" because "many sales are coming from cheap prices on foreclosed properties," he added. Obama is scheduled to hold a press briefing in Chicago at noon New York time today to unveil his economic team and discuss his response to the crisis.
Obama aides and Democratic Senator Charles Schumer have said a stimulus package of as much as $700 billion may be needed to shore up the economy. Stocks rose for a second day on optimism a rescue of Citigroup Inc. and prospects for a new stimulus package will stabilize the financial system and the economy. The Standard & Poor's 500 Stock Index rose 5 percent to 839.95 at 12:03 p.m. in New York. Yields on benchmark 10-year notes rose to 3.30 percent from 3.23 percent at last week's close.
Existing home sales were forecast to fall to an annual rate of 5 million, according to the median estimate in the Bloomberg survey. Sales dropped 3.1 percent from the previous month and 1.6 percent from a year earlier. Resales totaled 5.65 million in 2007. The median-sales price declined to $183,300. Today's figures compare with the 4.86 million level reached in June, the lowest in a decade and 33 percent below the record reached in September 2005. Resales have fluctuated around a 4.96 million rate this year. The number of previously owned unsold homes on the market at the end of October represented 10.2 months' at the current sales pace, up from 10 months' at the end of the prior month.
"The large number of homes already on the market and the number of those that will appear via foreclosure over the next several months only add to the diminished prospects for existing home sales," Maxwell Clarke, chief U.S. economist at IDEAglobal in New York, said before the report.
The median price of an existing home was the lowest since March 2004. Prices fell in all regions of the country, led by the West. Falling home values make it harder to refinance mortgages and have pushed foreclosure filings up 25 percent in October from a year ago, according to RealtyTrac Inc., the Irvine-California-based seller of default data. Resales account for about 90 percent of the market, while purchases of new homes make up the rest. Sales of existing homes are compiled from contract closings and may reflect contracts signed one or two months earlier. Today's report showed resales of single-family homes fell 3.3 percent to an annual rate of 4.43 million. Sales of condos and co-ops declined 1.8 percent to a 550,000 rate.
Purchases declined from the previous month in all regions, led by a drop of 6 percent in the Midwest. Sales fell 1.2 percent in the Northeast, 3.2 percent in the South and 1.6 percent in the West. Compared with a year earlier, sales jumped 37.5 percent in the West, while declining in other regions. "Markets where prices have plunged, the buyers are coming back and taking advantage," Lawrence Yun, chief economist for the Realtors group, said at a press conference. Home sales overall may be weighed down by a federal law that took effect Oct. 1 barring home sellers from providing down-payment assistance to purchasers.
Builders are scaling back residential projects as home sales decline. Construction of new homes plummeted 65 percent through October from a peak in January 2006. The number of building permits issued last month fell to the lowest level since record-keeping began in 1960, a sign that declines in construction will continue to hurt the economy. Companies are struggling to improve sales alongside a rise in foreclosures. Stuart Miller, chief executive officer of Lennar Corp., the second-largest U.S. homebuilder, said the housing market "continues to decline." "Clearly the market is weak," Miller said in comments broadcast from a Nov. 11 UBS conference in New York. "Clearly the supply side of the homebuilding world is dominated by the foreclosures that are coming in faster and more furiously than in the past."
A swift, rude fall for Hank Paulson
A surreal 14-hour interval last week captured in a microcosm how far Henry Paulson's star has plunged since he left Goldman Sachs to become Treasury secretary. Last Monday night, Mr. Paulson hobnobbed with the CEOs of companies such as IBM, Pfizer and Time Warner at the Four Seasons hotel in Washington, a venue familiar to Fortune 500 executives and lobbyists.
The guests feasted on jumbo prawn, roasted rack of lamb with mint chutney and chocolate mousse with spicy whipped cream. They washed dinner down with sauvignon blanc from New Zealand and pinot noir from California. Speaking after dinner, Mr. Paulson got a supportive response when he said his performance should be rated "very close to a 10" out of a possible 10 in terms of stabilizing the financial system. He conceded the administration has far to go to loosen credit markets and stabilize housing prices.
The next morning, Mr. Paulson made similar points to a congressional panel meeting in a nondescript hearing room. The reception there was decidedly less polite. Democratic lawmakers on the House Financial Services Committee repeatedly interrupted him before he could complete a sentence or while he was clearing his throat to speak. "I'm the one asking the questions here," lectured Rep. Nydia Velazquez (D-N.Y.).
Some congressmen invoked constituents struggling to keep their homes. Legislators raised their voices in exasperation at Mr. Paulson's refusal to curb foreclosures with the $700 billion authorized by Congress. "The fact that you took it on yourself to absolutely ignore this authority amazes me," said Rep. Maxine Waters (D-Calif.). Others cited Mr. Paulson's frequent changes in strategy, especially his decision to abandon the original purpose of the rescue, the purchase of troubled assets from banks. "You seem to be flying a $700 billion plane by the seat of your pants," said Rep. Gary Ackerman (D-N.Y.).
Even the senior Republican on the panel, Spencer Bachus of Alabama, faulted what he called the Treasury's "improvised and ad hoc" performance. Mr. Paulson, 62, maintained a stolid equanimity in the face of the unrelenting criticism, even managing a tight-lipped grin when committee chairman Barney Frank (D-Mass.) joked about a colleague's mixed metaphor. But it's been a swift, rude fall.
When Mr. Paulson was appointed Treasury secretary in June 2006, he was the best-paid CEO on Wall Street and had a stake in Goldman Sachs worth $485 million, according to Bloomberg News. The government would only pay him $191,300 a year, but he was stepping up for an administration that had managed economic policy largely out of the White House. Now the financial tsunami of the last couple of months has left his reputation in tatters.
"There is generalized frustration with Paulson," said Desmond Lachman, a fellow at the conservative-leaning American Enterprise Institute who was a managing partner at Salomon Smith Barney. "The markets are literally melting down, and he's mismanaged this every step of the way," Mr. Lachman said last Wednesday as the Dow Jones industrial average closed below 8,000 for the first time since early 2003. "Congress has every right to be furious with him."
Criticism has coalesced around several points. Some financial experts have argued that Mr. Paulson should have better anticipated the crisis and taken preventive measures, managed it more coherently with fewer fits and starts, been less secretive about his program, done far more to help homeowners, and attached conditions more favorable to taxpayers to the capital infusions for banks. "I find it all breathtaking," said Alan Blinder, a former Federal Reserve vice chairman who identified nine problems with Mr. Paulson's program in his testimony.
At the same time, Mr. Paulson has drawn some praise. Defenders have said he deserves credit for starting to right a collapsing financial system, for being flexible in adapting policy to a shifting and unique financial crisis, and for sheer hard work. "In a crisis, everyone's unforgiving," said Alice Rivlin, former vice chairman of the Federal Reserve and budget director under President Clinton. "Here's a smart man who knows a lot about markets who's trying to figure out what to do. I don't know that there's somebody who would have done a better job than Paulson."
Robert Rubin, an economic adviser to President-elect Barack Obama who served as Treasury secretary under President Clinton and is a former chairman of Goldman Sachs, said last week: "The financial system is in better shape than before Hank acted." Some observers say no one could have done better in the job given the way Washington operates. "This [crisis] really is about lack of confidence," Cardinal Health chief financial officer Jeffrey Henderson said at the annual MIT Sloan CFO Summit last Thursday in Newton, Mass. "Every time Washington changes gears, it lowers that confidence one notch further."
The Treasury did not respond to e-mail and phone messages seeking comment on the criticism of Mr. Paulson's performance. Looking ahead, Mr. Paulson testified that he plans to leave at least $350 billion of the $700 billion rescue funds to the Obama administration. He also said he will leave behind "a significantly more stable banking system," as well as tools and programs to ultimately restore the flow of credit.
"I am confident in a successful outcome," Mr. Paulson said. He may have anticipated what Congress was going to do anyway. Mr. Blinder recommended that Congress block the second half of the funds because Mr. Paulson has defied the law's intent in not using the money to refinance mortgages or buy banks' troubled assets. "I have concluded that taxpayers will be better served by waiting for the new administration to take office," Mr. Blinder said.
Obama Eyes $500 Billion in Stimulus; Paulson Weighs Ramping Up Aid Again
Aides to President-elect Barack Obama and President George W. Bush are rushing to craft measures to shore up financial markets and prevent a policy vacuum from further harming the economy during the transition of power between the two men. Mr. Obama's team is putting together a new economic stimulus plan containing more than $500 billion in federal spending and tax cuts over the next two years, Obama aides and advisers said Sunday. That package would be far more aggressive than anything envisioned during the campaign.
Democratic leaders in Congress are preparing to rush passage shortly after New Year's to have a stimulus-plan bill ready for Mr. Obama to sign once he is inaugurated Jan. 20. Meanwhile, Mr. Bush's outgoing Treasury secretary, Henry Paulson, is now considering a more activist stance in his final weeks in office than he had signaled as recently as last week. He is considering tapping the second half of the government's $700 billion financial-industry rescue fund, and rolling out new programs in response to worsening market conditions, according to people familiar with the matter. Among other things, he is seeking ways to make it easier for households to borrow money. He is also looking for ways to reduce the burden of foreclosures on homeowners.
The moves came as officials at the Treasury and the Fed spent the weekend on yet another emergency rescue plan, this one for giant Citigroup after its stock fell 60% the past week. Citigroup's deterioration underscores the fragile state of markets and the economy during Washington's long transition of power. Mr. Obama is planning a press conference Monday to introduce the leaders of his economic team, which is headed by Harvard economist Lawrence Summers, who will run the White House National Economic Council, and New York Federal Reserve Bank President Timothy Geithner, his choice for Treasury secretary. The president-elect is likely to use the event to assure investors and consumers that he will take rapid, large-scale action in the coming weeks and months. The message will be: "This is an extraordinary time, and extraordinary responses are going to be needed," said one aide.
Mr. Obama is also expected to try to calm Wall Street worries about trying to rewrite the rules of existing aid to Wall Street, and excessive spending in his new administration, according to Obama transition officials. So far, the main government response to the economic crisis has been the $700 billion Troubled Asset Relief Program, or TARP, designed to help banks and other financial institutions. Mr. Obama's economic-stimulus plan would be separate from that. On Monday, Mr. Obama will likely offer for the first time an explicit pledge to honor all commitments already made by the Bush administration in the TARP program, without imposing new conditions even if there are changes are made to the program in the future. Obama officials also say the president-elect will promise to find spending cuts to try to keep short-term stimulus spending from ballooning the budget deficit over the long term.
While Mr. Obama is moving quickly to give markets unusually early clarity on what he'll do when he takes office in January, Bush aides are rethinking how they'll handle their final weeks in power. The Bush Treasury is in the middle of injecting into banks some $250 billion of TARP funds, and Mr. Paulson had suggested earlier this month that he wasn't planning to do much beyond that before he leaves office in two months. Another $40 billion of the TARP money has been invested in American International Group, Inc., the giant insurer. But last week's deterioration in the markets heightened concern at the Treasury that it might need to take confidence-boosting steps before Mr. Obama's team takes over.
On Friday, Goldman Sachs Inc. revised down its projections for economic growth, saying the economy is in the process of contracting by 5% in the fourth quarter and would contract another 3% in the first three months of 2009. If Goldman is right, it would mark the worst performance since the 1982 recession, one of the deepest contractions since the Great Depression. Goldman placed the blame largely on Washington. "The main reason for the downgrade to our forecast is the policy impasse that has developed in Washington and the tightening in financial conditions it has provoked." Since winning the presidency Nov. 4, Mr. Obama has expressed reluctance to begin steering economic policy, repeatedly saying the country can have only one president at a time. Large-scale economic stimulus is all but impossible before Mr. Obama takes office, since Mr. Bush has said he would oppose big new spending plans before he leaves the White House.
But Mr. Obama and his team have chosen in recent days to signal fairly explicitly that a sizeable boost will come as soon as he takes office. Obama advisers decline to detail publicly just how large the stimulus would be. But several senior aides have pointed to analyst reports calling for $500 billion to $700 billion to be injected into the economy. In an appearance before chief executives in Washington earlier in the week, Mr. Summers suggested stimulus of that size was possible. He also said stimulus should be "speedy, substantial, and sustained" -- a shift in tone from his calls earlier in the year for "temporary" and "targeted" aid. "We're going to need impetus for the economy for two to three years," he now says. House Majority Leader Steny Hoyer said the new Congress, which will be dominated by Democrats, will have a stimulus package completed "during the first couple of weeks of January."
Mr. Obama's selection of Mr. Geithner for Treasury secretary has, in effect, given his administration a greater role in the current handling of the financial crisis. That's because Mr. Geithner has already been a close partner of Mr. Paulson in managing the bailouts in his role as New York Fed president. The selection of Mr. Geithner is providing comfort to Treasury officials, who view his selection as an indication they will be able to push ahead with using more of the $700 billion rescue fund to respond to the financial crisis than perhaps Mr. Paulson had suggested last week. Treasury spokeswoman Michele Davis on Sunday said Mr. Paulson had always planned to implement new programs when they were ready, and never ruled out tapping the remaining half of the $700 billion fund. "We're looking at a variety of programs to support the market and we'll implement them as soon as they're ready," she said.
Treasury's immediate focus is on establishing a program, along with the Federal Reserve, that would help increase the availability of auto loans, student loans and credit cards -- which Mr. Paulson believes will help alleviate strains in the consumer borrowing market. A person familiar with the planning said the Treasury and the Fed have agreed on the structure of such a program and are working on the details, such as whether the Fed should buy assets itself or provide loans to entice private investors to buy securities. The Treasury is expected to contribute $25 billion to $100 billion to the program, which could be announced within a few weeks, this person said.
Treasury is continuing to look for a way to prevent more foreclosures on homeowners, including trying to improve a proposal floated by Federal Deposit Insurance Corp. Chairman Sheila Bair. Democratic lawmakers have been pressuring Mr. Paulson to use some of the $700 billion rescue fund to help people in danger of foreclosure. Treasury had also been designing another capital-injection program aimed at financial institutions beyond banks, in addition to considering making more money available to banks that have already received a government infusion.
Comptroller: New York may need federal help
The ongoing financial crisis plaguing Wall Street may add up to more than $6 billion in losses to New York state and New York City over the next two years. And that may cause the state to seek assistance from the federal government, Comptroller Thomas DiNapoli said Monday. His office released an update Monday on New York's fiscal condition, saying as many as 225,000 jobs may be lost due to the collpase on Wall Street, depriving state coffers as much as $6.5 billion in securities industry-related tax revenue over the next two years. That could trigger the need for the federal government to step in.
"Wall Street is the engine that drives the economies of New York state and New York City, but the global credit crunch has slowed that engine down," DiNapoli said in a statement. "This year is on pace to be one of the worst years ever on Wall Street. Through the first half of this year, broker dealer operations of New York Stock Exchange member firms reported a loss of nearly $21 billion. The report said over the past year, the New York City securities industry has lost 16,300 jobs and those job losses might grow to 38,000 by October 2009 with another 10,000 jobs could be lost in banking, insurance and real estate.
According to the comptroller, while top executives may not receive bonuses, lower level employees will still receive payments although the size of the bonus pool will be much smaller than in prior years. Tens of billions of dollars in losses in the brokerage and securities industry have been reported this year, the report found. As Wall Street contracts, the comptroller estimates that jobs will be lost throughout the rest of the New York City economy due to the industry's multiplier impact on jobs, which estimates that for each financial sector job lost, two more jobs will be lost in other industries in New York City and 1.3 jobs will be lost elsewhere in the state.
Also, the report notes:
• The average securities industry salary reached a record high of nearly $400,000 in 2007 paying approximately 6.8 times the salary of all nonfinancial jobs in the city. Salaries averaged $150,640 in credit intermediation and insurance and $62,060 in real estate and related industries.
• Tax collections — personal income and business taxes — from Wall Street-related activities could drop by $4.5 billion for New York state and $2 billion for New York City by 2010.
• Wall Street-related activities account for 12 percent of New York City tax revenues and up to 20 percent of New York state revenues.
HSBC Would Consider Buying Some of Citigroup's Best Assets
HSBC Holdings Plc Chairman Stephen Green said the London-based bank would consider buying the "right" assets of Citigroup Inc., as the U.S. bank faces the threat of a breakup or sale. "It would depend," Green said in an interview at the Confederation of British Industry conference in London today. "We have a clear strategy to develop our business with a primary focus on emerging markets, and that means Asia, the Middle East and Latin America," he said. "We will not acquire things that do not fit in with our strategy. Where something fits" HSBC would look at it, he added.
HSBC, which earns more than three quarters of its profit in emerging markets, has avoided the funding strain that's led banks including HBOS Plc to be bailed out by the British taxpayer. Citigroup today received $306 billion of guarantees for troubled mortgages and toxic assets from the U.S. government to stabilize the bank. The New York-based bank has $2 trillion of assets and operations in more than 100 countries. Operations in emerging markets "are an area Citigroup may be reluctant to sell as it's one of the few areas that will generate growth in the next few years," said Julian Chillingworth, chief investment officer at Rathbone Brothers, who helps manage $21 billion, including shares of HSBC.
Buffett Will Give More Information on Derivatives
Billionaire investor Warren Buffett will provide more information to investors on how he calculates losses on his Berkshire Hathaway Inc.'s derivative bets in the firm's annual report early next year. The report will disclose "all aspects of valuation" and cover "deficiencies in the formula" for pricing the derivatives, "which we nevertheless use," Buffett said in an e- mail sent by his assistant, Debbie Bosanek.
The information may calm investors concerned about losses and potential ratings downgrades tied to Berkshire's sale of derivative contracts. Buyers of the derivatives would be entitled to billions of dollars from Omaha, Nebraska-based Berkshire if four stock indexes drop below agreed-upon levels on dates beginning in 2019. Berkshire shares have fallen about 18 percent since Nov. 7, when the insurer said writedowns on the contracts totaled $6.73 billion at the end of the third quarter.
Buffett's e-mail said the four stock indexes, including the Standard & Poor's 500, would all have to fall to zero for Berkshire to be liable for the entire $35.5 billion that's at risk. The sum was last estimated at $37 billion in a Sept. 30 filing and shrank because of fluctuations in currency exchange rates, he said. Speculation about the insurer's liability drove up prices last week on credit-default swaps tied to Berkshire debt. Fixed- income investors buy credit-default swaps to protect themselves against the possibility that a company won't meet its obligations and prices rose last week to levels typical of a company rated one level above junk.
"The market is so panicked that even the most respected investor in the world can see the stock in his company fall more than 30 percent on no news, other than on rumors that are clearly false based on the disclosures he's made," said Whitney Tilson, managing director of T2 Partners LLC, a New York-based hedge fund with about $100 million under management. "We are in a sell first, ask questions later world."
Tilson said his firm doubled its stake in Berkshire as the shares fell, increasing its holdings to 20 percent of assets under management from 10 percent, and buying some below $75,000 a share. The stock fell as low as $74,100 on Nov. 20, before rising to $90,000 the next day. Investors also were concerned that Berkshire might have to put up collateral, draining cash and setting off a chain of events like those that brought American International Group Inc. to the brink of failure this year. In his e-mail, Buffett said the collateral requirements are "under any circumstances, very minor." Berkshire had $33.4 billion in cash at the end of the third quarter.
Buffett sold the derivative contracts to undisclosed buyers for $4.85 billion. Under the agreements, Berkshire must pay out if, on specific dates starting in 2019, the market indexes are below the point where they were when he made the agreements. In the meantime, Berkshire can use the cash to buy stock or make acquisitions.
The writedowns taken on the derivatives are accounting losses that reflect the falling value of the stock indexes, not cash that Berkshire has paid out. Chief Financial Officer Marc Hamburg told the U.S. Securities and Exchange Commission in July that the firm values the derivative contracts using a model that includes equity prices, interest rates, the dollar's performance against other currencies and market volatility. The SEC had asked for "more robust disclosure" on how Berkshire values the contracts.
GM May Seek Debt Cut, New Union Rules to Win U.S. Aid
General Motors Corp., in danger of running out of cash this year, will seek to negotiate a cut in debt levels and new union work rules to help boost its chances of winning federal loans, people familiar with the plan said. The largest U.S. automaker also may ask to delay a $7 billion payment to a union retiree health fund, drop more brands and rework an accord with GMAC LLC to prove it can survive and repay the government, said the people, who asked not to be named because details haven't been presented to Congress.
Chief Executive Officer Rick Wagoner is under a Dec. 2 deadline set by House Speaker Nancy Pelosi and Senate Majority Leader Harry Reid to show how he'll reshape operations as a condition of a $25 billion industry rescue. Congress may vote on the package on Dec. 8. "A financial restructuring, along with government loans, is an alternative to bankruptcy," said Robert Schulz, a Standard & Poor's credit analyst in New York. "It doesn't fix the economic environment, though, and it's the economic conditions that are causing their cash burn."
Directors are scheduled to meet by phone today, Nov. 26 and Nov. 28, and then gather Nov. 30 and Dec. 1 to review the plan, the people said. Detroit-based GM expects to have a 10- to 12- page public report for a Dec. 5 congressional hearing and an 80- page semi-private report with background material, the people said. Besides courting Congress, Wagoner would have to persuade debt holders to go along with paring GM's debt and the United Auto Workers to amend its 2007 labor contract. The debt and union accords likely won't be done by Dec. 2, the people said.
Lawmakers grilled Wagoner over two days of testimony last week before deadlocking over how to let GM, Ford Motor Co. and Chrysler LLC tap $25 billion in low-interest borrowing amid U.S. sales that may slump next year to the lowest since 1991. Pelosi and Reid agreed to a second lame-duck congressional session and instructed Wagoner and fellow CEOs Alan Mulally of Ford and Robert Nardelli of Chrysler to prepare specifics on how they'll navigate past the crisis. While Republican critics such as Senator Richard Shelby from Alabama have said the auto chiefs were "arrogant" last week and that management changes might be needed, neither the government nor GM's board has signaled Wagoner will need to leave to get an agreement, people said.
GM now has $43 billion in debt, and will need to reduce that total significantly, even after a government loan that may be $12 billion, the people said. Analysts have said any increase in GM's debt load will make it uncompetitive. Should GM exchange debt at levels less than the original value, S&P would consider those issues in default while not necessarily cutting the automaker's overall debt rating, said Schulz. S&P would then consider a new rating for the replacement debt, he said. GM is now rated CCC+, or seven levels below investment grade.
GM's 8.375 percent bonds due in July 2033 fell 3.25 cents to 13.75 cents on the dollar, the lowest price ever, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. The yield rose to 60.4 percent. The shares slid 1 cent to $3.05 at 9:50 a.m. in New York Stock Exchange composite trading. They plunged 88 percent this year before today, the steepest drop among the 30 companies in the Dow Jones Industrial Average.
After burning through $6.9 billion in cash last quarter, GM said Nov. 7 that it had $16.2 billion as of Sept. 30, raising the prospect of falling short by year's end of the $11 billion minimum needed to pay monthly bills. GM has said a bankruptcy filing would be a "disaster." The plan to be presented to Congress may call for rescheduling the cash payment due in 2010 to the UAW trust fund for medical retirees' bills, possibly to allow the government debt to be repaid first, the people said. Such a move would require the consent of the UAW, as would GM's bid to adjust work rules such as the so-called jobs bank that determines how union workers are paid when factories are idled or closed. Changes to the health fund also would need approval in federal court.
While UAW President Ron Gettelfinger testified last week in favor of federal loans for the industry, he has said previously he expects GM and the other automakers to make the trust-fund payments as required under the union's 2007 labor contracts. The UAW is "at the bargaining table every day working on things to make these companies, to put them in better shape," Gettelfinger said in a Nov. 21 interview on Bloomberg Television's "Political Capital with Al Hunt."
GM, which is already marketing the Hummer unit to prospective buyers, will examine the viability of its seven remaining U.S. brands and the geographic distribution of its 6,468 U.S. dealers to cut overlap and boost the profits of the franchise system, the people said. GM also will work with Cerberus Capital Management LP, which owns the 51 percent of GMAC that GM doesn't control, to ensure the success of the lender's plan to convert to a bank- holding company and gain access to the $700 billion bailout fund for the U.S. financial system, the people said. GMAC needs to improve to assist GM with auto loans, they said.
The automaker expects to comply with agreements that federal debt be senior to other borrowing and that the government gain equity and oversight into GM, Ford and Chrysler in exchange for aid, the people said. "My expectation is we're going to see something," House Majority Leader Steny Hoyer, a Maryland Democrat, said yesterday on "Fox News Sunday" about the prospects for automakers presenting a survival plan to Congress next month.
"What we need is to show how they're going to be accountable and secondly how they're going to be viable in the long term," Hoyer said. "Those are the two key questions they have to answer."
Paulson May Ask for Remaining $350 Billion of TARP
Treasury Secretary Henry Paulson, less than a week after indicating he would let the Obama administration decide how to use the second half of the $700 billion financial fund, is considering asking for the money. Paulson may ask Congress for the remaining $350 billion from the Troubled Asset Relief Program as he puts together plans to boost consumer credit. Treasury and Federal Reserve officials are working on an effort to buttress the market for securities backed by auto, student and credit-card loans, Paulson said last week. He's also assembling an office to address mortgage foreclosures.
The plans are a shift from just six days ago, when Paulson told Congress "it was only prudent to reserve our TARP capacity, maintaining not only our flexibility, but that of the next administration." Since then, the collapse in Citigroup Inc. shares threatened a renewed bout of financial turmoil, and forced the Treasury to mount a rescue of the bank late yesterday. "We plan on using our resources aggressively to support the normalization of credit markets and the expansion of credit to support economic recovery," Paulson said in a Nov. 20 speech in Simi Valley, California. "We are actively engaged in developing programs to be implemented when ready."
Paulson's pivot is the latest in a series of changes. He won authorization from Congress in July to aid mortgage companies Fannie Mae and Freddie Mac by saying he doubted he would need to use it, seven weeks before doing exactly that. Two weeks ago he abandoned the TARP's original intent of buying bad bank assets in favor of direct capital injections.
"The markets got awfully shook up when Paulson spoke," said Fred Dickson director of research at DA Davidson & Co. in Lake Oswego, Oregon. "The credibility right now in terms of Treasury and the administration is part of the problem. We're not at all past concerns about financial institutions." The Citigroup rescue came five days after Paulson told the House Financial Services Committee that Treasury and the Fed's actions had resulted in "a significantly more stable banking system where the failure of a systemically relevant institution is no longer a pressing concern rattling the markets." Lawmakers used his appearance to criticize the decision to not use TARP funds for mortgage relief.
"You have systemic fear everywhere," said David Winters, who manages $3 billion as chief executive officer of Wintergreen Advisers LLC in Mountain Lakes, New Jersey. "People don't know what to believe" and "confidence is completely drained out of the system." Paulson, with less than two month left in his tenure, spent much of last week defending his actions. At the Nov. 20 speech at the Ronald Reagan Presidential Library, he pushed back against suggestions that he exacerbated the financial crisis in September by ruling out a government rescue of Lehman Brothers Holdings Inc. "Some have chosen to scapegoat the Lehman failure as the cause of the deepening crisis in September, as opposed to a symptom," he said. "That is at best naïve, and at worst disingenuous."
US Builders Make Plea for Federal Aid
Struggling U.S. auto makers left Washington empty-handed after weeks of pleading for a handout, but that hasn't deterred home builders from stepping up to lobby Congress for help. But any federal assistance would require policy makers to figure out how to stimulate demand for housing -- the problem at the root of the global financial meltdown -- without artificially propping up home values.
The builders' lobby is ramping up its sales pitch for a $250 billion stimulus package called "Fix Housing First," arguing that financial markets won't recover until home prices stop falling. They are calling for a generous tax credit for home purchases and a federal subsidy that would lower a homeowner's mortgage rate. Congress resisted a similar effort to pass a larger tax credit earlier this year, instead creating a $7,500 credit for new-home purchases that had to be paid back over 15 years, effectively extending an interest-free loan. Builders are promoting the campaign with full-page newspaper advertisements, but face an uphill battle, with critics suggesting the proposal is too expensive and that it too heavily promotes home purchases rather than addressing loan modifications for delinquent homeowners.
The effort aims to stop the adverse feedback loop gripping the market. The cycle begins when falling home prices prompt some borrowers to default, leading to foreclosures. That further depresses home prices, hitting the banks that hold mortgage-backed securities, causing them to pull back and freeze credit. That in turn causes the economy to slow. "The basic asset that is underlying all the financial problems that we're experiencing is highly unstable, and it's causing an ongoing hemorrhaging in the financial system," said David Ledford, who oversees housing finance and policy for the National Association of Homebuilders. "It's starting to snowball." The homebuilders' proposal would offer home buyers a tax credit equal to 10% of the home's value, capping it at $22,000, nearly three times the $7,500 credit Congress offered to new buyers earlier this year. Builders say the earlier credit didn't work because it wasn't big enough and had to be repaid.
Builders also want subsidies for interest rates on 30-year fixed-rate mortgages for government-backed "conforming" loans, which currently are around 6.2%, to bring rates down to 3% for loans made in the first half of 2009 and 4% for those in the second half of the year. Realtors are pushing a 4.5% interest-rate buy-down for new loans. Lawrence Yun, the chief economist for the National Association of Realtors, estimates that each 1% decline in interest rates could generate between 500,000 and 800,000 home sales. A rate reduction of about 1% on a 30-year mortgage typically costs the lender -- in this case the government -- around 4% of the principal. So a 2% buy-down on a $200,000 mortgage would cost $16,000. The NAHB estimates the subsidy portion of its proposal would cost the Treasury $143 billion.
But to some economists, "Fix Housing First" strikes an all-too-familiar refrain of "build more homes." Housing economist Thomas Lawler implores builders to "stop building." He and others argue that effectively setting a floor for home prices will prolong the pain because it will keep supply and demand out of sync. "The government does not have the tools to rewrite the laws of supply and demand," said Harvard University economist Edward Glaeser. "By artificially increasing prices, we are encouraging more building." Homebuilders frequently point to a similarly structured tax credit and interest-rate subsidy that Congress approved in 1975. The program gave qualified buyers a 5% credit up to $6,000 and bought down interest rates by around 1.5%, to 7%.
But a historical parallel could be misleading. In 1975, the U.S. was exiting -- not entering -- a recession, one induced by oil prices, and not a sharp run-up in housing prices. "You can offer people all sorts of credits, but if they don't have a job or income I don't know that they're going to take the bait," said Jared Bernstein of the Economic Policy Institute. Another potential hitch is that creating an incentive to buy, but not a mechanism to refinance existing mortgages, could prompt some people to purchase a new home on more favorable terms and then bail on their existing one. However, banks -- along with mortgage giants Fannie Mae and Freddie Mac -- have tightened restrictions on buying second homes to guard against such a maneuver.
Even critics of the proposal, however, worry that home prices could continue falling to below historical averages for a normal market. "The biggest question is, will there be an overshoot to the downside because of tightening mortgage credit and a declining prices on foreclosed homes," Mr. Lawler said. Indeed, the debate hinges on how much further economists believe home prices have to adjust before they are in line with historical norms relative to income. Mr. Yun, of the realtors' group, said the NAR's "Affordability Index" shows that most markets have returned to their pre-bubble levels, though he said some of the most overheated markets still have a ways to readjust. Already, the government has taken steps to subsidize the mortgage market by approving larger loan limits for Fannie Mae, Freddie Mac and the Federal Housing Administration, which together account for more than eight-in-10 new loans.
Other critics say that while a large tax credit could motivate buyers to get off the fence, it would do nothing for homeowners unable to refinance mortgages they can't afford, which is arguably a bigger problem. One idea with broader support -- but with a potentially bigger price tag -- is an interest-rate buy-down that would allow existing homeowners to refinance to lower rates. Chris Mayer, senior vice dean of Columbia Business School, has suggested that the government push interest rates down to 5.25% for homeowners who prove that they can afford to live in their new homes and can document their income.
Why Obama's Economic Program Will Collapse
Obama wasn't kidding when deferred to FDR as an economic guide. Roosevelt was an unmitigated economic disaster. His economic program of trying to maintain money wages and prices was a formula for mass unemployment. Nevertheless, the brilliant Mr Obama sees it otherwise: hence his dangerous proposal for public works of the Roosevelt kind plus his ridiculous promise to create 2.5 million jobs.
Let's first deal with the job situation. That maggot-infested carcase that we call the mainstream media has been busy burying economic views that point out that Obama's energy and tax policies are a direct assault on jobs and investment. Like all true ideologues he and his media supporters are impervious to facts. The US is the greatest job-creating machine in history. In 1970 there were 78.678 million Americans in jobs. By 2006 employment had climbed to 144.427 million. (These figures refer to the civilian labour force). The Obama's of this world do not create real jobs -- they destroy them.
The principle criticism of Obama's New-New Deal is that by the time any real money is spent on these grand projects the recession is over. This is because these projects take years of planning. According to these writers the basic problem is one of time lags. In support of this view they a Congressional Budget Office report that stated:Large-scale construction projects of any type require years of planning and preparation. Even those that are 'on the shelf' generally cannot be undertaken quickly enough to provide timely stimulus to the economy.
The error here is that these writers have assumed that Obama and his mates are focused on projects that would at least have some utility. Not at all, to Obama work is work irrespective of whether it has utility or not. As his other half Michelle said: "He will expect you to work". His expectations are unnecessary. Americans have always been ready to work. They don't need to be told otherwise by someone who went from university straight into the Democrats' corrupt Chicago machine and then into the Oval Office.
It's because of his primitive view of work that it seems he would consider any labour intensive scheme to be worth subsidising so long as it took people off the dole. Let us not forget that totalitarian states never had a problem with putting people to work. Their problem was always one of how to raise real wages. It's a problem they never solved -- only the free market can do that. Other critics have stressed that public works schemes implemented to reduce unemployment are actually destructive of jobs and investment.
If the money is collected out of taxes and savings then private spending and investments will fall. In addition, no matter how labour intensive the public works program is it will still drain resources from other parts of the economy. Hence the combination of taxation, borrowing and spending will destroy investments and firms that are resting on the margin. Notwithstanding the fact that all of these criticism are both valid and important a vital element is missing. The so-called boom-bust cycle is said to be the reason why the US economy is sliding into recession. Now there is no such cycle. What we do have are central banks that think that by manipulating interest rates and the money supply (no matter how they define it) they can stabilise the economy.
If only they were right. In fact, it's their monetary shenanigans that generates the booms that always ends in tears. When a central bank's loose monetary policy triggers a boom the production structure is distorted by creating malinvestments, investments that are not economically sustainable. When the recession breaks these malinvestments appear as idle capital. Unless they are liquidated they will continue to drag down the economy. This is why Japan's policy of massive funding of public works failed to lift the country out of recession, even though this has been going on for more than ten years.
I think the Japanese experience puts to rest the view that the problem with public works is the time lag. If Japan had ignored the advice of Keynesians and allowed the necessary economic adjustments to be made there is no doubt in my mind that there would have been a rapid recovery. Now this is not the first time Japan attempted to avoid the costs of a boom by halting the vital liquidation process that purges the economy of malinvestments.
During WW I the Japanese economy boomed. It also accumulated a mass of imbalances (malinvestments). In 1920 the economy crashed and the price level dropped, but not far enough. Rather than allow the depression to run its course and liquidate the malinvestments Japan tried to arrest the process and save its banks and other financial institutions. This policy kept Japan in depression for seven very long years, years filled with political instability and rising militarism.
In 1927 the internal contradictions of this policy were finally resolved by what was probably the severest financial crisis in Japanese history. It brought down industries and wiped out many branch bank systems. This was followed by about 18 months of consolidation that unfortunately helped build Japan's war machine. Thus ended Japan's first New Deal policy, all because she did not follow the American example of 1920-21 and allow market processes to fully liquidate her unsound investments and eliminate excess inventories.
The irony here is that Hoover and Roosevelt basically implemented the same policies that post-war Japan did, without, fortunately, the same political consequences. Any attempt to kick-start an economy with a program of public works, more regulations, higher taxes and greater government spending is doomed to fail. Such a program failed under Roosevelt, if failed in Japan and it will fail under Obama if he implements.
Why CitiGroup is About to Be Bailed Out and Not General Motors
Citigroup was once the biggest U.S. bank. General Motors was once the biggest automaker in the world. Now, both are on the brink. Yet Citigroup is likely to be rescued within days. General Motors may not be rescued at all.
Why the difference? Viewed from Wall Street, Citi is too big and important to be allowed to fail while GM is simply a big, clunky old manufacturing company that can go into chapter 11 and reorganize itself. The newly conventional wisdom on the Street is that the failure of the Treasury and the Fed to save Lehman Brothers was a grave mistake because Lehman's demise caused creditors and investors to panic, which turned the sub-prime loan mess into a financial catastrophe -- a mistake that must not occur again. But GM? GM is only jobs and communities. Citi is money.
The Street's view of the world is fundamentally flawed. Banks are important to the economy because they're financial intermediaries. They connect savers with investors and borrowers. This is a vital function, but there's nothing magical about it. At any given time the world contains a vast pool of money that can be put to all sorts of uses. Financial intermediaries simply link the pool to the uses.
To be sure, savers need to believe that intermediaries are trustworthy; otherwise, savers will prefer the underside of their mattresses. That's why governments regulate intermediaries, insure deposits, and do whatever else needs to be done to make savers feel safe. What governments and societies fear most are "runs" on banks -- panicked efforts by depositors to pull their money out all at once, before banks can possibly collect the money from all those who have used it to borrow or invest. That's what happened in the 1930s.
But the current panic on Wall Street is not a "run" in this sense. It has almost nothing to do with banks' roles as financial intermediaries. It's about money that's been lent to or invested in the banks themselves, in order to profit off of the banks' profits. Lehman's demise cost many investors and creditors lots of money, to be sure, but they were investors and creditors in Lehman, not in the real economy.
Before the asset bubbles burst, financial institutions were generating whopping profits, so naturally they attracted many investors and creditors. After the burst, the profits disappeared. These days, you'd be hard pressed to find many people who want to invest in or lend to financial institutions. Citigroup had a market value of $274 billion at the end of 2006. Now its value is about $21 billion. That's awful news for Citi, its executives and traders, and its investors and creditors. But it's not necessarily awful news for the economy as a whole. Even if Citigroup were to go belly up, the real economy would not be seriously harmed. The mutual funds, pension funds, and deposits overseen by Citi would be safe; fund managers would find their way to other banks.
In other words, Citigroup is not much different from General Motors. It's a company that once made lots of money but, through a series of management blunders, is now losing money hand over fist. Just like the shareholders and creditors of GM, Citi's shareholders and creditors are taking a beating.
So why save Citi and not GM? It's not clear. In fact, there may be more reason to do the reverse. GM has a far greater impact on jobs and communities. Add parts suppliers and their employees, and the number of middle-class and blue-collar jobs dependent on GM is many multiples that of Citi. And the potential social costs of GM's demise, or even major shrinkage, is much larger than Citi's -- including everything from unemployment insurance to lost tax revenues to families suddenly without health insurance to entire communities whose infrastructure and housing may become nearly worthless. I'm not arguing that GM should be bailed out; as I've noted elsewhere, GM's creditors, shareholders, executives, and workers should have to make substantial sacrifices before taxpayers should be expected to sacrifice as well.
Nonetheless, Citi is about to be bailed out while GM is allowed to languish. That's because Wall Street's self-serving view of the unique role of financial institutions is mirrored in the two agencies that run the American economy -- the Treasury and the Fed. Their job, as they see it, is to keep the financial economy "sound," by which they mean keeping Wall Street's own investors and creditors happy.
Because the public doesn't understand the intricacies of finance, it's easily persuaded that this is the same thing as keeping credit flowing to Main Street. That's why the public and its representatives have committed $700 billion of taxpayer money to Wall Street and another $500 to $600 billion of subsidized loans to the Street from the Fed -- bailing out the investors and creditors of every major bank, including , momentarily, Citi -- only to discover, at the end of this frantic and unbelievably expensive exercise, that American jobs and communities are more endangered than they were at the start.
Gilt Avalanche Looms on U.K. Recession, Revenue Slump
The U.K. may sell a record amount of gilts this year as Prime Minister Gordon Brown struggles to stave off a recession that's stifling tax revenue, according to a survey. The government will issue 138.1 billion pounds ($207 billion) of bonds in the year ending March 31, according to the median forecast in a survey of 11 banks that deal directly with the U.K. Treasury. That's more than double the amount sold last year and up from the 80 billion pounds the government estimated in March. Chancellor of the Exchequer Alistair Darling will set out the government's spending plans in the pre-budget report today.
"There's going be a big revision on borrowing, possibly even bigger than what the market is expecting," said John Wraith, head of sterling product development in London at Royal Bank of Canada Ltd. "It's a consequence of a sharp fall in tax receipts because of the financial and economic troubles. The surge in gilt issuance certainly increases the risk that somewhere along the way, bond auctions may go wrong." The government will issue 130 billion pounds of gilts, RBC said.
Brown pledged 37 billion pounds last month to bail out Royal Bank of Scotland Group Plc, HBOS Plc and Lloyds TSB Group Plc, three of the nation's biggest banks, and help thaw a lending freeze that brought the economy to the brink of a recession. Gross domestic product shrank 0.5 percent in the third quarter, after zero growth in the second. The slump will extend well into 2009, the Bank of England said Nov. 12.
A poll by ICM Ltd. published in yesterday's Sunday Mirror newspaper put Brown's Labour Party at 31 percent, 11 points behind the Conservatives' 42 percent. ICM interviewed a random sample of 1,010 voters by telephone on Nov. 19-20, weighting results to the profile of all adults. Britain's budget deficit swelled to 37 billion pounds in the first seven months of the fiscal year starting April 1 as tax receipts dwindled, the Office for National Statistics said Nov. 20. It was the largest gap since records began in 1993.
The deficit will top 63.9 billion pounds this year, according to the median forecast of 32 economists surveyed by the Treasury on Nov. 19. That will rise to 87.3 billion pounds in the year through April 2010 and to 97.5 billion pounds in 2011, or 6.5 percent of gross domestic product. The government's original gilt-issuance estimate in March for financing the shortfall was revised to 110 billion pounds in October when it decided to bail out the troubled banks. The cost of hedging against losses in U.K. government debt rose to a record today as the outlook for country's public finances deteriorated. Credit-default swaps on gilts rose 4 basis points to 87.5, according to CMA Datavision prices.
"As the banking system struggles to obtain funds to lend, the government is set to use its borrowing power to boost activity," said Andre de Silva, deputy head of fixed income at HSBC Holdings Plc in London, which predicted the government will sell 150 billion pounds of gilts this fiscal year. "Keynesian economics, boosting demand through fiscal spending, is back." Britain's government bonds returned 6.8 percent this year, according to Merrill Lynch & Co.'s U.K. Gilts Index. U.S. and European government bonds handed investors 9.1 percent and 7.4 percent, respectively, Merrill's U.S. Treasury Master and EMU Direct indexes showed.
Governments in the world's biggest economies are increasing borrowing to finance bank bailouts amid the worst economic slump since the Great Depression. The U.S. will issue at least $1.5 trillion of debt in 2009 while the euro-region nations will borrow as much as 880 billion euros ($1.1 trillion), according to Royal Bank of Scotland. Gilts fell today as investors demanded higher yields to compensate for the prospect of increased supply. The yield on the 10-year note rose four basis points to 3.90 percent as of 10 a.m. in London. Yields move inversely to bond prices.
Gilt sales are unlikely to drop below 100 billion pounds any time soon, according to Deutsche Bank AG, the world's biggest bond trader in 2007, according to Euromoney Institutional Investor Plc. Gilt issuance will be 150 billion pounds for this year, 130 billion pounds next year and 140 billion pounds the year after, Deutsche Bank said. "The situation is pointing to significantly weakening public finances," said George Buckley, chief U.K. economist at Deutsche Bank in London. "It might take a couple of years until you start seeing the peak in government borrowing. It normally takes two years before slowing GDP has a maximum impact on the deficit."
The 11 banks that participated in the survey belong to the group of 15 so-called Gilt-Edged Market Makers, or GEMMs. They are Barclays Capital, BNP Paribas SA, Credit Suisse Group AG, Deutsche Bank, Dresdner Bank AG, HSBC, JPMorgan Securities, Morgan Stanley, Royal Bank of Canada, Royal Bank of Scotland and UBS AG. Britain was among the world's first issuers of government bonds, selling debt in 1693 during the reign of King William III to fund a war with France.
UK Unemployment to near 3m next year, says CBI
Unemployment will rise to almost three million next year and the economy will contract by almost two per cent, following a "dramatic drop-off in business conditions" over the past two months. The Confederaton of British Industry (CBI) delivered its gloomy outlook forecast as it revised sharply downwards earlier forecasts made in September.
The employers' organisation predicts that the recession, which started in the third quarter of this year, will now run for most of 2009 and unemployment will peak at close to 2.9 million. An earlier prediction that the economy would grow by just 0.3 per cent next year has been scaled back to a forecast of a 1.7 per cent contraction. John Cridland, CBI Deputy Director-General, said: "What is clear is that the short and shallow recession we had hoped for a matter of months ago is now likely to be deeper and longer lasting."
The CBI has downgraded its expectations for UK economic growth "given the speed and force at which the downturn has hit the economy," said Mr Cridland. "But the fast-moving and global nature of this crisis means it is impossible to look far ahead with any certainty." Falling inflation, though, would clear the way for further cuts in bank rates. The CBI expects inflation to fall to 1.7 per cent by the end of next year, undershooting the Bank of England's 2 per cent target. Interest rates could therefore be cut to as low as 1.5 per cent.
The CBI says that it expects the economy to shrink quarter-on-quarter by 0.8 per cent between October and December this year, and to contract again for the next three quarters before beginning a slow recovery throughout 2010. Mr Cridland added: "An unwelcome consequence of the downturn will be a significant loss of jobs, many of them in sectors that have been relatively insulated until now."
High earners in UK to pay 45% tax as borrowing soars
Top earners face higher taxes as Gordon Brown and Alistair Darling reduce a borrowing bill that will hit nearly £120 billion next year. The Chancellor is expected to announce a new top rate of tax of 45 per cent that will apply to those earning more than £150,000. The new rate – which is likely to come into effect immediately after the next general election – is expected to be among the deferred tax rises announced to show how the Treasury intends to rebalance the books. It will affect nearly 300,000 people and raise about £1.2 billion.
Borrowing will rise sharply to record levels next year after Mr Darling today slashes VAT to 15 per cent, cuts income tax by £120 for those on the basic rate and postpones planned rises in vehicle duty and corporation tax. In the most important Pre-Budget Report since Labour came to power, the Chancellor will announce a tax-cutting and spending package worth about £16 billion aimed at helping people to get through the recession.
He will say that without it the downturn would be deeper and longer. The price will be heavy, however, with borrowing likely to soar to about £70 billion this year and then to a hoped-for peak of £120 billion the following year. The combined total equates to almost £10,000 per family. To pay for that Mr Darling will set out a series of deferred tax rises, alongside reductions in the growth of spending, designed to reassure the markets that the borrowing figure will decline sharply over the following three years.
Mr Brown resisted the temptation throughout his ten years as Chancellor to raise tax rates, although he introduced a one-off national insurance rise to increase health spending. However, he and Mr Darling know that they have to show that the borrowing surge will be reversed, and to specify the means of doing it. They believe that a higher rate for top earners would not be generally unpopular. The VAT cut from 17.5 per cent to 15 per cent, costing about £11 billion, will last just over a year before the rate reverts to 17.5 per cent early in 2010.
Mr Darling will announce plans to get banks lending to small companies again with an expansion of government guarantees for loans. A 1p rise in corporation tax for small companies will be postponed and firms will be told they can delay payment of tax bills if they are in trouble. School and hospital building projects will be brought forward to help the construction industry, as will a big "green" programme to make council houses more energy efficient.
Mr Brown said yesterday that to do nothing would be irresponsible and uncaring. "I don't see this as a gamble. I see this as necessary, responsible action that any sensible government would want to take. Those people who say do nothing now would leave people as in the 80s and 90s without hope that their mortgage or job problems could be sorted out," he said.
He suggested that the Conservative approach lacked compassion. In an obvious attempt to compare David Cameron's attitude to Margaret Thatcher's hardline stance in the 1980s, he added: "I really despair of people who say in a moment of difficulty facing a country there's nothing we can do . . . it's back to the idea that unemployment is a price worth paying."
Mr Cameron said that the PreBudget Report might not provide any lasting benefit because people were aware of the "tax bombshell" they faced in future to repay the national debt. "I think people are going to be shocked when they see the extent of government borrowing," he said.
World's house values fall for the first time
Global house prices fell for the first time on record over the past three months, underlining the extent of the downturn. Britain, which recorded falls of 4.6% during the quarter, was among the worst performers along with Latvia (6.2% down), Norway (4.5%) and Canada (4.9%), according to the property consultancy Knight Frank. The firm's global house price index said average prices across the world fell by 0.3% compared with the second quarter.
"It is now clear that no part of the world is likely to escape the credit crunch as property prices start to fall in more and more parts of the globe," said Nicholas Barnes, head of international research at Knight Frank. "We expect that trend to continue with the majority of locations showing zero or negative growth by the end of the year."
On an annualised basis, global house prices continued to grow, though the rate of 3.8% compared with the third quarter last year, has slowed. Over the past year, prices in Britain have suffered the fourth largest percentage decline in the table of 44 nations compiled from official national statistics. Compared with the third quarter in 2007, house prices in Britain have fallen by 10.6%. In Estonia prices have dropped by 16%, in the US prices are down 16.3% and Latvia declined by 24.1%.
Several countries, chiefly in eastern Europe, have seen strong growth over the past year, led by Slovakia, where prices have risen by 31.2%, Russia is 26.9% ahead and Bulgaria is up 26.8%. But in each case, growth has slowed sharply, suggesting they are reaching a turning point. In Slovakia, growth compared with the second quarter had slowed to 4.9%, in Russia the figure was 4.2% and in Bulgaria 3%.
"There are signs that some of the strongest performers of previous quarters are starting to weaken," Barnes said. The data also highlights the speed with which the British economy has reversed compared to others. In the same survey a year ago, Britain was showing annual house price growth of 9.5%, placing it 22nd in the rankings.
Dubai, included in the survey for the first time, is showing a 76.1% growth in house prices compared to the third quarter of 2007. Even in the oil-rich state demand is dropping, with prices easing at 15.7% against 42.4% in the second quarter.
The Economy Fell off the Cliff
SPIEGEL: Mr. Soros, in spite of massive interventions by governments and federal banks the financial crisis is getting worse. The stock markets are in free fall, millions of people could lose their jobs. More and more companies are in trouble, from General Motors in Detroit to BASF in Ludwigshafen. Have you ever seen anything like it?
Soros: Never. I find the present situation dramatic and overwhelming. In my latest book "The New Paradigm for Financial Markets: The Credit Crisis of 2008" I predicted the worst financial crisis since the 1930s. But to tell you the truth: I did not actually anticipate that it would get as bad as it did. It has gone beyond my wildest imagination.
SPIEGEL: What are your fears for the coming months?
Soros: I think that the dark comes before dawn. The financial markets are under great pressure because of the lack of leadership during the transition period. In the next two months, the markets will experience maximum pressure. Then we will see some initiatives from the Obama administration. How long the crisis lasts will depend on the success of these measures.
SPIEGEL: The markets don't seem to have much confidence in the new president -- in stark contrast to the enthusiasm in the population. Since Election Day on November 4, stocks have fallen by almost 20 percent.
Soros: I have great hopes for Barack Obama. But at the time of the election the financial community had not yet fully grasped the magnitude of the economic decline. They did not anticipate that the default of Lehman Brothers would cause cardiac arrest in the markets. The economy fell off the cliff, you begin to see mangled bodies lying at the bottom.
SPIEGEL: Was it a policy mistake to let Lehman Brothers go bankrupt?
Soros: It was a fatal mistake. I would have never expected that the authorities let such a big investment bank go.
SPIEGEL: Will there be more victims?
Soros: Possibly. CitiBank, one of the world's largest banks, is currently at the center of attention (eds. note: The $300 billion US government plan to stabilize CitiBank had not been approved by the time of this interview). There are some other bodies lined up for potential trouble. The situation is very similar to the 1930s -- but it is going to unfold differently. We have learned not to allow the financial market to collapse. We will spend all the money in the world to prevent that from happening.
SPIEGEL: Obama is supposed to save the banks, bail out the auto industry and boost the economy in general. Can a single person ever live up to such high expectations?
Soros: Perhaps not, but the problems can be handled much better than they have been by the current administration.
SPIEGEL: Currently, Treasury Secretary Henry Paulson is in charge of the bail-out. What are your misgivings about his performance?
Soros: He reacted to problems as they arose; he had no capacity to anticipate them. When he allowed Lehman Brothers to fail, the breakdown of the financial markets found him totally unprepared. He went to Congress not with a plan but with a plan to develop a plan. And the plan he had in mind -- to purchase toxic assets -- was ill-conceived. Injecting equity capital into the banking system made much more sense and he eventually came to see that, but again he went about it in the wrong way. Then he stopped doing anything, leaving a vacuum in leadership, and the markets collapsed.
SPIEGEL: What are your expectations for the next Secretary of the Treasury?
Soros: I think we need a large stimulus package which will provide funds for state and local government to maintain their budgets -- because they are not allowed by the constitution to run a deficit. For such a program to be successful, the federal government would need to provide hundreds of billions of dollars. In addition, another infrastructure program is necessary. In total, the cost would be in the 300 to 600 billion dollar range.
SPIEGEL: In addition to the $700 billion bailout for the financial industry?
Soros: Definitely. I think this is a great opportunity to finally deal with global warming and energy dependence. The US needs a cap and trade system with auctioning of licenses for emissions rights. I would use the revenues from these auctions to launch a new, environmentally friendly energy policy. That would be yet another federal program that could help us to overcome the current stagnation.
SPIEGEL: Your proposal would be dismissed at Wall Street as "big government." Republicans might call it European-style "socialism."
Soros: That is exactly what we need now. I am against market fundamentalism. I think this propaganda that government involvement is always bad has been very successful -- but also very harmful to our society.
SPIEGEL: Would you advise the new president to say that publicly?
Soros: He has already spoken about changing the political discourse . I think that it is better to have a government that wants to provide good government than a government that doesn't believe in government.
SPIEGEL: However, even a strong government can't perform miracles. It needs money from the taxpayers. There is a lot of talk in the US about the new role of the state and the government -- but no one seems to be willing to pay for it. Obama has announced to cut taxes for 95 percent of working Americans. Isn't that a contradiction?
Soros: At times of recession, running a budget deficit is highly desirable. Once the economy begins to recover, you have to balance the budget. In 2010, the Bush tax cuts will expire and we should not extend them. But we will also need additional revenues. Should the government not receive them, we will all get punished with higher interest rates.
SPIEGEL: Everybody says we have to regulate the financial markets more. That sounds good, but is it realistic? Can one really tame the markets?
Soros: Between regulators and market participants, there is a cat and mouse game going on which has been going on indefinitely…
SPIEGEL: ….where often the mice, the market participants, have the upper hand.
Soros: Because they got the extra boost from market fundamentalists. But the outcome was disastrous, as we see now. I think it is better to have a cat and mouse game where the cat has the upper hand than a cat and mouse game where the mice are ruling. Because the latter means that the market participants are given free range. That was actually the big misconception of our national hero Ronald Reagan who always talked about the magic of the market.
SPIEGEL: So, you support stricter regulation and more efficient control of the markets?
Soros: Indeed. However, you have to recognize that regulations will never be completely successful and they will always be full of holes. You must constantly be ready to fill new holes. Actually regulation should be kept to a minimum, but there has to be some cooperation between market participants and authorities -- as was the case in the early post war years. The Bank of England was a very successful regulator by cooperating with market participants. This cooperative spirit was broken by the market fundamentalists.
SPIEGEL: Not in Germany. We have many semi-private banks that largely dominate the market. Politicians serve on their supervisory boards. But they are in particularly bad shape.
Soros: These public-private partnerships are very, very dangerous. The most rotten part of the financial system in the US consisted of the government sponsored entities, Fannie Mae and Freddie Mac. They really kicked off this crisis. The state should set the rules and enforce them -- but not become involved as a market player.
SPIEGEL: You are one of the most powerful speculators in the world and have been heavily involved in your fund's activities over the past few months. How do you cope with the dilemma of being a speculator -- who often profits from a business transaction that might hurt society?
Soros: This is a false issue. I always play by the rules. At the same time, I try to improve the rules. In so doing I often suggest changes from which I would not personally benefit. I have the common interest at heart, not my personal interest.
SPIEGEL: But the perception many people have of you and your colleagues is very different. They blame speculators for the current financial crisis -- is that the reason for your decision to give billions of dollars to charity and your foundation?
Soros: People think I am giving money because I have pangs of conscience.
SPIEGEL: Isn't there some truth to it?
Soros: No. It is a total misconception. The big events in which I participated would have occurred whether I took part in them or not. For example, whether I had been born or not, the British pound would have been forced out of the European Exchange Rate Mechanism in 1992.
SPIEGEL: But are you really such a little wheel as you claim? If you bet against grain, rice or oil, many other investors follow suit. That could hurt consumers who can no longer afford essential foodstuffs or energy. You can definitely influence markets.
Soros: Since I became a public figure, the man who allegedly "broke the Bank of England," I have been cast as a financial guru who can influence markets. That has actually created more moral problems for me. It has forced me to impose certain self-constraints in my statements -- exactly because I can move markets, like the investor Warren Buffett. Therefore, we try to act very responsibly.
SPIEGEL: Does the world need hedge funds?
Soros: I think that hedge funds are a very efficient way of managing money. But I clearly see the risks. Hedge funds use credit and credit is a source of instability. My conclusion is that transactions involving credit should be regulated.
SPIEGEL: Now you sound like a person who runs to a police station and tells the officers: "Please, handcuff me -- I am dangerous!"
Soros: Not really. I think there need to be appropriate regulation of the financial markets, But it is impossible to prevent speculation. There is very little difference between speculation and investment. The only difference is basically that investments are successful speculations because if you successfully anticipate the future you make a speculative profit. I don't have a bad conscience at all. I am very proud to be a successful speculator.
SPIEGEL: Average citizens are not much impressed: They no longer trust Wall Street.
Soros: That mistrust is well placed. Those very prestigious institutions on Wall Street pursue their self-interest, and that is not identical to the common interest -- which needs to be protected.
SPIEGEL: Many people also no longer have confidence in the bailout measures taken by the Bush administration. Some critics claim that Treasury Secretary Henry Paulson is simply trying to bail out his former colleagues on Wall Street. Paulson was once the CEO of Goldman Sachs.
Soros: That may be going too far. But it is true that Paulson sees the problems too much from the perspective of a Wall Street banker.
SPIEGEL: He is also reluctant to push for salary caps for CEOs or bonus restrictions at banks receiving government aid.
Soros: Giving government aid to a bank basically transforms it into a utility. The huge salaries in this sector are only a symptom of a more profound misalignment. The profitability of the finance industry has been excessive. For a while, 35 percent of all corporate profits in the UK and the US came from the financial sector. That was absurd.
SPIEGEL: We talked a lot about the losers of the current financial disaster. Do you also see winners?
Soros: China could easily emerge as the great winner if the Chinese leaders handle the situation well. On the other hand, they could also turn out to be the biggest losers if they handle it poorly. If the management turns out be wrong, this could lead to a political crisis in China. It's still too early to declare winners and losers.
SPIEGEL: Could Obama be the first "post-American president" -- because his country loses economic force and "soft power"?
Soros: If Obama is wise, he will find common ground with China to solve this crisis. If he wants to do it alone, we will go into a worldwide depression because America is not in a position by itself to clean up the mess it created.
SPIEGEL: Mr. Soros, thank you very much for this conversation.
Six billion euro package to stimulate Dutch economy announced
The Dutch government has announced a six billion euro package of measures to stimulate consumer spending and help the economy withstand the worldwide financial crisis. Announcing the plans on Friday evening, prime minister Jan Peter Balkenende said that it is 'all hands on deck' as the country moves into a difficult economic period.
The most significant measure in the package is the re-introduction of accelerated write-offs on investments for businesses, which is expected to generate 2 billion euros in tax benefits for companies. The government will also allow firms that have to lay-off workers or introduce shorter working hours as a result of the credit crisis to use the unemployment benefit fund to pay employees for up to 24 weeks. Some 200 million euros is available for this.
The government will also make sure that it pays its bills to businesses on time. And to stimulate consumer spending, the lock-up on employees' tax-free savings schemes will be lifted. Under current regulations money invested in this scheme cannot be accessed for four years. Other measures include the possibility of speeding up building procedures to help the construction sector and bringing investments in infrastructure projects forward.
Ministers say all these measures are necessary because the country is starting to feel the effects of the credit crisis. Economic growth has reached a standstill, unemployment is rising and companies hare seeing a fall in orders and finding it harder to get credit. The aid package is the equivalent of around 1 percent of the gross national product and as such pre-empts a rescue plan currently being prepared by the European Union for all member states.
Balkendende expects the new Dutch measures count as the Netherlands' contribution to this plan.
Cash not yet king again, but coup may be coming
This holiday season, cash is in vogue again as consumers — maxed out on credit cards or trying to stick to a budget — are buying what they can actually pay for. Stores like J.C. Penney Co., Wal-Mart Stores Inc. and Target Corp. are noting a decline in credit card use as an overall form of payment, in favor of cash or debit cards.
The details:
CREDIT CLAMPDOWN: Since the financial meltdown accelerated in September, credit card issuers are further tightening their standards. A survey by the Federal Reserve released Nov.3, found that a sizable percentages of banks had "continued to tighten their lending standards and terms on all major loan categories over the previous three months." Nearly 60 percent of banks responding to the survey said they had tightened lending standards on credit card debt.
IMPACT ON RETAILERS: The trend is worrisome to retailers since paying in cash limits spending. Many stores are coming out with generous interest-free financing offers to make it easier for shoppers to splurge. Meanwhile, some upstarts are seeing new opportunities. Marwan Forzely, president and CEO of ebillme.com, an online option that doesn't require a credit card and allows Web shoppers to pay for purchases through their online bank accounts — says he expects to quadruple sales volume and the number of retailers he signs up as partners this year.
IMPLICATIONS FOR SPENDING: Buying what you can afford could be a new way of life for shoppers, who account for more than two-thirds of economic activity. Experts say the changes in consumer behavior may last long after this downturn and Americans are likely to stick with the more prudent ways of their parents or grandparents.
Experts predict aggressive promotions for electronic goods on 'Black Friday'
Lorraine Harrison scanned the flashy laptop computers seemingly yelling at her to buy them from the stuffed shelves at Circuit City.
The hard drive in her old Hewlett-Packard died, and a high-octane Toshiba model caught her attention, but it listed for just under $1,000. Beside it, she looked at a 15-inch Sony with less computing power for just over $500. Though the Sony was in her price range, she said she probably won't buy it this year.
"I'm working in landscaping, and the economy is horrible right now," the North Charleston resident said. "If I get anything this year, it would probably be an iPod for my daughter." Over at Best Buy meanwhile, Edna Carlton of Santee was in Charleston looking for a new 32-inch flat-screen TV to replace her old 19-inch analog bedroom set before the nationwide switchover to the all-digital TV signals in February.
The retired secretary set her budget at no more than $600 for a new television, but she didn't buy the Panasonic she was looking at. She's bargain hunting and planned to look around at competitors before making a purchase. "If it works out, I will get it this year," she said.
Harrison and Carlton represent the struggle that consumer electronics retailers face this year in not only luring customers into their stores, but getting them to buy once they are there. This is the time of year when such retailers ring up more than 30 percent of their annual sales, yet no one has a clear picture of just what shoppers will focus on. Many consumer electronics merchants already are hurting.
The faltering Richmond, Va.-based Circuit City closed 155 stores earlier this month and then filed for bankruptcy a week later. Its two stores in North Charleston and Mount Pleasant remain open, but it's anyone's guess how long they can survive the economic turmoil that has enveloped the nation. Canton, Mass.-based home and car stereo retailer Tweeter is closing all 103 of its stores, including one at Mount Pleasant Towne Centre, and liquidating the merchandise and fixtures, another sign of the trying times in not only the consumer electronics market, but the retail market in general.
The National Retail Federation predicts sales this holiday season will be about 2 percent above last year, and some retail analysts predict flat or negative sales this year. "It's scary," Harrison said. "All the places that are going out of business. Linens 'n Things ... and now Circuit City has filed for bankruptcy. Where's the bottom?" "I think it's going to get worse before it gets better," said Don Kleckner, a retired IBM programmer who moved from Colorado to the new Del Webb retirement community in Berkeley County earlier this month.
He and his wife were shopping for a flat-screen TV for their new home at the new H.H. Gregg store in North Charleston. They settled on a 47-inch model worth about $1,700. To counter what is expected to be one of the leanest shopping seasons in at least six years and possibly decades, consumer electronics merchants are pulling out all the stops to ring up what in past years were considered average holiday sales numbers. Though wounded, Circuit City hasn't given up. It touts its one-price promise no matter whether customers buy in a store or online.
Tweeter is discounting everything from 20 percent to 50 percent off until it's all gone, said Patrick Clise, a project manager who specializes in installations. He laments the store's demise and the 20 employees who will lose their jobs. "In the long term, this is going to hurt everyone. It's the Wal-Marting of consumer electronics," said Clise, who plans to open his own installation business to be called Tech Savvy when his job runs out.
Unlike other retailers this year, who have their own problems with tight-fisted shoppers, consumer electronics merchants face an even harder sell. "Their fortunes do not look very good," said Britt Beemer, chairman and founder of Charleston-based America's Research Group, a consumer research firm. "We have watched an incredible deflation in the electronics industry."
He said Wal-Mart, the world's largest retailer, introduced 42-inch, flat-screen TVs for $999 two years ago and $799 last year. This year, a leaked advertisement showed that Sears will offer a similar TV for $699 the day after Thanksgiving, known in retail circles as Black Friday, to lure shoppers into its stores. If true, Beemer said, he would not be surprised to see Wal-Mart undercut that.
"They could break $599 on Black Friday," he said. "Wal-Mart's prices will set the floor on where prices will be on toys, electronics and other holiday items."
With so much competition at lower prices, merchants will have to sell a lot more electronics to break even, Beemer said. "They can't weather the storm very long," he said.
Consumer electronics and home appliance sales fell nearly 14 percent in September after a 5.5 percent decline in August, according to MasterCard Advisors' SpendingPulse survey. The sharp drops in consumer spending forced Best Buy earlier this month to cut its earnings projections for the rest of the year. Comparable store sales for Best Buy fell by nearly 8 percent in October, the second month that Best Buy locations open for 14 months reported a drop in sales. The company predicts comparable store sales through February could decline between 5 percent and 15 percent.
Best Buy's move indicates it's not counting on any benefit from the fall of rival Circuit City, at least in the short term. "Since mid-September, rapid, seismic changes in consumer behavior have created the most difficult climate we've ever seen," Brad Anderson, Best Buy's vice chairman and chief executive, said in a statement.
Electronics industry promoters are not plugging into all the gloom and doom. The Consumer Electronics Association projects sales of televisions and audio equipment will be 4.7 percent higher than a year ago, while predicting video game hardware sales will rise 3.5 percent. They are counting on consumers buying electronics instead of going out to dinner or sporting events.
"There's a nesting phenomenon going on," said Anthony Chukumba, an industry analyst with FTN Midwest Securities. The concern for retailers is that customers might just nest with the TVs and other hard-wired gadgets they already have. "It's going to be a challenging year with profit margins falling and other things going on in the marketplace," said Beemer of America's Research Group. "I'm sure this year is going to weaken everybody before it's done."