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Eve Prince's midnight picnic in Warrenton, Virginia
Ilargi: Obama expands his job stimulus plan, moving the goalposts from 2 to 3 million jobs to be created over a 2 year period. There are a few things that don't add up in this. First, these are largely jobs that cost the US economy money, instead of making it richer. And that economy is already so broke that any more additional costs will weigh heavily on it. Second, the expectations for the numbers of jobs lost in the economy are rising towards a cruel, eye-popping and devastating 1 million per month for 2009, and likely beyond. Creating 3 million jobs while a potential 24 million will be lost, it's not a very reassuring statistic.
Besides, it puts the US in a category of economies that has members in the likes of Bulgaria before the Berlin wall came down. State run, inefficient, and most of all doomed to fail. The trillions of dollars spent so far to "rescue" the utterly bankrupt US banking industry have not created a single job. The billions thrown carelessly and with eyes closed at the automotive industries of America and Canada will not save one single job either. They'll just move the problem ahead for a few months, leaving Obama, as the proverbial patsy, to face an insurmountable issue that may well prove too much for him, perhaps as early as next year.
Still, all that could be forgiven if the current and incoming administrations would tackle the one problem that nobody dares stand up to: Toxic Assets. All of the money spent so far, all the trillions, every penny of it, will be a complete waste if these assets are not forced out of their closets. Everybody talks about the need to restore markets by restoring trust and confidence. Well, Mr. Obama, here is your key to reviving that trust. Find your own Elliott Ness, this one specialized in derivatives, get him the people he wants and needs, and start raiding the banks' vaults, and the hedge funds, and the pension funds. Force it all out into the open. Refuse to give them even one more nickel, until all of it is on the table. All of it, not just some of it. If that doesn't happen, the US economy will not recover, because there will be no trust and no confidence.
Would be nice, right? Well, don't count on it. The man behind the curtain of Obama's financial team is Robert Rubin, and his proxies are the likes of Tim Geithner and Larry Summers. These guys have one goal in mind only: to let the firms, and the very culture, that enriched them and provided them their lifestyle and friends, their yachts and mansions, and the power they so enjoy, endure. Even though they are smart enough to understand that that culture is gone, broke, bankrupt and dead, this is still the sole thing they will work towards. And they will do so at the expense of hard-working or no-longer working ordinary people.
The bankers' view is that their culture is indispensable for the future of the world, and of America. Many of them really think that is true, they know no other world. But for the man in the street, it makes no difference if the Wall Street titans are toppled. He simply needs access to his money, to feed his family, and he needs a job to provide that money. $8 trillion could have provided much of that. But it is now gone. And we'l never see it again, because it's been given to institutions that have losses that are far greater than $8 trillion. In toxic assets. It is not that hard to figure out.
So where do we go from here, knowing that our governments will keep on making the wrong decisions at every stage of the game? We go towards the prospect of unemployment so vast that it hasn't been seen since the Germany and Dust Bowl 1920's. We move into a time where nation states and their elected governments come under pressure so intense that many will fall. I still have yet to see a country that is making adequate preparations for the eventuality that the billions and trillions spent trying to keep alive what has already died will indeed not work.
For a future in which 10-20-30% of their populations may be out of work. For a social coherence that will make it possible to provide everyone of their citizens with their minimum basic human needs. Work. Water. Shelter. Heat. Food. Health Care. In Athens, the riots of the past weeks spring from one source: 70% of young people are unemployed, have no income, no prospects and no future. That will spread to other countries. And that is a recipe for collapsing societies.
It is still possible for countries, and societies, around the world, to prepare the contingency plans they will soon need. If things get much worse than they are today. Which I can guarantee you they will. If only because nobody prepares, and nobody has drafted any such plans. It's a self-fulfilling prophecy.
In western societies, the perhaps most important factor is the widespread sense of entitlement that rules the lives of those who've always had it good. Who've always had well-paying jobs. Who've put money away for savings and pensions and all these things. Already, there is a huge rift growing between the baby boomer haves and their offspring's have-nots. The few lucky Greek youth who are employed are known as the "€700 generation". They can make $1000 a month, and that's it. While the older generation sits pretty. This cannot last, that should be obvious to all.
Everybody in our societies needs to give, in order for everyone to have a life with at least a minimum in dignity. We're not doing it. Nobody talks about it. The few remaining politicians who are not clueless or out for their own gain, and that's a small group, realize that this is a message that would cost them their cushy seats. So they are silent. Positive messages sell, realistic ones do not. And so we head for the inevitable wall, and we will all say that we could not possibly have seen it coming. But that wall was always there all along, walls don't tend to sneak up on people. People rush into walls, not the other way around.
We have lived through a time of unprecedented affluence, and we have seen it as normal, and told ourselves we deserved all of it, that we are entitled to what it has given us. But it's over, and it will be no more, nor will it ever return in our lifetimes. If we are to live in a functioning society in the years to come, we will have to share much of our riches, and we will have to find out how to be fulfilled with much less material wealth. If we don't, our societies will collapse, and we will lose that wealth regardless. But looking around me, I see little hope that we will do all these things before it's too late. It you don't volunteer to share, the difference in wealth between you and your own children's generation will become so glaring that they will come and take it away from you.
An era is over. We have been the last of the affluent, the carefree and the innocent. Not that we're really all that inncoent, mind you, it was all just pretense all the way, many millions of people have died for our affluence. We just never told ourselves their life stories. They will be our stories soon.
Are you now ready to fight in the streets, to protect your family, to share your meal with the hungry? It's not about being a leftie, or a softie, and I certainly am neither. It's about survival. It's about being smart enough to read the world you live in. The model of the nuclear family will die with the affluence. It's never been but an aberration. You will, like your ancestors before you, need your family, your friends, and your neighbors.
Life itself is about to come calling.
Protectionist dominoes are beginning to tumble across the world
The riots have begun. Civil protest is breaking out in cities across Russia, China, and beyond. Greece has been in turmoil for 11 days. The mood seems to have turned "pre-insurrectionary" in parts of Athens - to borrow from the Marxist handbook This is a foretaste of what the world may face as the "crisis of capitalism" - another Marxist phase making a comeback - starts to turn two hundred million lives upside down. We are advancing to the political stage of this global train wreck. Regimes are being tested. Those relying on perma-boom to mask a lack of democratic or ancestral legitimacy may try to gain time by the usual methods: trade barriers, saber-rattling, and barbed wire.
Dominique Strauss-Kahn, the head of the International Monetary Fund, is worried enough to ditch a half-century of IMF orthodoxy, calling for a fiscal boost worth 2pc of world GDP to "prevent global depression". "If we are not able to do that, then social unrest may happen in many countries, including advanced economies. We are facing an unprecedented decline in output. All around the planet, the people have reacted with feelings going from surprise to anger, and from anger to fear," he said. Russia has begun to shut down trade as it adjusts to the shock of Urals oil below $40 a barrel. It has imposed import tariffs of 30pc on cars, 15pc on farm kit, and 95pc on poultry (above quota levels). "It is possible during the financial crisis to support domestic producers by raising customs duties," said Premier Vladimir Putin.
Russia is not alone. India and Vietnam have imposed steel tariffs. Indonesia is resorting to special "licences" to choke off imports. The Kremlin is alarmed by a 13pc fall in industrial output over the last five months. There have been street protests in Moscow, St Petersburg, Kaliningrad, Vladivostok and Barnaul. Police crushed "Dissent Marchers" holding copies of Russia's constitution above their heads in Moscow's Triumfalnaya Square. "Russia has not seen anything like these nationwide protests before," said Boris Kagarlitsky from Moscow's Globalization Institute. The Duma is widening the treason law to catch most forms of political dissent, and unwelcome forms of journalism. Jury trials for state crimes are to be abolished. Yevgeny Kiseloyov at the Moscow Times said it feels eerily like December 1 1934 when Stalin unveiled his "Enemies of the People" law, kicking off the Great Terror.
The omens are not good in China either. Taxis are being bugged by state police. The great unknown is how Beijing will respond as its state-directed export strategy hits a brick wall, leaving exposed a vast eyesore of concrete and excess plant. Exports fell 2.2pc in November. Toy, textile, footwear, and furniture plants are being closed across Guangdong, now the riot hub of South China. Some 40m Chinese workers are expected to lose their jobs. Party officials have warned of "mass-scale social turmoil". The Politburo is giving mixed signals. We don't yet know how much of the country's plan to boost domestic demand through a $586bn stimulus package is real, and how much is a wish-list sent to party bosses in the hinterland without funding.
Shortly after President Hu Jintao said China is "losing competitive edge in the world market", we saw a move towards export subsidies for the steel industry and a dip in the yuan peg - even though China already has the world's biggest reserves ($2 trillion) and the biggest trade surplus ($40bn a month). So is the Communist Party mulling a 1930s "beggar-thy-neighbour" strategy of devaluation to export its way out of trouble? Such raw mercantilism can only draw a sharp retort from Washington and Brussels in this climate. "During a global slowdown, you can't have countries trying to take advantage of others by manipulating their currencies," said Frank Vargo from the US National Association of Manufacturers.
It is a view shared entirely by President-elect Barack Obama. "China must change its currency practices. Because it pegs its currency at an artificially low rate, China is running massive current account surpluses. This is not good for American firms and workers, not good for the world," he said in October. The new intake of radical Democrats on Capitol Hill will hold him to it. There has been much talk lately of America's Smoot-Hawley Tariff Act, which set off the protectionist dominoes in 1930. It is usually invoked by free traders to make the wrong point. The relevant message of Smoot-Hawley is that America was then the big exporter, playing the China role. By resorting to tariffs, it set off retaliation, and was the biggest victim of its own folly. Britain and the Dominions retreated into Imperial Preference. Other countries joined. This became the "growth bloc" of the 1930s, free from the deflation constraints of the Gold Standard. High tariffs stopped the stimulus leaking out.
It was a successful strategy - given the awful alternatives - and was the key reason why Britain's economy contracted by just 5pc during the Depression, against 15pc for France, and 30pc for the US. Could we see such a closed "growth bloc" emerging now, this time led by the US, entailing a massive rupture of world's trading system? Perhaps. This crisis has already brought us a monetary revolution as interest rates approach zero across the G10. It may overturn the "New World Order" as well, unless we move with great care in grim months ahead. This is where events turn dangerous.
The last great era of globalisation peaked just before 1914. You know the rest of the story.
Is the Medicine Worse Than the Illness?
It is a sorry place at which we Americans find ourselves this none-too-festive holiday season. The biggest names on Wall Street have gone to their rewards or into partnership with the U.S. Treasury. Foreigners stare wide-eyed from across the waters. A $50 billion Ponzi scheme (baited with, of all things in this age of excess, the promise of low, spuriously predictable returns)? Interest rates over which tiny Japanese rates fairly tower? Regulatory policy seemingly set by a weather vane? A Federal Reserve that can't make up its mind: Is it in the business of central banking or of central planning? And to think -- our disappointed foreign friends mutter -- all of these enormities taking place under a Republican administration.
Trust itself entered a bear market in 2008, complementing and perhaps surpassing the selloffs in stocks, mortgages and commodities. Never to be confused with angels, we humans seem to outdo ourselves when money is on the line. So it is that Bernard Madoff, supposed pillar of the community, stands accused of perpetrating one of the greatest hoaxes since John Law discovered the inflationary possibilities of paper money in the early 18th century. Barely nudging Mr. Madoff out of the top of the news was the Federal Reserve's announcement last Tuesday that it intends to debase its own paper money. The year just ending has been a time of confusion as much as it has been of loss. But here, at least, was the bright beam of clarity.
Specifically, the Fed pledged to print dollars in unlimited volume and to trim its funds rate, if necessary, all the way to zero. Nor would it rest on its laurels even at an interest rate low enough to drive the creditor class back to work. It would, on the contrary, "continue to consider ways of using its balance sheet to further support credit markets and economic activity." Wall Street that day did handsprings. Even government securities prices raced higher, as if, somehow, Treasury bonds were not denominated in the currency with which the Fed had announced its intention to paper the face of the earth. Economic commentators praised the central bank's determination to fight deflation -- that is, to reinstate inflation. All hands, including President-elect Obama, seemed to agree that wholesale money-printing was the answer to the nation's prayers.
One market, only, registered a protest. The Fed's declaration of inflationary intent knocked the dollar for a loop against gold and foreign currencies. In many different languages and from many time zones came the question, "Tell me, again, now that the dollar yields so little, why do we own it?" It was on Oct. 6, 1979, that then-Fed Chairman Paul A. Volcker vowed to print less money to bring down inflation. So doing, he closed one monetary era and opened another. With Tuesday's promise to print much more money, the Federal Reserve of Ben S. Bernanke has opened its own new era. Whether Mr. Bernanke's policy of debasement will lead to as happy an outcome as that which crowned the Volcker anti-inflation initiative is, however, doubtful. Whatever the road to riches might be paved with, it isn't little green pieces of paper stamped "legal tender." Our troubles, over which we will certainly prevail, stem from a basic contradiction. The dollar is the world's currency, yet the Fed is America's central bank. Mr. Bernanke's remit is to promote low inflation, high employment and solvent finance -- in the 50 states. He wishes the Chinese well, of course, and the French and the Singaporeans and all the rest besides, but they don't pay his salary.
They do, however, buy the U.S. Treasury's bonds, which frames the emerging American dilemma. If the Fed is going to create boatloads of depreciating, non-yielding dollar bills, who will absorb them? Who will finance the Obama administration's looming titanic fiscal deficits? Who will finance America's annual surplus of consumption over production (after 25 more or less continuous years, almost a national trait)? Inflation is a kind of governmentally sanctioned white-collar crime. Every crime needs a dupe. Now that the Fed has announced its plan to deceive, where will it find its victims? Mr. Bernanke has good reason to worry about the economy. We all do. In the boom, a superabundance of mispriced debt led countless people down innumerable blind investment alleys. E-Z credit financed bubbles in real estate, commodities, mortgage-backed securities and a myriad of other assets. It punished saving and encouraged speculation. Imagine a man at the top of a stepladder. He is up on his toes reaching for something. Call that something "yield." Call the stepladder "leverage." Now kick the ladder away. The man falls, pieces of debt crashing to the floor around him. The Fed, watching this preventable accident unfold, rushes to the scene too late. Not only did Bernanke et al. not see it coming, but they actually egged the man higher.
You will recall the ultra-low interest rates of the early 2000s. The Fed imposed them to speed recovery from an earlier accident, this one involving a man up on a stepladder reaching for technology stocks. The underlying cause of these mishaps is the dollar and the central bank that manipulates it. In ages past, it was so simple. A central banker had one job only, and that was to assure that the currency under his care was exchangeable into gold at the lawfully stipulated rate. It was his office to make the public indifferent between currency or gold. In a crisis, the banker's job description expanded to permit emergency lending against good collateral at a high rate of interest. But no self-respecting central banker did much more. Certainly, none arrogated to himself the job of steering the economy by fixing an interest rate. None, I believe, had an economist on the payroll. None facilitated deficit spending by buying up his government's bonds. None cared about the average level of prices, which rose in wartime and sank in peacetime.
It sank in peacetime because technological progress and the opening of new regions to agricultural production made merchandise and commodities cheaper and more abundant. Not everyone agreed that these arrangements were heaven-sent. In comparison to the rigor of the gold standard, paper money seemed, to many, an intelligent and forgiving alternative. In 1878, a committee of the House of Representatives was formed to investigate the causes of the suffering of working people in the depression that was five years old and counting. Not a few witnesses pleaded for the creation of more greenbacks. They asked that the government not go through with its plan to return to the gold standard in 1879. But the nation did return to gold -- it had financed the Civil War with paper money -- and the depression ended in the very same year. Gold is a hard master, and a capricious one, too, insofar as growth in the world's monetary base depends on the enterprise of mining engineers. But, as we have seen lately, there is no caprice like the caprice of sleep-deprived Mandarins improvising a monetary solution to a credit crisis (or, for that matter, of fully rested Mandarins setting interest rates by the lights of their econometric models).
The times were hard in the 1870s and, for that matter, again in the 1890s, but Americans repeatedly spurned the Populist cries for a dollar you didn't have to dig out of the ground but could rather print up by the job lot. "If the Government can create money," as a hard-money propagandist put it in an 1892 broadside entitled "Cheap Money," "why should not it create all that everybody wants? Why should anybody work for a living?" And -- in a most prescient rhetorical question -- he went on to ask, "Why should we have any limit put to the volume of our currency?" A couple of panics later, the Federal Reserve came along -- the year was 1913. Promoters of the legislation to establish America's new central bank protested that they wanted no soft currency. The dollar would continue to be exchangeable into gold at the customary rate of $20.67 an ounce. But, they added, under the Fed's enlightened stewardship, the currency would become "expansive." Accordion-fashion, the number of dollars in circulation would expand or contract according to the needs of commerce and agriculture.
Elihu Root, Republican senator from New York, thought he smelled a rat. Anticipating the credit inflations of the future and recalling the disturbances of the past, Mr. Root attacked the bill in this fashion: "Little by little, business is enlarged with easy money. With the exhaustless reservoir of the Government of the United States furnishing easy money, the sales increase, the businesses enlarge, more new enterprises are started, the spirit of optimism pervades the community. "Bankers are not free from it," Mr. Root went on. "They are human. The members of the Federal Reserve board will not be free of it. They are human....Everyone is making money. Everyone is growing rich. It goes up and up, the margin between costs and sales continually growing smaller as a result of the operation of inevitable laws, until finally someone whose judgment was bad, someone whose capacity for business was small, breaks; and as he falls he hits the next brick in the row, and then another, and then another, and down comes the whole structure.
"That, sir," Mr. Root concluded, "is no dream. That is the history of every movement of inflation since the world's business began, and it is the history of many a period in our own country. That is what happened to greater or less degree before the panic of 1837, of 1857, of 1873, of 1893 and of 1907. The precise formula which the students of economic movements have evolved to describe the reason for the crash following the universal process is that when credit exceeds the legitimate demands of the country the currency becomes suspected and gold leaves the country."Little did Mr. Root suspect that the dollar would lose its gold backing altogether -- that, starting in 1971, there would be nothing behind it more than the good intentions of the U.S. government and (somewhat more substantively) the demonstrated strength of the U.S. economy. Still less could he have guessed that the world would nonetheless fall in love with that uncollateralized piece of paper or -- even more astoundingly -- that the United States would enjoy so great a reservoir of good will that it would be allowed to borrow its way to a net international investment position of minus $2.44 trillion ($17.64 trillion of foreign assets held by Americans vs. $20.08 trillion of American assets held by foreigners). "It goes up and up," Mr. Root said of the inflationary cycle, but just how high he could not have dreamt.
Knowledge of the precepts of classical central banking prepared no one to understand, much less to anticipate, the Fed's conduct in this credit crackup. The central bank is lending freely, all right, but not at the stipulated "high" interest rate. As a matter of fact, it is starting to lend at a rate below which there is no positive rate. The gold standard was objective. Modern monetary management is subjective (under Alan Greenspan, it was intuitive). The gold standard was rules-based. The 21st century Fed goes with what works -- or seems to work. What it hopes is going to work for the fellow who fell off the stepladder is more debt and more dollars. Just how much of each can be found every Thursday evening on the Fed's own Web site. Open up form H4.1 and prepare to be amazed. Since Labor Day, the Fed's assets have zoomed to $2.31 trillion from $905.7 billion. And what is the significance of this stunning rate of asset growth? Simply this: The Fed pays for its assets with freshly made dollars. It conjures them into existence on a computer; "printing" is a figure of speech. In this crisis, the Fed's assets have grown much faster than its capital. The truth is that the Federal Reserve is itself a highly leveraged financial institution. The flagship branch of the 12-bank system, the Federal Reserve Bank of New York, shows assets of $1.3 trillion and capital of just $12.2 billion. Its leverage ratio, a mere 0.9%, is less than one-third of that prescribed for banks in the private sector.
Such a thin film of protection would present no special risk if the bank managed by Timothy F. Geithner, the Treasury secretary-designate, owned only short-dated Treasurys. However, the mystery meat acquired from Bear Stearns and AIG foots to $66.6 billion. A writedown of just 18.3% in the value of those risky portfolios would erase the New York Fed's capital account. In congressional testimony eight years ago, Laurence Meyer, then a Fed governor, tried to allay any such concerns (which then must have seemed remote, indeed). "Creditors of central banks...are at no risk of a loss because the central bank can always create additional currency to meet any obligation denominated in that currency," he soothingly reminded his listeners. Yes, today's policy makers allow, there are risks to "creating" a trillion or so of new currency every few months, but that is tomorrow's worry. On today's agenda is a deflationary abyss. Frostbite victims tend not to dwell on the summertime perils of heatstroke.
But the seasons of finance are unpredictable. Prescience is rare enough in the private sector. It is almost unheard of in Washington. The credit troubles took the Fed unawares. So, likely, will the outbreak of the next inflation. Already the stars are aligned for a doozy. Not only the Fed, but also the other leading central banks are frantically ramping up money production. Simultaneously, miners and oil producers are ramping down commodity production -- as is, for instance, is Rio Tinto, the heavily encumbered mining giant, which the other day disclosed 14,000 layoffs and a $5 billion cutback in capital expenditure. Come the economic recovery, resource producers will certainly increase output. But it is far less certain that, once the cycle turns, the central banks will punctually tighten. The public has been slow to anger in this costliest and scariest of post World War II financial crises. Wall Street and the debt ratings agencies have come in for well-deserved castigation. But pointing fingers rarely find the Federal Reserve, whose low, low interest rates helped to set house prices levitating in the first place.
After Mr. Bernanke gets a good night's sleep, he should be called to account for once again cutting interest rates at the expense of the long-suffering (and possibly hungry) savers. He should be asked to explain how the central-banking methods of the paper-dollar era represent any improvement, either in practice or theory, over the rigor, elegance, simplicity and predictability of the gold standard. He should be directed to read aloud the text of critique by Elihu Root and explain where, if at all, the old gentleman went wrong. Finally, he should be directed to put himself into the shoes of a foreign holder of U.S. dollars. "Tell us, Mr. Bernanke," a congressman might consider asking him, "if you had the choice, would you hold dollars? And may I remind you, Mr. Chairman, that you are under oath?"
Who's to blame for the economy?
Investment Bankers In the war on drugs, the top target is always the traffickers. The same principle is true with the massive implosion of credit markets and corporate ethics. In this case, the traffickers were the Wall Street firms that created bundles of subprime mortgages and other toxic financial instruments, then peddled them as low-risk, high-return investments. These securities, and enormous side bets on them, fueled the housing bubble and infected the global financial system. Nearly all the big investment banks were culpable, though the poster child of mismanagement has to be Richard Fuld, former CEO of the former company known as Lehman Bros. Fuld, who received as much as $480 million in compensation from 2000 to this year, took risks that drove the storied investment house straight into the ground. But he had lots of co-conspirators.
Alan Greenspan The Federal Reserve's job, as one of Greenspan's predecessors famously said, is to remove the punch bowl once the party really gets going. As Fed chairman during the housing bubble, Greenspan spiked the bowl instead, by keeping interest rates low and shunning regulation that let Fuld and friends indulge in an orgy of irresponsibility and greed. In 2000, according to then-Fed Governor Ed Gramlich, Greenspan rejected an informal proposal to examine the lending practices of banks and mortgage brokers. Greenspan also shrugged off suggestions that the surging market for exotic securities, known as derivatives, needed greater scrutiny. Perhaps most important, he never stated the obvious: that something was terribly amiss. In testimony before Congress in October, a shaken Greenspan said his faith in the self-correcting nature of free markets was misplaced. Now he tells us.
Rating Agencies
Credit-rating agencies are supposed to provide the unvarnished truth to investors about the risk of debt securities. But just like the auditors who signed off on Enron's cooked books, they showed just how corrupted they could be. The big agencies - Standard & Poor's, Moody's and Fitch - frequently gave AAA ratings to bundles of toxic mortgages for the simple reason that it was the sellers of these loan portfolios, rather than potential buyers, who paid them. Company documents revealed at a congressional hearing in October that executives were aware that ratings were inflated. Company employees sometimes "drink the Kool-Aid" and bow to pressure for undeservedly high ratings, Moody's executive Raymond McDaniel warned his company's board.
Predatory Lenders Lending is easy when it is someone else's money. The widespread securitization of mortgages prompted lenders to give virtually anyone a loan that they could resell at a profit while offloading the risk. It also gave them incentive to mislead borrowers about what they could afford, what risks they were undertaking and, in some cases, the terms of the mortgage they were signing. The public face of this racket could well be Angelo Mozilo, co-founder of mortgage giant Countrywide Financial. But many others got into this game, as well. Subprime lending shot up from $130 billion in 2000 to $625 billion in 2005.
Clueless Borrowers It might seem cruel to put blame on people who have lost their homes, or are in jeopardy of it. But hundreds of thousands of homebuyers bought more house than they could afford, or financed investment properties with no clue about what they were doing. It takes two parties to sign a mortgage contract, so some borrowers share responsibility for the housing mess.
Congress In any crisis of confidence or failure of government, it's a pretty good bet that members of Congress are involved. The credit crisis is no exception. Lawmakers from both parties not only ignored signs of trouble but also actively invited irresponsibility in the name of protecting key constituencies. On the Democratic side, members supported virtually any program that provided credit to low-income purchasers and inner cities, regardless of whether this lending was prudent. The banking committee chairmen - Sen. Chris Dodd, D-Conn., and Rep. Barney Frank, D-Mass. - defended federally chartered Fannie Mae and Freddie Mac from charges that they were taking on too much risk and prodded the companies to back riskier loans. On the Republican side, then-House Majority Leader Tom DeLay, R-Texas, and other members thwarted efforts to rein in predatory lending.
George W. Bush The seeds of economic calamity were planted before Bush arrived in Washington, but his administration watered them regularly, then mindlessly watched them grow into a jungle that has entangled the economy in crisis. Regulators let banks and borrowers alike get into trouble. Worse yet, the president made himself the poster boy for fiscal irresponsibility, cutting taxes, increasing spending and turning budget surpluses into a record federal debt that leaves the nation less able to cope with crisis. If subprime borrowers and lenders wanted a role model, they found it in Bush.
Bill Clinton Bush gets much of the rap for the downturn, but Clinton and his Wall Street-schooled Treasury secretary, Robert Rubin, backed some of the changes that led to disaster. It was Clinton who signed the repeal of the Depression-era Glass-Steagall Act and amendments to the Community Reinvestment Act. The first of these removed the walls between commercial banks and brokerages, walls that might have restricted the growth of exotic mortgage finance or at least limited the negative effects when it unraveled. The use of derivatives accelerated on Rubin and Clinton's watch, and they did virtually nothing to control it.
Regulators Because the regulatory system over financial services is a woefully inadequate hodgepodge, it's hard to pin blame on specific agencies. But the Comptroller of the Currency's office stands out for not only failing to do anything constructive but also for turning itself into a banking industry lobby imbedded in the Treasury Department. Rather than protecting consumers, the agency saw its mission as protecting banks from state governments. In 2003, it announced that federally chartered banks could ignore predatory-lending laws passed in the states. Also deserving its lump is the Securities and Exchange Commission, chaired by former representative Christopher Cox, R-Calif. The SEC actively encouraged major investment banks to take on more risk, and it oversaw a failed experiment in self-regulation. Mail lumps of coal to your villain of choice. What links them is a matrix of greed, irresponsibility and cluelessness.
Obama Expands Economic Recovery Plan to Create 3 Million Jobs
President-elect Barack Obama, faced with a deteriorating economy, is expanding his stimulus package with a goal of creating or saving 3 million jobs over two years, a transition aide said last night. The revised target, up from 2.5 million jobs he previously announced, came at the suggestion of Christina Romer, Obama's pick to head the Council of Economic Advisers, during a Dec. 16 meeting with the president-elect's top economic advisers, the aide said, speaking on condition of anonymity. Romer said the short, medium and long-term economic forecasts have worsened since Obama outlined the plan on Nov. 22, the aide said. Romer said the economy is likely to lose 3 million to 4 million jobs over the next year and the unemployment rate is likely to rise to above 9 percent. As a result, she said, the initial jobs estimate for the package was too timid, according to the aide.
Obama has made his first priority after he takes office Jan. 20 to sign an economic recovery package with a significant focus on infrastructure projects to help boost jobs. Recent economic indicators have underscored the need for additional action, Romer said. The meeting also included Vice President-elect Joe Biden; Obama's designee for Treasury secretary, Timothy Geithner; director of the White House National Economic Council, Lawrence Summers; and Paul Volcker, Obama's choice to head a new Economic Recovery Advisory Board. The same day the meeting was held, the Federal Reserve lowered the interest rate for overnight loans between banks to between zero and 0.25 percent from 1 percent. The Labor Department reported on Dec. 5 that employers eliminated jobs at the fastest pace in 34 years in November and the unemployment rate rose to 6.7 percent. "We are running out of the traditional ammunition that's used in a recession," Obama said last week just before the Fed's announcement.
As unemployment has increased, estimates of what is needed to pull the nation out of the slump have continued to grow, with some economists calling for a $1 trillion spending program. Obama representatives met this week with congressional staffers to discuss a plan estimated between $675 million to $775 billion, the aide said, though earlier this week another aide said Obama may ask Congress to approve as much as $850 billion. Obama hasn't specified a figure. Obama's team on Dec. 16 discussed elements that could be included in the recovery plan to provide an immediate jobs boost while laying a foundation for long-term economic health, according to the aide. Examples of such projects included funding already approved infrastructure repair projects; weatherizing homes to save $1 billion in energy costs; modernizing health information technology by converting to paperless systems; and advancing technology in schools and provide teachers with better training.
Obama during the meeting told his advisers that spending proposals can't include lawmakers' pet spending projects; that funds should be directed toward already approved projects so jobs can be created quickly; and that government should help facilitate private ventures by removing bureaucratic red tape. Obama also said he wants to enact measures designed to protect workers and families from future recessions. Obama and his family arrived yesterday for a two-week holiday in Hawaii. Obama's advisers will use the guidelines with the intent of having a draft of the plan ready when he returns.
Bush's plan makes auto crisis Obama's problem
President George W. Bush might have made the initial installment of the auto industry bailout, but ultimately it is President-elect Barack Obama who will be "the decider" on how big a hit labor takes and how big the final tally will be. In a sternly worded radio address today, President Bush issued a dire warning to the Big Three automakers: Restructure -- fast -- or you're on your own. "The time to make the hard decisions to become viable is now, or the only option will be bankruptcy," Bush said. But he will be long gone before the March 31 deadline for General Motors and Chrysler to be in the black or pay back the $17 billion in loans, and it is Obama, along with a new and more Democratic Congress, who will have to make the decision about how to proceed then.
"Bush is punting this problem to the next administration," said Peter Morici, a professor at the University of Maryland's Robert H. Smith School of Business. "Obama can catch it or let it bounce into the end zone and let the parties work it out." Many analysts say the initial loans will not be enough to sustain G-M and Chrysler beyond March, and that at least two of the Big Three Detroit automakers, and possibly Ford as well, will be back for more. With more than 1 million jobs directly at stake, and more than 1 million more ready to topple like dominoes if the industry falls, the next president could have few options if the auto industry's woes threaten to lengthen a broad recession. "This is just kicking the can down the road to next spring. Seventeen billion dollars isn't going to be enough after March, April to keep them out of bankruptcy court. So they will be back, asking for more. And in all likelihood, the next administration will have no choice but to give it to them," said Mark Zandi, chief economist and cofounder of Moody's Economy.com.
"I think at the end of the day, when we look back two, three, four years from now, taxpayers will have committed over $100 billion to the automakers to get them to be viable, profitable companies," he said. GM chief executive officer Rick Wagoner says a March 31 deadline for the companies to be in the black or give the money back is a tight one. "I don't think it's impossible," he told reporters after the bailout was announced Friday. "We obviously have some big steps we have to take." One of those steps is dealing with auto workers' wages. The loans announced by President Bush includes a "target" of bringing the wages of Big Three auto workers down to the level of Japanese manufacturers operating in the United States.
The United Auto Workers union is already asking the Obama administration to reverse planned pay cuts. But, in an interview with ABC's George Stephanopoulos to be broadcast on "This Week" on Sunday, Vice President-elect Joe Biden warned that union workers will have to make more concessions. "Labor isn't the reason why the automobile companies are in the trouble they're in," Biden told ABC. But, he added, "Labor, in order to save their own jobs, in order to save the prospect of an industry, is going to have to make some more sacrifices." That puts the Obama administration on a collision course with some of its most reliable supporters in one of the nation's largest labor unions. "Organized labor feels it's giving too much, but if Obama gives labor what it wants, they will have to subsidize the industry forever," Morici said.
Union, Chrysler may be big losers in bailout plan
The $17.4 billion bailout loan approved for the automobile industry will accelerate a restructuring that has been in progress for nearly 15 years. The result will be a smaller General Motors and Ford in America, a bigger and more robust GM and Ford overseas, and barring the birth of a truly international labor union, a United Auto Workers that is a union in name only. There will be no independent Chrysler. That company is bereft of a full product line. It is bleeding cash and top executives. Chrysler is likely to use the loan to soften its inevitable fall into bankruptcy, or to speed its acquisition by a larger entity.
It all means that the restructure-or-perish talk heard in recent months on Capitol Hill and repeated Friday by President Bush is bunk. It's drama put on by politicians trying to make themselves look responsible. It is justification for helping the car companies continue doing what they have been doing all along — downsizing and, in the process, hastening the effective demise of the UAW. Domestic car companies have been trimming their U.S. market presence for nearly two decades. They've also been integrating more thoroughly into the global automotive business — combining North American and overseas operations for product development and design, streamlining procurement, and using computer-assisted product engineering and development to deliver truly world-class automobiles.
That means the hot European Ford Focus sold in Russia and London eventually will be sold here. It means an end to cheapskate anomalies, such as otherwise likable cars being equipped with state-of-the-art disc brakes up front and marginally acceptable drum brakes in the rear. GM and Ford already have started making such changes, largely because U.S. consumers have been demanding that the two companies give them the same quality and type of cars they sell overseas.
The world has changed. Think of it this way: In terms of cars, the United States once was the moral equivalent of a three-company town — General Motors, Ford and Chrysler. They had a lock on new-vehicle sales, pretty close to a 100 percent share of market. For the longest time, GM divisions such as Buick operated as separate engineering and marketing fiefdoms, duplicating at great cost and waste things being done at GM's Chevrolet, Pontiac, GMC and Cadillac divisions. A wide-open U.S. market changed that picture. Foreign automotive rivals took advantage of that open market and changed it for good, in much the manner that Wal-Mart has changed the department store dynamic in the United States.
The manufacturing and retail infrastructure built to sustain a nearly 100 percent domestic automobile market share became unsupportable. U.S. car companies began shutting down plants. Where there once were 50,000 domestic car dealerships, there are now barely 20,000. UAW employment rolls, reaching above 800,000 in their 1960s heyday, are now nearly half that much. And, despite claims to the contrary in White House and Capitol Hill bailout chatter, the UAW repeatedly has taken pay and benefits cuts to help the companies stay in business.
Continuously falling domestic market share did something else: It awakened a sleeping product development and design giant. GM and Ford, before the credit freeze knocked the bottom out of the U.S. car market, were regaining leadership in product design and innovation. The Cadillac CTS, Chevrolet Malibu sedan and new Ford Flex are examples. Chrysler was finding its way, improving manufacturing efficiencies. But Chrysler's problem was products, namely, not enough small, snazzy cars. Unlike GM and Ford, Chrysler has a negligible overseas operation, which means that it does not have the same kind of thick product portfolio held by its U.S. rivals.
Today's GM and Ford are not yesterday's corporate horrors. Both are committed to improving product quality and fuel efficiency. Both have a good chance to survive and thrive. Both are positioned to take advantage of the shift in retail focus from a mature North American market to potentially exploitable markets in Asia, Eastern Europe and South America. Those regions are coming under pressure to open up to U.S. exports and to countenance the presence of U.S.-owned manufacturing facilities, just as the United States has long been open to them. It thus makes sense for the United States to prop up its automobile industry as much as possible, at least until a better consumer credit environment revives sales here and abroad. That way, the multibillion dollar loan approved for the industry Friday likely will lead to more jobs. But it won't necessarily lead to better pay.
The UAW's failure to organize foreign rivals in America has undermined the value of the union's employment agreements with Detroit. As long as workers at nonunion companies receive lower pay than their counterparts at UAW-represented rivals, the union will be under pressure to make concessions. The federal bailout loan agreement greatly increases that pressure. The money will help the companies, which long ago began an aggressive restructuring of their operations. But its terms of agreement mean that the UAW will have to live with less, which means that nonunion workers will be asked to live with the same thing.
Canada offers $3.29 billion auto bailout
The federal and Ontario governments will provide the Canadian subsidiaries of the Detroit Three automakers with 4 billion Canadian dollars ($3.29 billion) in emergency loans, the prime minister said Saturday. The announcement follows a pledge Friday by U.S. President George W. Bush to offer $17.4 billion in emergency loans to General Motors Corp. and Chrysler LLC. Prime Minister Stephen Harper said Canada's bailout plan, the equivalent of 20 percent of the U.S. aid package, will help keep the plants afloat while the automakers restructure their businesses to retain one the country's most important economic sectors. "We cannot afford, in the United States or Canada, the catastrophic short-term collapse of the Big Three automakers. The U.S. has signaled that they are not going to allow these companies to fail, and we will do our share of the North American package to see that this doesn't happen either," said Harper speaking at a news conference in Toronto.
Canada's automotive industry represents 14 percent of the country's manufacturing output, 23 percent of manufactured exports, and directly employs more than 150,000 Canadians. The country's largest industry within the manufacturing sector, it has been suffering from its slowest sales in 26 years and dwindling operating cash.
Ontario has agreed to provide 1.3 billion Canadian dollars ($1.07 billion) of the total since the province alone employs about 400,000 auto sector workers — both directly and indirectly — and the industry is the mainstay of about 12 Ontario communities. "In Ontario, we've got thousands of people and their families who rely on the auto industry to be on firm ground, so they can put food on the table and keep a roof over their heads. ... No state or province employs more workers, and we're not going to give that up," said Premier Dalton McGuinty, speaking alongside Harper Saturday. The Canadian plan will provide General Motors Canada with loans of up to 3 billion Canadian dollars ($2.47 billion) and Chrysler Canada will receive up to 1 billion Canadian dollars ($823 million). The companies will get the money in three installments, with the first portion coming Dec. 29.
"The support announced today sends a significant signal of stability in the face of the economic and credit challenges faced by Canada's auto sector," said Arturo Elias, president of GM Canada. Chrysler Canada said the funds will ensure it has enough money to continue its restructuring, and thanked the governments for their understanding of the situation and their swift reaction. Ford Motor Company Canada did not ask for any emergency loans, just a line of credit to draw upon if required. Its parent company in the U.S. says it doesn't need any government cash now but would be badly damaged if one or both of the other U.S. automakers went under. Harper and McGuinty stressed that the government will not be handing over blank checks, saying that all stakeholders will be expected to make adjustments to reduce structural costs.
"Canadian taxpayers expect their money will be used to restructure and renew the automotive industry in this country," said Harper. "They expect all stakeholders to come to the table and work together towards sustainable long-term solutions to maintain our current production share of the North American market." Harper's statement was applauded by Canadian Auto Workers President Ken Lewenza, who said the union was willing to work with the automakers to protect jobs. "This will ensure that the Canadian industry is protected and the numerous investments governments have made over the years will continue to benefit our communities. This is a very sound decision on the part of both governments," said Lewenza, who has been lobbying the government to develop an aid package as soon as possible. Harper also announced two additional steps the federal government will take to support the overall competitiveness of the auto industry. Automotive suppliers will have greater access to accounts receivable insurance through Export Development Canada to compensate for the reduced availability of credit. A new facility will also be created to support access to credit for consumers to improve the accessibility of car loans and dealer financing.
Ford Canada said in a statement Saturday that it welcomes the government's plan to support the auto credit market because "Canadian consumers deserve access to affordable loans and leases when shopping for a new vehicle." Similar to the U.S. auto bailout package, the Canadian aid package comes with strings attached, including a request that parts suppliers get the money they are owed, that borrowers accept limits on executive compensation, and that they provide the government with warrants for nonvoting stock. McGuinty warned that the money will only be delivered after auto companies agree to meet conditions set by the federal and Ontario governments. "Those conditions include limits on executive compensations. The loans will only stay in place beyond March 31, 2009 if our governments are satisfied there are solid restructuring plans in place and under way," said McGuinty.
Cerberus tries to give away Chrysler to unions, banks
Cerberus Capital Management LP, Chrysler LLC's majority owner, said it plans to give its stake in the Auburn Hills automaker to unions, debtholders and other stakeholders in exchange for concessions, paving the way for Cerberus to exit Chrysler's automotive business -- though it is unclear if labor and banks would want the company. Cerberus' announcement came as the Bush administration announced plans to lend Chrysler as much as $4 billion, a loan expected to require stakeholders across the board to make sacrifices. The administration expects Chrysler to cut its debt by two-thirds and persuade the UAW to cut its wages and change its work rules to be more in line with foreign-owned automakers operating in the United States.
"Cerberus believes that concessions by all relevant constituencies will be required to facilitate a full restructuring and recapitalization of Chrysler," the New York private-equity fund said in a statement Friday. "In order to achieve that goal Cerberus has advised the Treasury that it would contribute its equity in Chrysler automotive to labor and creditors as currency to facilitate the accommodations necessary to affect the restructuring." Cerberus is not putting up its stake in Chrysler Financial. It said it would use $2 billion in proceeds from Chrysler Financial to back Chrysler's federal loan. Aaron Bragman, an industry analyst with IHS Global Insight, said there is no indication that unions or banks holding Chrysler's debt would want an ownership stake in the automaker. "It looks like Cerberus is washing their hands of Chrysler's automotive business," Bragman said.
Earlier this year, Chrysler's former majority owner, Daimler AG, valued its remaining 19.9% stake in the automaker at zero, down from $2.2 billion the previous year. Cerberus came under fire during congressional hearings, when lawmakers asked why it wouldn't invest more in the automaker. The move to give up its equity in Chrysler could be a sign of just how difficult it would be to successfully sell Chrysler, which earlier this year had been in merger talks with General Motors Corp. "Given this market, nobody has the cash to spend on it. Not only that, Chrysler is a company that is at risk. Their scope is very limited," Bragman said. "They have North America and basically nothing else. Their North American share is shrinking. "There doesn't seem to be any relief in sight."
Separately, two Chrysler executives are on their way out. Chrysler announced Friday that its Chief Marketing Officer Deborah Meyer, who was recruited from Toyota Motor Corp. last year, has left the company. Meyer's position will be eliminated with her departure. Phil Murtaugh, head of Chrysler's Asia operation, will be leaving at the end of the month. Murtaugh joined Chrysler after leading GM's expansion in China. Their hiring at Chrysler shortly after Cerberus took over was regarded as an industry coup, signaling the company's seriousness about building a competitive automaker.
Bush's Detroit bailout looks like a path to bankruptcy
Bush's Detroit bailout looks like a path to bankruptcy for General Motors and Chrysler. Billed as a way to give the two automakers breathing room, the deal actually imposes tough targets that must be hit in only three months. It's likely the companies will fall short, which would force them to file for Chapter 11 protection. But that's not necessarily bad - so long as they use the coming months to cut the deals with workers, creditors and others that they'll need to get out of bankruptcy fast.
The government wants the carmakers to modify or reduce their debt by at least two-thirds, lower executive and worker compensation and benefits, and cut new deals with suppliers and dealers, among other things. Come March 31, they'll also have to prove they're "viable" - defined as having a positive net present value. For this, the companies get debt with a skinny interest rate of 3 percentage points over Libor. If the carmakers fall short, they have to pay the debt back. Since there's little chance they'll have the funds, the government will be able to force them into bankruptcy. In that case, the government loans become part of a debtor-in-possession package. It may be impossible for GM and Chrysler to overcome some hurdles - such as state laws that protect car dealers - outside bankruptcy. But arrangements with, say, suppliers, workers and creditors, could be made in advance.
Having those deals and comprehensive restructuring plans in hand on March 31 would make a bankruptcy filing much less ominous. It could possibly take the form of a so-called prepackaged filing, where an agreed-upon plan gets rubber-stamped by the court, minimizing the time the companies spend in bankruptcy - and the risk that car buyers will turn up their noses. Of course, the carmakers might bet that they can get President-Elect Barack Obama to loosen the terms of the loans, given his backing from organised labour. Obama should make clear right up front that he's willing to force the companies into bankruptcy, and that their best option for survival is to prepare for that moment.
Soaring rates shove credit card holders into crushing debt
Aggressive rate increases on credit cards are threatening to push struggling consumers into financial ruin, accelerating home foreclosures and the nation's descent into recession. The growing problem is reflected in cases such as that of Dennis Spaulding, of Corona, Calif. He bought two last-minute plane tickets for his father's funeral in 2006, a purchase that increased the amount of credit he was using and made him appear riskier to banks. The result: Banks raised the interest rates on four of his credit cards - to 24 percent and higher - doubling his monthly payments to about $2,000. That led to a financial spiral that has put him on the verge of losing his home and filing for bankruptcy. "I see no light at the end of the tunnel," said Spaulding, a cabinet designer.
Valerie Walker, of Middletown, Del., tells a similar story: Increasingly high credit card rates mean she's scrambling to pay other debt obligations. She worries about falling behind on bills for her mortgage and business, Subway sandwich franchises. Across the nation, a growing number of consumers and financial experts are complaining that sudden credit card limit reductions and sharp interest rate increases are triggering a domino effect that makes it harder for consumers to juggle bills, stay in homes and avoid going broke. No official data are available on how many people are being pushed into financial distress by credit cards rather than mortgages. But credit counselors, bankruptcy lawyers and legislators say banks increasingly are pummeling consumers for making the smallest payment error - or making no error at all.
The shift comes as regulators and legislators have spent the last year pointing to toxic mortgages and overextended home buyers as the culprits behind the financial crisis. Credit cards, by encouraging a society of spenders rather than savers, have played a significant role in loading up consumers with unaffordable debt whose rates and terms can change at any time. "If people get charged 30 percent interest, that is going to push them over the edge," said Sen. Carl Levin, D-Mich., who has co-sponsored a bill to crack down on credit card fees and rates.
The Federal Reserve is expected to release a rule shortly aimed at cracking down on hair-trigger jumps in card rates and fees, but consumer advocates worry it won't go far enough in reforming credit card practices. During the housing boom, banks sharply raised card limits in part because of a surge in home equity, then guided borrowers to use mortgages to pay off card balances. The banks' practice of packaging and selling credit card debt to Wall Street has given them a powerful incentive to raise card rates and fees.
Now, bankruptcy lawyers and other financial experts show that as debt-saddled consumers struggle to stay afloat, banks are aggressively raising rates and fees - often stripping consumers of what little disposable income they have left and threatening to become another drag on the economy. "This is the only credit people have available," said Robert Manning, author of "Credit Card Nation: The Consequences of America's Addiction to Credit." "You raise their monthly payments ... this is going to drive people straight into bankruptcy."
Lagging indicators? Public beat economists in calling the recession
Which of two groups—economists or the general public—came closer to predicting the recession? Surprisingly, it looks like the Joe Six Packs of the world were better economic prognosticators than the elbow patch set. In November 2007, a Gallup public opinion poll found 54% of Americans believed a recession would probably or definitely occur in the next 12 months. By comparison, a Wall Street Journal survey of 52 economists conducted two weeks later found that, on average, the professionals put the chances of a recession at 38%. In reality, the longest recession in at least 26 years began in December 2007, almost immediately after the two surveys were conducted. A majority of the public got it right. Many economists did not.
"This recession, economists have done even worse than usual," said Franklin Allen, co-director of Wharton Financial Institutions Center at the University of Pennsylvania. "They muffed predicting the crisis." Earlier this month, the non-profit National Bureau of Economic Research announced that the economy has been in recession for a year. If the downturn extends past April, as most economists expect, it will be the longest recession since the Great Depression. It took most economists several months to identify the recession once it unofficially began. In January, the Journal's panel of Wall Street, academic and industry economists put the chances of a recession at less than 50%. They did it again in February.
In fact, the majority of the paper's experts didn't declare a recession until March, around the time that monthly retail sales started to plunge and job losses began to mount. Even more galling to some observers, though, was the failure of the Bush administration, including Mr. Bush himself, to acknowledge the downturn well into this year. "They did not awake to the recession risk until it was well underway," said Lakshman Achuthan, managing director of the Economic Cycle Research Institute.
While it's the job of many economists to forecast the future, they can take solace in knowing they weren't the only ones to get it wrong. Chief executives of top U.S. companies, who some think may be better grounded than economists, also were overly optimistic. A Business Roundtable survey of 105 CEOs in November 2007 found that they expected a 2.1% increase in gross domestic product for 2008, a slightly higher growth rate than in 2007. Few economists now expect any growth at all for 2008. The venerable Economist magazine also erred. "America should—just—avoid recession," Economist editor Daniel Franklin predicted a year ago.
"We never know what the future holds, and this period has been one unanticipated shock after another," said Peter Bernstein, an economic historian and editor of the Economics & Portfolio Strategy newsletter. "Nobody, even the bears, had any sense of how it was going to develop. Not so fast. A few economists did get it right. Among them: Lawrence Summers, whom President-elect Barack Obama has appointed as his chief economic adviser; Martin Feldstein, who was top economic adviser to President Reagan, and Jeffrey Frankel, a Harvard University economist who is on the NBER committee that declared the recession. "I had never seen a time in my professional career (over 30 years) when the economy was showing so many adverse signals short of having actually yet experienced substantial negative growth," Mr. Frankel wrote in an e-mail.
Dean Baker, co-director of the Center for Economic and Policy Research in Washington, predicted way back in November 2006 that recession would strike sometime in 2007. "The main factor pushing the economy into recession will be weakness in the housing market," he wrote in a spot-on analysis. How could other economists get it so wrong? "Economists are incredibly reluctant to acknowledge there could be asset bubbles," said Mr. Baker in an interview this week. "If you step out of line and are wrong, you're dead meat. No one will take you seriously again." What's more, some economists and academics did not expect that bubble to burst so soon. "Almost everyone believed that house prices would keep rising, or at least not fall," said Martin Baily, President Clinton's chief economic adviser, who is now at the Brookings Institution. "We missed the importance of the over-leveraging and we did not realize how vulnerable the financial system was."
The assumption that housing prices would always rise became embedded in forecasting models, Mr. Achuthan said. Many central banks' models did not take into account the stability of the financial sector on the premise that "finance is not very important," said Wharton's Mr. Allen. The housing slump that began with problems in the subprime sector has been a key factor in the deterioration of both the financial markets and the economy, according to Federal Reserve chairman Ben Bernanke and a number of economists. Falling housing prices and rising delinquencies led to major losses at many financial institutions.
One economist whose forecasts were erroneous was Ethan Harris, former chief economist of Lehman Brothers and now co-chief economist at Barclays Capital. "While it is a close call, we do not think the economy will fall into a recession," he was quoted as saying in the Journal's February survey. Reflecting on his predictions this week, Mr. Harris said, "The unique component of this recession is that the capital markets crisis has proved resistant to unprecedented monetary and fiscal medicine." He added that the administration's decision to let Lehman go bankrupt in September made the economy "unforecastable" and "ensured that this would be a major recession."
Perhaps the last word on the subject should go to Victor Zarnowitz of the Conference Board, whose study of recessions from 1960 to 1991 is in his textbook, Business Cycles. "I don't know many cases of successful forecasting of recessions," said Mr. Zarnowitz, who is also a member of the NBER committee that declared the downturn. "Recessions are more varied in origin than recoveries, and much less understood." He added that there may be a psychological component to forecasting in that many economists do not like to be the bearer of bad news. On the other hand, Mr. Zarnowitz said that because economists depend on the past for their forecasts, they do better at predicting the progress of a recession once it has begun.
The Journal's most recent surveys of economists should thus be taken more seriously than those of a year ago, Mr. Zarnowitz said. Fifty-four economists polled earlier this month said on average they expect the recession to end in June. "Still," he said, "I would take this with a very [big] grain of salt."
Currencies tumble amid renewed pessimism
Renewed worries over the world economy sent the dollar and the price of oil crashing to fresh lows this week. The US Federal Reserve's decision to cut interest rates to virtually zero was the main reason for the growing pessimism as it highlighted deep concerns among policy-makers over the severity of the economic crisis. Sterling was also a big faller this week as market expectations rose that the Bank of England would follow the Fed with more aggressive rate cuts. Edmund Shing, European equities strategist at BNP Paribas, said: "We have become even more pessimistic over the world economy, thanks to the Fed. Sentiment just gets worse and worse and that is even in economies such as Germany, which some had hoped would hold up better. "Poor numbers out of Germany this week were particularly significant, with the Ifo institute showing business confidence at its lowest since 1982. We know the US and the UK economies are in a terrible state, but now Germany is too. There is simply nowhere to hide." The Ifo business climate index fell to 82.6 on Thursday.
The main action was in the currency markets. By establishing a new target range of 0 per cent to 0.25 per cent for its main lending rate, the Fed sent the dollar to three-month lows against the euro and 13-year lows against the yen. It hit lows of $1.4719 against the euro on Thursday and Y87.11 against the yen the previous day. On Friday, the US currency steadied, although over the week it was down 4.1 per cent against the euro and 2.6 per cent against the yen. Sterling also plumbed new lows against the euro as minutes of the Bank of England's rate-setting meeting this month revealed policy-makers had considered even deeper cuts than the 100 basis point reduction in rates. Sterling was further undermined as Charlie Bean, deputy governor of the Bank of England, said a zero interest rate was possible in the UK and that the government was likely to pump billions more into the banking system. This increased expectations that the UK was set to follow the US and adopt a quantitative easing approach to monetary policy. The pound hit a record low of £0.9556 against the euro on Thursday – putting parity firmly within view – before retracing some of its losses on Friday. Over the week, the pound dropped 4 per cent to £0.9321 against the euro. It also fell 2.4 per cent to Y132.67 against the yen and dropped 5.7 per cent to SFr1.6570 against the Swiss franc.
In contrast, the euro has been shored up this week by hawkish comments from European Central Bank officials, who suggested eurozone interest rates would remain on hold at its next meeting. The yen also maintained its strength in spite of a Japanese interest rate cut on Friday. This was because the cut from 0.3 per cent to 0.1 per cent was anticipated and because talk of intervention to weaken the yen has grown this week. Oil was also under pressure this week as the main US crude benchmark dipped to $33 a barrel on Friday, lows last seen in April 2004. Oil fell 23 per cent over the week – one of its biggest ever falls – in spite of Opec, the group of oil producing nations, deciding to cut production. Analysts said fears of a deep recession had outweighed the prospect of reduced supply. Among the other commodities, gold was initially boosted by the Fed cuts as worries over the economy helped the precious metal, which is seen as a safe investment in times of uncertainty. However, it was only up about 1 per cent over the week amid some profit-taking, settling at $839.40 a troy ounce on Friday.
The increasingly gloomy outlook boosted bonds, with yields on the US 10-year benchmark Treasury falling at one point to 2.08 per cent, below all monthly levels recorded by the Fed since 1954. The yield on the 30-year Treasury fell to a fresh record low of 2.51 per cent. On Friday yields were a fraction higher. European bond yields also plumbed record lows with the 10-year gilts falling to lows last seen in 1961. Two-year gilts dropped to record lows last seen in the mid-1980s. Analysts said bond prices, which have an inverse relationship with yields, would continue to gain support from fears of deflation and a severe slowdown in the world economy in spite of the huge supply expected next year. Analysts estimate as much as $3,000bn of bonds could be issued next year – three times more than this year. Equities were fairly rangebound in spite of the pessimistic mood hanging over the market with volumes dwindling in the run-up to Christmas. The Nikkei 225 Average closed down 0.9 per cent on Friday, but it was up 4.2 per cent on the week. The FTSE 100 closed down 1 per cent on Friday, although over the week it was flat. The FTSE Eurofirst 300 was slightly lower on the week. In the US, the S&P 500 finished 0.9 per cent higher on the week.
Ilargi: No, leveraging is the confidence enemy. But this article -perhaps unwittingly- lets us know what is ahead.
Deleveraging is damaging confidence
Halting the tidal wave of deleveraging that has swept through the markets is paramount if policy moves to restore the financial system are to work, says Jonathan Wilmot, chief global strategist at Credit Suisse, as part of a report on the outlook for 2009. "Since Lehman Brothers' demise on the altar of moral hazard, deleveraging has become an overwhelming force", he says. "Trillions of dollars of asset value have been destroyed, freezing credit markets as usable collateral and counterparty confidence evaporates, and sparking a near vertical drop in orders, production and confidence." Mr Wilmot says that were this a standard panic, he would be very bullish on both equities and credit. "Valuations range from attractive to compelling. Buying cheap assets in a panic is what value investing is all about."
But the current crisis has all the hallmarks of an "extreme event" that could end up transforming the whole political, economic and financial landscape for decades to come, he says. "We believe 2009 will be a contest between the massive destructive power of systemic deleveraging and massive government action to nudge the credit system towards a healing equilibrium. Policy should win the next round, but ultimately we are more bullish than that. There is still time to convert an incipient depression into something like a classic 19th century panic, thus giving the world a chance to achieve full potential in the coming decade."
Expectations of high-yield defaults may be too low
Coming defaults on junk bonds are likely to be more severe than investors may be expecting, warned a report published yesterday in Distressed Debt Investor, a bi-weekly high-yield debt research service. The report, by Martin Fridson, noted that the number of defaults may be higher than, for example, Moody's Investors Service expects based on the experience of previous recessions and the fact that shareholders may have less incentive to service interest payments than is expected. Mr. Fridson said he expected defaults among bonds that Moody's rates Ba or lower to occur at an annual rate of at least 12%, rather than the 10% that Moody's expects.
Tribune Co.'s recent bankruptcy filing is an indication of why that may be the case, Mr. Fridson wrote. While the company faced an interest payment of only $70 million, it chose not to make it despite more than enough cash on hand to foot the bill. Mr. Fridson added that the filing should "jolt investors out of complacency" regarding the possibility of default by companies that face no immediate cash squeeze because they took advantage of highly favorable financing conditions to extend their maturities before the credit crunch materialized.
Citing research findings that have been neglected in the current cycle, Mr. Fridson noted that default "has nothing to do with imminent cash shortfalls or covenant violations." Instead, he noted, the phenomenon reflects the fact that when the expected value of future cash flows falls below the value of liabilities, "the rational equity holder ceases to have a motivation to continue servicing the debt." He reminded readers of the relevance of a famous line by the oft-divorced actor Mickey Rooney, who said that paying alimony was like pumping gas into another man's car.
Mr. Fridson went on to write that Moody's projection of a 10% default rate on high-yield bonds seems to be derived from the experience of the relatively mild 2001-2002 recession, whereas economists now expect the current recession to more closely resemble those of 1990-1991 and 1982-1983. In those deeper recessions, default rates were 19% and 9%, respectively (with the milder, more recent recession producing a higher rate because of heavier issuance). By comparison, default rates during the Great Depression peaked at 16% in December 1933, Mr. Fridson added.
He also dismissed observations that the high default rate of the 1990-1991 era was exaggerated by politically motivated federal officials out to punish the leveraged buyout financier Drexel Burnham Lambert, saying that factor was less likely to have driven defaults than market conditions. In the same vein, he noted that observers who suggest that that cycle was decidedly different from the current one fail to see how LBO activity drove the run-up in the market in both periods. "High yield boosters who expect the rate to peak in single digits look decidedly optimistic," Mr. Fridson concluded.
Turning Japanese: How Low Can Prices Go?
Comparisons between the United States today and Japan in the early 1990s just keep growing. The Japanese call that period the "Lost Decade," as it was marked by anemic growth, plummeting prices and the lingering death of insolvent banks. There was, however, one product everyone wanted: a safe. If you couldn't trust banks to hold your savings intact, why not do it yourself? No one remembers this history better than Federal Reserve chairman Ben Bernanke, which is why the Fed's Dec. 16 decision to slash a key interest rate to 0.25 percent caused a flicker of fear among those in the know.
That measure means that the United States' central bank is gearing up for a full-fledged pre-emptive strike against deflation, the sort of prolonged drop in prices that bedeviled the Japanese until just a few years ago and crippled the global economy back in the 1930s. Some optimists say it's too early to worry. Deflation, they insist, has to be chronic before it can be considered a serious problem; a couple of dips in the inflation rate don't qualify. So even though the consumer price index registered a big 1.7 percent drop in November, and even though that was the fourth monthly decline in a row, it's still a bit too early to get worried.
Two days after the cut, though, Federal Reserve Bank of Dallas president Richard Fisher let the cat out of the bag. "We have to do everything we can to lift the economy up and prevent deflation from taking [hold]," he warned. Fed bankers understand that the threat is not to be taken lightly. Once a deflationary dynamic takes hold, the central banker's traditional tool of reducing interest rates loses its power. You can't drop nominal interest rates below zero, as the Bank of Japan found out to its frustration in the early years of this century. The value of assets continued to erode as prices plunged—a "slow, corrosive force," as Richard Jerram of Macquarie Securities in Tokyo puts it.
And if the central bank isn't prepared to flood the system with lots of new money (as the Fed now seems prepared to do), a downward spiral can set in. No one wants to lend, since the loans will be worth less by the time creditors get around to paying them back; no one wants to invest in making stuff, since the products may be worth even less by the time they come to market. The scenarios look even more threatening for an economy ridden with debt, as America's is right now. In a deflationary environment, debts mushroom over time. But because the products and services produced by the debtor are losing their value, paying off the debt gets harder and harder. Could it happen in the United States today? The Fed has now demonstrated that it doesn't intend to wait and see. That means there's still hope the United States could avoid its own Lost Decade.
Fortisgate scandal topples Belgian government
Fortisgate, the growing scandal over the future of Belgian rump insurer Fortis, brought down the country's government soon after the justice minister resigned over suspected state meddling in legal decisions. Jo Vandeurzen stood down after the court of cassation, Belgium's supreme court, said it had found "significant signs" but no hard evidence that the government had tried to influence judges ruling on the bail-out and sale of Fortis. Within hours, prime minister Yves Leterme won a cabinet vote that the government should resign. King Albert now has to decide whether to accept the resignation.
Observers said the likely outcome would be a general election, an option few parties want amid deepening economic crisis. Leterme's government had been accused of trying to block a court of appeal ruling to freeze the group's break-up. Earlier, angry shareholders in Fortis, once Belgium's biggest financial services company, voted overwhelmingly to keep the business going in the desperate hope of brighter days. As investors railed against an assault on democracy and the rule of law, Jan-Michiel Hessels, acting chairman, warned that Fortis would have gone bankrupt without nationalisation. It lost €23bn of value in a few days in early October. Hessels told about 3,000 shareholders at an extraordinary meeting: "We didn't have a choice and, if we didn't act then, there was a likelihood that the Belgian state would have gone bankrupt - like Iceland."
Shareholders voted against immediate liquidation - and 97% in favour of continuing operations. The government's €11.2bn bail-out of Fortis, worth €40bn a year ago, failed as the bancassurer went into a liquidity crisis. Ministers handed over the group's Belgian banking and insurance operations, including substantial assets, for a knockdown price to France's BNP Paribas. But last week the court of appeal ruled in favour of small activist shareholder lobbies who opposed the sale, and BNP this week froze its planned €14.5bn takeover.
Its shares, savaged by investment losses linked to the Madoff scandal, lost 30% in a day and were down more than 5% yesterday. Fortis shares were up marginally at €1.20, or double their all-time low. BNP has said it could return to the Fortis deal if the court of appeal ruling is overturned, with judges last week freezing the deal for 65 days until mid-February. But, with lawyers warning that the case could take a year or more to unravel, Fortis's future is problematic.
World Bank: Russia may need help if oil falls more
Russia would come under crippling financial pressure and may need to raise money externally if oil languishes at an average of $30 a barrel over the next two years, the World Bank predicted Friday. The bleak scenario would mark a rapid unraveling of Russia's oil-fueled economic gains over the past eight years, during which time the government has paid down most of its foreign debt and built up a vast stockpile of international reserves.
"If oil prices in 2009 and 2010 average $30 a barrel, that would be a nightmare scenario for a global economy," Zeljko Bogetic, the World Bank's chief economist in Russia told investors on Friday. "The pressures on the current account and public finances in Russia would quickly rise to a point where the financing constraint would become so sharp that it's possible even to envisage Russia's return from a creditor to international organizations to a borrower." At $50 a barrel, Russia could drain much of its reserve funds and run budgetary deficits, but would not face a "meltdown" scenario, Bogetic said.
Oil prices took a sharp turn downward this week, with the February light sweet crude contract trading just over $42 a barrel _ more than $100 lower than its July peak _ despite a large output cut pledged Wednesday by oil producers' cartel OPEC. Some major oil-importing countries have criticized OPEC's move to push up prices during a global slowdown. The World Bank currently forecasts an average oil price of $75 a barrel over the next two years, said Bogetic. Among emerging markets, Russia has been one of the hardest hit by the global financial crisis and plunging oil prices, the mainstay of the Russian economy. These factors have put the national currency under intense strain and triggered massive stock market losses and capital outflows from the country.
Russia, which grew at over 8 percent last year, is facing a severe slowdown in growth, and possibly even recession next year, analysts say. Torrid figures released earlier this week showed that industrial output had plunged 10.8 percent in November from the previous month, signaling a dramatic slowdown in the final quarter. Russia's jobless swelled by 400,000 in November to 5 million, the Federal Statistics Service said Friday, as manufacturers increasingly slash staff and cut back working hours. Producers of industrial goods such as metal combines and cars have been particularly affected by falling demand. "Clearly we are in the middle of a major growth recession in Russia," said Bogetic. "I would call it a growth recession, not an output recession _ yet." He said the World Bank had tweaked its earlier projection of 3 percent growth next year to between 2-3 percent.
Russia riot police break up crisis protest
Riot police in Vladivostock in the far east of Russia broke up a protest on Sunday against a government decision to increase car import duties to protect the ailing domestic auto industry. Witnesses said at least 100 people were detained as police closed in on the unsanctioned rally, beating protesters and reporters covering the event. The crackdown came as motorists staged similar demonstrations in 30 other Russian cities, fuelling fears of a surge in social unrest as the economic crisis deepens. Vladimir Ryzhkov, an independent opposition leader, said the authorities had revealed they were "scared," after Moscow-based units of the dreaded Omon special forces were deployed to control the demonstration in Vladivostock over 3,750 miles away. "Local forces will not strike their own people," he said. The higher duty, adding about 50 per cent to the cost of an imported car, will hit dealers particularly badly in Vladivostock, a port city on the Pacific which is a hub for Japanese used car imports.
Vladimir Putin, the Russian prime minister, unveiled a $5bn package of protectionist measures last Friday to prop up auto manufacturers, including cheap credits for car buyers and free rail transport for Russian built cars to the far east of the country. Putin said importing cars was "inadmissible" while Russian manufacturers were being forced by the economic slowdown to reduce production. In Moscow about 300 mainly young people demonstrated against the higher tax under close watch by the police, but began dispersing within one hour. Sergei Kanaev, a lawyer and head of the Association for the Protection of Motorists' Rights, said, "This is not a political demonstration. We are here to protect our right to buy cars that we like and that are safe." Mr Ryzhkov said the higher tax was designed to support Russian oligarchs rather than the people. "It is stupid. No one will buy Russian cars because they are bad cars," he said. Russia was Europe's fastest growing auto market until the crisis with cheap credit bringing foreign cars within reach of ordinary people for the first time. Most large foreign automakers have established local car assembly ventures to cater for Russians' love of foreign brands.
Madoff probe uncovers fresh scams
Investigators are unearthing more irregularities in the financial affairs of Bernard Madoff, the man who stunned America's wealthy elite when he allegedly admitted running the biggest investment scam in history. Initially, it was thought he was running a simple pyramid scheme. But Steve Harbeck, head of the Securities Investor Protection Corporation and the receiver of Madoff's broker-dealer business, said the investigation had uncovered a trove of records stretching back at least 20 years.
"We do not seem to be dealing with a traditional Ponzi scheme alone," said Harbeck. "Ponzi" frauds occur when the money from new investors is used to pay existing ones. "This seems to be something of a hybrid," Harbeck said, adding that the potential losses could be far greater than anyone first thought. He was unable to elaborate on the types of fraud that were emerging. But sources close to the Madoff investigations suggested the trader may also have falsified tax documents and other records to show fake profits to his investors. Harbeck would only say: "It is just too early to say exactly what else was going on here."
The new allegations are understood to revolve around two sets of books that Madoff kept for his investment advisory business. Investigators have discovered records on thousands of trades in shares and bonds and other securities in seven binders stored on the private 17th floor of the Lipstick Building on Manhattan's Third Avenue. The investigators believe the positions detailed in the binders may be fake, used only to compile fraudulent statements of account to clients.
Harbeck said the case was unusual because of its scope. "The length of time we are dealing with - which by Madoff's own admission is at least a decade but probably more like two - is just incredible. A Ponzi scheme might usually last a year or so, but it is usually impossible to keep it going for long periods of time." So far dozens of high net worth individual investors and a long list of banks and investment firms have declared losses to Madoff of more than $27bn.
Harbeck said that under a traditional Ponzi scheme it was common to find that just as much cash had been paid out in fake profits to earlier investors as had been declared lost to newer investors. "But with this case being, as I said, a hybrid fraud, it is impossible to say how much has been paid out at this stage." In the US, all those who have made profits from a fraudulent scheme must pay back their gains to the receiver seeking to compensate the victims who have lost money.
Backing Madoff dents Santander's shining financial reputation
Call it the winner's curse. No sooner had Spain's Santander been named the World's Best Bank by Euromoney, and collected the Bank of The Year award from the Banker magazine than its pedestal began to wobble. Undoubtedly its biggest embarrassment is the revelation that its Swiss-based fund management business was one of the biggest investors in the hedge funds run by Bernard Madoff: Santander's wealthy clients have lost an estimated €2.33bn (£2.2bn) and legal action by them looks a pretty safe bet. That has dented not just the fearsome reputation of Emilio Botín-Sanz de Sautuola y Garcia de los Rios (Emilio Botín for short), the 73-year-old chairman who built Santander into a global giant, it may also have undermined his chances of sustaining the family dynasty.
Botín succeeded his father as chairman in 1986 and, while he deflects questions about his own departure, saying he will stay as long as shareholders want him to, observers were predicting that his daughter, the formidable Ana Patricia, would follow him. But her husband, Guillermo Morenes, ran M&B Capital Advisers, the Swiss bank that marketed the Madoff funds. While M&B trumpeted its "intensive due diligence" and "detailed scrutiny" of each investment, many other banks were suspicious enough, after even a cursory look at Madoff's practices, to shun the fund. The embarrassment comes as Botín faces growing challenges to his ability to steer through the financial turbulence. Around half the bank's business originates in Latin America which, thanks to the commodity boom and more effective political leadership, had been enjoying a spectacular boom.
At the end of October, Botín outlined his goal of becoming the number one bank in Brazil, adding: "Brazil has been able to take advantage of the favourable international situation of the last years to pave the way for sustainable future growth. It is inevitable that the impact of the international financial crisis is being felt. However, Brazil's macroeconomic situation is the best in decades." But in a recent note, analysts at Keefe Bruyette & Woods said: 'Most Latin American capital markets have experienced a steep sell-off, currencies have weakened, commodity prices have fallen, and the overall economic climate has deteriorated." Spain is in the grip of a housing and property slump. While Santander's reliance on its domestic market is lower than its rivals, it faces mounting losses on its own consumer lending as well as its exposure to residential developers. They account for some 7 per cent of its Spanish loan book and it has had to take on €2.5bn of their assets in exchange for unpaid debts.
Santander has been lauded for being one of few banks that could prosper from the financial crisis. It has taken advantage of the weakness of most of its rivals to snap up Alliance & Leicester, the savings business of Bradford & Bingley and Sovereign Capital in the US at bargain prices. It was vilified for launching a rights issue just a week after its chief executive Alfredo Sáenz said it did not need to raise new capital, but the €7.2bn rights issue was comfortably subscribed. It is also the only one of the trio that launched a £49bn joint bid for ABN Amro to have survived more or less intact. Royal Bank of Scotland is now 58 per cent owned by the government, has ejected its chief executive and is likely to have to sell off large parts of its business; Fortis has been broken up and parts of it are also under the control of the Dutch and Belgian governments.
Botín raised the funds to buy the ABN assets by selling 1,200 of its properties across Spain for €4bn just before the market started to crumple. Fortis took on a fund management business now showing the ravages of the stock market crash and RBS was landed with an investment banking business at the top of the market, but Santander's main purchases were in the less turbulent areas of retail banking. Botín also had a lucky escape with Alliance & Leicester: in January, he was ready to pay £5.50 a share for the former building society but his offer was spurned; less than six months and a tightening credit crunch later, he picked it up for £2.99 a share and a few weeks after that landed B&B's savings book for an even lower price.
However, those alert for signs of hubris note that the bank has just moved into Santander City, a 370-acre office complex north of Madrid, which boasts a swimming pool, gym, 18-hole golf course, five restaurants, a supermarket and a designer hairdresser. It is an uncanny echo of Royal Bank of Scotland, which moved into its Gogarburn campus - with its a gym, pool, tennis courts and a shopping street - three years ago. Botín is all too aware of the pain that followed: Santander owns a 2.1 per cent stake in the bank, a legacy of long co-operation between the businesses, and took up its rights issue in the spring, a stake that has lost 90 per cent of its value this year alone.
High street braced for Christmas sales carnage
Up to 15 national retail chains are predicted to go bust before the middle of January, forcing thousands more shopworkers onto the dole. The prediction came from insolvency expert Begbies Traynor as well-known retail chains clamour to sell enough goods to meet their quarterly rent payments on Christmas Day. Nick Hood, partner at Begbies Traynor, said: "I would not be surprised if between 10 and 15 national and regional chains collapsed before the middle of January." Hood refused to name specific store groups, but this weekend it emerged that The Officers Club, a 150-strong national menswear chain, had been put up for distressed sale through KPMG, while the specialist tea retailer, Whittards, and music store Zavvi remained on the critical list.
According to the accountancy firm Price Waterhouse Coopers, if only 10% of national retailers get into financial difficulty in the next 12 months, that would bring about 4,000 empty shop units onto the market. Rupert Eastell, head of retail at BDO Stoy Hayward, said: "From tomorrow until mid-January, it's going to be the worst three weeks for retailers in 20 years." A slew of high-profile names have already gone under this year, including Woolworths, MFI, SCS, Dolcis, MK One and Rosebys. Suppliers to big-name retailers are also facing collapse. House of Fraser has written to 200 of its suppliers asking them to be honest if they run into financial difficulties. It has already extended the offer of financial support to some stricken suppliers.
Leading shops have engaged in unprecedented levels of discounting to woo shoppers in the run-up to Christmas, but sales have continued to plunge. Leading British retail executives admitted privately this weekend that sales were down by between 10% and 30% on a year ago, and even a last-minute rush of shoppers would be too little, too late, to save their Christmas. Derek Lovelock, boss of Mosaic, the retail group that owns the women's fashion chains Karen Millen, Coast and Warehouse, said: "It is the worst run-up to Christmas I have ever experienced. The likelihood is that there is too little time left for the majority of retailers to make up the shortfall from the past two months." City analysts said that after Christmas there would be a rash of profit warnings and downgrades from retailers whose shares are listed on the stock market.
Nick Bubb, analyst at Pali International, said: "In January, there will be big downgrades and soon retailers will start to lose money. "The scale of the crisis will have an impact on consumer confidence. The sobering thing is that this downturn has only just begun. We have another two years of this." Marks & Spencer is rumoured to be among the many high-street chains having a torrid time, with sales thought to be sharply down despite heavy pre-Christmas discounting. Analysts have already slashed their profit forecasts for M&S, but the City believes the group will still be lucky to avoid a profit warning or a big profit downgrade. The news came as Britain's biggest sportswear chain, JJB, insisted that it had excellent relationships with its suppliers, despite speculation earlier in the week that it was late with payments to Nike.
New figures show British recession is deepening
Official figures this week will confirm that the economy has been sliding into recession for months and could show that the downturn is deeper and started earlier than first thought. Revised figures for gross domestic product (GDP) in the third quarter are set to show a fall of at least 0.5%. Several analysts believe that subsequent information, particularly on the dire performance of manufacturing, will see a sharper quarterly fall of 0.6%. Whitehall officials are also braced for a revision of earlier data, which could change the timing of the recession. Existing figures show that GDP was flat in the second quarter. That has allowed ministers to claim that Britain's recession started later than in other economies, notably the eurozone and Japan. Any downward revision to the figures would mean Britain was in "technical" recession from the spring.
Economists are getting gloomier about the outlook. The Centre for Economics and Business Research, a consultancy, predicts that Britain will contract by 3% in 2009 and a further 0.7% in 2010, implying a long, deep recession. Capital Economics, another consultancy, now predicts a fall of 2.5% in GDP next year, with a further drop of 1% during 2010. This compares with the Treasury's prediction of a decline in GDP of between 0.7% and 1.25% next year, followed by a recovery in 2010, when it expects to see the economy grow by between 1.5% and 2%. Analysts surveyed by Ideaglobal.com, the financial research company, expect the Bank of England to press ahead with interest-rate cuts in the new year. Asked where Bank rate would be at the end of the first quarter, the median expectation was 0.75%, compared with 2% now.
The Bank's monetary policy committee is widely expected to cut interest rates at its January meeting, but analysts are split on whether it will repeat this month's full percentage-point cut, or opt to slow the pace of easing. Business has welcomed the speed with which the Bank has cut rates, but there is concern about sterling's slide. Last week the pound hit an all-time low of €1.05 and also dipped back below $1.50. While its fall is good for exporters, business groups warn that, with overseas markets depressed, their members are seeing little benefit. "Manufacturers don't, in general, welcome volatility in currencies," said Steve Radley, chief economist at the Engineering Employers' Federation. "If we were to see the pound stabilise, that would be welcome."
Sterling's fall has raised the cost of source components and other supplies from Europe. In most cases it takes time to switch these supply sources. The fall accelerated last week as the US Federal Reserve cut its key interest rate to between zero and 0.25% and Charlie Bean, the Bank of England's deputy governor, said there was no bar on the Bank following suit. The minutes of its meeting this month showed it had considered a rate cut of more than a percentage point. Richard Lambert, the CBI director-general, said there should be an opportunity over time to strengthen Britain's manufacturing base as a result of what he described as the pound's overvaluation of recent years having been corrected. But he added that his immediate concern was not sterling, but the impact of the banking crisis throughout the economy. "We need to find more ways of getting the public-sector balance sheet to substitute for the private-sector balance sheet," he said. Analysts say one headache for the authorities will be dealing with deflation – falling prices – in 2009.
The big risk for Britain is not a falling pound but a devalued Government
If the world is so confident about UK economic policy, why has sterling been hit so hard by the markets? Well, I think we know the answer to that one, so try a harder one. To what extent will a weak pound be a blessing, or a curse, in the year ahead? Obviously this is a keen issue for many families, as this holiday season is traditionally the time when people plan their next holiday season – where they will go in the spring or summer. And for anyone planning to go abroad, the plunge of the pound is a disaster. Expect a boom in people going to the few countries with even weaker currencies than we do: hoteliers in Turkey and South Africa, stand by.
But if there is going to be a global recession, and something like that is going to happen, a weak currency does in the short term at least help boost demand. You could almost say that it is a benefit to have an economy and a Government in which the world has so little confidence. A couple of stories to illustrate this. One comes from a friend who plays the piano in an Italian restaurant in London. I was worrying that business must be terrible, given that one of the first things people cut down on when they are feeling poor is eating out. No, he said, all their customers were tourists from Europe who were flocking to London to do their Christmas shopping. The restaurant was full every night. The other was an acquaintance who had moved to the UK to set up a hedge fund in London. Why on earth had he chosen London when he could have based it anywhere in the world? Well, London used to be expensive but now he could get offices cheaply and could hire high- quality staff. The only other realistic alternative was New York, and our capital was now more cost-effective.
So while it is true that many businesses have been savaged by the fall in the pound, particularly those that need to import goods or services, a lower pound should, on balance, give a boost to the economy. It will take a while for exporters to benefit fully because there simply isn't much demand in the main export area, the eurozone. The most recent data suggests that the combination of the soaring euro and the lack of international demand is hitting German business confidence even harder than the burden of debt and the lack of domestic demand is hitting UK confidence. The danger is that the fall in sterling will get out of control and start to have perverse effects. You have to start by recognising that the pace and extent of the pound's collapse in the past year has been greater than at any stage since sterling left the gold standard in 1931. It has fallen by nearly 25 per cent. That is worse than the Second Word War. It is worse than the devaluations of 1949 and 1967. It is worse than the dreadful 1970s, when we had to get the International Monetary Fund to bail us out with a loan. It is worse than the ejection from the European exchange rate mechanism (ERM) in 1992.
After the 1967 devaluation, the pound dipped by 13 per cent for a year, then jumped back to the norm as the devaluation moved out of the statistics. (If you are wondering why the current devaluation is greater than the 1949 one when the pound fell from $4.00 to $2.80, it is because the trade-weighted fall was lower than the fall against the dollar as sterling area countries devalued along with the pound.) So what is our past experience of devaluations? It is a mixed bag. Starting with the most recent, the exit from the ERM was highly successful. It made sterling super-competitive and there was hardly any feed through into inflation because demand was low. Due to slack in the economy, business could not put prices up. After the collapse in the 1970s, the picture was more confused, but I think it would be fair to say that most of the competitive advantage we gained was thrown away in higher inflation. That was certainly the case after the 1967 devaluation. The 1949 devaluation was effective in the sense that the old exchange rate was clearly unsustainable, but since many other countries devalued too, we did not gain much advantage for very long. And finally the 1931 devaluation. Well that was indeed a success as it enabled the UK to make a faster recovery from the Depression than any other major economy.
So what about this one? Simon Ward, economist at New Star, questions the consensus view that the lower currency carries little inflation risk. The output gap now is not as large as in 1992 and though headline inflation will come down (thanks to falling commodity prices), he fears that it might not come down as fast as the Bank of England expects. That would lead to two dangers – one that the Bank can't cut rates further since to do so would not be credible, the other that confidence in the UK's financial management would face some kind of systemic collapse. The former seems to me less of a concern, just because we are at a level where further cuts will be ineffectual. You can see what has happened in the US and Japan: rates go to zero, or just about, and nothing happens.
The risk of a collapse of confidence in the UK's creditworthiness must surely be a real one. Next year we could end up with a fiscal deficit of more than 10 per cent of GDP. Our national debt, if you include the liabilities of the Royal Bank of Scotland now that it is majority-owned by the taxpayer, would become the highest in the world relative to GDP. Even without RBS (and I think that is a fairer calculation), it looks as though it will go from under 40 per cent of GDP to something close to 80 per cent. I don't think Gordon Brown has any idea of the contempt in which he is held in the rest of the world. I sat at lunch next to a top European politician a few months ago and his assessment was unrepeatable. (He cheered up noticeably when I said that the PM couldn't win an election.)
The big point here is that a competitive currency is helpful going into a global downturn, but if it is associated with a collapse of confidence in the Government, it can be dangerous. Most obviously, the cost of funding the deficit will rise and that will crowd out other borrowers. Fortunately, I don't think we are quite at that tipping point yet. So I suppose you could say the fall in the pound is not yet a disaster in itself, and if the interest rate recovers some in the months ahead, it will be a modest help. All currencies have their day in the dog- house – the euro has had one, the dollar too – so I don't think we should despair. But the underlying fiscal position of the country is quite dreadful and I worry about the ability of the Government to fund its debts. The collapse of sterling makes that harder still.
Private equity supremo faces shares battle after Lehman collapse
The private equity supremo Guy Hands is facing a battle to recover shares worth millions of pounds that are held in an account overseen by Lehman Brothers, the collapsed US investment bank. Terra Firma Capital Partners, Mr Hands' investment firm, bought a small stake in an undisclosed public company with a view to mounting a takeover bid several weeks before Lehman's September demise. The shares were kept in a Lehman custody account, according to a person close to the situation, because the bank was advising Terra Firma on its interest in the company. PricewaterhouseCoopers (PwC), the administrator of Lehman's European business, is understood to have told Terra Firma that it can wait until the administration process is complete or can pay the accounting firm a fee to indemnify it against any potential future claim on the shares. I
It was unclear this weekend which route Mr Hands' firm would take, although it is thought to have shelved plans to bid for the unidentified company. The shareholding in question was below the 3pc threshold which requires such purchases to be disclosed to the London Stock Exchange. Terra Firma's predicament reflects a significant gulf between administration laws in Britain and the US, where many Lehman creditors were able to recover assets within weeks of its bankruptcy filing. The issue was highlighted in a report earlier this month on the City's competitiveness which warned that London's reputation as a financial centre was being undermined. "The process the Lehman Brothers' London subsidiary administrators have had to go through – and the fact that they carry personal liability – is inconsistent with a rapid release of assets and settlements to creditors," said the report.
"This has been a major problem for many market participants who had assets or cash with Lehman, as global firms' UK operations fared materially worse in relation to Lehman's insolvency than in other financial centres." Mr Hands is far from the only party trying to recover assets held by Lehman. Chinalco, a Chinese state-owned aluminium producer, had a 12pc stake in Rio Tinto, the mining group, worth billions of pounds, caught up in the bank's collapse while a shareholding in UBS held by an investment fund overseen by Luqman Arnold, the former chief executive of Abbey, is also under administrator control. PwC has warned that untangling the Lehman empire could take up to a decade. Terra Firma and PwC declined to comment.
No growth, no jobs, no confidence... Yes, it's Germany
The conventional wisdom is that the pound's tumble against the euro in the past two months, which has seen it shed 20% of its value to approach parity with the single currency, is because the British economy is a total basket case. While that is difficult to dispute - we are ending the year in a deep recession - it is less clear why the pound should have fallen so far against an economic bloc that is arguably in just as bad shape. True, investors have been spooked by the British government's willingness to tear up its fiscal rulebook and let borrowing rip, and because they fear the economy's excessive reliance on the financial services sector means it will have a deeper downturn than its European neighbours.
There is, of course, the additional point that the Bank of England has slashed interest rates to 2% and is likely to cut them further and more quickly than the European Central Bank, thus further reducing the return on sterling assets and so encouraging selling of the pound. So far, so good. But all is far from well on the other side of the Channel, particularly in the zone's largest economy: Germany. "All the focus has been on the sterling side of this exchange rate but people will soon become aware of the scale of the deterioration in the European economy," says Nick Parsons, chief strategist at capital-markets house NabCapital. "We can't get away from the fact that Germany could well have a recession every bit as deep if not deeper than our own."
Germany has been particularly badly affected by the slowdown in the world economy this year, since its economy is highly dependent on exports. Thus, when the world economy was booming, it benefited the Germans greatly; now it has gone sharply into reverse, the impact has been severe. This week's keenly watched Ifo business confidence survey slumped to a record low while the economy contracted by 0.5% in the third quarter - the same pace at Britain's - after a 0.4% fall in the second quarter, meaning Germany has beaten Britain to achieving the technical definition of a recession. And the Ifo institute expects the German economy to shrink by 2.2% in 2009 - again, in line with gloomy forecasts for Britain. The country also starts from a worse base, with unemployment currently at 7.5%, well above Britain's 6%.
Germany has succeeded in getting its unemployment down in the past three years but most economists say it will now rise sharply as manufacturers shed jobs in the face of wilting global demand and, of course, the strong euro - exactly what it doesn't need. Similarly, France has seen business confidence fall to record lows. The Bank of France said this month growth would contract 0.7% in the fourth quarter, with analysts forecasting a recession in 2009. Add in the collapsing housing markets of Spain and Ireland, and the stagnation of Italy, and the whole picture looks grim. Britain's economy did not grow at all in the second quarter and shrank 0.5% in the third. It is widely expected to contract by more than 1% in the fourth quarter and by 2% or more next year.
Aggregate data for the eurozone shows it contracted by 0.2% in both the second and third quarters and is widely expected to contract faster in the current quarter. Survey data from the manufacturing and services sector has looked very weak. In all likelihood interest rates here will be as near to zero as makes no difference within three months, with the authorities following the US in carrying out other measures to try to revive the economy. By contrast, the ECB is unlikely to cut as far or as fast, potentially delaying recovery in the eurozone. And eurozone governments have had varying degrees of enthusiasm for fiscal easing. So it is reasonable to think Britain could emerge more quickly from recession, making the pound's weakness a bit of a mystery.
Nor is it really fair to assume that Britain is much more exposed to the financial sector than other countries. Contrary to popular belief, financial services here account for only around 8% of national income - half the size of the manufacturing sector. That figure is bigger than the European average of 5% but about the same as the US or Switzerland. But the UK has enjoyed much stronger growth than the eurozone for a decade or more, leading to the pound being very strong against the euro, so the sudden juddering to a halt has dealt a heavy blow to the pound. But it now looks possible that the pendulum may have swung too far in the other direction. "We are very close to or already at the bottom for the pound and the snap-back could be fairly dramatic," says Parsons.
Germany is already collapsing
The German economy is on the "brink of the abyss", says the IMK institute in Dusseldorf. The country's GDP could contract by 3.5pc next year. We are reaching depression levels here. The IFO confidence index published by its sister institute collapsed to a record low of 82.6. This is an industrial melt-down. It is becoming ever clearer that the surplus countries (angels) will suffer just as much - if not more - than the deficit countries (sinners), even if this offends moral justice. This was ultimately the story in the 1930s, though it did not look like that at the outset. Germany and China have become addicted to exports. This is not as healthy as it looks. They will bear the brunt of belt-tightening by the Anglosphere Club, and East Europe. Carsten Brzeski, ING's Europe economist, said Germany's fourth quarter will "very likely make history as the worst collapse of the German industry ever. One thing is evident: The current downturn could behave like a rock that threatens to roll down a hill. Once the boulder has gained momentum, it will simply mow down everything in its path. It should be stopped in time."
Quite. Unfortunately the fractured Left-Right coalition of Peer Steinbruck and Angela Merkel lacks the leadership capable of stopping it in time. They have quite simply lost the plot. Like the hapless Bruning government in 1932. (Note that the German economy tipped into recession even earlier than Britain's economy and faces an equally bad year in 2009. This is not to gloat, nor is it Schadenfreude. It is merely to put matters in perspective at a time when the British press is in extreme self-flagellation mood.) IMK may or may not be right in calling for another €50bn (£47bn) stimulus for Germany. But it should clear be now that the German people have been very badly let down by the do-nothing crowd in Berlin. It should also be clear that the ECB has been asleep at the wheel. The IMK institute took the rare step today of attacking the bank, saying it had been "very late" in responding to the crisis. Julian Callow at Barclays Capital says the euro's trade-weighted index has risen 10.7pc this month (sterling is a big part of it). This is equal to a rate rise of 175 basis points. Monetary policy is tightening like a vice, although its awful effects will not be felt until deep into next year. (Never underestimate those killer FX time-lags).
The ECB is taking a big risk by refusing to follow the lead of the Switzerland, Sweden, Norway, the US, Canada, and Britain in slashing rates. The result of going it alone has been to drive its currency to levels that have ensured the now inevitable bankruptcy of scores of companies next year. Many of them might have survived under a more pro-active central bank. A case can be made that the ECB is better off engaging in "qualitative easing" - to borrow the term from Willem Buiter - rather than cutting rates so far that its paralyzes up the money markets and repo system. Jean-Claude Trichet has not ruled out the purchase of eurozone government debt. The ECB is banned by the Maastricht Treaty from doing this directly - for fear it would be used as a covert bail-out for EMU's profligate states - but it could in theory do it on the secondary market. This would be a political can of worms, of course. I am coming round to the view that zero rates may be an error. It may be better to hold at 1pc and do "quantitative easing" instead - ie, printing money. If the ECB chooses this enlightened - albeit late - course of action, I promise readers to be fulsome in my praise.
After all the monetary madness, surely things can only get better
Way back in the 70s, I wrote a light financial thriller called A Real Killing. It did quite well, although it did not make a financial killing for me. Now, I am absolutely convinced that if I had named one of the central characters Mr Madoff, my publisher would have said: "Don't be ridiculous - think of a more plausible name." Yet, that is of course the real name of the Wall Street character who was cultivated by so many because his funds made suspiciously high, regular returns. Unfortunately, this was apparently out of one of the oldest dodges in the book - a so-called "pyramid" scheme under which the dividends are provided by filching the money from new deposits. As long as the pyramid is rising, everything is all right for the swindler. He is only found out when things go into reverse, and people want their money back. (I have always thought the phrase "pyramid selling" was unfair to the original pyramids, which have lasted a lot longer than pyramid schemes.)
But, somehow, the emergence of what is being described as the biggest fraud in history just seems par for the course these days. It is symbolic of the era of excess that may be at an end; and, as the economic news goes from bad to worse, nothing seems to surprise us, not even that a British politician who rashly promised an end to "the policies of boom and bust" has been recovering his position in the opinion polls. Incidentally, if the prime minister's colleagues and spin doctors have any sense, they ought to play down suggestions that Gordon Brown is in some sense enjoying this crisis. That, frankly, is not what the unemployed, those fearful of becoming unemployed and businessmen in dire straits wish to hear. Good luck to a leader whose time has come; but steady on. Perhaps I am old-fashioned, but I find talk of a "snap election" to capitalise on the public's apparent desire to "keep a-hold of nurse, for fear of finding something worse" just a little distasteful. In any case, goodness knows what ghastly economic and financial news might emerge in the course of an election campaign.
For the fact of the matter is that there is panic in the ranks now throughout the once-feted "globalised economy". The reduction in US official interest rates to zero last week was the latest indication of how desperate policy makers are now. When interest rates are at zero, by the way, the difference between monetary policy (changes in interest rates and/or the stock of money) and changes in fiscal policy (tax rates and public spending) becomes cloudy. One noted economist last week suggested that "fiscal policy and monetary policy become the same". As governments and central banks contemplate a desperate resort to the printing presses (or technical moves in the money and bond market which amount to the same thing: as Edward G Robinson once said: "Don't bother me with the de-tails'), the attempt to boost purchasing power resembles further tax cuts.
In which context I find the revival of the Ricardian notion that tax cuts are ineffective because people know taxes will rise in the future about as convincing as those other two economic doctrines that ought by now to have been consigned to the scrapheap: "rational expectations" and the so-called "efficient markets hypothesis". The current crisis has finally put paid, as it were, to both these theories and, after a generation during which the economics profession has been producing articles whose very titles are often incomprehensible, one thing the impending economic slump will have achieved is a return to first principles. Anyone who doubts the degree to which modern conventional economic wisdom has blown up in its propagators' faces need look no further than the recent Confessions of a Former Master of the Universe, which is not as yet the official title of Alan Greenspan's next book, but which epitomises his recent message to US congressional hearings.
And now a word from our sponsors: among the many people with whom I sympathise at a time such as this are the government's economic forecasters. Although in the early days of the Brown chancellorship the Treasury's experts persistently surprised their critics, they have recently run into a bad patch. Their broad message now is that everybody should retain a sense of proportion and that, by the second half of next year, the British economy should be "picking up", powered by the combined forces of a massive devaluation (which is aimed as much at encouraging "import substitution" as exports - which latter face the obvious problem of weak overseas demand) and the expected boost to purchasing power from the combination of much lower oil and commodity prices; reduced taxes; and the quite dramatic easing of monetary policy.
There is, however, a catch. This crisis is unlike those of the 70s, the early 80s and the 90s because it has become essentially a crisis of trust and confidence. Western capitalism has had a nervous breakdown, and the financial system is broken. It may be that everything miraculously improves in 2009, but it may not. These days black holes are not confined to outer space. Eat, drink and try to be merry. A Happy Christmas to all my readers.
Irish banks are saved in $10 billion bailout
The Irish government is in talks to bail out its three biggest banks, in a move that would see it take a stake of up to 80% in Anglo Irish Bank, which was last week rocked by a scandal over secret loans to its former chairman. A total of up to €7 billion (£6.5 billion) will be injected into the three biggest banks, most of it through the government buying new preference shares in the institutions. Bank of Ireland and Allied Irish Bank, the country's two largest banks, will get €2 billion each from the government, with shareholders able to invest another €1 billion in each. Anglo will receive €1 billion from the state. Shareholders in Anglo have already been hard hit. The bank's shares have lost 98% of their value in the past year, falling sharply last week with revelations that the chairman, Sean Fitzpatrick, had failed to disclose €87m of loans he had received from the bank.
Over eight years, Fitzpatrick hid the loans by swapping them to rival lender Irish Nationwide the day before Anglo's financial year-end, so they would not need to be disclosed in the annual report. Anglo chief executive David Drumm also resigned to allow a new boss to give the bank "fresh impetus". A condition of the capital injection into Anglo is that the entire board – with the exception of newly appointed chairman Donal O'Connor, a former managing partner of Price Waterhouse Coopers – resign to allow the appointment of new directors. It has been widely speculated that senior executives at other banks could also be asked to step down under the programme, but no details have yet emerged.
The participation of Allied Irish Bank comes in spite of the bank's repeated protestations that it does not need new capital. At a recent investor conference, chief executive Eugene Sheehy said that the bank would "rather die" than raise additional equity. Merger talks between Irish Life & Permanent and EBS, two of the three other banks covered by the government's guarantee scheme, are under way. The outline terms of the bailout are already drawing scorn from Irish investors, who are concerned about the level of dilution. The bulk of the money will be raised through preference shares, with the state likely to charge a coupon of 7%-9%.
Existing shareholders and new investors are being offered the opportunity to participate in an ordinary share placing for around a third of the total sum being raised. Sources said that Mallabraca, the private-equity consortium that includes JC Flowers, was reviewing whether it would participate in the limited €2 billion equity fundraising. The Irish bailout plan comes amid mounting speculation that Britain's banks may need further capital injections. Analysts also speculate that HSBC may come under pressure to launch a multi-billion-pound rights issue. France's BNP Paribas and Germany's Deutsche Bank are rumoured to be examining fundraisings.
Iceland recovering well, says IMF
Iceland has taken the first important steps towards restoring financial stability according to an International Monetary Fund mission to the country. Poul Thomsen, heading the mission, said the key objective of stabilising the country's currency was being met. He added that he was "very confident" that the $2.1bn (£1.37bn) loan from the IMF in November would be sufficient to revive the economy. In October, Iceland's government was forced to take control of three banks.
"Iceland's IMF-supported programme is advancing well," Mr Thomsen said. He added that "judicious monetary policy" had helped to stabilise the country's currency, the krona, and that focus would soon turn to lifting capital controls and reducing interest rates. The worst was behind the country, he told a press conference. "This is obviously a very, very serious crisis," he said. "But the impact on Iceland is going to be very limited because you were hit with full force upfront."
Progress has also been made on restructuring the financial sector after the government was forced to take over three of the country's biggest commercial banks. "A framework has been put in place to engage creditors of the old banks, an asset recovery strategy has been put in place and the groundwork has been laid for a valuation of new and old bank assets," Mr Thomsen said. Work to value assets should start now as a prelude to recapitalising the banks by the end of first quarter, he added. Another IMF mission will visit Iceland in February next year to conduct a formal review of the economic support programme.
Finland shows Sweden benefit of joining club
More than 1,000km north of Stockholm, close to the Arctic Circle and on the border with Finland, the remote Swedish town of Haparanda lies a stone's throw from the Finnish town of Tornio, to which it is connected by a bridge across the Torne river. Haparanda's declining industrial fortunes were reversed in 1996 when Ikea, the Swedish company, set up its most northerly flatpack furniture store to attract Finns, Norwegians and even Russians. The town of 4,800 people receives 2m visitors a year and its economy has undergone an Ikea-led revival. "We are completely dependent on each other," said Ritva Nousiainen, a member of the local government. She says Haparanda's decision to become a eurocity, meaning shoppers can use either euros or Swedish crowns, was a crucial element of the transformation. Finland is a eurozone member, while Sweden rejected it in a referendum in 2003.
Haparanda has become a model for Swedish advocates of eurozone membership. They point to the investment, reduced unemployment, a doubling of house prices and the town's renewed sense of pride. They argue this might be repeatable on a national level if Sweden were to join. A euro-friendly retail policy might be good news for Haparanda, what it says about the advantages and disadvantages of eurozone membership for Finland and Sweden is less clear. Sweden, like Finland, is an EU member and both economies have moved in virtual lockstep in the past few years as intra-EU trade has increased. Erkki Liikanen, governor of the Bank of Finland, says: "The question remains of why Sweden and Finland have performed basically the same despite having different monetary regimes. The answer is that they are both open economies that encourage competition, both have prudent fiscal policies and a healthy surplus, and both invest in R&D, which is critical for innovation." However, Sweden's ability to benefit from rising EU trade without having to abide by European monetary policy rules has attracted sniffy comments. "Sweden is what I call a free rider," says Sixten Korkman, managing director of the Research Institute of the Finnish Economy, a private economic research organisation.
Now the global economic crisis is exposing the difference between Sweden and Finland stemming from their positions on the euro. Johnny Munkhammar, research director at the European Enterprise Institute, a Brussels-based non-profit group, says: "The euro provides more stability in times of crises. The krona fluctuates in an exaggerated way, simply because it is too small. The fluctuations make foreign trade risky and difficult, especially for smaller businesses." Recent currency movements add weight to this argument. Sweden's krona weakened to more than SKr11 ($1.45, £0.95) against the euro on Monday. "The uncertainty of staying outside has been displayed with the falling krona," says Mr Munkhammar. On the Finnish side, currency stability remains the main benefit of membership, protecting the economy against unforeseen economic shocks from elsewhere in the world.
Mr Liikanen shudders when he remembers the endless damaging devaluations of the Finnish markka. "One reason for joining was the depression of the early 1990s and the cost of protecting the currency. That is a key difference between then and now. Then, Finnish companies were highly indebted and their borrowings were in foreign currency, so when the markka devalued, many companies went under. Now there is no exchange rate risk." There is also a political element. Mr Liikanen makes is perfectly clear that Finland, as a small country, saw the eurozone in geo-strategic as well as economic terms. "Finland wants to be around all the tables where decisions are being made, so it was both economics and politics," he said. Mr Munkhammar agrees, saying recent moves in Brussels to address the crisis had highlighted Swedish diplomatic weakness. These twin factors of currency stability and political influence are having an impact on Swedish public opinion. A poll released on Tuesday said 38 per cent now wanted the euro, up from 35 per cent in May.
White House Philosophy Stoked Mortgage Bonfire
"We can put light where there's darkness, and hope where there's despondency in this country. And part of it is working together as a nation to encourage folks to own their own home." — President Bush, Oct. 15, 2002
The global financial system was teetering on the edge of collapse when President Bush and his economics team huddled in the Roosevelt Room of the White House for a briefing that, in the words of one participant, "scared the hell out of everybody." It was Sept. 18. Lehman Brothers had just gone belly-up, overwhelmed by toxic mortgages. Bank of America had swallowed Merrill Lynch in a hastily arranged sale. Two days earlier, Mr. Bush had agreed to pump $85 billion into the failing insurance giant American International Group. The president listened as Ben S. Bernanke, chairman of the Federal Reserve, laid out the latest terrifying news: The credit markets, gripped by panic, had frozen overnight, and banks were refusing to lend money. Then his Treasury secretary, Henry M. Paulson Jr., told him that to stave off disaster, he would have to sign off on the biggest government bailout in history. Mr. Bush, according to several people in the room, paused for a single, stunned moment to take it all in. "How," he wondered aloud, "did we get here?"
Eight years after arriving in Washington vowing to spread the dream of homeownership, Mr. Bush is leaving office, as he himself said recently, "faced with the prospect of a global meltdown" with roots in the housing sector he so ardently championed. There are plenty of culprits, like lenders who peddled easy credit, consumers who took on mortgages they could not afford and Wall Street chieftains who loaded up on mortgage-backed securities without regard to the risk. But the story of how we got here is partly one of Mr. Bush's own making, according to a review of his tenure that included interviews with dozens of current and former administration officials. From his earliest days in office, Mr. Bush paired his belief that Americans do best when they own their own home with his conviction that markets do best when let alone. He pushed hard to expand homeownership, especially among minorities, an initiative that dovetailed with his ambition to expand the Republican tent — and with the business interests of some of his biggest donors. But his housing policies and hands-off approach to regulation encouraged lax lending standards.
Mr. Bush did foresee the danger posed by Fannie Mae and Freddie Mac, the government-sponsored mortgage finance giants. The president spent years pushing a recalcitrant Congress to toughen regulation of the companies, but was unwilling to compromise when his former Treasury secretary wanted to cut a deal. And the regulator Mr. Bush chose to oversee them — an old prep school buddy — pronounced the companies sound even as they headed toward insolvency. As early as 2006, top advisers to Mr. Bush dismissed warnings from people inside and outside the White House that housing prices were inflated and that a foreclosure crisis was looming. And when the economy deteriorated, Mr. Bush and his team misdiagnosed the reasons and scope of the downturn; as recently as February, for example, Mr. Bush was still calling it a "rough patch." The result was a series of piecemeal policy prescriptions that lagged behind the escalating crisis. "There is no question we did not recognize the severity of the problems," said Al Hubbard, Mr. Bush's former chief economics adviser, who left the White House in December 2007. "Had we, we would have attacked them." Looking back, Keith B. Hennessey, Mr. Bush's current chief economics adviser, says he and his colleagues did the best they could "with the information we had at the time." But Mr. Hennessey did say he regretted that the administration did not pay more heed to the dangers of easy lending practices. And both Mr. Paulson and his predecessor, John W. Snow, say the housing push went too far.
"The Bush administration took a lot of pride that homeownership had reached historic highs," Mr. Snow said in an interview. "But what we forgot in the process was that it has to be done in the context of people being able to afford their house. We now realize there was a high cost." For much of the Bush presidency, the White House was preoccupied by terrorism and war; on the economic front, its pressing concerns were cutting taxes and privatizing Social Security. The housing market was a bright spot: ever-rising home values kept the economy humming, as owners drew down on their equity to buy consumer goods and pack their children off to college. Lawrence B. Lindsay, Mr. Bush's first chief economics adviser, said there was little impetus to raise alarms about the proliferation of easy credit that was helping Mr. Bush meet housing goals. "No one wanted to stop that bubble," Mr. Lindsay said. "It would have conflicted with the president's own policies." Today, millions of Americans are facing foreclosure, homeownership rates are virtually no higher than when Mr. Bush took office, Fannie and Freddie are in a government conservatorship, and the bailout cost to taxpayers could run in the trillions. As the economy has shed jobs — 533,000 last month alone — and his party has been punished by irate voters, the weakened president has granted his Treasury secretary extraordinary leeway in managing the crisis.
Never once, Mr. Paulson said in a recent interview, has Mr. Bush overruled him. "I've got a boss," he explained, who "understands that when you're dealing with something as unprecedented and fast-moving as this we need to have a different operating style." Mr. Paulson and other senior advisers to Mr. Bush say the administration has responded well to the turmoil, demonstrating flexibility under difficult circumstances. "There is not any playbook," Mr. Paulson said. The president declined to be interviewed for this article. But in recent weeks Mr. Bush has shared his views of how the nation came to the brink of economic disaster. He cites corporate greed and market excesses fueled by a flood of foreign cash — "Wall Street got drunk," he has said — and the policies of past administrations. He blames Congress for failing to reform Fannie and Freddie. Last week, Fox News asked Mr. Bush if he was worried about being the Herbert Hoover of the 21st century. "No," Mr. Bush replied. "I will be known as somebody who saw a problem and put the chips on the table to prevent the economy from collapsing." But in private moments, aides say, the president is looking inward. During a recent ride aboard Marine One, the presidential helicopter, Mr. Bush sounded a reflective note. "We absolutely wanted to increase homeownership," Tony Fratto, his deputy press secretary, recalled him saying. "But we never wanted lenders to make bad decisions."
Darrin West could not believe it. The president of the United States was standing in his living room. It was June 17, 2002, a day Mr. West recalls as "the highlight of my life." Mr. Bush, in Atlanta to unveil a plan to increase the number of minority homeowners by 5.5 million, was touring Park Place South, a development of starter homes in a neighborhood once marked by blight and crime. Mr. West had patrolled there as a police officer, and now he was the proud owner of a $130,000 town house, bought with an adjustable-rate mortgage and a $20,000 government loan as his down payment — just the sort of creative public-private financing Mr. Bush was promoting. "Part of economic security," Mr. Bush declared that day, "is owning your own home." A lot has changed since then. Mr. West, beset by personal problems, left Atlanta. Unable to sell his home for what he owed, he said, he gave it back to the bank last year. Like other communities across America, Park Place South has been hit with a foreclosure crisis affecting at least 10 percent of its 232 homes, according to Masharn Wilson, a developer who led Mr. Bush's tour. "I just don't think what he envisioned was actually carried out," she said.
Park Place South is, in microcosm, the story of a well-intentioned policy gone awry. Advocating homeownership is hardly novel; the Clinton administration did it, too. For Mr. Bush, it was part of his vision of an "ownership society," in which Americans would rely less on the government for health care, retirement and shelter. It was also good politics, a way to court black and Hispanic voters. But for much of Mr. Bush's tenure, government statistics show, incomes for most families remained relatively stagnant while housing prices skyrocketed. That put homeownership increasingly out of reach for first-time buyers like Mr. West. So Mr. Bush had to, in his words, "use the mighty muscle of the federal government" to meet his goal. He proposed affordable housing tax incentives. He insisted that Fannie Mae and Freddie Mac meet ambitious new goals for low-income lending. Concerned that down payments were a barrier, Mr. Bush persuaded Congress to spend up to $200 million a year to help first-time buyers with down payments and closing costs. And he pushed to allow first-time buyers to qualify for federally insured mortgages with no money down. Republican Congressional leaders and some housing advocates balked, arguing that homeowners with no stake in their investments would be more prone to walk away, as Mr. West did. Many economic experts, including some in the White House, now share that view.
The president also leaned on mortgage brokers and lenders to devise their own innovations. "Corporate America," he said, "has a responsibility to work to make America a compassionate place." And corporate America, eyeing a lucrative market, delivered in ways Mr. Bush might not have expected, with a proliferation of too-good-to-be-true teaser rates and interest-only loans that were sold to investors in a loosely regulated environment. "This administration made decisions that allowed the free market to operate as a barroom brawl instead of a prize fight," said L. William Seidman, who advised Republican presidents and led the savings and loan bailout in the 1990s. "To make the market work well, you have to have a lot of rules." But Mr. Bush populated the financial system's alphabet soup of oversight agencies with people who, like him, wanted fewer rules, not more. The president's first chairman of the Securities and Exchange Commission promised a "kinder, gentler" agency. The second was pushed out amid industry complaints that he was too aggressive. Under its current leader, the agency failed to police the catastrophic decisions that toppled the investment bank Bear Stearns and contributed to the current crisis, according to a recent inspector general's report.
As for Mr. Bush's banking regulators, they once brandished a chain saw over a 9,000-page pile of regulations as they promised to ease burdens on the industry. When states tried to use consumer protection laws to crack down on predatory lending, the comptroller of the currency blocked the effort, asserting that states had no authority over national banks. The administration won that fight at the Supreme Court. But Roy Cooper, North Carolina's attorney general, said, "They took 50 sheriffs off the beat at a time when lending was becoming the Wild West." The president did push rules aimed at forcing lenders to more clearly explain loan terms. But the White House shelved them in 2004, after industry-friendly members of Congress threatened to block confirmation of his new housing secretary. In the 2004 election cycle, mortgage bankers and brokers poured nearly $847,000 into Mr. Bush's re-election campaign, more than triple their contributions in 2000, according to the nonpartisan Center for Responsive Politics. The administration did not finalize the new rules until last month.
Among the Republican Party's top 10 donors in 2004 was Roland Arnall. He founded Ameriquest, then the nation's largest lender in the subprime market, which focuses on less creditworthy borrowers. In July 2005, the company agreed to set aside $325 million to settle allegations in 30 states that it had preyed on borrowers with hidden fees and ballooning payments. It was an early signal that deceptive lending practices, which would later set off a wave of foreclosures, were widespread. Andrew H. Card Jr., Mr. Bush's former chief of staff, said White House aides discussed Ameriquest's troubles, though not what they might portend for the economy. Mr. Bush had just nominated Mr. Arnall as his ambassador to the Netherlands, and the White House was primarily concerned with making sure he would be confirmed. "Maybe I was asleep at the switch," Mr. Card said in an interview. Brian Montgomery, the Federal Housing Administration commissioner, understood the significance. His agency insures home loans, traditionally for the same low-income minority borrowers Mr. Bush wanted to help. When he arrived in June 2005, he was shocked to find those customers had been lured away by the "fool's gold" of subprime loans. The Ameriquest settlement, he said, reinforced his concern that the industry was exploiting borrowers.
In December 2005, Mr. Montgomery drafted a memo and brought it to the White House. "I don't think this is what the president had in mind here," he recalled telling Ryan Streeter, then the president's chief housing policy analyst. It was an opportunity to address the risky subprime lending practices head on. But that was never seriously discussed. More senior aides, like Karl Rove, Mr. Bush's chief political strategist, were wary of overly regulating an industry that, Mr. Rove said in an interview, provided "a valuable service to people who could not otherwise get credit." While he had some concerns about the industry's practices, he said, "it did provide an opportunity for people, a lot of whom are still in their houses today." The White House pursued a narrower plan offered by Mr. Montgomery that would have allowed the F.H.A. to loosen standards so it could lure back subprime borrowers by insuring similar, but safer, loans. It passed the House but died in the Senate, where Republican senators feared that the agency would merely be mimicking the private sector's risky practices — a view Mr. Rove said he shared.
Looking back at the episode, Mr. Montgomery broke down in tears. While he acknowledged that the bill did not get to the root of the problem, he said he would "go to my grave believing" that at least some homeowners might have been spared foreclosure. Today, administration officials say it is fair to ask whether Mr. Bush's ownership push backfired. Mr. Paulson said the administration, like others before it, "over-incented housing." Mr. Hennessey put it this way: "I would not say too much emphasis on expanding homeownership. I would say not enough early focus on easy lending practices." Armando Falcon Jr. was preparing to take on a couple of giants. A soft-spoken Texan, Mr. Falcon ran the Office of Federal Housing Enterprise Oversight, a tiny government agency that oversaw Fannie Mae and Freddie Mac, two pillars of the American housing industry. In February 2003, he was finishing a blockbuster report that warned the pillars could crumble. Created by Congress, Fannie and Freddie — called G.S.E.'s, for government-sponsored entities — bought trillions of dollars' worth of mortgages to hold or sell to investors as guaranteed securities. The companies were also Washington powerhouses, stuffing lawmakers' campaign coffers and hiring bare-knuckled lobbyists.
Mr. Falcon's report outlined a worst-case situation in which Fannie and Freddie could default on debt, setting off "contagious illiquidity in the market" — in other words, a financial meltdown. He also raised red flags about the companies' soaring use of derivatives, the complex financial instruments that economic experts now blame for spreading the housing collapse. Today, the White House cites that report — and its subsequent effort to better regulate Fannie and Freddie — as evidence that it foresaw the crisis and tried to avert it. Bush officials recently wrote up a talking points memo headlined "G.S.E.'s — We Told You So." But the back story is more complicated. To begin with, on the day Mr. Falcon issued his report, the White House tried to fire him. At the time, Fannie and Freddie were allies in the president's quest to drive up homeownership rates; Franklin D. Raines, then Fannie's chief executive, has fond memories of visiting Mr. Bush in the Oval Office and flying aboard Air Force One to a housing event. "They loved us," he said. So when Mr. Falcon refused to deep-six his report, Mr. Raines took his complaints to top Treasury officials and the White House. "I'm going to do what I need to do to defend my company and my position," Mr. Raines told Mr. Falcon. Days later, as Mr. Falcon was in New York preparing to deliver a speech about his findings, his cellphone rang. It was the White House personnel office, he said, telling him he was about to be unemployed.
His warnings were buried in the next day's news coverage, trumped by the White House announcement that Mr. Bush would replace Mr. Falcon, a Democrat appointed by Bill Clinton, with Mark C. Brickell, a leader in the derivatives industry that Mr. Falcon's report had flagged. It was not until 2003, when Freddie became embroiled in an accounting scandal, that the White House took on the companies in earnest. Mr. Bush decided to quit the long-standing practice of rewarding supporters with high-paying appointments to the companies' boards — "political plums," in Mr. Rove's words. He also withdrew Mr. Brickell's nomination and threw his support behind Mr. Falcon, beginning an intense effort to give his little regulatory agency more power. Mr. Falcon lacked explicit authority to limit the size of the companies' mammoth investment portfolios, or tell them how much capital they needed to guard against losses. White House officials wanted that to change. They also wanted the power to put the companies into receivership, hoping that would end what Mr. Card, the former chief of staff, called "the myth of government backing," which gave the companies a competitive edge because investors assumed the government would not let them fail.
By the spring of 2005 a deal with Congress seemed within reach, Mr. Snow, the former Treasury secretary, said in an interview. Michael G. Oxley, an Ohio Republican and then-chairman of the House Financial Services Committee, had produced what Mr. Snow viewed as "a pretty darned good bill," a watered-down version of what the president sought. But at the urging of Mr. Card and the White House economics team, the president decided to hold out for a tougher bill in the Senate. Mr. Card said he feared that Mr. Snow was "more interested in the deal than the result." When the bill passed the House, the president issued a statement opposing it, effectively killing any chance of compromise. Mr. Oxley was furious. "The problem with those guys at the White House, they had all the answers and they didn't think they had to listen to anyone, including the Treasury secretary," Mr. Oxley said in a recent interview. "They were driving the ideological train. He was in the caboose, and they were in the engine room." Mr. Card and Mr. Hennessey said they had no regrets. They are convinced, Mr. Hennessey said, that the Oxley bill would have produced "the worst of all possible outcomes," the illusion of reform without the substance. Still, some former White House and Treasury officials continue to debate whether Mr. Bush's all-or-nothing approach scuttled a measure that, while imperfect, might have given an aggressive regulator enough power to keep the companies from failing. Mr. Snow, for one, calls Mr. Oxley "a hero," adding, "He saw the need to move. It didn't get done. And it's too bad, because I think if it had, I think we could well have avoided a big contributor to the current crisis."
Jason Thomas had a nagging feeling. The New Century Financial Corporation, a huge subprime lender whose mortgages were bundled into securities sold around the world, was headed for bankruptcy in March 2007. Mr. Thomas, an economic analyst for President Bush, was responsible for determining whether it was a hint of things to come. At 29, Mr. Thomas had followed a fast-track career path that took him from a Buffalo meatpacking plant, where he worked as a statistician, to the White House. He was seen as a whiz kid, "a brilliant guy," his former boss, Mr. Hubbard, says. As Mr. Thomas began digging into New Century's failure that spring, he became fixated on a particular statistic, the rent-to-own ratio. Typically, as home prices increase, rental costs rise proportionally. But Mr. Thomas sent charts to top White House and Treasury officials showing that the monthly cost of owning far outpaced the cost to rent. To Mr. Thomas, it was a sign that housing prices were wildly inflated and bound to plunge, a condition that could set off a foreclosure crisis as conventional and subprime borrowers with little equity found they owed more than their houses were worth.
It was not the Bush team's first warning. The previous year, Mr. Lindsay, the former chief economics adviser, returned to the White House to tell his old colleagues that housing prices were headed for a crash. But housing values are hard to evaluate, and Mr. Lindsay had a reputation as a market pessimist, said Mr. Hubbard, adding, "I thought, 'He's always a bear.' " In retrospect, Mr. Hubbard said, Mr. Lindsay was "absolutely right," and Mr. Thomas's charts "should have been a signal." Instead, the prevailing view at the White House was that the problems in the housing market were limited to subprime borrowers unable to make their payments as their adjustable mortgages reset to higher rates. That belief was shared by Mr. Bush's new Treasury secretary, Mr. Paulson. Mr. Paulson, a former chairman of the Wall Street firm Goldman Sachs, had been given unusual power; he had accepted the job only after the president guaranteed him that Treasury, not the White House, would have the dominant role in shaping economic policy. That shift merely continued an imbalance of power that stifled robust policy debate, several former Bush aides say. Throughout the spring of 2007, Mr. Paulson declared that "the housing market is at or near the bottom," with the problem "largely contained." That position underscored nearly every action the Bush administration took in the ensuing months as it offered one limited response after another.
By that August, the problems had spread beyond New Century. Credit was tightening, amid questions about how heavily banks were invested in securities linked to mortgages. Still, Mr. Bush predicted that the turmoil would resolve itself with a "soft landing." The plan Mr. Bush announced on Aug. 31 reflected that belief. Called "F.H.A. Secure," it aimed to help about 80,000 homeowners refinance their loans. Mr. Montgomery, the housing commissioner, said that he knew the modest program was not enough — the White House later expanded the agency's rescue role — and that he would be "flying the plane and fixing it at the same time." That fall, Representative Rahm Emanuel, a leading Democrat, former investment banker and now the incoming chief of staff to President-elect Barack Obama, warned the White House it was not doing enough. He said he told Joshua B. Bolten, Mr. Bush's chief of staff, and Mr. Paulson in a series of phone calls that the credit crisis would get "deep and serious" and that the only answer was big, internationally coordinated government intervention. "You got to strangle this thing and suffocate it," he recalled saying. Instead, Mr. Bush developed Hope Now, a voluntary public-private partnership to help struggling homeowners refinance loans. And he worked with Congress to pass a stimulus package that sent taxpayers $150 billion in tax rebates.
In a speech to the Economic Club of New York in March 2008, he cautioned against Washington's temptation "to say that anything short of a massive government intervention in the housing market amounts to inaction," adding that government action could make it harder for the markets to recover. Within days, Bear Sterns collapsed, prompting the Federal Reserve to engineer a hasty sale. Some economic experts, including Timothy F. Geithner, the president of the New York Federal Reserve Bank (and Mr. Obama's choice for Treasury secretary) feared that Fannie Mae and Freddie Mac could be the next to fall. Mr. Bush was still leaning on Congress to revamp the tiny agency that oversaw the two companies, and had acceded to Mr. Paulson's request for the negotiating room that he had denied Mr. Snow. Still, there was no deal. Over the previous two years, the White House had effectively set the agency adrift. Mr. Falcon left in 2005 and was replaced by a temporary director, who was in turn replaced by James B. Lockhart, a friend of Mr. Bush from their days at Andover, and a former deputy commissioner of the Social Security Administration who had once run a software company. On Mr. Lockhart's watch, both Freddie and Fannie had plunged into the riskiest part of the market, gobbling up more than $400 billion in subprime and other alternative mortgages. With the companies on precarious footing, Mr. Geithner had been advocating that the administration seize them or take other steps to reassure the market that the government would back their debt, according to two people with direct knowledge of his views.
In an Oval Office meeting on March 17, however, Mr. Paulson barely mentioned the idea, according to several people present. He wanted to use the troubled companies to unlock the frozen credit market by allowing Fannie and Freddie to buy more mortgage-backed securities from overburdened banks. To that end, Mr. Lockhart's office planned to lift restraints on the companies' huge portfolios — a decision derided by former White House and Treasury officials who had worked so hard to limit them. But Mr. Paulson told Mr. Bush the companies would shore themselves up later by raising more capital. "Can they?" Mr. Bush asked. "We're hoping so," the Treasury secretary replied. That turned out to be incorrect, and did not surprise Mr. Thomas, the Bush economic adviser. Throughout that spring and summer, he warned the White House and Treasury that, in the stark words of one e-mail message, "Freddie Mac is in trouble." And Mr. Lockhart, he charged, was allowing the company to cover up its insolvency with dubious accounting maneuvers. But Mr. Lockhart continued to offer reassurances. In a July appearance on CNBC, he declared that the companies were well managed and "worsts were not coming to worst." An infuriated Mr. Thomas sent a fresh round of e-mail messages accusing Mr. Lockhart of "pimping for the stock prices of the undercapitalized firms he regulates."
Mr. Lockhart defended himself, insisting in an interview that he was aware of the companies' vulnerabilities, but did not want to rattle markets. "A regulator," he said, "does not air dirty laundry in public." Soon afterward, the companies' stocks lost half their value in a single day, prompting Congress to quickly give Mr. Paulson the power to spend $200 billion to prop them up and to finally pass Mr. Bush's long-sought reform bill, but it was too late. In September, the government seized control of Freddie Mac and Fannie Mae. In an interview, Mr. Paulson said the administration had no justification to take over the companies any sooner. But Mr. Falcon disagreed: "They absolutely could have if they had thought there was a real danger." By Sept. 18, when Mr. Bush and his team had their fateful meeting in the Roosevelt Room after the failure of Lehman Brothers and the emergency rescue of A.I.G., Mr. Paulson was warning of an economic calamity greater than the Great Depression. Suddenly, historic government intervention seemed the only option. When Mr. Paulson spelled out what would become a $700 billion plan to rescue the nation's banking system, the president did not hesitate. "Is that enough?" Mr. Bush asked. "It's a lot," the Treasury secretary recalled replying. "It will make a difference." And in any event, he told Mr. Bush, "I don't think we can get more."
As the meeting wrapped up, a handful of aides retreated to the White House Situation Room to call Vice President Dick Cheney in Florida, where he was attending a fund-raiser. Mr. Cheney had long played a leading role in economic policy, though housing was not a primary interest, and like Mr. Bush he had a deep aversion to government intervention in the market. Nonetheless, he backed the bailout, convinced that too many Americans would suffer if Washington did nothing. Mr. Bush typically darts out of such meetings quickly. But this time, he lingered, patting people on the back and trying to soothe his downcast staff. "During times of adversity, he bucks everybody up," Mr. Paulson said. It was not the end of the failures or government interventions; the administration has since stepped in to rescue Citigroup and, just last week, the Detroit automakers. With 31 days left in office, Mr. Bush says he will leave it to historians to analyze "what went right and what went wrong," as he put it in a speech last week to the American Enterprise Institute. Mr. Bush said he was too focused on the present to do much looking back. "It turns out," he said, "this isn't one of the presidencies where you ride off into the sunset, you know, kind of waving goodbye."
Who Wants to Kick a Millionaire?
During the Great Depression, American moviegoers seeking escape could ogle platoons of glamorous chorus girls in "Gold Diggers of 1933." Our feel-good movie of the year is "Slumdog Millionaire," a Dickensian tale in which we root for an impoverished orphan from Mumbai's slums to hit the jackpot on the Indian edition of "Who Wants to Be a Millionaire." It's a virtuoso feast of filmmaking by Danny Boyle, but it's also the perfect fairy tale for our hard times. The hero labors as a serf in the toilet of globalization: one of those mammoth call centers Westerners reach when ringing an 800 number to, say, check on credit card debt. When he gets his unlikely crack at instant wealth, the whole system is stacked against him, including the corrupt back office of a slick game show too good to be true.
We cheer the young man on screen even if we've lost the hope to root for ourselves. The vicarious victory of a third world protagonist must be this year's stocking stuffer. The trouble with "Slumdog Millionaire" is that it, like all classic movie fables, comes to an end — as it happens, with an elaborately choreographed Bollywood musical number redolent of "Gold Diggers of 1933." Then we are delivered back to the inescapable and chilling reality outside the theater's doors. Just when we thought that reality couldn't hit a new bottom it did with Bernie Madoff, a smiling shark as sleazy as the TV host in "Slumdog." A pillar of both the Wall Street and Jewish communities — a former Nasdaq chairman, a trustee at Yeshiva University — he even victimized Elie Wiesel's Foundation for Humanity with his Ponzi scheme. A Jewish financier rips off millions of dollars devoted to memorializing the Holocaust — who could make this stuff up? Dickens, Balzac, Trollope and, for that matter, even Mel Brooks might be appalled.
Madoff, of course, made up everything. When he turned himself in, he reportedly declared that his business was "all just one big lie." (The man didn't call his 55-foot yacht "Bull" for nothing.) As Brian Williams of NBC News pointed out, the $50 billion thought to have vanished is roughly three times as much as the proposed Detroit bailout. And no one knows how it happened, least of all the federal regulators charged with policing him and protecting the public. If Madoff hadn't confessed — for reasons that remain unclear — he might still be rounding up new victims. There is a moral to be drawn here, and it's not simply that human nature is unchanging and that there always will be crooks, including those in high places. Nor is it merely that Wall Street regulation has been a joke. Of what we've learned about Madoff so far, the most useful lesson can be gleaned from how his smart, well-heeled clients routinely characterized the strategy that generated their remarkably steady profits. As The Wall Street Journal noted, they "often referred to it as a 'black box.' "
In the investment world "black box" is tossed around to refer to a supposedly ingenious financial model that is confidential or incomprehensible or both. Most of us know the "black box" instead as that strongbox full of data that is retrieved (sometimes) after a plane crash to tell the authorities what went wrong. The only problem is that its findings arrive too late to save the crash's victims. The hope is that the information will instead help prevent the next disaster. The question in the aftermath of the Madoff calamity is this: Why do we keep ignoring what we learn from the black boxes being retrieved from crash after crash in our economic meltdown? The lesson could not be more elemental. If there's a mysterious financial model producing miraculous returns, odds are it's a sham — whether it's an outright fraud, as it apparently is in Madoff's case, or nominally legal, as is the case with the Wall Street giants that have fallen this year.
Wall Street's black boxes contained derivatives created out of whole cloth, deriving their value from often worthless subprime mortgages. The enormity of the gamble went undetected not only by investors but by the big brains at the top of the firms, many of whom either escaped (Merrill Lynch's E. Stanley O'Neal) or remain in place (Citigroup's Robert Rubin) after receiving obscene compensation for their illusory short-term profits and long-term ignorance. There has been no punishment for many of those who failed to heed this repeated lesson. Quite the contrary. The business magazine Portfolio, writing in mid-September about one of the world's biggest insurance companies, observed that "now that A.I.G is battling to survive, it is its black box that may save it yet." That box — stuffed with "accounting or investments so complex and arcane that they remain unknown to most investors" — was so huge that Washington might deem it "too big to fail."
Sure enough — and unlike its immediate predecessor in collapse, Lehman Brothers — A.I.G. was soon bailed out to the tune of $123 billion. Most of that also disappeared by the end of October. But not before A.I.G. executives were caught spending $442,000 on a weeklong retreat to a California beach resort.
There are more black boxes still to be pried open, whether at private outfits like Madoff's or at publicly traded companies like General Electric, parent of the opaque GE Capital Corporation, the financial services unit that has been the single biggest contributor to the G.E. bottom line in recent years. But have we yet learned anything? Incredibly enough, as we careen into 2009, the very government operation tasked with repairing the damage caused by Wall Street's black boxes is itself a black box of secrecy and impenetrability. Last week ABC News asked 16 of the banks that have received handouts from the Treasury Department's $700 billion Troubled Asset Relief Program the same two direct questions: How have you used that money, and how much have you spent on bonuses this year? Most refused to answer.
Congress can't get the answers either. Its oversight panel declared in a first report this month that the Treasury is doling out billions "without seeking to monitor the use of funds provided to specific financial institutions." The Treasury prefers instead to look at "general metrics" indicating the program's overall effect on the economy. Well, we know what the "general metrics" tell us already: the effect so far is nil. Perhaps if we were let in on the specifics, we'd start to understand why. In its own independent attempt to penetrate the bailout, the Government Accountability Office learned that "the standard agreement between Treasury and the participating institutions does not require that these institutions track or report how they plan to use, or do use, their capital investments." Executives at all but two of the bailed-out banks told the G.A.O. that the "money is fungible," so they "did not intend to track or report" specifically what happens to the taxpayers' cash.
Nor is there any serious accounting for executive pay at these seminationalized companies. As Amit Paley of The Washington Post reported, a last-minute, one-sentence loophole added by the Bush administration to the original bailout bill gutted the already minimal restrictions on executive compensation. And so when Goldman Sachs, Henry Paulson's Wall Street alma mater, says that it is not using public money to pay executives, we must take it on faith. In the wake of the Madoff debacle, there are loud calls to reform the Securities and Exchange Commission, including from the president-elect. Under both Clinton and Bush, that supposed watchdog agency ignored repeated and graphic warnings of Madoff's Ponzi scheme as studiously as Bush ignored Al Qaeda's threats during the summer of 2001.
But fixing that one agency is no panacea. All the talk about restoring "confidence" and "faith" in capitalism will be worthless if we still can't see what's going on in the counting rooms. In his role as chairman of the Federal Reserve Bank of New York, Timothy Geithner, Barack Obama's nominee for Treasury secretary, has been at the center of the action in the bailout's black box, including the still-murky and conflicting actions (and nonactions) taken with Lehman and A.I.G. His confirmation hearings demand questions every bit as tough as those that were lobbed at the executives from Detroit's Big Three. On Friday, Geithner's partner in bailout management, Paulson, asked Congress to give the Treasury the second half of the $700 billion bailout stash.
But without transparency and accountability in Washington's black box, as well as Wall Street's, there will continue to be no trust in the system, no matter how many cops the S.E.C. puts on the beat. Even the family-owned real-estate company of Eliot Spitzer, the former "Sheriff of Wall Street," had entrusted money with Madoff. We'll keep believing, not without reason, that the whole game is as corrupt as the game show in "Slumdog Millionaire" — only without the Hollywood/Bollywood ending. We'll keep wondering how so many at the top keep avoiding responsibility and reaping taxpayers' billions while relief for those at the bottom remains as elusive as straight answers from those Mumbai call centers fielding American debtors. This wholesale loss of confidence is a catastrophe that not even the new president's most costly New Deal can set right.