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CIT still fighting to stay out of bankruptcy

2009-07-17T08:19:00.000-07:00

CIT still working to secure financing, stay out of bankruptcy despite government's rejection.

CIT Group Inc. is continuing talks with potential lenders to secure billions in much-needed financing and stay out of bankruptcy court after the U.S. government declined to extend emergency aid to the troubled commercial lender.

CIT shares lost three-quarters of their value Thursday as bondholders made a last-ditch effort to prevent a Chapter 11 bankruptcy filing. CIT is trying to line up $2 billion to $4 billion in rescue financing from its debtholders within the next 24 hours, two sources familiar with the talks told The Associated Press. They requested anonymity because they weren't authorized to speak publicly.

But there is no guarantee bondholders will be able to save the ailing company, which teeters on the brink after rescue talks with regulators broke off late Wednesday after days of round-the-clock negotiations. The New York-based bank, one of the country's largest lenders to small and mid-sized businesses, faces $7.4 billion in debt that's due in the first quarter of next year.

CIT, which got $2.3 billion of bailout money in December, had warned that depriving it of more federal aid could imperil about a million corporate borrowers -- from Dunkin' Donuts franchisees to retailer Dillards Inc. But the Obama administration turned down the company's request, showing it's drawing a line in the sand on federal rescues for troubled financial firms.

CIT bondholders discussed their options Thursday in a conference call that involved restructuring firm Houlihan Lokey, according to the sources. Another conference call with the largest bondholders was to be organized by bond manager Pimco, the sources said. Houlihan Lokey and Pimco didn't return calls seeking comment.

If CIT can improve its liquidity, either through debt restructuring or by getting an injection of private equity, that could give it better leverage to reopen talks with regulators. The most likely avenue for survival would be getting permission to transfer assets to the company's bank. The bank could then borrow against that money at a discount if the Fed allows it.

Such transfers require approval from the Fed and the FDIC because regulators don't want banks -- whose deposits are insured -- to risk insolvency by bailing out their parent companies.

Regulators resisted CIT's earlier plea for permission to make a transfer because they didn't think the company was strong enough, and worried it would default on any loans from the Fed. With a stronger balance sheet, CIT may make a better case.

But investors were acting as if bankruptcy were unavoidable, sending CIT shares skidding $1.23, or 75 percent, to close at 41 cents after sinking as low as 31 cents earlier in the session.

Both Fitch Ratings and Moody's further downgraded CIT's debt Thursday following the company's announcement that it expects no further federal support.

"I think it makes a bankruptcy filing a near certainty," banking analyst Bert Ely said of the refusal to bail out CIT.

For its part, the market seemed unfazed by CIT's woes, with all three of the major indices ending up about 1 percent Thursday. The muted response suggests investors are more focused on signs that the economic slump may be easing, said Paul Baiocchi, senior market strategist at Delta Global Advisors in San Francisco.

CIT's small size relative to other big commercial banks may also ease worries of a ripple effect. Though a major lender to small and midsize U.S. business with about a million clients, CIT is one-eighth of the size of Lehman Brothers when massive credit losses forced the investment bank into bankruptcy last fall.

CIT had also begun cutting back on lending in recent months, diminishing the risk a possible bankruptcy could cause significant damage to the broader economy. The lender had $5.3 billion in credit lines to customers as of March, down from $6.1 billion at the end of 2008.

"That shows they were pulling back and should lessen the immediate blow of this," said Kathleen Shanley, an analyst at corporate bond research firm Gimme Credit. "I don't see a real contagion effect here."

The Bush administration paid a price for its decision not to save Lehman Brothers, whose collapse helped spark the financial crisis last fall.

Asked about CIT, a Treasury Department spokeswoman said in an e-mail that "even during periods of financial stress, we believe that there is a very high threshold for exceptional government assistance to individual companies."

A bankruptcy filing would wipe out CIT's shareholders and the government's $2.3 billion stake. But CIT's clients would not automatically lose their lines of credit, longtime banking analyst Bert Ely said.

Still, with other lenders to retailers already under financial strain, many CIT clients may lose their financing options.

"The industry just won't be able to absorb the amount of volume," said Michael Cipriani, executive vice president of Rosenthal & Rosenthal Inc., a competitor of CIT that's considered healthy.

The company in April posted a larger first-quarter loss than expected and has seen funding options disappear as investors shy away from purchasing all but the safest forms of debt. The lender has $7.4 billion in debt coming due in the first quarter of 2010, plus other obligations.

Though a fraction of the size of big commercial banks, CIT's holdings are substantial. The company had $75.7 billion in assets as of March 31, according to a corporate filing.

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Lehman Brothers, which collapsed after former Treasury Secretary Henry Paulson declined to save it, listed $639 billion in assets when it filed for bankruptcy Sept. 15.

The other-worldly philosophers

2009-07-17T08:10:00.000-07:00

Although the crisis has exposed bitter divisions among economists, it could still be good for economics. Our first article looks at the turmoil among macroeconomists.

ROBERT LUCAS, one of the greatest macroeconomists of his generation, and his followers are “making ancient and basic analytical errors all over the place”. Harvard’s Robert Barro, another towering figure in the discipline, is “making truly boneheaded arguments”. The past 30 years of macroeconomics training at American and British universities were a “costly waste of time”.

To the uninitiated, economics has always been a dismal science. But all these attacks come from within the guild: from Brad DeLong of the University of California, Berkeley; Paul Krugman of Princeton and the New York Times; and Willem Buiter of the London School of Economics (LSE), respectively. The macroeconomic crisis of the past two years is also provoking a crisis of confidence in macroeconomics. In the last of his Lionel Robbins lectures at the LSE on June 10th, Mr Krugman feared that most macroeconomics of the past 30 years was “spectacularly useless at best, and positively harmful at worst”.

These internal critics argue that economists missed the origins of the crisis; failed to appreciate its worst symptoms; and cannot now agree about the cure. In other words, economists misread the economy on the way up, misread it on the way down and now mistake the right way out.

On the way up, macroeconomists were not wholly complacent. Many of them thought the housing bubble would pop or the dollar would fall. But they did not expect the financial system to break. Even after the seizure in interbank markets in August 2007, macroeconomists misread the danger. Most were quite sanguine about the prospect of Lehman Brothers going bust in September 2008.

Nor can economists now agree on the best way to resolve the crisis. They mostly overestimated the power of routine monetary policy (ie, central-bank purchases of government bills) to restore prosperity. Some now dismiss the power of fiscal policy (ie, government sales of its securities) to do the same. Others advocate it with passionate intensity.

Among the passionate are Mr DeLong and Mr Krugman. They turn for inspiration to Depression-era texts, especially the writings of John Maynard Keynes, and forgotten mavericks, such as Hyman Minsky. In the humanities this would count as routine scholarship. But to many high-tech economists it is a bit undignified. Real scientists, after all, do not leaf through Newton’s “Principia Mathematica” to solve contemporary problems in physics.

They accuse economists like Mr DeLong and Mr Krugman of falling back on antiquated Keynesian doctrines—as if nothing had been learned in the past 70 years. Messrs DeLong and Krugman, in turn, accuse economists like Mr Lucas of not falling back on Keynesian economics—as if everything had been forgotten over the past 70 years. For Mr Krugman, we are living through a “Dark Age of macroeconomics”, in which the wisdom of the ancients has been lost.

What was this wisdom, and how was it forgotten? The history of macroeconomics begins in intellectual struggle. Keynes wrote the “General Theory of Employment, Interest and Money”, which was published in 1936, in an “unnecessarily controversial tone”, according to some readers. But it was a controversy the author had waged in his own mind. He saw the book as a “struggle of escape from habitual modes of thought” he had inherited from his classical predecessors.

That classical mode of thought held that full employment would prevail, because supply created its own demand. In a classical economy, whatever people earn is either spent or saved; and whatever is saved is invested in capital projects. Nothing is hoarded, nothing lies idle.

Keynes appreciated the classical model’s elegance and consistency, virtues economists still crave. But that did not stop him demolishing it. In his scheme, investment was governed by the animal spirits of entrepreneurs, facing an imponderable future. The same uncertainty gave savers a reason to hoard their wealth in liquid assets, like money, rather than committing it to new capital projects. This liquidity-preference, as Keynes called it, governed the price of financial securities and hence the rate of interest. If animal spirits flagged or liquidity-preference surged, the pace of investment would falter, with no obvious market force to restore it. Demand would fall short of supply, leaving willing workers on the shelf. It fell to governments to revive demand, by cutting interest rates if possible or by public works if necessary.

The Keynesian task of “demand management” outlived the Depression, becoming a routine duty of governments. They were aided by economic advisers, who built working models of the economy, quantifying the key relationships. For almost three decades after the second world war these advisers seemed to know what they were doing, guided by an apparent trade-off between inflation and unemployment. But their credibility did not survive the oil-price shocks of the 1970s. These condemned Western economies to “stagflation”, a baffling combination of unemployment and inflation, which the Keynesian consensus grasped poorly and failed to prevent.

The Federal Reserve, led by Paul Volcker, eventually defeated American inflation in the early 1980s, albeit at a grievous cost to employment. But victory did not restore the intellectual peace. Macroeconomists split into two camps, drawing opposite lessons from the episode.

The purists, known as “freshwater” economists because of the lakeside universities where they happened to congregate, blamed stagflation on restless central bankers trying to do too much. They started from the classical assumption that markets cleared, leaving no unsold goods or unemployed workers. Efforts by policymakers to smooth the economy’s natural ups and downs did more harm than good.

America’s coastal universities housed most of the other lot, “saltwater” pragmatists. To them, the double-digit unemployment that accompanied Mr Volcker’s assault on inflation was proof enough that markets could malfunction. Wages might fail to adjust, and prices might stick. This grit in the economic machine justified some meddling by policymakers.

Mr Volcker’s recession bottomed out in 1982. Nothing like it was seen again until last year. In the intervening quarter-century of tranquillity, macroeconomics also recovered its composure. The opposing schools of thought converged. The freshwater economists accepted a saltier view of policymaking. Their opponents adopted a more freshwater style of modelmaking. You might call the new synthesis brackish macroeconomics.

Pinches of salt

Brackish macroeconomics flowed from universities into central banks. It underlay the doctrine of inflation-targeting embraced in New Zealand, Canada, Britain, Sweden and several emerging markets, such as Turkey. Ben Bernanke, chairman of the Fed since 2006, is a renowned contributor to brackish economics.

For about a decade before the crisis, macroeconomists once again appeared to know what they were doing. Their thinking was embodied in a new genre of working models of the economy, called “dynamic stochastic general equilibrium” (DSGE) models. These helped guide deliberations at several central banks.

Mr Buiter, who helped set interest rates at the Bank of England from 1997 to 2000, believes the latest academic theories had a profound influence there. He now thinks this influence was baleful. On his blog, Mr Buiter argues that a training in modern macroeconomics was a “severe handicap” at the onset of the financial crisis, when the central bank had to “switch gears” from preserving price stability to safeguarding financial stability.

Modern macroeconomists worried about the prices of goods and services, but neglected the prices of assets. This was partly because they had too much faith in financial markets. If asset prices reflect economic fundamentals, why not just model the fundamentals, ignoring the shadow they cast on Wall Street?

It was also because they had too little interest in the inner workings of the financial system. “Philosophically speaking,” writes Perry Mehrling of Barnard College, Columbia University, economists are “materialists” for whom “bags of wheat are more important than stacks of bonds.” Finance is a veil, obscuring what really matters. As a poet once said, “promises of payment/Are neither food nor raiment”.

In many macroeconomic models, therefore, insolvencies cannot occur. Financial intermediaries, like banks, often don’t exist. And whether firms finance themselves with equity or debt is a matter of indifference. The Bank of England’s DSGE model, for example, does not even try to incorporate financial middlemen, such as banks. “The model is not, therefore, directly useful for issues where financial intermediation is of first-order importance,” its designers admit. The present crisis is, unfortunately, one of those issues.

The bank’s modellers go on to say that they prefer to study finance with specialised models designed for that purpose. One of the most prominent was, in fact, pioneered by Mr Bernanke, with Mark Gertler of New York University. Unfortunately, models that include such financial-market complications “can be very difficult to handle,” according to Markus Brunnermeier of Princeton, who has handled more of these difficulties than most. Convenience, not conviction, often dictates the choices economists make.

Convenience, however, is addictive. Economists can become seduced by their models, fooling themselves that what the model leaves out does not matter. It is, for example, often convenient to assume that markets are “complete”—that a price exists today, for every good, at every date, in every contingency. In this world, you can always borrow as much as you want at the going rate, and you can always sell as much as you want at the going rate.

Before the crisis, many banks and shadow banks made similar assumptions. They believed they could always roll over their short-term debts or sell their mortgage-backed securities, if the need arose. The financial crisis made a mockery of both assumptions. Funds dried up, and markets thinned out. In his anatomy of the crisis Mr Brunnermeier shows how both of these constraints fed on each other, producing a “liquidity spiral”.

What followed was a furious dash for cash, as investment banks sold whatever they could, commercial banks hoarded reserves and firms drew on lines of credit. Keynes would have interpreted this as an extreme outbreak of liquidity-preference, says Paul Davidson, whose biography of the master has just been republished with a new afterword. But contemporary economics had all but forgotten the term.

Fiscal fisticuffs

The mainstream macroeconomics embodied in DSGE models was a poor guide to the origins of the financial crisis, and left its followers unprepared for the symptoms. Does it offer any insight into the best means of recovery?

In the first months of the crisis, macroeconomists reposed great faith in the powers of the Fed and other central banks. In the summer of 2007, a few weeks after the August liquidity crisis began, Frederic Mishkin, a distinguished academic economist and then a governor of the Fed, gave a reassuring talk at the Federal Reserve Bank of Kansas City’s annual symposium in Jackson Hole, Wyoming. He presented the results of simulations from the Fed’s FRB/US model. Even if house prices fell by a fifth in the next two years, the slump would knock only 0.25% off GDP, according to his benchmark model, and add only a tenth of a percentage point to the unemployment rate. The reason was that the Fed would respond “aggressively”, by which he meant a cut in the federal funds rate of just one percentage point. He concluded that the central bank had the tools to contain the damage at a “manageable level”.

Since his presentation, the Fed has cut its key rate by five percentage points to a mere 0-0.25%. Its conventional weapons have proved insufficient to the task. This has shaken economists’ faith in monetary policy. Unfortunately, they are also horribly divided about what comes next.

Mr Krugman and others advocate a bold fiscal expansion, borrowing their logic from Keynes and his contemporary, Richard Kahn. Kahn pointed out that a dollar spent on public works might generate more than a dollar of output if the spending circulated repeatedly through the economy, stimulating resources that might otherwise have lain idle.

Today’s economists disagree over the size of this multiplier. Mr Barro thinks the estimates of Barack Obama’s Council of Economic Advisors are absurdly large. Mr Lucas calls them “schlock economics”, contrived to justify Mr Obama’s projections for the budget deficit. But economists are not exactly drowning in research on this question. Mr Krugman calculates that of the 7,000 or so papers published by the National Bureau of Economic Research between 1985 and 2000, only five mentioned fiscal policy in their title or abstract.

Do these public spats damage macroeconomics? Greg Mankiw, of Harvard, recalls the angry exchanges in the 1980s between Robert Solow and Mr Lucas—both eminent economists who could not take each other seriously. This vitriol, he writes, attracted attention, much like a bar-room fist-fight. But he thinks it also dismayed younger scholars, who gave these macroeconomic disputes a wide berth.

By this account, the period of intellectual peace that followed in the 1990s should have been a golden age for macroeconomics. But the brackish consensus also seems to leave students cold. According to David Colander, who has twice surveyed the opinions of economists in the best American PhD programmes, macroeconomics is often the least popular class. “What did you learn in macro?” Mr Colander asked a group of Chicago students. “Did you do the dynamic stochastic general equilibrium model?” “We learned a lot of junk like that,” one replied.

It takes a model to beat a model

The benchmark macroeconomic model, though not junk, suffers from some obvious flaws, such as the assumption of complete markets or frictionless finance. Indeed, because these flaws are obvious, economists are well aware of them. Critics like Mr Buiter are not telling them anything new. Economists can and do depart from the benchmark. That, indeed, is how they get published. Thus a growing number of cutting-edge models incorporate one or two financial frictions. And economists like Mr Brunnermeier are trying to fit their small, “blackboard” models of the crisis into a larger macroeconomic frame.

But the benchmark still matters. It formalises economists’ gut instincts about where the best analytical cuts lie. It is the starting point to which the theorist returns after every ingenious excursion. Few economists really believe all its assumptions, but few would rather start anywhere else.

Unfortunately, it is these primitive models, rather than their sophisticated descendants, that often exert the most influence over the world of policy and practice. This is partly because these first principles endure long enough to find their way from academia into policymaking circles. As Keynes pointed out, the economists who most influence practical men of action are the defunct ones whose scribblings have had time to percolate from the seminar room to wider conversations.

These basic models are also influential because of their simplicity. Faced with the “blooming, buzzing confusion” of the real world, policymakers often fall back on the highest-order principles and the broadest presumptions. More specific, nuanced theories are often less versatile. They shed light on whatever they were designed to explain, but little beyond.

Would economists be better off starting from somewhere else? Some think so. They draw inspiration from neglected prophets, like Minsky, who recognised that the “real” economy was inseparable from the financial. Such prophets were neglected not for what they said, but for the way they said it. Today’s economists tend to be open-minded about content, but doctrinaire about form. They are more wedded to their techniques than to their theories. They will believe something when they can model it.

Mr Colander, therefore, thinks economics requires a revolution in technique. Instead of solving models “by hand”, using economists’ powers of deduction, he proposes simulating economies on the computer. In this line of research, the economist specifies simple rules of thumb by which agents interact with each other, and then lets the computer go to work, grinding out repeated simulations to reveal what kind of unforeseen patterns might emerge. If he is right, then macroeconomists, like zombie banks, must write off many of their past intellectual investments before they can make progress again.

Mr Krugman, by contrast, thinks reform is more likely to come from within. Keynes, he observes, was a “consummate insider”, who understood the theory he was demolishing precisely because he was once convinced by it. In the meantime, he says, macroeconomists should turn to patient empirical spadework, documenting crises past and present, in the hope that a fresh theory might later make sense of it all.

Macroeconomics began with Keynes, but the word did not appear in the journals until 1945, in an article by Jacob Marschak. He reviewed the profession’s growing understanding of the business cycle, making an analogy with other sciences. Seismology, for example, makes progress through better instruments, improved theories or more frequent earthquakes. In the case of economics, Marschak concluded, “the earthquakes did most of the job.”

Economists were deprived of earthquakes for a quarter of a century. The Great Moderation, as this period was called, was not conducive to great macroeconomics. Thanks to the seismic events of the past two years, the prestige of macroeconomists is low, but the potential of their subject is much greater. The furious rows that divide them are a blow to their credibility, but may prove to be a spur to creativity.

economist

Out of work, out of benefits, out of luck

2009-07-17T08:04:00.000-07:00

By August, 65% of all filers for unemployment insurance will have run out of their standard 26 weeks. And that's just the beginning.

More than 650,000 Americans will have used up all of their unemployment benefits by September, in what experts say could be the start of a looming crisis.

In the early days of the downturn, the government extended unemployment benefits beyond the standard 26 weeks to as many as 79 weeks in hopes of giving the jobless a longer lifeline. Officials predicted the economy worsening and businesses further contracting, resulting in fewer jobs for the newly unemployed to find.

With the recession now 18 months deep and the national unemployment rate standing at 9.5%, it appears that the effort wasn't robust enough for those in the crisis' first wave of layoffs.

"We need to get the issue attention now, because people are running out of benefits and there's just nothing for them," said Andrew Stettner, deputy director of the National Employment Law Project, an advocacy group that has calculated the number of people who will exhaust their unemployment benefits.

In fact, Stettner and the Labor Department are expecting the problem to accelerate. In the next few weeks, the victims of the mass layoffs that happened six months ago -- when the pace of layoffs was at its zenith -- will start running out of their basic benefits. A total of 4.4 million people are expected to face this fate -- or 65% of the entire filing population.

And while they may have up to another year of unemployment insurance benefits -- thanks to the confusing patchwork of extensions that were enacted last summer -- they will be soon be unaccounted for in government unemployment reports.

The Labor Department doesn't track anyone who has moved beyond 26 weeks of unemployment in its weekly data on continuing claims (the number of people who request benefits after their first week). And, said Stella Cromartie, spokeswoman for the Bureau of Labor Statistics, said the agency does not currently have plans to begin tracking this population.

As a result, by late summer the government may begin reporting significant declines in continuing filers. But it won't be cause for celebration. Instead of of indicating that the economy is on the rebound, it could mean that more people are falling off the radar.

"We will see a decline in continuing filers," said the NELP's Stettner. "People are falling out of these numbers, and the pace of more recent layoffs replacing them is not as steep."

"They're not included in these unemployment numbers we hear about every week," said the NELP's Stettner. "They're desperate, asking, 'What's going to happen to me?'"

That's the question facing Jay Ridinger, 54, of Baxter, Tenn. The self-proclaimed "road warrior" once worked for a contract management company, happily bouncing from city to city to complete federal projects.

Ridinger was accustomed to the stop-start schedule of a contractor, so he wasn't worried when his last stint ended in August. But he soon realized this stretch of unemployment was different: "I thought it was the status quo, and instead here I am, applying for food stamps. I just sat in the office and cried and cried."

When he was first laid off, Ridinger received the maximum $250 unemployment check per week -- at the time, Tennessee's standard benefits lasted 13 weeks. Revisions of laws allowed him to get additional weeks of benefits.

"Every time you run out of benefits, you think, 'What the heck am I gonna do?'" Ridinger said. "And then a month later, maybe a check will be in your mailbox -- maybe not. Even if you get one, it's like, 'Ain't that nice, after all that emotion?'"

In most states, the unemployed receive a maximum 26 weeks of state-funded benefits. Two extension programs may also be available for an extra 53 weeks of benefits. (Click here for further detail on unemployment benefits programs.)

The availability and duration of the programs depends on the state's unemployment rates and whether it agreed to participate in part or all of the federal programs. (View the map to see how many weeks of benefits your state offers.)

These extension programs are "difficult to understand, unprecedented and tough to administer," noted Heidi Shierholz, an economist at the Economic Policy Institute, a nonprofit think tank. "It surprised me how difficult it is to get data on this. I study labor markets all the time, and even I didn't know just how much of a behemoth it is."

But just because filers may not be counted in the weekly jobless claims data, it does not mean they don't impact the national unemployment rate. The Labor Department doesn't rely on unemployment-benefit claims to calculate the unemployment rate; instead the agency conducts interviews through a population survey and simply asks people if they have looked for work in the past four weeks. If they have, they're included in the rate.

So, if you have run through all of your benefits and say, "yes," you would still impact the unemployment rate. If you are unemployed and looking for work but aren't claiming benefits, you would be included as well.

Still, the weekly jobless claims number is a good indicator of the health and direction of the economy. And Edward Stuart, an employment economics expert from Northeastern Illinois University, believes the NELP's data may even be "conservative."

"The unemployment rate is going up, and the time spent unemployed is also going up," Stuart said. "Jobs are disappearing, and we aren't replacing them."

In the meantime, Ridinger waits -- checking about 80 Web sites daily and has applied for jobs all over the country in a variety of fields. After almost a year, he's had only one interview.

"This experience has hit me with every possible emotion," he said. "It's humiliating, degrading. I've changed my complete attitude toward the system. I just never expected to be a part of it."

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7 Ways to Save on Gas

2009-06-21T05:44:00.000-07:00

That budget road trip you planned for the family this summer is starting to look a lot more expensive now that gas prices are on the rise.

Some of the spike is seasonal. Increased demand -- from all of those other families hitting the road -- tends to lift gas prices each summer, says Paul Hess, information analyst at the Energy Information Administration (EIA). Oil prices have also been creeping higher in recent weeks as optimism grows on Wall Street that demand for crude will rise worldwide once the global economy stabilizes, says Tom Kloza, chief information analyst at Oil Price Information Service, which monitors oil prices in North America. And further boosting prices at the pump is an Environmental Protection Agency requirement to add a fuel blend to gasoline in certain regions during the summer months that reduces ozone damage. This additive alone can add another five to 10 cents to the price per gallon, says Kloza.

As a result, regular unleaded gas costs $2.67 a gallon, up 16% from $2.30 a month ago, according to AAA’s Fuel Gauge Report. According to the EIA, gas prices won’t begin declining significantly until fall.

In the meantime, drivers can lessen the pain at the pump by taking some inexpensive and easy steps.

Here are seven ways to save on gas this summer.

Shop Around

Sure, it’s convenient to visit the gas station closest to home, but it may not be the best place to fill up.

To find the cheapest gas prices, compare prices at stations near your home or along your commute. Price-comparison web sites like GasBuddy.com and BillShrink.com let you plug in your daily destinations to find the most affordable gas stations on those roads. The price difference per gallon can be up to 50 cents, says Samir Kothari, co-founder of BillShrink.com.

Last summer, gas stations rolled out higher prices for consumers who paid with credit or debit cards (the idea was to pass along the merchant fees associated with such transactions). Many gas stations are still at it, which means those who pay in cash can often save. ARCO (a subsidiary of BP) stations, located in California, Washington, Oregon, Arizona and Nevada, for example, only accept cash and charge between five and 10 cents per gallon less than competing stations. (ARCO recently introduced a debit MasterCard which consumers can use to purchase gas at no extra charge. Other debit cards are accepted at these stations, but there’s a 45-cent fee.)

Cash discounts are popular in California, Connecticut, Florida, Michigan, New Jersey and New York, according to GasBuddy.com. (Discounts for cash-paying customers are legal in every state, as long as the gas station makes it clear that prices are different when you pay in cash vs. credit or debit, says Jason Toews, cofounder of GasBuddy.com.)

Fill Up at the Warehouse Club

In addition to frozen food, toiletries and appliances, Costco, BJ’s and Sam’s Club sell discounted gas at some of their locations.

“It depends on local market conditions but usually they sell it cheaply enough so that they’re beating out the competition,” says Toews. For example, at a BJ’s location in York, Pa., regular unleaded gas is selling for $2.59 a gallon. Local competitors there sell gas for $2.61 to $2.65 a gallon, according to GasBuddy.com.

Keep Your Car in Good Shape

Routine maintenance on your car’s tires and engine can increase its fuel efficiency (and even exptend its life). Plus, most of the things you need to do to maintain your car's health don’t even require pricey visits to the mechanic.

Just keeping your tires properly inflated can help save you cash. Underinflated tires require more energy to roll and decrease a car’s fuel efficiency, says Kothari. Driving with properly-inflated tires can improve fuel economy by 3% over a year, saving 20 gallons of gasoline and up to $45 annually, according to the Alliance to Save Energy. Check your car owner's manual to find out what the proper air pressure.

Also, be sure to regularly change your air filter. Clogged air filters can damage your engine and decrease fuel efficiency. A new air filter will improve gas mileage by 10%, according to the Department of Energy (DOE). Even better: Air filters are fairly cheap, ranging in price from $20 to $60.

Also, stick to the motor oil that’s recommended by your car's manufacturer, and buy one that states “energy-conserving” on the label, says Kateri Callahan, president of the Alliance to Save Energy. This can increase fuel efficiency by up to 2%, according to the Alliance to Save Energy.

Avoid Road Rage

Aggressive driving isn’t just dangerous. It also wastes a lot of fuel.

Consumers pay an extra 24 cents per gallon for every five miles per hour (mph) over 60 mph they drive, according to the Alliance to Save Energy. Rapid acceleration, hard braking and speeding can lower a car’s gas mileage by 33% on the highway and 5% in the city, according to the Department of Energy (DOE).

Clean Out the Clutter

Golf clubs, bowling balls or that bag of salt from last winter -- any unnecessary equipment or baggage in a car can decrease its fuel efficiency. According to the DOE, gas mileage decreases by up to 2% for every 100 pounds.

Another helpful tip: On your next road trip, try to pack everything inside the car rather than piling it on the roof. Stashing stuff on top of the car increases drag and decreases fuel economy by 5% or more, according to the DOE.

Limit A/C Use

Whenever possible try to keep the air conditioner at the lowest level. Having it maxed out can reduce your fuel efficiency by up to 25% compared to having the A/C turned off, according to the Alliance to Save Energy.

smart money

No empty threat

2009-06-21T05:38:00.000-07:00

Credit-default swaps are pitting firms against their own creditors.

SIX FLAGS, an American theme-park operator, filed for Chapter 11 bankruptcy protection on June 13th, bringing its long ride to reduce debt obligations to an abrupt halt. The surprise was that bondholders, not the tepid credit markets, stymied the restructuring effort. Bankruptcy codes assume that creditors always attempt to keep solvent firms out of bankruptcy. Six Flags and others are finding that financial innovation has undermined that premise.

Pragmatic lenders who hedged their economic exposure through credit-default swaps (CDSs), a type of insurance against default, can often make higher returns from CDS payouts than from out-of-court restructuring plans. In the case of Six Flags, fingers are pointing at a Fidelity mutual fund for turning down an offer that would have granted unsecured creditors an 85% equity stake. Mike Simonton, an analyst at Fitch, a ratings agency, calculates that uninsured bondholders will receive less than 10% of the equity now that Six Flags has filed for protection.

Some investors take an even more predatory approach. By purchasing a material amount of a firm’s debt in conjunction with a disproportionately large number of CDS contracts, rapacious lenders (mostly hedge funds) can render bankruptcy more attractive than solvency.

Henry Hu of the University of Texas calls this phenomenon the “empty creditor” problem. About two years ago Mr Hu began noticing odd behaviour in bankruptcy proceedings—one bemused courtroom witnessed a junior creditor argue that the valuation placed on a firm was too high. With default rates climbing, he sees such perverse incentives as a looming threat to financial stability. Already the bankruptcies of AbitibiBowater, a paper manufacturer, and General Growth Properties, a property investor, in mid-April have been blamed on bondholders with unusual economic exposures. Some also suspect that CDS contracts played a role in General Motors’ filing earlier this month.

Solutions to the problem are, so far, purely theoretical. One option would be regulation requiring disclosure by investors of all credit-linked positions. There is now almost no disclosure of who owns derivatives on a company’s debt, leaving firms to guess how amenable creditors will be when approached with a restructuring plan. Longer-term solutions rest on an overhaul of the bankruptcy code and debt agreements to award votes and control based on net economic exposure, rather than the nominal amount of debt owned. Supporters of the market point to the value of CDSs in reducing the cost of capital and to plans for a central clearing house that will reduce redundancy and increase transparency. But the reform roller-coaster has not yet come to a halt.

economist

Obama puts critics of financial overhaul on notice

2009-06-20T05:44:00.001-07:00

Obama to financial overhaul critics: `While I'm not spoiling for a fight, I'm ready for one'

President Barack Obama said Saturday that current financial rules exploit consumers and he put critics of his proposed overhaul on notice: "While I'm not spoiling for a fight, I'm ready for one."

Obama used his weekly radio and Internet address to defend his recent proposal, which is intended to prevent a repeat of the breakdown that has sent the U.S. economy reeling. But such major changes face a fight in Congress and opposition from some leaders in the banking and insurance industries.

In the address, Obama focused on a consumer watchdog office that he wants to set up.

"This is essential," Obama said. "For this crisis may have started on Wall Street. But its impacts have been felt by ordinary Americans who rely on credit cards, home loans and other financial instruments."

The Consumer Financial Protection Agency would take over oversight of mortgages, requiring that lenders give customers the option of "plain vanilla" plans with clear and affordable terms.

"It will have the power to set tough new rules so that companies compete by offering innovative products that consumers actually want and actually understand," Obama said. "Those ridiculous contracts -- pages of fine print that no one can figure out -- will be a thing of the past. You'll be able to compare products, with descriptions in plain language, to see what is best for you."

More broadly, Obama's changes would begin to reverse the easing on federal regulations pressed by President Ronald Reagan in the 1980s. Democratic leaders in Congress are promising legislation will get passed this year, but that depends in part on how Congress answers big questions about the overhaul, including the role of the Federal Reserve.

"I welcome a debate about how we can make sure our regulations work for businesses and consumers," Obama said. "But what I will not accept -- what I will vigorously oppose -- are those who do not argue in good faith."

By that, Obama said, he meant those who defend the status quo at any cost. He didn't name any people or organizations, but said special interests are already mobilizing to fight change. He called that typical Washington.

"These are the interests that have benefited from a system which allowed ordinary Americans to be exploited," Obama said. The president said he would stand up for his plans, saying: "While I'm not spoiling for a fight, I'm ready for one. The most important thing we can do to put this era of irresponsibility in the past is to take responsibility now."

White House: http://www.whitehouse.gov

The fear factor in health care costs

2009-06-20T05:37:00.000-07:00

Industry watchers say the practice of 'defensive medicine' is a controversial and wasteful contributor to the nation's escalating cost of medical care.

Every time a doctor orders an extra test for you, it pushes up your medical costs and -- some experts say -- contributes to the waste in the nation's $2.2 trillion in health care spending.

While there's much debate about the actual dollar impact of this controversial practice called "defensive medicine," experts agree it's an obstacle to reining in the medical care expenses.

Defensive medicine occurs when a doctor orders tests or procedures not based on need but concern over liability, explained Dr. Alan Woodward, former president of the Massachusetts Medical Society (MMS) and vice chairman of its committee on professional liability.

"If you're serious about (health care) reform, you have to be serious about this issue," Woodward said. He estimates that more than 80% of doctors across the country are engaged in defensive medicine.

President Obama, who has so far made information technology a key to his plan to reform health care, addressed this issue Monday in his speech to the American Medical Association (AMA).

"Some doctors may feel the need to order more tests and treatments to avoid being legally vulnerable. That's a real issue," he said. "While I'm not advocating caps on malpractice awards, I do think we need to explore a range of ideas about how to put patient safety first, let doctors focus on practicing medicine, and encourage broader use of evidence-based guidelines."

"That's how we can scale back the excessive defensive medicine reinforcing our current system of more treatment rather than better care," he said.

A 2008 study from PricewaterhouseCoopers found that wasteful spending in the health system accounts for more than half of all of health care spending. The firm identified defensive medicine as the biggest area of excess.

Pricing fear: Still, the effects of defensive medicine aren't easy to quantify. Estimates vary vastly.

"Each doctor has a very different risk profile," said Dr. David Chin, managing partner of consulting firm PricewaterhouseCoopers' Global Healthcare Research Institute. "If one doctor asks for an additional test, it's not always because they are practicing defensive medicine."

The Congressional Budget Office, the federal agency that will calculate how much money health reform will cost or save, has estimated that medical malpractice costs -- which include defensive medicine -- amount to less than 2% of overall health care spending.

Chin said his guess is in line with the CBO's number.

Michael Morrisey, a professor of health economics and health insurance at the University of Alabama's Lister Hill Center for Health Policy, is also skeptical about defensive medicine's impact on health care costs. He said states that have capped malpractice claims haven't seen any significant decreases in health care costs or heath insurance premiums.

"To me, the three biggest challenges for health care reform are tax treatment of employer-sponsored insurance, retooling health care payment systems and technological advancement in health care," said Morrisey.

Woodward disagreed. He ranks defensive medicine as the second-biggest burden on health care costs after the fee-for-service model in which doctors are paid for the quantity, rather than the quality, of services provided.

Woodward estimates that defensive medicine accounts for about 10% of health care costs. Some industry studies have translated that to more than $100 billion in health care costs annually.

"We are driving the standard of care more and more in the defensive direction," he said. "Physicians are practicing maximalist medicine rather than optimalist care.

Woodward defines optimalist care as everyone getting high-quality care, when they need it, in a cost-effective way.

He said the uninsured are getting "minimalist" care while insured Americans are getting maximalist care, or more than what they need from doctors due to fear of liability, the fee-for-service payment model and direct-to-consumer advertising.

Consumer impact: Redundant tests can pump up premiums for the insured. "Consumers' premiums could be 10% lower if doctors stopped this practice," Woodward said.

From a medical standpoint, excessive tests can also be harmful to patients if errors or complications occur, said Dr. Manish Sethi, a member of the MMS' board of trustees and co-author of a 2008 study that investigates and quantifies defensive practices in Massachusetts.

The MMS surveyed more than 830 physicians across eight specialty areas in the state and found 83% reported practicing defensive medicine at an estimated cost of $1.4 billion per year.

"The bottom line is doctors across the country are ordering more tests because of liability concerns," said Sethi. "I am not advocating liability reform but we could look at other options."

The American Medical Association, the group representing doctors, last month mentioned "health courts" as one option.

"Let's have special courts for patients just like bankruptcy court or patents courts and judges have medical training," said Woodward. "In the current system, medical cases are heard by judges who may not be trained in health care. Jurors have no background in health care and jury awards are huge."

Sethi offered other ideas such as a national standard of care, enforced by the Department of Health and Human Services, mandating specific clinical practice guidelines for doctors.

Sethi feels this would mitigate some of the liability concerns and encourage more doctors to accept high-risk patients, countering another aspect of defensive medicine.

In Massachusetts, lawmakers are also considering a bill allowing doctors to apologize to patients and their families for a medical error. However, that apology wouldn't be admissible in court during any future lawsuit brought by the patient.

"What a patient wants when errors happen is full disclosure, an apology and assurance that it won't happen again and compensation," said Woodward, adding that this process can help prevent complaints ultimately going to court.

"We have to move from a reactive to a proactive health care system. I think Obama gets it, but I don't know how aggressive he will be about it," he added.

Cnn money

An EU fudge on bank reform

2009-06-20T05:33:00.000-07:00

European Union leaders avoided a row over bank regulation—but only by being ambiguous.

TWO DAYS after Barack Obama announced what he intends to be the biggest overhaul of American financial regulation since the Depression era, the European Union’s leaders, meeting in Brussels on June 18th and 19th, agreed that financial institutions in the 27-country block should be subject to common rules and overseen by new EU-level supervisors able to make binding rulings in disputes between national regulators. The heads of national government also agreed to create a European Systemic Risk Board, charged with providing early warning of potential threats to financial stability. The French president, Nicolas Sarkozy, hailed Britain’s agreement to the plan as a “complete change in Anglo-Saxon strategy” on financial regulation. But was it? The British prime minister, Gordon Brown, insisted he had conceded nothing.

The 27 national leaders offered unanimous backing for the creation of a trio of EU supervisory authorities to watch over the banking, insurance and securities sectors. These would have the power to resolve clashes between national supervisors in financial firms’ home and host countries, and to decree that national supervisors were flouting EU rules. At the moment, multinational banks and other financial institutions are watched over by a patchwork of national bodies, with no clear mechanisms for resolving disputes.

Within the EU, France and Germany have been in the forefront of calling for ambitious European regulation of financial markets. That has raised alarm in the City of London, which is by far the largest financial centre in Europe. Earlier this month, Lord Myners, a government minister with responsibility for the City, told a House of Commons committee that Britain opposed an EU-level supervision, “because national governments are the only bodies capable of providing any fiscal support to firms.”

The idea of a clash of wills among Europe’s biggest powers was reinforced shortly before the summit, when Mr Sarkozy gave a speech pledging to rein in a global financial system “rendered mad by a total absence of regulation”. In the event, the summit passed off without public clashes, and Mr Brown secured a guarantee that national governments, and not the new European supervisors, will have a final say when it comes to decisions that involve taxpayers' money, such as calls to bail out failing banks. The new pan-European supervisors would improve the quality of cross-border supervision, Mr Brown said. However, he added: “I have ensured that the British taxpayer will be fully protected on this.”

Britain led the charge to secure language that EU supervisors’ decisions “should not impinge in any way on the fiscal responsibilities” of member nations of the union. But in truth other countries were hiding their own doubts behind British objections, as Mr Sarkozy himself acknowledged. Germany’s chancellor, Angela Merkel, was also “concerned” about the idea of regulators at the European level having responsibility over decisions that would have to be paid for at the national level, he said.

How this guarantee will be squared with the principle of EU-level supervision remains to be seen, senior officials admitted. The wrangling can be expected to resume again when the laws and directives to implement the EU leaders’ agreement are drafted by the European Commission later this year.

Ambiguity also surrounded the method that will be used to choose the head of the new systemic-risk council. Britain argued against a proposal from the European Commission that the council should at all times be headed by the president of the European Central Bank (ECB). As one of 11 EU countries that does not use the euro, Britain wields limited influence in the ECB. In the end, EU leaders decided that the chairman of the new systemic-risk watchdog would be elected by central-bank governors from all 27 EU countries; although as the French president unhelpfully noted, this was not much of a concession, since euro-zone countries hold a permanent majority within the union.

More broadly, senior politicians and officials were at pains to defend Europe from charges of falling behind America, when it comes to crafting new regulations for the financial system. Mr Obama’s reforms were in fact “much inspired” by European plans, insisted a senior EU official, speaking off-the-record, citing the example of a systemic-risk council, which was first mooted in Europe. Moreover, it was easier for America to move quickly, as it was a single federal country, with one president, one treasury and one central bank. Europe had “28 central banks”, said the Eurocrat, counting the national banks and the ECB.

The battles are not over. Further EU legislation is coming on hedge funds, executive pay and other issues that have become favoured talking points for European politicians keen to blame the crisis on “Anglo-Saxon” excesses. As Mr Sarkozy said, with apparent relish, at the summit’s end, the measures agreed so far were only a starting point, and would doubtless “evolve”.

economist

China’s Economic Growth Slows in First Quarter

2009-04-16T05:39:00.000-07:00

China’s economy grew more slowly than usual in the first quarter, and joblessness increased, but fairly strong investment and consumer spending helped prevent falling exports from dragging down economic output even further, the government said Thursday.

China’s economic output was 6.1 percent larger in the first quarter of this year than a year earlier, the National Bureau of Statistics said, but a range of statistics showed that March was better than January or February.

China’s annual growth rate appeared slow in the first quarter after the 6.8 percent rate in the fourth quarter of 2008, partly because it was being compared with the economy’s formidable output in the first quarter of last year. Then, many factories were operating with extensive overtime, and the rate of inflation was approaching double digits despite considerable efforts by Chinese officials to prevent the economy from overheating.

Still, 6.1 percent is substantially below the double-digit growth rates China has frequently posted this decade. China’s leaders have called for 8 percent growth just to create enough jobs for school graduates and for the tens of millions of rural migrants pouring into the country’s cities.

Chinese officials responded to the latest data with a mixture of hope and worry, seeking to show sympathy for those who have lost their jobs or had wages cut while trying to instill confidence that better times are coming.

Premier Wen Jiabao said after a cabinet meeting that the economy’s condition was “better than expected” and attributed it to government stimulus measures, according to Xinhua, the official news agency.

But the cabinet, with Mr. Wen as chairman, issued a report warning against “blind optimism” on the economy. The report said the foundations for China’s recovery were not solid, citing weak overseas demand, overcapacity in some industries, job losses and lackluster investment by the private sector.

Chinese economic output data may be less reliable during times of economic stress. Studies by Western economists have found that the Chinese government tends to smooth its quarterly economic data, underestimating gains during booms and losses during downturns.

Some economists were skeptical Thursday about the figures for the first quarter.

“The economy is definitely recovering, but for it to have troughed at 6 percent seems a little high,” said Ben Simpfendorfer, the China economist at Royal Bank of Scotland.

Using another measure of economic growth — the annualized rate of growth from one quarter to the next — China’s economy may have actually accelerated during the first quarter of this year.

Qu Hongbin, a China economist at HSBC, calculated that using that measure, China’s economy had grown at an annual rate of 6.2 percent in the first quarter, compared with just 2.5 percent in the fourth quarter of last year.

“The fourth quarter was actually the weakest,” he said.

The Chinese government releases only the growth rate in each quarter compared with a year earlier, as well as the total value of economic production for the year to date. Performing the calculation done by Mr. Qu requires estimating the exact value of each output in each quarter, a difficult process that entails coming up with seasonal adjustments as well.

The National Bureau of Statistics said Thursday that, next year, it would also start releasing the annualized growth rate from one quarter to the next, a measurement widely used in Western countries to capture short-term fluctuations in the pace of economic growth.

The government agency mentioned joblessness briefly in a statement on Thursday but provided no new details. The official unemployment rate among urban workers who are still living in the cities in which the government originally registered them edged up to 4.2 percent in the fourth quarter after hovering at 4 percent since the summer of 2007.

But that politically sensitive figure excludes more than 100 million workers who have migrated from rural areas or between cities to find jobs, often in the export sector, and are now feeling the brunt of dismissals, pay cuts and sharply shortened work hours.

China’s huge export sector remained a formidable drag on the economy during the first quarter of this year, tumbling 20 percent from a year earlier. But retail sales were up 14.7 percent in March from a year ago, accelerating from a gain of 11.6 percent in February.

Many business executives at the opening of the Canton Fair on Wednesday said that they were trying to sell more in their home market after concluding that overseas markets were far weaker.

China’s economic stimulus measures, from a record surge in bank lending to heavy government spending on new rail lines and other infrastructure, have started to increase the level of domestic investment; many economists expect an even stronger effect to show up in data for the second quarter, particularly given that urban fixed asset investment jumped 30.3 percent in March from a year earlier.

Joe Zhang, the general manager of Famous Grand M&E Equipment, which manufactures welding equipment for the assembly of boilers at factories, said his attention was increasingly on buyers in China, not those on the other side of the world.

“We sell a lot to the domestic market, and with the stimulus program, our sales are up from a year ago by 10 percent,” he said.

Thursday’s economic statistics prompted some investment banks to revise upward their growth estimates for the Chinese economy for all of this year. R.B.S. increased its estimate to 7 percent, from 5 percent, while UBS raised its estimated to between 7 and 7.5 percent, from 6.5 percent.

Falling prices were less of a worry in March at the consumer level, as deflation compared with a year earlier slowed to 1.2 percent, from 1.6 percent in February.

But prices continued to tumble rapidly at factory gates because of lower energy prices and industrial overcapacity. Producer prices dropped 6 percent in March from a year earlier, compared with a fall of 4.5 percent in February.

The data seemed to neither encourage nor discourage investors. The Hang Seng Index in Hong Kong closed with a loss of 0.55 percent while the A-share market in Shanghai fell 0.08 percent.

Why Weak Funds May Bounce Higher

2009-04-16T05:33:00.000-07:00

Past performance does not guarantee future results, as all mutual fund advertising cautions. In fact, when a bull market begins, you may fare best with funds that performed miserably in the bear market just before it.

Consider the 100 domestic equity funds that performed the worst during 2002, the last year of a bear market. Their average loss that year was 53.3 percent, according to Morningstar — more than double the 20.9 percent loss of the overall stock market, as measured by the Dow Jones Wilshire 5000.

In 2003, the first year of the subsequent bull market, those funds were among the best performers. They gained an average of 60.3 percent, compared with “just” 31.6 percent for the market as a whole.

This reversal of fortunes between 2002 and 2003 could have been expected, according to Russ Wermers, a finance professor at the Smith School of Business as the University of Maryland. In an interview, he said that the funds that lost the most during market declines tended to be quite risky. Of course, this risk tends to work against them during declines — but often bolsters their performance when the market rises. This is part of the reason that a new bull market causes fund rankings to be turned upside down.

In his research, Professor Wermers has found that another big part of the explanation is the changing fortunes of various stock sectors as the market’s overall trend shifts. Funds that bet on a sector that did well in a market downturn, for example, tend to do poorly when the market rises, he said.

His findings help to explain why Morningstar’s star-rating system has great difficulty in the early stages of a new bull market. The firm bases its star rating for a given fund on how it compares with others having a similar investment style.

Consider two hypothetical portfolios of mutual funds constructed according to their Morningstar ratings at the end of the 2000-02 bear market. The first contained all domestic equity funds that, at that time, had a one-star rating (Morningstar’s lowest); the second contained all those with a five-star rating (the highest).

In 2003, the first portfolio produced a return almost five percentage points higher than the second, according to an analysis that Morningstar conducted for Sunday Business. That’s the opposite of what an investor might have expected by using Morningstar’s ratings to pick funds at the beginning of that bull market.

These reversals stand out because they are the exception to the rule. So long as stock market’s major trend is not in transition, Professor Wermers has found, there is a modest amount of persistence in funds’ year-to-year rankings.

Similarly, Russel Kinnel, Morningstar’s director of fund research, reports that since 2002, when Morningstar adopted its current fund rating method, the average five-star fund has outperformed the average one-star fund over the year after the funds received their ratings.

The investment implication of these results depends on whether you choose funds on the basis of recent returns. If you do, Professor Wermers argues, you should at least temporarily stop doing so whenever you think stocks’ general trend may be about to shift from down to up.

But that doesn’t mean you should ignore all past performance at the beginning of a bull market, he added. After all, it is only the funds’ returns during the preceding decline that are a particularly poor guide. At such times, he said, you should instead look back at periods much longer than the previous year or two.

How far back to go? There is no consistent answer, he said, because the period needs to be long enough not to be dominated by any bear market years. Ten years might be enough in some cases, but right now the period should probably be even longer, because the stock market is lower today than it was 10 years ago.

His advice presents a particular challenge to fund investors who rely on Morningstar’s ratings, because a fund’s overall star rating is heavily influenced by its recent performance. Morningstar does calculate a separate rating based on a fund’s performance over the last 10 years; it is available on the firm’s Web site. But even that longer-term rating is less than optimal now.

Even better, Professor Wermers added, would be a rating “conditioned on the current state of the economy,” such as a “5-star bear-market fund” or a “5-star bull market fund.”

JPMorgan Chase earns $2.1 billion

2009-04-16T05:30:00.000-07:00

Although profits fell 10% from a year ago, earnings still beat expectations. CEO Jamie Dimon said bank is strong but added that bank may boost credit reserves.

JPMorgan Chase reported a better-than-expected profit of $2.1 billion in the latest quarter, even as the bank aggressively set aside money to cope with rising loan losses, the company said Thursday.

The New York City-based bank said its net income for the first quarter was $2.1 billion, or 40 cents a share. Profits were down 10% from a year ago, but still handily beat expectations.

Analysts were anticipating JPMorgan Chase to record a profit of $1.38 billion, or 32 cents a share, for the quarter, according to Thomson Reuters.

Bolstering the bank's results were both its consumer and investment banking divisions, but JPMorgan Chase also logged $10 billion in credit costs during the quarter, which included a $4 billion addition to its loan loss reserves.

JPMorgan Chase CEO Jamie Dimon warned that this number could go higher if the recession intensifies, but added that he was comforted by his firm's robust capital levels.

"These levels of capital and reserves, combined with our significant pre-provision earnings power, enable us to withstand an even worse economic scenario than we face today," Dimon said in a statement.

As of the end of the quarter, Chase's Tier 1 capital ratio, a key measure of a bank's ability to absorb losses, stood at 11.3%. Not including the $25 billion that the Treasury Department injected into the firm in October, Chase's Tier 1 ratio was 9.2%. A Tier 1 ratio above 8% is generally considered healthy.

JPMorgan Chase is among a handful of banks that have hinted at their interest in repaying taxpayer funds, given the increasing restrictions imposed on banks participating in government rescue programs.

Goldman Sachs announced earlier this week that it would sell new stock to help pay back the government. But JPMorgan Chase did not give any further indications in its earnings release Thursday about when it might return funds to the Treasury.
Investment banking bounces back, cards take a hit

Delving deeper into the results, Chase's investment banking division came roaring back from a loss in the fourth quarter and posted a profit of $1.6 billion.

The strong investment banking performance was driven by a revenue surge in its fixed income division, which reported record results in some of its operations including trading and emerging markets.

The bank's retail financial services and commercial banking divisions helped contribute to the firm's overall profit for the quarter as well, but those gains were offset in other areas.

Chase's credit card division, for example, reported a net loss of $547 million, down from a profit of $609 million a year ago. The bank cited a sizable increase in allowances for loan losses and higher charge-offs, or loans the company doesn't think are collectable.

Despite facing such issues as rising credit costs, Dimon maintained that the bank was financially strong enough to weather the current downturn, and is well-positioned for an eventual recovery.

The bank also noted that it was making "excellent progress" with its late September purchase of failed Seattle-based lender Washington Mutual.

Chase has been working hard to integrate WaMu's assets, including its nationwide retail branch network. Chase said that it had total branches of just under 5,200 as of the end of the quarter, down from 5% from late last year as it consolidated some Chase and WaMu locations.

Chase's encouraging results come on the heels of impressive numbers put up in the last week by two of its biggest rivals - Goldman Sachs (GS, Fortune 500) and Wells Fargo (WFC, Fortune 500).

Goldman Sachs reported a profit of $1.8 billion earlier this week -- which topped Wall Street estimates. San Francisco-based Wells Fargo said late last week it expected to book a record profit of $3 billion in the latest quarter, also higher than Wall Street's forecasts.

Following Chase's report, investors' eyes will now turn to two of the nation's most embattled banks - Citigroup (C, Fortune 500) and Bank of America (BAC, Fortune 500). Citi and BofA are slated to report their first quarter numbers Friday and Monday respectively.

Shares of JPMorgan Chase (JPM, Fortune 500), which are up more than 50% from lows reached earlier this year, fell nearly 3% in pre-market trading.

money.cnn.com

Activist investors: Flight of the locusts

2009-04-13T05:21:00.000-07:00

Will the retreat of activist investors give industrial bosses more leeway to manage?

A YEAR ago Stephan Howaldt, the chief executive of Hermes Focus Asset Management Europe, a British activist fund, was in full cry against the Pesenti family, an Italian industrial dynasty. The fund had taken a stake in Italmobiliare, a financial holding company controlled by the family, which in turn controls Italcementi, the world’s fifth-largest cement-maker. Hermes demanded a performance review for Carlo Pesenti, Italcementi’s chief executive, and said the cement firm should sell its stakes in unrelated businesses such as newspapers and banking. Things got personal: the family executives, Mr Howaldt said, became “unusually closed-up”.

Italcementi’s management was therefore delighted when Hermes said in January that it was reorganising its fund and replacing Mr Howaldt. The fund’s activist style had been “disproportionately hit” by the financial crisis, it explained. Hermes still owns shares in Italmobiliare, but its management is not expecting much further pressure for change.

Around the world, activist funds are on the back foot, performing poorly, facing investor withdrawals and struggling to assemble the financial firepower to take on new targets. The activist technique of investing in a few underperforming companies and pressing for change is particularly difficult in falling markets, as other investors seek safe havens. In America investors began only two new activist campaigns in the fourth quarter of 2008, down from 32 in the preceding nine months and 61 in 2007, according to Thomson Reuters, a provider of financial data. William Ackman, a well-known activist who started a fund to pursue Target, a discount retailer, wrote to investors in February to apologise for the fund’s “dreadful performance”. It has fallen in value by around 90%.

In continental Europe, where shareholder activism is a newer phenomenon, corporate chiefs will be quick to seize on signs of failure. On March 26th the chief executive of Wendel, a prominent French investment fund, resigned after an activist investment in Saint-Gobain, a 344-year-old French building-materials firm, went disastrously wrong. Shares in Saint-Gobain fell precipitously after Wendel’s investment, dragging down the fund’s own performance. In recent years, comments Alain Minc, a business consultant in Paris, financial investors were encouraged by cheap liquidity to think they were geniuses who knew better than chief executives how to run companies. In future, he says, they will need real industrial credentials.

On April 2nd Christopher Hohn, chief of The Children’s Investment Fund (TCI), a British hedge fund labelled a “locust” in Germany for its aggressive tactics, abandoned its efforts to force further change at Germany’s main stock exchange. It cut its stake in Deutsche Börse from 10% to below 1%. Last year Mr Hohn conceded that activism is “unpredictable and expensive” in current market conditions. In Japan, too, activists are backing down; in October last year, for instance, TCI sold out of J-Power, the country’s former state-run energy wholesaler, having failed to influence its strategy, and suffered an estimated $130m loss. “Our focus has shifted to buying stocks that don’t require activism,” says the local manager of another big fund.

To be sure, there is little chance that chief executives will feel less overall pressure from shareholders to perform. But demands from short-term investors are likely to subside. In 2007 Moody’s, a credit-rating agency, published a controversial report which concluded that the expansion of shareholder power at American companies was increasing potential credit risk, to the detriment of bondholders and long-term shareholders. Short-term investors in America and Europe, it said, were using new powers such as the ability to nominate board directors to push for actions which could damage credit quality. On top of activists’ own difficulties, companies now have a powerful argument to push back against such initiatives. The pressure from investors trying to force through specific changes—such as increased leverage, spin-offs, acquisitions or share buybacks—has receded, probably for several years.

That will delight chief executives. They resented being given advice on important strategic decisions by people with no industrial experience, and feared the long-term consequences of gearing up. “You end up spending too much time in front of these people rather than running your business,” says one European boss, who adds that short-term shareholders have been a “plague” on industrial firms.

“Creating value through financial leverage will be harder in future, so we can get back to our real job,” says Hakan Samuelsson, chairman of MAN, a German truckmaker, “which is creating industrial value through technology, innovation and efficient manufacturing.” He expects less pressure to sell businesses, because the perceived value of divisions that generate cash is greater now that credit is more expensive. Conglomerates, therefore, stand a better chance of staying intact or even bulking up further over the next few years. Mr Samuelsson also expects more patience for organic growth.

“The dialogue with long-term shareholders has never been as robust,” says Jean-Pascal Tricoire, the president and chief executive of Schneider Electric, a 171-year old French firm which makes equipment for electrical distribution and industrial control. “I believe financial investors are now increasingly realising that industrial people can manage and develop businesses very well.”

In America, too, the financial crisis offers an opportunity to push back against short-term pressure from shareholders, so that managers can go back to running firms for the long term, says Martin Lipton, a Wall Street lawyer who has questioned the value of shareholder activism. Quarterly reporting to Wall Street, long unpopular with industry, is now under fire for having contributed to a push for higher returns and more risk-taking in banking. But American bosses are unlikely to take much comfort from any shift to a longer-term philosophy. Public anger at banks has spilled over into broad fury at corporate chiefs and their pay, and they expect more rather than less scrutiny.

As chief executives regain the freedom to manage, they may seize the opportunity to invest for the long term. But there is also a risk they will indulge in empire-building and roll back improvements in corporate governance. “As activism subsides the result is likely to be that management will tend to become even less accountable, and whether that is in the long-term interests of shareholders is a serious question,” says Nathan Gelber of Stamford Associates, a pension-fund consultancy in London. In Japan in particular, the retreat of activist investors is lamentable.

At some firms vocal fund managers are being replaced by a new kind of activist: the government. Barack Obama proved himself more brutal than any hedge fund when he removed Rick Wagoner as the boss of General Motors last month. But having ousted managers they hold responsible for past failures, governments will seek to build big, stable companies capable of increasing employment, rather than stripping them down in the name of efficiency and shareholder value. On March 29th Christian Streiff, chief executive of PSA Peugeot Citroën, was also ousted, possibly because the French government was infuriated by his plan to cut 11,000 jobs at the firm, announced two days after taking a big loan from the state. Industrial bosses should take note: the wind has changed direction, for a few years at least.

www.economist.com

Wall St. to Goldman: Remove the TARP

2009-04-13T05:14:00.000-07:00

Investors expect a healthy first-quarter profit but results may be overshadowed by talk that the big bank will soon repay its $10 billion government loan.

Wall Street is counting down to Tuesday morning, when Goldman Sachs is due to report quarterly earnings. But the firm's first-quarter profits aren't the main source of suspense.

Instead, investors are betting that Goldman (GS, Fortune 500) will put itself on track to become the first big bank to wean itself from direct government support.

The Wall Street Journal reported Friday that Goldman may announce a multibillion-dollar stock offering along with its first-quarter numbers. A sale would be Goldman's first capital raise since it got $10 billion from Treasury in October in the first round of Henry Paulson's Troubled Asset Relief Program.

Goldman dismissed the stock-sale report, and questions about how soon the firm might repay TARP funds, as speculation.

Still, a stock sale would give the firm a chance to cash in on the past month's financial sector rally. Goldman shares have surged 70% in the past month.

The bounce has boosted Goldman stock to around $125 a share -- a level it hasn't traded it since shortly after the collapse of Lehman Brothers and the near implosion of AIG (AIG, Fortune 500) in September forced Goldman to raise new funds. Goldman ended up selling billions of dollars in stock to investors, including Warren Buffett's Berkshire Hathaway (BRKA, Fortune 500), that month.

Goldman executives have said they want to repay government funds once they get regulators' blessing. But the timeline of any repayment remains unclear, depending in large part on decisions being made by officials at the Federal Reserve and Treasury.

And though investors would welcome any move toward TARP repayment as a sign of strength, some analysts question whether it makes sense to return cheap government funds at a time when the financial system is still under stress and investors and the government are closely scrutinizing bank capital levels.

Regulators are conducting so-called stress tests of the nation's largest banks, including Goldman, to determine if they need to raise more capital. The stress tests are not expected to be completed until the end of the month, and according to several reports, the government has instructed executives at big banks not to discuss the results. Goldman declined to comment.

Goldman isn't required to raise new capital before it repays the Treasury. But analysts expect it would sell either stock or perhaps part of its stake in a Chinese bank to further bolster its balance sheet before returning TARP funds.

Paying back TARP could reduce Goldman's Tier 1 capital ratio -- a measure favored by regulators -- to 13% from over 15%, according to calculations by Bernstein Research analyst Brad Hintz.

But doing so wouldn't hurt Goldman using another measure of capital, the tangible common equity measure investors have been focusing on amid deepening problems at big banks like Citigroup (C, Fortune 500) and Bank of America (BAC, Fortune 500).

A TARP payoff could also save the firm some $500 million in annual preferred stock dividends, Hintz wrote last month. It would also free Goldman from federal oversight of its pay practices.

That's noteworthy because Wall Street's desire to pay off TARP loans has intensified as complaints about federal involvement in the banking sector have risen.

Jamie Dimon, the CEO of JPMorgan Chase (JPM, Fortune 500), warned in a speech last month of the dangers of the "vilification of corporate America." Less than a week later, Dick Kovacevich, the chairman of Wells Fargo (WFC, Fortune 500), pronounced the government's plans to test the balance sheets of big banks "asinine."

Goldman execs have been considerably more politic. Asked last month at a conference whether Goldman would become the first big bank to return TARP funds, Gary Cohn, the firm's co-president, replied that he would be surprised if anyone "is really in position to give back TARP money till the results of the stress tests and first-quarter earnings are out of the way."

Regardless of whether the firm decides to sell stock, investors will be also waiting to see if Goldman can bounce back from its dismal last quarter and if its earnings justify the recent runup in the company's share price.

For the first quarter, which ended in March, Goldman is expected to report a profit of $1.60 a share, according to analysts surveyed by Thomson Reuters. Consensus estimates have been steadily rising during the past few weeks, with analysts expecting a profit of just $1.21 a share in mid-March.

Goldman lost $2.1 billion, or $4.97 a share during its fiscal fourth quarter, which ended in November. That was the company's first loss since it went public in 1999.

This is the first time Goldman is reporting results with a first quarter that ended in March. Previously, Goldman's first quarter ended in February, but the Wall Street giant changed its fiscal year to correspond with the calendar year after the Federal Reserve approved its request to become a bank holding company.

Goldman applied for bank holding company status in the midst of the credit crisis. The move could allow Goldman to raise more money from deposits, though executives have said they don't expect to change their strategy of focusing on trading and investment banking.

money.cnn.com

How the crisis happened

2009-04-08T05:15:00.000-07:00

Harvard historian Niall Ferguson argues that financial crises are inevitable - and that some radical thinking will be needed to get us out of this one.

For many people, the most shocking aspect of the financial crisis is that something of this scale could happen at all. Wasn't it just a couple of years ago that the rise of globalization - and the growing sophistication of financial markets - offered the promise of perpetually low inflation, cheap money, and fat returns?

But for British historian Niall Ferguson, what's remarkable is that anyone could have thought this at all. In his latest book, "The Ascent of Money," the Harvard history and business professor traces the evolution of the world's financial systems from the earliest known coins in 600 B.C. to the collateralized debt obligations that brought down Wall Street.

Though the development of finance gave rise to civilizations and empires, he argues, the evolution of financial institutions has never been, and can never be, smooth. "Financial crises happen, and they happen very often," he says. "So to talk as if this could have been avoided is to misunderstand history."

So what does history teach us about this crisis - and how we'll come out of it? Ferguson shared his thoughts with Money senior editor Paul Lim.

What was the root of this crisis? Was it the housing meltdown, a lack of regulation, too much cheap money?

The origins lie in globalization itself. You couldn't really imagine the credit bubble or the housing bubble of 2001 to 2007 taking place without the great flow of cheap capital from Asia to the U.S., which financed U.S. deficit spending. This was also a story of innovation. Financial history is an evolutionary story. And we saw a great flourishing of new financial species in the conditions made possible by globalization.

How do you see the financial markets evolving from this point on?

When Planet Finance reached the size it had reached in 2007, when the derivatives market was vastly larger than the output of the planet, it was clear that we were on the verge of a natural selection clear-out. The species that flourished in this recent era of leverage - when you could wager 50 to 1 if you were a bank - will look a little like a dinosaur after the meteors hit the earth.

So the era of massive financial conglomerates is coming to an end?

Absolutely. While we will prevent the great dinosaurs like Citigroup (C, Fortune 500) and Bank of America (BAC, Fortune 500) from dying, they are never going to be able to operate the way they did.

How come so few foresaw this crisis?

Plenty of intelligent observers did. But market actors failed to heed the warnings. Part of the problem was that incentives for executives and investors discouraged them from taking heed.

Also, a crisis of this magnitude is so rare that it's beyond most people's experience. Only somebody who studies financial history could say, as I was trying to say, "Look, something as big as the liquidity crisis of 1914 or as big as the banking crisis of 1931 is imminent." Most people have a career memory of 25 years at most. If you want to understand how globalization worked - and failed - in the past, you need to go back not 20 years but 100 years.

Isn't the government attempting to go back nearly 100 years now, trying to jump-start the economy through spending as it did in the Great Depression?

The economy of the 1930s, when the New Deal began, was basically a closed economy. The protectionist barriers were so high that the U.S. could increase government expenditures and have the demand ring just around the domestic world. We're not in that situation now. You just can't stop people spending an increment of their income on Chinese imports. So I don't think the stimulus is going to yield anything like the kind of addition to employment or GDP that the government is assuming.

Still, doesn't something need to be done?

Yes, but you can't have the U.S. run a $2 trillion deficit and expect foreign investors to finance it in the midst of a massive contraction of trade. Let's assume the federal deficit grows to 14% or 15% of GDP. That's a number we haven't seen since World War II.

This is why I prefer more radical solutions to reduce private-sector debt. You need to stabilize the real estate market. As long as property prices are falling at an annual rate of 19%, you can't stabilize bank balance sheets. The assets they're linked to keep becoming worth less.

Isn't Obama's housing plan aimed at reducing private debt?

It doesn't go far enough. The plan is to use $75 billion to incentivize lenders to reduce monthly payments. There will also be an opportunity for Fannie Mae and Freddie Mac-backed mortgages to be refinanced. To be effective, a large-scale restructuring of household indebtedness would need to be mandatory.

So lenders should be forced to renegotiate?

I'd be trying to think about how to effectively convert mortgages nationwide into 20- or 30-year debt at, say, 3%.

Has anything like that been done before?

Yes. It was a frequent occurrence in the 19th century. Governments that were paying 6% on bonds would say, "Look, circumstances have changed. From now on you get 3%." What's different today is that these are private debts, not public debts, and that entails a lot more complexity.

Wouldn't a cram-down like that make credit markets more volatile?

We don't really have a great many options here. If we stay the present course, you're going to see the tailspin continue.

Is a depression still possible?

It is. The Great Depression was initially a U.S. financial crisis. But what made it a depression was its global contagion, and then the breakdown of trade and the retreat into protectionism. All of that can happen. All of that is in fact happening with terrifying speed. Countries have started to use protectionist language, whether it's "Buy American" or "British jobs for British workers."

Do investors need to change the way they think?

Paradoxically, this American crisis makes the U.S. seem like a more attractive place to invest - including for foreigners. America's "safe haven" tag is an important one.

money.cnn.com

Time for a new driver

2009-04-08T05:10:00.000-07:00

General Motors gets a new boss, but Barack Obama is really in control.

IF AMERICA’S two beleaguered carmakers, General Motors (GM) and Chrysler, had harboured the hope that Barack Obama would prove a soft touch, any such illusion has been robustly dispelled. When the news leaked on March 29th that Rick Wagoner, GM’s chief executive for nine years, had been told to step down by the president’s auto task-force in favour of his number two, Fritz Henderson (pictured), there was little doubt that more unpleasant medicine was on the way. So it proved.

The next day the task-force gave its analysis of the “viability plans” the two firms had submitted in February as a condition of the $17.4 billion emergency-loan package agreed on December 31st ($13.4 billion for GM, $4 billion for the much smaller Chrysler). Its verdict on both plans was damning; its threat that bankruptcy, albeit of a “quick and surgical kind”, could still be the best option, was unambiguous.

Although GM was given some credit for restructuring its business in recent years, the task-force concluded that progress had been far too slow, and that something much more thorough than GM’s management and key stakeholders seemed willing to contemplate was needed. Furthermore, the assumptions on which GM was basing its plans were a good deal too rosy and left uncomfortably little margin for error.

The task-force identified six areas where it found GM to be over-optimistic or in denial: domestic market share, which it expects to contract by only 0.3 percentage points a year after 30 years of falling by 0.7 points; pricing in a collapsing market which still doubts the quality of GM’s products; the drag of underperforming dealers; the consequences of the failure of GM’s European arm to secure outside investment or government support; a weakening product mix as consumer tastes and tighter fuel-economy rules eat into sales of high-margin trucks and sport-utility vehicles; and legacy health-care and pension liabilities that will reach $6 billion a year by 2013, forcing GM to maximise volume rather than return on investment.

But GM can take one quite substantial crumb of comfort from this otherwise bleak assessment: Mr Obama’s team reckons that if it can shove the company, its unions and its bondholders into taking more drastic and painful action, a healthy business could yet emerge. GM has started making some good, desirable cars in efficient, flexible factories. Critically, GM also has the scale, technology and reach that a capital-intensive, highly competitive global industry demands.

None of this, unfortunately, applies to Chrysler. On just about every count, the task-force sees Chrysler as a basket-case. Saddled with out-of-date factories, over-reliance on the North American market and unfashionable trucks, a poor reputation for quality, a dearth of new models in the pipeline and insufficient resources to fund future power-train development, Chrysler is too weak and too small to survive on its own.

Chrysler’s only hope, Mr Obama said on March 30th, is to consummate the deal it has been discussing since January with Fiat. The Italian firm would supply it with “cutting-edge technology” in the form of fuel-efficient engines, small-car platforms and factory automation. In return, Fiat had expected a 35% stake in Chrysler, a strong base from which to buy the rest of the company should it so wish, as well as a manufacturing and distribution base in America. In negotiations held in March between Steven Rattner, the investment banker who leads the task-force, and Sergio Marchionne, Fiat’s boss, Fiat agreed to scale back its initial stake to 20% and not to increase it beyond 49% until Chrysler had repaid American taxpayers in full.

Chrysler now has until the end of April to get the deal done. Meanwhile the government will continue to supply it with working capital. Mr Obama says he will “consider” lending the firm a further $6 billion if it can construct a credible plan with Fiat. But can it? Mr Marchionne is adamant that Fiat will not put any of its own much-needed cash at risk, and the Fiat team that has been carrying out due diligence on Chrysler thinks it will be two years before the American firm will feel real benefit from the partnership. Given that Chrysler has spent most, if not all, of the $4 billion it received in January, it is hard to see how $6 billion will take it through to 2011.

The government says that if Chrysler is to survive alongside Fiat it will require “at a minimum…extinguishing the vast majority of Chrysler’s outstanding secured debt [about $9 billion] and all its unsecured debt and equity.” Cerberus Capital Management, the private-equity firm that acquired an 80% stake in Chrysler in August 2007, seems resigned to surrendering its equity, and the banks that hold unsecured debt are also in a weak position. But the senior debt holders may decide that they will fare better if Chrysler files for bankruptcy and they can make a grab for whatever sellable assets are left.

The outlines of GM’s future are not much clearer, but at least it seems to have one. “We cannot, we must not, and we will not let our auto industry simply vanish,” Mr Obama said this week. That does not, however, mean that GM will necessarily avoid bankruptcy, as Mr Henderson acknowledged. In a marked change of tone from the old regime, of which he was a part, Mr Henderson said he was prepared to do whatever was necessary to reorganise GM—including making a trip to the bankruptcy court if agreements could not be reached with bondholders and the United Auto Workers union to slash more than $50 billion of liabilities.

Mr Obama has given Mr Henderson 60 days (and sufficient working capital) to bang heads together and drive through other changes. Above all, the task-force will want to see evidence that GM can repair its balance-sheet and become capable of generating positive free cashflow in a car market somewhat bigger than today’s, but smaller than in the past.

There is, however, a growing belief that the best way to achieve that may be a “quick rinse” bankruptcy reorganisation which separates a new, lean and mean GM from an old GM that holds legacy health-care obligations, dud brands and unwanted factories. Supposedly, the former would swiftly fly free, while the latter would remain in bankruptcy and be slowly wound down. In practice, nothing is likely to be that neat. The only certainty is that even though GM has a new boss, the government is really in control.

www.economist.com

The semiconductor industry: under new management

2009-04-05T04:03:00.000-07:00

Chipmakers were suffering even before the global economic downturn. Recession is heightening the pain and highlighting changes in structure and ownership.

MOST tourists come to Dresden to view the city’s architectural wonders. Beautifully rebuilt, the Frauenkirche (Church of Our Lady), for instance, reveals no hint that its huge cupola once crumbled after a rain of British bombs. But the capital of the German state of Saxony also has more contemporary attractions—at least for technically inclined travellers. It is the hub of one of Europe’s biggest technology clusters. Silicon Saxony, as the region has come to be called, boasts 1,500 high-tech firms employing 43,000 people, most of them in the semiconductor industry.

Yet industrial tourists had better hurry. Recently Silicon Saxony has taken some hits that have weakened its foundations. On April 1st Qimonda, a maker of memory chips and the cluster’s largest employer, mothballed its factory, having been forced into insolvency earlier this year. Its last hope is to be bought by an outside investor lured by money from the Saxon government. Inspur, a Chinese computer-maker, is among those expressing interest in Qimonda, which has developed some cutting-edge technology.

At Dresden’s other big “fab”, as chip-fabrication plants are called, is an indicator of another change that may prove just as damaging. There is a new logo at the entrance: visitors are no longer welcomed to AMD but to Globalfoundries. AMD, a maker of microprocessors for personal computers (PCs), decided last year to spin off its fabs into a separate company and to sell a majority stake to investment funds controlled by the government of Abu Dhabi. A good deal of production, some fret, may eventually move from Dresden to the Gulf.

The likely death of Qimonda and the birth of Globalfoundries have turned Silicon Saxony into an industrial showcase of a very different kind. It is a visible token of how hard recession around the world has hit the semiconductor industry, which had already been weakened by one of its periodic downturns. Just as important, it demonstrates the longer-term upheavals in the industry. The semiconductor business is becoming less vertically integrated and more concentrated. And its centre of gravity is shifting eastwards.

Despite a few signs that the worst may be over—Asian chipmakers’ share prices soared recently after shortages were predicted—the industry is still in the midst of the longest slump in its 50-year history. If market researchers are right, it will shrink again in 2009 before resuming growth in 2010. iSuppli, one such forecaster, thinks that revenues will fall by more than 20% this year, to $205 billion (see chart 1). Other observers have been making similarly gloomy predictions.

To understand why the semiconductor industry has been so pummelled, think of integrated circuits (ie, chips) not as tiny pieces of silicon engraved with millions of transistors, but as an essential resource. Before long every man-made object will come with at least one embedded microchip (see chart 2). Jerry Sanders, AMD’s founder, once called chips “the crude oil of industry”. This seems apt: integrated circuits have become the grease of the information economy. The flip side is that chipmakers have come to depend increasingly on the health of the rest of the economy.

The chip cycle

However, the industry’s own economics are also to blame. Even without the world’s wider troubles, these would have caused problems. In explaining how, Dan Hutcheson, chief executive of VLSI Research, a consultancy, likens semiconductor manufacturing to a different industry: farming. Investment decisions have to be made long before products can be sold. Chip farmers have to spend billions and wait years before they can start etching circuits onto “wafers”, those thin disks of semiconductor material, the size of pizzas, which are sliced into hundreds of chips at the end of the production process.

This goes a long way towards explaining why chipmakers, like farmers, have a tendency to oversupply the market, particularly if they sell memory chips, an undifferentiated product (like winter wheat). Even if prices fall below costs, they have an interest in keeping their fabs humming, in order not to lose their heavy upfront investment and to recover the variable costs. What is more, they are caught on a “technology treadmill”, in the words of Mr Hutcheson. Competition forces them always to employ the latest technology, which both increases output and puts pressure on prices.

Finally, just as in agriculture, governments further fuel this innate tendency to oversupply. In prestige, national security, industrial policy or just a desire to create jobs, politicians have always found a reason to support their semiconductor industries, mostly with cash. Silicon Saxony, for instance, has received more than €1.5 billion (nearly $2 billion at today’s exchange rate) from the state of Saxony alone, much of it to coax AMD into investing.

Asian governments have been the most active. Thanks to Taiwan’s industrial policy, more than half of the world’s chips are now made there. Support from the South Korean government made Samsung and Hynix the world’s biggest makers of memory chips; they supply about 50% of this segment. China seems intent on turning its semiconductor companies into market leaders at almost any price, above all Semiconductor Manufacturing International Corporation, or SMIC. All this explains why of the 40 fabs under construction in 2007, 35 were in Asia, three in America and only two in Europe.

Not surprisingly, at times supply far outstrips demand. From 2002 until last year Asian makers of memory chips, especially, invested as if capital were free—which explains why everybody is now bleeding money. In July 2007 the price of a DRAM (dynamic random access memory) chip with a capacity of 512 megabits was more than $2. In early April it was about 50 cents. Smaller makers cannot cope. Qimonda, for instance, piled up losses of about €1.5 billion between October 2007 and June 2008. Its revenues were only €1.3 billion.

Given the scale of the losses and the screaming from other industries, governments look less inclined to help this time. Even Taiwan is having second thoughts about an ambitious plan to save its memory-chip industry, announced only last month. The idea is to merge and bail out the country’s six makers of memory chips, which have lost $12.5 billion in the past two years and accumulated $11 billion in debts.

Even if Taiwan were to let these firms fail, which is highly unlikely, supply would still exceed demand, according to iSuppli. Global sales of memory chips will not start growing again before next year. And growth will not reattain its 2006 rate before 2015.

Whatever happens to Qimonda and its Taiwanese rivals, the current crisis is sure to speed up two seemingly contradictory long-term trends in the industry. It is consolidating, in that the manufacture of chips is becoming concentrated among fewer companies. At the same time, it is splitting up, in that more companies are specialising in design, and contracting out or quitting the making of chips. Both developments are mainly the consequence of what has come to be called “Moore’s Second Law”, an economic counterpart to a better known observation by Gordon Moore, one of the founders of Intel, the world’s biggest chipmaker by revenue.

The original Moore’s Law is usually summarised thus: the number of transistors on a chip doubles every 18 months. In fact Mr Moore first predicted this would happen every year and later changed his forecast to every two years; the average has become his law. Mr Hutcheson points out that Mr Moore made more than a purely technical prediction. He also stated that the cost of an integrated circuit would stay the same, a halving of the cost per transistor with every doubling of the number.

This has turned out to be essentially correct, but progress has come at a high price. The ever more sophisticated equipment required to make semiconductors has been getting dearer with every iteration of Moore’s Law. The most advanced chips are built using 32-nanometre technology, meaning that transistors are now so tiny that more than 4m can fit on this full stop. Lithographic tools for transferring Lilliputian circuitry onto a wafer cost up to $50m a pop. To reach the economies of scale needed to make such investments pay, chipmakers must build bigger fabs.

Rising fixed costs give rise to Moore’s Second Law: as the cost of transistors comes down, the cost of fabs goes up, albeit not at quite the same rate. In 1966 a new fab cost $14m. By 1995 the price had risen to $1.5 billion. Today, says Intel, the cost of a leading-edge fab exceeds $6 billion, including all the preparatory work. And the Taiwanese Semiconductor Manufacturing Company (TSMC) has built two “GigaFabs” for between $8 billion and $10 billion each, which would buy you four nuclear power stations. The output of such monsters depends on the mix of products, but they each could easily churn out 3 billion chips a year.

These ever-increasing costs and the need for specialisation have caused the industry to splinter, says Derek Lidow, iSuppli’s chief executive. Originally, all chipmakers were vertically integrated, meaning they designed the chip, built the tools to make them, ran the fabs and added the necessary connectors. As costs went up and certain activities became more and more complex, they were spun out to spread expenses and know-how. Semiconductor equipment, design software and packaging have long been done by separate companies. But the past ten years have seen the rise of “fabless” firms, which merely design integrated circuits.

Now established chipmakers can no longer afford to develop their own manufacturing processes or even to run their own fabs. To share the pain, IBM, Samsung and others have teamed up to use chipmaking technology jointly. Some firms, such as Texas Instruments, have chosen to go “fab-lite”, meaning that they have their own fabs only for certain chips. Others, such as AMD, have spun off manufacturing completely (although AMD’s decision had much to do with a lack of cash after it bought ATI, a maker of graphics chips, for $5.4 billion in 2006).

Hence the rise of “foundries”, the smelters of the information age. These are essentially contract manufacturers. Although far from household names, they are huge companies, churning out about one quarter of the world’s semiconductors. The biggest, TSMC, has a manufacturing capacity greater even than Intel’s. Its revenues grew at an annual average rate of 13% for several years, topping $10.6 billion, before falling by almost a third in the last quarter of 2008.

TSMC also illustrates a corollary of Moore’s Second Law: even the biggest chipmakers must keep expanding. Intel today accounts for 82% of global microprocessor revenue and has annual revenues of $37.6 billion because it understood this long ago. In the early 1980s, when Intel was a $700m company—pretty big for the time—Andy Grove, once Intel’s boss, notorious for his paranoia, was not satisfied. “He would run around and tell everybody that we have to get to $1 billion,” recalls Andy Bryant, the firm’s chief administrative officer. “He knew that you had to have a certain size to stay in business.”

Grow, grow, grow

Intel still appears to stick to this mantra, and is using the crisis to outgrow its competitors. In February Paul Otellini, its chief executive, said it would speed up plans to move many of its fabs to a new, 32-nanometre process at a cost of $7 billion over the next two years. This, he said, would preserve about 7,000 high-wage jobs in America. The investment (as well as Nehalem, Intel’s new superfast chip for servers, which was released on March 30th) will also make life even harder for AMD, Intel’s biggest remaining rival in the market for PC-type processors.

Two other long-term developments also point towards further concentration of chipmaking. The first is technological change beyond that ordained by Moore’s Law. Fully automated “lights-out” fabs are in operation. Within a few years fabs will be producing wafers with a diameter of 450mm, up from 300mm now, making them even more productive. “When the industry goes to 450mm and this happens at 22 or even 11 nanometres, it is conceivable to have one factory handle all our needs as a company,” says Mr Otellini. He adds, however, that Intel would never put all its eggs in one basket.

The other development is the maturing of the industry. Its annual growth has slid from double digits in the mid-1990s to an average of around 5% since then. And since 2004 the profitability of chip firms has dropped steadily as many chipmakers have lowered prices to expand their markets. In the future, only three types of semiconductor firm will make a decent return, predicts Mr Lidow: those with unique intellectual property; those happy to make commodity chips; and those with enough cash to achieve unprecedented scale.

How far will consolidation go? High-ranking executives at leading firms, who prefer not to be quoted, give similar answers. In the long run, they say, there will be only three viable entities, at least at the leading edge of chipmaking: Samsung in memory chips, Intel in microprocessors and TSMC in foundries. The rest will be “nationalistic” ventures in need of regular government bail-outs.

Yet such predictions may be a little off the mark. Largely because of that nationalism, the semiconductor industry is unlikely to end up as a bunch of near-monopolies. The Taiwanese are unlikely to let the South Koreans rule the memory roost. The newly founded Taiwan Memory Company (TMC), which is to take over the six local firms, could become the core of a global memory giant. It will hook up with Elpida Memory, Japan’s sole maker of memory chips. TMC is also said to be interested in Qimonda.

As for microprocessors, in the fast-growing market for netbooks and other mobile devices, Intel has to do battle with many “fabless” firms, most of which build chips based on designs by ARM, a British company. What is more, after spinning off manufacturing, “our customers no longer have to ask: is AMD able to invest in the next generation of manufacturing?” says Dirk Meyer, the firm’s chief executive. And Abu Dhabi’s investment in Globalfoundries is part not just of its preparations for the post-oil age, but also of a long-term plan to create a “global” alternative to foundries in Taiwan and mainland China. The company will build a fab in New York state and perhaps one day in the Gulf state.

Whatever the precise number of firms, the semiconductor industry will be highly concentrated and much of it will be dominated by Asian companies. Does this matter? From a purely economic standpoint, probably not much. The industry’s extreme capital-intensity is certainly a barrier to entry, and in theory a market with only a few suppliers is ripe for rigging. But chipmakers are unlikely to be able to extract a disproportionate rent or restrict supply—or even to try. For one thing, the industry has a history of intense competition. This is especially fierce among Asian national champions, for which prestige plays a big role. More important, the global production network of the information-technology industry is much too interdependent. If foundries, for instance, took a much larger piece of the pie, others in the value chain, such as chip designers, would find it hard to survive.

From a political perspective, the shift towards Asia could matter much more—especially for Europe. Although America has lost much of the “back end” of chipmaking—the packing and testing—to Asia, it still is the home of many leading-edge fabs, notably those run by Intel. Intel’s finances, thanks to its dominance, are still healthy, but the big European chip firms such as STMicroelectronics (revenues of $9.8 billion in 2008), Infineon Technologies ($6 billion) and NXP Semiconductors ($5.4 billion) are struggling. NXP has just announced a financial restructuring to lighten its debt burden of nearly $6 billion.

Worse, over the past ten years Europe’s market share in semiconductors has dropped from more than 23% to about 15%, according to Future Horizons, a consultancy. A recent report by the European Semiconductor Industry Association (ESIA), a lobbying group, listed some of the reasons for this erosion: the appreciation of the euro, much more generous subsidies in other regions and lagging R&D spending. If governments do not act soon, the report concludes, chipmakers will continue to migrate elsewhere and put Europe’s competitiveness at risk.

Although sophisticated chips are an essential ingredient of many European exports, from cars to medical equipment, the answer is unlikely to be a splurge of taxpayers’ money. A lot has already been spent on manufacturing, to create jobs. But this approach will work even less well in the future. Trying to draw level with Asia in chipmaking would be futile.

What is more, although there has been a lack of spending on research, the real problem has been a lack of successful commercialisation. What Europe’s semiconductor industry—and its technology sector as a whole, for that matter—badly needs is a better environment for entrepreneurs, says Dan Breznitz of the Georgia Institute of Technology, a specialist in the global IT industry. Because Europe’s semiconductor industry has been dominated by big, hierarchical companies, fabless firms are still rare. In Israel, by contrast, with its newly entrepreneurial culture, they have multiplied. Europe, argues Mr Breznitz, is still too focused on manufacturing.

Europe could stage a comeback, some say, should an old idea finally take off: “mini-fabs”—small, flexible and agile production units. Such a revolution has happened before, in steel: giantism once seemed insuperable, yet today plenty of steel is made in “mini-mills”, which use scrap as raw material. Might the foundries of the information age one day be under a similar threat? Maybe. But experts are right to be sceptical: transistors may get ever smaller, but in chipmaking scale rules.

www.economist.com

Heading in the same direction?

2009-04-05T04:00:00.000-07:00

America wants Europe to offer more than words of support for the new battle against the Taliban.

THE international diplomatic caravan moves from the Thames to the Rhine. NATO leaders, many fresh from discussing the financial crisis at the G20 summit in London, will spend this weekend debating Western security. Gathered on the Franco-German border, they will consider NATO’s future, its relations with Russia and, above all, Afghanistan.

Many allies welcomed Barack Obama’s announcement on March 27th of a new strategy for the faltering war in Afghanistan. This will combine a big increase in troops, a rapid expansion of the Afghan army, initiatives to strengthen the government, a concerted campaign to prod and help Pakistan to fight extremists, and a regional diplomatic effort designed, in part, to draw in Iran. But will European allies offer America more than praise?

Take the Dutch, who hosted a big conference on Afghanistan this week that endorsed Mr Obama’s strategy. Dutch work in Uruzgan province is a rare success within Afghanistan. But the Dutch still intend to withdraw fighting troops by the end of next year. France says it already reinforced its soldiers last year. Even the trusty British are reluctant to send more (although the army says it could add about 2,000 soldiers to the 8,000 now in Afghanistan, mostly in Helmand).

The problem is that European voters have little enthusiasm for the war in Afghanistan. To judge by the anti-NATO riots on the streets of Strasbourg on the eve of the summit, some young Europeans would rather fight French policemen than the Taliban.

As a result the campaign in Afghanistan is becoming inexorably Americanised: the extra 21,000 American troops just announced by Mr Obama may be followed by more later this year; they come on top of the 38,000 already in place. Even the United Nations’ job of co-ordinating the political and reconstruction work is acquiring a stronger American flavour with the appointment of Peter Galbraith, an American veteran of the Balkans, as deputy to the Norwegian envoy, Kai Eide.

For Mr Obama the “comprehensive” approach to Afghanistan also means getting Europeans to do more to support the non-fighting dimension of his strategy. He wants European trainers for the growing Afghan army and police, civilian experts to back the government, and lots of money to pay for it all. He may be disappointed. The European Union’s police training mission, always inadequate, is struggling to find staff to increase its contingent from about 200 to 400. France has offered to send gendarmes, although it is unclear if others will support this proposal.

President Nicolas Sarkozy of France has expressed his delight at “working with a president of the United States who wants to change the world” and defended his decision to rejoin NATO’s integrated military structure. “NATO has existed for 60 years. If there has been peace it is not an accident,” he said on Friday. He agreed in principle to take in at least one detainee now imprisoned by America at Guantánamo Bay, when the prison eventually closes. Mr Obama repaid him with a strong general endorsement for France’s attempt to strengthen the EU’s defence arm, saying that: “We want strong allies…We are not looking to be patrons of Europe. We are looking to be partners of Europe.”

Much of the summit will be taken up with ceremonies to celebrate NATO’s 60th anniversary, and France’s full return to the fold. This includes a symbolic handshake over the Rhine, once Europe’s military fault-line, between Mr Sarkozy and the German chancellor, Angela Merkel.

Relations with Russia are improving after last summer’s war in Georgia. On Wednesday Mr Obama agreed with Russia’s President Dmitry Medvedev to restart negotiations to reduce stockpiles of nuclear weapons. Within NATO, the disputes over how far it should expand are in abeyance. The membership campaigns by Georgia and Ukraine have been set aside and, uncontroversially, Croatia and Albania will be welcomed to the club.

NATO’s soul-searching may return later this year as the alliance begins to debate a new “strategic concept”. Some countries, such as Norway and Poland, are pressing the organisation to focus more on defending NATO’s territory (mainly against Russia) and less on distant wars.

One issue could yet spoil the party: the choice of a secretary-general to succeed Jaap de Hoop Scheffer. The front-runner, backed by America and several big European countries, is the Danish prime minister, Anders Fogh Rasmussen. But Turkey, in particular, is resisting his nomination. One reason is that Denmark is disliked by many Muslims after the publication in a Danish newspaper of controversial cartoons depicting the Prophet Muhammad. Mr Fogh Rasmussen has declined to apologise for the cartoons.

Instead the Polish foreign minister, Radek Sikorski, may get a chance. But many allies will worry that appointing a figure from the former Warsaw Pact, from a country that agreed to deploy American anti-missile defences on its soil, might antagonise Russia. This may explain why Mr Sikorski has been working hard to reassure the Kremlin of late, even suggesting that Russia could one day become a member of NATO.

www.economist.com

G-force

2009-04-03T03:00:00.000-07:00

The G20 outcome is better than nothing, but can the IMF save the world?

WHEN an infamous summit of world powers in London ended in 1933, such was the mood of protectionist acrimony that many argued it would have been better if the meeting had not been held at all. At times in the run up to the G20 gathering of world leaders in London on Thursday April 2nd it looked as if history might be repeated. But the leaders have shown some grit, and some ingenuity in finding money when little is about. Many holes can be picked in their pledges to reflate the world economy and re-regulate global finance. But, at the very least, it was better that they met than not.

The centerpiece of the leaders’ plan is, conveniently, the IMF, which they believe can add an extra $1 trillion in funding to the world economy without the risk of ballooning national budgets, or obstruction from national politicians. That financial conjuring trick gets the G20 out of a bind. Gordon Brown, the British prime minister, has made much of $5 trillion in public spending that governments around the world have promised to help shunt their economies out of recession in 2009-10. But big spenders such as America and Britain are up against their limits and fiscal hawks such as Germany are stubbornly convinced they have done enough.

That leaves the IMF as pump-primer of last resort, although not all of the funding promises made on Thursday were new. Japan and the European Union had already agreed to put $100 billion each into the IMF’s kitty. Rich countries such as America will provide a $500 billion credit line, known as New Arrangements to Borrow. This was trailed several weeks ago. Significantly, the IMF will print $250 billion of its own currency, known as special drawing rights, allocating sums to its members according to their quotas. It is not clear whether this can be redirected from rich countries to poor ones.

This flood of extra resources, plus an enhanced oversight role the G20 has given to the fund, will be a huge turnaround for an institution whose relevance had slumped in the boom years. Now the new money must be directed to developing countries, especially in eastern Europe. Many such countries have been loth to tap the fund because of the stigma involved. A pledge by the G20 to reform the fund’s governance soon may convince them that the leopard has changed its spots. This week Mexico secured a $47 billion credit line with the fund, with no strings attached, which may set a trend. Eswar Prasad of the Brookings Institution believes the commitment to reform is credible. His evidence is that China has agreed to chip in $40 billion, prior to any changes to its voting power in the IMF (it has the same heft as Belgium). Others, however, remain sceptical. “This is still supply chasing demand,” says Arvind Subramanian of the Centre for Global Development.

The importance of offering new sources of funds to the developing world should not be underestimated, however. By some estimates poor countries have $1.4 trillion of debts to roll over this year alone and Western creditors are hoarding their cash. These countries have far less fiscal room for manoeuvre than rich economies. They are also areas of the world where growth could rebound quite quickly, because households are not weighed down by the crushing debts typical in America and Europe. In a further fillip to many of them, the G20 agreed to ensure $250 billion in trade finance to help reboot global trade—though it was not clear how much of this was new money.

As for efforts to drag the developed world out of the mire, the G20 went perhaps further than had been expected, though undoubtedly not far enough. It emphasised the problem of scrubbing toxic assets off banks’ balance-sheets, but gave little guidance on how banks should be forced to mark down their assets to saleable prices. (Undermining that effort, on Thursday American accounting standard-setters watered down a mark-to-market provision that would have forced banks to value their assets at market prices. The short-sighted reprieve led to a huge rally in the shares of stricken banks such as Citigroup.)

It also, in a nod to strongly held German and French sentiments, called for regulation of hedge funds and other parts of the shadow banking system, a crack down on tax havens and banking secrecy, and more oversight of credit-rating agencies. There was little to suggest that one of the main causes of the crisis, incentives for banks to grow too big to fail, was being tackled.

Financial markets rallied after the G20 news, though this was as much because of sprigs of good economic news emerging as the harmony that was displayed. This was despite disappointment that the European Central Bank had cut its main interest rate on Thursday, by just a quarter of a percentage point, to 1.25%. American unemployment figures on Friday, which could be shocking, may puncture some of that optimism, and should temper any temptation among G20 leaders to claim success. Their efforts to reflate the world economy may have avoided a 1930s-style depression so far. But rising joblessness and years of pain may lie ahead as banks, businesses and households in the West continue to struggle to pay down their debts.

www.economist.com

The Obama effect

2009-04-03T02:57:00.000-07:00

The disarming charm of Barack Obama at the G20 in London.

BARACK OBAMA had difficulty pronouncing the name of his Russian counterpart, Dmitry Medvedev, but people forgave him. In fact, they forgave him for almost everything: his aura seemed to glow ever brighter as he made his first foray into global, crisis-busting diplomacy.

A general willingness to give Mr Obama the benefit of the doubt was palpable even among the exuberant anti-capitalist demonstrators jamming the streets of London’s financial district—a minority of whom turned violent and clashed with police as they attacked a branch of the Royal Bank of Scotland. “He’s got good morals,” conceded a graffiti artist called Monkey, while helping his friend scale a traffic light and drape a banner: it depicted a grim reaper clutching fistfuls of banknotes.

Nico, a French resident of London who sported a cardboard box over his head (to denounce climate-change denial), said in muffled tones that he was “not sure about Obama—but he can’t be worse than George Bush.” Anyway, he opined, “the problem is the madness of the economic system—growth wrecks the environment.”

Even the Russians, so determined to wrong-foot America for the past few years, were gracious after the two presidents met and agreed to seek deeper cuts in their strategic arsenals than those foreseen by an existing treaty, which could slash each side’s stockpile to 1,700 warheads by 2012. Negotiators were told to set new goals by July, when Mr Obama will visit Moscow.

Recent strains in American-Russian relations had not been good for either country, said Mr Medvedev, as he and Mr Obama vowed to begin a “constructive dialogue” on everything from curbing terrorism to economics. Konstantin Kosachev, head of the Russian parliament’s foreign-affairs committee, claimed that the two presidents had broken a “closed circle” in which each side felt the need to respond forcefully to a perceived provocation by the other. These upbeat noises from a hitherto grumpy Russian official marked a change of tone.

These days, America’s ties with China probably matter more to the world than the remnants of superpower diplomacy. And on that front, too, the chemistry was good. With China’s President Hu Jintao, Mr Obama agreed that his treasury secretary, Timothy Geithner, would start a Sino-American “strategic and economic dialogue” beginning in Washington, DC, this summer. The Americans said Mr Hu assured them of his commitment to boosting demand as well as improving economic management.

Visiting Downing Street earlier in the day, Mr Obama was at once emollient, self-critical and articulate, in a way that put an initially bashful Gordon Brown at his ease. “I came here to put forward ideas but I also came here to listen and not to lecture,” the president said, setting the tone—one that subtly combined humility with firmness about the responsibilities of others—for his meeting with the leaders of 19 developed and emerging economies.

The president admitted that the United States “has some accounting to do” over the failures in its regulatory system. He said the world had become used to viewing American consumers as the engine of global growth—with a clear hint that his country could no longer play this role, and that spenders in other countries should now be doing their bit. But he rejected the idea of American decline, saying that was an old theory, which had been repeatedly belied by the existence of “a vibrancy to our economic model, a durability to our political model, and a set of ideals that has sustained us through difficult times.”

If any of the participants arrived in London spoiling for a fight, it was the leaders of France and Germany, who were at pains from the beginning to stress their absolute accord with one another and their differences with everybody else. At a splashy joint appearance, President Nicolas Sarkozy and Chancellor Angela Merkel said Europe had done a lot already to provide economic stimulus. What was needed was far tougher regulation, whose targets would include hedge funds, traders’ pay, rating agencies and tax havens. Both of them seemed keener on trying to prevent financial crises in future than on dealing with the one that is raging now.

But Mr Obama was anxious not to let the Franco-German duo spoil the party. Instead he stressed the “enormous consensus” that existed on the need to reinvigorate the sagging world economy. Among governments, anyway: Nico the box-wearer might beg to disagree.

Elsewhere on the sidelines, more conventional voices were stressing that there could be limits to Mr Obama’s ability to dissolve global problems at a stroke: the warming of the American-Russian atmosphere was not a breakthrough comparable with the one achieved by Mikhail Gorbachev in the last days of the cold war.

Dmitri Trenin, director of the Moscow Carnegie Centre, a think-tank, said Messrs Obama and Medvedev had merely “plucked some low-hanging fruit” by signalling that rows over Georgia were no longer the central to their relationship. It was now conceivable, Mr Trenin said, that Russia and America could talk business over NATO expansion and possible Russian help to America over Iran. But Russia might not really want American-Iranian ties to improve too much—and the mood of anti-Americanism which was fanned under ex-President Vladimir Putin (now prime minister) would not disappear from the Russian scene. There are some tricks that even Obama magic cannot pull off.

www.economist.com

U.S. bank rescue plan could come on Monday

2009-03-21T09:30:00.000-07:00

The U.S. government will announce as soon as Monday a long-awaited plan to try to get bad assets off the books of banks, a cornerstone of its efforts to tackle the credit crisis, The Wall Street Journal reported.

The Obama administration, battling a deepening recession, is set to adopt a three-pronged approach to ridding the financial system of so-called toxic assets, the newspaper and the New York Times said on their websites on Friday.

The plan would create an entity, backed by the Federal Deposit Insurance Corp, a U.S. banking regulator, to buy and hold loans, the reports said.

It would expand a newly launched Federal Reserve facility -- that lends money to investors to buy securities backed by consumer loans -- to include toxic assets. And it would create new public and privately financed funds to buy such securities under the management of private investment experts.

The Obama administration plans to contribute between $75 billion and $100 billion in new capital to the effort although that amount could be expanded, the Wall Street Journal said.

The Treasury Department and Federal Reserve declined to comment. Sources familiar with the government's thinking have told Reuters details of a plan could be announced next week.

The Bush administration tried without success late last year to set up a mechanism to get bad assets off the balance sheets of commercial banks.

The banks have been hammered by losses incurred by mortgage-related debt that has turned sour amid a fall in house prices and a pickup in defaults, sparking a credit crisis that has strangled the U.S. and global economies.

Obama's Treasury secretary, Timothy Geithner, has outlined a new proposal to soak up as much as $1 trillion in assets through a public-private program.

But investors have grown increasingly concerned that his efforts are running into problems more than a month after he outlined the plan.

The slow start of the new Federal Reserve consumer lending program this week has been seen as a sign that private capital may shun the toxic-asset plan because of public outrage over large executive bonuses.

Many big private investors are worried they could face tough new rules in U.S. financial rescue programs after Congress pressed ahead with efforts to claw back bonuses paid to executives at failed insurer American International Group.

The Wall Street Journal said the Treasury would match private sector finance for the public-private toxic asset funds on a one-for-one basis in most cases.

Washington would be a co-investor also in the new FDIC troubled loans program but could contribute 80 percent in some cases, and would guarantee as much as $500 billion in loans investments, the newspaper said in its report.

The New York Times said the FDIC program could involve government funding for up to 97 percent of the equity.

It also said the plan is likely to offer generous taxpayer subsidies, in the form of low-interest loans, to coax investors to form partnerships with the government.

msn money

After Bonusgate, what next?

2009-03-21T09:23:00.000-07:00

The AIG bloodletting let everyone vent. But there's still a financial system to fix. Why Treasury Secretary Tim Geithner's job just got harder.

Treasury Secretary Tim Geithner sat alone at the witness table answering questions and getting an earful from a panel of senators.

Sen. Kent Conrad, D-N.D., chairman of the Senate Budget Committee, cautioned Geithner that Americans were crazy angry about corporate bailouts.

"I have never -- in the 22 years I've been here, I've never seen such anger, with the sense of betrayal, that people in positions of responsibility took advantage of them," said Conrad. "The outrage of people cannot be dismissed."

That was on March 12. It turns out, the next day was when American International Group would award $165 million in bonuses to some 400 employees.

Over the past week, Congress turned the anger over AIG into legislation. The House rushed through a bill to tax bonuses, and the Senate made a similar proposal.

Now, with the Obama administration about to announce its most significant step yet in trying to rescue the banks, the blowback over the AIG bonuses threatens to sour its relations with Congress, some experts say.

"The notion you're going to get more money out of Congress to stabilize the financial system is a pipe-dream at this point," said Jaret Seiberg, a banking expert with research firm Concept Capital. "Politically, it's not possible to approve more cash and get re-elected."

Geithner, who marks his 8th week on the job on Monday, is on the spot. He is already facing what President Obama called the toughest challenges of any Treasury secretary since Alexander Hamilton. A few Republicans have even called for his resignation.

House Minority Leader John Boehner, R-Ohio, said Geithner was on "thin ice," claiming he didn't do enough early on to stop the bonuses. Democrats have been more measured in their criticism, saying last week that they wished Treasury did a better job of communicating with Capitol Hill.

A Treasury spokesman declined to comment on relations with Congress, but pointed out Obama's defense of Geithner and his economic team several times this week -- even on Jay Leno's "The Tonight Show."

0:00 /24:35Geithner opens up

"He understands that he's on the hot seat, but I actually think that he is taking the right steps, and we're going to have our economy back on the move," Obama said.

Critical time

The flare-up over AIG bonuses comes at a critical time in Treasury's handling of the financial rescue.

Within the next few days, the department is expected to reveal details of its program to help wipe out toxic assets from the balance sheets of the nation's struggling banks and investment firms. Such a program is key to clearing bad debt and getting the financial markets rolling again.

Geithner has suggested the plan could cost close to $1 trillion. And the Obama administration has placed hundreds of billions in its budget outline as a placeholder for future bailouts.

Most experts believe the administration will likely have to ask Congress for more money again. Right now, Congress will be hard-pressed to cough up more dough for taxpayer financed recovery efforts.

"As of today, it's not possible to ask for more money," said Brian Gardner, an analyst for investment firm Keefe, Bruyette & Woods, who added it could be several months before more bailout money could be made available.

Moreover, Congress is now intensely focused on targeting bonuses at companies that received bailout dollars.

On Friday, new anti-bonus legislation circulated among key House members. And the Senate was also expected to start discussing similar legislation next week.

"The atmosphere is very poisonous right now," said Bert Ely, a financial policy consultant. "I wouldn't want to put something forward, simply because all the flap on the AIG bonuses."

Big agenda

It had already been a rough couple weeks for Geithner and his team.

After surviving an onslaught of criticism during his confirmation hearings for failing to pay some taxes, Geithner has yet to put top deputies in place. Several applicants dropped out while facing heightened scrutiny in the screening process.

"Because they're not there, the Treasury ends up making sloppy mistakes, and that hurts them," Gardner said.

Geithner is also attempting to negotiate a coordinated global effort to recovery.

On March 10, the day he said he first "fully learned" about the AIG bonuses, Geithner was preparing for a tough meeting in London with other finance ministers whose recovery priorities differed from the Obama administration's.

In the midst of all this, Geithner has been trying to nail down specifics of his plan to woo the private sector to buy bad assets from troubled banks and investment firms. The administration has high hopes that it will get a better reception than the last time Geithner broached the subject -- and caused the stock markets to tank.

Now the AIG flap threatens to derail those efforts, even before it's fully understood. It's clear that the Treasury wants to draw on the private sector to work with the government to figure out how much these assets are worth and clear them out.

But private investors, saying that episodes like the legislation attacking the AIG bonuses show that the rules of the game can change at any time, are becoming increasingly skittish of taking taxpayer dollars.

"Everyone is going to think twice about wanting government assistance," said Charles Calomiris, a finance professor at Columbia University's business school. "You know you're going to have to deal with the fact that compensation to your middle managers is going to be micromanaged by [Rep.] Barney Frank, leading a mob with pitchforks."

Geithner's next public date with Congress was supposed to be on Thursday and give him a platform to highlight his ideas for rescuing the system and strengthening regulations.

Instead, Geithner first on Tuesday has to face lawmakers to answer questions about AIG bonuses.

This time he won't be alone. Federal Reserve Chairman Ben Bernanke, who knew about the AIG bonuses for months, will answer tough questions beside him.

CNN Money.com

Where the Jobs Will Be This Spring

2009-03-15T03:36:00.000-07:00

A quarterly survey reveals the cities expecting the largest employment growth--and losses--across the country.

Thanks to last year's strong harvest of apples and the jobs that followed in juicing, packaging and shipping, Yakima, Wash., has the strongest employment outlook in the country for the second quarter of 2009, according to a quarterly survey by employment services firm Manpower.
"This is an agricultural base, a huge apple-growing region," says Bill Cook, director of community and economic development for Yakima. "Last year's apple harvest was huge, and it helped carry employment through the winter. Even in a normal economic year that wouldn't happen."

Cities in the Pacific Northwest and Texas have the best employment outlook for April through June, while cities in the Southeast have the weakest, according to the study.

Manpower's Employment Outlook Survey is conducted quarterly to measure employers' intentions of increasing or decreasing their numbers of employees. Each employer was asked: "How do you anticipate total employment at your location to change in the three months to the end of June 2009 compared with the current quarter?" The answer is the net employment outlook--the difference between employers who plan to increase and those who plan to decrease.

Of the 31,800 public and private sector employers surveyed in 201 metropolitan areas throughout the U.S., 15% anticipated increases in hiring, 14% said they'd likely decrease staff, and 67% foresaw no change.

Five Florida cities came in among the 10 weakest metropolitan areas for employment outlook. That's largely because of the downturn in the construction industry there, combined with the slowdown in tourism.

"Hospitality was hit hard," says Michael Doyle, vice president and general manager of Manpower's Southeast region. "People aren't traveling to Florida, and all the service industries, like hotels, rental cars and restaurants, are affected. Everything gets hit when fewer people come to visit."

Meanwhile, Anchorage, Alaska, has the third-strongest employment outlook, thanks to a strong showing in health care. That sector has added nearly 2,700 jobs since 2003 and employs close to 15,000 people. Also, Target just opened in Anchorage, and the town will soon get its first Walgreens and Kohl's.

Among industries nationwide, leisure and hospitality is expected to add the most positions. Across the country, employers expect a 14% net employment gain in the sector, but not because Americans are going on vacation. Rather, they are dining at inexpensive restaurants like McDonald's, Chili's and the Olive Garden, which will all have to beef up their staffs.

Business services--accountants and lawyers--also expect to see a boost in hiring in the next quarter, with a +9% net employment outlook. Also in that group are data processors, thanks largely to President Obama's push to get health care records digitized.

Manufacturing of durable goods will take the hardest hit, particularly in the Southeast. "The bulk of what the South is known for is manufacturing, and that's on a decline because of emerging markets and because of the general lack of need," says Doyle. "That's the whole theme in the South."

Best Cities for New Jobs This Spring

1.Yakima, Wash.
Net employment outlook: +21%

Yakima is known for its abundance of apple varieties, and last year's harvest boosted employment. Packing and juice companies that revolve around the apple orchards helped carry that employment through the winter, something that wouldn't happen in a more ordinary year. Yakima also grows hops for beer and ships them around the world.

2. Kennewick, Wash.
Net employment outlook: +19%

Once home to the nation's most Ph.D.'s per capita, Kennewick has an impressive number of engineers and scientists. Pacific Northwest National Lab employs many of them to convert agricultural materials into plastics and biofuels and perform research involving fuel cells. The region's farmland also provides jobs, with workers growing potatoes, corn, asparagus and wheat.

3. Anchorage, Alaska
Net employment outlook: +18%

A high-growth area in Anchorage this year is health care, which has added nearly 2,700 jobs since 2003 and employs close to 15,000 people. Retail is also booming, and although it may seem strange to those in the rest of the country, Anchorage just added its first Target and is soon to get its first Walgreens and Kohl's.

4. Amarillo, Texas
Net employment outlook: +15%

Pantex is one of Amarillo's largest employers, with more than 3,000 workers refurbishing nuclear warheads--the only place in the world where it's done. Beyond that, medical services and food processing are big. The Harrington Medical Center employs 8,000 to 10,000 people, and Blue Cross and Nationwide Insurance are also a presence. California-based Hilmar Cheese recently opened a plant in Amarillo.

5. Sioux Falls, S.D.
Net employment outlook: +14%

Despite recent economic news, financial services are flourishing in Sioux Falls. Citigroup built its headquarters there, and Wells Fargo, HSBC and Premier Bankcard employ close to 3,000 people. In addition to the banks, Avera Health and Sanford employ more than 10,000 people.

Worst Cities For New Jobs This Spring

1. Cape Coral--Ft. Myers, Fla.
Net employment outlook: -16%

The entire state of Florida has taken a hit from the crumbling of its construction and real estate industries. Florida and Arizona were among the first states struck by the housing slump, and they have yet to recover. The state's hospitality industry has also been hit hard since fewer people are taking vacations.

2. San Juan, Puerto Rico
Net employment outlook: -16%

Manufacturing has taken a beating here. Not too long ago Puerto Rico was considered an emerging market for manufacturing since the cost of doing business was inexpensive. Large companies built plants because it was cheaper than in the States. Now Vietnam and the Dominican Republic are cheaper, and manufactures are sending their business there.

3. Port St. Lucie, Fla.
Net employment outlook: -14%

Like so many areas in Florida, Port St. Lucie was hit by the one-two punch of drops in both the hospitality industry and construction.

4. Miami--Fort Lauderdale--Pompano Beach, Fla.
Net employment outlook: -14%

In addition to leisure, hospitality and construction, professional and financial services in this stretch of southeastern Florida have also suffered.

5. Santa Barbara--Santa Maria--Goleta, Calif.
Net employment outlook: -11%

There has been a significant decline in construction in this part of the country. What's more, there has been a reduction in financial activities, which in these parts means mortgage brokers. While many homeowners elsewhere have been refinancing their mortgages to get lower interest rates, homeowners here haven't, probably because so many owe more than their homes are worth and are in foreclosure. Another weak area is durable-goods manufacturing, which was a core industry here and has taken a hit too.

finance.yahoo.com

Going down quietly

2009-03-15T03:29:00.000-07:00

Bernard Madoff, history's biggest swindler, faces life behind bars.

SURELY a drama this dark deserved a more explosive finale. A previous wave of financial fraud produced many an entertaining courtroom battle, featuring the likes of Enron’s Jeffrey Skilling and Tyco’s Dennis Kozlowski. But Bernard Madoff has robbed the world of such a catharsis, just as he robbed almost 5,000 credulous clients of billions of dollars. On Thursday March 12th he pleaded guilty in a Manhattan court to 11 charges, ranging from securities and mail fraud to money laundering and perjury. Together they carry a maximum jail term of 150 years, leaving the 70-year-old “Monster Mensch” all but certain to spend the rest of his life behind bars.

The fraud he masterminded was remarkable for its scale, longevity and the sophistication of its victims: hedge-fund founders, Swiss banks and movie moguls, as well as charities and small investors, some of whom put in their life savings. The charge sheet confirms that he ran a Ponzi scheme of unprecedented boldness, dating at least as far back as the 1980s. Mr Madoff claimed to achieve healthy, stable returns through a whizzy stock- and options-trading strategy. In reality, there was no trading for well over a decade. Money from new investors was used to cover redemptions for old ones. It was that simple and brazen.

The fraud was bigger than the $50 billion Mr Madoff originally claimed to have lost. On paper, he had $65 billion in client accounts just before he was arrested in December, say prosecutors, who are claiming an eye-popping $171 billion in restitution. But there now appears to be little left for investors who stuck with him: a court-appointed liquidator has so far recovered just $1 billion. Even Charles Ponzi’s victims got a third of their money back.

Mr Madoff’s guilty plea is especially anticlimactic because he has apparently refused to co-operate with investigators, leaving many a loose thread. Few believe that he acted alone, but identifying those who colluded, and how, is proving difficult. Friends and relatives who helped to run the firm remain under scrutiny. Junior employees were apparently made to generate fake trade confirmations and monthly statements, though it is not clear if they knew they were partaking in a fraud. Mr Madoff creamed off commissions from his investment business to support his share-trading operations. But how much he kept for himself is anyone’s guess.

The drama has several more acts. Those who channelled investors’ money to Mr Madoff, such as his now notorious “feeder funds”, face years of litigation as victims go after those with deep pockets. Some conduits, such as Santander, a Spanish bank, have already offered partial reimbursement. Lawyers are also targeting investors who withdrew their funds (plus fictional interest) before the fraudster’s arrest. Whether that includes the charity that withdrew $90m more than it paid in remains to be seen.

Seething victims and pundits have variously denounced Mr Madoff as a “terrorist”, a “financial serial killer” and, most cuttingly, a “turd”. For now, they will have to make do with seeing him locked up without the fireworks of a trial, still guarding his biggest secrets. To hope for more may only court further disappointment.

www.economist.com

Is it the Time to kill the big banks?

2009-03-10T01:35:00.000-07:00

Two key Republican senators suggest that troubled big banks should be allowed to fail. It is an idea with merit but it may not be that simple.

What's the best way to fix the nation's banking system? Well, at least two senators making the rounds on the Sunday morning political TV gabfests think it's to let the megabanks fail.

Sen. Richard Shelby, R.-Ala., said on ABC's "This Week" that the most troubled banks are already dead and should be "buried."

Meanwhile, Sen. John McCain, R.-Ariz., added on "Fox News Sunday" that big banks had to fail even if it meant that shareholders will "take a beating." (Note to Sen. McCain: with the stocks of both Citigroup and Bank of America down more than 90%, shareholders already have taken a beating.)

So is the solution really that simple? After already propping up two huge banks, Citi and BofA, with $90 billion in bailout funds and hundreds of billions of dollars in loan guarantees, should the government just shut them down the same way that the FDIC closes small, community banks?

There is some merit to the idea that Citi, which Shelby derisively referred to Sunday as a "problem child," and BofA have done so much damage to the economy already that they should no longer be allowed to survive -- at least in their current form.

"Letting more banks fail is something we should at least consider. Blanket capital injections for all banks no matter how healthy they appear to be seems to be counterintuitive," said J.W. Verret, senior scholar for the Mercatus Center at George Mason University. "Some banks need to go through FDIC receivership."

And the Federal Deposit Insurance Corp. does do a good job of taking over small banks and finding a buyer for them quickly -- often a purchaser is announced the same day that the bank fails.

But closing a bank the size of Citi or BofA -- which is what Shelby appeared to suggest Sunday -- is more complicated.

You can't simply let the banks go out of business. Something has to be done with all the deposits, assets and branches. This would not be your typical FDIC bank failure where regulators swoop in on Friday night, slap up a new sign and it's business as usual on Saturday morning.

Consider the size of some of the banks that have failed in recent weeks. Typically, they have just a handful of branches and only a few hundred million dollars in deposits. For example, Freedom Bank of Commerce, Georgia, which failed Friday, had four branches and $161 million in deposits.

Cleaning up a huge money center bank wouldn't be so easy. If BofA or Citi were to be seized by the FDIC, they would likely have to be sold off in pieces, a process that could take months, if not years. And you don't have to look any further than the mess that is AIG to see how difficult (and costly to taxpayers) it is to break up a struggling financial behemoth.

The collapse of Washington Mutual last September, which was taken over by the FDIC and immediately sold to JPMorgan Chase , is more likely the exception instead of the rule in terms of big bank failures.

Keep in mind that last year's other large bank failure -- IndyMac -- turned out to be far more complicated. IndyMac failed in July and the FDIC had to run it for several months before agreeing to sell it to a private investment group on the last day of 2008. The FDIC has estimated that the failure of IndyMac will cost it $8.5 billion to $9.4 billion.

IndyMac had deposits of about $19.1 billion at the time it failed. So how much would a shutdown of Citi or BofA, which had worldwide deposits of $774.2 billion and $893 billion as of the end of last year, cost the FDIC?

"There would be a Main Street impact the size that we've never seen before. The FDIC would be stretched beyond belief," said Jess Varughese, managing partner of Milestone, an independent management consulting firm focused on financial services.

And fears of such a big failure could be one reason why Senate Banking Committee chair, Chris Dodd, D-Conn, and Sen. Mike Crapo, R-Idaho, proposed a bill last week that would let the FDIC temporarily borrow up to $500 billion from the government to keep the deposit insurance fund solvent.

Finally, what would the goal of shutting down a big bank be at this point? Shelby said Sunday that the government would be sending a "strong message to the market" and that people might start investing in banks again afterwards.

Varughese wasn't sure that would work out and pointed to the last time a big financial institution was allowed to fail.

"There's a populist message here and there's reality. This idea of letting one of the large global institutions fail does not sit well. Lehman Brothers brought us to the brink of financial Armageddon," he said.

Another financial expert agreed, saying that the damage created by a megabank failure would be "calamitous," since it could lead to more job losses and even tighter credit conditions.

"The economy needs a level of confidence to come back and it would fall even deeper if Bank of America or Citi were allowed to go under," said Bob Hartnett, managing director of Lenox Advisors, a New York-based investment firm with about $1 billion in assets.

So when all is said and done, Hartnett said the government may have to take over failing banks not to put them out of business but to keep them in business and force them to start doing what healthy banks are supposed to do: extend credit to responsible individuals and businesses.

"Everyone is looking to save their own skin and to hell with the borrower. We need to get banks to start lending again. We want them to start lending," he said.

CNN Money.com

Oil rises to near $48 as OPEC signals supply cuts

2009-03-10T01:30:00.000-07:00

Oil rises to near $48 as OPEC signals another supply cut likely at Sunday's meeting.

Oil rose to near $48 a barrel Tuesday in Asia after OPEC signaled it will likely announce another production cut within days, adding to large supply reductions the cartel has already implemented.Benchmark crude for April delivery rose 73 cents to $47.80 a barrel by midafternoon in Singapore on the New York Mercantile Exchange. Oil prices gained $1.55 on Monday to settle at $47.07.

Leaders of the Organization of Petroleum Exporting Countries have suggested for weeks that the group may cut output quotas at its next meeting on March 15 in Vienna.

On Monday, Kuwaiti Supreme Petroleum Council member Moussa Marafi told the Kuwait News Agency that an OPEC production cut of a million barrels a day would raise prices to over $50 a barrel by the third quarter of 2009.

Marafi said OPEC compliance with the 4.2 million barrels a day of cuts announced since September has been "very high" at 80 percent and would reach 90 percent by the time the group meets Sunday.

Investors expect OPEC to announce fresh production cuts of between 500,000 and 1 million barrels a day, said Clarence Chu, a trader with market maker Hudson Capital Energy in Singapore.

"If the cut exceeds expectations, there would be a short-term pop in prices," Chu said. "But it will take months for the cut to affect supplies in the U.S. It's not an overnight thing."

Iraqi Oil Minister Hussain al-Shahristani said Monday on Sharqiyah television station that oil prices were too low and OPEC is working to "inch them up."

Investors largely brushed off OPEC's output cut announcements for months, doubting whether the 12-member group would have the discipline to implement them. But OPEC has complied with most of the quota reductions, earning back some credibility, Chu said.

"Everybody used to produce over quota, and OPEC lost credibility," Chu said. "According to Game Theory, cartels don't work because each member gains from cheating."

"But with prices so low, they've had to cooperate."

Oil prices have fallen from $147 a barrel in July as crude demand plummeted amid the worst global economic slump in decades. Prices won't likely jump higher until the U.S. economy stabilizes and crude demand increases, Chu said.

"The bad economic news won't go away for a while," Chu said. "But demand should pick up by the end of the year, and I see prices drifting toward $55 a barrel in the second half."

In other Nymex trading, gasoline for April delivery was steady at $1.36 a gallon, while heating oil was little changed at $1.22 a gallon. Natural gas for April delivery was steady at $3.86 per 1,000 cubic feet.

Brent prices rose 86 cents to $44.99 on the ICE Futures exchange in London.

Yahoo! Finance.com