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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

Washington prepares for big bank failure

2009-03-07T01:47:00.000-08:00

A bill introduced in the Senate would give FDIC chief, Sheila Bair, a huge loan to handle 'emergency situations' in the banking sector.

The government is bracing for a big bank failure.

A bill introduced in Congress would give the FDIC, the agency that stands behind Americans' bank deposits, temporary authority to borrow as much as $500 billion from the government to shore up the deposit insurance fund.

The bill -- the Depositor Protection Act of 2009, backed by Senate Banking Committee Chairman Chris Dodd, D-Conn. and Sen. Mike Crapo, R-Idaho -- wouldn't change the status of individual bank accounts, which through the end of this year are insured up to $250,000.

But the Dodd-Crapo bill acknowledges what the financial markets have been signaling for the past month -- that the government must take the lead in a costly cleanup of the mess in the financial sector.

"I think it's a commendable start," said Simon Johnson, a former International Monetary Fund chief economist who tracks the crisis on his BaselineScenario.com blog.

Dodd said he introduced the legislation at the behest of other regulators, notably Federal Deposit Insurance Corp. chief Sheila Bair, Federal Reserve Chairman Ben Bernanke and Treasury Secretary Tim Geithner. All three recently wrote Dodd to support an emergency expansion of the FDIC's capacity to borrow from the Treasury.

"This mechanism would allow the FDIC to respond expeditiously to emergency situations that may involve substantial risk to the financial system," Bernanke wrote in a Feb. 2 letter to Dodd.

The Senate bill is being introduced at a time of rising market stress about the health of the banking industry. Seventeen relatively small banks have already failed this year and 25 went under in 2008. Last year's failures included the July demise of mortgage lender IndyMac and the September collapse of Washington Mutual, which was the sixth-biggest depository institution in the nation at the time it failed.

Shares of Citigroup , the giant financial company that last week received a third round of government aid, have fallen 58% since the government outlined a plan to convert the bank's preferred shares to common stock. The stock even dropped below $1 Thursday.

The Citi plan aimed to ease market concerns about the bank's health. But fears have only increased, judging by the swoon in financial stocks this week and the sharp rise in the cost of protecting financial-sector debt against default.

Fear of a big collapse continues to rise

The Credit Derivatives Research counterparty risk index -- a measure of the annual cost of insuring the bonds of 14 global financial companies against default -- surged nearly 30% this week as investors rushed to protect themselves against possible defaults at giant institutions.

It now costs an average of $289,000 per year to buy insurance on $10 million's worth of bank debt, according to the CDR index. That's just shy of the $300,000 average premium in force the day the index hit its all time high -- Sept. 17, 2008.

That was the day after the government's $85 billion first bailout of AIG , two days after the failure of broker-dealer Lehman Brothers and a week before WaMu was seized by regulators.

The current degree of stress in the financial sector is "totally shocking," said Johnson, given the massive resources governments around the globe have devoted to reducing fears of a major collapse.

The financial fears point to the need for the Obama administration to produce a detailed plan of how it will deal with troubled too-big-to-fail institutions and bad assets in the banking sector, said Johnson, who teaches in the business school at MIT.

"If you don't do a systemic plan fast, you set up a target for speculators," said Johnson.

The market's reaction to Geithner's failure to produce an adequately articulated proposal as promised on Feb. 10 stands as a cautionary tale. The Dow Jones Industrial Average has dropped 20% since then.

FDIC may need to hit Congressional ATM

The insurance that the FDIC provides to bank depositors is funded by annual assessments on banks. But the fund has been depleted by a sharp rise in bank failures over the past year, and efforts to raise the fees that support the deposit fund have been complicated by the poor health of the banking industry.

The deposit fund's balance fell 64% in 2008 to $19 billion, putting deposit fund assets at just 0.4% of banking industry assets. That's barely a third of the 1.15% statutory minimum.

Despite the welcome signs that policymakers are coming to grips with the extent of the U.S. banking crisis, observers say officials have yet to make clear that they fully grasp the scope of the financial industry's problems.

A $500 billion loan to the FDIC "begins to approximate the maximum loss from resolving the top four banks," said Chris Whalen, a managing director at Institutional Risk Analytics, a financial research and hedge fund advice firm.

The five biggest U.S. bank holding companies - Bank of America , Citi, JPMorgan Chase , Wells Fargo and Wachovia, which is now owned by Wells - had domestic deposits of between $271 billion and $701 billion at the end of the second quarter of 2008, according to the most recent data available from the FDIC.

With credit costs, which reflect expenses tied to bad mortgage and credit card loans, on the way to doubling the levels reached in the 1991 recession, Whalen expects the cost of fixing troubled banks to hit $1 trillion.

Whalen adds that he believes regulators may have to swing into action in coming weeks. With bad loans rising sharply even at the better managed banks, the next round of financial reports from the most troubled banks, due out in April, could be truly horrific.

"Does anybody really want to see Citi's first-quarter numbers?" Whalen said.

CNN Money.com

Huge layoffs push joblessness toward double digits

2009-03-07T01:29:00.000-08:00

Record layoffs propel jobless rate to 8.1 percent, surging toward double digits.

Tolling grimly higher, the recession snatched more than 650,000 Americans' jobs for a record third straight month in February as unemployment climbed to a quarter-century peak of 8.1 percent and surged toward even more wrenching double digits.
The human carnage from the recession, well into its second year, now stands at 4.4 million lost jobs. Some 12.5 million people are searching for work -- more than the population of the entire state of Pennsylvania.

No one seems immune: The jobless rate for college graduates has hit its highest point on record, just like the rate for people lacking high school diplomas.

Employers also are holding hours down and freezing or cutting pay as the recession eats into sales and profits. If part-time workers who can't find full-time jobs are counted in, along with those who have simply given up looking, the rate would be 14.8 percent, the highest in records going back to 1994.

The wintertime blizzard of layoffs -- nearly 2 million lost jobs in just three months -- is destroying any hope for an economic turnaround this year while feeding insecurities among people who still have jobs as well as those who desperately want to find work.

"In this economy, if you have a family to feed like I do, beggars can't be choosers," said Greg Ovetsky, who lost his job at an information technology company two weeks ago.

Ovetsky, 37, of Staten Island, N.Y., said he'll take any position. "You can rest assured I'll say yes. Get a paycheck, get food on the table."

Across the country, Douglas Walch, 54, worries about losing his job as a park maintenance foreman because his employer of 15 years -- the city of Sacramento -- is preparing for layoffs.

"It's the worst I've ever seen it in my lifetime," Walch said.

President Barack Obama, barely a month into his own new job, acknowledged the layoffs were coming at an "astounding" clip but urged Americans to allow him time for his economic revival policies take root.

"This recovery plan won't turn our economy around or solve every problem," Obama said. "All of this takes time, and it will take patience."

For a day, Wall Street seemed to agree. Stocks seesawed up and down before finishing with a modest Dow Jones industrials gain of 32.5 points. Still the Dow was down a dispiriting 6.2 percent for the week.

The Labor Department's report, released Friday, showed pink slips nationwide hitting all categories -- blue-collar, white-collar, highly educated and not.

Employers slashed payrolls by a net total of 651,000 last month -- the third month in a row that job losses topped 600,000. It was the first time that's happened in government record-keeping dating to 1939.

"These are gargantuan declines," said Stuart Hoffman, chief economist at PNC Financial Services Group.

"Horrible," said Ian Shepherdson, chief economist at High Frequency Economics.

The unemployment rate leapt to 8.1 percent from 7.6 percent in January, the highest in more than 25 years. Some economists now predict the rate could hit 10 percent by year-end and peak at 11 percent or higher by the middle of 2010.

"The massive hemorrhage of jobs is reminiscent of the 1982 recession when the jobless rate hit 10.8 percent. Unfortunately, it will get much worse," predicted Sung Won Sohn, economist at the Martin Smith School of Business at California State University. "It is hard to see where the bottom is."

Besides the 12.5 million total for unemployed people in February, the number of people forced to work part time for economic reasons rose by a sharp 787,000 to 8.6 million. Those are people who would like to work full time but whose hours were cut back or were unable to find full-time work.

If those people -- along with discouraged workers -- were factored in, the rate would have been 14.8 percent in February.

The jobless rate for people with bachelor's degrees or higher jumped to 4.1 percent. And the rate for people without a high-school diploma climbed to 12.6 percent. Both are the highest in records dating to 1992.

The jobless rate for blacks rose to 13.4 percent, the highest since June 1993; the rate for Hispanics hit 10.9 percent, the highest since April 1993.

With no place to land, the number of "long-term unemployed" -- those out of work for 27 weeks or more -- climbed to 2.9 million, the most in records back to 1948.

Construction companies eliminated 104,000 jobs last month. Factories axed 168,000. Retailers cut nearly 40,000. Professional and business services got rid of 180,000, temporary-help agencies 78,000. Financial companies reduced payrolls by 44,000. Leisure and hospitality firms chopped 33,000.

The few areas spared: education and health services, as well as government, which boosted employment last month.

For those with jobs, employers kept a tight rein on hours. The average workweek in February stayed at 33.3 hours, matching the record low set in December.

Disappearing jobs and evaporating wealth from tanking home values, 401(k)s and other investments have forced consumers to retrench, driving companies to lay off workers. It's a vicious cycle in which all the economy's problems feed on each other, worsening the downward spiral.

A bit of positive economic news came from the Federal Reserve, which reported that consumer borrowing increased at an annual rate of $1.76 billion in the first month of the year. Still, the small rise is unlikely to shake economists' views that borrowing will remain weak this year as fearful consumers tighten their belts.

The economy contracted at 6.2 percent in the final three months of 2008, the worst showing in a quarter-century. Analysts believe the economy in the current January-March quarter is contracting at a pace between 5.5 and 6 percent or more.

A new wave of layoffs hit this week, with General Dynamics Corp., Northrop Grumman Corp., Tyco Electronics Ltd., and others announcing job cuts.

Obama is counting on a multipronged assault to lift the country out of recession: a $787 billion stimulus package of increased federal spending and tax cuts, a revamped bailout program for troubled banks and a $75 billion effort to stem home foreclosures.

But economists said the jobs situation seems to be killing any hopes for an economic recovery later this year as some had hoped.

"Faith in a rebound is running low no matter where you look these days," said Stephen Stanley, chief economist at RBS Greenwich Capital.

Yahoo! Finance.com

Worst is yet to come for job market

2009-03-06T04:09:00.000-08:00

This is the most brutal downturn in decades, but the unemployment numbers only show part of the pain.

It's no secret that the job market is bad.

The Labor Department will release its latest jobs report Friday. Economists surveyed by Briefing.com forecast that the unemployment rate rose to 7.9% in February and that 650,000 jobs were lost.

Still, as bad as those numbers are, some have argued that this jobs downturn is not as bad as the early 1980s. The unemployment rate peaked at 10.8% in late 1982.

But several experts say it would be a mistake to come to that conclusion. They argue that unemployment rate only hints at why this jobs downturn is worse than any since the Great Depression.

Steep decline

If the job loss forecasts for February turn out to be accurate, it would be the worst monthly drop since 1949.

It would also bring total job losses over the last six months to 3.1 million, the largest six-month job loss since the end of World War II.

Even adjusting for the large growth in the nation's job base in recent decades, this would be the biggest six-month job loss since 1975.

Economists say the steepness of this decline will make it tougher for the job market to improve any time soon. The increasing job losses create a downward spiral in which businesses, faced with lower demand because people can't afford to buy their products, lay off even more people.

"The dramatic hemorrhaging of jobs means we're in this for the long-haul," said Heidi Shierholz, economist with Economic Policy Institute, a Washington think tank supported by foundations and labor unions.

Another reason why this downturn is more painful is because the layoffs have come from companies in virtually all parts of the economy.

"There's no place to hide in terms of job losses," said Lakshman Achuthan, managing director of Economic Cycle Research Institute. "And when measuring the impact of job losses, it's very important how pervasive the losses are. That's what makes this the worst since the Great Depression."

Achuthan points to something called the diffusion index of employment change, which showed that three out of four business sectors cut jobs in January.

According to Achuthan, this was the first time in the past 30 years when there were job losses in more than two-thirds of the sectors of the economy. When the recession started in December 2007, about 58% of industries were still adding jobs.

Long-term pain

Barring a major surprise, February will mark the 14th straight month of job losses, the third-longest streak since 1939.

This long period of job losses is swelling unemployment rolls to record levels and causing long-term unemployment to rise sharply.

In January, 3% of the nation's workers had been out of work for 16 or more weeks, with about half of that total being out of work at least six months. Several states' unemployment funds have run out money as a result.

And most economists think the job market woes are far from over. Many economists are projecting job losses through the end of the year.

But even when the job losses end, the unemployment rate is likely to continue rising. That's because the modest hiring that will follow the downturn won't be enough to make up for population growth and unemployed Americans who had become discouraged starting to look for jobs again.

With that in mind, Dean Baker, co-founder of the Center for Economic and Policy Research, said he thinks the unemployment rate will hit a peak of above 10% sometime in 2010.

Underemployed, or discouraged

Finally, economists caution that the unemployment rate only captures a portion of Americans unable to find full-time jobs. It doesn't count people working at part-time jobs but cannot find a full-time job, for example.

And the average number of hours worked per week is now at a record low, according to Labor Department readings.

The unemployment rate also doesn't count many people who tell the Labor Department they want to work but haven't looked for work recently.

The government has a so-called underemployment reading which counts people working part-time jobs for economic reasons rather than by choice, as well as some who have become discouraged from looking for work.

That measure hit 13.9% in January - the highest reading since the Labor Department started calculating it back in 1994.

But there are other discouraged job seekers who are not looking because they don't think they can find work, have decided to return to school, or for other personal reasons. Counting all of those people in the underemployment rate takes it to 15.7% in January.

Comparable figures aren't available from the Labor Department for the pre-1994 period, but there are full-year government estimates for those outside the labor force who wanted to work in earlier years.

Using those figures, the underemployment rate reached a high of 21.5% in November 1982. While that's higher than this January, it's probably not fair to compare the current reading to the worst result of that downturn since most believe this jobs crisis is far from over.

"No one is going to tell you we're at the trough," said Baker.

CNN Money.com

European stocks mixed ahead of US jobs report

2009-03-06T04:04:00.000-08:00

European markets mixed ahead of expected bleak US jobs report; Asia markets resume slide.

European markets were mixed Friday ahead of the publication of what is expected to be an especially bleak U.S. jobs report.

By noon in mainland Europe, Britain's FTSE 100 was up 0.1 percent at 3,533.59, Germany's DAX slipped 0.6 percent at 3,673.66, and France's CAC 40 dropped 0.9 percent to 2,547.76.

Investors were awaiting a U.S. Labor Department report later in the day that economists predict will show U.S. employers slashed 648,000 jobs in February -- more than the 598,000 cut in January.

If they are right, it would mark the worst month of job losses since the recession started in December 2007. It also would represent the single biggest month of job reductions since October 1949, when the country was just pulling out of a painful recession, although the labor force has grown significantly since then.

European shares had risen in early trading, with the FTSE gaining over 1 percent. This was "mostly short-term relief after the falls we have had," according to David Hussey, London-based Head of European Equities with MFC Global Investment Management.

"The market is today waiting for more evidence out of the States on payrolls, although that is a bit of a late indicator," he said.

"We have had a terrible run on the markets; it's been pretty much a one-way bet. People have been very bearish, the economic news has been bad. It kind of feels like we are in no man's land at the moment."

Wall Street was headed for a weaker open as stock futures traded lower. Dow futures were down 0.7 percent at 6,599, while Standard & Poor's 500 futures fell 0.3 percent to 684.20.

That comes after Asian stock markets resumed their downward and after Wall Street fell to its lowest levels in more than 12 years.

The Dow fell overnight by 281.40 points, or 4.1 percent, to 6,594.44, its lowest close since April 1997. The S&P 500 index dropped 30.32, or 4.3 percent, to 682.55, the lowest close since September 1996.

Investors, already deflated after Beijing failed to deliver new stimulus measures, were forced to grapple with a warning from General Motors that the struggling automaker may have to file for bankruptcy.

Financials were also hit, with Citigroup Inc. falling below $1 a share.

"You can buy Citi at the 99 cent store now," said Paul Schulte, a chief Asia equity strategist at Nomura International in Hong Kong. "It's nauseating. We keep grasping at straws to find hope, and the markets keep punishing us."

In Asia, the losses were somewhat more muted than the sharp declines in the U.S. overnight.

Japan's Nikkei 225 stock average fell 260.39 points, or 3.5 percent, to 7,173.10, while Hong Kong's Hang Seng shed 289.72, or 2.4 percent, to 11,921.52. South Korea's Kospi was off 0.3 percent at 1,055.03.

Shanghai's benchmark swooned 1.3 percent, Australia's stock measure was 1.4 percent lower and Singapore's key index shed 0.8 percent. Bucking the trend, markets in India and Taiwan gained 1.6 percent and 0.4 percent.

China has become a growing source of hope for many investors, helping buoy sentiment in Asia at a time when the region's export-driven economies are hurting as demand dries up in industrial Western countries.

A day after Beijing stopped short of announcing new stimulus plans, the government said Friday it sees signs economic growth is recovering and is watching closely to determine whether it needs to expand its huge stimulus effort.

"It really depends on the changing situation to determine whether we need additional investment," Zhang Ping, the chairman of the country's planning body, said in Beijing. He and central bank Gov. Zhou Xiaochuan said positive data showed Beijing's policies were working so far.

Analysts said the outlook for equities was not going to improve any time soon.

"I think the markets are going to continue to tread water," said George Kanaan, managing director at UBS in Sydney. "All the companies need to get more capital and that's going to hold markets relatively down until we go through the process."

Robert Howe of asset manager Geomatrix in Hong Kong said the latest bout of selling was likely part of the second of three phases in a bear market that could last another year and a half. He pointed out that stocks investors usually pour into during turbulent times, including utilities, staple goods and pharmaceuticals, were hit this week in both the U.S. and Asia.

"Sentiment is very negative," Howe said. "What we're seeing is defensive stocks are ... getting whacked, which tells us it might be close to the end of the capitulatory period of phase two."

Oil prices were higher in European trade, with benchmark crude for April delivery up $1.09 at $44.70 a barrel by late afternoon in Singapore on the New York Mercantile Exchange. The contract fell $1.77 overnight to settle at $43.61 a barrel.

Yahoo! Finance.com

What went wrong

2009-03-06T04:01:00.000-08:00

The IMF blames inadequate regulation, rather than global imbalances, for the financial crisis.

IN RECENT months many economists and policymakers, including such unlikely bedfellows as Paul Krugman, an economist and New York Times columnist, and Hank Paulson, a former American treasury secretary, have put “global imbalances”—the huge surpluses run by countries like China, with their counterparts in America’s huge current-account deficit—at the root of the financial crisis. But the IMF disagrees. It argues, in new papers released on Friday March 6th, that the “main culprit” was deficient regulation of the financial system, together with a failure of market discipline. Olivier Blanchard, the IMF's chief economist said this week that global imbalances contributed only “indirectly” to the crisis. This may sound like buck-passing by the world’s main international macroeconomic organisation. But the distinction has important consequences for whether macroeconomic policy or more regulation of financial markets will provide the solutions to the mess.

In broad strokes, the “global imbalances” view of the crisis argues that a glut of money from countries with high savings rates, such as China and the oil-producing states, came flooding into America. This kept interest rates low and fuelled the credit boom and the related boom in the prices of assets such as houses and equity, whose collapse precipitated the financial crisis. A workable long-term fix for the problems of the world economy would, therefore, involve figuring out what to do about these imbalances.

But the IMF argues that imbalances could not by themselves have caused the crisis without the ability of financial institutions to develop new structures and instruments to cater to investors’ demand for higher yields. These instruments turned out to be more risky than they appeared. Investors, overly optimistic about continued rises in asset prices, did not look closely into the nature of the assets that they bought, preferring to rely on the analysis of credit-rating agencies which were, in some cases, selling advice on how to game the ratings system. This “failure of market discipline”, the fund argues, played a big role in the crisis.

As big or bigger a problem, according to the IMF, was that financial regulation was flawed, ineffective, and too limited in scope. What it calls the “shadow banking system”—the loosely regulated but highly interconnected network of investment banks, hedge funds, mortgage originators, and the like—was not subject to the sorts of prudential regulation (capital-adequacy norms, for example) that applied to banks.

In part, the fund argues, this was because these were not thought to be systemically important, in the sense that banks were understood to be. But their being unregulated made it more attractive for banks (whose affiliates the non-banks often were) to evade capital requirements by pushing risk into these entities. In time, this network of institutions grew so large that they were indeed systemically important: in the now familiar phrase, they were “too big” or “too interconnected” to fail. By late 2007, some estimates of the assets of the bank-like institutions in America outside the scope of existing prudential regulation for banks, was around $10 trillion, as large as the assets of the American banking system itself.

Given this interpretation, it is not surprising that the IMF has thrown its weight strongly behind an enormous increase in the scale and scope of financial regulation in a series of papers leading up to the G20 meetings. Among many other proposals, it wants the shadow banking system to be subjected to the same sorts of prudential requirements that banks must follow. Sensibly, it is calling for regulation to focus on what an institution does, not what it is called (that is, the basis of regulation should be activities, not entities). It also wants regulators to focus more broadly on things that contribute to systemic risk (leverage, funding, and interconnectedness), the significance of some of which was probably under-appreciated until the collapse of Lehman Brothers and the subsequent chaos. And there is much more to be done, it suggests, involving cross-border banking, disclosure requirements, indices of systemic risk and international co-operation.

Yet there is an underlying inconsistency here. The IMF’s version of “how it all happened” is a classic example of institutions gaming the regulatory system. It is impossible to anticipate all the possible ways in which regulations can be evaded. And while the wisdom of hindsight may make it appear blindingly obvious that non-bank financial institutions could become large enough to pose a risk to the entire system, surely this was not apparent to policymakers at the time. Increasing the scope of regulation may well prevent the precise problems that led to this crisis from recurring in the same way, but nothing prevents problems from morphing to evade the plethora of regulations that the fund is proposing. It is hard to shoot a moving target.

And what about those pesky imbalances? The IMF’s view, broadly speaking, is that without excessive risk-taking by financial institutions, which was aided by the absence of regulation, they would not by themselves have caused the meltdown. But equally, without the flood of money seeking returns, the risky financial instruments that the IMF is blaming for increasing systemic risk may not have grown and posed the risk that they did. Some blame the IMF’s policies during the Asian crisis for spurring Asian countries to build up enormous reserves. That may offer part of the explanation for why the Fund has come down so strongly on one side of the debate.

www.economist.com

Underinsured Americans: The cost to you

2009-03-05T01:57:00.000-08:00

As the recession shrinks health care coverage for more households, experts warn of a double-whammy on all consumers.

Americans already shouldering the cost of millions of people without health insurance should brace for a double-whammy, thanks to a surge in the number of "underinsured" - consumers who have some but not enough health insurance coverage.

The problem, according to health care industry experts, is that the government and those with employer-based health plans will have to pick up the tab as more Americans are unable to pay their entire medical bill.

As the recession puts a bigger strain on consumers' wallets, many underinsured Americans either can't or won't pay the high deductibles and co-pays for treatment they receive in hospitals and emergency rooms.

Many people without adequate insurance are also delaying or forgoing medical care until it becomes an absolute emergency, said Dr. David Chin, managing partner of consulting firm PricewaterhouseCooper's Global Healthcare Research Institute.

By law, hospitals have to treat all emergency admission regardless of insurance.

"If the underinsured can't pay the bills, the hospital either writes it off as bad debt or shifts the cost to its charity care program," said John Pickering, principal and consulting actuary with consulting firm Milliman Inc.

"As bad debt increases, more hospitals are also shifting the cost of both the underinsured and insured to those who can pay," said Wynn Bailey, partner and health care expert with consulting firm AT Kearney. "That's the government, private insurers and the self-insured."

Bailey said hospitals are negotiating higher treatment rates with insurance companies to offset the bad debt.

In turn, commercial insurance providers are charging higher premiums to their clients, both businesses and individuals, to cover their cost increases. As businesses struggle their employee health care costs, they are shifting a higher percentage of overall premiums to their workers, charging higher deductibles, or encouraging greater use of generic drugs.

"It's a vicious cycle," said Pickering.

Bailey said he wouldn't be surprised if people with employer-based health insurance have to pay 5% to 10% more for their coverage over the next year or two.

Not tracked by government

One reason the exponential growth in underinsured Americans hasn't made headlines is because this group isn't yet tracked by the government, explained Sara Collins, economist and assistant vice president with health policy research group The Commonwealth Fund.

"It's harder to define the underinsured," Collins said.

The Commonwealth Fund defines underinsured as those who incur high out-of-pocket costs - excluding premiums - relative to their income, despite having coverage all year.

Using that measure in consumer surveys, Collins' firm estimates that 25 million adults under age 65 were underinsured in 2007.

More importantly, Collins pointed out that the number of underinsured increased 60% from 2003 to 2007. That compares with a 5.1% increase in the number of uninsured Americans - to about 46 million - over the same period, according to the U.S. Census Bureau.

"The 25 million [number] can still be an underestimate," Collins said.

What's also troubling, she said, is that the ranks of the underinsured are spreading across income levels and have seen the most rapid increases lately in middle-income households earning between $40,000 to $60,000.

Obama's plans

President Obama has made health care reform a top priority, detailing both a dramatic overhaul of the system in his budget and setting a White House "summit" on the issue Thursday.

Some of Obama's initiatives will provide short-term relief to both the uninsured and underinsured.

Specifically, the government will provide a 65% subsidy to businesses who continue COBRA premiums for laid off employees for a period of 9 months.

"But what happens after that period?," said Bailey. "Many people are wary about finding another job in a year in this economy."

Longer term, Obama last month extended the Children's Health Insurance Program Reauthorization Act which renews and expands health coverage by an additional 3 million children, to 11 million children.

Investments in health care technology will eliminate unnecessary costs and prevent duplicative care, Bailey said.

Also, in his budget, Obama proposed a 10-year health care reserve fund of $630 billion to "bring down costs and expand coverage."

Bailey has reservations.

That $630 billion "sounds like a lot of money. But total health care consumption this year is expected to be about $2 trillion," he said. "So is spending $630 billion a year enough to transform this gigantic beast?"

"Obama's proposals certainly are a start, but much more is needed," said Bailey.

CNN Money.com

Obama budget hopes meet bailout rage

2009-03-04T00:20:00.000-08:00

Government's rescue team goes before Congress, but budget hearings serve as forum for larger questions about consequences of financial fixes.

President Obama's economic A-team went to Capitol Hill on Tuesday to address questions about the administration's ambitious budget request.

But they also ended up being grilled on everything from the latest AIG bailout to the risk of propping up zombie institutions.

Proposals like Obama's plans to reform federal efforts on health care and energy are big heaves in normal times. Now the president has to sell his budget at a time when many lawmakers are worried about the effectiveness of the government's expensive efforts to stem the economic and financial crises so far.

That was made abundantly clear as Treasury Secretary Tim Geithner, Federal Reserve Chairman Ben Bernanke and White House budget director Peter Orszag testified in hearings before the House and Senate.

"It's not a partisan attack on you when you hear some of us saying that we are very concerned about where we're going to be at the level of federal debt in the next five years ... a lot of that hinges on how successful the plans that you're putting out there are," Rep. Devin Nunes, R-Calif., said to Geithner at a House Ways and Means Committee hearing.

All three officials stressed in their comments that the country has to embark on a two-pronged mission:

do all it can to combat the crises even though that means running up the deficit in the near term to record levels;\
make efforts to put the country on a fiscally sustainable course for the long run.

"We need to act, both to address the dramatic shortfall in national output in the near term and to tackle the medium- and long-term deficits that would ultimately become a drain on the nation's potential for economic growth," Orszag told the House Budget Committee.

But lawmakers find some of the near-term fixes -- like Monday's overhaul of the rescue of giant insurer American International Group -- harder to swallow than others.

"Yesterday, after it was reported that AIG lost $62 billion last quarter, an estimated $460,000 per minute, the federal government offered AIG yet another check," Sen. Ron Wyden, D-Ore., asked Bernanke at the Senate Budget hearing. "Small businesses across the country, who played by the rules, paid their bills on time, can't get a line of credit, while AIG seems to have an open spigot for taxpayer money."

Bernanke was asked variations of that same question throughout the hearing.

"Our belief was that to allow the company to fail at this juncture, putting aside its huge adverse affects on the financial system and on the economy, would have greatly also impaired the ability of the government to recover the investments that have already been made in the company," Bernanke said.

Lawmakers on both sides of the aisle would welcome that. But until there's evident return on the government's investments in its rescue and stimulus ventures, all they will see is the potential for red ink.

Bernanke was asked how high a debt level the country can carry without jeopardizing the ability of the Treasury to borrow.

"It's hard to judge in an explicit way," he said, noting that countries can for short times carry high rates of debt relative to their GDP but that the United States will have to stabilize its debt-to-GDP ratio in order to be able to borrow at favorable rates.

But ultimately, Bernanke said, "maintaining the confidence of the financial markets requires that we begin planning now for the restoration of fiscal balance."

CNN Money.com

UBS official to face Senate questioning

2009-03-04T00:18:00.000-08:00

UBS official facing Senate panel's questions on thousands of US clients avoiding taxes.

An official of UBS AG on Wednesday will face questions from a Senate panel for the first time since Switzerland's biggest bank formally acknowledged responsibility for helping tens of thousands of American clients hide assets from the U.S. government.
In a cross-border battle, the Internal Revenue Service is trying to pry from UBS the names of as many as 52,000 wealthy Americans who maintain secret accounts with UBS. The bank maintains that turning over the account names would violate Swiss privacy law and jeopardize UBS' license to stay in business.

The Swiss government -- which is providing financial support to UBS as it struggles with massive losses stemming from the U.S. subprime mortgage crisis -- has refused to send a representative to Wednesday's Senate subcommittee hearing, in protest of the IRS lawsuit against the bank.

Cloak-and-dagger tactics said by the U.S. government to have been employed by UBS -- coded language in internal e-mails and memos, foreign shell companies and phony charitable trusts, use of pay phones and foreign area codes and credit cards -- will be on display at the hearing, which starts at 2:30 p.m. EST.

UBS allegedly staged training sessions so that "client advisers" could travel frequently to the U.S. -- on average 30 days a year each -- to consult with secret U.S. customers without attracting the attention of tax agents or law enforcement officials. The advisers were told to rotate the hotels they stayed in and to "protect the banking secrecy" if they were questioned by any authorities, according to excerpts of UBS internal documents filed in the IRS suit and provided by the subcommittee.

The dispute has prompted heated debate in Switzerland over the country's cherished banking secrecy, a tradition that has helped transform the nation into one of the world's richest.

The investigative panel of the Senate Homeland Security and Governmental Affairs Committee, led by Sen. Carl Levin, D-Mich., is voicing outrage at what it says is obstruction of the U.S. government by both UBS and the Swiss.

Levin said Tuesday the panel hopes to learn from UBS official Mark Branson the exact number of American account holders. Branson is the chief financial officer of the bank's global wealth management and Swiss bank division, based in Zurich.

"We've been stymied," Levin told reporters. "These are abuses that are unconscionable."

Now that UBS has acknowledged "participating in a scheme to defraud the United States government and its agency, the IRS," the bank rightfully should turn over the names of American clients, Levin said.

Karina Byrne, a UBS spokeswoman in New York, declined to comment.

UBS on Feb. 18 agreed to pay a hefty $780 million in fines and restitution for conspiring to help American citizens violate their country's tax laws by hiding assets -- estimated to be worth at least $14.8 billion -- from the U.S. government. In the deal struck in federal court in Fort Lauderdale, Fla., the Justice Department agreed to defer criminal prosecution of UBS in exchange for the payment of fines and restitution, and the names of up to 300 U.S. clients.

The bank says it has shut down the improper foreign-account business, and taken corrective measures to tighten its compliance and internal control systems.

The agreement didn't cover the much broader list of as many as 52,000 customer names now sought by the IRS, but both sides knew the U.S. government would ask for them.

In its civil suit against UBS, the IRS has asked a federal judge to enforce so-called "John Doe summonses" seeking information about the Americans' accounts. Another federal judge approved the summonses in July 2008, but UBS never complied.

By providing the 300 or so names, the bank says, it has complied with the summonses as fully as it can without violating Swiss law.

Wednesday's hearing is the latest in an extensive series by the Senate panel examining offshore tax abuse, which is estimated to cost the United States $100 billion a year in lost tax revenue.

Recovering tax revenue has taken on amplified urgency amid the economic crisis, when the federal deficit is expected to balloon to nearly four times the highest level in history as hundreds of billions of dollars are spent on the bailout for financial institutions and the economic stimulus plan.

Also testifying will be IRS Commissioner Douglas Shulman, who has warned U.S. taxpayers hiding money overseas that it was time to come clean with the agency.

"People who have hidden unreported income offshore need to get right with their government. They should come forward and take advantage of our voluntary disclosure process," Shulman said last month.

On Tuesday, Treasury Secretary Timothy Geithner said President Obama supported legislation authored by Levin that would tighten U.S. tax laws and close loopholes to fight offshore tax-haven abuses.

The president's support "greatly improves the chances of an offshore tax bill becoming law this year ... (and) sends a strong signal to tax havens that this administration is not going to tolerate the kind of offshore tax abuses that have been draining" the Treasury, Levin said.

Yahoo! Finance.com

American International Group: In a state

2009-03-02T17:04:00.000-08:00

Despite another rescue for AIG, problems at the state-owned insurer weigh heavily on the markets.

AT EACH lurch downwards in the financial crisis, American International Group (AIG) has played an infamous starring role. Yet again, as the Dow Jones Industrial Average closed below 6,800 on Monday March 2nd, its lowest level in almost 12 years the company deemed to be too big to fail has proven almost too big to rescue.

Once the world’s largest insurer, now AIG is in the record books for all the wrong reasons. On Monday it revealed the biggest quarterly loss of any company in American history, at $61.7 billion, down from a loss of $5.3 billion in the fourth quarter of 2007. Much of the red ink stemmed from misplaced bets in the credit-derivatives markets; what it called “market-disruption related” lost the insurer $25.9 billion, which is more than the combined loses in the fourth quarter of both Merrill Lynch and Citigroup, two of America’s biggest banking casualties.

AIG’s losses, though shockingly large, could have been worse. Its problems mainly stem from the insurance coverage it provided to banks on devilishly complex structured products. According to Creditsights, a research firm, the loss of value in these so-called super senior credit-default swaps (CDSs), as well as the company’s operating businesses, was no worse than expected.

But the results had threatened to trigger a downgrade by the credit-rating agencies, which would have required AIG to post billions of dollars more of collateral to back its CDS exposures. This provoked another of those feverish weekends at the Treasury and the Federal Reserve that were so prominent in the closing months of the Bush administration, as the authorities scrambled to find a new way out for AIG.

The upshot was the firm’s fourth bail-out since the Fed first threw it an $85 billion lifeline in September and took a 79.9% stake in the company in return. The announcement, issued on the same day as the fourth-quarter earnings, marks quite a substantial softening of the terms of that rescue package, as well as providing up to $30 billion in new capital. It removes the coupon on $40 billion of government equity injected into AIG in November and lowers the interest rate on the Fed’s credit line. While the new plan pacifies the credit-rating agencies for the moment, and provides some solace to AIG’s creditors and counterparties, it provides little reason for taxpayers to hope that much of the cost of this colossal bail-out—by far the biggest so far in the crisis—will be recouped.

In exchange for cancelling a $34.5 billion debt to the New York Fed, the government will receive preferred stakes in two Asia-based AIG subsidiaries, American International Assurance and American Life Insurance, as well as interests in life-insurance businesses in AIG’s home country. The two Asian units have performed well, but efforts to sell American International Assurance have recently drawn a blank, partly because of the severity of the global crisis and the lack of funding for buyers. The government clearly believes that rather than offloading them in a fire sale, it is better to hold them and sell them at a better price when the market improves.

That is assuming they are well managed in the interim, however; so far government ownership appears to have done little to improve the rest of the business. Hopes that official backing would enable AIG somehow to fence off the troubled financial-services division where the CDSs are housed, allowing the other businesses to run more smoothly, have come to nothing. Edward Liddy, the AIG boss parachuted in by the government, said he was surprised by how bad things had turned out at the firm and in the economy in general. He offered no forecasts for the first quarter.

AIG’s tide of red ink makes the record so far of government support for stricken financial institutions, albeit one that bridges two administrations, even more depressing. Messy rescues of Citigroup and Bank of America have failed to staunch their losses. Fannie Mae and Freddie Mac, the two giant mortgage agencies that, like AIG, are also wards of the state, have continued to bleed. Fannie last week reported a $25.2 billion fourth-quarter loss. Freddie expects to seek up to another $35 billion in public funds when it announces results shortly that are expected to be disastrous. On Monday David Moffett, its chief executive, resigned six months after the government had given him the job. It was yet another reminder that problems for big financial firms continue to get worse even when they are wrapped in the forgiving arms of the state.

www.economist.com

HSBC's rights issue: Ruffled feathers

2009-03-02T17:01:00.000-08:00

HSBC plans to raise $17.7 billion of equity—a sign of weakness or strength?

APOLOGIES are all the rage in banking now. As well as a general grovel on behalf of the industry, on Monday March 2nd HSBC said sorry for its original sin in 2003: buying Household, an American consumer-credit company that has since blown up. “With the benefit of hindsight, this is an acquisition we wish we had not undertaken,” the bank’s chairman said. Europe’s biggest lender by market value now hopes to draw a line under the affair by winding up the bulk of its American consumer-credit book. For good measure it also plans to raise $17.7 billion, in Britain’s biggest-ever rights issue and slash its dividend, after 15 years of consecutive double-digit growth.

That may all sound like a disaster but, depressingly, HSBC is one of the best-performing banks in the western world right now. Its 2008 results were riddled with one-off items, but the bank still made an annual pre-tax profit of over $9 billion in a year when most peers made losses. Bad debts are rising outside America, but at a moderate rather than seriously alarming pace. HSBC’s share price has roughly halved in the past year--less catastrophic than many competitors, a few of whom have just entered the deadly embrace of their governments. Its deposits still exceed loans made, making it relatively less dependent on the whims of wholesale markets for funding.

One interpretation of HSBC’s capital raising is that it is keen to make the gap between it and unhealthy banks even wider. Its ratio of equity to tier-one capital will rise from 7% to 8.5% if the rights issue is completed. That is far above the level of America’s mega-banks (JP Morgan Chase sits at 6.4%) and exceeds Europe’s other big beast (Santander’s ratio is 7.2%). Extra capital will allow HSBC to grow as other cash-starved competitors are forced to shrink their businesses.

Acquisitions might even be on the cards as weak banks with global operations are broken up, as is already happening to Royal Bank of Scotland and seems likely to be Citigroup’s fate. Yet is HSBC’s capital position quite as it seems? The bank has a large portfolio of available-for-sale securities (mainly asset-backed instruments). Deducting the marked-to-market losses on this would reduce the tier-one ratio back below 7%.

On top of that HSBC faces continued losses in America as its winds down its consumer business there. The bank has quite rightly rejected calls to let this division, which it does not legally guarantee, default. But the ongoing financial burden could be heavy. This unit produced an underlying pre-tax loss of $7 billion in 2008--a couple more years like that would knock a sixth or so off HSBC’s core capital.

All of which suggests that HSBC is undertaking a balancing act. Although it hopes further realised losses in America and on its asset-backed securities will be limited, a rights issue leaves it prepared for the very worst. That is not a position of strength, at least in absolute terms. But very few other banks are even capable of raising equity from external investors right now: their only response to the worst-case scenario is to cross their fingers. HSBC does not look in a great state, but remains fit enough to be able to admit its weaknesses.

www.economist.com

Sources: AIG to get up to $30B more in Fed aid

2009-03-02T00:21:00.000-08:00

American International Group to get up to $30 billion more in Fed assistance, sources say

Struggling insurer American International Group Inc. will receive up to $30 billion in additional federal assistance in the fourth government rescue of the company, people familiar with the matter told The Associated Press on Sunday
The new infusion is intended to prop up AIG -- once the world's largest insurer -- as it is expected to announce $60 billion in quarterly losses early Monday, a person said on the condition of anonymity because the discussions are still ongoing.

The company, which is considered too large to be allowed to fail, previously received about $150 billion in loans from the government, which currently holds an 80 percent stake in the company.

Under the new deal, the U.S. Treasury and the Federal Reserve would provide about $30 billion in fresh capital to AIG from the government's Troubled Assets Relief Program, or TARP. The money would be provided as a standby line of equity that AIG could tap as its losses mount, the person said.

AIG has already received $40 billion from TARP.

The new plan also calls for the Federal Reserve to take stakes in two international units, the person said.

Instead of paying back $38 billion in cash with interest that it has used from a Federal Reserve credit line, AIG now will repay that amount with equity stakes in Asia-based American International Assurance Co. and American Life Insurance Co., which operates in 50 countries.

The $20 billion to $25 billion remaining on the Federal Reserve credit line will be available for borrowing, the person said.

In order to strengthen the company, AIG also plans to combine its U.S. and foreign property-casualty insurance operations into a new unit, with a new name and separate management, the person said. About 20 percent of the property-casualty business would be taken public.

To further reduce its debt, AIG will turn $5 billion to $10 billion worth of debt into new securities backed by life insurance assets.

The decision to approve a third revision of the AIG bailout is a continued bet by the federal government that there would be even greater risk to letting AIG fail, a person familiar with the Treasury's decision told The Associated Press on Sunday.

Federal officials feared that a bankruptcy of AIG could be disastrous for the global economy, which is in worse shape than it was six months ago, the person said, requesting not to be named because the talks are ongoing. Talk of the new rescue package has been going on for several weeks, as the Treasury gained insight of AIG's quarterly performance, the person added.

AIG spokesman Nick Ashooh declined to comment on the rescue package. The Federal Reserve Bank of New York, which is handling the government loan, did not return requests for comment Sunday evening. Treasury Department spokesman Isaac Baker also declined to comment.

The company's board met Sunday to vote on the revised bailout plan.

Major credit rating agencies have already signed off on the deal, according to media reports. Without the support of the credit rating agencies, AIG would have faced crippling cuts to its ratings.

AIG has been forced to seek more help in part because of the ongoing recession and its falling stock price, now well under $1. Among its biggest problems: It can't sell assets to pay back government loans because the credit crisis is preventing would-be buyers from getting financing to complete such deals.

As of Feb. 13, AIG had sold interests in nine businesses.

In November, the U.S. government restructured previous loans provided to AIG, giving the company about $150 billion in total as part of a rescue package to help the insurer remain in business amid the worsening credit crisis. That package replaced earlier loans, including the original $85 billion lent in September, after it became apparent the insurer needed more funds.

Problems at AIG did not come from its traditional insurance operations, but instead from its financial services units, and primarily its business insuring mortgage-backed securities and other risky debt against default.

Shares of AIG closed at 42 cents on Friday. The stock, which traded at $49.50 a year ago, has lost nearly all of its value since the market meltdown began in September.

Yahoo! Finance.com

Wall Street: Teetering on 12-year lows

2009-03-02T00:14:00.000-08:00

As the Dow and S&P 500 hover near '97 levels, investors brace for a barrage of economic news and watch for the latest from Washington.

Fasten your seat belts. The week ahead could be critical as the stock market sits on the precipice of nearly 12-year lows.

All the pressure points are in play, with reports or Congressional hearings due on housing, consumer spending, government spending, bank rescue efforts, manufacturing and perhaps most significantly - the labor market.

How Wall Street reacts to the news will be key. Investors continue to look for signs that the market has factored in enough of the bad news to at least stabilize, if not move higher.

"That we are at 12-year lows tells you that we are in a period of enormous uncertainty and that nobody knows where the bottom is," said Bernard McGinn, CEO at McGinn Investment Management.

"It shows that people are losing their belief in equities as a way to grow assets, and that they'd rather put their money elsewhere," he said.

Believe it or not, it is still not bleak enough to suggest a so-called bottom is forming -- at least not by contrarian standards.

The S&P 500 and Dow industrials are both now roughly 50% off their all-time highs from October 2007 and this has made some investors think that a big rally could be brewing, said Richard Sparks, senior equities analyst at Schaeffer's Investment Research.

However, the retreat could easily surpass 50% and the fact that some people are optimistic about a rally starting concerns him. "That's not what you see at a bottom," Sparks said. "You usually see panic or apathy and we're not seeing either right now."

Bad news bears: Traders and technicians were discouraged Friday when the S&P 500 fell below its trading low from Nov. 21 of last year, previously thought to be the bear market bottom. That put the S&P 500 at a nearly 12-year intraday low a few days after it made a nearly 12-year closing low. The Dow also hit 1997 trading levels and closed at a nearly 12-year low Friday. The Nasdaq, which has held up better than the broader market, remains above its Nov. 21 lows.

These technical levels will be relevant in the week ahead as investors sort through what is expected to be another barrage of rough economic news.

Standouts include January readings on personal income and spending and the February ISM manufacturing index, both due Monday. Tuesday's highlights are the January pending home sales report and Congressional hearings on Obama's budget proposal.

On Wednesday, employment moves front and center with reports from payroll processing firm ADP and outplacement firm Challenger, Gray & Christmas. In Washington, there's a hearing on oversight of the TARP, a.k.a. the bank bailout.

Thursday brings a slew of February sales from the nation's retailers as well as the weekly jobless claims report and a January report on factory orders. There's also a Congressional hearing on AIG. Friday is the February jobs report.

Economy

Monday: January personal income is expected to have declined by 0.3% after falling 0.2% in the previous month, according to a consensus of economists surveyed by Briefing.com. But spending is expected to have risen by 0.3% after falling 1% in December. The Core PCE deflator, the report's inflation component, is expected to have risen by 0.1% versus a flat reading in December.

Construction spending is expected to have fallen 1.5% in January after dropping 1.4% in the previous month.

The ISM manufacturing index is expected to have declined to 34 from 35.6 in January, remaining in recessionary territory.

Tuesday: The pending home sales index for January is expected to have fallen 3% after rising 6.3% in the previous month.

Wednesday: Payroll processing firm ADP releases its monthly employment report before the start of trading. Private-sector employers are expected to have cut 613,000 jobs in February after cutting 522,000 in the previous month.

Separately, outplacement firm Challenger, Gray & Christmas releases its February report on planned job cuts.

The ISM services sector index, due after the start of trade, is expected to have fallen to 41.3 from 42.9 in February.

Wednesday also brings the government's weekly oil inventories report and the Fed's periodic "beige book" reading on economic activity.

Thursday: Factory orders in January are expected to have fallen 2.1% after having fallen 3.9% in the previous month.

Thursday also brings the weekly jobless claims report, a slew of February sales reports from the nation's retailers and a revised reading on fourth-quarter productivity.

Friday: The government's February employment report is due before the market open. Employers are expected to have cut 615,000 jobs from their payrolls after cutting 598,000 in January. The unemployment rate, generated by a separate survey, is expected to have risen 7.9% from 7.6% in the previous month.

Washington

Tuesday: Federal Reserve Chairman Ben Bernanke testifies before the Senate Budget Committee on economic and budget challenges, starting at 10 a.m. ET.

Peter Orszag, director of the White House Office of Management and Budget, testifies before the

House Budget Committee about the fiscal 2010 budget, starting at 10 a.m. ET. He also testifies Wednesday, before the House Ways and Means Committee starting at 2:00 p.m. ET.

Last week, Obama outlined his outlook for the federal budget over the next ten years, including a roughly $3.6 trillion budget for 2010.

Wednesday: A House Financial Services subcommittee holds a hearing on oversight of the Troubled Asset Relief Program (TARP), staring at 2:30 p.m. ET.

Thursday: There's a Senate Banking Committee hearing on AIG, with Federal Reserve Vice Chairman Donald Kohn scheduled to testify. The hearing begins at 10 a.m. ET.

Also Thursday, the Obama administration is expected to provide more details on the already announced $75 billion housing rescue plan.

CNN Money.com

Ailing in the east

2009-03-02T00:11:00.000-08:00

European Union leaders decline to bail-out eastern Europe.

EUROPEAN UNION leaders have rejected calls for a special €180 billion ($229 billion) rescue fund for ex-communist countries in east and central Europe. Leaders gathered in Brussels on Sunday March 1st for an emergency summit to discuss the economic crisis dismissed suggestions, led by Hungary, that a single plan was needed to save the region. Without massive help for ex-communist nations, Hungary’s prime minister, Ferenc Gyurcsany, had said, a “new Iron Curtain” risked splitting the continent anew.

But Angela Merkel, the German chancellor, squashed talk of a dedicated plan for eastern Europe, saying the ten ex-communist countries in the EU faced “very different” degrees of peril in this economic crisis. It was ill-advised to throw “massive figures” around, added Mrs Merkel. Hers is a voice that counts: Germany pays more into EU coffers than any other nation.

In Brussels, it was seen as highly significant when German ministers signalled last month that they might be prepared to step in to prevent a country defaulting within the 16-member group that shares the single currency. But a dedicated bail-out for the ten ex-communist countries that have joined the EU since 2004 is clearly a step too far. Germany will hold federal elections later this year, and voters there are acutely sensitive to suggestions that Germany and other rich nations should bail out weak or profligate members of the European club.

The German chancellor was one of several western leaders who also dismissed calls to ease the rules that govern membership of the single currency. Some eastern European governments would like to see the two-year probation period for prospective members cut short, to allow them to enjoy the sheltering embrace of the euro sooner. Mrs Merkel held out only the prospect of speeding up access to a preliminary stage of monetary union, in which countries peg their currencies to the euro.

Nobody doubts that several members of the former communist block are in desperate economic straits: Latvia and Hungary have already received billions of euros in EU stabilisation funds as part of bail-out plans organised by the International Monetary Fund. The fate of the newcomers is of acute interest to those western countries whose banks have invested heavily in the east, including Austria, Greece, Italy and Belgium. Further north, Scandinavian banks are heavily exposed in the Baltic republics.

There has been much rhetoric in the days running up to Sunday’s summit about the need to avoid splitting Europe along east-west lines, including from the meeting’s formal host, the Czech prime minister, Mirek Topolanek, whose country holds the current EU rotating presidency.

But in the end for very different reasons, a consensus formed among EU leaders that such talk is dangerous. For countries like Poland or the Czech Republic, whose economies are in relatively robust shape, there are strong arguments against allowing the impression to form that there is a single disaster area in the east of Europe, which worldwide investors enter at their peril.

Mr Topolanek invited fellow leaders to stress instead the importance of Europe’s single market, with its competition rules and founding principles of free movement of workers, goods, capital and services within the EU. Everyone at the summit understood the reference: eastern European governments were appalled when the French president, Nicolas Sarkozy, last month suggested that French carmakers should promise not to shift production out of France in exchange for €6 billion in cheap loans. In a television interview, Mr Sarkozy had added that it was “unjustified” for firms like Renault or Peugeot to make cars in places like the Czech Republic, for sale in France.

Mr Sarkozy originally wanted to call a summit of heads of government from the 16 nations that use the euro, but his idea was rejected by Mrs Merkel, in favour of a gathering of all 27 nations, chaired by the Czech Republic (which does not use the single currency).

Perhaps understandably, the French president was on prickly, defensive form, insisting he was opposed to protectionism, and saying France should in fact be “thanked” for making a million cars a year in overseas factories, many of them in eastern Europe. The French car plan has now been approved by European Commission regulators, who said they had been assured that French car firms were free to produce cars where they wished.

Others remained keen to make a point. Gordon Brown, the British prime minister, told the summit that protectionism was a “road to ruin”. It was not clear if his joke was intentional.

www.economist.com

Government could own up to 36 pct. of Citigroup

2009-02-27T05:14:00.001-08:00

Citigroup reaches deal that could give the government up to a 36 percent stake in the bank.

Citigroup Inc. said Friday it reached a deal that will give the government up to a 36 percent stake in the struggling bank.

The government, along with other private investors, will convert some of their preferred stock in Citi to common shares.

iti will offer to exchange up to $27.5 billion of its existing preferred stock held by private investors at a conversion price of $3.25 per share, a 32 percent premium over Thursday's closing price of $2.46. The government will match up to $25 billion of preferred stock it currently owns for conversion at the same price.

If the maximum amount of preferred stock is converted, current common stockholders will see their ownership stake fall to about 26 percent.

The conversion will help provide Citi the mix of capital to withstand further weakening in the economy.

The Government of Singapore Investment Corp., Saudi Arabian Prince Alwaleed Bin Talal, Capital Research Global Investors, Capital World Investors are among the private investors that said they would participate in the exchange.

One of the hardest hit banks by the ongoing credit crisis, Citi has already received $45 billion in cash from the government and guarantees protecting it from the bulk of losses on $300 billion of risky investments.

Under the exchange agreement, the Treasury Department's remaining $20 billion in preferred shares will be converted into a more senior preferred stock that carries an 8 percent cash dividend rate.

Citigroup said the increase in government ownership will not require additional taxpayer money. The government currently holds about an 8 percent stake in Citi.

As part of the agreement, Citi will suspend dividends on both its common stock and preferred shares.

Citi will also reshape its board of directors, Richard Parsons, the bank's chairman, said in a statement. The board will have a majority of new independent directors as soon as possible, Parsons added.

The company also said it recorded a goodwill impairment charge of about $9.6 billion due to deterioration in the financial markets.

The goodwill charge was added to Citi's 2008 results along with a $374 million impairment charge tied to its Nikko Asset Management unit. The charges resulted in Citi revising its 2008 loss to $27.7 billion, or $5.59 per share.

Shares of Citi tumbled 56 cents, or 22.7 percent to $1.90 in premarket trading.

Yahoo! Finance.com

Will we see your like again?

2009-02-27T05:08:00.000-08:00

The Royal Bank of Scotland announces a huge loss. It will now be dismantled.

AT ITS obligatory roasting by the Treasury Select Committee this week, Britain’s financial regulator was accused of “being responsible for supervising ten big banks and allowing five to collapse”. In response, the boss of the Financial Services Authority, Lord Turner, promised a “revolution” at his organisation.

That is not far off what is taking place north of the border, at Royal Bank of Scotland (RBS), the most spectacular of those failures. Two bail-outs have left RBS majority state-owned. On Thursday, amid furore over his discredited predecessor’s lavish and now taxpayer-funded pension, its new boss, Stephen Hester, provided details on plans to break up the group. He also described RBS’s probable use of the government’s asset-guarantee scheme, which will soon be rolled out to other banks as well. For good measure Mr Hester also announced the largest loss in British corporate history.

There is a lot to break up: acquisitive RBS was the world’s largest bank by assets in 2008. Its purchase of bits of ABN AMRO, a Dutch bank, in 2007 brought the kind of geographic spread (try 20 branches in Indonesia) that looks sage at the pinnacle of a bull market and more like imperial overstretch at any other time. Mr Hester plans to split the bank into two parts: the good and the mediocre.

Into the good pot will go about three-quarters of the bank’s existing activities, consisting mainly of its British and American banking operations, its insurance division and the less-dangerous bits of its investment bank, which is to be halved in size. Some tasty overseas businesses, for example in India, will be retained. The mediocre pot will contain the other foreign retail assets, which RBS will attempt to auction. But it will consist overwhelmingly of the dodgy bits of the investment bank (such as its leveraged-loan and property activities), which will probably be wound up over several years.

To bolster capital and prod the bank into lending more, the government will guarantee assets on RBS’s books with a value of £302 billion ($430 billion)—equivalent to about a quarter of its total risk-weighted balance-sheet. RBS will be responsible for the first £19.5 billion of any losses, and the state for most of the rest. By limiting its risk (for a fee of £6.5 billion to the Treasury), RBS will boost its core capital ratio from 7% to 9%. It also promises to lend £50 billion more in the next two years, expanding its domestic loan book by a fifth.

That punchy rate of growth helps explain the biggest surprise. The Treasury is investing a further £13 billion which, like the guarantee fee, will take the form of a new kind of preference stock that can be converted to ordinary shares. This stock will bolster capital more securely than the suspect hybrid stuff that American regulators are keen to inject into banks, since its dividends can be cancelled. The result will be that RBS’s core capital ratio hits a whopping 12.4%, about double the level at JPMorgan Chase, America’s soundest big bank.

All of which may seem overgenerous, particularly since the state’s voting rights will be capped at 75% of the total—less than its likely financial stake in the business. But the advantages to taxpayers of having a bank that is well-capitalised enough to lend, but also well-run enough to be sold back to private investors one day, should not be underestimated.

www.economist.com

A credible budget?

2009-02-27T04:52:00.000-08:00

Barack Obama's ambitious budget is unveiled.

ON THURSDAY February 26th Barack Obama unveiled a draft budget that promises to cut the deficit from a vast $1.75 trillion in fiscal 2009 (which ends this September) to $533 billion in 2013, when his first term ends. As a share of GDP, the draft has the deficit falling from this year’s post-war high of 12% to just 3%.

Is that promise credible? At a minimum, Mr Obama seems more fiscally honest than George Bush, whose accounting gimmicks vied with Enron’s. Mr Bush’s budgets routinely excluded unavoidable outlays, such as those for wars and natural disasters, incorporated tax increases and spending trims that he knew would never occur, and masked his policies’ impact on the deficit by shortening the forecast horizon to five years from ten. Mr Obama puts most of the missing items back in the budget, and restores its horizon to ten years. However, he undoes some of this laudable clarity with a rosy economic forecast.

To boost revenue, Mr Obama will let Mr Bush’s 2001 tax cuts for the 2% of richest Americans (typically those earning more than $250,000) expire as scheduled at the end of 2010. Corporations will no longer be able to exclude foreign-source income from tax. Many popular tax deductions, such as those for local taxes, mortgage interest and charitable gifts, will be limited for the rich. A cap-and-trade programme for carbon emissions that is yet to be designed will raise additional revenue starting in 2012. To curb spending, Mr Obama promises to remove most American troops from Iraq before the end of 2010, reduce payments to privately managed Medicare plans and farmers, and find other savings.

Mr Obama told Congress in his address on the 24th that “everyone…will have to sacrifice some worthy priorities for which there are no dollars. And that includes me.” Yet the evidence of such sacrifice remains scarce. He appears to earmark his tax increases and spending cuts mostly to pay for his long-standing priorities: making permanent the worker tax credit in the fiscal-stimulus plan; expanding public subsidies to reduce the number of those without health insurance (though no details have been provided); more money for parents, students, the disabled and the unemployed; investment in alternative energy; and extra deployments to Afghanistan. And he suggested that he will need more money to bail out banks than the $700 billion already authorised. A $250 billion facility is being set aside for this, one reason why this year’s deficit is so huge.

Most of Mr Obama’s targeted deficit-reduction comes not from his own actions, but from the expiry of the stimulus, a halt to bail-outs, and the natural restoration of tax revenue as the economy pulls out of recession, growing by a robust 4% on average from 2010 through to 2013. And therein lies the biggest threat to the president’s plans. Mr Obama’s forecast is already more optimistic than the private sector consensus was in January, and that consensus has since become more pessimistic. Ben Bernanke, the Federal Reserve chairman, said this week that the recession would end this year only if the financial system stabilises, which so far it has not.

A longer recession or long-term stagnation pose two distinct fiscal risks. First, Mr Obama will be (rightly) reluctant to raise taxes and tempted to extend parts of the stimulus package if unemployment is not dropping by 2010. Premature fiscal tightening, after all, could lengthen the recession, as Japan learned in the 1990s.

Second, a longer recession makes it harder for America to grow out of its debt burden as it, and other countries, have done at previous debt peaks. Because of stagnating output and declining prices, Japan’s nominal GDP in 2005 was smaller than in 1996, contributing mightily to a climb in that country’s net debt from 29% of GDP to 85% (it will reach 98% this year). One worrying parallel for America is that its nominal GDP will probably decline this year for the first time since 1949 (the administration optimistically sees it creeping up by 0.1%)

So Mr Obama’s 3% deficit target may be much harder to reach than he thinks; and it may not be tough enough anyway. Using reasonable policy assumptions, Alan Auerbach of the University of California at Berkeley, and William Gale of the Brookings Institution, think the deficit will bottom out near 5% of GDP in 2013 then climb to almost 6% by 2019, while debt continues to rise as a share of GDP. That is before the government has to deal with the full impact of the surge in health and pension entitlement costs. The academics reckon higher taxes or lower spending equal to a staggering 8% of GDP a year are necessary to contain those costs and stabilise the long-run debt.

Despite his inspiring rhetoric, Mr Obama’s plans for dealing with those long-term obligations have been frustratingly vague. He called on Americans to “address the crushing cost of health care” but proposes to spend many billions more, not less. He reportedly abandoned support for a commission to restore solvency to Social Security, the public-pension system, because congressional Democrats objected to this loss of their authority. He had a golden opportunity to introduce the idea of the rich, multinational corporations and carbon-emitters paying higher taxes as part of a broad reform of a monstrously inefficient tax system, and so make the economy more productive. He passed it up.

In fairness, these are early days in his presidency, and stabilising the economy needs to be his priority. The summit and the speech to Congress were just part of the essential process of softening up the public for the long and contentious chore of fixing entitlements and the tax system.

It was also an opportunity for Mr Obama to counter the pervasive economic gloom that he himself engendered with his warnings of “catastrophe” if his stimulus plan was not passed. With the rhetorical flair for which he is famous, he asserted that Americans would triumph because “amid the most difficult circumstances”—his voice briefly descending to a warm and coaxing growl—“there is a generosity, a resilience, a decency”. As if to prove his point, legislators gave one of their longest ovations to Leonard Abess, a Miami banker in attendance who sold most of his bank for $927m and gave $60m of the proceeds to 471 current and past employees. Even amid the gloom, there are occasional flashes of light.

www.economist.com

Wall Street opens higher as investors bet on banks

2009-02-26T06:52:00.000-08:00

Stocks open higher as investors grow more upbeat on prospects for banking industry.

Wall Street is opening higher as investors show some relief over more government help for the banking system.

President Barack Obama's budget proposal outlines the possibility of spending $250 billion more for additional financial industry rescue efforts on top of the $700 billion that Congress has already authorized, a senior administration official told The Associated Press.

Investors also are applauding planned job cuts at JPMorgan Chase & Co. and moves by the British government to help banks remove toxic assets from their books.

The Dow Jones industrial average is up 77 at 7,348, while the Standard & Poor's 500 index is up 9 at 774. The Nasdaq composite index is up 10 at 1,436.

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GM loses $9.6 billion

2009-02-26T06:48:00.000-08:00

Embattled automaker reports larger than expected in fourth quarter loss and burns through more than $5 billion in cash; says it needs new loans this year.

General Motors posted a $9.6 billion net loss in the fourth quarter, a period in which its sales plunged and it needed a federal bailout to avoid filing for bankruptcy.

The company also disclosed that its auto operations burned through $5.2 billion in cash during the last three months of the year. The company ended the quarter with cash of $14 billion.

If not for the $4 billion federal loan it received in the quarter's closing days, GM's cash level would have fallen below the $11 billion to $14 billion in cash the company has said it needs to continue operations.

Since receiving the first installment of that loan, GM has gotten another $9.4 billion in federal assistance. The company asked for an additional $16.6 billion in the turnaround plan it submitted to the Treasury Department last week. GM disclosed Thursday it will need this money in 2009 to weather the current downturn.

The company also said it anticipates its outside auditors will issue a statement on whether the company is a "going concern." The statement could be important not only to investors but to federal officials who are determining whether the company is viable in the long-term.

If the government determines GM is not viable, it would demand immediate repayment of the company's loans.

The auditor's statement will be included in GM's year-end results filing with the Securities and Exchange Commission. GM disclosed Thursday it had filed for a two-week extension to submit that report.

As bad as the net loss was, it could have been worse. The company posted a $533 million gain because of the fact that GMAC, the finance unit in which it held a 49% stake during the quarter, got its bond holders to agree to swap debt for equity. GMAC become a bank holding company as a result of the debt swap, which significantly reduced GM's stake in the unit.

Excluding special items, GM lost $5.9 billion, or $9.65 a share, in the quarter. Analysts surveyed by Thomson Reuters had forecast a loss of $7.39 a share, compared to a profit of 8 cents a share on that basis a year ago.

The operating losses were particularly pronounced in GM's core North American market. It lost $3.5 billion before taxes in the quarter, up from a $1.3 billion loss in North America a year earlier.

Revenue in the North American unit plunged about 32% to $19.3 billion. GM's market share also slid 1.7 percentage points to 21%.

But GM, which now sells more than half its vehicles outside of North America, is facing challenges around the globe.

Losses more than quadrupled in Europe, and the company lost money in its Asia-Pacific and Latin America-Africa-Middle East units. GM posted profits in those two regions a year ago.

Overall revenue at GM plunged 34% to $30.8 billion, significantly worse than the Thomson-Reuters forecast of $35.1 billion.

For the full year, GM reported a net loss of $30.9 billion. The automaker has posted net losses of $82 billion over the past four years as its U.S. sales and market share plunged and it closed plants and slashed staff in an unsuccessful effort to stem losses.

CNN Money.com

Spy scandal in Estonia.

2009-02-26T06:45:00.000-08:00

A senior spy for Russia in NATO is convicted.

WHY he did it is still unclear. But the “how” is leaking out. Hermann Simm, a former Estonian official who was one of Russia’s highest-placed spies in NATO, pleaded guilty to treason on Wednesday February 25th and was jailed for 12½ years. The Estonian authorities have released some details of a case that has had the spook world buzzing for the past year.

Russia’s foreign-intelligence service, the SVR, recruited Mr Simm on his holiday in Tunisia in 1995. He was a prime catch. He had finished a stint as a top policeman, and was starting a new security job at the defence ministry. The approach was made by Valery Zentsov, once a KGB officer in Soviet-occupied Estonia. Mr Simm was neither blackmailed nor, at first, bribed; he just wanted his Soviet-era rank of colonel back. At a third meeting he was put on the payroll, receiving just over $100,000 in all.

Mr Simm betrayed every secret that crossed his desk. There were plenty: as the man in charge of Estonia’s national security system, he organised the flow of all classified military documents in the country and abroad. Once Estonia joined NATO in 2004, he acted as the Kremlin’s eyes and ears on the alliance too (although his poor English, say some, may have limited his usefulness). He also tried but failed to get hold of secrets from Estonia’s security and intelligence services, which are separate from the defence ministry.

In 2002, say Estonian officials, Mr Zentsov was replaced by another Russian handler. Sergei Yakovlev worked for the SVR’s elite S-directorate, which runs “illegals”: spies who acquire a genuine identity in a foreign country. Mr Yakovlev, a near-native speaker of Portuguese, appears to have acquired Portuguese citizenship illegally, gaining a passport in the name of Antonio de Jesus Amurett Graf. Travelling as a business consultant, he met Mr Simm every three months or so, in at least 15 countries in the EU and elsewhere.

The plan came unstuck because of poor spycraft. According to spycatchers elsewhere, Mr “Graf” tried to recruit a senior official in another country, who reported the incident to his own counter-intelligence service. Under scrutiny, the Portuguese was seen meeting Mr Simm. That set alarm bells clanging across NATO. The difficulty was to observe Mr Simm closely enough to build a criminal case without sparking his suspicion. Estonia’s security service is getting many plaudits for this, which culminated in his arrest last September. In a separate prosecution, Mr Simm was ordered to pay 20m Estonian kroons ($1.7m) for the cost of new security systems. The SVR did not immediately reply to a request for comment.

Mr Simm is not the only Russian spy at high level in NATO. Several other countries are apparently following up five leads arising out of Mr “Graf’s” activities. The results are unlikely to become public. The way in which Estonia put Mr Simm openly on trial is striking. In other countries, those caught spying for Russia tend to be eased out discreetly rather than being brought to justice in the painful light of day.

www.economist.com

A brighter future, but who pays?

2009-02-26T06:41:00.000-08:00

Barack Obama, in his address to Congress, asks for sacrifice but skips the details.

AS A new president, Barack Obama’s first speech to Congress was not, officially, a state-of-the-union address. That was just as well: its current state is awfully precarious. On Tuesday February 24th, a few hours before he spoke to the Senate and House of Representatives, a survey reported that consumers’ confidence in the future was at its lowest in 40 years of polling.

Mr Obama did not sugar-coat matters. The economic crisis “is the source of sleepless nights,” he said. His budget, to be delivered on Thursday, “reflects the stark reality of what we’ve inherited—a trillion dollar deficit, a financial crisis and a costly recession.”

He promised that beyond this grim present lies a brighter future of plug-in hybrid-energy cars, wind- and solar-powered cities, digital health records, vanquished disease, and the world’s highest college-graduation rates. And, with the inspirational flourish for which he is famous, he insisted that Americans would triumph because there exist “amid the most difficult circumstances”—his voice descending to a throaty growl—“a generosity, a resilience, a decency”.

Such speeches are typically meant to sketch a president’s broad agenda rather than deliver specifics. This one at times felt like an economics class with simple explanations of how credit markets work, and at others like a late-night cable TV commercial: “The average family who refinances today can save nearly $2,000 per year on their mortgage.”

Still, he did give clues to his priorities. Congress, he said, had to act soon to overhaul America’s multiplicity of financial regulators, which struggled to anticipate and cope with the financial crisis. He called for a cap-and-trade system to reduce the growth of greenhouse-gas emissions. He gave warning that the Treasury would probably need more than the $700 billion that Congress has already authorised for propping up the banking system (while studiously avoiding the debate over whether banks should be nationalised in the process). He strongly indicated that there would be more aid for General Motors and Chrysler, which are now contemplating whether to file for bankruptcy to shrink themselves more rapidly. “The nation that invented the automobile cannot walk away from it,” he said.

A theme that permeated the speech was rapidly rising national debt, following the budget-busting $787 billion stimulus that Mr Obama just signed. “Everyone in this chamber—Democrats and Republicans—will have to sacrifice some worthy priorities for which there are no dollars. And that includes me,” Mr Obama said. But he has yet to say what he is prepared to sacrifice. He still plans to expand publicly financed health care, make permanent tax credits to the majority of workers, expand college assistance and invest in alternative energy.

The budget on Thursday is expected to show that Mr Obama inherited a deficit of $1.3 trillion this fiscal year, and raised it to $1.5 trillion with the fiscal stimulus (a post-war high of some 10% of gross domestic product). Mr Obama will promise to get it down to $533 billion or 3% of GDP by fiscal year 2013. Most of that drop will come from the expiration of temporary stimulus measures, the cessation of capital injections and the hoped-for start of economic recovery. The rest will come from withdrawing troops from Iraq, trimming payments to privately-managed Medicare plans, letting George Bush’s tax cuts expire as scheduled in 2010 for the richest 2% of Americans, the taxation of foreign corporate income and the sale of permits for carbon-emissions trading. He promised, as every previous president has, to vet the budget “line by line” for waste; he will find it just as hard as his predecessors to kill programmes with powerful congressional backers.

At a Monday budget summit with congressional leaders and again on Tuesday Mr Obama rightly noted that the cost of old people’s health care and pensions are the country’s biggest long-term fiscal threats, but on neither occasion did he propose how to deal with them. In fairness it is early and stabilising the economy should be Mr Obama’s priority, not long-term fiscal discipline. Premature fiscal tightening could abort a recovery. The summit on Monday and the speech on Tuesday were part of the process of softening up the public for future pain.

Both events also demonstrated that despite being jilted on his quest for some Republican support during the debate on the fiscal stimulus, he is not giving up on his pursuit of bipartisanship. On Tuesday night, at least, Republicans were co-operative, rising in applause almost as often as Democrats.

www.economist.com

Stimulus: Can it feed the hungry?

2009-02-24T03:34:00.000-08:00

The economic stimulus plan provides $150 million for food banks. Advocates for the hungry say it can't arrive soon enough.

For Jesse Taylor, the debate over the federal stimulus plan wasn't about politicians trying to score points or economists parsing the unemployment rate.

It was about the growing ranks of hungry people lining up outside his Harlem food pantry.

"We're in the midst of a perfect storm: We've received budget cuts, we've seen an increase in the number of people coming in, and we've seen the cost of food going up," said Taylor, senior director of Community Kitchen, a food pantry and soup kitchen run by the New York City Food Bank.

On a recent cold morning, the unassuming and friendly Taylor greeted members of the community -- some of whom he has come to know by name -- waiting to enter the pantry for a bundle of groceries.

"We definitely need to bail out the hungry," Taylor said.

The $787 billion economic stimulus plan signed by President Obama on Feb. 17 allocates $150 million to the U.S. Department of Agriculture's Emergency Food Assistance Program.

The 28-year old program, known as TEFAP, sends shipments of federally purchased food to states, which in turn gets the food in the hands of large food banks. The food banks then allocate the food to soup kitchens and pantries that serve people in need.

The $150 million for TEFAP provided by stimulus about doubles the amount of money allotted to the program in 2009, and the funds will be distributed starting soon, according to the USDA. But with the economic situation still deteriorating, people on the front lines of the nation's hunger problem worry that it's not enough.

"It's a great first step, and we're grateful to the administration for putting those funds into TEFAP," said Taylor, whose parent agency is set to receive about $6 million more in food this year because of the stimulus package. "But it's not enough to cover all the people coming in and requesting emergency food assistance."

The $150 million is half of what Feeding America, a network of more than 200 food banks that advocates in Washington for food assistance programs, sought from Congress. Feeding America said its member food banks are reporting a 30% increase in the number of people seeking assistance over a year ago, and 72% of food banks have been unable to adequately meet demand.

New York Gov. David Patterson's office estimates that 3.5 million New Yorkers will require some form of food assistance in 2009. New York City Food Bank, the largest in the country, said that 2 million of those people will have never accessed food assistance programs in the past.

One such person is Rosetta Stokes, a former postal worker who retired 10 years ago due to a disability. She had managed to get by on her disability payments until now. Thursday was her first day at a soup kitchen.

"I do have my disability, but it doesn't seem like it's lasting. Food prices are rising and sizes are getting smaller," said Stokes, who called her grits and eggs served up by the Community Kitchen staff "a blessing."

"Everything's just gotten overwhelming," she added. "Every day it's something like, 'Wow, I can't do ... what I was doing yesterday.' "

Rising prices worry advocates

People seeking emergency food have cited unemployment and soaring food prices as the leading causes of their need. Food costs rose 5.9% last year, and staple foods like corn, wheat and other grains have grown even more expensive.

"Food is the most elastic expenditure in a household's budget," said Maura Daley, vice president of government relations and advocacy and Feeding America. "Food prices are still rising, so it's hard to predict how quickly we'll see relief."

Even though the stimulus plan plans to alleviate hunger by allocating $20 billion to food stamp programs, rising food prices could still put a dagger into those plans.

"They helped us by raising the food stamps, but the food [costs] have gone higher," said Carmen Quinones, a foster mother in Harlem, who has been coming to the Community Kitchen's food pantry for two months.

"You still have to come out of pocket to make ends meet at the end of the month," said Quinones. "Hopefully this stimulus package will provide more funds for us and more jobs. That's what it's all about - creating jobs and getting people off the system."

Stimulus: A good start

Some experts are optimistic that the recovery plan's aim of creating or saving 3.5 million jobs over the next two years will indirectly help the hunger situation.

"The more preventative work we can do, obviously the better," said Aine Duggan, vice president of government relations at the New York City Food Bank. "The more jobs we create at this time, then the less people we'll see turning to emergency food programs."

Still, Duggan said organizations that work with the huger issue are readying themselves for even greater demand for food banks' services in 2009 than in 2008. She expects resources to be stretched thin but said the stimulus money will help.

"The message with the economic stimulus bill is there isn't a silver bullet here. There is no way to fix the entire problem with one bill," Duggan said. "But we can certainly provide assistance to people who are most in need - at least in a temporary way."

CNN Money.com

World markets fall amid relentless financial fears.

2009-02-24T03:28:00.000-08:00

World stock markets fall amid relentless fears about financial system; HK off nearly 3 pct.

Asian stock markets tumbled Tuesday, with Hong Kong and South Korea down around 3 percent, after relentless fears about the financial system and world economy drove Wall Street to its worst finish in nearly 12 years. European shares opened lower.
Every major market shuddered from losses across a range of sectors, from banks to technology firms, exporters and commodities, wiping out solid gains from the previous day.

Tokyo's benchmark languished near a 26-year low as news that Nomura Holdings, Japan's biggest broker, will raise billions more in capital by selling shares added to worries about the financial sector.

Most Asian bourses advanced strongly Monday on reports the U.S. government may take a greater stake in tottering financial giant Citigroup.

But concerns that Citigroup and other banks will keep suffering severe losses flared overnight amid pessimism about a quick economic recovery and doubts the government can return the reeling financial system to working order.

As the Obama administration tried to pacify fears, saying it would launch a revamped bank rescue program this week, U.S. investors hammered stocks. The Dow Jones and Standard & Poor's 500 indexes plummeted to their lowest closes since 1997.

"Investors are just selling out in disgust across the board -- disgust with the market, disgust with the financial problems," said Lorraine Tan, director of equities research at Standard & Poor's in Singapore.

"The government seems to keep throwing in money, but there doesn't seem to be any end to the declines or solutions to the problems," she said.

European stocks fell in early trade, with Britain's FTSE 100 down 1.1 percent, Germany's DAX lower 2.4 percent and France's CAC 40 off 1.8 percent. Stock futures suggested Wall Street would rise modestly Tuesday. Dow futures were up 33, or 0.5 percent, at 7,149 and S&P500 futures rose 3.6, or 0.5 percent, at 748.30.

Earlier in Japan, Japan's Nikkei 225 stock average lost 107.60 points, or 1.5 percent, to 7,268.56, though selling eased somewhat as the government signaled it may prop up stock prices, possibly by buying shares with public funds. Nomura dived 9.3 percent.

Hong Kong's Hang Seng sank 376.58, or 2.9 percent, to 12,798.52, while South Korea's Kospi fell 3.2 percent to 1,063.88.

Mainland Chinese shares, among the year's best performers, got slammed, and the Shanghai benchmark plunged 4.6 percent.

Sentiment there also took a hit after China's central bank said the country's economic downturn could worsen and warned the risk of deflation is "quite big" amid collapsing consumer demand. The bank's report could temper expectations that China's slump might be bottoming out and a recovery might be taking shape,

Elsewhere, Australia's stock measure was off 0.6 percent, and Singapore's benchmark lost 1 percent.

Overnight, U.S. investors seemed unconvinced after regulators promised to ensure the viability of banks by providing capital and said they would start conducting "stress tests" on Wednesday to gauge the health of financial firms.

Amid the assurances, however, came more reports of financial gloom.

Struggling insurer American International Group Inc. said it's evaluating "potential new alternatives" to tackle its financial problems amid reports it will soon announce a $60 billion loss and ask the government for more aid.

After the markets closed, JPMorgan Chase said it was slashing its quarterly dividend to preserve capital in case economic conditions drastically worsen.

The Dow plunged 250.89, or 3.4 percent, to 7,114.78. It last closed this low on May 7, 1997 when it finished at 7,085.65. The Dow hasn't traded below the 7,000 mark since October 1997.

While the S&P500 managed to close above its Nov. 21 trading low -- considered a key threshold among investors -- it still took a beating. The benchmark fell 26.72, or 3.5 percent, to 743.33. It was the lowest close since April 11, 1997.

Oil prices languished in Asian trade, with light, sweet crude for April delivery down 36 cents at $38.08 a barrel the New York Mercantile Exchange. The contract lost 4 percent, or $1.59, to settle at $38.44 overnight.

In currencies, the dollar strengthened to 95.45 yen from 94.43 yen. The euro was up slightly at $1.2790 from $1.2705.

Yahoo! Finance.com

Banks under stress

2009-02-24T03:21:00.000-08:00

Is it time to nationalise Citigroup and Bank of America?

AMERICA has been dithering about how to sort out its banking crisis. The market has forced its hand. On the morning of Monday February 23rd a joint statement by banking regulators said that they stood “firmly behind” the banking system and would initiate promised stress tests of banks’ capital positions on Wednesday. The fine print remains critical and, so far, unclear, but the statement should at least halt the scary market moves that took place last week.

In a five-day period last week shares of two of the biggest and most vulnerable banks, Citigroup and Bank of America (BoA), fell by 44% and 32% respectively. Those of better capitalised institutions, such as JPMorgan Chase, fell by less. Far more worryingly, this sorting of the wheat from the chaff occurred in the credit defaults swap market, which showed the perceived risk of bankruptcy ballooning for Citi and rising sharply for BoA, while JPMorgan remained more secure. Investors seemed to be betting that new injections of straight equity from the state (rather than more dollops of preferred shares) would dilute existing shareholders, but also that the state might insist that a “haircut” be imposed on those further up the capital structure.

However emotionally satisfying, forcing banks to default on debt would cause the type of liquidity runs and market dislocation that brought chaos after the collapse of Lehman Brothers last year. The regulators’ statement seems designed to reassure on this front. What it still sidesteps is the basis on which new equity will be injected into tottering banks. Clearly the government could take all sorts of forensic decisions about the carrying values of assets that banks have on their balance sheets. But the market is mainly betting that the government will bow to common sense. Headline tier-one capital ratios show all three banks at 11-12% (with BoA including Merrill Lynch). But Citi and BoA have flattered these ratios with huge amounts of preference stock, much of it issued by the state.

This capital is not genuinely loss bearing: for example Citi can defer dividends on its latest government preference stock but not cancel them entirely in the same way as common shares. Strip out the hybrid capital and JPMorgan is at 6.4%. This is in line with the best capitalised European banks—for example Britain's state-controlled RBS, even after it latest round of big losses, stands at about 7%. However Citi and BoA look much weaker, with ratios at about 3-4% as well as carrying higher investment banking exposure.

Investors appear only to trust banks with high levels of pure equity capital. That suggests it would be a good idea to convert existing government preference stock into pure equity. If this occurred at current market prices, the state would own about two thirds of BoA and about 80% of Citi. But instead the regulators’ announcement on Monday appears to support the idea of more “temporary” preferred shares that would convert into common stock “over time” as and when losses materialise. This further fiddlyness seems designed to avoid the appearance of nationalisation, but it could well create even more confusion about the true loss bearing capacity of these two firms, and of other banks that are likely to fail the test. It is hard to believe the solution to banks’ problems is to make their capital structures more, not less, complicated.

www.economist.com

Citi in talks over bigger U.S. stake - Report.

2009-02-23T03:49:00.000-08:00

Bank and regulators discuss plan for government to convert preferred shares, according to Wall Street Journal.

Citigroup Inc. is in discussions with regulators about a plan for the federal government to take a larger ownership stake in the bank, according to a report Sunday.

The Wall Street Journal, citing sources familiar with the matter, reported that the government would convert a large portion of its preferred Citigroup shares to common shares.

The government received the preferred shares in return for investing $45 billion in Citi as part of the $700 billion bailout of the financial system.

According to the Journal, the talks involve Citi executives and regulators at the Federal Reserve and Office of the Comptroller of the Currency. Officials in the Obama administration have not said whether they support the plan, the Journal reported.

Citigroup spokesman Michael Hanretta declined to comment on the Journal report. On Friday, the bank issued a statement saying that its capital base is "very strong" and capital reserves were among the highest in the industry at the end of the fourth quarter.

"We continue to focus and make progress on reducing the assets on our balance sheet, reducing expenses and streamlining our business for future profitable growth," Hanretta said.

The report is sure to stoke speculation about whether the Obama administration may have to nationalize large banks to stabilize the financial system.

The question of nationalization has weighed on the minds of investors in the two weeks since Treasury Secretary Tim Geithner announced a comprehensive stability plan that fell flat.

The issue came to a head on Friday when nationalization fears helped drag down shares of Citi and Bank of America as much as 36% at one point.

BofA recovered most of its losses to finish down just 3.6%. But Citi's stock closed with a 22% loss.

The Obama administration has said it wants to keep the banking system in private hands, which seems to suggest it isn't aiming to run the likes of Citi and BofA. But that leaves the door open to an "intervention" -- a takeover of a troubled bank for the purpose of breaking it up, bringing in new capital and finding new owners and management.

The term nationalization has been used to cover a range of very different outcomes. Most obviously, it refers to the outright takeover of troubled firms, such as when the Treasury Department put mortgage giants Fannie Mae and Freddie Mac into conservatorship.

But it has also been used by some people to cover sizable investments that give government officials considerable say in a firm's activities -- such as the loan guarantees extended in recent months to Citi and BofA.

Asian, European stocks advance on Citigroup report

2009-02-23T03:43:00.000-08:00

World stocks mostly rise on report US could take bigger stake in Citigroup; HK up 3.8 pct.

Asian and European stock markets advanced Monday, as investors digested reports the U.S. government might expand its stake in troubled banking giant Citigroup to ease the financial crisis.
Worries that major Western banks like Citigroup Inc. and Bank of America Corp might have to be nationalized because of mounting bad debts sent global markets sharply lower last week.

But investors seemed relieved, at least for now, to have some clarity about the fate of Citigroup after the Wall Street Journal said late Sunday the company is negotiating with authorities to increase the U.S. government's stake in the teetering lender to as much as 40 percent.

Executives would prefer to keep the government's stake closer to 25 percent, according to the Journal, which cited people familiar with the situation. The talks arose after Citigroup made the proposal to regulators.

The Obama administration has not indicated whether it would back the plan, the Journal said. Just last week, Obama officials voiced support for keeping the banking system private as widespread talk about nationalization led investors to unload shares in Citigroup and Bank of America.

The news was unlikely to give stocks extended support, analysts said. Should the U.S. end up taking greater ownership, however, the move could help restore long-term confidence in the hard hit financial sector, raising prospects of a faster recovery in the world economy.

"People are taking it as a positive sign," said Francis Lun, general manager of Fulbright Securities Ltd. in Hong Kong. "It shows the government will not allow a major bank to fail again. They've learned their lesson with Lehman Brothers that the ramifications are so great, sometimes no amount of money can rebuild confidence."

As markets opened in Europe, Britain's FTSE 100 rose 1.1 percent, Germany's DAX added 1.7 percent and France's CAC-40 was up 1.5 percent.

Earlier in the day, Hong Kong's Hang Seng closed up 475.93 points, or 3.8 percent, at 13,175.10, and South Korea's Kospi was up 33.60, or 3.2 percent, at 1099.55 as the country's currency, the won, recovered some after plummeting against the dollar last week.

In mainland China, the Shanghai benchmark added almost 2 percent amid expectations of further government measures to help the real estate sector. Markets in Taiwan, Singapore, Indonesia, Thailand and the Philippines also edged higher.

In Japan, the Nikkei 225 stock average recouped some of its losses to end down just 40.22 points, 0.5 percent, at 7,376.16 as the dollar gained against the yen.

The market was pressured partly by the collapse of Japanese bank SFCG Co., a major high-interest lender focusing on small business. The firm filed for bankruptcy protection with $338 billion ($3.6 billion) in liabilities.

Australian and New Zealand shares also fell.

U.S. futures were higher on the Citigroup report, suggesting Wall Street would recover at the open. Dow futures rose 118 points, or 1.6 percent, to 7,470 and Standard & Poor's 500 index futures were up 13.1 points, or 1.7 percent, at 782.60.

Selected banks in Asia were buoyed by news about Citigroup. KB Financial Group Inc., the holding company for top South Korean lender Kookmin Bank, advanced 5.3 percent. HSBC, its shares pummeled in recent days, added almost 1 percent in Hong Kong.

Citigroup and other banking heavyweights in the U.S., Britain and other countries have already received hundreds of billions of dollars in government aid in hopes of saving the financial system from collapse.

While providing a short-term of jolt of optimism, the measures have failed to put to rest fears that more institutions could follow in the footsteps of Lehman Brothers, which declared bankruptcy in September, without governments assuming full or partial ownership.

Earlier this month, President Barack Obama's financial rescue plan met with a lukewarm reception from investors concerned the measures were vague or didn't go far enough to recapitalize the banks. This week, investors are expecting more details on Obama's program.

Last Friday, relentless financial and economic worries sent the Dow industrials down 100.28 points, or 1.3 percent, to 7,365.67. On Thursday, the Dow broke through its Nov. 20 low of 7,552.29, and closed at its lowest level since Oct. 9, 2002.

The S&P500 index fell 8.89, or 1.1 percent, to 770.05.

Oil prices were higher in Asian trade, with light, sweet crude for April delivery up 28 cents at $40.31 a barrel. The contract edged down 15 cents to settle at $40.03 Friday.

In currencies, the dollar rose to 94.34 yen from 93.32 yen, while the euro strengthened to $1.2869 from $1.2825.

Yahoo! Finance.com

The American car industry: In pieces

2009-02-23T03:39:00.000-08:00

General Motors and Chrysler say they need more help. So do their suppliers.

FROM the moment in December that the outgoing Bush administration reluctantly threw a $17.4 billion lifeline to General Motors and Chrysler, it was always likely that one way or another the government would have to provide a lot more money. So it has proved.

On February 17th the two struggling carmakers submitted recovery plans to the Treasury Department, as required under the terms of the emergency-loan deal. GM said that it would need at least another $16.6 billion, in addition to the $13.4 billion it has already received, to become smaller, leaner and, it hopes, profitable. It is also seeking $6 billion from other governments to prop up its generally more successful overseas operations. To stay in business, Chrysler asked for $5 billion on top of its existing $4 billion loan.

Both firms insisted that if they did not get the money, bankruptcy would end up costing the taxpayer a great deal more. GM reckoned the government might have to stump up $86 billion to finance its passage through Chapter 11, and Chrysler put the cost of “debtor-in-possession” financing of an orderly wind down of its operations at $24 billion. Most of that money would have to come from the government.

The numbers, though big, were foreseen. The money advanced by President George Bush was only a down-payment designed to see the companies through the first quarter, while his successor decided what to do. Since then, the light-vehicle market has deteriorated further. New-car registrations in America fell by 37.1% year-on-year in January. That equates to an annual market of just 9.5m vehicles, compared with 13.2m in 2008 and 16.1m in 2007. GM is now projecting a market of 10.5m this year, rather than the 12m it had thought was a cautious assumption in December. The company has decided to shut 14 factories in America instead of the nine it had announced. It will eliminate nearly 2,000 dealers and cut 47,000 employees from its payroll, 20,000 of them in America. The Hummer, Saturn and Saab brands are all up for sale or closure. GM thinks it can break even next year, provided the market recovers to 12.5m vehicles or so.

Chrysler attempted, somewhat unconvincingly, to show how it might survive either in a shrunken form as an independent company or as a more successful and global outfit if a proposed alliance with Fiat goes ahead. The Italian carmaker has offered to supply Chrysler with fuel-efficient engines and small-car platforms in exchange for a 35% stake. In that case Chrysler expects, optimistically, to reduce its capacity by only 100,000 vehicles a year.

Both firms (and Ford) also announced tentative agreements with the United Auto Workers union to bring labour costs fully into line with those at the American factories of Asian and European carmakers. But they have been less successful in meeting two of the government’s other conditions for funding. The UAW is unwilling to accept that half the payments into a union-run trust to cover retired workers’ health care should be in company stock. GM is also struggling to unite its bondholders in an agreement to convert two-thirds of its $28 billion debt into equity.

One problem may well have been an absence of sustained government pressure on the negotiators. Only the day before GM and Chrysler were due to present their plans did the administration finally get around to setting up a presidential task-force that will assess both the restructuring efforts of the two companies and the plight of the rest of the American automotive industry. The panel, to be chaired by the treasury secretary, Tim Geithner, and the director of the National Economic Council, Larry Summers, includes Ron Bloom, a former banker and consultant to the United Steelworkers, who played a big part in restructuring the American steel industry.

The task-force faces an unenviable task. In theory, if it is unimpressed by what GM and Chrysler have come up with by March 31st, when the carmakers have to show that their plans are bearing fruit, it could demand immediate repayment of the loans the government has already granted. Given the noises coming from the White House, that is highly unlikely. But the task-force still faces three big, urgent and inextricably related questions.

The first is whether GM really can achieve the required degree of restructuring without entering into some form of managed bankruptcy. The second is whether Chrysler—even with Fiat’s assistance—has a future as an independent company. If not, would it make more sense to grasp the nettle now by selling those assets, such as the Jeep brand, that still have some value? The third is what help should be given to the car-parts industry, which receives far less attention than its famous customers, but which is facing acute problems of its own.

The plight of the parts-makers demonstrates both the urgency and the complexity of the situation. Their trade organisation, the Motor and Equipment Manufacturers Association (MEMA), wrote to Mr Geithner on February 13th warning him that the entire industry, which is the largest manufacturing employer in the country, was facing “breakdown”. In the 18 months to June 2008 the industry’s employment fell from 783,000 to 653,000, since when the rate of job losses and bankruptcies has accelerated.

Although the suppliers are heavily exposed to the difficulties of the Detroit Three, most of them also sell parts to the Asian and European manufacturers in America (see table). Given the extreme interdependency of the supply chain and the degree of specialisation within it, the failure of even one or two small firms can lead to stoppages on vehicle-assembly lines.

The collapse in new-vehicle demand has traumatised parts-makers. They have seen their cashflow fall by half or more during the first quarter, as carmakers have scrambled to cut production, in many cases entirely shutting factories for weeks and months. MEMA’s surveys suggest that a third of the supply base is already in financial distress, and another third expects to fall into that state before the end of the quarter. With inventories finally thinning, the carmakers are now starting to ramp up production, albeit at a much reduced rate. But parts-makers, which typically get paid only after 55 days, must somehow find the cash to supply their customers when no one will lend to them and no payments can be expected before late April.

Parts suppliers used to be able to borrow against payments owing from the Detroit Three, but now cannot find any lenders willing to bear that risk. So they are asking Mr Geithner to guarantee the debt, and to oblige GM and Chrysler, as a condition of their federal loans, to pay them within ten days rather than the usual 55.

But it is unlikely that even these measures would be enough to stave off mass bankruptcies were the task-force to allow GM to go into Chapter 11, which in turn would jeopardise the ability of the carmakers so far not seeking bail-outs—Ford and the foreign transplants—to keep their factories open.

President Obama has said that the final decisions about the future of America’s automotive industry will rest with him. It is doubtful whether any of the choices his task-force presents him with will be either cheap or palatable.

www.economist.com

Wall Street falls sharply at opening.

2009-02-20T07:21:00.000-08:00

Wall Street slides sharply Friday morning as investors continue to worry about economy.

Wall Street fell sharply early Friday, with the Dow Jones industrials reaching new six-year lows as investors around the world keep selling on pessimism about the global economy. Financial stocks led the market lower.
Disappointing fourth-quarter earnings reports from Lowe's and J.C. Penney provided new evidence that the recession is taking a heavy toll on U.S. businesses. The pair also forecast 2009 earnings below analysts' expectations.

The reports came as investors are increasingly worried about the weakening banking industry and what the government is doing to stabilize it.

The Dow tumbled 131.10, or 1.76 percent, to 7,334.85. On Thursday, the Dow fell to its lowest level since Oct. 9, 2002, the depths of the last bear market.

The Standard & Poor's 500 index tumbled 14.05, or 1.80 percent, Friday to 764.89, while the Nasdaq composite index fell 16.14, or 1.12 percent, to 1,426.68.

Key financial stocks including Citigroup Inc. and Bank of America Corp. were falling again after being battered Thursday. Both Citi and Bank of America have been among the hardest hit by the ongoing turmoil in the industry and received multiple multibillion investments from the government to help stabilize their operations.

Citi shares tumbled 52 cents, or 20.9 percent, to $1.99. Bank of America shares sank 72 cents, or 18.3 percent, to $3.21.

"There's perceived disappointment from the lack of clarity from the Treasury (Department) for what it will do with the financial sector," said Wasif Latif, portfolio manager at USAA Investment Management Co. "That's hitting financials regularly."

Stocks have fallen steadily over the past two weeks as investors lost confidence in multiple Obama administration programs aimed at bolstering the economy. The market's inability to rally signals that investors don't have a sense of when the recession, already 14 months old, will end.

"We're going through a tug of war between optimism and pessimism," Latif said. "When there is a lack of clarity, it becomes more of an emotional or psychological environment. The mood can sway on any given day based on the flow of news coming out."

Friday's sell-off followed steep drops overseas. Japan's Nikkei stock average fell 1.87 percent and Hong Kong's Hang Seng fell 2.49 percent. In afternoon trading, Britain's FTSE 100 declined 3.09 percent, Germany's DAX index tumbled 4.08 percent, and France's CAC-40 fell 3.50 percent.

Investors received further evidence of the sagging economy as home improvement retailer Lowe's said its fourth-quarter profit dropped 60 percent after customers cut back on spending. Lowe's also provided a 2009 earnings forecast that was short of analysts' expectations.

Department store chain J.C. Penney said its fourth-quarter profit tumbled 51 percent, but beat analysts' expectations. However, J.C. Penney forecast a first-quarter loss greater than what analysts are forecasting.

Shares of Lowe's fell 42 cents, or 2.5 percent, to $16.56. J.C. Penney shares declined 33 cents, or 2.2 percent, to $14.59.

Yahoo! Finance.com

Consumer prices edge higher.

2009-02-20T07:18:00.001-08:00

Gain is first for government index since July. Annual rate of inflation is lowest since 1955.

Consumer prices rose last month for the first time since July, the government said Friday, but the year-over-year inflation rate was at the lowest level in more than a half-century.

The Consumer Price Index, the key measure of prices at the retail level, was up 0.3% in January, in line with the consensus forecast of economists surveyed by Briefing.com. But the index was unchanged from January 2008 levels, the first time that reading has not shown a year-over-year increase since August 1955, when prices were falling on an annual basis.

Consumer prices fell 0.8% in December.

On an annual basis, the so-called core CPI, which strips out volatile food and energy prices, was up 1.7%, the lowest increase in nearly 5 years. Core prices rose 0.2% in January, a bit more than the 0.1% rise forecast by economists.

Even though there wasn’t a 12-month decline in CPI, it fell at an 8.4% compounded annual rate over the last three months, even with the modest rise in January. And the core CPI rose at a compounded annual rate of only 0.9% over that period, which is below the range of 1% to 2% annual rise in that closely watched reading that is widely believed to be optimal for economic growth.

With inflation in check, there has been growing concern by some economists that the economy could be hurt by deflation, or the widespread drop in prices. James Bullard, president of the Federal Reserve Bank of St. Louis, said in a speech Tuesday that deflation is the greatest risk facing the economy this year.

Lower prices are one way businesses respond to the lack of demand for their products in a slowdown. But if companies can't make a profit selling their products at the lower price, they'll respond by cutting production and laying off more people.

More job losses can cut even further into demand. But even if consumers have jobs and money, they're likely to hold off on purchases if they come to believe that prices will head even lower. All of which adds up to even more weakness in the economy.

The January increase in overall consumer inflation was due largely to a 1.7% rise in overall energy prices, which included a 6% boost in the cost of gasoline.

On a year-over-year basis, energy prices were down 20%, driven by a 40% drop in gasoline.

But the decline in energy prices was not the only thing keeping inflation in check. Overall weak demand for goods and services due to rising job losses and tight credit kept prices low for a wider range of products. Products such as clothing, hotels, video and audio entertainment, and cars and trucks were all cheaper than they were in January 2008.

CNN Money.com

Can’t pay or won’t pay?

2009-02-20T07:13:00.000-08:00

Barack Obama’s team wades into a debate over what is driving foreclosures.

NO PART of the financial crisis has received so much attention, with so little to show for it, as the tidal wave of home foreclosures sweeping over America. Government programmes have been ineffectual, and private efforts not much better. Now it is Barack Obama’s turn. On Wednesday February 18th he pledged $75 billion to reduce the mortgage payments of homeowners at risk of default. Lenders who help people to refinance their mortgages will receive matching subsidies from the government. These could reduce a borrower’s monthly payments to as little as 31% of their income, and last for up to five years.

Firms that service mortgages held by investors will also receive fees for successful modifications. As a stick, Mr Obama reiterated his intention to alter the bankruptcy code so that courts can reduce mortgage principal. The details will depend on negotiations with Congress.

Some 5m homes have entered foreclosure in the past three years. Credit Suisse estimates that over 9m more will enter the process in the next four years. (In normal times, new foreclosures run at fewer than 1m a year.) Mr Obama predicts his plan will prevent up to 4m foreclosures. In a separate initiative, up to 5m borrowers will be able to refinance their mortgages at lower rates even if their equity is less than the 20% usually required by Fannie Mae and Freddie Mac, the now nationalised mortgage agencies.
Previous, less ambitious, efforts have flopped. George Bush’s first plan aimed to help up to 240,000 delinquent subprime borrowers refinance their debts into government-backed fixed-rate mortgages. Only 4,000 did so. A Democrat-inspired $300 billion plan to guarantee up to 400,000 mortgages attracted just 517 applications, as lenders balked at the requirement that they first write down the principal. Private-sector programmes have achieved higher numbers, but their success is mixed. Of 73,000 loans modified in the first quarter of last year, 43% were again delinquent eight months later.

Mr Obama’s chances of being any more successful depend on whether his team has correctly diagnosed what is driving the wave of foreclosures. Is it that homeowners cannot afford to pay; or is it that they are declining to do so, because their homes are now worth less than their mortgages, the phenomenon known as negative equity?

Both factors play a part, but economists are divided on their relative importance. One school thinks that, even in cases of negative equity, most homeowners will not default if they can afford the payments—not least because defaulting will wreck their credit records. A second school believes that once the home is worth less than the mortgage, homeowners have a significant incentive to walk away even if they can make the payment, since in many states lenders cannot then pursue them for the shortfall.

Mr Obama’s advisers were drawn to the first school, in part by a Federal Reserve Bank of Boston study that found that when home prices fell by 23% in Massachusetts between 1988 and 1993, only 6.4% of borrowers with negative equity ended up in foreclosure. The authors concluded that most such borrowers felt what they got from their home was still worth the payment. The advisers were also influenced by the Federal Deposit Insurance Corporation’s apparent success in reducing the payments of delinquent customers of IndyMac, a failed bank. In a matter of months, 10% of the bank’s 56,000 seriously delinquent borrowers had their payments reduced to 38% or less of income.

But others question the likelihood of success without reducing the principal. Edward Pinto, an independent financial industry consultant, estimates that 20% of borrowers with negative equity went to foreclosure in the past three years, in part because they started out much less creditworthy than their counterparts in Massachusetts two decades ago.

If negative equity is the real problem, principal will have to be reduced to stem the foreclosures. But lenders are reluctant: they worry that many homeowners who can afford their payments will choose to default, or that investors in the loans will sue them. With house prices still falling, many borrowers would soon have negative equity again. And the write-downs, whether voluntary or court-ordered, could destroy the lenders’ capital. Aggregate negative housing equity is thought to top $500 billion. The government could absorb some or all of this, but at an astronomical and politically unpalatable price.

In truth, both lower payments and lower principal would help reduce foreclosures. At present, banks aren’t doing much of either. Last month Communities Creating Opportunity, a non-profit group in Kansas City, Missouri, invited representatives of Bank of America and Countrywide to negotiate loan modifications with local customers. Damon Daniel, an organiser, says none of the 16 who applied got a write-down, though some might have their mortgages converted from an adjustable to a fixed interest rate.

Leslie Kohlmeyer and her husband fell behind on their payments two years ago when his construction business dried up. He eventually found new work and they resumed payments, but could not pay their arrears. Three days after Christmas, Countrywide notified them of foreclosure. Ms Kohlmeyer went to Mr Daniel’s event, where a Countrywide official arranged to suspend the foreclosure; her arrears were added to the loan balance, and her monthly payment went up by $20. She thinks she’ll be fine. Unless either she or her husband lose their jobs.

www.economist.com

Obama plan seeks to save millions from foreclosure

2009-02-18T01:27:00.000-08:00

Obama plan seeks to attack home mortgage foreclosures at heart of nation's economic crisis.

His massive stimulus plan now signed into law, President Barack Obama is turning to attack the home foreclosure crisis at the heart of the nation's deepening economic woes.

His goal is to prevent millions of American families from losing their houses because they can't make mortgage payments.

"We must stem the spread of foreclosures and falling home values for all Americans, and do everything we can to help responsible homeowners stay in their homes," Obama said Tuesday as he signed his tax cut and spending package into law.

The ambitious plan he was announcing at a Phoenix high school Wednesday was expected to offer government cash to mortgage companies that reduce interest rates -- and therefore monthly payments -- for homeowners in danger of default, according to several people briefed on the plan. What remained unclear was how the government will decide who qualifies for relief.

One Democratic official familiar with the plan said it also would allow homeowners to refinance their mortgages if they owed more than their homes were valued. Still another section would give bankruptcy judges more authority to change mortgages. That last provision has been opposed by lenders, who said it would add risk and lead to higher interest rates.

The official, who spoke on the condition of anonymity to avoid pre-empting the president, said the Obama administration also would use Fannie Mae and Freddie Mac to help prevent borrowers from defaulting on their mortgages, and create national standards for loan modifications.

The biggest players in the mortgage industry already had halted foreclosures pending Obama's announcement.

Obama's announcement was coming a day after he signed into law a $787 billion economic stimulus plan he hopes will spark an economic turnaround and create or save 3.5 million jobs.

In a ceremony at the Denver Museum of Nature and Science, he hailed the plan's spending on green technology, education and health care, as well as badly needed repair of roads and bridges, and said those, plus middle-class tax cuts, represent the "essential work of keeping the American dream alive in our time."

Obama cautioned that the initiative isn't "the end of our economic troubles. Nor does it constitute all of what we are going to have to do to turn our economy around. But today does mark the beginning of the end."

Republicans dismissed the stimulus plan as hugely expensive and unlikely to succeed. To House Minority Leader John Boehner, R-Ohio, it was "a missed opportunity, one for which our children and grandchildren will pay a hefty price."

At the same time, the administration was grappling with the darkening prospects for the U.S. auto industry.

Even as Detroit carmakers submitted restructuring plans to qualify for continued government loans, General Motors Corp. and Chrysler LLC asked for another $14 billion in bailout cash.

White House press secretary Robert Gibbs said the car companies' plans were being reviewed, but added, "It is clear that going forward, more will be required from everyone involved -- creditors, suppliers, dealers, labor and auto executives themselves -- to ensure the viability of these companies."

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