The Dow Jones industrials fell almost 340 points and the major indexes all fell sharply for the second straight week.Hedge fund selling in advance of a Saturday deadline contributed to the market's gyrations, and some retrenchment was to be expected following a big rally Thursday, when the Dow rallied more than 550 points after falling near its lows for the year. But there was plenty of discouraging news for investors to focus on, including comments from Federal Reserve Chairman Ben Bernanke that the markets remain under "severe strain" and a sobering report on October retail sales.Analysts believe the market is still searching for a bottom after last month's huge losses, and that the pattern of volatility will continue for some time -- selling, even on technical reasons like looming deadlines for cashing out hedge fund holdings, is still coming against a backdrop of an extremely weak economy."Clearly, the trading crowd like hedge funds can take this market in any direction they want to. Anybody looking to build a position is just not confident," said Joseph V. Battipaglia, chief investment officer at Ryan Beck & Co.The session saw another stream of bad news. Bernanke said during a speech in Frankfurt, Germany, that he would work closely with other central banks to try to alleviate the global financial crisis and left open the door to a fresh interest rate cut. The Fed is scheduled to meet Dec. 16 at its last regularly scheduled meeting this year.While Wall Street would like to see another rate cut, many investors aren't sure, given the litany of bad economic and corporate news, of how effective a rate reduction would be in the near term. Many investors are still trying to assimilate the idea that the economy's downturn will be protracted, lasting well into next year and perhaps longer."The economic news continues to be very negative," said Ben Halliburton, chief investment officer of Tradition Capital Management. "The realization that '09 is going to be a very bad year for economic activity is starting to dawn on people and they are starting to digest how bad it's going to be."The Commerce Department reported that retail sales plunged by the largest amount on record in October as consumers cut back on spending in the wake of the financial crisis. Retail sales fell by 2.8 percent last month, surpassing the old mark of a 2.65 percent drop in November 2001 in the wake of the terrorist attacks that year.
Analysts believe the market is still searching for a bottom after last month's huge losses, and that the pattern of volatility will continue for some time -- selling, even on technical reasons like looming deadlines for cashing out hedge fund holdings, is still coming against a backdrop of an extremely weak economy.
"Clearly, the trading crowd like hedge funds can take this market in any direction they want to. Anybody looking to build a position is just not confident," said Joseph V. Battipaglia, chief investment officer at Ryan Beck & Co.
The session saw another stream of bad news. Bernanke said during a speech in Frankfurt, Germany, that he would work closely with other central banks to try to alleviate the global financial crisis and left open the door to a fresh interest rate cut. The Fed is scheduled to meet Dec. 16 at its last regularly scheduled meeting this year.
While Wall Street would like to see another rate cut, many investors aren't sure, given the litany of bad economic and corporate news, of how effective a rate reduction would be in the near term. Many investors are still trying to assimilate the idea that the economy's downturn will be protracted, lasting well into next year and perhaps longer.
"The economic news continues to be very negative," said Ben Halliburton, chief investment officer of Tradition Capital Management. "The realization that '09 is going to be a very bad year for economic activity is starting to dawn on people and they are starting to digest how bad it's going to be."
The Commerce Department reported that retail sales plunged by the largest amount on record in October as consumers cut back on spending in the wake of the financial crisis. Retail sales fell by 2.8 percent last month, surpassing the old mark of a 2.65 percent drop in November 2001 in the wake of the terrorist attacks that year.
As far are stocks are concerned, I still think we are heading higher in the near term. Looking at the 5-day chart of the Dow, I think yesterday was a key reversal day.
Hedge funds started it off and mutual funds and pension funds will follow through next week and going into the end of the year.
However, this is just another bear market rally. The synchronized global economic downturn is just unfolding and it will get a lot worse. Moreover, this will be a protracted recession, which means that global interest rates are heading lower and will stay low for the next two years and possibly a lot longer.
Consumers are retrenching everywhere. All you need to do is read the latest economic outlooks from the IMF and the OECD to see this is a global consumer recession.
Going into this weekend's G-20 meeting, leaders of the world's 20 largest economies will have to come up with solutions to deal with the worst economic crisis we have experienced since the Great Depression of the 1930s.
Ken Georgetti, president of the Canadian Labour Congress and chair of the committee on workers' capital of the International Trade Union Confederation, wrote an excellent article for the Vancouver Sun, stating that real economic solutions require listening to those that are affected:
Some, including President Nicolas Sarkozy of France, have called for nothing less than a profound transformation of the global economic system as it has existed for the past two decades.Leaders of the international labour movement, including myself, will be in Washington to press our own ideas for real change. We will be meeting with the head of the International Monetary Fund and with representatives of president-elect Barack Obama's transition team.We expect that the world's political leaders will finally heed the voice of labour. We've been telling governments for years that working people have been experiencing a crisis, yet many leaders continue to talk to the people who got us into this market-led mess in the hope that they can get us out of it.The immediate cause of this crisis was the inadequate regulation of investment banks, hedge funds and other self-serving players prepared to take huge risks with enormous amounts of other people's money (including workers' savings and pension funds.) But this crisis began in the real economy.The rise of the financial sector and casino capitalism produced huge profits for the Masters of the Universe on Wall Street and in the City of London, but investment in the real economy needed to produce good jobs stagnated as once viable companies were loaded up with unproductive debt and squeezed by private equity funds, hedge funds and investment banks.Meanwhile, the soaring share of financial profits and the global shift of income to a tiny elite at the top of the corporate ladder squeezed the wages and the incomes of ordinary working families almost everywhere.In Canada, as in the U.S., the average worker has barely seen a real wage increase for 20 years. Consumer spending and home purchases have kept economic growth going, but only at the cost of over-stretched families working even longer hours and going deeper into debt.The G-20 has to come up with a new game plan, a return to a world in which finance serves the real economy, and where we invest in a sustainable real economy to boost the living standards of working people in all countries.The G-20 leaders will have to put in place much more stringent rules around the financial sector to stop a crisis like this from happening again. The Canadian Labour Congress is proposing that a small tax be levied on all financial transactions as a means of curbing speculation and funding rescue packages for ordinary workers hit by this crisis, not just for the banks. I have proposed that the proceeds of such a tax in Canada go toward improving public pensions and protecting private pension benefits.The world needs not just lower interest rates and a temporary stimulus, but a major, coordinated, longer term shift to growth and job creation driven by public investment, especially investment in energy conservation and new energy systems, environmental infrastructure, education and skills training, as well as in public services like child care and care for the elderly.Governments can now borrow at a low cost, and their actions will support new private investment in the industries of the future. We also need a plan to raise wages and living standards so as to put a floor under the fast-sinking real economy. The Great Depression of the 1930s happened not just because the banks failed, but also because of a self-feeding downward spiral of rising unemployment and falling wages.We must also ensure that workers have rights to organize and bargain throughout the global economy, and that basic systems of social protection like minimum wages, unemployment insurance and decent public pensions are in place.I don't expect for a minute that the G-20 heads of government will solve the problems of the world in a single day. What I do hope is that they, our prime minister included, see the need for a real change of direction in the troubled days ahead.
Some, including President Nicolas Sarkozy of France, have called for nothing less than a profound transformation of the global economic system as it has existed for the past two decades.
Leaders of the international labour movement, including myself, will be in Washington to press our own ideas for real change. We will be meeting with the head of the International Monetary Fund and with representatives of president-elect Barack Obama's transition team.
We expect that the world's political leaders will finally heed the voice of labour. We've been telling governments for years that working people have been experiencing a crisis, yet many leaders continue to talk to the people who got us into this market-led mess in the hope that they can get us out of it.
The immediate cause of this crisis was the inadequate regulation of investment banks, hedge funds and other self-serving players prepared to take huge risks with enormous amounts of other people's money (including workers' savings and pension funds.) But this crisis began in the real economy.
The rise of the financial sector and casino capitalism produced huge profits for the Masters of the Universe on Wall Street and in the City of London, but investment in the real economy needed to produce good jobs stagnated as once viable companies were loaded up with unproductive debt and squeezed by private equity funds, hedge funds and investment banks.
Meanwhile, the soaring share of financial profits and the global shift of income to a tiny elite at the top of the corporate ladder squeezed the wages and the incomes of ordinary working families almost everywhere.
In Canada, as in the U.S., the average worker has barely seen a real wage increase for 20 years. Consumer spending and home purchases have kept economic growth going, but only at the cost of over-stretched families working even longer hours and going deeper into debt.
The G-20 has to come up with a new game plan, a return to a world in which finance serves the real economy, and where we invest in a sustainable real economy to boost the living standards of working people in all countries.
The G-20 leaders will have to put in place much more stringent rules around the financial sector to stop a crisis like this from happening again. The Canadian Labour Congress is proposing that a small tax be levied on all financial transactions as a means of curbing speculation and funding rescue packages for ordinary workers hit by this crisis, not just for the banks. I have proposed that the proceeds of such a tax in Canada go toward improving public pensions and protecting private pension benefits.
The world needs not just lower interest rates and a temporary stimulus, but a major, coordinated, longer term shift to growth and job creation driven by public investment, especially investment in energy conservation and new energy systems, environmental infrastructure, education and skills training, as well as in public services like child care and care for the elderly.
Governments can now borrow at a low cost, and their actions will support new private investment in the industries of the future. We also need a plan to raise wages and living standards so as to put a floor under the fast-sinking real economy. The Great Depression of the 1930s happened not just because the banks failed, but also because of a self-feeding downward spiral of rising unemployment and falling wages.
We must also ensure that workers have rights to organize and bargain throughout the global economy, and that basic systems of social protection like minimum wages, unemployment insurance and decent public pensions are in place.
I don't expect for a minute that the G-20 heads of government will solve the problems of the world in a single day. What I do hope is that they, our prime minister included, see the need for a real change of direction in the troubled days ahead.
I do not expect that a tax on financial transactions will be warmly received by Prime Minister Harper or President Bush. Nor am I convinced that it will curb speculation (it might even exacerbate it).
But clearly something needs to be done to protect public and private pension plans that are being decimated by virulent deleveraging and excessive volatility.
While some are writing that pension plans may produce the next wave of trouble, I can tell you unequivocally that if leaders do not come up with solutions, the global pension crisis will deepen and threaten the financial security of millions of people across the world.
Capitalism as we know it is at a historic crossroad. I read an article in Bloomberg today that I found extremely disturbing. It seems that more senior citizens in Japan are resorting to picking pockets and shoplifting to cope with cuts in government welfare spending and rising health-care costs in a fast ageing society:
Criminal offences by people 65 or older doubled to 48,605 in the five years to 2008, the most since police began compiling national statistics in 1978, a Ministry of Justice report said. Theft is the most common crime of senior citizens, many of whom face declining health, low incomes and a sense of isolation, the report said. Elderly crime may increase in parallel with poverty rates as Japan enters another recession and the budget deficit makes it harder for the government to provide a safety net for people on the fringes of society. ``The elderly are turning to shoplifting as an increasing number of them lack assets and children to depend on,'' Masahiro Yamada, a sociology professor at Chuo University in Tokyo and an author of books on income disparity in Japan, said in an interview yesterday.``We won't see the decline of elderly crimes as long as the income gap continues to rise.''
Criminal offences by people 65 or older doubled to 48,605 in the five years to 2008, the most since police began compiling national statistics in 1978, a Ministry of Justice report said.
Theft is the most common crime of senior citizens, many of whom face declining health, low incomes and a sense of isolation, the report said. Elderly crime may increase in parallel with poverty rates as Japan enters another recession and the budget deficit makes it harder for the government to provide a safety net for people on the fringes of society.
``The elderly are turning to shoplifting as an increasing number of them lack assets and children to depend on,'' Masahiro Yamada, a sociology professor at Chuo University in Tokyo and an author of books on income disparity in Japan, said in an interview yesterday.
``We won't see the decline of elderly crimes as long as the income gap continues to rise.''
As you enjoy your weekend, I would like you to stop and think about these poor elderly people in Japan that have to resort to crime to cope with economic hardship. What does this say about the values of our wealthy economies when we can't provide a decent retirement or basic social services for the elderly and those in need of social assistance?
It's high time that we stop treating pension funds like casinos and start thinking about solid long-term solutions to the pension crisis. When it comes to the pension promise, failure to deliver is simply unacceptable.
Leo Kolivakis
Pension Pulse
U.S. stocks rallied today after two days of intense selling despite the fact that unemployment rate bolted to a 14-year high 6.5%:
The new snapshot, released Friday by the Labor Department, showed the crucial jobs market quickly eroding. The jobless rate zoomed to 6.5 percent in October from 6.1 percent in September, matching the rate in March 1994.
Unemployment has now surpassed the high seen after the last recession in 2001. The jobless rate peaked at 6.3 percent in June 2003.
October's decline marked the 10th straight month of payroll reductions, and government revisions showed that job losses in August and September turned out to be much deeper. Employers cut 127,000 positions in August, compared with 73,000 previously reported. A whopping 284,000 jobs were axed in September, compared with the 159,000 jobs first reported.
So far this year, a staggering 1.2 million jobs have disappeared. Over half of the decrease occurred in the past three months alone.Although the unemployment report was worse than expected, and Ford Motor Co. reported dismal third-quarter results and announced plans to cut more than 2,000 additional white-collar jobs, Wall Street investors appeared to take it all in stride. The Dow Jones industrial average was up more than 190 points in morning trading.
So far this year, a staggering 1.2 million jobs have disappeared. Over half of the decrease occurred in the past three months alone.
Although the unemployment report was worse than expected, and Ford Motor Co. reported dismal third-quarter results and announced plans to cut more than 2,000 additional white-collar jobs, Wall Street investors appeared to take it all in stride. The Dow Jones industrial average was up more than 190 points in morning trading.
Another company that reported a dismal third quarter was General Motors who warned it may be running out of operating cash this year:
General Motors Corp., seeking federal aid to avoid collapse, said it may not have enough cash to keep operating this year and will fall ``significantly short'' of the amount needed by the end of June unless the auto market improves or it raises more capital. The largest U.S. automaker reported a $4.2 billion third- quarter operating loss today and said its available cash fell to $16.2 billion on Sept. 30 from $21 billion at the end of June. Merger talks with Chrysler LLC were suspended. ``GM is making a pretty direct plea for help,'' said Pete Hastings, a fixed-income analyst at Morgan Keegan Inc. in Memphis, Tennessee. ``The message is, `we've done all the things we can do, and we need help.' And if we don't get help, fill in the blank.'' The cash drain reflected the strain of a 21 percent slump in U.S. sales in the quarter as the credit freeze deepened. It also added urgency to U.S. automakers' request for government aid. The companies are asking for $50 billion in new loans, a person familiar with the proposal said. Chief Executive Officer Rick Wagoner and the CEOs of Ford Motor Co. and Chrysler renewed the push for assistance yesterday in meetings with U.S. House and Senate leaders in Washington. Wagoner said GM also has been in contact with the staff of President-elect Barack Obama.
General Motors Corp., seeking federal aid to avoid collapse, said it may not have enough cash to keep operating this year and will fall ``significantly short'' of the amount needed by the end of June unless the auto market improves or it raises more capital.
The largest U.S. automaker reported a $4.2 billion third- quarter operating loss today and said its available cash fell to $16.2 billion on Sept. 30 from $21 billion at the end of June. Merger talks with Chrysler LLC were suspended.
``GM is making a pretty direct plea for help,'' said Pete Hastings, a fixed-income analyst at Morgan Keegan Inc. in Memphis, Tennessee. ``The message is, `we've done all the things we can do, and we need help.' And if we don't get help, fill in the blank.''
The cash drain reflected the strain of a 21 percent slump in U.S. sales in the quarter as the credit freeze deepened. It also added urgency to U.S. automakers' request for government aid. The companies are asking for $50 billion in new loans, a person familiar with the proposal said.
Chief Executive Officer Rick Wagoner and the CEOs of Ford Motor Co. and Chrysler renewed the push for assistance yesterday in meetings with U.S. House and Senate leaders in Washington. Wagoner said GM also has been in contact with the staff of President-elect Barack Obama.
Poor President-elect Obama, he is just beginning to get a taste of the devastation that awaits him.
In fact, a new report by a leading U.S. think-tank has drawn a doomsday picture for the North American auto industry that shows that if Detroit's automakers shrink further - even fail - the U.S. economy would suffer a crushing blow, losing at least 2.46 million jobs in the first year alone:
In a report released Wednesday, the Center for Automotive Research in Ann Arbor, Mich., outlined what would happen in two separate scenarios if General Motors Corp., Ford Motor Co. and Chrysler LLC were forced to scale back or shut entirely. If all three Detroit manufacturers were to cease operations, the U.S. economy would lose 2.95 million direct and indirect jobs in the first year. Governments would lose at least US$156.4-billion in taxes over the first three years. If Detroit cut output and employment by 50% to meet ever-shrinking market share, which would mean contraction by two of the automakers, 2.46 million jobs would be lost initially. Governments would lose US$108-billion in revenue over three years, according to the analysis."The circumstances are such that either of these scenarios is possible, and indeed one or the other is probable, within the next 12 months," the non-profit think-tank said.
In a report released Wednesday, the Center for Automotive Research in Ann Arbor, Mich., outlined what would happen in two separate scenarios if General Motors Corp., Ford Motor Co. and Chrysler LLC were forced to scale back or shut entirely.
If all three Detroit manufacturers were to cease operations, the U.S. economy would lose 2.95 million direct and indirect jobs in the first year. Governments would lose at least US$156.4-billion in taxes over the first three years.
If Detroit cut output and employment by 50% to meet ever-shrinking market share, which would mean contraction by two of the automakers, 2.46 million jobs would be lost initially. Governments would lose US$108-billion in revenue over three years, according to the analysis.
"The circumstances are such that either of these scenarios is possible, and indeed one or the other is probable, within the next 12 months," the non-profit think-tank said.
The report discusses the ripple effects into Canada and Mexico:
It is reasonable to expect that a permanent contraction in the U.S. auto industry would negatively impact the auto industries of Canada and Mexico, since producers in these regions rely heavily upon U.S.-produced parts and components. This interdependency of the NAFTA automotive producers means that the total economic impacts presented here underestimate the full impact of the scenarios. The decline of Detroit Three production in Canada and Mexico would result in further U.S. losses in employment, income, and government revenues.
And it ends with this stark warning:
Finally, the bankruptcy of any of the Detroit automakers may have serious implications for their pension funds and the level of obligations of the Pension Benefit Guarantee Corporation, as well as funding of the nation’s health care system. The Detroit Three are directly and indirectly responsible for funding the health care of 2 million employees, retirees, and dependents of their own companies and their suppliers.
That is why the PBGC is keeping a tight watch on GM:
General Motors Corp. is being monitored by the Pension Benefit Guaranty Corp., “as financial reports come in,” said Jeffrey Speicher, PBGC public affairs specialist.“We will be looking with great concern as financial reports come in,” he said. “We aren’t sending out any flares or raising any panic.”GM’s pension plan was overfunded, based on its latest filings, he said. “From our point of view, it is difficult to say what the impact (of the market turmoil) is” on the plan, he said.“I don’t know of any public contacts” the PBGC has had with GM executives, he said. “But there are no public steps we can talk about,” he added.GM’s defined benefit plan was $9 billion overfunded, based on assets of $117 billion and accumulated benefit obligations of $108 billion as of Dec. 31, according to a Milliman report.GM’s 10-K showed a funded status of $19 billion, based on assets of $104 billion and liabilities of $85 billion as of Dec. 31.GM’s pension asset allocation was 48.9% fixed income, 30.1% equity and 21% other, according to the Milliam report. GM’s 10-K lists the allocation as 26% equity, 52% debt, 9% real estate and 13% other.Because the GM plan is overfunded, it would not be affected by curtailments of pension benefits, including shutdown benefits in the event of layoffs, under the Pension Protection Act of 2006, according to an ERISA attorney who asked not to be named because of potential conflicts with corporate clients.In 2006, GM froze its salaried defined benefit plan for all active participants, moving them into a new defined contribution plan. That reduced pension expense $383 million in 2006 and reduced the pension benefit obligations by $2.8 billion, according to its 2007 10-K.Standard & Poor’s on Thursday put the bond ratings of GM and its finance unit, GMAC, on negative credit watch, triggering an S&P review of the financial situation over the next three months.The negative watch “reflects the rapidly weakening state of most global automotive markets, along with capital market conditions that will remain a serious challenge for the foreseeable future,” the S&P report said. It did not address pension issues.
General Motors Corp. is being monitored by the Pension Benefit Guaranty Corp., “as financial reports come in,” said Jeffrey Speicher, PBGC public affairs specialist.
“We will be looking with great concern as financial reports come in,” he said. “We aren’t sending out any flares or raising any panic.”
GM’s pension plan was overfunded, based on its latest filings, he said. “From our point of view, it is difficult to say what the impact (of the market turmoil) is” on the plan, he said.
“I don’t know of any public contacts” the PBGC has had with GM executives, he said. “But there are no public steps we can talk about,” he added.
GM’s defined benefit plan was $9 billion overfunded, based on assets of $117 billion and accumulated benefit obligations of $108 billion as of Dec. 31, according to a Milliman report.
GM’s 10-K showed a funded status of $19 billion, based on assets of $104 billion and liabilities of $85 billion as of Dec. 31.
GM’s pension asset allocation was 48.9% fixed income, 30.1% equity and 21% other, according to the Milliam report. GM’s 10-K lists the allocation as 26% equity, 52% debt, 9% real estate and 13% other.
Because the GM plan is overfunded, it would not be affected by curtailments of pension benefits, including shutdown benefits in the event of layoffs, under the Pension Protection Act of 2006, according to an ERISA attorney who asked not to be named because of potential conflicts with corporate clients.
In 2006, GM froze its salaried defined benefit plan for all active participants, moving them into a new defined contribution plan. That reduced pension expense $383 million in 2006 and reduced the pension benefit obligations by $2.8 billion, according to its 2007 10-K.
Standard & Poor’s on Thursday put the bond ratings of GM and its finance unit, GMAC, on negative credit watch, triggering an S&P review of the financial situation over the next three months.
The negative watch “reflects the rapidly weakening state of most global automotive markets, along with capital market conditions that will remain a serious challenge for the foreseeable future,” the S&P report said. It did not address pension issues.
Why is PBGC worried about GM? To answer this, we have to go back three years when GM's pension fund was pouring billions into hedge funds and other alternative investments:
One of the first pensions to start working with hedge funds is also the nation's biggest corporate pension fund, the $90 billion General Motors fund. It started with a small test investment in 1999 and increased it to about $2 billion in 2003, said Jerry Dubrowski, a G.M. spokesman.The company is using hedge funds, along with other unconventional investments, in hopes of getting something close to stock market returns without the market's volatility, Mr. Dubrowski said. To pay out the $6.5 billion G.M. owes to its retirees each year, the pension fund must produce annual returns of a little more than 7 percent. Otherwise, G.M. will have to dip into the fund's principal. At current interest rates, G.M. cannot get those returns with bond investments, and if it tries to juice returns by betting on the stock market, it will have to cope with market swings.
One of the first pensions to start working with hedge funds is also the nation's biggest corporate pension fund, the $90 billion General Motors fund. It started with a small test investment in 1999 and increased it to about $2 billion in 2003, said Jerry Dubrowski, a G.M. spokesman.
The company is using hedge funds, along with other unconventional investments, in hopes of getting something close to stock market returns without the market's volatility, Mr. Dubrowski said. To pay out the $6.5 billion G.M. owes to its retirees each year, the pension fund must produce annual returns of a little more than 7 percent. Otherwise, G.M. will have to dip into the fund's principal. At current interest rates, G.M. cannot get those returns with bond investments, and if it tries to juice returns by betting on the stock market, it will have to cope with market swings.
By 2007, GM's pension fund was getting rave reviews for being a "high-performance pension machine":
There hasn't been much good news out of General Motors in recent years, but you'll be glad to know that at least one part of GM's U.S. operation is finally fixed: its pension funds. GM may be having a hard time turning around its auto business and getting its financial statements straight, but it's kicked butt in pensionland. In fact, GM's funds have done so well that the company has switched about $20 billion in pension assets to lower-risk bonds from higher-risk stocks. It's the equivalent of taking chips off the table after you've gotten ahead of the game.Here's the deal. For reasons we'll examine later, GM's pension surplus increased by $9.6 billion in 2006. That gain would have made GM spectacularly profitable if pension results were part of companies' income statements, as some folks propose. I think that's a bad idea because pension returns distort results, which in turn would discourage companies from offering them. Not that they need much discouragement these days.GM shows just how volatile pensions can be. In a mere four years, its U.S. funds have swung $35 billion, going from $17.8 billion underfunded (according to generally accepted accounting principles) in 2002 to $17.1 billion overfunded last year.To lock in those hard-earned gains, GM has switched investment targets in its $101 billion pension portfolio to just 29 percent stocks and 52 percent bonds from 49 and 32, respectively. (The other 19 percent is in real estate and "alternative investments" such as hedge funds.) Bonds are much less volatile than stocks, hence the change. "It's all about maintaining the funded status of your pension funds," GM's chief financial officer, Fritz Henderson, told me. "We want to take pension risk off the table."How did GM go from the most underfunded corporate plans in the country four years ago to the most overfunded? By putting a ton of money -- $18.5 billion -- into the funds in 2003, most of which it raised in a giant bond issue. It wanted to fix its pension problems once and for all, which it did by getting above-market returns on that new money in what turned out to be an excellent investment market. GM has a stellar investment staff, and I've joked for years that it should dump the car biz and become a money manager. But who listens to me?
There hasn't been much good news out of General Motors in recent years, but you'll be glad to know that at least one part of GM's U.S. operation is finally fixed: its pension funds. GM may be having a hard time turning around its auto business and getting its financial statements straight, but it's kicked butt in pensionland. In fact, GM's funds have done so well that the company has switched about $20 billion in pension assets to lower-risk bonds from higher-risk stocks. It's the equivalent of taking chips off the table after you've gotten ahead of the game.
Here's the deal. For reasons we'll examine later, GM's pension surplus increased by $9.6 billion in 2006. That gain would have made GM spectacularly profitable if pension results were part of companies' income statements, as some folks propose. I think that's a bad idea because pension returns distort results, which in turn would discourage companies from offering them. Not that they need much discouragement these days.
GM shows just how volatile pensions can be. In a mere four years, its U.S. funds have swung $35 billion, going from $17.8 billion underfunded (according to generally accepted accounting principles) in 2002 to $17.1 billion overfunded last year.
To lock in those hard-earned gains, GM has switched investment targets in its $101 billion pension portfolio to just 29 percent stocks and 52 percent bonds from 49 and 32, respectively. (The other 19 percent is in real estate and "alternative investments" such as hedge funds.) Bonds are much less volatile than stocks, hence the change.
"It's all about maintaining the funded status of your pension funds," GM's chief financial officer, Fritz Henderson, told me. "We want to take pension risk off the table."
How did GM go from the most underfunded corporate plans in the country four years ago to the most overfunded? By putting a ton of money -- $18.5 billion -- into the funds in 2003, most of which it raised in a giant bond issue. It wanted to fix its pension problems once and for all, which it did by getting above-market returns on that new money in what turned out to be an excellent investment market. GM has a stellar investment staff, and I've joked for years that it should dump the car biz and become a money manager. But who listens to me?
While I applaud GM's foresight to move aggressively into bonds, I wonder how those alternative investments are doing following the latest hedge fund, private equity and real estate debacles.
Much has been written on what's good for GM or more specifically, "What is good for General Motors is good for America".
As I watch GM and other automakers beg for a $25 billion no-strings attached loan while they slash more jobs, I think about how they squandered the opportunity to introduce the electric car on the market.
I also wonder about the state of GM's pension fund. In particular, as I recall that arrogant and pompous statement uttered over 50 years ago, I wonder if what's good for GM's pension fund is good for American pension funds?
Unfortunately, I get this eerie feeling that GM's pension fund is not as solid as some make it out to be and that it too may be running on fumes.
Investors believing that Wall Street is on the verge of a yearend rally piled into the market Tuesday, brushing off more weak economic data while they scarfed up stocks and propelled the Dow Jones industrials up 300 points to its highest close in four weeks.It was the biggest Election Day rally ever for the Dow, which rose 3.28 percent and topped the 1.2 percent gain seen in 1984 when Ronald Reagan defeated Walter Mondale. Prior to 1980, the market was closed on Election Day.Broader market indexes were also up more than 3 percent Tuesday.Some analysts said the market rose on relief that the presidential election was about to be decided. But others said investors were anticipating a year-end recovery from Wall Street's huge sell-off and bought to be sure they didn't miss out on its start."I seriously doubt it has much to do with the election, other than we're all looking forward to it being over," said independent investment strategist Edward Yardeni.The fact that Wall Street is in the final stretch of a tough year is probably lifting stocks more than the elections, he said. "It's almost been a classic textbook crash in September and October followed by a year-end rally."Steven Goldman, chief market strategist at Weeden & Co., said, "historically, we were at the most oversold levels since October 1974.""We've come to levels that would tend to discount a lot of bad news," he said.There's still a feeling the market might fall back and retest the trading lows reached Oct. 10 before entering a true bull market. But it's possible that the retrenchment won't happen until 2009 -- in similar oversold markets in 1974 and 2002, Goldman said, the return to the lows of the bear market did not happen until two months later.
Broader market indexes were also up more than 3 percent Tuesday.
Some analysts said the market rose on relief that the presidential election was about to be decided. But others said investors were anticipating a year-end recovery from Wall Street's huge sell-off and bought to be sure they didn't miss out on its start.
"I seriously doubt it has much to do with the election, other than we're all looking forward to it being over," said independent investment strategist Edward Yardeni.
The fact that Wall Street is in the final stretch of a tough year is probably lifting stocks more than the elections, he said. "It's almost been a classic textbook crash in September and October followed by a year-end rally."
Steven Goldman, chief market strategist at Weeden & Co., said, "historically, we were at the most oversold levels since October 1974."
"We've come to levels that would tend to discount a lot of bad news," he said.
There's still a feeling the market might fall back and retest the trading lows reached Oct. 10 before entering a true bull market. But it's possible that the retrenchment won't happen until 2009 -- in similar oversold markets in 1974 and 2002, Goldman said, the return to the lows of the bear market did not happen until two months later.
As I have stated many times, hedge funds are hemorrhaging, mutual funds are bleeding and pension funds are reeling so you can pretty much bet that institutions are buying this sucker up going into year-end. They need to window dress their pathetic returns.
But make no mistake about it, this is a huge bear market rally, not the start of a new bull market in stocks. Forget it, you can pray all you want but the the game is over, and there are many, many more shoes that are going to drop in 2009.
The great deleveraging that started last summer, and hit full throttle in mid-September to mid-October, is still going on and it is is wreaking havoc on alternative investments like hedge funds, private equity and real estate.
Moreover, the debt overhang from private equity deals will pinch many companies:
Private equity firms embarked on one of the biggest spending sprees in corporate history for nearly three years, using borrowed money to gobble up huge swaths of industries and some of the biggest names - Neiman Marcus, Metro-Goldwyn-Mayer and Toys "R" Us, among them. The new owners then saddled the companies with the billions of dollars of debt used to buy them. But now many of the loans and bonds sold to finance the deals are about to come due at the worst possible time. Like homeowners with adjustable-rate mortgages that just went up, some of private equity's titans are facing a huge squeeze. And that is coming at the same time as consumers are staying home with their wallets closed. Already this year, big U.S. retailers backed by private equity, like Linens 'n Things, Mervyn's and Steve & Barry's, have filed for bankruptcy. And analysts expect an even broader array of companies backed by private equity - including resorts like Harrah's Entertainment and lenders like GMAC, the financing arm of General Motors - to face more pressure as profits shrivel and creditors come knocking. On Monday, the problems for private equity deepened. Kohlberg Kravis Roberts, the leveraged buyout firm, said it would postpone its plans to go public as the credit crisis worsened. "There's absolutely going to be a lot of pain to go around," said Josh Lerner, a professor of investment banking at Harvard Business School, who wrote a seminal paper on private equity. "The big question is how apocalyptic it will be."Private equity firms, which are lightly regulated, use investors' money to buy undervalued public companies and take them private. The shakeout could have enormous implications for both the U.S. and the global economies: People who work for companies owned by private equity firms could lose their jobs as the companies cut costs to meet debt obligations. And private equity firms like Apollo Management, which owns Harrah's and Linens 'n Things, face deep markdowns on the value of their holdings. Pension funds and university endowments that invested in these funds in recent years hoping for big returns are likely to suffer as well, and many of those investors could face a cash squeeze because they are probably going to have to hold on to the investments for years, until the economy turns around. "The dangling other shoe is now about to drop," said Jeffrey Sonnenfeld, senior associate dean of the Yale School of Management.
Private equity firms embarked on one of the biggest spending sprees in corporate history for nearly three years, using borrowed money to gobble up huge swaths of industries and some of the biggest names - Neiman Marcus, Metro-Goldwyn-Mayer and Toys "R" Us, among them.
The new owners then saddled the companies with the billions of dollars of debt used to buy them. But now many of the loans and bonds sold to finance the deals are about to come due at the worst possible time. Like homeowners with adjustable-rate mortgages that just went up, some of private equity's titans are facing a huge squeeze. And that is coming at the same time as consumers are staying home with their wallets closed.
Already this year, big U.S. retailers backed by private equity, like Linens 'n Things, Mervyn's and Steve & Barry's, have filed for bankruptcy. And analysts expect an even broader array of companies backed by private equity - including resorts like Harrah's Entertainment and lenders like GMAC, the financing arm of General Motors - to face more pressure as profits shrivel and creditors come knocking.
On Monday, the problems for private equity deepened. Kohlberg Kravis Roberts, the leveraged buyout firm, said it would postpone its plans to go public as the credit crisis worsened.
"There's absolutely going to be a lot of pain to go around," said Josh Lerner, a professor of investment banking at Harvard Business School, who wrote a seminal paper on private equity. "The big question is how apocalyptic it will be."
Private equity firms, which are lightly regulated, use investors' money to buy undervalued public companies and take them private.
The shakeout could have enormous implications for both the U.S. and the global economies: People who work for companies owned by private equity firms could lose their jobs as the companies cut costs to meet debt obligations. And private equity firms like Apollo Management, which owns Harrah's and Linens 'n Things, face deep markdowns on the value of their holdings.
Pension funds and university endowments that invested in these funds in recent years hoping for big returns are likely to suffer as well, and many of those investors could face a cash squeeze because they are probably going to have to hold on to the investments for years, until the economy turns around.
"The dangling other shoe is now about to drop," said Jeffrey Sonnenfeld, senior associate dean of the Yale School of Management.
The shoes are dropping like flies and you know things are bad when you read Harvard University's $36.9 billion endowment is in talks to reduce its private-equity holdings as the financial crisis makes leveraged buyouts less profitable:
Harvard officials are in preliminary discussion to sell some of its stakes in private-equity funds, said the person, who asked not to be named because the negotiations are private. The Wall Street Journal reported today that the Cambridge, Massachusetts, school is seeking to drop about $1.5 billion in partnerships managed by companies including Bain Capital LLC. Endowments such as Harvard's, the world's largest university fund, and pension-plan managers pumped a record $1.01 billion into buyout firms in 2006 and 2007 as they chased returns that exceeded those available from public stocks and bonds. They are scaling back as the credit shortage makes it almost impossible for buyout firms to acquire and sell companies, crimping investment profits. Commitments to private-equity pools fell to a three-and-a- half year low of $82.3 billion in the third quarter, according to researcher Private Equity Intelligence Ltd. in London. A Harvard official declined to comment. The private-equity portion of Harvard's endowment returned 9.3 percent in the year ended June 30, compared with an overall return of 8.6 percent, according to a Sept. 12 letter from Harvard Management Co., which oversees the fund. Private equity had a 10-year annualized average return of 28.3 percent, beating the endowment's 13.8 percent average annual return, Harvard said in the letter. Harvard Management has been led since July by Chief Executive Officer Jane Mendillo, who formerly oversaw the endowment of Wellesley College in Massachusetts. Model Portfolio Harvard's policy portfolio, a benchmark model against which it measures the fund's performance, calls for 13 percent of the holdings to be allocated to private equity in the current fiscal year, an increase from 11 percent in the year ended June 30, the management company said in the letter. Investors are seeking buyers in secondary markets for private-equity, real-estate and hedge-fund interests so they can limit their stakes in those asset classes. A drop in the value of public equities has pushed the percentage of assets allocated to private-equity funds too high for some managers.
Harvard officials are in preliminary discussion to sell some of its stakes in private-equity funds, said the person, who asked not to be named because the negotiations are private. The Wall Street Journal reported today that the Cambridge, Massachusetts, school is seeking to drop about $1.5 billion in partnerships managed by companies including Bain Capital LLC.
Endowments such as Harvard's, the world's largest university fund, and pension-plan managers pumped a record $1.01 billion into buyout firms in 2006 and 2007 as they chased returns that exceeded those available from public stocks and bonds. They are scaling back as the credit shortage makes it almost impossible for buyout firms to acquire and sell companies, crimping investment profits.
Commitments to private-equity pools fell to a three-and-a- half year low of $82.3 billion in the third quarter, according to researcher Private Equity Intelligence Ltd. in London.
A Harvard official declined to comment.
The private-equity portion of Harvard's endowment returned 9.3 percent in the year ended June 30, compared with an overall return of 8.6 percent, according to a Sept. 12 letter from Harvard Management Co., which oversees the fund.
Private equity had a 10-year annualized average return of 28.3 percent, beating the endowment's 13.8 percent average annual return, Harvard said in the letter. Harvard Management has been led since July by Chief Executive Officer Jane Mendillo, who formerly oversaw the endowment of Wellesley College in Massachusetts.
Model Portfolio
Harvard's policy portfolio, a benchmark model against which it measures the fund's performance, calls for 13 percent of the holdings to be allocated to private equity in the current fiscal year, an increase from 11 percent in the year ended June 30, the management company said in the letter.
Investors are seeking buyers in secondary markets for private-equity, real-estate and hedge-fund interests so they can limit their stakes in those asset classes. A drop in the value of public equities has pushed the percentage of assets allocated to private-equity funds too high for some managers.
And how are hedge funds responding to this onslaught of redemptions? What else? They are telling their clients the gates are closed so bugger off and wait until the good old days come back.
I am serious. GLG, one of Europe’s largest hedge funds, sent a letter to investors this past weekend saying it is to launch a “liquidity review” of its funds.
Liquidity review?!? Is that a new euphemism in Hedge Land to cover up for gross incompetence? Give me a break.
Bloomberg also reported that Autonomy Capital halted withdrawals from its flagship fund and Permal Group temporarily blocked clients from taking money out of two hedge funds that invest with NWI Management LP while NWI changes its redemption rules.
More bloody incompetence! Who the hell would invest with any hedge fund or fund of hedge funds that blocks or extends the waiting period of your redemption? This is ludicrous, giving new meaning to the term dumb money.
Speaking about changing redemption rules, I heard about one large Canadian public pension fund that is about to change its real estate benchmark in 2009. More incompetence!!!
Of course, their incompetence was rewarded with large bonuses for their real estate team and senior managers who kept mum as they easily beat bogus benchmarks in private markets, claiming they were adding "significant alpha". Yeah right!
But now the real estate benchmark needs to be changed because the economy's downdraft is blowing through commercial real estate:
With few lenders doling out money these days, commercial real estate sales -- including office, mall and warehouse properties -- are expected to be less than half of last year's record-setting $514 billion, according to Real Capital Analytics of New York. More than $14.5 billion in deals have been canceled or pulled away from this yearincluding about $1 billion in the Washington region, according to Cassidy & Pinkard Colliers. In addition, growing layoffs and falling profits mean companies are giving up office space at rapid rates. Nationwide, more than 19 million square feet of space -- enough to fill more than 300 football fields -- has been emptied by office users this year, the most since the months after the Sept. 11 attacks. Locally, about 1 million square feet of office space is dark and empty, according to Reis Inc., a New York based real estate research firm. PriceWaterhouseCoopers and the Urban Land Institute concluded in a recently released report that "U.S. commercial real estate faces its worst year since the wrenching 1991-1992 industry depression." Analysts say that nationwide, rents are stagnant and likely to drop. Vacancy rates at offices, shopping malls and hotels are expected to rise and billions of dollars of loans are coming due next year. "This is a record-setter because it transcends real estate," said John Germano, managing director of the mid-Atlantic region for CB Richard Ellis, one of the country's largest commercial real estate firms. "You've seen companies that real estate depends on like Merrill Lynch, Lehman either be retrenched, sold or go under." Things will get worse if unemployment rises nationwide and consumers continue to cut back on spending, according to analysts. Stores and businesses would lease less space, probably resulting in a glut of office space and lower rents. "We haven't had the second shoe drop," said Dan Fasulo, a managing director at Real Capital Analytics, the real estate research company. "You're going to see more tenants closing up shop." "If we get pushed into a recession, all bets are off. This is affecting everybody," he said. There are a few large, blue-chip projects around the country that are having troubles -- a sign that has brokers, developers and lenders in the industry worried that even deals in good, solid locations with established developers behind them are at risk.
With few lenders doling out money these days, commercial real estate sales -- including office, mall and warehouse properties -- are expected to be less than half of last year's record-setting $514 billion, according to Real Capital Analytics of New York. More than $14.5 billion in deals have been canceled or pulled away from this yearincluding about $1 billion in the Washington region, according to Cassidy & Pinkard Colliers.
In addition, growing layoffs and falling profits mean companies are giving up office space at rapid rates. Nationwide, more than 19 million square feet of space -- enough to fill more than 300 football fields -- has been emptied by office users this year, the most since the months after the Sept. 11 attacks. Locally, about 1 million square feet of office space is dark and empty, according to Reis Inc., a New York based real estate research firm.
PriceWaterhouseCoopers and the Urban Land Institute concluded in a recently released report that "U.S. commercial real estate faces its worst year since the wrenching 1991-1992 industry depression."
Analysts say that nationwide, rents are stagnant and likely to drop. Vacancy rates at offices, shopping malls and hotels are expected to rise and billions of dollars of loans are coming due next year.
"This is a record-setter because it transcends real estate," said John Germano, managing director of the mid-Atlantic region for CB Richard Ellis, one of the country's largest commercial real estate firms. "You've seen companies that real estate depends on like Merrill Lynch, Lehman either be retrenched, sold or go under."
Things will get worse if unemployment rises nationwide and consumers continue to cut back on spending, according to analysts. Stores and businesses would lease less space, probably resulting in a glut of office space and lower rents.
"We haven't had the second shoe drop," said Dan Fasulo, a managing director at Real Capital Analytics, the real estate research company. "You're going to see more tenants closing up shop."
"If we get pushed into a recession, all bets are off. This is affecting everybody," he said. There are a few large, blue-chip projects around the country that are having troubles -- a sign that has brokers, developers and lenders in the industry worried that even deals in good, solid locations with established developers behind them are at risk.
I am wondering what happened to all these geniuses who "measured risk" and "managed risk"? They forgot the biggest risk of all ...SYSTEMIC RISK!!!
Bruce Friesen, an independent and extremely competent consultant who runs CanadianMgrSearch, sent me these words of wisdom:
The premise that is so often repeated by the investment world "changing asset mix is timing and we all know you can't time the markets" needs to be challenged. Winning the Loser's Game by Charles D. Ellis says it all in the asset mix. We need to rethink active asset allocation. Those that did move assets out of equities when assumptions of the growth of the economy were so stretched the last few years need to be rewarded.
Instead, board of directors of large public pension funds rewarded gross incompetence as their pension fund managers ramped down government bonds to plow billions into public and private equity, hedge funds, real estate, CDS, CDOs, ABCP, and all sorts of sexy investments that were suppose to match pension liabilities without taking "undue risks".
Now that is total incompetence!
And on that note, let me end it here and savour a historic moment as Americans vote in a competent president who represents real change.
YES, WE CAN!!!
Some analysts believe certain jobs, such as Treasury secretary, could be announced within days of the election and speculation is already rife about several names. The next Treasury secretary will inherit one of the hottest seats in Washington, tasked both with guiding a $700 billion economic bailout package and the regulatory reform needed to prevent a repeat of the current crisis. Should Obama win, the short list for Treasury would likely include former Treasury secretary Larry Summers, former Federal Reserve Chairman Paul Volcker and Timothy Geithner, president of the Federal Reserve Bank of New York. Both candidates have spoken favorably about investor Warren Buffett, an Obama supporter. McCain has also mentioned former eBay chief Meg Whitman and Cisco Systems CEO John Chambers as possible Treasury picks. Also in the running would be Sheila Bair, head of the Federal Deposit Insurance Corp who has pushed a plan to modify home loans to prevent mortgage defaults. For secretary of State, Massachusetts Democratic Sen. John Kerry; former diplomat Richard Holbrooke, outgoing Republican Sen. Chuck Hagel and former Georgia Democratic senator Sam Nunn are names circulating for Obama. Connecticut Sen. Joseph Lieberman, an Independent, and World Bank President Robert Zoellick are two people McCain would consider. Both Obama and McCain might consider keeping Robert Gates on as secretary of Defense. Obama could also consider tapping former Navy secretary Richard Danzig, a close adviser. McCain has been willing to discuss a few names for jobs such as Treasury secretary. Obama is not tipping his hand either on names on his short lists or the timing of any picks. TRANSITION PLANS Obama's campaign is maintaining the utmost secrecy on planning for the transition, which will occur in the 11 weeks between the November 4 vote and January 20, when a successor to President George W. Bush is sworn in. Obama, a Democratic senator from Illinois, told ABC News he had "some pretty good ideas" about people he might tap for senior jobs, although he emphasized he is focused on the final days of the campaign and takes nothing for granted. He said he would "absolutely" include Republicans in his Cabinet but he sidestepped a question about whether he would ask Gates to stay on at Defense. The Bush administration has emphasized its willingness to make resources available to both candidates to enable them to vet candidates prior to the election. Stephen Wayne, professor of government at Georgetown University, said that in addition to those major Cabinet posts, it would be important for an incoming president to designate a chief of staff early. Rep. Rahm Emanuel, who hails from Obama's home state of Illinois, would be a potential chief of staff for the Democrat as would former Senate Majority leader Tom Daschle. Former Navy Secretary John Lehman might serve that role in a McCain administration.
Some analysts believe certain jobs, such as Treasury secretary, could be announced within days of the election and speculation is already rife about several names.
The next Treasury secretary will inherit one of the hottest seats in Washington, tasked both with guiding a $700 billion economic bailout package and the regulatory reform needed to prevent a repeat of the current crisis.
Should Obama win, the short list for Treasury would likely include former Treasury secretary Larry Summers, former Federal Reserve Chairman Paul Volcker and Timothy Geithner, president of the Federal Reserve Bank of New York.
Both candidates have spoken favorably about investor Warren Buffett, an Obama supporter.
McCain has also mentioned former eBay chief Meg Whitman and Cisco Systems CEO John Chambers as possible Treasury picks. Also in the running would be Sheila Bair, head of the Federal Deposit Insurance Corp who has pushed a plan to modify home loans to prevent mortgage defaults.
For secretary of State, Massachusetts Democratic Sen. John Kerry; former diplomat Richard Holbrooke, outgoing Republican Sen. Chuck Hagel and former Georgia Democratic senator Sam Nunn are names circulating for Obama. Connecticut Sen. Joseph Lieberman, an Independent, and World Bank President Robert Zoellick are two people McCain would consider.
Both Obama and McCain might consider keeping Robert Gates on as secretary of Defense. Obama could also consider tapping former Navy secretary Richard Danzig, a close adviser.
McCain has been willing to discuss a few names for jobs such as Treasury secretary. Obama is not tipping his hand either on names on his short lists or the timing of any picks.
TRANSITION PLANS
Obama's campaign is maintaining the utmost secrecy on planning for the transition, which will occur in the 11 weeks between the November 4 vote and January 20, when a successor to President George W. Bush is sworn in.
Obama, a Democratic senator from Illinois, told ABC News he had "some pretty good ideas" about people he might tap for senior jobs, although he emphasized he is focused on the final days of the campaign and takes nothing for granted.
He said he would "absolutely" include Republicans in his Cabinet but he sidestepped a question about whether he would ask Gates to stay on at Defense.
The Bush administration has emphasized its willingness to make resources available to both candidates to enable them to vet candidates prior to the election.
Stephen Wayne, professor of government at Georgetown University, said that in addition to those major Cabinet posts, it would be important for an incoming president to designate a chief of staff early.
Rep. Rahm Emanuel, who hails from Obama's home state of Illinois, would be a potential chief of staff for the Democrat as would former Senate Majority leader Tom Daschle. Former Navy Secretary John Lehman might serve that role in a McCain administration.
I would include Paul Krugman among those being vetted for the position of Treasury Secretary.
Needless to say, the stakes are high in these elections, and no matter who wins, there are tremendous challenges ahead.
To understand some of the economic challenges, you need to read John Mauldin's latest weekly letter, Electing the Janitor-in-Chief:
The second quarter of 2008 saw an anemic $9.5 billion. At that run rate, we could see a drop-off of well over 90% from 2005! Now, think what the second quarter would have been without the federal stimulus program of $150 billion. It might have looked and felt like this quarter! In the economic data which came out today, consumer spending was down 3.1%. You have to go back to the intense and deep recession of 1980 to find a worse number. And we are just in the middle innings of what is likely to become a much worse recession. So, did American consumers cut back on borrowing? Not if they had a credit card! Total loans from commercial banks to consumers grew by $89 billion for the 12 months ending in September. $61 billion of that was credit card debt, and the amount in recent weeks has exploded. Let's look at this analysis from my favorite slicer and dicer of numbers, data-wizard Greg Weldon (www.weldononline.com). Going with a Halloween theme: "FAR MORE 'telling' is the LOPSIDED degree to which Credit Card balance growth is 'contributing' to total growth in Consumer Loans, a sign of intensifying 'stress' on consumers, amid accelerating job loss, home price deflation, and equity-market paper wealth devaluation. "Even the raging Frankenstein stops to note the shockingly UGLY data details: Commercial Banks, Outstanding Credit Card Balances ... SOARED by an eye-opening + $7.1 billion in the WEEK ending October 15th, representing a +1.9% single-week rate of expansion ... or ... nearly ONE-HUNDRED PERCENT annualized (+98.4%). "Even more 'telling' is the 'read' acquired by contemplating the following pair of data FACTS: * Credit Card Loans, 10 months Sep07-thru-Jul-08 ... up + $29.1 billion * Credit Card Loans, 10 weeks Aug-08-to-mid-Oct-08 ... up + $32.3 billion "In other words, Commercial Bank 'exposure' via the total amount of Credit Card 'loans' outstanding has risen MORE in the last ten WEEKS, than it did in the previous ten MONTHS COMBINED !!! "Moreover, the growth in the last ten-weeks, $32.3 billion, or about $600 million per 'shopping day' since the beginning of August ... represents nominal growth of + 9.3% ... or ... + 48.3% annualized over the last ten weeks. "According to American Express, delinquencies on credit payments rose to 4.1% of all credit outstanding in the 3Q, up from 2.5% in 3Q of 2007, with Bank of America's rate rising even more steeply, to 5.9% in the quarter. "Moreover, the 'pool' of loans deemed 'uncollectable' rose to a high 6.7% in the 3Q, soaring from 3.6% last September." [Emphasis mine.] What consumer spending there is has been fueled in part by credit card. Greg notes this uncomfortable piece of data: the second largest "merchant-vendor" for credit card use is now McDonalds. This suggests that many consumers are in serious distress when they need to get their $4 Big Mac and fries with a credit card. This is the problem facing the economy next year. Credit card growth like we have seen in the last few months has never been sustained at such a level, and is unlikely to be this time either. This is especially true as credit card delinquencies have been rising, as noted above. The next administration is going to be faced with a retrenching consumer, which will likely push the economy even deeper into recession. This will of course result in higher unemployment. In the first year of the next president's term, he is likely to see another one million people lose their jobs, pushing unemployment to almost 8%. Peter Bernstein, in his regular letter, notes the rising levels of the DURATION of unemployment. It is now over 9 months, close to 38 weeks. As the recession deepens, this means a lot of people will stop receiving unemployment benefits. Oh, and of course, unemployment is not good for consumer spending. And it will put even more pressure on homeowners behind on their mortgages. And unemployed people do not pay taxes, widening the deficit. If you thought the recovery under Bush was the "jobless recovery," wait until you see the next version without the benefit of profligate consumer borrowing and spending.
The second quarter of 2008 saw an anemic $9.5 billion. At that run rate, we could see a drop-off of well over 90% from 2005! Now, think what the second quarter would have been without the federal stimulus program of $150 billion. It might have looked and felt like this quarter!
In the economic data which came out today, consumer spending was down 3.1%. You have to go back to the intense and deep recession of 1980 to find a worse number. And we are just in the middle innings of what is likely to become a much worse recession.
So, did American consumers cut back on borrowing? Not if they had a credit card! Total loans from commercial banks to consumers grew by $89 billion for the 12 months ending in September. $61 billion of that was credit card debt, and the amount in recent weeks has exploded.
Let's look at this analysis from my favorite slicer and dicer of numbers, data-wizard Greg Weldon (www.weldononline.com). Going with a Halloween theme:
"FAR MORE 'telling' is the LOPSIDED degree to which Credit Card balance growth is 'contributing' to total growth in Consumer Loans, a sign of intensifying 'stress' on consumers, amid accelerating job loss, home price deflation, and equity-market paper wealth devaluation.
"Even the raging Frankenstein stops to note the shockingly UGLY data details:
Commercial Banks, Outstanding Credit Card Balances ... SOARED by an eye-opening + $7.1 billion in the WEEK ending October 15th, representing a +1.9% single-week rate of expansion ... or ... nearly ONE-HUNDRED PERCENT annualized (+98.4%).
"Even more 'telling' is the 'read' acquired by contemplating the following pair of data FACTS:
* Credit Card Loans, 10 months Sep07-thru-Jul-08 ... up + $29.1 billion * Credit Card Loans, 10 weeks Aug-08-to-mid-Oct-08 ... up + $32.3 billion
* Credit Card Loans, 10 months Sep07-thru-Jul-08 ... up + $29.1 billion
* Credit Card Loans, 10 weeks Aug-08-to-mid-Oct-08 ... up + $32.3 billion
"In other words, Commercial Bank 'exposure' via the total amount of Credit Card 'loans' outstanding has risen MORE in the last ten WEEKS, than it did in the previous ten MONTHS COMBINED !!!
"Moreover, the growth in the last ten-weeks, $32.3 billion, or about $600 million per 'shopping day' since the beginning of August ... represents nominal growth of + 9.3% ... or ... + 48.3% annualized over the last ten weeks.
"According to American Express, delinquencies on credit payments rose to 4.1% of all credit outstanding in the 3Q, up from 2.5% in 3Q of 2007, with Bank of America's rate rising even more steeply, to 5.9% in the quarter.
"Moreover, the 'pool' of loans deemed 'uncollectable' rose to a high 6.7% in the 3Q, soaring from 3.6% last September." [Emphasis mine.]
What consumer spending there is has been fueled in part by credit card. Greg notes this uncomfortable piece of data: the second largest "merchant-vendor" for credit card use is now McDonalds. This suggests that many consumers are in serious distress when they need to get their $4 Big Mac and fries with a credit card.
This is the problem facing the economy next year. Credit card growth like we have seen in the last few months has never been sustained at such a level, and is unlikely to be this time either. This is especially true as credit card delinquencies have been rising, as noted above.
The next administration is going to be faced with a retrenching consumer, which will likely push the economy even deeper into recession. This will of course result in higher unemployment. In the first year of the next president's term, he is likely to see another one million people lose their jobs, pushing unemployment to almost 8%.
Peter Bernstein, in his regular letter, notes the rising levels of the DURATION of unemployment. It is now over 9 months, close to 38 weeks. As the recession deepens, this means a lot of people will stop receiving unemployment benefits. Oh, and of course, unemployment is not good for consumer spending. And it will put even more pressure on homeowners behind on their mortgages. And unemployed people do not pay taxes, widening the deficit.
If you thought the recovery under Bush was the "jobless recovery," wait until you see the next version without the benefit of profligate consumer borrowing and spending.
No doubt about it, the honeymoon will be short and expectations are running high to deliver real change.
President Obama and his new administration need to restore the United States to what it once was - a great nation with a strong middle class. I remain optimistic that they will succeed in bringing about meaningful change to millions of Americans that are suffering right now, but I am worried, knowing full well that the path to success will be long and tortuous, not only for the United States, but for the rest of the world. Leo Kolivakis Pension Pulse
``Downside risks to growth remain,'' the Federal Open Market Committee said today in a statement in Washington. ``Recent policy actions, including today's rate reduction, coordinated interest-rate cuts by central banks, extraordinary liquidity measures, and official steps to strengthen financial systems, should help over time to improve credit conditions and promote a return to moderate economic growth.'' Central bankers worldwide are trying to revive credit and stop a self-reinforcing downturn in consumer spending and bank lending from triggering a global recession. Today's decision follows the half-point reduction the Fed coordinated with the European Central Bank and four other central banks on Oct. 8. Borrowing costs were pared today in Norway and China.
``Downside risks to growth remain,'' the Federal Open Market Committee said today in a statement in Washington. ``Recent policy actions, including today's rate reduction, coordinated interest-rate cuts by central banks, extraordinary liquidity measures, and official steps to strengthen financial systems, should help over time to improve credit conditions and promote a return to moderate economic growth.''
Central bankers worldwide are trying to revive credit and stop a self-reinforcing downturn in consumer spending and bank lending from triggering a global recession. Today's decision follows the half-point reduction the Fed coordinated with the European Central Bank and four other central banks on Oct. 8. Borrowing costs were pared today in Norway and China.
The cut in the target lending rate sent the U.S. dollar lower against all the major currencies:
The ICE's Dollar Index, which tracks the greenback against the euro, the yen, the pound, the Canadian dollar, the Swiss franc and the Swedish krona, fell 0.5 percent, extending the biggest decline since October 1998. It touched the highest level since April 2006 on Oct. 28....The Canadian dollar gained the most in at least 37 years as its U.S. counterpart weakened and commodities including oil, natural gas, copper and gold increased. The loonie appreciated as much as 5 percent to C$1.2126 per U.S. dollar.
``It's pretty much about the Fed today,'' said Martin Roberge, portfolio strategist at Dundee Securities in Montreal. ``A huge decline in the U.S. dollar is a prerequisite for a commodity rally. We probably saw the market lows two days ago.''
I will add my two cents here: powerful vested interests want this market to rally as much as possible going into year-end. Mutual funds, hedge funds and pension funds are all hemorrhaging so bad that they will be buying this sucker on every dip going into the final two months of 2008.
The ferocity of the last selloff was indiscriminate, hitting many solid companies that are now trading at attractive valuations. This explains why Warren Buffett is buying and why Stephen Schwarzman, chairman of Blackstone Group LP, said private-equity firms that buy companies during the credit crisis may see "phenomenal'' profits once global economic growth resumes:
``In periods like this, people get scared out of their minds,'' Schwarzman said in a speech at the North American Venture Capital Summit in Quebec City today. ``This kind of environment is tailor-made for making absolute fortunes in the private-equity business.'' Falling asset prices are bound to help investors, said Schwarzman, whose New York-based firm oversaw $119.4 billion on June 30, including the world's largest buyout fund. Companies being acquired by private-equity firms at just three to four times earnings before taxes, depreciation and amortization will boost future returns, he said. ``I'm not Robert De Niro, but I'm close to a raging bull on private equity,'' Schwarzman said. ``This is a wonderful time to be an investor. In almost every asset class because of this dislocation, you can make phenomenal returns with very little risk.''
``In periods like this, people get scared out of their minds,'' Schwarzman said in a speech at the North American Venture Capital Summit in Quebec City today. ``This kind of environment is tailor-made for making absolute fortunes in the private-equity business.''
Falling asset prices are bound to help investors, said Schwarzman, whose New York-based firm oversaw $119.4 billion on June 30, including the world's largest buyout fund. Companies being acquired by private-equity firms at just three to four times earnings before taxes, depreciation and amortization will boost future returns, he said.
``I'm not Robert De Niro, but I'm close to a raging bull on private equity,'' Schwarzman said. ``This is a wonderful time to be an investor. In almost every asset class because of this dislocation, you can make phenomenal returns with very little risk.''
Nowhere was the "dislocation" more irrational and brutal than the solar sector which got pummeled along with oil and commodities during the last selloff.
But solar is hot right now after solar panel maker First Solar Inc. announced its third-quarter profit more than doubled to beat Wall Street expectations by a wide margin.
I will say it again, solar stocks are "no internet hype". Alternative energy will be the focus of the soon-to-be President Obama and his administration, so pick these stocks up because they have a lot more room to run-up from these levels.
(Here are some solar symbols to track: CSIQ, ESLR, FSLR, JASO, SPWR, STP, SOL, SOLF, TSL, and YGE in the U.S. and TIM.TO and VNP.TO in Canada)
That was the sunny near term forecast. Now, let me give you some worrisome trends I see on the horizon.
There is a huge pension storm looming. It looks like a category 2 hurricane right now, but it can quickly escalate into a category 5 hurricane in 2009.
Today the Globe and Mail reported that Canadian companies are lobbying the federal government for relief from their pension funding obligations as market turmoil drives down the value of their pension-fund assets:
Some companies say they are facing possible financial devastation if they are required to immediately make enormous contributions to their pension plans to fund shortfalls. "There are companies that would absolutely fold if they had to make contributions based on the provisions of the legislation as they stand now," said pension consultant Jeff Kissack of Watson Wyatt in Toronto. One company executive, who spoke on condition of anonymity, said his firm cannot afford to fund the huge gulf in its pension plan, which was already a problem even before stock markets tumbled this fall. Since the beginning of 2008, Canada's benchmark S&P/TSX composite index has fallen about 37 per cent and yesterday's surge will do little to offer much relief. The executive said it cannot be the government's policy intent to act in defence of employee pension plans if it means fatally weakening companies that would otherwise have no other financial problems. "If you actually force some of those companies out of business, it would be a disaster for the poor pensioners who only get 70 cents on the dollar or 80 cents or whatever it was at that point," the executive said. "It's not asking for a tax break or a bailout or a handout. ... You're really saying let us use the money earned within the company and being spent to do the best things for people's jobs and for the company in the long run."...One solution proposed by companies would be a temporary extension of the time limit for funding pension shortfalls, increasing it to 10 or 15 years. Companies currently have five years to make up shortfalls. Another proposal being weighed by Ottawa would give companies a reprieve from doing a pension solvency valuation at year-end, which would help them avoid recording and "locking in" their lower asset valuations for required funding purposes. Pension funds normally have to do a valuation of their obligations and assets every three years, then plan sponsors have five years to fund shortfalls. However, once federally regulated funds are in a shortfall position, OSFI requires valuations to be done annually. Ms. Cameron said about half the pension plans OSFI oversees were in a shortfall position prior to this year, so are doing valuations annually. That means a majority of Canada's federally regulated pension funds will be required to do a valuation report at Dec. 31 this year, giving companies no leeway to wait to see whether asset values recover over the next year or two. Another pension industry expert said the funding situation is especially exaggerated because pension funds are required to measure their obligations and assets on a "solvency" basis, which assumes a company is going to shut its doors immediately and must fund its pension now. He said the calculation is artificial for most companies that are in good health, but they must nonetheless make large contributions to allow for this worst-case scenario. "Before the market turmoil, this was a big issue, but now it's much worse," he said.
Some companies say they are facing possible financial devastation if they are required to immediately make enormous contributions to their pension plans to fund shortfalls.
"There are companies that would absolutely fold if they had to make contributions based on the provisions of the legislation as they stand now," said pension consultant Jeff Kissack of Watson Wyatt in Toronto.
One company executive, who spoke on condition of anonymity, said his firm cannot afford to fund the huge gulf in its pension plan, which was already a problem even before stock markets tumbled this fall. Since the beginning of 2008, Canada's benchmark S&P/TSX composite index has fallen about 37 per cent and yesterday's surge will do little to offer much relief.
The executive said it cannot be the government's policy intent to act in defence of employee pension plans if it means fatally weakening companies that would otherwise have no other financial problems.
"If you actually force some of those companies out of business, it would be a disaster for the poor pensioners who only get 70 cents on the dollar or 80 cents or whatever it was at that point," the executive said.
"It's not asking for a tax break or a bailout or a handout. ... You're really saying let us use the money earned within the company and being spent to do the best things for people's jobs and for the company in the long run."
...
One solution proposed by companies would be a temporary extension of the time limit for funding pension shortfalls, increasing it to 10 or 15 years. Companies currently have five years to make up shortfalls.
Another proposal being weighed by Ottawa would give companies a reprieve from doing a pension solvency valuation at year-end, which would help them avoid recording and "locking in" their lower asset valuations for required funding purposes.
Pension funds normally have to do a valuation of their obligations and assets every three years, then plan sponsors have five years to fund shortfalls. However, once federally regulated funds are in a shortfall position, OSFI requires valuations to be done annually.
Ms. Cameron said about half the pension plans OSFI oversees were in a shortfall position prior to this year, so are doing valuations annually. That means a majority of Canada's federally regulated pension funds will be required to do a valuation report at Dec. 31 this year, giving companies no leeway to wait to see whether asset values recover over the next year or two.
Another pension industry expert said the funding situation is especially exaggerated because pension funds are required to measure their obligations and assets on a "solvency" basis, which assumes a company is going to shut its doors immediately and must fund its pension now.
He said the calculation is artificial for most companies that are in good health, but they must nonetheless make large contributions to allow for this worst-case scenario.
"Before the market turmoil, this was a big issue, but now it's much worse," he said.
The situation for corporate plans in the United States is equally dire to the point where a trade group whose members include Lockheed Martin Corp., Dow Chemical Co. and General Motors Corp. is pressing Congress to help close a record $200 billion deficit in U.S. pensions created by this month's global stock-market collapse:
The Committee on Investment of Employee Benefit Assets is kicking off a lobbying effort today to delay provisions of the Pension Protection Act that it says will force companies to drain cash flow to comply with funding rules set to take effect next year. ``This will be real money that companies will have to come up with,'' said Judy Schub, managing director of the Bethesda, Maryland-based group, which represents 110 of the nation's largest retirement plans holding almost half of U.S. assets. ``The law will be forcing people to be taking money out of operations at the worst possible time.'' Aetna Inc., the third-largest U.S. health insurer, said today that pension expenses caused by stock market declines will lop 30 cents to 40 cents a share off next year's operating earnings. Ryder System Inc.'s pension contributions will ``significantly increase in 2009'' and force ``cost management'' to protect profit, Chief Executive Officer Gregory Swienton told a conference call Oct. 22. The Miami-based, truck-leasing company's plan had $1.5 billion in assets in 2007 and was underfunded by $1 million, according to Standard & Poor's Corp. Pension obligations at Lockheed, the world's biggest defense contractor, would also deplete cash and hurt earnings, Chief Financial Officer Bruce Tanner said last week. Lockheed, Bethesda, Maryland-based maker of F-22 Raptor stealth fighter jets, said on Oct. 21 that 2009 profit will be shaved by about 30 cents a share as it records a $60 million expense next year, compared with the projected $125 million gain on its pension this year. Better Uses for Cash Even companies that aren't necessarily anticipating an impact on earnings are suggesting better uses for the cash. ``While we support the Pension Protection Act and improved funding for corporate pension plans, we are very concerned about the immediate impact to the overall economy if massive cash contributions are required due to the recent stock market declines,'' FedEx Corp. CFO Alan B. Graf Jr. said yesterday. ``In the current liquidity crisis, that money would be better used to support immediate working capital needs, make capital investments and protect American jobs.'' The value of so-called defined benefit plans fell to $1.1 trillion by Oct. 24 from $1.3 trillion at the end of September, according to Mercer, a pension consulting unit of Marsh & McLennan Cos., as the Standard & Poor's 500 index declined 36 percent this year. The $200 billion gap between U.S. retirement plan assets and liabilities indicates that pensions are about 85 percent funded, said Adrian Hartshorn, who advises corporate programs at New York-based Mercer. 94 Percent Funded The Pension Protection Act of 2006 compels companies to cover 94 percent of retirement-plan liabilities to be considered fully funded in 2009. The legislation was passed after funding dropped following the technology sector collapse in 2001. Plans covered 104 percent of obligations and posted a $60 billion surplus at the end of 2007, Mercer said. Companies must cut benefits if assets fall below 80 percent of liabilities and eliminate lump-sum payments below 60 percent, according to the law. At that level, companies must also freeze their plans and prevent participation by new hires. The law ``was unnecessarily conservative in its funding requirements and unnecessarily punitive in cases where companies make an unwise decision relative to plan funding,'' said North Dakota Representative Earl Pomeroy, a member of the House Ways and Means Committee, which will hold hearings on pensions and economic-recovery plans today. `Squeeze on Cash' ``Any stimulus package needs to address the pension issue,'' said Pomeroy, a Democrat and sponsor of legislation that would delay the pension act's ``draconian'' funding provisions. ``The squeeze on cash may not happen tomorrow, but I can assure Congress that if it fails to act, this will be upon us before we know it.'' The first deadline most companies will need to meet is Dec. 31, when they will have to calculate their funding ratio and develop budgets for contributions beginning in the second half of 2009. ``Companies will be facing quite significant cash calls in 2009 and 2010 and more than a few will find it difficult to meet these,'' Hartshorn said. The impact of rising pension expense is making companies cut spending in areas including dividends, said Howard Silverblatt, an S&P analyst in New York. Dividends will fall 10 percent this quarter the worst year-over-year decline since 1958, he said. ``The cash-flow hit is killer,'' Silverblatt said. ``You look in your pocket and there is a hole all the way through to your socks.'' 2008 Returns Next year's pension costs will be determined by 2008 returns on plan assets and interest rate assumptions that won't be made until year-end, according to federal rules. ``Like every other defined-benefit plan, we'll have suffered losses in line with what the markets have done, and we'll have to see what happens,'' Burlington Northern Santa Fe Corp. CFO Thomas Hund said in an Oct. 23 call. ``We were fairly well funded, although not fully funded, prior to the disruption this year,'' said the second-biggest U.S. railroad's CFO. ``And so, there will be funding required if the assets don't return back to previous levels.'' The Dec. 31 deadline to set next year's plan contributions gives Congress, which returns from recess Nov. 17, less than six weeks to resolve the issue. Push Off Rules Congress should push off the 94 percent funding requirement and compel the Treasury Department to redefine how companies deal with market volatility as they calculate assets and liabilities, according to the Committee on Investment of Employee Benefit Assets. The American Benefits Council, another pension-plan trade group, asked for similar action last month. Canadian companies are lobbying that country's federal Finance Department for temporary relief from their pension-fund obligations, including an extension of the time allowed to make up shortfalls, the Globe and Mail reported today. About 59 percent of the 100 largest U.S. pension plans will fall short of the required 2009 funding level, even if stocks pared their decline to 13 percent, Pomeroy said. Midland, Michigan-based Dow's pension funds were overfunded as of Sept. 30, CFO Geoffery Merszei said on the company's Oct. 23 earnings conference call. He didn't say how they'd been affected by the market decline since then. It's ``too early'' to comment on 2009 pension expenses, he said. Dow is the largest U.S. chemical maker. ``Of course, we all know that the equity markets have suffered since the end of September,'' Merszei said. ``I don't know where we are right now, and I don't have the crystal ball to tell you what's going to happen by the end of this year.'' Raytheon Overfunding Raytheon Co., the world's largest missile maker and fifth- largest U.S. defense contractor, predicts it will meet the new pension-funding levels. Raytheon, based in Waltham, Massachusetts, contributed funds to its pension plan ``well in excess'' of requirements, spokesman Jon Kasle said in an e-mailed statement. In 2007, the company added $1.3 billion, of which $900 million was discretionary. This year, the company will add about $550 million, he said. ``Raytheon is focused on managing its pension plan to the guidelines of the Pension Protection Act with an objective to be fully funded well within its required timeframe for our company,'' Kasle said.
The Committee on Investment of Employee Benefit Assets is kicking off a lobbying effort today to delay provisions of the Pension Protection Act that it says will force companies to drain cash flow to comply with funding rules set to take effect next year.
``This will be real money that companies will have to come up with,'' said Judy Schub, managing director of the Bethesda, Maryland-based group, which represents 110 of the nation's largest retirement plans holding almost half of U.S. assets. ``The law will be forcing people to be taking money out of operations at the worst possible time.''
Aetna Inc., the third-largest U.S. health insurer, said today that pension expenses caused by stock market declines will lop 30 cents to 40 cents a share off next year's operating earnings.
Ryder System Inc.'s pension contributions will ``significantly increase in 2009'' and force ``cost management'' to protect profit, Chief Executive Officer Gregory Swienton told a conference call Oct. 22. The Miami-based, truck-leasing company's plan had $1.5 billion in assets in 2007 and was underfunded by $1 million, according to Standard & Poor's Corp.
Pension obligations at Lockheed, the world's biggest defense contractor, would also deplete cash and hurt earnings, Chief Financial Officer Bruce Tanner said last week. Lockheed, Bethesda, Maryland-based maker of F-22 Raptor stealth fighter jets, said on Oct. 21 that 2009 profit will be shaved by about 30 cents a share as it records a $60 million expense next year, compared with the projected $125 million gain on its pension this year.
Better Uses for Cash
Even companies that aren't necessarily anticipating an impact on earnings are suggesting better uses for the cash.
``While we support the Pension Protection Act and improved funding for corporate pension plans, we are very concerned about the immediate impact to the overall economy if massive cash contributions are required due to the recent stock market declines,'' FedEx Corp. CFO Alan B. Graf Jr. said yesterday. ``In the current liquidity crisis, that money would be better used to support immediate working capital needs, make capital investments and protect American jobs.''
The value of so-called defined benefit plans fell to $1.1 trillion by Oct. 24 from $1.3 trillion at the end of September, according to Mercer, a pension consulting unit of Marsh & McLennan Cos., as the Standard & Poor's 500 index declined 36 percent this year. The $200 billion gap between U.S. retirement plan assets and liabilities indicates that pensions are about 85 percent funded, said Adrian Hartshorn, who advises corporate programs at New York-based Mercer.
94 Percent Funded
The Pension Protection Act of 2006 compels companies to cover 94 percent of retirement-plan liabilities to be considered fully funded in 2009. The legislation was passed after funding dropped following the technology sector collapse in 2001. Plans covered 104 percent of obligations and posted a $60 billion surplus at the end of 2007, Mercer said.
Companies must cut benefits if assets fall below 80 percent of liabilities and eliminate lump-sum payments below 60 percent, according to the law. At that level, companies must also freeze their plans and prevent participation by new hires.
The law ``was unnecessarily conservative in its funding requirements and unnecessarily punitive in cases where companies make an unwise decision relative to plan funding,'' said North Dakota Representative Earl Pomeroy, a member of the House Ways and Means Committee, which will hold hearings on pensions and economic-recovery plans today.
`Squeeze on Cash'
``Any stimulus package needs to address the pension issue,'' said Pomeroy, a Democrat and sponsor of legislation that would delay the pension act's ``draconian'' funding provisions. ``The squeeze on cash may not happen tomorrow, but I can assure Congress that if it fails to act, this will be upon us before we know it.''
The first deadline most companies will need to meet is Dec. 31, when they will have to calculate their funding ratio and develop budgets for contributions beginning in the second half of 2009.
``Companies will be facing quite significant cash calls in 2009 and 2010 and more than a few will find it difficult to meet these,'' Hartshorn said.
The impact of rising pension expense is making companies cut spending in areas including dividends, said Howard Silverblatt, an S&P analyst in New York. Dividends will fall 10 percent this quarter the worst year-over-year decline since 1958, he said.
``The cash-flow hit is killer,'' Silverblatt said. ``You look in your pocket and there is a hole all the way through to your socks.''
2008 Returns
Next year's pension costs will be determined by 2008 returns on plan assets and interest rate assumptions that won't be made until year-end, according to federal rules.
``Like every other defined-benefit plan, we'll have suffered losses in line with what the markets have done, and we'll have to see what happens,'' Burlington Northern Santa Fe Corp. CFO Thomas Hund said in an Oct. 23 call.
``We were fairly well funded, although not fully funded, prior to the disruption this year,'' said the second-biggest U.S. railroad's CFO. ``And so, there will be funding required if the assets don't return back to previous levels.''
The Dec. 31 deadline to set next year's plan contributions gives Congress, which returns from recess Nov. 17, less than six weeks to resolve the issue.
Push Off Rules
Congress should push off the 94 percent funding requirement and compel the Treasury Department to redefine how companies deal with market volatility as they calculate assets and liabilities, according to the Committee on Investment of Employee Benefit Assets. The American Benefits Council, another pension-plan trade group, asked for similar action last month.
Canadian companies are lobbying that country's federal Finance Department for temporary relief from their pension-fund obligations, including an extension of the time allowed to make up shortfalls, the Globe and Mail reported today.
About 59 percent of the 100 largest U.S. pension plans will fall short of the required 2009 funding level, even if stocks pared their decline to 13 percent, Pomeroy said.
Midland, Michigan-based Dow's pension funds were overfunded as of Sept. 30, CFO Geoffery Merszei said on the company's Oct. 23 earnings conference call. He didn't say how they'd been affected by the market decline since then.
It's ``too early'' to comment on 2009 pension expenses, he said. Dow is the largest U.S. chemical maker.
``Of course, we all know that the equity markets have suffered since the end of September,'' Merszei said. ``I don't know where we are right now, and I don't have the crystal ball to tell you what's going to happen by the end of this year.''
Raytheon Overfunding
Raytheon Co., the world's largest missile maker and fifth- largest U.S. defense contractor, predicts it will meet the new pension-funding levels.
Raytheon, based in Waltham, Massachusetts, contributed funds to its pension plan ``well in excess'' of requirements, spokesman Jon Kasle said in an e-mailed statement. In 2007, the company added $1.3 billion, of which $900 million was discretionary. This year, the company will add about $550 million, he said.
``Raytheon is focused on managing its pension plan to the guidelines of the Pension Protection Act with an objective to be fully funded well within its required timeframe for our company,'' Kasle said.
Corporations should do exactly what Raytheon is doing with its pension plan, contributing funds well in excess of requirements during good periods to weather the storm during bad periods.
The the truth is that too many corporate pension plan surpluses were being plundered in the good old days to "pad" earnings and now that pensions laws are forcing companies to fund obligations during a liquidity crisis, many are crying foul.
Clearly the funding rules need to be revised. In my pension liabilities section, I posted a link to a paper by Christian Weller of the Center for American Progress, Sensible Funding Rules to Stabilize Pension Benefits.
In this study, Mr. Weller states that a closer look at pension funding and proposed rule changes shows the following:
The pension fund now looks set to tap Californian state employers for higher contributions, at a time when the state's budget is stretched to the limit as a result of its own investment problems. CalPERS, which was one of the first public pension funds to begin investing in private equity and hedge funds, has seen its net worth fall from approximately $240bn in February to $190bn today. A decision on whether employers will need to increase their contributions will not be taken until returns for the 2008 fiscal year are known. "Cushioning the impact of investment setbacks is the fact that Calpers experienced double-digit gains in the four years leading up to the 2007/08 fiscal year," said Ron Seeling, the fund's chief actuary. "We had saved 14pc of the fund for cushioning the blow of a future market downturn, and our smoothing policy is working as it should." If returns do not improve, Calpers said it may require employers to increase payments. The current average employer contribution rate is 13pc of payroll – but increases in contributions could exceed 4pc if losses continue. Even if increases are needed, they will only come into effect in the fiscal year beginning July 2010, due to the benefit of substantial gains in previous years. Whether Californian state and local authorities could meet those payments remains to be seen, however. The state has been one of the hardest hit by the foreclosure crisis, reducing tax-take and leading to additional spending on social welfare. The situation in California had become so bad at one stage earlier this month that Governor Arnold Schwarzenegger said he may need a $7bn loan from the US government in order to meet short-term cash needs as a result of money locked up in the frozen credit markets. That immediate need was resolved after institutional investors purchased revenue anticipation notes from the State treasury, but the overall financial picture remains gloomy. Calpers is not alone in its problems, with the California State Teachers' Retirement System, America's second-largest fund with 795,000 members, seeing a 9.4pc drop in value to $147bn in the three months to the end of September. The situation adds further woes to Americans already struggling with price inflation and reduced incomes as a result of the continued economic downturn across the nation.
CalPERS, which was one of the first public pension funds to begin investing in private equity and hedge funds, has seen its net worth fall from approximately $240bn in February to $190bn today.
A decision on whether employers will need to increase their contributions will not be taken until returns for the 2008 fiscal year are known.
"Cushioning the impact of investment setbacks is the fact that Calpers experienced double-digit gains in the four years leading up to the 2007/08 fiscal year," said Ron Seeling, the fund's chief actuary. "We had saved 14pc of the fund for cushioning the blow of a future market downturn, and our smoothing policy is working as it should."
If returns do not improve, Calpers said it may require employers to increase payments. The current average employer contribution rate is 13pc of payroll – but increases in contributions could exceed 4pc if losses continue.
Even if increases are needed, they will only come into effect in the fiscal year beginning July 2010, due to the benefit of substantial gains in previous years.
Whether Californian state and local authorities could meet those payments remains to be seen, however. The state has been one of the hardest hit by the foreclosure crisis, reducing tax-take and leading to additional spending on social welfare.
The situation in California had become so bad at one stage earlier this month that Governor Arnold Schwarzenegger said he may need a $7bn loan from the US government in order to meet short-term cash needs as a result of money locked up in the frozen credit markets.
That immediate need was resolved after institutional investors purchased revenue anticipation notes from the State treasury, but the overall financial picture remains gloomy.
Calpers is not alone in its problems, with the California State Teachers' Retirement System, America's second-largest fund with 795,000 members, seeing a 9.4pc drop in value to $147bn in the three months to the end of September.
The situation adds further woes to Americans already struggling with price inflation and reduced incomes as a result of the continued economic downturn across the nation.
CalPERS' results should cause politicians around the world to quiver. As world leaders meet next month to discuss how they are going to deal with the financial crisis, there is another more insidious crisis going on - THE PENSION CRISIS!
And CalPERS is not alone. If the stock market does not rebound soon and the recession stretches into next year, as many analysts predict, state leaders may be faced with difficult choices to shore up pension funds that have lost billions of dollars in value since January:
Among immediate options: postponing retirees' cost-of-living increases [Ontario Teachers will cut inflation protection by 50% in 2010]. Other, long-term choices include cutting benefits, increasing employee payroll contributions or relying on more taxpayer dollars to make up for the losses."Those are all definitely things to be considered," said Terry Slattery, president of the National Association of State Retirement Administrators and executive director of the Public Employees Retirement Association of New Mexico.Any policy choices would be agonizing not only for retirees but all state taxpayers. Employees contribute to state pension funds as do government agencies through tax dollars. About 20 million current state and local government employees and 7 million retirees, ranging from teachers to police officers to office workers, are promised pensions, according to a recent GAO report. Benefit checks total about $150 billion a year.Paying retired public employees already is one of states' growing costs, so the market falloff could not come at a worse time. Thousands of aging baby boomers are claiming retirement benefits, and many states are issuing pension checks for longer periods because people are living longer.On top of this, many states are struggling to finance Medicaid, education, transportation and other programs while their tax revenue is shrinking.Hardly a day goes by without a state announcing a double-digit loss in the value of its pension fund. The latest was Virginia, which reported Oct. 16 that its state worker pension fund declined 20 percent in value since July, or about $11 billion.North Carolina's $66 billion public pension fund dropped 12 percent in value over the last year. Tennessee's $30 billion fund declined 10.7 percent since July 1, or more than $5 billion. Just since Sept. 29, New Mexico's $9.7 billion public employee pension fund fell 10.2 percent and its $7 billion teacher retirement fund by 12.5 percent. Pension officials also reported losses in Connecticut (11 percent) and Massachusetts (15 percent). Even Maine's $9.6 billion pension fund, which analysts regard as having one of most conservative investment mixes in the country, has lost 14.5 percent in value since January.State pension officials had been nervously watching their portfolios decline all year. Then the credit crunch hit in September, causing battered stocks to plunge further despite the federal rescue plan. "It's painful. It's hard to watch," said Slattery of New Mexico.Pension funds that had investments tied to Lehman Brothers Holdings Inc., which filed for bankruptcy, and insurance giant AIG International Group Inc., which received a federal bailout, lost tens of millions of dollars in value, although only a fraction of their overall holdings.Florida's pension system, for example, lost nearly $350 million in September in securities of Lehman, AIG and two troubled financial institutions, Washington Mutual and Wachovia Corp. That sounds like a lot of money, but state officials said it was less than two-tenths of 1 percent of the fund's total holdings.Pension fund managers have been assuring retirees and employees over the last month that the funds are safe and their assets ample to pay benefits for several years. They say the funds are more diversified than most Americans' tax-deferred retirement plans, and are designed to withstand the variations of the stock market. History bears this out; pension funds survived the 1987 market crash and most recently the 2001 terrorist attacks."Markets go up and down," said Carroll South, executive director of the Montana Board of Investments, whose teacher and public employee pension funds lost about 5 percent in value since July 1, compared to two years ago when they posted double-digit gains. "You have to take the good along with the bad."South's counterpart in neighboring Wyoming, state treasurer Joe Meyer, was more succinct. Asked by state lawmakers Oct. 9 whether they should be worried about the state's pension fund loss of about $275 million this year, or about 3 percent, Meyer's confident advice was, "Go fishing."Still, state pension fund managers and other analysts say they are worried that a recession, which many economists say could last as long as two years, could dig a deeper hole for many pension plans that already are underfunded. A study released in December by the Pew Center on the States (of which Stateline.org is a part) said the 50 states have promised to pay $2.7 trillion in pension and health benefits over the next 30 years. But states have only set aside about $2 trillion, the report said.Pension specialists say that the funding ratio, or the assets of the fund divided by its benefit liabilities, should be at least 80 percent.New research by Sujit CanagaRetna, a senior fiscal analyst at the Council of State Governments, shows that 30 state pension plans met the 80 percent benchmark at the end of 2007, the most recent year data were available. Five states - Oregon, North Carolina, Florida, Delaware and New York - were 100 percent or more. The bottom five states were Illinois, Oklahoma, Connecticut, Rhode Island and West Virginia [go to the link to see table]. The fear now is that with the recent plunge in the value of state pension funds, many states will fall below the 80 percent benchmark. The lower the funding ratio, the more it is likely a state would have to make up the difference by reducing benefits, increasing contributions or raising taxes."The losses in their pension and other asset funds along with the freezing up of the credit markets has only made the financial position of states even more dire," said CanagaRetna.Girard Miller, a benefits and investment analyst , said in a recent column for Governing magazine and in an interview with Stateline.org that he believes the average public pension plan's funding ratio could fall as low as 65 percent next year, boosting states' unfunded pension liabilities. That assumes an average decline in a fund's investment value of as much as 25 percent, he said.Most pension fund actuaries-outside analysts who calculate risk-had assumed that the investment value of most state funds would rise by 8 percent. If a state's return is below projections, the actuaries could ask them to budget more money.Miller said pension fund managers soon could be telling state policymakers, "Unless something dramatic happens in the markets, we're not going to be able to afford what we thought we would."The market downswing has drawn attention to the change in investment strategy that has evolved in states. Twenty years ago, most state pension funds invested in safe, government securities such as bonds or U.S. Treasury bills.To produce higher yields in their underfunded plans, states gradually have been putting their money into somewhat riskier nongovernmental securities such as stocks, corporate bonds and foreign investments. Some states also have invested in hedge funds, and venture capital funds, or seed money to start a business.Federal Reserve Board data show that about 70 percent of state and local pension investments are in equities, compared to 62 percent in 2000 and 38 percent in 1990.By diversifying their investments, analysts said, states can survive hits such as the bankruptcy of Lehman and collapse of AIG. Pension analysts say that over time, stocks are still the best-performing investment. Fund managers contacted by Stateline.org said they have no immediate plans to make radical changes in their investment mix despite the financial crisis.South of Montana said he has been put on the defensive recently to explain why the state invests in stocks. "It would be riskier not to invest in stocks," he says he answers.
Riskier not to invest in stocks? Take the good along with the bad? Go fishing? Really? Ask Japanese pension fund managers what was the number one asset class during the lost decade of deflation (hint: its starts with a "B" not an "S").
Sometimes I feel like I am the only guy fighting a lonely battle trying to tell people to wake up and smell the coffee. Millions of workers are totally oblivious to the shenanigans that are going to end up costing them and taxpayers billions of dollars.
Mark my words: all pension funds will get slammed this year and for many years to come. Some a lot worse than others, but pension bombs are exploding everywhere and there is no end in sight.
If you think the $700 billion bailout was the end of it, you're dreaming. Just today, Rep. George Miller, D-Calif., said that the government agency that guarantees pension plans for millions of Americans lost at least $3 billion in the past year after investing in mortgage-backed securities:
The government-run Pension Benefit Guaranty Corp. lost at least $3.1 billion in the first 11 months of fiscal year 2008, according to preliminary unaudited figures obtained by the House Education and Labor Committee, of which Miller is chairman."This dramatic loss represents a swing of more than $6 billion from the previous year," Miller said during a hearing in San Francisco. "It's likely that the agency's losses will be substantially worse once numbers from September are reported."
This pension scandal has been years in the making. The herd mentality took over as pension trustees bought the crap pension consultants were feeding them, "diversifying" away from low yielding government bonds into equities, including private equity, commodities, hedge funds, real estate and even CDOs and CDS.
Having met many of the pension officials from U.S. and Canadian public pension funds, I can tell you that most of them have no clue of the inherent risks of hedge funds and even private equity funds. I saw how many of these "senior" pension managers heavily relied on pension consultants who were peddling bad advice to serve their own funds.
It is the biggest scandal of our era. Most of these "top"pension consultants were investing with the funds they were recommending. They were all full of conflicts of interest (they were full of something else too).
Other pension funds just followed the herd and did what Ontario Teachers did or what Harvard and Yale did, fearing "peer group" risk. But they too are going to pay a heavy price for their mindless stupidities. There is a reason why the hedge fund guys call it "dumb money".
If I were a stakeholder or a union representing workers, I would be grilling pension fund managers, the same way I used to grill arrogant hedge fund managers who thought they could pull fast ones on me.
First, I would demand to know if the benchmarks governing each and every investment activity of internal and external managers accurately reflect the risks of the underlying investments.
Stakeholders should force their pension funds to write a public document on how the benchmarks governing each and every investment activity accurately reflect the risks and beta of underlying investments.
As I have stated many times, financial audits are simply not enough. You need to perform rigorous semi-annual performance audits of each and every investment activity right down to the internal guys managing the cash (remember ABCP here in Canada? That saga is far from over!!!).
Importantly, when it comes to hedge funds, private equity, private real estate funds, commodity funds, infrastructure or whatever, make sure you get the benchmarks right or else you risk paying your pension fund managers for taking undue risks and/or delivering beta (market) returns.
Second, ask your pension managers how their results stack up to a portfolio made up of 50% bonds, 50% stocks. I am willing to bet you that all the big "sophisticated" pension funds are under-performing this benchmark.
When it comes to pension governance, remember the three Ts: transparency, transparency, TRANSPARENCY!!!!!
Finally, Dutch pension fund ABP, one of the largest pension funds worldwide, released a press release stating it's been hit by the credit crisis and it reported a shortage in reserves:
Its smaller peer Pensioen Fonds Zorg en Welzijn (PFZW) told Dow Jones Newswires it has also reached a reserve shortage, due to further losses on its investments in the past weeks.ABP's cover ratio, the ratio between its funds and its financial obligations, has dropped below the requirement of around 125% set by the Dutch central bank, or DNB, due to a negative return on investments in the first nine months of 2008. During this period APB lost euro 22 billion on its investments.ABP's cover ratio has dropped to 118% at the end of the third quarter, from 132% at the end of the second quarter. ABP is now legally required to write a recovery plan to show it will bring its ratio back to the required level.ABP provides pensions for Dutch workers in the government and educational sectors. It is one of the top three global pension funds, together with the Government Pension Fund of Norway and the Government Pension Investment Fund of Japan.ABP said the cover ratio has further deteriorated following the end of the third quarter, but didn't provide the current ratio.However, ABP did say its cover ratio is still above the minimum cover ratio of 105%, below which a pension fund can no longer meet its obligations to pensioners.Although PFZW's cover ratio of 126% at the end of the third quarter was still above the required level set by the central bank, the ratio dropped in October due to losses on its investments.The PFZW spokesperson declined to comment on the current ratio but said it was above the critical 105%-level.Both pension funds have been strongly hit by the crisis on the stock markets. During the first nine months of the year ABP lost 24.1% on its equity portfolio, PFZW lost 18.2%.They also reported negative returns on their investments in real estate. ABP reported a negative return of 7.2% on this investment category, PFZW lost 3.4%.[read my last comment on commercial real estate] Overall ABP and PFZW lost 9.8% and 8.1% respectively on their total investments.The total value of ABP's assets dropped to euro 195 billion at the end of the third quarter. At the end of 2007 ABP still held euro 217 billion.In the third quarter alone it lost euro 10 billion. PFZW saw its assets drop to euro 81.9 billion.ABP Chairman Elco Brinkman said the ABP pension fund was hit by the credit crisis, but the payment of pensions wouldn't be affected."Financial markets worldwide have been hit by a strong storm. Of course ABP feels this," Brinkman said, adding, "We will continue to pay out pensions in a normal way."ABP said it will present a recovery plan to DNB before the end of 2008.
I am not as worried about ABP as I am of U.S. state pension plans. A minimum coverage ratio of 105% is pretty solid, if they can maintain it in these treacherous markets. Moreover, unlike their North American counterparts, they are now legally required to write a recovery plan to show how they will bring the coverage ratio back to the required level.
In a few months, we will find out the performance of the large Canadian pension funds. I can guarantee you they will not fare any better as most are hemorrhaging after this year. The financial crisis wreaked havoc on all asset classes, including alternative investments like hedge funds, private equity funds and private real estate funds. It's going to be an extremely ugly year.
Let me end by stating that I sincerely hope politicians and government regulators worldwide are paying attention to the global pension crisis.
Forget the "credit tsunami", watch this "pension tsunami" wreak havoc around the world over the next decade and possibly decades.
***Update on MOSERS
Missouri’s state employees’ pension assets have taken a big hit this year as the stock market has tanked:
But Gary Findlay, executive director of the Missouri State Employees’ Retirement System (MOSERS), remains largely unperturbed. He credits a diversified asset base, a smart allocation strategy and a strong long-term record for allowing the fund to avoid some of the damage while positioning the system for good long-term returns.
“We have exposure to asset classes that are not all that common,” Findlay said. “And we’re very nimble because we’re not that large.” As of June 30, the fund had 6.5 percent of its investments in timber, another 6.2 percent in real estate, 3.1 percent in commodities and 8.8 percent in debt and equity investments not traded on public markets. But the fund, whose assets totaled about $8 billion at the end of June, couldn’t dodge the tumult in this year’s financial markets. From Jan. 1 through Oct. 17, the value of the fund’s assets dropped between $1.6 billion and $1.7 billion, or 19.6 percent, Findlay said. However, passive investing in the same asset classes as the fund holds would have produced a loss of 26 percent, he said. And the All-Country World Index, which the fund uses as a benchmark, dropped 40.7 percent in the same period. “We strive to be, on a relative bases, in the mainstream during up markets, ” Findlay said. “For the year ended June 2007, for example, we were up 18.7 percent, which was slightly better than the median. But our goal is to be defensive enough so that we do substantially better in down markets. Being down 19 percent is not pretty, but it’s better than down 26 or down 40 percent.” The fund, which covers 54,500 state workers and 30,132 retirees, also follows a strategy that allows it to take advantage of tough times in the market. The fund divides its assets among three board categories: roughly 45 percent in stocks, 30 percent in bonds and 25 percent in alternative investments. As the different asset classes move up or down in value, managers occasionally buy and sell assets to keep the total fund close to the target allocation. That forces managers to buy asset classes that have dropped in value and sell assets that have risen or at least have held up better. Findlay said. “By buying assets that have depreciated and selling those that have not, we are buying low and selling high,” Findlay said. The result is a solid long-term performance record. As of June 30, the fund had an annual return of 12.1 percent over the last five years, about 40 percent higher than needed to meet the fund’s objective of earning 5 percentage points above the inflation rate. While the most recent year’s return was a modest 1.6 percent, Missouri was one of only two states’ employee pension funds that produced a positive return that year, Findlay said. The other was Pennsylvania.
“We have exposure to asset classes that are not all that common,” Findlay said. “And we’re very nimble because we’re not that large.”
As of June 30, the fund had 6.5 percent of its investments in timber, another 6.2 percent in real estate, 3.1 percent in commodities and 8.8 percent in debt and equity investments not traded on public markets.
But the fund, whose assets totaled about $8 billion at the end of June, couldn’t dodge the tumult in this year’s financial markets. From Jan. 1 through Oct. 17, the value of the fund’s assets dropped between $1.6 billion and $1.7 billion, or 19.6 percent, Findlay said.
However, passive investing in the same asset classes as the fund holds would have produced a loss of 26 percent, he said. And the All-Country World Index, which the fund uses as a benchmark, dropped 40.7 percent in the same period.
“We strive to be, on a relative bases, in the mainstream during up markets, ” Findlay said. “For the year ended June 2007, for example, we were up 18.7 percent, which was slightly better than the median. But our goal is to be defensive enough so that we do substantially better in down markets. Being down 19 percent is not pretty, but it’s better than down 26 or down 40 percent.”
The fund, which covers 54,500 state workers and 30,132 retirees, also follows a strategy that allows it to take advantage of tough times in the market.
The fund divides its assets among three board categories: roughly 45 percent in stocks, 30 percent in bonds and 25 percent in alternative investments. As the different asset classes move up or down in value, managers occasionally buy and sell assets to keep the total fund close to the target allocation.
That forces managers to buy asset classes that have dropped in value and sell assets that have risen or at least have held up better. Findlay said.
“By buying assets that have depreciated and selling those that have not, we are buying low and selling high,” Findlay said.
The result is a solid long-term performance record. As of June 30, the fund had an annual return of 12.1 percent over the last five years, about 40 percent higher than needed to meet the fund’s objective of earning 5 percentage points above the inflation rate.
While the most recent year’s return was a modest 1.6 percent, Missouri was one of only two states’ employee pension funds that produced a positive return that year, Findlay said. The other was Pennsylvania.
MOSERS is one of the best pension funds in North America and their CIO, Rick Dahl, is one of the best CIOs in the pension industry. I have tremendous respect for Rick and his team.
What impresses me from MOSERS is that they are transparent, they educate their board members and their stakeholders, they got the benchmarks right, including on alternative investments, and they are small enough to be nimble and pick their spots when opportunities arise.
But even they can't escape the carnage in equity markets and the deflation that has spread across all asset classes.
Kenneth Griffin, who founded Citadel in 1990, said in a letter to investors this week that returns for the $10 billion Kensington Global Strategies Fund may swing wildly as markets are battered by the global credit crunch. Griffin holds 30 percent of the firm's $18 billion of assets in cash, according to an Oct. 8 report by Standard & Poor's. ``In the weeks to come, I expect we will continue to see significant volatility in our earnings as the world manages through the unfolding crisis,'' wrote Griffin, 40. ``It is incumbent upon us to navigate through this period and to create value for our stakeholders over the years to come.'' Kensington's loss, more than double the decline of the Credit Suisse/Tremont Hedge Fund Index, may dent Griffin's reputation as a consummate risk manager with no patience for traders who can't make money. Kensington's only annual loss was a 4 percent drop in 1994. Katie Spring, a Citadel spokeswoman, declined to comment. Citadel may have difficulty selling convertible bonds, which accounted for about a quarter of the loss, because there is little demand. The market tumbled 13 percent in October, according to a Merrill Lynch & Co. index. The benchmark is down 21.5 percent since the end of August. ``It's very hard to get out of positions,'' said Tom Sowanick, chief investment officer at Clearbrook Financial LLC in Princeton, New Jersey, which manages $22 billion.
Kenneth Griffin, who founded Citadel in 1990, said in a letter to investors this week that returns for the $10 billion Kensington Global Strategies Fund may swing wildly as markets are battered by the global credit crunch. Griffin holds 30 percent of the firm's $18 billion of assets in cash, according to an Oct. 8 report by Standard & Poor's.
``In the weeks to come, I expect we will continue to see significant volatility in our earnings as the world manages through the unfolding crisis,'' wrote Griffin, 40. ``It is incumbent upon us to navigate through this period and to create value for our stakeholders over the years to come.''
Kensington's loss, more than double the decline of the Credit Suisse/Tremont Hedge Fund Index, may dent Griffin's reputation as a consummate risk manager with no patience for traders who can't make money. Kensington's only annual loss was a 4 percent drop in 1994.
Katie Spring, a Citadel spokeswoman, declined to comment.
Citadel may have difficulty selling convertible bonds, which accounted for about a quarter of the loss, because there is little demand. The market tumbled 13 percent in October, according to a Merrill Lynch & Co. index. The benchmark is down 21.5 percent since the end of August.
``It's very hard to get out of positions,'' said Tom Sowanick, chief investment officer at Clearbrook Financial LLC in Princeton, New Jersey, which manages $22 billion.
But Mr. Griffin isn't ready to throw in the towel:
Even with the losses, Griffin continues to take steps to turn Citadel into a diversified financial firm. He is close to hiring a senior executive for his capital-markets business, according to a person familiar with the matter. At the beginning of the year, Citadel separated that business, which includes an options market-making group and a service that handles administrative chores for hedge funds, from its money-management operations. The options market-making group has returned about 30 percent this year. Citadel also plans to start single-strategy hedge funds, including a fixed-income fund, a macro fund and a convertible- bond fund. These funds will charge investors 2 percent of assets and 20 percent on any investment gains. Citadel's current funds also get 20 percent of any gains, and instead of paying a management fee, clients cover the fund's expenses.
Even with the losses, Griffin continues to take steps to turn Citadel into a diversified financial firm. He is close to hiring a senior executive for his capital-markets business, according to a person familiar with the matter. At the beginning of the year, Citadel separated that business, which includes an options market-making group and a service that handles administrative chores for hedge funds, from its money-management operations. The options market-making group has returned about 30 percent this year.
Citadel also plans to start single-strategy hedge funds, including a fixed-income fund, a macro fund and a convertible- bond fund. These funds will charge investors 2 percent of assets and 20 percent on any investment gains. Citadel's current funds also get 20 percent of any gains, and instead of paying a management fee, clients cover the fund's expenses.
I wouldn't bet against Ken Griffin and I am confident he will reemerge from this brutal hedge fund shakeout a stronger and better money manager. I can't say the same thing about 95% of the hedge funds out there, but he is one manager who understands what true alpha is and he knows how to capture it.
Hedge funds will not be getting any help from U.S. Secretary of Treasury Henry Paulson who today said his plan to inject capital into financial companies is focused on banks and thrifts, indicating unregulated firms such as hedge funds won't initially get government aid:
``It is important to me that when you look at financial institutions that we not have perverse incentives or people's interests in compensation encourage excessive risk-taking,'' Paulson said, while declining to comment on compensation at specific firms.
Mr. Paulson walked away Goldman Sachs with $500 million and a tax exemption on capital gains when he became Treasury Secretary, so he is now eminently qualified to lecture the rest of Wall Street on distorted compensation schemes (!#@?!).
Meanwhile, Bloomberg reports that the U.S. Treasury's pledge to inject $250 billion into banks may coax private-equity leaders Stephen Schwarzman, David Rubenstein and Henry Kravis to resume investing after more than a year spent mostly on the sidelines:
The founders of Blackstone Group LP, Carlyle Group and KKR & Co. LP told investors in Dubai this week that the biggest government intervention in the financial system since the 1930s will help attract private capital to lenders. The U.S. plan, following similar steps by Britain and other nations, may lead to investments of tens of millions dollars, not the $20 billion- plus deals that capped the leveraged-buyout boom of 2006-2007, they said. Private-equity firms have been hunkered down since the onset of the credit crisis about 16 months ago, scarred by broken deals and frustrated by the evaporation of debt financing crucial to buyouts. The efforts to shore up the credit system may pave a slow road back to deploying the almost $500 billion in uncommitted cash they have raised from pension funds, endowments and foreign governments. ``There's a crying need for capital, and now there's a chance that the government will invest alongside,'' said Rubenstein, the 59-year-old co-founder of Washington-based Carlyle, whose $80 billion in assets rank it second in the buyout industry after Blackstone and ahead of KKR.
The founders of Blackstone Group LP, Carlyle Group and KKR & Co. LP told investors in Dubai this week that the biggest government intervention in the financial system since the 1930s will help attract private capital to lenders. The U.S. plan, following similar steps by Britain and other nations, may lead to investments of tens of millions dollars, not the $20 billion- plus deals that capped the leveraged-buyout boom of 2006-2007, they said.
Private-equity firms have been hunkered down since the onset of the credit crisis about 16 months ago, scarred by broken deals and frustrated by the evaporation of debt financing crucial to buyouts. The efforts to shore up the credit system may pave a slow road back to deploying the almost $500 billion in uncommitted cash they have raised from pension funds, endowments and foreign governments.
``There's a crying need for capital, and now there's a chance that the government will invest alongside,'' said Rubenstein, the 59-year-old co-founder of Washington-based Carlyle, whose $80 billion in assets rank it second in the buyout industry after Blackstone and ahead of KKR.
I am willing to bet you that Comrade Paulson's next gig will be sitting on the board of one of these "prestigious" private equity funds collecting huge "advisory" fees.
But my sarcasm aside, investors should pay attention to what these private equity funds do, not what they say. If they do come back to the market, it is very bullish, signalling an end to the credit crisis and the beginning of an important market consolidation phase.
If that happens, I would also expect mergers & acquisitions to pick up and bring the market higher as firms get taken out at higher multiples.
The injection of private equty capital couldn't come soon enough. The volatility that Ken Griffin alluded to earlier in my post was once again present in today's stock market as stocks came back from testing the lows and soared into the close:
It is clear that investors are reacting in the extreme to any negative economic news, including disappointing numbers Thursday on industrial production that sent stocks skidding. But traders are also responding to the market's own dynamics, and when there was no late-session plunge, as there was on Wednesday, buyers piled in before the close.Analysts expect this extraordinary volatility to continue, and warned that just as Monday's huge 936-point surge in the Dow was overdone, there was little reason to trust that Thursday's gains would hold.
It is clear that investors are reacting in the extreme to any negative economic news, including disappointing numbers Thursday on industrial production that sent stocks skidding. But traders are also responding to the market's own dynamics, and when there was no late-session plunge, as there was on Wednesday, buyers piled in before the close.
Analysts expect this extraordinary volatility to continue, and warned that just as Monday's huge 936-point surge in the Dow was overdone, there was little reason to trust that Thursday's gains would hold.
I happen to disagree. As I stated yesterday, institutions like hedge funds, mutual funds and pension funds will do everything they can to bring this market up from these depressed levels to make up for the numbing losses they suffered thus far this year. This is my "vested interests" theory and why I believe this bear market rally has legs to continue grinding higher.
But as we grind higher, it will remain a choppy and volatile market:
``We have a manic-depressive market,'' said Frederic Dickson, who helps oversee about $20 billion as chief market strategist at D.A. Davidson & Co. in Lake Oswego, Oregon. ``The speed at which markets are reacting to news right now is close to mind-numbing. If the bond insurers are going to line up at the Treasury, that's probably a good thing. Oil at $70 a barrel has just given the American public a tax break.''
So fasten your seatbelts and keep my "vested interests" theory in mind as you watch this volatile market grind higher. When you finally muster the strength to open your monthly statements at the end of the month, just remember that institutions have not fared better in these savage markets and they have a lot of catching up to do before they see greener pastures.
U.S. stocks slumped for a second day, hammered by the biggest drop in retail sales in three years and growing doubt that plans to bail out banks will keep the nation out of a prolonged recession:
``The state of the economy is weighing heavily on investors' minds,'' said Lawrence Creatura, a fund manager at Clover Capital Management in Rochester, New York, which oversees $2.7 billion. ``This has so far been largely a Wall Street problem, but it's starting to cross over to Main Street and the data today supports that.''...``A big chunk of our economy is in recession right now,'' said Tom Wirth, senior investment officer at Chemung Canal Trust Co. in Elmira, New York, which manages $1.5 billion. ``There's fear the Christmas season is going to be miserable.''
Almost immediately after the market’s historic rebound Monday, investors began to dread the inevitable: a so-called “test” of the previous lows, an occurrence that generally follows just about all massive selloffs. But the idea of a “test” is one that’s easily misinterpreted. For a variety of reasons, stocks don’t move in straight lines, but this does not mean that the major indexes do not have to descend to the previous levels reached in order for investors to conclude that a test has taken place. “Some people think it has to go right back to the low, but it could be shallow, or deep, or a lower low,” says Phil Roth, chief technical strategist at Miller Tabak. “At this point, a test started yesterday. How deep it’s going to be, I don’t have the answer to that yet.” Friday, the Standard & Poor’s 500-stock index bottomed out at 839.80, and the Dow industrials hit a low of 7882.51, before both indexes recovered to close out the session. William Gibson, managing director of research at Nollenberger Capital Markets, says he’s looking for the half-way point between Tuesday’s high and Friday’s low — which comes to 942.06 on the S&P — as a harbinger that a “test is underway.”What happens from there is anyone’s guess. History provides only a modicum of comfort here. In 1987, following Black Monday, the subsequent selloff held about 10% above the low, which would translate to about 8670 on the Dow this time, according to Marc Pado, chief investment strategist at Cantor Fitzgerald. The halfway point between the recent low and the bounce following would be about 8838, which Mr. Pado believes is an optimistic, but valid projection based on the massive rescue effort and the cash raised by funds for redemptions. After the 1929 crash, the activity that followed was worse. The market crashed in October, made a lower low in November, recovered for five months after that, and then went down for two years. In 1962, the market rallied sharply from a low in May and then dropped again, falling to a lower low in June. Obviously, not all of the movement can be attributed to technical factors — the policy response in 2008 has been much stronger than in 1929, Mr. Roth notes. In addition, the point at which the selling crescendo occurs can also contribute to whether the market falls further later on. The 1929 crash started that period’s bear market, while the 1987 crash was basically a bear market in and of itself. This time, the process is further along, but the market get a “rebuilding noted by declining volume and volatility, and emotion comes out of the market — and then people will be saying, ‘Now, what about the recession?‘” Mr. Roth says.
But the idea of a “test” is one that’s easily misinterpreted. For a variety of reasons, stocks don’t move in straight lines, but this does not mean that the major indexes do not have to descend to the previous levels reached in order for investors to conclude that a test has taken place.
“Some people think it has to go right back to the low, but it could be shallow, or deep, or a lower low,” says Phil Roth, chief technical strategist at Miller Tabak. “At this point, a test started yesterday. How deep it’s going to be, I don’t have the answer to that yet.”
What happens from there is anyone’s guess. History provides only a modicum of comfort here. In 1987, following Black Monday, the subsequent selloff held about 10% above the low, which would translate to about 8670 on the Dow this time, according to Marc Pado, chief investment strategist at Cantor Fitzgerald. The halfway point between the recent low and the bounce following would be about 8838, which Mr. Pado believes is an optimistic, but valid projection based on the massive rescue effort and the cash raised by funds for redemptions.
After the 1929 crash, the activity that followed was worse. The market crashed in October, made a lower low in November, recovered for five months after that, and then went down for two years. In 1962, the market rallied sharply from a low in May and then dropped again, falling to a lower low in June. Obviously, not all of the movement can be attributed to technical factors — the policy response in 2008 has been much stronger than in 1929, Mr. Roth notes.
In addition, the point at which the selling crescendo occurs can also contribute to whether the market falls further later on. The 1929 crash started that period’s bear market, while the 1987 crash was basically a bear market in and of itself. This time, the process is further along, but the market get a “rebuilding noted by declining volume and volatility, and emotion comes out of the market — and then people will be saying, ‘Now, what about the recession?‘” Mr. Roth says.
Having seen this plenty of times on individual stocks, please let me explain what "retesting the lows" means. When markets gap up in an explosive rally following a long down period, like they did on Monday, we see profit taking and then prices go back to "fill the gap" opening of that day.
Check out the 5 day chart on the Dow. You can see what "retesting the lows" means. This happens often in markets and individual stocks after an explosive rally (that is why you shouldn't rush to buy after explosive moves up!!!).
It isn't necessarily a bad thing: if the 8500 levels hold on the Dow, we can grind back up and possibly test the 50 and 200 day moving averages in the following weeks and months ahead.
Of course, in these jittery markets, investors might throw in the towel and just start selling indiscriminately again.
I do not think this will be the case. Why? Because hedge funds, stock mutual funds and pension funds do not want to kill the market. They need a bounce from these levels going into year-end. 2009 is another story, but from here, I expect us to grind higher.
The Dow plunged 733 points to close at 8,578 today. If you look at these historic prices, you see we opened at 8,462 on Monday after reaching intra-day lows of 7,773 last Friday and closing last week at 8,841.
In the next few days, my "vested interests" theory will be put to the test. If we do not hold these levels, watch out below, it will get very ugly.
The Standard & Poor's 500 Index rebounded from its worst week in 75 years with an 11.6 percent advance, its steepest since 1939, and the Dow Jones Industrial Average climbed more than 936 points. Morgan Stanley soared 87 percent after sealing a $9 billion investment from Japan's Mitsubishi UFJ Financial Group Inc. Alcoa Inc., Johnson & Johnson, Chevron Corp. and Prudential Financial Inc. posted their biggest gains since Bloomberg began tracking the data. Europe's benchmark index climbed 10 percent, its best jump ever, and Asia's added 3.1 percent. ``The worst of the immediate danger is past,'' said Bruce McCain, chief investment strategist at Key Private Bank in Cleveland, which manages $30 billion. ``It's always easier when you've got markets going up and you're not having to talk clients back in off the ledge.'' The S&P 500 rose 104.13 points to 1,003.35. The Dow increased 936.42, or 11 percent, to 9,387.61, eclipsing its previous record 499-point gain in March 2000 and posting its best percentage advance since 1933. The Nasdaq Composite Index climbed 194.74, or 12 percent, to 1,844.25. Sixteen stocks gained for each that fell on the New York Stock Exchange. The S&P 500 halted an eight-day losing streak, its longest since 1996. Last week's 18 percent declines pushed both the S&P 500 and Dow down more than 40 percent from their peaks last October. The S&P 500 ended last week trading for 17 times reported earnings of its companies, the cheapest valuation in more than a year. ... Today's rally boosted the index's price-to-earnings ratio to 19.2. The S&P 500 is still down 32 percent in 2008, poised for its worst yearly loss since 1937. All 10 industries in the S&P 500 added more than 7 percent. The rally from Tokyo to New York sent the MSCI World Index up 9.5 percent, the biggest gain since the gauge was created in 1970. Some 1.5 billion shares changed hands on the floor of the NYSE, less than 1 percent more than the three-month daily average. The bond market was closed for the Columbus Day holiday. The dollar fell the most in three weeks against the euro.
The Standard & Poor's 500 Index rebounded from its worst week in 75 years with an 11.6 percent advance, its steepest since 1939, and the Dow Jones Industrial Average climbed more than 936 points. Morgan Stanley soared 87 percent after sealing a $9 billion investment from Japan's Mitsubishi UFJ Financial Group Inc. Alcoa Inc., Johnson & Johnson, Chevron Corp. and Prudential Financial Inc. posted their biggest gains since Bloomberg began tracking the data. Europe's benchmark index climbed 10 percent, its best jump ever, and Asia's added 3.1 percent.
``The worst of the immediate danger is past,'' said Bruce McCain, chief investment strategist at Key Private Bank in Cleveland, which manages $30 billion. ``It's always easier when you've got markets going up and you're not having to talk clients back in off the ledge.''
The S&P 500 rose 104.13 points to 1,003.35. The Dow increased 936.42, or 11 percent, to 9,387.61, eclipsing its previous record 499-point gain in March 2000 and posting its best percentage advance since 1933. The Nasdaq Composite Index climbed 194.74, or 12 percent, to 1,844.25. Sixteen stocks gained for each that fell on the New York Stock Exchange.
The S&P 500 halted an eight-day losing streak, its longest since 1996. Last week's 18 percent declines pushed both the S&P 500 and Dow down more than 40 percent from their peaks last October. The S&P 500 ended last week trading for 17 times reported earnings of its companies, the cheapest valuation in more than a year.
Today's rally boosted the index's price-to-earnings ratio to 19.2. The S&P 500 is still down 32 percent in 2008, poised for its worst yearly loss since 1937.
All 10 industries in the S&P 500 added more than 7 percent. The rally from Tokyo to New York sent the MSCI World Index up 9.5 percent, the biggest gain since the gauge was created in 1970.
Some 1.5 billion shares changed hands on the floor of the NYSE, less than 1 percent more than the three-month daily average. The bond market was closed for the Columbus Day holiday. The dollar fell the most in three weeks against the euro.
So the big question now is this another sucker's rally or time to buy? I quote the following:
On the heels of the worst week in history, the prevailing wisdom on Wall Street is the stock market is now cheap, especially relative to Treasuries and most especially for long-term investors, With the S&P trading at 13 times expected 2009 earnings and 17.2 times on a trailing P/E basis, "buy the dip" is the mantra from many observers: "The sell-off has gone much too far and stocks are poised to rally powerfully if the downturn is less severe than investors," according to The New York Times. The "Ben Graham P/E" - which divides the price of stocks by their inflation-adjusted net earnings average for the past 10 years - is the lowest its been since 1989, The WSJ reports. Even typically skeptical observers like Barron's Alan Abelson and FusionIQ's Barry Ritholtz were writing this weekend about the potential for a short-term market bounce of between 20%-30%. That message, along with news of the U.K.'s injection of capital into big banks and Mitsubishi UFJ's investment in Morgan Stanley, helped the U.S. stock market rally strongly early Monday, following the path of global proxies.I would caution against reading too much into Monday's action: the bond market and U.S. banks are closed in observance of Columbus Day while Japan's financial markets were also closed for holiday observance.More importantly, I'm highly skeptical Friday marked anything more than a temporary bottom for stocks, for a variety of reasons:The continued lack of a coordinated global policy response, and the U.S. continuing to lag other nations in taking the most dramatic steps like insuring all bank deposits and directly injecting capital into banks.Accelerating weakness in the "real" economy; ISI's Ed Hyman dramatically reduced his GDP estimates through the second half of 2009 and predicts unemployment will hit 8.5% before the cycle turns. Valuations tend to overshoot on the downside and bear markets historically don't end until P/E ratios hit single digits.Even after devastating declines in recent weeks, "buy the dip" remains the conventional wisdom, meaning sentiment still remains overly optimistic. "The past week has demonstrated that trying to buy 'close' to the bottom of a bear market can be a very dangerous strategy," Lowry's Reports commented this weekend. Last week's "series of 90% down days" - trading sessions where 90% or more of both price action and volume is to the downside - "is, at this point, solid evidence that the desire to sell has not been exhausted."Veteran market watchers like Art Cashin of UBS and John Roque of Natixis Bleichroeder are using the 2002 lows - about Dow 7300 and S&P 775 - as downside targets.
On the heels of the worst week in history, the prevailing wisdom on Wall Street is the stock market is now cheap, especially relative to Treasuries and most especially for long-term investors,
With the S&P trading at 13 times expected 2009 earnings and 17.2 times on a trailing P/E basis, "buy the dip" is the mantra from many observers:
That message, along with news of the U.K.'s injection of capital into big banks and Mitsubishi UFJ's investment in Morgan Stanley, helped the U.S. stock market rally strongly early Monday, following the path of global proxies.
I would caution against reading too much into Monday's action: the bond market and U.S. banks are closed in observance of Columbus Day while Japan's financial markets were also closed for holiday observance.
More importantly, I'm highly skeptical Friday marked anything more than a temporary bottom for stocks, for a variety of reasons:
"The past week has demonstrated that trying to buy 'close' to the bottom of a bear market can be a very dangerous strategy," Lowry's Reports commented this weekend. Last week's "series of 90% down days" - trading sessions where 90% or more of both price action and volume is to the downside - "is, at this point, solid evidence that the desire to sell has not been exhausted."
I happen to think that this powerful rally will have legs but I am still curious to see how we close tomorrow (I expect profit taking in the morning but I want to see if fresh cash comes into the market).One thing I do know is that hedge funds are still performing miserably, stock mutual funds are no better, and Canadian pension funds took their worst hit in ten years (same for global pension funds).What does all this mean? I suspect institutions will be buying this sucker as much as possible heading into the end of the month. They need to make up for lost ground.Make sure you read yesterday's commentary, Beyond the 2008 Stock Market Crash. I took the time to research what hedge fund and mutual fund managers were buying during last week's savage selloff.Also, I highly recommend you read John Mauldin's latest Outside the Box commentary, Why the Worst Will Soon Be Over.
Leo Kolivakis Pension Pulse
Krugman, 55, was honored ``for his analysis of trade patterns and location of economic activity,'' said the Royal Swedish Academy of Sciences, which selects the winners. His work showed how economies of scale influence trade and urbanization. While Krugman found broader fame with his newspaper columns attacking Bush, he gained his reputation in economics by arguing countries could gain a competitive advantage through subsidies to key industries. His research helped explain how the development of large-scale production for the world market has attracted more people to cities and led to higher wages. ``This award is clearly for Paul Krugman the economist, not for Paul Krugman the journalist or political critic,'' said Robert Solow, a 1987 Nobel laureate who once taught Krugman.``What's remarkable about Paul is he manages to do everything. He's a contributor to fundamental economic theory and a top-ranked journalist.'' In a brief telephone interview after the award was announced, Krugman said ``it's a total surprise.'' The Princeton economist's academic work analyzed how world trade came to be dominated by countries that both import and export similar products -- automobiles, for example. ``This kind of trade enables specialization and large-scale production, which result in lower prices and a greater diversity of commodities,'' the Royal Academy said in a statement today.
Krugman, 55, was honored ``for his analysis of trade patterns and location of economic activity,'' said the Royal Swedish Academy of Sciences, which selects the winners. His work showed how economies of scale influence trade and urbanization.
While Krugman found broader fame with his newspaper columns attacking Bush, he gained his reputation in economics by arguing countries could gain a competitive advantage through subsidies to key industries. His research helped explain how the development of large-scale production for the world market has attracted more people to cities and led to higher wages.
``This award is clearly for Paul Krugman the economist, not for Paul Krugman the journalist or political critic,'' said Robert Solow, a 1987 Nobel laureate who once taught Krugman.
``What's remarkable about Paul is he manages to do everything. He's a contributor to fundamental economic theory and a top-ranked journalist.''
In a brief telephone interview after the award was announced, Krugman said ``it's a total surprise.''
The Princeton economist's academic work analyzed how world trade came to be dominated by countries that both import and export similar products -- automobiles, for example.
``This kind of trade enables specialization and large-scale production, which result in lower prices and a greater diversity of commodities,'' the Royal Academy said in a statement today.
It may be a surprise to Krugman, but to those of us who studied his theorems, read all his books as well as his NYT op-ed articles, we knew it was only a matter of time.
Congratulations professor Krugman. If you need any ideas on how to invest your prize, please read my last comment.
I spent the weekend enjoying my new nephews, the beautiful fall weather in Montreal and listening to some excellent interviews like CharlieRose's discussion with Peter Thiel, Maria Bartiromo, Michael McKee, Steven Pearlstein and Fareed Zakaria's excellent interviews with George Soros and Jeffrey Sachs.I also dusted off a copy of John Rothchild's, The Bear Book: Survive and Profit in Ferocious Bear Markets. I figured it doesn't get any more ferocious than this so why not read some words of wisdom?By pure coincidence, I opened the book on page 52, right on the section of HITTING BEAR BOTTOM:
A bear market is a bull in gestation- AnonymousAfter the final plunge in stock prices that heralds the bear's demise, you're presented with a buying opportunity, perhaps the opportunity of a lifetime.You need two things to take advantage: ready cash and a tin ear. The latter is necessary to drown out the drone of doomsaying that's sure to accompany stocks at the bottom of the Wall of Worry, where doubters are preeminent. Theyve been disappointed too often to believe the next turnaround is for real.Capitalizing on these opportunities is easier said than done. those who sold already are sitting on a pile of cash, reminding themselves never to gamble in stocks again. When the new bull market begins, they don't benefit. Those who haven't sold already are obvious candidates to sell into the next rally.An excellent example was the Great Depression bull market of 1932-1937, a happy interlude lost in the gloom of the day. People who bought stocks near the Dow's low of 41.22 in 1932 nearly quintupled their money as the Dow advanced to 194.40 in five years.They got a quicker payout in the S&P 500 - up 154 percent in three years. Such gains are always uncommon, but in the 1930s, with one out of four adults lacking a paycheck, they were nothing short of fantastic.How could you sense it was time to jump into stocks at their nadir in 1932? Not from the newspapers. They were spreading despair headline by headline: banks going bankrupt, companies closing their doors, one out of four workers out of work. None from expert commentators, none of whom was calling for a rally.Not from your broker, if you still had a broker in 1932. Brokers with clients were more fearful of stocks than clients were. Groucho Marx's broker was gloomier than Groucho, as Groucho himself reported:Groucho: Aren't you the fella that said nothing can go wrong...that we are in a world market?Broker: I guess I made a mistakeGroucho: No, I am the one who made a msitake, I listened to you.Broker: I lost all my money, too.Groucho: Well, buck up. Don't let it get you down. Just remember - twenty years from now you'll be looking back on these as the good old days.This, on the eve of the most profitable advance for stocks in any five-year period before or since! To take part in this bonanza, you had to ignore prevailing opinion and rely on the obvious fact: stocks were incredibly cheap.By the end of 1931, Dow stocks were throwing off nearly 11 percent in annual dividends. No matter what happened to the market going forward, you could be reasonably confident of collecting that huge yield, made more attractive with inflation in remission and long-term bonds paying 5-6 percent.
Mining, Steel and Aluminum Mining shares got slaughtered in the last selloff. I noticed the Soros Fund picked up Cameco (CCJ) and in steel and aluminium, keep an eye on AK Steel (AKS), Mittal (MT) and Alcoa (AA).
HealthcareThe healthcare sector is another one I like long-term based on demographics. Names like Abbott Labs (ABT), Amgen (AMGN), Novartis (NVS), Bristol Myers (BMY), GlaxoSmithKline (GSK) and Pfizer (PFE) are well known but keep other smaller ones like Forest Labs (FRX) on your radar screen.Among healthcare plan companies, I like Cigna (CI), Humana (HUM) and WellPoint (WLP) but also lesser known healthcare plan companies like Psychiatric Solutions (PSYS), a company that provides inpatient behavioral health care services in the United States.Biotech ETFs are worth investing in but institutional investors should also look at top performing healthcare funds like Montreal's Sectoral Asset Management. Among biotechs, I like Affymax (AFFY), Genentech (DNA) and Vertex (VRTX), but given the volatility in the sector, ETFs are better for most investors.Another healthcare sector I like is medical devices where I am tracking companies like Align Technology (ALGN), China Medical Technologies (CMED), Hologic (HOLX), and Syneron Medical (ELOS).InfrastructureInfrastructure stocks are also an excellent long-term play because decaying infrastructure needs to be replaced. Infrastructure ETFs already exist (IGF), but there are good companies like KBR (KBR), URS (URS), Tetra Tech (TTEK) and Canada's SNC-Lavalin (SNC.TO) that are worth tracking.Keep an eye on utilities like Duke Energy (DUK), FPL Group (FPL), and SouthWestern Energy (SWN).
Among the big conglomerates, I was told by someone I trust that 3M Co. (MMM) is a well run company. I am also keeping my eye on Dupont (DD) and Dow Chemical (DOW).Small Cap StocksSmall cap stocks got creamed in the last selloff. I am looking at the Ultra Russell 2000 (UWM), but there are plenty of names to picks from including tech stocks that are worth their weight in cash.
Technology
The technology sector was crushed last week but the tech heavy Nasdaq will snap back strongly if confidence is restored.
If you want to take a sector bet, buy the Ultra Pro Shares QQQ (QLD) or focus on individual names that were slammed like Apple (AAPL), Research in Motion (RIMM), Intel (INTC), Cisco Systems (CSCO), EMC (EMC), Qualcomm (QCOM) and Yahoo (YHOO).
In the sofware space, I like Microsoft (MSFT), Symantec (SYMC) and Citrix Systems (CTXS).
On the global level, I like Taiwan Semiconductor (TSM), China Mobile (CHL) and Nokia (NOK).
Finally, in a slowing economy, I really like Priceline (PCLN).
FinancialsI hate this sector the most because I simply do not trust bankers. If I were to buy a bank, I'd stick with Warren Buffett and buy Wells Fargo (WFC) and Goldman Sachs (GS). I am also keeping an eye on Bank of America (BAC) and HSBC (HBC), arguably one of the best banks in the world.
If you want to take a leveraged long position in the financial sector but do not want to pick specific companies, you can buy the Ultra Financials (UYG) Proshares ETF.
Insurance stocks like Allstate (ALL), AXA (AXA) and Canada's Manulife (MFC.TO) and Great West Life (GWO.TO) caught my eye. Of course, you might just want to buy Power Corp (POW.TO) and stick with the Desmarais family, the Buffetts of Canada.
On a global level, I would go Greek for value and buy the National Bank of Greece (NBG):
NBG is Greece's largest lender, with total assets of $132 billion, 579 branches and some 32% of the country's mutual fund business. While mortgages and consumer loans account for 56% of the bank's domestic lending portfolio, both continue to experience healthy growth rates. In fact, NBG profits are growing at a 30% clip and its return on equity is a healthy 28%. What really excites Christy, however, is not NBG's healthy share in Greece, but rather its position as the junction between Europe, Africa and Asia and its growth outside the relatively tiny nation. In 2006, NBG bought Turkey's Finansbank and, more recently, NBG has been gaining share in Romania, Bulgaria and Serbia. Business is booming in southeastern Europe and already accounts for 12% of NBG's earnings. Investors are worried Europe will follow the U.S. into a recession, but Christy is confident that bargain-priced NBG, bolstered by its growth in emerging Europe, will continue to prosper.
NBG is Greece's largest lender, with total assets of $132 billion, 579 branches and some 32% of the country's mutual fund business. While mortgages and consumer loans account for 56% of the bank's domestic lending portfolio, both continue to experience healthy growth rates. In fact, NBG profits are growing at a 30% clip and its return on equity is a healthy 28%.
What really excites Christy, however, is not NBG's healthy share in Greece, but rather its position as the junction between Europe, Africa and Asia and its growth outside the relatively tiny nation.
In 2006, NBG bought Turkey's Finansbank and, more recently, NBG has been gaining share in Romania, Bulgaria and Serbia. Business is booming in southeastern Europe and already accounts for 12% of NBG's earnings.
Investors are worried Europe will follow the U.S. into a recession, but Christy is confident that bargain-priced NBG, bolstered by its growth in emerging Europe, will continue to prosper.
I have to agree that NBG is one of the best run banks in Europe and with a 11% dividend yield, the stock is cheap after being crushed last week. (Another Greek stock worth looking at is DryShips (DRYS), a shipping company which also got crushed during this last selloff and it carries a 5% dividend yield).
As I end my biased commentary, I see that Asian stocks and U.S. futures advanced as governments back banks.
It looks like the worst stock selloff in history is behind us (for now), but I need to see at least two consecutive up days in the markets before I can breath easier.
Japanese Finance Minister Shoichi Nakagawa said he is set to make the proposal at the Group of Seven meeting of finance and central bank officials that he is attending in Washington."Japan would like to see what it can do to work with other countries to ensure ample capital supply," he said on nationally televised NHK news.He did not give details of the plan. But he said Japan's experience in dealing with its bad debt crisis in the 1990s may offer lessons for the other G-7 nations.He said he hopes to tell others how Japan injected public money into banks at that time to bolster their capital after the so-called bubble economy of soaring land and stock prices burst and banks got stuck with mountains of bad debt.His comments come at a time when Washington, which is implementing a $700 billion bailout, mainly to buy bad mortgages and mortgage-related securities from banks and financial institutions, may also need to inject capital in them and take partial ownership.Britain is moving to pour cash into troubled banks in exchange for stakes in them -- a partial nationalization. In Iceland, the government now has control of all three of the country's major banks as it struggles to contain the troubles there.Japan's proposal will call for setting up a cooperative scheme through the International Monetary Fund to dole out emergency lending to nations whose financial systems run out of cash, The Nikkei, Japan's top business daily, reported in its Friday's editions, without citing sources.China and Middle Eastern nations will also be asked to contribute money to the fund, the report said, in an effort to prevent the further spread of the global fallout from the U.S. credit crisis.
"Japan would like to see what it can do to work with other countries to ensure ample capital supply," he said on nationally televised NHK news.
He did not give details of the plan. But he said Japan's experience in dealing with its bad debt crisis in the 1990s may offer lessons for the other G-7 nations.
He said he hopes to tell others how Japan injected public money into banks at that time to bolster their capital after the so-called bubble economy of soaring land and stock prices burst and banks got stuck with mountains of bad debt.
His comments come at a time when Washington, which is implementing a $700 billion bailout, mainly to buy bad mortgages and mortgage-related securities from banks and financial institutions, may also need to inject capital in them and take partial ownership.
Britain is moving to pour cash into troubled banks in exchange for stakes in them -- a partial nationalization. In Iceland, the government now has control of all three of the country's major banks as it struggles to contain the troubles there.
Japan's proposal will call for setting up a cooperative scheme through the International Monetary Fund to dole out emergency lending to nations whose financial systems run out of cash, The Nikkei, Japan's top business daily, reported in its Friday's editions, without citing sources.
China and Middle Eastern nations will also be asked to contribute money to the fund, the report said, in an effort to prevent the further spread of the global fallout from the U.S. credit crisis.
The G7 should seriously consider Dr. Doom's prescription:
Another rapid round of policy rate cuts of the order of at least 150 basis points on average globally; a temporary blanket guarantee of all deposits while a triage between insolvent financial institutions that need to be shut down and distressed but solvent institutions that need to be partially nationalized with injections of public capital is made; a rapid reduction of the debt burden of insolvent households preceded by a temporary freeze on all foreclosures; massive and unlimited provision of liquidity to solvent financial institutions; public provision of credit to the solvent parts of the corporate sector to avoid a short-term debt refinancing crisis for solvent but illiquid corporations and small businesses; a massive direct government fiscal stimulus packages that includes public works, infrastructure spending, unemployment benefits, tax rebates to lower income households and provision of grants to strapped and crunched state and local government; a rapid resolution of the banking problems via triage, public recapitalization of financial institutions and reduction of the debt burden of distressed households and borrowers; an agreement between lender and creditor countries running current account surpluses and borrowing, and debtor countries running current account deficits to maintain an orderly financing of deficits and a recycling of the surpluses of creditors to avoid a disorderly adjustment of such imbalances.
And I would add that they should guarantee all interbank lending and criminally prosecute the CEO of any major bank that continues to hoard cash!
This last recommendation is draconian but as Bloomberg reports, the value of U.S. and European high risk, high-yield loans fell to a record low as banks tried to sell holdings of the debt.
Markit LCDX, a benchmark credit-default swap index used to hedge against losses on U.S. leveraged loans, which falls as credit risk increases, dropped 2.5 percentage points to a mid- price of 82.75 percent of face value, paring an earlier decline to 82, according to Goldman Sachs Group Inc. The Markit iTraxx LevX index of European loans fell 2 to 86.5, Deutsche Bank AG prices show. Prices of leveraged loans tumbled on concern that banks and hedge funds are being forced to sell assets in the wake of the collapse of Iceland's banks this week and the failure of Lehman Brothers Holdings Inc. in New York. Rapid declines in the value of loans will make it more expensive for companies to raise capital. ``Selling pressure is likely to continue as nobody really knows how many more loans are going to be dumped on the market,'' said Robert Jaeger, a high-yield debt analyst at Societe Generale SA in London. Loan prices fell yesterday as Iceland took control of Kaupthing Bank hf, the nation's biggest lender, completing the nationalization of the country's top three banks. The seizure came as brokers sent details of loans used to fund leveraged buyouts for sale to investors and traders, according to four people who saw the lists. ``We are seeing the continued forced selling of leveraged loans across Europe,'' said Raja Visweswaran, a London-based trader at Asteri Capital Ltd. ``There is no credit-specific news out today, this is more the sign of a systemic meltdown.''
Markit LCDX, a benchmark credit-default swap index used to hedge against losses on U.S. leveraged loans, which falls as credit risk increases, dropped 2.5 percentage points to a mid- price of 82.75 percent of face value, paring an earlier decline to 82, according to Goldman Sachs Group Inc. The Markit iTraxx LevX index of European loans fell 2 to 86.5, Deutsche Bank AG prices show.
Prices of leveraged loans tumbled on concern that banks and hedge funds are being forced to sell assets in the wake of the collapse of Iceland's banks this week and the failure of Lehman Brothers Holdings Inc. in New York. Rapid declines in the value of loans will make it more expensive for companies to raise capital.
``Selling pressure is likely to continue as nobody really knows how many more loans are going to be dumped on the market,'' said Robert Jaeger, a high-yield debt analyst at Societe Generale SA in London.
Loan prices fell yesterday as Iceland took control of Kaupthing Bank hf, the nation's biggest lender, completing the nationalization of the country's top three banks. The seizure came as brokers sent details of loans used to fund leveraged buyouts for sale to investors and traders, according to four people who saw the lists.
``We are seeing the continued forced selling of leveraged loans across Europe,'' said Raja Visweswaran, a London-based trader at Asteri Capital Ltd. ``There is no credit-specific news out today, this is more the sign of a systemic meltdown.''
Meanwhile, currency markets were reeling today as the Canadian dollar suffered its biggest decline since 1971 as oil prices fell below $80 for the first time in a year and copper headed for its biggest weekly drop in more than 20 years on concern that the deepening financial crisis will push the global economy into a recession.
Now CNBC reports that "radical measures" may be in the wings:
With the legislation’s main mechanism—an auction system to purchase bad mortgage-based securities—still weeks away from implementation, Paulson may have to inject capital into any number of financial institutions—even non-depository ones like investment banks, insurers and hedge funds. “I don't wish to spread alarm on the line people but the big issue confronting the market is I'm afraid the health and sustainability of Morgan Stanley and Goldman Sachs," Hugh Hendry, Partner and CIO at Eclectica, told CNBC. "It is unimaginable that they can be allowed to go, I suspect that they will be nationalized at some point today or over the weekend," he add. Some say the Emergency Economic Stabilization Act of 2008’s vague language gives Paulson almost unlimited power to intervene. “He’s free to just strike deals, to do special deals,” says Lawrence White, a former White House economist and savings and loan regulator, who adds Congress was aware of the powers being given to Paulson and thus pressed hard for an oversight board. Like the auction process, however, that board has yet to be set up, and with developments in the financial markets moving much faster than the Washington bureaucracy it might not be long before Paulson takes action.
With the legislation’s main mechanism—an auction system to purchase bad mortgage-based securities—still weeks away from implementation, Paulson may have to inject capital into any number of financial institutions—even non-depository ones like investment banks, insurers and hedge funds.
“I don't wish to spread alarm on the line people but the big issue confronting the market is I'm afraid the health and sustainability of Morgan Stanley and Goldman Sachs," Hugh Hendry, Partner and CIO at Eclectica, told CNBC. "It is unimaginable that they can be allowed to go, I suspect that they will be nationalized at some point today or over the weekend," he add.
Some say the Emergency Economic Stabilization Act of 2008’s vague language gives Paulson almost unlimited power to intervene.
“He’s free to just strike deals, to do special deals,” says Lawrence White, a former White House economist and savings and loan regulator, who adds Congress was aware of the powers being given to Paulson and thus pressed hard for an oversight board.
Like the auction process, however, that board has yet to be set up, and with developments in the financial markets moving much faster than the Washington bureaucracy it might not be long before Paulson takes action.
Not everyone wants G7 action or any type of action. Legendary investor Jim Rogers prefers that G7 officials "do nothing", but Ken Rogoff thinks that policy makers need to "get ahead of the turmoil". Meanwhile Roubini told Bloomberg that if policy makers do not act, he sees risks of a severe global depression.
Time is running out fast. If they do not restore confidence in the financial system, we are starring at Armageddon.
Confidence is the key here. I urge you to take the time to watch Charlie Rose's excellent interview with former Fed Chairman Paul Volcker (click here to watch the entire interview).
Volcker goes at lengths to discuss the importance of restoring confidence. He understands how left to their own devices, the savageness of "animal spirits" can destroy the financial system.
A few things Voclker said in that interview caught my attention. First, how did the credit derivative market mushroom to $62 trillion to cover $10 trillion in loans? (Remember CDO Squared and Cubed?!?!?)
Second, Volcker referred to the 1933 banking crisis and how President Roosevelt restored confidence in the banking system by proclaiming "these banks are safe to do business with". And little by little, people started doing business with a few banks and the system got going again.
Finally, I got an email telling me that this is the buying opportunity of a lifetime. One person wrote me the following:
As Junius Morgan (JP's father) said: "Remember, my son, that any man who is a bear on the future of this country will go broke.Nathaniel Rothschild: "The time to buy is when there is blood on the street, even if it's your own blood."Time for long-termmoney to go to work!
As Junius Morgan (JP's father) said: "Remember, my son, that any man who is a bear on the future of this country will go broke.
Nathaniel Rothschild: "The time to buy is when there is blood on the street, even if it's your own blood."
Time for long-termmoney to go to work!
But as I read this I recalled Keynes' famous statement that "markets can stay irrational longer than you can stay solvent."
My father who has practiced clinical psychiatry for over 40 years, and continues to do so at the tender age of 76, told me he likes Keynes' warning because he always said "if you are not prepared for the unthinkable and the unbelievable, you are bound for a rude awakening."
Sound advice from a man who has seen a lot of crazy things in his career but none as crazy as what is going on in the financial markets these days.
Stocks sold off in the final hour of trading. The Dow Jones industrial average plunged 679 points, dropping below the 9,000 mark for the first time in five years.
The selloff came as Standard & Poor's Ratings Services put GM and its finance affiliate GMAC LLC under review to see if its rating should be cut. GM has been struggling with weak car sales in North America.The action means there is a 50 percent chance that S&P will lower GM's and GMAC's ratings in the next three months.General Motors Corp. led the Dow lower, falling about 30 percent.
The action means there is a 50 percent chance that S&P will lower GM's and GMAC's ratings in the next three months.
General Motors Corp. led the Dow lower, falling about 30 percent.
In fact GM shares fell below $5 to their lowest level since 1950.
I have already written that deflated balloons can't bounce but I was expecting some bear market rally to develop because we are due for an oversold bounce.
Moreover, the volatility index (VIX) keeps heading up to record territory, leading some to conclude that it the market has gone down too far, too fast and that it feels like capitulation.
But now that we sliced through key support levels, it could easily get worse. I am very worried that we are heading for a good old fashioned "capitulation crash" where the VIX explodes up exponentially above 100 on huge sell-off volume never before seen.
Tomorrow is Friday and I do not expect traders to be holding positions going into the weekend (we are blessed it is Thanksgiving weekend here in Canada and the Toronto Stock Exchange will be closed on Monday).
If this relentless rout continues tomorrow, we are going to see real panic and fear grip markets early next week.
The Dow Jones industrials average ended down 189 points, after falling 316 points in the final 28 minutes of the session. The broader market finished down 1.1 percent, a modest decline compared to the rest of the week, as measured by the Standard & Poor's 500-stock index. "It just feels like more of the same," said Richard Sparks, an analyst at Schaeffer's Investment Research. "This is an extremely weak market with a tremendous amount of uncertainty." The Asian markets opened mixed Thursday, showing that concerted international interest rate cuts announced overnight failed to entirely dispel fears of a global downturn that would also affect the region.The Nikkei 225 stock average rose 0.1 percent to 9,910 soon after the open, after falling 9.4 percent on Wednesday, in its biggest one-day fall in 21 years. However, in Australia, the Standard and Poor's/Australian Stock Exchange 200 index extended the previous days' losses, falling another 1.8 per cent. Stocks were volatile in Europe and the United States through much of Wednesday, lurching up and down the chart across a 400-point range. Investors had appeared conflicted about the extraordinary global rate cut by the world's central banks that came before trading opened in New York. Stocks ducked in and out of positive territory as investors weighed the good — a half-point reduction in the Federal Reserve's benchmark interest rate — against the bad, namely the growing realization that a serious recession may be difficult to avoid. "The Fed, worldwide government agencies and central banks have done just about anything they can now," Sparks said. "And that may be the biggest fear now. They've used up all their bullets and there's really nothing left to do other than let it work its way through the system."..."Rate cuts, federal funds cuts, are not going to be enough," at a time when banks are reluctant to lend to one another, Genberg said, adding that considerable academic research suggests that the United States must find a way to restore the capital bases of its banks.
The Dow Jones industrials average ended down 189 points, after falling 316 points in the final 28 minutes of the session.
The broader market finished down 1.1 percent, a modest decline compared to the rest of the week, as measured by the Standard & Poor's 500-stock index.
"It just feels like more of the same," said Richard Sparks, an analyst at Schaeffer's Investment Research. "This is an extremely weak market with a tremendous amount of uncertainty."
The Asian markets opened mixed Thursday, showing that concerted international interest rate cuts announced overnight failed to entirely dispel fears of a global downturn that would also affect the region.
The Nikkei 225 stock average rose 0.1 percent to 9,910 soon after the open, after falling 9.4 percent on Wednesday, in its biggest one-day fall in 21 years.
However, in Australia, the Standard and Poor's/Australian Stock Exchange 200 index extended the previous days' losses, falling another 1.8 per cent.
Stocks were volatile in Europe and the United States through much of Wednesday, lurching up and down the chart across a 400-point range.
Investors had appeared conflicted about the extraordinary global rate cut by the world's central banks that came before trading opened in New York. Stocks ducked in and out of positive territory as investors weighed the good — a half-point reduction in the Federal Reserve's benchmark interest rate — against the bad, namely the growing realization that a serious recession may be difficult to avoid.
"The Fed, worldwide government agencies and central banks have done just about anything they can now," Sparks said. "And that may be the biggest fear now. They've used up all their bullets and there's really nothing left to do other than let it work its way through the system."
"Rate cuts, federal funds cuts, are not going to be enough," at a time when banks are reluctant to lend to one another, Genberg said, adding that considerable academic research suggests that the United States must find a way to restore the capital bases of its banks.
The coordinated global rate cuts have reduced the risk of a market crash, but won't resolve the underlying crisis. The central banks should have cut at least 100 basis points, Roubini says. World governments should also immediately band together and put together a comprehensive plan: Guarantee all bank deposits temporarily (not just up to $250,000, and not just in the United States).Triage the banking system by recapitalizing survivors with equity injections and letting the rest die.Get ahead of the crisis instead of looking panicky and reactive; failure to do so continues to undermine confidence. Roubini's best-case scenario? “At this point, the recession train has left the station. The financial and banking crisis has left the station. We’re going to have a severe recession. We’re going to have a severe financial crisis. What we can avoid is a systemic collapse of the financial system.And the corporate sector is going to lead us to something close to the Great Depression or to what happened to Japan, with a stagnation of economic growth for a decade. So at this point, it’s going to be ugly regardless, but at this point we can avoid a total meltdown of the system and a multi-year collapse of the global economy.” The financial market crisis has unfolded even quicker than Roubini expected (which is saying something), and the economist now thinks the Dow and S&P will suffer 50% declines from last October's peak vs. 40% previously.In other words, the Dow is going to 7,000, but over the course of months vs. days if Roubini is right, as -- unfortunately for bulls -- he mostly has been for the past two years."The policy response is going to become more aggressive [but] a steady flow of bad financial and macro economic news is going to push down equity markets," he says, forecasting a real bottom won't be hit until "sometime next year."Because of growing slack in the global economy, Roubini says deflation is going to become a much bigger threat in the next six months vs. inflation. In such an environment, cash, Treasuries and gold are the only safe bets he says -- provided your holdings are within the FDIC's new $250,000 insurance cap.The dramatic meltdown of the financial markets has shifted focus from the real economy, which Roubini says is where the downturn is truly being felt. he notes that the $700 billion bailout and today's global rate cuts may have helped avert a complete financial collapse. But the recession -- which he says began in Q1 of this year -- is deepening and will last into early 2010. Retail and personal spending fell sharply over the summer, marking a drop in consumption for the first time since 1991 -- and the Q3 numbers are only going to be worse, says Roubini. Moreover, corporate capital spending is down, which will translate into even fewer jobs in the coming months. Roubini adds: "I worry that it'll be worse than I expected," in which he predicts a slow, possibly L-shaped recovery a la Japan.
The coordinated global rate cuts have reduced the risk of a market crash, but won't resolve the underlying crisis. The central banks should have cut at least 100 basis points, Roubini says. World governments should also immediately band together and put together a comprehensive plan:
Roubini's best-case scenario? “At this point, the recession train has left the station. The financial and banking crisis has left the station. We’re going to have a severe recession. We’re going to have a severe financial crisis. What we can avoid is a systemic collapse of the financial system.
And the corporate sector is going to lead us to something close to the Great Depression or to what happened to Japan, with a stagnation of economic growth for a decade. So at this point, it’s going to be ugly regardless, but at this point we can avoid a total meltdown of the system and a multi-year collapse of the global economy.”
In other words, the Dow is going to 7,000, but over the course of months vs. days if Roubini is right, as -- unfortunately for bulls -- he mostly has been for the past two years.
"The policy response is going to become more aggressive [but] a steady flow of bad financial and macro economic news is going to push down equity markets," he says, forecasting a real bottom won't be hit until "sometime next year."
Because of growing slack in the global economy, Roubini says deflation is going to become a much bigger threat in the next six months vs. inflation. In such an environment, cash, Treasuries and gold are the only safe bets he says -- provided your holdings are within the FDIC's new $250,000 insurance cap.
The dramatic meltdown of the financial markets has shifted focus from the real economy, which Roubini says is where the downturn is truly being felt. he notes that the $700 billion bailout and today's global rate cuts may have helped avert a complete financial collapse.
But the recession -- which he says began in Q1 of this year -- is deepening and will last into early 2010.
Retail and personal spending fell sharply over the summer, marking a drop in consumption for the first time since 1991 -- and the Q3 numbers are only going to be worse, says Roubini. Moreover, corporate capital spending is down, which will translate into even fewer jobs in the coming months.
Roubini adds: "I worry that it'll be worse than I expected," in which he predicts a slow, possibly L-shaped recovery a la Japan.
As if hedge-fund managers haven't felt enough pain lately, now the U.S. government is cracking down on them.
Tucked away inside the recent $700 billion U.S. plan to buy toxic mortgage assets are unrelated changes to the tax code -- effectively eliminating a favorite tax-deferral dodge of hedgies.
"I see this volatility as a good sign we're approaching the end,'' said Barry James, president of James Investment Research Inc., which manages $2 billion in Xenia, Ohio. ``It's pure fear right now and that's the best time to buy.''
The CPP board says the fund is designed to withstand the kinds of short-term market fluctuations that trouble many Canadian investors.It says the fund was sheltered from the U.S. credit crisis because it had no exposure to sub-prime mortgages when cracks began to show in August 2007.But a board spokesman declined to say whether recent volatility on the stock markets has ebbed away the fund's assets.The board is an arm's-length agency that invests the funds not needed by the Canada Pension Plan to pay current benefits.The CPP's assets totalled $127.7 billion during quarter ending June 30 - a one per cent investment rate return over the previous quarter.
It says the fund was sheltered from the U.S. credit crisis because it had no exposure to sub-prime mortgages when cracks began to show in August 2007.
But a board spokesman declined to say whether recent volatility on the stock markets has ebbed away the fund's assets.
The board is an arm's-length agency that invests the funds not needed by the Canada Pension Plan to pay current benefits.
The CPP's assets totalled $127.7 billion during quarter ending June 30 - a one per cent investment rate return over the previous quarter.
Just between you and me, there is no way CPPIB is not exposed to this credit crisis, which started in the subprime area but quickly spread to other sectors.
All pension funds will get slaughtered in 2008 and 2009 primarily because global equity indexes are down anywhere between 30% to 60%.
***Morning update:
It looks like stocks will open higher this morning based on IBM's better than expected results, but the credit markets remain a concern as Libor rates jumped to the highest level in a year:
``To see little or no reaction in the fixings is very disappointing and reinforces the fact that Libor is broken and the transmission mechanism from central banks isn't working,'' said Barry Moran, a currency trader in Dublin at Bank of Ireland, the country's second-biggest bank. ``Things are still very stressed and we don't know what's going to fix it.'' The London interbank offered rate, or Libor, for three-month loans rose to 4.75 percent today, the highest level since Dec. 28. The Libor-OIS spread, a measure of cash scarcity, widened to a record. The overnight rate fell to 5.09 percent, still 359 basis points more than the Fed's 1.5 percent target rate....South Korea, Taiwan and Hong Kong cut interest rates today, a day after reductions by central banks including the Federal Reserve and European Central Bank that were designed to stem damage from the global financial crisis. The U.K. government pledged yesterday to spend 50 billion pounds ($87 billion) to stave off a collapse of the British banking system. ``I don't see a wave of liquidity coming into the market,'' said Alessandro Tentori, an interest-rate strategist in London at BNP Paribas SA. ``People are still holding on to their cash because there's still a great deal of uncertainty out there.'' ...``Libor spreads are still wide, which suggest offshore banks are not willing to take more risks lending to other banks,'' said Cezar Bayonito, a liquidity trader at Allied Banking Corp. in the Philippines. ``Interest-rate cuts will be of little help in the near term because the issue is trust, not rates.'' Libor, set by 16 banks in a daily survey by the British Bankers' Association at about noon in London, determines rates on $360 trillion of financial products worldwide, from home loans to derivatives. Member banks provide estimates on how much it would cost to borrow in 10 currencies for periods ranging from a day to a year. Overnight rates on dealer-placed commercial paper rose 56 basis points to 3.5 percent yesterday, while investors seeking a haven for their money pushed the yield on three-month Treasury bills down 15 basis points to 0.6 percent. Bill yields rose 4 basis points today to 0.66 percent.
``To see little or no reaction in the fixings is very disappointing and reinforces the fact that Libor is broken and the transmission mechanism from central banks isn't working,'' said Barry Moran, a currency trader in Dublin at Bank of Ireland, the country's second-biggest bank. ``Things are still very stressed and we don't know what's going to fix it.''
South Korea, Taiwan and Hong Kong cut interest rates today, a day after reductions by central banks including the Federal Reserve and European Central Bank that were designed to stem damage from the global financial crisis. The U.K. government pledged yesterday to spend 50 billion pounds ($87 billion) to stave off a collapse of the British banking system.
``I don't see a wave of liquidity coming into the market,'' said Alessandro Tentori, an interest-rate strategist in London at BNP Paribas SA. ``People are still holding on to their cash because there's still a great deal of uncertainty out there.''
``Libor spreads are still wide, which suggest offshore banks are not willing to take more risks lending to other banks,'' said Cezar Bayonito, a liquidity trader at Allied Banking Corp. in the Philippines. ``Interest-rate cuts will be of little help in the near term because the issue is trust, not rates.''
Libor, set by 16 banks in a daily survey by the British Bankers' Association at about noon in London, determines rates on $360 trillion of financial products worldwide, from home loans to derivatives. Member banks provide estimates on how much it would cost to borrow in 10 currencies for periods ranging from a day to a year.
Overnight rates on dealer-placed commercial paper rose 56 basis points to 3.5 percent yesterday, while investors seeking a haven for their money pushed the yield on three-month Treasury bills down 15 basis points to 0.6 percent. Bill yields rose 4 basis points today to 0.66 percent.
We shall see if we can maintain any gains today.
The Dow Jones Index put on 485 points or 4.7 per cent to end at 10,851. The tech-heavy Nasdaq gained almost 5 per cent. The Standard and Poor's 500 rose slightly more. Investors were optimistic that the bailout plan would eventually be passed as US President, George W Bush, again appealed for legislators to give it the go ahead. Meanwhile, the White House has strongly urged the media not to describe the rescue effort as a bailout. White House spokesman, Tony Fratto, says that is a loaded term used by critics to defeat the plan.
The Dow Jones Index put on 485 points or 4.7 per cent to end at 10,851.
The tech-heavy Nasdaq gained almost 5 per cent.
The Standard and Poor's 500 rose slightly more.
Investors were optimistic that the bailout plan would eventually be passed as US President, George W Bush, again appealed for legislators to give it the go ahead.
Meanwhile, the White House has strongly urged the media not to describe the rescue effort as a bailout.
White House spokesman, Tony Fratto, says that is a loaded term used by critics to defeat the plan.
Don't you just love this political spin doctors? Had they done this plan properly from the get-go and explained it to the public thoroughly, we probably would have had some package on the table by now.
But in this world of non-transparency, which permeates Wall Street, Washington and yes, public pension funds, nobody is willing to own up their mistakes and state that they screwed up.
Anyways, I am not going to get into why stocks surged today, but I will refer you to Tim Knight's blog, Slope of Hope. Tim does an outstanding job of explaining the technical signals of the market. This is a technical rally, not the start of another bull market (the trend remains down).
Regardless of the surge in stocks, the story remains the turbulence in credit markets:
The London interbank offered rate, a key measure of banks' willingness to lend, has surged in recent days and Tuesday was no different. Overnight Libor spiked to 6.88, from 2.56%, while three-month Libor was up to 4.05%, from 3.89%. The closely-watched Ted spread -- the difference between Libor and the yield on a three-month U.S. Treasury bill -- actually narrowed somewhat Tuesday as the three-month T-bill yield rose to 0.92%, from 0.51%. Short-term Treasury yields had been dropping of late as traders sought a safe place to park their money, regardless of the return, particularly during Monday's plunge. (See "Banks Are Squeezed, Credit Is Crushed.") The wider the Ted spread, the more fear in the credit markets. In addition to interbank lending, problems are also lurking in other corners of the credit markets like derivatives and commercial paper. Many companies use commercial paper, basically short-term IOUs, to fund daily operations like payroll.On Wednesday, the Federal Reserve shares its latest data on the commercial paper market, with another decline expected after the Sept. 24 report showed the market shrank by $113.0 billion over the previous two weeks.Another decrease would indicate companies have struggled to find buyers and roll over existing commercial paper, and that they may need to turn to tap more expensive bank credit lines or issue bonds to raise cash.
The London interbank offered rate, a key measure of banks' willingness to lend, has surged in recent days and Tuesday was no different. Overnight Libor spiked to 6.88, from 2.56%, while three-month Libor was up to 4.05%, from 3.89%. The closely-watched Ted spread -- the difference between Libor and the yield on a three-month U.S. Treasury bill -- actually narrowed somewhat Tuesday as the three-month T-bill yield rose to 0.92%, from 0.51%. Short-term Treasury yields had been dropping of late as traders sought a safe place to park their money, regardless of the return, particularly during Monday's plunge. (See "Banks Are Squeezed, Credit Is Crushed.") The wider the Ted spread, the more fear in the credit markets.
In addition to interbank lending, problems are also lurking in other corners of the credit markets like derivatives and commercial paper. Many companies use commercial paper, basically short-term IOUs, to fund daily operations like payroll.
On Wednesday, the Federal Reserve shares its latest data on the commercial paper market, with another decline expected after the Sept. 24 report showed the market shrank by $113.0 billion over the previous two weeks.
Another decrease would indicate companies have struggled to find buyers and roll over existing commercial paper, and that they may need to turn to tap more expensive bank credit lines or issue bonds to raise cash.
This is the credit crunch in action. If companies start tapping more expensive credit lines or issuing bonds to raise cash, their cost of financing goes up and they will have to shed cost elsewhere.
The bond market sold off today as Treasuries plummeted as speculation lawmakers will salvage financial-rescue legislation eased concern that capital markets will deteriorate further:
Traders pushed up 10-year note yields by the most in more than a week, erasing the bulk of yesterday's rally, as an advance in stocks damped demand for government debt. A gauge of expectations for Treasury volatility surged to the highest in at least 20 years. Senate leaders vowed to act this week on the $700 billion rescue package, which the House rejected yesterday. "It's just this manic reversal from yesterday,'' said William Hornbarger, a fixed-income strategist at Wachovia Securities in St. Louis. "Yesterday it felt like the world was ending; today it feels a bit better.''
Traders pushed up 10-year note yields by the most in more than a week, erasing the bulk of yesterday's rally, as an advance in stocks damped demand for government debt. A gauge of expectations for Treasury volatility surged to the highest in at least 20 years. Senate leaders vowed to act this week on the $700 billion rescue package, which the House rejected yesterday.
"It's just this manic reversal from yesterday,'' said William Hornbarger, a fixed-income strategist at Wachovia Securities in St. Louis. "Yesterday it felt like the world was ending; today it feels a bit better.''
I am willing to bet that this erratic volatility will persist for the next six to twelve months, but the big trend in stocks will remain down, not up.
One final important note on mark-to-market. A senior banker brought to my attention that the SEC announced today that they will give banks more leeway on the mark-to-market rule:
In the new guidance, first reported by Reuters, the U.S. Securities and Exchange Commission reminded financial services firms that they don't need to use fire sale prices when evaluating their hard to price assets. "This is a significant first step and adds stability, confidence, and liquidity within the capital markets," said Steve Bartlett, president and chief executive of The Financial Services Roundtable. "By clarifying how to treat assets in an uncertain market, the SEC is continuing to provide transparency to investors and helping institutions to provide credit in periods of market stress." U.S. accounting rule maker, the Financial Accounting Standards Board said on its Web site on Tuesday that it would change the agenda for its Wednesday meeting to focus on fair value accounting. The board is contemplating issuing additional guidance through a FASB staff position as soon as Wednesday, according to a person familiar with the matter.... The SEC's guidance says that sometimes the level 3 inputs may be more appropriate than the so-called level 2, or observable factors. "In essence, the SEC wants to stop the avalanche of declining prices," said Tom Sowanick, chief investment officer at Clearbrook Financial. Sowanick said that the new guidance should allow banks to rely more on their own assumptions when they determine fair value rather than the distressed sale prices occurring in the markets. But fair value accounting has been popular with many investors who said it greatly increased transparency about the risks banks are facing. "This letter (SEC document) could be titled, pick a number, any number, as it gives bankers great leeway in choosing what numbers they will give to investors," said Lynn Turner, who served as chief accountant at the SEC from 1998 through 2001. Others, however, said that the changes have not gone far enough. "Fair value accounting is a utopian dream that ran into the reality of business and litigation," said Chris Whalen, co-founder of Institutional Risk Analytics, which provides ratings and analytical tools to investors. "Equating an opinion with a market price is crazy," he continued. "It doesn't matter who gives the opinion -- the auditor is still going to say to the client, 'Why don't you write it down?'" Under U.S. accounting rules, a "Level 1" asset can be marked-to-market based on a simple price quote in an active market. However, the price of a "Level 2" asset is "mark-to-model" and is estimated based on observable market prices and inputs. A "Level 3" asset is so illiquid that its value is based entirely on management's best estimate derived from complex mathematical models. The SEC release indicated that the agency does not believe distressed, or forced liquidation sales are orderly transactions.
In the new guidance, first reported by Reuters, the U.S. Securities and Exchange Commission reminded financial services firms that they don't need to use fire sale prices when evaluating their hard to price assets.
"This is a significant first step and adds stability, confidence, and liquidity within the capital markets," said Steve Bartlett, president and chief executive of The Financial Services Roundtable. "By clarifying how to treat assets in an uncertain market, the SEC is continuing to provide transparency to investors and helping institutions to provide credit in periods of market stress."
U.S. accounting rule maker, the Financial Accounting Standards Board said on its Web site on Tuesday that it would change the agenda for its Wednesday meeting to focus on fair value accounting. The board is contemplating issuing additional guidance through a FASB staff position as soon as Wednesday, according to a person familiar with the matter.
The SEC's guidance says that sometimes the level 3 inputs may be more appropriate than the so-called level 2, or observable factors.
"In essence, the SEC wants to stop the avalanche of declining prices," said Tom Sowanick, chief investment officer at Clearbrook Financial. Sowanick said that the new guidance should allow banks to rely more on their own assumptions when they determine fair value rather than the distressed sale prices occurring in the markets.
But fair value accounting has been popular with many investors who said it greatly increased transparency about the risks banks are facing.
"This letter (SEC document) could be titled, pick a number, any number, as it gives bankers great leeway in choosing what numbers they will give to investors," said Lynn Turner, who served as chief accountant at the SEC from 1998 through 2001.
Others, however, said that the changes have not gone far enough.
"Fair value accounting is a utopian dream that ran into the reality of business and litigation," said Chris Whalen, co-founder of Institutional Risk Analytics, which provides ratings and analytical tools to investors.
"Equating an opinion with a market price is crazy," he continued. "It doesn't matter who gives the opinion -- the auditor is still going to say to the client, 'Why don't you write it down?'"
Will this help shore up the banks' balance sheets during this critical time? Yes, loosening the mark-to-market rule will help, but it will not stop the deleveraging process, only slow it down a little.
Roubini is right, the recession train has already left the station.
Canadian stocks also crumbled today. The Standard & Poor's/TSX Composite Index, fell 6.9 percent to 11,285, the most since Oct. 25, 2000. The main Canadian benchmark has fallen 18 percent in September, poised for its worst monthly drop in a decade (Note: Canadian and global public pension funds will get clobbered in 2008):
"This is 1987 in slow motion,'' said David Cockfield, who helps oversee about $2 billion as a portfolio manager at Leon Frazer & Associates in Toronto, referring to the crash of October 1987, when the main Canadian index dropped 17 percent in two days. "The panic continues. Why stick your neck out?''
Bear in mind that it is end of quarter, so lots of window dressing is going on as mutual funds sell the losers and buy the winners (not that there are many winners in this Ursa Major). Also, hedge funds are preparing for massive redemptions, which means more forced selling into weakness.
What is likely to happen next? With a bit of luck, the House will be frightened by its own audacity and will reverse itself. If a substantively similar bill (or a better bill that addresses not just the problem of valuing toxic assets and getting them off the banks’ books, but also the problem of recapitalising the US banking sector) is passed in the next day or so, the damage can remain limited. If the markets fear that the nays have thrown their toys out of the pram for the long term, the following scenario is quite likely: The US stock market tanks. Bank shares collapse, as do the valuations of all highly leveraged financial institutions. Weaker versions of this occur in Europe, in Japan and in the emerging markets.CDS spreads for banks explode, as will those of all highly leveraged financial institutions. Credits spreads generally take on loan-shark proportions, even for reputable borrowers. Again the rest of the world will experience a slightly milder version of this.No US bank will lend to any other US bank or any other highly leveraged institution. The same will happen elsewhere. Remaining sources of external finance for banks, other than the facilities created by the central banks and the Treasuries, will dry up.Banks and other highly leveraged institutions will try to unload assets at fire-sale prices in illiquid markets. Even assets not viewed as toxic before will become unsaleable at any price.The interaction of a growing lack of funding liquidity and increasing market illiquidity will destroy the banks’ business models.Banks will stop providing credit to households and to non-financial enterprises.Banks will collapse, both through balance sheet insolvency and through liquidity insolvency. No bank will be safe, not even the household names for whom the crisis has thus far brought more opportunities than disasters.Other highly leveraged financial institutions collapse on a large scale.Households and non-financial businesses revert to financial autarky, among wide-spread defaults and insolvencies.Consumer demand and investment demand collapse. Unemployment shoots up.The government suspends all trading in financial stocks until further notice.The government nationalises all US banks and other highly leveraged financial institutions. The shareholders get nothing up front and have to wait for an eventual re-privatisation or liquididation to find out whether they are left with anything at all. Holders of bank debt get a sizeable haircut ‘up front’ on the face value of the debt and have part of the remainder converted into equity that shares the fate of the old equity.We have the Great Depression of the 2010s. None of this is unavoidable, provided the US Congress grows up and adopts forthwith something close to the Emergency Economic Stabilization Act as a first, modest but necessary step towards re-establishing functioning securitisation markets and restoring financial health to the banking sector. Cutting off your nose to spite your face is not a sensible alternative.
What is likely to happen next? With a bit of luck, the House will be frightened by its own audacity and will reverse itself. If a substantively similar bill (or a better bill that addresses not just the problem of valuing toxic assets and getting them off the banks’ books, but also the problem of recapitalising the US banking sector) is passed in the next day or so, the damage can remain limited. If the markets fear that the nays have thrown their toys out of the pram for the long term, the following scenario is quite likely:
None of this is unavoidable, provided the US Congress grows up and adopts forthwith something close to the Emergency Economic Stabilization Act as a first, modest but necessary step towards re-establishing functioning securitisation markets and restoring financial health to the banking sector. Cutting off your nose to spite your face is not a sensible alternative.
In response to today's vote, central banks around the world are pumping billions of dollars into the financial system to ease credit markets as banks continue to stop lending to each other:
The Federal Reserve on Monday prepared to pour an extra $630bn (€437bn, £350bn) into the global financial system in coordination with other central banks around the world, in a massive effort to curb extreme stress in international money markets.The move is designed to reinforce the impact of the $700bn bail-out bill proceeding through the US Congress and directly relieve market stress in the near term, before the new government fund can start operating.
The Federal Reserve on Monday prepared to pour an extra $630bn (€437bn, £350bn) into the global financial system in coordination with other central banks around the world, in a massive effort to curb extreme stress in international money markets.
The move is designed to reinforce the impact of the $700bn bail-out bill proceeding through the US Congress and directly relieve market stress in the near term, before the new government fund can start operating.
I am getting this sick feeling in my stomach that they are pushing on a string. The freeze in credit markets is more troubling than any plunge in stock prices. If payrolls aren't met, you will see true panic and fear grip Main Street and Wall Street.
Tonight, I wish Jews around the world Happy Rosh Hashanah as they celebrate the Jewish New Year.
As the global financial system teeters on collapse, I will also be praying for world peace and happiness now that we entered uncharted territory.
Policymakers are rightfully focused on the credit markets. If banks are unwilling to lend to each other -- as surging LIBOR rates suggest -- they sure aren't going to lend to consumers or businesses, which has profound implications for the economy (which grew slower in the second quarter than originally reported, by the way.) In the short term, companies like Goodyear Tire can't access their cash because of stress in the money market and overnight lending operations. Most businesses need this capital to fund day-to-day operations. In the longer- to intermediate-term, a slowing economy means more earnings disappointments such as delivered in recent days by GE and Research In Motion. Thus far, the stock market has held up remarkably well given those threats. Barring some resolution on the bailout in Washington, stocks won't be able to ignore strains in the credit markets much longer."It is unclear at this time whether this intense stress in credit markets is the result of Washington not moving fast enough, or moving ahead with the wrong approach, or simply the result of a cascade of forced balance sheet liquidation," writes Michael Darda, chief economist of MKM Partners. "In any event, these stresses suggest equities could come under considerable pressure in the near term."
Policymakers are rightfully focused on the credit markets. If banks are unwilling to lend to each other -- as surging LIBOR rates suggest -- they sure aren't going to lend to consumers or businesses, which has profound implications for the economy (which grew slower in the second quarter than originally reported, by the way.)
Thus far, the stock market has held up remarkably well given those threats. Barring some resolution on the bailout in Washington, stocks won't be able to ignore strains in the credit markets much longer.
"It is unclear at this time whether this intense stress in credit markets is the result of Washington not moving fast enough, or moving ahead with the wrong approach, or simply the result of a cascade of forced balance sheet liquidation," writes Michael Darda, chief economist of MKM Partners. "In any event, these stresses suggest equities could come under considerable pressure in the near term."
And just how bad is the credit in the United States? It's very bad and it is even affecting banks outside the United States.
A senior Canadian banker called me this morning to tell me that Libor rates are not adjusting quickly enough to reflect the depth of the unfolding liquidity crisis. "The cost of funding for Canadian banks and other around the world is a lot higher than normal. This could degenerate quickly as banks stop lending money and keep hoarding cash."
He went on to tell me that the benchmarks for pricing instruments are "in disarray." Moreover, he admitted that thousands of banks in the United States are teetering on collapse. "It doesn't take much to have a run on banks. If payrolls do not clear because banks do not free up cash, then you will see a classic run on banks."
He also correctly pointed out the following: "Why do people think we are smarter than they were in the 1930s? I do not see any evidence of this wisdom."
Scary thoughts coming from a banker who is pretty conservative in his views.
The evidence certainly supports his views as U.S. credit enters a lockdown:
In many corporate offices, in company cafeterias and around dining room tables, however, the reality of tight credit already is limiting daily economic activity. "Loans are basically frozen due to the credit crisis," said Vicki Sanger, who is now leaning on personal credit cards bearing double-digit interest rates to finance the building of roads and sidewalks for her residential real estate development in Fruita, Colorado. "The banks just are not lending." With the economy already suffering the strains of plunging housing prices, growing joblessness and the new-found austerity of debt-saturated consumers, many experts fear the fraying of the financial system could pin the nation in distress for years. Without a mechanism to shed the bad loans on their books, financial institutions may continue to hoard their dollars and starve the economy of capital. Americans would be deprived of financing to buy houses, send children to college and start businesses. That would slow economic activity further, souring more loans, and making banks tighter still. In short, a downward spiral.Fear of this outcome has become self-fulfilling, prompting a stampede toward safer investments. Investors continued to pile into Treasury bills on Thursday despite rates of interest near zero, making less capital available for businesses and consumers. Stock markets rallied exuberantly for much of Thursday as a bailout deal appeared in hand. Then the deal stalled, leaving the markets vulnerable to a pullback. "Without trust and confidence, business can't go on, and we can easily fall into a deeper recession and eventually a depression," said Andrew Lo, a finance professor at MIT's Sloan School of Management. "It would be disastrous to have no plan."...Suddenly, people who have spent their careers arguing that government is in the way of progress — that its role must be pared to allow market forces to flourish — are calling for the biggest government bailout in American history. "We are in a very serious place," said William Beach, an economist at the conservative Heritage Foundation in Washington. "There is risk of contagion to the entire economy."
In many corporate offices, in company cafeterias and around dining room tables, however, the reality of tight credit already is limiting daily economic activity.
"Loans are basically frozen due to the credit crisis," said Vicki Sanger, who is now leaning on personal credit cards bearing double-digit interest rates to finance the building of roads and sidewalks for her residential real estate development in Fruita, Colorado. "The banks just are not lending."
With the economy already suffering the strains of plunging housing prices, growing joblessness and the new-found austerity of debt-saturated consumers, many experts fear the fraying of the financial system could pin the nation in distress for years.
Without a mechanism to shed the bad loans on their books, financial institutions may continue to hoard their dollars and starve the economy of capital. Americans would be deprived of financing to buy houses, send children to college and start businesses. That would slow economic activity further, souring more loans, and making banks tighter still. In short, a downward spiral.
Fear of this outcome has become self-fulfilling, prompting a stampede toward safer investments. Investors continued to pile into Treasury bills on Thursday despite rates of interest near zero, making less capital available for businesses and consumers. Stock markets rallied exuberantly for much of Thursday as a bailout deal appeared in hand. Then the deal stalled, leaving the markets vulnerable to a pullback.
"Without trust and confidence, business can't go on, and we can easily fall into a deeper recession and eventually a depression," said Andrew Lo, a finance professor at MIT's Sloan School of Management. "It would be disastrous to have no plan."
Suddenly, people who have spent their careers arguing that government is in the way of progress — that its role must be pared to allow market forces to flourish — are calling for the biggest government bailout in American history.
"We are in a very serious place," said William Beach, an economist at the conservative Heritage Foundation in Washington. "There is risk of contagion to the entire economy."
The risk of contagion is quickly spreading outside the United States as Libor rates soar worldwide:
The three-month London interbank offered rate, or Libor, that banks charge each other for dollar loans jumped today by the most since 1999 and the euro rate rose to the highest level since November 2000. Rates in Hong Kong and Singapore climbed as Bank of East Asia faced a run Wednesday on deposits. The difference between the three-month dollar rate and the overnight indexed swap rate, the Libor-OIS spread, widened to the most on record. "Liquidity in the money markets in maturities over a week is desperately scarce," said Tim Bond, head of global asset allocation at Barclays Capital in London. "A near-term solution to the crisis is urgent. Unchecked, the current crisis would turn into a self-reinforcing vortex of defaults, bank capital contraction and deep recession within a matter of weeks." Money-market rates signal banks have all but stopped lending to each other. Treasury Secretary Henry Paulson's bailout plan, which proposes removing tainted assets from bank balance sheets, may be cut back in size, U.S. House Budget Committee Chairman John Spratt said Thursday. The U.S. faces a "painful" recession if the package isn't approved, President George W. Bush said Wednesday."The message coming from our money-market traders is that nothing's working," said Padhraic Garvey, the Amsterdam-based head of investment-grade debt strategy at ING Bank. "Banks are not dealing with one another and the situation has gotten worse. The real market is probably about 10 to 20 basis points above where Libor fixings are."
The three-month London interbank offered rate, or Libor, that banks charge each other for dollar loans jumped today by the most since 1999 and the euro rate rose to the highest level since November 2000. Rates in Hong Kong and Singapore climbed as Bank of East Asia faced a run Wednesday on deposits. The difference between the three-month dollar rate and the overnight indexed swap rate, the Libor-OIS spread, widened to the most on record.
"Liquidity in the money markets in maturities over a week is desperately scarce," said Tim Bond, head of global asset allocation at Barclays Capital in London. "A near-term solution to the crisis is urgent. Unchecked, the current crisis would turn into a self-reinforcing vortex of defaults, bank capital contraction and deep recession within a matter of weeks."
Money-market rates signal banks have all but stopped lending to each other. Treasury Secretary Henry Paulson's bailout plan, which proposes removing tainted assets from bank balance sheets, may be cut back in size, U.S. House Budget Committee Chairman John Spratt said Thursday. The U.S. faces a "painful" recession if the package isn't approved, President George W. Bush said Wednesday.
"The message coming from our money-market traders is that nothing's working," said Padhraic Garvey, the Amsterdam-based head of investment-grade debt strategy at ING Bank. "Banks are not dealing with one another and the situation has gotten worse. The real market is probably about 10 to 20 basis points above where Libor fixings are."
I am hopeful that politicians will come up with something to avert catastrophe, but I remain bearish on stocks and the U.S. economy.
What people need to realize is that the structural problems underlying this financial crisis are so perverse, so widespread and regrettably until recently, so underestimated that there is no way we are going to get out of this mess quickly.
It will take years to clear this mess up and restore confidence in the global financial system.
My only concern right now is that U.S. politicians are skirting with catastrophe here and they better come up with something fast to calm credit markets or else we will all pay a heavy price for their posturing.
Stocks dropped again today as doubts over the rescue plan mount and uncertainty continues to reign over markets. The Dow Jones industrials ended 161 points lower, or 1.5 percent.I spent most of the day watching the "Comrades" get grilled on the $700 billion rescue plan by the Senate Banking Committee:
Investors were also taking a wait-and-see attitude to the package. After a steep slide on Monday, European markets closed down again Tuesday, while afternoon trading was moderately lower on Wall Street. Oil and gold prices also retreated. (Page 20) In Washington, Dodd called the crisis "entirely foreseeable and preventable, not an act of God," and said that it angered him to think about "the authors of this calamity" walking away with the proverbial golden parachutes while taxpayers bore the cost. "There is no second act on this," Dodd said, acknowledging that speed was important. But it is more important, he said, "to get it right." Paulson said in response to questions that he shared the senators' exasperation. "I'm not only concerned, I'm angry" over the events that led to the problem, Paulson said. He blamed an outdated regulatory system for the turmoil and, in an attempt to counter any impression that the proposed rescue plan was for the benefit of fat-cats on Wall Street, said: "This is all about the taxpayers. That is all we are about." Paulson said that "this troubled-asset purchase program is the single most effective thing we can do to help homeowners, the American people, and stimulate our economy." He and Bernanke said that the problems in the housing industry were the core of the crisis but that the problems would continue to spread far outside the housing sector if the problems in the mortgage markets were not addressed, and soon.
In Washington, Dodd called the crisis "entirely foreseeable and preventable, not an act of God," and said that it angered him to think about "the authors of this calamity" walking away with the proverbial golden parachutes while taxpayers bore the cost.
"There is no second act on this," Dodd said, acknowledging that speed was important. But it is more important, he said, "to get it right."
Paulson said in response to questions that he shared the senators' exasperation.
"I'm not only concerned, I'm angry" over the events that led to the problem, Paulson said. He blamed an outdated regulatory system for the turmoil and, in an attempt to counter any impression that the proposed rescue plan was for the benefit of fat-cats on Wall Street, said: "This is all about the taxpayers. That is all we are about."
Paulson said that "this troubled-asset purchase program is the single most effective thing we can do to help homeowners, the American people, and stimulate our economy."
He and Bernanke said that the problems in the housing industry were the core of the crisis but that the problems would continue to spread far outside the housing sector if the problems in the mortgage markets were not addressed, and soon.
At one point, Senator Richard Shelby of Alabama, the ranking Republican asked Paulson: "What do I say to my constituents who feel like they are on the hook for bailing out Wall Street?"
In an incredible moment of candor, Comrade Paulson looked at him and said: "Tell them they are already on the hook."
That ladies and gentlemen is all she wrote. When Comrade Paulson uttered "they are already on the hook," he mind as well be speaking in front of the United Nations where Comrade Bush was speaking today.
Another noteworthy testimony today was given by Comrade Cox, the chariman of the SEC who said that said Congress should "immediately'' grant authority to regulate credit-default swaps amid concern the bets are fueling the global financial crisis (read yesterday's entry on better regulation).
In another unusual moment of candor, Comrade Bernanke let the cat out of the bag and said that the the government should buy devalued assets at above-market values to make its proposed $700 billion rescue package most effective in combating the financial crisis:
"Accounting rules require banks to value many assets at something close to a very low fire-sale price rather than the hold-to-maturity price,'' Bernanke said in testimony to the Senate Banking Committee today. "If the Treasury bids for and then buys assets at a price close to the hold-to-maturity price, there will be substantial benefits.''
Bravo Comrade Bernanke! Bravo! [roll eyes!]
Let me quote Paul Krugman on this idea:
As I wrote earlier this morning, the whole “take these assets off the balance sheets” line is fundamentally disingenuous; the key question is what price Treasury pays for the assets. And here we have Bernanke effectively saying that it’s going to pay above-market prices — prices that allegedly reflect “hold-to-maturity” value, but still more than private investors are willing to pay. This should be read in the context of Brad Setser’s calculations: he finds that if Treasury pays a price that seems appropriate given the poor quality of the assets, “The hit to the banks balance sheet might be too big” — the losses would be much larger than the amounts banks have already acknowledged, so that their capital position would be severely weakened. So the plan only helps the financial situation if Treasury pays prices well above market — that is, if it is in effect injecting capital into financial firms, at taxpayers’ expense. What possible justification can there be for doing this without acquiring an equity stake? No equity stake, no deal.
As I wrote earlier this morning, the whole “take these assets off the balance sheets” line is fundamentally disingenuous; the key question is what price Treasury pays for the assets. And here we have Bernanke effectively saying that it’s going to pay above-market prices — prices that allegedly reflect “hold-to-maturity” value, but still more than private investors are willing to pay.
This should be read in the context of Brad Setser’s calculations: he finds that if Treasury pays a price that seems appropriate given the poor quality of the assets, “The hit to the banks balance sheet might be too big” — the losses would be much larger than the amounts banks have already acknowledged, so that their capital position would be severely weakened.
So the plan only helps the financial situation if Treasury pays prices well above market — that is, if it is in effect injecting capital into financial firms, at taxpayers’ expense.
What possible justification can there be for doing this without acquiring an equity stake?
No equity stake, no deal.
I have my own conspiracy theories on the possible justification, including the fact that Comrade Paulson has close ties to Goldman Sachs, the "venerable" Wall Street investment banks he once led which is now scrambling to survive as it faces a lawsuit of misleading investors in a $6 billion offering of Freddie Mac stock in November. Could it be that he is helping the new Goldman Sachs Bank to receive full benefit of the bailout?
(Note...this just in: Warren Buffett just dropped a cool $5 billion into Goldman Sachs preferred shares. Buffett knows all about alignment of interests and where Comrade Paulson's interests lie.)
The problems on Wall Street are also impacting the rest of the word. The Times of London reports that the Government of Singapore Investment Corporation (GIC), Singapore's large sovereign wealth fund, has warned that it was now “unrealistic” to expect that the sort of returns achieved over the past two decades could be repeated in future.
In an article in today's FT, Daniel Gross and Stefano Micossi report that "synchronised movements in global markets over the last few weeks have shown that contagion works on the way down and on the way up." The article warns that European banking is on borrowed time:
The crucial problem on this side of the Atlantic is that the largest European banks have become not only too big to fail, but also too big to be saved.For example, the total liabilities of Deutsche Bank (leverage ratio over 50!) amount to about €2,000bn (more than Fannie Mae) or more than 80 per cent of the gross domestic product of Germany. This is simply too much for the Bundesbank or even the German state, given that the German budget is bound by the rules of the European Union’s stability pact and the German government cannot order (unlike the US Treasury) its central bank to issue more currency. Similarly, the total liabilities of Barclays of around £1,300bn (leverage ratio 60!) are roughly equivalent to the GDP of the UK. Fortis bank has a leverage ratio of “only” 33, but its liabilities are three times the GDP of its home country of Belgium.With banks that have outgrown their home turf, national treasuries and regulators in Europe are living on borrowed time: they cannot simply develop “road maps” (the only result of various Ecofin discussions of regulatory reform by finance ministers), but must contemplate a worst-case scenario.Given that solutions for the largest institutions can no longer be found at the national level it is apparent that the European Central Bank will need to be put in charge as it is the only institution that can issue unlimited amounts of a global reserve currency. The authorities in the UK and Switzerland – which cannot rely on the ECB – can only pray that no accident happens to the giants they have in their own garden.
The crucial problem on this side of the Atlantic is that the largest European banks have become not only too big to fail, but also too big to be saved.
For example, the total liabilities of Deutsche Bank (leverage ratio over 50!) amount to about €2,000bn (more than Fannie Mae) or more than 80 per cent of the gross domestic product of Germany. This is simply too much for the Bundesbank or even the German state, given that the German budget is bound by the rules of the European Union’s stability pact and the German government cannot order (unlike the US Treasury) its central bank to issue more currency. Similarly, the total liabilities of Barclays of around £1,300bn (leverage ratio 60!) are roughly equivalent to the GDP of the UK. Fortis bank has a leverage ratio of “only” 33, but its liabilities are three times the GDP of its home country of Belgium.
With banks that have outgrown their home turf, national treasuries and regulators in Europe are living on borrowed time: they cannot simply develop “road maps” (the only result of various Ecofin discussions of regulatory reform by finance ministers), but must contemplate a worst-case scenario.
Given that solutions for the largest institutions can no longer be found at the national level it is apparent that the European Central Bank will need to be put in charge as it is the only institution that can issue unlimited amounts of a global reserve currency. The authorities in the UK and Switzerland – which cannot rely on the ECB – can only pray that no accident happens to the giants they have in their own garden.
The FT's Martin Wolfson also asks whether Paulson's plan is the true solution to the crisis:
The US public expects action. The question is whether it will get the right action. To answer it, we must agree on the challenge the US financial system faces and the criteria for judging how it should be met.What then is the challenge? The answer given by Hank Paulson, the all-action US Treasury secretary, last Friday, in announcing his “troubled asset relief programme”, is that “the underlying weakness in our financial system today is the illiquid mortgage assets that have lost value as the housing correction has proceeded. These illiquid assets are choking off the flow of credit that is so vitally important to our economy.” The core challenge, then, is viewed as illiquidity, not insolvency. By creating a market for the toxic assets, Mr Paulson hopes to halt the spiral of falling prices and bankruptcies. I suggest we should take a broader view of events. The aggregate stock of US debt rose from a mere 163 per cent of gross domestic product in 1980 to 346 per cent in 2007. Just two sectors of the economy were responsible for this massive rise in leverage: households, whose indebtedness jumped from 50 per cent of GDP in 1980 to 71 per cent in 2000 and 100 per cent in 2007; and the financial sector, whose indebtedness jumped from just 21 per cent of GDP in 1980 to 83 per cent in 2000 and 116 per cent in 2007 (see charts). The balance sheets of the financial sector exploded, as did the sector’s notional profitability. But leverage, alas, works both ways. Since US net international debt was 39 per cent of GDP at the end of 2007, virtually all of this debt is an asset of another domestic entity and would net out to zero. But when the gross debt stock is huge and economic conditions difficult, the chances that many entities are bankrupt is high. When people fear mass insolvency, lenders stop lending and the indebted stop spending.The result can be the “debt deflation”, described by the American economist, Irving Fisher, in 1933 and experienced by Japan in the 1990s.
The US public expects action. The question is whether it will get the right action. To answer it, we must agree on the challenge the US financial system faces and the criteria for judging how it should be met.
What then is the challenge? The answer given by Hank Paulson, the all-action US Treasury secretary, last Friday, in announcing his “troubled asset relief programme”, is that “the underlying weakness in our financial system today is the illiquid mortgage assets that have lost value as the housing correction has proceeded. These illiquid assets are choking off the flow of credit that is so vitally important to our economy.” The core challenge, then, is viewed as illiquidity, not insolvency. By creating a market for the toxic assets, Mr Paulson hopes to halt the spiral of falling prices and bankruptcies.
I suggest we should take a broader view of events. The aggregate stock of US debt rose from a mere 163 per cent of gross domestic product in 1980 to 346 per cent in 2007. Just two sectors of the economy were responsible for this massive rise in leverage: households, whose indebtedness jumped from 50 per cent of GDP in 1980 to 71 per cent in 2000 and 100 per cent in 2007; and the financial sector, whose indebtedness jumped from just 21 per cent of GDP in 1980 to 83 per cent in 2000 and 116 per cent in 2007 (see charts). The balance sheets of the financial sector exploded, as did the sector’s notional profitability. But leverage, alas, works both ways.
Since US net international debt was 39 per cent of GDP at the end of 2007, virtually all of this debt is an asset of another domestic entity and would net out to zero. But when the gross debt stock is huge and economic conditions difficult, the chances that many entities are bankrupt is high. When people fear mass insolvency, lenders stop lending and the indebted stop spending.
The result can be the “debt deflation”, described by the American economist, Irving Fisher, in 1933 and experienced by Japan in the 1990s.
You know my thoughts on debt deflation. This is where we are heading despite the efforts of Bernanke and Paulson to engineer inflation and another stock market/real estate bubble.
I end this post by quoting Paul Krigman's Good ideas and lies:
Daniel Davies, in one of the great blog posts of this era, laid down a key principle: Good ideas do not need lots of lies told about them in order to gain public acceptance. He was talking about the selling of the Iraq war, but it applies more generally. So, this morning Hank Paulson told a whopper: We gave you a simple, three-page legislative outline and I thought it would have been presumptuous for us on that outline to come up with an oversight mechanism. That’s the role of Congress, that’s something we’re going to work on together. So if any of you felt that I didn’t believe that we needed oversight: I believe we need oversight. We need oversight. What the proposal actually did, of course, was explicitly rule out any oversight, plus grant immunity from future review: Sec. 8. Review. Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency. I’m not playing gotcha here. This is telling: if Paulson can’t be honest about what he himself sent to Congress — if he not only made an incredible power grab, but is now engaged in black-is-white claims that he didn’t — there is no reason to trust him on anything related to his bailout plan.
Daniel Davies, in one of the great blog posts of this era, laid down a key principle:
Good ideas do not need lots of lies told about them in order to gain public acceptance.
He was talking about the selling of the Iraq war, but it applies more generally.
So, this morning Hank Paulson told a whopper:
We gave you a simple, three-page legislative outline and I thought it would have been presumptuous for us on that outline to come up with an oversight mechanism. That’s the role of Congress, that’s something we’re going to work on together. So if any of you felt that I didn’t believe that we needed oversight: I believe we need oversight. We need oversight.
What the proposal actually did, of course, was explicitly rule out any oversight, plus grant immunity from future review:
Sec. 8. Review. Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.
Sec. 8. Review.
Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.
I’m not playing gotcha here. This is telling: if Paulson can’t be honest about what he himself sent to Congress — if he not only made an incredible power grab, but is now engaged in black-is-white claims that he didn’t — there is no reason to trust him on anything related to his bailout plan.
I don't know about you, but I do not trust Comrade Paulson or anyone telling us that this rescue plan is good for the global financial system and the global economy. I know it is good for his net worth and that of his buddies at Goldman Sachs and other Wall Street firms but they are the crooks who made sure taxpayers "are already on the hook."
But despite the rumblings on Capitol Hill today, politicians will sign off on this rescue plan, holding their noses and praying to God that it works. (If it doesn't work, Paulson will come back in the near future to utter: "Tell them they can eat cake").
As I write this and reflect on today's hearings, Lord Acton's dire warning that "absolute power corrupts absolutely" keeps resonating in my head.
The plan would give the government broad power to buy the bad debt of any United States financial institutions for the next two years.
Speaking at the White House Saturday morning, the president said he decided to act boldly once he realized how bad the financial crisis was.
"It turns out there are a lot of inner links throughout the financial system," said Bush. "The system had grown to a point where a lot of people were dependent upon each other. And the collapse of one part of the system wouldn't just affect a part of the financial markets, it would affect the average citizen."
[Duh!]
It's still unclear what the government would get in return from the companies it helps.
Will this massive bailout help stabilize markets and restore investor confidence? Who knows?
On the technical side, I am paying attention to the 50 and 200 day exponential moving averages for both the Dow and S&P 500. As you can see, if you're long stocks like most people are, the trend is not your friend.
On the fundamental side, even if we wipe out all that toxic debt from banks' balance sheets, what is the next shoe to fall?
More importantly, what is the catalyst that will propel stocks to new highs? Higher unemployment? Stagflation or even worse, debt deflation? Does anyone have a clue?
Jeremy Siegel, author of Stocks for the Long Run, sees a silver lining:
"There's about a half trillion dollars' worth of write-downs already embedded in the prices of these financial stocks," which suggests that financial firms overall are finally being forced to come clean about investments. "We're seeing a changing of the players," he added. "There is still a huge demand for financial services. That demand is going to grow, and international flows of credit are going to be bigger than ever.... We are now making transparent what these instruments are worth."
Siegel's comment echoed his opinion piece in the Wall Street Journal the morning of the panel. In acknowledging the turmoil caused by the overleveraging, he noted: "There is good evidence that the worst is over, especially for the commercial banks with access to Federal Reserve credit."
Others, like Joseph Gyourko, chairman of Wharton's real estate department, are more skeptical:
"There are emerging problems on the commercial side [of the real estate market]," he said. After the session, Gyourko shook his head at what he feels is a downward spiraling securities market for commercial real estate. "There are going to be so many banks going under," he stated. "If I could re-invent myself, I'd be a distressed property fund. You simply can't get debt in this market."
According to Gyourko, stock prices for real estate investment trusts are suffering, too. But his fears for the CMBS market are well-grounded. AIG, for example, could be forced to sell off assets at a time when CMBS demand is practically non-existent. The insurer owns in excess of $21 billion of CMBS.
As for the residential side, he noted that the excess supply of new homes continued throughout 2007. "The excess supply will wear off by the end of 2009, but not before.... The end of this debacle keeps getting put off and put off."
I am not sure if "RTC-II" will absorb all the bad debt on banks' balance sheets, including commercial mortgage backed securities (CMBS).
Importantly, it's not just banks that are exposed to the CMBS market. Insurance companies and pension funds are also exposed to CMBS. If that market crumbles, watch out, it will wreak havoc on the portfolios of many public pension funds.
And what about hedge funds? While some fear the new rules will rattle their business, others are more cautious, waiting to gauge the effects of the bailout:
Hedge funds raised cash holdings during the biggest two-day global stock rally in history because they aren't sure where markets are headed after the U.S. moved to bail out banks and limit bets against financial companies.
"The rally hurt us quite a bit'' because the firm shorted some stocks in expectation they would fall, said Chris Wang, co- founder of SYW Capital Management LLC in New York, which oversees less than $100 million. "The best thing for us to do is shrink our books and hold more cash.''
The increase in cash indicates fund managers don't expect calm to return to markets in the next several weeks, said Bill Grayson, president of Falcon Point Capital LLC, a San Francisco- based investment firm. Some funds are seeking to protect the year's gains, while others are hoping to pare losses.
"The one thing I can guarantee is incredible volatility in the foreseeable future,'' he said.
The fact that Wall Street is collapsing is a given. How it survived as long as it did under its corrupted model is the question that will be debated in history books for the next generation.
For example, imagine a business model that bases remuneration to brokers on how much money they make for their Wall Street employer and not one dime for how well their customers’ portfolios perform. A Wall Street broker receives remuneration that rises from approximately 30 to 50 per cent of the gross commission based on their cumulative trading commissions with zero regard to how well the clients’ accounts have done. There is no acknowledged internal mechanism in any of the major Wall Street firms to gauge the overall success of the accounts the broker is managing.
Make no mistake that what ever the dollar amount announced next week to funnel into an entity to buy bad debts from banks and Wall Street firms, it won’t be enough. It’s a Band-Aid on a malignant tumor. That tumor is Credit Default Swaps (CDS) with over $60 trillion now owed through secret contracts in an unregulated market created, financed and owned by the unintelligent design masters, Wall Street firms themselves. (See “How Wall Street Blew Itself Up,” CounterPunch, January 21, 2008.)
Much of the blame should go to the Clinton Administration for leading the call to repeal Glass-Steagall in 1999, letting the banks merge with casinos. Or rather, the casinos have absorbed the banks. That is what has put the savings of Americans at risk.
But does this really mean that the only solution is to re-inflate the real estate market? The Paulson-Bernanke plan is to enable the banks to sell off the homes of five million home mortgage debtors faced with default or foreclosure this year! Homeowners with “exploding adjustable-rate mortgages” will lose their homes, but the Fed will pump enough credit into the mortgage-lending agencies to enable new buyers to go deeply enough into debt to take the junk mortgages off the hands of the gamblers who presently own them. Time for another financial and real estate bubble to bail out the junk mortgage lenders and packagers.
America has entered into a new war – a War to Save Computerized Derivative Traders. Like the Iraq war, it is based largely on fictions and entered into under seeming emergency conditions – to which the solution has little relation to the underlying cause of the problems. On financial security grounds the government is to make good on the collateralized debt obligations packaged (CDOs) that Warren Buffett has called “weapons of mass financial destruction.”
Hardly by surprise, this giveaway of public money is being handled by the same group that warned the country so piously about weapons of mass destruction in Iraq. Pres. Bush and Treasury Secretary Paulson have piously announced that this is no time for partisan disagreements over this shift of public policy to favor creditors rather than debtors. There is no time to make the biggest bailout in election history an election issue. Not an appropriate time to debate whether it is a good thing to re-inflate housing prices to a level that will continue to oblige new home buyers to go so deeply into debt that they must pay some 40 percent of their take-home pay on housing.
Remember when President Bush and Alan Greenspan informed the American people that there was no money left to pay Social Security (not to mention Medicare) because at some future date (a decade from now? 20 years? 40 years?) the system might run a deficit of what now seems to be merely a trivial trillion dollars spread over many, many years. The moral was that if we can’t figure out how to pay, let’s plow the program under right now.
Mr. Bush and Greenspan did have a helpful solution, of course. The Treasury could turn Social Security and medical insurance money over to Bear Stearns, Lehman Brothers and their brethren to invest at the “magic of compound interest.”
What would have happened to U.S. Social Security had this been done? Perhaps we should view the past two weeks’ events as having assigned to Wall Street gamblers all the money that has been set aside since the Greenspan Commission in 1983 shifted the tax burden onto FICA wage withholding. It is not retirees who are being rescued, but the Wall Street investors who signed papers saying that they could afford to lose their money. The Republican slogan this November should be “Gambling insurance, not health insurance.”
This is not how the much-vaunted Road to Serfdom was mapped out to be. Frederick Hayek and his Chicago Boys insisted that serfdom would come from government planning and regulation. This view turned upside down the classical and Progressive Era reformers who depicted government as acting as society’s brain, its steering mechanism to shape markets – and free them from income without playing a necessary role in production. The theory of democracy rested on the assumption that voters would act in their self-interest.
Market reformers made a kindred happy assumption that consumers, savers and investors would promote economic growth by acting with full knowledge and understanding of the dynamics at work. But the Invisible Hand turned out to be accounting fraud, junk mortgage lending, insider dealing and a failure to relate the soaring debt overhead to the ability of debtors to pay – all of this mess seemingly legitimized by computerized trading models, and now blessed by the Treasury.
This mess is far from over. Nobody knows what the future will bring but if you are concerned, do not be afraid to take money off the table (ie. sell stocks after big rallies!) and increase your cash reserves.
As always, talk to your financial adviser and ask them to take into account your present and future needs. If you're still not sure, do not be afraid to ask a second or third opinion.
