Monday, June 30, 2008
Now I know, Mr. President, that you’re already addicted to those nicotine smokes and I’m not trying to promote a caffeine habit here, but this economy will need an additional jolt of $500 billion or so of government spending real quick. It must replace both reduced residential investment and consumption whose decline has placed the U.S. economy near, if not in a recession. Some quick math for you Sir: gross private domestic investment (machines, houses, inventories) has declined by $200 billion since its peak in late 2006. Due to higher unemployment and energy costs, domestic consumption will soon be $300 billion less than it should be if we are to return to historical economic growth rates. According to that old C + I + G formula (scratch the trade deficit for now) when C + I is reduced by $500 billion, then G should increase by that amount in order to fill the gap. The G, Sir, is you – the government deficit, the fiscal stabilizer popularized by Keynes following the Depression. And since the fiscal deficit for 2008 is likely to press $500 billion even before you take the oath of office, well there you have it: $500 billion + $500 billion = $1 trillion big ones, probably by sometime in 2011 or so. It takes time to spend those types of bucks.
Investment Houses Tout Second-Quarter Rebound That Isn't All It Might Seem Ever meet an investment banker who didn't say his mergers-and-acquisitions pipeline was just bursting? The next time, he was probably unemployed. It is unbridled optimism that fuels investment banking, especially during the roughest patches. It is what has chief executives daftly chirping about the end of the credit crunch. Take this year's second quarter. Bankers will tell you European equity issuance bounced back to the second busiest second quarter on record, corporate bond issuance set a record, and big acquisitions by companies were on the rise -- all according to preliminary data released June 27 by Thomson Reuters and Dealogic. That certainly is one way to look at it. On the other hand, most of the equity capital-markets activity hinged on banks helping to raise capital for one another. The rescue rights issues helped mask a 67% global drop in quarterly initial public offering volume. Something similar happened in the debt markets. Investment-grade issuers rushed in to sell paper when credit risk premiums narrowed in May, fearing what could happen to liquidity and interest rates in the second half. But high-yield issuance, which typically generates three times as much in fees as the investment-grade side, plummeted 57%. Then there are the mergers and acquisitions, where the dollar value of announced deals fell 35%. That is OK, bankers say. That puts it in line with 2005, which was a very good year. But in 2005 the trend was up, whereas this time it is down. By the same logic, volume in 2009 would look something like it did in 2002. And that could mean plenty of bankers with no pipelines at all. Not that they would ever admit it. An Economic Lesson So much for the stimulus. U.S. consumers' disposable income rose 5.7% in May, largely because of $48 billion in tax rebates the government sent out in an attempt to prop up spending. But instead of blowing their windfalls on flat-screen televisions, the latest fashions and sundry strip-mall offerings, consumers did something more remarkable. They squirreled most of it away -- sending the savings rate for the month skyrocketing to 5%, a 13-year high. It is a one-time thing so far, but it could be a first step toward addressing U.S. economic imbalances. If so, it is welcome over the long run. But shorter term, it may signal that pain from the credit crunch could worsen -- that is, if the Scandinavian economic crisis of the early 1990s is any example. Some of the parallels are eerie. Negative real interest rates and financial deregulation set off a boom in the late 1980s in Finland, Norway and Sweden. Savings rates dropped, and even turned negative. Banks eased lending standards. A wave of leveraged buyouts took place, and real estate boomed. Finnish home prices, for example, doubled from 1987 to 1989. The subsequent unwind proved nasty. House prices started to fall rapidly and credit became scarce. The first financial victims were smaller banks and finance companies that relied on hot money. Although the details varied in the different countries, in general the financial companies were allowed to fail, while the smaller banks were merged with healthier competitors. The crunch really hit, though, when consumers started repairing their own debt-laden balance sheets. Savings rates turned positive. That caused consumption to fall quickly, sending the economies into tailspins. The resulting pressure on the banks forced governments throughout Scandinavia to recapitalize and effectively nationalize several large banks. Luckily, the bailouts were eventually effective. While the downturns were sharp, expansion in the three economies soon resumed. Of course, the U.S. could well muddle though. The ability of Americans to consume beyond their means is legendary. And one month's data don't prove they have renounced their spendthrift ways. But the day when they do so, at least for a while, is surely coming.
Financial stocks are down 17% this month, and the simple explanation is that investors have lost their trust in banks and brokerages. Further evidence of investor distrust: Citigroup Inc. and Bank of America Corp. are both trading at nearly 80% of book value, while J.P. Morgan Chase & Co., considered to be the soundest of the big banks, is only trading around book value. Many smaller banks are trading at less than half of book values. How then can banks win back that trust? A lesson from the savings-and-loan crisis is that banks that fail to quickly acknowledge problems and act on them pay a steep price. So far, too many banks have drip-fed losses, and then capital raises, out over a number of quarters. Yet regulators haven't pushed hard enough to force banks to quickly write down the value of their assets. And not enough banks have been willing to sell stock at low prices to bolster their balance sheets. A reluctance to recognize these two realities has led to two proposed fixes being discussed by the banks, potential investors, politicians and, to a lesser extent, regulators. Both could potentially help the situation, but the assistance would come at a cost. And it's not clear that the system won't heal itself without them. First are rules on private-equity investments in banks and second are rules concerning mergers between banks. Banking regulations say that if a private-equity firm buys more than 25% of a bank, the firm itself will be treated just like a fully regulated bank, a level of scrutiny that a Carlyle Group or Blackstone Group would never submit to. Making a smaller investment doesn't help. With a stake between 10% and 25%, the investor would typically have to enter an agreement with the regulator not to control the bank's management. And private-equity guys want control in return for their money. Private-equity firms argue that the rules are archaic and prevent them from riding to the rescue of failing banks. But there's a logic to the rules. They're designed to prevent a firm from using the bank to lend money to its other investments, in effect using the bank like a giant credit card. And since the banking sector relies on a range of government subsidies -- embedded, for example, in deposit insurance -- taxpayers deserve this protection. Also, any rule changes could lead to an unfair playing field, where unregulated private-equity firms compete for acquisitions with regulated banks or public investors. The rules are less restrictive than they first appear. Private-equity firms can set up separate bank-holding companies that can be used to acquire banks. JLL Partners did this in December when it set up a regulated entity that has acquired several Texan banks. Regulators also have to doubt how much money private-equity firms would put into banks. To make investments pay off, they typically use enormous leverage, which no regulator is going to allow in the banking sector. That means banks only become attractive if their valuations fall to rock-bottom levels. Another area that has drawn attention: banks' longstanding complaint that rules make it tough for strong banks to buy weaker banks. Banks typically don't have to put a market price on many of their assets, typically big portions of their loan portfolios, even if the market has tanked. But if one bank buys another, the buyer must mark the seller's assets to the current market price, even if the loans are still current. That would force losses which would hit the levels of capital the regulators require banks to hold. Banks gripe that this makes it tougher for them to do deals. But that misses a big, underlying cause of banks' current problems -- lack of investor trust. By dumping bank stocks, investors are in effect doing what would happen in a bank merger -- marking down the banks' assets, even if the banks themselves are holding the values steady. When a bank trades at half of book value, investors are saying the bank's assets are worth somewhere near half of what the bank says they are. The way to end this problem is by recognizing more, not less, of the losses that investors believe will prove real. Until banks accept that the housing market won't magically return to normal, the gap between share prices and book values may only grow wider. The shortage in bank capital has nothing to do with rules that private-equity investors or banks themselves deem to be unfriendly. It's that banks haven't confessed enough to regain investor trust. That might be painful, but in the end, it will heal the system.
Sunday, June 29, 2008
It is quite possible that we are now at the most dangerous moment since the American financial crisis began last August. Staggering increases in the prices of oil and other commodities have brought American consumer confidence to new lows and raised serious concerns about inflation, thereby limiting the capacity of monetary policy to respond to a financial sector which – judging by equity values – is at its weakest point since the crisis began. With housing values still falling and growing evidence that problems are spreading to the construction and consumer credit sectors, there is a possibility that a faltering economy damages the financial system, which weakens the economy further. After a period of intense activity at the beginning of the year with the passage of fiscal stimulus legislation, strong action by the Federal Reserve to cut rates and provide liquidity and the introduction of anti-foreclosure legislation, policy has again fallen behind the curve. The only important policy actions of the past several months have been those forced on the Fed by the Bear Stearns crisis. It would be a mistake to overstate the extent to which policy can forestall the gathering storm. But the prospects for a more favourable outcome would be enhanced if four actions were taken promptly. First, the much debated housing bill should be passed immediately by Congress and signed into law. It provides some support for mortgage debt reduction and strengthens the government’s hand in its troubled relationship with the government-sponsored enterprises – Fannie Mae and Freddie Mac. While it is an imperfect vehicle – too limited in the scope it provides for debt reduction, insufficiently aggressive in strengthening GSE regulation and failing to increase the leverage of homeowners in their negotiations with creditors through bankruptcy reform – it would contribute to the repair of the nation’s housing finance system. Failure to pass even this minimal measure would undermine confidence. Second, Congress should move promptly to pass further fiscal measures to respond to our economic difficulties. The economy would be in a far worse state if fiscal stimulus had not come on line two months ago. The forecasting community is having increasing doubts about the fourth quarter of this year and beginning of the next as the impact of the current round of stimulus fades. With long-term unemployment at recession levels, there is a clear case for extending the duration of unemployment insurance benefits. There is now also a case for carefully designed support for infrastructure investment, as financial strains have distorted the municipal credit markets to the point where even the highest-quality municipal borrowers are, despite their tax advantage, paying more than the federal government to borrow. There are legitimate questions about how rapidly the impact of infrastructure spending will be felt. But with construction employment in free fall, there will be a need for stimulus tied to the needs of less educated male workers for quite some time. Fiscal stimulus measures must be coupled to budget process reform that provides reassurance that, once the crisis passes, the fiscal policy discipline of the 1990s will be re-established. Third, policymakers need to make a clear commitment to addressing the non-monetary factors causing inflation concerns. Though this could change rapidly and vigilance is necessary, it does not now appear that there are embedded expectations of a continuing wage price spiral. Rather, the primary source of inflation concern is increases in the price of oil, food and other commodities. Even if structural measures to address these issues do not have an immediate impact on commodity prices, they may serve to address medium-term inflation expectations. Appropriate steps include reform of misguided ethanol subsidies that distort grain markets to minimal environmental benefit, allowing farm land now being conserved to be planted; measures to promote the use of natural gas; and reform of Strategic Petroleum Reserve Policy to encourage swaps at times when the market is indicating short supply. Major importance should be attached to encouraging the reduction or elimination of energy subsidies in the developing world. Fourth, it needs to be recognised that in the months ahead there is the real possibility that significant financial institutions will encounter not just liquidity but solvency problems as the economy deteriorates and further writedowns prove necessary. Markets are anticipating further cuts in financial institution dividends; regulators should encourage this to happen sooner rather than later and more broadly to reduce stigma. They should also recognise that no one can afford to be too picky about the timing or source of capital infusions and rapidly complete the review of regulations that limit the ability of private equity capital to come into the banking system. Most important, regulators should do what is necessary, including possibly seeking new legislative authority, to assure that in the event of an institution becoming insolvent they can manage the resolution in a way that protects the system while also protecting taxpayers. It was fortunate that a natural merger partner was available when Bear Stearns failed – we may not be so lucky next time. Unfortunately we are in an economic environment where we have more to fear than fear itself. But this is no excuse for fatalism. The policy choices made in the next few months will matter to the lives of millions of Americans, to America’s economic strength and to the global economy.
Despite strict capital controls, China is being flooded by the biggest wave of speculative capital ever to hit an emerging economy A POPULAR game this summer among watchers of the Chinese economy is to guess the size of speculative capital or “hot money” flowing into the country. One clue is that although China’s trade surplus has started to shrink this year, its foreign-exchange reserves are growing at an ever faster pace. The bulk of its net foreign-currency receipts now comes from capital inflows, not the current-account surplus. According to leaked official figures, China’s foreign-exchange reserves jumped by $115 billion during April and May, to $1.8 trillion. In the five months to May, reported reserves swelled by $269 billion, 20% more than in the same period of last year. But even this understates the true rate at which the People’s Bank of China (PBOC) has been piling up foreign exchange. Logan Wright, a Beijing-based analyst at Stone & McCarthy, an economic-research firm, has done some statistical detective work to make sense of the figures. The first problem is that reported reserves exclude the transfer of foreign exchange from the PBOC to the China Investment Corporation, the country’s sovereign-wealth fund. The reserve figures have also been reduced in book-keeping terms this year by the PBOC “asking” banks to use dollars to pay for the extra reserves that they are now required to hold at the central bank. Adding these two items to reported reserves, Mr Wright reckons that total foreign-exchange assets rose by an astonishing $393 billion in the first five months of 2008 (see chart), more than double the increase in the same period last year. China’s trade surplus and foreign direct investment (FDI) explain only 30% of this. Deducting investment income and the increase in the value of non-dollar reserves as the dollar has fallen still leaves an unexplained residual of $214 billion, equivalent to over $500 billion at an annual rate. Some economists use this as a proxy for hot-money inflows. But some of it may reflect non-speculative transactions, such as foreign borrowing by Chinese firms. Mr Wright therefore estimates that China received up to $170 billion in hot money in the first five months of 2008. This far exceeds anything previously experienced by any emerging economy. Michael Pettis, an economist at Peking University’s Guanghua School of Management, reckons that speculative inflows during that period were perhaps well over $200 billion, because hot money also comes into China through companies overstating FDI and over-invoicing exports. Foreign firms are bringing in more capital than they need for investment: the net inflow of FDI is 60% higher than a year ago, yet the actual use of this money for fixed investment has fallen by 6%. Some of it has been diverted elsewhere. It is one thing to deduce how much money is coming in. It is another to work out where it is going and how it gets past China’s strict capital controls. The stockmarket, which continues to plunge (see article), is no home for hot money. Some has gone into property. The lion’s share is in bog-standard bank deposits. An interest rate of just over 4% on yuan deposits compared with 2% on dollars, combined with an expected appreciation in the yuan, offers a seemingly risk-free profit for those who can get money into China. It comes in via various circuitous routes. Big Western investment funds which care about liquidity would find it hard to move money into China, although rumours abound of hedge funds that are investing money through Chinese partners. Trade and investment offers a big loophole for Chinese and foreign firms. Resident individuals can use the $50,000 annual limit for bringing money into China from abroad—many also use their friends’ and relatives’ quotas. Another big loophole lets Hong Kong residents transfer 80,000 yuan ($11,600) a day into mainland bank deposits. The government is trying to crack down, but that risks shifting the activity towards underground money exchangers. And if the government were to increase its monitoring of FDI and trade flows, the extra bureaucracy could harm the real economy. China needs to reduce the incentive for destabilising capital inflows, rather than block the channels. Massive hot-money inflows present two dangers to China’s economy. One is that capital could suddenly flow out, as it did from other East Asian countries during the financial crisis a decade ago and Vietnam this year. China’s economy is protected by its current-account surplus and vast reserves, but its banking system would be hurt by an abrupt withdrawal. A more immediate concern is that capital inflows will fuel inflation. The more foreign capital that flows in, the more dollars the central bank must buy to hold down the yuan, which, in effect, means printing money. It then mops up this excess liquidity by issuing bills (as “sterilisation”) or by lifting banks’ reserve requirements. But all this complicates monetary policy. China’s interest rates are below the inflation rate, but the PBOC fears that higher rates would attract yet more hot money and so end up adding to inflationary pressures. The central bank has instead tried to curb inflation by allowing the yuan to rise at a faster pace against the dollar—by an annual rate of 18% in the first quarter of this year. But this encouraged investors to bet on future appreciation, exacerbating capital inflows. Since April the pace of appreciation has been much reduced, in a vain effort to discourage speculators. Mass sterilisation Some economists argue that the problems caused by hot money have been exaggerated. After all, the PBOC has so far succeeded in sterilising most of the increase in reserves. Inflation, at an annual rate of 7.7% in May, has also started to decline, and the impact of last week’s rise in fuel prices is likely to be offset over the next couple of months by falling food-price inflation. The snag is that money-supply growth would explode without sterilisation, which is now close to its limit. It is becoming very costly for the central bank to mop up liquidity by selling bills, so it is now relying more heavily on raising banks’ reserve requirements (the PBOC pays banks only 1.9% on their reserves, against over 4% on bills). Since January 2007 the minimum reserve ratio has been raised 16 times, from 9% to 17.5%. But it cannot climb much higher without hurting banks’ profits. To curb future inflation, China therefore needs to stem the flood of capital. One solution would be a large one-off appreciation of the yuan so that investors no longer see it as a one-way bet. This, in turn, would give the PBOC room to raise interest rates. The snag is that the yuan would probably have to be wrenched perhaps 20% higher to alter investors’ expectations, and this is unacceptable to Chinese leaders, especially when global demand has slowed and some exporters are already being squeezed. This implies that monetary policy will remain too loose. The longer that the torrent of hot money continues and interest rates remain too low, the bigger the risk that underlying inflation will creep up
Friday, June 27, 2008
The Federal Reserve may soon make it easier for private-equity firms and others to invest in the nation's ailing banks, according to people familiar with the matter. With bank stocks crumbling and the second quarter drawing to a close Monday, the changes could offer a lifeline to cash-strapped lenders desperate to secure capital. "This would be a bit of a sea change for the Fed," said Gregory Lyons, head of the financial-services practice at law firm Goodwin Procter LLP. "A number of banks would love to access the private-equity pool. It's a clean slug of money." The move comes as regulators grow increasingly worried about the ability of many banks to replenish capital amid the worst banking crisis in decades. Small and regional lenders are expected to have a tougher time lining up new investors, particularly since some recent capital infusions have stuck banks' new shareholders with big losses. The Fed and other banking regulators historically have resisted unregulated entities' exerting control over banks, and tough enforcement of federal rules has often prevented private-equity firms from pumping much cash into banks. Instead, banks recently have drummed up cash from a combination of government investment funds, mutual funds and other investors, often through public offerings of stock or other securities. But there are signs that the capital pool is starting to dry up at a time when many financial institutions are still ailing. "We are looking at ways we can make those things more workable and gain from the experience we've had over the past few years," Federal Reserve general counsel Scott Alvarez said. Fed officials recently have met with big buyout firms -- including J.C. Flowers & Co., Carlyle Group, Kohlberg Kravis Roberts & Co. and Warburg Pincus -- and banking lawyers to discuss the obstacles, according to people familiar with the matter. Under federal law, to own more than 24.9% of a bank, an entity must register as a bank holding company, which is subject to heavy regulation and can be forced to serve as a "source of strength" for the bank. Ownership of more than 9.9% of a bank also subjects the entity to regulatory scrutiny to ensure that it isn't controlling -- or even influencing -- the bank's operations. The Fed can't change those laws, but it has wiggle room in how it interprets them. For example, the Fed recently has been reluctant to approve deals involving private-equity firms' owning more than 9.9% of a bank unless the buyers agree to limit their voting power and not have more than one seat on the bank's board. That tends to make bank deals much less attractive to private-equity firms, which crave large positions and control over their portfolio companies but don't want to fall under federal regulation. The Fed has been trying to determine whether private-equity firms are demanding more board representation than is currently permitted in bank deals, one person said. And would-be investors are pressing their case for an expanded role in the industry. "If we don't facilitate private equity's role in that, that's one less pool of capital to stand between these losses and the taxpayer," said Randall Quarles, a managing director at Carlyle and a former senior U.S. Treasury official, who has been in discussions with the Fed. Private-equity infusions are looking increasingly important because stronger banks are still averse to snapping up peers with damaged balanced sheets. Accounting rules also have inflated the price tags on many such deals. Even if private-equity firms are permitted to take a more active role, it isn't clear that they will jump headfirst into the banking sector. For one thing, most of the recent capital infusions have lost money. That could temper enthusiasm as private-equity firms examine opportunities. Some banks need cash quickly. When lenders report second-quarter earnings next month, many are expected to show steep declines in capital levels. One of the banks that could benefit from looser rules is BankUnited Financial Corp., based in Coral Gables, Fla., that is currently seeking some $400 million in capital. A number of private-equity firms approached the small lender earlier this year, but bank executives rejected their interest, says a person familiar with the situation. Some of these firms are probably still interested in the bank, and with other investors expressing reluctance about pumping more money into small and regional lenders, the Florida bank may welcome that interest.
Corporate lawyer Marty Lipton, widely credited with inventing the "poison pill" takeover defense in 1982, has never cared much for activist investors or other threats to the sanctity of the boardroom. Time has largely washed his viewpoint away. Courts, Congress, regulators and boards themselves all are giving holders more power. In an address June 25 at the University of Minnesota School of Law, he wondered aloud whether the move to shareholder-centric governance will "simply overwhelm American business corporations." For Mr. Lipton, this has adverse effects: Boards' ability to recruit quality directors, greater isolation of CEOs, nettlesome regulatory duties. But the most provocative threat of all: "The board-centric model of governance is premised on the notion that boards merit the vote of confidence of shareholders and the public markets, and notwithstanding the strong current of distrust that runs through many corporate-governance reforms, history has proven this vote of confidence to be well-deserved. I believe it is the only way to assure that public corporations will be able to compete with the state corporatism that is transforming the economies of China, Russia and other rapidly industrializing countries, cope with the demands for short-term (and shortsighted) stock gains by activist hedge funds and make the long-term investments in the future of their businesses that are essential for future prosperity of our nation."
Thursday, June 26, 2008
The one bright spot for GMAC used to be its auto-loan business. Now, that, too, is dimming. Declining values of gasoline-guzzling pickup trucks and sport utility vehicles are looming over the lender, adding to its existing problems with souring mortgages through its ailing home-loan unit. This leaves GMAC in worse shape than rival Ford Motor Credit. And it is unlikely GMAC can look to General Motors Corp. for help. The auto maker, struggling to cope with a steep decline in sales of pickups and SUVs, announced production cuts Monday. The company has a 49% stake in GMAC after a consortium led by private-equity group Cerberus Capital Management LP, parent of Chrysler LLC, bought 51% of GMAC in 2006 for about $14 billion. GMAC, set up in 1919 to provide financing to buyers of GM vehicles, made $50.8 billion in loans for new and used vehicles last year. The lender, which once propped up GM with steady profit during economic downturns, has been weakened by the billions of dollars it pumped into its struggling mortgage subsidiary, Residential Capital LLC. GMAC posted a net loss of $589 million in the first quarter, compared with a loss of $305 million a year earlier. In addition, falling demand for pickup trucks and SUVs, which make up a sizable chunk of GM's production mix, amid $4-a-gallon gasoline, should further hurt GMAC. The value of gas guzzlers has dropped sharply in the used-car market. GMAC is saddled with inventories of thousands of these vehicles as they come off leases or are repossessed from owners unable to keep up with payments. Typically, GMAC takes back vehicles at the end of leases and sells them to dealers at discounted prices based on estimated values. On average, auction prices on trucks and SUVs fell by more than 20% in May compared with year-earlier prices, according to data from Manheim, a wholesale auction company for used cars. "GMAC is monitoring the market conditions closely," a GMAC spokeswoman says. A representative of Cerberus said GMAC's management is "working hard to strengthen the balance sheet and emerge from this unprecedented economic environment better positioned for the future." GMAC also faces rising delinquencies in loan payments and increasing numbers of repossessions as owners of pickups and SUVs owe more on the vehicles than they are worth. Another worry is GMAC's high level of borrowings compared with its equity cushion. One measure of GMAC's leverage ratio, as calculated by Moody's Investors Service, shows that the company has 23 times its net worth in borrowings. Ford Credit has 11 times its net worth. GMAC's leverage "is an aggressive measure and has negatively impacted GMAC's credit standing," says Mark Wasden, a debt analyst at Moody's. GMAC has a hefty cash balance of $14.84 billion on hand, but steeper-than-expected declines in residual values mean GMAC won't ride to GM's rescue during this downturn.
In a move that could facilitate the flow of capital to cash-strapped banks, the Federal Reserve is considering steps to make it easier for private-equity firms and others to invest in banks, according to regulators and other people familiar with the matter. Under federal law, to own more than 24.9% of a bank, an entity must register as a bank holding company, which is subject to heavy regulation and can be forced to serve as a "source of strength" for the bank. Ownership of more than 9.9% of a bank also subjects the entity to regulatory scrutiny to ensure that it isn't controlling – or even influencing – the bank's operations
Wednesday, June 25, 2008
Consumer glumness is being fueled by an acceleration of home-price declines. Prices of single-family homes in 20 major cities dropped by 15.3% in April from the year before and are now back to 2004 levels, according to the Case-Shiller home price index released by Standard & Poor's. The Office of Federal Housing Enterprise Oversight, which oversees Fannie Mae and Freddie Mac and tracks prices of homes purchased with their mortgages, said home prices were down 4.6% in April from the previous year, the lowest level since its tracking began in 1991. The S&P/Case-Shiller index shows larger price declines in part because it tracks metropolitan areas where prices are more sensitive than in rural locations. Ofheo, on the other hand, may understate the weakness because it tracks only so-called agency-backed mortgages, which exclude homes purchased with subprime loans. Both surveys show that price declines vary sharply by region. Las Vegas and Miami continue to have the largest one-year drops, of 26.8% and 26.7% respectively. Los Angeles, San Diego, San Francisco and Tampa, Fla., have also seen declines of more than 20%, according to the S&P/Case-Shiller data. Other regions are faring better. In eight areas -- including Boston, Dallas, Denver, Portland, Ore., and Seattle -- prices either rose or stabilized in April from the month before. "If there is anywhere to look for possible improvement, it would be that the pace of monthly declines has slowed down for most of the markets," said David M. Blitzer, chairman of S&P's index committee
Regulators are increasingly worried about a lending practice that allows real-estate developers to delay paying construction-loan interest but can mask problems at the banks that made the loans. Small banks, which are more exposed relative to bigger banks, have $280 billion of outstanding construction loans overall, mostly to condominium developers and home builders. When the loans were made, the banks calculated the interest that would be paid and put that money aside in "interest reserves." In essence, the banks pay themselves until the loan becomes due or the property generates cash flow. Regulators fear this practice can be abused to keep recording loans as performing even though the underlying real-estate projects are failing. This month, the Federal Deposit Insurance Corp. alerted its bank supervisors to be on the lookout for banks that haven't come clean about potentially problem loans. "You don't want to have a false sense of security because the interest reserve is paying the loan," Steve Fritts, the FDIC's associate director for risk management and exam oversight, said in an interview. "You need to look to the credit fundamentals of the project." The issue is gaining attention because the housing slump means many of the projects funded by construction loans either will never be completed, or won't get sold or rented. That means banks likely will see a sudden jump in the number of dud construction loans as interest reserves deplete. A warning that interest reserves might have disguised loan problems can pop up when a bank shows a relatively low percentage of delinquent construction loans in one quarter followed by a big jump in nonaccruing loans the following quarter. While there can be other reasons for this shift, one possible explanation is that interest reserves kept delinquencies low. However, once the well ran dry, troubled projects were immediately moved to the nonaccrual category, said Mr. Anderson. Meridian Bank in Phoenix is among the banks where nonaccrual rates have outpaced delinquencies. Only 6.4% of Meridian Bank's construction loans were delinquent in the fourth quarter of 2007, but its nonaccruing loans jumped to 30% in this year's first quarter. That jump was among the largest of banks with a sizable proportion of construction loans, according to FDIC data on more than 8,000 banks analyzed by The Wall Street Journal.
Tuesday, June 24, 2008
Optimists say that emerging-market defaults are a thing of the past. Emerging markets today, the argument goes, are relying more on domestically issued local currency debt, both inflation-indexed and non-indexed. This means their debts are far more stable and reliable than in the recent past, when a much larger share of government debt was issued externally and denominated in hard currency. This argument is wrong. In the past, the combination of high levels of domestic debt and inflation surges has often proven deadly for both foreign and domestic investors. Just look at Argentina today, a country not nearly as prosperous as its abundant natural resources would warrant. Already, a good share of Argentina's debt is in default. What else do you call it when a government that owes over $30 billion in inflation-indexed debt manipulates its consumer-price statistics? Through a variety of crude measures (such as firing its top statisticians), the government is publishing an understated inflation rate that is used for calculating indexation payments. The official inflation rate in Argentina for the past 12 months is under 10%. But the true inflation rate appears to be at least 30%, according to virtually every neutral source. Fudging indexation clauses to effectively default on debt is an old game. During the second half of the 1980s, Brazil abrogated inflation-indexation clauses embedded in its debt contracts. In the Great Depression, the U.S. government revalued gold to $35 per ounce from $20, effectively rewriting the contracts of foreign holders of U.S. debt. If external debt holders think that abuse of domestic debt holders is no cause for alarm, they should think again. Governments do not usually cheat holders of only one type of debt. In April, we published a National Bureau of Economic Research paper based on centuries of debt data from many countries. We found that most countries default on external debt only a bit less freely than on domestic debt. That is, contrary to popular belief, domestic debt holders are not necessarily a cushion for "senior claimants" holding externally issued debt. Over the course of history, emerging-market economies have had a hard time shaking off serial default. Each period of quiescence has been invariably followed by more turmoil, with the share of total countries in the world in default sometimes exceeding 40%, as it did during the mid-19th and 20th centuries. Considering the duress of domestic bond holders across the world as global inflation rises, it is surprising that both private investors and multilateral international financial institutions seem so complacent about the rising risks of defaults on external debts. The "this time is different" mentality is based on two mistakes. The first is the idea that domestic debt is something new. The other is the faulty economic logic that payments to domestic debt holders come out of a different pot than payments to external debt holders. There have been many episodes in the past where rising levels of domestic debt have sharply raised risks to external debt holders. There is nothing new about the rise of domestic debt markets. They are simply growing again after a bout of suppression during the high-inflation 1980s and 1990s. Earlier eras offer scant evidence that external creditors have been much safer than domestic debt holders. When India effectively defaulted on its domestic debt through massive inflation and financial repression in the early 1970s, external debt holdings suffered payment reschedulings even though they constituted only a tiny fraction of overall debt. Emerging markets could be in much greater trouble than the optimistic consensus suggests. If today's tepid growth in the U.S., Japan and Europe begins to take hold in emerging markets, Argentina's miserable indexed bond holders may soon have company.
Investors in loans made to junk-rated U.S. companies could be surprised by how little they get back if borrowers start defaulting. A report to be published Tuesday by Moody's Investors Service argues that the explosion of loans issued by junk-rated companies in the past few years means that if they default, the recoveries on these loans might be less than in the past. The highest-priority loans, called first-lien senior secured bank loans, will likely recover on average 68 cents on the dollar upon default in this downturn, compared with a historical average of 87 cents, Moody's said. Typically, loan holders are considered the senior creditors when a company defaults, so they are the first lenders in line for a company's assets. But because companies issued so much of this debt, the loan holders will likely get back less than they have in the past, according to the report. Companies issued so much of this debt because it was popular with investors after the tech bubble burst, and the loans held up well during the previous downturn. Now, Moody's expects loan investors to fare almost as badly as investors in riskier junk bonds have done in previous busts. "It doesn't matter what you call something," says Kenneth Emery, author of the report. "What matters is where you sit in the liability structure." Since 2004, the number of junk-rated companies that borrowed money only in the loan market has doubled, according to the report. Now, these loan-only issuers amount to a third of all U.S. junk companies. Wall Street packaged these loans into popular structured-investment vehicles called collateralized loan obligations, which were among the biggest buyers of leveraged loans. Since the credit markets faltered last summer, loans have already logged unprecedented declines in their value as the M&A boom left a hefty pile of unsold loans hanging over the market. About $173 billion of that has been sold off since July, leaving $64 billion, according to Standard & Poor's Leveraged Commentary & Data. Valuations have improved, putting the average loan price back to 93 cents on the dollar from a low point earlier this year of 86 cents. But corporate defaults are expected to rise amid the economic slowdown and tighter lending standards by banks and other creditors. Weak recoveries don't help prospects for investors or for managers of collateralized loan obligations, which bought about 60% of the loans issues in the past few years. The credit-ratings agencies expect corporate defaults to rise to at least 5% by year end. "It's going to be 18 to 24 months before we slog through these pending defaults and get back to a more normal market," says Michael Bacevich, co-head of leveraged credit at Hartford Investment Management, which manages loan funds and collateralized loan obligations. Moody's also says second-lien, or low priority, loan holders are expected to recover just 21 cents on the dollar in this cycle, compared with 61 cents historically. Senior unsecured junk bonds are likely to recover 32 cents on the dollar compared with a 40-cent historical average. According to Standard & Poor's, the market is already showing investors expectations for weak recoveries on recent bankruptcies. California real-estate development entity LandSource Communities Development filed for Chapter 11 bankruptcy protection earlier this month, and its loans are trading at about 75 cents on the dollar. Its second-lien debt was most recently priced in the high teens, says S&P. For the 19 loans that have defaulted this year, the average price immediately after the default was 70 cents on the dollar, much lower than the average 91 cents during pre-2007 boom times.
Monday, June 23, 2008
The U.S. has long depended on the kindness of strangers to finance its import bill. These days, those strangers are likely to be in China, Brazil, Mexico or some other emerging nation. The U.S. has to import, on net, almost $2 billion in capital a day to cover its enormous trade gap. Of the $920 billion that foreigners pumped into U.S. stocks, bonds and government securities last year, $361 billion -- a stunning 39% -- came from emerging-market nations, according to calculations by Bank of America, using Treasury Department data. China alone accounted for 21 percentage points of the total, with Brazil at 8.4 points, Russia at 2.8 points, and Mexico, Singapore, Malaysia, South Korea and others in the mix. That's probably just the tip of the iceberg. Capital from the oil-soaked Persian Gulf states often flows through London on its way to New York, so billions of dollars in investment flows that look British in the government reports are actually Arab. "Not only are we addicted to other people's money, but the money we're addicted to is from the poor countries," says Joseph Quinlan, chief market strategist at Bank of America. Of course, the Persian Gulf nations aren't exactly impoverished. But relative to the U.S., Brazil, Mexico and Russia are. In economic textbooks, capital is supposed to flow from slow-growing, rich countries that have a lot of it to fast-growing, poor countries that don't. Certainly that was the case before World War I, when Europeans exploited the natural wealth of their colonies. Now the textbooks are being turned upside down. "It's a historical anomaly that, in the last five or six years, even more money has been flowing from poor to rich than rich to poor," says Barry Eichengreen, an economist at the University of California at Berkeley. In part, the situation is the flip side of U.S. dependence on Chinese electronics, Russian oil and Mexican appliances. The more Americans spend, the more dollars the sellers accumulate. It would be one thing if they turned around and spent all of the money on Fords or Hollywood movies. But they don't. The Chinese, for instance, save almost half of their economic output. "They can't invest 48% of [gross national product] productively at home in a year, so they've got to take some of that money and park it abroad," Mr. Eichengreen says. But a lot of what's going on is that emerging-market nations are buying up dollars and looking for places to invest them. The trend has been building since the Asian crisis of the late 1990s. Back then, the Thais, Koreans and others got into trouble because they ran low on foreign-currency reserves and couldn't cover their foreign-currency debts. The Asians learned their lesson and began stockpiling foreign currencies to protect themselves from a run on the bank. The accumulation accelerated in 2002. As the U.S. dollar began to weaken, governments in South Korea, China, Taiwan and Japan decided to buy up dollars to keep their own currencies in line with the greenback. Last year, officials in Brazil, India, Malaysia and other emerging-market nations intervened in markets to avoid currency appreciation that they thought would hurt their companies and economies. This year, it's mostly China and the Persian Gulf oil powers that are awash in dollars and looking for places to invest them. In April alone, China's reserves grew by $75 billion. All told last year, central banks in emerging countries added about $1.2 trillion in Western currencies to their reserves, about $800 billion of it in dollars, according to Brad Setser, a fellow at the Council on Foreign Relations. Emerging-market sovereign-wealth funds added another $150 billion. Much of that ends up invested back in the U.S. The U.S. needs the money and shouldn't shun it, of course. But there are several reasons to be concerned about what's going on. President Bush's administration has long argued that foreigners park their money in the U.S. because of the attractive returns here. But new research by Massachusetts Institute of Technology economist Kristin Forbes, a former Bush adviser, finds that from 2002 to 2006, as the dollar slid, foreigners earned an average annual return of 4.3% on their U.S. investments, while Americans earned 11.2% on their investments overseas. Ms. Forbes concludes that it's not the profits that attract foreign money to the U.S., it's the sophistication of U.S. capital markets. Of course, the implication is that foreigners would run scared if they lost confidence in the transparency and fairness of Wall Street. And, these days, the Chinese could be forgiven if two words spring to mind when they think about U.S. financial markets: subprime mortgages. "They're probably questioning the efficiency of our financial markets," Ms. Forbes says. "Maybe they're thinking twice about continuing to invest such large sums in the U.S. in the future." They might lose even more faith if they see the U.S. succumb to protectionist sentiment and block the very exports that China and other nations sell. "You're not talking about goods anymore," says Bank of America's Mr. Quinlan. "You're talking about our financial lifeline." Furthermore, the U.S. finds itself not only dependent on money from the developing world, but in large part dependent on money from governments in the developing world -- and undemocratic ones. So far, those governments seem to have made the political decision that they're willing to hang onto their U.S. assets, despite the falling dollar. Private investors might have bailed out by now, in search of higher returns. "So far, it is stabilizing rather than destabilizing," Mr. Setser says. But there's no guarantee that the benevolence will last and, at some point, governments in places like Beijing may decide to exercise the leverage that their riches imply. "You're looking at an incredibly large flow of one country's money into the U.S. market," Mr. Setser says.
Thursday, June 19, 2008
Q1 asset quality mortgage -- Company recorded mortgage proprietary trading net writedowns of approximately $1.2 billion, half of which was related to U.S. subprime exposures --Company recorded writedowns of approximately $204 million related to mortgage-related securities portfolios in the Company’s domestic subsidiary banks -- Company’s primary exposure to ABS CDOs is to synthetic CDOs that hold or are referenced to collateral with ratings of BBB+, BBB or BBB- (“mezzanine CDOs”). --Total U.S. subprime (ABS CDO) net trading position 7.6 bil, net exposure (loss) 1.8 (~30% ) --Non-subprime net trading position 14.5 bil, net exposure (8.7 bil) Corporate Lending (corporate loan commitments and funded loans) Q2 08 , Q1 08, Q4 07 --IG: 54.5, 59.8 , 63.2 --HY: 22.3, 26, 30.9 --Total net hedge: 40.1, 45.2, 56.5 --For the quarters ended November 30, 2007, February 29, 2008 and May 31, 2008, the leveraged acquisition finance portfolio of pipeline commitments and closed deals was $19.6 billion, $15.9 billion and $12.7 billion, respectively CMBS --$23.5 billion Q1 08, $31.5 billion Q4 07 **Funded loans represent loans that have been drawn by the borrower and that were outstanding as of February 29, 2008 Q2 asset quality Mortgage: net exposure 10.5 bil Q1 08, 6.7 bil Q2 08 Commercial mortgage: net exposure 11.6 bil Q1 08, 6.4 bil Q2 08 Leverage loan: net exposure 15.9 bil Q1 08, 12.7 bil Q2 08 opinion --exiting risky assets ~30 bil, potential max mark down ~1 to 2 bil. earning close to Q3 last year, ~$1 per share
While the woes afflicting Lehman Brothers Holdings are the result of a balance sheet weighed down by toxic assets, Morgan Stanley in its fiscal second quarter, ended May 31, was tripped up by bad trades, poor management and investments, as well as less-than-stellar risk management. Without big gains related to the sales of assets, Morgan Stanley's net profit of about $1 billion would have been closer to break-even. The firm did take some balance-sheet hits, on things like leveraged loans, commercial real estate and securities backed by troubled monoline insurers. But investors should perhaps be more worried by a bad bet on the direction of electricity prices and a $120 million loss due to a rogue trader. Chief Financial Officer Colm Kelleher acknowledged that Morgan faced a tough quarter, both in terms of market conditions and trades failing to work as planned. But he added that "more often than not, we get those right" and that the firm "continues strengthening our capital and liquidity positions." Morgan Stanley's stock rose Wednesday, suggesting investors were willing to shrug off the quarter. That might make a lot more sense if the company's shares were cheap. They aren't. Despite taking a beating this year, the stock still trades at nearly 1.5 times tangible common equity of about $29.5 billion, which excludes junior subordinated debt that the firm includes in its own calculation of this figure. Morgan Stanley clearly deserves a better valuation than Lehman, which trades at 0.7 times tangible common equity and is deservedly at a lower multiple than Goldman Sachs Group, which trades at about 2.15 times. Still, it is tough to justify Morgan Stanley's premium until the firm shows it has the basics under control and can prevent its traders from causing whiplash volatility. Take a look at the performance of Morgan Stanley's fixed-income business in the second quarter. Revenue at this key business plunged to $414 million from $2.9 billion in the first quarter. Even worse, it is almost impossible for outsiders to tell how the sharp decline came about. Morgan Stanley's commodities traders, for example, placed some bad bets on North American electricity prices, but the firm didn't disclose how much that contributed to the decline in fixed-income revenue. While investors may be willing to give the commodities unit a pass this time, the market has no tolerance for sloppy risk-management -- and that is another factor that could weigh on Morgan Stanley's valuation. The firm's record doesn't appear to be improving after a trading strategy went badly awry in the fourth quarter of fiscal 2007, leading to massive losses. In the second quarter, Morgan Stanley booked a $120 million loss after a now-suspended London trader improperly valued trades that apparently went undetected for at least a quarter. Morgan Stanley can't fumble this way and hope to be spoken of in the same breath with Goldman.
In January, Astoria Financial Corp. told investors that its pile of nonperforming loans had grown to about $106 million as of the end of last year. Three months later, the thrift holding company said the number was just $68 million. How did Astoria do it? By changing its internal policy on when mortgages are classified on its books as troubled. The Lake Success, N.Y., company now counts home loans as nonperforming when the borrower misses at least three payments, instead of two. Astoria says the change was made partly to make its disclosures on shaky mortgages more consistent with those of other lenders. An Astoria spokesman didn't respond to requests for comment. But the shift shows one of the ways lenders increasingly are trying to make their real-estate misery look not quite so bad. From lengthening the time it takes to write off troubled mortgages, to parking lousy loans in subsidiaries that don't count toward regulatory capital levels, the creative maneuvers are perfectly legal. Yet they could deepen suspicion about financial stocks, already suffering from dismal investor sentiment as loan delinquencies balloon and capital levels shrivel with no end in sight. "Spending all the time gaming the system rather than addressing the problems doesn't reflect well on the institutions," said David Fanger, chief credit officer in the financial-institutions group at Moody's Investors Service, a unit of Moody's Corp. "What this really is about is buying yourself time. ... At the end of the day, the losses are likely to not be that different." Still, as long as the environment continues to worsen for big and small U.S. banks, more of them are likely to explore such now-you-see-it, now-you-don't strategies to prop up profits and keep antsy regulators off their backs, bankers and lawyers say. At Wells Fargo & Co., the fourth-largest U.S. bank by stock-market value, investors and analysts are jittery about its $83.6 billion portfolio of home-equity loans, which is showing signs of stress as real-estate values tumble throughout much of the country. Until recently, the San Francisco bank had written off home-equity loans -- essentially taking a charge to earnings in anticipation of borrowers' defaulting -- once borrowers fell 120 days behind on payments. But on April 1, the bank started waiting for up to 180 days. 'Out of Character' Some analysts note that the shift will postpone a potentially bruising wave of losses, thereby boosting Wells Fargo's second-quarter results when they are reported next month. "It is kind of out of character for Wells," says Joe Morford, a banking analyst at RBC Capital Markets. "They tend to use more conservative standards." Wells Fargo spokeswoman Julia Tunis says the change was meant to help borrowers. "The extra time helps avoid having loans charged off when better solutions might be available for our customers," she says. In a securities filing, Wells Fargo said that the 180-day charge-off standard is "consistent with" federal regulatory guidelines. BankAtlantic Bancorp Inc., which is based in Fort Lauderdale, Fla., earlier this year transferred about $100 million of troubled commercial-real-estate loans into a new subsidiary. That essentially erased the loans from BankAtlantic's retail-banking unit. Since that unit is federally regulated, BankAtlantic eventually might have faced regulatory action if it didn't substantially beef up the unit's capital and reserve levels to cover the bad loans. Because the BankAtlantic subsidiary that holds the bad loans isn't regulated, it doesn't face the same capital requirements. But the new structure won't insulate the parent company's profits -- or shareholders -- from losses if borrowers default on the loans, analysts said. Alan Levan, BankAtlantic's chief executive, declined to comment on how much the loan transfer bolstered the regulated unit's capital levels. "The reason for doing it is to separate some of these problem loans out of the bank so that they can get special focus in an isolated subsidiary," he said. Other lenders have been considering the use of similar "bad-bank" structures as a way to cleanse their balance sheets of shaky loans. In April, Peter Raskind, chairman and CEO of National City Corp., said the Cleveland bank "could imagine...several different variations of good-bank/bad-bank kinds of structures" to help shed problem assets. Two banks that investors love to hate, Wachovia Corp. and Washington Mutual Inc., troubled some analysts by using data from the Office of Federal Housing Enterprise Oversight when they announced first-quarter results. Other lenders rely on a data source that is more pessimistic about the housing market. Charter Switch Another eyebrow raiser: switching bank charters so that a lender is scrutinized by a different regulator. Last week, Colonial BancGroup Inc., Montgomery, Ala., announced that it changed its Colonial Bank unit from a nationally chartered bank to a state-chartered bank, effective immediately. That means the regional bank no longer will be regulated by the Office of the Comptroller of the Currency, which has become increasingly critical of banks such as Colonial with heavy concentrations of loans to finance real-estate construction projects. Instead, Colonial's primary regulators now are the Alabama Banking Department, also based in Montgomery, and the Federal Deposit Insurance Corp. The change probably "is meant to distance [Colonial] from what is perceived as the more aggressive and onerous of the bank regulators," said Kevin Fitzsimmons, a bank analyst at Sandler O'Neill & Partners. Colonial spokeswoman Merrie Tolbert denies that. Being a state-chartered bank "gives us more flexibility" and will save the company more than $1 million a year in regulatory fees, she said. Trabo Reed, Alabama's deputy superintendent of banking, said his examiners won't give Colonial a free pass. "There's not going to be a significant amount of difference" between the OCC and state regulators, he says.
With hardly a pause for reflection, central bankers, markets and economic commentators are casting aside angst that the housing bust and credit crunch might cause another Great Depression and are turning instead to inflation anxiety. It's easy to see why. It's easy to overdo it. In the U.S., higher prices for energy and food have pushed consumer prices up 4.2% over last year, a return to the pace of the early 1990s. Producer prices are up a startling 7.2%. In Europe, inflation is running at 3.7%, the highest in the European Central Bank's short life. In Britain, consumer prices are 3.3% ahead of last year. The Bank of England anticipates inflation will top 4% in the second half and remain "markedly above" its 2% target into 2009. In many emerging markets, inflation is worse: 10.5% in Saudi Arabia, 10.4% in South Africa, 7.7% in China. Headlines scream "whiff of stagflation," recalling the painful combination of sluggish growth and rising prices that plagued the 1970s. Central banks toughen anti-inflation rhetoric and raise rates, or prepare to do so. Federal Reserve Chairman Ben Bernanke vows that the Fed "will strongly resist an erosion of longer-term inflation expectations." Finance ministers from the Group of Eight major economies, preoccupied when they met just few months ago with financial-market and banking woes, last week emphasized "global inflationary pressure." In one sense, the fact that central bankers are fretting about inflation is a relief. It means they're less worried that the U.S. housing mess has brought the world dangerously close to the abyss of financial disaster. It's really hard to have a depression and rising prices simultaneously. From the Fed's vantage point, the U.S. economy is doing better than officials feared a few months ago. Although the triple whammy of rising oil prices, falling home prices and a continuing credit crunch pose significant "downside risks," in the Fed's parlance, the U.S. economy kept growing, perhaps feebly, through the current quarter. And rising oil prices and an upward creep in consumer prices, though challenges, are familiar issues to seasoned central bankers and their staffs; the credit crisis was uncomfortably novel. In the midst of it, U.S. Treasury Secretary Henry Paulson recalled the words of an investment-banking client confronting a hostile takeover: "This would be interesting if it wasn't happening to me." Inflation is up primarily because energy and food prices are up so much. Yes, that has spilled over to prices for airline tickets and overnight package delivery. (Fed Ex said Wednesday that U.S. revenue per package increased 9% because of increased "fuel surcharges" and higher charges per pound; package volume declined 3%.) But the rest of the U.S. economy hasn't yet caught the inflation virus. Excluding food and energy prices, the consumer price index is up 2.3%, not much different from the past couple years. That's no comfort to those of us who eat, drive and use electricity daily. It does mean that if energy and food prices stop rising and stick at today's elevated levels, the headline inflation rate will fall abruptly. So far, U.S. wages haven't started climbing faster despite rising prices and inflation headlines. The Fed's strategy is to make sure they don't. It is, essentially, trying to keep enough slack in the economy so prices outside energy and food don't take off. One reason the ECB sounds harsher than the Fed is that the pace of European wage increases has begun to pick up, a hint of what central bankers dub the "second-round effects" of oil-price increases. "It doesn't necessarily imply second-round effects are materializing, but is indicative of intensifying domestic inflation pressures," ECB No. 2 Lucas Papademos told reporters recently while visiting South Korea. Ben Bernanke, a student of economic history, knows that today's conditions are a long way from the Great Inflation of the 1970s. (The annual reported increase in the CPI went from 1.07% in January 1965 to a peak 13.7% in March 1980, and didn't drop below 4% until 1983.) But he also knows that the Great Inflation occurred because the Fed badly misunderstood what was happening in the economy and kept interest rates too low and because consumers and businesses expected inflation and acted accordingly. He wants to avoid the second -- the dreaded increase in "inflation expectations" -- by loudly assuring everyone that the Bernanke Fed knows its history. For much of the past year, Mr. Bernanke has demonstrated that he is determined to avoid a repeat of the Fed mistakes of the 1920s and 1930s that contributed to the Great Depression. He still is. But he also is mindful of the Fed mistakes of the 1970s that contributed to the Great Inflation, and wants you to know that he is determined to avoid those as well.
Wednesday, June 18, 2008
(Fortune Magazine) -- Three decades ago, in a bleak stretch of the 1970s, an economic phenomenon emerged that was as ugly as its name: stagflation. It was the sound of the world hitting a wall, a combination of no growth and inflation. It created an existential crisis for the global economy, leading many to argue that the world had reached its limits of growth and prosperity. That day of reckoning was postponed, but now, after a 30-year hiatus, at least a mild bout of stagflation has returned, and matters could get much worse. We are back to the future, with the question we asked 30 years ago: How can we combine robust economic growth with tight global supplies of such critical commodities as energy, food, and water? It's worth comparing the earlier episode of stagflation with our current travails to help us find our way. In fact, this time the resource constraints will prove even harder to overcome than in the last round, since the world economy is much larger and the constraints are much tighter than before. The similarities with the first half of the 1970s are eerie. Then as now, the world economy was growing rapidly, around 5% per year, in the lead-up to surging commodities prices. Then as now, the United States was engaged in a costly, unpopular, and unsuccessful war (Vietnam), financed by large budget deficits and foreign borrowing. The Middle East, as now, was racked by turmoil and war, notably the 1973 Arab-Israeli war. The dollar was in free fall, pushed off its strong-currency pedestal by overly expansionary U.S. monetary policy. And then as now, the surge in commodity prices was dramatic. Oil markets turned extremely tight in the early 1970s, not mainly because of the Arab oil boycott following the 1973 war, but because mounting global demand hit a limited supply. Oil prices quadrupled. Food prices also soared, fueled by strong world demand, surging fertilizer prices, and massive climate shocks, especially a powerful El Niño in 1972. Here we go again. Oil prices have roughly quintupled since 2002, once again the result of strong global demand running into limited global supply. World grain prices have doubled in the past year. Just as in 1972, the recent run-up in food prices is aggravated by climate shocks. Australia's drought and Europe's heat waves put a lid on grain production in 2005-06. Even the politics are strangely similar. In both 1974 and 2008, an unpopular Republican President, battling historically low approval ratings, was distracted from serious macroeconomic policymaking. The country was adrift. Then as now, Dick Cheney was close to the helm. What's more, the erroneous lessons he took away from the 1970s contribute to the problems that haunt us today. Cheney was Gerald Ford's chief of staff in 1976, when soaring oil prices helped doom Ford's reelection campaign. Cheney became obsessed with the fight to control the flow of Middle Eastern oil. That obsession, which by many accounts contributed to Cheney's urge to launch the Iraq war, has made the United States much more vulnerable in terms of energy, not only by tying the United States down in a disastrous military effort but also by diverting attention from a more coherent energy strategy. The first stagflation was overcome at very high cost, including 15 years of slower global growth. While the world economy expanded by about 5.1% during the period 1960-73, it grew by a much slower 3.2% during the period 1973-89. A lot of the slowdown had to do with the worldwide profit squeeze and restraint on investments, jobs, and growth caused by tight energy supplies. A side effect of rising oil prices was to heighten financial turmoil, since central banks around the world, including the Federal Reserve, initially tried to use monetary expansion to overcome the supply-side constraints. The result was inflation rather than a restoration of economic growth. That is a key lesson for today, at a time when the Fed seems intent on lowering interest rates despite fast-rising commodity prices. There are limits to what a central bank can do in the face of a severe resource squeeze. The first episode of stagflation opened a great debate about the global adequacy of primary commodities, especially energy and food. In 1972 the Club of Rome published its manifesto, "Limits to Growth," which predicted that the global economy would "overshoot" the earth's natural-resource limits and subsequently collapse. Yet once the world economy surmounted the extreme stagflation and returned to lower inflation and stronger growth from the mid-1980s onward, it became fashionable to dismiss the earlier fears of resource pessimism. Critics mocked "neo-Malthusians," who, inspired by the warnings of the late-18th-century thinker Thomas Malthus, predicted that society would outstrip the earth's carrying capacity. Didn't the Malthusians know that scarcity would generate new resource discoveries, new substitutes for scarce commodities, and new technologies? Now the debate has returned with a vengeance, and a careful look back to the first stagflation is a sobering one. Yes, the world economy surmounted the stagflation, but not easily and not robustly. To an important extent, the workarounds on resource constraints were themselves limited and are showing decided strains today. We are not exactly running out of resources, but we are once again running up against serious resource and ecological limits that can hold back global economic progress. We will need to put a much greater priority on easing those constraints. Conventional oil supplies will remain tight in the years ahead. New discoveries will not suffice. World crude-oil production nearly tripled in 1960-73 (from 21 million barrels a day to 56 million), but has grown a mere 30% since then, to around 73 million barrels per day in 2006. In fact, Persian Gulf crude-oil production stopped growing entirely after 1974, peaking at around 21 million barrels per day. Discoveries and production increases outside the Middle East rose only modestly and now in many cases are in decline in such fields as Britain's North Sea and Alaska's North Slope. The simultaneous food scarcity of the 1970s proved to be shorter-lived than the energy scarcity, since the 1970s ushered in a nearly worldwide "green revolution" of higher grain yields, based on the adoption of improved seed varieties, intensive inputs of fertilizer, and vast increases of irrigation. The achievement was stunning but also not without its limits. Many areas of increased food production, such as in India and China, have relied on massive pumping of ground water for irrigation, and that ground water is being depleted. Heavy use of fertilizer, often inappropriately applied, has also proved to be an environmental threat in some parts of the world, as runoff creates dead zones in places like the Gulf of Mexico. To make matters worse, human-made climate change is now adding enormous risks to global food production. Today's dry land regions, as varied as the U.S. Southwest, the Sahel of Africa, the Mediterranean, and Australia, are facing the increased frequency and severity of droughts, with hugely adverse consequences for global food security. A host of other global environmental problems also threaten the global food supply: disappearing glaciers (which feed rivers and irrigation), temperature stress, soil erosion, destruction of fragile habitats, and the loss of biodiversity, including the dramatic decline of birds and insects that pollinate food crops. The climate-change challenge is incomparably greater than in the 1970s. In 1973 the world emitted roughly 17 billion tons of carbon dioxide from fossil-fuel use. Today the world emits roughly 30 billion tons from those sources. The atmospheric CO2 concentration, which stood at 325 parts per million (ppm) and was rising at roughly one ppm each year in 1973, has risen dangerously, to 385 ppm and now increases by 2.4 ppm each year. Global resource constraints The implications are clear and sobering. Our global resource binds are much tighter now than in the 1970s, because the world economy is that much larger, the resource constraints are tighter, and quick fixes are harder to find. In 1974 the world population was four billion, and total world income was around $23 trillion (in today's dollars adjusted for purchasing power). Now the world population is 6.7 billion, and the economy is around $65 trillion. The same annual growth rate of the world economy, say 4% per annum, requires vastly more natural resources - energy, water, and arable land - than in the 1970s and poses much larger risks for the world's climate and ecosystems. We are therefore facing a prolonged period in which global economic growth will be constrained not by broad macroeconomic policies or market institutions, nor by limits of global trade, nor by the general ability of today's emerging markets to invest in new industries. The more pressing limits will be in resources and a safe climate. It took 15 tumultuous years to overcome the limits on energy and food after 1973. Unless we act more cleverly today, we could face an even more harrowing and prolonged adjustment ahead. Fortunately, there is a better way forward than we took after 1974. We need to adopt coherent national and global technology policies to address critical needs in energy, food, water, and climate change. Just as we invest $30 billion of public funds each year in the National Institutes of Health, we should invest at least as much each year in a new National Institutes of Sustainable Technologies. Just as private biomedical firms live in a kind of symbiosis with NIH, the energy and food sectors should be backstopped by a major public effort to promote sustainable technologies. There is certainly no shortage of promising ideas, merely a lack of federal commitment to support their timely development, demonstration, and diffusion. Solar power, for example, has the potential to meet the world's energy needs many times over, and engineers are closer than ever to cutting costs and solving the problems of intermittency (cloudy days), nighttime storage, and long-distance transmission from sunny deserts to population centers. High-mileage automobiles (like plug-in hybrids with advanced batteries), green buildings, carbon capture, cellulose-based ethanol, safe nuclear power, and countless other technologies on the horizon can reconcile a world of growing energy demands with increasingly scarce fossil fuels and rising threats of human-made climate change. As for food supplies, new drought-resistant crop varieties have the potential to bolster global food security in the face of an already changing climate. New irrigation technologies can help impoverished farmers move from one subsistence crop to several high-value crops year round. Yet as promising as these alternatives are, we have not been investing enough to bring them to fruition. While we squander hundreds of billions of dollars in Iraq, the U.S. government spends a mere $3 billion or so per year on all its energy research - around 36 hours of Pentagon spending! Yet it will be the new technologies, deployed quickly and on a global scale, that offer the real keys to energy and food security, and the chances for sustained economic development globally. In the years ahead, technological development, with both public and private funding, must become a core part of our national economic and security arsenal.
Tuesday, June 17, 2008
segments --Net revenues in Investment Banking were $1.69 billion, 2% lower than the second quarter of 2007 and 44% higher than the first quarter of 2008. --Net revenues in Trading and Principal Investments were $5.59 billion, 16% lower than the second quarter of 2007 and 9% higher than the first quarter of 2008 a.Net revenues in Fixed Income, Currency and Commodities (FICC) were $2.38 billion, 29% lower than the second quarter of 2007, reflecting significantly lower results in credit products. Credit products included a loss of approximately $775 million (including a loss of approximately $500 million from hedges) related to non-investment-grade credit origination activities, and lower results from investments compared with the second quarter of 2007. b.The decrease in credit products was partially offset by higher net revenues in mortgages, which improved from a difficult second quarter of 2007, as well as higher net revenues in interest rate products, commodities and currencies. c.Principal Investments (e.g ICBC) recorded net revenues of $725 million for the second quarter of 2008 --Net revenues in Asset Management and Securities Services were $2.15 billion, 18% higher than the second quarter of 2007 and 5% higher than the first quarter of 2008. Asset manager, mortgage, and commodity (largest commodity trader) offset the loss in credit products.
关于国内的热钱数据一直是焦点所在，最新分析认为，通过对分渠道热钱流入规模的估算，可以看出，中国热钱大多形成于2005年之后，目前热钱总规模在6000亿美元左右。但考虑到该方法的高估，实际热钱规模可能在5000亿美元左右。 关于热钱总量的测算有两种方法，一是“错误与遗漏项”法，二是残差法。残差法是世界银行用来估算热钱规模的常用方法，即用外汇储备的增加量减去贸易顺差和FDI的净流入量。虽然2005年和2006年的热钱流入有所减缓，但是总体上热钱流入规模保持上升态势，值得注意的是，2008年一季度的热钱流入竟达到852亿美元。按照这种方法估算中国现有的热钱规模大约在4200亿美元左右，但是这种方法的缺陷在于不能准确估算通过贸易渠道和直接投资渠道流入的热钱，因此，实际热钱规模要大于4200亿美元。 除了总量法外，也可以通过不同的流入渠道来测算。 贸易渠道流入规模：与2001年至2004年的平稳增长态势相比，自2005年开始，中国的贸易顺差出现大幅上涨，而在此期间，中国的贸易结构并没有发生明显变化，还是以低附加值和劳动密集型产业为特征的出口加工贸易为主，因此在一定程度上可以将此期间贸易顺差的异常变化理解为与贸易渠道的热钱流入有关。2001年至2004年中国的贸易顺差年均增长率为22%，据此推算2005年至2007年的实际贸易顺差，然后根据账面贸易顺差与实际贸易顺差的差额估算热钱流入规模。以此估算，2005年至2007年中国由贸易渠道流入的热钱规模分别为647亿美元、1356亿美元和2181亿美元。 直接投资渠道流入规模：国际收支平衡表的FDI数据与商务部公布的实际利用外资数据存在差异，这种差异表明FDI中有部分资金没有用于实体经济部门，可以简单地看作是通过FDI渠道流入的热钱。以此估算，从2005年开始，热钱开始通过FDI渠道流入，2007年通过该渠道流入国内的热钱规模达557亿美元。 外商投资企业的外债渠道流入规模：如前所述，部分热钱混入外商投资企业从国外出口商、国外企业和私人的借款中流入国内。2003年至2005年的三年间，外商投资企业的该类借款并没有明显增加，但是2006年和2007年的该类借款增加明显。另一方面，这期间中国实际利用外资数量的增长幅度也不大。因此，可以将此类外债在2006年和2007年的增量与此前三年的增量平均数大致看作热钱通过该渠道的流入规模。据此，2006年和2007年通过该渠道实现热钱流入36亿美元和42亿美元。 通过对分渠道热钱流入规模的估算，可以看出，中国热钱大多形成于2005年之后，截至2007年末总的热钱规模在5200亿美元左右，考虑到2008年第一季度的情况，估算的热钱总规模在6000亿美元左右。但是，对热钱的分渠道估算会把正常的资金流入也计算在内，因此，实际热钱规模应该不会有这么大。 考虑到总规模估算的低估以及分渠道估算的高估影响，中国现有热钱在5000亿美元左右。 进一步分析认为，自2005年汇改之后，人民币存在升值预期，加上国内A股市场出现牛市行情，热钱流入规模逐渐扩大，2008年由于国内出现比较严重的通货膨胀，通过人民币升值来减缓通胀压力的预期愈发强烈，更加刺激了热钱的流入。 从流入渠道考虑，贸易渠道是目前国外热钱的主要流入通道，其次为直接投资，其他如外商投资企业的外债、职工报酬及个人汇兑等渠道也发挥了重要作用。究其原因，是因为中国已经实现经常账户的完全开放，资本可以在经常项目下自由流动，相比受到管制的资本账户下的资本流动而言，热钱通过贸易渠道流入更加便利。
WASHINGTON -- The Bush administration, seeking to jump-start the struggling mortgage market, is pushing a method of financing popular in Europe that could make it easier for home buyers to obtain loans. The Treasury Department is hosting a meeting Tuesday between regulators, bankers and other financial players. On the agenda: encouraging lenders to issue a type of debt known as a "covered bond" to raise money for mortgage lending, according to people familiar with the matter. Washington's interest stems from the success of the $2.75 trillion covered-bond market in Europe. Such bonds are the primary source of mortgage-loan funding for European banks. Some analysts have predicted that a covered-bond market in the U.S. could grow to $1 trillion over the next few years. Currently, the market is minuscule compared with the $11 trillion in home mortgages outstanding in the U.S. Covered bonds are a type of mortgage-backed security, but they are quite different from the products that fueled the housing boom and landed many Wall Street banks in trouble. The problematic types were held off financial institutions' balance sheets and were sometimes backed by shaky, subprime mortgages. Investors received not only the rights to the mortgage payments but also the risk of any defaults, which turned out to be plentiful. Covered bonds are considered safer investments because they stay on a bank's balance sheet and the buyer of the bonds gets double protection. The bonds are backed first by a "cover pool" of high-quality mortgages that must meet certain criteria, such as being in good standing. If the mortgages go bad, the bank must step in to ensure bond holders get their interest. Banks like the concept because it could provide a stable source of funding for making mortgages. The quality of the underlying loans translates into high credit ratings, which can result in lower interest payments to investors. The loan quality also attracts a different group of investors than a bank's unsecured debt, which helps diversify the bank's funding sources. Banks seeking funds to make home loans also have the traditional method -- garnering deposits from consumers. That is still important, but deposits can be expensive to attract and less stable than bonds sold to big institutional investors. Until last year, lenders had little trouble getting the money to make loans. They could easily package mortgages into securities, sell them and use the proceeds to make more loans. Now, however, investors spooked by rising defaults have lost confidence in mortgage-backed securities other than those guaranteed by government-related entities like Fannie Mae, Freddie Mac and the Federal Housing Administration. Treasury Secretary Henry Paulson and other policy makers see covered bonds as a way to provide another source of funding for the housing market. "There is such enormous potential for covered bonds to play a role in mortgage financing," said Bert Ely, a banking consultant in Alexandria, Va. The effort is being orchestrated by Mr. Paulson, Federal Reserve Chairman Ben Bernanke, Federal Deposit Insurance Corp. Chairwoman Sheila Bair and other financial regulators, who fear that the weak housing market may continue hamper economic growth. U.S. banks can issue covered bonds here, but just two have done so: Bank of America Corp. and Washington Mutual Inc. The market in the U.S. has been hobbled by unfamiliarity with the concept and some regulatory hurdles. The Treasury may soon issue a document to provide regulatory clarity, said people familiar with the efforts. It also hopes to persuade some brand-name banks to spearhead the idea. In a speech earlier this year, Mr. Paulson said covered bonds "may address the current lack of liquidity in, and bring more competition to, mortgage securitization." Covered bonds have been used for centuries in Europe, where the market began in agriculture and grew to focus on residential and commercial real estate. About 20 countries in Europe have covered-bond legislation, which provides clarity to investors about their claim on the assets, interest payments and the types of collateral allowed in the pool. Another hurdle in the U.S. has been legal uncertainty about the rights of investors if a bank defaults. The FDIC has 90 days in the case of a bank failure to pay off the covered bonds. The provision helps the FDIC minimize the cost of winding up a bank but creates delay for investors and some uncertainty. The FDIC has recently proposed a new rule shrinking the time period to 10 days. A final rule could be issued later this summer.
June 17 (Bloomberg) -- Goldman Sachs Group Inc. andDeloitte & Touche LLP will sell some assets of a $7 billionstructured investment vehicle set up by hedge fund CheyneCapital Management (UK) LLP, in a model that may be used to winddown similar credit funds. The auction will determine the price at which the remainingassets held by SIV Portfolio Plc, previously known as CheyneFinance Plc, will be transferred to a company set up byGoldman, said Neville Kahn, a partner at Deloitte in London.The auction will take place during the first three weeks ofJuly, according to Kahn, whose firm is acting as the receiverfor the SIV. SIVs, which use short-term to buy higher-yieldingsecurities, owned more than $400 billion of assets at their peaklast year. The market collapsed as investors shunned SIV debt onconcern that the funds held mortgage-linked assets that werelosing value and they would be forced into fire sales. ``Goldman appears to have come close to solving the SIVpuzzle by auctioning off the assets belonging to Cheyne's SIV,which is likely to provide a template for other defaultedSIVs,'' said Chris Greener, an analyst at Societe Generale SA inLondon. Deloitte has been trying to reorganize Cheyne Finance sinceSeptember after the SIV was shut out of the commercial papermarket and forced to sell assets at a loss. Cheyne Finance hadalmost half of its assets in securities linked to U.S.residential mortgages and 7 percent in collateralized debtobligations made up of asset-backed securities, according to areport by Moody's Investors Service in October. Forced Sales Deloitte said in December that it had agreed to initialterms for selling the Cheyne SIV's assets to Goldman as part ofa restructuring. Proceeds from the asset sale will be distributed to theSIV's senior bondholders first, Deloitte said in an e-mailedstatement. There is unlikely to be enough cash to cover any payments to holders of subordinated debt including capitalnotes, according to the statement. ``We are pleased that Goldman and Deloittes now appear tohave got this deal done,'' London-based Cheyne said in an e-mailed statement earlier today. Deloitte is also the receiver to Golden Key, a $1.5 billiondefaulted SIV set up by Geneva-based hedge-fund manager AvendisGroup, and is overseeing the winding down of WhistlejacketCapital Ltd., a $7 billion SIV set up by London-based StandardChartered Plc, and IKB Deutsche Industriebank AG's RhinebridgePlc. Deloitte reached agreement with Goldman to restructureGolden Key in May. SuperSIV ``It's expected that other SIV restructurings will followthis model,'' Kahn said in an interview today. SIVs were designed to offer investors higher returns on top-rated securities than they could get on their own by lendingat benchmark rates. The vehicles issued commercial paper, ordebt due in nine months or less, and used the proceeds to buy longer-term assets such as bonds sold by banks and securitiesbacked by mortgages. The first SIV, Alpha Finance Corp., was created byCitigroup Inc. in the late 1980s. The threat of SIVs collapsing last year and further roilingcredit markets prompted U.S. Treasury Secretary Henry Paulson tostart talks on setting up an $80 billion bailout fund.Citigroup, Bank of America Corp. and JPMorgan Chase & Co.abandoned the so-called SuperSIV after banks began rescuingtheir own funds, led by London-based HSBC Holdings Plc. Citigroup, the largest manager of SIVs, rescued its sevenfunds in December by taking on their $49 billion of assets. HSBC bailed out its two SIVs by assuming $45 billion oftheir assets. Dresdner Bank AG, Germany's third-largest lender,supported its $18.8 billion K2 SIV in February. SIVs with at least $31 billion of debt defaulted in thepast 11 months, according to Standard & Poor's.
Monday, June 16, 2008
Liquidity: unregulated: 34 bil + 64 bil = 98 bil, (14% of liability) asset quality --MBS and ABS inventory 60.8 bil (-18% decrease from 74.4 bil), sold nearly 14 bil, unrealized loss ~3 bil, (28% discount in fire sale) a.possible mark down -1.5 bil to 2 bil Leverage Loan: (acquisition facility) 18 bil (-30% decrease from 28 bil), sold nearly 10 bil (5% markdown)
Investors are caught between the desire for growth and the fear of inflation POOR Goldilocks is suddenly out of sorts. After five years when economic conditions have been, like baby bear's porridge, “just right”—strong growth and low inflation—they are now spoiling fast. And as central banks begin to react vigorously, investors are taking fright. When 2008 started, most investors assumed that the lingering effects of the credit crunch would allow interest rates to fall, or at worst be kept on hold. But over the past week markets have priced in a number of rate rises later in the year from the Federal Reserve, the European Central Bank (ECB) and the Bank of England. That has caused turmoil in short-term government-bond markets (see chart), as yields have been forced sharply higher. The problem is inflation. Central bankers may hope that soaring oil and food prices will prove to be just a blip, and will not result in secondary effects such as higher wages. But they know that higher inflation expectations, once entrenched, are difficult to eliminate. So they are sounding as tough as they can. Tricky Trichet This has not been well co-ordinated. On June 3rd Ben Bernanke, the chairman of the Fed, tried to talk up the dollar (a falling currency adds to inflationary pressures). But on June 5th Jean-Claude Trichet, the ECB president, gave a strong hint that euro-zone rates were soon to rise. That sent the euro sharply higher. As Albert Edwards, a strategist at Société Générale, put it: “Only [two days] after Bernanke made his dollar-supportive comments and retreated to the sidelines, he received the studmarks from Trichet's boot in his chest.” If that central-banking snafu was not bad enough, June 6th saw both an unexpected rise in American unemployment and an $11 gain in the price of oil—a combination that points to higher inflation and slower growth. Small wonder that the Dow Jones Industrial Average tumbled nearly 400 points on the day. Investors fear that central banks, in their zeal to prove their anti-inflationary credentials, may inflict some severe damage on economic growth. The problems of the financial sector are far from over, as the $2.8 billion second-quarter loss at Lehman Brothers illustrated. Its share price continued to take a hammering this week as investors worried about its balance sheet and business model. There have been few bond defaults as yet, but Stephen Dulake, a credit strategist at JPMorgan, reckons investors may be looking in the wrong place for trouble; there have already been 26 defaults in the American corporate-loan market this year. Credit spreads (the excess rates paid by risky borrowers), having fallen sharply between mid-March and mid-May, have been edging higher again. Meanwhile, house prices are falling in America and Britain. Consumers are struggling to cope with the impact of that on their wealth and with the effect of higher fuel and food prices on their wallets; a rise in interest rates may push them over the edge. In the global economy, more bad news came on June 11th: Australian consumer confidence and New Zealand home sales fell to 16-year lows. Nor is the task of balancing inflation and growth confined to the developed world. In China the central bank raised the amount of reserves banks must hold against their loans, in an effort to restrain inflation, and shares fell for seven days in a row up to June 12th. Inflationary fears led India's central bank to raise interest rates for the first time in more than a year. In essence, the global economy has received two shocks in the past 12 months—the credit crunch and higher commodity prices. Those shocks have made the outlook more uncertain, not just for the economy but for monetary policy. And uncertainty makes investors nervous, not least because it comes after a long period when markets seem to have underpriced risk. “Recent years have seen the world get all the benefits of globalisation without the costs,” says Peter Oppenheimer, a strategist at Goldman Sachs. “Emerging markets got growth, developed countries kept the lid on inflation.” But higher commodity prices are a zero-sum game; for every winner, there is a loser. Many of those losers are likely to be companies. Profit margins have been at historic highs in some big countries, in large part because businesses have been successful in controlling labour costs. But higher raw-material prices present firms with a problem. Pass those costs on, and not only will consumer demand falter, but central banks may raise rates. So they may have to accept lower margins instead. At the start of the year analysts were forecasting 15% profits growth for European companies in 2008. Revisions have brought that number down to 4%, largely because of problems in the finance industry. But Goldman Sachs thinks analysts are still too optimistic; it is predicting an earnings decline of 12% this year. A combination of higher interest rates and lower profits makes it difficult to see how stockmarkets could advance much during the rest of the year. Currency markets are also likely to be volatile. The Fed would like to engineer a rise in the dollar against the euro and the yen and a fall against the developing Asian currencies. But that will be hard to pull off as central banks around the world grapple with the inflation/growth trade-off. The dollar's yield will continue to look unattractive, since American interest rates are likely to remain lower than most (bar Japan's). The Bank of Canada, which was widely expected to cut rates this week, decided to keep them steady. And government-bond markets may also be set for turmoil. Analysts have been scratching their heads at some of the recent moves. “If we told you that the Dow fell by 400 points one Friday after the largest rise in the unemployment rate in nearly three decades, would you buy or sell two-year Treasury notes?” asks William O'Donnell, a strategist at UBS. The usual response would be to buy, but investors sold. Expectations of higher short-term interest rates trumped the safe-haven appeal of the bonds. At the ten-year level, it may seem odd that investors are willing to receive a Treasury-bond yield of just 4.1% when headline inflation is 3.9%. But if the American economy slips into recession, ten-year yields could fall a lot lower than that; they were 3.1% in June 2003. So, a world without Goldilocks would be a harsh one for investors. It is not a place where bears eat porridge and go for strolls in the wood. It is one where bears eat ingénues for breakfast.