Dow Theory Letters on The three phases of a gold bull market

Richard Russel “Every major primary bull market takes place in three sentiment phases. The first phase of the gold bull market occurred around 1999 to 2005. This was the ‘dirt cheap’ phase of gold when only the true believers assumed positions. Old timers probably remember back in 2000 when I wrote that the listed gold shares were so ridiculously cheap that they could be bought and ‘put away’ as perpetual warrants. “The second phase of the gold bull market started around 2005 and is still in force. This is the phase where the seasoned professionals and a few more sophisticated funds take their positions. It is in the second phase where we see the most painful secondary corrections. And it is in the second phase where the public first notices the persistent rise in gold. In the current area, gold is just starting to attract the attention of the public. “Every major primary bull market that I have studied or lived through ends up with a wildly speculative third phase. This is the phase where the public and the crowd rushes head-long into the market. We saw this last in the years around 2000 when people bought any kind of tech stock. ‘I don’t care what it is, if it’s tech, just get me in!’ “My belief is that we’re now nearing the beginning of the third speculative phase of the great gold bull market. The huge secondary reaction that has held gold in its grip since early 2008 is coming to an end. Interestingly, this reaction has taken the form of a large head-and-shoulders bottoming pattern. Most recently, gold has been climbing (almost unnoticed) up the formation’s right shoulder. If June gold can close above 1003, I believe that will signal the beginning of gold’s third speculative phase.”

One Country, Three Economies

May 29, 2009 By Qing Wang & Steven Zhang Hong Kong This is an excerpt from Strategy and Economics: One Country, Three Economies: Play the Regional Disparity in China by Qing Wang, Jerry Lou and Steven Zhang, May 27, 2009. One Country, Three Economies There is large economic disparity among the regions in China. At the broadest level, China consists of three economies: the eastern area, which accounts for 64% of the national economy and consists of 11 provinces (including Beijing, Tianjin, Hebei, Liaoning, Shanghai, Jiangsu, Zhejiang, Fujian, Shandong, Guangdong and Hainan); the central area, which accounts for 26% of national economy and consists of eight provinces (including Shanxi, Jilin, Heilongjiang, Anhui, Jiangxi, Henan, Hubei and Hunan); and the western area, which accounts for 19% of national GDP and consists of 12 provinces (Inner Mongolia, Guangxi, Chongqing, Sichuan, Guizhou, Yunnan, Tibet, Shaanxi, Gansu, Qinghai, Ningxia and Xinjiang). The income level among the three areas is quite uneven. In 2008, while GDP per capita in the eastern area was US$4,790, central and western areas were US$2,820 (or about 60% of the eastern area level) and US$2,500 (or about 50% of the eastern area level), respectively. The large regional disparity in income level becomes even more pronounced when the comparison is made at a provincial level. For example, Shanghai has the highest level of GDP per capita of US$10,440, or more than eight times of that in Guizhou province. In fact, the regional income disparity in China is larger than both that among the states in the US and the country disparity in the Euro-zone. Specifically, the coefficient of variation (COV) - as a normalized measure of dispersion of a distribution - of provincial GDP per capita in China is 0.64. This is much higher than the COV of state GDP in the US of 0.39, and even higher than the country GDP per capita in the Euro-zone of 0.49. The regional income disparity reflects several fundamental structural factors. First, urbanization tends to be much higher in the eastern area than in the central and western areas. Provinces with the highest urbanization such as Guangdong, Liaoning, Zhejiang and Jiangsu are concentrated in the eastern area, while the provinces with lowest urbanization such as Yunan, Gansu, Tibet and Guizhou are in the western area. Second, openness to external trade tends to be much higher in the eastern area than in central and western areas. Measured by exports as a percentage of GDP, eastern provinces such as Guangdong, Jiangsu and Zhejiang are 15-25 times as exposed to foreign demand as central and western provinces such as Qinghai, Gansu, Inner Mongolia and Henan. When the Chinese economy was stricken by the global financial turmoil and economic recession, the shock impact varied significantly on different regions, depending on each region's initial conditions such as its economic structure in general and exposure to foreign demand in particular. We compared the growth rates of industrial value-added between 1Q09 and 1Q08 and used the difference as a gauge of the underlying shock impact from the crisis. It turns out that two types of provinces - which have either large direct exposure to foreign demand (e.g., Shanghai, Zhejiang and Fujian) or are major producers of natural resource commodities (Shanxi, Ningxia and Qinghai) - were most severely affected. While the impact on the former reflected a sharp contraction of external demand, the impact on the latter had largely to do with the collapse of commodity prices. On the other hand, the impact on regions that are less exposed to external demand or commodity-producing industries (e.g., Hunan, Guizhou and Anhui) has been substantially milder. Three Economies, One Policy Stance The crisis's impact on different regional economies in China varies. Mitigating the impact of the most serious crisis since the Great Depression in 1929-33 has entailed an unprecedentedly strong policy response. Ideally, the larger the negative impact on a region, the stronger the policy response should be. In another words, the policy response to the eastern provinces should be in principle stronger and more aggressive than that applied to the western provinces. However, an equally strong and aggressive policy stance appears to have been applied across the regions in practice, independent of the shock impact of the crisis. As part of the Rmb4 trillion stimulus package, each provincial government is allowed to issue local government bonds. The proceeds from the bond issuances are to be used as ‘seed money' to help raise more funds - primarily in the form of bank loans - to finance investment projects undertaken under the stimulus plan. Therefore, the amount of local government bonds should be a good proxy for the strength of the local policy response, be it fiscal or monetary, to help the local economy, in our view. In theory, there should be a positive correlation between the amount of local bond issuance and the magnitude of the negative impact each province suffers; however, such a relationship simply does not exist in practice. This pattern reflects the particular nature of the central-local government relationship in China, in our view. Compared to many other countries in the world, local governments in China traditionally have a much stronger interest in developing their local economies. In fact, academic literature considers this unique incentive structure as a key - albeit unorthodox - contributing factor to the success of China's economic reform. We think that the seemingly egalitarian approach in determining the size of policy support in coping with the crisis is a result of competition among provincial governments and intense bargaining between local and central governments, as every local government wants to seize this opportunity afforded by the global turmoil to give its own economy a boost through policy stimulus. In this context, a one-size-fits-all policy approach becomes an inevitable outcome: while the strength of Chinese authorities' anti-crisis policy responses is determined with respect to the adverse situation in those regions that have been hardest hit by the ongoing crisis (e.g., Pearl River Delta and Yangtze River Delta), the regions will likely benefit from a policy response applied equally across them. In another words, despite de facto three economies there is only one policy stance, meaning that the policy boost is appropriately supportive for some regions but super-accommodative for others. Diverging Regional Growth Trends Different regions in China will likely demonstrate a pronounced divergence in growth trends during this global economic recession. The impact of global economic recession on different regions inside China is quite uneven, reflecting each region's initial conditions such as its economic structure in general and exposure to foreign demand in particular. At the same time, the policy responses will be largely non-discriminative across regions, with the stance being determined by the adverse situation of the regions hardest hit by the crisis. In this context, the policy support received by those regions that have been less affected by the global recession may more than offset the negative impact of external demand shocks such that their regional economy could do substantially better than China's macroeconomic situation would suggest. We rank China's 30 provinces by their potential economic performance amid the current global recession by factoring in not only the initial negative impact of the external shocks on the local economies but also the policy support received by each region. Eastern provinces such as Fujian, Zhejiang, Shandong and Guangdong will likely be among the regions that would be most negatively affected by the current global recession, while Guizhou, Hainan, Jilin and Sichuan will likely be among the least affected regions, by our estimate. Our ranking of economic performance by region seems broadly consistent with the recent passenger car sales, which is a useful proxy for households' purchasing power and consumer confidence, and cement consumption, which is a good proxy of local construction activity. Looking ahead, with potentially diverging regional growth trends, the firms that have disproportionally large business exposures to a region will likely find their performance critically tied to the performance of the local, instead of national, economy. Identifying those firms that are well positioned to benefit from the regional economies expected to substantially outperform the national economy will likely become an important investment theme, especially when uncertainty surrounding the overall macroeconomic outlook diminishes. Beyond the near term, the current global economic turmoil and the Chinese authorities' policy response should serve to help narrow the regional economic disparities that have widened in the past decade, and thus are a source of considerable tension in China's economic and social development; this bodes well for a more integrated nationwide market and balanced growth in the long run.

The Global Liquidity Cycle Revisited

May 29, 2009 By Joachim Fels & Manoj Pradhan London Reality check: One of our key macro themes for 2009 has been the emergence of a new global liquidity cycle powered by massive monetary stimulus, which should help to support asset markets, end the recession and prevent lasting deflation (see "A New Global Liquidity Cycle", The Global Monetary Analyst, January 14, 2009). A little more than four months later, it is time to review the evidence that has accumulated since then and discuss whether the theme is likely to have staying power for 2H09. In short, our conclusion is - yes, it is. Excess liquidity surges to a new record-high... Back in January, the available data indicated that the new liquidity cycle was only in its infancy. Our favourite metric for excess liquidity - the ratio of money supply M1 to nominal GDP (a.k.a. the ‘Marshallian K') - had only started to tick up slightly for the G5 advanced economies (the US, euro area, Japan, Canada and UK) and was still declining for the BRICs aggregate. Now, our updated metrics, which include data up to March 2009, confirm that a powerful liquidity cycle is underway, with excess liquidity surging to a new record-high both in the advanced and the emerging economies. Thus, the jump in excess liquidity over the past two quarters has more than fully reversed the preceding decline in excess liquidity, which had foreshadowed the credit crisis. ...and further increases are likely in the coming quarters: The surge in excess liquidity reflects both rapid M1 growth in response to monetary easing, and the outsized declines in GDP in most economies over the past couple of quarters (recall that the growth rate of excess liquidity equals the growth rate of M1 minus the growth rate of nominal GDP). Looking ahead, further growth in excess liquidity appears likely, though probably at a slower pace. We expect M1 growth to remain strong or even accelerate further, reflecting the active quantitative easing in the US, UK, Japan and euro area that is underway and still has further to go. At the same time, we expect global GDP to bottom out soon, so that the real economy will start to ‘absorb' some of the additional money that central banks are printing. Yet, further growth in excess liquidity appears likely in the foreseeable future as central banks are far from done with quantitative easing, and we deem a V-shaped economic recovery to be unlikely. Asset markets supported: We have argued repeatedly over the years that the ups and downs in excess liquidity have been key drivers of past asset booms and busts. The bond market rally of the early 1990s was led by a build-up of excess liquidity and gave way to a bear market for bonds in 1994 as excess liquidity evaporated. The equity bull market of the late 1990s was also accompanied by a build-up of excess liquidity, culminating in the dotcom bubble which burst early this decade as excess liquidity turned down. The mother of all credit and housing bubbles was also fuelled by the surge in excess liquidity that started in 2002, just as the downturn in excess liquidity in the G5 from 2006 onwards and in the BRICs from mid-2007 foreshadowed the crisis of 2007/08. This time around, it doesn't seem to be any different. Risky assets such as equities, credit and commodities have rallied over the past few months as excess liquidity has surged. The ‘wall of money' has dominated the (justified) concerns about the outlook for corporate earnings and the implications of deleveraging in the financial sector and the private household sector. Whether the rally in risky assets can continue remains to be seen - our European and US equity strategists are cautious and our EM equity strategist Jonathan Garner has become less bullish recently. In any case, our analysis suggests that there is plenty of liquidity around - and more coming - to support asset prices. Global bottoming is near: Also, our view expressed in January that the massive liquidity injections by central banks would find traction and help to end the recession in the course of this year appears to be on track. Most economic indicators suggest that the global economy will bottom out soon, though we continue to think that any recovery during 2H09 will be rather anaemic. While the bank lending channel remains impaired, easy monetary policy has been affecting the global economy through several other channels, including asset markets, inflation expectations and cross-border money flows into countries pegging to the dollar, such as China (for more detail on these channels, see "Money Talks", The Global Monetary Analyst, May 6, 2009). Deflation fears dispelled: Finally, decisive monetary action has in fact helped to dispel the fears of lasting deflation that were so widespread around the turn of the year. Market-based measures of inflation expectations have increased significantly from very low levels back to more normal levels over the past several months. In our view, however, inflation expectations still look too low and could move substantially higher once markets start to focus more on the potential implications of the monetisation of government debt that is currently underway. Sure, hyperinflation is a tail event, but one that cannot be dismissed lightly against the backdrop of massive central banks' balance sheet expansion and rapidly rising public sector debt (see "Could Hyperinflation Happen Again?" The Global Monetary Analyst, January 28, 2009). Sovereign risk = inflation risk: Indeed, there are some signs that, over the past week or so, investors have started to worry about inflation risks. While the headlines have been dominated by concerns about sovereign risk and potential sovereign downgrades, we find it interesting that the accompanying rise in nominal bond yields has been almost entirely due to a rise in breakeven inflation rates, rather than real yields. This makes sense as the risk of a sovereign default for countries such as the US, where government debt is denominated in the domestic currency, is virtually zero. If needed, the central bank will simply be instructed to print more money to service the debt. Thus, sovereign risk in these cases is really inflation risk, and should be reflected in rising breakeven inflation rates. Bottom line: Reviewing the evidence to date, we conclude that the new global liquidity cycle, which started late last year, is alive and kicking. Excess liquidity has surged, asset markets have rallied, the global economy looks set to bottom out, fears of lasting deflation have been dispelled, and inflation risks are on the rise. With quantitative easing still in full swing and the economic recovery in 2H09 expected to be rather anaemic, we believe that there is no early end in sight for this liquidity cycle.

The Big Inflation Scare

PAUL KRUGMAN Suddenly it seems as if everyone is talking about inflation. Stern opinion pieces warn that hyperinflation is just around the corner. And markets may be heeding these warnings: Interest rates on long-term government bonds are up, with fear of future inflation one possible reason for the interest-rate spike. But does the big inflation scare make any sense? Basically, no — with one caveat I’ll get to later. And I suspect that the scare is at least partly about politics rather than economics. First things first. It’s important to realize that there’s no hint of inflationary pressures in the economy right now. Consumer prices are lower now than they were a year ago, and wage increases have stalled in the face of high unemployment. Deflation, not inflation, is the clear and present danger. So if prices aren’t rising, why the inflation worries? Some claim that the Federal Reserve is printing lots of money, which must be inflationary, while others claim that budget deficits will eventually force the U.S. government to inflate away its debt. The first story is just wrong. The second could be right, but isn’t. Now, it’s true that the Fed has taken unprecedented actions lately. More specifically, it has been buying lots of debt both from the government and from the private sector, and paying for these purchases by crediting banks with extra reserves. And in ordinary times, this would be highly inflationary: banks, flush with reserves, would increase loans, which would drive up demand, which would push up prices. But these aren’t ordinary times. Banks aren’t lending out their extra reserves. They’re just sitting on them — in effect, they’re sending the money right back to the Fed. So the Fed isn’t really printing money after all. Still, don’t such actions have to be inflationary sooner or later? No. The Bank of Japan, faced with economic difficulties not too different from those we face today, purchased debt on a huge scale between 1997 and 2003. What happened to consumer prices? They fell. All in all, much of the current inflation discussion calls to mind what happened during the early years of the Great Depression when many influential people were warning about inflation even as prices plunged. As the British economist Ralph Hawtrey wrote, “Fantastic fears of inflation were expressed. That was to cry, Fire, Fire in Noah’s Flood.” And he went on, “It is after depression and unemployment have subsided that inflation becomes dangerous.” Is there a risk that we’ll have inflation after the economy recovers? That’s the claim of those who look at projections that federal debt may rise to more than 100 percent of G.D.P. and say that America will eventually have to inflate away that debt — that is, drive up prices so that the real value of the debt is reduced. Such things have happened in the past. For example, France ultimately inflated away much of the debt it incurred while fighting World War I. But more modern examples are lacking. Over the past two decades, Belgium, Canada and, of course, Japan have all gone through episodes when debt exceeded 100 percent of G.D.P. And the United States itself emerged from World War II with debt exceeding 120 percent of G.D.P. In none of these cases did governments resort to inflation to resolve their problems. So is there any reason to think that inflation is coming? Some economists have argued for moderate inflation as a deliberate policy, as a way to encourage lending and reduce private debt burdens. I’m sympathetic to these arguments and made a similar case for Japan in the 1990s. But the case for inflation never made headway with Japanese policy makers then, and there’s no sign it’s getting traction with U.S. policy makers now. All of this raises the question: If inflation isn’t a real risk, why all the claims that it is? Well, as you may have noticed, economists sometimes disagree. And big disagreements are especially likely in weird times like the present, when many of the normal rules no longer apply. But it’s hard to escape the sense that the current inflation fear-mongering is partly political, coming largely from economists who had no problem with deficits caused by tax cuts but suddenly became fiscal scolds when the government started spending money to rescue the economy. And their goal seems to be to bully the Obama administration into abandoning those rescue efforts. Needless to say, the president should not let himself be bullied. The economy is still in deep trouble and needs continuing help. Yes, we have a long-run budget problem, and we need to start laying the groundwork for a long-run solution. But when it comes to inflation, the only thing we have to fear is inflation fear itself.

Chinese Banks Lend Now, May Pay Later

By ANDREW BATSON and JASON LEOW A historic increase in China's bank lending this year has helped keep the world's third-largest economy growing during a global recession. Yet there are concerns that this explosion in credit will mean a setback to the progress Chinese banks have made after years of financial reform. China's state-controlled banks have spent the past several years trying to transform themselves into commercial entities for which making loans is a business decision, not a political one. They have overhauled their operations with foreign investors and international expertise. Then the financial crisis hit, and Beijing turned to the banks to help finance its huge stimulus program. The result: In the first four months of 2009, China's banks extended 5.17 trillion yuan ($757.15 billion) of new loans, more than in all of 2008. The banks deny they lowered their standards to meet government demands for more credit. "We have never loosened our risk-control assessment, not even for government-stimulus projects and infrastructure lending," says Wang Zhenning, a spokesman for Industrial & Commercial Bank of China Ltd., the country's largest bank by assets. But the costs of their lending spree are becoming apparent. The push to extend credit so quickly has cut profit margins. Despite banks having 30% more loans paying interest, most banks' earnings are down this year. These loans are also being made while corporate profits are falling sharply. So there are already early signs that more loans are starting to turn bad. "Everyone agrees that China's stimulus lending is damaging future bank balance sheets," says Daniel Rosen, partner at Rhodium Group, a research firm, and visiting fellow at the Peterson Institute for International Economics. The push to support growth now is understandable, but, Mr. Rosen says, "pillaging bank balance sheets is not a strategy for recovery." The question is whether the cost of bad loans in the future is worth the improvement in the economy today. If China's stimulus can get growth back on track, then tax revenues will keep rising and the government should have the resources to bail out banks for any losses. But if the recovery stalls, bad loans could become a bigger burden on future government finances. From 1998 to 2006, the government and private investors spent about 3.8 trillion yuan -- about $475 billion at the time -- recapitalizing China's banks, according to an estimate by Guonan Ma of the Bank of International Settlements. View Full Image Bloomberg News China's government has acknowledged risks from the lending boom but says the boost to the economy is worth it. "In a situation of financial crisis, rapid growth in lending does more good than harm," deputy central bank governor Yi Gang said in a speech last month. He added that "we should also consider the sustainability of the rapid growth of credit and the possible adverse impact." Nonperforming loans now account for about 2% of the total in the Chinese banking system, a relatively low figure. That figure won't rise soon, as analysts believe Chinese banks are now rolling over problem loans rather than calling them in. Indeed, regulators in January specifically instructed banks to support companies that had been affected by the downturn. Yet there are other signs that businesses are having more trouble paying back debts. So-called special-mention loans, those that banks have identified as potentially weak but not officially bad, are starting to increase. The four biggest publicly traded Chinese banks reported a combined increase of 7.69 billion yuan in such loans over the course of 2008, according to their financial statements. That isn't a large sum relative to their total lending, but it is still a sharp reversal from 2007, when those banks reduced special-mention loans by 202.74 billion yuan. Analysts say there isn't enough historical information to predict how much bad loans in China might increase in the current slowdown. The main worry is that pressure from the government might keep banks from properly screening borrowers, causing bad loans to pile up faster. "Credit policy from the government is really driving lending, as opposed to banks' own internal decisions," says Charlene Chu, an analyst at Fitch Ratings in Beijing. The Chinese government is hoping that by pushing banks to lend they can "bring growth back to a robust pace and let all the losses take care of themselves," she says. The banks deny that. Wang Zhaowen, spokesman for Bank of China Ltd., another state-controlled bank, says, "Of course we didn't relax our standards." But the slowing economy is now taking its toll on loans made in earlier years. Mr. Wang says Bank of China recognized about five billion yuan in new bad loans in the first quarter of 2009, compared with about two billion yuan a year earlier, though the bank still cut nonperforming loans overall. "The borrowers are exporters who have suffered during the financing crisis," he says. The increased competition to lend this year has pushed margins down. According to the central bank, the average interest rate on loans fell 0.80 percentage point, to 4.76%, in the first quarter of this year, even though authorities didn't cut benchmark interest rates. The profits of the 14 publicly traded Chinese banks were down 8.9% from a year earlier in the first quarter of 2009, according to Dragonomics, a research firm in Beijing. With profits getting pushed down, banks may be more likely to turn to the government for help with bad loans. Write to Andrew Batson at andrew.batson@wsj.com and Jason Leow at jason.leow@wsj.com

Durable-Goods Orders Post 1.9% Gain in April 2009

By JUSTIN LAHART U.S. orders for big-ticket items jumped in April, offering more evidence that the manufacturing slump has abated. But a sharp downward revision to the March figures damped hopes that manufacturers are on the edge of recovery. The Commerce Department said orders for durable goods -- long-lasting items that include everything from machine tools to treadmills -- rose 1.9% last month to a seasonally adjusted $161.45 billion. Much of the gain was driven by a 5.4% rise in orders for transportation equipment. Overall orders fell 2.1% in March, a steeper decline than the initially reported 0.8% drop. Even so, the decrease in orders that began in the fall appears to have ended. "We've bounced around this low point for a couple of months now," said Nomura Securities economist David Resler. "If you look at the level of orders, it's starting to look like a bottom." Orders for capital goods excluding defense items and aircraft, which economists use as a proxy for business spending on new equipment, fell 1.5%. But the first increase in orders for metals and metal products in nine months suggested that manufacturers have run down their inventories of raw materials to the point where they need to buy more. Separately, the U.S. Labor Department reported that the number of workers filing new unemployment claims fell 13,000 to 623,000 in the week ended May 23. Much of the jump in claims that came earlier this month, as workers furloughed by the Chrysler LLC bankruptcy filing signed up for unemployment benefits, has reversed itself. But with bankruptcy looking likely for General Motors Corp., claims filings could jump again. The four-week average, used to smooth the volatile initial-jobless-claims figures, fell 3,000 to 626,750. But the total number of workers filing for claims hit a new high of 6.8 million. Meanwhile, sales of new single-family homes rose 0.3% last month to a 352,000 annual rate, the Commerce Department said. But sales in March fell 3%, more than the initially reported 0.6% decline. Sales rose 10% in February. Write to Justin Lahart at justin.lahart@wsj.com

Quantitative Easing Among US, UK, and Eurozone

--Unlike US and UK, ECB has refrained from quantitative easing over the concern of inflation --Still ECB has its own version of QE. European banks bought $250 bil worth of government bonds --It serves two purposes. First, it helps Eurozone governments fund themselves, plugging the budget deficit. In US, banks only contributed 10th of its budget deficit. --Second, it helps European banks recapitalise themselves while they shelt in a regulatory twilight. Banks borrow unlimited 12-month money from ECB at 1% and lend to government for 10 years at about 4%, earning a spread. --This is a more honest way to plug budget deficits as the private sector is providing funds rather than the printing press. It is eqivalently effective in controlling interest rates, as showen that yield curves in Europrean is similar to US and UK.

U.S. Economy Contracted at 5.7% Rate in First Quarter

--US economy shrank 5.7% in Q1, capping the worst 6-month performance in five decades --Narrower trade deficits and small decline in stockpile eased the GPD growth loss in Q1 --Consumer spent 1.5%, less than 2% forecasted --Reduction in stockpile, 91.4 bil, was the highest since 1947 By Bob Willis May 29 (Bloomberg) -- The U.S. economy shrank at a 5.7 percent annual pace in the first quarter, capping its worst six- month performance in five decades and reflecting declines in housing, inventories and business investment. The contraction in gross domestic product was smaller than the government estimated last month, revised figures from the Commerce Department showed today in Washington. The drop was larger than economists had forecast, and followed a 6.3 percent tumble in the last three months of 2008. The slowdown is forecast to ease this quarter, reflecting smaller declines in stockpiles of unsold goods and in construction, which may set the stage for a return to growth later this year. Still, companies are likely to continue cutting jobs as profits remain under pressure, causing consumers to limit spending and slowing any expansion. “The recession is gradually moderating, but the road to recovery will be difficult,” Ryan Sweet, a senior economist at Moody’s Economy.com in West Chester, Pennsylvania, said before the report. “The recession should end late this year.” Stock-index futures, which had risen earlier in the day, remained higher after the report, while Treasuries were little changed. Contracts on the Standard & Poor’s 500 Stock Index were up 0.6 percent at 910.30 as of 8:34 a.m. in New York and yields on benchmark 10-year notes were at 3.61 percent. Economists’ Forecasts The median forecast of 75 economists surveyed by Bloomberg News projected GDP, the sum of all goods and services produced, would shrink at a 5.5 percent pace. Estimates ranged from declines of 4.9 percent to 6.3 percent. The improvement from the 6.1 percent pace of contraction estimated last month reflected a narrower trade deficit and a smaller reduction in stockpiles than previously estimated. Today’s preliminary GDP report is the second of three estimates on first-quarter growth. Consumer spending rose at a 1.5 percent annual rate last quarter, less than previously estimated, after plunging at a 4.3 percent annual rate in the last three months of 2008, when it fell the most since 1980. Spending may falter again this quarter as job losses mount. Economists surveyed by Bloomberg forecast unemployment, currently at a 25-year high of 8.9 percent, may reach almost 10 percent by the end of the year. Auto Pain Firings in the auto industry, with Chrysler LLC already in bankruptcy and General Motors Corp. likely to follow next week, will probably depress the labor market in coming months. Commerce today revised down their estimate for wages and salaries in the fourth quarter as the job market deteriorated. Pay decreased by $21 billion in the last three months of 2008, $8.6 billion more than previously estimated. The update reflects more comprehensive figures from employer payrolls. Companies trimmed stockpiles at a $91.4 billion annual rate last quarter, the biggest drop since records began in 1947. Still, the decline was smaller than the $$103.7 billion estimated last month. Excluding the reduction, the economy would have contracted at a 3.4 percent pace. Reduced stockpiles raise the odds the economy will once again grow in the second half of the year as government stimulus measures and Federal Reserve efforts to reduce borrowing costs and unclog lending start to pay off. ‘More to Go’ “We still have more to go, but lean inventory positions can be a strong source of leverage for the economy once demand stabilizes and starts to grow again,” Russell Price, a senior economist at Ameriprise Advisor Services in Detroit, said before the report. Corporate profits, including estimates for the value of inventories and adjustments for capital investments, climbed 3.4 percent from the previous three months, the first gain in almost two years. United Technologies Corp., the maker of Otis elevators and Carrier air conditioners, is among companies seeing signs that government stimulus programs, particularly in China, may be starting to take hold. “China could be the first market to recover as we see government stimulus starting to take effect,” Chief Executive Officer Louis Chenevert said yesterday during a presentation at conference in New York. “Both Otis and Carrier have seen increased dialogue with builders and developers in China, only in the last few weeks. It’s still early to conclude” recovery is under way. Otis Sales Orders at Otis, the world’s biggest elevator maker, had been declining at a rate of 30 percent to 40 percent from a year earlier. The drops are now “smaller than this,” Chenevert said. Increasing demand from overseas means the trade gap may keep shrinking and help foster a recovery. The deficit shrank to $302.6 billion last quarter, adding 2.2 percentage points to GDP. Companies cut total spending, including equipment, software and construction projects, at a record 37 percent annual pace. Residential construction fell at a 39 percent pace last quarter, the most since 1980. Government spending fell at a 3.5 percent pace, the most since 1995. The drop reflected cutbacks in defense spending and the biggest decrease in state and local government outlays since 1981. To contact the reporter on this story: Bob Willis in Washington at bwillis@bloomberg.net

Fed Holds Steady as Rates Rise in Market

By JON HILSENRATH and LIZ RAPPAPORT WASHINGTON -- Federal Reserve officials believe the recent sharp rise in yields on U.S. Treasury bonds could reflect a mending economy and a receding risk of financial catastrophe, suggesting the central bank won't rush to react -- even though some investors see danger in the government's rising cost of borrowing. Bond markets continued to gyrate Thursday after a sharp run-up in 10-year Treasury yields the day before. The bond market pushed yields of 10-year Treasurys down to 3.674% from 3.70% Wednesday, but they remain well over mid-March's 2.5% level. Yields on mortgage-backed securities continued to climb, pushing 30-year fixed-rate mortgages to 5.44%, the highest since early February. The Fed has embarked on a massive effort in recent months to buy Treasurys and mortgage-backed securities, a bid to drive up their prices and push down yields. It aims to keep borrowing costs low, hoping cheap mortgages in particular will spur the still-weak economy. Its purchases also provide the financial system with money it hopes banks will lend, part of an approach some call quantitative easing. The Fed could eventually decide to step up bond purchases to restrain long-term rates, a question Fed officials will confront at their June 23-24 meeting. So far, the Fed has purchased $130.5 billion of the $300 billion in long-term Treasury debt it began buying in March. It also has bought $481 billion in mortgage-backed securities and has said it could buy as much as $1.25 trillion worth. "The market believes that the Fed will expand its purchases of mortgage-backed securities and Treasurys," said Ronti Pal, head of U.S. interest rates trading at Barclays Capital. "But the longer it takes the Fed to do so, the more the market overwhelms the Fed's efforts and the risk increases for an even sharper rise in yields." Fed Chairman Ben Bernanke, in testimony to Congress earlier this month, emphasized the Fed is not trying "to target a particular interest rate," despite market speculation to the contrary. Fed officials viewed the rise in Treasury yields in March and April as largely benign. In their most recent policy meeting, in late April, Fed staff concluded the rise was tied to "the improved economic outlook, an easing of concern about financial institutions and perhaps some reversal of flight-to-quality flows," according to minutes of the meeting. In other words, the Fed was heartened that investors were moving out of the safe haven of Treasurys and into riskier investments. Journal Community Vote: Do you think the economy is on the mend? Share your thoughts at Journal Community. At that meeting, Fed policy makers decided "to see how the economy and financial conditions respond to the policy actions already in train before deciding whether to adjust the size or timing of asset purchases," the minutes said. But the surge in yields has forced the central bank to re-examine what has driven it, whether it needs to be addressed, and, if so, how. The Fed could view rising yields more as a sign of healing -- an indication that investors are willing to leave the safety of U.S. Treasury securities for other securities, or a sigh of relief that deflation appears less of a worry. If this is the case, the Fed is unlikely to respond aggressively to restrain yields. Or, Fed officials could see the bond market as endangering the economy by prematurely pushing up yields because of market dysfunction or unfounded fears of inflation. In this case, it could ramp up its purchases. Fed officials have watched private-sector borrowing rates. They hope their various programs will narrow the difference, or spread, between low-risk Treasury bonds and riskier assets -- like junk bonds or mortgage-backed securities -- and in turn spur more economic activity. While yields on mortgage securities are moving higher, those on corporate borrowing aren't. Yields on Baa-rated corporate bonds have fallen from 9.20% since March, when Treasurys hit a low, to 7.80%. The narrowing gap is seen as one of several signs that credit markets are gradually improving. At the same time, markets are pushing up mortgage rates. The Fed bought $25 billion in mortgage-backed securities through the week ended Wednesday. But as investors sell, the gap between yields on mortgage-backed securities and comparable Treasurys widened about 1.69 percentage points Thursday from 1.33 points a week ago, according to FTN Financial. "This has turned into a two-day sell-off, which is unusual," said Kevin Cavin, an FTN strategist. Over the past six months, any significant widening on a single day has been followed by a tightening as mortgage-security yields catch up with a movement in Treasury rates. "Today is different. This is at odds with what the Fed is trying to do." The Fed may be reluctant to step up mortgage-securities purchases because it doesn't want to crowd out the market's other investors. In addition, some Fed officials worry that an expansion of Fed purchases could make it difficult for the Fed to back away from its extraordinary actions when the economy recovers. Among the more benign explanations of the bond market's gyrations is the sense that the odds of a dangerous bout of deflation, in which prices and wages fall, are waning. Movements in inflation-indexed Treasury securities suggest that expected inflation over the next 10 years has moved up from near zero early in the year to nearly 2% today -- roughly the Fed's target. But bond markets may be expressing worry over the government's borrowing to finance its large budget deficit. The White House anticipates the deficit will reach $1.8 trillion this fiscal year. President Barack Obama's budget would add $7 trillion to the federal debt load through 2019. The Obama administration Thursday downplayed market fears about excessive federal borrowing, insisting that Mr. Obama has a credible long-term plan to curb the deficit. Some Fed officials worry that ramping up Treasury purchases could be read by investors as a sign that the central bank is willing to finance government budget deficits to the point where it could spark inflation or trigger a decline in the dollar. Officials see the next big Treasury auction of three-, 10- and 30-year Treasury debt in early June as a test of how much debt world markets can digest. The auction's size will be announced next week. —Jonathan Weisman contributed to this article. Write to Jon Hilsenrath at jon.hilsenrath@wsj.com and Liz Rappaport at liz.rappaport@wsj.com

Treasury Auction Lifts Stocks

Article Video Comments (21) more in Markets Main »Email Printer By GEOFFREY ROGOW and PETER A. MCKAY Stocks pushed higher in thin trading as a better-than-feared auction of seven-year Treasury notes helped restore confidence in an economic recovery and as energy company shares jumped amid an increase in crude-oil prices. Demand for the Treasury's $26 billion seven-year sale was in line with the last sale. An auction of notes on Wednesday had fanned concern about increased supplies of government debt and traders had been fearing the worst going into the Thursday auction. Market Data Center > Most Actives | Gainers | Losers New Highs and Lows | Money Flows Intraday Futures | Currencies "The sell-off yesterday showed there was some real fear coming into this. Clear cut case of sell on the rumor, buy on the news," said Kent Engelke, chief economic strategist for Capitol Securities Management. Major indexes had seesawed all morning after better-than-expected reports on jobless claims and durable-goods orders were followed by discouraging data on new home sales. But after the Treasury auction, stocks moved sharply higher. The Dow Jones Industrial Average rose 103.78 points, or 1.3%, to 8403.80. The S&P 500-stock index gained 13.77, or 1.5%, to 906.83, boosted by its energy and financial sectors. Financials sold off aggressively Wednesday. The tech-heavy Nasdaq Composite Index climbed 20.71, or 1.2%, to 1751.79. Setting off the jump in energy stocks, crude-oil prices rose after data showed a much bigger drawdown in U.S. energy stockpiles than analysts expected. The front-month crude contract rose $1.63 to settle at $65.08 a barrel in New York. Steve Bellino, senior vice president at MF Global, a New York futures brokerage, said the oil market is looking more like it did during the bubble that included record prices near $150 last summer. Though he's not expecting those levels to be breached again, he said triple-digit prices are a possibility now that participants are again willing to trade crude purely as an investment. "In a thin market, it doesn't really take a lot of money to come in that way to move prices," he said. "But if you ask anyone who trades this market all the time, there's no way the fundamentals justify the move we've seen over the last month," with crude futures up more than 30%. Traders said the stock market's moves were exaggerated Thursday by a lack of participation. At times when activity dries up, a few buyers can cause outsized gains in major indexes. Mike Mainwald, head trader at Lek Securities, a New York brokerage, said there were few long-term investors involved in Thursday's action, just short-term traders looking to get in and out of certain names quickly. In particular, Mr. Mainwald said options activity in General Motors suggested that many investors are still looking for a near-term plunge in its stock -- a scenario he believes is less likely in light of a deal approved by bondholders. "I really thought the government was going to step in and wipe out some of the bondholders," claiming rights to be repaid ahead of private lenders, said Mr. Mainwald. "I'm glad we avoided that situation. It's a really positive development." Markets reversed yesterday's downward trend, as the Treasury's auction lifted markets in a see-saw trading day. Peter McKay reports. GM, which appears to be on the verge of a bankruptcy filing, slid three cents to $1.12. Sentiment on the economy continues to shape trading. While Wall Street's current consensus is that the worst of the credit and economic crisis-related selling may be over, the economy still remains on a weak footing. "We are seeing some encouraging changes in trends, but the data is showing us this recovery will be very slow and hard earned, and that's going to keep washing back on investor consciousness," said RidgeWorth Large Cap Core Equity Fund Portfolio Manager Jeff Markunas. Sales of new homes edged up by 0.3% in April, but the median price of a new home fell 14.9% from a year ago and the backlog of unsold homes remained high, at about 10 months of supply. In addition, about 12% of first-lien home mortgages in the U.S. were overdue or in foreclosure at the end of March, the Mortgage Bankers Association said Thursday. That's up from 8.1% a year earlier. But traders noted employment is the largest determining factor in foreclosure data, and welcomed a report that new claims for unemployment benefits eased slightly last week. Also helping stocks, durable-goods demand picked up in April. —Deborah Lynn Blumberg contributed to this report. Write to Geoffrey Rogow at geoffrey.rogow@dowjones.com and Peter A. McKay at peter.mckay@wsj.com

Old-School Sitcoms Find Fans Among A Younger Set

by Nate DiMeo All Things Considered, May 28, 2009 · The days when each of the broadcast networks programmed multiple nights of old-school multi-camera sitcoms are long gone. But we're still living in the golden age of the sitcom — if you turn on Nickelodeon or its mortal enemy, The Disney Channel. That's what plenty of kids do when they want to watch Drake and Josh, the Jonas Brothers, Zoey 101, Hannah Montana or iCarly. "With people all the way from 17 to 2 ... iCarly often is the No. 1 show, not just on cable but all of television," says Nickelodeon's Dan Schneider. Over at The Disney Channel, programming executive Andy Bonnet says he knows why sitcoms for kids are so popular at a time when adults don't seem as interested in laugh tracks. The success of Seinfeld and Friends in the 1990s bred too many pale imitations. Adults burned out on schlubby husbands with improbably hot wives and wacky neighbors. "There was a generation of adults that just saw a lot of bad sitcoms," Bonnet explains. "The beauty of kids is they weren't part of that audience, so they come in with open eyes and embrace the format." The Disney Channel has embraced the format with outrageous success. Shows like Hannah Montana and The Suite Life of Zack and Cody have helped build the network — and have fueled the Disney juggernaut by launching its current generation of movie and pop stars, such as Miley Cyrus and The Jonas Brothers. "I don't think of myself as a guy who writes for kids, I really don't," says Nickelodeon's Dan Schneider. "I try really hard to write a good, solid sitcom." The writing staffs of 'tween sitcoms are often stacked with veterans from the heyday of the network sitcom — people who wrote for Roseanne, The Facts of Life and The Jeffersons. Schneider himself has been in sitcoms most of his life. He started out as an actor on one, years ago. He played one of the nerds of the '80s high school show Head of the Class. He says the people at Nickelodeon go out each time trying to write something that can stand alongside a Taxi or Bewitched, even if his audience has no idea what those shows are. "Kids today don't know the classics," he laments. "They don't even know The Brady Bunch anymore." Still, he says, that doesn't give writers license to slip an old Laverne and Shirley bit into a script just because the kids won't know any better. Disney's Bonnet and Nickelodeon's Schneider agree that there's a lot of satisfaction in making sitcoms for kids. They loved classics like Taxi, Cheers and Diff'rent Strokes. In fact they still love those shows — and they hope their shows will have a long life for their audience now in their 'tweens. "I can enjoy watching an episode of The Brady Bunch even though I'm a 41-year-old man," Bonnet admits. "I hope adults will look back fondly at episodes of Hannah Montana because those shows meant so much to them growing up." Schneider says he's happy to be in the only corner of the TV business where he can still have the kind of impact classic network sitcoms once had. In past decades, everyone could stand around a water cooler talking about last night's M*A*S*H finale. Now, he says, it's good to know that someday his audience will be crowding around a keg in college, reminiscing about that one iCarly episode that made them laugh so hard.

Mortgage Delinquencies, Foreclosures, 30-Year Rates Increase

--Delinquency rated soared to 9.12%, share of foreclosruing rose to 1.37%, highest since 1972 --One in eight Americans were delinquent or in foreclosure. --Mortgage issue has shfited to prime borrowers By Kathleen M. Howley May 28 (Bloomberg) -- Mortgage delinquencies and foreclosures rose to records in the first quarter and home-loan rates jumped to the highest since March as the government’s effort to revive the housing market lost momentum. The U.S. delinquency rate climbed to a seasonally adjusted 9.12 percent and the share of loans entering foreclosure rose to 1.37 percent, the Mortgage Bankers Association said today. Both figures are the highest in records going back to 1972. Fixed rates rose to 4.91 percent, Freddie Mac said. New home sales fell 34 percent from April 2008, the Commerce Department said. The three-year housing slump is proving resistant to efforts by the Federal Reserve and the Obama administration to lower rates and keep homeowners from failing on their mortgages. One in every eight Americans is now late on a payment or already in foreclosure as mounting job losses cause more homeowners to fall behind on loans, the MBA said. “If people don’t have a paycheck they can’t support a mortgage,” Jay Brinkmann, the MBA’s chief economist, said in an interview. “The longer the recession lasts the more people run through their savings reserves, leading to higher delinquencies and higher foreclosures.” Rates Rise The average rate for a 30-year loan jumped to 4.91 percent from 4.82 percent a week earlier, Freddie Mac, the McLean, Virginia-based mortgage buyer, said today in a statement. The rate was 5.1 percent at the beginning of the year. The unemployment rate rose to 8.1 percent in the first quarter, the highest since the end of 1983, according to the Bureau of Labor Statistics. Sales of new homes increased 0.3 percent to an annual pace of 352,000, lower than forecast, after a 351,000 rate in March, the Commerce Department said. The inventory of new and old defaults rose to 3.85 percent, the MBA said today. Prime fixed-rate mortgages given to the most creditworthy borrowers accounted for the biggest share of new foreclosures at 29 percent, and prime adjustable-rate mortgages were 24 percent, Brinkmann said. It shows the mortgage problem has shifted from a subprime issue to a job-loss problem, he said. Delinquencies are continuing to rise even as forecasts show the economy may start improving later this year. The U.S. economic recession probably will end in the third quarter, a survey of business economists showed yesterday, even as rising joblessness indicates the recovery will be weaker than previously estimated. The world’s largest economy will begin to expand next quarter, according to 74 percent of economists in a National Association for Business Economics survey. Home Sales Home sales may reach a bottom by mid-year, according to 72 percent of the panelists, and more than six in 10 predicted housing starts will hit a trough by that time. The survey showed home prices have further to fall, with 40 percent of the respondents forecasting that declines will continue into 2010 or later. Home resales in the U.S. gained in April as foreclosure auctions enticed bargain hunters, Chicago-based National Association of Realtors said yesterday. Purchases increased 2.9 percent to an annual rate of 4.68 million from 4.55 million in March, the trade group said. The median price slumped 15 percent from a year earlier, the second-biggest drop on record, and distressed properties accounted for 45 percent of all sales. Foreclosures The Realtors said in a May 12 report foreclosures dragged down the first-quarter median U.S. price by 14 percent to $169,000 from a year earlier, the biggest decline on record. The U.S. median home price tumbled 9.5 percent last year, the most ever recorded, according to the Realtors’ group. That’s more than six times the 1.4 percent drop in 2007, the first decline in the national median since the 1930s. This year, prices probably will fall 4.9 percent before posting a 4.4 percent gain in 2010, according to Lawrence Yun, the trade group’s chief economist. Sales of previously owned homes probably will rise 1.1 percent this year, the first gain since the end of the five-year real estate boom in 2005, Yun said. To contact the reporter on this story: Kathleen M. Howley in Boston at kmhowley@bloomberg.net.

Auto Supplier Visteon Files for Chapter 11 in U.S.

By JEFFREY MCCRACKEN and ANDREW GROSSMAN DETROIT -- Visteon Corp., a former division of Ford Motor Co. and one of the country's largest auto suppliers, confirmed it filed for bankruptcy protection for its U.S. operations Thursday after continued production cutbacks by its auto maker customers eroded the company's financial stability. Visteon's bankruptcy makes it the latest casualty in the U.S. auto industry, which has been hit by the Chrysler LLC bankruptcy and awaits an imminent filing by General Motors Corp. Though expected for months, a Visteon filing could complicate matters for Ford, the one Detroit auto maker to so far avoid government aid. Visteon doesn't have any financing lined up from banks, and will have to lean heavily on Ford and other auto companies for cash to get it through a restructuring. "Visteon is taking this step to maximize the long-term value of the company," Visteon Chief Executive Donald J. Stebbins said in a written statement. "During the reorganization period, we will seek to address our capital structure and legacy costs that are not sustainable given the current economic environment." Visteon expects to fund its operations with its U.S. cash balance, cash flows from operations and a debtor-in-possession facility. Ford has executed a commitment letter to support debtor-in-possession financing for Visteon's restructuring efforts and to ensure long-term continuity of supply. Other global customers have also expressed their support, the company said. "Ford's top priority is to ensure we have sufficient parts and material to protect our production," Ford's Global Purchasing Group Vice President Tony Brown said in a written statement. "As a result of the growing financial pressure in the supply base, it is not unusual for suppliers to request assistance from Ford -- as well as other automakers. Ford evaluates these requests on a case-by-case basis and takes action when appropriate to maintain our production. Because Visteon is an important, preferred supplier to Ford, we have committed to providing financial support to help Visteon meet its business challenges." As of Dec. 31, Visteon employed 11,000 salaried workers and 22,500 hourly workers worldwide. It also had $893 million in unfunded pension obligations. Auto-supplier bankruptcies have frequently caused unforeseen and expensive problems for auto makers, as suppliers can use the courts to reject contracts and demand higher pay for much-needed parts. Some suppliers are unable to line up enough financing from lenders, forcing auto makers to inject money to keep the companies afloat. Visteon is by far Ford's largest parts supplier, and the auto maker accounts for one-third of Visteon's $9 billion of annual sales. Korean-based auto maker Hyundai Motor Co. is the next biggest customer, with 30% of Visteon's sales. Parts from the Van Buren Township, Mich.-based firm lie at the heart of many Ford vehicles, making the radios for the Fusion sedan, instrument clusters on the F-150 pickups and climate-control parts on the new Flex crossover. Ford hasn't experienced any production issues as a result of Visteon's business issues, Brown said. The auto maker will continue to monitor the situation. Visteon received waivers from its lenders after it violated the provisions of its loans in March, after independent accountants said they doubted the company's ability to remain a going concern. One of those waivers expires on May 30. Whether Visteon is able to restructure or is forced to liquidate depends largely on how much support Ford is willing to give, said Doug Bernstein, managing partner of the bankruptcy group at law firm Plunkett Cooney P.C. "How dependent is Ford?" he said. "If Ford's not there to support, it could very well end up in liquidation because I don't know who's going to finance it then." Ford assumed $167 million in Visteon secured loans this month. Visteon hopes Ford will let it borrow against that loan for bankruptcy financing and also provide other lending as well, said people familiar with the matter. Visteon has hired law firm Kirkland & Ellis as bankruptcy counsel and financial advisers Rothschild LLC and Alvarez & Marsal. Visteon's bankruptcy comes at the beginning of what is likely to be a painful global contraction among companies that supply auto parts. With auto makers building fewer cars and taking longer to pay their bills, suppliers are burning through cash and finding banks reluctant to lend to an industry beset by uncertainty. "Basically put, it's a high level of chaos right now," said Van Conway, president of turnaround firm Conway, MacKenzie and Dunleavy. Visteon has failed to turn an annual profit since it was spun off by Ford in 2000. In 2005, the auto maker took back the majority of Visteon's plants. Since then, Ford has whittled those 17 plants to six. The filing was made in a Wilmington, Del., federal bankruptcy court. Write to Jeffrey McCracken at jeff.mccracken@wsj.com

JPMorgan chief in alert over WaMu credit card loans

By Henny Sender and Saskia Scholtes in New York Published: May 28 2009 03:00 Last updated: May 28 2009 03:00 Jamie Dimon, JPMorgan Chase chief executive, warned yesterday that loss rates on the credit card loans of Washington Mutual, the troubled bank acquired last year by JPMorgan, could climb to 24 per cent by the year end. In the past, credit card loss rates have tracked the unemployment rate but that relationship has been breaking down for more troubled credit card portfolios, such as the $25.9bn in WaMu credit card loans. At the end of the first quarter, 12.63 per cent of the WaMu credit card loans were deemed uncollectable by JPMorgan. The bank estimates that figure could reach 18 per cent to 24 per cent by the end of 2009, depending on economic conditions. Describing credit cards as JPMorgan's most challenged business, Mr Dimon said loss rates for the company's larger $150bn portfolio of Chase credit cards could reach 9 per cent in the third quarter and as much as 10.5 per cent by the end of the year, depending on housing and unemployment trends. That compares with first-quarter charge-off rates of 6.86 per cent on the Chase card portfolio. In parts of the US that are particularly distressed - such as the states of Arizona, California, Florida, Nevada and Virginia - net charge-offs for the Chase credit card loans already amounted to 9.9 per cent of the total at the end of the first quarter, up from 5.5 per cent in the first quarter of 2008, Mr Dimon said. He said he believed that a new law restricting higher interest rates on delinquent credit card debt for the first 60 days could make credit cards more expensive. Banks are repricing credit cards and cutting credit lines before the new rules take effect, pushing borrowers into distress in some instances, according to industry executives. Turning to other subjects, Mr Dimon said it was "a given that commercial real estate will get worse". However, he said JPMorgan had been cautious about making loans in the sector and was comparatively less exposed to the problem. Mr Dimon gave an upbeat view of the bank's earnings power, noting that reduced leverage would be more than offset by increased spreads in the markets, giving JPMorgan the ability to aspire to an 18 per cent to 20 per cent return on equity.

The Drawbacks of Banks' Free Money

By PETER EAVIS For banks, even free money may have its drawbacks. A key part of the bank-recovery story is that this interest-rate environment will let certain banks enjoy big margins on loan portfolios. The Federal Reserve's zero-interest-rate policy was expected to fatten those margins as banks funded themselves at low rates and lent at higher ones. Funding was going to get a boost at banks amassing new deposits, either from weaker rivals or through acquisitions. But the numbers suggest a less-compelling story. While margins have been respectable, they are hardly knocking the cover off the ball. Banks with over $10 billion in assets had a net interest margin, or NIM, of 3.21% in the first quarter, according to SNL Interactive. That is below 3.4% in the fourth quarter and under the 3.34% average since 2000. Banks perceived as strong aren't showing blowout NIMs, either. Wells Fargo's declined to 4.16% in the first quarter, from 4.7% in the fourth quarter, though some of this may be from buying Wachovia. Meanwhile, J.P. Morgan Chase's NIM rose only slightly, to 3.18% from 3.11%. The bank offset a big drop in its asset yield by reducing the cost of its liabilities by more. Banks often say it is better to watch net interest income in dollars, as well as margins. Yet J.P. Morgan's fell 3.4% in the first quarter. Wells Fargo's rose only 1.5%, excluding Wachovia, but soared nearly 70% with that acquisition. Granted, the first quarter may be a lull before banks start adding higher-yielding loans, causing higher margins and net interest income. Also, if the economy improves and fewer loans go bad, interest income improves because more borrowers can service debt. Another positive: Moribund securitization markets might allow banks to grab more business and price loans more profitably, said Gerard Cassidy, analyst with RBC Capital Markets. But Japanese banks' experience with zero-interest-rate policies suggests there are risks. When rates are unusually low, it is hard for banks with large deposits to maintain lending margins, because it becomes harder to cut deposit rates enough to fully offset declines in asset yields. Depositors typically want some return for keeping money in the bank. What's more, profitability gets further dented by the expenses of maintaining the branch network needed to collect deposits. This scenario is exacerbated if the yield on loans stagnates because banks can't find enough safe households and companies willing to borrow at rates that would create worthwhile margins. So far, talk about zombie banks has focused on the asset side of the balance sheet and loan losses. But Japan's experience suggests the liabilities also can put lenders in a quagmire. U.S. banks aren't there. But one thing is clear: Investors need to keep nitpicking the NIM. Write to Peter Eavis at peter.eavis@wsj.com

FDIC Paints Dark Picture of U.S. Banking

First-Period Profit of $7.6 Billion Was Nice, but Problem Loans and 'Problem Banks' Are Rising By MICHAEL R. CRITTENDEN WASHINGTON -- U.S. banks reported a first-quarter profit of $7.6 billion, buoyed by revenue at a few larger companies, but overall the credit picture remained grim as the number of banks in trouble continued to rise and borrowers increasingly fell behind on their loans. The combined profit at more than 8,000 commercial banks and savings institutions insured by the Federal Deposit Insurance Corp. fell 61% from $19.3 billion in the first quarter of 2008. Still, the latest results were an improvement from the industry's net loss of $36.9 billion in last year's fourth quarter. There also were plenty of negative signs in data released Wednesday by the FDIC. The number of banks on the FDIC's "problem" list climbed to 305 as of March 31, up from 252 three months earlier and the highest level since 1994. Banking regulators don't disclose the names of these problem banks. More Banks Aiming to Play Both Sides of Coin Real Time Econ: FDIC List of Problem Banks Continues to Grow Meanwhile, the number of loans more than 90 days past due climbed across all major loan categories. "The first-quarter results are telling us that the banking industry still faces tremendous challenges," FDIC Chairman Sheila Bair said. "And that going forward, asset quality remains a major concern." Banks continued to aggressively add to their reserves during the quarter. The FDIC said nearly two out of every three banks increased their loss provisions during the quarter and that the industry set aside $60.9 billion in loan-loss provisions. Despite those actions, banks were increasingly unable to build their reserves fast enough to keep up with noncurrent loans. The ratio of reserves to noncurrent loans fell to 66.5% in the first quarter from 74.8% in the fourth quarter. It was the lowest level in 17 years. "Troubled loans continue to accumulate, and the costs associated with impaired assets are weighing heavily on the industry's performance," Ms. Bair said. The FDIC said that banks responded to the rising amount of troubled loans by charging off $37.8 billion during the first three months of 2009, led by loans to commercial and industrial borrowers, credit cards and real-estate construction loans. The agency said the high-level of charge-offs did little to slow the rise in loans at least 90 days past due, which increased $59.2 billion during the quarter, as the percentage of loans and leases considered non-current hit the highest level since the second quarter of 1991. The problems were spread across all major categories, though the FDIC said that real-estate loans accounted for 84% of the overall increase. Sheila Bair FDIC Chief Economist Richard Brown told reporters said regulators are seeing increasing woes in the commercial real-estate market. "That probably hasn't hit full-force yet," Mr. Brown said. The 21 bank failures during the first quarter were the most in any quarter since the last three months of 1992. The failures reduced the fund that protects consumers' deposits to $13 billion from $17.3 billion at the end of 2008. The FDIC has already taken steps to address the declining fund, voting Friday to charge banks a special fee they project will raise $5.6 billion to replenish the fund. Ms. Bair said the FDIC has no plans to access its $100 billion line of credit with the U.S. Treasury Department to help stabilize the fund. "We really don't want to go to that step," she said. "For planning purposes, we intend to continue to rely on our industry-funded reserves."

Plan to Buy Banks' Bad Loans Founders

By DAMIAN PALETTA and DEBORAH SOLOMON WASHINGTON -- A government program designed to rid banks of bad loans, part of a broader effort once viewed as central to tackling the financial crisis, is stalling and may soon be put on hold, according to people familiar with the matter. View Full Image Bloomberg News FDIC Chairman Sheila Bair on Wednesday said banks may now lack incentive to sell bad loans. The Legacy Loans Program, being crafted by the Federal Deposit Insurance Corp., is part of the $1 trillion Public Private Investment Program the Obama administration announced in March as a way to encourage banks to sell securities and loans weighing on their balance sheets to willing investors. But prospective buyers and sellers have expressed reluctance to the FDIC about participating for fear the program's rules will change in a political atmosphere hostile to Wall Street. In addition, some banks that might have sold troubled loans into the program earlier in the year have become less eager as they regained a sense of stability. PPIP was to be split between the FDIC program, which would buy whole loans, and one run by the Treasury Department focusing on securities. Treasury is expected to push ahead with its plan -- the larger and more substantial of the two -- and could begin purchases sometime this summer. But the size of that program could be smaller than initially envisioned, government officials say. The scaling back of the FDIC program is potentially good and bad news for investors, indicating that the health of the financial system -- while improving -- remains fragile. Government officials are still concerned about distressed assets, including residential and commercial real-estate loans, which continue to rot banks' capital. FDIC officials said Wednesday some losses had not yet peaked and government officials believe banks still hadn't fully recognized the value of some distressed assets on their balance sheet. But, at the same time, administration officials say they believe the program to purchase toxic securities mightn't be as integral to a recovery as it once seemed. Markets seem to have stabilized and banks appear more able to digest losses associated with the troubled securities. The program's announcement and the release earlier this month of stress-test results of the country's 19 largest banks helped stabilize public fears about the sector. The stress tests looked closely at banks' exposure to certain securities, such as real-estate holdings, and required some firms to improve their capital positions to withstand further losses. Banks have been able to raise close to $40 billion in new capital in the second quarter, stabilizing their financial position. At a Wednesday news conference to discuss the condition of the banking industry, FDIC Chairman Sheila Bair hinted at the program's uncertain future, without providing details. "There are a couple of factors that are still at play here as we try and develop this structure," Ms. Bair said. She added: "Banks have been able to raise a lot of new capital even before taking more aggressive steps to cleanse their balance sheets, so the incentives to sell may be less." People familiar with the matter say the FDIC is expected to delay a test run of the program that was set to take place next month. The program could be put on hold in the near future, people familiar with the matter said. FDIC officials had initially believed the program could buy as much as $500 billion in loans. The program has also been controversial. Bank trade groups asked the FDIC to allow banks to use the program to purchase their own assets, which some felt could allow banks to game the process. Ms. Bair on Wednesday said that would never have been allowed to happen. The Treasury and FDIC programs were developed in response to widespread fear that the banking sector didn't have enough capital to absorb future losses on bad bets made at the height of the housing bubble. Government officials felt the programs would allow the banks to get rid of their assets and then use the proceeds to bulk up on their capital reserves. Both programs would be boosted through leverage provided by government funding or guarantees. Now, officials say it is hard to gauge how much demand there might be to both buy and sell assets. One complication is that the Obama administration still hasn't given a definitive answer as to how, or whether, various executive compensation restrictions developed in recent months might apply to PPIP participants. The Treasury wants to exclude participants from the Troubled Asset Relief Program rules, which restrict bonuses and other pay, but hasn't yet made a final decision. Government officials "hoped and believed that each of the programs would work, but I think they were realistic enough to know that this is an unprecedented situation, and if you try everything you can, some of it is not going to work," said Douglas Elliott, a fellow at the Brookings Institution. Investors are worried about interference from Congress, which could balk at the sight of Wall Street firms making fat profits from a government rescue program. The American International Group Inc. bonus flap and the strong-arming of banks and hedge-funds who were Chrysler LLC creditors have also given pause. Another reason is concern about government scrutiny related to potential conflicts of interest. A recent law that allows the special inspector general of TARP to conduct audits of participants in the public/private partnerships spooked some investors, Ms. Bair said. "Treasury will need to issue regulations, I think, to clarify those issues before we will have comfort by the participants," she said. Senior Treasury officials weren't keen on the FDIC's program because of the large gap between potential buyers and sellers. In fact, some Treasury officials didn't want the FDIC program to even be created. Treasury is currently selecting asset managers to run the handful of funds it plans to create, which will enjoy unprecedented levels of government financing. A team of Treasury staffers has been poring over the more than 100 applications the government received and has whittled the list down to about a dozen finalists. Some of those firms have started making presentations to Treasury officials about how they would operate the funds. Write to Damian Paletta at damian.paletta@wsj.com and Deborah Solomon at deborah.solomon@wsj.com

Knocked off balance

May 21st 2009 NEW YORK From The Economist print edition A once-glittering business loses its shine CREDIT-CARD borrowers who roll over a portion of their balance each month are known as revolvers. These days lenders are in a spin as they struggle to cope with write-offs, a regulatory crackdown and changes in consumer behaviour. On May 18th American Express, a credit- and charge-card giant, announced a second round of job cuts (bringing the total to 11,000), slashed its marketing and business-development budgets and offered a “very cautious” outlook. A few days earlier Advanta, a provider of cards to small businesses, froze all existing accounts after charge-offs (uncollectable debt) reached a dizzying 20%. The shutdown sent a shiver through the market for bonds backed by credit-card debt, which is only now starting to recover from the ravaging securitised assets took last year. The rise in unemployment—which card defaults track and may now be exceeding, given the recession’s severity—has spattered a once-profitable business with red ink (see chart). David Robertson of the Nilson Report, a newsletter, expects card write-offs in America to hit $94 billion this year, up from $61 billion in 2008. As hopes that credit cards would avoid the pain felt in mortgages have dwindled, so has any chance of the industry avoiding a political backlash. This week both houses of Congress voted through a bill that would sharply curtail card issuers’ ability to charge punitive fees and raise interest rates. Barack Obama, who has railed against card issuers’ “anytime, any-reason rate hikes”, was expected to sign it into law after The Economist went to press. Edward Yingling, head of the American Bankers Association, huffed that the bill “fundamentally changes the entire business model of credit cards by restricting the ability to price credit for risk.” Some banks will react by reintroducing annual fees that they cut as they jostled for business during the boom, predicts Dennis Moroney of Tower Group, a consultancy. The industry’s claim that the bill will choke off access to credit is a bit rich given its own rush to reduce its unsecured lending. The three largest card issuers—Citigroup, JPMorgan Chase and Bank of America—withdrew credit lines worth $320 billion in the first quarter alone. By the end of 2010, the industry will have cut a staggering $2.7 trillion, forecasts Meredith Whitney, an analyst, triggering an “unprecedented liquidity crunch” that could tip creditworthy consumers into distress. Card firms face further headwinds. One is the rise of the debit card, which takes payment directly from the customer’s current account and is less lucrative for banks than credit, because transaction fees are lower and there is no opportunity to earn interest. This year, for the first time, debit- and prepaid-card spending in America on Visa is expected to overtake purchases on its credit cards (like MasterCard, Visa is a network that processes cards on behalf of banks). Much is spending that would otherwise go on credit cards. The “interchange” fees that credit-card firms earn from retailers, which have traditionally provided 10% of their revenue, are also under attack. America may yet follow Australia in capping them. Revolution, an upstart, web-based card that charges no interchange fee, is gaining traction. Little wonder, then, that card issuers feel shell-shocked. Their investors’ nerves will be tested, too. The adverse scenario for card losses envisaged in American banks’ stress tests, a cumulative two-year loss rate of 22.5%, looks increasingly like the base case to others. Betsy Graseck of Morgan Stanley expects the big three issuers to post losses in their card businesses this year and next. When they clamber back into profit, they can expect returns on assets of only one-half to two-thirds of pre-crisis levels, she reckons—enough to knock the sturdiest executive off balance.

Home Resales, Inventories Rise in April 2009

By JEFF BATER WASHINGTON -- Existing-home sales climbed modestly in April as buyers took advantage of foreclosures and snatched up property carrying discounted price tags. Home resales rose by 2.9% to a 4.68 million annual rate from 4.55 million in March, the National Association of Realtors said Wednesday. The NAR originally reported March sales fell 3.0% to 4.57 million. The April resales level of 4.68 million reported Wednesday by NAR was above Wall Street expectations of a 4.67 million sales rate for previously owned homes. About 45% of the 4.68 million in April sales were foreclosures and short sales. The large number of these distressed property sales has driven prices lower, year over year. The median price for an existing home last month was $170,200, down 15.4% from $201,300 in April 2008. Weak demand has kept inventories of unsold homes high. Inventories of previously owned homes jumped 8.8% at the end of April to 3.97 million available for sale. That represented a 10.2-month supply at the current sales pace, compared to 9.6 in March. Bloated inventories, in turn, are depressing prices. "Most of the sales are taking place in lower price ranges and activity is beginning to pick up in the mid-price ranges, but high-end home sales remain sluggish," NAR economist Lawrence Yun said. Lower prices, combined with historically low borrowing costs, have increased affordability. The average 30-year mortgage rate was 4.81% in April, down from 5.00% in March, Freddie Mac data show. Realtors also hope demand is stirred by the $8,000 tax credit for first-time home buyers included in the Obama administration's economic stimulus package. A decline in price is troubling because it can give pause to would-be buyers, hesitant in hope for a better deal. On a bright note, the median price, on a monthly basis, has climbed three months in a row. It was $169,900 in March, a downward revision from an originally reported $175,200. Working against sales are tighter mortgage lending standards, which have made it harder to finance a purchase. And the uncertain economic outlook is also hurting the existing-home market. The unemployment rate rose to 8.9% in April from 8.5%. Previously owned home sales, year over year, were down 3.5% from the pace in April 2008, Thursday's report said. Regionally, sales in April compared to March rose 11.6% in the Northeast, 1.8% in the South, and 3.5% in the West. Sales dropped 2.0% in the Midwest. Write to Jeff Bater at jeff.bater@dowjones.com

Problem banks rise t o305, highest since 1994, FDIC says

By Margaret Chadbourn and Alison Vekshin May 27 (Bloomberg) -- U.S. “problem” banks climbed 21 percent to the highest total in 15 years in the first quarter, and provisions set aside for loan losses weighed on industry earnings, the Federal Deposit Insurance Corp. said. The FDIC classified 305 banks with $220 billion in assets as “problem” lenders as of March 31, rising from 252 with $159 billion in assets in the fourth quarter, the agency said today without naming any institutions. The FDIC said its insurance fund slumped 25 percent in the period. “The first-quarter results are telling us that the banking industry still faces tremendous challenges, and that going forward asset quality remains a major concern,” FDIC Chairman Sheila Bair said today in a statement. Regulators have taken over 36 lenders this year, including BankUnited Financial Corp. in Florida on May 21 and Silverton Bank of Atlanta on May 1, which combined cost the FDIC’s deposit insurance fund $6.2 billion. Twenty-one banks collapsed in the first quarter compared with 25 that failed in 2008, as the pace of failures accelerated amid the worst financial crisis since the Great Depression. FDIC-insured banks reported net income of $7.6 billion in the first quarter compared with a $36.9 billion loss in the fourth. The insurance fund fell to $13 billion, from $17.3 billion in the previous quarter. The FDIC is imposing an emergency fee to raise $5.6 billion to rebuild the fund. Citigroup Inc. reported a $1.6 billion first quarter profit on April 17 after five consecutive quarterly losses. JPMorgan Chase & Co., Goldman Sachs Group Inc., and Wells Fargo & Co. also beat analysts’ expectations with gains between January and March. Funds set aside by banks to cover loan losses rose to $60.9 billion in the first quarter from $37.2 billion in the year- earlier quarter. The FDIC insures deposits at 8,246 institutions with $13.5 trillion in assets. The agency reimburses customers for deposits of as much as $250,000 when a bank fails.

Twice Shy On Structured Products?

By LARRY LIGHT Wall Street burned thousands of investors with so-called structured products that were supposed to provide healthy profits and limit losses. Brokers, hoping investors' memories are short, are pushing these high-fee products again with safety as the big selling point. Overall, investors purchased $5.9 billion of structured products in last year's fourth quarter, down 75% from 2008's first quarter, according to data provider mtn-i. Sales have started to nudge upward, rising 7% compared to the fourth quarter, though they are still way down from a year ago. "There's more appetite for them today than we had six months ago," says Lori Heinel, a Citi Private Bank managing director who oversees structured products. But the action now is with the safer kinds, called principal protected notes and return-enhanced notes. They have dethroned once-popular reverse convertibles, bond instruments that last year often posted losses worse than the market's. Brokers are eager to sell these structured products because commissions are high, but they face explaining why many of these products didn't perform as advertised. They also must convince clients that the firms behind these products are solid. Investors who bought products backed for firms that failed, such as Lehman Brothers, have big losses. Structured products are distant cousins to other derivatives such as credit default swaps and collateralized debt obligations that helped sink the world financial system last year. The Obama administration has said it wants tighter regulation of derivatives, and structured products may well be swept up in that. The Norwegian government last year banned selling structured products to individuals, reasoning they were too complex for people to understand the risks. Before the bear market hit, structured products sold exceedingly well. Sales surged from $62 billion in 2006 to $105 billion in 2007, then lost altitude as 2008 wore on, finishing at $70 billion. Unlike, say, mutual funds, structured products aren't a portfolio of securities. Instead, they are a contract in which the issuer, often an investment bank, promises to pay the purchaser specific payments in specific circumstances. When Lehman Brothers Holdings Inc., which floated at least $900 million in structured products last year, filed for bankruptcy in September, investors sustained big losses. Many are hoping to recover just 20% of their investment, says John Barry, chief executive of fixed-income trading platform Bonds.com. Jay Wang, a 33-year-old oncologist, and his brother Jimmy, 32, a dental student, last year invested almost $70,000 in Lehman principal-protected notes, glad to be in one of the safest structured products. Now, what is left of their money is mired in court. The brothers, who bought the notes through a Houston branch office of UBS Financial Services, have filed an arbitration complaint against UBS with the Financial Industry Regulation Authority, in a bid to get their money back. UBS refused comment. Some of the worst blow-ups occurred with reverse convertibles, perhaps the most risky structured product. Following a single well-known stock such as Apple Inc. or AT&T Inc., these instruments are short-term bonds that give fat interest yet slam investors if the underlying stock tanks. Instead of getting their money back, investors receive the shriveled shares, valued at far less than the principal. "Reverse convertibles are dead," says Mr. Barry of Bonds.com. "They burned people badly." Dominic Annino, a retired contractor now 78 years old, invested $300,000 in two reverse convertibles offered by Wells Fargo Investments. Half of it was in reverse convertibles tied to Jet Blue stock; the other half was linked to IndyMac Bancorp stock. In an arbitration complaint filed with Finra, the Santa Monica, Calif., man claims he insisted to the Wells Fargo broker that he wanted nothing to do with the stock market, and was misled about how the instruments were connected to it. The broker told him he was investing in triple-A bonds of these companies, he contends. The holdings paid an appealing 16% and 17% annually. But when they matured after six months in late 2007, JetBlue and IndyMac stock had tumbled and he ended up losing money. Mr. Annino says he didn't know that, if the stock fell to a certain point, known as the "knock-in" level, he would be force-fed those lower-value shares, in lieu of his principal. Mr. Annino found himself the unwilling owner of JetBlue shares, down 36%, and IndyMac, off 34%, the complaint says. Wells Fargo says it disputes the claims and will "vigorously defend" itself. Among the most popular structured products these days are principal-protected notes where most of the initial investment is put into federally insured certificates of deposit to add another layer of protection. The rest is invested in securities that track stock-market indexes. In the past, this principal had been invested partly in the issuers' zero-coupon bonds. With these products, investors are shielded from market losses but only get a bit of upside if markets rebound sharply -- perhaps half the Standard & Poor's 500-stock index's gains. While they generally didn't harm investors in 2008, their sales also dropped because of the taint from other structured products. "They are a conservative way to play the market, especially in the CD format," says Phillipe El-Asmar, head of investor solutions at Barclays PLC's Barclays Capital. Write to Larry Light at larry.light@wsj.com

Banks Aiming to Play Both Sides of Coin

Industry Lobbies FDIC to Let Some Buy Toxic Assets With Taypayer Aid From Own Loan Books By DAVID ENRICH, LIZ RAPPAPORT and JENNY STRASBURG Some banks are prodding the government to let them use public money to help buy troubled assets from the banks themselves. Banking trade groups are lobbying the Federal Deposit Insurance Corp. for permission to bid on the same assets that the banks would put up for sale as part of the government's Public Private Investment Program. PPIP was hatched by the Obama administration as a way for banks to sell hard-to-value loans and securities to private investors, who would get financial aid as an enticement to help them unclog bank balance sheets. The program, expected to start this summer, will get as much as $100 billion in taxpayer-funded capital. That could increase to more than $500 billion in purchasing power with participation from private investors and FDIC financing. The lobbying push is aimed at the Legacy Loans Program, which will use about half of the government's overall PPIP infusion to facilitate the sale of whole loans such as residential and commercial mortgages. Federal officials haven't specified whether banks will be allowed to both buy and sell loans, but a list released by the FDIC and Treasury Department of the types of financial firms likely to be buyers made no mention of banks. Allowing banks to have it both ways would give them added incentive to sell assets at low prices, even at a loss, the banks contend. They claim it also would free up capital by moving the assets off balance sheets, spurring more lending. "Banks may be more willing to accept a lower initial price if they and their shareholders have a meaningful opportunity to share in the upside," Norman R. Nelson, general counsel of the Clearing House Association LLC, wrote in a letter to the FDIC last month. The New York trade group represents 10 of the world's largest banks, including Bank of America Corp., Citigroup Inc. and Wells Fargo & Co. Those banks are seen as likely sellers of assets using PPIP. Officials at the banks declined to comment. "It's an issue that's been raised and an issue we're aware will need specific guidelines," said an FDIC spokesman, adding that the agency still is working on the final structure of its program and plans to launch a $1 billion pilot program this summer, which likely won't include an infusion from the Treasury. Some critics see the proposal as an example of banks trying to profit through financial engineering at taxpayer expense, because the government would subsidize the asset purchases. "To allow the government to finance an off-balance-sheet maneuver that claims to shift risk off the parent firm's books but really doesn't offload it is highly problematic," said Arthur Levitt, a former Securities and Exchange Commission chairman who is an adviser to private-equity firm Carlyle Group LLC. "The notion of banks doing this is incongruent with the original purpose of the PPIP and wrought with major conflicts," said Thomas Priore, president of ICP Capital, a New York fixed-income investment firm overseeing about $16 billion in assets. One risk is that certain hard-to-value assets mightn't be fairly priced if banks are essentially negotiating with themselves. Inflated prices could result in the government overpaying. Recipients of taxpayer-funded capital infusions under the Troubled Asset Relief Program also could use those funds to buy their own loans. "Sensible restrictions should be placed on banks, especially those that have received government capital, from investing their own balance sheets in a backdoor effort to reacquire what could be their own assets with an enormous amount of federally guaranteed leverage," said Daniel Alpert, managing director at Westwood Capital LLC, an investment bank. Even supporters of letting banks buy their own loans said it could be a tough sell. "A bank bidding on its own assets really has the potential to look awful in the public's mind," said Mark J. Tenhundfeld, an American Bankers Association lobbyist. Some bankers said the concerns can be addressed through strong oversight by the government and outsiders. The banking industry's lobbying is meant to overcome a hurdle facing PPIP: unwillingness by banks to sell assets at steep discounts. Banks generally would rather hold on to assets they believe have more inherent value, avoiding selling them at a low point in the market. Many mortgage securities are valued at less than half their original price. "Bankers see it as a win-win," said Tanya Wheeless, chief executive of the Arizona Bankers Association, which has urged the FDIC to let banks buy their own assets through PPIP. U.S. banks held about $4.7 trillion in commercial and residential mortgages of the type that banks are lobbying to buy as of the end of the third quarter of 2008, according to Federal Reserve data. PPIP is designed in part to mitigate $600 billion of potential losses through the end of 2010 tied to toxic assets at the nation's 19 largest banks, according to the Fed's stress tests. Mr. Nelson proposed to the FDIC that banks be allowed to control as much as half the capital in a buyers' group. In some cases, he wrote, "the selling bank should be able to participate as the only private-sector equity investor." The California Bankers Association said in a letter that the FDIC's supervision of the asset-pricing process "should alleviate concerns about the inability to effect arm's length transactions between a bank and its affiliate that purchases through a public-private investment fund." Irene Esteves, the chief financial officer at Regions Financial Corp., which has been lobbying to buy assets through PPIP, included a reference to gobbling up loans under the heading "Conflict of Interest" in a letter to the FDIC. A spokesman for the Birmingham, Ala., bank declined to comment. Towne Bank of Arizona plans to sell some of its soured real-estate loans into PPIP and wants to profit from the program. "We think it would be attractive to our shareholders to be able to share in whatever profits there are from the venture," said CEO Patrick Patrick. —Damian Paletta contributed to this article. Write to David Enrich at david.enrich@wsj.com, Liz Rappaport at liz.rappaport@wsj.com and Jenny Strasburg at jenny.strasburg@wsj.com

GM Moves Closer to Bankruptcy as Bondholder Offer Falls Short

By JOHN KELL General Motors Corp. said it won't proceed with the repurchase any of the $27.2 billion of notes it sought, saying bondholder interest was far below the 90% threshold it was looking for. The auto maker had been seeking to swap the debt for a 10% stake in a restructured company that is on the brink of filing for bankruptcy. GM, which is surviving on government loans, has said it faces bankruptcy if less than 90% of bondholders accepted the deal, a take rate considered almost impossible to meet. GM has been looking to focus on four core brands, while closing and selling off its underperforming lines as it hopes to remake itself amid a sharp downturn in auto sales. The company could file for bankruptcy before a government-imposed Monday deadline to reorganize itself into a viable company. GM hopes to rush through bankruptcy court in as few as 30 days, but the drive for an expedited bankruptcy could be challenged by GM's investors and dealers. GM and the United Auto Workers have agreed to a new restructuring plan that would give the union a significantly smaller stake in the company than previously envisioned, and leave the U.S. government owning as much as 70% of the car maker. The government's plan also calls for paying off in full GM's secured lenders – including banks such as Citigroup Inc. and J.P. Morgan Chase & Co., which are owed about $6 billion. That would remove one potential obstacle to a speedy bankruptcy reorganization. GM shares were down 9.7% premarket at $1.30. Write to John Kell at john.kell@dowjones.com